Financial Analysis
Lou Felice, Health and Solvency Policy
Advisor
NAIC
1
Presentation Overview
• Overview of the Financial Analysis
Handbook (Handbook)
• Financial Analysis vs. Financial Examiner
Roles
• NAIC I-SITE Reports & Insurer Profile
Summary
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© 2012 The National Association of Insurance Commissioners
NAIC Financial Analysis Handbook
• Assists regulators in performing riskfocused financial analysis to identify
companies that may have financial
problems or that have the greatest
potential for developing financial
problems
• Provides guidance to evaluate particular
areas of concern in troubled companies
• Consistent and uniform method
• Qualitative and quantitative analysis
• Updated annually
Confidential – Regulator Only
3
© 2012 The National Association of Insurance Commissioners
Financial Analysis Handbook
• Analyst Reference Guides
• Level 1 Procedures
• Level 2 Procedures
• Level 2 – Investments, Cash Flow & Liquidity,
Reinsurance, Affiliated Transactions, MGA & TPAs,
Risk-Based Capital, Income Statement and Surplus,
Unpaid Losses and LAE
• Supplemental Procedures
o
Management Considerations, Audited Financial Report, Actuarial
Opinion, Management Discussion & Analysis, Holding Company
Analysis
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© 2012 The National Association of Insurance Commissioners
Handbook - Risk-Focused Financial
Analysis
• Depth of the analysis will depend on the
complexity and the financial strength of the
insurer and the existing or potential issues
and problems found during review of the
financial statements
• At a minimum the following must be analyzed:
o
o
o
o
o
o
Annual and quarterly financial statements
Actuarial opinion
Management’s discussion and analysis
Audited CPA report
Holding company filings
Financial ratios
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© 2012 The National Association of Insurance Commissioners
Handbook - Analyst Reference Guide
Example - Investments
• Overview - Discusses specific topics: investment
income, asset and liability matching, diversification of a
portfolio, key areas of consideration when reviewing a
portfolio
• Discussion of Level 1, 2 and Supplemental Procedures
– provides considerations and guidance for the
procedures
• Additional Reference Sources - SVO Purposes &
Procedures Manual, Accounting Practices &
Procedures Manual, NAIC Annual Statement
Instructions, etc.
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© 2012 The National Association of Insurance Commissioners
Handbook - Annual Level 1 Procedures
• Background Analysis
o
Last priority designation, inter-department
communication, regulatory actions, NRSRO
rating
• Management Assessment
o
•
•
•
•
Shift in management or philosophy
Balance Sheet Assessment
Operations Assessment
Investment Practices
Review of Disclosures
o
Notes to Financial Statements, General
Interrogatories, etc.
• Assessment of Latest Examination Report
and Results
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F
A
H
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Handbook - Annual Level 1 Procedures
• Overall high-level review of insurer
• At the conclusion of the Level 1, the
analyst is directed as to whether
greater analysis must be completed
within the Level 2 procedures given risk
discovered in Level 1
o
For example, does the insurer have
complex affiliated agreements in place
that would require further detailed review
beyond discovery work completed within
Level 1?
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© 2012 The National Association of Insurance Commissioners
Handbook – Annual Level 2
Procedures
Level 2 Procedures
• Detailed analysis focused on key risk areas
• Procedures are quantitative (benchmark oriented) and
qualitative
o
o
o
o
o
o
o
o
Investments
Unpaid Losses and LAE
Income Statement and Surplus
Risk-Based Capital
Cash Flow & Liquidity
Reinsurance
Affiliated Transactions
MGAs & TPAs
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© 2012 The National Association of Insurance Commissioners
Handbook – Supplemental Procedures
Supplemental Procedures
• Management Considerations
• Audited Financial Report
• Statement of Actuarial Opinion & Actuarial Opinion
Summary
• Management’s Discussion and Analysis
• Holding Company Analysis
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© 2012 The National Association of Insurance Commissioners
Handbook – Supplemental Procedures
Management Considerations
Procedures address:
• Assessment of corporate governance
pertaining to the board of directors and
management
• Compliance with state statutes, accounting
and reporting
• Reputational risk
• Legal issues
• Business plans and projections
• Risk management
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© 2012 The National Association of Insurance Commissioners
Handbook – Supplemental Procedures
Management Considerations
• Special Note: It may not be necessary to complete all
procedures within this chapter. Procedures completed
are based on the level of concern an analyst may
have with management performance and the driving
forces behind operations.
