Presentation on theme: "Lou Felice, Health and Solvency Policy Advisor NAIC"— Presentation transcript:
1 Lou Felice, Health and Solvency Policy Advisor NAIC Financial AnalysisLou Felice, Health and Solvency Policy AdvisorNAIC
2 Presentation Overview Overview of the Financial Analysis Handbook (Handbook)Financial Analysis vs. Financial Examiner RolesNAIC I-SITE Reports & Insurer Profile SummaryAs you all are aware there are many financial resources available to you through ISITEWe are going to focus mainly on the FAHThis is a free publication to regulators and is available both in hard copy and electronicallyWe will also talk briefly on analyst v. examiner rolesAnd lastly, we will talk a bit about the mysterious FAWG
4 Financial Analysis Handbook Analyst Reference GuidesLevel 1 ProceduresLevel 2 ProceduresLevel 2 – Investments, Cash Flow & Liquidity, Reinsurance, Affiliated Transactions, MGA & TPAs, Risk-Based Capital, Income Statement and Surplus, Unpaid Losses and LAESupplemental ProceduresManagement Considerations, Audited Financial Report, Actuarial Opinion, Management Discussion & Analysis, Holding Company Analysis
5 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 statementsAt a minimum the following must be analyzed:Annual and quarterly financial statementsActuarial opinionManagement’s discussion and analysisAudited CPA reportHolding company filingsFinancial ratiosSo this is what is required for accreditationThe keys: Depth of review, documentation, follow-upThe financial statements provide a good start, financial data, notes, interrogatories along with the financial profiles reports which provide both ratio and trend information. This is a good start in assisting you on where you need to focusThe actuarial opinion provides an independent view of reservesThe MDA provides managements view of the companyThe audit provides an independent view of the company’s financialsWith the new requirements on holding company, we also need to look at the entire holding company system
6 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 portfolioDiscussion of Level 1, 2 and Supplemental Procedures – provides considerations and guidance for the proceduresAdditional Reference Sources - SVO Purposes & Procedures Manual, Accounting Practices & Procedures Manual, NAIC Annual Statement Instructions, etc.The Analyst Reference Guide offers discussions on the checklist questions which encompass both the annual statement general checklist and the supplemental checklistsIf there is one section an analyst would need to read in this book, the Analyst Ref Guide would be the one.The outline of each chapter offers background information on the topic, the purpose of each procedure and the additional sources.Detailed discussion on most financial topics is included in the analyst reference guide.At the end of each section is also a bibliography that will provide you additional sources of information.
7 Handbook - Annual Level 1 Procedures Background AnalysisLast priority designation, inter-department communication, regulatory actions, NRSRO ratingManagement AssessmentShift in management or philosophyBalance Sheet AssessmentOperations AssessmentInvestment PracticesReview of DisclosuresNotes to Financial Statements, General Interrogatories, etc.Assessment of Latest Examination Report and ResultsAs you all know, per accreditation, a level 1 or similar set of procedures is the minimum required.The level one checklist provides an overview of the insurance company and its operations. Some of the questions include information on the balance sheet, income statement and cash flow statement.There is also detailed information on the insurers interrogatories and notes to the financial statements.You will also determine if the Company is currently a priority company.
9 Handbook - Annual Level 1 Procedures Overall high-level review of insurerAt 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 1For example, does the insurer have complex affiliated agreements in place that would require further detailed review beyond discovery work completed within Level 1?Read slideAfter completing the Level One analysis, the analyst will decide whether to recommend that the insurer be considered a priority company, and the extent to which Level Two procedures should be performed and the areas to be covered.
