State Examinations

1. State Examinations Have No Fear, Help is Here

2. Risk-Focused Financial Condition Exams • NAIC mandated for state insurance departments beginning 1/1/2010 • Goal is to identify solvency issues earlier • Compliance with laws and regulations

3. Risk-Focused Financial Condition Exams Difference between former approach and risk-focused approach • Former approach: Find material misstatements through detailed testing of account balances • New approach: Evaluate effectiveness of risk management function; conduct testing in areas with high residual risk

4. Risk-Focused Financial Condition Exams

5. Pre-Examination Phase Review recent financial examination reports released by your state’s department of insurance • Available on states’ websites • Findings may be similar from company to company • Evaluate your company’s compliance relative to these findings

6. Pre-Examination Phase Familiarize yourself with the NAIC’s Financial Condition Examiner’s Handbook • Examination repositories (control listings) • Sample interview questions • Exam planning questionnaires

7. Pre-Examination Phase • Update/create process documentation including IT and corporate governance functions • Consider whether controls are evidenced

8. Risk-Focused Financial Condition Exams Phase 1: Understand company and identify key functional activities • Corporate governance • Audit function • Risk management program • Key business processes/units • Prospective risks

9. Risk-Focused Financial Condition Exams Corporate governance – “Tone at the Top” • Competency • Independence • Code of conduct • Involvement in risk management

10. Risk-Focused Financial Condition Exams Audit function • Independent • Maintain or improve effectiveness of risk management function • Assure accuracy and completeness of financial reporting • Operational effectiveness

11. Risk-Focused Financial Condition Exams Risk management program • Active board oversight • Adequate processes, monitoring and management • Clear policies, authorization limits and procedures • Comprehensive internal controls • Compliance with laws and regulations

12. Risk-Focused Financial Condition Exams Key business process/units • Activities and sub-activities • Information technology • Third party relationships • SSAE 16 reports

13. Risk-Focused Financial Condition Exams Prospective risks • Asset liability matching • Loss reserve development • Pricing and underwriting • Reinsurance • Growth, earnings • Capital adequacy • Other business risks

14. Risk-Focused Financial Condition Exams Phase 2: Identify and assess inherent risks • C-level interviews • Financial and environmental review • IT risk assessment • Likelihood of occurrence and significance of impact

15. Risk-Focused Financial Condition Exams C-level interviews • Tone at the top • Risk areas • Corporate strategy

16. Risk-Focused Financial Condition Exams Prepare for C-level interviews • Circulate sample questions in advance • Consistent message

17. Risk-Focused Financial Condition Exams Financial and environmental review • Environmental pressures • Key solvency risks

18. Risk-Focused Financial Condition Exams Assess IT risk • Quality and integrity of information • Access controls • Application controls • Availability of information • Security • Recoverability and business continuity

19. Risk-Focused Financial Condition Exams Likelihood of occurrence and magnitude of impact • Percent of surplus • Material rating agency downgrade • Impact on reputation • Board and/or senior management attention

20. Risk-Focused Financial Condition Exams Phase 3: Identify and evaluate risk mitigation strategies/controls • Management oversight • Risk management program • Policies and procedures • Control monitoring • Compliance evaluation

21. Risk-Focused Financial Condition Exams Management oversight and risk management program • Evaluated during Phase I • Impacts activity-level controls

22. Risk-Focused Financial Condition Exams Policies and procedures • Comprehensive and documented? • Followed?

23. Risk-Focused Financial Condition Exams Control monitoring • Compare to commonly accepted standard • Perform control testing • Reliance on external auditor’s work • Evaluate control design and effectiveness

24. Risk-Focused Financial Condition Exams Compliance evaluation • Test control procedures

25. Risk-Focused Financial Condition Exams Phase 4: Determine residual risk Phase 5: Conduct exam procedures Phase 6: Update prioritization Phase 7: Draft examination report and management letter

26. Overview of Phases 4-7 • Examiners consider the results of the control testing and then apply professional judgment to determine whether the residual risk in each business cycle is high, moderate or low • High residual risk = Substantive, more detailed tests • Moderate risk = Some substantive tests and analytical procedures • Low residual risk = Few, if any, substantive tests. Mostly high level analytical procedures

27. Overview of Phases 4-7 Manage examination process using best practices • Provide information in a complete and timely manner • Participate in regular update meetings with examiners • Carefully review exam report and management letter for accuracy

28. Risk-Focused Financial Condition Exams

29. Contact Information Marc Smith, CPA, CPCU Partner Johnson Lambert LLP msmith@johnsonlambert.com Kellie S. Mixon Director of Finance New Mexico Mutual KellieM@NewMexicoMutual.com Janet Byrne, CPA Sr. Financial Controls Analyst Pinnacol Assurance Janet.byrne@pinnacol.com