Calumet Equity Mutual Insurance Company

Report of the Examination of Calumet Equity Mutual Insurance Company New Holstein, Wisconsin As of December 31, 2006 TABLE OF CONTENTS Page I. INTRODUCTION ............................................................................................................... 1 II. REINSURANCE................................................................................................................. 7 III. FINANCIAL DATA ........................................................................................................... 10 IV. SUMMARY OF EXAMINATION RESULTS..................................................................... 14 V. CONCLUSION ................................................................................................................. 32 VI. SUMMARY OF COMMENTS AND RECOMMENDATIONS ........................................... 33 VII. ACKNOWLEDGMENT..................................................................................................... 35 State of Wisconsin / OFFICE OF THE COMMISSIONER OF INSURANCE Jim Doyle, Governor Sean Dilweg, Commissioner Wisconsin.gov October 18, 2007 125 South Webster Street • P.O. Box 7873 Madison, Wisconsin 53707-7873 Phone: (608) 266-3585 • Fax: (608) 266-9935 E-Mail: information@oci.state.wi.us Web Address: oci.wi.gov Honorable Sean Dilweg Commissioner of Insurance State of Wisconsin 125 South Webster Street Madison, Wisconsin 53703 Commissioner: In accordance with your instructions, an examination has been performed as of December 31, 2006, of the affairs and financial condition of: CALUMET EQUITY MUTUAL INSURANCE COMPANY New Holstein, Wisconsin and the following report thereon is respectfully submitted: I. INTRODUCTION The previous examination of Calumet Equity Mutual Insurance Company (the company) was made in 2003 as of December 31, 2002. The current examination covered the intervening time period ending December 31, 2006, and included a review of such subsequent transactions deemed essential to complete this examination. The “Summary of Examination Results” contains elaboration on all areas of the company's operations. Special attention was given to the action taken by the company to satisfy the recommendations and comments made in the previous examination report. The company was organized as a town mutual insurance company on March 10, 1873, under the provisions of the then existing Wisconsin Statutes. The original name of the company was the Mutual Fire Insurance Company of the Town of New Holstein. Subsequent amendments to the company's articles and bylaws changed the company's name to that presently used. During the period under examination, there were two amendments to the articles of incorporation and no amendments to the bylaws. Board membership was reduced from seven to six members divided into three classes in 2004. The annual policyholders’ meeting start time was changed from 1:00 p.m. to 10:00 a.m. in 2005. Current year board of director minutes indicate plans to reduce the board from six to five members, in conjunction with the recent retirement of the Secretary/Treasurer, which is to be presented for approval at the 2008 annual meeting of policyholders. The company is currently licensed to write property, including windstorm and hail, and nonproperty insurance. The company is currently licensed to write business in the following counties: Brown Dodge Green Lake Manitowoc Outagamie Shawano Washington Waushara Calumet Fond du Lac Kewaunee Oconto Ozaukee Sheboygan Waupaca Winnebago A review was made of the policy and application forms currently used by the company. The company issues approved policies with or without endorsements for terms of one year with premiums payable on the advance premium basis. The company also charges a policy fee based on type of policy and payment frequency. Homeowner policy fees range from $30-$32, farmowner policy fees range from $65-$70, while dwelling fire policy fees range from $65-$76. Business of the company is acquired through approximately 177 agents representing 40 agencies. Agents are presently compensated for their services as follows: Type of Policy Homeowner & Mobile Homeowner Farmowner Town & Country Standard Non-Farm Standard Farm Commercial Compensation 17% 15 15 17 15 15 2 Agents do not have authority to adjust losses. The majority of losses are adjusted by the company’s loss inspector. The loss inspector is a salaried employee who receives $0.485 per mile for travel allowance. Directors may also adjust losses but do so infrequently. They are paid an hourly fee depending on the claim size, as approved by the board, plus the above travel allowance. The adjustor has authority to settle claims up to $25,000. Losses in excess of this amount are reviewed and approved by the Loss Adjustment Committee. Policyholders may participate in the management and control of the company by attending and voting at all annual or special meetings of the members. No member may vote by proxy. The annual meeting of Calumet Equity Mutual Insurance Company for the election of directors and special meetings of the company are held in accordance with its articles of incorporation. Board of Directors The board of directors consists of five members divided into three classes. One class is elected at each annual meeting for a term of three years. Vacancies on the board may be filled by the directors for the interim to the next annual meeting when a director shall be chosen for the unexpired term. The current board of directors consists of the following policyholders of the company: Name Jerry Criter Gerald Heus Glen Calnin Grant Mortimer Paul Hofacker Principal Occupation Farmer Excavation Contractor Banking Distribution Farmer Residence Chilton New Holstein Chilton Chilton Appleton Expiry 2010 2010 2009 2009 2008 The current articles of incorporation require board membership composed of six directors. Effective April 30, 2007, the company’s former Secretary/Treasurer and member of the board retired. The April 2007 minutes of the board of directors indicate an intention to present an amendment to the articles of incorporation reducing the board from six to five members for approval at the 2008 annual meeting of policyholders. 