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SUBCHAPTER A. Examination and Financial Analysis

28 TAC §§7.18 and 7.85

The Commissioner of Insurance adopts new §7.18 and amendments to §7.85 concerning examination and financial analysis. The adoption of §7.18 is made with changes to the text as proposed in the October 13, 2000 issue of the Texas Register (25 TexReg 10283). Section 7.85 is adopted without changes and will not be republished.

New §7.18 is necessary to provide independent accountants, insurance companies, and department examiners and analysts with more complete accounting guidance, to permit the use of a widely used regulatory tool, and to enhance regulatory efficiency. Simultaneously the department is adopting the repeal of the existing §7.18, which is published elsewhere in this issue of the Texas Register. The amendments to §7.85 are necessary to conform the requirements of that section with the requirements of the new §7.18.

The adopted §7.18 will provide for the adoption by reference of statutory accounting principles which provide guidance to independent accountants, industry accountants and department analysts and examiners as to how to properly record business transactions for the purpose of accurate statutory reporting. According to information available to the department, all 50 states have or will propose adoption of the Accounting Practices and Procedures Manual (Manual) published by the National Association of Insurance Commissioners (NAIC). The Manual, previously known as "Codification," is designed to provide a nationwide standard method of accounting which most insurers, including health maintenance organizations, will be required to use for statutory financial reporting guidance, thus creating a more consistent regulatory environment. The principles in the Manual will be updated from time to time as accounting issues arise. When new versions of the Manual are made available by the NAIC, the Commissioner of the Texas Department of Insurance will consider the new version and, if he deems appropriate, propose for public comment adoption of the new version, with any necessary modifications, by rule. The Manual is a single source intended to replace three accounting manuals and accounting guidance contained in the NAIC examiner´s handbook which the department previously adopted by rule. The Manual contains a preamble, Statements of Statutory Accounting Principles (SSAPs), and Appendices. There are a total of 73 SSAPs, with each SSAP providing specific guidance on the accounting treatment to be afforded insurance transactions. The SSAPs are designed to capture the accounting concepts of conservatism, recognition, and consistency. Conservatism is a concept which mandates that when there is exposure to uncertainty and risk, a company´s accounting measurement and disclosure should be cautious and prudent until the given situation is more certain. The concept of recognition addresses the issue of when a transaction should be recorded; recognition generally takes place when the data is reliable, measurable, relevant and meets a definition for the purposes of classification. The concept of consistency means that the accounting procedure used should conform with the procedure that has been previously used to record that particular type of transaction. In addition, the Manual furthers the accounting concept of comparability in that it is a single source of statutory accounting guidance which will ensure that all insurers report their financial information in a format that allows for reconciliation between differing state requirements. The comparability of insurers' financial statements increases the usefulness of financial information to the public and the department and also eases the regulatory burden upon insurers doing business in more than one state. For instance, under the Manual, a foreign insurer need only prepare one set of statutory documents in accordance with its domiciliary state requirements and limitations and then merely prepare a reconciliation indicating the impact resulting from differences between that domiciliary state's accounting requirements and limitations and the requirements of the Manual. Conversely, a Texas domestic insurer need only prepare one set of statutory documents for the department and prepare a reconciliation indicating the differences between Texas' accounting requirements and the Manual for other states. The Manual is not intended to preempt state legislative or regulatory authority, but is rather to serve as guidance for Texas' statutory accounting principles subject to the pronouncements of the Texas Legislature and the Commissioner of Insurance. To the extent the Manual conflicts with Texas law and regulations, Texas law and regulations prevail. Nothing in this adoption alters the investment or managerial decisions that an insurer may legally make under the Insurance Code or applicable rules. If a transaction is not permitted by the Insurance Code, the transaction continues to be prohibited even if the Manual provides a method to account for such transaction. If an item is not admitted as an asset by the Insurance Code or by rule, it is still not admitted even if the Manual indicates otherwise. Also, if an item is admitted by the Insurance Code or by rule, that asset will continue to be admitted notwithstanding the provisions of the Manual. Furthermore, any liabilities or reserves which are required by the Insurance Code or by rule must still be established even if such reserves are not contemplated by the Manual. Again, the adoption by reference of the Manual merely provides guidance as to the proper accounting methods to be used, in the absence of any statutory or regulatory mandate, to record transactions into which an insurer enters. To ensure that the Commissioner reserves the necessary discretion to direct companies that are placed in supervision or conservation, the directives of his appointed supervisor or conservator are placed in new §7.18 as a source of accounting guidance. Also, to further ensure the Commissioner reserves needed discretion, instructions such as those contained in permitted practice letters are listed as a source of accounting guidance that may be used to resolve statutory accounting issues as they may arise from time to time. Section 7.85, concerning annual audits of insurers by certified public accountants, is amended to harmonize its provisions with the provisions of the new §7.18. The adopted §7.18 exempts farm mutual insurance companies, mutual assessment companies, mutual aid associations, and mutual burial associations from the requirements of the Manual since such companies only do business in the State of Texas and have traditionally accounted for their business on a cash basis. In response to comments, the date contained in §7.18(c)(1) was changed from December 31, 2000, to December 31, 2001 and the date in §7.18(c)(2) was changed from January 1, 2001, to December 31, 2001, to allow Texas domestic insurers which have not previously established an Interest Rate Maintenance Reserve or an Asset Maintenance Reserve an additional year to establish these reserves. A new paragraph (8) was added to §7.18(c) to allow insurers licensed only in Texas that produce a majority of their business through a managing general agency until January 1, 2002 to comply with SSAP No. 6 concerning the aging of agents balances.

