July 2009

Greetings!

The continuing economic situation and related investigations into whom or what may have caused or exacerbated its impacts are triggering increasing calls for changes in business practices and in regulation alike. The Obama Administration’s recently-released proposal for regulatory reforms is a key, but not yet determinative, point of view about necessary changes. The role of accounting standards is also being questioned, and has piqued the interest of legislators on Capitol Hill and around the globe. Other changes are also coming to the Medicare market, as well as to insurers who must now comply with new financial reporting and internal control reporting requirements.

Invotex® Group is pleased to share insights about these and other current matters of interest to the insurance industry and the regulatory communities. We welcome your feedback and invite you to share Insurance Perspectives with your colleagues and business acquaintances.

Tom Finnell
Managing Director 

Jim Stangroom
Managing Director

In this Issue

1. Insurance Regulatory Reforms - Much Ado About Nothing?
2. No Rest for the Weary: SOX-Compliant Insurers Face New Statutory Reporting Requirements
3. Potential Shakeout in the Medicare Advantage Market
4. IFRS: Accounting for the Politics
5. Upcoming Speaking Engagements

Insurance Regulatory Reforms - Much Ado About Nothing?
by Tom Finnell

Much attention has recently been focused on the Obama administration’s blueprint for Financial Regulatory Reform. The release of the 88-page document by the Department of the Treasury on June 17, 2009 quickly eclipsed news of developments from the NAIC’s Summer National Meeting, which had concluded in Minneapolis only a day earlier.

For the most part, those who earn their living in or around the insurance industry appear to remain largely unscathed by the administration’s proposal. Even the NAIC “commend[ed] President Obama and the Treasury for proposing a plan to help improve stability and supervision of the financial sector, while preserving the role of states as regulators of insurance.”

Nonetheless, we are only at the outset of another long road towards reform. If recent news and market conditions are any sign, the economy is still far from recovery. As developments continue to emerge, support for various reforms will ebb and flow. For example, even the notion of anointing the Fed with powers as a national systemic risk regulator is now in jeopardy as Congress wrestles with whether the Fed may have strong-armed bail-outs of large firms. In the oft-quoted words of Winston Churchill, this may be only, “perhaps, the end of the beginning.”

The administration’s proposal does not overtly support a federal role that would usurp state powers of insurance regulation. However, the language does provide for more consideration and the application by Treasury of various principals which nonetheless could eventually lead down that path. For example, the proposal states that “if additional insurance regulation would help to further reduce systemic risk or would increase integration into the new regulatory regime, we will consider those changes.”

With respect to insurance regulation, the following provisions of the proposal are noteworthy:

• The paper supports the creation of an Office of National Insurance within Treasury, and would provide for heightened consolidated supervision and regulation of any financial firm whose failure could pose a threat to financial stability.
• The recent failure of AIG was clearly on the minds of the proposal’s authors who provided that “any new regulatory regime must address the current gaps in insurance holding company regulation.”
• A Financial Services Oversight Council would be created to facilitate information sharing and coordination, identify emerging risks –  including about firms whose failure could pose a threat to financial stability – and provide a forum for resolving jurisdictional disputes between regulators. The Council would comprise various federal agency regulators, but no provision was made in the proposal for representation on the Council either by the Office of National Insurance, by the NAIC, or by any states through their insurance regulators.
• A new Consumer Financial Protection Agency (CFPA) would be created to oversee consumer protection regulations, to reduce gaps in federal supervision and enforcement, improve coordination with the states, set higher standards for financial intermediaries, and promote consistent regulation of similar products. We note that industry trade groups and the NAIC generally are against such a new federal agency, contending that the states perform effectively in the consumer protection area with regard to insurance products.
• The paper notes that state regulation of insurance “has led to a lack of uniformity and reduced competition across state and international boundaries.” While the proposal did not go so far as to take a position for the concept of an Optional Federal Charter as was previously supported by certain industry trade organizations, it did leave that door open by adopting the principal of “increased national uniformity through either a federal charter or effective action by the states.”

Current events with regard to proposed insurance regulatory reforms remind us of the old adage that the more things change the more they seem to stay the same. The threat of federal regulation was effective during the early 1990s in prodding state-based reforms with the help of the NAIC.  Like then, the onus appears to once again be on the states and the NAIC to make further inroads with respect to uniform and effective regulation in order to avoid a stronger and more direct federal role in insurance regulation. In that regard, we note that much is already underway at the NAIC, which has an aggressive Solvency Modernization Initiative of its own.

