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Financial Analysis Lou Felice, Health and Solvency Policy Advisor NAIC 1.

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Presentation on theme: "Financial Analysis Lou Felice, Health and Solvency Policy Advisor NAIC 1."— Presentation transcript:

1 Financial Analysis Lou Felice, Health and Solvency Policy Advisor NAIC 1

2 © 2012 The National Association of Insurance Commissioners Presentation Overview Overview of the Financial Analysis Handbook (Handbook) Financial Analysis vs. Financial Examiner Roles NAIC I-SITE Reports & Insurer Profile Summary 2

3 © 2012 The National Association of Insurance Commissioners NAIC Financial Analysis Handbook Assists regulators in performing risk- focused financial analysis to identify companies that may have financial problems or that have the greatest potential for developing financial problems Provides guidance to evaluate particular areas of concern in troubled companies Consistent and uniform method Qualitative and quantitative analysis Updated annually Confidential – Regulator Only 3

4 © 2012 The National Association of Insurance Commissioners Financial Analysis Handbook Analyst Reference Guides Level 1 Procedures Level 2 Procedures Level 2 – Investments, Cash Flow & Liquidity, Reinsurance, Affiliated Transactions, MGA & TPAs, Risk-Based Capital, Income Statement and Surplus, Unpaid Losses and LAE Supplemental Procedures o Management Considerations, Audited Financial Report, Actuarial Opinion, Management Discussion & Analysis, Holding Company Analysis 4

5 © 2012 The National Association of Insurance Commissioners Handbook - Risk-Focused Financial Analysis Depth of the analysis will depend on the complexity and the financial strength of the insurer and the existing or potential issues and problems found during review of the financial statements At a minimum the following must be analyzed: o Annual and quarterly financial statements o Actuarial opinion o Management’s discussion and analysis o Audited CPA report o Holding company filings o Financial ratios 5

6 © 2012 The National Association of Insurance Commissioners Handbook - Analyst Reference Guide Example - Investments Overview - Discusses specific topics: investment income, asset and liability matching, diversification of a portfolio, key areas of consideration when reviewing a portfolio Discussion of Level 1, 2 and Supplemental Procedures – provides considerations and guidance for the procedures Additional Reference Sources - SVO Purposes & Procedures Manual, Accounting Practices & Procedures Manual, NAIC Annual Statement Instructions, etc. 6

7 Handbook - Annual Level 1 Procedures Background Analysis o Last priority designation, inter-department communication, regulatory actions, NRSRO rating Management Assessment o Shift in management or philosophy Balance Sheet Assessment Operations Assessment Investment Practices Review of Disclosures o Notes to Financial Statements, General Interrogatories, etc. Assessment of Latest Examination Report and Results 7

8 FAHFAH 8

9 © 2012 The National Association of Insurance Commissioners Handbook - Annual Level 1 Procedures Overall high-level review of insurer At the conclusion of the Level 1, the analyst is directed as to whether greater analysis must be completed within the Level 2 procedures given risk discovered in Level 1 o For example, does the insurer have complex affiliated agreements in place that would require further detailed review beyond discovery work completed within Level 1? 9

10 © 2012 The National Association of Insurance Commissioners Handbook – Annual Level 2 Procedures Level 2 Procedures Detailed analysis focused on key risk areas Procedures are quantitative (benchmark oriented) and qualitative o Investments o Unpaid Losses and LAE o Income Statement and Surplus o Risk-Based Capital o Cash Flow & Liquidity o Reinsurance o Affiliated Transactions o MGAs & TPAs 10

11 © 2012 The National Association of Insurance Commissioners Handbook – Supplemental Procedures Supplemental Procedures Management Considerations Audited Financial Report Statement of Actuarial Opinion & Actuarial Opinion Summary Management’s Discussion and Analysis Holding Company Analysis 11

12 © 2012 The National Association of Insurance Commissioners Handbook – Supplemental Procedures Management Considerations Procedures address: Assessment of corporate governance pertaining to the board of directors and management Compliance with state statutes, accounting and reporting Reputational risk Legal issues Business plans and projections Risk management 12

