Financial Oversight Update

1. Casualty Actuarial Society Casualty Loss Reserves Seminar September 14, 2004 Financial Oversight Update Kris DeFrain, FCAS, MAAA NAIC Property & Casualty Actuary National Association of Insurance Commissioners

2. Overview • State of the Industry • Financial Analysis • Examination White Paper • Risk-Focused Examinations • Other Solvency Issues © 2004 National Association of Insurance Commissioners

3. How many P/C insolvencies a year?

4. Trend of P&C InsolvenciesAs of April 2004 © 2004 National Association of Insurance Commissioners

5. Financial Analysis

6. Data/Information Sources • Annual & Quarterly Statements • Management’s Discussion & Analysis Letters • Independent Auditors Reports • Actuarial Reports • RBC Report • Holding Company Filings • Securities and Exchange Commission Filings • Rating Agency Reports/Actions © 2004 National Association of Insurance Commissioners

7. Ratio AnalysisP/C Insurers Focus • Profitability • Leverage • Asset and Liquidity • Cashflow/Surplus © 2004 National Association of Insurance Commissioners

8. Characteristics Ownership Writings Age Growth  Deficient Reserves  Inadequate Pricing  Rapid Growth  Overstated Assets  Fraud  Change in Business  Reinsurance Failure  Catastrophic Losses Characteristics and CausesP/C Insurers © 2004 National Association of Insurance Commissioners

9. Gross Prem. Written/ Surplus Net Prem. Written/ Surplus Chg. In Net Writings Surplus Aid/Surplus Change in Combined Ratio Investment Yield Re Recoverables to Surplus Change in Surplus Liabilities to Liquid Assets Gross Agents’ Balances/Surplus Affiliated Assets to Surplus 2 Yr. Reserve Development/Surplus Reserves to Surplus Cashflow from Operations Ratio Analysis P/C Insurers © 2004 National Association of Insurance Commissioners

10. Examination Oversight Task Force

11. Examination White Paper • White paper submitted to the NAIC from seven trade associations requesting the NAIC to address the following areas: • Examination fees • Enhanced coordination with CPAs • Training for regulators © 2004 National Association of Insurance Commissioners

12. Examination White Paper “A Call for Change” • Recommendations Report adopted at the Spring National Meeting • Referrals & proposals distributed to numerous working groups and task forces © 2004 National Association of Insurance Commissioners

13. Recommendations Report • Enhance the Zone Examination Process • Referral to the FEHTG and ASWG • Develop Procedures for the Utilization and Monitoring of Consultants and Contract Examiners • Referral to the FEHTG • Enhance examination process with technology • Refer to the Audit Software Working Group © 2004 National Association of Insurance Commissioners

14. Recommendations Report • Increase level of cooperation provided by company during a regulatory examination • Refer to the EOTF and ASWG • Improve effectiveness of examination planning • Refer to the FEHTG and IHCWG • Increase coordination of group-wide examinations • Refer to the IHCWG © 2004 National Association of Insurance Commissioners

15. Recommendations Report • Improve the level of coordination between external auditors and regulators • Refer to the NAIC/AICPA WG • Develop and document the process for accelerating statutory due date • EOTF • Communicate with Audit Committees • Refer to NAIC/AICPA WG and FEHTG © 2004 National Association of Insurance Commissioners

16. Recommendations Report • Eliminate the 20% Retesting of CPA work • FEHTG completed in March 2003 • Increase Use of Interim External Auditor Workpapers • Refer to NAIC/AICPA WG and FEHTG • Develop Enhanced Training Program for Examiners • Refer to FEHTG and EOTF • Continue Development of Risk Assessment Process © 2004 National Association of Insurance Commissioners

17. Coordination Among States • Enhance coordination among states • Promote the Insurance Regulatory Modernization Action Plan • Implement Recommendations in response to the industry’s Examination White Paper • Reduce travel time and cost to states © 2004 National Association of Insurance Commissioners

18. Financial Condition (E) Committee 2004 Projects

19. Federal Tools • NAIC Framework for a National System of State-Based Regulation • Developed in partnership with the House Financial Services Committee • Focus upon modernization and uniformity • NAIC Roadmap © 2004 National Association of Insurance Commissioners

20. Federal Tools • Financial Focus • Surplus Lines • Reinsurance • Receivership • Enhancing Financial Surveillance • Permitted Practices • Institute National Practices • Meetings with Insurers • Corporate Governance • Administrative Supervision © 2004 National Association of Insurance Commissioners