10 Handbook – Annual Level 2 Procedures Detailed analysis focused on key risk areasProcedures are quantitative (benchmark oriented) and qualitativeInvestmentsUnpaid Losses and LAEIncome Statement and SurplusRisk-Based CapitalCash Flow & LiquidityReinsuranceAffiliated TransactionsMGAs & TPAsLevel 2 may ask the analyst to consider:High risk investments, the level of loss reserves, a negative trend in liquidity or an more detailed understanding of a complex reinsurance transactionRead some of the chapter titles
11 Handbook – Supplemental Procedures Management ConsiderationsAudited Financial ReportStatement of Actuarial Opinion & Actuarial Opinion SummaryManagement’s Discussion and AnalysisHolding Company AnalysisThe supplemental reports can provide a wealth of information, lets look at some of the contents
12 Handbook – Supplemental Procedures Management Considerations Procedures address:Assessment of corporate governance pertaining to the board of directors and managementCompliance with state statutes, accounting and reportingReputational riskLegal issuesBusiness plans and projectionsRisk managementCorporate Governance – Board of DirectorsFollow-up on issues from recent ExaminationsReview Board of Director meeting minutesChanges in Board of Director membershipConcerns regarding the Board of DirectorsCorporate Governance—Changes in Management or Organizational StructureManagement TurnoverChanges in the Organizational StructureOperational ChangesMergers/ConsolidationsWe do have procedures in Level One to look for compliance issues with regard to reporting or compliance with state statutes and also with news or ratings that impact the company, so again this chapter provides some additional procedures to help assess those risk areas. A few of the procedures cover Compliance with State Statutes, Accounting, and ReportingMaterial Reporting Errors, Validation ErrorsFailure to comply with State StatutesSuspensions, Revocations, Consent OrdersReputational RiskConcerns about poor Financial Strength/Credit RatingsNews, Industry Issues with potential negative impactLegal/FraudSignificant LitigationUnderstanding potential for Fraud/Legal riskIT issues are something that probably come from market conduct analysis – (examples include; claims handling problems due to IT issues, changes to I.T. systems that could cause a disruption in claims processing, reserve calculations or financial reporting. )The Handbook includes a procedure in Level 1 to identify any potential market conduct concerns and this chapter provides some follow-up to that – for example, what is the financial impact of market conduct remediation, fines, & settlements.Level one asks the analyst to review the most recent Business plan if there is one available, and if warranted based on the review, to request one. The procedures here explain some things to consider in the review of the business plan such as whether any significant changes have taken place, have initiatives been accomplished, and a review of actual vs. projected variances.The Risk Management procedures ask if the Company does an Enterprise Risk Management assessment and to follow up on work performed by the examiners regarding assessment of risk management and any subsequent changes.
13 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.Read slide
14 Handbook – Supplemental Procedures Audited Financial Report Procedures address:Overview of opinionOpinion issued and rationaleAccounting basis and type of opinion (individual insurer or consolidated)Data cross-checking to annual financial statementInternal controlsCPA’s Letter of QualificationsChange in CPAAudit CommitteeRead slideModel Audit Rule (Accred Standard)Letter of Qual. – independent, background & experience, filing and complianceAudit committee – oversight of internal and external functions of the company
15 Handbook – Supplemental Procedures Statement of Actuarial Opinion and Actuarial Opinion Summary Procedures address:Identification and qualifications of the actuaryScope of the opinionThe OpinionRelevant comments and exhibit disclosuresConclusions and recommendationsProcedures related to the Actuarial Opinion SummaryRead slideThere is a major benefit to knowing the range of reasonable reserves through your confidential actuarial opinion summary and within this section, there are procedures for its review
16 Handbook – Supplemental Procedures Management’s Discussion and Analysis Procedures address:Overview of filing in accordance with Annual Statement InstructionsNon-consolidated basis?Results of operationsProspective informationMaterial changesAssessment of balance sheet and liquidityAssessment of investment transactionsSummary and conclusionSo the MDA is from the managements prospective !Use it for background and basic content, however, do your own investigative work when there are areas of concernORSA will build on this.
