Report to the Honorable John D.

Dingell, Ranking Minority Member,

Committee on Energy and Commerce,

House of Representatives

United States General Accounting Office

GAO

August 2001 INSURANCE

REGULATION

The NAIC

Accreditation Program

Can Be Improved

GAO-01-948
Page i GAO-01-948 NAIC Accreditation Program

Letter 1

Results in Brief 1

Background 3

NAIC’s Accreditation Program Has Improved Over Time, Helping

States Strengthen Solvency Regulation 7

Accreditation Program Still Has Gaps and Weaknesses 11

Conclusions 22

Recommendations for Executive Action 24

Agency Comments and Our Evaluation 24

Scope and Methodology 26

Appendix I Tennessee and Mississippi Received Accreditation

During and After Thefts Causing Company

Insolvency 28

Appendix II An Overview of the NAIC Accreditation Program 33

Appendix III Comments From the National Association of

Insurance Commissioners 41

Appendix IV GAO Contacts and Staff Acknowledgments 46

Tables

Table 1: Overview of Accreditation Program Weaknesses 12

Table 2: Regulatory Oversight Weaknesses Identified by GAO in

Our September 2000 Report 31

Table 3: Accreditation Standards for Laws and Regulations 35

Table 4: Accreditation Standards for Regulatory Practices and

Procedures 37

Table 5: Accreditation Standards for Organizational and Personnel

Practices 38

Contents
Page ii GAO-01-948 NAIC Accreditation Program

Figures

Figure 1: Comparison of the Dates of Accreditation Reviews in

Tennessee and Mississippi With the Term of the Fraud in

Those and Other States 7
Page 1 GAO-01-948 NAIC Accreditation Program

August 31, 2001

The Honorable John D. Dingell

Ranking Minority Member

Committee on Energy and Commerce

House of Representatives

Dear Mr. Dingell:

As you requested, this report provides information about the National

Association of Insurance Commissioners’ (NAIC) voluntary accreditation

program for state regulation of insurers’ solvency. NAIC evaluates a state’s

regulatory program about once every 5 years to determine if it meets the

association’s minimum standards for effective solvency regulation. The

accreditation program has now been in place for about 10 years. During

that period, NAIC has expanded the standards and modified the process

for evaluating the adequacy of states’ solvency regulation. As discussed in

our report of September 2000, weaknesses in solvency regulation in

Tennessee and Mississippi and three other states allowed a $200 million

insurance fraud, allegedly masterminded by Martin Frankel, to continue

for 8 years, resulting in the failure of seven insurance companies.1

 The

fraud was uncovered and made public in May 1999. During 2000 both

Tennessee and Mississippi underwent accreditation reviews by NAIC and

were reaccredited. As agreed with your office, the objectives of this report

are to (1) discuss NAIC’s ongoing efforts to improve the accreditation

program, and (2) analyze the NAIC’s accreditation reviews in Tennessee

and Mississippi after the fraud was uncovered and identify actions NAIC

can take to strengthen its accreditation of state insurer solvency

regulation.

NAIC’s voluntary accreditation program has existed now for more than 10

years. During this time, the program has demonstrated its value by

defining a common set of basic regulatory requirements for solvency

regulation and successfully engineering their adoption by nearly all states.

 1

See Insurance Regulation: Scandal Highlights Need for Strengthened Regulatory

Oversight (GAO/GGD-00-198, Sept. 19, 2000).

United States General Accounting Office

Washington, DC 20548

Results in Brief
Page 2 GAO-01-948 NAIC Accreditation Program

Currently, 47 state insurance departments and the District of Columbia are

accredited through NAIC. In the years since its inception, NAIC has moved

to improve and strengthen its accreditation program by adding model laws

and regulations to the required standards in order to address the changing

environment of the insurance industry and insurance regulation. In

addition, it has revised the way accreditation reviews are performed and

scored and has improved training for members of review teams.

However, our analysis of the accreditation reviews done in Tennessee and

Mississippi (the principal regulators of several insurance companies that

failed because of the scam allegedly perpetrated by Martin Frankel)

disclosed gaps and weaknesses in the accreditation program. First, we

found that the program does not cover a key area of solvency regulation—

chartering and change in ownership of insurance companies. Oversight of

chartering and changes in ownership is key to preventing inappropriate

and undesirable individuals from gaining control of insurance companies.

The insurance fraud exposed weaknesses in state regulation and oversight

in this area that are not addressed in NAIC’s accreditation program.

Second, we found weaknesses in on-site accreditation review procedures.

These weaknesses included incomplete analyses of exam information, a

questionable scoring methodology that can give misleading results, limited

on-site compliance testing, and insufficient flexibility in tailoring reviews

to address the most material issues. While we identified these weaknesses

during our review of the reaccreditations in Tennessee and Mississippi, it

is likely that similar issues would arise in other reviews, as NAIC officials

report that the reaccreditation reviews done in Tennessee and Mississippi

conformed to the accreditation processes and practices routinely followed

by NAIC in the reaccreditation of all other states.

To further improve the voluntary state accreditation program and to

address weaknesses that raise questions about the credibility of NAIC’s

accreditation reviews, this report recommends that NAIC take several

actions. First, we recommend that NAIC expand the accreditation

standards by developing or amending the necessary model laws,

regulations, and accreditation review guidelines to ensure effective

oversight of chartering and change in ownership. We also recommend that

NAIC implement on-site review team procedures that require the inclusion

of all relevant examination information and the use of a scoring

methodology that emphasizes those standards with the most direct impact

on insurer solvency. Finally, we recommend that NAIC make the

accreditation process more flexible—allowing the review team to focus on

the areas of greatest risk by extending visits when appropriate and

targeting the most material issues through expanded testing. NAIC
Page 3 GAO-01-948 NAIC Accreditation Program

generally agreed to consider each of these recommendations. Their

comments are discussed near the end of this report.

Insurance companies are regulated principally by the states and are

chartered under the laws of a single state, known as the state of domicile.

Companies may conduct business in multiple states, but the state of

domicile remains the primary regulator. States in which an insurer is

licensed to operate but is not chartered typically rely heavily on the

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

NAIC is a voluntary association of the heads of insurance departments

from each state, the District of Columbia, and four U.S. territories. State

insurance commissioners created NAIC in part to help address the

problems that arise when state insurance regulators try to oversee insurers

that operate in a number of states, each with its own regulatory authority

and laws. NAIC provides a national forum for addressing and resolving

major insurance issues and for promoting the development of consistent

policies among the states. It also serves as an information clearinghouse

and provides a structure for interstate cooperation in examining multistate

insurers. In addition, NAIC develops and distributes model insurance laws

and regulations for consideration by member states and reviews the

regulatory activities of state insurance departments as part of its national

accreditation program.

The need for a national accreditation program was recognized during the

1980s to early 1990s when many insurance companies became insolvent

(between 1986 and 1992, there were 276 insurance company insolvencies).

The severity of the problem focused attention not only on state regulators’

ability to address solvency issues, but also on the lack of uniformity in

solvency regulation at the state level. In June 1990, NAIC established its

voluntary accreditation program to improve state oversight of insurers’

solvency.2

 The program’s overall goal is to achieve a consistent, statebased system of solvency regulation throughout the country. The specific

objectives of the accreditation program are to identify the basic authorities

needed for solvency regulation at the state level and thereby to provide

baseline requirements for effectively regulating the solvency of multistate

insurers.

 2

A detailed description of the NAIC accreditation program can be found in appendix II,

together with the standards that states must comply with in order to be accredited.

Background
Page 4 GAO-01-948 NAIC Accreditation Program

NAIC’s accreditation program emphasizes adequate solvency laws and

regulations, efficient and effective financial analysis, examination

processes and communication, and appropriate organizational and

personnel practices. According to NAIC’s description of the accreditation

program, the standards are grouped under three objectives. Part A covers

laws and regulations, Part B deals with regulatory practices and

procedures, and part C includes organizational and personnel practices.3

To meet the requirements of Part A, state insurance departments must

have adequate statutory and administrative authority to regulate an

insurer’s corporate and financial affairs. Essentially, state legislatures need

to have adopted NAIC’s 18 suggested model laws or substantially similar

versions and authorized the state insurance regulators to implement

appropriate regulation. The Part B compliance standards are designed to

assess whether a state seeking accreditation has “effective and efficient

financial analysis and examination processes.” In order for the state

insurance department to satisfy the 19 Part B standards, a state must

demonstrate the necessary capabilities and practices to conduct financial

analyses and examinations, to communicate with other states, and to

develop and implement procedures for troubled companies. Part C has

three standards designed to ensure that state insurance departments have

appropriate organizational and personnel practices that encourage

professional development, establish minimum educational and experience

requirements, and allow the departments to attract and retain qualified

personnel.

To receive NAIC accreditation, state insurance departments must satisfy

these minimum standards. To be accredited initially, a state must undergo

an on-site accreditation review. To maintain accredited status, states must

undergo interim annual reviews (off-site evaluations by NAIC staff) and

full on-site reviews every 5 years. As of August 2001, most accredited

states had completed their second on-site accreditation review, and some

states have already completed their third. Evaluating the state’s oversight

of insurer’s financial condition is the major focus of the on-site reviews.

Since the accreditation program is focused solely on solvency regulation,

it does not evaluate other aspects of an insurance department’s regulatory

responsibility and oversight. For example, market conduct is one

important area of regulatory responsibility that accreditation does not

 3

Financial Regulation Standards and Accreditation Program, June 2001, p. 2.
Page 5 GAO-01-948 NAIC Accreditation Program

address. Market conduct includes all issues related to the sale of insurance

products to consumers of insurance.