COMMENT: Three commenters supported adoption of the new §7.18.

AGENCY RESPONSE: The department appreciates the comments.

COMMENT: Two commenters requested that Texas domestic insurers that have not established the Asset Maintenance Reserves or Interest Rate Maintenance Reserves in the past be exempted from the Manual's requirement in SSAP No. 7 to establish these reserves or be given some relief from the requirement.

AGENCY RESPONSE: The department realizes that domestic insurers may need additional time to comply with SSAP No. 7 and has changed §7.18(c)(1)and (2) to allow these insurers an extra year to establish these reserves.

COMMENT: One commenter stated that the Manual's requirement in SSAP No. 6 concerning the aging of agents' balances would materially affect county mutual insurers that use managing general agents.

AGENCY RESPONSE: The department disagrees with the comment; however, the department recognizes that some insurers may need additional time to comply with the requirements of SSAP No. 6. Therefore, the department added a new paragraph (8) to §7.18(c) to allow insurers licensed only in Texas that produce a majority of their business through a managing general agency until January 1, 2002 to comply with SSAP No. 6.

COMMENT: One commenter opposed the adoption of the Manual, stating that new accounting standards in the Manual could not be adopted by the Commissioner without legislative authorization. The commenter stated that the Commissioner does not have the legislative authorization required by Insurance Code §36.004 to adopt the Manual because it is an NAIC standard. It also objected to the adoption of paragraph 7, SSAP No. 1, which requires insurers to disclose accounting practices that differ from those of the Manual and state their effect on statutory surplus. It stated that the requirement would pose a tremendous cost burden on Texas insurers as well as forcing them to be judged on a national standard that has not been adopted by the Legislature or the Commissioner.

AGENCY RESPONSE: The department disagrees. The department has statutory authority pursuant to Insurance Code Articles 1.11, 1.15, 1.32, 3.01, 3.33, 5.61, 6.12, 8.07, 20A.22, 21.28-A, 21.39, 21.49-1, and §§32.041 and 36.001 to adopt the Manual. Each of these articles and §32.041 address various financial aspects of a company and in conjunction with §36.001 authorize the Commissioner to adopt the Manual. These statutes expressly authorize the Commissioner to adopt an NAIC standard such as the Manual. The department also disagrees with the comment that the Manual SSAP No. 7 imposes a tremendous cost burden and forces insurers to be judged by a national standard. The disclosure of accounting practices that differ from those of the Manual and their effect on statutory surplus or risk-based capital is much more efficient than the current system of preparing unique financial reports for each state and the department will judge insurers by the standards established under Texas law. Given that, the department believes that its assessment of probable economic costs to persons required to comply with the rule, contained in the proposed rule, was adequate.