17 Handbook – Supplemental Procedures Holding Company Analysis Procedures address:Holding company structureInterstate coordinationEvaluate financial condition of holding companyForm A – Statement of Acquisition of Control of or Merger with a Domestic InsurerForm B – Insurance Holding Company System Annual Registration StatementForm D – Prior Notice of a TransactionExtraordinary Dividend/DistributionsReally focused on Holding Company SystemKEY ELEMENT OF GROUP ASSESSMENTKnowing the risks in both the insurance and non-insurance segmentsUnderstanding who to communicate withUnderstanding the overall financial condition of the holding company system and what segments are driving the resultsWithin this chapter we also may need to review forms A, B, D, or E
18 Handbook – Holding Company Analysis Holding company analysis is a standard part of the financial analysis process as outlined in the NAIC’s Financial Analysis HandbookIncludes reviewing the upstream and downstream holding company entities (both financial or non-financial entities)Understanding the structure, affiliated relationships, financial condition, management, etc.Utilizing public information, such as SEC filings, international filings, and/or requested informationRead slide
19 Holding Company Analysis Considerations NAIC has been conducting HC analysis training for state insurance departmentsRecently adopted amendments to accreditation program for Part B – Financial Analysis guidelines with regard to HC analysis effective 2012GSIWG continues to create best practices and standards for HC analysisFocus on lead state reportMaintaining the Holding Company Analysis Liaison ListThe Insurance Analysis and Information Services department of the NAIC has been conducting Holding Company analysis training for state insurance departments.As part of this training we look at the domestic companies in their state. We provide them guidance and feedback on what they should be including in their analysis.The first step and the foundation for good holding company analysis is to understand the holding company structure and to understand what types of relationships exist between the companies within the group. Once you know what those relationships are, then you can assess if there is enterprise risk and if other entities in the group pose a risk to your domestic or to the insurance operations within the group.
21 Lead State ReportIt is intended to facilitate efficiencies when one or more states coordinate the regulatory processes of all states involvedSo these are some of the groups MO is the lead state on, we select the lead state by looking at:A Lead State(s) may be determined using, but not limited to, the following criteria: * premium volume of legal entity; * net admitted asset size of legal entity; * reinsurance arrangements; * unique political considerations; * location of books and records; and * market exposure of business written within a state (sometimes with a state without a domestic in the group
22 Handbook - Quarterly Procedures Level 1 and 2 proceduresFocuses on Significant Changes from Quarter to Quarter and Quarter to Prior Year EndRatio calculations are automatedNEW Quarterly Level 1 for Non-Troubled InsurersAdopted for First Quarter 2012Significantly reduced proceduresProcedures address key risk areasBackground informationManagement assessmentBalance sheet and operations assessmentReview of disclosures and assessment of results from analytical toolsMore limited reviewPreviously focused on following companies that had been flagged in the annual analysis / Expanded starting in 2012Lastly, there are checklists on ISITE and in the bound version of the financial analysis handbook for the quarterly statement as well.It should be noted that the Level One checklist for quarterly analysis serves the same purpose as Level One for the annual analysis, even though not all the same tools are available.
