INSURANCE

REGULATION

Scandal Highlights

Need for

Strengthened

Regulatory Oversight

United States General Accounting Office

GAO Report to the Honorable

John D. Dingell

Ranking Minority Member

Committee on Commerce

House of Representatives

September 2000

GAO/GGD-00-198

United States General Accounting Office General Government Division

Washington, D.C. 20548

Page 1 GAO/GGD-00-198 Insurance Regulatory Oversight

B-284347

September 19, 2000

The Honorable John D. Dingell

Ranking Minority Member

Committee on Commerce

House of Representatives

Dear Mr. Dingell:

As you requested, this report presents our evaluation of insurance

regulatory oversight and information-sharing in the matter of a highly

publicized insurance investment scam exposed in May 1999. Under

indictment for embezzling more than $200 million in insurance company

assets over nearly an 8-year period is Martin Frankel. Mr. Frankel, a

former securities broker who was barred from that industry in 1992,

allegedly migrated to the insurance industry and continued to operate as a

rogue by engaging in illegal activity.

The specific objectives of this report are to (1) describe the alleged scam;

(2) evaluate the oversight and information-sharing by insurance regulators;

and (3) identify cross-financial-sector coordination issues, including those

emanating from the scam relevant to financial regulators’ efforts to

implement the Gramm-Leach-Bliley (GLB) Act.1

Throughout the 1990s, Martin Frankel, with assistance from others,

allegedly obtained secret control of entities in both the insurance and

securities industries. He is alleged to have anonymously acquired and

controlled insurance companies in several states and, despite being barred

from the securities industry, to have exercised secret control over a small

securities firm. Using the name of this securities firm, Mr. Frankel

allegedly took custody of insurance company assets and provided false

documents on investment activity to disguise his actual purpose. Instead

of managing these assets in a prudent manner, he allegedly diverted them

to other accounts he controlled and used them to support the ongoing

scam and his lifestyle. The scam was finally exposed after insurance

regulators in Mississippi took enforcement action against three of the

Frankel-connected insurers by placing them under regulatory supervision.

At the time this report was being written, a federal criminal probe against

Mr. Frankel was still ongoing.

1 Pub. L. 106-102 (Nov. 12, 1999).

Results In Brief
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Weaknesses in key insurance regulatory oversight activities, including

inadequate analysis of securities investments and failure to detect the

misappropriation of assets, contributed to delays in detecting the

investment scam for years. We observed some regulatory weaknesses in

multiple states over several years during each of the key phases of

insurance regulatory oversight—change of ownership approvals, routine

financial analyses, and periodic on-site examinations. Specifically we

observed inadequate measures for assessing the appropriateness of buyers

of insurance companies, analyzing securities investments, evaluating the

appropriateness of asset custodians, verifying the insurers’ assets, and

sharing information within and outside the insurance industry. We also

found some weaknesses in support services provided by the National

Association of Insurance Commissioners (NAIC), a voluntary association

of state insurance regulators. Some of these weaknesses were similar to

those identified in our previous reports on the insurance regulatory

system, including weaknesses in interstate coordination, oversight of

entities under holding companies, and gaps in controls to prevent the

migration of unscrupulous securities brokers to other sectors of the

financial services industry. NAIC and the Tennessee Comptroller of the

Treasury have also conducted parallel reviews of the scam and disclosed

similar weaknesses along with recommendations for corrective actions.

Successful implementation of recommendations emanating from the

scandal to improve fraud prevention safeguards will require a sustained,

high-level commitment by NAIC and the states.

The GLB Act financial modernization legislation highlights the importance

of consultation and information-sharing among federal financial regulators

and state insurance regulators when banks and insurance companies are

affiliated. The fraudulent activities allegedly perpetrated by Mr. Frankel

further demonstrate the need for heightened coordination of oversight

activities among regulators in cases where affiliated entities exist.

Although the legislation is recent, regulators have recognized the need to

improve their coordination and have taken or plan to take a number of

actions. Generally, the actions consist of establishing formal agreements

for sharing information and creating working groups for periodic meetings

to discuss matters of mutual interest. These regulatory actions are in their

infancy, but the expected continued blurring of distinctions and

separations in financial markets will require an increased and continuing

commitment to enhance regulatory cooperation in performing oversight.

Insurance regulators and the Securities and Exchange Commission (SEC)

have also indicated a desire to move toward more regulatory coordination,

although the GLB Act does not specifically address coordination between

securities and insurance regulators.
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This report includes recommendations to help prevent or detect similar

investment scams in insurance companies by proposing the adoption of

appropriate asset custody arrangements, improved asset verification

procedures, and the sharing of confidential regulatory information across

industries and agencies. In addition to the above recommendations

emanating from the Frankel matter, this report contains a

recommendation designed to broaden and help sustain cooperation among

regulators of different financial services sectors. Agencies responding to

the report with comments generally concurred with the report’s findings,

conclusions, and recommendations. We also suggest that Congress

consider requesting periodic status reports on regulatory progress and

plans in these areas. Such reports would enable Congress to monitor

progress and would encourage states to adopt needed reforms.

In 1999, federal authorities indicted Martin R. Frankel for allegedly

masterminding an insurance investment scam. Mr. Frankel is a former

securities broker who, following a permanent bar from that industry in the

early 1990s, allegedly migrated into the insurance industry where he

perpetrated an investment scam. The insurance companies negatively

affected by the scam were regulated by individual states. Another entity

tied to the scam, a broker-dealer, was subject to regulation in the

securities industry. The migration of undesirable persons, or rogues, from

one industry to another is one of many issues of concern for financial

services regulators that are attempting to implement the GLB Act,

legislation aimed at modernizing the financial services industry. As

detailed in appendix I, our previous work in the insurance and securities

industries highlights some long-standing issues in these industries germane

to the fraud allegedly perpetrated by Mr. Frankel.

On October 7, 1999, the United States Attorney’s Office in Connecticut

announced that “a federal grand jury sitting in Bridgeport, Connecticut

returned a thirty-six count indictment against Martin R. Frankel, age 44,

formerly of Greenwich, Connecticut, charging him with twenty counts of

wire fraud, thirteen counts of money laundering, and one count each of

securities fraud, racketeering and conspiracy.” The indictment identifies

entities in the insurance and securities industries that Frankel allegedly

used to steal in excess of $200 million in assets belonging to insurers. In

addition to the criminal indictment, federal and state authorities have also

filed civil actions to recover assets obtained through Frankel’s alleged

investment scam. At the time of this report, the criminal and civil cases

involving Mr. Frankel were ongoing.

Background

Martin Frankel Is Charged

with Stealing Over $200

Million from Insurance

Companies
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Insurance companies are regulated by the states. In contrast to banking

and securities entities (other than national banks) that are subject to dual

federal and state oversight, the states are solely responsible for regulating

the business of insurance. An insurance company is chartered under the

laws of a single state, known as its state of domicile. Insurers can conduct

business in multiple states, but the regulator in the insurer’s state of

domicile is its primary regulator. States in which an insurer is licensed to

operate, but in which it is not chartered, typically rely on the company’s

primary regulator in its state of domicile to oversee the insurer.

States are assisted in their regulatory responsibilities through guidance,

model (or recommended) laws and regulations, and information-sharing

tools provided by NAIC. NAIC is a voluntary association of the heads of

each state insurance department, the District of Columbia, and four U.S.

territories. It does not have regulatory authority over the state insurance

departments. NAIC provides a national forum for addressing and resolving

major insurance issues and for allowing regulators to develop consistent

policies on the regulation of insurance when consistency is deemed

appropriate. State insurance commissioners created NAIC, in part, to help

address problems that differing state-by-state authorities, laws, and

regulations can cause as state insurance regulators oversee insurers that

operate in more than one state. NAIC serves as a clearinghouse for

exchanges of information, provides a structure for interstate cooperation

for examinations of multistate insurers, distributes model insurance laws

and regulations for consideration by states, and reviews state insurance

departments’ regulatory activities as part of its national accreditation

program.

The oversight activities of state insurance regulators may differ, but each

oversees the safety and solvency of insurance companies through key

phases of oversight activities, which include

• chartering and change in ownership approvals,2

• routine financial analyses, and

• periodic on-site examinations.

Adverse findings in the first phase could result in the refusal to permit a

change in ownership. Adverse findings in the other two phases could

2

Regulators generally require applicants to follow the same process to acquire a charter for a new

insurance company or to purchase an existing company. The companies that Mr. Frankel allegedly

acquired were all previously owned and operated by others before their purchase by Frankelcontrolled entities.

Insurance Companies Are

Regulated by the States

With Assistance from NAIC

Insurance Regulation

Entails Key Oversight

Activities
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result in a variety of regulatory enforcement actions up to the takeover

and/or closure of the company.

The initial oversight activities involve state approval of the proposed new

ownership of an insurance company—whether to start a new company or

to acquire an existing company. Applicants to form or acquire an insurer

apply for approval in the state in which the company will be domiciled.3

Key information collected to render a decision on the ownership

application is submitted on a standard form developed by NAIC known as

a Form A. In addition to going through the ownership approval process

with the domiciliary state, an insurer may also apply to become licensed in

other states where it seeks to conduct business.

After a domiciliary state has approved an ownership application, that state

continues to oversee the insurer through routine financial analyses. An

important element of the financial analysis work is the review of annual

and quarterly statements submitted by the insurance companies containing

information, such as financial statements, responses to various questions

about company activities, and various schedules summarizing investment

and other business activity. NAIC assists the states’ annual review efforts

with numerous financial analysis tools, including the calculation of

financial analysis ratios on insurance companies, known as the Insurance

Regulatory Information System (IRIS) ratios.4 These ratios, which are

provided to the appropriate state regulators, help state insurance analysts

identify areas of potential regulatory concern, particularly indicators that

could suggest financial difficulties.

The states’ on-site insurance examinations are intended to validate the

insurers’ financial condition and market conduct. According to NAIC’s

guidelines, examinations are to occur at least once every 5 years. One of

the most fundamental tasks of the on-site examinations is to verify

information the insurers have provided in regulatory reports. Because a

company’s solvency is determined by comparing the value of its assets and

liabilities, a key regulatory concern is the existence and value of the

insurer’s reported assets.

3

The state of domicile, or domiciliary state, is the primary regulator of an insurance company.

4

Nearly all insurers, except for the smallest ones, submit their annual and quarterly regulatory reports

to NAIC as well as to their domiciliary regulator. States where the companies are licensed also receive

copies of the reports. NAIC then calculates a number of financial ratios, known as the IRIS ratios,

performs some preliminary analyses, and returns the information to the domiciliary state. Ratios that

are outside the “usual range” are flagged by NAIC for regulatory attention.
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NAIC also issues guidance to assist regulators in performing financial

analyses and examinations. For example, NAIC’s Financial Analysis

Handbook is designed to help states identify, as early as possible,

insurance companies that may be financially troubled. It includes

checklists on financial concepts and analyses deemed important to assess

the company’s financial condition. It is intended to serve as an advisory

guide but is not an NAIC accreditation standard. The Examiner’s

Handbook is another tool developed by NAIC to assist state regulators in

detecting as early as possible those insurers in financial trouble and/or

engaging in unlawful and improper activities and to develop the

information needed for timely, appropriate action. Both handbooks

employ the use of checklists, but they also note or imply that state

regulators must exercise sound judgement and assess the insurers in

accordance with their own state laws and regulations.

Within the securities industry, securities firms are regulated by the SEC,

which delegates regulatory responsibilities to several self-regulatory

organizations (SROs). The SROs for broker-dealers include the New York

Stock Exchange and the National Association of Securities Dealers

Regulation Inc. (NASDR). Additionally, state securities offices work in

conjunction with SEC and the SROs to regulate securities firms. The

functions of state securities offices include the licensing of some

securities-related entities and agents. States also collect and monitor

financial data of broker-dealers that they license in their states. The

securities firm connected to the investment scam was a broker-dealer

regulated by NASDR and licensed to conduct business in numerous states.

Federal regulators, among others, have testified in recent years that

constraints segregating various sectors of the financial marketplace have

outlived their usefulness. Banks, securities firms, and insurance

companies have increasingly offered a similar array of products and

services. Moreover, these institutions have been merging. The

technological advances and the development of new financial products

and services has increasingly blurred the lines once separating the

offerings of banks, securities firms, and insurance companies and thus also

blurred the lines among regulators. The GLB Act’s purpose was to

establish a comprehensive framework to permit affiliations among

commercial banks, securities firms, and insurance companies, allowing a

“level playing field” while maintaining the safety and soundness of the

financial system. It also recognized the need for greater regulatory

consultation and coordination.

Broker-Dealers Are

Regulated by Federal and

State Organizations

Congress Has Enacted

Financial Services

Modernization Legislation
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To identify the nature of Mr. Frankel’s alleged insurance investment scam,

we obtained publicly available documents through the Department of

Justice, including the federal indictment against Mr. Frankel. We also met

with officials and conducted file reviews at SEC and NASDR to ascertain

Mr. Frankel’s past and recent activities in the securities industry. Within

the insurance industry, we reviewed regulatory files and discussed the

chronology of events with officials in states where the principal insurers

connected to Mr. Frankel’s alleged scam were domiciled—Tennessee,

Mississippi, Missouri, Oklahoma, and Arkansas. We also visited officials in

Virginia, where an insurer was negatively affected by a transaction with

one of the Frankel-connected insurers. In addition, we conducted

literature searches related to this investment scam.

To assess the regulatory oversight and information-sharing activities that

occurred in connection with the Frankel matter, we visited the states

identified above that were responsible for overseeing the insurers

victimized by the scam and reviewed the pertinent regulatory files.

Additionally, we reviewed the relevant policies and procedures in effect in

those states during the years that Frankel apparently controlled the

insurance companies. We also contacted officials in other states, including

Alabama and Washington, to understand their dealings with insurance

entities allegedly connected to Frankel. To ascertain the types of

regulatory information available in the insurance and securities industries,

we met with officials from NAIC, selected state securities offices, SEC, and

NASDR and reviewed the appropriate records. We also discussed

insurance regulators’ access to criminal databases with Department of

Justice officials.

To understand regulatory efforts to implement features of the financial

services modernization legislation, the GLB Act, we met with regulatory

officials in the insurance, banking, and securities industries who have

worked closely on regulatory coordination issues. Specifically, we

discussed the status of regulatory coordination efforts across industry

sectors with officials at NAIC, the State of Connecticut’s Insurance

Department, the Federal Reserve Board, the Office of the Comptroller of

the Currency (OCC), the Office of Thrift Supervision (OTS), and SEC.

The activities and events associated with Martin Frankel described in this

report are alleged in the federal indictment. Federal and state authorities

had criminal and civil cases pending against Mr. Frankel at the time of this

report. Thus, additional facts relevant to regulatory activities are likely to

be revealed as these cases proceed through the courts.

Scope and

Methodology
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During our review, NAIC and state officials, with one exception, fully

cooperated with our review, including granting us full access to records.

In Mississippi, state officials did not provide us access to nonpublic

records, such as workpapers associated with annual reviews and on-site

exams, citing concerns over the release of such information because of

ongoing litigation on the matter. During our review, we briefed some state

officials and NAIC on our preliminary findings and observations to assist

their efforts in developing corrective actions. The regulatory weaknesses

we observed were not based upon an exhaustive analysis of all insurance

regulatory procedures and practices, but rather on those most relevant to

this particular scam.

We conducted our review in Nashville, TN; Jackson, MS; Jefferson City,

MO; Oklahoma City, OK; Little Rock, AR; Richmond, VA; Montgomery, AL;

New York, NY; Chicago, IL; Kansas City, MO; Hartford, CT; Bridgeport, CT;

and Washington D.C., between October 1999 and August 2000 in

accordance with generally accepted government auditing standards.

Throughout the 1990s, Martin Frankel allegedly gained secret control of

entities in both the insurance and securities industries. While undergoing

a disciplinary proceeding in the securities industry, Frankel allegedly

migrated to the insurance industry. Working through others, he

established a trust that was used to purchase insurance companies.

Concurrently, he gained secret control of a broker-dealer that he used to

disguise his diversion of insurance company assets. With the insurance and

securities entities under his control, Frankel allegedly stole over $200

million belonging to the insurers before his scam unraveled. An overview

of Frankel’s alleged activities is depicted on a time line in Figure 1. His

activities to gain control over entities in the insurance and securities

industries and expand his investment scam are described in the sections

below.

How Was the Alleged

Scam Carried Out?
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1985-1988, Mr. Frankel works in the securities

industry and is fired from two firms for

personal differences with management

and activities subsequently leading to an

SEC investigation.

December 1989, SEC begins a formal

investigation of Mr. Frankel for omissions and

misstatements to investors about his

investment practices.

August 1992, Mr. Frankel settles with SEC

and is permanently barred from the

securities industry.

August 1991, Liberty National Securities

registers in Tennessee and is allegedly

controlled by Mr. Frankel.