FOR: The American Council of Life Insurance Companies, Texas Life and Health Association and American General Financial Group.

FOR WITH CHANGES: Texas Association of Insurance Officials, Employees Life Insurance Company, and Texas County Mutual Association.

AGAINST: The National Alliance of Life Companies.

The sections are adopted under Insurance Code Articles 1.11, 1.15, 1.32, 3.01, 3.33, 5.61, 6.12, 8.07, 20A.22, 21.28-A, 21.39, 21.49-1, and §§32.041 and 36.001. Article 1.15 mandates that the department of insurance examine the financial condition of each carrier organized under the laws of Texas or authorized to transact the business of insurance in Texas and, by rule, adopt procedures for the filing and adoption of examination reports. Article 1.11 and §32.041 authorize the Commissioner to provide required financial statement forms. Article 21.39 authorizes the Commissioner to adopt rules for establishing reserves applicable to each line of insurance recommended by the NAIC. Article 1.32 authorizes the Commissioner to establish standards for evaluating the financial condition of an insurer. Article 20A.22 authorizes the Commissioner to promulgate rules as are necessary to carryout the provisions of the Texas Health Maintenance Organization Act. Article 5.61 provides that reserves shall be computed in accordance with rules adopted by the Commissioner for the purpose of adequately protecting insureds. Article 21.28-A authorizes the Commissioner to adopt rules necessary to accomplish the purposes of the act. Articles 6.12, 8.07 and 3.01 authorize the Commissioner to adopt rules defining electronic machines and systems, office equipment, furniture, machines and labor saving devices and the maximum period for which each such class may be amortized. Article 3.33 authorizes the Commissioner to adopt such rules, minimum standards, or limitations as may be appropriate for the implementation of the article. Article 21.49-1 authorizes the Commissioner to issue rules, and orders necessary to implement the provisions of the article. Section 36.001 authorizes the Commissioner to adopt rules for the conduct and execution of the powers and duties of the department only as authorized by statute.

§7.18 NAIC Accounting Practices and Procedures Manual.

(a) The purpose of this section is to adopt statutory accounting principles, which will provide independent accountants, industry accountants and department analysts and examiners guidance as to how to properly record business transactions for the purpose of accurate statutory reporting. The March 2000 version of the National Association of Insurance Commissioners Accounting Practices and Procedures Manual (Manual) will be utilized as the guideline for statutory accounting principles in Texas to the extent the Manual does not conflict with provisions of the Texas Insurance Code or rules of the department. The Commissioner reserves all authority and discretion to resolve any accounting issues in Texas. When making a determination on the proper accounting treatment for an insurance or health plan transaction the Commissioner shall refer to the sources in paragraphs (1)-(6) of this subsection in the respective order of priority listed. Furthermore, §§3.1501-3.1505, 3.1605, 3.1606, 3.7004, 7.7, 7.85 and 11.803 of this title (relating to Annuity Mortality Tables, General Requirements, Required Opinions, Contract Reserves, Subordinated Indebtedness, Audited Financial Reports and Investments, Loans and Other Assets), preempt any contrary provisions in the Manual.

(1) Texas statutes;

(2) department rules;

(3) directives, instructions and orders of the Commissioner;

(4) the Manual;

(5) other NAIC handbooks, manuals, and instructions, adopted by the department; and

(6) Generally Accepted Accounting Principles.