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

regulator is to oversee several safety and solvency functions through key

phases of oversight activities, including chartering and change in

ownership approvals,4 routine financial analyses, and periodic on-site

examinations. Before approving a new charter or change of ownership,

regulators are to review the background and qualifications of individuals

making the request. The application must be made in the domiciliary state.

Subsequently, an insurer may also apply for a license in other states where

it intends to sell insurance.

In general, once a domiciliary state has approved an ownership

application, that state continues to oversee the insurer through routine

financial analyses and reviewing annual and quarterly reports and

supplemental filings submitted by the insurance companies. These reports

contain information such as financial statements, responses to questions

about company activities, and schedules summarizing investment and

other business activity. NAIC assists these review efforts with financial

analysis tools such as Insurance Regulatory Information System (IRIS) and

Financial Analysis Solvency Tracking (FAST) ratios.5

 These tools help

state insurance analysts identify areas of potential regulatory concern,

particularly indicators that could suggest financial difficulties.

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 troubled insurance

companies as early as possible. The handbook includes checklists on

financial concepts and analyses deemed important for assessing the

 4

Regulators generally require applicants to follow the same process both for chartering a

new insurance company and for purchasing an existing one. The companies that Mr.

Frankel allegedly acquired had all been previously owned and operated by others before

Frankel-controlled entities purchased them.

5

Nearly all insurers, except for the smallest ones, submit their annual and quarterly 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 and FAST ratios, performs some preliminary analyses, and returns the

information to the domiciliary state. NAIC flags ratios that are outside the “usual range” for

additional regulatory attention.

Oversight Activities of

State Insurance Regulators
Page 6 GAO-01-948 NAIC Accreditation Program

company’s financial condition. The NAIC’s Financial Condition

Examiner’s Handbook is another tool NAIC has developed to assist state

regulators in detecting as early as possible insurers experiencing financial

trouble or engaging in unlawful and improper activities and to develop the

information needed for timely, appropriate action.

In September 2000, we reported on a $200 million fraud that resulted in

insurance company failures in six states. Four of the failed insurance

companies were domiciled in Tennessee and Mississippi.6

 Both Tennessee

and Mississippi received their initial accreditation in 1994.7

 The fraud was

subsequently discovered in May 1999. In the aftermath of the failures, the

Tennessee Bureau of Insurance did not control certain documents related

to the failed insurance company that were being reviewed by other

Tennessee officials. As a result, Tennessee’s second-round accreditation

review was delayed until February 2000. NAIC suspended the state’s

accreditation in March 2000. However, Tennessee’s accreditation was

reinstated in September 2000 after another on-site review. Mississippi’s

second round accreditation was awarded in December 2000, about one

year after the five-year anniversary date of its initial accreditation.8

Both the Tennessee and Mississippi second-round accreditations occurred

in an environment of long-standing insurance solvency oversight

weaknesses that had been uncovered by the discovery of the $200 million

insurance fraud (fig.1). Each company that ultimately failed because of the

fraud had been looted of its assets shortly after the company’s purchase by

Thunor Trust, the entity allegedly controlled by Martin Frankel. The

investment fraud scheme then continued, in some cases for years, until the

fraud became public in May 1998. Appendix I describes the details of the

fraud allegedly perpetrated by Mr. Frankel.

 6

Fraud occurs in all types of financial institutions and its detection is an important

responsibility of all regulators. However, detection of fraud can be difficult because

perpetrators often falsify records, lie under oath, and use other deceptions to avoid

discovery.

7

At the time of Mississippi’s first-round accreditation, only one of the three Mississippi

insurance companies allegedly purchased by Martin Frankel was under his control.

8

NAIC officials told us that the Mississippi second-round accreditation review was not

deferred because of events associated with the fraud. The Mississippi review, along with

the reviews of four other states, was deferred at NAIC’s request because of the review

teams’ workload.

Key States Affected by

Insurance Fraud

Subsequently Receive

Reaccreditation
Page 7 GAO-01-948 NAIC Accreditation Program

Figure 1: Comparison of the Dates of Accreditation Reviews in Tennessee and

Mississippi With the Term of the Fraud in Those and Other States

Source: NAIC documents and GAO analysis.

Prior to the inception of the NAIC accreditation program, solvency

regulation varied widely across the states.9

 NAIC had developed numerous

model laws and regulations, but adoption by the states was inconsistent.

NAIC instituted the accreditation program in order to improve the quality

and consistency of solvency regulation across the states. The program has

demonstrated its value by defining a broadly accepted set of basic

regulatory requirements for solvency regulation and successfully

engineering their adoption in nearly all states. Currently, 47 state

insurance departments and the District of Columbia are accredited—a

level of consistency far superior to what existed before the program. The

number of insurance company insolvencies in 1993−2000 was 109, a

substantial decrease from the 276 insolvencies reported in the previous 7-

year period. Although several factors have likely contributed to this

decline, one, according to NAIC officials, was a concerted effort by NAIC

and state governors’ offices, legislatures, and insurance departments to

 9

See Insurance Regulation: Assessment of the National Association of Insurance

Commissioners, (GAO/T-GGD , May 22, 1991).

NAIC’s Accreditation

Program Has

Improved Over Time,

Helping States

Strengthen Solvency

Regulation
Page 8 GAO-01-948 NAIC Accreditation Program

improve solvency regulation in the states, including the adoption of NAIC’s

Financial Regulation Standards and Accreditation Program.

In addition to encouraging the widespread adoption of fundamental

insurance laws and regulations, the accreditation program has required

state insurance departments to make other changes in order to satisfy the

solvency standards. For example, NAIC officials described to us

improvements in the financial analysis and examination processes used by

state insurance departments that can be attributed to the accreditation

program. Between 1990 and 2000, state insurance departments increased

the number of financial analysts from 165 to 471. To support increased

demands for training from the states, NAIC has expanded its training

programs for financial analysis and examination staff from state insurance

departments. In 2000, more than 1,900 insurance regulators attended the

training programs. In addition, NAIC officials added a new standard to the

accreditation program requiring states to adopt and follow the NAIC’s

Financial Condition Examiners’ Handbook or develop a document that

is substantially similar. NAIC officials said that the new standard has

improved the consistency and quality of state examination procedures.10

GAO first reviewed NAIC’s accreditation program about 10 years ago.11

Since then, NAIC has made several improvements, some in response to

GAO’s recommendations and others in response to suggestions from

within NAIC itself and from other outside observers. It has added model

laws and regulations—for example, the standards now require insurance

companies to measure and report risk-based capital, and depending on the

level reported, departments must take specific corrective actions. NAIC

has also added standards that reflect best practices for conducting

financial analyses and examinations. For example, it has expanded the

financial analysis standards to require departments to analyze each

company in depth, document the financial analysis procedures, and report

 10Both the NAIC’s Financial Condition Examiners’ Handbook and Financial Analysis

Handbook are intended to serve as advisory guides for state insurance departments. Only

the Financial Condition Examiners’ Handbook is required as part of the accreditation

standards.

11’Assessment of the National Association of Insurance Commissioners

(GAO/T-GGD-91-37, May 22, 1991); The Financial Regulation Standards and

Accreditation Program of the National Association of Insurance Commissioners

(GAO/T-GGD-92-27, Apr. 9, 1992); The National Association of Insurance Commissioner’s

Accreditation Program Continues to Exhibit Fundamental Problems (GAO/T-GGD-93-26,

June 9, 1993).
Page 9 GAO-01-948 NAIC Accreditation Program

and act on material adverse findings. The expanded financial examination

standards require the examination staff to exchange information with

other department staff. In addition, a new standard requires states to

adopt the statutory authority required to share confidential information

with other state insurance departments and to protect confidential

information those departments provide.12 Finally, NAIC has increased its

reviews of insurance department files documenting actual financial

analyses and examinations, changed the scoring system, and provided

detailed guidance for accreditation review teams.

In the first round of accreditation reviews, the review team was

responsible primarily for assessing whether each state had the laws,

regulations, processes, and resources necessary to regulate solvency. With

the beginning of the second round of accreditation reviews in 1996, the

focus expanded to better assess how effectively a state has used the laws,

regulations, processes, and resources to regulate the solvency of insurers

since the last accreditation on-site review. In the original round of

accreditations, the review team concentrated only on the most current

state analysis and examination procedures. While current department

procedures continue to be the primary focus in the second and subsequent

rounds of reviews, the teams may also review department analysis and

examination files for all years since the previous review. For example,

when selecting a sample of insurance company analysis and examination

files, NAIC now requires the review teams to select at least one company

from each of the following three categories, even if they have to go back as

long as 5 years to find examples:

• companies that are not financially troubled;

• companies the state has identified as financially troubled;

• companies that are insolvent and that have been subject to receivership

proceedings during the last 5 years.

Although the teams may have selected companies from each of these

categories in the first round of reviews, NAIC did not specifically direct

them to do so.

 12The standard does not require documented evidence that such communication actually

took place, only that the states have both the legal authority and a written policy allowing

them to do it.
Page 10 GAO-01-948 NAIC Accreditation Program

NAIC continues to be open to improvements in the accreditation program.

In our September 2000 report on the $200 million fraud allegedly

perpetrated by Martin Frankel, we identified a number of regulatory

weaknesses that contributed to the failures of seven insurance companies.

Although the accreditation program had minimum standards that the NAIC

believed were sufficient for effective solvency regulation, the alleged

Frankel scam exposed weaknesses in the accreditation program standards

for financial examination, analysis, and related review guidelines, and in

the standard for communication among states. Specifically, the program

did not have an accreditation standard for asset custodians and lacked

review team guidelines requiring the use of investment specialists.