3 External members of the board currently receive $150 for each meeting, while internal members receive no fee for board meetings attended. All board members receive $0.485 per mile for travel expenses. Section 612.13 (1m), Wis. Stat., requires after April 30, 2006: (1) If a town mutual has fewer than 9 directors, no more than one director may be an employee or representative of the town mutual and; (2) Employees and representatives of a town mutual may not constitute a majority of its board. The company is in compliance with these requirements. Officers Officers are elected by the board of directors from among its members and hold office for one year or until their successors are duly elected and qualified. Officers serving at the present time are as follows: 2007 Compensation $13,292 4,510 55,000 Name Jerry Criter Gerald Heus April Tarras Office President Vice President Secretary/Treasurer Reported compensation is the total salary compensation paid by the insurer for the full year and includes director fees and other special meeting fees as of the third quarter of 2007, as applicable. Committees of the Board The company's bylaws allow for the formation of certain committees by the board of directors. The committees at the time of the examination are listed below: Adjusting Committee Lee Scott (Loss Adjustor), Chair Jerry Criter Gerald Heus April Tarras Rate Committee Gerald Heus, Chair Jerry Criter April Tarras Other board members called to assist Executive Committee Jerry Criter, Chair Gerald Heus April Tarras 4 Growth of Company The growth of the company since the previous examination as compiled from its filed annual statements was as follows: Net Premiums Earned $742,344 842,510 906,767 883,099 740,525 Policies In Force 1,653 1,759 2,028 2,347 2,743 Net Income $ (60,535) 262,915 124,793 119,631 (547,940) Admitted Assets $2,143,731 2,073,859 1,821,612 1,475,394 1,559,863 Policyholders' Surplus $1,326,320 1,292,747 934,104 560,585 463,777 Year 2006 2005 2004 2003 2002 The ratios of gross and net premiums written to surplus as regards policyholders since the previous examination were as follows: Gross Premiums Written $1,095,363 1,185,491 1,320,678 1,450,695 1,507,507 Net Premiums Written $713,000 774,049 852,681 787,212 871,221 Policyholders' Surplus $1,326,320 1,292,747 934,104 560,585 463,777 Writings Ratios Net Gross 54% 60 91 140 188 83% 92 141 259 325 Year 2006 2005 2004 2003 2002 For the same period, the company's operating ratios were as follows: Other Underwriting Expenses Incurred $358,558 387,289 399,033 410,067 461,264 Year 2006 2005 2004 2003 2002 Net Losses and LAE Incurred $547,650 346,655 515,456 472,769 912,427 Net Premiums Earned $742,344 842,510 906,767 883,099 740,525 Loss Ratio 74% 41 57 54 123 Expense Ratio 50% 50 47 52 53 Composite Ratio 124% 91 104 106 176 The company has experienced fluctuating underwriting and net income trends with losses in 2002 and 2006, along with corresponding increases in Net Losses and LAE incurred and loss ratios since 2002. The above financial loss results are primarily attributed to hailstorm and fire related claims experience. Gross and net premiums written, as well as policies in force, have declined during the period since the prior examination, associated primarily with the impact of a moratorium placed on new business in 2003 due to prior year loss experience, higher premiums and a soft market. The company intends to emphasize marketing efforts going forward through agency visitations to renew 5 interest in Calumet Equity Mutual with the objective of generating new business to improve overall profitability. Admitted assets and surplus declined in 2002-2003 associated with the above sustained losses. Improving surplus trends are attributed to unrealized gains, primarily associated with gains in the value of the common stock of Wisconsin Reinsurance Corporation. 6 II. REINSURANCE The examiners' review of the company's reinsurance portfolio revealed there is currently one ceding treaty. The treaty contained a proper insolvency clause and complied with s. Ins 13.09 (3), Wis. Adm. Code, concerning maximum wind loss. Company retentions of risk complied with s. Ins 13.06, Wis. Adm. Code. Reinsurer: Effective date: Termination provisions: Wisconsin Reinsurance Corporation January 1, 2007 The company or reinsurer may terminate this contract of reinsurance as of 12:01 a.m. Central Standard Time on any January 1, by giving the other party at least 90 days’ prior written notice The coverages provided under this treaty are summarized as follows: 1. Type of contract: Lines reinsured: Class A Casualty Excess of Loss All business classified as casualty or liability written by the company $5,000 in respect to each and every loss 100% of any loss, including loss adjustment expense, in excess of the company’s retention subject to maximum policy limits as follows: (a) $1,000,000 per occurrence, single limit, combined for bodily injury and property damage liability (b) $1,000,000 split limits, in any combination of bodily injury and property damage liability (c) $25,000 for medical payments per person; $25,000 per accident Company agrees to retain sole responsibility for milk contamination if it does not impose the deductible on its insured policies; however, the reinsurer agrees to waive the deductible if the insured provides the company evidence of completion of the Dairy Quality Assurance Program within 12 months prior to the date of the claim Reinsurance premium: 47.5% of net premium written subject to: (a) Minimum Annual Premium of 75% of Annual Deposit Premium (b) Annual Deposit Premium = $80,750 Company's retention: Coverage: 7 2. Type of contract: Lines reinsured: Company's retention: Class B First Surplus All property business written by the company $400,000 plus at least 50% on a pro rata basis per ceded risk when the company’s net retention is $400,000 or less Company shall retain on each loss a per loss retention in an amount equal to 10% of the loss and loss adjusting expenses otherwise recoverable Coverage: Company may cede on a pro rata basis and the reinsurer shall be obligated to accept up to $800,000, when the company’s net retention is $400,000 or more in respect to a risk Company may cede on a pro rata basis and the reinsurer shall be obligated to accept up to 50% of such risk, when the company’s net retention is $400,000 or less in respect to a risk Reinsurance premium: Pro rata portion of all premiums, fees and assessments charged by the company, corresponding to the amount of each risk ceded hereunder Reinsurer shall allow the company a commission allowance equal to 15% of premiums ceded to reinsurer Return commission shall be allowed at the same rate on all return premiums paid to the company Reinsurer shall pay the company a profit commission of 15% of net profit accruing to the reinsurer during each accounting period in accordance with profit commission formulas outlined in the contract Ceding commission: 3. Type of contract: Lines reinsured: Company's retention: Coverage: Class C-1 First Layer Excess of Loss All property business written by the company $45,000 100% of any loss, including loss adjustment expense, in excess of the company’s retention subject to a $55,000 limit of liability in respect to each and every loss occurrence 6.5% of net premiums written (NPW) based on the loss experience for the prior four years, subject to the following minimum and maximum rates: Minimum Rate: Maximum Rate: Annual Deposit Premium: Minimum Premium: 6.5% NPW 15.0% NPW $51,675 75% Annual Deposit Premium Reinsurance premium: 4. Type of contract: Class C-2 Second Layer Excess of Loss 8 Lines reinsured: Company's retention: Coverage: All property business written by the company $100,000 100% of any loss, including loss adjustment expense, in excess of the company’s retention, subject to a $300,000 limit of liability in respect to each and every loss occurrence 4.0% of net premium written subject to the following: Annual