Corporate Governance- A Self-Evaluation Tool for I

A Self-Evaluation Tool

for Insurance

Company Directors

Donna Imhoff, J.D.*

Abstract

Enactment of the federal Sarbanes-Oxley Act of 2002 (SOX) sparked intense debate before the NAIC over whether it should adopt new corporate governance standards for insurers that correspond to those of the federal law. The NAIC’s new standards, adopted in June 2006, supplement standards already

in effect for insurers.

In the midst of discussions over the appropriate insurance regulatory response to SOX principles, the NAIC adopted another measurement for corporate governance specifically tailored to the insurance industry for assessment of risk management processes. Adopted in 2004, this new tool for financial regulators anticipates that boards and their individual directors take an affirmative role in measuring, managing and monitoring the risks associated with the insurance business.

This article discusses the evolving standards governing the activities of insurance company boards of directors. These standards are essential to the NAIC Financial Regulation Standards and Accreditation Program and are derived from the annual statement, the Financial Condition Examiners Handbook, changes to the Model Regulation Requiring Annual Audited Financial Reports (Model Audit Rule) and the Risk-Focused Surveillance Framework. Before enactment of SOX, NAIC uniform financial standards and state insurance regulation included review of board of director functions and director activities, although, in most cases, without specific sanctions. While corporate governance might not have been a prominent issue in financial examinations, it has long been an established part of the examination. New corporate governance standards and the discussion surrounding their adoption

* Imhoff is of counsel to Funk & Bolton, P.A., resident in the law firm’s Baltimore office, where she concentrates in the insurance regulatory practice area. She is a former Maryland regulator, serving as associate commissioner for life and health insurance (1997 to 2000) and then as deputy insurance commissioner (2001 to 2003); dimhoff@fblaw.com.

© 2007 National Association of Insurance CommissionersJournal of Insurance Regulation 18

have highlighted the importance of reviewing director functions and activities as part of the financial examination of insurers. In some states, more careful review of current standards during the examination process might ensue.

Directors who wish to assess their compliance in advance of a scheduled financial examination might use this article as the basis for a self-evaluation tool. Introduction

For publicly traded companies, the Sarbanes-Oxley Act of 2002 (SOX) has resulted in intense scrutiny of the activities of boards of directors. Against the backdrop of national discussions on corporate governance and new NAIC corporate governance standards, directors of insurance companies should understand how state insurance regulators currently evaluate director activities as a function of financial regulation. In light of the newly adopted standards, directors also should understand how board activities might be evaluated in future financial examinations. Indeed, corporate directors would be prudent to conduct a self-evaluation and to review corporate responsibilities in advance of any scheduled financial examinations.

The activities of corporate directors of any insurance company — whether or not the company is publicly traded — are subject to review by state insurance regulators. The discussions about corporate governance within the NAIC since the U.S. Congress adopted SOX, which undoubtedly were closely monitored by all insurance regulators, almost certainly have magnified the importance of corporate governance and director activities within the context of financial examinations.

Standards established by the NAIC, under the Financial Regulation Standards and Accreditation Program, provide corporate directors with a framework for self-evaluation. Adopted in 1990, the Accreditation Program has resulted in uniformity of financial regulation standards across all accredited jurisdictions. Through annual reporting and financial examinations, state insurance regulators continually evaluate insurers against NAIC standards.

To be complete, however, the self-evaluation also must incorporate standards imposed by an insurer’s state of domicile under any state-specific laws governing director activities that supplement those laws the state has adopted to comply with the NAIC Accreditation Program. Each state is unique in its approach.

As the basis for a self-evaluation tool that focuses on director responsibilities, this article discusses:

•Uniform standards applied by solvency regulators in a

financial examination;

•Newly adopted NAIC changes to annual financial reporting

standards that correspond to SOX standards, which become effective

January 1, 2010; and

•NAIC guidance on the role of directors in risk management.

© 2007 National Association of Insurance CommissionersCorporate Governance: A Self-Evaluation Tool

19 Current NAIC Standards Governing

Director Activities

Annual Statement Reporting

In an accredited state, each insurer must file an annual statement in the form approved by the NAIC. The General Interrogatories section of the annual statement blank includes several questions specifically addressing activities of the board of directors. The questions establish three basic rules for directors:

•The board or one of its committees should review the purchase or sale of all investments of the company.

