May 19, Dear Mr. Stolte and Members of the Working Group:

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1 May 19, 2004 Mr. Douglas C. Stolte, Chair, and Members NAIC/AICPA Working Group National Association of Insurance Commissioners 2301 McGee Street, Suite 800 Kansas City, Missouri C/O Ms. Julie Glaszczak By Dear Mr. Stolte and Members of the Working Group: The National Association of Mutual Insurance Companies (NAMIC) takes this opportunity to submit testimony on the April 13, 2004, draft of the Working Group s proposal to amend the Model Audit Rule to include elements of the federal Sarbanes- Oxley Act of NAMIC represents more than 1,200 insurers that collectively write approximately 41 per cent of the property-casualty premium in this country, and the great majority of those NAMIC member companies would be very materially affected by the proposed amendments. In this letter of comment we submit data to the Working Group on estimated costs of compliance with Section 16. of the proposal, which Section replicates Section 404. of Sarbanes-Oxley. These data do not constitute an effort to comprehensively assess the costs of the proposal but instead make estimate of what are understood by all parties as the most expensive elements of the proposal. In other words, our estimates address only part of those costs expected to be added to insurers costs as a result of application of the proposal. Before presenting these data, we review immediately below our concerns communicated to the Working Group in our March 4, 2004, letter. That letter responded to the Working Group s original proposal of February 3, 2004, and acknowledges the temper of the times in the wake of Enron, Tyco, and other scandals involving egregious lapses in corporate governance and misstatement in financial reporting that were addressed by the Sarbanes- Oxley Act. In the strongest terms in that March 4, letter, however, we noted that regulation of insurance exists for purposes wholly different from those applied to entities that issue securities into the public capital markets. Sarbanes-Oxley, we reiterate, is addressed to these entities that take investors money via the public capital markets for an entire spectrum of economic enterprise: 1

2 The existing state insurance regulatory apparatus has very extensive power. Its premise is affirmative protection of the policyholder in both solvency regulation and creating and maintaining orderly markets. Its operation is to make sure insurers promises to policyholders are kept, per contract. The regulatory regimen for public companies as conducted by the Securities Exchange Commission, including those additional elements of the Sarbanes- Oxley Act now applicable to public companies, emphasizes responsible stewardship by those in corporate governance and compliant, accurate financial reporting to investors. It is crucial to reiterate that absent in this regulation of public companies and those companies duties toward their investors is any requirement that investors be made whole in any respect. Whatever the distress to investors, companies are free to fail, and the regulatory regimen provides no safety net or rescue or rehabilitation. It has not been demonstrated that recent failures of insurers involve problems that have high probability of being remedied through what is now proposed by the Working Group. In our knowledge and from the perspective of the propertycasualty world, it is clear that reserving is a problem of higher probability among failed companies. The NAIC/state requirements for actuarial certification already address this matter. Regulators, in other words, already have power and precedent in this area What demands attention, given the internal and external costs inevitably associated with the proposal, is an understanding or measurement of cost-benefit. We believe it is undeniable that the proposal will generate millions and millions of dollars in additional internal and external costs of compliance. Given what we believe is fully adequate existing insurance regulatory power, we doubt such additional costs would be worth the amount of supposed savings in company failures and the consequent assessments on surviving insurers. * * * Toward a beginning in understanding the cost consequences of the proposal, NAMIC surveyed a number of member companies, seeking their estimates of internal and external costs of compliance with Section 16. of the proposal on both an initial and ongoing basis. That survey instrument is attached as Appendix A. As noted in that survey instrument, the survey does not seek all costs of compliance with the proposal. Three strata, differing as to premium revenue, are presented: 2

3 Estimates of Added Costs Required By Section 16 Percentage Basis Companies (a) With Premium Revenue Greater Than $500 million: First year Ongoing Internal External Internal External 123% 76% 57% 64% (a) Four respondents on external; three respondents on internal. Companies (b) With Premium Revenue From $100 million To $500 million: First year Ongoing Internal External Internal External 84% 61% 48% 45% (b) Seven respondents. Companies (c) With Premium Revenue Less Than $100 million: First year Ongoing Internal External Internal External 81% 67% 51% 60% (c) Seven respondents. * * * With these data in mind, and knowing that large companies currently spend millions of dollars yearly on such costs and that smaller companies costs are somewhat proportional, we believe all concerned should be asking whether benefit can be expected: Would the aggregate incremental costs suggested above spare the industry that sum in aggregate assessments? Or would those incremental costs simply add to aggregate costs of doing business without commensurate benefit? We assert to the Working Group this question is valid and suggest that commensurate benefit would not be shown. Finally, in this second letter of comment to the Working Group, we suggest that the questions we pose above, both here and in our first letter of comment, were not 3