Deposit Premium: $31,800 Minimum Premium: 75% Annual Deposit Premium Reinsurance premium: 5. Type of contract: Lines reinsured: Company's retention: Class D/E1 First Aggregate Excess of Loss All lines of business written by the company Losses, including loss adjustment expenses, in an amount equal to not less than 60% of net premiums written 100% of aggregate net losses, including loss adjustment expense, in excess of the company’s Attachment Point equal to 60% of net premium written 10% of net premium written (NPW) based on the company’s loss experience for the prior eight years subject to the following minimum and maximum rates: Minimum Rate: Maximum Rate: Annual Deposit Premium: Minimum Premium: 6% NPW 10% NPW $88,425 75% Annual Deposit Premium Coverage: Reinsurance premium: 6. Type of contract: Lines reinsured: Company's retention: Class D/E2 Second Aggregate Excess of Loss All business written by the company Losses, including loss adjustment expenses, in an amount equal to not less than 120% of NPW 100% of aggregate net losses, including loss adjustment expense, in excess of the Attachment Point equal to 120% of net premium written, subject to a limit of 100% of all loss 3% of net premium written subject to: Annual Deposit Premium: $26,528 Minimum Premium: 75% Annual Deposit Premium Coverage: Reinsurance premium: 9 III. FINANCIAL DATA The following financial statements reflect the financial condition of the company as reported to the Commissioner of Insurance in the December 31, 2006, annual statement. Adjustments made as a result of the examination are noted at the end of this section in the area captioned "Reconciliation of Policyholders' Surplus." 10 Calumet Equity Mutual Insurance Company Statement of Assets and Liabilities As of December 31, 2006 Assets Cash in company's office Cash deposited in checking account Cash deposited at interest Bonds Stocks and mutual fund investments Real estate Premiums, agents' balances and installments: In course of collection Deferred and not yet due Investment income accrued Reinsurance recoverable on paid losses and LAE Electronic data processing equipment Fire dues recoverable Other expense-related assets: Reinsurance commission receivable Furniture and fixtures Totals $ Ledger 60 4,731 872,660 20,032 1,014,710 53,317 Nonledger $ Not Admitted $ Net Admitted $ 60 4,731 872,660 20,032 1,014,710 53,317 6,826 147,581 12,419 1,146 1,393 327 6,826 147,581 12,419 1,146 1,393 327 8,529 2,560 $2,133,872 $12,419 8,529 2,560 $2,560 $2,143,731 Liabilities and Surplus Net unpaid losses Unpaid loss adjustment expenses Commissions payable Unearned premiums Reinsurance payable Amounts withheld for the account of others Payroll taxes payable (employer’s portion) Other liabilities: Expense-related: Accounts payable Accrued property tax Nonexpense-related: Premiums received in advance Rent security deposit Total liabilities Policyholders' surplus Total Liabilities and Surplus $ 188,702 2,170 31,636 507,613 45,761 2,390 2,989 10,058 3,339 22,023 730 817,411 1,326,320 $2,143,731 11 Calumet Equity Mutual Insurance Company Statement of Operations For the Year 2006 Net premiums and assessments earned Deduct: Net losses incurred Net loss adjustment expenses incurred Other underwriting expenses incurred Total losses and expenses incurred Net underwriting gain (loss) Net investment income: Net investment income earned Other income (expense): Miscellaneous Installment and policy fees Total other income Net income (loss) before federal income taxes Federal income taxes incurred Net Income (Loss) $ 742,344 $447,947 99,703 358,558 906,208 (163,864) 22,666 75 80,588 80,663 (60,535) 0 $ (60,535) 12 Calumet Equity Mutual Insurance Company Reconciliation and Analysis of Surplus as Regards Policyholders For the Five-Year Period Ending December 31, 2006 The following schedule is a reconciliation of surplus as regards policyholders during the period under examination as reported by the company in its filed annual statements: 2006 Surplus, beginning of year Net income Net unrealized capital gains or (losses) Change in nonadmitted assets Surplus, end of year 2005 2004 2003 2002 $1,292,747 (60,535) 90,601 3,507 $1,326,320 $ 934,104 262,915 94,254 1,474 $1,292,747 $560,585 124,793 253,850 (5,124) $934,104 $463,777 119,631 (21,383) (1,440) $560,585 $1,172,569 (547,940) (161,741) 889 $ 463,777 Reconciliation of Policyholders' Surplus A reconciliation of the policyholders' surplus as reported by the company in its filed annual statement and as determined by the examination is detailed in the following schedule: Policyholders' surplus per December 31, 2006, annual statement Item Reinsurance commissions receivable Total Decrease to surplus per examination Policyholders' Surplus per Examination Increase $ $ Decrease $8,529 $8,529 8,529 $1,317,791 $1,326,320 13 IV. SUMMARY OF EXAMINATION RESULTS Compliance with Prior Examination Report Recommendations Comments and recommendations contained in the last examination report and the action taken on them by the company are as follows: 1. Claims Adjusting—It is again recommended that the company’s loss adjustment committee consist of at least three directors in accordance with s. 612.13 (4), Wis. Stat. Action—Compliance with this recommendation was deemed acceptable for this examination. See further comments under the Current Examination Results section captioned “Claims Adjusting.” 2. Investment Rule Compliance—It is recommended that the company either comply with the existing limitation of investing no more than 30% of admitted assets in Type 2 investments, or request a modification to the limitation of OCI with the proper justification for such request. Action—Compliance with this recommendation was deemed acceptable for this examination. See further comments under the Current Examination Results section captioned “Investment Rule Compliance.” 3. Net Unpaid Losses—It is recommended that the company include an IBNR estimate for nonproperty losses for both the gross and recoverable amounts when completing J-1 of the annual statement. Action—Compliance 4. Amounts Withheld for the Account of Others—It is recommended that amounts withheld for the account of others be reported on the correct line on the annual statement according to Town Mutual Annual Statement Instructions. Action—Compliance 14 Current Examination Results Corporate Records The minutes of the annual meetings of policyholders and meetings of the board of directors and committees thereof were reviewed for the period under examination and also for the subsequent period. Prior year board of director minutes contain general statements indicating that financial statement transactions were presented and reviewed with no supporting detail as to financial results noted. Similarly, the board of director minutes typically contain a general statement indicating the claims adjustor reported on claims or inspections with limited supporting detail related to specific claim status or payment approvals. Current year 2007 board of director minutes were generally prepared in the format of an agenda outline with very limited