September 1991, Mr. Frankel allegedly forms

Thunor Trust using nominee grantors and

files application and later buys a Tennessee

Insurance company.

February 1994 - March 1995, Thunor Trust

purchases 4 more insurance companies

domiciled in Mississippi, Oklahoma, and 

Missouri.

February 1998, Thunor Trust purchases an

insurance company domiciled in Alabama.

February 1999, Thunor Trust purchases an

insurance company domiciled in Arkansas.

The scheme unravels, and

Mr. Frankel flees.

9 10

Mr. Frankel migrates to the insurance industry,

and allegedly steals $200 million.

4 5 7 8

A

2 3

1

2

3

4

5

6

7

8

Late 1998, Tennessee and

Mississippi insurance regulators

became suspicious of insurers'

asset custody arrangements.

Early May 1999, Mr. Frankel flees

the U.S.

September - October 1999,

Mr. Frankel is arrested in Germany

and then indicted in federal court

in Connecticut.

9

10

11

B

C

1

6

11

Mr. Frankel works in the securities industry,

but engages in activities leading to his permanent bar.

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

A B C

Source: GAO.

In the early 1990s, Mr. Frankel is alleged to have gained control over

entities in the insurance industry at the same time he was being

investigated by SEC for misconduct in the securities industry. According

to SEC officials, Frankel’s activities as a rogue broker began in the mid

1980s when he made misstatements and misrepresentations to investors.

In a 1991 civil complaint, SEC charged that Frankel raised over a million

dollars through the offer and sale of limited partnerships in an investment

fund he established. The complaint stated that Frankel had made

omissions and misstatements about the use of proceeds from investors, his

background and experience, and the performance of the fund he

Figure 1: Overview of the Scandal

Frankel, a Rogue Broker,

Allegedly Migrated to the

Insurance Industry
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controlled. In August 1992, Frankel consented to a permanent ban from

the securities industry and agreed to return funds to the investors.

At the time he was being investigated by SEC, Frankel is alleged to have

anonymously established Thunor Trust in 1991 and subsequently used it to

purchase entities in the insurance industry. He is alleged to have

anonymously formed this trust using the names of three acquaintances,

identifying them as grantors to the trust. Another individual, who was

named as the sole and irrevocable trustee, managed the trust.

Frankel allegedly used his anonymous control of Thunor Trust to purchase

insurance companies. Shortly after it was formed in 1991, Thunor Trust

acquired the majority interest in Franklin American Corporation, which, in

turn, owned Franklin American Life Insurance Company, an insurer

domiciled in Tennessee. Frankel allegedly continued to use Thunor Trust

as a means to acquire other insurers with the assets of those that he had

previously acquired.

Our review of the insurance regulatory files on the Thunor Trust group of

insurers confirmed that Mr. Frankel’s name did not appear on the change

in ownership applications, which were documented on a Form A

(previously described in the background section). Ownership of the

insurers could be traced back to Thunor Trust, which, in turn, was

managed by another individual who served as the sole, irrevocable trustee

on behalf of the trust’s beneficiaries. These beneficiaries were identified

in the Form A documentation as relatives of the three grantors who

ostensibly established Thunor Trust.

At the same time Mr. Frankel was allegedly acquiring the assets of

insurance companies, he also controlled certain business activities of a

small broker-dealer registered with securities regulators. Frankel then

allegedly used the name of this broker-dealer when (1) taking custody of

insurance company assets and (2) providing false documents concerning

the insurers’ investment activities. With the broker-dealer serving as a

front for his investment scam, Frankel allegedly diverted insurance

company assets unlawfully into accounts he controlled to support his

lifestyle and perpetuate the scam.

Despite being barred from the securities industry in 1992, Frankel allegedly

controlled a small brokerage firm named Liberty National Securities

(LNS).5

Frankel allegedly used LNS as a front, controlling LNS’ business

5 LNS, a small broker-dealer established in Ohio in 1991, moved to Michigan in 1993.

Concurrently, Frankel

Allegedly Gained Control of

a Broker-Dealer to Help

Disguise the Scam
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activities with assistance of an individual associated with the firm.

According to information obtained from NASDR, Frankel paid this

individual $2,000 per month to perform certain business functions in the

securities industry.

Borrowing the name of LNS, Frankel allegedly took custody of insurance

company assets and provided false documents on investment activity to

the insurance companies. Through his association with an individual from

the real LNS, Frankel allegedly got the firm’s name licensed in numerous

states throughout the country, including those where he had insurance

companies under his control. In addition, telephone calls and mail were

forwarded through LNS, located in Dundee, MI, to Frankel’s mansion in

Connecticut. Authorities charge that Frankel operated the scam from this

residence. Instead of investing the assets in a prudent manner, Frankel

allegedly diverted the insurer assets to other accounts he controlled.

Our review of information available at SEC and NASDR revealed that LNS

was a small broker-dealer located in Toledo, OH, with less than $10,000 in

assets when it was formed in 1991. In April 1993, the firm moved to

Dundee, MI. Mr. Frankel’s name did not appear on the filings LNS made

with SEC and NASDR. Regulatory data from state securities offices and

NASDR revealed that before the collapse of the scam in 1999, LNS had

approximately $60,000 in assets and was licensed to conduct business in

numerous states throughout the country, including those where Mr.

Frankel allegedly controlled insurers’ assets. In addition, records at SEC

revealed numerous investment accounts under Mr. Frankel’s direct control

at other brokerage firms.

With entities in the insurance and securities industry under his control,

Frankel allegedly expanded his investment scam throughout the 1990s,

stealing over $200 million of insurer assets. Assets belonging to the

insurers held by Thunor Trust were ostensibly invested with LNS and

systematically funneled by Frankel into other accounts he controlled. Mr.

Frankel allegedly continued a pattern of purchasing insurance companies

using money from previously acquired insurers. By 1999, the Thunor Trust

group of insurers included seven insurance companies, one domiciled in

Tennessee; three in Mississippi; and one each in Missouri, Oklahoma, and

Arkansas. A simplified organizational chart of the entities connected to

the investment scam is shown in figure 2.

Frankel Allegedly Expanded

His Scam from 1991-1999

and Stole Over $200 Million
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Thunor Trust

(TN)

International Financial

Corporation

(OK Holding Co.)

Franklin American

Corporation

(TN Holding Co.)

Farmers and Ranchers

Life Insurance Co.

(OK)

Franklin American

Life Insurance Co.

(TN)

Franklin Protective

Life Insurance Co.

(MS)

International Financial

Life Insurance Co.

(MO)

Old Southwest

Life Insurance Co.

(AR)

Family Guaranty

Life Insurance Co.

(MS)

Real Liberty

National Securities

(MI)

$ $

Bogus Liberty

National Securities

(CT, NY, MI, OH)

First National

Life Insurance Company

of America

(MS)

a

Source: GAO summary of insurance regulatory data.

To portray his investment operation as legitimate, Frankel allegedly

fabricated phony account statements that seemingly reflected positive

results on investment activities of the insurers’ assets that LNS was

managing. These account statements typically reported a relatively high

level of trading volume on the insurers’ assets, often indicating that

significant portions of the companies’ assets were being traded on almost a

daily basis. Furthermore, the LNS account statements generally reported

above market returns on the trading activity of U.S. government securities.

The insurers subsequently used figures from these allegedly phony

statements in their required annual filings with regulators, attesting to the

financial health and business activities of the insurance companies.

Allegedly, the assets were not traded and invested as reported in the LNS

Figure 2: Simplified Structure of the Thurnor Trust Insurance Companies
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statements. Instead, they were diverted into other accounts controlled by

Frankel, who used the funds to perpetuate the investment scam and

support his lifestyle.

Frankel continued to expand the asset portfolio under his control through

reinsurance agreements, particularly in the later years of the scam.6Under

these agreements, insurers under Thunor Trust purchased books of

business from other insurers and assumed the assets and liabilities from

the other insurers. Through these reinsurance agreements, Frankel

allegedly obtained control over significant assets from other insurers

outside those under Thunor Trust. One such insurer was Settlers Life,

domiciled in Virginia. The company lost about $45 million through a

reinsurance transaction with one of the Thunor Trust insurers in April

1999.

After operating for nearly 8 years, the investment scam began to unravel as

insurance regulators placed more scrutiny on the insurers’ asset custody

arrangements with LNS. Eventually, the Thunor Trust insurers domiciled

in Tennessee and Mississippi were ordered by their respective state

insurance departments to remove their assets from the custody of LNS. In

April 1999, through the enforcement of a law fashioned after a model law

recommended by NAIC to safeguard insurer’s assets, the Tennessee

Department of Commerce and Insurance was able to safeguard the assets

belonging to the insurer domiciled in its state, which were ultimately

placed into a state of Tennessee account in May 1999. On April 29, 1999,

the Mississippi Insurance Department decided to place three of the Thunor

Trust insurers domiciled in that state under Administrative Supervision

because of concerns related to LNS and the possibility that Thunor Trust

might have been taken over by another organization, the Saint Francis of

Assisi Foundation, without prior approval. Prior to the collapse of his

investment scam, Frankel had allegedly attempted to purchase other

insurers through this foundation.

During the first week in May 1999, the sole trustee of Thunor Trust and its

affiliated insurance companies announced that the assets of the insurers

were gone. Insurance regulators in Missouri, Oklahoma, Arkansas, and

Virginia said they were informed of the investment scam involving

companies domiciled in their states shortly thereafter. In the aftermath,

federal authorities alleged that Frankel stole the insurers’ assets.

6

In reinsurance transactions, generally the insurer that purchases a book of business assumes the

assets and liabilities associated with the policies of that business in exchange for the purchase price.
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Federal and state authorities now have criminal and civil cases pending

against Frankel and others allegedly connected to the scam. In addition to

the criminal indictment information previously described, several states

have now joined in civil suits against Frankel, his associates, an accounting

firm that audited the Thunor Trust insurers, and legal professionals. Some

associates of Frankel have pled guilty on certain offenses to federal

authorities for their roles in the scam, and federal and state criminal

investigations and efforts to recover funds from those who perpetrated the

scam are ongoing. Appendix II summarizes key events associated with the

investment scam.

Taxpayers and certain policyholders in some states will bear much of the

financial burden resulting from the scam unless federal and state

authorities successfully recover significant funds from those who

perpetrated it. According to the National Organization of Life and Health

Insurance Guarantee Associations (NOLHGA), the initial estimated costs

to state guarantee associations is approximately $133 million on covered

obligations of approximately $190 million.7 Other indirect costs include

additional legal and regulatory costs incurred by state and federal officials

emanating from the scandal. Although state guarantee funds help protect

policyholders in cases where insurers become insolvent, a portion of such

losses is ultimately borne by the public at large, because insurers

domiciled in some states are eligible to offset a portion of the amounts

assessed by the states’ guarantee funds against premium taxes collected by

these states. Numerous policyholders have also been victimized by the

scandal through shortfalls in coverage from certain state guarantee fund

programs. For example, according to the liquidator for First National Life

Insurance Company of America (one of the Frankel-controlled insurers),

about 3,000 policyholders and annuitants of the insurer who are California

residents are backed for only 80 percent of the value of their policies

through the state’s insurance guarantee program. This insurer also sold

policies with annuity riders on U.S. military installations overseas, and

some policyholders who are not U.S. citizens are not covered by any state

guarantee association program.

7

After an insurance company becomes insolvent, policyholders are protected to varying degrees by

their own state’s insurance guarantee program. Therefore, one insurance company failure can trigger

the need for coverage from numerous state insurance guarantee programs to the extent that

policyholders of the failed insurer are residents of different states. Coverage under each state’s

insurance guarantee program is limited, and the limits vary by state. According to NOLHGA, over 90

percent of policyholders have been fully protected from insurer insolvencies since 1992, when the last

guarantee associations were established.

Victims of the Scandal

Include Taxpayers and

Policyholders
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Page 15 GAO/GGD-00-198 Insurance Regulatory Oversight

Weaknesses associated with insurance regulatory tools and inadequate

oversight and coordination activities contributed to delays in detecting the

investment scam for years. Regulatory weaknesses were observed in the

domiciliary states’ oversight activities as well as with certain support

services provided by NAIC. As shown in table 1 below, we identified

weaknesses in the three key phases of regulatory oversight—change of

ownership approval, routine financial analyses, and on-site examinations.

We observed repeated instances of inadequate tools, policies, procedures,

and practices as well as a lack of information-sharing among different

regulators, within and outside the insurance industry. Many of the specific

events and circumstances that we found were not necessarily inconsistent

with laws or regulations; however, they were sufficiently unusual that

either individually or collectively, they provided reasonable grounds for

regulators to have asked additional questions beyond those routinely

addressed. The answers or, in some cases, the lack of answers, to those

questions could have resulted in a much earlier exposure of the scam.

Unfortunately, these questions were not sufficiently pursued and resolved

in a timely manner. Insurance regulators, working through NAIC, have

recognized the regulatory weaknesses we identified and have begun

addressing or intend to address them with corrective actions to help

reduce the industry’s vulnerability to fraud.

Numerous Regulatory

Oversight Weaknesses

Contributed to Delays

in Detection
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Oversight

phase Weakness Specific observations

Inadequate due diligence

performed on buyer application

data

- Failure to act on “red flags” associated with trust managed by a sole and

irrevocable trustee that left grantors with no control over money

- Inadequate questioning of prospective buyers

Inadequate tools and procedures

to validate individuals’ regulatory

or criminal backgrounds

- Inability to readily access regulatory history data

- Inability to access criminal history data on individuals

Change in

ownership

approvals

Lack of coordination between

regulators within and outside the

insurance industry

- Failure to exchange insurance regulatory concerns among states on a timely basis

- Absence of an industry “clearinghouse” of insurer application data

- Inability to routinely access data from other financial regulators

Inadequate analysis of securities

investments

- Inadequate state procedures and practices to flag high asset turnover ratios and no

use of thresholds to trigger additional scrutiny

- Lack of NAIC policies, procedures, or practices to assess asset turnover

- Insufficient securities expertise exhibited by insurance departments to question

unusual investment strategy

- Lack of NAIC consolidated financial analysis of affiliated insurers in multiple states

Ineffective mechanisms to

safeguard and monitor control of

insurers’ securities held by

another entity

- Inconsistent and ineffective policies regarding appropriate asset custodial

relationships

- Failure of insurance regulators to require from insurers sufficient information to

allow independent verification of legitimacy and appropriateness of new custodians

- Inadequate information collected annually to understand who had control of the

insurers’ assets

Routine

financial

analyses

Inadequate securities-related

expertise and information

gathering

- Lack of expertise to assess the viability of the insurers’ investment strategy

- Failure to obtain securities-related expertise from state securities regulators or from

contracted assistance

- Lack of communication with state securities regulators to verify the appropriateness

and legitimacy of the broker-dealer

Failure to detect misappropriation

of assets

- Failure of four completed exams on companies owned by Thunor Trust to identify

any material weaknesses

- Inadequate examination guidelines and procedures to verify book-entry securities

that were not held by a depository institution

- Inadequate assessment of highly unusual investment activities

- Questionable ability of insurance examiners to assess securities related activities

Inadequate practices and

procedures to verify the

legitimacy of asset custodians

- Inadequate efforts to independently validate the identity and appropriateness of the

asset custodian

- Improperly executed custodial agreements not detected

On-site

examinations

Limited sharing of information and

coordination among regulators

- Lack of proactive alerts to warn other states of examination concerns so as to deter

scam from spreading

- Lack of communication with securities regulators

- Lack of coordinated on-site examinations for insurers in the same group

Source: GAO analysis of insurance regulatory data.

Table 1: Overview of Regulatory Weaknesses
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Regulatory weaknesses observed during change in ownership approval

activities included inadequate (1) due diligence of buyer application data,

(2) tools and procedures for verifying applicants’ backgrounds, and (3)

regulatory information-sharing both within and outside the insurance

industry. The states’ review of the data associated with an application for

the change in ownership of an insurance company, documented in a

format prescribed by NAIC known as a Form A, did not include checks on

individuals’ regulatory or possible criminal histories. Furthermore,

regulators often did not appear to question unusual aspects of the

purchase of an insurer under Thunor Trust. Additionally, insurance

regulators did not effectively share information on the status of Form A

applications among states nor did they seek regulatory data on applicants

from other financial services industries.

The purchase of insurance companies under Thunor Trust provided a

number of opportunities for regulators to ask questions about the

prospective owners. We believe some of these questions should have been

routine--part of the normal process of approving a regulated insurer’s

change in ownership control. Other questions could have been raised by

the unusual characteristics of the trust or of the change in ownership. Had

regulators exercised a higher degree of scrutiny or professional skepticism

during these purchases, the scam may have been detected earlier.