13 © 2012 The National Association of Insurance Commissioners Handbook – Supplemental Procedures Management Considerations Special Note: It may not be necessary to complete all procedures within this chapter. Procedures completed are based on the level of concern an analyst may have with management performance and the driving forces behind operations. In performing analysis of management considerations, the analyst should utilize the risk-focused surveillance examination work that has been most recently completed related to these risk areas. Where applicable, the analyst should follow up on the work performed by the examiners including any comments or recommendations made by the examiners. 13

14 © 2012 The National Association of Insurance Commissioners Handbook – Supplemental Procedures Audited Financial Report Procedures address: Overview of opinion o Opinion issued and rationale o Accounting basis and type of opinion (individual insurer or consolidated) o Data cross-checking to annual financial statement Internal controls CPA’s Letter of Qualifications Change in CPA Audit Committee 14

15 © 2012 The National Association of Insurance Commissioners Handbook – Supplemental Procedures Statement of Actuarial Opinion and Actuarial Opinion Summary Procedures address: Identification and qualifications of the actuary Scope of the opinion The Opinion Relevant comments and exhibit disclosures Conclusions and recommendations Procedures related to the Actuarial Opinion Summary 15

16 © 2012 The National Association of Insurance Commissioners Handbook – Supplemental Procedures Management’s Discussion and Analysis Procedures address: Overview of filing in accordance with Annual Statement Instructions Non-consolidated basis? Results of operations Prospective information Material changes Assessment of balance sheet and liquidity Assessment of investment transactions Summary and conclusion 16

17 © 2012 The National Association of Insurance Commissioners Handbook – Supplemental Procedures Holding Company Analysis Procedures address: Holding company structure Interstate coordination Evaluate financial condition of holding company Form A – Statement of Acquisition of Control of or Merger with a Domestic Insurer Form B – Insurance Holding Company System Annual Registration Statement Form D – Prior Notice of a Transaction Extraordinary Dividend/Distributions 17

18 © 2012 The National Association of Insurance Commissioners Handbook – Holding Company Analysis Holding company analysis is a standard part of the financial analysis process as outlined in the NAIC’s Financial Analysis Handbook o Includes reviewing the upstream and downstream holding company entities (both financial or non-financial entities) o Understanding the structure, affiliated relationships, financial condition, management, etc. o Utilizing public information, such as SEC filings, international filings, and/or requested information 18

19 © 2012 The National Association of Insurance Commissioners Holding Company Analysis Considerations NAIC has been conducting HC analysis training for state insurance departments Recently adopted amendments to accreditation program for Part B – Financial Analysis guidelines with regard to HC analysis effective 2012 GSIWG continues to create best practices and standards for HC analysis Focus on lead state report Maintaining the Holding Company Analysis Liaison List 19

20 © 2012 The National Association of Insurance Commissioners Link to SEC Filings 20

21 © 2012 The National Association of Insurance Commissioners Lead State Report 21

22 © 2012 The National Association of Insurance Commissioners Handbook - Quarterly Procedures Level 1 and 2 procedures Focuses on Significant Changes from Quarter to Quarter and Quarter to Prior Year End Ratio calculations are automated NEW Quarterly Level 1 for Non-Troubled Insurers Adopted for First Quarter 2012 Significantly reduced procedures Procedures address key risk areas o Background information o Management assessment o Balance sheet and operations assessment o Review of disclosures and assessment of results from analytical tools 22

23 © 2012 The National Association of Insurance Commissioners I-SITE Categories Page 23

24 Summary Reports 24

25 © 2012 The National Association of Insurance Commissioners Financial Profile Reports The Financial Profile Report is a summary of key financial information for a company over the last five years Includes a Financial Summary page There are also detailed sections for: Assets, Liabilities, Capital & Surplus, Loss & LAE Reserve Analysis, Income Statement, Cash Flow and Exhibit of Business and Profitability 25

26 © 2012 The National Association of Insurance Commissioners Insurer Profile Summary Insurer Profile Summary Sharing Best Practices Guide Adopted by the Financial Analysis Handbook (E) Working Group Outlines best practices for effective and efficient sharing of a domestic state’s Insurer Profile Summary with other interested state insurance regulators Highly Confidential Document 26