• In performing analysis of management considerations,
the analyst should utilize the risk-focused surveillance
examination work that has been most recently
completed related to these risk areas. Where
applicable, the analyst should follow up on the work
performed by the examiners including any comments
or recommendations made by the examiners.
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© 2012 The National Association of Insurance Commissioners
Handbook – Supplemental Procedures
Audited Financial Report
Procedures address:
• Overview of opinion
o
o
o
•
•
•
•
Opinion issued and rationale
Accounting basis and type of opinion (individual insurer or
consolidated)
Data cross-checking to annual financial statement
Internal controls
CPA’s Letter of Qualifications
Change in CPA
Audit Committee
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© 2012 The National Association of Insurance Commissioners
Handbook – Supplemental Procedures
Statement of Actuarial Opinion and Actuarial Opinion Summary
Procedures address:
• Identification and qualifications of the
actuary
• Scope of the opinion
• The Opinion
• Relevant comments and exhibit
disclosures
• Conclusions and recommendations
• Procedures related to the Actuarial
Opinion Summary
© 2012 The National Association of Insurance Commissioners
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Handbook – Supplemental Procedures
Management’s Discussion and Analysis
Procedures address:
• Overview of filing in accordance with Annual Statement
Instructions
• Non-consolidated basis?
• Results of operations
• Prospective information
• Material changes
• Assessment of balance sheet and liquidity
• Assessment of investment transactions
• Summary and conclusion
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© 2012 The National Association of Insurance Commissioners
Handbook – Supplemental Procedures
Holding Company Analysis
Procedures address:
• Holding company structure
• Interstate coordination
• Evaluate financial condition of holding company
• Form A – Statement of Acquisition of Control of or Merger
with a Domestic Insurer
• Form B – Insurance Holding Company System Annual
Registration Statement
• Form D – Prior Notice of a Transaction
• Extraordinary Dividend/Distributions
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© 2012 The National Association of Insurance Commissioners
Handbook – Holding Company Analysis
• Holding company analysis is a standard
part of the financial analysis process as
outlined in the NAIC’s Financial Analysis
Handbook
o
o
o
Includes reviewing the upstream and
downstream holding company entities (both
financial or non-financial entities)
Understanding the structure, affiliated
relationships, financial condition, management,
etc.
Utilizing public information, such as SEC filings,
international filings, and/or requested information
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© 2012 The National Association of Insurance Commissioners
Holding Company Analysis Considerations
• NAIC has been conducting HC analysis training for state
insurance departments
• Recently adopted amendments to accreditation program
for Part B – Financial Analysis guidelines with regard to
HC analysis effective 2012
• GSIWG continues to create best practices and standards
for HC analysis
• Focus on lead state report
• Maintaining the Holding Company Analysis Liaison List
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© 2012 The National Association of Insurance Commissioners
Link to SEC Filings
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© 2012 The National Association of Insurance Commissioners
Lead State Report
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© 2012 The National Association of Insurance Commissioners
Handbook - Quarterly Procedures
• Level 1 and 2 procedures
• Focuses on Significant Changes from Quarter to
Quarter and Quarter to Prior Year End
• Ratio calculations are automated
NEW Quarterly Level 1 for Non-Troubled Insurers
•
Adopted for First Quarter 2012
•
Significantly reduced procedures
•
Procedures address key risk areas
o
Background information
o
Management assessment
o
Balance sheet and operations assessment
o
Review of disclosures and assessment of results from analytical
tools
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© 2012 The National Association of Insurance Commissioners
I-SITE Categories Page
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© 2012 The National Association of Insurance Commissioners
Summary Reports
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Financial Profile Reports
• The Financial Profile Report is a
summary of key financial information
for a company over the last five years
• Includes a Financial Summary page
• There are also detailed sections for:
Assets, Liabilities, Capital & Surplus,
Loss & LAE Reserve Analysis, Income
Statement, Cash Flow and Exhibit of
Business and Profitability
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© 2012 The National Association of Insurance Commissioners
Insurer Profile Summary
• Insurer Profile Summary Sharing Best
Practices Guide
• Adopted by the Financial Analysis
Handbook (E) Working Group
• Outlines best practices for effective and
efficient sharing of a domestic state’s
Insurer Profile Summary with other
interested state insurance regulators
• Highly Confidential Document
© 2012 The National Association of Insurance Commissioners
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Risk-Focused Exams
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What is a Financial Examination?