Moreover, while the program did have a standard about communication

with other regulators, the standard did not require a regulator to

proactively tell other interested states about a troubled insurer. Similarly,

there was no standard requiring a state to obtain ownership applicant

information from other states or to alert other states about possible fraud.

The insurance fraud led NAIC, as part of its overall corrective actions

strategy, to propose changes to its accreditation standards and guidelines

that are designed to minimize the likelihood of a similar fraud occurring

again. NAIC has given these changes—one new standard and four review

team guidelines—high priority and anticipates making them effective

during 2002. The standard identifies requirements for asset custodians.

NAIC expects to add it to the accreditation standards after adopting the

model law at the 2001 Fall National Meeting. The three review team

guidelines cover the use of investment expertise, more frequent

examination of troubled insurers, and proactive communication by states

regarding troubled insurers have been adopted and are expected to

become effective in January 2002. The fourth review team guideline would

require that states use a centralized database on applicants seeking to

charter or buy an insurer that is currently being developed. This database

is to be called the Form A database because the information will come

from Form A’s filed by insurers and those seeking to charter or buy an

insurer. At present, specifications for the Form A database have been

approved and a prototype of the database system was presented at the

NAIC 2001 Summer National Meeting. The database is expected to become

operational in March 2002.

Other changes to the review team guidelines have been suggested, but

their prospects and time frames are less certain. These include

requirements that actions associated with the Part A process be reviewed

during the financial analysis and examination processes and that

communication between state insurance departments and other federal
Page 11 GAO-01-948 NAIC Accreditation Program

and state regulators be improved. A proposal to revise the Preamble to the

Review Team Guidelines that would require the accreditation review

teams to evaluate the implementation of the Part A standards has been

presented to the relevant NAIC committee. Other proposals to expand

accreditation standards by requiring communication with other state and

federal regulators are under consideration.

While there have been changes and improvements in the NAIC

accreditation program since its inception, our analysis of the second round

of accreditation reviews for Tennessee and Mississippi disclosed

shortcomings in the scope, operations, and methodology of the

accreditation program (table 1). Tennessee and Mississippi were the states

of domicile for four of the seven companies that were looted of their

assets early in the insurance fraud allegedly perpetrated by Martin Frankel

that extended over an 8-year period ending in May 1999. The long-term

failure of insurance regulators to uncover the fraud and associated asset

theft revealed a number of regulatory deficiencies in both states. These

shortcomings were identified in our September report. NAIC officials, as

well as the head of the NAIC accreditation review teams that conducted

on-site accreditation reviews in Tennessee and Mississippi, knew of the

investment fraud prior to the accreditation reviews. However, because of

gaps and procedural weaknesses in the structure of the accreditation

program, known regulatory oversight deficiencies existing in Tennessee

and Mississippi had a relatively minor effect on the accreditation process

and resulting decisions.

Accreditation

Program Still Has

Gaps and Weaknesses
Page 12 GAO-01-948 NAIC Accreditation Program

Table 1: Overview of Accreditation Program Weaknesses

Accreditation program

element Weakness Specific observation

Coverage of all key

aspects of solvency

regulation

• Gap in “front-end” coverage involving

chartering and change in ownership of

insurance companies

• A critical area of state insurance regulation

designed to prevent undesirable individuals from

owning companies or engaging in questionable

business strategies is not assessed.

Accreditation review team

analysis procedures

• Incomplete analysis of prior examinations

• Use of a scoring methodology that can yield

misleading results

• Reliance on limited on-site compliance testing

• Review procedures are inflexible

• Only the most recent exam is fully considered,

rather than all relevant exams during the 5-year

review period.

• Equal weighting of standards in each section of

Part B allows states to obtain passing scores

despite material problems that may not have been

correcteda

• “No basis for evaluation” scores contain a bias

toward passing.

• Averaging within segments can result in passing

scores despite unresolved problems.

• Review team members have only 3 days during

their 4−5 day visit to perform testing, regardless of

the size of the insurance department and the

complexity of its workload.

• Review procedures and practices are not riskfocused. That is, they are not adjusted to focus on

areas deemed most crucial, such as known

material issues.

a

Appendix II explains the standards in full.

The accreditation program is intended to provide baseline requirements

for effective solvency protection by state insurance departments.

Overseeing chartering and changes of control of insurance companies is a

key element of solvency regulation. However, the accreditation program

largely ignores this important aspect of oversight—the so-called front-end

of solvency regulation.

None of the NAIC accreditation reviews in Tennessee and Mississippi

looked at or commented on this aspect of solvency regulation. Our review

of the accreditation program material and the work papers for these

reviews shows why. Accreditation standards and review team guidelines

focusing on a department’s performance during chartering and change in

ownership do not exist. However, one Part A standard requires a state to

have statutory authority for changes in the control of insurance

companies; what this standard requires is substantially similar to the

authority provided by the NAIC’s model Insurance Holding Company

System Regulatory Act and Regulation. The Act and Regulation sets out

the procedures that insurance companies must follow when requesting a

The Accreditation Program

Does Not Evaluate

Chartering and Changes in

Ownership
Page 13 GAO-01-948 NAIC Accreditation Program

change in control of an insurer. Moreover, according to an NAIC

representative, both Tennessee and Mississippi had these statutory and

administrative authorities in place at the time Martin Frankel was allegedly

buying insurance companies. However, the accreditation program includes

no standards for the chartering process and no Part B Standards or review

team guidelines requiring evaluation of the states’ performance in these

areas. As a result, the existing weaknesses were ignored.

Although not fully addressed in the accreditation reviews, regulatory

oversight in this area is key to preventing undesirable individuals from

owning or managing insurance companies and to blocking companies

from becoming involved in questionable business strategies. Both

Tennessee and Mississippi had regulatory oversight processes in place for

approving charters and changes in ownership for insurance companies.

However, our report on the insurance fraud perpetrated in those states

noted several weaknesses in regulatory performance existing during

change in ownership approval activities. These weaknesses included (1)

inadequate due diligence performed on buyer application data, (2)

inadequate tools and procedures to validate individuals’ regulatory or

criminal backgrounds, and (3) lack of coordination between regulators

within and outside the insurance industry.

As we noted in our earlier report, performing due diligence on buyer

application data is an essential part of regulatory oversight, as the

purchase of insurance companies provides a number of opportunities for

regulators to ask questions about the prospective owners. This phase of

insurance regulation involves determining the intentions and

appropriateness of the buyer and the business strategy they intend to

employ. In addition, 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, requires

key information to be provided by applicants, but does not include checks

on individuals’ regulatory or possible criminal histories. A fundamental

aspect of the investment fraud was the concealment of a secret affiliation

that allegedly existed between entities in the insurance and securities

industries, so that the investment entity controlling the insurers and the

entity controlling their invested assets were one and the same. Had

regulators in Tennessee and Mississippi (as well as the four other states

having primary regulatory responsibility for companies involved in the

insurance fraud) exercised a higher degree of scrutiny or professional

skepticism during the Form A application process, the fraud might have

unraveled at the outset.
Page 14 GAO-01-948 NAIC Accreditation Program

NAIC and state officials have acknowledged the need to include additional

assessments of chartering and change of ownership in the accreditation

program. However, NAIC officials told us that they don’t plan to add new

accreditation standards until after establishing a Form A database that can

be shared by the states. A prototype of the database has been

demonstrated, and it is expected to become operational in March 2002.

Once this step is completed, NAIC intends to begin focusing on developing

accreditation standards for front-end solvency regulation. NAIC, through

its committee process, has already made progress in developing checklists

and procedures for the review of Form A filings. Such checklists and

procedures may further enable state insurance departments to evaluate

solvency issues related to change of ownership.

NAIC’s descriptions of the accreditation program stress the importance to

consumers of “effective solvency regulation.” NAIC’s guidance on the

standards and the review process for the second round accreditation

reviews requires review teams to evaluate the insurance department’s

performance in addition to determining whether the departments has the

appropriate procedures in place. 13 Second round accreditation policy

guidance from NAIC for the Part B Standards (Regulatory Practices and

Procedures)states that insurance departments are to “...demonstrate to

the review team that they timely identify potentially troubled insurers and

institute appropriate courses of action.” Regulators’ failure to do so was

precisely the problem in both Tennessee and Mississippi. The failure of the

accreditation process to fully recognize this regulatory failure illustrates

additional weaknesses that limit the effectiveness of NAIC’s accreditation

process. These weaknesses include the review teams’ failure to adequately

consider all potentially relevant examination information, the use of a

biased scoring methodology, a reliance on cursory compliance testing, and

a general inflexibility in review procedures that does not allow reviewers

to address all material issues. As a result, accreditation reviews may not

consistently focus on important regulatory weaknesses and areas of

vulnerability—that is, those that heighten the risk of material losses.

Accreditation review teams generally include only the most recent

examination activity for the companies they sample when assessing a state

for accreditation. For this reason, the analysis does not include all the

 13NAIC Policy Statement on Financial Regulation Standards for the Second Round of

Accreditation Reviews, National Association of Insurance Commissioners, May 20, 1998.