(b) The Commissioner adopts by reference the March 2000 version of the Accounting Practices and Procedures Manual published by the NAIC, with the exceptions and additions set forth in subsections (c) and (d) of this section, as the source of accounting principles for the department when examining financial reports and for conducting statutory examinations and rehabilitations of insurers and health maintenance organizations licensed in Texas, except where otherwise provided by law. This adoption by reference shall be applied to examinations conducted as of January 1, 2001 and thereafter and also shall be used to prepare all financial statements filed with the department for periods after January 1, 2001.

(c) The Commissioner adopts the following exceptions and additions to the Manual:

(1) Unless a Texas domestic insurer is licensed in a state that requires an Interest Maintenance Reserve (IMR), a Texas domestic insurer need only establish an IMR, as would be required by Statement of Statutory Accounting Principles number 7, for applicable investments disposed of after December 31, 2001.

(2) Unless a Texas domestic insurer is licensed in a state that requires an Asset Valuation Reserve (AVR), a Texas domestic insurer need only establish an AVR, as would be required by Statement of Statutory Accounting Principles number 7, on investments held as of December 31, 2001, and acquired thereafter.

(3) Electronic machines, constituting a data processing system or systems and operating systems software used in connection with the business of an insurance company acquired after December 31, 2000, may be an admitted asset as permitted by Texas Insurance Code Articles 3.01, 6.12, 8.07, and any other applicable law and shall be amortized as provided by the Manual. All such property acquired prior to January 1, 2001, may be an admitted asset as permitted by Texas Insurance Code Articles 3.01, 6.12, 8.07, and any other applicable law, and shall be amortized in full over a period not to exceed ten years.

(4) Furniture, labor-saving devices, machines, and all other office equipment may be admitted as an asset as permitted by Texas Insurance Code Articles 3.01, 6.12, 8.07, and any other applicable law and, for such property acquired after December 31, 2000, depreciated in full over a period not to exceed five years. All such property acquired prior to January 1, 2001, may be an admitted asset as permitted by Texas Insurance Code Articles 3.01, 6.12, 8.07, and any other applicable law, and shall be depreciated in full over a period not to exceed ten years.

(5) Written premiums for all property and casualty contracts, other than contracts for workers' compensation, shall be recorded as of the effective date of the contract rather than on the effective date of the contract as stated in Statement of Statutory Accounting Principles number 53.

(6) Goodwill, as reported on a regulated entity´s statutory financial statements as of December 31, 2000, and any additional goodwill acquired thereafter, beginning January 1, 2001, shall be admitted as an asset and accounted for as permitted by Statements of Statutory Accounting Principles numbers 61 and 68. All other amounts of goodwill, including, but not limited to, such amounts that may have been previously expensed, shall not be allowed as an admitted asset. However, notwithstanding the provisions of Statements of Statutory Accounting Principles numbers 61 and 68, all methods of non-insurer subsidiary and affiliate valuation permitted by Article 21.49-1 §6A may be used for the purposes of goodwill calculation.

(7) All certificates of deposit, of any maturity, may be classified as cash and are subject to the accounting treatment contained in Statement of Statutory Accounting Principles number 2, notwithstanding the provisions of Statement of Statutory Accounting Principles number 26.

(8) Agents balances of insurers licensed only in Texas that use a managing general agency to produce a majority of their business are not subject to Statement of Statutory Accounting Principles number 6 until January 1, 2002.

(d) A farm mutual insurance company, statewide mutual assessment company, local mutual aid association, or mutual burial association that has less than $5 million in annual direct written premiums need not comply with the Manual .

(e) This section shall not be construed to either broaden or restrict the authority provided under the Texas Insurance Code to insurers, including health maintenance organizations.

§7.85. Audited Financial Reports.

(a) Definitions. The following words and terms, when used in this section, shall have the following meanings, unless the context clearly indicates otherwise.

(1) Accountant--An independent certified public accountant or accounting firm that meets the requirements of Insurance Code, Article 1.15A, §12.

(2) Audited Financial Report--The annual audit report required by Insurance Code, Article 1.15A.