21. Federal Tools • Financial Focus • Enhancing Financial Surveillance • Standardize financial surveillance regarding affiliated insurers • Coordinate on-site examination scheduling • Standardize the exchange of information on affiliated insurers • Lead state concept © 2004 National Association of Insurance Commissioners

22. Risk Assessment Working Group Advantages to the proposed approach • Provides clearer methodology for assessing residual risk • Allows the assessment of risk management processes other than those that result in financial statement line item verifications • Allows utilizing the examination findings to establish, verify or revise the uniform company priority rating system © 2004 National Association of Insurance Commissioners

23. Risk Assessment Working Group © 2004 National Association of Insurance Commissioners

24. Risk-Focused Examination • Seven-Phased Process Provides the “Roadmap” for a Risk Assessment • Understanding the Company and Identifying Functional Activities of Insurer • Identifying and Assessing an Inherent Risk Rating in Activity • Identify and Assess Risk Management Systems in Place to Mitigate Inherent Risk © 2004 National Association of Insurance Commissioners

25. Risk-Focused Examination (Continued) • Seven-Phased Process Provides the “Roadmap” for a Risk Assessment • Assign a Residual Risk Rating, which is a function of the Inherent Risk Rating offset by the Control Assessment Rating • Establish/Conduct Examination Procedures based upon the Residual Risk Rating • Update CARRMEL Priority Rating and Supervisory Plan Based upon Findings • Draft Examination Report and Management Letter Based upon Findings © 2004 National Association of Insurance Commissioners

26. Financial Analysis • Financial Analysis Includes • Risk Assessment Results • Financial Analysis Handbook Process • Ratio Analysis (IRIS, FAST, Internal Ratios) • Actuarial Analysis © 2004 National Association of Insurance Commissioners

27. Internal/External Changes • Consider Changes to • Rating Agency Ratings • Ownership/Management/Corporate Structure • Business Strategy/Plan • CPA Report or Auditor • Legal or Regulatory Status © 2004 National Association of Insurance Commissioners

28. Prioritization System • Standard prioritization system • CARRMEL: Capital Adequacy, Asset Quality, Reinsurance, Reserve Adequacy, Management Assessment, Earnings, and Liquidity • Objective and mathematical based • Incorporates existing FAST Ratios • Pilot Projects © 2004 National Association of Insurance Commissioners

29. Supervisory Plan • Develop Plan for Ongoing Supervision • Frequency of Exams • Scope of Exams • Meetings with Company Management • Follow-Up on Recommendations • Financial Analysis Monitoring © 2004 National Association of Insurance Commissioners

30. Risk Assessment Working Group • Risk Focused Surveillance Framework • Risk Assessment Matrix • Revised CPA Checklist • Insurer Profile Summary • Prioritization Report © 2004 National Association of Insurance Commissioners

31. Risk Assessment Working Group • Revisions to the NAIC Financial Condition Examiners Handbook • Best Practices Supplement • Interviewing states to compile best practices • Examiner Training Program • Currently working to get approval to engage a consultant © 2004 National Association of Insurance Commissioners

32. NAIC SVO Objectives • Assist the Regulatory Community in the Conduct of Financial Solvency Monitoring by Providing: • Classifications (Debt/Preferred/Common) • Designations (Credit Rating) • Pricing (Value for Statutory Financials) • Provide Technical Advice Relative to Investments & Identify Investment Trends and Innovations © 2004 National Association of Insurance Commissioners

33. 2003 NY Proposal To Enhance The SVO Process - Goals • More Effectively Produce, or Provide Ability to Monitor/Verify, Accurate Credit Ratings and Valuations for Bonds, Preferred Stock, and Common Stock • Leverage off Rating Agencies and Market Facilitators (Stock Exchanges, Broker/Dealers) for Ratings and Valuations • Consider Enhancing the SVO’s Role via the Research Unit © 2004 National Association of Insurance Commissioners

34. 2003 New York Initiatives • Exempt All Rated Securities Equivalent to an NAIC 1 or 2 Designation - DONE! • Have Regulators Guide Role of Research Unit - DONE! • Exempt All Rated Securities and Mechanize Valuation Process - DONE! • Consider Alternatives to the Filing of Securities Not Rated by an NRSRO UNDER CONSIDERATION © 2004 National Association of Insurance Commissioners

35. SVO And Solvency Regulation • SVO Function is Critical • Focus As Far As Credit Review Should Be on the Universe of Non-Rated Securities • Research Function Can Better Assist State Insurance Departments • A Potential Role in Risk Assessment © 2004 National Association of Insurance Commissioners

36. Questions? • If you have additional questions, please contact me! Kris DeFrain 816-783-8229 kdefrain@naic.org © 2004 National Association of Insurance Commissioners