Insurance Regulation: The NAIC Accreditation Program Can Be
Improved (31-AUG-01, GAO-01-948).
The National Association of Insurance Commissioners' (NAIC)
voluntary accreditation program for state regulation of insurers'
solvency evaluates a state's regulatory program about once every
five years to determine if it meets the association's minimum
standards for effective solvency regulation. The accreditation
program has now been in place for about 10 years. During that
period, NAIC has expanded the standards and modified the process
for evaluating the adequacy of states' solvency regulation.
Weaknesses in solvency regulation in Tennessee and Mississippi
and three other states allowed a $200 million insurance fraud to
continue for eight years, resulting in the failure of seven
insurance companies. The fraud was uncovered and made public in
May 1999. During 2000 both Tennessee and Mississippi underwent
accreditation reviews by NAIC and were reaccredited. NAIC has
moved to improve and strengthen its accreditation program by
adding model laws and regulations to the required standards in
order to address the changing environment of the insurance
industry and insurance regulation. In addition, it has revised
the way accreditation reviews are performed and scored and has
improved training for members of review teams. Accreditation
reviews done in Tennessee and Mississippi disclosed gaps and
weaknesses in the accreditation program. In particular, the
program does not cover a key area of solvency
regulation--chartering and change in ownership of insurance
companies. Oversight of chartering and change in ownership is key
to preventing inappropriate and undesirable individuals from
gaining control of insurance companies. The insurance fraud
exposed weaknesses in state regulation and oversight in this area
that are not addressed in NAIC's accreditation program. Moreover,
GAO found weaknesses in on-site accreditation review procedures.
These weaknesses included incomplete analyses of exam
information, a questionable scoring methodology that can give
misleading results, limited on-site compliance testing, and
insufficient flexibility in tailoring reviews to address the most
material issues.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-01-948
ACCNO: A01704
TITLE: Insurance Regulation: The NAIC Accreditation Program Can
Be Improved
DATE: 08/31/2001
SUBJECT: Fraud
Institution accreditation
Insurance
Insurance companies
Insurance regulation
Mississippi
NAIC Accreditation Program
NAIC Insurance Regulatory Information
System
Tennessee
******************************************************************
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GAO-01-948
Report to the Honorable John D. Dingell, Ranking Minority Member, Committee
on Energy and Commerce, House of Representatives
United States General Accounting Office
GAO
August 2001 INSURANCE REGULATION
The NAIC Accreditation Program Can Be Improved
GAO- 01- 948
Page i GAO- 01- 948 NAIC Accreditation Program Letter 1
Results in Brief 1 Background 3 NAIC?s Accreditation Program Has Improved
Over Time, Helping
States Strengthen Solvency Regulation 7 Accreditation Program Still Has Gaps
and Weaknesses 11 Conclusions 22 Recommendations for Executive Action 24
Agency Comments and Our Evaluation 24 Scope and Methodology 26
Appendix I Tennessee and Mississippi Received Accreditation During and After
Thefts Causing Company Insolvency 28
Appendix II An Overview of the NAIC Accreditation Program 33
Appendix III Comments From the National Association of Insurance
Commissioners 41
Appendix IV GAO Contacts and Staff Acknowledgments 46
Tables
Table 1: Overview of Accreditation Program Weaknesses 12 Table 2: Regulatory
Oversight Weaknesses Identified by GAO in
Our September 2000 Report 31 Table 3: Accreditation Standards for Laws and
Regulations 35 Table 4: Accreditation Standards for Regulatory Practices and
Procedures 37 Table 5: Accreditation Standards for Organizational and
Personnel
Practices 38 Contents
Page ii GAO- 01- 948 NAIC Accreditation Program Figures
Figure 1: Comparison of the Dates of Accreditation Reviews in Tennessee and
Mississippi With the Term of the Fraud in Those and Other States 7
Page 1 GAO- 01- 948 NAIC Accreditation Program
August 31, 2001 The Honorable John D. Dingell Ranking Minority Member
Committee on Energy and Commerce House of Representatives
Dear Mr. Dingell: As you requested, this report provides information about
the National Association of Insurance Commissioners? (NAIC) voluntary
accreditation program for state regulation of insurers? solvency. NAIC
evaluates a state?s regulatory program about once every 5 years to determine
if it meets the association?s minimum standards for effective solvency
regulation. The accreditation program has now been in place for about 10
years. During that period, NAIC has expanded the standards and modified the
process for evaluating the adequacy of states? solvency regulation. As
discussed in our report of September 2000, weaknesses in solvency regulation
in Tennessee and Mississippi and three other states allowed a $200 million
insurance fraud, allegedly masterminded by Martin Frankel, to continue for 8
years, resulting in the failure of seven insurance companies. 1 The fraud
was uncovered and made public in May 1999. During 2000 both Tennessee and
Mississippi underwent accreditation reviews by NAIC and were reaccredited.
As agreed with your office, the objectives of this report are to (1) discuss
NAIC?s ongoing efforts to improve the accreditation program, and (2) analyze
the NAIC?s accreditation reviews in Tennessee and Mississippi after the
fraud was uncovered and identify actions NAIC can take to strengthen its
accreditation of state insurer solvency regulation.
NAIC?s voluntary accreditation program has existed now for more than 10
years. During this time, the program has demonstrated its value by defining
a common set of basic regulatory requirements for solvency regulation and
successfully engineering their adoption by nearly all states.
1 See Insurance Regulation: Scandal Highlights Need for Strengthened
Regulatory Oversight (GAO/ GGD- 00- 198, Sept. 19, 2000).
United States General Accounting Office Washington, DC 20548
Results in Brief
Page 2 GAO- 01- 948 NAIC Accreditation Program
Currently, 47 state insurance departments and the District of Columbia are
accredited through NAIC. In the years since its inception, NAIC has moved to
improve and strengthen its accreditation program by adding model laws and
regulations to the required standards in order to address the changing
environment of the insurance industry and insurance regulation. In addition,
it has revised the way accreditation reviews are performed and scored and
has improved training for members of review teams.
However, our analysis of the accreditation reviews done in Tennessee and
Mississippi (the principal regulators of several insurance companies that
failed because of the scam allegedly perpetrated by Martin Frankel)
disclosed gaps and weaknesses in the accreditation program. First, we found
that the program does not cover a key area of solvency regulation-
chartering and change in ownership of insurance companies. Oversight of
chartering and changes in ownership is key to preventing inappropriate and
undesirable individuals from gaining control of insurance companies. The
insurance fraud exposed weaknesses in state regulation and oversight in this
area that are not addressed in NAIC?s accreditation program. Second, we
found weaknesses in on- site accreditation review procedures. These
weaknesses included incomplete analyses of exam information, a questionable
scoring methodology that can give misleading results, limited on- site
compliance testing, and insufficient flexibility in tailoring reviews to
address the most material issues. While we identified these weaknesses
during our review of the reaccreditations in Tennessee and Mississippi, it
is likely that similar issues would arise in other reviews, as NAIC
officials report that the reaccreditation reviews done in Tennessee and
Mississippi conformed to the accreditation processes and practices routinely
followed by NAIC in the reaccreditation of all other states.
To further improve the voluntary state accreditation program and to address
weaknesses that raise questions about the credibility of NAIC?s
accreditation reviews, this report recommends that NAIC take several
actions. First, we recommend that NAIC expand the accreditation standards by
developing or amending the necessary model laws, regulations, and
accreditation review guidelines to ensure effective oversight of chartering
and change in ownership. We also recommend that NAIC implement on- site
review team procedures that require the inclusion of all relevant
examination information and the use of a scoring methodology that emphasizes
those standards with the most direct impact on insurer solvency. Finally, we
recommend that NAIC make the accreditation process more flexible- allowing
the review team to focus on the areas of greatest risk by extending visits
when appropriate and targeting the most material issues through expanded
testing. NAIC
Page 3 GAO- 01- 948 NAIC Accreditation Program
generally agreed to consider each of these recommendations. Their comments
are discussed near the end of this report.
Insurance companies are regulated principally by the states and are
chartered under the laws of a single state, known as the state of domicile.
Companies may conduct business in multiple states, but the state of domicile
remains the primary regulator. States in which an insurer is licensed to
operate but is not chartered typically rely heavily on the company?s primary
regulator in its state of domicile to oversee the insurer.
NAIC is a voluntary association of the heads of insurance departments from
each state, the District of Columbia, and four U. S. territories. State
insurance commissioners created NAIC in part to help address the problems
that arise when state insurance regulators try to oversee insurers that
operate in a number of states, each with its own regulatory authority and
laws. NAIC provides a national forum for addressing and resolving major
insurance issues and for promoting the development of consistent policies
among the states. It also serves as an information clearinghouse and
provides a structure for interstate cooperation in examining multistate
insurers. In addition, NAIC develops and distributes model insurance laws
and regulations for consideration by member states and reviews the
regulatory activities of state insurance departments as part of its national
accreditation program.
The need for a national accreditation program was recognized during the
1980s to early 1990s when many insurance companies became insolvent (between
1986 and 1992, there were 276 insurance company insolvencies). The severity
of the problem focused attention not only on state regulators? ability to
address solvency issues, but also on the lack of uniformity in solvency
regulation at the state level. In June 1990, NAIC established its voluntary
accreditation program to improve state oversight of insurers? solvency. 2
The program?s overall goal is to achieve a consistent, statebased system of
solvency regulation throughout the country. The specific objectives of the
accreditation program are to identify the basic authorities needed for
solvency regulation at the state level and thereby to provide baseline
requirements for effectively regulating the solvency of multistate insurers.
