a Monday morning four years ago, I dashed through the pouring rain
to get to the office. I barely had my coat off when a co-worker
came rushing in. “Bev,” he panted, “the Commissioner
wants to see you right now.” My stomach tightened as I headed
toward her office. There are only two reasons the Commissioner wants
to urgently see one of us ... she wants to know why an assignment
isn’t finished, or she needs your report to be redone.
This time was different. As I approached her office, several people
were buzzing around. “Bev, come on in right away,” the
Commissioner greeted me and quickly announced, “I just received
the court approval. You have been appointed the receiver for Phantom
Receiver? I stood frozen in place. I’d never been a receiver
for a delinquent company before. I soon became excited ... it meant
I’d take over the Phantom Insurance Company (a fictitious
name to protect the innocent), martial all its assets and pay the
policyholders’ claims. “Yes, Commissioner,” I
responded with confidence. “I will start immediately.”
I dug into the court records to understand the situation. The Phantom
Insurance Company had sold health insurance to small companies for
their employees. In the next few days, I pawed through stacks of
records, then started receiving phone calls from policyholders -
10 calls, 20 calls, then 100. The numbers kept growing. This was
big. This company had not paid medical bills for policyholders.
Many were several months old. The situation was worse than I thought.
In my career at the Colorado Division of Insurance, my mission for
years had been to protect policyholders. These phone calls about
Phantom’s non-payments really troubled me. One person owed
his doctor $100. He didn’t know how he could pay this bill
and still find money for rent at the end of the month. Another owed
$1,000 to his doctor and would have to borrow it. Breast cancer
treatment for a woman totaled $35,000; a pacemaker for an elderly
man came to $27,000.
As receiver, I alone held the purse strings. These people touched
me deeply. And they looked to me to pay their medical bills so they
could get on with their healing.
My dilemma was serious. How can I help them? I only have 25 cents
on the dollar to work with ... a measly 25 cents on the dollar.
I need money. Lots of it.
Return Their Commissions
the law; I searched the records. It finally came to me. The agents
needed to return their commissions ... the illegal commissions they
earned. My next step: to get both the records and the money back
from the agents. I needed to move fast.
I marched to the Commissioner’s office, grabbing the assistant
attorney general, Steve, on the way. As we dashed into her office,
I explained my strategy to both of them. “I am so worried
we may not have the vital records we need. The agents may be destroying
key information as we speak -- information to help the policyholders.
I’m particularly concerned about six agents ... the big players
in Phantom. I want to seize their records post haste.”
Steve turned to me and suggested, “Bev, don’t you think
we should make appointments with them first?”
“Appointments!” I replied with surprise. “And
let these agents destroy vital information. They will disappear
if we call them first. We need their records to help policyholders.
It’s the law—we’re entitled to have them.”
The Commissioner stood up, tucked her thumbs in her waistband and
said in jest, with a touch of adventure, “Yes, I want to go
too!” That told me I was granted the authority to carry out
the necessary raids.
Case for Elliot Ness
I walked back to my office, pleased as punch. Then I panicked. “Wait
a minute,” I thought. “What am I doing? I’m not
Elliot Ness. What if some of these agents are truly bad dudes? Okay,
I’ll send the investigators to those suspected of being corrupt,
and select some tough examiners to help. Then I’ll check with
the investigators to learn who the wimpiest agent is for me to visit.”
two days, 12 of us met in the hearing room and planned our strategy.
We formed six teams and would make the “sting” in one
hour. With an investigator named Bob, I headed for a selected agent’s
office. He was standing near his office exit door when we walked
in. After I introduced us and our mission, he nearly hugged me ...
in the style of Bugsy Malone. Then, realizing he had to be on his
best behavior, he declared he was worried about the situation and
what could he do? I responded by handing him the Commissioner’s
order and said, “Abide by all these demands.” He glared
at the order as he plopped into a nearby chair to read it. Then
he jumped up, slapping the paper and shooting me a fierce look.
“What do you mean I have to give my commissions back? I’ve
already spent the money.” As he commenced pacing, the phone
rang. He picked it up and we heard him say, “Yah, yah, those
insurance guys are here too. How many are at your office? Two? Yah,
two here. Yah, they want all my records. Of course, I’m going
to give them my records ...but the commissions? This broad ain’t
going to see one red cent.”
Despite the protest, nearly 50 of the 100 agents involved came forward
with records and pleas to be exonerated from penalties. Throughout
the long process that followed, I couldn’t get the plight
of the policyholders out of my mind. Thankfully, I was able to recover
thousands of dollars from the agents to help right a serious wrong.