comments as to issues discussed or results. It is recommended that the board of director minutes demonstrate active oversight of operations through the inclusion of more specific comments or reference to attachments, as it relates to investment decisions, financial results and claim approval status. The board has established the following committees and related responsibilities: • Executive Committee - authority to invest, redeem, or surrender bonds, stocks, mutual funds or cash and appoint new agents or terminate existing agents. Loss Adjustment Committee - authority to oversee claims settlement and adjust losses above $25,000. Rate Committee - responsible for reviewing and recommending policy rates. • • No formal meetings were held or minutes documented for the Executive, Loss Adjustment or Rate Committees during the period since the prior examination from 2002 to 2006. The Rate Committee held one recent meeting in 2007. It is recommended that the board appointed committees meet on a regularly scheduled basis to demonstrate more active involvement of the board’s committees and prepare minutes demonstrating oversight or otherwise demonstrate that similar oversight is conducted at the full board level. Biographical data relating to company officers and directors have been reported in accordance with the provisions of s. Ins 6.52, Wis. Adm. Code. 15 The company has executed formal written agreements with its agents. The contracts include language indicating the agent will represent the company's interests "in good faith." Business Plans Business plans are particularly important to Calumet Equity Mutual Insurance Company, as it relates to the company’s need to grow new in-force business and remain competitive to retain existing business, in light of its underwriting and net loss trend. The business plan provided during the current examination has not been updated since the prior examination in 2002. The five-year business plan provided as of the prior examination did not incorporate any objectives or goals beyond 2005. The recent hiring of a new Secretary/Treasurer is envisioned to capitalize on prior agent and sales related experience to emphasize new business growth and should be an integral component of updated business plans. Specifically, business plans should consider target objectives such as: • • • • • • • • • New business volume growth Existing in-force business retention Geographic business distribution to minimize weather-related claim impacts Agency visitation programs Business volume growth by agency Expense reduction goals Property valuation and inspection goals Policy pricing comparisons to remain competitive Other company-specific goals It is recommended that the company update its business plan on an annual basis to provide more meaningful goals and objectives against which to measure operating performance. Review of the Annual Statement Schedule K – Net Expenses Incurred, indicated that the company does not prepare any formal budgets to monitor expected versus actual operating performance. Key expense trend changes between current and prior year generally appeared reasonable, although management explanations were not always readily apparent. Year-to-date 2007 financial statement trends reported by the company continued to indicate underwriting and net loss trends. It is recommended that the company also complete formal budgetary expense projections to provide a measure for monitoring expense performance in relation to business plan goals and objectives. 16 Conflict of Interest In accordance with a directive of the Commissioner of Insurance, each company is required to establish a procedure for the disclosure to its board of directors of any material interest or affiliation on the part of its officers, directors, or key employees which conflicts or is likely to conflict with the official duties of such person. A part of this procedure is the annual completion of a conflict of interest questionnaire by the appropriate persons. The company has adopted such a procedure for disclosing potential conflicts of interest. Conflict of interest questionnaires were reviewed for the period under examination with two apparent conflicts being noted. One potential conflict involved the prior Secretary/Treasurer affiliation as a director with the company’s reinsurer, Wisconsin Reinsurance Corporation. Another prior director disclosed crop appraiser relationships with Rural Community Insurance Services. There did not appear to be any voting issues noted in the minutes which would have necessitated a director’s abstention. These reported conflicts present no concern going forward, since both directors have subsequently terminated membership on the board of directors. Underwriting The company has a written underwriting guide. The guide covers all the lines of business that the company is presently writing. The company does not have a formal inspection procedure for both new and renewal business. The company is in process of completing an inspection program for all in-force business based on concerns for non-current property valuations experienced with prior year loss trends and the new business moratorium in 2003. However, the company indicated that it has no current procedure in place to conduct ongoing inspections to maintain the above valuations on a reasonably current basis. It is recommended that the company review and implement a periodic, ongoing inspection program on a reasonable cyclical basis, whereby a sampling of new applications and renewal business is inspected, including maintenance of reasonably current property value information. 17 Fidelity Bond and Other Insurance The company is afforded coverage under the terms of the following bonds or contracts and has complied with s. Ins 13.05 (6), Wis. Adm. Code, which sets forth the minimum requirements for fidelity bond coverage: Type of Coverage Fidelity bond Worker’s compensation: Employee injury Employee liability: Each accident Each employee Policy limit Combined professional and D&O liability: Company professional liability Directors & officers liability Deductible each claim Employment practices liability: Each claim and aggregate Deductible each claim Commercial umbrella: Aggregate limits Products/completed operations Limit per occurrence Retained limit Building – home office: Building Aggregate limit Limit per occurrence Fire legal limit Medical limit Deductible Commercial liability – rental property Aggregate limit Personal & advertising injury limit Limit per occurrence Fire damage limit Medical expense limit Business auto: Bodily injury – each person/accident Property damage – each accident Medical payments – each person Uninsured motorist – each person/accident Underinsured motorist – each person/accident Comprehensive deductible Collision deductible Coverage Limits $ 500,000 Statutory 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 10,000 1,000,000 5,000 3,000,000 3,000,000 3,000,000 10,000 213,000 2,000,000 1,000,000 100,000 5,000 250 3,000,000 1,000,000 1,000,000 100,000 5,000 500,000 500,000 2,000 1,000,000 1,000,000 500 1,000 18 Claims