27 27

28 Risk-Focused Exams 28

29 © 2012 The National Association of Insurance Commissioners What is a Financial Examination? A financial condition exam is an on-site regulatory review of an insurer’s key processes with the primary goal of assessing financial solvency of the company. –An exam is risk-focused because the examiner focuses on areas of higher risk of an insurance company. 29

30 Why Conduct Financial Exams? Detect insurers with potential financial trouble; Picks up where analysis ends Determine compliance with state statutes and regulations; Compile information needed for timely, appropriate regulatory action; 30

31 Why Conduct Financial Exams? To provide a clear methodology for assessing residual risk and how it translates into examination procedures; To allow the assessment of risk-management processes in addition to those which relate to financial statement line items; and To utilize examination findings to establish, verify or revise company’s priority score. 31

32 Financial Analysis vs. Financial Examiner Roles 32

33 Roles of Examiner and Analyst Examiner o Identifies risk by reviewing business processes o Utilizes control & detail tests to identify solvency concerns and findings o Focuses on Residual Risk Analyst o Identifies risk by reviewing reported financial results o Utilizes analytical review, (ratio analysis, benchmarking, inquiry) to identify solvency concerns and compliance On-site and Off-site solvency monitoring involve roles and skill-sets that are different, but complement each other: 33

34 © 2012 The National Association of Insurance Commissioners Roles of Examiner and Analyst State Insurance Analysts typically perform the following functions: Collection and analysis of insurer and group financial information Desk audits to assess risk and compliance Review of non-financial information regarding insurance companies that is routinely collected by other department units Review of insurance company transactions Coordination with other department functions Determining regulatory courses of action regarding identified troubled insurance companies Evaluating and monitoring corrective plans Communicating results of regulatory actions Licensing and admissions 34

35 © 2012 The National Association of Insurance Commissioners Roles of Examiner and Analyst Example: Investments Off-site analysis can monitor balance and composition of portfolio, benchmark the company’s investments against competitors and gather information from the insurer to explain significant changes. Help set priorities for examiner On-site examination can evaluate the process in place at the insurer to monitor investment performance and reporting; establish company specific risks; gain an understanding of the effectiveness of controls; and tailor substantive procedures to apply underlying transactions, reviewing reconciliations, obtaining confirmations, etc. 35

36 Conducting Examinations The NAIC Financial Condition Examiners Handbook provides guidance to assist state insurance departments to effectively plan, conduct, and report on the financial condition of insurers. Approach changed to a Risk-Focused Surveillance approach in 2007 Model Law and Accreditation Standard 36

37 © 2012 The National Association of Insurance Commissioners Model Law on Examinations Exams must be conducted on each licensed insurer at least once every 5 years o Some state statutes require more frequent exams o Initial Priorities se through analysis process A state may accept an examination report on a company prepared by another state if: o The state department performing the exam was accredited at the time of the exam; or o The exam was performed under the supervision of or participation by an accredited insurance department 37

38 © 2012 The National Association of Insurance Commissioners Examination Classifications Insurer Type o Single-state insurer: A company that does not meet the definition of a multi-state insurer such as a Health Maintenance Organization. o Multi-state insurer: A company that is domiciled or chartered in one state and licensed, registered, qualified or accredited, eligible or operating in at least one other state. 38

39 © 2012 The National Association of Insurance Commissioners Examination Classifications Exam Scope: o Full-scope: An examination in which the scope of the control and substantive procedures to be performed during the examination is based on the implementation and documentation of the risk assessment procedures required under the NAIC Financial Condition Examiners Handbook. o Review all areas of exam and focus on high-risk areas. o Limited-scope: An examination which is limited to a review or examination of specific financial statement line items or particular risk areas. 39

40 © 2012 The National Association of Insurance Commissioners Examination Type o Individual exam: A financial exam over one insurer. o Group exam: A financial exam over more than one insurer. This type of exam is typically conducted when multiple companies in a holding company group have similar key processes, systems and/or management. Exams can also be coordinated between regulators from multiple states. Examination Classifications 40

41 © 2012 The National Association of Insurance Commissioners Key Examination Participants The following individuals from a state insurance department are the key participants that conduct and oversee the examinations of domestic insurance companies: o Chief Examiner (or designee): Schedule examinations, assign staff, coordinate with other state and zones examiners, and approve exam plan o Examiner-in-charge: Coordinate review of company and examination testwork. Coordinate meetings with company and personnel. o Staff Examiner: Conduct examination testwork and become knowledgeable of company operations. o Financial Analysts: Interpret key financial and operational ratios, provide examiners with insight on company management, operating results, current events, etc. 41