• A financial condition exam is an on-site
regulatory review of an insurer’s key
processes with the primary goal of
assessing financial solvency of the
company.
– An exam is risk-focused because the
examiner focuses on areas of higher risk
of an insurance company.
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© 2012 The National Association of Insurance Commissioners
Why Conduct Financial Exams?
• Detect insurers with potential financial
trouble;
• Picks up where analysis ends
• Determine compliance with state
statutes and regulations;
• Compile information needed for timely,
appropriate regulatory action;
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Why Conduct Financial Exams?
• To provide a clear methodology for assessing
residual risk and how it translates into
examination procedures;
• To allow the assessment of risk-management
processes in addition to those which relate to
financial statement line items; and
• To utilize examination findings to establish,
verify or revise company’s priority score.
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Financial Analysis
vs.
Financial Examiner Roles
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Roles of Examiner and Analyst
On-site and Off-site solvency monitoring involve roles and
skill-sets that are different, but complement each other:
• Analyst
• Examiner
o Identifies risk by
o Identifies risk by
reviewing business
reviewing reported
processes
financial results
o Utilizes control &
o Utilizes analytical review,
detail tests to identify
(ratio analysis,
solvency concerns and
benchmarking, inquiry) to
findings
identify solvency concerns
o Focuses on Residual
and compliance
Risk
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Roles of Examiner and Analyst
State Insurance Analysts typically perform the following functions:
• Collection and analysis of insurer and group financial information
• Desk audits to assess risk and compliance
• Review of non-financial information regarding insurance
companies that is routinely collected by other department units
• Review of insurance company transactions
• Coordination with other department functions
• Determining regulatory courses of action regarding identified
troubled insurance companies
• Evaluating and monitoring corrective plans
• Communicating results of regulatory actions
• Licensing and admissions
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© 2012 The National Association of Insurance Commissioners
Roles of Examiner and Analyst
Example: Investments
• Off-site analysis can monitor balance and composition of portfolio,
benchmark the company’s investments against competitors and gather
information from the insurer to explain significant changes. Help set
priorities for examiner
• On-site examination can evaluate the process in place at the insurer to
monitor investment performance and reporting; establish company specific
risks; gain an understanding of the effectiveness of controls; and tailor
substantive procedures to apply underlying transactions, reviewing
reconciliations, obtaining confirmations, etc.
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© 2012 The National Association of Insurance Commissioners
Conducting Examinations
• The NAIC Financial Condition Examiners
Handbook provides guidance to assist
state insurance departments to effectively
plan, conduct, and report on the financial
condition of insurers.
• Approach changed to a Risk-Focused
Surveillance approach in 2007
• Model Law and Accreditation Standard
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Model Law on Examinations
• Exams must be conducted on each licensed
insurer at least once every 5 years
o
o
Some state statutes require more frequent
exams
Initial Priorities se through analysis process
• A state may accept an examination report on
a company prepared by another state if:
o
o
The state department performing the exam
was accredited at the time of the exam; or
The exam was performed under the
supervision of or participation by an
accredited insurance department
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© 2012 The National Association of Insurance Commissioners
Examination Classifications
• Insurer Type
o
o
Single-state insurer: A company that does
not meet the definition of a multi-state
insurer such as a Health Maintenance
Organization.