•The board should keep a complete and permanent record of all its proceedings and those of its subordinate committees.

•There should be an established procedure for disclosure to the board of any material interest or affiliation on the part of any officer, director,

trustee or responsible employee that is likely to conflict with the

individual’s official duties.

The General Interrogatories also ask for the total amount loaned during the year to directors. The amount reported must include separate accounts, but exclude policy loans. If any such loans were made, the amount of loans outstanding must be reported.

Criteria Applied to Director Activities in a Financial Examination

A critical component of the Accreditation Program, and an important tool for financial regulators, is the NAIC Financial Condition Examiners Handbook (Examiners Handbook). The Examiners Handbook guides examiners in the questions they ask and the materials they review in evaluating business and corporate practices, including director activities, as part of the financial examination process. The Examiners Handbook, intended for use in all accredited jurisdictions, offers a measure of uniformity in the review and analysis of insurance company solvency by the company’s domestic regulator. Because there is a uniform procedure for review and analysis, all states in which an insurer is authorized to do business can rely on the quality of the financial examination carried out by the domestic regulator. While the Examiners Handbook, per se, does not establish standards of conduct for corporate directors, nonetheless the guidance it gives to examiners does imply that standards exist.

The Examiners Handbook divides the financial examination process into three major phases. Directors should be aware of the phases and the progression of questions within each phase that relates to board activities. Directors should understand the appropriate response to each question. Absent an independent understanding of the response, a director should seek the information from management, corporate counsel or board colleagues.

© 2007 National Association of Insurance CommissionersJournal of Insurance Regulation 20

Planning Phase

General guidelines on planning a financial examination describe procedures for management assessment. The following questions about the board of directors are included in the guidelines:

•Are criteria and terms for board membership sufficient to enable the effective monitoring and oversight of management?

•Does the board effectively monitor and oversee management activities?

A related question under the heading “Management Competence” asks whether a member of management has ever been a director of an insurance company that, while the individual was a director, became insolvent or was placed in conservation, was enjoined or ordered to cease from violating any securities or insurance law, or suffered suspension or revocation of its certificate of authority in any state. An affirmative answer might lead an examiner to question a board’s effectiveness in monitoring and overseeing management.

The Examiners Handbook includes an Examination Planning Questionnaire as an exhibit. A number of items relate to the board of directors, as listed below.

•Is there an audit committee? How many members are outside directors?

How often does the committee meet? Are minutes of meetings prepared

and retained?

•From the articles of incorporation, describe the duties assigned and performed by the board of directors, its audit committee and

other committees.

•Has the company developed a long-term strategic plan? How often is it reviewed and updated?

•Do internal auditors prepare and follow written audit programs? Is the scope of internal audit activities planned in advance with the board

of directors?

•Do internal auditors have direct access to the board of directors?

•Are financial statements submitted at regular intervals to the board of directors?

•Does the board of directors review and approve financial information for public distribution; e.g., filings with regulatory bodies?

•Are all investment activities approved by the board of directors?

•Do reinsurance agreements require formal review and approval before execution by the board of directors?

•Are transactions with employees, directors and officers regularly reviewed for compliance with regulatory requirements?

© 2007 National Association of Insurance CommissionersCorporate Governance: A Self-Evaluation Tool

21

Examination Phase

General procedures for conducting examinations include a review of the minutes of board of directors’ and committee meetings. The procedures instruct examiners to read the minutes of all meetings of the board of directors and important committees.

Good business judgment dictates that corporate minutes be accurate and complete. Specific instructions in the Examiners Handbook offer some guidance on the question of completeness of corporate minutes:

The examination team should read the minutes of all meetings

of the board of directors, shareholders, and executive and

other important committees for the entire examination period

through the end of fieldwork. Matters affecting the annual

statement should be cross-referenced to the appropriate work

papers. (Emphasis supplied.)

The Examiners Handbook addresses the first two of the three basic rules for directors derived from the annual statement blank: Board review of the purchase and sale of investments and maintenance of a permanent record of board proceedings. As to the third rule, established disclosure procedures, examiners conducting a financial examination would review the annual statements filed since the last examination, and presumably, would review the procedure for disclosure by directors of any material interest or affiliation that is likely to conflict with an individual’s official duties. The form and content of the disclosure and the standard for measuring the impact of a potential conflict might differ from state to state. Unless a state’s law imposes a standard, the form, content and substance of a disclosure would be measured by a subjective standard — that of the most senior regulator who signs the examination report. Post-Examination Phase

As to general procedures on post-examination follow-up, the Examiners Handbook instructs examiners to contact the company to elicit the extent of corrective action resulting from an examination report. It concludes, “lack of satisfactory corrective action by the company may be cause for consideration of official proceedings against the directors and officers.”