42 © 2012 The National Association of Insurance Commissioners Risk-Focused Exam Approach Examination methodology included within the NAIC Handbook is a ‘risk-focused’ approach. Required by Accreditation Standards for exams commencing on or after Jan. 1, Under this approach, examination fieldwork will emphasize the review of an insurer’s current or prospective solvency risk areas and the fair presentation of surplus. Examiner will focus work and resources on identified risk areas and focus less on areas with less risk. 42

43 © 2012 The National Association of Insurance Commissioners Risk-Focused Surveillance The risk-focused surveillance process requires examiners to prospectively consider the company’s financial condition by assessing whether the company’s current processes provide indications of future solvency concerns. Examples of items considered for prospective assessments include: o Corporate Governance o Future Business Plans o Rate of Company Growth o Liquidity of Assets 43

44 © 2012 The National Association of Insurance Commissioners Risk-Focused Surveillance In accordance with the risk-focused surveillance guidance, examination work will shift so that more time is spent during the planning and risk assessment processes of the examination. Efficiencies should be gained as examiners utilize knowledge from prior exams as well as information provided through on-going monitoring by analysts to stay aware of risks within insurer operations. 44

45 Risk Assessment Matrix 45

46 © 2012 The National Association of Insurance Commissioners Seven Phase Examination Process Understand the Company and Identify Key Functional Activities to be Reviewed Identify and Assess Inherent Risks in Activities Identify and Evaluate Risk Mitigation Strategies/Controls Determine Residual Risk Establish/Conduct Exam Procedures Update Prioritization and Supervisory Plan Draft Exam Report and Management Letter Based on Findings Phase 1 Phase 2 Phase 3 Phase 4 Phase 5 Phase 6 Phase 7 PlanningPlanning 46

47 Risk Assessment Cycle INSURER PROFILE SUMMARY Internal/External Changes Examination Priority System Supervisory Plan Risk-Focused Examination Seven Phase Process: Identify Functional Activities Identify/Assess Inherent Risk Identify & Evaluate Controls Determine Residual Risk Establish Procedures and Conduct Exam Update Supervisory Plan Exam Report//Mgmt Letter Develop Ongoing Supervision That Includes: Frequency of Exams Scope of Exams Meetings with Company Management Follow-Up on Recommendations Financial Analysis Monitoring Company Priority Score Determined By: Priority System Based on Dept. analysis and NAIC financial Analysis tools: Scoring System ATS Results IRIS Ratios Exam Results Financial Analysis includes: Risk Assessment Results Financial Analysis Handbook Process Ratio Analysis (IRIS, FAST, Internal Ratios) Actuarial Analysis Update with internal/external changes Financial Analysis Consider Changes to: NRSRO Ratings Ownership/Management/ Corporate Structure Business Strategy/Plan CPA Report or Auditor Legal or Regulatory Status 47

48 © 2012 The National Association of Insurance Commissioners Steps to Phase 1, Part 1 Understanding the Company Gather necessary planning information Review the gathered information Perform Analytical and Operational Reviews Consider Information Technology Risk Update the Insurer Profile Summary Step 1Step 2Step 3Step 4Step 5 1 Note: Portfolio Analysis would be completed in conjunction with Phase 1, Part 1. 48

49 © 2012 The National Association of Insurance Commissioners Parts to Phase 1 Understanding the Corporate Governance Structure Assessing the Adequacy of the Audit Function Indentifying Key Functional Activities Consideration of Prospective Risk

50 © 2012 The National Association of Insurance Commissioners Phase 2 – Identify and Assess Inherent Risk Inherent risk – Risk of economic loss or inaccurate financial reporting before considering internal controls 50

51 © 2012 The National Association of Insurance Commissioners Phase 2 – Identify and Assess Inherent Risk Identify inherent risk o Other than financial reporting inherent risk Items not directly related to a current f/s line item Generally related monitoring, policies, BOD interaction, strategic type risk, etc. o Financial reporting inherent risk Typically directly related to a current f/s line item 51