Routine questioning during the change in ownership approval process

includes determining the intentions and appropriateness of the buyer; that

is, those who are providing the money for the purchase. In the case of

Thunor Trust, the money to purchase the first insurance company was

supposedly provided by three individuals or grantors. However, during

our review of change in ownership application data, we found no evidence

that state regulators sought financial information from the grantors to

validate their financial condition despite the trust’s dependence on the

grantors for funds. Moreover, we found no evidence that any state

regulators ever directly questioned the Thunor Trust grantors to validate

their ownership interests, business intentions, and control of the trust in

spite of a number of unusual characteristics associated with the change in

ownership applications.

Unusual conditions or red flags present on the change in ownership

applications associated with Thunor Trust centered on the trust

arrangement itself. A review of the documentation on the trust revealed

that the three grantors who supposedly provided $3.75 million to establish

the trust in 1991 had no control over their money. In assessing the

ultimate controlling interests behind an insurance company, one would

Regulatory Weaknesses

Observed During Change In

Ownership Approvals

Inadequate Due Diligence

Performed on Buyer Application

Data
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expect to see a connection between the firm’s control and the individual(s)

who provided the money to purchase it. Instead, the trust was established

in a manner that left one individual, who was not a grantor to the trust, in

complete control of the trust and whose authority to manage the trust was

irrevocable, even by the grantors of the trust. The trustee was supposed to

manage the assets of the trust on behalf of the trust’s beneficiaries, who

were family members of the grantors. However, the trust agreement did

not give the purported grantors any authority to remove the sole trustee on

the basis of how that individual managed the trust, thus leaving the

grantors with no control over their money.

The Thunor Trust entity apparently deceived regulators about who the

actual ultimate controlling interests were behind the trust and, in turn, the

interests behind the insurance companies purchased under the trust. The

trust arrangement that appeared to leave those who established the trust

with no mechanism of control in how the trust operated provided red flags

that could have raised questions for regulators. The federal indictment

now alleges that Frankel himself established the trust using the names of

three acquaintances who never actually contributed funds to the trust.

Had regulators followed the money trail back to the reported sources of

origin and questioned the grantors directly to validate their interests and

actual control in the trust, as the money was being used to purchase

insurance companies, the scam could have been uncovered during the

Form A application process.

Tools and procedures used by insurance regulators were not adequate to

verify applicants’ regulatory histories or potential criminal backgrounds.

During our visits to the states and review of the applications associated

with the insurer acquisitions under Thunor Trust, we found that states

could not readily validate an individual’s background in other financial

services industries. Furthermore, in contrast to bank and securities

regulators, state insurance regulators generally cannot verify self-reported

information provided by individuals in response to questions about their

criminal history. According to NAIC, most states lack the regulatory

authority to obtain criminal history data for noncriminal purposes.

During this investment scam, a check into the regulatory history of the

grantors of Thunor Trust would have revealed unfavorable incidents with

one of the grantors in the securities industry. These incidents, which were

not necessarily of a nature to preclude the individual from owning an

insurance company could, however, have prompted additional regulatory

scrutiny on the grantor’s intentions in the insurance industry. Because

Frankel is alleged to have formed the trust without the money of the

Inadequate Tools and

Procedures to Validate

Individuals’ Regulatory or

Criminal Backgrounds
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supposed grantors, questioning these individuals directly about their

regulatory histories and interest in the trust could have unraveled the scam

at the outset.

NAIC officials acknowledged that there is not currently an expectation in

NAIC’s guidance for the states to perform regulatory and criminal

background checks on the self-reported information provided in Form A

applications. There are limitations to insurance regulators’ access to

regulatory and criminal history data from other government agencies.

Insurance regulators cannot readily access disciplinary-related information

generated on individuals in the banking or securities industry, other than

through publicly available means. Additionally, insurance regulators

generally cannot routinely validate whether or not an individual has a

criminal background in spite of a federal insurance fraud prevention

provision that prohibits individuals with a felony criminal history involving

fraud or breach of trust from entering the insurance industry without the

consent of insurance regulators.8 Insurance regulators maintain that they

cannot verify an individual’s potential criminal background because most

state insurance departments do not have access to criminal history data.

Background data on key individuals associated with the purchase of an

insurer are obtained in the Form A application through self-reported data

on a Biographical Affidavit. This affidavit asks, among other things, if an

individual has ever been charged with any wrongdoing by any

governmental authority or been charged or convicted of a crime.

Although other financial services regulators have established mechanisms

that allow them to routinely conduct criminal history checks through the

Federal Bureau of Investigation (FBI), state insurance regulators and the

Department of Justice have not yet implemented a similar mechanism for

insurance regulators. Officials from several banking regulatory agencies

explained that as part of their due diligence processes on charter

applications, they submit information on key officials associated with the

applications to the FBI for the purpose of conducting criminal background

checks. An FBI representative confirmed that banking and securities

regulators conduct background checks by submitting information on

individuals to the FBI. The representative mentioned that insurance

regulators could obtain criminal history data in such a manner, provided

they had the statutory authority to do so. Another Justice official

concurred that most insurance regulators do not currently have access to

8

18 U.S.C. § 1033 provides that, among other things, a person who has been convicted of any criminal

felony involving dishonesty or a breach of trust or any offense described in the section may engage in

the business of insurance only through the written consent of an insurance regulatory official

authorized to regulate the insurer.
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criminal history data, given their lack of law enforcement status. This

official believed that current legislation may give insurance regulators the

right to such criminal history data for noncriminal justice purposes,

although implementation of such authority has yet to be accomplished and

may require an Executive Order. Justice officials stated that procedural

matters need to be worked out between the FBI and the insurance

industry.

Although insurance regulators lacked the tools to directly access

regulatory history information from other financial sectors, we were able

to access such information from other available sources. As previously

mentioned, NAIC officials acknowledged that state insurance regulators

are not expected to validate regulatory or criminal background data

provided by applicants on Form A filings. However, concerning the

purchases of insurers under Thunor Trust, regulatory data available to

insurance regulators from state securities departments could have raised

concerns over the regulatory history of an individual supposedly providing

the money to purchase the insurance companies. Additionally, lack of

regulatory coordination within the insurance industry hindered detection

of the investment scam.

During visits we made to the states, we were able to access regulatory

history data available from state securities regulators through a database

known as the Central Registration Depository (CRD).9 As previously

mentioned, information from CRD revealed that an individual whose name

appeared in the Form A applications as a grantor to Thunor Trust was

involved in incidents concerning consumer complaints while working in

the securities industry. Although the incidents identified through CRD

varied in their degree of severity, they could have prompted insurance

regulators to question the grantors directly concerning their previous

activities in the securities industry and the nature of their business

interests in the trust and insurance industry. Because the grantors may

have been unaware of the trust and deny having provided any funds, this

level of due diligence may have caused regulators to refuse approval for

Thunor Trust’s purchase of insurance companies.

Other information-sharing issues that surfaced during the change in

ownership approval oversight phase involved the lack of informationsharing about regulatory concerns and actions among insurance regulators

9

CRD is a database maintained by NASD and used by state securities regulators, SROs, and SEC that

contains information on broker-dealers, including incidents of disciplinary items tied to individuals and

firms.

Lack of Coordination Among

Regulators Within and Outside

the Insurance Industry
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in different states. For example, regulators in Arkansas considered and

approved a Form A application involving the purchase of Old Southwest

Life Insurance Company under the Thunor Trust organization. Prior to

this approval, another Form A application was submitted and withdrawn in

Colorado by the Saint Francis of Assisi Foundation, an entity that had been

identified as being affiliated with the insurers under Thunor Trust.

Arkansas insurance officials indicated they would have been better able to

scrutinize the Form A application submitted on Old Southwest had they

known an entity linked to Thunor Trust, the Saint Francis of Assisi

Foundation, had withdrawn a Form A application in Colorado. However,

no such clearinghouse of Form A information exists. Regulatory officials

pointed out that the withdrawal of a Form A application itself would “raise

a red flag.” On the basis of this experience, the Insurance Commissioner in

Arkansas recommended that NAIC consider creating a resource for

regulators to review other relevant From A application information from

other states.

Another information-sharing issue surfaced during the redomestication of

an insurer.10 When an insurer under Thunor Trust was redomesticating

from Alabama to Mississippi, examiners in Mississippi already had

concerns about the possibility that a broker-dealer, LNS, was affiliated

with two other Thunor Trust insurance companies already domiciled in

Mississippi. However, we found no evidence that Mississippi Insurance

Department officials approving the redomestication of the company from

Alabama knew of these concerns.

The purchase of Old Southwest Life Insurance Company also exhibits

another example of inadequate information-sharing among state

regulators. Prior to this purchase in late February 1999, regulators in

Tennessee were warned that Franklin American Life, the company that

intended to purchase Old Southwest, might have been looted of its assets.

However, this information was not conveyed to regulators in Arkansas,

who approved the Old Southwest acquisition. The insurer subsequently

experienced losses of over $5 million. Similarly, other insurance

regulators were unaware of concerns that regulators in Tennessee and

Mississippi had with insurers connected to Thunor Trust in early 1999. In

April 1999, Settlers Life in Virginia lost approximately $45 million through

a reinsurance transaction with First National Life Insurance Company of

America. If Virginia regulators had known in February that an insurer

under Thunor Trust may have been looted of its assets, they could have

had an opportunity to ask additional questions and warn their domiciled

10 Redomestication of an insurer refers to the insurer’s action to change its state of domicile.
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insurers against entering into transactions with an insurer(s) connected to

Thunor Trust without prior regulatory approval.

An exception to instances of inadequate information-sharing between

insurance regulators during change in ownership approval activities

occurred shortly before the scam collapsed; it involved the coordination

efforts between regulators in Mississippi and the state of Washington.

Regulators in Washington State had been urged by the proposed buyers to

proceed in an expedited fashion with their planned purchase of an insurer

domiciled in that state. The proposed buyer was the Saint Francis of

Assisi Foundation, now reported to have been an entity that Frankel

created to further enhance the appearance of legitimacy in purchasing and

controlling the insurance companies. In contacts initiated by regulators in

Washington State, Mississippi insurance officials warned their

counterparts to proceed cautiously with the approval of the proposed

purchase. Mississippi regulators had encountered the name of Saint

Francis of Assisi Foundation in connection with their ongoing examination

of two insurers and became concerned that the Foundation may have

obtained control of Thunor Trust without prior regulatory approval.

Heeding the warnings from their Mississippi counterparts, regulators in

Washington State continued to scrutinize the legitimacy of the Saint

Francis of Assisi Foundation. The investment scandal unfolded before a

formal Form A application was ever submitted.

Regulatory weaknesses we observed during routine financial analyses

performed on the Thunor Trust insurers included inadequate asset

investment analysis activities, ineffective safeguards and procedures to

monitor and verify control of the assets, and virtually no efforts to seek

securities-related information on the broker-dealer from other financial

regulators. Controls pertaining to asset safeguards and investment

activities are key solvency considerations. Regulatory weaknesses in

these areas were observed in multiple states over several years.

Insurance regulators and NAIC did not have procedures or expertise to

assess the viability of the securities trading activities reported by the

Thunor Trust insurers. State insurance regulators and NAIC received

annual statements from the Thunor Trust insurers that clearly showed the

unique investment activities of the insurers. These activities were

characterized by an unusually high level of trading and turnover of the

insurers’ assets, which primarily consisted of government bonds.

Generally, our review of available documents covering several years and

related analyses by insurance regulators and NAIC found virtually no

Regulatory Weaknesses

Observed During Routine

Financial Analyses

Inadequate Analysis of Securities

Investments
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concerns about asset investment practices until the later stages of the

investment scam.

During our review, we found little evidence that state insurance

department financial analysis staff had concerns about the massive asset

trading activity being reported by the Thunor Trust insurers. Only in

Tennessee did we observe isolated instances of concerns by regulatory

staff but not sufficient to generate timely follow-up and resolution of such

concerns. Routine financial analysis reviews conducted in accordance

with NAIC’s guidelines on the Thunor Trust insurers in Oklahoma,

Missouri, and Mississippi also did not trigger additional scrutiny.

Our review showed that NAIC’s activities and guidance to support the

states’ routine financial review efforts did not address asset turnover.11

Specifically, the ratio analyses that are generated for insurance companies

did not include an asset turnover ratio. For example, NAIC’s policies and

procedures in the Financial Analysis Handbook, used by state insurance

regulators to conduct routine financial analyses on insurers, did not reveal

any specific analysis requirement related to asset turnover nor a threshold

test that would trigger additional regulatory scrutiny of this type of

investment activity. Additionally, the analyst worksheets associated with

routine reviews on the Thunor Trust insurers did not disclose evidence of

concerns over the massive trading activity being reported or the

consistently greater-than-normal government bond trading returns. We

also noted that these year-end company numbers were subject to

independent Certified Public Accountant (CPA) audits each year, and the

reports were furnished to regulators and NAIC. Our review of available

audit reports, company management and discussion analysis documents,

and NAIC synopses contained in NAIC files did not reveal any skepticism

about the trading activity. Because of ongoing investigations and civil

cases, we could not assess the adequacy of the financial statement audits

conducted by a CPA firm on the Thunor Trust insurers.

From the company filings made with NAIC and concurrently with the state

insurance departments, we performed a simple financial ratio test

11 NAIC aids the states’ efforts to perform annual financial reviews on companies through the

generation of the IRIS ratios and an Analyst Team that performs an additional financial review on

certain companies on the basis of the IRIS ratio results. The process for generating the IRIS ratios

includes obtaining insurers’ annual statements, entering the reported financial data into a computer

system, performing cross-checks on the data to check for errors, and calculating 12 different financial

ratios (for life and health insurers) to help identify companies that could experience financial

difficulties. Once these ratios are calculated, an Analyst Team conducts a further review of insurers

whose IRIS results exceeded certain unusual thresholds. This team then recommends to the states the

regulatory attention required by the insurers to help the regulators prioritize their workload.
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structured to flag highly speculative trading activity—also referred to as an

asset turnover test. This analysis, highlighting the unusually high asset

turnover activity, is presented in table 2 below. 12

Life insurance company

(domicile state)

Time period

(calendar year)

Asset turnover ratio

(end of year average)

Asset turnover ratio

(end of year range)

Franklin American (TN) 1992-98 85 10-207

International Financial Services (MO) 1994-98 54 12-115

First National of America (MS) 1998 27 27

Franklin Protective (MS) 1995-98 89 30-124

Family Guaranty (MS) 1994-98 113 30-193

Farmers and Ranchers (OK) 1994-98 119 29-204

Source: GAO analysis of insurer financial data in the annual statements.

For perspective, an asset turnover ratio of 52 would equate to selling and

buying the entire value of the company’s assets weekly. By contrast, a

mutual fund expert recently cited concern about equity fund managers

whose asset turnovers now average about 0.9.13

In April 2000, NAIC officials advised us that new ratio tests to flag possible

speculative asset investment activities have been developed and

implemented. The threshold test for indicating abnormal investment

activity is now an asset turnover of 0.25, about one fortieth of the lowest

asset turnover ratio shown for the companies in table 2. NAIC officials

also reported they have revised the Financial Analysis Handbook

instructions in this area.

Throughout the 1990s, regulators were unable to properly safeguard and

monitor the assets of the Thunor Trust insurers. The regulators’ inability

to effectively safeguard and monitor control of insurers’ assets centered on

the varied and ineffective policies regarding asset custodial arrangements.

In some instances, regulators discovered there was no custody agreement

between the insurer and LNS. In other cases, the custody agreement did

not provide sufficient measures to safeguard or recover insurers’ assets.

12 This calculation method consisted of the company schedule showing assets acquired and sold each

year as the numerator and total company assets as the denominator. This method was selected for

illustration because it could be performed easily (or roughly estimated by visual inspection) by

regulatory financial analysts. The end of calendar year numbers were used for six of the insurance

company submissions during the period the companies were allegedly under Frankel’s control. The

remaining company, domiciled in Arkansas, was acquired shortly before the collapse of the scam, and

regulators had not yet received a quarterly statement for the period that the insurer was under Thunor

Trust.

13 Wall Street Journal, June 20, 2000.

Table 2: Summary of Asset Turnover Ratios

Ineffective Mechanisms to

Safeguard and Monitor Control

of Insurers’ Securities Held By

Another Entity
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In addition, regulators did not seek sufficient information to verify the

legitimacy of new custodians. Lastly, the annual statement information

obtained from insurers was inadequate to monitor who had control of the

insurers’ assets.

One key regulatory tool that could have helped regulators hinder the

investment scam at different points in the oversight process was a model

law developed by NAIC to help safeguard insurers’ assets. This model law,

NAIC Model Law No. 295, together with its accompanying model

regulation, NAIC Model Regulation No. 298, requires that only national

banks, state banks, or trust companies be used as custodians for securities

belonging to insurers.14 Furthermore, the model regulation includes forms

that can be used for the purposes of preparing custody agreements.