4 examined and should have been before introduction of any proposal of this nature. The proposal now pending proceeds without firm foundation for its applicability to and practicability for the insurance industry. We suggest, therefore, that the proposal be tabled indefinitely, or at least pending resolution of the many questions that accompany it. Respectfully submitted, William Boyd Financial Regulation Manager 4

5 Appendix A May 19, 2004, letter to NAIC/AICPA Working Group A Survey: Understanding Certain Costs of Compliance Associated with the NAIC s Statutory Sarbanes-Oxley Proposal The NAIC/AICPA Working Group has proposed addition of content from the Sarbanes- Oxley Act of 2002 to the NAIC s Model Audit Rule (formally known as the Model Regulation Requiring Annual Audited Financial Reports ) so that non-public insurers would become subject to requirements similar to those for public companies. This survey is sent to your company to gather information on the cost impact of this proposal. Responses, collated on an anonymous basis, will be presented to the NAIC by NAMIC. This brief survey solicits your best estimate of your company s expected incremental costs, both internal and external, that would be incurred in complying with the NAIC proposal s Sections 11 and 16 (excerpted below), which require a report from management on internal control and the independent auditor s attestation on that report. (Using reference to the Sarbanes-Oxley Act, this would be the incremental cost of complying with Section 404 of the Act.) This survey does not solicit your estimate of other, additional costs of complying with the NAIC proposal. You will see in the response section below that your estimates are sought for both internal and external components of such estimated compliance costs on the basis of percentage of change over current costs. With respect to internal costs of compliance, your own estimate would be best. With respect to external costs, your auditor s estimate would be appropriate. Further, your estimates are sought on a first-year basis and on an ongoing basis. Please submit your response (and pose any questions about the survey) to William Boyd (bboyd@namic.org) by May 14, First-year estimated percentage change (over current cost) for compliance: Internally incurred % Externally incurred % Ongoing estimated percentage change (over current cost) for compliance: Internally incurred % Externally incurred % 5

6 Company s 2003 direct and assumed premium in $millions: 6

7 Excerpted Sections 11 and 16 from NAIC/AICPA proposal: Section 11. Accountant s Reports on Internal Controls In addition to the annual audited financial statements, each insurer shall furnish the commissioner with the following: A. An attestation report prepared by the accountant on management s assessment of internal control over financial reporting, if such report is required, that includes an opinion, or states that an opinion cannot be expressed, concerning management s assessment of the effectiveness of the insurer s internal control over financial reporting. This report shall be filed in conjunction with the annual audited financial report. Section 16. Management s Report on Internal Control over Financial Reporting A. An insurer required to file an audited financial report pursuant to this regulation and who has direct written and assumed premiums of $25,000,000 or more shall also file a report prepared by management on the insurer s internal control over financial reporting, as defined in Section 3. Notwithstanding the $25,000,000 premium threshold, the Commissioner may require an insurer to file a report prepared by management on the insurer s internal control over financial reporting if such insurer is in a RBC action level event, meets any one or more of the standards of an insurer deemed to be in hazardous financial condition, or otherwise exhibits qualities of a troubled insurer. If an insurer is a member of an insurance holding company system and the insurers within this group share common systems and controls over financial reporting, the individual insurers may file the report of the insurance holding company provided that the report clearly identifies the specific insurers covered by the report and also identifies which systems and controls are applicable to the insurer. The report shall contain: (1) A statement of management s responsibility for establishing and maintaining adequate internal control over financial reporting for the insurer; (2) A statement identifying the framework used by management to evaluate the effectiveness of the insurer s internal control over financial reporting; (3) Management s assessment of the effectiveness of the insurer s internal control over financial reporting as of the end of the insurer s most recent fiscal year, including a statement as to 7

8 whether internal control over financial reporting is effective. This discussion shall include disclosure of any material weaknesses in the insurer s internal control over financial reporting identified by management. Management is not permitted to conclude that the insurer s internal control over financial reporting is effective if there are one or more material weaknesses in the insurer s internal control over financial reporting; and (4) A statement indicating that the independent certified public accountant that audited the insurer s financial statements has issued an attestation report on management s assessment of the insurer s internal control over financial reporting. B. The insurer shall also provide the independent certified public accountant s attestation report on management s assessment of the insurer s internal control over financial reporting in the audited financial report, as required by Section 11. C. The insurer shall disclose any change in the insurer s internal control over financial reporting identified in the connection with the evaluation required by Subsection A of this section that occurred during the insurer s last fiscal quarter (the insurer s fourth fiscal quarter in the case of an annual financial report) that has materially affected, or is reasonably likely to materially affect, the insurer s internal control over financial reporting. 8