2 A detailed description of the NAIC accreditation program can be found in
appendix II, together with the standards that states must comply with in
order to be accredited. Background
Page 4 GAO- 01- 948 NAIC Accreditation Program
NAIC?s accreditation program emphasizes adequate solvency laws and
regulations, efficient and effective financial analysis, examination
processes and communication, and appropriate organizational and personnel
practices. According to NAIC?s description of the accreditation program, the
standards are grouped under three objectives. Part A covers laws and
regulations, Part B deals with regulatory practices and procedures, and part
C includes organizational and personnel practices. 3 To meet the
requirements of Part A, state insurance departments must have adequate
statutory and administrative authority to regulate an insurer?s corporate
and financial affairs. Essentially, state legislatures need to have adopted
NAIC?s 18 suggested model laws or substantially similar versions and
authorized the state insurance regulators to implement appropriate
regulation. The Part B compliance standards are designed to assess whether a
state seeking accreditation has ?effective and efficient financial analysis
and examination processes.? In order for the state insurance department to
satisfy the 19 Part B standards, a state must demonstrate the necessary
capabilities and practices to conduct financial analyses and examinations,
to communicate with other states, and to develop and implement procedures
for troubled companies. Part C has three standards designed to ensure that
state insurance departments have appropriate organizational and personnel
practices that encourage professional development, establish minimum
educational and experience requirements, and allow the departments to
attract and retain qualified personnel.
To receive NAIC accreditation, state insurance departments must satisfy
these minimum standards. To be accredited initially, a state must undergo an
on- site accreditation review. To maintain accredited status, states must
undergo interim annual reviews (off- site evaluations by NAIC staff) and
full on- site reviews every 5 years. As of August 2001, most accredited
states had completed their second on- site accreditation review, and some
states have already completed their third. Evaluating the state?s oversight
of insurer?s financial condition is the major focus of the on- site reviews.
Since the accreditation program is focused solely on solvency regulation, it
does not evaluate other aspects of an insurance department?s regulatory
responsibility and oversight. For example, market conduct is one important
area of regulatory responsibility that accreditation does not
3 Financial Regulation Standards and Accreditation Program, June 2001, p. 2.
Page 5 GAO- 01- 948 NAIC Accreditation Program
address. Market conduct includes all issues related to the sale of insurance
products to consumers of insurance.
The oversight activities of state insurance regulators may differ, but each
regulator is to oversee several safety and solvency functions through key
phases of oversight activities, including chartering and change in ownership
approvals, 4 routine financial analyses, and periodic on- site examinations.
Before approving a new charter or change of ownership, regulators are to
review the background and qualifications of individuals making the request.
The application must be made in the domiciliary state. Subsequently, an
insurer may also apply for a license in other states where it intends to
sell insurance.
In general, once a domiciliary state has approved an ownership application,
that state continues to oversee the insurer through routine financial
analyses and reviewing annual and quarterly reports and supplemental filings
submitted by the insurance companies. These reports contain information such
as financial statements, responses to questions about company activities,
and schedules summarizing investment and other business activity. NAIC
assists these review efforts with financial analysis tools such as Insurance
Regulatory Information System (IRIS) and Financial Analysis Solvency
Tracking (FAST) ratios. 5 These tools help state insurance analysts identify
areas of potential regulatory concern, particularly indicators that could
suggest financial difficulties.
NAIC also issues guidance to assist regulators in performing financial
analyses and examinations. For example, NAIC?s Financial Analysis Handbook
is designed to help states identify troubled insurance companies as early as
possible. The handbook includes checklists on financial concepts and
analyses deemed important for assessing the
4 Regulators generally require applicants to follow the same process both
for chartering a new insurance company and for purchasing an existing one.
The companies that Mr. Frankel allegedly acquired had all been previously
owned and operated by others before Frankel- controlled entities purchased
them.
5 Nearly all insurers, except for the smallest ones, submit their annual and
quarterly reports to NAIC as well as to their domiciliary regulator. States
where the companies are licensed also receive copies of the reports. NAIC
then calculates a number of financial ratios, known as the IRIS and FAST
ratios, performs some preliminary analyses, and returns the information to
the domiciliary state. NAIC flags ratios that are outside the ?usual range?
for additional regulatory attention. Oversight Activities of
State Insurance Regulators
Page 6 GAO- 01- 948 NAIC Accreditation Program
company?s financial condition. The NAIC?s Financial Condition Examiner?s
Handbook is another tool NAIC has developed to assist state regulators in
detecting as early as possible insurers experiencing financial trouble or
engaging in unlawful and improper activities and to develop the information
needed for timely, appropriate action.
In September 2000, we reported on a $200 million fraud that resulted in
insurance company failures in six states. Four of the failed insurance
companies were domiciled in Tennessee and Mississippi. 6 Both Tennessee and
Mississippi received their initial accreditation in 1994. 7 The fraud was
subsequently discovered in May 1999. In the aftermath of the failures, the
Tennessee Bureau of Insurance did not control certain documents related to
the failed insurance company that were being reviewed by other Tennessee
officials. As a result, Tennessee?s second- round accreditation review was
delayed until February 2000. NAIC suspended the state?s accreditation in
March 2000. However, Tennessee?s accreditation was reinstated in September
2000 after another on- site review. Mississippi?s second round accreditation
was awarded in December 2000, about one year after the five- year
anniversary date of its initial accreditation. 8
Both the Tennessee and Mississippi second- round accreditations occurred in
an environment of long- standing insurance solvency oversight weaknesses
that had been uncovered by the discovery of the $200 million insurance fraud
(fig. 1). Each company that ultimately failed because of the fraud had been
looted of its assets shortly after the company?s purchase by Thunor Trust,
the entity allegedly controlled by Martin Frankel. The investment fraud
scheme then continued, in some cases for years, until the fraud became
public in May 1998. Appendix I describes the details of the fraud allegedly
perpetrated by Mr. Frankel.
6 Fraud occurs in all types of financial institutions and its detection is
an important responsibility of all regulators. However, detection of fraud
can be difficult because perpetrators often falsify records, lie under oath,
and use other deceptions to avoid discovery.
7 At the time of Mississippi?s first- round accreditation, only one of the
three Mississippi insurance companies allegedly purchased by Martin Frankel
was under his control. 8 NAIC officials told us that the Mississippi second-
round accreditation review was not deferred because of events associated
with the fraud. The Mississippi review, along with the reviews of four other
states, was deferred at NAIC?s request because of the review teams?
workload. Key States Affected by
Insurance Fraud Subsequently Receive Reaccreditation
Page 7 GAO- 01- 948 NAIC Accreditation Program
Figure 1: Comparison of the Dates of Accreditation Reviews in Tennessee and
Mississippi With the Term of the Fraud in Those and Other States
Source: NAIC documents and GAO analysis.
Prior to the inception of the NAIC accreditation program, solvency
regulation varied widely across the states. 9 NAIC had developed numerous
model laws and regulations, but adoption by the states was inconsistent.
NAIC instituted the accreditation program in order to improve the quality
and consistency of solvency regulation across the states. The program has
demonstrated its value by defining a broadly accepted set of basic
regulatory requirements for solvency regulation and successfully engineering
their adoption in nearly all states. Currently, 47 state insurance
departments and the District of Columbia are accredited- a level of
consistency far superior to what existed before the program. The number of
insurance company insolvencies in 1993 2000 was 109, a substantial decrease
from the 276 insolvencies reported in the previous 7year period. Although
several factors have likely contributed to this decline, one, according to
NAIC officials, was a concerted effort by NAIC and state governors? offices,
legislatures, and insurance departments to
9 See Insurance Regulation: Assessment of the National Association of
Insurance Commissioners, (GAO/ T- GGD , May 22, 1991). NAIC?s Accreditation
Program Has Improved Over Time, Helping States Strengthen Solvency
Regulation
Page 8 GAO- 01- 948 NAIC Accreditation Program
improve solvency regulation in the states, including the adoption of NAIC?s
Financial Regulation Standards and Accreditation Program.
In addition to encouraging the widespread adoption of fundamental insurance
laws and regulations, the accreditation program has required state insurance
departments to make other changes in order to satisfy the solvency
standards. For example, NAIC officials described to us improvements in the
financial analysis and examination processes used by state insurance
departments that can be attributed to the accreditation program. Between
1990 and 2000, state insurance departments increased the number of financial
analysts from 165 to 471. To support increased demands for training from the
states, NAIC has expanded its training programs for financial analysis and
examination staff from state insurance departments. In 2000, more than 1,900
insurance regulators attended the training programs. In addition, NAIC
officials added a new standard to the accreditation program requiring states
to adopt and follow the NAIC?s
Financial Condition Examiners? Handbook or develop a document that is
substantially similar. NAIC officials said that the new standard has
improved the consistency and quality of state examination procedures. 10
GAO first reviewed NAIC?s accreditation program about 10 years ago. 11 Since
then, NAIC has made several improvements, some in response to GAO?s
recommendations and others in response to suggestions from within NAIC
itself and from other outside observers. It has added model laws and
regulations- for example, the standards now require insurance companies to
measure and report risk- based capital, and depending on the level reported,
departments must take specific corrective actions. NAIC has also added
standards that reflect best practices for conducting financial analyses and
examinations. For example, it has expanded the financial analysis standards
to require departments to analyze each company in depth, document the
financial analysis procedures, and report
10 Both the NAIC?s Financial Condition Examiners? Handbook and Financial
Analysis Handbook are intended to serve as advisory guides for state
insurance departments. Only the Financial Condition Examiners? Handbook is
required as part of the accreditation standards.
11 ?Assessment of the National Association of Insurance Commissioners
(GAO/ T- GGD- 91- 37, May 22, 1991); The Financial Regulation Standards and
Accreditation Program of the National Association of Insurance Commissioners
(GAO/ T- GGD- 92- 27, Apr. 9, 1992); The National Association of Insurance
Commissioner?s Accreditation Program Continues to Exhibit Fundamental
Problems (GAO/ T- GGD- 93- 26, June 9, 1993).
Page 9 GAO- 01- 948 NAIC Accreditation Program
and act on material adverse findings. The expanded financial examination
standards require the examination staff to exchange information with other
department staff. In addition, a new standard requires states to adopt the
statutory authority required to share confidential information with other
state insurance departments and to protect confidential information those
departments provide. 12 Finally, NAIC has increased its reviews of insurance
department files documenting actual financial analyses and examinations,
changed the scoring system, and provided detailed guidance for accreditation
review teams.