Analysis Procedures

Contain Many Weaknesses

Potentially Relevant Exam

Information Is Not Adequately

Considered
Page 15 GAO-01-948 NAIC Accreditation Program

examinations of these companies that were completed during the current

accreditation cycle. In the case of the first Tennessee reaccreditation

review in February 2000, reviewers selected six companies for the review

of examination files. One of these companies was the Franklin American

Life Insurance Company, which failed after having been looted in the fraud

allegedly perpetrated by Martin Frankel.14 The theft of company assets,

which occurred shortly after the company changed ownership in 1991, had

been discovered in the most recent exam (between September 1998 and

May 1999). Because the theft was discovered, the examination received

good marks from the review team. This good score contributed to the

state’s high mark for the examination standard.

At the time of the reaccreditation on-site review in February 2000,

Tennessee had completed three solvency examinations of Franklin

American during the period of its participation in the fraud, two of them

covering the full scope of the company’s activities and one targeted to

investment activities. The first two exams had missed the fraud and the

theft of assets. Accreditation officials explained that the review team did

not consider the first examination of the company because, although the

examination report had been issued after the first-round review, the “as

of” date of the examination was December 31, 1992, before the date of the

review. The second examination, in September 1996, also missed the

fraud. This examination specifically targeted Franklin American’s

investment activities—the precise area that was the focal point of the

fraud. Accreditation officials told us that this examination was considered

by the review team in its review and deliberations. However, it could not

have been given much weight in the scoring. Summary notes from the

review team voting session indicated that the reporting of material adverse

findings by the Tennessee department was “good” (with a score of 4.2 out

of 5) and action on material adverse findings was “timely” (also given a

 14Franklin American was included in the review team sample only indirectly because it was

one of the companies affected by the $200 million fraud. Second-round accreditation

procedures require the sample of companies to include at least one failed company.

Franklin American was Tennessee’s only failed multistate insurer in the period since the

last accreditation review.
Page 16 GAO-01-948 NAIC Accreditation Program

score of 4.2).15 In fact, both the fraud and the fact that the assets of the

company had been stolen went undetected by the department for nearly 8

years.

One possible explanation for the accreditation review team’s apparent

disregarding of the department’s failure to identify the theft of assets from

Franklin American in a timely manner may be found in the standards

themselves and in the review team guidelines. While there are two

standards on material adverse conditions, there is no standard for

assessing the failure of examiners to find an existing material adverse

condition. Even without an explicit standard, however, the review team

could have considered whether a department failed to find a material

adverse condition. This consideration would be included in the scoring of

the standard for reporting a material adverse condition, because if the

condition is not found, it can not be reported. Yet the review team

guidelines do not include any direction to the team concerning this

important scoring issue, and the Tennessee review team did not choose to

consider the failure of Tennessee examiners to identify the fraud in a

timely fashion. As a consequence, Tennessee’s accreditation results did

not fully reflect the department’s performance during the accreditation

review period.

The accreditation reviews in Tennessee and Mississippi revealed three

weaknesses in the scoring methods used that, taken collectively, can dilute

the role of professional judgement and cause misleading or questionable

results. Part B, where the scoring weaknesses occur, is broken into three

components, or subparts—financial analysis (with eight elements),

financial examinations (with nine elements), and troubled companies and

communication with other regulators (with two elements). (See appendix

II.) The weaknesses in scoring the Part B standards include giving equal

weight to each of the elements of the standards, averaging or “netting” the

 15While there is little argument that the Tennessee examination started in late 1998 was

instrumental in identifying the fraud and, for the first time, uncovering the theft of

company assets, it should be noted that the contract examiner reported the fraud and theft

to the department in February 1999. The department did not subsequently take control of

the company until after the Mississippi Department raised concerns in May 1999. By that

time, an additional $50 million had been stolen from other insurance companies, and

Martin Frankel had fled the country.

Scoring Can Provide Misleading

Assessments
Page 17 GAO-01-948 NAIC Accreditation Program

scores within each of the subparts of the Part B standards, and

maintaining an inherent scoring bias toward passing.16

The scoring system assigns equal weights to all 19 elements in Part B. Thus

the elements in each section are treated equally, irrespective of their

potential impact on an insurance company’s solvency. For example, two of

the eight financial analysis elements on which states are scored are

reporting of material adverse findings and action on material adverse

findings. During the first Tennessee accreditation review in February 2000,

reviewers gave the department a score of 4.24 for reporting on material

adverse findings (a process-oriented element) and a score of 1.54 for

action on material adverse findings (an outcome-oriented element). Thus,

the fact that the state took no action on an adverse material finding of

fraud—which resulted in theft and a company’s failure—carried no more

weight than the other elements.

A March 1996 Ernst and Young analysis of the accreditation program (the

only independent analysis of the accreditation program requested by

NAIC) recommended that the elements of Part B standards be weighted.

The report noted that the overall contribution each standard made to

regulating financial solvency appeared to vary. For example, according to

the report, supervisory review of work papers appeared to Ernst and

Young analysts to be a more critical activity than formatting examination

reports, even though NAIC accreditation procedures weighted them

equally. NAIC’s Financial Regulation Standards and Accreditation

Committee considered revising the scoring system and weighting the

elements of the standards. However, the committee concluded that all of

the standards were equally important to an overall financial solvency

program and thus decided not to revise the scoring system.

The second scoring methodology weakness involves the averaging of

scores for standards within the financial analysis and examination

sections. For example, the scores for each of the nine financial

examination elements are totaled and a straight average calculated to

 16In accordance with NAIC’s accreditation procedures, a state must attain a passing score

in both the Part A and B Standards (C is not scored). Part A is scored on a Pass/Fail basis.

States must have substantially similar authority for each of the Part A standards to be

considered in compliance with them. To be in compliance with the Part B Standards, states

must attain a passing score in each of the three sections of Part B with a 3.0 or higher

average and must also attain a score of at least 1.0 on each of the individual Part B

Standards.
Page 18 GAO-01-948 NAIC Accreditation Program

determine the score for the financial examination section. Such an

approach allows a “netting” process to take place by allowing an above

average score on one element to offset a below average score on another

element within the same section. This “netting” feature is particularly

critical because the standards themselves are all of equal weight. For

example, on the first Tennessee accreditation review in February 2000, a

score of 3.88, above that needed for passing, was awarded for the element

on scheduling of exams and a 2.60, or below that required overall for

passing, for the element on appropriate supervisory review. Thus, the 3.24

straight average of the two scores is above that needed for a passing grade

even though one element received a low score. Tennessee’s accreditation

was suspended because it failed to pass the financial analysis section

portion of the review. However, the failing score was by the slimmest of

margins—a 2.98 average, with a 3.0 average needed in order to pass. Thus,

above average scores for some elements, including that for “reporting of

material adverse findings,” were nearly able to offset below average scores

for others, most notably the element for “action on material adverse

findings.” To further illustrate how close Tennessee came to passing, in

spite of the known problems, three of the five review-team members’

individual scores averaged to a passing score for the entire financial

analysis section.

The third area of scoring weakness is the built-in bias toward passing,

which comes into play when there is no basis to judge a department’s

performance on an element. For example, if none of the companies

sampled in a state had an identified adverse material finding during the

period under review, then review team members (following NAIC policy

for second-round accreditation scoring) assign a score of 4 (out of 5) for

both reporting and acting on material adverse findings. This situation

occurred in the second Tennessee review, since the review team did not

identify any material adverse issues for the companies reviewed in the

sample. Such a policy, when used in conjunction with other scoring

techniques such as giving equal weight to all elements and averaging

scores, makes it easier for a state to attain an overall passing score, even if

there are deficiencies in other elements. Some rating systems attempt to

reduce this type of bias, either by having a “no basis to judge” category

that excludes a standard or element from the scoring, or by assigning a

neutral score to minimize the impact on the overall score.

Compliance testing may be cursory because reviewers are allowed only 1

week or less on site, regardless of the size and complexity of the insurance

department or the extent of problems that are identified. Moreover, the

review is typically performed by 4 or 5 contract staff and an NAIC

Compliance Testing Is

Sometimes Cursory Because of

Limited On-Site Review
Page 19 GAO-01-948 NAIC Accreditation Program

observer, whether the state being reviewed has more than 100 multistate

insurers or only a handful. While team members review the selfassessment materials prepared by insurance departments before on-site

visits, the parameters on time and resources limit the team’s ability to

perform in-depth analyses and independently corroborate what the

insurance department officials report. According to NAIC, the first day of a

review commonly consists of meeting with state insurance department

officials and obtaining an overview of the states’ financial and examination

procedures and resources. In addition, the review team selects a

judgmental sample of multistate companies for an in-depth review that

begins the afternoon of the first day. The team generally continues

reviewing the sample files during the 2nd, 3rd, and sometimes 4th days of

the on-site visit, while also interviewing insurance department staff

associated with the sampled companies. At the same time, the team

reviews the adequacy of the state’s organizational and personnel

practices—the Part C standards. During the 4th and 5th days, the team

must also make time for internal team member discussions of findings,

accreditation review scoring, preparing and writing the team report and

management letter, and discussing the findings with state insurance

department officials. NAIC officials explained that the Tennessee visit in

February 2000 lasted 5 days and had a five-member team and one NAIC

observer—typical numbers for both the duration and level of resources of

on-site visits.

While it may not always be necessary to schedule more than 5 days for an

on-site accreditation review, the ability to do so when appropriate would

help avoid inadequate compliance testing. Too little compliance testing

can have serious consequences for the effectiveness of the review process.