23 I-SITE Categories Page Collection of analytical tools designed to provide an integrated approach to screening and analyzing the financial condition of insurersFinancial Analysis Solvency Tools (FAST)AnalyticalFinancial Profile Reports, Financial Analysis Handbook, Summary Reports, Jumpstart Reports, Investment Snapshot, Form A, Etc.Prioritization ToolsIRIS Ratios, ATS, Scoring System, Handbook Automated Yes, RBC, RBC Trend
24 Summary ReportsSome of the key reports: FAH sum, RBC Trend, Lead state, IRIS sum, permitted practice, prioritization, and scoring reportsWe also have on the right side market share reports where you can pick an LOB and pull back data such as writings and loss ratios
25 Financial Profile Reports The Financial Profile Report is a summary of key financial information for a company over the last five yearsIncludes a Financial Summary pageThere are also detailed sections for: Assets, Liabilities, Capital & Surplus, Loss & LAE Reserve Analysis, Income Statement, Cash Flow and Exhibit of Business and Profitability
26 Insurer Profile Summary Insurer Profile Summary Sharing Best Practices GuideAdopted by the Financial Analysis Handbook (E) Working GroupOutlines best practices for effective and efficient sharing of a domestic state’s Insurer Profile Summary with other interested state insurance regulatorsHighly Confidential DocumentEarlier this year the Financial Analysis Handbook (E) Working Group adopted a INSURER PROFILE SUMMARY SHARING BEST PRACTICES GUIDEIt outlines best practices for effective and efficient sharing of a domestic state’s Insurer Profile Summary with other interested state insurance regulators.When to request an Insurer Profile SummaryHow to request a Summary – what is the processSuggested language to put in the request (i.e. you can hold it confidential)What the Insurer Profiles Summary should and should not be used forAccreditation ConsiderationsHighly Confidential DocumentPosted to StateNet (under “Financial Analysis” Link)
33 Roles of Examiner and Analyst On-site and Off-site solvency monitoring involve roles and skill-sets that are different, but complement each other:AnalystIdentifies risk by reviewing reported financial resultsUtilizes analytical review, (ratio analysis, benchmarking, inquiry) to identify solvency concerns and complianceExaminerIdentifies risk by reviewing business processesUtilizes control & detail tests to identify solvency concerns and findingsFocuses on Residual RiskAnalysis = historic perspective on risk based on documentation - Establish initial priorities / foster further interaction. Support other regulatory functions (licensing)Examiner = Concurrent and prospective risks based on interaction with management
34 Roles of Examiner and Analyst State Insurance Analysts typically perform the following functions:Collection and analysis of insurer and group financial informationDesk audits to assess risk and complianceReview of non-financial information regarding insurance companies that is routinely collected by other department unitsReview of insurance company transactionsCoordination with other department functionsDetermining regulatory courses of action regarding identified troubled insurance companiesEvaluating and monitoring corrective plansCommunicating results of regulatory actionsLicensing and admissions1 – analysts look at financial statements every quarter and are identifying risks as they happen every quarter.2 – Through desk audits the analyst is identifying risk and determining if they company is out of compliance, be it mis-reporting or non-compliance with state statutes.3 – You are talking to other departments each quarter – market conduct, rates and forms, licensing, actuarial. So you should have the most current information from those other departments on activities that may be going on that are not immediately financial but that could post a risk to the insurer’s solvency in the long run. Are there significant complaints that market conduct staff are investigating, or is the company requesting rate increases on large blocks of business.4 – Classification of insurance company transactions. The analysts are going to be involved on some level in reviewing and understanding material transactions that the company is engaging in through review of Form D, annual review of From B or even Form A if there is an acquisition taking place.5 – Coordination with other departments – it’s not just that you are taking a report that the market conduct staff hand you and sticking it in a file, but you are coordinating with them. For example if you have a troubled company that has material market conduct violations, you may be sitting down with the market conduct staff to understand what those violations are and what the financial impact will be on the insurer should they be required to remediate – reprocess claims, pay fines – or if their market conduct violations result in reputational damage and lost sales, what does that do to their financial solvency? So analysts are coordinating information sharing with other departments.6 – Evaluating and monitoring corrective plans – if you have a company that has a RBC corrective action plan or some other corrective plan, it is the analyst that will be monitoring if those plans have been implemented and how successful they are. Did they receive the capital contributions they said they would? Did their expenses drop due to the cost cutting efforts they planned to make. If they were planning new marketing strategies or on the flip side planning to run-off on unprofitable block of business, what are the results of that – do you see the changes in premium?
35 Roles of Examiner and Analyst Example: InvestmentsOff-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 examinerOn-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.Here is an example where we compare what the analyst does to what the examiner does.READ SLIDE Analyst is going to be looking for shifts in the investment portfolio, the impact of current economic conditions, which we just saw in the last couple years with huge write-downs and capital losses. The analyst is also going to be communicating with the insurer to get an explanation for why real estate holding jumped 15% or why they reported capital losses when the industry trend was the opposite.