To this day, no matter what decision I make concerning an insurance
company, I remember the devastation inflicted on so many people
by so few agents acting improperly. I recall the impact I felt of
people suffering, trying to pick up the pieces after a medical and
financial disaster. More profoundly, I always ask myself, “Will
this decision I am about to make help or hurt the policyholders
the Basics in Mind
Our jobs are about people. Whether you’re an analyst or a
field examiner, think about the basic concepts you uphold as you
determine the financial stability of an insurance company. With
so much information to analyze, sometimes it’s hard to get
to the basics, let alone stay with them. Always remember the purpose
of our jobs ... the reason you strive to make a difference every
day. The following sections are designed to help you do just that.
Maintain a healthy
perspective. Approach your work with curiosity, preserve your sense
of skepticism and blend these with a recognition of reality and
an open mind.
If it ain’t broke, don’t fix it. Josephine Driscoll,
former Insurance Commissioner for Oregon, gave a presentation years
ago and strongly emphasized the idea “if it ain’t broke,
don’t fix it.” Be sure of what you are doing, for unnecessary
or inappropriate regulatory interference could do more damage than
good. Don’t get me wrong. I’m in favor of swift and
decisive action upon troubled insurers. Our job, in fact, is to
detect as early as possible those companies operating illegally
or in a hazardous financial condition. Think about the power you
have. A doctor affects the life of one person at a time. A lawyer
affects the life of one person at a time. But your decisions (or
lack thereof) affect thousands of people.
Components of Insurance Business
A company cannot operate and succeed without these basic components.
the insurance product - If the insurer prices the product
too high, it will lose market share. If the insurer prices the product
too low, it will get high market share, but will likely not be able
to pay claims when they come due.
the funds - The insurer has the fiduciary responsibility
to receive and handle the funds (premiums) properly and not to misuse
risks through reinsurance - To maintain a proper financial
balance and diversification, the insurer needs to engage in sound
reinsurance arrangements to share risks.
adequate reserves - It is of paramount importance that
insurers establish and maintain adequate reserves. (Reserves being
the liability established in recognition of amounts that are due
and will be due to policyholders.)
claims - The insurer must have the funds to pay claims
and make the claim payments in a timely manner.
All these components
of insurance business require good organization, sound judgment
and competence of management. Without these, an insurer may be successful
for awhile, but will suffer failure in time.
of Financial Statement Analysis
Weatherford, former insurance commissioner for Oklahoma and current
Executive Vice President of the National Association of Insurance
Commissioners (NAIC) stated it well when she said, “The cornerstone
of solvency regulation is the financial reporting.” The basic
component of financial reporting is the annual statement, often
referred to as the convention blank. Folks, this statement is not
new by any stretch of the imagination. In 1851 New Hampshire enacted
a law which established the requirements for a full-time board of
three insurance commissioners to oversee the yearly examinations
of the affairs of all insurance companies in New Hampshire. In 1871,
uniform financial reporting was initiated at the first convention
of what was to become the NAIC. There, the term “convention
blank” arose. Today, they are generally referred to as the
NAIC annual statement blanks.
The NAIC financial statements are unique to the insurance industry.
They are designed not only to describe the financial position of
the company at a point in time, but also to trace the financial
progress of the company over time. The statements provide continuity
in reporting. Albeit, various state laws differ and permitted practices
prevail which causes variances in reporting. The format and content
are continually reviewed and revised to keep it current with industry
changes and enhance its utility to the state regulator.
statements filed with the state insurance departments are prepared
on a statutory accounting principles (SAP) basis.
accounting principles are based on the concepts of solvency, conservatism,
consistency and flexibility. The NAIC Statutory Accounting Principles
Statement of Concepts 1994 draft define these concepts as follows:
- The ability to meet policyholder obligations is predicated on
the existence of readily marketable assets available when both current
and future obligations are due. All liabilities that will eventually
require the use of assets should be recorded as they are incurred.
Conservatism - Financial reporting by insurers
requires the use of substantial judgments and estimates by management.
Such estimates may vary from the actual amounts for various reasons.
SAP requires that the concept of conservatism be followed in developing
such estimates to provide a margin of protection against adverse
fluctuations in financial condition or operating results.
Consistency - The need for meaningful, comparable
financial information to determine an insurer’s financial
condition requires consistency in the development and application
Flexibility - Because the marketplace, the economic
and business environment, and insurance industry products and practices
are constantly changing, regulatory concerns are also changing.