In the first round of accreditation reviews, the review team was responsible
primarily for assessing whether each state had the laws, regulations,
processes, and resources necessary to regulate solvency. With the beginning
of the second round of accreditation reviews in 1996, the focus expanded to
better assess how effectively a state has used the laws, regulations,
processes, and resources to regulate the solvency of insurers since the last
accreditation on- site review. In the original round of accreditations, the
review team concentrated only on the most current state analysis and
examination procedures. While current department procedures continue to be
the primary focus in the second and subsequent rounds of reviews, the teams
may also review department analysis and examination files for all years
since the previous review. For example, when selecting a sample of insurance
company analysis and examination files, NAIC now requires the review teams
to select at least one company from each of the following three categories,
even if they have to go back as long as 5 years to find examples:
companies that are not financially troubled; companies the state has
identified as financially troubled; companies that are insolvent and that
have been subject to receivership
proceedings during the last 5 years. Although the teams may have selected
companies from each of these categories in the first round of reviews, NAIC
did not specifically direct them to do so.
12 The standard does not require documented evidence that such communication
actually took place, only that the states have both the legal authority and
a written policy allowing them to do it.
Page 10 GAO- 01- 948 NAIC Accreditation Program
NAIC continues to be open to improvements in the accreditation program. In
our September 2000 report on the $200 million fraud allegedly perpetrated by
Martin Frankel, we identified a number of regulatory weaknesses that
contributed to the failures of seven insurance companies. Although the
accreditation program had minimum standards that the NAIC believed were
sufficient for effective solvency regulation, the alleged Frankel scam
exposed weaknesses in the accreditation program standards for financial
examination, analysis, and related review guidelines, and in the standard
for communication among states. Specifically, the program did not have an
accreditation standard for asset custodians and lacked review team
guidelines requiring the use of investment specialists. Moreover, while the
program did have a standard about communication with other regulators, the
standard did not require a regulator to proactively tell other interested
states about a troubled insurer. Similarly, there was no standard requiring
a state to obtain ownership applicant information from other states or to
alert other states about possible fraud.
The insurance fraud led NAIC, as part of its overall corrective actions
strategy, to propose changes to its accreditation standards and guidelines
that are designed to minimize the likelihood of a similar fraud occurring
again. NAIC has given these changes- one new standard and four review team
guidelines- high priority and anticipates making them effective during 2002.
The standard identifies requirements for asset custodians. NAIC expects to
add it to the accreditation standards after adopting the model law at the
2001 Fall National Meeting. The three review team guidelines cover the use
of investment expertise, more frequent examination of troubled insurers, and
proactive communication by states regarding troubled insurers have been
adopted and are expected to become effective in January 2002. The fourth
review team guideline would require that states use a centralized database
on applicants seeking to charter or buy an insurer that is currently being
developed. This database is to be called the Form A database because the
information will come from Form A?s filed by insurers and those seeking to
charter or buy an insurer. At present, specifications for the Form A
database have been approved and a prototype of the database system was
presented at the NAIC 2001 Summer National Meeting. The database is expected
to become operational in March 2002.
Other changes to the review team guidelines have been suggested, but their
prospects and time frames are less certain. These include requirements that
actions associated with the Part A process be reviewed during the financial
analysis and examination processes and that communication between state
insurance departments and other federal
Page 11 GAO- 01- 948 NAIC Accreditation Program
and state regulators be improved. A proposal to revise the Preamble to the
Review Team Guidelines that would require the accreditation review teams to
evaluate the implementation of the Part A standards has been presented to
the relevant NAIC committee. Other proposals to expand accreditation
standards by requiring communication with other state and federal regulators
are under consideration.
While there have been changes and improvements in the NAIC accreditation
program since its inception, our analysis of the second round of
accreditation reviews for Tennessee and Mississippi disclosed shortcomings
in the scope, operations, and methodology of the accreditation program
(table 1). Tennessee and Mississippi were the states of domicile for four of
the seven companies that were looted of their assets early in the insurance
fraud allegedly perpetrated by Martin Frankel that extended over an 8- year
period ending in May 1999. The long- term failure of insurance regulators to
uncover the fraud and associated asset theft revealed a number of regulatory
deficiencies in both states. These shortcomings were identified in our
September report. NAIC officials, as well as the head of the NAIC
accreditation review teams that conducted on- site accreditation reviews in
Tennessee and Mississippi, knew of the investment fraud prior to the
accreditation reviews. However, because of gaps and procedural weaknesses in
the structure of the accreditation program, known regulatory oversight
deficiencies existing in Tennessee and Mississippi had a relatively minor
effect on the accreditation process and resulting decisions. Accreditation
Program Still Has Gaps and Weaknesses
Page 12 GAO- 01- 948 NAIC Accreditation Program
Table 1: Overview of Accreditation Program Weaknesses Accreditation program
element Weakness Specific observation
Coverage of all key aspects of solvency regulation
Gap in ?front- end? coverage involving chartering and change in ownership
of insurance companies
A critical area of state insurance regulation designed to prevent
undesirable individuals from owning companies or engaging in questionable
business strategies is not assessed. Accreditation review team analysis
procedures
Incomplete analysis of prior examinations
Use of a scoring methodology that can yield misleading results
Reliance on limited on- site compliance testing
Review procedures are inflexible
Only the most recent exam is fully considered, rather than all relevant
exams during the 5- year review period.
Equal weighting of standards in each section of Part B allows states to
obtain passing scores despite material problems that may not have been
corrected a
?No basis for evaluation? scores contain a bias toward passing.
Averaging within segments can result in passing scores despite unresolved
problems.
Review team members have only 3 days during their 4 5 day visit to perform
testing, regardless of the size of the insurance department and the
complexity of its workload.
Review procedures and practices are not riskfocused. That is, they are not
adjusted to focus on areas deemed most crucial, such as known material
issues. a Appendix II explains the standards in full.
The accreditation program is intended to provide baseline requirements for
effective solvency protection by state insurance departments. Overseeing
chartering and changes of control of insurance companies is a key element of
solvency regulation. However, the accreditation program largely ignores this
important aspect of oversight- the so- called front- end of solvency
regulation.
None of the NAIC accreditation reviews in Tennessee and Mississippi looked
at or commented on this aspect of solvency regulation. Our review of the
accreditation program material and the work papers for these reviews shows
why. Accreditation standards and review team guidelines focusing on a
department?s performance during chartering and change in ownership do not
exist. However, one Part A standard requires a state to have statutory
authority for changes in the control of insurance companies; what this
standard requires is substantially similar to the authority provided by the
NAIC?s model Insurance Holding Company System Regulatory Act and Regulation.
The Act and Regulation sets out the procedures that insurance companies must
follow when requesting a The Accreditation Program
Does Not Evaluate Chartering and Changes in Ownership
Page 13 GAO- 01- 948 NAIC Accreditation Program
change in control of an insurer. Moreover, according to an NAIC
representative, both Tennessee and Mississippi had these statutory and
administrative authorities in place at the time Martin Frankel was allegedly
buying insurance companies. However, the accreditation program includes no
standards for the chartering process and no Part B Standards or review team
guidelines requiring evaluation of the states? performance in these areas.
As a result, the existing weaknesses were ignored.
Although not fully addressed in the accreditation reviews, regulatory
oversight in this area is key to preventing undesirable individuals from
owning or managing insurance companies and to blocking companies from
becoming involved in questionable business strategies. Both Tennessee and
Mississippi had regulatory oversight processes in place for approving
charters and changes in ownership for insurance companies. However, our
report on the insurance fraud perpetrated in those states noted several
weaknesses in regulatory performance existing during change in ownership
approval activities. These weaknesses included (1) inadequate due diligence
performed on buyer application data, (2) inadequate tools and procedures to
validate individuals? regulatory or criminal backgrounds, and (3) lack of
coordination between regulators within and outside the insurance industry.
As we noted in our earlier report, performing due diligence on buyer
application data is an essential part of regulatory oversight, as the
purchase of insurance companies provides a number of opportunities for
regulators to ask questions about the prospective owners. This phase of
insurance regulation involves determining the intentions and appropriateness
of the buyer and the business strategy they intend to employ. In addition,
the states? review of the data associated with an application for the change
in ownership of an insurance company, documented in a format prescribed by
NAIC known as a Form A, requires key information to be provided by
applicants, but does not include checks on individuals? regulatory or
possible criminal histories. A fundamental aspect of the investment fraud
was the concealment of a secret affiliation that allegedly existed between
entities in the insurance and securities industries, so that the investment
entity controlling the insurers and the entity controlling their invested
assets were one and the same. Had regulators in Tennessee and Mississippi
(as well as the four other states having primary regulatory responsibility
for companies involved in the insurance fraud) exercised a higher degree of
scrutiny or professional skepticism during the Form A application process,
the fraud might have unraveled at the outset.
Page 14 GAO- 01- 948 NAIC Accreditation Program
NAIC and state officials have acknowledged the need to include additional
assessments of chartering and change of ownership in the accreditation
program. However, NAIC officials told us that they don?t plan to add new
accreditation standards until after establishing a Form A database that can
be shared by the states. A prototype of the database has been demonstrated,
and it is expected to become operational in March 2002. Once this step is
completed, NAIC intends to begin focusing on developing accreditation
standards for front- end solvency regulation. NAIC, through its committee
process, has already made progress in developing checklists and procedures
for the review of Form A filings. Such checklists and procedures may further
enable state insurance departments to evaluate solvency issues related to
change of ownership.
NAIC?s descriptions of the accreditation program stress the importance to
consumers of ?effective solvency regulation.? NAIC?s guidance on the
standards and the review process for the second round accreditation reviews
requires review teams to evaluate the insurance department?s performance in
addition to determining whether the departments has the appropriate
procedures in place. 13 Second round accreditation policy guidance from NAIC
for the Part B Standards (Regulatory Practices and Procedures) states that
insurance departments are to ?? demonstrate to the review team that they
timely identify potentially troubled insurers and institute appropriate
courses of action.? Regulators? failure to do so was precisely the problem
in both Tennessee and Mississippi. The failure of the accreditation process
to fully recognize this regulatory failure illustrates additional weaknesses
that limit the effectiveness of NAIC?s accreditation process. These
weaknesses include the review teams? failure to adequately consider all
potentially relevant examination information, the use of a biased scoring
methodology, a reliance on cursory compliance testing, and a general
inflexibility in review procedures that does not allow reviewers to address
all material issues. As a result, accreditation reviews may not consistently
focus on important regulatory weaknesses and areas of vulnerability- that
is, those that heighten the risk of material losses.
