It Simply Makes Sense! Insurers Should Be Held To A Higher Standard

Throughout this process, the Working Group has been questioned as to why it is considering subjecting mutual and non-public stock insurance companies to requirements similar to those of Sarbanes-Oxley, a legislative bill focused purely on public companies and other SEC registrants. The Working Group believes the following principles explain why it is also important to subject non-public insurance companies to these requirements.

Insurance companies should be held to a higher standard.

With the development and implementation of Sarbanes-Oxley and its related mandates, the Securities and Exchange Commission is "raising the bar" on the regulation of public companies.

Public companies are regulated because their investors, in purchasing shares of stock, have assumed the risk of loss if the company's financial condition deteriorates. The investing public, therefore, needs timely and reliable financial reporting. Based on this information, investors can make informed, intelligent decisions.

How does this differ from insurance companies?

One could argue that standards applied to insurance companies should be just as high, if not higher.

In the case of a public company, the investors have assumed, and accepted, the risk of loss. In the case of insurance companies, the policyholder pays a premium to transfer the risk of loss to the insurer.

The risk being transferred by the policyholder is not to protect against the loss of discretionary income, as is the case in many situations for public investors. Rather, the policyholder's risk of loss consists of items that are essential to one's continued health and livelihood: their home, health, personal property and the protection of income.

In these situations, the insurer has promised to compensate the policyholder if there is a future loss. It is therefore imperative that the policyholder is able to depend on the sound solvency regulation to ensure that the insurance company will be able to fulfill its future obligations.

Transferring such risks of loss to an insuring entity versus personally accepting the possibility of investment loss is a much riskier venture. Accordingly, there should be higher regulatory standards to ensure that future promises are satisfactorily fulfilled.

Other government and regulatory bodies are following suit.

As written, Sarbanes-Oxley is to apply only to those companies that are required to file with the SEC. The fact is that many of the mandates within Sarbanes-Oxley are becoming the national business standard to which sound financial reporting (and regulation) will be measured.

Various governmental and regulatory bodies have already implemented or are currently developing requirements similar to those included in Sarbanes-Oxley. For example, the Federal Deposit Insurance Corporation has discussed that it is considering possible amendments to its regulations that would extend certain provisions of Sarbanes-Oxley to all insured institutions with $500 million or more in total assets, regardless of whether or not they are public companies. The FDIC encourages small banks with assets under $500 million to adopt certain accounting and governance processes that are in line with provisions in Sarbanes-Oxley.

In addition, several states are contemplating legislation that would subject non-public companies to mandates similar to those included in Sarbanes-Oxley.

Development of a risk-based approach.

For many months, the NAIC and state regulators have been developing a risk assessment framework that would assist in the regulation of insurance companies. Specifically, this tool will allow the regulator to utilize a more prospective risk-based approach in the preparation and conduct of its examinations of insurance companies.

This framework places a great deal of importance on the controls in place at the insurance company and possible reliance on these controls to increase the overall efficiency of the examination. When this risk-based examination framework is fully implemented, management's assessment of internal controls over financial reporting will be an essential component of the risk-based approach.

One size does not fit all.

Many have questioned the applicability of provisions similar to the requirements of Sarbanes-Oxley to non-public companies and whether a "one-size-fits-all" approach is appropriate. The Working Group has considered the comments and concerns raised by members of industry and is developing guidance that will incorporate the spirit of Sarbanes-Oxley while attempting to limit the reporting requirements for insurance companies.

For example, the current revisions to the Model Audit Rule do not require the existence of an audit committee at each individual legal-entity level. Rather, the audit committee of the ultimate controlling entity may act as the audit committee of its various insurance company subsidiaries.

The Working Group has indicated that, under certain circumstances, it may be appropriate to assess internal controls over financial reporting at the holding company level, rather than for each legal entity.

In addition, the Working Group has discussed including certain small-company exemptions on a section-by-section basis. These exemptions would be included for the companies in which the cost of implementing the requirements would be prohibitive when compared to the size of the company.

Potentially lower costs than expected.

One of the goals of Sarbanes-Oxley is to require greater integrity over financial reporting. Increased integrity over financial reporting will provide more timely and reliable financial information and would allow state insurance departments to more quickly intervene in the case of a troubled insurance company.

This should help to reduce the magnitude of insurance company insolvencies, which would lead to lower guaranty fund assessments. This coupled with examination efficiencies created by a risk-based approach, will lower the overall cost of implementing the proposed revisions being contemplated by the Working Group.

The overriding principle of insurance company regulation is to promote the solvency of insurance companies and their ability to pay insurance claims in a timely manner. Through the financial deterioration and subsequent dissolution of various companies, the regulatory community has learned a few lessons.

There is a need for greater auditor independence, increased corporate governance, and an increased focus on internal controls over financial reporting. It is evident from recent insurance company insolvencies that the insurance industry is not immune to the threats that have destroyed various public companies.

The insurance industry sells a promise. Insurers are in an industry that requires significant public trust and responsibility. The industry should be on par with public companies and other financial service providers with regard to corporate governance and internal controls over financial reporting.

Much of the debate to date has centered on cost. As chairman of the Working Group, I contend that the incorporation of the mandates of Sarbanes-Oxley may not be as costly as one might expect. I believe that the cost of not implementing applicable provisions of Sarbanes-Oxley in terms of lost public trust far exceeds the implementation costs. I challenge the industry to show otherwise.

I have read reports that certain sectors of the insurance industry are requiring improved financial reporting and governance practices similar to those required by Sarbanes-Oxley as a condition for renewing insurance coverage. I find it a bit ironic that the insurance industry uses Sarbanes-Oxley as part of its underwriting process on one hand, but on the other hand argues that such provisions are not right for them.

Douglas Stolte is deputy commissioner of insurance for Commonwealth of Virginia. Mr. Stolte also serves as the chairman of the NAIC/AICPA Working Group of the Financial Condition Committee.

Reproduced from National Underwriter Edition, April 23, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.