Once again, unless a state’s law imposes standards for determining what constitutes “satisfactory” corrective action and for deciding which “official proceedings” will be brought against directors and officers, the standards necessarily would be subjective.

© 2007 National Association of Insurance CommissionersJournal of Insurance Regulation 22

Newly Adopted Standards: Director

Oversight in Financial Reporting

(Effective January 1, 2010)

In June 2006, the NAIC adopted the Annual Financial Reporting Model Regulation (the Model), which revises and renames the Model Regulation Requiring Annual Audited Financial Reports (Model Audit Rule), to impose on insurers new requirements corresponding to some of the standards applicable to public companies under the federal Sarbanes-Oxley Act of 2002 (SOX).

The new requirements, which become effective January 1, 2010, alter requirements for independent auditors, add new corporate governance standards and require internal control over financial reporting for companies having annual premium in excess of $500 million.

Before the effective date, the Model must be adopted by law or regulation in each jurisdiction that wishes to comply with the NAIC Accreditation Program. Although a minority of states has incorporated the Model Audit Rule into their financial regulatory programs based on its reference within the annual statement instructions, those states now must join the majority of accredited jurisdictions to adopt the financial reporting requirements through the formality of the legislative or regulatory process. Similarly, those jurisdictions that have used a legislative or regulatory process to adopt the Model Audit Rule must reactivate that process to adopt the Model changes.

Various summaries of the Model have been available since its adoption. The new requirements generally correspond to similar provisions of SOX. Consistent with the intent of this article, the summary below emphasizes the impact that changes will have on insurance company directors, individually and collectively as a board.

Applicability of the Annual Financial Reporting Model Regulation

The Model applies to every authorized insurer except those having direct premiums of less than $1 million in a state in any calendar year or less than 1,000 policyholders of direct policies nationwide at the end of the calendar year. In any given state, the commissioner may make a finding that compliance is necessary for an insurer that otherwise may be exempt due to its size. This provision on general applicability is unchanged from the Model Audit Rule.

There are several exemptions within the specific requirements of the Model. For directors, the most notable is the exemption from new audit committee standards for insurers that already are SOX-compliant.

Establishment of Audit Committee

While the boards of directors of many insurers already have established an audit committee, the Model expressly requires an audit committee. For an insurer within a holding company system, the controlling person may elect to

© 2007 National Association of Insurance Commissioners

have its audit committee act as the audit committee for the insurer. To exercise the election, the controlling person must give written notice to the insurance commissioner before issuance of its annual audit and must describe the basis for the election.

The Model describes an audit committee as a body established by the board of directors for the purpose of overseeing the accounting and financial reporting of an insurer. If a board of directors fails to designate an audit committee, the entire board constitutes the audit committee.

The Model adopts standards for audit committees, but exempts an insurer that is required to be compliant or is voluntarily compliant with SOX provisions relating to preapproval of certain auditing services by the auditing committee, audit committee independence requirements and internal control over financial reporting. Unless an insurer is exempt, the standards as stated in the Model apply. However, an insurer with direct written and assumed premiums less than $500 million may apply to the insurance commissioner for a hardship exemption from the provision requiring direct responsibility of the audit committee over the accountant handling the audited financial report and from the audit committee independence requirements. The Model does not describe what constitutes a hardship, but an Implementation Guide for the Model describes circumstances that might constitute hardship as those based on business type, availability of qualified board members, or organizational structure. It would seem that the application for an exemption and the determination of a hardship might vary somewhat from state to state.

Audit Committee Oversight of Financial Reporting

An insurer’s audit committee is directly responsible for appointment, compensation and oversight of the work of an accountant preparing and issuing an audited financial report. Oversight includes resolution of disagreements between management and the accountant regarding financial reporting. Each accountant shall report directly to the audit committee.

The audit committee shall require the accountant to report specified information, including:

•All significant accounting policies and material practices;

•All material alternative treatments of financial information within statutory accounting principles that have been discussed with

management; and

•Other material written communications between the accountant and management.