During the Mississippi second-round accreditation review, Franklin

Protective Life (one of the Mississippi companies that failed owing to

losses associated with the $200 million fraud) was selected for review by

the Mississippi accreditation team. By the time the accreditation on-site

review took place (in October 2000), it was commonly known that

Franklin Protective Life and two other insurance companies domiciled in

Mississippi had operated for several years after having been looted of their

assets in the fraud. Financial analysts from the Mississippi Insurance

Department had failed over a number of years to notice that the company’s

assets were missing and either failed to notice or failed to take action on

other “red flags” that could have led to an earlier identification of the

fraud. Nevertheless, the accreditation team leader, after reviewing the

financial analysis files for Franklin Protective Life, concluded in the

review team’s summary notes that “no serious failing in regulatory duties
Page 20 GAO-01-948 NAIC Accreditation Program

and responsibilities was noted in the five year analysis review for this

company.”

By way of contrast in terms of depth of review, the Tennessee state

auditors spent from July 1999 to July 2000, or about 1 year, analyzing and

summarizing their findings.17 While the objectives and approach of the

state auditors and the accreditation review team differed, both efforts

were, in part, an attempt to evaluate the performance effectiveness of the

Tennessee Department of Commerce and Insurance. The state auditors’

more detailed and comprehensive analysis disclosed a number of serious

problems, including the failure to take action on reported material adverse

findings—the principal reason Tennessee’s accreditation was suspended

in March 2000. The audit report noted the Tennessee Insurance Division’s

gross regulatory breakdown in this case, despite significant warning signs

of questionable activity. The report also recommended a number of

improvements, including additional confirmation procedures for insurance

company assets held by custodians, improved documentation, improved

supervisory review procedures, longer retention of examination work

papers when a troubled insurer is involved, and improved supervisory

control over financial analysis checklists. While a year would certainly be

too long for an accreditation review, limiting all reviews to a week or less

may be too constraining.

We compared the February 2000 accreditation findings in Tennessee with

findings disclosed in our prior report on the investment fraud and found a

number of weaknesses that were noted in our report but were not

identified in the accreditation reviews. In analyzing the review team’s

work papers, we found no discussion of weaknesses or concerns that had

been identified in areas such as staff investment expertise or failure to

detect misappropriation of assets. (See appendix I for a listing of

weaknesses identified in our earlier report.)

Perhaps the most significant weakness of the accreditation review team

process is its limited flexibility. Without flexibility, the examination team

is unable to focus on areas known to be of concern or to use the limited

 17After the fraud allegedly masterminded by Martin Frankel became public in May 1999, the

Tennessee State Auditor performed a compliance review of the Tennessee Insurance

Department and issued a report in July 2000 noting that weaknesses existed. These

weaknesses included the regulators’ failure to exercise sufficient professional skepticism,

inadequate procedures for reviewing an insurance company, and misapplied review

procedures.

Review Teams Lack Flexibility

to Focus on the Most Material

Issues
Page 21 GAO-01-948 NAIC Accreditation Program

review team time to concentrate on material issues. Instead, the team uses

exactly the same process and procedures regardless of the prevailing

circumstances—even in an environment where fraud is known to have

occurred. In spite of the fact that the NAIC accreditation officials and the

accreditation team’s leader knew about the insurance fraud problems in

Tennessee, the review team’s work plans were not substantially modified

to address what was clearly the most material event existing in the

department at that time.

To further illustrate this inflexibility, the Mississippi accreditation work

plans were not tailored to address weaknesses in the Mississippi Insurance

Department, even though both NAIC and the Mississippi Insurance

Department had acknowledged them. While a detailed review of the same

issues could be viewed as unfair, we found no evidence that the review

team was instructed or attempted to determine what corrective actions

were being taken or whether closer scrutiny of certain standards were

warranted based on recent material adverse events. The program’s

inflexibility, which does not allow the review team to focus its limited

capacity on material issues, seems counter to the goal of increasing public

trust in the solvency regulation process. Moreover, a risk-focused

approach would allow the most efficient use of limited review team time

and resources.

Our assessment of the accreditation reviews in Tennessee and Mississippi

showed that the processes and practices were in accordance with

accreditation guidelines and instructions. NAIC also reports that the

accreditation reviews conducted in Tennessee and Mississippi were

typical of the review processes used in all the accreditation reviews

conducted in other states. NAIC officials reported that a total of 99 firstand second-round accreditation reviews were brought before the Financial

Regulation Standards and Accreditation Committee between the

program’s inception and July 26, 2001. A total of two suspensions resulted

from these on-site reviews—Tennessee and Washington State—both in

Additional Observations

About the Accreditation

Program
Page 22 GAO-01-948 NAIC Accreditation Program

connection with second-round reviews. Both states were subsequently

reaccredited.18

We also found two other structural features of the accreditation program

that could affect its effectiveness. First, while NAIC advises and provides

technical assistance to individual states, it does not oversee or supervise

state insurance departments. Thus, any recommendations and suggestions

made by NAIC to the states do not have to be accepted. Second, the

accreditation assessments are not independent, because NAIC is an

association of the heads of the state insurance departments. Specifically,

the commissioners are simultaneously the source of the standards, the

heads of the entities being evaluated—and the state insurance

departments, and the ultimate judges of the departments’ success or

failure in terms of accreditation. This lack of organizational independence

creates inherent impairments that can affect the ability of review teams to

do their work and report their findings impartially. For example, states

have a “right of refusal” regarding individuals selected for the on-site

review team. In addition, while NAIC can choose from a number of

contract review team members, it has only four review team leaders. While

the experience and continuity provided by this small pool of team leaders

might be a plus, there is also the possibility that the leaders could be “coopted” by the program and its undeniably positive goals.

The accreditation program has been evolving since its inception more than

10 years ago. NAIC has taken a number of steps that it believes have

strengthened the program. NAIC has reported improvements in a number

of areas, including adding standards that suggest best practices for the

states; expanding NAIC’s reviews of state solvency regulation, which now

include analyses of a sample of failed or troubled companies; and

increasing the number of states in the program, so that most are now

participating. Following the scam allegedly perpetrated by Martin Frankel,

NAIC and state insurance regulators in Tennessee and Mississippi as well

as other states acknowledged the need to further strengthen insurer

solvency regulation. Corrective actions emanating from the insurance

fraud have included identifying the appropriate custodial requirements for

 18New York, the first state accredited, was subsequently suspended as a result of an interim

annual review. The New York State legislature declined to pass two laws that are required

for accreditation. In addition, the West Virginia Insurance Department was suspended due

to a failure to undergo the on-site review required every 5 years for second-round

accreditation.

Conclusions
Page 23 GAO-01-948 NAIC Accreditation Program

insurers’ assets, using investment specialists on certain examinations,

implementing more proactive communications between states, and

establishing a Form A database to help states track the status of change-inownership applications that are submitted to other state regulators. We

believe these positive steps have been designed to strengthen NAIC’s

accreditation program in its efforts to strengthen solvency oversight of

insurance companies.

NAIC’s description of its accreditation program points out that America’s

insurance consumers need “a system of effective solvency regulation.” The

accreditation program is intended to certify that accredited states have the

baseline authorities, processes, procedures, and resources needed to

provide a system to protect consumers not only in those states where

insurance companies are domiciled, but also in every state where the

companies operate. Clearly, determining whether a state has the laws and

regulations necessary for insurance regulators to act is fundamental.

Moreover, NAIC has designed its accreditation program so that model

laws and regulations can be added to the standards as needed, and a

number of such models have been added since the program’s inception.

The recent fraud in Tennessee, Mississippi, and other states has

illuminated another area where NAIC can assist the states. The

accreditation program can be improved by developing or revising model

laws relative to chartering and changes in the control of insurance

companies and adding them to the standards along with associated

practices and procedures.

Measuring a state’s effective performance of its regulatory responsibilities

for solvency may be more difficult than determining whether it has the

necessary laws and regulations. However, differentiating an “effective”

system of solvency regulation from an ineffective one is an important

objective of the accreditation program, particularly since the start of the

second round of accreditation reviews. The examiner team instructions

for determining compliance with Part B standards (Regulatory Practices

and Procedures) require the teams to evaluate not only whether state

insurance departments have the necessary laws and regulation on the

books, but also whether the departments have implemented them

appropriately. The instructions add, “To satisfy the standards set forth in

this section, the Department should demonstrate to the review team that

they timely identify potentially troubled insurers and institute appropriate

courses of action....” This did not occur in Tennessee or Mississippi. As a

result, while Tennessee’s accreditation was suspended for a short time, the

accreditation reviews did not identify many of the regulatory weaknesses

that had allowed the affected companies in both states to evade detection
Page 24 GAO-01-948 NAIC Accreditation Program

and operate for several years not only without adequate capital but also

without assets. While we recognize the difficulties of detecting deliberate

fraud, there is room for the accreditation program to continue improving

its mechanisms for assessing the effectiveness of states’ regulatory

performance in the same way it has expanded the basic set of laws and

regulations states are expected to have. Its success in making these

improvements will enhance the level of confidence insurance consumers

can have in each accredited state’s insurance regulatory system. Without

these improvements, the accreditation program may not succeed in clearly

differentiating between the state insurance departments that can be

expected, on the basis of past performance, to effectively regulate the

solvency of insurance companies and those departments that may not.

We recommend that the Executive Vice President of NAIC

• Strengthen the accreditation program’s focus on chartering and change of

ownership by

• developing appropriate model laws, regulations, and procedures for

chartering insurance companies;

• reviewing the current standards and guidelines related to change in

ownership and make any necessary changes;

• including the new and improved model laws and regulations in the

accreditation standards and developing companion compliance

standards for regulatory practices and procedures; and

• providing appropriate guidance to the review teams to assure better

assessment of a state’s performance in these areas of solvency

regulation.

• Implement new on-site review team procedures by

• requiring the inclusion of all relevant exam information since the last

accreditation review, and

• developing a scoring methodology that places more emphasis on

standards that directly affect insurance company solvency.

