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Subchapter C. Audit Coverages Required For Guaranty Associations 28 TAC §§31.201-31.207

The Commissioner of Insurance adopts new §§31.201-31.207 concerning the requirements for, and audit coverages applicable to, each guaranty association established under Insurance Code Articles 9.48, 21.28-C and 21.28-D. Sections 31.204-31.206 are adopted with changes to the proposed text as published in the November 30, 2001 issue of the Texas Register (26 TexReg 9734). Sections 31.201-31.203 and 31.207 are adopted without changes and will not be republished.

The sections are required by Insurance Code Article 21.28 §12(j) which directs the commissioner to adopt rules prescribing the audit coverage required for each guaranty association established under Insurance Code Articles 9.48, 21.28-C and 21.28-D. The sections are necessary to provide guidance to the guaranty associations on the types and scope of audits, as well as their frequency, and to enhance the commissioner's oversight of the guaranty fund associations, and the guaranty associations' governance of their own operations.

The adopted sections will provide the commissioner more effective oversight of the guaranty associations' operations by specifying procedures for, and types of, audits to be undertaken. Sections 31.201 and 31.202 state the purpose and applicability of the subchapter. Adopted §31.203 requires the board of directors of a guaranty association to select auditors with a competitive process and to periodically rotate auditors. Section 31.204 prescribes the nature of the audits that may be performed as part of an audit program. Section 31.205 provides for the scope and frequency of audits including a requirement that the board of an association annually adopt an audit plan. In developing the audit plan, the board of the association shall consider the types of audits enumerated in §31.204 (2)-(4). Furthermore, the audit plan and any modifications to the plan, must be filed with the commissioner. This requirement will aid the commissioner in the performance of his oversight of a guaranty association by keeping him informed of the audits that will be performed or why other audits will not be performed. In response to comments §31.204(5) was deleted and §31.205(c) was changed to maintain consistency concerning the commissioner's authority to order any audit he finds necessary. Adopted §31.206 contains the audit reporting requirements. Subsection (e) of §31.206 was changed in response to comments that the board of an association could not file a response to an audit report as proposed in the section. Catchlines were added to subsections (c) and (f) of §31.206 for consistency. Section 31.207 determines the manner of reimbursing audit costs.

Two comments were timely received by the department.

Comment: One commenter supports the concept in §31.205(b) that each guaranty association board should be responsible for having a comprehensive audit program in place.

Response: The department agrees.

Comment: A commenter believes §31.203 is consistent with the Insurance Code standard and provides sufficient flexibility in auditor selection while also assuring a periodic change in auditors.

Response: The department agrees, and appreciates the comment.

Comment: The commenters expressed concern that the multiple audits enumerated in proposed §31.204 could impact operational efficiency and that the proposed section is unnecessary and overly broad. One commenter suggested the section should augment, not diminish, the authority of a guaranty association board to formulate and execute an audit plan. A commenter also stated there was no reasonable basis to include special audits by the commissioner in §31.204(5).

Response: The department notes that the only audit required by the rules is the financial audit in §31.204(1). The Property and Casualty Insurance Guaranty Association is required by statute, Insurance Code Article 21.28-C §14, to annually provide an audited financial statement to the State Auditor. Similarly the statutes creating the Title Insurance Guaranty Association and the Life, Accident, Health and Hospital Service Insurance Guaranty Association provide that the commissioner can request annual financial reports. Section 31.205(b) directs the board of directors of a guaranty association to consider utilizing the other audits described in §31.204 when the board annually adopts an audit plan, but there is no requirement that such audits be performed, nor is the board's audit plan limited to only the enumerated audits. The responsibility for the audit program rests with the board of directors of the guaranty association and §31.204 does not mandate the performance of any audit, other than the annual financial audit. In response to the comment that special audits required by the commissioner should not be included in §31.204, the department has deleted paragraph (5) as unnecessary. The authority of the commissioner to conduct special audits was acknowledged by the commenters. The intent of the proposed §31.204(5) was to emphasize that the section did not preempt the commissioner's authority to conduct special audits. The deletion of paragraph (5), required the department to change §31.205(c) to consistently state the commissioner's authority to order any type of audit of an association.