However, NAIC, in its accreditation program, does not require states to

adopt or follow this model law and regulation. We found that asset

custodial requirements prescribed by this model law and regulation were

not followed in Missouri, Mississippi, and Oklahoma on the Thunor Trust

insurers domiciled in those states. Another state, Tennessee, adopted the

custody agreement prescribed in the model regulation, but it failed to

properly enforce insurer compliance with the custody agreement

throughout most of the 1990s by allowing the insurer to execute the

agreement with a broker-dealer, contrary to NAIC’s guidance and

Tennessee’s insurance regulations.15 Proper enforcement of such

requirements on a regular basis could have helped prevent the scam,

because this would have prohibited a broker-dealer from maintaining

custody over the insurers’ assets. Additional information on NAIC’s Model

Law No. 295 and Model Regulation No. 298 is discussed in Appendix III.

The procedures and practices to monitor control of the insurers’ assets

were also inadequate, because they did not always convey a clear

understanding of who controlled these assets. Insurance regulators

monitor the financial condition of insurers through the analysis of annual

and quarterly statements that are prepared in accordance with NAIC

guidelines and instructions. The General Interrogatories section of the

annual statements addressed the issue of which entity(ies) had control and

custody of the insurer’s assets. One of the questions in this section

essentially asked the insurers if they had physical custody of their assets at

14 NAIC’s Model Law 295 and the accompanying Model Regulation 298 outline the asset custody

requirements recommended for assets traded through clearing corporations using the Federal Reserve

book-entry system. Book-entry refers to a method of settlement in which no physical delivery of the

item bought or sold is made, but the change in ownership is recorded by the custodian, normally on a

computer system.

15 Tennessee Rules of Department of Insurance, Chapter 0780-1-46.
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year-end.16 A “yes” response would indicate that the insurer had custody of

its assets, whereas a “no” response would prompt the insurer to describe

further details concerning who had custody of its assets. On quarterly

updates of the financial statements, the General Interrogatories did not

specifically address the issue of physical custody of the assets.

We found no evidence that state regulators had carefully scrutinized

information in the annual statements that highlighted the asset custody

situation until the later stages of the investment scam. Our review of the

annual statements between 1991 and 1998 revealed incomplete and

inconsistent reporting by the Thunor Trust insurance companies. For

example, in 14 of the 28 statements submitted during the 1990s in which

the insurer acknowledged it did not have physical possession of its assets,

the insurer did not provide sufficient information as to who did control its

assets. Specifically, the instructions for this annual statement question

state “If no, give full and complete information relating thereto.” However,

the instructions do not indicate the types of information needed in the case

of a “no” response. In such cases, the Thunor Trust insurers typically

responded that the assets were “HELD BY BROKER IN STREET NAME.”

Such a response did not provide regulators with sufficient information to

determine the entity(ies) that had control of the insurers’ assets. In these

instances, regulators needed to pursue additional questions and research

into the matter to determine who did have control of the assets. Moreover,

we found instances in Tennessee, Missouri, and Oklahoma where the

analysts’ review of the annual statements did not flag the “no” response for

further supervisory review.

We also observed that inconsistent information reported by the insurers

was not detected due to the lack of procedures and practices to verify the

self-reported data. In instances where the insurer responded affirmatively

that it had physical custody of its assets, we did not find evidence that

regulators attempted to validate the insurer’s response. We noted on

several occasions that such a response was inconsistent with other

regulatory information available on the insurer. For instance, in

Tennessee, Missouri, and Oklahoma, insurance companies sometimes

reported in annual statements that they had control of their assets despite

other information from annual reports and examinations that suggested

their assets were in the custody of a broker-dealer.

16In annual statements filed by the Thunor Trust group of insurers for years ending 1991 through 1998,

in accordance with the format prescribed by NAIC, a question related to asset control reads “Were all

the stocks, bonds and other securities owned December 31 of the current year, over which the

company has exclusive control, in the actual possession of the company on the said date, except as

shown by the Schedule of Special Deposits?”
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Responses to the asset custody-related question in the annual statement

could have been compared for consistency with other regulatory records

related to the custody of the insurer’s assets as well as with financial

statements of other Thunor Trust insurers. Regulatory records associated

with asset control include custodial agreement(s) between the insurer and

the entity(ies) with possession of the insurer’s assets as well as those used

by the independent CPA firm to verify asset balances with other financial

institutions annually. However, NAIC’s Financial Analysis Handbook

guidance does not address the steps regulators could take to verify

insurers’ responses about the custody of their assets. Rather, NAIC

officials indicated that such asset verification steps would occur during onsite examinations. Because on-site examinations generally occur only

once every 3 to 5 years, an improper response on the annual statements

related to who was maintaining custody of the insurer’s assets may not be

detected in a timely fashion. Furthermore, because annual financial

reviews were not conducted on a consolidated basis to assess the financial

statement information across all the insurers of the same group, regulators

could not easily identify inconsistencies in responses related to asset

control among the Thunor Trust insurers.

There are other more general problems with the asset custody information

collected by regulators. For instance, the question in the General

Interrogatories of the annual statements addresses only asset control on

December 31st. Additionally, the question could be confusing in cases

where assets are maintained in book-entry form with the Federal Reserve,

because the question refers to the physical custody of securities. Although

instructions to this general interrogatory have been revised over time to

clarify its meaning, the responses to the question still did not clearly

convey a meaningful understanding of the entity(ies) that may have

controlled the insurers’ assets throughout the year.

When questions concerning an insurer’s investment activities did arise,

financial analysts did not generally seek regulatory data or expertise from

regulators in the securities industry. A check of basic information on LNS

at any point throughout the 1990s with state securities offices could have

helped unravel the investment scam. However, during our review, we did

not find evidence that state insurance analysts obtained information from

state securities offices while conducting their annual reviews because the

NAIC guidelines do not specifically require such coordination. During our

review, we collected information from several state securities offices on

the real LNS that revealed inconsistencies with the information on the LNS

entity that insurance regulators had been provided by their domiciled

insurers. As mentioned earlier, Frankel allegedly used the real LNS as a

Inadequate Securities-Related

Expertise and InformationGathering
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Page 28 GAO/GGD-00-198 Insurance Regulatory Oversight

front, getting the firm’s name licensed in states where he intended to

perpetrate his scam. We reviewed information from the state securities

offices on the real LNS through annual statements on file and information

contained in the CRD system.

The CRD information, which would have been available to state insurance

regulators through their state securities offices during the entire period of

the scam, would have revealed that the real LNS was located in Dundee,

MI, contrary to the location on the account statements insurers received

from LNS. The real LNS was a firm that started out in Toledo, OH and

moved to Dundee, MI. However, the account statements that insurers

were receiving from LNS indicated that the firm had locations in multiple

states, including a New York, NY address. Additionally, financial

statements available in state securities offices revealed that the real LNS

typically had reported assets of less than $100,000 during the 1990s. Such

information alone could have generated other red flags given the high level

of trading that was being reported in the account statements that insurers

were receiving from LNS. Also, a check into the officers of the real LNS

would have revealed an inconsistency between those actually employed by

LNS and the name of an individual who was supposedly signing the asset

verification documents used by state insurance regulators and a CPA firm.

Although some insurance regulators acknowledged the insurers’

investment activities were unusual, they did not seek such outside

securities expertise. For instance, in Tennessee, analysts were sent to

Franklin American Life in 1996 to review the company’s unusual

investment activities. According to the Tennessee Comptroller of the

Treasury’s report, the Insurance Division was concerned that the company

might be “short selling” its assets, a risky and prohibited type of trading

activity involving the sale of investments instruments without ownership in

anticipation of a fall in prices.17 However, the analysts involved in the

targeted review acknowledged that they did not have a background in

securities for adequately assessing the reasonableness of the insurer’s high

volume of trading. After a 1-day target review to assess the company’s

investment practices, which revealed no indication that the company was

“short selling,” analysts recommended that a securities expert be brought

in to review the insurers’ investment practices further. However, rather

than seeking such expertise externally or from their local state securities

office, the Tennessee Department of Commerce and Insurance did not

17 Special Report: Review of Inaction on the Part of Insurance Division Employee’s Involved in the

Regulation of Franklin American Life Insurance Company, Tennessee Comptroller of the Treasury

(Jul. 7, 2000).
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conduct a meaningful review into the issue until an on-site examination

was conducted approximately 2 years later.

The regulatory weaknesses observed from our review of the states’ on-site

examinations included the failure to detect the misappropriation of assets,

inadequate procedures and practices to verify the legitimacy of the

custodian, and inadequate information-sharing of examination concerns to

prevent the scam from spreading further. Such weaknesses resulted in

missed opportunities for regulators to uncover the scam earlier.

Examinations conducted in the early and mid-1990s did not reveal the

investment scam, even though assets had already been removed from the

control of the insurers. Finally, during examinations conducted in 1998

through 1999, examiners in Mississippi and Tennessee began to scrutinize

the LNS entity itself, and the investment scam began to unravel.

Unfortunately, the lack of proactive information-sharing among regulators

resulted in additional losses as the scam spread further before it was fully

revealed in May 1999.

We found that four completed examinations on the Thunor Trust insurers

did not uncover any material weaknesses even though Frankel allegedly

embezzled the insurers’ assets shortly after their purchase, prior to the

examinations. One key reason that examiners were not aware that the

insurers did not have control over their assets related to NAIC’s

examination procedures for verifying securities-related assets. These

procedures require the insurance examiner to verify the insurers’

securities by actual inspection and count unless these securities are being

held under a custodial arrangement by a depository institution, such as a

bank, trust, or securities depository.18 However, examiners could not

physically inspect the book-entry government securities because records

of such transactions are maintained through computers, and no physical

possession of the securities takes place. Consequently, examiners

accepted listings from the broker-dealer to satisfy asset verification tasks

on numerous occasions as if the entity were a bank or trust custodian,

contrary to procedures in NAIC’s Examiners Handbook.

Although adherence to NAIC’s model law and regulation on suitable asset

custodians is not currently a requirement of NAIC’s accreditation program,

adherence to the Examiners Handbook is. As mentioned earlier, NAIC’s

Model Law No. 295 and Model Regulation No. 298 recommend that only

18 NAIC’s examination guidelines explains that acceptable securities depositories are those that are

subject to the regulation of SEC, the Federal Reserve System, and state banking authorities in the state

of domicile. According to NAIC, broker-dealers are not securities depositories.

Regulatory Weaknesses

Observed During On-Site

Examinations

Failure to Detect

Misappropriation of Assets
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Page 30 GAO/GGD-00-198 Insurance Regulatory Oversight

banks and trust companies, including subsidiary trust companies of

brokerage firms, be used as custodians for insurer assets. The Examiners

Handbook, which state insurance examiners follow to conduct on-site

examinations of insurers, contains procedures to verify assets that build

upon the premise that only these types of depository institutions be used

as asset custodians.19 If these kinds of institutions hold insurers’ assets,

asset verification procedures can be satisfied through a certified listing of

the insurers’ securities provided by the custodian. Otherwise, the

securities belonging to the insurers are supposed to be verified through

physical inspection and count.

The examination procedures applicable during the examinations

completed on the Thunor Trust insurers did not specifically include

measures for verifying book-entry securities being held by a broker-dealer.

Although the examination procedures require examiners to physically

inspect and count the securities that are not held by a bank, trust

company, or securities depository, the assets were book-entry government

securities that could not be physically inspected. As a result, the existing

examination procedures did not address how to perform independent

asset verifications under these circumstances.

To verify insurers’ assets, state regulators requested that the broker-dealer

identify what securities it held on behalf of the insurer and the associated

value of these securities. In turn, an “authorized representative” of LNS

sent back the document, in the form of an unnotarized letter or account

balance type of form, affirming that such securities belonging to the

insurer existed. After the scam collapsed, it was apparent that LNS and

the insurers were, in fact, affiliated institutions, allegedly being controlled

by Frankel. Therefore, the examinations completed on several Thunor

Trust insurers never achieved an independent check on the assets and

failed to detect the misappropriation of assets.

Additionally, as was the case in the annual financial analyses, the unusual

investment activities being pursued by the Thunor Trust insurers could

have prompted further regulatory action during the on-site examinations.

Although the Examiner’s Handbook does not specifically instruct

regulators to assess the turnover of the insurer’s assets, the practice of

19 Two portions of this handbook in force when examinations were conducted on the Thunor Trust

insurers relate to the assessment of asset custody arrangements and procedures to verify insurer

assets. The first of such guidance in Part 1 of the Examiners Handbook contains specific narrative

guidance on acceptable asset verification procedures and custody requirements. Part 2 of the

Examiner’s Handbook, titled “Specific Risk Analysis,” contains a section on “Investments Cycle.” This

section in Part 2 describes the specific step-by-step procedures to verify insurers’ assets that mirror the

general narrative guidance described in Part 1.
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investing virtually all of the firm’s assets with one broker-dealer and

constantly turning over these assets could have prompted more queries

into LNS, including an assessment of the possibility that the insurers under

Thunor Trust and LNS were related parties. Such inaction in response to

these red flags raises questions about the level of expertise present in

insurance departments to assess investment strategies being reported and

pursued by the insurers. We did not find evidence that such an issue was

substantively addressed during examinations completed in the mid 1990s

on insurers in Tennessee, Missouri, and Oklahoma. Only in late 1998 and

early 1999 did examiners in Tennessee and Mississippi begin to question

the relationship between the insurers and LNS. When regulators finally

began to scrutinize the investment activities and legitimacy of LNS, the

investment scam began to unravel.

Examination procedures used by insurance regulators were also

inadequate to assess the legitimacy of the custodial entity or its authorized

representatives. The examiners accepted custodial agreements and asset

verifications for LNS that were supposedly signed by an individual that

represented an officer of LNS. Such methods were not fundamentally

different from those used to verify asset balances on a yearly basis, even

though examinations may occur only once every 5 years, in accordance

with NAIC’s minimum accreditation standards. The individual who

supposedly signed as the asset custodian on several asset verification

documents was no longer employed by the real LNS at the time the asset

certifications were made. State insurance regulators, believing they had

received a certification on the assets from a legitimate entity and

individual, were tricked.

On examinations completed on several Thunor Trust insurers, we found no

evidence that any checks were made to validate the legitimacy or

appropriateness of the custodian, LNS, or its representatives despite the

unusual investment practices being pursued by the Thunor Trust insurers.

The Examiners Handbook instructs insurance examiners to “satisfy

themselves as to the integrity of the accounting controls and verification

and security procedures” of the custodian. However, we found no

evidence that examiners evaluated such information on the broker-dealer

for years. This information could have been obtained through audits on

the broker-dealer as well as policy statements on internal controls and risk

management practices. Furthermore, the examination procedures did not

instruct examiners to assess whether or not the insurer performed

adequate due diligence on its asset custodian. Ideally, the “first line of

defense” to ensure the legitimacy of the asset custodian would rest with

the insurer, followed by the regulator.

Inadequate Practices and

Procedures to Verify the

Legitimacy of Asset Custodians
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One state that had adopted a key feature of NAIC’s model law and

regulation, requiring that only depository institutions such as banks or

trust companies be used as custodians, did not properly enforce its rules.

Tennessee insurance regulators allowed insurers to execute asset

custodian agreements with a broker-dealer, instead of a bank or trust

custodian, contrary to NAIC’s guidance and Tennessee Rules of

Department of Insurance. Furthermore, the form itself received back

from LNS in 1993 was not executed properly. The document had been

altered with text changes to indicate the words “bank” and “bank

corporation” had been replaced with the words “securities brokerage

firm.” In addition, the custodial agreement had not been notarized as

required. It was signed with the name of a person who was supposedly an

officer of LNS, a signature that now appears to have been a phony.

Had regulators not accepted the custody agreement either for the reason

that LNS was not an authorized custodian or because the form had been

altered and was not notarized, the scam could have been hindered.

Enforcement of the custodial requirements would have prompted LNS to

return Franklin American Life’s assets back to the state in 1993, thus

further impeding the perpetuation of the scam. Additionally, a request to

obtain a notarized signature on the custody agreement may have led to

suspicions of a fraud because the signatory on the agreement was phony,

as the person had supposedly already left the country.20 Thus, a request to

obtain a notarized signature may have complicated matters for the

person(s) behind the scam, requiring them to find another signatory or

obtain a fraudulent notarized signature.

Once serious regulatory concerns surfaced over insurers connected to

Thunor Trust during on-site examinations, such concerns were not

adequately shared with other states to help prevent further losses. Instead,

state insurance regulators appeared to pursue actions that favored their

own states’ interests, negating opportunities for other state regulators to

prevent or limit losses to their domiciled insurers.

In 1998 and early 1999, regulators in Tennessee and Mississippi raised

serious concerns during their on-site examinations of insurers under

Thunor Trust. The Tennessee Department of Commerce and Insurance,

Division of Insurance, was conducting an examination of Franklin

20 Our review of information at NASDR indicated that the signature of the individual in the custodial

agreement differed vastly from a notarized signature of the same individual found on other SEC

documents. Documentation from the examinations performed on the real LNS revealed that the

person who supposedly signed the custodial agreement for the Tennessee insurer’s assets in July 1993

had already left the country.