Adjusting The company has a loss adjustment committee whose function is to adjust or supervise the adjustment of losses. However, the committee does not currently have at least three participating directors as required by s. 612.13 (4), Wis. Stat. The company initially complied with the prior examination recommendation related to the above loss adjusting committee membership requirements by naming the President, Vice-President and Secretary/Treasurer, who were all past directors, as members of the loss adjustment committee, along with the company’s loss adjustor. However, the April 2007 retirement of the Secretary/Treasurer has resulted in noncompliance, since the current Secretary/Treasurer is not a member of the board of directors. It is recommended that the company comply with s. 612.13 (4), Wis. Stat., by appointing at least three directors to its loss adjustment committee. Accounts and Records The examiners' review of the company's records indicated that the company is in compliance with s. Ins 13.05, Wis. Adm. Code, which sets forth the minimum standards for the handling of cash and recording of cash transactions by town mutual insurance companies. The examiners noted the following: 1. 2. 3. 4. 5. A proper policy register is maintained. A proper cash receipts journal is maintained. A proper cash disbursements journal is maintained. A proper general journal is maintained. A proper general ledger is maintained. An extensive review was made of income and disbursement items. Cash receipts were traced from source records and the proper recording and eventual deposit thereof ascertained. Negotiated checks issued during the period under examination were reviewed, test checked for proper endorsement, and traced to cash records. The verification of assets and determination of liabilities were made as of December 31, 2006. The company is audited annually by an outside public accounting firm. 19 EDP Environment Company personnel were interviewed with respect to the company’s electronic data processing environment. Access to the computers is limited to people authorized to use the computers. Company personnel back up the computers on a daily, weekly, monthly and annual basis. The backed-up data is kept off-site, although the backup site is located in close proximity to the company’s home office location. Backup files were compared to the company’s backup log for reasonable consistency with retention requirements. The company has manuals documenting the use of its software and outlining the steps to complete specific tasks. The manuals assist in the continuity of operations by providing instructions for seldom-used applications or when staff turnover occurs. Business Continuity Plan A business continuity plan identifies steps to be performed by a company in the event of business interruptions including, but not limited to, the inability to access its computer, the loss of information on its computer, the loss of a key employee, or the destruction of its office building. The company has developed a business disaster recovery plan. The company’s business disaster recovery plan has been improved since the prior examination and appears to be adequate. However, the company’s disaster plan does not reflect required changes associated with the recent retirement of the former Secretary/Treasurer. It is recommended that the company update its disaster recovery plan to reflect necessary changes associated with the identification of the primary coordinator replacement, control center replacement and manager responsibility changes for backup storage, in conjunction with the recent retirement of its former Secretary/Treasurer. In conjunction with the review of responsibility changes for backup storage, it was noted that the company’s disaster plan manual does not fully document the file backup process. It is recommended that the company’s disaster recovery plan incorporate the specific data file backup measures as it relates to daily, weekly, monthly and annual file generation and rotation between the home office and its backup storage site. 20 Invested Assets Section 610.23, Wis. Stat., requires insurers to hold all investments and deposits of its funds in its own name except that: (1) Securities kept under a custodial agreement or trust arrangement with a bank or banking and trust company may be issued in the name of a nominee of the bank or banking and trust company; and Any insurer may acquire and hold securities in bearer form. (2) For securities not held under a custodial agreement or trust arrangement with a bank or banking and trust company, s. Ins 13.05 (4), Wis. Adm. Code, requires that: Non-negotiable evidences of company investments such as registered bonds, certificates of deposits, notes, etc., shall be maintained in a safe or vault with adequate safety controls or in a safety deposit box in a bank. Negotiable evidences of company investments shall be maintained in a safety deposit box in a bank. Access to a company safety deposit box containing negotiable securities shall require the presence and signature of at least 2 officers, directors or employees of the company. The company is in compliance with these requirements. Investment Rule Compliance The investment rule for town mutual insurers allows a company to invest in common stocks, common stock mutual funds, and other higher risk investments (referred to as “Type 2”) provided that the town mutual has a sufficient amount of lower risk investments (referred to as “Type 1”). A town mutual may invest in Type 2 securities only if it already has sufficient Type 1 investments. Type 1 investments must equal or exceed the greater of items 1, 2, or 3. 1. Liabilities plus $300,000 2. Liabilities plus 33% of gross premiums written 3. Liabilities plus 50% of net premiums written 4. Amount required (greater of 1, 2, or 3) 5. Amount of Type 1 investments as of 12/31/2006 6. Excess or (deficiency) The company does not have sufficient Type 1 investments. The company’s investment portfolio consists primarily of certificates of deposit and the common stock of Wisconsin Reinsurance Corporation. The company has continued to report a $1,117,411 1,178,881 1,173,911 1,178,881 972,126 $ (206,755) 21 deficiency in Type 1 investments, in accordance with the Town Mutual Investment Rule, during the period since the prior examination with a deficiency of $(206,755) reported as of the current examination date. Type 2 investments were approximately 44% of admitted assets, which exceeds the 30% limit approved by this office. The investment rule prescribes that a town mutual shall divest any investment which does not comply with the rule within three years of its noncompliance, unless the Commissioner permits a longer period or requires a shorter period. Type 2 investments consist primarily of the common stock holdings of Wisconsin Reinsurance Corporation, which approximates 79% of the investments in common stocks, preferred stocks and stock mutual funds, limiting the ability to achieve compliance by divestment in the short term. No new Type 2 investments have been made given the Type 1 deficiency. Long-range compliance would appear to depend primarily on growth in the volume of quality business. It is recommended that the company establish a formal investment policy, which includes directions for addressing long-range objectives for meeting compliance with the Town Mutual Investment Rule, as well as reviewing other potential investment options. It is also recommended that the company divest itself of any common or preferred stock that is publicly traded to address compliance with Type 2 investment rule guidelines. 