Under current standards suggested by the planning questionnaire in the Examiners Handbook, directors already should be familiar with audit programs and the scope of internal audit activities, and therefore have the basis of knowledge for interpreting and evaluating the information accountants must report under the Model. Beginning no later than January 1, 2010, directors would be prudent to ensure that board minutes document that the audit © 2007 National Association of Insurance Commissionerscommittee has established a direct relationship with the accountant issuing the annual audited financial report and that the audit committee receives and maintains the information specified in the Model.

Audit Committee Independence Requirements

The Model establishes standards for independence of board members who serve on the audit committee of an insurer whose direct written and assumed premiums for the preceding calendar year exceeded $300 million.

To maintain independence a director, other than as a member of the board, may not accept any consulting, advisory, or other compensatory fee from the insurer or its affiliate or subsidiary.

An insurer with more than $300 million in prior year written and assumed premiums shall have a majority (50% or more) independent membership.

An insurer with more than $500 million in prior year written and assumed premiums shall have a supermajority (75% or more) independent membership.

Drafting notes to the Model state that all insurers with less than $500 million in written and assumed premiums are encouraged to structure their audit committees with a supermajority of independent members; and a state’s law may authorize its insurance commissioner to impose independence of audit committee members for insurers that exhibit qualities of a troubled insurer. As previously noted, an insurance commissioner may grant a hardship exemption from the independence requirements.

Directors should be familiar with developments in the laws of the insurer’s domestic state related to corporate governance and any materials the insurance commissioner may publish on director independence in the form of regulations and financial examination reports.

Qualifications of Independent Certified Public Accountants

The Model adds provisions intended to assure auditor independence. The provisions are similar to those contained in SOX.

Audit Partner Rotation

The Model changes the rotation and disqualification period, established by the Model Audit Rule, for independent certified public accountants who audit insurers. Disqualification specifically applies to the audit partner having primary responsibility for an audit, rather than to any persons responsible for rendering an audit report. The Model reduces from seven years to five years the consecutive period during which the audit partner may have primary responsibility for an insurer’s audit. It also increases to five years the period of disqualification due to five years of consecutive service.

The Model continues the current practice, under the Model Audit Rule, allowing an insurer to request an exemption from the rotation, but requires an application for an exemption to be made at least 30 days before the end of a calendar year. An insurer that has an approval for the exemption must file the approval with its annual statement.

© 2007 National Association of Insurance CommissionersLimitation on Non-Audit Activities

The Model prohibits the insurance commissioner from accepting an annual audited financial report prepared by an accountant who provides an insurer, contemporaneously with the audit, certain non-audit services. The insurance commissioner may grant an exemption to an insurer having direct and assumed premiums of less than $100 million in any calendar year.

The prohibition on contemporaneous non-audit services is based on three principles of auditor independence expressly described in the Model: an accountant cannot function in the role of management, cannot audit the accountant’s own work and cannot serve in an advocacy role while conducting an independent audit.

Contemporaneous non-audit services that would disqualify an accountant are:

•Bookkeeping or other services related to accounting records or financial statements;

•Design and implementation of financial information systems;

•Appraisal or valuation services, fairness opinions or

contribution-in-kind reports;

•Actuarially-oriented advisory services involving the determination of amounts recorded in the financial statements;

•Internal audit outsourcing services;

•Management functions or human resources;

•Broker-dealer, investment adviser or investment banking services;

•Legal services or expert services unrelated to the audit; and

•Other services the commissioner determines, by regulation,

are impermissible.

Under limited circumstances, an accountant’s actuary may issue an actuarial opinion on an insurer’s reserves. In addition, if the audit committee approves a service in advance, an accountant may engage in non-audit services, including tax services, that are not expressly prohibited and that do not conflict with the three principles of auditor independence.

In light of the direct responsibility of the audit committee over the accountant engaged in preparing the insurer’s financial reports, directors should understand how the Model defines independence for accountants and the limits on non-audit activities that an accountant may provide. In addition, directors should know the three principles of auditor independence and be prepared to apply those principles to activities not specifically described in the list of services that would disqualify an accountant.

© 2007 National Association of Insurance CommissionersAudit Committee Approval of Services

The audit committee shall give advance approval for all auditing services and non-auditing services that the independent certified public accountant provides the insurer. The advance approval requirement does not apply to an insurer that is compliant with SOX or is a direct or indirect wholly owned subsidiary of an entity that is so compliant.

