State Examinations

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State Examinations

• Have No Fear, Help is Here

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Risk-Focused Financial Condition Exams

• NAIC mandated for state insurance departments
  beginning 1/1/2010
• Goal is to identify solvency issues earlier
• Compliance with laws and regulations

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Risk-Focused Financial Condition Exams

• Difference between former approach and
  risk-focused approach
• Former approach Find material misstatements
  through detailed testing of account balances
• New approach Evaluate effectiveness of risk
  management function conduct testing in areas
  with high residual risk

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Risk-Focused Financial Condition Exams
Phases of a Risk-Focused Examination
Phase 1 Understand the company and identify key functional activities to be reviewed
Phase 2 Identify and assess inherent risk in activities
Phase 3 Identify and evaluate risk mitigation strategies/controls
Phase 4 Determine residual risk
Phase 5 Establish/conclude examination procedures
Phase 6 Update prioritization and supervisory plan
Phase 7 Draft examination report and management letter based up on findings
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Pre-Examination Phase

• Review recent financial examination reports
  released by your states department of insurance
• Available on states websites
• Findings may be similar from company to company
• Evaluate your companys compliance relative to
  these findings

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Pre-Examination Phase

• Familiarize yourself with the NAICs Financial
  Condition Examiners Handbook
• Examination repositories (control listings)
• Sample interview questions
• Exam planning questionnaires

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Pre-Examination Phase

• Update/create process documentation including IT
  and corporate governance functions
• Consider whether controls are evidenced

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Risk-Focused Financial Condition Exams

• Phase 1 Understand company and identify key
  functional activities
• Corporate governance
• Audit function
• Risk management program
• Key business processes/units
• Prospective risks

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Risk-Focused Financial Condition Exams

• Corporate governance Tone at the Top
• Competency
• Independence
• Code of conduct
• Involvement in risk management

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Risk-Focused Financial Condition Exams

• Audit function
• Independent
• Maintain or improve effectiveness of risk
  management function
• Assure accuracy and completeness of financial
  reporting
• Operational effectiveness

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Risk-Focused Financial Condition Exams

• Risk management program
• Active board oversight
• Adequate processes, monitoring and management
• Clear policies, authorization limits and
  procedures
• Comprehensive internal controls
• Compliance with laws and regulations

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Risk-Focused Financial Condition Exams

• Key business process/units
• Activities and sub-activities
• Information technology
• Third party relationships
• SSAE 16 reports

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Risk-Focused Financial Condition Exams

• Prospective risks
• Asset liability matching
• Loss reserve development
• Pricing and underwriting
• Reinsurance
• Growth, earnings
• Capital adequacy
• Other business risks

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Risk-Focused Financial Condition Exams

• Phase 2 Identify and assess inherent risks
• C-level interviews
• Financial and environmental review
• IT risk assessment
• Likelihood of occurrence and significance of
  impact

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Risk-Focused Financial Condition Exams

• C-level interviews
• Tone at the top
• Risk areas
• Corporate strategy

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Risk-Focused Financial Condition Exams

• Prepare for C-level interviews
• Circulate sample questions in advance
• Consistent message

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Risk-Focused Financial Condition Exams

• Financial and environmental review
• Environmental pressures
• Key solvency risks

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Risk-Focused Financial Condition Exams

• Assess IT risk
• Quality and integrity of information
• Access controls
• Application controls
• Availability of information
• Security
• Recoverability and business continuity

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Risk-Focused Financial Condition Exams

• Likelihood of occurrence and magnitude of impact
• Percent of surplus
• Material rating agency downgrade
• Impact on reputation
• Board and/or senior management attention

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Risk-Focused Financial Condition Exams

• Phase 3 Identify and evaluate risk
  mitigation strategies/controls
• Management oversight
• Risk management program
• Policies and procedures
• Control monitoring
• Compliance evaluation

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Risk-Focused Financial Condition Exams

• Management oversight and risk management program
• Evaluated during Phase I
• Impacts activity-level controls

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Risk-Focused Financial Condition Exams

• Policies and procedures
• Comprehensive and documented?
• Followed?

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Risk-Focused Financial Condition Exams

• Control monitoring
• Compare to commonly accepted standard
• Perform control testing
• Reliance on external auditors work
• Evaluate control design and effectiveness

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Risk-Focused Financial Condition Exams

• Compliance evaluation
• Test control procedures

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Risk-Focused Financial Condition Exams

• Phase 4 Determine residual risk
• Phase 5 Conduct exam procedures
• Phase 6 Update prioritization
• Phase 7 Draft examination report and
  management letter

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Overview of Phases 4-7

• Examiners consider the results of the control
  testing and then apply professional judgment to
  determine whether the residual risk in each
  business cycle is high, moderate or low
• High residual risk Substantive, more detailed
  tests
• Moderate risk Some substantive tests and
  analytical procedures
• Low residual risk Few, if any, substantive
  tests. Mostly high level analytical procedures

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Overview of Phases 4-7

• Manage examination process using best practices
• Provide information in a complete and timely
  manner
• Participate in regular update meetings with
  examiners
• Carefully review exam report and management
  letter for accuracy

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Risk-Focused Financial Condition Exams
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Contact Information

• Marc Smith, CPA, CPCU
• Partner
• Johnson Lambert LLP
• msmith_at_johnsonlambert.com
• Kellie S. Mixon
• Director of Finance
• New Mexico Mutual
• KellieM_at_NewMexicoMutual.com
• Janet Byrne, CPA
• Sr. Financial Controls Analyst
• Pinnacol Assurance
• Janet.byrne_at_pinnacol.com