Comment: One commenter stated that the proposed rule only analyzed costs of financial audits, but did not estimate the cost of the additional audits listed in §31.204(2)-(4). As such, the commenter said, the proposed rule failed to comply with Government Code §2001.024(a)(5) which requires that the notice of a proposed rule include a note which states the probable economic cost to persons required to comply with a proposed rule.

Response: The department disagrees. The proposed rule estimated costs of recent financial audits, based on information furnished by the guaranty associations themselves in addition to estimated costs for audits of receivership estates. In addition, the proposed rule stated that the cost of other audits would vary, and estimated hourly charges by audit firms for such work. Therefore, the notice of a proposed rule did not fail to comply with the requirements of the Government Code. The department additionally notes that the audits in §31.204(2)-(4) are not required to be performed, but only requires that the guaranty associations prepare an audit plan that considers use of the listed audits. Furthermore, the cost of any of the audits described in §31.204(2)-(4) is determined by the specific cost of a particular audit.

Commenter: A commenter stated that a guaranty association board of directors could not always comply with the proposed requirement in §31.206(e) that the board response to an audit be filed no later than 30 days after the audit is presented to the board and suggested it be changed to allow any board response to an audit report to be filed with the commissioner no later than the next scheduled meeting of the board of directors of the audited guaranty association.

Response: The department agrees with the comment and has changed the section accordingly.

Comment: A commenter noted that the proposal did not include the receiver and special deputy receiver even though Insurance Code Article 21.28 §12(j), the primary statutory authority for the proposal, directs the commissioner to adopt rules prescribing the audit coverages for the receiver and each special deputy receiver as well as the guaranty associations.

Response: The department disagrees. The receiver and special deputy receivers were not addressed in these rules because §§31.101-31.107 of this title (relating to Audit Coverages Required for the Receiver and Special Deputy Receivers) were previously adopted in accordance with the statutory directive noted by the commenter.

For, with changes: The Association of Fire and Casualty Companies of Texas and Texas Property and Casualty Insurance Guaranty Association.

These sections are adopted under the Insurance Code Article 21.28 and §36.001. Article 21.28 §12(j) authorizes the commissioner to adopt rules related to the scope, frequency, reporting requirements and costs of audits for each guaranty association established under Articles 9.48, 21.28-C, or 21.28-D of the Insurance Code. Section 36.001 provides the commissioner with the authority to adopt rules for the conduct and execution of the duties and functions of the department only as authorized by statute.

§31.201. Purpose. The purpose of this subchapter is to prescribe the audit requirements for, and audit coverages applicable to, the Title Insurance Guaranty Association established under the Insurance Code Article 9.48; the Property and Casualty Insurance Guaranty Association established under the Insurance Code Article 21.28-C; and the Life, Accident, Health and Hospital Service Insurance Guaranty Association established under the Insurance Code Article 21.28-D.

§31.202. Applicability. The provisions of this subchapter apply to any guaranty association established under the Insurance Code, Articles 9.48, 21.28-C and 21.28-D.

§31.203. Qualification of Accountant. The independent certified public accountant for the financial audit required by §31.204(1) of this title (relating to the Nature of Audits) must be selected by a competitive process. An independent certified public accountant may not perform the financial audit required by §31.204(1) for more than seven consecutive years. An independent certified public accountant responsible for performing the financial audit for seven consecutive years may not perform the financial audit during the two years following the seventh year.

§31.204. Nature of Audits. Audits applicable to the guaranty associations subject to the provisions of this subchapter shall take the form of financial, performance or operational audits, and may include, but not be limited to, the types of audits which are described in paragraphs (1)-(4) of this section.

(1) Financial audits. The financial audit shall be undertaken annually by an independent certified public accountant to determine whether the financial statements of the audited entity present fairly the financial position and the results of financial operations in accordance with generally accepted accounting principles. The financial audits shall be conducted in accordance with generally accepted auditing standards.