We will continue to report on further developments at both the federal and state levels in future editions of Insurance Perspectives.

For more information, contact Tom Finnell.

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No Rest for the Weary: SOX-Compliant Insurers Face New Statutory Reporting Requirements
by Tom Finnell and Jim Morris

Large SEC registrants have devoted substantial resources towards achieving compliance with the internal control reporting requirements of the Sarbanes Oxley Act (SOX) since its passage in 2002. Readiness efforts for initial year-end 2004 filings were extraordinary, but it didn’t end there. Much effort has since been expended by companies in “right-sizing” the effort to take advantage of more recent SEC and PCAOB guidance and to make the overall annual effort more efficient and risk-focused. Nonetheless, their efforts aren’t over yet.

Now comes the NAIC’s Annual Financial Reporting Model Regulation (AFRMR), which imposes on all insurers – including larger non-public entities such as mutuals – requirements that in some respects are similar to SOX. It does so in a manner that aims to minimize incremental efforts on the part of insurers that are already SOX-compliant. Nonetheless, such SOX-compliant insurers should read the fine print because additional work may be required, and it could be significant.

The AFRMR is a re-write of the NAIC’s former Model Audit Rule, the latter having previously focused on requiring insurers to obtain an independent audit and the related responsibilities, both for insurers as well as their auditors. The genesis of the new regulation dates back to the period immediately following the passage of SOX; the NAIC compared the provisions of the former Model Audit Rule to SOX and highlighted several areas that the model was lacking in comparison. These included provisions relating to governance, independence of the independent auditor, and reporting on internal controls. After much debate, such provisions were added as part of the new AFRMR and approved by the NAIC. [For more information, see article by Tom Finnell published by the National Association of Mutual Insurance Companies]. See the attached exhibit for a summary of the AFRMR provisions and how they compare with SOX.

The AFRMR treads lightly on insurers that are already compliant with SOX. However, it recognizes that there may be financial reporting areas that are material to the company and that may not have been covered by the insurer’s SOX-related efforts which are focused on consolidated GAAP reporting. Examples may include the following:

• Areas unique to statutory accounting practices (SAP), such as statutory life reserves, which are valued differently and often use different systems for SAP v. GAAP.
• Areas that may not be material at the consolidated level, which is the focus of SOX, but that are material at a legal entity level for an insurance subsidiary.
• Accounts that are eliminated in consolidation and therefore ignored for SOX but that are nonetheless material at the legal entity level, such as intercompany reinsurance balances.

Having finally institutionalized the SOX reporting process to a more efficient level, public insurers should nonetheless be cognizant of areas such as those above that may have escaped the scope of their SOX efforts but nonetheless are required to be covered by the AFRMR. They should assess gaps between their SOX- and AFRMR-required coverage for reporting on internal controls and perform documentation and testing as required. Time will run out this year and, if not addressed, the new AFRMR requirements can expose SOX-compliant insurers to additional compliance and regulatory risks.

For more information, contact Tom Finnell or Jim Morris.

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Potential Shakeout in the Medicare Advantage Market
by Kerby Baden

The recent announcement by the Centers for Medicare and Medicaid Services (“CMS”) that Medicare Advantage plan reimbursements will be shaved by more than 4% beginning in 2010 is causing insurers to rethink their future plans and their willingness to offer the product to seniors going forward. Click here for the CMS press release.

Medicare Advantage plans allow the disabled and elderly to receive benefits administered through a private health insurer.  Offering insurers generally provide higher benefit levels than those under traditional Medicare plans and, in turn, receive a government subsidy.  Under a Medicare Advantage plan, government payments are made to insurers to manage members’ care rather than being made to physicians and hospitals directly. In the past several years, Medicare Advantage plans have come under fire due to their higher cost levels relative to other Medicare offerings.

CMS’ announcement clearly confirms the Obama Administration’s intent to rein in the cost of privately-administered Medicare plans, which currently provide benefits to more than 10 million Medicare beneficiaries.  The planned reduction in reimbursement rates promises to be just the beginning of a developing Administration agenda to overhaul the financing of health care in the U.S.

Several large health insurers have already opted to exit Medicare Advantage lines of business. For example, Coventry Health Care, Inc. and WellCare Health Plans, Inc. have both announced that they will not renew their contracts with CMS for Medicare Advantage Private Fee-For-Service (PFFS) products in 2010.  These two insurers alone covered more than 400,000 enrollees under their Medicare Advantage plans. In a Form 8-K filed with the Securities and Exchange Commission on May 5, 2009, Coventry disclosed that it “considered a number of factors in determining to not renew its PFFS product, including the profitably of this product in light of federal reimbursement rates and medical cost trends….”