Accreditation review teams generally include only the most recent
examination activity for the companies they sample when assessing a state
for accreditation. For this reason, the analysis does not include all the
13 NAIC Policy Statement on Financial Regulation Standards for the Second
Round of Accreditation Reviews, National Association of Insurance
Commissioners, May 20, 1998. Analysis Procedures
Contain Many Weaknesses Potentially Relevant Exam Information Is Not
Adequately Considered
Page 15 GAO- 01- 948 NAIC Accreditation Program
examinations of these companies that were completed during the current
accreditation cycle. In the case of the first Tennessee reaccreditation
review in February 2000, reviewers selected six companies for the review of
examination files. One of these companies was the Franklin American Life
Insurance Company, which failed after having been looted in the fraud
allegedly perpetrated by Martin Frankel. 14 The theft of company assets,
which occurred shortly after the company changed ownership in 1991, had been
discovered in the most recent exam (between September 1998 and May 1999).
Because the theft was discovered, the examination received good marks from
the review team. This good score contributed to the state?s high mark for
the examination standard.
At the time of the reaccreditation on- site review in February 2000,
Tennessee had completed three solvency examinations of Franklin American
during the period of its participation in the fraud, two of them covering
the full scope of the company?s activities and one targeted to investment
activities. The first two exams had missed the fraud and the theft of
assets. Accreditation officials explained that the review team did not
consider the first examination of the company because, although the
examination report had been issued after the first- round review, the ?as
of? date of the examination was December 31, 1992, before the date of the
review. The second examination, in September 1996, also missed the fraud.
This examination specifically targeted Franklin American?s investment
activities- the precise area that was the focal point of the fraud.
Accreditation officials told us that this examination was considered by the
review team in its review and deliberations. However, it could not have been
given much weight in the scoring. Summary notes from the review team voting
session indicated that the reporting of material adverse findings by the
Tennessee department was ?good? (with a score of 4.2 out of 5) and action on
material adverse findings was ?timely? (also given a
14 Franklin American was included in the review team sample only indirectly
because it was one of the companies affected by the $200 million fraud.
Second- round accreditation procedures require the sample of companies to
include at least one failed company. Franklin American was Tennessee?s only
failed multistate insurer in the period since the last accreditation review.
Page 16 GAO- 01- 948 NAIC Accreditation Program
score of 4.2). 15 In fact, both the fraud and the fact that the assets of
the company had been stolen went undetected by the department for nearly 8
years.
One possible explanation for the accreditation review team?s apparent
disregarding of the department?s failure to identify the theft of assets
from Franklin American in a timely manner may be found in the standards
themselves and in the review team guidelines. While there are two standards
on material adverse conditions, there is no standard for assessing the
failure of examiners to find an existing material adverse condition. Even
without an explicit standard, however, the review team could have considered
whether a department failed to find a material adverse condition. This
consideration would be included in the scoring of the standard for reporting
a material adverse condition, because if the condition is not found, it can
not be reported. Yet the review team guidelines do not include any direction
to the team concerning this important scoring issue, and the Tennessee
review team did not choose to consider the failure of Tennessee examiners to
identify the fraud in a timely fashion. As a consequence, Tennessee?s
accreditation results did not fully reflect the department?s performance
during the accreditation review period.
The accreditation reviews in Tennessee and Mississippi revealed three
weaknesses in the scoring methods used that, taken collectively, can dilute
the role of professional judgement and cause misleading or questionable
results. Part B, where the scoring weaknesses occur, is broken into three
components, or subparts- financial analysis (with eight elements), financial
examinations (with nine elements), and troubled companies and communication
with other regulators (with two elements). (See appendix II.) The weaknesses
in scoring the Part B standards include giving equal weight to each of the
elements of the standards, averaging or ?netting? the
15 While there is little argument that the Tennessee examination started in
late 1998 was instrumental in identifying the fraud and, for the first time,
uncovering the theft of company assets, it should be noted that the contract
examiner reported the fraud and theft to the department in February 1999.
The department did not subsequently take control of the company until after
the Mississippi Department raised concerns in May 1999. By that time, an
additional $50 million had been stolen from other insurance companies, and
Martin Frankel had fled the country. Scoring Can Provide Misleading
Assessments
Page 17 GAO- 01- 948 NAIC Accreditation Program
scores within each of the subparts of the Part B standards, and maintaining
an inherent scoring bias toward passing. 16
The scoring system assigns equal weights to all 19 elements in Part B. Thus
the elements in each section are treated equally, irrespective of their
potential impact on an insurance company?s solvency. For example, two of the
eight financial analysis elements on which states are scored are reporting
of material adverse findings and action on material adverse findings. During
the first Tennessee accreditation review in February 2000, reviewers gave
the department a score of 4.24 for reporting on material adverse findings (a
process- oriented element) and a score of 1.54 for action on material
adverse findings (an outcome- oriented element). Thus, the fact that the
state took no action on an adverse material finding of fraud- which resulted
in theft and a company?s failure- carried no more weight than the other
elements.
A March 1996 Ernst and Young analysis of the accreditation program (the only
independent analysis of the accreditation program requested by NAIC)
recommended that the elements of Part B standards be weighted. The report
noted that the overall contribution each standard made to regulating
financial solvency appeared to vary. For example, according to the report,
supervisory review of work papers appeared to Ernst and Young analysts to be
a more critical activity than formatting examination reports, even though
NAIC accreditation procedures weighted them equally. NAIC?s Financial
Regulation Standards and Accreditation Committee considered revising the
scoring system and weighting the elements of the standards. However, the
committee concluded that all of the standards were equally important to an
overall financial solvency program and thus decided not to revise the
scoring system.
The second scoring methodology weakness involves the averaging of scores for
standards within the financial analysis and examination sections. For
example, the scores for each of the nine financial examination elements are
totaled and a straight average calculated to
16 In accordance with NAIC?s accreditation procedures, a state must attain a
passing score in both the Part A and B Standards (C is not scored). Part A
is scored on a Pass/ Fail basis. States must have substantially similar
authority for each of the Part A standards to be considered in compliance
with them. To be in compliance with the Part B Standards, states must attain
a passing score in each of the three sections of Part B with a 3.0 or higher
average and must also attain a score of at least 1.0 on each of the
individual Part B Standards.
Page 18 GAO- 01- 948 NAIC Accreditation Program
determine the score for the financial examination section. Such an approach
allows a ?netting? process to take place by allowing an above average score
on one element to offset a below average score on another element within the
same section. This ?netting? feature is particularly critical because the
standards themselves are all of equal weight. For example, on the first
Tennessee accreditation review in February 2000, a score of 3.88, above that
needed for passing, was awarded for the element on scheduling of exams and a
2.60, or below that required overall for passing, for the element on
appropriate supervisory review. Thus, the 3.24 straight average of the two
scores is above that needed for a passing grade even though one element
received a low score. Tennessee?s accreditation was suspended because it
failed to pass the financial analysis section portion of the review.
However, the failing score was by the slimmest of margins- a 2.98 average,
with a 3.0 average needed in order to pass. Thus, above average scores for
some elements, including that for ?reporting of material adverse findings,?
were nearly able to offset below average scores for others, most notably the
element for ?action on material adverse findings.? To further illustrate how
close Tennessee came to passing, in spite of the known problems, three of
the five review- team members? individual scores averaged to a passing score
for the entire financial analysis section.
The third area of scoring weakness is the built- in bias toward passing,
which comes into play when there is no basis to judge a department?s
performance on an element. For example, if none of the companies sampled in
a state had an identified adverse material finding during the period under
review, then review team members (following NAIC policy for second- round
accreditation scoring) assign a score of 4 (out of 5) for both reporting and
acting on material adverse findings. This situation occurred in the second
Tennessee review, since the review team did not identify any material
adverse issues for the companies reviewed in the sample. Such a policy, when
used in conjunction with other scoring techniques such as giving equal
weight to all elements and averaging scores, makes it easier for a state to
attain an overall passing score, even if there are deficiencies in other
elements. Some rating systems attempt to reduce this type of bias, either by
having a ?no basis to judge? category that excludes a standard or element
from the scoring, or by assigning a neutral score to minimize the impact on
the overall score.
Compliance testing may be cursory because reviewers are allowed only 1 week
or less on site, regardless of the size and complexity of the insurance
department or the extent of problems that are identified. Moreover, the
review is typically performed by 4 or 5 contract staff and an NAIC
Compliance Testing Is
Sometimes Cursory Because of Limited On- Site Review
Page 19 GAO- 01- 948 NAIC Accreditation Program
observer, whether the state being reviewed has more than 100 multistate
insurers or only a handful. While team members review the selfassessment
materials prepared by insurance departments before on- site visits, the
parameters on time and resources limit the team?s ability to perform in-
depth analyses and independently corroborate what the insurance department
officials report. According to NAIC, the first day of a review commonly
consists of meeting with state insurance department officials and obtaining
an overview of the states? financial and examination procedures and
resources. In addition, the review team selects a judgmental sample of
multistate companies for an in- depth review that begins the afternoon of
the first day. The team generally continues reviewing the sample files
during the 2nd, 3rd, and sometimes 4th days of the on- site visit, while
also interviewing insurance department staff associated with the sampled
companies. At the same time, the team reviews the adequacy of the state?s
organizational and personnel practices- the Part C standards. During the 4th
and 5th days, the team must also make time for internal team member
discussions of findings, accreditation review scoring, preparing and writing
the team report and management letter, and discussing the findings with
state insurance department officials. NAIC officials explained that the
Tennessee visit in February 2000 lasted 5 days and had a five- member team
and one NAIC observer- typical numbers for both the duration and level of
resources of on- site visits.
While it may not always be necessary to schedule more than 5 days for an on-
site accreditation review, the ability to do so when appropriate would help
avoid inadequate compliance testing. Too little compliance testing can have
serious consequences for the effectiveness of the review process. During the
Mississippi second- round accreditation review, Franklin Protective Life
(one of the Mississippi companies that failed owing to losses associated
with the $200 million fraud) was selected for review by the Mississippi
accreditation team. By the time the accreditation on- site review took place
(in October 2000), it was commonly known that Franklin Protective Life and
two other insurance companies domiciled in Mississippi had operated for
several years after having been looted of their assets in the fraud.