In recognition of such changes, SAP must be flexible enough to respond
to regulatory concerns.
As you likely know, the NAIC is engaged in developing codification
of accounting principles. The project will result in more consistent
and comparable financial statements which will make our analysis
techniques more meaningful and effective.
techniques vary among states. I suggest that you review the NAIC
Financial Analysis Handbooks (life-health and property-casualty)
and the guidelines used by your department for guidance in performing
your financial analysis.
of Financial Analysis
The financial analyst evaluates data derived from financial statements
and other sources to reach conclusions regarding the insurer’s
current and future financial stability. A number of resource documents
must be filed along with the annual statements. We often tend to
go through the motions after awhile due to the enormous volume of
information. But it is good to stop and think about what these documents
and reports provide us. The following
chart shows documents and reports which are valuable tools for
the financial analysis process. Though not an exhaustive list, it
does contain the most frequently used resources.
You can pick up the NAIC Financial Analysis Handbook or your own
department’s analysis guidelines and follow them precisely
to conduct an analysis and come to a conclusion. The goal is to
arrive at the best conclusion; the key is to know what you are looking
at. Critical questions include: What are the primary causes of failure
among insurers? When I see a trend, what does that really indicate?
Answers to these questions come through knowledge, experience and
sound judgment. The following compilation of ideas and factors will
assist you in reaching sound conclusions about the financial stability
Remember, the insurer receives large sums of money and will not
have to pay a claim until sometime in the future. An opportunity
exists for an insurer to waste assets through greed, incompetence
and neglect of duty. You may ask, “How am I going to prevent
such activity?” Obviously, prevention is difficult, but detecting
such activity early is the key. On-site examination may be the only
way to get behind the numbers and ascertain illegal activity. Though
difficult to determine this through analysis, trends and sudden
changes can trigger your sense that something is not right. Ask
for an examination to target the detected problem area(s). And,
remember the idiom, “If it walks like a duck, and quacks like
a duck, then it is a duck.”
In an article about Best’s Insolvency Study of Life/Health
Insurers published in Best’s Insurance Management Reports,
June, 1992, some interesting facts emerged. Best’s insolvency
study covered 290 life/health insurers which became insolvent or
financially impaired during the period from 1976 through 1991. (This
study did not cover Blue Cross and Blue Shield organizations, managed
care companies and like-type entities.) While economic and market
conditions change and the industry changes with it, the chart below
shows the primary causes of financially impaired companies. This
offers background and assistance in conducting financial analysis
Causes of Financially Impaired Companies
of Total Identified
Change in Business
pricing/surplus and rapid growth top the causes of impairment. This
information alone indicates that the primary causes of financially
impaired companies involved some form of company mismanagement.
It stands to reason, that insurance company management is primary
in preventing failures. Hence, the quality and completeness of the
regulator’s relationship with the management of insurers is
important in continuously assessing the competence of management.
report, a publication of the Federal Bureau of Investigation concerning
insurance company insolvency fraud schemes, published in 1991, was
included in a presentation by Betty Cordial at this year’s
SOFE CDS. Of the 74 FBI investigations, “premium diversion”
was the most prevalent form of fraud, occurring in 41 of these investigations.
One type of premium diversion was the failure of an insurance agent,
broker, or managing general agent to remit premiums to the insurer.
Another type of premium diversion was selling insurance without
“Use of fraudulent assets” was the second most frequent
scheme, occurring in 38 investigations. The most recent trend involved
the purported assignment of GNMA (Government National Mortgage Association)
securities not actually owned by the insurer.
company transactions” was the third most frequent scheme,
occurring in 17 investigations. The presence of affiliated companies
cannot by itself be considered a fraudulent scheme. One of the common
types of fraud using affiliates is for a holding company to contribute
surplus to the insurance subsidiary while retaining the offsetting
liability on its books. This makes the financial position of the
insurer stronger and the insurance company can write additional
common fraud scheme using affiliates involves collecting premium
income and under-reserving for future losses, thereby booking excessive
profits in the current accounting period. The income produced by
the insurance subsidiary is then “upstreamed” to the
parent where it is dispersed outside the range of review by state
insurance departments. This type of fraud is extremely difficult
to prove since the method of establishing loss reserves is highly
technical and somewhat subjective.