Multi-state insurer: A company that is
domiciled or chartered in one state and
licensed, registered, qualified or
accredited, eligible or operating in at least
one other state.
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© 2012 The National Association of Insurance Commissioners
Examination Classifications
• Exam Scope:
o
Full-scope: An examination in which the
scope of the control and substantive
procedures to be performed during the
examination is based on the implementation
and documentation of the risk assessment
procedures required under the NAIC
Financial Condition Examiners Handbook.
o
o
Review all areas of exam and focus on high-risk
areas.
Limited-scope: An examination which is
limited to a review or examination of specific
financial statement line items or particular
risk areas.
© 2012 The National Association of Insurance Commissioners
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Examination Classifications
• Examination Type
o
o
Individual exam: A financial exam over
one insurer.
Group exam: A financial exam over more
than one insurer. This type of exam is
typically conducted when multiple
companies in a holding company group
have similar key processes, systems
and/or management.
• Exams can also be coordinated
between regulators from multiple
states.
© 2012 The National Association of Insurance Commissioners
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Key Examination Participants
• The following individuals from a state insurance
department are the key participants that conduct
and oversee the examinations of domestic
insurance companies:
o
o
o
o
Chief Examiner (or designee): Schedule examinations,
assign staff, coordinate with other state and zones
examiners, and approve exam plan
Examiner-in-charge: Coordinate review of company and
examination testwork. Coordinate meetings with company
and personnel.
Staff Examiner: Conduct examination testwork and become
knowledgeable of company operations.
Financial Analysts: Interpret key financial and operational
ratios, provide examiners with insight on company
management, operating results, current events, etc.
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© 2012 The National Association of Insurance Commissioners
Risk-Focused Exam Approach
• Examination methodology included within the
NAIC Handbook is a ‘risk-focused’ approach.
• Required by Accreditation Standards for
exams commencing on or after Jan. 1, 2010.
• Under this approach, examination fieldwork
will emphasize the review of an insurer’s
current or prospective solvency risk areas
and the fair presentation of surplus.
• Examiner will focus work and resources on
identified risk areas and focus less on areas
with less risk.
© 2012 The National Association of Insurance Commissioners
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Risk-Focused Surveillance
• The risk-focused surveillance process requires
examiners to prospectively consider the
company’s financial condition by assessing
whether the company’s current processes
provide indications of future solvency
concerns. Examples of items considered for
prospective assessments include:
o Corporate Governance
o Future Business Plans
o Rate of Company Growth
o Liquidity of Assets
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© 2012 The National Association of Insurance Commissioners
Risk-Focused Surveillance
• In accordance with the risk-focused
surveillance guidance, examination work will
shift so that more time is spent during the
planning and risk assessment processes of
the examination.
• Efficiencies should be gained as examiners
utilize knowledge from prior exams as well as
information provided through on-going
monitoring by analysts to stay aware of risks
within insurer operations.