Financial analysts from the Mississippi Insurance Department had failed over
a number of years to notice that the company?s assets were missing and
either failed to notice or failed to take action on other ?red flags? that
could have led to an earlier identification of the fraud. Nevertheless, the
accreditation team leader, after reviewing the financial analysis files for
Franklin Protective Life, concluded in the review team?s summary notes that
?no serious failing in regulatory duties
Page 20 GAO- 01- 948 NAIC Accreditation Program
and responsibilities was noted in the five year analysis review for this
company.?
By way of contrast in terms of depth of review, the Tennessee state auditors
spent from July 1999 to July 2000, or about 1 year, analyzing and
summarizing their findings. 17 While the objectives and approach of the
state auditors and the accreditation review team differed, both efforts
were, in part, an attempt to evaluate the performance effectiveness of the
Tennessee Department of Commerce and Insurance. The state auditors? more
detailed and comprehensive analysis disclosed a number of serious problems,
including the failure to take action on reported material adverse findings-
the principal reason Tennessee?s accreditation was suspended in March 2000.
The audit report noted the Tennessee Insurance Division?s gross regulatory
breakdown in this case, despite significant warning signs of questionable
activity. The report also recommended a number of improvements, including
additional confirmation procedures for insurance company assets held by
custodians, improved documentation, improved supervisory review procedures,
longer retention of examination work papers when a troubled insurer is
involved, and improved supervisory control over financial analysis
checklists. While a year would certainly be too long for an accreditation
review, limiting all reviews to a week or less may be too constraining.
We compared the February 2000 accreditation findings in Tennessee with
findings disclosed in our prior report on the investment fraud and found a
number of weaknesses that were noted in our report but were not identified
in the accreditation reviews. In analyzing the review team?s work papers, we
found no discussion of weaknesses or concerns that had been identified in
areas such as staff investment expertise or failure to detect
misappropriation of assets. (See appendix I for a listing of weaknesses
identified in our earlier report.)
Perhaps the most significant weakness of the accreditation review team
process is its limited flexibility. Without flexibility, the examination
team is unable to focus on areas known to be of concern or to use the
limited
17 After the fraud allegedly masterminded by Martin Frankel became public in
May 1999, the Tennessee State Auditor performed a compliance review of the
Tennessee Insurance Department and issued a report in July 2000 noting that
weaknesses existed. These weaknesses included the regulators? failure to
exercise sufficient professional skepticism, inadequate procedures for
reviewing an insurance company, and misapplied review procedures. Review
Teams Lack Flexibility
to Focus on the Most Material Issues
Page 21 GAO- 01- 948 NAIC Accreditation Program
review team time to concentrate on material issues. Instead, the team uses
exactly the same process and procedures regardless of the prevailing
circumstances- even in an environment where fraud is known to have occurred.
In spite of the fact that the NAIC accreditation officials and the
accreditation team?s leader knew about the insurance fraud problems in
Tennessee, the review team?s work plans were not substantially modified to
address what was clearly the most material event existing in the department
at that time.
To further illustrate this inflexibility, the Mississippi accreditation work
plans were not tailored to address weaknesses in the Mississippi Insurance
Department, even though both NAIC and the Mississippi Insurance Department
had acknowledged them. While a detailed review of the same issues could be
viewed as unfair, we found no evidence that the review team was instructed
or attempted to determine what corrective actions were being taken or
whether closer scrutiny of certain standards were warranted based on recent
material adverse events. The program?s inflexibility, which does not allow
the review team to focus its limited capacity on material issues, seems
counter to the goal of increasing public trust in the solvency regulation
process. Moreover, a risk- focused approach would allow the most efficient
use of limited review team time and resources.
Our assessment of the accreditation reviews in Tennessee and Mississippi
showed that the processes and practices were in accordance with
accreditation guidelines and instructions. NAIC also reports that the
accreditation reviews conducted in Tennessee and Mississippi were typical of
the review processes used in all the accreditation reviews conducted in
other states. NAIC officials reported that a total of 99 firstand second-
round accreditation reviews were brought before the Financial Regulation
Standards and Accreditation Committee between the program?s inception and
July 26, 2001. A total of two suspensions resulted from these on- site
reviews- Tennessee and Washington State- both in Additional Observations
About the Accreditation Program
Page 22 GAO- 01- 948 NAIC Accreditation Program
connection with second- round reviews. Both states were subsequently
reaccredited. 18
We also found two other structural features of the accreditation program
that could affect its effectiveness. First, while NAIC advises and provides
technical assistance to individual states, it does not oversee or supervise
state insurance departments. Thus, any recommendations and suggestions made
by NAIC to the states do not have to be accepted. Second, the accreditation
assessments are not independent, because NAIC is an association of the heads
of the state insurance departments. Specifically, the commissioners are
simultaneously the source of the standards, the heads of the entities being
evaluated- and the state insurance departments, and the ultimate judges of
the departments? success or failure in terms of accreditation. This lack of
organizational independence creates inherent impairments that can affect the
ability of review teams to do their work and report their findings
impartially. For example, states have a ?right of refusal? regarding
individuals selected for the on- site review team. In addition, while NAIC
can choose from a number of contract review team members, it has only four
review team leaders. While the experience and continuity provided by this
small pool of team leaders might be a plus, there is also the possibility
that the leaders could be ?coopted? by the program and its undeniably
positive goals.
The accreditation program has been evolving since its inception more than 10
years ago. NAIC has taken a number of steps that it believes have
strengthened the program. NAIC has reported improvements in a number of
areas, including adding standards that suggest best practices for the
states; expanding NAIC?s reviews of state solvency regulation, which now
include analyses of a sample of failed or troubled companies; and increasing
the number of states in the program, so that most are now participating.
Following the scam allegedly perpetrated by Martin Frankel, NAIC and state
insurance regulators in Tennessee and Mississippi as well as other states
acknowledged the need to further strengthen insurer solvency regulation.
Corrective actions emanating from the insurance fraud have included
identifying the appropriate custodial requirements for
18 New York, the first state accredited, was subsequently suspended as a
result of an interim annual review. The New York State legislature declined
to pass two laws that are required for accreditation. In addition, the West
Virginia Insurance Department was suspended due to a failure to undergo the
on- site review required every 5 years for second- round accreditation.
Conclusions
Page 23 GAO- 01- 948 NAIC Accreditation Program
insurers? assets, using investment specialists on certain examinations,
implementing more proactive communications between states, and establishing
a Form A database to help states track the status of change- inownership
applications that are submitted to other state regulators. We believe these
positive steps have been designed to strengthen NAIC?s accreditation program
in its efforts to strengthen solvency oversight of insurance companies.
NAIC?s description of its accreditation program points out that America?s
insurance consumers need ?a system of effective solvency regulation.? The
accreditation program is intended to certify that accredited states have the
baseline authorities, processes, procedures, and resources needed to provide
a system to protect consumers not only in those states where insurance
companies are domiciled, but also in every state where the companies
operate. Clearly, determining whether a state has the laws and regulations
necessary for insurance regulators to act is fundamental. Moreover, NAIC has
designed its accreditation program so that model laws and regulations can be
added to the standards as needed, and a number of such models have been
added since the program?s inception. The recent fraud in Tennessee,
Mississippi, and other states has illuminated another area where NAIC can
assist the states. The accreditation program can be improved by developing
or revising model laws relative to chartering and changes in the control of
insurance companies and adding them to the standards along with associated
practices and procedures.
Measuring a state?s effective performance of its regulatory responsibilities
for solvency may be more difficult than determining whether it has the
necessary laws and regulations. However, differentiating an ?effective?
system of solvency regulation from an ineffective one is an important
objective of the accreditation program, particularly since the start of the
second round of accreditation reviews. The examiner team instructions for
determining compliance with Part B standards (Regulatory Practices and
Procedures) require the teams to evaluate not only whether state insurance
departments have the necessary laws and regulation on the books, but also
whether the departments have implemented them appropriately. The
instructions add, ?To satisfy the standards set forth in this section, the
Department should demonstrate to the review team that they timely identify
potentially troubled insurers and institute appropriate courses of action?.?
This did not occur in Tennessee or Mississippi. As a result, while
Tennessee?s accreditation was suspended for a short time, the accreditation
reviews did not identify many of the regulatory weaknesses that had allowed
the affected companies in both states to evade detection
Page 24 GAO- 01- 948 NAIC Accreditation Program
and operate for several years not only without adequate capital but also
without assets. While we recognize the difficulties of detecting deliberate
fraud, there is room for the accreditation program to continue improving its
mechanisms for assessing the effectiveness of states? regulatory performance
in the same way it has expanded the basic set of laws and regulations states
are expected to have. Its success in making these improvements will enhance
the level of confidence insurance consumers can have in each accredited
state?s insurance regulatory system. Without these improvements, the
accreditation program may not succeed in clearly differentiating between the
state insurance departments that can be expected, on the basis of past
performance, to effectively regulate the solvency of insurance companies and
those departments that may not.
We recommend that the Executive Vice President of NAIC Strengthen the
accreditation program?s focus on chartering and change of
ownership by developing appropriate model laws, regulations, and
procedures for
chartering insurance companies; reviewing the current standards and
guidelines related to change in
ownership and make any necessary changes; including the new and improved
model laws and regulations in the
accreditation standards and developing companion compliance standards for
regulatory practices and procedures; and providing appropriate guidance to
the review teams to assure better
assessment of a state?s performance in these areas of solvency regulation.
Implement new on- site review team procedures by requiring the inclusion
of all relevant exam information since the last
accreditation review, and developing a scoring methodology that places
more emphasis on
standards that directly affect insurance company solvency. Ensure that the
accreditation program provides the review team with the
flexibility to adjust the time and scope of on- site visits as necessary to
conduct the level of testing required to address known material issues.