• Ensure that the accreditation program provides the review team with the

flexibility to adjust the time and scope of on-site visits as necessary to

conduct the level of testing required to address known material issues.

We requested and received written comments on a draft of this report

from the Executive Vice President, NAIC (see app. III for the complete text

of NAIC’s letter). In summary, they were pleased to note the positive

comments we made about the various improvements and successes since

Recommendations for

Executive Action

Agency Comments

and Our Evaluation
Page 25 GAO-01-948 NAIC Accreditation Program

the accreditation program’s inception. They also appreciated our

recommendations for further improvements and stated that they are

committed to giving each of them serious consideration.

Regarding our specific recommendations, NAIC generally agreed with our

first recommendation concerning the need to strengthen the accreditation

program’s focus on chartering and change in ownership and noted some

specific actions being taken or planned in that regard. Consistent with our

second recommendation, NAIC is currently considering changes that

would require review teams to consider examinations from earlier in the

accreditation cycle. In addition, while NAIC has considered on more than

one occasion the concept of weighting accreditation standards, it agreed

to again review its scoring system in light of our concerns. Finally,

regarding our third recommendation addressing the need to ensure review

team flexibility to adjust on-site visits so that appropriate testing can

occur, NAIC believed its program had the flexibility to consider known

areas of weakness, but agreed to review its procedures in light of our

concerns.

In NAIC’s more detailed comments (see page 2 of the comment letter in

app. III), NAIC stated that not even the best-designed systems can ensure

that fraud, intentionally perpetrated upon an insurance company, can be

immediately detected. In addition, it believed that a Department’s

performance on one individual company that was the subject of an alleged

fraudulent scheme was not necessarily an accurate indicator of a

Department’s overall financial solvency program. We agree that it can be

difficult to immediately detect fraud, but note that the fraud discussed in

this report went undetected for nearly 8 years despite numerous

indicators, or red flags—many in documents available to regulators

throughout this period. Further, we found no clear indication that the

oversight weaknesses contributing to the long-term success of this fraud

were unique to a single company. In fact, three of the failed companies

were domiciled in Mississippi (although the NAIC review team looked at

only one). Moreover, in the aftermath of the failures, both Tennessee and

Mississippi acknowledged systemic weaknesses in their regulatory

oversight practices that had made them overly vulnerable to the fraudulent

activity. Since the fraud was uncovered, Tennessee, Mississippi, and NAIC

have begun to implement various corrective actions designed to reduce

the possibility of future occurrences. In a similar light, we believe that

further corrective actions can be made to NAIC’s accreditation program to

better ensure its success in evaluating the effectiveness of the states’

financial solvency programs.
Page 26 GAO-01-948 NAIC Accreditation Program

To obtain information on NAIC’s efforts to improve its accreditation

program, we visited NAIC Headquarters in Kansas City, Missouri, and

attended the open portions of the three most recent quarterly meetings of

NAIC’s Financial Regulation Standards and Accreditation Committee

(FRSAC). At NAIC headquarters, we obtained and analyzed relevant

documents describing the accreditation program’s goals, objectives, scope,

and accomplishments, as well as summary statistics. Officials at NAIC also

provided us with their view of improvements made to the program since

its inception in 1990. We did not independently verify every improvement,

not did we independently review the laws and regulations of individual

states to verify their adoption of the NAIC models. At NAIC quarterly

meetings, we obtained various documents on accreditation issues and

plans and discussed these with FRSAC members as appropriate. In

addition, we interviewed key accreditation officials about the program’s

operations and obtained their view of major accomplishments and

improvements.

To analyze the accreditation reviews in Tennessee, we visited NAIC

headquarters and reviewed all work papers and related reports

summarizing the two reviews. We also reviewed the work papers and

associated documents from the Mississippi accreditation review. We

subsequently discussed these reviews with representatives of both the

Tennessee and Mississippi Insurance Departments. We obtained and

analyzed various documents pertaining to the goals, objectives,

accreditation review procedures, scoring methodology, and criteria. We

also interviewed NAIC officials responsible for these reviews and the

contractor who functioned as team leader for the on-site visits. In addition,

we reviewed an operational study of the accreditation program conducted

by Ernst and Young, the only outside analysis of the program requested by

NAIC.

We conducted our review in Kansas City, Missouri; Nashville, Tennessee;

and Jackson, Mississippi, between December 2000 and July 2001 in

accordance with generally accepted government auditing standards. While

the findings of this report apply to the accreditation program as a whole,

other issues related to NAIC’s accreditation program may need to be

addressed. Our focus was on the accreditation process in Tennessee and

Mississippi during and after the insurance scam allegedly perpetrated by

Martin Frankel. Other issues unrelated to the circumstances found in

those two states were outside the scope of our review.

Scope and

Methodology
Page 27 GAO-01-948 NAIC Accreditation Program

As agreed with your office, unless you publicly release its contents earlier,

we plan no further distribution of this report until 30 days from the date of

this letter. At that time, we will send copies of this report to the Chairman

of the House Committee on Energy and Commerce as well as the

Chairman and Ranking Member of the House Committee on Financial

Services and the Senate Banking, Housing, and Urban Affairs Committee.

At that time, we will also send copies of this report to the Executive Vice

President of NAIC and to the 55 state and other governmental entities that

are members of NAIC and also make copies of the report available to other

interested parties upon request.

Sincerely yours,

Richard J. Hillman

Director, Financial Markets and

 Community Investment
Appendix I: Tennessee and Mississippi

Received Accreditation During and After

Thefts Causing Company Insolvency

Page 28 GAO-01-948 NAIC Accreditation Program

In September 2000, we reported on a $200 million theft involving insurance

company failures in six states.1

 Four of the failed insurance companies

were domiciled in Tennessee and Mississippi. In 1994, both Tennessee and

Mississippi received their first round accreditation during the theft, which

had not yet been discovered. The theft was subsequently discovered in

May 1999. Events associated with that discovery led to the delay of the

second round accreditation reviews in Tennessee. Tennessee’s second

round accreditation was suspended in March 2000 and reinstated in

September 2000. Mississippi’s second round accreditation was granted in

December 2000. As discussed below, the Tennessee and Mississippi

accreditation events occurred in an environment of long-standing

insurance solvency regulatory oversight weaknesses.

In the 1980s, Martin Frankel worked in the securities industry. SEC

permanently banned him from the securities industry in 1992. Even prior

to his removal from the securities industry, he was setting up the

mechanism to move into the insurance industry. He allegedly gained secret

control of a small securities firm called Liberty National Securities (LNS),

which in 1991, a year before his ban from the securities industry, he

directed to become registered with the state securities department in

Tennessee. The same year, he allegedly anonymously established an entity

known as Thunor Trust, using the names of nominee grantors as the

apparent source of the money. Thunor Trust then applied for regulatory

approval from the Tennessee Department of Commerce and Insurance,

Division of Insurance, to purchase the Franklin American Life Insurance

Company, a small, financially weak insurer. This application was

subsequently approved. In this and all subsequent interactions with

insurers or with regulators, Mr. Frankel’s name was never used. He

allegedly operated by using aliases or through fronts.

From 1991 to 1999, Thunor Trust purchased six more insurance companies

domiciled in five additional states. All of the insurance companies owned

by Thunor Trust were managed out of the Franklin American headquarters

in Franklin, Tennessee, even though they continued to be domiciled for

regulatory purposes in the states of Mississippi, Oklahoma, Missouri,

Alabama, and Arkansas. The insurer bought by Thunor Trust in Alabama

was later redomesticated (moved) for regulatory purposes to Mississippi,

even though it continued to be operated out of Tennessee. Mr. Frankel

 1

Insurance Regulation: Scandal Highlights Need for Strengthened Regulatory Oversight

(GAO/GGD-00-198, Sept. 19, 2000).

Appendix I: Tennessee and Mississippi

Received Accreditation During and After

Thefts Causing Company Insolvency
Appendix I: Tennessee and Mississippi

Received Accreditation During and After

Thefts Causing Company Insolvency

Page 29 GAO-01-948 NAIC Accreditation Program

allegedly used the same scheme to loot each of the insurance companies.

After purchasing a company, Frankel removed the company’s assets from

the control of the insurance company, using LNS as a front. Shortly after

Thunor Trust purchased an insurer, the company’s assets would all be sold

and apparently replaced with government bonds purchased on the

insurer’s behalf by LNS, acting under the direction of Mr. Frankel who

allegedly operated using an alias. None of this activity involved the real

LNS; rather, it was carried out by a bogus LNS operated by Mr. Frankel out

of his mansion in Connecticut.

In actuality, the companies lost control of their assets when the money

was allegedly turned over to LNS. Mr. Frankel’s bogus company, using the

name of the firm he secretly controlled—that is, the real LNS—provided

monthly statement to each insurance company detailing a very active

trading strategy and showing the bonds that were supposedly bought and

sold that month by LNS as agent for the insurer. According to these

statements, the bond trading was profitable, and the profits were returned

to the company. In fact, the securities transactions shown on these

statements did not happen. The statements were fabrications. Allegedly,

Mr. Frankel actually used the company’s assets to (1) return phony profits

to the company, (2) purchase additional insurance companies—a

necessary step to continue the fraud, and (3) support his own lavish

lifestyle. Ultimately, taxpayers, other insurers, and certain policyholders

will bear the losses resulting from the scam.

