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Public Policy Analysis & Opinion It's close enough Changing insurance accounting one yawn at a time By Kevin P. Hennosy It is difficult to think of accounting issues without thinking of comedy. George Robert Newhart earned an accounting degree from Loyola University in Chicago in 1952. Young Mr. Newhart entered the business world with every intention of using his academic training, but things changed. It became apparent that he was not cut out to be an accountant, and he headed instead for standup comedy. As part of an early routine, Bob Newhart explained his shift in career choice: “I worked as an accountant for a number of years in Chicago. And I had kind of a strange theory of accountancy. I had always felt if you got within two or three bucks of it…but this never really caught on.” Or so it seemed for 40 years. Then, in the early years of the 21st century, Enron, WorldCom and entire accounting firms like Arthur Andersen managed to make Newhart appear positively stodgy. As a result of these corporate accounting shenanigans, hundreds of thousands of people lost material sums of money. Investors and pensioners took an indescribable hit to their financial security. Good people lost jobs, homes and savings. Furthermore, perhaps millions more people lost opportunities to invest and gain because of a general lack of trust in Wall Street and corporate America. Newhart’s “it’s close enough” school of accounting did not seem so funny anymore. Congress sprang into action and passed reform legislation, which increased financial transparency and attacked conflicts of interest. The legislation became known as the Sarbanes-Oxley Act of 2002 or “SOX.” As is usually the case when Congress passes landmark legislation, the insurance sector presented a special set of circumstances. It was clear that publicly traded insurers would need to comply with the new accounting rules. The question arose whether the same would apply to mutual insurers and other corporate entities. Over the past four years, state regulators have argued over whether or not to treat all insurers the same, or to recognize that “policyholder-owned” insurers cannot engage in the speculative activities that SOX was designed to correct. This debate has raged through the dusty committee system of the National Association of Insurance Commissioners (NAIC) for four years. Generally, the NAIC is not known as a funny place, at least since that incident with the ice sculpture and the scantily clad models at a Miami Beach meeting in the late 1970s. But I digress. That is not to say that the NAIC’s consideration of SOX implementation has been devoid of entertainment value. Where else could one repeatedly gather a thousand insurance accountants, lawyers and a smattering of actuaries for hours of PowerPoint presentations in hotel ballrooms? One could assume that some of these high-level accounting gurus had their own loopholes named after them. The inclusion of the actuaries lent a certain amount of gravitas to the process. Let us remember that an actuary is generally defined as an accountant without a sense of humor. Accountants become actuaries only when they find bookkeeping too exciting. The NAIC did not win too many friends over the past four years of debate. The National Association of Mutual Insurance Companies (NAMIC) argued against the application of SOX-like rules to its sector. In response to the pressure placed on the NAIC by big mutual companies, the regulators talked more about the need to reduce the risk of insurer insolvencies and less about transparency and auditors’ independence. The NAIC tried, but advocates for NAMIC had none of it. Early in 2006, the NAIC tried to settle the issue with an “alternative plan” to govern the inclusion of mutual companies under the SOX framework. The NAIC tried to hype the possibility of reduced guaranty fund assessments that could result from application of a SOX-based accounting framework. NAMIC issued a statement that shot down the alternate proposal. The statement said that the NAIC proposal “errs in applying to mutual insurers costly and burdensome internal accounting control measures not demonstrated to preclude or materially reduce insurer failures. “Fundamentally, regulation should be rational—it should fit the nature and behavior of the regulated entities—and cost no more than is necessary for that goal. This proposal fails both tests,” said NAMIC Financial Regulation Manager William D. Boyd. “It was meant for public companies and it simply costs too much.” Most put the cost of the alternative plan at $80 million using basic NAMIC data of first-year implementation costs for mutual insurers. This is still approximately two-and-one-half times the estimated saving in avoided guaranty-fund assessments to surviving insurers. “The alternate, because of this undesirable ratio, continues to be something NAMIC cannot support,” said Boyd. The opposition of NAMIC, indivi-dual mutual companies and other organized groups stymied the NAIC’s attempts to adopt final SOX recommendations in March 2006. The NAIC went back to the drawing board. The NAIC will take another run at arriving at establishing a SOX-like accounting regime for all insurers. Regulators hope to reach agreement before this year’s NAIC Summer National Meeting scheduled for June 10-13 in Washington, D.C. The