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Risk-Focused Exams for Reinsurance: What's Going On?

Beginning in 2010, state insurance examiners will be conducting “Risk-Focused Examinations” per the new Financial Condition Examiners Handbook. This is a revised approach to the exam as examiners will be concentrating on reviewing a company’s procedures and internal controls over functional areas to:

1. Be better equipped to identify current solvency risks,
2. Monitor them on an ongoing basis and
3. Proactively mitigate future problems that might cause a company to fail

The revised risk-focused surveillance process, developed by the National Association of Insurance Commissioners (NAIC) “was based on the need to enhance the qualitative aspects of examination and financial analysis functions. These enhancements will allow the financial solvency surveillance process to better incorporate prospective risk assessment in identifying insurers that have or will encounter solvency issues and bring focus to the broader issues of the ability of management to identify, assess and manage the business risks of the insurer.”

The enhancements that were proposed in the Risk-Focused Surveillance Framework in June 2004 were intended to:

1. Better formalize and document the assessment process via the use of the Risk Assessment Matrix
2. Expand risk assessment to provide a more comprehensive and prospective look at an insurer’s risks and to identify the insurer’s current and/or prospective high-risk areas
3. Coordinate the results of the examination risk assessment process with other financial solvency surveillance functions

Some of the risk-focused enhancements in the risk-focused approach are as follows:

1. Improved regulatory understanding of corporate governance function
2. Enhanced risk evaluations via inherent risk assessment
3. Identification of emerging risks earlier
4. Greater focus on higher risk areas
5. Enhanced regulatory understanding of insurer’s management, their business and their risks
6. More effective procedures to monitor and assess the solvency of insurers on a continuing basis

Some benefits to examiners reviewing reinsurance are as follows:

1. Review of “other than financial reporting risks”5 (from Exhibit O) such as credit, strategic, liquidity and reputational risks
2. More use of CPA workpapers
3. Establishment of a forward-looking view of insurers’ risk profiles and management practices
4. Focus on the greater risk areas—not on the small stuff
5. Regulators can be more proactive; identify problems earlier and act more quickly
6. More efficient exams and exchange of info between field examiners and financial analysis area
7. Better able to respond to solvency problems from “current or emerging risks”

Some benefits to companies in the reinsurance area are as follows:

The company can be better prepared for the exam by obtaining and reading the following Reinsurance Sections of the New Handbook: Section 4 Repositories-G, H and I, for Life, Property and Casualty and Health Reinsurance, Section 6, and Exhibits C and D. These sections describe not only what the examiner may review but can actually be utilized by a company to review and organize their own reinsurance area.

By reading and understanding the procedures that are stated in the handbook, and what the examiners are asked to review in Section 4, company personnel can actually prepare for the exam by gathering the source information the examiner might select ahead of the exam. Company personnel can also review these procedures and adapt some of them internally to better monitor and control their own ceded and assumed reinsurance areas.

Some of the procedures listed for ceded and assumed reinsurance review follows.

Sample of Procedures from The 2009 NAIC Financial Condition Examiners Handbook

For Assumed Reinsurance (P&C)

• Read the reinsurance contract, related correspondence and underwriting file to obtain an understanding of the contract, its business purpose and its expected impact on operations.
• Examine documentation of required management review and approval of the contract.
• Determine compliance with underwriting guidelines.
• Obtain and analyze recent financial information, or other available sources of information of the ceding company, such as financial reports filed with the SEC or with the insurance industry reporting and rating services.
• Verify that the overall accounting treatment of assumed reinsurance transactions complies with accounting guidelines described in SSAP 62 paragraphs 36–42.

For Ceded Reinsurance (P&C)

• Categorize the types of reinsurance contracts and determine whether the contracts transfer risk in accordance with SSAP 62, paragraphs 10–17. If a contract does not transfer risk, verify that it has received deposit accounting treatment in accordance with SSAP 75.
• Verify the overall accounting treatment of reinsurance contracts complies with accounting guidelines described in SSAP 62, paragraphs 18–34.
• Obtain financial information, and determine the financial strength of all significant reinsurers to which business was ceded.
• Obtain and analyze recent financial information, or other available sources of information of the assuming company, such as financial reports filed with the SEC or with insurance industry reporting and rating services, such as IRIS results filed with regulatory authorities.
• Determine if all required disclosures noted in SSAP 62 are properly included in the financial statements.

Summary

A byproduct of this new exam approach is better communication on an ongoing basis with one’s state regulatory body—not just when problems arise or an exam is to take place.

Though the risk-focused exams have been and are currently being conducted by several states, 2010 will begin a new era for both regulator and company. Both will be learning about this new focus at the same time.

It should be noted that though this approach contains additional items to review and procedures to perform, it does not mean that these will— via osmosis or some other knowledge transfer “method”—ensure that the reinsurance area will be completely understood by either the examiners performing the exam or the company personnel involved. Continuing education, the utilization of various insurance and reinsurance professionals and training will be quite valuable.

Questions about risk-focused exams for reinsurance? Contact Evan Bennett, Director, at 312-980-3353 or your Blackman Kallick Representative.

 

 

 

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.