As such large insurers who benefit from size and scale find that future terms for Medicare Advantage PFFS products are an insufficient inducement to put capital at risk, smaller insurers may be even more hard pressed to stay the course. And unlike their larger brethren, smaller insurers may not have as many alternatives to replace lost Medicare Advantage revenues and profits, at least not without substantial start-up costs and related risks.

For more information, contact Kerby Baden.

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IFRS: Accounting for the Politics
by Tim Foley

Accounting, considered by some an arcane art left to technically-minded auditors and financial managers, is increasingly becoming political fodder on both sides of the pond. Last fall, a member of the European Commission threatened to introduce legislation that would override the International Accounting Standards Board (IASB) if it did not change rules under International Financial Reporting Standards (IFRS) to address what the member perceived as an inequity between IFRS and U.S. GAAP. A gun to its head, the IASB relented.

More recently this spring, a U.S. Congressman and powerful committee chairman threatened that the body should “act itself” if the FASB did not move faster to offer clarifying guidance to the industry. Lo and behold, FASB did so move, releasing such guidance in short order thereafter.

What could possibly interest such powerful politicians and cause them to intervene in such arcane matters? The answer: current value accounting and its impact on the reported financial position by companies during the recent financial crisis.

Last October, and with the credit crunch well under way and the markets for many typically liquid assets all but gone, the FASB sought to clarify aspects of FAS 157 that dealt specifically with asset valuations within inactive markets.  It responded by issuing FSP FAS 157-3 which provided, in part, that “in determining fair value for a financial asset, the use of a reporting entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates is acceptable when relevant observable inputs are not available.” This was welcome news to many practitioners as well as financial institutions in the U.S. who were faced with unprecedented levels of actual and potential asset impairments. 

Across the Atlantic, this news was instead met with much concern. In early October, the European Commission met in Paris with leaders of Britain, France, Germany and Italy to discuss the worldwide financial crisis.  One objective, as stated in its press releases was to ensure that European Banks would not face a competitive disadvantage relative to the United States “in terms of their accounting rules and their interpretation” – a direct response to the FAS 157-3, interpreted as softening fair value accounting rules.

What occurred next was stunning. Recognizing that all accounting rules must be adopted as legislation by the EU, the Commission stated its intention to remove the existing fair value standards, leaving nothing in its place, if the IASB did not counter the FASB’s action with comparable guidance of its own. The IASB and its Chairman, Sir David Tweedie, acquiesced, citing a lack of time and little choice but to cede to the Commission on the issue. The result: better than expected results reported by a number of EU-regulated financial institutions, but also a big dent in the credibility of the IASB – just as it appeared to be on the verge of assuming the post as the independent world-wide accounting standard setter. 

For those who think such political heavy-handedness could never happen in the U.S., fast-forward to this past spring. Lawmakers from both parties took turns criticizing the FASB as well as the SEC and the Office of the Comptroller of the Currency for not moving fast enough to offer more guidance amid the market turmoil. Some of the lawmakers, including the panel's chairman, threatened to intervene with legislation if progress wasn't made soon. "If the regulators and standard setters do not act now to improve the standards, then the Congress will have no other option than to act itself," said House Financial Services Capital Markets Subcommittee Chairman Paul Kanjorski (D., Pa.).” So it may have been no surprise when, on March 12, 2009, the Wall Street Journal reported that, “after facing a barrage of criticism…, the chairman of the Financial Accounting Standards Board (Robert Herz) told a U.S. House panel that he will work to expedite issuing guidance to companies on the application of mark-to-market rules.”

The result?  The FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” The statement provides guidelines for making fair value measurements more consistent with the principles presented in FASB Statement No. 157, “Fair Value Measurements.” In short, FAS 157-4 allows management to employ more judgment in the application of FAS 157, although the FASB considers this to be merely a clarification.  The FASB and IASB continue to seek a final, joint solution to these reporting issues. Last month, the IASB published draft guidance on fair value measurement that is part of its long-term program to achieve convergence between U.S. GAAP and IFRS on this topic.

These events suggest that both the IASB and the FASB have implemented rather quick and patchwork amendments to existing standards largely at the behest of industry and pressured by government officials, and the credibility of both has taken some hits.

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Upcoming Speaking Engagements

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