association announced its plans to conduct a public hearing in an attempt to hammer out a compromise before the NAIC’s Summer National Meeting in June. The public hearing was scheduled for May 11 in Atlanta. In announcing this hearing, the NAIC would entertain comments on a series of amendments to the NAIC’s Model Rule Requiring Annual Audited Financial Reports, also known as the Model Audit Rule. These amendments were crafted to ease opposition from trade associations and lobbyists representing mutual insurance interests. “These amendments collectively strengthen the integrity of the insurance industry’s statutory financial reports, thereby mitigating the number and size of insurer insolvencies,” said Virginia Deputy Commissioner Doug Stolte, chair of the NAIC/AICPA Working Group. “These amendments will also facilitate movement toward a more risk-based system of solvency oversight and a principle-based valuation system for insurers,” added Stolte. This statement by Stolte is very interesting. The NAIC has felt pressure primarily from large life insurance companies for several years to make insurance financial oversight look more like the less onerous system applied to banks. Linking the two issues appears to offer a political carrot and stick to insurers. The movement to a risk-based system based on banking rules is very controversial among insurance regulators. Examiners and financial analysts in most states argue that banking and insurance are too different to employ the same approach to financial oversight. Banking offers safety and soundness to depositors. Insurers accept and distribute risk from policyholders across large populations. Insurance is a trickier business with less room for error in the eyes of many insurance regulators. Nevertheless, the NAIC seems poised to pressure states to accept a weaker system of banking-like “supervision” in return for industry support for a SOX-like system of accounting. It is not clear whether this quid pro quo will have the effect that the NAIC leadership desires. One sideshow that seems to have the attention of numerous insurance industry advocates relates to the NAIC’s own commitment to financial transparency. The NAIC refuses to file a standard financial statement with the IRS known as a Form 990. The annual deadline for filing a Form 990 was May 15, and observers expected the association to ignore the deadline. A Form 990 filing compiles basic information about a tax-exempt organization’s finances and business operations. The form must be filed with the IRS and made available for public review by any tax-exempt organization that realizes more than $25,000 a year income. The NAIC’s annual budget discloses income of more than $59 million; however, the association claims it is exempt from filing this baseline disclosure of its finances. The insistence on secrecy irritates insurance advocates and consumer advocates alike. In various venues, the NAIC has claimed to have a special opinion letter from the IRS that exempts the association from filing a Form 990. The argument appears based on a ruling made by the IRS in the mid-1980s, when a predecessor entity asked the IRS for a tax-exempt opinion letter to shield the NAIC from paying taxes in New York. Any opinion letter or exemption would be based on the IRS’s review of the association at that time, before the NAIC incorporated and made extensive changes to its constitution and bylaws in 1999. Even if the NAIC is correct in applying these old opinion letters offered on an unincorporated association to the legal entity incorporated seven years ago, an exemption from filing is not a prohibition from filing. The NAIC should take the high road and file a Form 990. NAIC critics (or champions, as the case may be) argue that the association should file a Form 990 for each year after the incorporation and for every year going forward. Filing a Form 990, even if voluntary, would demonstrate the NAIC’s commitment to financial transparency and abhorrence of conflicts of interest, but the NAIC does not appear ready to make such a commitment. The NAIC appears anxious to preserve its special-interest standing in a gray area of corporate legality. In this place the association realizes vast income but completes neither a tax-form nor a standard financial disclosure. At no time does an executive officer of the NAIC sign a sworn statement attesting to the accuracy of the association’s books. It is hard for knowledgeable observers to integrate the SOX approach to financial accounting with the NAIC’s own operations. I guess the assumption of most commissioners is—It’s close enough. Increasing numbers of regular attendees at the NAIC meetings express concerns about the association’s business operations, but they refuse to go on the record because they fear retribution against the regulated entities that they represent. Commissioners seem content to ignore these concerns while association income from fees, data sales, licensing agreements and publications continues to grow. This laissez faire attitude could change. The NAIC’s approach to manage-ment reminds me of a statement attributed to John F. Kennedy: There are three things in life that are real: God, human folly and laughter. The first two are beyond our comprehension, so we must do what we can with the third. * The author |
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