Limitation on Company Officers Formerly Employed by Accountant

A member of an insurer’s board, its president, chief executive officer, controller, chief financial officer, chief accounting officer or equivalent position may not have participated in an audit of the insurer as a partner or senior manager of the insurer’s accountant within the one-year period preceding the date of the most current statutory opinion. An insurer may apply for an exemption of the prohibition based on unusual circumstances. An insurer that has an approval for the exemption must file the approval with its annual statement.

Officer and Director Liability for Conduct Related to Accountant

Work Product

The Model specifies behavior that would result in sanctions against an officer or director. The prohibition is stated in terms that generally would apply criminal sanctions. However, whether commission of the specified behavior constitutes criminal conduct and whether the conduct would be subject to conviction as a misdemeanor or felony rests with state policymakers who adopt the Model in their respective states through the legislative process. The new language of the Model emphasizes the important fiduciary responsibility each member of a board of directors has with respect to a company.

Under the new language, an officer or director may not, directly or indirectly:

•Make or cause a materially false or misleading statement to an accountant in connection with any audit, review or communication

required under the Model.

•Omit to state or cause another to omit to state a material fact necessary to ensure that statements are not misleading to an accountant in

connection with any audit, review, or communication required under

the Model.

•Take any action to coerce, manipulate, mislead or fraudulently influence an accountant engaged in an audit if the officer or director

knew or should have known that the action could result in rendering

financial statements to be materially misleading. (Emphasis supplied.)

© 2007 National Association of Insurance CommissionersIn light of the direct relationship the audit committee must have with the accountant, directors should be particularly attuned to the personal liability the Model imposes on perceived abuses of that relationship. They should refrain from any actions that, though innocent, give the appearance of being misleading, coercive, manipulative or otherwise prohibited. Directors also should understand the specific sanctions associated with this liability in the insurer’s state of domicile.

Internal Controls

The Model establishes two requirements related to the internal control a company maintains over its financial reporting. The first applies to all insurers and relates to information required in the annual audit; it mandates a specific communication for all audits. The second applies only to insurers having direct and assumed premiums in excess of $500 million; it mandates those insurers to submit a report on internal control over financial reporting.

The Model defines internal control over financial reporting to be a process effected by the board of directors, management, and other personnel designed to provide reasonable assurance of the reliability of financial statements through the following:

•Maintenance of records;

•Recording of transactions; and

•Timely detection of unauthorized transactions.

Communication of Internal Control Related Matters Noted in

an Audit

An accountant who prepares an insurer’s annual audited financial statement must prepare a written communication as to any unremediated material weaknesses in internal controls over financial reporting noted in an audit. The Model requires that if no unremediated material weaknesses were noted, the communication should so state. The communication, which is governed by standards issued by the American Institute of Certified Public Accountants (AICPA), must be filed with the domiciliary insurance commissioner within 60 days after the filing of the annual audited financial report.

If the accountant describes unremediated material weaknesses and does not provide a description of corrective remedial actions, the insurer must provide the commissioner with the description.

Management’s Report of Internal Control over

Financial Reporting

The Model requires certain insurers to file with the commissioner a report on internal control over financial reporting. An insurer must file the report if: •It has annual direct and assumed premiums of $500 million or more (excluding premiums reinsured with federal crop and flood programs).

© 2007 National Association of Insurance Commissioners•The commissioner requires the report because the insurer is in any risk-based capital (RBC) level event or is deemed to be in a hazardous

financial condition.

An insurer may file its or its parent company’s report prepared in accordance with SOX Section 404 if:

•The insurer is directly subject to SOX Section 404.

•The insurer is part of a holding company system whose parent is subject to SOX Section 404.

•The insurer or its parent, though not directly subject SOX Section 404, is a SOX-compliant entity.

•Along with the Section 404 report, the insurer files an addendum.

The addendum must:

•Include a positive statement by management that no material

processes related to preparation of the insurer’s audited financial

statements are excluded from the Section 404 report; or

•If internal controls having a material impact on preparation of the insurer’s audited financial statements are excluded from the

Section 404 report, include a report on the internal controls not

covered by the Section 404 report.

The bases for all assertions made in the report on internal control must be documented and made available when the insurance commissioner conducts a financial examination.