We requested and received written comments on a draft of this report from
the Executive Vice President, NAIC (see app. III for the complete text of
NAIC?s letter). In summary, they were pleased to note the positive comments
we made about the various improvements and successes since Recommendations
for
Executive Action Agency Comments and Our Evaluation
Page 25 GAO- 01- 948 NAIC Accreditation Program
the accreditation program?s inception. They also appreciated our
recommendations for further improvements and stated that they are committed
to giving each of them serious consideration.
Regarding our specific recommendations, NAIC generally agreed with our first
recommendation concerning the need to strengthen the accreditation program?s
focus on chartering and change in ownership and noted some specific actions
being taken or planned in that regard. Consistent with our second
recommendation, NAIC is currently considering changes that would require
review teams to consider examinations from earlier in the accreditation
cycle. In addition, while NAIC has considered on more than one occasion the
concept of weighting accreditation standards, it agreed to again review its
scoring system in light of our concerns. Finally, regarding our third
recommendation addressing the need to ensure review team flexibility to
adjust on- site visits so that appropriate testing can occur, NAIC believed
its program had the flexibility to consider known areas of weakness, but
agreed to review its procedures in light of our concerns.
In NAIC?s more detailed comments (see page 2 of the comment letter in app.
III), NAIC stated that not even the best- designed systems can ensure that
fraud, intentionally perpetrated upon an insurance company, can be
immediately detected. In addition, it believed that a Department?s
performance on one individual company that was the subject of an alleged
fraudulent scheme was not necessarily an accurate indicator of a
Department?s overall financial solvency program. We agree that it can be
difficult to immediately detect fraud, but note that the fraud discussed in
this report went undetected for nearly 8 years despite numerous indicators,
or red flags- many in documents available to regulators throughout this
period. Further, we found no clear indication that the oversight weaknesses
contributing to the long- term success of this fraud were unique to a single
company. In fact, three of the failed companies were domiciled in
Mississippi (although the NAIC review team looked at only one). Moreover, in
the aftermath of the failures, both Tennessee and Mississippi acknowledged
systemic weaknesses in their regulatory oversight practices that had made
them overly vulnerable to the fraudulent activity. Since the fraud was
uncovered, Tennessee, Mississippi, and NAIC have begun to implement various
corrective actions designed to reduce the possibility of future occurrences.
In a similar light, we believe that further corrective actions can be made
to NAIC?s accreditation program to better ensure its success in evaluating
the effectiveness of the states? financial solvency programs.
Page 26 GAO- 01- 948 NAIC Accreditation Program
To obtain information on NAIC?s efforts to improve its accreditation
program, we visited NAIC Headquarters in Kansas City, Missouri, and attended
the open portions of the three most recent quarterly meetings of NAIC?s
Financial Regulation Standards and Accreditation Committee (FRSAC). At NAIC
headquarters, we obtained and analyzed relevant documents describing the
accreditation program?s goals, objectives, scope, and accomplishments, as
well as summary statistics. Officials at NAIC also provided us with their
view of improvements made to the program since its inception in 1990. We did
not independently verify every improvement, not did we independently review
the laws and regulations of individual states to verify their adoption of
the NAIC models. At NAIC quarterly meetings, we obtained various documents
on accreditation issues and plans and discussed these with FRSAC members as
appropriate. In addition, we interviewed key accreditation officials about
the program?s operations and obtained their view of major accomplishments
and improvements.
To analyze the accreditation reviews in Tennessee, we visited NAIC
headquarters and reviewed all work papers and related reports summarizing
the two reviews. We also reviewed the work papers and associated documents
from the Mississippi accreditation review. We subsequently discussed these
reviews with representatives of both the Tennessee and Mississippi Insurance
Departments. We obtained and analyzed various documents pertaining to the
goals, objectives, accreditation review procedures, scoring methodology, and
criteria. We also interviewed NAIC officials responsible for these reviews
and the contractor who functioned as team leader for the on- site visits. In
addition, we reviewed an operational study of the accreditation program
conducted by Ernst and Young, the only outside analysis of the program
requested by NAIC.
We conducted our review in Kansas City, Missouri; Nashville, Tennessee; and
Jackson, Mississippi, between December 2000 and July 2001 in accordance with
generally accepted government auditing standards. While the findings of this
report apply to the accreditation program as a whole, other issues related
to NAIC?s accreditation program may need to be addressed. Our focus was on
the accreditation process in Tennessee and Mississippi during and after the
insurance scam allegedly perpetrated by Martin Frankel. Other issues
unrelated to the circumstances found in those two states were outside the
scope of our review. Scope and
Methodology
Page 27 GAO- 01- 948 NAIC Accreditation Program
As agreed with your office, unless you publicly release its contents
earlier, we plan no further distribution of this report until 30 days from
the date of this letter. At that time, we will send copies of this report to
the Chairman of the House Committee on Energy and Commerce as well as the
Chairman and Ranking Member of the House Committee on Financial Services and
the Senate Banking, Housing, and Urban Affairs Committee. At that time, we
will also send copies of this report to the Executive Vice President of NAIC
and to the 55 state and other governmental entities that are members of NAIC
and also make copies of the report available to other interested parties
upon request.
Sincerely yours, Richard J. Hillman Director, Financial Markets and
Community Investment
Appendix I: Tennessee and Mississippi Received Accreditation During and
After Thefts Causing Company Insolvency
Page 28 GAO- 01- 948 NAIC Accreditation Program
In September 2000, we reported on a $200 million theft involving insurance
company failures in six states. 1 Four of the failed insurance companies
were domiciled in Tennessee and Mississippi. In 1994, both Tennessee and
Mississippi received their first round accreditation during the theft, which
had not yet been discovered. The theft was subsequently discovered in May
1999. Events associated with that discovery led to the delay of the second
round accreditation reviews in Tennessee. Tennessee?s second round
accreditation was suspended in March 2000 and reinstated in September 2000.
Mississippi?s second round accreditation was granted in December 2000. As
discussed below, the Tennessee and Mississippi accreditation events occurred
in an environment of long- standing insurance solvency regulatory oversight
weaknesses.
In the 1980s, Martin Frankel worked in the securities industry. SEC
permanently banned him from the securities industry in 1992. Even prior to
his removal from the securities industry, he was setting up the mechanism to
move into the insurance industry. He allegedly gained secret control of a
small securities firm called Liberty National Securities (LNS), which in
1991, a year before his ban from the securities industry, he directed to
become registered with the state securities department in Tennessee. The
same year, he allegedly anonymously established an entity known as Thunor
Trust, using the names of nominee grantors as the apparent source of the
money. Thunor Trust then applied for regulatory approval from the Tennessee
Department of Commerce and Insurance, Division of Insurance, to purchase the
Franklin American Life Insurance Company, a small, financially weak insurer.
This application was subsequently approved. In this and all subsequent
interactions with insurers or with regulators, Mr. Frankel?s name was never
used. He allegedly operated by using aliases or through fronts.
From 1991 to 1999, Thunor Trust purchased six more insurance companies
domiciled in five additional states. All of the insurance companies owned by
Thunor Trust were managed out of the Franklin American headquarters in
Franklin, Tennessee, even though they continued to be domiciled for
regulatory purposes in the states of Mississippi, Oklahoma, Missouri,
Alabama, and Arkansas. The insurer bought by Thunor Trust in Alabama was
later redomesticated (moved) for regulatory purposes to Mississippi, even
though it continued to be operated out of Tennessee. Mr. Frankel
1 Insurance Regulation: Scandal Highlights Need for Strengthened Regulatory
Oversight
(GAO/ GGD- 00- 198, Sept. 19, 2000). Appendix I: Tennessee and Mississippi
Received Accreditation During and After Thefts Causing Company Insolvency
Appendix I: Tennessee and Mississippi Received Accreditation During and
After Thefts Causing Company Insolvency
Page 29 GAO- 01- 948 NAIC Accreditation Program
allegedly used the same scheme to loot each of the insurance companies.
After purchasing a company, Frankel removed the company?s assets from the
control of the insurance company, using LNS as a front. Shortly after Thunor
Trust purchased an insurer, the company?s assets would all be sold and
apparently replaced with government bonds purchased on the insurer?s behalf
by LNS, acting under the direction of Mr. Frankel who allegedly operated
using an alias. None of this activity involved the real LNS; rather, it was
carried out by a bogus LNS operated by Mr. Frankel out of his mansion in
Connecticut.
In actuality, the companies lost control of their assets when the money was
allegedly turned over to LNS. Mr. Frankel?s bogus company, using the name of
the firm he secretly controlled- that is, the real LNS- provided monthly
statement to each insurance company detailing a very active trading strategy
and showing the bonds that were supposedly bought and sold that month by LNS
as agent for the insurer. According to these statements, the bond trading
was profitable, and the profits were returned to the company. In fact, the
securities transactions shown on these statements did not happen. The
statements were fabrications. Allegedly, Mr. Frankel actually used the
company?s assets to (1) return phony profits to the company, (2) purchase
additional insurance companies- a necessary step to continue the fraud, and
(3) support his own lavish lifestyle. Ultimately, taxpayers, other insurers,
and certain policyholders will bear the losses resulting from the scam.
The first round accreditations for Tennessee and Mississippi occurred in
September 1994 and December 1994, respectively. After the $200 million theft
became public in May 1999, NAIC delayed its second round accreditation
review for Tennessee, scheduled for September 1999, at the request of the
Tennessee State Auditors because of their ongoing review of the Tennessee
Insurance Department triggered by the theft. In March 2000, Tennessee?s
accreditation was suspended for failing the financial analysis portion of
the review. Six months later, at Tennessee?s request, NAIC conducted an
additional accreditation review that resulted in reaccreditation of the
state in September 2000. NAIC also conducted a reaccreditation review of
Mississippi after the $200 million theft became public, resulting in
reaccreditation of Mississippi in December 2000.
Among other weaknesses in state regulatory oversight it exposed, the theft
uncovered weaknesses in chartering and change in ownership approvals, a key
phase of oversight for preventing undesirable individuals from controlling
insurance companies and insurer involvement in questionable business
strategies. The theft also showed that financial losses associated
Appendix I: Tennessee and Mississippi Received Accreditation During and
After Thefts Causing Company Insolvency
Page 30 GAO- 01- 948 NAIC Accreditation Program
with risks heightened by such weaknesses in oversight could be material,
leading to insurer failures and hundreds of millions of dollars in lost
insurer assets. Because the accreditation reviews discussed in this report
involved states closely involved with the scandal, an overview of our
findings regarding regulatory oversight weaknesses is included in table 1.