(3) Commissioner--The Commissioner of Insurance.

(4) Department--The Texas Department of Insurance.

(5) Examiner--Staff appointed by the Commissioner pursuant to Insurance Code, Articles 1.17 and 1.18.

(6) Generally Accepted Accounting Principles (GAAP)--The conventions, rules, and procedures that define accepted accounting practice, including broad guidelines and detailed procedures, set forth by the Accounting Principles Board of the American Institute of Certified Public Accountants, which was superseded by the Financial Accounting Standards Board, and which principles are specifically defined by SAS Number 69 (AU §411.05).

(7) Generally Accepted Auditing Standards (GAAS)--The standards adopted by the American Institute of Certified Public Accountants to conduct an audit and to ensure the quality of the performance by accountants who are engaged in an audit of financial statements.

(8) NAIC--The National Association of Insurance Commissioners.

(9) Statutory Examination--An examination performed by the Department's examiners or other persons or firms retained by the Department specifically for examination of insurers, corporations, or associations.

(10) Work Papers--The records kept by the accountant supporting that accountant's audit opinion, including the audit records defined by Insurance Code, Article 1.15A, §17(a); the accountant's audit planning records; and any record of communications related to the audit between the accountant and the insurer pursuant to the Insurance Code, Article 1.15A, §17(b).

(11) Material--As defined in the NAIC Accounting Practices and Procedures Manual adopted in §7.18 of this title (relating to NAIC Accounting Practices and Procedures Manual).

(b) Priority of Accounting Guidance. The priority for determination of accounting standards is set out in §7.18 of this title.

(c) Applicability. This section applies only to audited financial reports with audit dates as of December 31, 1995, or later. A foreign or alien insurer may be exempt from this rule if the foreign or alien insurer files an audited financial report in another state and the requirements for that state's audited financial reports are determined by the Commissioner pursuant to the Insurance Code, Article 1.15A, §6(a), to be substantially similar to the requirements in Insurance Code, Article 1.15A. A foreign or alien insurer is exempt from this rule if the foreign or alien insurer files an audited financial report in another state and the requirements for that state's audited financial reports have already been determined by the Commissioner pursuant to the Insurance Code, Article 1.15A, §6(a), to be substantially similar to the requirements in Insurance Code, Article 1.15A.

(d) Purpose. The Department recognizes that the Insurance Code, Article 1.15A, requires audited financial reports to be prepared, and that statutory examinations are periodically conducted pursuant to the Insurance Code. To improve coordination between the audited financial reports and statutory examinations, and to promote the utilization of work papers to the fullest extent during the conduct of statutory examinations, certain minimum standards, guidelines, and procedures must be incorporated by the accountant during the preparation of the work papers and the audited financial report. The purpose of this section is to establish those requirements.

(e) Conduct of audit. The annual audit required by the Insurance Code, Article 1.15A, shall be conducted in accordance with GAAS. It is not the department's intent to expand audit testing beyond the requirements of GAAS. To the extent not inconsistent with GAAS, consideration shall be given to the procedures and conventions set out in paragraphs (1)-(4) of this subsection, as follows:

(1) audit procedures and format contained in the NAIC Examiners Handbook;

(2) accounting treatments for the particular line(s) of insurance contained in §7.18 of this title and the NAIC Annual Statement Instructions adopted by the Commissioner;

(3) valuation procedures contained in the NAIC Purposes and Procedures of the Securities Valuation Office manual; and

(4) any order(s) of the Commissioner issued to a particular company.

(f) Contents of audited financial reports. In addition to the contents specified in the Insurance Code, Article 1.15A, §10(a)-(c), audited financial reports shall contain the statements and reports set out in paragraphs (1)-(3) of this subsection.

(1) audit procedures and format contained in the NAIC Examiners Handbook;

(2) The statement of gain or loss from operations, statement of changes in capital and surplus, and the statement of cash flow prepared in accordance with the Texas Administrative Code and the NAIC Annual Statement Instructions adopted by the Commissioner.

