1 Risk-Focused Surveillance Framework Enterprise Risk Management Symposium Chicago, Illinois April 26, 2004 Terri Vaughan, Iowa Insurance Commissioner

2 Today’s Agenda Motivation for Risk-Focused Surveillance Motivation for Risk-Focused Surveillance Description of Framework and Supporting Tools Description of Framework and Supporting Tools Implementation Challenges Implementation Challenges Project Timeline Project Timeline

3 Key Benefits of Risk Focused Surveillance Key Benefits of Risk Focused Surveillance Respond to increased complexity of products, investment strategies, etc. Respond to increased complexity of products, investment strategies, etc. Greater emphasis on early identification of emerging risks at individual insurers and on a sector wide basis Greater emphasis on early identification of emerging risks at individual insurers and on a sector wide basis Increased regulatory understanding of insurer’s quality of management, characteristics of the insurer’s business and risk it assumes Increased regulatory understanding of insurer’s quality of management, characteristics of the insurer’s business and risk it assumes More effective use of regulatory resources through a sharper focus on higher risk areas More effective use of regulatory resources through a sharper focus on higher risk areas

4 Key Benefits Risk Focused Surveillance Leverage trends in insurer risk management and corporate governance Leverage trends in insurer risk management and corporate governance Enhanced utilization of management information Enhanced utilization of management information Better evaluation of risks through assessment of inherent risks and risk management process Better evaluation of risks through assessment of inherent risks and risk management process –Accuracy of financial statements –Ability of management to identify, control, and evaluate risk Consistency with other financial regulators and global trends Consistency with other financial regulators and global trends

5 Risk Classifications Risk Classifications CreditCredit MarketMarket Pricing/UnderwritingPricing/Underwriting ReservingReserving LiquidityLiquidity OperationalOperational LegalLegal StrategicStrategic ReputationalReputational

6 Risk-Focused Surveillance Framework Risk-Focused Surveillance Framework What Financial Solvency Oversight Functions are Impacted in the Proposed Framework? What Financial Solvency Oversight Functions are Impacted in the Proposed Framework?  Risk-Focused Examinations  Off-Site Risk-Focused Financial Analysis  Review of Internal/External Changes  Priority System (CARRMELS)  Supervisory Plan Results are summarized in the Insurer Profile, which includes key information, regulatory findings and the regulatory plan. Results are summarized in the Insurer Profile, which includes key information, regulatory findings and the regulatory plan.

7 Proposed Regulatory Cycle INSURER PROFILE Internal/External Changes Examination Priority System Supervision Consider Changes to: NRSRO Ratings Ownership/Management/ Corporate Structure Business Strategy/Plan CPA Report or Auditor Legal or Regulatory Status Risk-Focused Examination Identify Functional Activities Identify/Assess Inherent Risk Identify & Evaluate Controls Determine Residual Risk Establish Procedures and Conduct Exam 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 Priority System Based on Ratios and Analysis to Measure: Capital Adequacy Asset Quality Reinsurance Reserves Management Earnings Liquidity Sensitivity to Market Financial Analysis includes : Risk Assessment Results Financial Analysis Handbook Process Ratio Analysis (IRIS, FAST, Internal Ratios) Actuarial Analysis Financial Analysis

8 Risk-Focused Examination Six Phased Process Provides the “Roadmap” for a Risk Assessment Six Phased Process Provides the “Roadmap” for a Risk Assessment –Understanding the Company and Identifying Functional Activities of Insurer –Identifying and Assessing an Inherent Risk Rating in Activity –Identify and Assess Risk Management Systems in Place to Mitigate Inherent Risk (Policies & Procedures, Internal Audit, Reporting, Corporate Governance, etc.)

9 Risk-Focused Examination (continued) –Assign a Residual Risk Rating, which is a Function of the Inherent Risk Rating offset by the Control Assessment Rating –Establish/Conduct Examination Procedures Based Upon the Residual Risk Rating –Draft Examination Report and Management Letter Based Upon Findings

10 Enhanced Regulatory Risk Assessment Framework (DRAFT) Examinations Flow Chart NAIC Financial Condition Examiners Handbook Examination Planning Are Risks Assessable? Are Controls Identifiable? Is financial solvency risk limited? Can reliance be placed on CPA work? Is external source information favorable? “Less Balance Sheet Oriented, More Prospective Risk- Focused Approach” Risk focused procedures Work in Progress Substantive Procedures Report of Examination Includes F/S Confidentia l Manageme nt Letter Products of Examination More Balance Sheet Oriented Approach Credit Risk Market Risk Pricing/ Underwriting Risk Risk Assessment Liquidity Risk Reserving Risk Legal Risk Operational Risk Strategic Risk Reputational Risk YESNO