37 Model Law on Examinations Exams must be conducted on each licensed insurer at least once every 5 yearsSome state statutes require more frequent examsInitial Priorities se through analysis processA state may accept an examination report on a company prepared by another state if:The state department performing the exam was accredited at the time of the exam; orThe exam was performed under the supervision of or participation by an accredited insurance departmentThe domestic state typically assumes responsibility for the exam and shares their report with other states.
38 Examination Classifications Insurer TypeSingle-state insurer: A company that does not meet the definition of a multi-state insurer such as a Health Maintenance Organization.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.HMO’s – are licensed by state and is a type of group insurance that entitles members to services of participating hospitals and clinics and physiciansA single-state insurer is defined as any company that is licensed in only one state does not meet thedefinition of a multi-state insurer.• A multi-state insurer is defined as a company that is licensed in more than one state domiciled or charteredin one state and licensed, registered (for risk retention groups), qualified or accredited (for reinsurers),eligible (for surplus lines) or operating in at least one other state. For purposes of this definition, the term“state” is intended to include any NAIC member jurisdiction, including U.S.territories.
39 Examination Classifications Exam Scope: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.Review all areas of exam and focus on high-risk areas.Limited-scope: An examination which is limited to a review or examination of specific financial statement line items or particular risk areas.Full-Scope Examination - This should include 1) assessing the risks that an insurer's surplus is not materially misstated, and 2) assessing the quality and reliability of management to identify, control, assess, and manage its business and financial reporting risks. A full scope examination shall make an assessment of the insurer's financial condition. A full-scope examination meets the requirements of the NAIC Accreditation Program.Limited-Scope Examination – This could be determined on a basis other than the implementation and documentation of the risk assessment procedures within the NAIC Financial Condition Examiners Handbook. A limited scope statutory examination may result in a Report of Examination which may include a conclusion on the financial condition of the insurer based on work performed in the specific areas. Completion of limited-scope examinations does not satisfy the five-year examination requirements of the NAIC Accreditation Program.
41 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:Chief Examiner (or designee): Schedule examinations, assign staff, coordinate with other state and zones examiners, and approve exam planExaminer-in-charge: Coordinate review of company and examination testwork. Coordinate meetings with company and personnel.Staff Examiner: Conduct examination testwork and become knowledgeable of company operations.Financial Analysts: Interpret key financial and operational ratios, provide examiners with insight on company management, operating results, current events, etc.The chief examiner is the person who the head of the examination department of a particular state. Their ultimate responsibility is to take part in the planning and coordination between other states / examiners in those states.The examiner in charge oversees more of the day to day activity within the exam of a single company. This is slightly different than the Chief Examiner, who oversees the companies within their state. The examiner in charge does a lot of coordination between the company and the examination team.Staff Examiners actually do the testing and perform work to understand the operations of a company. A lot of the actual examination steps that are located in the Examiners Handbook are performed by the Staff Examiner.Financial Analysts look at the company’s financial data and perform review procedures on ratios. These ratios are reviewed by the analysts for reasonableness and so they can identify possible trends within the company that the examiners may want to be aware of.Other participants not mentioned on this slide are specialists which include actuaries, who look at the reserves reported by the company. In addition IT specialists may be used to review the company’s IT environment.
42 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, 2010.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.Risk-focused surveillance process includes identifying risks and assessing those risks to determine the ongoing monitoring and surveillance of an insurer.
43 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:Corporate GovernanceFuture Business PlansRate of Company GrowthLiquidity of AssetsOn a higher level, the risk-focused surveillance process is designed to be prospective and to encourage the examiner to continually assess the financial health of the insurance company. It encourages the examiner to evaluate the company on a higher level, regarding their business, leadership and growth of the company.
44 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.Some last thoughts:The risk-focused surveillance method will encourage examiners to spend more time focusing on planning and really understanding the company itself, rather than on the testing. It also encourages ongoing monitoring of the companies to identify future risks within the insurers operations.