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© 2012 The National Association of Insurance Commissioners
2aRisk 2b 2c 2d
2e
Identificatio Inherent Risk
n
Assessment
Phase 5
Phase 6
Phase7
4a
4b
4c
Residual Risk
Assessment
5
6
7
Report Findings &
Management Letter
Comments
Overall Residual Risk
Assessment
Judgmental Residual
Risk
Phase 4
Prioritization Results
Supervisory Plan
Phase 3
Examination
Procedures / Findings
3a Risk3b
Mitigation3c
Strategy/Control
Assessment
Calculated Residual
Risk
1d
Overall Risk Mitigation
Strategy/Control
Assessment
Phase 2
Evidence & Document
Testing Controls
Phase 1
Risk Mitigation
Strategy/Control
Overall Inherent Risk
Assessment
1a
Impact
Likelihood
Branded Risk
Identified Risks
Sub-activities
Risk Assessment Matrix
Key
Activity
1b – Overall Risk
Statement:
1c – Analytical
Assessment:
Risks Other than Financial Reporting
Financial Reporting Risks
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Seven Phase Examination Process
Phase 1
Understand the Company and Identify Key
Functional Activities to be Reviewed
Phase 2
Identify and Assess Inherent Risks in Activities
Phase 3
Identify and Evaluate Risk Mitigation
Strategies/Controls
Phase 4
Determine Residual Risk
Phase 5
Establish/Conduct Exam Procedures
Phase 6
Update Prioritization and Supervisory Plan
Phase 7
Draft Exam Report and Management Letter
Based on Findings
P
l
a
n
n
i
n
g
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© 2012 The National Association of Insurance Commissioners
Risk Assessment Cycle
Examination
Supervisory Plan
Risk-Focused
Examination Seven
Phase Process:
Develop Ongoing
Supervision That
Includes:
•Frequency of Exams
•Scope of Exams
•Meetings with Company
Management
•Follow-Up on Recommendations
•Financial Analysis Monitoring
INSURER
PROFILE
SUMMARY
•Identify Functional Activities
•Identify/Assess Inherent Risk
•Identify & Evaluate Controls
•Determine Residual Risk
•Establish Procedures and
Conduct Exam
•Update Supervisory Plan
•Exam Report//Mgmt Letter
Priority System
Financial Analysis
Company Priority Score
Determined By:
Financial Analysis includes:
•Priority System Based on Dept.
analysis and NAIC financial
Analysis tools:
•Scoring System
•ATS Results
•IRIS Ratios
•Exam Results
Internal/External Changes
Consider Changes to:
•NRSRO Ratings
•Ownership/Management/
Corporate Structure
•Business Strategy/Plan
•CPA Report or Auditor
•Legal or Regulatory Status
•Risk Assessment Results
•Financial Analysis Handbook
Process
•Ratio Analysis (IRIS, FAST,
Internal Ratios)
•Actuarial Analysis
•Update with internal/external
changes
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Steps to Phase 1, Part 1
1
Understanding the Company
Step 1
Step 2
Step 3
Step 4
Step 5
Gather
necessary
planning
information
Review the
gathered
information
Perform
Analytical
and
Operational
Reviews
Consider
Information
Technology
Risk
Update the
Insurer
Profile
Summary
Note: Portfolio Analysis would be completed in conjunction with Phase 1, Part 1.
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© 2012 The National Association of Insurance Commissioners
Parts to Phase 1
2
Understanding the
Corporate Governance
Structure
3
Assessing the Adequacy
of the Audit Function
4
Indentifying Key
Functional Activities
5
Consideration of
Prospective Risk
49
© 2012 The National Association of Insurance Commissioners
Phase 2 – Identify and Assess
Inherent Risk
• Inherent risk – Risk of economic loss or
inaccurate financial reporting before
considering internal controls
50
© 2012 The National Association of Insurance Commissioners
Phase 2 – Identify and Assess
Inherent Risk
• Identify inherent risk
o
Other than financial reporting inherent risk
• Items not directly related to a current f/s line item
• Generally related monitoring, policies, BOD interaction,
strategic type risk, etc.