The Role of Directors in Risk Management In Plenary session in September 2004, the NAIC adopted the Risk-Focused Surveillance Framework. The Framework proposes ways in which the financial examination process may assess an insurer’s risk prospectively, in part through assessment of risk management processes such as board of director effectiveness and corporate governance activities. The Framework states that it intends to enhance the current retrospective examination-based process for identifying insurers at financial risk. The Framework describes the bases for a regulatory program, necessary steps in carrying out the program, and characteristics that can be identified with strong, moderate, and weak risk management in the insurance industry.

While the Framework seems to intend uniformity, there are no calculations on which to base regulatory judgment. Consequently, the extent to which a board or its directors, individually, manage risk will be measured by the subjective standard of the insurer’s state of domicile. As a guide to regulators the Framework describes “Five Elements of a Sound Risk Management Process”, or controls an examiner might review when assessing a company’s aptitude for risk management.

© 2007 National Association of Insurance Commissioners

Corporate Governance: A Self-Evaluation Tool

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The Framework places responsibility for risk management squarely on the board’s shoulders. Notably, the first element of a sound risk management process is active board and senior management oversight. As described in the Framework, regulatory review of this element includes evaluation of whether the board, in conjunction with senior management:

•Identifies and has a clear understanding of the types of risk inherent in business lines and has taken appropriate steps to ensure continued

awareness of any changes in the levels of risk.

•Has been actively involved in development and approval of policies to limit risks, consistent with the insurer’s risk appetite.

•Is knowledgeable about the methods available to measure risks for various activities.

•Carefully evaluates all risks associated with new activities and ensures that proper infrastructure and internal controls are in place.

•Has provided adequate staffing and designated staff with appropriate credentials to supervise new activities.

The next three elements might not be measurable in specific board actions, but directors should expect regulatory review to include board influence and oversight in these areas. The second, third and fourth elements of sound risk management as described in the Framework are, respectively:

•Organizational policies, procedures, and limits that have been developed and implemented to manage business activities effectively;

•Adequate risk measurement, monitoring and management information systems to support all business activities; and

•Established internal controls and the performance of comprehensive audits to detect deficiencies in the internal control environment.

The last of the five elements of a sound risk management process is compliance with laws and regulations. Recognizing that insurers operate in a highly regulated environment, the Framework states that review of this element includes an evaluation of:

•Whether the board and senior management establish policies and processes to proactively ensure compliance.

•Periodic reporting to the board of compliance initiatives, successes and problems.

The Framework establishes a risk assessment process that is somewhat more complicated than the snapshot representing the five elements of sound risk management. However, this article focuses on board responsibilities and the five elements comprise a relatively concise statement of those responsibilities as they relate to measuring, managing and monitoring the risks associated with the insurance business.

© 2007 National Association of Insurance CommissionersJournal of Insurance Regulation 30

After the 2004 adoption of the Framework, the NAIC began drafting corresponding changes to the Examiners Handbook so that regulators could apply the risk assessment process to prospectively evaluate business and corporate practices within the financial examination.

Risk-Focused Examinations: Future Trends

in Regulatory Assessment

Current regulatory assessment of directors, as carried out through annual statement reporting and the criteria applied to director activities in a financial examination, is undergoing a modernization process, evidently in response — at least in part — to national discussions on corporate governance. Directors who know and understand the current system are likely to note dramatic changes between their company’s most recent examination and any future examination.

In Plenary session in December 2006, the NAIC adopted revisions to the Examiners Handbook that were being drafted during the two years that had elapsed since adoption of the Framework. Early in 2007, the NAIC published and distributed the new edition of the Examiners Handbook, which incorporates the revisions. As a next step toward adoption of the revisions as uniform standards, the NAIC Financial Regulation Standards and Accreditation (F) Committee will consider mandatory use of the 2007 Examiners Handbook in accredited jurisdictions beginning January 1, 2010. The implementation date for mandatory use coincides with that of the Model and its newly adopted standards. Unless and until use of the 2007 Examiners Handbook becomes a uniform standard, its application in any particular state is discretionary; and presumably the regulator could use the 2007 edition for examination of some companies and the 2006 edition for examination of other companies.