11 Proposed Regulatory Cycle INSURER PROFILE Internal/External Changes Examination Priority System Supervision Consider Changes to: NRSRO Ratings Ownership/Management/ Corporate Structure Business Strategy/Plan CPA Report or Auditor Legal or Regulatory Status Risk-Focused Examination Identify Functional Activities Identify/Assess Inherent Risk Identify & Evaluate Controls Determine Residual Risk Establish Procedures and Conduct Exam 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 Priority System Based on Ratios and Analysis to Measure: Capital Adequacy Asset Quality Reinsurance Reserves Management Earnings Liquidity Sensitivity to Market Financial Analysis includes : Risk Assessment Results Financial Analysis Handbook Process Ratio Analysis (IRIS, FAST, Internal Ratios) Actuarial Analysis Financial Analysis

12 Off-Site Risk-Focused Financial Analysis Financial Analysis includes: Risk Assessment Results Risk Assessment Results Financial Analysis Handbook Process Financial Analysis Handbook Process Ratio Analysis (IRIS, FAST, Internal Ratios) Ratio Analysis (IRIS, FAST, Internal Ratios) Actuarial Analysis Actuarial Analysis

13 Review of Internal/External Changes Consider Changes to: NRSRO Ratings NRSRO Ratings Ownership/Management/ Corporate Structure Ownership/Management/ Corporate Structure Business Strategy/Plan Business Strategy/Plan CPA Report or Auditor CPA Report or Auditor Legal or Regulatory Status Legal or Regulatory Status

14 Prioritization System Develop standard prioritization system (CARRMELS) Capital Adequacy, Asset Quality, Reinsurance, Reserve Adequacy, Management Assessment, Earnings, and Liquidity Capital Adequacy, Asset Quality, Reinsurance, Reserve Adequacy, Management Assessment, Earnings, and Liquidity Objective and mathematical based Objective and mathematical based Incorporates existing FAST Ratios in system Incorporates existing FAST Ratios in system Pilot Project Pilot Project

15 Supervisory Plan Develop Plan for Ongoing Supervision That Includes: Frequency of Exams Frequency of Exams Scope of Exams Scope of Exams Meetings with Company Management Meetings with Company Management Follow-Up on Recommendations Follow-Up on Recommendations Financial Analysis Monitoring Financial Analysis Monitoring

16 Proposed Regulatory Cycle INSURER PROFILE Internal/External Changes Examination Priority System Supervision Consider Changes to: NRSRO Ratings Ownership/Management/ Corporate Structure Business Strategy/Plan CPA Report or Auditor Legal or Regulatory Status Risk-Focused Examination Identify Functional Activities Identify/Assess Inherent Risk Identify & Evaluate Controls Determine Residual Risk Establish Procedures and Conduct Exam 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 Priority System Based on Ratios and Analysis to Measure: Capital Adequacy Asset Quality Reinsurance Reserves Management Earnings Liquidity Sensitivity to Market Financial Analysis includes : Risk Assessment Results Financial Analysis Handbook Process Ratio Analysis (IRIS, FAST, Internal Ratios) Actuarial Analysis Financial Analysis

17 Insurer Profile Components Components –Descriptive Information, Overview of Business –Risk Profile. Priority Rating –External Information –Key Financial Data –Regulatory Findings, Regulatory Plan –Other State’s Action Confidential, but available to other states upon request Confidential, but available to other states upon request

18 Risk-Focused Surveillance Framework What is the role of the CPA in this Framework? What is the role of the CPA in this Framework? –Leverage Off of CPAs Work - WHERE APPROPRIATE –Recent Accounting Failures »Enron »Global Crossing »WorldCom –Sarbanes-Oxley »NAIC/AICPA Working Group

19 Risk-Focused Surveillance Framework Risk-Focused Surveillance Framework What other tools/processes will be utilized to enhance current solvency processes? What other tools/processes will be utilized to enhance current solvency processes? –Enterprise Risk Assessment Form –Revised CPA Checklist –Increased Coordination Between Auditors and Examiners –Enhanced Information Resources for Regulators –Guidance on Best Practices for Managing Risk

20 Challenges of Risk Assessment The Three “Cs” Challenges of Risk Assessment The Three “Cs” Confidentiality Confidentiality –Risk Assessment Confidentiality Approaches »Laws and State Statute »Accreditation Program »Annual Confidentiality Agreement - Similar to FAST Competency Competency –Regulatory resources and expertise Consolidated Approach: Regulating on a Groupwide Perspective Consolidated Approach: Regulating on a Groupwide Perspective

21 Risk-Focused Surveillance Framework Project Timeline Project Timeline Deliverables Deliverables –Revisions to Framework –Prioritization Report, Insurer Profile –Risk Matrix, CPA Checklist –Updated Examiner Handbook Guidance –Revisions to Analysis Handbook –Best Practices Compilation, –Implementation plan, Training Program –Confidentiality Agreement Retaining Consultant to assist with Examiner Handbook, Best Practices Retaining Consultant to assist with Examiner Handbook, Best Practices

22 Risk-Focused Surveillance Framework Risk-Focused Surveillance Framework QUESTIONS…????