Limited Sharing of Information

and Coordination Among

Regulators
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Page 33 GAO/GGD-00-198 Insurance Regulatory Oversight

American Life while regulators in Mississippi were conducting

examinations of Franklin Protective Life Insurance Company and Family

Guaranty Life Insurance Company. At times, the examiners were at the

same location together in Franklin, TN, where the headquarters operations

for all the insurers under the Thunor Trust organization were situated.

During the course of the examinations, regulators in both states raised

concerns over the investment activities of insurer assets and concerns that

the insurers might somehow be affiliated with LNS.

On February 1, 1999, the Examiner-In-Charge hired by Tennessee’s

Division of Insurance wrote a letter to the Division warning that there was

a possibility that Franklin American Life had been looted of its assets. The

examiner detailed the possible scam that was being perpetrated on the

insurer under Thunor Trust that pointed toward an affiliation between LNS

and the insurer, a scheme that is now being alleged in the federal

indictment against Frankel. During our review, we found no evidence that

this information was proactively shared with other state regulators to help

prevent the possibility of a potential scam spreading.

After regulators in Tennessee had been informed of the possible fraud and

inappropriate relationships between Franklin American Life and LNS by

the Examiner-In-Charge, insurers in Arkansas and Virginia lost

approximately $50 million through the scam because regulators in those

states were unaware of the potential fraudulent activities that existed

within Thunor Trust. Arkansas officials maintained they were not aware

of regulatory concerns on entities affiliated with Thunor Trust prior to its

approval of an acquisition involving Old Southwest Life Insurance

Company, domiciled in Arkansas, with Franklin American Life, a Thunor

Trust insurer domiciled in Tennessee. They approved the purchase on

February 25, 1999. Likewise, regulators in Virginia were not aware of the

regulatory concerns associated with entities connected to Thunor Trust.

Settlers Life, an insurer domiciled in Virginia, fell victim to the investment

scam after entering into a reinsurance transaction with one of the Thunor

Trust insurance companies domiciled in Mississippi, First National Life

Insurance Company of America. Given that Virginia officials were unaware

of regulatory concerns on insurers affiliated with Thunor Trust, they were

not able to prevent the transaction between these insurers on April 9th that

ultimately resulted in the loss of approximately $45 million.

In 1998 and 1999, Mississippi regulators also had serious concerns with

insurers under Thunor Trust and their investment activities with LNS.

Regulatory officials in Mississippi mentioned that concerns over a possible

affiliation between LNS and the insurers surfaced in the summer of 1998.
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On March 12, 1999, Mississippi regulators sent a series of questions to the

insurers under Thunor Trust domiciled in Mississippi. The regulators were

acting on unresolved examination concerns related to the ownership

interests behind Thunor Trust and the investment activities of the insurers,

including a possible affiliation between LNS and the insurers. On April 8,

Mississippi regulators received responses to these questions that they

considered to be evasive and inconsistent. One of the more startling

responses was the revelation that another entity named the “Saint Francis

of Assisi Foundation, to Serve and Help the Poor and Alleviate Suffering”

had supposedly become the owner of Thunor Trust and all of its insurers.

We noted a few instances where some examination concerns raised in

Mississippi and Tennessee were shared with other regulators, but only in

circumstances where another regulator asked for such information.

Regulators in Mississippi and Tennessee shared some examination-related

information with each other in late 1998 and early 1999, as examiners from

both states met while conducting examinations on different insurers

owned by Thunor Trust that were headquartered at the same location in

Tennessee. In April 1999, when regulators from Washington State inquired

about the Saint Francis of Assisi Foundation’s desire to purchase an

insurer domiciled in Washington, Mississippi officials warned their

counterparts to proceed cautiously with the Form A approval process

because of examination-related concerns over the interests behind Thunor

Trust. These coordination efforts are laudable. However, a proactive alert

to other states on the examination concerns raised, particularly involving a

possible fraud or an affiliation between LNS and the insurers, may have

afforded other regulators an opportunity to review and alert their

domiciled insurers. Instead, regulators in Missouri, Oklahoma, Virginia,

and Arkansas were not aware of the serious problems and concerns

uncovered during the Tennessee and Mississippi examinations until the

insurers collapsed in May 1999.

The NAIC examination guidelines do not require proactive communication

by the state of domicile to other states that have a regulatory interest in a

troubled insurer. Rather, these guidelines simply require that the state

have a policy addressing these communications when requested by

another insurance department. Nevertheless, insurance regulators

currently have a mechanism to alert other regulators about confidential

regulatory concerns within the regulatory environment.

We inquired about existing information-sharing tools available to

regulators with NAIC. The NAIC information-sharing systems that are

available to regulators include databases known as the Regulatory
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Information Retrieval System (RIRS) and the Special Activities Database

(SAD). The RIRS database is intended to convey regulatory actions

against companies or individuals, and the SAD system was developed to

confidentially convey areas of regulatory concern that may or may not

evolve into circumstances necessitating a regulatory action or sanction.

Accordingly, such regulatory concerns would be considered confidential.

However, according to NAIC officials, no entries related to the Thunor

Trust group of insurers were made by any states in the system to alert

other insurance regulators of potential problems with the companies.

A principal concern for regulators about sharing such information relates

to the implications of sharing examination-related information prior to the

release of the examination report. Insurance regulators and NAIC officials

acknowledge that regulators are often reluctant to share regulatory

information apart from that disclosed in a published examination report.

However, examination reports, because they are public documents, often

do not include information that could cause negative publicity for an

insurer. A key concern for regulators is the possibility that disclosure of

unfavorable information may, in turn, create cause for other states to

suspend the insurer's business activities, thereby exacerbating the

problems for the insurer. In turn, regulators could be blamed for any harm

rendered to the insurer as a result of such information disclosures.

Another information-sharing issue among insurance regulators that may

have hindered regulators’ ability to detect the investment scam was the

lack of coordinated examination efforts focused on insurers belonging to

the same group. Insurance regulators generally do not examine all

affiliated companies at the same time. By 1994, the Thunor Trust family of

insurers had grown to include insurers in Tennessee, Oklahoma, Missouri,

and Mississippi. Concerns present among regulators in one state over the

insurers’ investment activities might have prompted greater awareness of

these unusual activities in other states had such concerns been conveyed.

Also, a call on all the insurers' assets at one time would negate

opportunities to shift assets from one affiliated entity to another, or play a

“shell game.” Given that the scam was premised on the ability to take

assets from one insurer to purchase others and, allegedly, to support

Frankel’s lifestyle, a proper verification of all the insurers’ assets at once

could have uncovered the investment scam earlier.

In addition to the lack of information-sharing within the insurance

industry, insurance examiners did not generally seek information and

resources available from regulators of other financial sectors. In cases

where concerns were raised over the investment activities of the insurer,
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Page 36 GAO/GGD-00-198 Insurance Regulatory Oversight

regulators could have sought information and expertise from local state

securities offices. Finally, in January 1999, an examiner hired by

Tennessee visited the state’s securities office and noted inconsistencies

between the securities regulatory information available on the real LNS

and the investment account information being reported to Franklin

American Life by an entity named LNS. As mentioned earlier, we were

able to access regulatory information on the real LNS from state securities

offices through financial statements filed by the company and through the

CRD system. Such information was available to insurance regulators

throughout the period of the investment scam and could have helped

uncover it much sooner if the regulators had accessed the information.

NAIC and other state officials have proposed corrective actions to reduce

the likelihood of a scam similar to that allegedly perpetrated by Frankel

from happening again, but other unresolved issues could hamper future

fraud prevention efforts. In addition, NAIC has proposed near-term and

longer term corrective actions to remedy other insurance regulatory

weaknesses highlighted by this scandal. Additionally, the Tennessee

Comptroller of the Treasury, Division of State Audit, identified internal

control weaknesses in the Tennessee Insurance Division, and the Division

has implemented new policies designed to correct the deficiencies. Other

unresolved issues that will also have an impact on future fraud prevention

efforts within the insurance industry center around regulators’ ability to

access regulatory and criminal history data maintained by other

government agencies. A key element of insurance regulators’ fraud

prevention efforts is their ability to prevent a rogue in another financial

sector from migrating to the insurance industry. Similarly, state insurance

regulators are also now faced with the challenge of fulfilling their

responsibility under a federal insurance fraud prevention provision (18

U.S.C. § 1033) to prevent certain convicted criminals from engaging in the

business of insurance. The extent to which insurance regulators will be

able to successfully implement recommendations emanating from the

Frankel case will depend on the sharing of regulatory and criminal history

information across industry sectors and levels of government (state and

federal agencies) and will require a continuing commitment by NAIC and

the states.

In a report issued on April 13, 2000, NAIC’s Ad Hoc Task Force on

Solvency and Anti-Fraud recommended immediate and longer term

corrective actions emanating from the alleged scam perpetrated by Martin

Frankel. These corrective actions included recommended improvements

to financial analysis and examination procedures, model laws and

regulations, accreditation standards, and certain antifraud activities.

A Number of Corrective

Actions are Planned, But

Unresolved Database Issues

Remain

NAIC Has Proposed a Series of

Corrective Actions
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These corrective actions are detailed in the Task Force’s report, which is

reproduced in appendix IV. Additionally, some states have proposed other

corrective actions to help prevent this type of investment scam from

occurring again.

The corrective actions proposed by NAIC include those that can be

implemented relatively quickly as well as longer term measures requiring

adoption by the states’ insurance commissioners. Some immediate and

short-term corrective actions include the incorporation of an asset

turnover ratio in the IRIS ratios, revisions to the Financial Analysis

Handbook and Examiners Handbook, enhancements to accreditation

standards, and improved sharing of information among insurance

regulators. For example, improvements to accreditation standards include

the adoption and implementation of a model law and regulation on the

“Use of Clearing Corporations and Federal Reserve Book-Entry System.”

Another accreditation change proposed is a requirement for states to seek

input from an investment specialist on examinations involving high risk or

complex investment strategies. Concerning information-sharing activities,

NAIC has proposed more proactive communications between states and

the use of a “Form A database” to help states track the status of other

change in ownership applications being submitted to other state

regulators.

Other longer term corrective actions being proposed by NAIC, requiring

the approval and adoption of the states’ insurance commissioners,

encompass improvements to the accreditation program, financial analysis

and examination procedures, and the sharing of information outside the

insurance industry. Improvements to the accreditation program include

prioritizing oversight functions and instituting communication guidelines

with other state and federal banking and securities regulators. Longer

term enhancements to the financial analysis guidelines would consider

methods for reporting and assessing financial statement data of

consolidated insurance groups. Additionally, NAIC has proposed

considering methods to coordinate and conduct examinations on a

consolidated basis for insurers belonging to the same group. In

circumstances involving troubled companies, examinations would also be

required more often than once every 5 years. Other longer term actions

proposed by NAIC include obtaining access to nationwide criminal history

data for state insurance regulators and sharing confidential information

among insurance regulators and law enforcement authorities.

NAIC has already implemented some corrective actions to revise its

guidance, but other corrective measures will require sustained cooperation
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from the states. Thus far, NAIC has expanded its IRIS ratio analysis to

include an analysis of asset turnover. NAIC has also revised its Examiners

Handbook to include new guidance on evaluating investment management

and controls. For example, the revised guidance instructs examiners to

periodically evaluate the financial condition and capabilities of bank

custodians, broker-dealers, servicing agents, property managers, and

others with access to the company’s assets. Other corrective actions

proposed by NAIC will require sustained cooperation from other state and

federal agencies because changes can take several years from initial

development to implementation. For instance, two of NAIC’s proposals,

(1) developing a process for coordinating financial examinations of insurer

groups and (2) providing statutory accounting guidance that will support

consolidated accounting and reporting for groups of insurers, will require

further development and action by NAIC committees and, subsequently,

consideration and action by each state.

Another investigation, conducted by auditors from the Tennessee

Comptroller of the Treasury, has also prompted corrective actions by the

state’s insurance regulators.21 The Comptroller of the Treasury’s Division

of State Audit concluded that the Tennessee Department of Commerce and

Insurance failed to detect the fraudulent nature of Frankel’s alleged

activities before May 1999 because regulators failed to exercise sufficient

professional skepticism, used inadequate procedures to review Franklin

American Life, and misapplied review procedures. The audit report noted

the Tennessee Insurance Division’s gross breakdown in its regulation

despite significant warning signs of questionable activity. The state

auditors also cited a lack of communication between the Insurance

Division staff and other department officials (the state’s Securities Division

is part of the Department of Commerce and Insurance). State

investigators reported that many situations that involved unusual business

transactions and circumstances were not acted upon further because

department staff concluded they could take no action unless there was a

law, regulation, or policy that was clearly violated. The report notes that

the Insurance Division’s inaction on analysts’ recommendations to assess

the insurer’s investment activities with a securities expert, available from

the Securities Division of the same department, extended the period the

fraudulent scam went undetected.

21 Special Report: Review of Inaction on the Part of Insurance Division Employees Involved in the

Regulation of Franklin American Life Insurance Company, Tennessee Comptroller of the Treasury

(Jul. 7, 2000).

Tennessee State Auditors

Identified Regulatory

Weaknesses Prompting Several

Corrective Actions
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In response to the auditor’s report, Tennessee insurance regulators noted

that several policy changes had been implemented. These included more

detailed policies and procedures for financial analysts and examiners

regarding reviewing asset custodian status, where assets are located,

investment scrutiny, and supervisory review. Supervisory review

procedures were also implemented regarding the analysis of the general

interrogatories contained in the annual statements submitted by insurance

companies and computation of asset turnover ratios and a benchmark that

asset turnover should be no more than once a year. Other changes were

made that were designed to strengthen documentation of activities on

target exams, enhance supervisory review, and ensure record retention.

Insurance regulators’ ability to screen undesirable applicants and reduce

the potential for fraud could be facilitated by improved access to

regulatory and criminal history data during reviews of change in

ownership and licensing applications. As mentioned earlier, insurance

regulators can access NAIC’s RIRS and SAD databases to obtain regulatory

history information on individuals and firms in the insurance industry.

However, insurance regulators generally do not have direct access to other

financial regulatory and criminal databases.

Disciplinary-related data on securities brokers are maintained in CRD,

available from state securities offices. Banking regulators use numerous

other systems to track individuals sanctioned in the banking industry.

Although NAIC has met with securities and banking regulators to discuss

the sharing of information across industry sectors, insurance regulators

generally do not have direct access to such systems other than through

publicly available means.

Insurance regulatory access to criminal history data has been limited.

NAIC officials pointed out that only a handful of state insurance

departments have the ability to obtain criminal history data through

agencies in their departments that have some type of law enforcement

authority. Thus, NAIC officials acknowledge that insurance regulators

cannot meet their responsibilities under the federal insurance fraud

prevention provision, 18 U.S.C. § 1033. In contrast, banking and securities

regulators routinely perform criminal history checks on individuals by

submitting information to the FBI.

Justice officials we spoke to indicated that the National Crime Prevention

and Privacy Compact outlines a legal framework for exchanging criminal

history records between federal and state officials for noncriminal

Unresolved Issues Could

Hamper Future Fraud

Prevention Efforts
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Page 40 GAO/GGD-00-198 Insurance Regulatory Oversight

purposes.22 Implementation of this Compact could allow insurance

regulators to access criminal history data, improving their ability to keep

certain criminals out of the insurance business. Justice officials indicated

that the Criminal Justice Information Services Division of the FBI would

be the organization ultimately responsible for coordinating the mechanism

through which the exchange of criminal history data under the Compact

might be implemented. To date, insurance regulators and the FBI have not

yet developed a method by which insurance regulators could conduct

routine criminal history checks on individuals entering the insurance

business.

In the future, insurance regulators’ fraud prevention efforts could be

strengthened through the assessment and review of regulatory data from

banking and securities regulators and criminal history data from Justice.

NAIC has proposed developing a means to query an individual’s regulatory

and criminal history from multiple databases in a batch process during offpeak business hours. NAIC officials maintain that such an approach would

be the most efficient and effective manner to conduct routine background

checks on individuals from all the states that desire to enter the insurance

business. However, insurance regulators’ ability to perform background

checks in such a manner would require the sharing of information across

different financial sectors and government agencies, as well as allowing

NAIC, not itself a regulator, to serve as a clearinghouse and facilitator for

such information-sharing.

The consolidation of financial services industries allowed by the GLB

financial modernization legislation heightens the importance of

consultation and information-sharing between federal and state regulators

in the performance of their respective oversight duties. The fraudulent

activities allegedly perpetrated by Mr. Frankel also demonstrate the need

for heightened coordination among regulators. Although the GLB Act is

recent, regulators recognize the need to improve their coordination and

have taken or plan to take a number of actions. Generally, the actions

consist of establishing formal agreements for sharing information and

establishing working groups for periodic meetings to discuss matters of

mutual interest. These regulatory actions are in their infancy, but the

expected continued blurring of distinctions and separations in financial

markets will require an increased and continued commitment to enhanced

regulatory cooperation and information-sharing across financial sectors.