22 ASSETS Cash and Invested Cash The above asset is comprised of the following types of cash items: Cash in company's office Cash deposited in banks-checking accounts Cash deposited in banks at interest Total $ 60 4,731 872,660 $877,451 $877,451 Cash in company's office at year-end represents the company's petty cash fund. A physical count was made by the examiners during the course of the examination and the balance reconciled to year-end. Cash deposited in banks subject to the company's check and withdrawal consists of three accounts maintained in two banks. Verification of checking account balances was made by obtaining confirmations directly from the depositories and reconciling the amounts shown thereon to company records. Bookkeeping staff has the primary responsibility for processing general ledger cash receipt and disbursement entries, system reporting and bank statement reconciliation. Manager check signature requirements provide an element of segregation of duties. It is recommended that procedures also be established for manager review and initialing of bank reconciliations to provide additional management oversight. Cash deposited in banks represents the aggregate of 28 deposits in 14 depositories. Deposits were verified by direct correspondence with the respective depositories and by an actual count and inspection of certificates and/or passbooks. Interest received during the year 2006 totaled $40,109 and was verified to company cash records. Rates of interest earned on cash deposits ranged from 0.55% to 5.3%. Accrued interest on cash deposits totaled $7,845 at year-end. Physical inventory of certificate of deposit records indicated a few instances in which the general ledger descriptions had not been updated to reflect the correct issuing bank or internal records did not reflect the correct issue date, due to certificate of deposit redemption or renewals. 23 It is recommended that certificate of deposit records be maintained to reflect current bank issuer and issue dates in accordance with renewals and redemptions. Book Value of Bonds $20,032 The above asset consists of the aggregate book value of bonds held by the company as of December 31, 2006. Bonds owned by the company are located in a safe deposit box in a local bank or held under a custodial agreement. Bonds were physically inspected by the examiners. There were no bond purchases and sales in 2006. The company's investment in bonds was in conformance with Wisconsin Statutes and the rules of the Commissioner of Insurance as regards investments made by town mutual insurers. Interest received during 2006 on bonds amounted to $1,304. Accrued interest of $225 at December 31, 2006, was checked and allowed as a nonledger asset. Stocks and Mutual Fund Investments $1,014,710 The above asset consists of the aggregate market value of stocks and mutual funds held by the company as of December 31, 2006. Stocks owned by the company are located in a safe deposit box at a local bank. Stock certificates were physically examined by the examiners. There were no stock and mutual fund purchases and sales for the period under examination. The company's investment in individual stocks and mutual funds was in conformance with Wisconsin Statutes and the rules of the Commissioner of Insurance as regards investments made by town mutual insurers. However, the aggregate investment in common stocks, preferred stocks and mutual funds exceeds the 30% of admitted asset limit approved by this office. A recommendation regarding the sale of common and preferred stock which is publicly traded to address this issue was made, as previously discussed under the section captioned “Investment Rule Compliance.” Dividends received during 2006 on stocks and mutual funds amounted to $9,750 and were traced to cash receipts records. Accrued dividends of $4,349 at December 31, 2006, were checked and allowed as a nonledger asset. 24 Book Value of Real Estate $53,317 The above amount represents the company's investment in real estate as of December 31, 2006. The company's real estate holdings consisted of the company’s home office building valued at $6,684 and an adjacent rental property valued at $46,633. The required documents supporting the validity of this asset were reviewed and were in order. Adequate hazard insurance was carried on the real estate and contents as noted under the caption, "Fidelity Bond and Other Insurance." The company's investment in real estate and related items was in conformance with the Wisconsin Statutes and the rules of the Commissioner of Insurance as regards investments made by town mutual insurers. Real estate depreciation is calculated using the straight-line method. Premiums, Agents' Balances in Course of Collection $6,826 This asset represents the amounts due from agents or policyholders which are not in excess of 90 days past due at year-end. A review of policy balance due premium records verified the accuracy of this asset. Premiums Deferred and Not Yet Due $147,581 This asset represents modal premium installments (such as monthly, quarterly, etc.) that are not yet due. This balance was reconciled to the company’s Unearned Premium Report based on the “Billing Basis,” which includes future unbilled installments. Verification of this asset relied on the recalculation of a sample of unearned premiums reported on the “Annual Basis,” as discussed further under the section captioned “Unearned Premium.” Investment Income Accrued Interest due and accrued on the various assets of the company on December 31, 2006, consists of the following: Cash deposited at interest Bonds Stocks and mutual fund dividends Total $ 7,845 225 4,349 $12,419 $12,419 Interest due and accrued amounts were verified on a sample basis through recalculation based on ainvestment terms. 