The concepts underlying the 2007 Examiners Handbook are not foreign to the regulatory arena; those concepts form the basis for current guidelines for the planning and examination phases under current uniform standards. However, the level of scrutiny of governance, management and the enterprise as a whole is more intense than the level heretofore applied by insurance regulators to a healthy insurer. The result is a new approach to financial examinations that is quite different from previous editions of the Examiners Handbook. Directors should gain a general understanding of the guidance to examiners, and ensure that the company is ready to respond to this new trend in financial examinations. At a minimum, directors should view a copy of the Examiners Handbook and ask company financial officers and legal counsel to explain aspects of the revisions that might change the scope of a financial examination for their particular company. Directors who wish to understand in more detail how their role will be assessed should read Exhibit M – Understanding the Corporate Governance Structure. In its six pages, the Exhibit sets forth a series of questions and key measures of good governance the examiner should apply to assess the board and to understand the company’s organizational structure and assignment of authority and responsibility. In several references to the board of directors, the Examiners Handbook calls for evaluation of the appropriateness

© 2007 National Association of Insurance CommissionersCorporate Governance: A Self-Evaluation Tool

31

and effectiveness of the “tone at the top.” Even if a uniform definition could be articulated for “tone at the top,” any such evaluation most certainly would be subjective.

For boards that have delegated governance to management or otherwise have been distant from company operations, the Examiners Handbook suggests that more active oversight might be warranted. While the guidance is intended to be flexible for use with a variety of insurers, the overriding expectation for directors of all insurers seems to be that they carry out their responsibilities in a manner that is both knowledgeable and thorough.

Conclusion

This article has reviewed the uniform standards that apply to the governing board of an insurance company under the NAIC’s Accreditation Program, along with risk management and new corporate governance standards that the NAIC will incorporate into the Accreditation Program in the foreseeable future. However, the uniform standards are only part of the corporate governance equation. Each state has authority to adopt additional standards applicable to its domestic companies. A self-evaluation can be complete only if it incorporates the requirements an insurer’s state of domicile places on the board and its directors individually.

A highly defined set of responsibilities and new liabilities accompany appointment to the governing board of an insurance company. Lest the board as a whole be judged for any act or omission inconsistent with those responsibilities, each director individually should understand the entire set of responsibilities. As appropriate, board minutes or reports appended to the minutes should document compliance with uniform standards and with any state-specific standards applicable to the insurer.

Under the current system for regulatory assessment of directors, there is some exposure to subjective evaluation. However, the degree of subjectivity is limited because it exists within annual statement reporting and financial examinations, both of which view board activities retrospectively. Directors should be aware that future trends in regulatory assessment, as evidenced by the 2007 Examiners Handbook, incorporate prospective evaluation into the system. Subjectivity, a necessary component of any prospective view, can either clarify or obscure that view.

To carry out their corporate responsibilities collectively as a board, each director in an individual capacity should have a reasonably complete understanding of all aspects of the company. Directors who comprise the board’s audit committee will be held to a higher standard than other directors, commensurate with their fiduciary responsibility and the knowledge of financial matters they would be expected to bring to a board appointment.

If multiple board appointments have been an attractive sideline in the past, new responsibilities and the probability that insurance regulators will closely monitor and evaluate one’s actions as a director may make them less so in the future.

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References

National Association of Insurance Commissioners, 2004. Risk-Focused Surveillance Framework (adopted June 14), Kansas City, Mo.: NAIC. National Association of Insurance Commissioners, 2005. Financial Standards and Accreditation Program, Kansas City, Mo.: NAIC.

National Association of Insurance Commissioners, 2006. Financial Condition Examiners Handbook (2006), Kansas City, Mo.: NAIC.

National Association of Insurance Commissioners, 2006. Implementation Guide for the Annual Financial Reporting Model Regulation (June 6 draft), Kansas City, Mo.: NAIC.

National Association of Insurance Commissioners, 2006. Model Regulation Requiring Annual Audited Financial Reports, Revised (adopted June 11), Kansas City, Mo.: NAIC.

National Association of Insurance Commissioners, 2007. Financial Condition Examiners Handbook (2007), Kansas City, Mo.: NAIC.

National Association of Insurance Commissioners, Annual Statement Blank, Kansas City, Mo.: NAIC.

National Association of Insurance Commissioners. Model Regulation Requiring Annual Audited Financial Reports (Model Audit Rule), Kansas City, Mo.: NAIC.

© 2007 National Association of Insurance Commissioners