Appendix I: Tennessee and Mississippi Received Accreditation During and
After Thefts Causing Company Insolvency
Page 31 GAO- 01- 948 NAIC Accreditation Program
Table 2: Regulatory Oversight Weaknesses Identified by GAO in Our September
2000 Report Oversight phase Weakness Specific observations
Change in ownership approvals
Inadequate due diligence performed on buyer application data
Failure to act on ?red flags? associated with trust managed by a sole and
irrevocable trustee that left grantors with no control over money
Inadequate questioning of prospective buyers Inadequate tools and
procedures to validate individual?s regulatory or criminal backgrounds
Inability to readily access regulatory history data
Inability to access criminal history data on individuals Lack of
coordination between regulators within and outside the insurance industry
Failure to exchange insurance regulatory concerns among states on a timely
basis
Absence of an industry ?clearinghouse? of insurer application data
Inability to routinely access data from other financial regulators Routine
financial analyses Inadequate analysis of
securities investments
Inadequate state procedures and practices to flag high asset turnover
ratios and no use of thresholds to trigger additional scrutiny
Lack of NAIC policies, procedures, or practices to assess asset turnover
Insufficient securities expertise exhibited by insurance departments to
question unusual investment strategy
-Lack of NAIC consolidated financial analysis of affiliated insurers in
multiple states Ineffective mechanisms to safeguard and monitor control of
insurer?s securities held by another entity
Inconsistent and ineffective policies regarding appropriate asset
custodial relationships
Failure of insurance regulators to require from insurers sufficient
information to allow independent verification of legitimacy and
appropriateness of new custodians
Inadequate information collected annually to understand who had control of
the insurer?s assets Inadequate securities- related expertise and
information gathering
Lack of expertise to assess the viability of the insurer?s investment
strategy
Failure to obtain securities- related expertise from state securities
regulators or from contracted assistance
Lack of communication with state securities regulators to verify the
appropriateness and legitimacy of the broker- dealer On- site examinations
Failure to detect
misappropriation of assets
Failure of four completed exams on companies owned by Thunor Trust to
identify any material weaknesses
Inadequate examination guidelines and procedures to verify book- entry
securities that were not held by a depository institution
Inadequate assessment of highly unusual investment activities
Questionable ability of insurance examiners to assess securities- related
activities Inadequate practices and procedures to verify the legitimacy of
asset custodians
Inadequate efforts to independently validate the identity and
appropriateness of the asset custodian
Improperly executed custodial agreements not detected Limited sharing of
information and coordination among regulators
Lack of proactive alerts to warn other states of examination concerns so
as to deter scam from spreading
Lack of communication with securities regulators
Lack of coordinated on- site examinations for insurers in the same group
Source: GAO analysis of insurance regulatory data.
The report included recommendations to help prevent or detect similar
investment scams in insurance companies by proposing the adoption of
appropriate asset custody arrangements, improved asset verification
Appendix I: Tennessee and Mississippi Received Accreditation During and
After Thefts Causing Company Insolvency
Page 32 GAO- 01- 948 NAIC Accreditation Program
procedures, and the sharing of confidential regulatory information across
industries and agencies. In addition to the above recommendations emanating
from the Frankel matter, this report also contained a recommendation
designed to broaden and help sustain cooperation among regulators of
different financial services sectors.
NAIC and three affected states also conducted parallel reviews of the scam
and disclosed similar weaknesses along with recommendations for corrective
actions. In July 2001, we provided a status report on corrective actions
that NAIC, Tennessee, Mississippi, and Missouri have taken or are taking to
address recommendations contained in our September 2000 report to address
the regulatory oversight weaknesses. 2
2 Regulatory Initiatives of the National Association of Insurance
Commissioners,
(GAO- 01- 885R, July 6, 2001).
Appendix II: An Overview of the NAIC Accreditation Program
Page 33 GAO- 01- 948 NAIC Accreditation Program
Although the market for insurance is national in scope, with many companies
selling insurance in multiple, if not all, states, the state- by- state
system of insurance solvency regulation has traditionally been uneven.
Regulatory capacity has varied across states, and laws, regulations, and
practices have lacked uniformity. During the 1980s and early 1990s, a number
of insurance companies became insolvent, focusing attention on the
weaknesses of state insurance regulation and leading to speculation that the
federal government would take over regulatory responsibility. In February
1990, Congressman John Dingell released a report entitled ?Failed Promises:
Insurance Company Insolvencies? that increased speculation about the
imminent federal takeover. The National Association of Insurance
Commissioners (NAIC), governors, and state legislatures realized that in
order to preserve state regulatory authority, something had to be done to
address the regulatory inconsistencies. NAIC had previously formed a special
committee to address state regulation of insurance companies and devise an
accreditation program. In 1989, NAIC formulated the Financial Regulation
Standards (Standards) that would form the basis of the accreditation
program, and in 1990 it implemented the program itself. Since the program
began, the number of accredited states has grown to 47 and the District of
Columbia.
The accreditation program is designed to make monitoring and regulating the
solvency of multistate insurance companies easier by ensuring that states
adhere to the NAIC?s standards, which establish the basic recommended
practices for an effective regulatory department. To be accredited, states
must show that they have solvency laws and regulations that protect
insurance consumers; effective, efficient financial analysis and examination
processes; and appropriate organizational and personnel practices. A team
from NAIC examines state insurance departments that are seeking
accreditation for compliance with the Standards. NAIC?s Financial Regulation
Standards and Accreditation Committee (FRSAC), which comprises regulators
from across the country, decides whether states are in compliance and
provides additional guidance to those that are not.
States must be accredited every 5 years, and NAIC makes annual interim
evaluations of Self- Evaluation Guides submitted by the states. The program
uses a scoring system that ranges from a low of 0 (unacceptable) to a high
of 5 (excellent). Insurance departments are examined for compliance with all
three categories of Standards: Part A (laws and Appendix II: An Overview of
the NAIC
Accreditation Program How the Accreditation Program Works
Appendix II: An Overview of the NAIC Accreditation Program
Page 34 GAO- 01- 948 NAIC Accreditation Program
regulations), Part B (regulatory practices and procedures), and Part C
(organizational and personnel practices).
The purpose of this set of standards is to ensure that states have
sufficient authority to regulate the solvency of multistate domestic
insurers. To meet the requirements of Part A, state legislatures must adopt
all of NAIC?s 18 model laws (or versions that are substantially similar) and
have authorized the state insurance regulators to implement appropriate
regulations. The required laws and regulations cover a range of issues as
detailed in table 1. Part A: Laws and
Regulations
Appendix II: An Overview of the NAIC Accreditation Program
Page 35 GAO- 01- 948 NAIC Accreditation Program
Table 3: Accreditation Standards for Laws and Regulations Subject area
Description
1. Examination Authority The Department should have authority to examine
companies with complete access to all books and records, including the
records of any affiliated companies, and to examine officers, employees, and
agents of the company under oath. 2. Capital and Surplus Requirement The
Department should have the ability to require that insurers have and
maintain a
minimum level of risk based capital and surplus to transact business and the
authority to require additional capital and surplus based upon the type,
volume and nature of insurance business transacted. 3. NAIC Accounting
Practices and Procedures The Department should require that all companies
reporting to the Department file the
appropriate NAIC annual statement blank, which should be prepared in
accordance with the NAIC?s instructions handbook and accounting practices
and procedures manual. 4. Corrective Action State law should authorize the
Department to order a company to take necessary
corrective action or cease and desist certain practices that, if not
corrected, could place the company in a hazardous financial condition. 5.
Valuation of Investments The Department should require that securities owned
by insurance companies be valued
in accordance with those standards promulgated by NAIC. 6. Holding Company
Systems State law should contain the NAIC Model Insurance Holding Company
System Regulatory
Act or an act substantially similar, and the Department should have adopted
NAIC?s model regulation relating to this law. 7. Risk Limitation State law
should prescribe the maximum net amount of risk to be retained by a property
and liability company for an individual risk, based upon the company?s
capital and surplus. 8. Investment Regulations State statute should require
a diversified investment portfolio for all domestic insurers both
as to type and issue and include a requirement for liquidity. 9. Liabilities
and Reserves State statute should prescribe minimum standards for the
establishment of liabilities and
reserves resulting from insurance contracts issued by an insurer. 10.
Reinsurance Ceded State law should contain the NAIC Model Law on Credit for
Reinsurance Model Regulation
and the Life and Health Reinsurance Agreement Model Regulation or
substantially similar laws. 11. CPA Audits State statute or regulation
should contain a requirement for annual audits of domestic
insurance companies by independent certified public accountants. 12.
Actuarial Opinion State statute or regulation should contain a requirement
for an opinion on reserves and
loss and loss adjustment expense reserves by a qualified actuary or
specialist on an annual basis for all domestic insurance companies. 13.
Receivership State law should set forth a receivership scheme for the
administration, by the insurance
commissioner, of insurance companies found to be insolvent, as set forth in
NAIC?s Insurers Rehabilitation and Liquidation Model Act. 14. Guaranty Funds
State law should provide for a regulatory framework, such as that contained
in NAIC?s
model acts on the subject, to ensure the payment of policyholders?
obligations, subject to appropriate restrictions and limitations when a
company is deemed insolvent. 15. Filings With NAIC State statute, regulation
or practice should mandate filing of annual and quarterly
statements with NAIC. 16. Producer- Controlled Insurers States should
provide evidence of a regulatory framework, such as that contained in
NAIC?s model act on the subject or similar provisions. 17. Managing General
Agents Act States should provide evidence of a regulatory framework, such as
that contained in
NAIC?s model act on the subject or similar provisions 18. Reinsurance
Intermediaries Act States should provide evidence of a regulatory framework,
such as that contained in
NAIC?s model act on the subject or similar provisions. Source: Financial
Regulation Standards and Accreditation Program, June 2001.