22 The National Crime Prevention and Privacy Compact, Pub. L. No. 105-251, October 9, 1998 (42 U.S.C.

§ 14616), establishes policies and procedures for the states to access criminal history data for

noncriminal purposes.

Financial

Modernization

Highlights the

Importance of

Regulatory

Coordination Across

Financial Sectors
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However, the regulatory coordination provision of the GLB Act is focused

on regulating institutions within financial holding companies; that is,

affiliated institutions that have different functional regulators. The

Frankel case illustrates the importance of regulatory coordination even in

the absence of a financial holding company structure.

Lessons learned from Frankel’s alleged investment scam highlight the

importance of sharing information between regulators of different

financial sectors at different phases in the oversight process as well as

adequately safeguarding and verifying insurer assets at other financial

institutions.

One lesson learned from the scam was the lack of insurance regulatory

tools and procedures for seeking and obtaining information from other

financial sectors. At each phase in the oversight process, insurance

regulators could have benefited from securities regulatory information to

review ownership changes and business transactions involving individuals

and entities in the securities and insurance industries. For instance,

applicants desiring to engage in the business of insurance that had come

from the securities industry could have been better scrutinized. Likewise,

banking and securities regulators have indicated a need to properly review

individuals during charter application and licensing review functions who

are entering the banking or securities industry from the insurance industry.

To facilitate routine regulatory background checks, regulators will have to

resolve long-standing issues concerning the sharing of disciplinary-related

information from databases maintained in different financial sectors.

Another lesson learned from the scam is the need to strengthen the

proactive sharing of confidential information among state insurance

regulators. Once regulatory concerns were raised during on-site

examinations of the Thunor Trust insurers, these concerns were not

proactively conveyed to other state insurance regulators to help prevent

the scam from spreading to other insurers. As the distinctions between the

financial sectors continue to blur, regulators of different financial sectors

will need to ensure the proactive sharing of confidential regulatory

information.

The Frankel case also provides a lesson relevant to efforts to implement

the GLB Act, which is to recognize the importance of properly

safeguarding and verifying assets across affiliated institutions in different

financial sectors. Insurance regulators must consider the appropriate

regulatory procedures as well as the additional accounting and auditing

standards necessary to adequately verify insurer assets being held by

Lessons Learned from

Frankel’s Alleged Scam Can

Help Regulators Better

Prepare for Rogues in the

Future
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Page 42 GAO/GGD-00-198 Insurance Regulatory Oversight

related parties, such as affiliate banks or securities entities. As financial

services regulators coordinate their oversight efforts they must ensure that

gaps are not created that could compromise their ability to obtain

independent verification of transactions and assets across affiliated

financial institutions.

The need for increased cooperation between federal bank regulators and

state insurance regulators is clearly recognized in section 307 of the GLB

Act. The section specifically states the congressional belief that the

Federal Reserve Board and state insurance regulators should share, on a

confidential basis, information relevant to the supervision of companies

that control both a depository institution and a company engaged in

insurance activities. Additionally, appropriate federal banking agencies,

such as OCC, OTS, and the Federal Deposit Insurance Corporation (FDIC),

should also share information with their regulatory counterparts in the

insurance industry. The sharing of information, on a confidential basis,

with relevant state insurance regulators should involve transactions and

relationships between depository institutions and affiliated companies

engaged in insurance activities. The purpose of section 307 is to

encourage coordination and to thereby improve the quality and efficiency

of the supervision of financial holding companies and their affiliated

depository institutions and companies engaged in insurance activities.

The Federal Reserve recognizes the importance of blending its

responsibilities for umbrella supervision with the functional regulation of

subsidiaries or affiliates by other regulators, including insurance

regulators. Federal Reserve officials explained that they have had only

one situation to date necessitating close coordination with the insurance

industry. This involved the merger between Citicorp and Travelers Group

in September 1998. Subsequently, in August 1999, the Federal Reserve

entered into a Memorandum of Understanding (MOU) with the state of

Connecticut Department of Insurance, the primary regulator of Travelers,

concerning the sharing of confidential supervisory information. This MOU

was designed to push down to the supervisory levels of the bank and

insurance affiliates the authority for examiners to talk directly to each

other. Because this agreement predated the passage of the GLB Act, it is

undergoing revision to reflect current law. Additional MOUs with other

insurance regulators are anticipated as banks and insurance companies are

merged or acquired.

In the future, Federal Reserve officials said some known issues will need

to be addressed, and others may emerge. For example, the treatment of

bars and sanctions that now apply only to banking agencies may need to

Regulatory Coordination

Efforts Recommended by

the Financial Modernization

Legislation Have Begun
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Page 43 GAO/GGD-00-198 Insurance Regulatory Oversight

be extended to institutions in other financial sectors. Also, insurance

companies that become part of financial holding companies are required to

submit Suspicious Activity Reports to the Federal Reserve. To address

these issues, the Federal Reserve is hosting Cross-Sector Regulatory

Working Group meetings, two of which have been held thus far this year.

Federal Reserve officials acknowledge the need for more regularized

communication, although its form has not yet been established. The

Federal Reserve has indicated that coordinating the regulation of

Travelers/Citigroup has not presented substantial difficulty. However, in

the future, when financial holding companies exist in multiple states,

coordination challenges might be much more difficult.

OCC officials explained they are working to strengthen communication

and coordination with the insurance industry. Specifically, they have

signed an agreement for sharing complaint information with 28 states as of

May 31, 2000, and anticipate signing agreements with the remaining states.

They are also working toward sharing supervisory information, but to date,

no agreements have been reached with any of the states. Since passage of

the GLB Act, OCC has received about 30 notifications for designations as

financial subsidiaries, and all but 2 have insurance-related business. Thus,

OCC officials believe they will need formal sharing agreements with

insurance regulators regarding supervisory information. They explained

their belief that they are now legislatively walled-off from directly

obtaining information on insurance affiliates absent a formal regulatory

finding that an affiliated insurer would materially affect the bank and that

insurance regulators are unable to adequately regulate the insurance

affiliate. OCC officials noted that they could more easily obtain insurance

affiliate information when needed prior to the GLB Act. For the future,

OCC regulators specifically mentioned the need to share information on

undesirable persons within the banking and insurance industries to reduce

migration from one industry to another. They also acknowledged they

would need to better understand the operations of insurance affiliates of

national banks, how the insurance affiliates are regulated, and how to

proceed with insurance regulators when insolvency issues arise.

Concerns about OCC’s reliance on state-provided insurance information

have been expressed by the Department of the Treasury Inspector General

(IG), however. The Treasury IG recently warned that bank regulators may

not be able to rely fully on each state’s regulatory work to adequately

assess the risks banks incur while selling insurance. 23 The Treasury IG

23 Office of the Comptroller of the Currency’s Supervision of Banks Selling Insurance (OIG-00-098,

Jun. 27, 2000).
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Page 44 GAO/GGD-00-198 Insurance Regulatory Oversight

report mentioned that states’ ability to monitor banks’ insurance-related

activities varied, given the varying resources and regulatory philosophy of

each department. Therefore, the Treasury IG recommended that OCC

proactively assess the reliance it can place on states’ oversight of

insurance activities performed by banks. However, OCC regulatory

oversight officials did not concur with most of the report’s

recommendations, citing that reliance on state insurance regulatory

activities is mandated by the GLB Act’s functional regulatory approach.

OTS officials stated that they recognize the need for improved and

continuing coordination. They also noted that insurance companies have

been able to own thrifts for some time. Since 1996, OTS regulators have

begun seeing increasing operational integration of the thrift with other

affiliates, including insurance companies, within holding companies.

Areas of increasing integration included the cross-marketing of products

and the consolidation of risk management, internal control, and internal

audit functions. In recognition of the trend, a regulatory cooperation and

information-sharing model agreement was approved in March 2000

between OTS and NAIC, with 22 states and the District of Columbia having

signed as of August 23, 2000. The remaining states are expected to sign

similar agreements. The only complication that has arisen involves a

couple of states with statutes barring sharing of confidential information.

We also found this problem in our work on the insurance regulators’

readiness for the year 2000.24

OTS officials also explained that in the future, areas needing attention with

the insurance industry will include (1) sharing of information to guard

against the migration of undesirable persons between banking and

insurance; (2) ensuring that key officials of insurance company affiliates

have had appropriate background checks, as now required for key officials

of the affiliated thrift; (3) understanding the statutory framework for

insurance in the 50 states; (4) understanding the similarities and/or gaps

between insurance and thrift regulation in areas such as shifting of assets,

cross-affiliate activity, employees holding dual jobs, and use of outside

directors on boards of directors and committees; (5) ensuring clear

disclosure of which products are insured—a special challenge with the

growth of Internet marketing of products; and (6) cross-training of

examiners to better understand the extent to which regulators can rely

upon each others’ work.

24 Year 2000: Insurance Regulators Have Accelerated Oversight, but Some Gaps Remain (GAO/GGD00-42, Dec. 20, 1999).
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Page 45 GAO/GGD-00-198 Insurance Regulatory Oversight

In December 1999, NAIC noted in a letter to federal regulators that mutual

consultation and close cooperation would be essential to achieving the

goals and requirements of the GLB Act. In particular, a need for federalstate interaction was noted for reviewing mergers and changes in

management control; consultation when regulators contemplate actions

affecting insurers; developing and administering effective consumer rules

dealing with insurance sales practices, customer complaints, and personal

privacy; and sharing regulatory information and examination findings. In

March 2000, NAIC established a series of working groups to implement

requirements of the GLB Act and set regulatory priorities. In the area of

regulatory coordination, working groups will (1) explore all aspects of

coordinating with federal regulators; (2) make recommendations regarding

the analysis, examination, and review of holding companies; and (3)

explore options for increased regulatory uniformity within a state-based

system to achieve efficiencies.

The GLB Act does not address all existing gaps or weaknesses in

regulatory coordination. Beyond the efforts toward resolving database

access issues to enhance fraud prevention as previously discussed, the

Frankel case demonstrates, in part, a need for improved coordination

between the securities and insurance regulators, even when there is no

known affiliation between insurance and securities entities. In the Frankel

case, had insurance regulators routinely coordinated with either state or

federal securities regulators, the scam may have been detected much

earlier.

The GLB Act focuses on holding company structures and bank activities; it

is silent on the need for coordination between insurance and securities

regulators. However, both NAIC and SEC have stated a desire to improve

their coordination since the passage of the financial modernization

legislation. SEC officials pointed out that prior to the GLB Act, SEC and

insurance regulators had a mutual interest in variable annuity products

created by insurance companies that were also deemed securities products

by the courts.25 Broker-dealers also often sell these products.

SEC also has a regulatory interest in material insurance affiliates of

broker-dealers and in how financial and solvency issues of the insurance

affiliate could affect the broker-dealer. These affiliations were allowed

before passage of the GLB Act. NAIC has established a working group on

holding companies to identify, in part, the insurance information needs of

25 Securities and Exchange Commission v. Variable Annuity Life Insurance Co. of America, 359 U.S. 65

(1959).

SEC and NAIC Have

Indicated a Need to

Improve Regulatory

Coordination
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Page 46 GAO/GGD-00-198 Insurance Regulatory Oversight

functional regulators, such as SEC. In addition, as illustrated by the

Frankel case, sharing disciplinary information could reduce the movement

of undesirables from one industry to another. NAIC officials have told us

that the current level of coordination does not extend to all areas of

current regulatory concern. At this time, we are unaware of specific,

direct regulatory coordination between the SEC and insurance regulators

beyond the narrow issues related to annuities, or any substantive

discussions on mechanisms for improved sharing of regulatory

information between insurance and securities regulators.

Insurance companies in several states lost in excess of $200 million

through an investment scam. A fundamental aspect of the scam was the

concealment of a secret affiliation alleged to exist between entities in the

insurance and securities industries, in which the interests behind the

ownership of the insurers as well as the investment entity controlling the

insurers’ assets were one and the same. Other key aspects of the scam

that have been alleged included the use of aliases, fraudulent paperwork

and reporting, and assistance by other individuals or entities serving as

fronts. The scope and duration of this scam indicates that a number of

people and entities either participated in the scam or neglected their legal,

fiduciary, or contractual duties. The role of Mr. Frankel and others is

presently the subject of a federal criminal investigation as well as other

state criminal and civil actions. Taxpayers will ultimately bear much of the

losses resulting from the scandal, as well as policyholders who are not

fully covered by their own states’ insurance guarantee programs.

Insurance regulators were not prepared to prevent or detect a scam

allegedly perpetrated among several insurers for nearly 8 years by a rogue

broker who had migrated into the insurance industry. Although routine

regulatory monitoring and examination activities are not designed to

proactively look for fraud, there is a regulatory responsibility to be alert

for fraud. Additionally, mechanisms should be in place that are designed

to detect possible fraud—so called “red flags” that trigger additional

regulatory scrutiny. In the scam allegedly carried out by Mr. Frankel, these

red flags included peculiarities with the trust, inconsistencies in regulatory

data related to asset custody and control, and the unusual investment

activities being reported by insurers. Given these unusual activities and

circumstances, even though they were not specifically contrary to law or

regulation, insurance regulators could have reacted to the warning signals

by judiciously asking additional questions. In a number of circumstances,

those questions could have unraveled the scam. Clearly, in this particular

case, there was a lack of professional skepticism.

Conclusions
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Page 47 GAO/GGD-00-198 Insurance Regulatory Oversight

Compounding the difficulties in uncovering the scam were inadequate

regulatory tools, policies, procedures, and practices. In addition, longstanding information-sharing issues among federal and state financial

services regulators further exacerbated the negative impacts of the scam.

Most of the regulatory oversight weaknesses were related to insufficient

means for conducting background checks and measures to safeguard and

verify the insurers’ invested assets. In addition, state insurance regulators

apparently did not have or seek sufficient expertise in the area of

securities and investments to adequately scrutinize the unusual investment

activities being reported to them by the Thunor Trust insurers. Similarly,

the most significant information-sharing weakness observed was the

inability or failure of insurance regulators to access regulatory information

available from the securities industry. At each phase in the oversight

process, insurance regulators would have benefited from information

available through local state securities regulators to further validate the

business transactions between the insurance companies and other

individuals and entities. Accessing this information was neither suggested

nor required, either by the policies and procedures of insurance

departments or those of NAIC.

Currently, regulators generally do not routinely conduct regulatory

background checks on individuals trying to enter the business of

insurance. Additionally, most state insurance commissioners do not have

the means to fulfill their responsibilities under a federal insurance fraud

prevention provision to prevent certain convicted felons from engaging in

the business of insurance. In this case, a regulatory review and inquiry of

the individuals associated with Thunor Trust could have helped unravel

the scam at the outset. Furthermore, the safeguards and methods used by

state regulators to protect insurers’ assets held by a broker-dealer did not

accomplish their purpose. Adoption and enforcement of a model law and

regulation developed by NAIC that identifies asset custodial requirements

would have been one way to strengthen safeguards on the insurers’ assets.

In addition, the asset verification procedures used by regulators during

examinations, generally performed once every 3 to 5 years, failed to work.

Limited or nonexistent information-sharing within the insurance industry

and with securities regulators delayed detection of the investment scam

for years. Additionally, the lack of information-sharing among state

insurance regulators hindered efforts that might have prevented the scam

from spreading to other states. Once concerns arose from examinations

on insurers under Thunor Trust, such concerns were not proactively

shared with other state insurance regulators to help prevent the scam from

expanding. Had concerns over the possible affiliation between LNS and
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Page 48 GAO/GGD-00-198 Insurance Regulatory Oversight

the Thunor Trust insurers been shared with other state regulators in early

February 1999, subsequent deals, resulting in the theft of $50 million from

insurers in two other states, may have been averted. Although tools exist

to facilitate proactive alerts, some regulators have been reluctant to share

concerns with their counterparts in other states, citing liability or

regulatory implications and the possibility that such information-sharing

could further harm the insurer if other states restrict its activities. In this

case, we believe that regulators confronted with the possibility of a fraud

and/or an affiliation between the Thunor Trust insurers and LNS were

presented with clear justification for immediately sharing this information

with the other states.

In the aftermath of the scandal, we have observed a desire by the states

and NAIC to address both the known inadequacies associated with the

scandal as well as other areas of vulnerability. Although the corrective

actions proposed to date are commendable, success in implementing them

will require continued commitment by NAIC and the states, as some are

expected to take several years to implement. Insurance regulators will

need to apply the lessons learned from this scandal to resolve existing

regulatory weaknesses and effectively coordinate with their banking and

securities counterparts as we enter a new environment where the blurring

of historical differences in the financial sectors continues.

We believe that it is too early to fully assess regulatory oversight

coordination efforts emanating from the GLB Act. However, it is clear that

federal and state regulators recognize the need to improve coordination as

they begin implementing the financial services modernization legislation.