(3) In addition to the items that must be recorded in the notes to the financial statements as required by the Insurance Code, Article 1.15A, §10(c), any exceptions to compliance with the financial, investment, and holding company provisions of the Insurance Code or the Texas Administrative Code noted during the audit and a schedule and explanation of material non-admitted assets shall also be recorded in notes. The notes shall also include those items required by the appropriate NAIC Annual Statement Instructions and the NAIC Accounting Practices and Procedures Manual. Furthermore, the notes shall include a reconciliation of any differences, if any, between the audited statutory financial statements and the Annual Statement filed with the department, with written description of the nature of these differences.

(g) Contents of work papers.

(1) For those items subjected to detailed tests by the accountant during the course of the audit, the work papers shall contain notation of whether any material exceptions exist for each of the items set out in subparagraphs (A) and (B) of this paragraph.

(A) For invested assets:

(i) compliance as an authorized investment has been determined and does not exceed statutory limitations;

(ii) ownership and possession have been verified; and

(iii) securities are valued in accordance with the instructions of the NAIC Purposes and Procedures of the Securities Valuation Office manual.

(B) For assets other than invested assets:

(i) such assets are admitted in accordance with the appropriate provision of the Insurance Code or Texas Administrative Code; and

(ii) such assets are valued in accordance with the Texas Administrative Code and §7.18 of this title.

(2) If the regulated entity subject to the audit has any material reinsurance agreement or agreements, the work papers shall contain an outline addressing the items set out in subparagraphs (A)-(E) of this paragraph as follows:

(A) summary of the insurer's overall reinsurance program;

(B) explanation of relevant provisions by which liabilities are transferred to the reinsurer and any contingency provisions by which the reinsurer can cause the ceding insurer to reassume liabilities previously transferred to the reinsurer;

(C) explanation about assets held in trust, depositories, or letters of credit by which any reserve liabilities are collateralized;

(D) verification of any material reinsurance balance ceded or assumed; and

(E) explanation of amounts recoverable from unlicensed reinsurers that are not collateralized, or disputed reinsurance recoverables.

(3) The work papers of any audited entity shall contain:

(A) any letters from the accountant to management commenting on or explaining internal management operating procedures;

(B) computer-generated work papers;

(C) audit program;

(D) reports prepared by outside consultants;

(E) for policy liabilities, a note that reserves are established in accordance with policy and statutory provisions, and that required payments were made pursuant to any contract provisions;

(F) for all other liabilities, that all material liabilities of the company have been properly recorded; and

(G) internal control work papers.

(4) The work papers of any audited entity shall contain a notation that the accountant has determined that such entity met the requirements of subparagraphs (A) and (B) of this paragraph.

(A) Filing requirements have been met of the Insurance Code, Article 21.49-1, §3 and §4, and the Texas Administrative Code, including but not limited to the requirements that all dividends have been reported to the Department within two business days after declaration and at least ten days prior to payment, and that all dividends have been declared to have been paid in accordance with the provisions of Insurance Code, Articles 3.11, 21.31, 21.32, 21.32A, or 22.08, whichever statute is applicable.

(B) Unencumbered assets have been maintained in an amount at least equal to reserve liabilities as required by Insurance Code, Article 21.39-A.(h) Accessibility of work papers. The accountant shall provide all work papers to the examiner, whether during or after the preparation of the audited financial report. The examiner may obtain, if necessary, photocopies of work papers as provided by the Insurance Code, Article 1.15A, §17(c), so as not to burden the accountant if a statutory examination is occurring at the same time as an annual audit. Information obtained under this section is subject to the confidentiality standards imposed by Insurance Code, Articles 1.15, §8(b); 1.15A, §17(c); 1.18; and 21.49-1, §10.

(i) Noncompliance with this section may result in the Commissioner initiating action pursuant to Insurance Code, Articles 1.10, §7, and 1.15A, §12(d).



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