If you were an investor comparing two different companies, financial health and assets would be important criteria to consider, especially in the current economy. And if one company had a better balance sheet — perhaps millions of dollars better than the other — you might think it was superior, as well as a safer investment.
But suppose the company that seemed better actually used alternate accounting methods in order to make its numbers look stronger, taking advantage of less stringent requirements to imply a stronger financial position? Suppose it had the same investment results as the other company (or even worse) but was able to utilize number-crunching techniques to appear better? How would you be able to accurately compare them and determine how safe and profitable they really were?
Of course, you’re not an investor; you’re an agent. Instead of considering companies in which to invest, you review insurance carriers and select the ones that appear strong and meet your clients’ needs. But some life insurance companies in select states are doing exactly what was described above under exceptions known as “permitted practices.”
What are permitted practices?
While the National Association of Insurance Commissioners has a standard set of accounting practices to which companies must conform, state regulators can relax them under special circumstances, allowing alternate practices. Last year, the American Council of Life Insurance (ACLI) proposed nine changes to the existing standards in order to assist companies burdened by the changing economy. These changes included altering reserve requirements, allowing more regulator discretion regarding collateral, and relaxing restrictions on deferred tax assets.
While the NAIC’s Capital and Surplus Relief Working Group gave a green light to six of the nine proposed changes — albeit in altered forms — the group’s executive committee ultimately rejected them. While the issue will be revisited later this year and many believe more changes will occur, companies who want to use them now must apply for permitted practice exceptions in individual states. That mean agents now have to determine if and how these changes will affect their ability to accurately judge companies, as well as how the changes will impact their business.
While most states have not allowed the use of permitted practices, Maine has been especially vocal about its skepticism toward the requests. In a bulletin, state Superintendent of Insurance Mila Kofman — who was a member of the NAIC’s working group and voted against the proposed changes — made it clear that Maine would not accept alternate accounting procedures allowed in other states.
“The current reporting period has witnessed an unprecedented volume of permitted practice requests. Many are motivated, or appear to be motivated, by a desire to mitigate the impact of the current financial crisis on insurers’ investment performance,” stated the bulletin, dated March 3, 2009. “The effects of the recent slides in the financial markets are widely shared, not unique, and the NAIC has determined that they do not justify changes in the accounting manuals. Accordingly, special accounting practices approved in a Maine-licensed insurer’s home state will not be automatically approved for use in Maine.”
Financial statements sent to the state will need to be re-calculated according to the codified practices, and Maine will use those figures to evaluate an insurer’s financial situation unless insurers can explain why an exception should be made.
On the other hand, Susan Voss, Iowa’s insurance commissioner, decided that some permitted practices were appropriate. She said that care was taken to set up limitations and rules for companies that accepted permitted practices that prevent turning the savings into undue financial reward. For example, companies would not be able to send certain dividends to the parent company, and the state evaluated factors such as solvency and credit ratings before making a decision to allow permitted practices. As a result, Voss feels comfortable that Iowa was able to balance the companies’ needs with necessary oversight and limitations.
“You know you’re going to get criticized if you (grant permitted practices), but we felt we put enough parameters around it so they had to be very careful about the use of that additional capital,” Voss said. “We wanted to make sure that any assistance that was provided wasn’t just going to be used to give bonus or extraordinary dividends.” While the permitted practices that Iowa allowed can be superficially beneficial to companies, Voss said that they are not designed to make a weak company look healthy. In fact, she said that all companies in her state are well above necessary risk-based capital levels.
The authority to grant permitted practices is not new, and state commissioners have leeway regarding what they can allow, but Voss explained that the NAIC’s procedure to grant them allows feedback from within the organization. Other states and groups could weigh in if they see something inappropriate being considered in a particular state.
“They’re going to be watching closely if we were giving assistance to a company that may be on the watch list or we may have some issues with,” Voss said.
Thomas Hampton, Washington, D.C. insurance commissioner and chairman of the NAIC working group that recommended the six proposals for approval, agrees that inappropriate permitted practices would face harsh scrutiny from fellow commissioners.
“It’s not like they’re doing anything in a vacuum, so everybody is looking at it, and they are understanding that this could cause some disdain with their fellow regulators,” he said.
Once a company requests a permitted practice from its home state, a notice is sent to every state in which the company does business. While the state’s regulator still has the final say, all interested parties have a chance to review and comment on the issue.
But that doesn’t mean the system is perfect, and Hampton acknowledges that the process doesn’t appear as transparent as it could. His working group is also considering recommendations to update the permitted practice procedures to allow more healthy dialogue.
“What we’re looking at now is, how can we have a more collaborative process?” Hampton explained. “I think the optics of it has caused a lot of people a lot of concern, even though everyone knew this was a power that the domestic regulator had.”
Hampton also explained that many of the accounting change requests were actually issues already being considered for future implementation over the next couple of years. Instead of waiting, the NAIC considered expediting some of those changes before the idea was ultimately rejected. But that doesn’t mean the ideas themselves are out of favor, and accounting changes could be reviewed (and possibly approved) before September of this year.
Approval would be welcome news to the ACLI. According to spokesman Whit Cornman, the organization believes that the changes are not designed to make accounting standards weaker or to assist troubled companies, but rather to provide a more realistic measure of where companies stand and what requirements they should have.
“The previous standards forced insurers to hold capital beyond what was necessary, so it did not give an accurate picture of the amount of capital they had available,” he said. “The effort underway at the NAIC is a way of looking at current capital reserve standards and putting them at more appropriate levels of reserves for insurers to meet their obligations, but also giving a more accurate picture of the capital insurers have on hand.”
Cornman also said it would be better to adopt those standards and provide consistent uniform relief rather than rely on options that vary from state to state. In fact, he believes the changes would benefit agents because they would offer a better evaluation of capital reserves and financial strength, providing a clearer picture for those considering those factors.
In addition, Cornman stressed that the proposed changes could provide balance sheet relief in a challenging economic environment, but they won’t alter a company’s ability to meet its financial obligations.
“They’re not designed to bolster weak companies. They’re designed to make sure that strong companies can weather any further economic downturn and remain strong,” he said.
Those measures are not in place as official accounting standards right now, but agents should be prepared for that to change soon. According to Hampton, it’s likely that a modification will be made this year to increase the acceptable limits of tax deferred assets. He also sees an adoption of statutory accounting literature as it relates to presenting investments using fair market values. In fact, the NAIC’s Financial Accounting Standards Board is reviewing the standards used to determine fair value in a variety of situations.
What can you do?
But until changes are made, agents in some states will be challenged with evaluating companies that could be operating under different accounting standards. So what’s the best course of action when conducting research on an insurance company?
Voss said that agents have a number of options that could provide more pertinent information than considering which are using permitted practices.
“They could look at the annual filings, they could look at the RBC (risk-based capital) levels. They could even call our office and determine when was the last time there was a financial examination and look at the exam reports,” she said. “That’s going to give them a clearer picture of the health of the company.”
If there are concerns regarding permitted practices in a particular state, Hampton said that all it takes is a little research to compare the numbers with and without them. A company’s financial statement will include notes that specify a permitted practice was used, as well as a reconciliation showing the numbers without the permitted practice.
But he also suggested that producers should consider a company’s rating for a fair determination of where it stands.
“The rating agencies look at all of this stuff without deviation, and they make determinations on these companies without that,” Hampton said. “If you want to look at something you compare apples to apples, and you have a rating agency that’s looking at all the companies. You can just do a comparison that way.”
Michael Murillo is a freelance writer and frequent contributor to the Agent’s Sales Journal. He can be reached at email@example.com.