Insurance regulators’ future fraud prevention efforts will depend on the

sharing of regulatory data between themselves and the banking and

securities industries. Privacy and data security are legitimate concerns

that will need to be addressed as information-sharing mechanisms are

developed. Additionally, enhancements for safeguarding and

independently verifying insurers’ assets need to be addressed as

affiliations between insurers, banks, and securities firms become more

prevalent in the future. Regulators in the banking and insurance industries

are taking steps to formalize the coordination mechanisms through memos

of understanding and the establishment of interagency working groups.

We also believe SEC and NAIC are correct in their stated need to improve

their coordination. However, beyond the narrow issue of variable

annuities, we are unaware of any concrete actions or plans for actions to

strengthen coordination. Although the GLB Act does not specifically

address coordination efforts between insurance and securities regulators,
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we believe that such coordination efforts will become increasingly

important as the lines distinguishing the offerings of different financial

sectors continue to blur. Moreover, the movement of undesirables from

one industry to another would be more easily controlled with better

sharing of disciplinary information. Overall, as illustrated by the Frankel

case, each of the financial regulators need to consider regulatory data from

other financial sectors to properly oversee the business relationships and

transactions between institutions in different financial sectors.

We recommend that state insurance commissioners:

• develop and adopt the appropriate mechanisms to adequately safeguard

and verify insurer assets that are not in the physical possession of the

insurance company, including requirements for ensuring the

appropriateness of asset custodians;

• improve information-sharing by

• developing mechanisms for routinely obtaining regulatory data from

individuals and firms from other financial services regulators, and

• implementing policies and procedures for proactively sharing regulatory

concerns with other state insurance departments; and

• increase the level of securities expertise available to their departments’

staff and ensure that insurance analysts and examiners have appropriate

training, tools, and procedures to analyze securities assets and to

recognize unusual investment strategies.

We recommend that the President of NAIC:

• ensure that the corrective actions identified by the Ad Hoc Task Force on

Solvency and Anti-Fraud are implemented as quickly and fully as possible,

in particular those that NAIC can accomplish unilaterally;

• ensure that the accreditation program requires the states to have adequate

controls for safeguarding and verifying assets that are not in the physical

possession of the insurer and to have access to securities-related

expertise; and

• supplement existing guidance in the financial analysis and examiner

handbooks reinforcing the importance of reviewers exercising an

Recommendations to

Regulators
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Page 50 GAO/GGD-00-198 Insurance Regulatory Oversight

appropriate level of professional skepticism and due professional care

when indicators of fraud or other irregularities surface.

We recommend that the Chairman of SEC and the President of NAIC:

• increase the attention given to the development of more routine processes

and procedures for sharing and communicating information to address

common regulatory oversight matters, including efforts to help prevent the

migration of rogues between the securities and insurance industries. .

We recommend that the United States Attorney General, the President of

NAIC, and state insurance commissioners:

• work together to establish a mechanism by which state regulators can

perform criminal background checks on individuals for the purpose of

meeting insurance regulators’ responsibilities under the federal insurance

fraud prevention provision, 18 U.S.C. § 1033.

In order to encourage and monitor progress by insurance regulators,

Congress may want to consider requesting that NAIC periodically report

on the status of corrective actions recommended in this report and by

NAIC’s Ad Hoc Task Force on Solvency and Anti-Fraud, including a

discussion of

• states’ adoption of appropriate laws, regulations, and processes to

safeguard and verify insurer’s assets that are not in the physical possession

of the insurer;

• regulators’ ability to access criminal history data to meet the requirements

of federal insurance fraud prevention requirements, as identified in 18

U.S.C. § 1033; and insurer;

• efforts and agreements between insurance regulators and banking and

securities regulators to oversee insurance-related entities of affiliated

financial institutions, including methods for safeguarding and verifying

insurer assets held by an affiliated institution and mechanisms to access

individual disciplinary data from other financial services regulators.

We requested comments on a draft of the report from the Insurance

Commissioners of Tennessee, Mississippi, Missouri, Oklahoma, and

Arkansas; NAIC; the Tennessee Comptroller of the Treasury; the Federal

Reserve; OCC; OTS; SEC; NASDR; and the Department of Justice. All of

the agencies chose to respond orally. These oral comments were

Matter for

Congressional

Consideration

Agency Comments
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approved by commissioners of the state insurance departments; the

President of the NAIC; the Director of State Audit, Tennessee Comptroller

of the Treasury; an Associate Director and other senior officials of the

Division of Bank Supervision and Regulation of the Federal Reserve, the

Comptroller of the Currency, the Director of the Office of Thrift

Supervision; the Assistant Chief Counsel of the Division of Market

Regulation of SEC, an Associate Vice President, Enforcement Department

of the NASDR; the Supervisory Assistant U.S. Attorney in Connecticut; the

Deputy Chief of the Fraud Section, Criminal Division of the Department of

Justice; and a Supervisory Special Agent of the Economics Crimes Unit,

Financial Crimes Section, Criminal Investigative Division of the FBI.

The agencies commenting on our draft report responded orally that they

generally concurred with the report’s findings, conclusions, and

recommendations or had no comments on the report. Officials from some

agencies also provided technical suggestions that we incorporated where

appropriate. Additionally, NAIC and SEC commented on implementation

issues associated with our recommendation to them on enhancing

coordination and information-sharing. NAIC emphasized its desire to

enhance communications and information-sharing between insurance

regulators and SEC and provided us with a recent letter sent by the

President of NAIC to the Chairman of SEC requesting future discussions

on information-sharing issues. SEC officials agreed with the need to

maintain open lines of communication, but they specifically mentioned

that, by statute, they could not use disciplinary information from insurance

regulators in determining eligibility to license brokers. NAIC officials also

noted that regulatory information-sharing could be facilitated with federal

legislation allowing for and protecting the confidentiality of informationsharing between federal agencies, state regulators, and NAIC.

We are providing copies of this report to the President and 55 state and

other governmental entities who are members of NAIC; the Honorable

Arthur Hayes Jr., Director of State Audit, Tennessee Comptroller of the

Treasury; the Honorable Alan Greenspan, Chairman of the Board of

Governors of the Federal Reserve System; the Honorable John D. Hawke,

Jr., Comptroller of the Currency; the Honorable Ellen Seidman, Director of

the Office of Thrift Supervision; the Honorable Arthur Levitt, Chairman of

the Securities and Exchange Commission; the Honorable Mary L. Schapiro,

President of the NASD Regulation Inc.; the Honorable Janet Reno,

Attorney General; and other interested parties. We will also make copies

available to others on request.
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If you or your staff have any questions regarding this report, please contact

me at (202) 512-8678 or Lawrence D. Cluff at (202) 512-8678. Key

contributors to this report are acknowledged in appendix V.

Sincerely yours,

Thomas J. McCool

Director, Financial Institutions

and Markets Issues
Page 53 GAO/GGD-00-198 Insurance Regulatory Oversight
Page 54 GAO/GGD-00-198 Insurance Regulatory Oversight

Contents

1 Letter

Appendix I 56

Selected Observations

from Prior GAO

Insurance and

Securities-Related

Reports

Appendix II 60

Summary of Key

Events Associated

With the Scam

Allegedly Perpetrated

by Martin Frankel

Appendix III 64

NAIC’s Model Law and

Regulation Related to

Insurer Asset

Custodial

Requirements

Appendix IV 66

NAIC’s Proposed

Corrective Actions

Emanating From the

Frankel Scandal
Contents

Page 55 GAO/GGD-00-198 Insurance Regulatory Oversight

Appendix V

GAO Contacts and

Staff

Acknowledgments

73

Table 1: Overview of Regulatory Weaknesses 16

Table 2: Summary of Asset Turnover Ratios 24

Table I.1: Selected Observations from GAO Insurance and

Securities-Related Reports

57

Table II.1: Summary of Key Events 60

Tables

Figure 1: Overview of the Scandal 9

Figure 2: Simplified Structure of the Thurnor Trust

Insurance Companies

12 Figures

Abbreviations

CPA Certified Public Accountant

CRD Central Registration Depository

FBI Federal Bureau of Investigation

FDIC Federal Deposit Insurance Corporation

IRIS Insurance Regulatory Information System

LNS Liberty National Securities

MOU memorandum of understanding

NAIC National Association of Insurance Commissioners

NASDR National Association of Securities Dealers Regulation

OCC Office of the Comptroller of the Currency

OTS Office of Thrift Supervision

RIRS Regulatory Information Retrieval System

SAD Special Activities Database

SEC Securities and Exchange Commission
Appendix I

Selected Observations from Prior GAO

Insurance and Securities-Related Reports

Page 56 GAO/GGD-00-198 Insurance Regulatory Oversight

During the 1980s, the number and size of property/casualty insurance

failures and the number of insurers in danger of failure increased. In

addition, in the early 1990s, several large life insurance companies failed.

At the request of Congress, GAO began a series of reviews of the statebased system of monitoring insurer solvency and dealing with insurer

failures. These reviews also included an assessment of the capability of

NAIC to create and maintain an effective national system of solvency

regulation.

As a result of these reviews, GAO found a number of weaknesses with

state-based insurance regulation and NAIC’s ability to both effectively

monitor the essential functions of state insurance departments and

establish a national system of uniform insurance regulation. At least some

of these weaknesses remain. For example, the lack of interstate

coordination and information-sharing about problem insurers is a

regulatory oversight weakness that, in part, allowed the Frankel scheme to

go undetected for many years.

In addition to the insurance-related reviews, some prior GAO observations

of problems in the securities industry are relevant to the Frankel matter.

Specifically, a persistent weakness observed is the difficulty for regulators

to prevent the migration of unscrupulous brokers between the securities

industry and other financial services industries.

Table I.1 presents selected findings from a range of GAO insurance and

securities-related reports that relate to regulatory weaknesses in the

insurance and securities industries.
Appendix I

Selected Observations from Prior GAO Insurance and Securities-Related Reports

Page 57 GAO/GGD-00-198 Insurance Regulatory Oversight

Insurance Regulation: Problems in the State Monitoring of Property/Casualty Insurer Solvency (GAO/GGD-89-129, Sept. 1989)

—Time lags in reviewing annual financial data

A company can have a problem for more than a year before a state regulator is aware of it.

—Time lags in field examinations

Most states require field examinations only once every 3 to 5 years (a few states have no statutory requirement), and such

examinations can take months and sometimes years to complete.

—NAIC’s warning system is of varied usefulness to states

Officials in four of the five states GAO visited generally regarded NAIC’s IRIS ratios and examiner team reports as of limited

usefulness when compared to their own work in annual statement analysis.

—The need for interstate coordination

Although NAIC prescribes in its Financial Regulation Standards that a state that identifies a financially troubled insurer should notify

other jurisdictions in which the insurers does business, in practice, states will leave the primary responsibility for solvency

monitoring to the state in which a company is located.

—States vary in the amount of information they will share about problem insurers

State regulators are divided in their policy on information-sharing between a desire to keep other departments informed and a concern

that doing so may harm efforts to rehabilitate insurers.

—NAIC has had limited success in bringing states together

The extent to which states are willing or able to use the coordination opportunities (such as participation in committees,

subcommittees, task forces, and working groups) provided by NAIC varied.

Insurance Regulation: State Reinsurance Oversight Increased, but Problems Remain (GAO/GGD-90-82, May 1990)

—Reinsurance data limitations affect regulatory review

Primary insurers assuming reinsurance combine primary insurance and reinsurance financial data in their annual statements. These

aggregate data have not been detailed enough to reflect reinsurance activity and its impact on an insurer’s financial condition.

Insurance Regulation: Assessment of the National Association of Insurance Commissioners (GAO/T-GGD-91-37, May 22, 1991)

—Limits to NAIC’s authority

NAIC cannot surmount the fundamental barriers to its long-term effectiveness as a regulator because NAIC lacks authority to

enforce its accreditation standards.

Table I.1: Selected Observations from GAO Insurance and Securities-Related Reports
Appendix I

Selected Observations from Prior GAO Insurance and Securities-Related Reports

Page 58 GAO/GGD-00-198 Insurance Regulatory Oversight

Insurance Regulation: The Failures of Four Large Life Insurers (GAO/T-GGD-92-13, February 18, 1992)

—Regulators’ information was neither timely, complete, nor accurate

(1) Financial statements filed in accordance with statutory accounting practices did not fairly reflect the four insurers’ true financial

condition.

(2) An insurance holding company is not required to file consolidated financial statements based on statutory insurance accounting.

(3) Regulators relied on infrequent field examinations to verify financial data reported by the insurers. Such examinations were done

about once every 3 years and took months or even years to complete.

(4) Regulators did not get financial information early enough to identify and react to the rapid deterioration in these companies.

(5) States did not keep one another informed about solvency problems, despite their interdependence in monitoring the troubled

insurers.

—Holding companies are a regulatory blind spot

Regulators cannot effectively assess interaffiliate transactions if the insurer fails to report either the identity of its affiliates or the

transactions. Except for infrequent field examinations, regulators have no way to verify the insurer’s reported information. Interaffiliate

transactions can mask an insurer’s true condition, and improper transactions with affiliates have caused previous life insurer failures.

In addition, an insurance holding company is not required to file consolidated financial statements based on statutory insurance

accounting.

Insurance Regulation: The Financial Regulation Standards and Accreditation Program of the National Association of Insurance

Commissioners (GAO/T-GGD-92-27, April 9, 1992)

—Weaknesses observed in NAIC’s accreditation program

The accreditation program experienced three problems: (1) the financial regulation standards were for the most part general and have

been interpreted permissively; (2) the program has too little focus on a state insurance department’s implementation of its regulatory

authorities, that is, how well the state does its job; and (3) the NAIC review teams’ documentation of their accreditation decisions has

not consistently supported their compliance decisions.

Insurer Failures: Regulators Failed to Respond in Timely and Forceful Manner in Four Large Life Insurer Failures (GAO/T-GGD92-43, September 9, 1992)

—Regulator’s information was not timely, complete, or accurate

The infrequency with which on-site examinations are done, even for companies known to be experiencing difficulty, significantly

impairs the regulator’s ability to evaluate financial condition and act on adverse findings.

Insurance Regulation: The National Association of Insurance Commissioners’ Accreditation Program Continues to Exhibit

Fundamental Problems (GAO/T-GGD-93-26, June 9, 1993)

—Weaknesses observed in NAIC’s accreditation program

Lack of Focus on Performance Allows States With Weak Examination Quality to be Accredited
Appendix I

Selected Observations from Prior GAO Insurance and Securities-Related Reports

Page 59 GAO/GGD-00-198 Insurance Regulatory Oversight

Securities Markets: Actions Needed to Better Protect Investors Against Unscrupulous Brokers (GAO/GGD-94-208, Sept. 1994)

—Potential exists for the migration of undesirable persons to other sectors of the financial services industry

GAO analyzed the records of 96 unscrupulous brokers who had left the securities industry and found that 3 of these brokers had

migrated to the insurance industry. In addition, existing broker surveillance systems could be improved by enhancing the reporting of

disciplinary actions and information on customer complaints into the CRD.

Insurance Regulation: Chronology of F.T. Riley’s Activities and Related Regulatory Actions (GAO/OSI-95-5, Oct. 1994)

—Increased regulatory scrutiny can create incentives for insurers to redomesticate to another state

States with statutes prohibiting fraud are reluctant to investigate and prosecute insurance fraud cases because of budget and

jurisdictional problems. By taking advantage of this environment, Mr. Riley and his related companies have continued to operate in a

questionable manner by moving from state to state. Mr. Riley’s practice was to locate an insurance company in one state but sell

insurance in another state. He then claimed exemption from home state regulation on the grounds that he was a foreign insurer (an

out-of-state insurer) and was not doing the business of insurance in the state of domicile. Further, when a state of domicile

strengthened its laws, Mr. Riley moved the company to another state with weaker regulations.

Insurance Regulation: Observations on the Receivership of Monarch Life Insurance Company (GAO/GGD-95-95, Mar. 1995)

—Interaffiliate transactions were a regulatory blind spot

State regulators did not regulate either the parent holding companies or the noninsurance affiliates and subsidiaries of the failed

insurers.

SEC Enforcement: Responses to GAO and SEC Recommendations Related to Microcap Stock Fraud (GAO/GGD-98-204, Sept.

30, 1998)

—Actions on the migration of unscrupulous brokers is not complete

No record exists of the movement of unscrupulous securities brokers.

Year 2000: Insurance Regulators Have Accelerated Oversight, but Some Gaps Remain (GAO/GGD-00-42, Dec. 1999)

—Limitations in the sharing of information among insurance regulators

State regulators have restrictions on sharing examination-related information with other state regulators.
Appendix II

Summary of Key Events Associated With the

Scam Allegedly Perpetrated by Martin Frankel

Page 60 GAO/GGD-00-198 Insurance Regulatory Oversight

An abbreviated chronology of key events is described in Table II.1 below.

Some details have been left out to simplify what is in reality a much more

complicated story. Other details are left out for sensitivity reasons.

Readers should also keep in mind that ongoing criminal and civil cases are

likely to provide additional details at a later date.