o
Financial reporting inherent risk
• Typically directly related to a current f/s line item
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© 2012 The National Association of Insurance Commissioners
Phase 2 – Identify and Assess
Inherent Risk
• Assess inherent risk based on:
o
o
Likelihood of Occurrence
Magnitude of Impact
• To reach overall inherent risk levels of:
o
o
o
High
Moderate
Low
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© 2012 The National Association of Insurance Commissioners
CALCULATED OVERALL INHERENT RISK
Magnitude of Impact
Likelihood of
Occurrence
Threatening
Severe
Moderate
Immaterial
High
High
High
High
Moderate
Moderatehigh
High
High
Moderate
Moderate
Moderatelow
High
Moderate
Moderate
Low
Low
Moderate
Moderate
Low
Low
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© 2012 The National Association of Insurance Commissioners
Phase 3 - Control Identification &
Evaluation
1. Identify and understand internal controls that the
insurer has in place for each risk
o
Document Understanding
2. Consider whether the controls appear to be
designed appropriately to mitigate each risk
o
If not, no need to test controls
3. If so, test the controls for operating effectiveness
o
Not required if testing will be inefficient
4. Conclude whether the internal controls effectively
mitigate each inherent risk
o
Strong, Moderate or Weak
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© 2012 The National Association of Insurance Commissioners
Phase 3 – Risk Mitigation Strategies
Assessment of Controls
The Overall Risk Mitigation Strategy/Control
Assessment ratings to be indicated in the Risk
Assessment Matrix are:
• Strong risk management
• Moderate risk management
• Weak risk management
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© 2012 The National Association of Insurance Commissioners
Phase 3 – Risk Mitigation
Strategies
Control
Testing
Intended to provide assurance
that control procedures are
operating as prescribed
Control testing is generally performed using one of the following methods
Walkthrough
Re-performance
Corroborative
inquiry
Observation
Examination of
Documents
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© 2012 The National Association of Insurance Commissioners
Phase 3 - Utilization of Existing
Work
• Existing Control Documentation
o
o
o
SOX Workpapers
Internal Audit Workpapers
External Audit Workpapers
• Utilize where relevant to exam
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© 2012 The National Association of Insurance Commissioners
Phase 4 – Determine Residual Risk
• Residual risk is determined by how well the
risk mitigation strategies/controls mitigate the
inherent risk.
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© 2012 The National Association of Insurance Commissioners
Phase 4 – Residual Risk Grid
INHERENT
RISK
HIGH
STRONG
RISK
CONTROLS
MODERATE
RISK
CONTROLS
WEAK RISK
CONTROLS
Mod or High Mod or High High
MODERATE Low or Mod Mod
Mod
LOW
Low
Low
Low
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© 2012 The National Association of Insurance Commissioners
Phase 5 – Establish/Conduct Exam
Procedures
Phase 5 Handbook Guidance:
• Detail examination procedures should be
selected to correspond with the level of residual
risk determined for each identified risk.
High Residual
Risk
Detail procedures required.
Moderate
Residual Risk
Fewer detail procedures performed (i.e. tests of details
of transactions), including more utilization of analytical
procedures.
Low Residual
Risk
Limited or no detail procedures performed, which may
be limited to analytical procedures.
60
Phase 6 – Update Prioritization &
Supervisory Plan
• Supervisory Plan
o
o
o
o
o
Created/updated at least yearly by domiciliary
state
Based on recent exams and analysts’ reports
Lead state concept with multi-state companies
Outline type of surveillance planned, resources,
and how coordination planned
Part of Insurer Profile Summary
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© 2012 The National Association of Insurance Commissioners
Phase 7 – Draft Examination
Report & Management Letter
• Examination Report
o
o
o
o
Table of contents
Salutation
Scope of examination
Body of report
• Company history & corporate governance
• Financial statements
• Findings & recommendations
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© 2012 The National Association of Insurance Commissioners
Phase 7 – Draft Examination
Report & Management Letter
• Management Letter
o
o
o
Part of exam workpapers
Used for results or observations that are not
material to public report
Optional
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© 2012 The National Association of Insurance Commissioners
Phase 7 – Draft Examination
Report & Management Letter
Examination ReportCommon Findings
Management ReportCommon Findings
• Proprietary Company
• Additional Reserves
Issues
Needed
• Prospective Risk
• Asset Valuation- OTTI
Discussions
• Items not recorded in
• Internal Control
Deficiencies
accordance with SAP
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© 2012 The National Association of Insurance Commissioners
Post Examination Procedures
The following activities should be performed
after the examination report is issued and
prior to the next examination:
• Follow up on examination findings
• Communication with financial analyst
between examination dates
• Supervisory Report
The goal is to continually monitor the
companies under examination, rather than to
only perform examinations.
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© 2012 The National Association of Insurance Commissioners
Questions
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© 2012 The National Association of Insurance Commissioners