The first round accreditations for Tennessee and Mississippi occurred in

September 1994 and December 1994, respectively. After the $200 million

theft became public in May 1999, NAIC delayed its second round

accreditation review for Tennessee, scheduled for September 1999, at the

request of the Tennessee State Auditors because of their ongoing review of

the Tennessee Insurance Department triggered by the theft. In March 2000,

Tennessee’s accreditation was suspended for failing the financial analysis

portion of the review. Six months later, at Tennessee’s request, NAIC

conducted an additional accreditation review that resulted in

reaccreditation of the state in September 2000. NAIC also conducted a

reaccreditation review of Mississippi after the $200 million theft became

public, resulting in reaccreditation of Mississippi in December 2000.

Among other weaknesses in state regulatory oversight it exposed, the theft

uncovered weaknesses in chartering and change in ownership approvals, a

key phase of oversight for preventing undesirable individuals from

controlling insurance companies and insurer involvement in questionable

business strategies. The theft also showed that financial losses associated
Appendix I: Tennessee and Mississippi

Received Accreditation During and After

Thefts Causing Company Insolvency

Page 30 GAO-01-948 NAIC Accreditation Program

with risks heightened by such weaknesses in oversight could be material,

leading to insurer failures and hundreds of millions of dollars in lost

insurer assets. Because the accreditation reviews discussed in this report

involved states closely involved with the scandal, an overview of our

findings regarding regulatory oversight weaknesses is included in table 1.
Appendix I: Tennessee and Mississippi

Received Accreditation During and After

Thefts Causing Company Insolvency

Page 31 GAO-01-948 NAIC Accreditation Program

Table 2: Regulatory Oversight Weaknesses Identified by GAO in Our September 2000 Report

Oversight phase Weakness Specific observations

Change in

ownership

approvals

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

individual’s regulatory or

criminal backgrounds

• Inability to readily access regulatory history data

• Inability to access criminal history data on individuals

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

Routine financial

analyses

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 insurer’s 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 insurer’s assets

Inadequate securities-related

expertise and information

gathering

• Lack of expertise to assess the viability of the insurer’s 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

On-site

examinations

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

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.

The report included recommendations to help prevent or detect similar

investment scams in insurance companies by proposing the adoption of

appropriate asset custody arrangements, improved asset verification
Appendix I: Tennessee and Mississippi

Received Accreditation During and After

Thefts Causing Company Insolvency

Page 32 GAO-01-948 NAIC Accreditation Program

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 also contained a

recommendation designed to broaden and help sustain cooperation among

regulators of different financial services sectors.

NAIC and three affected states also conducted parallel reviews of the

scam and disclosed similar weaknesses along with recommendations for

corrective actions. In July 2001, we provided a status report on corrective

actions that NAIC, Tennessee, Mississippi, and Missouri have taken or are

taking to address recommendations contained in our September 2000

report to address the regulatory oversight weaknesses.2

 2

Regulatory Initiatives of the National Association of Insurance Commissioners,

(GAO-01-885R, July 6, 2001).
Appendix II: An Overview of the NAIC

Accreditation Program

Page 33 GAO-01-948 NAIC Accreditation Program

Although the market for insurance is national in scope, with many

companies selling insurance in multiple, if not all, states, the state-by-state

system of insurance solvency regulation has traditionally been uneven.

Regulatory capacity has varied across states, and laws, regulations, and

practices have lacked uniformity. During the 1980s and early 1990s, a

number of insurance companies became insolvent, focusing attention on

the weaknesses of state insurance regulation and leading to speculation

that the federal government would take over regulatory responsibility. In

February 1990, Congressman John Dingell released a report entitled

“Failed Promises: Insurance Company Insolvencies” that increased

speculation about the imminent federal takeover. The National

Association of Insurance Commissioners (NAIC), governors, and state

legislatures realized that in order to preserve state regulatory authority,

something had to be done to address the regulatory inconsistencies. NAIC

had previously formed a special committee to address state regulation of

insurance companies and devise an accreditation program. In 1989, NAIC

formulated the Financial Regulation Standards (Standards) that would

form the basis of the accreditation program, and in 1990 it implemented

the program itself. Since the program began, the number of accredited

states has grown to 47 and the District of Columbia.

The accreditation program is designed to make monitoring and regulating

the solvency of multistate insurance companies easier by ensuring that

states adhere to the NAIC’s standards, which establish the basic

recommended practices for an effective regulatory department. To be

accredited, states must show that they have solvency laws and regulations

that protect insurance consumers; effective, efficient financial analysis and

examination processes; and appropriate organizational and personnel

practices. A team from NAIC examines state insurance departments that

are seeking accreditation for compliance with the Standards. NAIC’s

Financial Regulation Standards and Accreditation Committee (FRSAC),

which comprises regulators from across the country, decides whether

states are in compliance and provides additional guidance to those that are

not.

States must be accredited every 5 years, and NAIC makes annual interim

evaluations of Self-Evaluation Guides submitted by the states. The

program uses a scoring system that ranges from a low of 0 (unacceptable)

to a high of 5 (excellent). Insurance departments are examined for

compliance with all three categories of Standards: Part A (laws and

Appendix II: An Overview of the NAIC

Accreditation Program

How the

Accreditation

Program Works
Appendix II: An Overview of the NAIC

Accreditation Program

Page 34 GAO-01-948 NAIC Accreditation Program

regulations), Part B (regulatory practices and procedures), and Part C

(organizational and personnel practices).

The purpose of this set of standards is to ensure that states have sufficient

authority to regulate the solvency of multistate domestic insurers. To meet

the requirements of Part A, state legislatures must adopt all of NAIC’s 18

model laws (or versions that are substantially similar) and have authorized

the state insurance regulators to implement appropriate regulations. The

required laws and regulations cover a range of issues as detailed in table 1.

Part A: Laws and

Regulations
Appendix II: An Overview of the NAIC

Accreditation Program

Page 35 GAO-01-948 NAIC Accreditation Program

Table 3: Accreditation Standards for Laws and Regulations

Subject area Description

1. Examination Authority The Department should have authority to examine companies with complete access to all

books and records, including the records of any affiliated companies, and to examine

officers, employees, and agents of the company under oath.

2. Capital and Surplus Requirement The Department should have the ability to require that insurers have and maintain a

minimum level of risk based capital and surplus to transact business and the authority to

require additional capital and surplus based upon the type, volume and nature of

insurance business transacted.

3. NAIC Accounting Practices and

Procedures

The Department should require that all companies reporting to the Department file the

appropriate NAIC annual statement blank, which should be prepared in accordance with

the NAIC’s instructions handbook and accounting practices and procedures manual.

4. Corrective Action State law should authorize the Department to order a company to take necessary

corrective action or cease and desist certain practices that, if not corrected, could place

the company in a hazardous financial condition.

5. Valuation of Investments The Department should require that securities owned by insurance companies be valued

in accordance with those standards promulgated by NAIC.

6. Holding Company Systems State law should contain the NAIC Model Insurance Holding Company System Regulatory

Act or an act substantially similar, and the Department should have adopted NAIC’s model

regulation relating to this law.

7. Risk Limitation State law should prescribe the maximum net amount of risk to be retained by a property

and liability company for an individual risk, based upon the company’s capital and surplus.

8. Investment Regulations State statute should require a diversified investment portfolio for all domestic insurers both

as to type and issue and include a requirement for liquidity.

9. Liabilities and Reserves State statute should prescribe minimum standards for the establishment of liabilities and

reserves resulting from insurance contracts issued by an insurer.

10. Reinsurance Ceded State law should contain the NAIC Model Law on Credit for Reinsurance Model Regulation

and the Life and Health Reinsurance Agreement Model Regulation or substantially similar

laws.

11. CPA Audits State statute or regulation should contain a requirement for annual audits of domestic

insurance companies by independent certified public accountants.

12. Actuarial Opinion State statute or regulation should contain a requirement for an opinion on reserves and

loss and loss adjustment expense reserves by a qualified actuary or specialist on an

annual basis for all domestic insurance companies.

13. Receivership State law should set forth a receivership scheme for the administration, by the insurance

commissioner, of insurance companies found to be insolvent, as set forth in NAIC’s

Insurers Rehabilitation and Liquidation Model Act.

14. Guaranty Funds State law should provide for a regulatory framework, such as that contained in NAIC’s

model acts on the subject, to ensure the payment of policyholders’ obligations, subject to

appropriate restrictions and limitations when a company is deemed insolvent.

15. Filings With NAIC State statute, regulation or practice should mandate filing of annual and quarterly

statements with NAIC.

16. Producer-Controlled Insurers States should provide evidence of a regulatory framework, such as that contained in

NAIC’s model act on the subject or similar provisions.

17. Managing General Agents Act States should provide evidence of a regulatory framework, such as that contained in

NAIC’s model act on the subject or similar provisions

18. Reinsurance Intermediaries Act States should provide evidence of a regulatory framework, such as that contained in

NAIC’s model act on the subject or similar provisions.

Source: Financial Regulation Standards and Accreditation Program, June 2001.
Appendix II: An Overview of the NAIC

Accreditation Program

Page 36 GAO-01-948 NAIC Accreditation Program

The Part B standards, regulatory practices and procedures, are

recommended practices designed to ensure that states have the necessary

resources and capabilities to conduct financial analyses and examinations

of firms operating within its jurisdiction. The standards cover the three

areas considered necessary for effective solvency regulation: financial

analysis, financial examinations, and communication with states and

procedures for troubled companies (see table 2). To be accredited, states

must attain an average score of 3 in both financial analysis and

examinations.