52 © 2012 The National Association of Insurance Commissioners Phase 2 – Identify and Assess Inherent Risk Assess inherent risk based on: o Likelihood of Occurrence o Magnitude of Impact To reach overall inherent risk levels of: o High o Moderate o Low 52

53 © 2012 The National Association of Insurance Commissioners CALCULATED OVERALL INHERENT RISK Magnitude of Impact Likelihood of Occurrence ThreateningSevere Moderate Immaterial High Moderate- high Moderate- low Low High Moderate High Moderate High Moderate Low Moderate Low Moderate 53

54 © 2012 The National Association of Insurance Commissioners Phase 3 - Control Identification & Evaluation 1.Identify and understand internal controls that the insurer has in place for each risk o Document Understanding 2.Consider whether the controls appear to be designed appropriately to mitigate each risk o If not, no need to test controls 3.If so, test the controls for operating effectiveness o Not required if testing will be inefficient 4.Conclude whether the internal controls effectively mitigate each inherent risk o Strong, Moderate or Weak 54

55 © 2012 The National Association of Insurance Commissioners Phase 3 – Risk Mitigation Strategies Assessment of Controls The Overall Risk Mitigation Strategy/Control Assessment ratings to be indicated in the Risk Assessment Matrix are: Strong risk management Moderate risk management Weak risk management 55

56 © 2012 The National Association of Insurance Commissioners Phase 3 – Risk Mitigation Strategies Control Testing Intended to provide assurance that control procedures are operating as prescribed Control testing is generally performed using one of the following methods Corroborative inquiry Re-performance Observation Examination of Documents Walkthrough 56

57 © 2012 The National Association of Insurance Commissioners Phase 3 - Utilization of Existing Work Existing Control Documentation o SOX Workpapers o Internal Audit Workpapers o External Audit Workpapers Utilize where relevant to exam 57

58 © 2012 The National Association of Insurance Commissioners Phase 4 – Determine Residual Risk Residual risk is determined by how well the risk mitigation strategies/controls mitigate the inherent risk. 58

59 © 2012 The National Association of Insurance Commissioners Phase 4 – Residual Risk Grid INHERENT RISK STRONG RISK CONTROLS MODERATE RISK CONTROLS WEAK RISK CONTROLS HIGHMod or High High MODERATELow or ModMod LOWLow 59

60 Phase 5 – Establish/Conduct Exam Procedures Phase 5 Handbook Guidance: Detail examination procedures should be selected to correspond with the level of residual risk determined for each identified risk. High Residual Risk Detail procedures required. Moderate Residual Risk Fewer detail procedures performed (i.e. tests of details of transactions), including more utilization of analytical procedures. Low Residual Risk Limited or no detail procedures performed, which may be limited to analytical procedures. 60

61 © 2012 The National Association of Insurance Commissioners Phase 6 – Update Prioritization & Supervisory Plan Supervisory Plan o Created/updated at least yearly by domiciliary state o Based on recent exams and analysts’ reports o Lead state concept with multi-state companies o Outline type of surveillance planned, resources, and how coordination planned o Part of Insurer Profile Summary 61

62 © 2012 The National Association of Insurance Commissioners Phase 7 – Draft Examination Report & Management Letter Examination Report o Table of contents o Salutation o Scope of examination o Body of report Company history & corporate governance Financial statements Findings & recommendations 62

63 © 2012 The National Association of Insurance Commissioners Phase 7 – Draft Examination Report & Management Letter Management Letter o Part of exam workpapers o Used for results or observations that are not material to public report o Optional 63

64 © 2012 The National Association of Insurance Commissioners Phase 7 – Draft Examination Report & Management Letter Examination Report- Common Findings Additional Reserves Needed Asset Valuation- OTTI Items not recorded in accordance with SAP Management Report- Common Findings Proprietary Company Issues Prospective Risk Discussions Internal Control Deficiencies 64

65 © 2012 The National Association of Insurance Commissioners Post Examination Procedures The following activities should be performed after the examination report is issued and prior to the next examination: Follow up on examination findings Communication with financial analyst between examination dates Supervisory Report The goal is to continually monitor the companies under examination, rather than to only perform examinations. 65

66 © 2012 The National Association of Insurance Commissioners Questions 66


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