25 Reinsurance Recoverable on Paid Losses and LAE $1,146 The above asset represents recoveries due to the company from reinsurance on losses and loss adjusting expenses which were paid on or prior to December 31, 2006. A review of year-end accountings with the reinsurer verified the above asset. Electronic Data Processing Equipment $1,393 The above balance consists of computer hardware and operating system software, net of depreciation as of December 31, 2006. Non-operating system software was properly nonadmitted. Depreciation is calculated on the straight-line method. Current depreciation expense and accumulated depreciation were verified on a sample basis. The examination primarily relied on fixed asset records, which are maintained by the company’s external CPA, given the immaterial balance. Fire Dues Recoverable $327 This asset represents the amount overpaid to the State of Wisconsin for 2006 fire dues. The examiners reviewed the company's fire department dues calculation and found this asset to be overstated by an immaterial difference, which was attributed to certificate of authority fee requirements which are filed in conjunction with fire dues. Reinsurance Commission Receivable $8,529 The above asset represents the amount of reinsurance commissions that the company expected to receive as of December 31, 2006, based on the profit commission under its First Surplus contract with the reinsurer. A review of the terms of the reinsurance agreement and year-end accountings with the reinsurer indicated that the company’s CPA established an estimated profit commission receivable for 2006 based on subsequent mediation of a relatively large claim in late January 2007. However, Wisconsin Reinsurance Corporation (WRC) calculated no profit commission for 2006 based on a strong First Surplus reserve associated with the above claim, prior to mediation. WRC follow-up correspondence requested during the examination indicated that WRC views the above reserve change as a 2007 event, which will go toward the 2007 profit commission calculation. While the above claim settlement is anticipated to result in a positive impact in 2007, the current receivable is greater than 90 days outstanding and 26 there is no way of knowing the final results of future calculations. This examination reversed the Reinsurance Commission Receivable balance established by the company’s CPA for potential profit commission receivable under the First Surplus reinsurance contract, in accordance with WRC treatment of this as a subsequent year event. This adjustment is reflected under the Financial Data section of this report captioned “Reconciliation of Policyholders’ Surplus.” Furniture and Fixtures This asset consists of $2,560 of furniture and fixtures owned by the company at December 31, 2006. In accordance with annual statement requirements, this amount has been reported as a nonadmitted asset, thus the balance shown above is $0. $0 27 LIABILITIES AND SURPLUS Net Unpaid Losses $188,702 This liability represents losses incurred on or prior to December 31, 2006, that remained unpaid as of that date. The examiners reviewed the reasonableness of this liability by totaling actual loss payments made subsequent to December 31, 2006, with incurred dates in 2006 and prior years. To the actual paid loss figure was added an estimated amount for 2006 and prior losses remaining unpaid at the time of the examination. The examiners' development of unpaid losses is compared with the amount estimated by the company in the following schedule. Company Estimate Incurred but unpaid losses Less: Reinsurance recoverable on unpaid losses Net Unpaid Losses $588,417 399,714 $188,703 Examiners' Development $781,738 636,819 $144,919 Difference $(193,321) (237,105) $ 43,784 No surplus adjustment for the above difference is being made given the possibility of further loss development and the fact that approximately 50% of the difference is related to liability claims, which are primarily managed by the company’s reinsurer and were subject to a more limited review by the examiners. The examiners' review of claim files included open claims, paid claims, claims closed without payment, and claims which were denied during the examination period. The review indicated that claims are investigated and evaluated properly and that payments are made promptly and in accordance with policy provisions upon the submission of a proper proof of loss. In addition, the review of claims handling procedures and files revealed the following: 1. 2. 3. A proper loss register is maintained. Claim files contained sufficient investigatory data and documentation to verify settlement payments or reserve estimates. Proofs of loss were not consistently signed. Claim file review indicated no proof of loss statement and/or release signoff by the policyholder for approximately 40% of the claims sampled. Claims adjustor comments indicated that the company has generally relied on the policyholder’s cashing of the claim payment check. Establishment of some reasonable dollar threshold for obtaining policyholder signoff would ensure 28 more consistent evidence of proof of loss and release acceptance. It is recommended that proof of loss form signoffs by the policyholder should be obtained based on a reasonable dollar threshold. Unpaid Loss Adjustment Expenses $2,170 This liability represents the company's estimate of amounts necessary to settle losses which were incurred prior to December 31, 2006, but which remained unpaid as of year-end. The methodology used by the company in establishing this liability is based on the number of open claims at year-end and an average adjusting expense amount per claim. The examiners' analysis of expenses incurred in the current year related to the settlement of prior year losses, as well as estimates of amounts necessary to settle any prior losses remaining unpaid at the examination date, determined this liability to be adequately stated. Commissions Payable $31,636 This liability represents the commissions payable to agents as of December 31, 2006. The examiners reviewed the company’s subsequent commission payments for a sample of commissions payable and found the liability to be reasonably stated. Commissions payable sampled were also traced to evidence of a signed agency agreement. Commission rates were reviewed for reasonableness in accordance with company commission rate schedules. Unearned Premiums $507,613 This liability represents the reserve established for unearned premiums in compliance with s. Ins 13.08 (3), Wis. Adm. Code. This reserve was established using a daily pro rata methodology, which was previously approved by this office. This liability was verified by tracing the premium cash receipts sample selected under the cash transaction cycle to inclusion on the company’s Unearned Report. Unearned premiums were verified for the above policy sample based on recalculation of unearned premium reported on the “Annual Basis,” which includes only billed installments. 