What about the every day events that can provide insight into the
financial stability of an insurer? Numerous operating conditions
may indicate troubles dwelling within an insurer. Though mere existence
of these events is not an assurance that problems exist, these factors
are worthy of observation and potential investigation. The NAIC
Troubled Company Handbook is a great source for providing information
on indicators for trouble. The following
chart of operational conditions shows a selection of indicators
leading to potential problems.
To control the analysis process, have an orderly flow, and review
the highest risk companies first, it is important to prioritize
or classify insurance companies according to each insurer’s
relative stability and the perceived need for analysis. Suggested
factors to consider (though not totally inclusive) include some
or all of the following factors:
1. Result of
the prior year analysis
2. Whether the insurer was a priority company in the prior year
3. Adequacy of the insurer’s capital and surplus
4. Significant changes in the insurer’s capital and surplus
5. Negative trends in income and/or cash flow
6. IRIS ratio results and the NAIC Examiner Team Synopsis
7. FAST ratio results
8. Changes in the insurer’s management or board of directors
9. Results of the preliminary annual statement analysis
10. Analysis performed by the NAIC’s Financial Analysis Working
11. Examination reports issued (financial condition and market conduct)
12. Information from other divisions or areas of the insurance department
13. Independent rating organization ratings and reports
14. Impact on the public of insurer insolvency
As an analyst
you should use professional judgment in prioritizing the reviews.
Past analysis experience will give you considerable insight into
the company’s stability, regardless of some adverse trends.
During your analysis develop and document your findings to support
and explain your overall conclusion regarding the insurer’s
financial condition. Take into consideration significant financial
and operational conditions and trends. While you may see a predominant
trend, generally there are a number of factors that will cause a
company to become troubled and these should be included with your
you find that the company you are analyzing made a shift in investments
from conservative to high-yield, risky investments. The new investments
resulted in a large non-admitted amount (based on your state law)
on the annual statement. They also made a shift in product line
from life products to annuity products. This could explain the change
in investment portfolio to support the higher yield products being
sold. But can the surplus and investment structure of the company
support the new product line? Can it support the cost of placing
new business on the books? Is the new annuity product promising
too much - a higher than feasible interest return? How do you interpret
what is going on? Basically, it is often difficult to come to a
final interpretation from the documents in front of you when you
are confronted with a troubled company.
have a variety of directions you can take based on guidelines (used
by your state) and your judgment. For a starter, it is advisable
to discuss your findings with company management. At this point,
put everything in writing. You may need this information later to
support your actions. Ask the management to answer questions about
everything that concerns you - the change in investments, the change
in the product line, etc. Make your inquiry as comprehensive as
possible. Review the managers’ response and determine the
reasonableness of their answers. You can often see if they are genuinely
giving you valid responses or just blowing smoke. You are the judge.
And if you are not satisfied with their responses, let them know.
you have all the pertinent details in front of you, make a determination
about the stability of the company. Record (in the workpapers) your
conclusion, spell it out and include the factors that indicate problems
with this company. For example, include comprehensive notes about
the investment portfolio, the change in product line, and the policyholder
surplus level. You need to answer the question. “Do we have
a solvency issue here?”
you have determined that the company is troubled, develop a plan
for monitoring the company. Involve the company. This will let management
know you are serious about your concerns. Ask for special filings
or more information as you deem appropriate. A business plan prepared
by the company is a valuable tool - a plan that sets forth projected
income, expenses, investment activities, surplus infusions from
the parent, marketing plans and so forth. With this plan in hand,
you can monitor the company’s ability to meet its objectives
over time. Remember, it is easy for the company to deceive you,
either intentionally or unintentionally.
company is dangerously close to impairment or indeed has become
impaired, then regulatory action is in order. When your analysis
results in a recommendation for regulatory action (supervision,
conservatorship, rehabilitation, receivership), the commissioner
will need sufficient and competent information that will stand the
test of court proceedings.
the level of regulatory action recommended, your evidentiary records
must be accurate and descriptive. Have you ever written something
and, months later, picked up the document and couldn’t figure
out what your were talking about? If not, you are doing better than
I have at times. The most helpful record of your analysis will stand
on its own, interpret the data clearly, and can be understood months
While we have an abundance of tools to assist us today in our analysis,
your skills and abilities are the key to carrying out the regulatory
process. Remember, this narrative offers ideas and suggestions,
but the “artistry” in regulation comes from you. Despite
the obstacles, creative solutions abound. When you practice the
art of financial regulation, you’ll paint a “picture”
you can view with pride because you’ve helped policyholders
who couldn’t help themselves.