Appendix II: An Overview of the NAIC Accreditation Program
Page 36 GAO- 01- 948 NAIC Accreditation Program
The Part B standards, regulatory practices and procedures, are recommended
practices designed to ensure that states have the necessary resources and
capabilities to conduct financial analyses and examinations of firms
operating within its jurisdiction. The standards cover the three areas
considered necessary for effective solvency regulation: financial analysis,
financial examinations, and communication with states and procedures for
troubled companies (see table 2). To be accredited, states must attain an
average score of 3 in both financial analysis and examinations. Part B:
Regulatory
Practices and Procedures
Appendix II: An Overview of the NAIC Accreditation Program
Page 37 GAO- 01- 948 NAIC Accreditation Program
Table 4: Accreditation Standards for Regulatory Practices and Procedures
Subject area Description
1. Financial Analysis (a) Sufficient Qualified Staff and Resources The
Department should have the resources to review effectively, on a periodic
basis, the
financial condition of all domestic insurers. (b) Communication of Relevant
Information to/ From Financial Analysis Staff
The Department should ensure that relevant information and data received by
the Department, which could assist in the financial analysis process, is
provided to the financial analysis staff, and that findings of the financial
analysis staff are communicated to the appropriate person( s). (c)
Appropriate Supervisory Review The Department?s internal financial analysis
process should provide for appropriate
supervisory review and comment. (d) Priority- Based Review The Department?s
financial analysis procedures should be priority- based to ensure that
potential problem companies are reviewed promptly. (e) Appropriate Depth of
Review The Department?s financial analysis procedures should ensure that
domestic insurers
receive an appropriate level or depth of review commensurate with their
financial strength and position. (f) Documented Analysis Procedures The
Department should have documented financial analysis procedures and/ or
guidelines to provide for consistency and continuity in the process and to
ensure that appropriate analysis procedures are being performed on each
domestic insurer. (g) Reporting of Material Adverse Findings The
Department?s procedures should require that all material adverse indications
be
promptly presented to the commissioner or an appropriate designee for
determination and implementation of appropriate regulatory action. (h)
Action on Material Adverse Findings Upon the reporting of any material
adverse findings from the financial analysis staff, the
Department should take timely action in response to such findings or
adequately demonstrate the determination that no action was required. 2.
Financial Examinations (a) Sufficient Qualified Staff and Resources The
Department should have the resources to effectively examine all domestic
insurers
on a periodic basis in a manner commensurate with the financial strength and
position of each insurer. (b) Communication of Relevant Information to/ From
Examination Staff The Department should provide relevant information and
data received by the
Department, which may assist in the examination process, to the examination
staff and ensure that findings of the examination staff are communicated to
the appropriate person( s). (c) Use of Specialists The Department?s
examination staff should include specialists with appropriate training
and/ or experience or otherwise have access to available qualified
specialists, which will permit the Department to effectively examine any
insurer. (d) Appropriate Supervisory Review The Department?s procedures for
examinations should provide for supervisory review of
examination workpapers and reports. (e) Use of Appropriate Guidelines and
Procedures The Department?s policies and procedures for the conduct of
examinations should
generally follow those set forth in NAIC?s Examiners Handbook. Appropriate
variations in methods and scope should be commensurate with the financial
strength and position of the insurer. (f) Scheduling of Examinations In
scheduling financial examinations, the Department should follow procedures
such as
those set forth in NAIC?s Examiners Handbook that provide for the periodic
examination of all domestic companies on a timely basis. This system should
accord priority to companies that exhibit adverse financial trends or
otherwise demonstrate a need for examination. (g) Examination Reports The
Department?s reports of examination should be prepared in accordance with
the
format adopted by NAIC and should be sent in a timely fashion to other
states in which the insurer transacts business.
Appendix II: An Overview of the NAIC Accreditation Program
Page 38 GAO- 01- 948 NAIC Accreditation Program
Subject area Description
(h) Reporting of Material Adverse Findings The Department?s procedures
should require that all material adverse findings be
promptly presented to the commissioner or an appropriate designee for
determination and implementation of appropriate regulatory action. (i)
Action on Material Adverse Findings Upon the reporting of any material
adverse findings from the examination staff, the
Department should take timely action in response to such findings or
adequately demonstrate the determination that no action was required. 3.
Communication With States and Procedures for Troubled Companies (a)
Communication With States States should allow for the sharing of otherwise
confidential information, administrative
or judicial orders, or other action with other state regulatory officials
providing that those officials are required, under their law, to maintain
its confidentiality. This policy should also include cooperation and sharing
information with respect to domestic companies subject to delinquency
proceedings. (b) Procedures for Troubled Companies The Department should
generally follow and observe procedures set forth in NAIC?s
Troubled Insurance Company Handbook.
Source: Financial Regulation Standards and Accreditation Program, June 2001.
The Part C standards, organizational and personnel practices, are intended
to ensure that the staff of state insurance departments have the appropriate
skills and training to promote effective regulatory practices. The standards
cover professional development, minimum educational and experience
requirements, and personnel retention as detailed in table 5. These
standards are not scored; instead, the review team provides comments to the
state insurance department officials.
Table 5: Accreditation Standards for Organizational and Personnel Practices
Subject area Description
1. Professional Development The Department should have a policy that
encourages the professional development of staff involved with financial
surveillance and regulation. 2. Minimum Educational and Experience
Requirements The Department should establish minimum educational and
experience requirements for
all professional employees and contractual staff positions in the financial
regulation and surveillance area. 3. Retention of Personnel The Department
should have the ability to attract and retain qualified personnel for those
positions involved with financial surveillance and regulation. Source:
Financial Regulation Standards and Accreditation Program, June 2001.
States request an accreditation or reaccreditation review by contacting
NAIC, which requires them to first fill out a ?Self- Evaluation Guide.? This
guide allows the state to assess itself against the detailed requirements of
the Standards. The chair of FRSAC selects a review team of three to six
contract examiners and appoints a review team leader. NAIC sends the names
of the review team to the state, which can challenge any member. In this
case, NAIC and the state negotiate until a new team is selected. Part C:
Organizational and
Personnel Practices How Accreditation Reviews Are Conducted
Appendix II: An Overview of the NAIC Accreditation Program
Page 39 GAO- 01- 948 NAIC Accreditation Program
Once the review team is established, NAIC and the state schedule the visit.
Generally, a site visit requires 3 to 5 days, depending on the size of the
department. NAIC sends copies of the state?s completed Financial Regulation
Standards Self- Evaluation Guide, with any applicable supporting
documentation, to the review team and tells the state what the team will
need for its review. Prior to the on- site review, the state can request an
abbreviated review (? pre- review?) by an NAIC official in order to learn
about any improvements that need to be made.
The review team follows a set of procedural guidelines that are designed to
make the evaluation process uniform across states. Before the on- site
review, team members meet to discuss comments and concerns raised by the
Self- Evaluation Guide and supporting documentation. During the onsite
review itself, the team examines compliance with laws and regulations;
assesses examination reports (usually six), supporting work papers, and
interviews; inspects financial analysis and regulatory files for a sample of
companies (usually 12); interviews department personnel and reviews
organizational and personnel practices; and does a walk- through of the
department. Once they have completed these tasks, the team members meet to
discuss their findings and vote on a score for whether the state is in
compliance with NAIC?s accreditation standards addressing regulatory
practices and procedures. The team then holds a closing conference with the
state and provides a copy of the scores and draft copies of the compliance
report and other material, including the management letter addressed to the
insurance department. After the site visit, the review team submits its
report, a compliance report, and management letter comments to FRSAC. The
reports summarize the procedures performed during the site visit, document
the findings, highlight major recommendations, and recommends that
accreditation be approved or suspended.
FRSAC meets quarterly at the NAIC national meetings to discuss the
accreditation reviews from the previous 3 months with team leaders,
representatives of the states applying for accreditation, and the NAIC
observers. FRSAC members will have reviewed the self- evaluation guides and
supporting documents from each review, and team leaders present their
reports and recommendations. FRSAC may also query the state insurance
department representatives. On the basis of the review team?s recommendation
and the meeting, FRSAC decides whether the state should be accredited,
reaccredited, or have its accreditation suspended. If On- Site Review
Procedures FRSAC?s Evaluation Process
Appendix II: An Overview of the NAIC Accreditation Program
Page 40 GAO- 01- 948 NAIC Accreditation Program
suspended, a state can apply for another accreditation review at a later
date.
While states must undergo the full review process every 5 years in order to
maintain accreditation, they may be subject to a special review if FRSAC
receives information suggesting that a state may no longer meet the
Standards. FRSAC then determines whether the state?s accreditation should be
suspended or revoked. The state has the right to appeal the decision.
The annual reviews take place on the anniversary of the initial
accreditation. For these reviews, states submit an updated self- evaluation
guide. For the first annual review, states must also respond to any
recommendations made during the initial accreditation review. NAIC reviews
these materials and summarizes them for FRSAC. FRSAC then determines whether
the state remains in compliance. The state has the right to appeal a
negative decision.
Appendix III: Comments From the National Association of Insurance
Commissioners
Page 41 GAO- 01- 948 NAIC Accreditation Program
Appendix III: Comments From the National Association of Insurance
Commissioners
Appendix III: Comments From the National Association of Insurance
Commissioners
Page 42 GAO- 01- 948 NAIC Accreditation Program
Appendix III: Comments From the National Association of Insurance
Commissioners
Page 43 GAO- 01- 948 NAIC Accreditation Program
Appendix III: Comments From the National Association of Insurance
Commissioners
Page 44 GAO- 01- 948 NAIC Accreditation Program
Appendix III: Comments From the National Association of Insurance
Commissioners
Page 45 GAO- 01- 948 NAIC Accreditation Program
Appendix IV: GAO Contacts and Staff Acknowledgments Page 46 GAO- 01- 948
NAIC Accreditation Program
Richard J. Hillman, (202)- 512- 8678 Lawrence D. Cluff, (202) 512- 8678
In addition to those named above, James R. Black, Emily Chalmers, Thomas H.
Givens III, Barry A. Kirby, LaSonya Roberts, and Desiree W. Whipple made key
contributions to this report. Appendix IV: GAO Contacts and Staff
Acknowledgments GAO Contacts Acknowledgements
(250013)
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