A regulator and a consumer advocate say a new analysis of the costs and benefits of strengthening insurance company financial reporting rules fails to reflect the full cost of insurer insolvencies.[@@]

On the eve of several planned discussions on implementation of changes to the Model Audit Rule, the National Association of Mutual Insurance Companies, Indianapolis, says the cost of implementing requirements comparable to those given in the Sarbanes-Oxley Act of 2002, including an attestation by management to the strength of internal audit controls, will add $300 million in costs in year 1 of implementation for mutual insurers with the burden falling more heavily on smaller companies.

NAMIC says mutual insolvency costs were 27% of total insolvency costs from 1977 to 1991 and since 1991 have represented only 5% of the industry total.

The discussion is scheduled to take place here during the summer meeting of the National Association of Insurance Commissioners, Kansas City, Mo.

Doug Stolte, deputy insurance commissioner with the Virginia bureau of insurance and chair of the NAIC/AICPA working group, says losses often extend beyond the $300,000 limit paid out by property-casualty guarantee funds and the $100,000 paid out by life guaranty funds. The harm that can be done to life policyholders and to creditors can be in excess of those totals and is a “major hole” in the study.

Stolte also says regulators have invited insurers to come up with a alternative proposal to insure strong internal audit controls and that they “are not wedded to SOX.” Regulators are concerned with a system of controls that cover the major processes and not necessarily all processes as covered by Title IV of SOX, he says.

He says of the announcement of the study, that “it is a big frustration that there is an obvious attempt to kill it[changes to MAR.] It is an obvious attempt to frustrate discussion on the topic.”

Regulators need tools to look into internal management controls of insurers, according to Stolte. For instance, he says in Virginia, they are getting ready to ask questions of American International Group Inc., New York, regarding categorizing workers compensation premiums as a liability in order to avoid the payment of tax.

Of those who are opposing implementation of internal controls, he says, “I don’t know what they have to fear. Give us a proposal.”

And, according to Stolte, it is hard to analyze costs when a structure for assessing internal controls has not been decided upon yet. He says a dialogue and framework should be decided upon before looking at costs.

“I don’t see why they wouldn’t want the best available governance,” says Brendan Bridgeland, an NAIC funded consumer and a representative of the Center for Insurance Research, Boston. “It is not like we are living in an age where there are no problems. If it can happen at AIG, it can happen at smaller companies. It might be more important for smaller companies to have it [internal controls].”

Bridgeland says that while he can understand concern about expense and difficulty in complying with potential new requirements, if smaller companies experience problems they may be less able to handle them than a company the size of AIG.

Companies should counterbalance costs by looking at the potential for savings if a company is saved from rehabilitation and guarantee fund assessments are not levied, he adds.

“Regulators are really on the ball to be looking at this,” Bridgeland says.

But during a discussion of the study, NAMIC representatives disagreed with the idea the companies will ultimately benefit.

“The pending proposal is unnecessary, ill-advised and too expensive,” said Chuck Chamness, NAMIC president.

The NAMIC study found that the cost of the proposal for mutuals would be almost 8 times the estimated benefit. Although estimated second-year cost reductions range from 41% for larger companies, they are only 14% for smaller companies, NAMIC says.

Rick Nelson, a NAMIC spokesman, responded to critics of the NAMIC study by noting that the group believes the benefits of protecting consumers from insurer insolvencies amount to no more than 25% of the total cost of complying with SOX-like financial reporting rules.