29 Reinsurance Payable $45,761 This liability consists of amounts due to the company's reinsurer of $29,822 at December 31, 2006, relating to transactions which occurred on or prior to that date. The Reinsurance Payable balance consists of the following components: Class A liability premium Class B first surplus premium Class B first surplus commission Class C-1 premium Class C-2 premium Class D-1 premium Class D-2 premium Total reinsurance premium due Less deposit overpayment Net Reinsurance Premiums Payable $ 6,375 7,784 (1,168) 5,886 2,251 7,787 2,336 31,251 (1,429) $29,822 Reinsurance Payable also consists of a pro rata balance of $15,939, which represents the company’s CPA estimate for premiums to be earned by the reinsurer as future premiums are billed by the company and paid by policyholders. Review of the reinsurer confirmation of deferred premiums verified the reasonableness of this balance. Amounts Withheld for the Account of Others $2,390 This liability represents employee payroll deductions in the possession of the company at December 31, 2006. Supporting records and subsequent cash disbursements verified this item. Payroll Taxes Payable $2,989 This liability represents the company's portion of payroll taxes incurred prior to December 31, 2006, which had not yet been paid. Supporting records and subsequent cash disbursements verified this item. Accounts Payable This account represents various expenses the company incurred prior to December 31, 2006, which had not yet been paid. The balance primarily includes accrued employee vacation as well as miscellaneous office billings. Review of supporting payroll records and the search for unrecorded liabilities verified the reasonableness of this balance. $10,058 30 Accrued Property Taxes $3,339 This liability represents property taxes as of December 31, 2006, which had not yet been paid. A review of the company’s real estate tax bills and subsequent cash disbursements verified this liability. Premiums Received in Advance $22,023 This liability represents the total premiums received prior to year-end for policies with effective dates after December 31, 2006. The examiners reviewed 2006 premium and cash receipt records to verify the accuracy of this liability. Rent Security Deposits $730 This liability represents security deposits received for the company’s rental property. Review of tenant deposits verified the accuracy of this liability. 31 V. CONCLUSION Calumet Equity Mutual Insurance Company reported admitted assets of $2,143,731, liabilities of $817,411 and surplus of $1,326,320 as of December 31, 2006. The company has provided property and liability insurance for over 134 years within a territory of 16 counties. The company has experienced fluctuating underwriting and net loss trends during the current and prior examination periods. The above loss trends are primarily attributed to weather and fire related claims experience. Premium written and in-force business volume have continued to decline, primarily attributed to the impact of a moratorium placed on new business in 2003 and rate increases. Calumet Equity Mutual Insurance Company’s primary objective going forward is to grow new in-force business, while remaining competitive to retain existing business, in light of these underwriting and net loss trends. The current examination has made a number of recommendations, which would potentially provide a stronger foundation for achieving this overall business objective, as follows: • • • • • • Board of director minutes demonstration of more active oversight through more specific comments related to review of financial results, investment decisions and claims status Board of director committee meetings on a regularly scheduled basis to demonstrate more active engagement of the board’s committees with minutes documenting oversight Business plan update on an annual basis to provide meaningful goals and objectives against which to measure operating performance Formal budget projections to provide a measure for monitoring expense performance in relation to business plan goals and objectives Formal investment policy establishment to provide long-range directions for attaining Town Mutual Investment Rule compliance and review of potential investment options Inspection schedule implementation on a reasonable cycle basis to provide ongoing current property valuation information for both new and existing business 32 VI. SUMMARY OF COMMENTS AND RECOMMENDATIONS 1. Page 15 - Corporate Records—It is recommended that the board of director minutes demonstrate active oversight of operations through the inclusion of more specific comments or reference to attachments, as it relates to investment decisions, financial results and claim approval status. Page 15 - Corporate Records—It is recommended that the board appointed committees meet on a regularly scheduled basis to demonstrate more active involvement of the board’s committees and prepare minutes demonstrating oversight or otherwise demonstrate that similar oversight is conducted at the full board level. Page 16 - Business Plans—It is recommended that the company update its business plan on an annual basis to provide more meaningful goals and objectives against which to measure operating performance. Page 16 - Business Plans—It is recommended that the company also complete formal budgetary expense projections to provide a measure for monitoring expense performance in relation to business plan goals and objectives. Page 17 - Underwriting—It is recommended that the company review and implement a periodic, ongoing inspection program on a reasonable cyclical basis, whereby a sampling of new applications and renewal business is inspected, including maintenance of reasonably current property value information. Page 19 - Claims Adjusting—It is recommended that the company comply with s. 612.13 (4), Wis. Stat., by appointing at least three directors to its loss adjustment committee. Page 20 - Business Continuity Plan—It is recommended that the company update its disaster recovery plan to reflect necessary changes associated with the identification of the primary coordinator replacement, control center replacement and manager responsibility changes for backup storage, in conjunction with the recent retirement of its former Secretary/Treasurer. Page 20 - Business Continuity Plan—It is recommended that the company’s disaster recovery plan incorporate the specific data file backup measures as it relates to daily, weekly, monthly and annual file generation and rotation between the home office and its backup storage site. Page 22 - Investment Rule Compliance—It is recommended that the company establish a formal investment policy, which includes directions for addressing longrange objectives for meeting compliance with the Town Mutual Investment Rule, as well as reviewing other potential investment options. Page 22 - Investment Rule Compliance—It is also recommended that the company divest itself of any common or preferred stock that is publicly traded to address compliance with Type 2 investment rule guidelines. Page 23 - Cash and Invested Cash—It is recommended that procedures also be established for manager review and initialing of bank reconciliations to provide additional management oversight. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 33 12. Page 24 - Cash and Invested Assets—It is recommended that certificate of deposit records be maintained to reflect current bank issuer and issue dates in accordance with renewals and redemptions. Page 29 - Net Unpaid Losses—It is recommended that proof of loss form signoffs by the policyholder should be obtained based on a reasonable dollar threshold. 13. 34 VII. ACKNOWLEDGMENT The courteous cooperation extended to the examiners by the company's personnel is hereby acknowledged. In addition to the undersigned, Kelly A. Schauer of the Office of the Commissioner of Insurance, State of Wisconsin, participated in the examination. Respectfully submitted, Tom M. Janke Examiner-in-Charge 35