Part B: Regulatory

Practices and Procedures
Appendix II: An Overview of the NAIC

Accreditation Program

Page 37 GAO-01-948 NAIC Accreditation Program

Table 4: Accreditation Standards for Regulatory Practices and Procedures

Subject area Description

1. Financial Analysis

 (a) Sufficient Qualified Staff and

Resources

The Department should have the resources to review effectively, on a periodic basis, the

financial condition of all domestic insurers.

 (b) Communication of Relevant

Information to/From Financial Analysis

Staff

The Department should ensure that relevant information and data received by the

Department, which could assist in the financial analysis process, is provided to the

financial analysis staff, and that findings of the financial analysis staff are communicated

to the appropriate person(s).

 (c) Appropriate Supervisory Review The Department’s internal financial analysis process should provide for appropriate

supervisory review and comment.

 (d) Priority-Based Review The Department’s financial analysis procedures should be priority-based to ensure that

potential problem companies are reviewed promptly.

 (e) Appropriate Depth of Review The Department’s financial analysis procedures should ensure that domestic insurers

receive an appropriate level or depth of review commensurate with their financial

strength and position.

 (f) Documented Analysis Procedures The Department should have documented financial analysis procedures and/or

guidelines to provide for consistency and continuity in the process and to ensure that

appropriate analysis procedures are being performed on each domestic insurer.

 (g) Reporting of Material Adverse

Findings

The Department’s procedures should require that all material adverse indications be

promptly presented to the commissioner or an appropriate designee for determination

and implementation of appropriate regulatory action.

 (h) Action on Material Adverse Findings Upon the reporting of any material adverse findings from the financial analysis staff, the

Department should take timely action in response to such findings or adequately

demonstrate the determination that no action was required.

2. Financial Examinations

 (a) Sufficient Qualified Staff and

Resources

The Department should have the resources to effectively examine all domestic insurers

on a periodic basis in a manner commensurate with the financial strength and position of

each insurer.

 (b) Communication of Relevant

Information to/From Examination Staff

The Department should provide relevant information and data received by the

Department, which may assist in the examination process, to the examination staff and

ensure that findings of the examination staff are communicated to the appropriate

person(s).

 (c) Use of Specialists The Department’s examination staff should include specialists with appropriate training

and/or experience or otherwise have access to available qualified specialists, which will

permit the Department to effectively examine any insurer.

 (d) Appropriate Supervisory Review The Department’s procedures for examinations should provide for supervisory review of

examination workpapers and reports.

 (e) Use of Appropriate Guidelines and

Procedures

The Department’s policies and procedures for the conduct of examinations should

generally follow those set forth in NAIC’s Examiners Handbook. Appropriate variations in

methods and scope should be commensurate with the financial strength and position of

the insurer.

 (f) Scheduling of Examinations In scheduling financial examinations, the Department should follow procedures such as

those set forth in NAIC’s Examiners Handbook that provide for the periodic examination

of all domestic companies on a timely basis. This system should accord priority to

companies that exhibit adverse financial trends or otherwise demonstrate a need for

examination.

 (g) Examination Reports The Department’s reports of examination should be prepared in accordance with the

format adopted by NAIC and should be sent in a timely fashion to other states in which

the insurer transacts business.
Appendix II: An Overview of the NAIC

Accreditation Program

Page 38 GAO-01-948 NAIC Accreditation Program

Subject area Description

 (h) Reporting of Material Adverse

Findings

The Department’s procedures should require that all material adverse findings be

promptly presented to the commissioner or an appropriate designee for determination

and implementation of appropriate regulatory action.

 (i) Action on Material Adverse Findings Upon the reporting of any material adverse findings from the examination staff, the

Department should take timely action in response to such findings or adequately

demonstrate the determination that no action was required.

3. Communication With States and

Procedures for Troubled Companies

 (a) Communication With States States should allow for the sharing of otherwise confidential information, administrative

or judicial orders, or other action with other state regulatory officials providing that those

officials are required, under their law, to maintain its confidentiality. This policy should

also include cooperation and sharing information with respect to domestic companies

subject to delinquency proceedings.

 (b) Procedures for Troubled Companies The Department should generally follow and observe procedures set forth in NAIC’s

Troubled Insurance Company Handbook.

Source: Financial Regulation Standards and Accreditation Program, June 2001.

The Part C standards, organizational and personnel practices, are intended

to ensure that the staff of state insurance departments have the

appropriate skills and training to promote effective regulatory practices.

The standards cover professional development, minimum educational and

experience requirements, and personnel retention as detailed in table 5.

These standards are not scored; instead, the review team provides

comments to the state insurance department officials.

Table 5: Accreditation Standards for Organizational and Personnel Practices

Subject area Description

1. Professional Development The Department should have a policy that encourages the professional development of

staff involved with financial surveillance and regulation.

2. Minimum Educational and Experience

Requirements

The Department should establish minimum educational and experience requirements for

all professional employees and contractual staff positions in the financial regulation and

surveillance area.

3. Retention of Personnel The Department should have the ability to attract and retain qualified personnel for those

positions involved with financial surveillance and regulation.

Source: Financial Regulation Standards and Accreditation Program, June 2001.

States request an accreditation or reaccreditation review by contacting

NAIC, which requires them to first fill out a “Self-Evaluation Guide.” This

guide allows the state to assess itself against the detailed requirements of

the Standards. The chair of FRSAC selects a review team of three to six

contract examiners and appoints a review team leader. NAIC sends the

names of the review team to the state, which can challenge any member.

In this case, NAIC and the state negotiate until a new team is selected.

Part C: Organizational and

Personnel Practices

How Accreditation

Reviews Are

Conducted
Appendix II: An Overview of the NAIC

Accreditation Program

Page 39 GAO-01-948 NAIC Accreditation Program

Once the review team is established, NAIC and the state schedule the visit.

Generally, a site visit requires 3 to 5 days, depending on the size of the

department. NAIC sends copies of the state’s completed Financial

Regulation Standards Self-Evaluation Guide, with any applicable

supporting documentation, to the review team and tells the state what the

team will need for its review. Prior to the on-site review, the state can

request an abbreviated review (“pre-review”) by an NAIC official in order

to learn about any improvements that need to be made.

The review team follows a set of procedural guidelines that are designed

to make the evaluation process uniform across states. Before the on-site

review, team members meet to discuss comments and concerns raised by

the Self-Evaluation Guide and supporting documentation. During the onsite review itself, the team examines compliance with laws and

regulations; assesses examination reports (usually six), supporting work

papers, and interviews; inspects financial analysis and regulatory files for a

sample of companies (usually 12); interviews department personnel and

reviews organizational and personnel practices; and does a walk-through

of the department. Once they have completed these tasks, the team

members meet to discuss their findings and vote on a score for whether

the state is in compliance with NAIC’s accreditation standards addressing

regulatory practices and procedures. The team then holds a closing

conference with the state and provides a copy of the scores and draft

copies of the compliance report and other material, including the

management letter addressed to the insurance department. After the site

visit, the review team submits its report, a compliance report, and

management letter comments to FRSAC. The reports summarize the

procedures performed during the site visit, document the findings,

highlight major recommendations, and recommends that accreditation be

approved or suspended.

FRSAC meets quarterly at the NAIC national meetings to discuss the

accreditation reviews from the previous 3 months with team leaders,

representatives of the states applying for accreditation, and the NAIC

observers. FRSAC members will have reviewed the self-evaluation guides

and supporting documents from each review, and team leaders present

their reports and recommendations. FRSAC may also query the state

insurance department representatives. On the basis of the review team’s

recommendation and the meeting, FRSAC decides whether the state

should be accredited, reaccredited, or have its accreditation suspended. If

On-Site Review

Procedures

FRSAC’s Evaluation

Process
Appendix II: An Overview of the NAIC

Accreditation Program

Page 40 GAO-01-948 NAIC Accreditation Program

suspended, a state can apply for another accreditation review at a later

date.

While states must undergo the full review process every 5 years in order to

maintain accreditation, they may be subject to a special review if FRSAC

receives information suggesting that a state may no longer meet the

Standards. FRSAC then determines whether the state’s accreditation

should be suspended or revoked. The state has the right to appeal the

decision.

The annual reviews take place on the anniversary of the initial

accreditation. For these reviews, states submit an updated self-evaluation

guide. For the first annual review, states must also respond to any

recommendations made during the initial accreditation review. NAIC

reviews these materials and summarizes them for FRSAC. FRSAC then

determines whether the state remains in compliance. The state has the

right to appeal a negative decision.
Appendix III: Comments From the National

Association of Insurance Commissioners

Page 41 GAO-01-948 NAIC Accreditation Program

Appendix III: Comments From the National

Association of Insurance Commissioners
Appendix III: Comments From the National

Association of Insurance Commissioners

Page 42 GAO-01-948 NAIC Accreditation Program
Appendix III: Comments From the National

Association of Insurance Commissioners

Page 43 GAO-01-948 NAIC Accreditation Program
Appendix III: Comments From the National

Association of Insurance Commissioners

Page 44 GAO-01-948 NAIC Accreditation Program
Appendix III: Comments From the National

Association of Insurance Commissioners

Page 45 GAO-01-948 NAIC Accreditation Program
Appendix IV: GAO Contacts and Staff Acknowledgments

Page 46 GAO-01-948 NAIC Accreditation Program

Richard J. Hillman, (202)-512-8678

Lawrence D. Cluff, (202) 512-8678

In addition to those named above, James R. Black, Emily Chalmers,

Thomas H. Givens III, Barry A. Kirby, LaSonya Roberts, and Desiree W.

Whipple made key contributions to this report.

Appendix IV: GAO Contacts and Staff

Acknowledgments

GAO Contacts

Acknowledgements

(250013)
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