(2) Compliance audit. A compliance audit may be undertaken to determine whether the following objectives are being met:

(A) the audited entity has obligated, expended, received, and used funds in accordance with the purpose for which those funds have been authorized by law;

(B) the audited entity has obligated, expended, received, and used funds in accordance with any limitations, restrictions, conditions, or mandatory directions imposed by law on those obligations, expenditures, receipts, or uses;

(C) the audited entity has maintained its books, records, and accounts in a manner which accurately reflects its financial and fiscal operations relating to the obligation, receipt, expenditure, and use of funds including, but not limited to, funds collected for a public purpose;

(D) the audited entity has collected all revenues and receipts in accordance with the applicable laws and regulations of this state; and

(E) the audited entity has properly and legally handled or administered any money, negotiable securities, or similar assets received in accordance with the entity's governing statute.

(3) Economy and efficiency audit. An economy and efficiency audit may be undertaken to determine whether the objectives set out in subparagraphs (A) and (B) of this paragraph are being met and such audit shall make the identifications set out in subparagraph (C) of this paragraph, as follows:

(A) the audited entity is managing or utilizing its resources, including funds, personnel, contractors and subcontractors, consultants, procurement of professional services, property, equipment, and space, in an economical and efficient manner;

(B) the audited entity has presented financial, program, and statistical reports in a fair manner, and such reports contain useful data; and

(C) the causes of inefficiencies or uneconomical practices, including inadequacies in management information systems, internal and administrative policies and procedures, purchasing, procurement and contracting practices, organizational structure, use of personnel, contractors, equipment and other resources, have been identified.

(4) Effectiveness audit. An effectiveness audit may be undertaken to determine whether the following objectives are being met:

(A) the audited entity is attaining program objectives established pursuant to statutes and regulations, or by program criteria or program evaluation standards applicable to it, in an efficient and effective manner;

(B) the audited entity is contributing to achievement of those benefits intended by program design in an efficient and effective manner;

(C) the audited entity is discharging its duties and responsibilities under statutes and regulations or according to program performance criteria or program evaluation standards applicable to it in an efficient and effective manner; and

(D) the audited entity is performing its duties and responsibilities in connection with a program which does not duplicate, overlap, or conflict with the duties, functions, and responsibilities of another entity with respect to the same program, or with another program designed and intended to be applied to the same persons served by the audited entity.

§31.205. Scope and Frequency of Audits.

(a) Annual audit required. Each guaranty association subject to the provisions of this subchapter shall undergo an annual financial audit at the end of each calendar year as required by §31.204(1) of this title (relating to Nature of Audits).

(b) Audit plan. The boards of directors of each guaranty association subject to the provisions of this subchapter shall annually adopt an audit plan. In developing the plan, the boards shall consider utilizing the audits described in §31.204(2) - (4). The plan may be modified at the discretion of the boards. The plan and any modifications of the plan shall be filed with the commissioner.

(c) Commissioner may order audit. No provision of this subchapter prohibits or precludes the commissioner from ordering any entity subject to the provisions of this subchapter to submit to one or more audits at a frequency determined by the commissioner, based upon facts and circumstances.

§31.206. Audit Reporting Requirements.

(a) Report required. A written report shall be prepared in connection with any audit authorized or required pursuant to this subchapter.

(b) Contents of report. The written report must include a management letter containing the following items, as applicable:

(1) the criteria selected to measure effectiveness and efficiency;

(2) internal controls;

(3) compliance with state or federal laws;

(4) conditions found by auditors and the effects of such conditions; and

(5) any recommendations for improving operations or program effectiveness.

(c) Required opinion. The report also must include an opinion on fair presentation of financial statements when included as part of the scope of the audit.

(d) Supplemental items to be reported. The auditing entity's report should also include, to the extent necessary, each of the following items:

(1) an analysis of the overall performance of the entity being audited;

(2) an analysis of the audited entity's financial operations and condition; and

(3) an analysis of receipts and expenditures made by each audited entity.

(e) Filing requirements for audits. Copies of the auditing entity's report shall be filed with the Commissioner of Insurance no later than 30 days after the audits are presented to the board of directors of the audited guaranty association. Any response to the report by the board of directors must be submitted to the commissioner no later than the next meeting of the board of directors.

(f) Audits excluded. This subchapter shall not apply to audits made by the Office of the State Auditor.

§31.207. Cost of Audits. The cost of audits required by this subchapter shall be paid by the audited entity.



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