1985-1988 Martin Frankel works in the securities industry as a registered representative. He is fired from two brokerdealers located in Ohio and Illinois.

December 1989 SEC begins a formal investigation of Frankel.

August 1991 Liberty National Securities, a small broker-dealer in Ohio, registers in Tennessee.

August 1991 SEC files a civil complaint alleging that from June 1987 to April 1988 Frankel raised over $1 million through

offer and sale of limited partnerships in the Frankel Fund. Frankel then made omissions and misstatements

about the use of proceeds from investors, Frankel’s background and experience, and the Frankel Fund

performance.

September 1991 Frankel allegedly arranges the formation of Thunor Trust using three nominee grantors. The Tennessee State

Department of Insurance receives the Form A filing and later approves the Thunor Trust’s acquisition of

Franklin American Corporation and its subsidiary company Franklin American Life Insurance Company.

August 1992 Frankel settles with SEC consenting to a bar from the securities industry and disgorgement of funds.

March 1, 1993 The Tennessee State Department of Insurance receives Franklin American Life Insurance Company’s

December 31, 1992, annual financial statement. The statement shows that (1) the value of Franklin

American’s U.S. government securities increased 28% from the prior year’s end, and (2) Franklin American’s

entire portfolio of these securities “turned over” 17 times during the year. The CPA firm issued a clean

opinion.

April 1993 Liberty National Securities moves from Toledo, OH to Dundee, MI.

June 1993 The Tennessee State Department of Insurance begins an examination of Franklin American Life as of

December 31, 1992. The examination report is issued April 1994 with no adverse material findings.

February 1994 Family Guaranty Life Insurance Company domiciled in Mississippi is purchased by an affiliate of Thunor

Trust.

February 25, 1994 The Tennessee Department of Insurance receives Franklin American Life Insurance Company’s year-end

1993 annual financial statement showing that (1) the value of Franklin American’s securities portfolio

increased by 53% from the prior year’s end, and (2) Franklin American’s entire portfolio of securities “turned

over” 40 times during the year.

March 1994 Farmers and Ranchers Life Insurance Company domiciled in Oklahoma is purchased by an affiliate of Thunor

Trust.

August 1994 International Financial Services Life Insurance Company domiciled in Missouri is purchased by an affiliate of

Thunor Trust.

Table II.1: Summary of Key Events
Appendix II

Summary of Key Events Associated With the Scam Allegedly Perpetrated by Martin Frankel

Page 61 GAO/GGD-00-198 Insurance Regulatory Oversight

February 25, 1995 The Tennessee Department of Insurance receives Franklin American Life’s year-end 1994 financial

statement showing that (1) the value of Franklin American’s securities portfolio increased by 3% from the

prior year’s end, and (2) Franklin American Life’s entire portfolio of securities “turned over” 172 times during

the year.

March 1995 Family Protective Life Insurance Company domiciled in Mississippi is acquired by an affiliate of Thunor Trust.

February 29, 1996 The Tennessee Department of Insurance receives Franklin American’s year-end 1995 annual financial

statements. They show that (1) the company’s securities were “held by broker in street name” in violation of

Tennessee custody regulations, (2) the value of Franklin American’s securities portfolio increased by 14%

from the prior year’s end, and (3) Franklin American’s entire portfolio of securities “turned over” 245 times

during the year.

April 25, 1996 A routine exam completed of Farmers and Ranchers (Oklahoma) with an “as of” date of December 31, 1994.

There are no material adverse findings.

September 25, 1996 A target examination is conducted of Franklin American Life Insurance Company’s securities investments by

Tennessee State Insurance Department because of concerns that Franklin might be engaged in “shortselling” its government securities, i.e., selling a security before it is actually owned. After a 1-day on-site

review, staff members conclude the company is not short-selling but recommend that a securities expert be

retained to examine Franklin American’s securities investments.

February 26, 1997 The Tennessee State Insurance Department receives Franklin American’s year-end 1996 annual financial

statement. This statement indicated the value of Franklin’s securities portfolio increased by 19% from the

prior year’s end and that the portfolio of securities turned over 167 times during the year.

May 1997 Missouri’s routine exam of International Services Life is made public and has an “as of’ date of December 31,

1995. There are no material adverse findings in the exam report.

January 1998 Mississippi State examiners begin a routine exam of both Family Protective Life Insurance Company and

Family Guarantee Life Insurance Company with an “as of date” December 31, 1997. During this exam,

examiners were aware the securities were with a broker and that this did not violate state law. They also had

trouble confirming the relationship of the broker, Liberty National Securities of NY, and confirming that the

broker had the securities in its possession. By fall 1998, Mississippi officials had a draft report saying that

FAC was not reporting the ultimate controlling person. This exam continues until January 29, 1999.

February 1998 First National Life Insurance Company domiciled in Alabama is purchased by an affiliate of Thunor Trust.

March-May, 1998 Thunor Trust officials and representatives meet with Alabama Insurance officials to advise that they intend to

terminate the existing custodial agreement with a bank holding the marketable securities and transfer them to

a brokerage with a national reputation. Alabama regulators deny the request because broker-dealers are not

permitted to be custodians under Alabama law. Two years later Alabama regulators learn that nearly $100

million was removed from the bank custodian anyway and in violation of the custodial agreement that

required regulatory approval for withdrawals.

May 11, 1998 Oklahoma completes its second routine exam of Farmers and Ranchers since purchase by Thunor Trust with

“as of” date of December 31, 1997. There are no material adverse findings.

September 1998 An independent contractor for the Tennessee Insurance Department begins his examination of Franklin

American Life Insurance Company with an “as of” date of December 31, 1997.

September 29-30, 1998 First National redomesticates in Mississippi from Alabama.
Appendix II

Summary of Key Events Associated With the Scam Allegedly Perpetrated by Martin Frankel

Page 62 GAO/GGD-00-198 Insurance Regulatory Oversight

October 1998 The St. Francis of Assisi Foundation, another investment vehicle allegedly controlled by Frankel, files a Form

A application with the Colorado Division of Insurance to purchase an insurance company. The Colorado

Division of Insurance advises the foundation that the Form A filing is incomplete and requests additional

information. A purchase is never approved.

Late 1998 The Tennessee examination reveals that the insurer was placing nearly all of its assets with Liberty National

Securities, apparently in violation of state rules that require assets to be held by a bank custodian.

Tennessee insurance regulators issue an order requiring the insurer to retrieve its investment assets and put

them in a bank. Franklin American Life Insurance Company’s securities are, for the first time, placed in a

qualifying banking institution, effective December 31, 1998. However, soon into the next year, the assets are

removed again.

January 14, 1999 A Thunor Trust affiliate files a Form A application to purchase Old Southwest Life Insurance Company

domiciled in Arkansas. Arkansas regulators approve the purchase in February 1999.

January 1999 The contract examiner for the Tennessee Insurance Department has problems getting custodial information

on the bonds held by Liberty National and reference material on Liberty National. Tennessee regulators meet

with officials under the Thunor Trust umbrella to discuss concerns about the lack of public information on

Liberty National, the bond trading strategy’s apparent lack of logic, why brokerage fees are so low, bond

custodial issues under Tennessee law, and other matters. Afterward, the Tennessee contract examiner

obtains information on Liberty National from Tennessee securities regulators that shows geographic location

and firm size inconsistencies with material received from the Thunor Trust affiliates.

January 29, 1999 Mississippi examiners have their closeout conference with Thunor Trust representatives. They also receive

the information obtained from the Tennessee securities regulators showing the inconsistencies about Liberty

National’s location and size. The examiners tell the Thunor Trust representatives they are taking their

concerns about asset verification and Liberty National’s affiliation to their superiors.

February 1, 1999 The Tennessee contract examiner sends a memo to the Insurance Department Chief Examiner noting the

possibility that the Tennessee insurance company has been looted of its assets. He notes that fraud would

explain some otherwise unexplainable information, including (1) the grantors giving the sole trustee

irrevocable control over millions with no contractual assurance that it be returned to the grantors or their

beneficiaries; (2) use of a little known brokerage firm for massive bond transactions; and (3) the

expertise/secretive process, which permits the Tennessee insurance company to consistently record

exceptional gains on bond trades but prevents the bonds from being under a custodial arrangement with a

bank or trust company.

February 8, 1999 Tennessee State Department of Insurance officials grant a 60-day grace period to the Tennessee insurance

affiliate of Thunor Trust to move its securities to a Tennessee bank. Liberty National Securities now has until

April 1999 to return the assets.

February 23, 1999 Mississippi insurance officials talk to representatives of the Thunor Trust Tennessee affiliate by phone and

once again are told that Liberty National Securities is not an affiliated entity of Thunor Trust.

February 25, 1999 Old Southwest Life Insurance Company, domiciled in Arkansas, is approved for purchase by an affiliate of

Thunor Trust.

February-April 1999 Mississippi regulators send questions to the appropriate affiliates of Thunor Trust about their concerns and

later receive written answers. Copies of the questions are also sent to Tennessee regulators.

Early April 1999 The Thunor Trust affiliate, First National Life, domiciled in Mississippi, enters into an approximately $44

million reinsurance agreement with Settlers Life Insurance Company domiciled in Virginia.
Appendix II

Summary of Key Events Associated With the Scam Allegedly Perpetrated by Martin Frankel

Page 63 GAO/GGD-00-198 Insurance Regulatory Oversight

April 28, 1999 Meeting in a Jackson, MS hotel reportedly attended by Frankel and others to discuss the meeting the next

day with Mississippi regulators.

April 29, 1999 Mississippi regulators decide to place all three Mississippi companies under administrative supervision after

the meeting between the Mississippi Department of Insurance and insurance company officials of the

Mississippi domiciled companies.

May 3, 1999 Mississippi regulators go to Franklin American to take control of the Mississippi companies.

May 4, 1999 First time Mississippi regulators look at documents belonging to First National Life Insurance Company of

America.

May 5, 1999 Greenwich, CT police and firefighters responded to the burning of Frankel’s $3 million estate.

May 7, 1999 Sole trustee of Thunor Trust signs affidavits acknowledging that the whereabouts of the money belonging to

the insurance companies under the trust was unknown. Mississippi insurance officials contact the FBI.

May 8, 1999 Mississippi regulators meet with Mr. Heath of Leuty & Heath, the CPA firm for the Frankel companies. Heath

kept very few records. Mssrs. Leuty and Heath were the only CPAs in the firm. The Frankel companies were

apparently the primary clients.

May 10, 1999 Mississippi regulators place three Mississippi companies into receivership.

May 11, 1999 The Tennessee Department of Commerce and Insurance confirms its request that Franklin American Life

Insurance Company place $57.5 million of its assets into a Tennessee bank, and the money is transferred.

The Arkansas, Alabama, Oklahoma, and Virginia regulators first become aware of the apparent fraud.

September 4, 1999 Frankel is taken into custody in Hamburg, Germany.

October 7, 1999 U.S. Attorney/Connecticut files criminal indictment alleging Frankel stole in excess of $200 million in cash

reserves from the insurance companies he controlled anonymously. Following the theft, the funds were used

to purchase cars, real estate, diamonds, and gold.

December 3, 1999 David Rosse, a bodyguard and associate of Frankel, pleads guilty to one racketeering conspiracy charge in

Federal District Court (Connecticut).

December 27, 1999 Karen Timmins, an office assistant to Frankel at his Connecticut mansion, pleads guilty to one count of

concealing the laundering activities of others and failing to report them to authorities.

March 23, 2000 An NAIC committee votes to suspend Tennessee’s accreditation largely because of the Frankel matter.

March 27, 2000 Philip Miller pleads guilty to one count of conspiracy in Federal District Court (Connecticut).

June 2000 Martin Frankel pleads guilty to tax evasion in Germany in connection with diamonds he purchased and

transported into the country but appeals the sentence.
Appendix III

NAIC’s Model Law and Regulation Related to

Insurer Asset Custodial Requirements

Page 64 GAO/GGD-00-198 Insurance Regulatory Oversight

In the mid 1990s, NAIC reaffirmed that broker-dealers should not be used

as custodians for insurer assets.1

In 1993, a working group was appointed

to study the issue of whether or not broker-dealers should serve as

custodians for insurers’ assets. After collecting position papers from

interested parties, including those representing broker-dealers, the NAIC

working group expressed concerns over the safeguards present on

insurers’ assets should the broker-dealer become insolvent and concluded

that safeguards for insurers’ assets with banks and trusts were superior to

those of broker-dealers. Furthermore, the working group noted that

additional costs that may be associated with using banks or trust

companies as custodians would not be significant to most insurers. The

working group concluded in 1994 that NAIC’s existing policy to exclude

broker-dealers from serving as custodians of insurer assets be maintained.

NAIC’s Model Law No. 295 and Model Regulation No. 298 have not been

adopted in many states, in part, because such adoption is not a

requirement for state accreditation by NAIC. As part of its accreditation

program, NAIC requires that states adopt certain model laws and

requirements, or substantially similar laws and requirements, to receive

accreditation. These accreditation standards do not currently include this

particular model law related to the custody of assets. Although many

states have laws related to asset custody requirements, NAIC officials

could not say definitively how many states allowed institutions other than

banks or trust companies to act as custodians for insurer assets.

During our discussions and reviews of regulatory files at the insurance

departments we visited, we found that Tennessee, Mississippi, Missouri,

and Oklahoma allowed a broker-dealer entity, LNS, to maintain the

custody of insurers’ assets, contrary to NAIC’s model law and regulation.

One of these states, Tennessee, had adopted the use of NAIC’s model

custody agreement, but it did not enforce the agreement properly between

Franklin American Life and LNS. Instead, Tennessee Insurance Division

officials allowed the insurer to place its assets in the custody of a brokerdealer for years, contrary to NAIC’s model law and regulation that required

the insurer to place its assets in a bank or trust company. Later, the state

retrieved approximately $57 million of insurer assets into an approved

account by enforcing state rules regarding asset custody arrangements,

which were based on NAIC’s guidelines.

1

According to NAIC officials, an acceptable trust under the model law could include a trust company

that was a subsidiary to a securities firm.
Appendix III

NAIC’s Model Law and Regulation Related to Insurer Asset Custodial Requirements

Page 65 GAO/GGD-00-198 Insurance Regulatory Oversight

One state hindered the alleged investment scam through the enforcement

of its insurance requirements that prohibited broker-dealers from

maintaining custody of an insurer’s assets. In 1998, after an insurer

domiciled in Alabama was purchased under Thunor Trust, company

officials requested that insurance regulators allow the insurer to invest its

assets with LNS. State officials denied the request, citing state

requirements that an insurer’s assets be maintained in a bank or trust,

similar to those recommended in NAIC’s model law. Subsequently, the

insurer, First National Life Insurance Company of America,

redomesticated to Mississippi, where a similar requirement did not exist.

Unfortunately, the insurer’s assets were stolen through the bogus LNS

operation Frankel allegedly established. The evidence now suggests that

officials connected to Thunor Trust pulled out the assets of the Alabama

insurer prior to the redomestication to Mississippi, in violation of

Alabama’s rules and without the Alabama Insurance Department’s

knowledge.
Appendix IV

NAIC’s Proposed Corrective Actions

Emanating From the Frankel Scandal

Page 66 GAO/GGD-00-198 Insurance Regulatory Oversight
Appendix IV

NAIC’s Proposed Corrective Actions Emanating From the Frankel Scandal

Page 67 GAO/GGD-00-198 Insurance Regulatory Oversight
Appendix IV

NAIC’s Proposed Corrective Actions Emanating From the Frankel Scandal

Page 68 GAO/GGD-00-198 Insurance Regulatory Oversight
Appendix IV

NAIC’s Proposed Corrective Actions Emanating From the Frankel Scandal

Page 69 GAO/GGD-00-198 Insurance Regulatory Oversight
Appendix IV

NAIC’s Proposed Corrective Actions Emanating From the Frankel Scandal

Page 70 GAO/GGD-00-198 Insurance Regulatory Oversight
Appendix IV

NAIC’s Proposed Corrective Actions Emanating From the Frankel Scandal

Page 71 GAO/GGD-00-198 Insurance Regulatory Oversight
Appendix IV

NAIC’s Proposed Corrective Actions Emanating From the Frankel Scandal

Page 72 GAO/GGD-00-198 Insurance Regulatory Oversight
Appendix V

GAO Contacts and Staff Acknowledgments

Page 73 GAO/GGD-00-198 Insurance Regulatory Oversight

Richard J. Hillman, (202) 512-8678

Lawrence D. Cluff, (202) 512-8678

In addition to those named above, James R. Black, Thomas H. Givens III,

Rosemary Healy, Barry A. Kirby, Paul G. Thompson, Karen C. Tremba, and

Desiree W. Whipple made key contributions to this report.

GAO Contacts

Acknowledgments
Page 74 GAO/GGD-00-198 Insurance Regulatory Oversight
Page 75 GAO/GGD-00-198 Insurance Regulatory Oversight
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