Community Insurance Corporation

Report of the Examination of Community Insurance Corporation Madison, Wisconsin As of December 31, 2003 TABLE OF CONTENTS Page I. INTRODUCTION .................................................................................................................. 1 II. HISTORY AND PLAN OF OPERATION .............................................................................. 3 III. MANAGEMENT AND CONTROL ........................................................................................ 7 IV. AFFILIATED COMPANIES AND KEY SERVICE PROVIDERS ........................................ 13 V. REINSURANCE ................................................................................................................. 17 VI. FINANCIAL DATA .............................................................................................................. 25 VII. SUMMARY OF EXAMINATION RESULTS ....................................................................... 35 VIII. CONCLUSION.................................................................................................................... 88 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS.............................................. 89 X. ACKNOWLEDGMENT ....................................................................................................... 98 XI. SUBSEQUENT EVENTS ................................................................................................... 99 State of Wisconsin / OFFICE OF THE COMMISSIONER OF INSURANCE Jim Doyle, Governor Jorge Gomez, Commissioner Wisconsin.gov July 22, 2005 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 Jorge Gomez Commissioner of Insurance State of Wisconsin 125 South Webster Street Madison, Wisconsin 53702 Commissioner: In accordance with your instructions, a compliance examination has been made of the affairs and financial condition of: COMMUNITY INSURANCE CORPORATION Madison, Wisconsin and this report is respectfully submitted. I. INTRODUCTION This is the first examination of Community Insurance Corporation (the company or CIC). The examination covered the period from the incorporation of the company, April 24, 2002, through December 31, 2003, and included a review of such 2004 transactions as deemed necessary to complete the examination. The examination consisted of a review of all major phases of the company's operations, and included the following areas: History Management and Control Corporate Records Conflict of Interest Fidelity Bonds and Other Insurance Territory and Plan of Operations Affiliated Companies Growth of Company Reinsurance Financial Statements Accounts and Records Data Processing Emphasis was placed on the audit of those areas of the company's operations accorded a high priority by the examiner-in-charge when planning the examination. The section of this report titled "Summary of Examination Results” contains comments and elaboration on those areas where adverse findings were noted or where unusual situations existed. Comment on the remaining areas of the company's operations is contained in the examination work papers. The company is annually audited by an independent public accounting firm as prescribed by s. Ins 50.05, Wis. Adm. Code. An integral part of this compliance examination was the review of the independent accountant's work papers. Based on the results of the review of these work papers, alternative or additional examination steps deemed necessary for the completion of this examination were performed. The examination work papers contain documentation with respect to the alternative or additional examination steps performed during the course of the examination. Independent Actuary's Review An independent actuarial firm was engaged under a contract with the Office of the Commissioner of Insurance. The actuary reviewed the adequacy of the company’s loss and loss adjustment expense reserves. The actuary’s results were reported to the examiner-in-charge. As deemed appropriate, reference is made in this report to the actuary’s conclusion. 2 II. HISTORY AND PLAN OF OPERATION The company was incorporated on April 24, 2002, under ch. 611, Wis. Stat., as a stock property and casualty insurance company licensed in Wisconsin. The sole shareholder of the company is the Wisconsin County Mutual Insurance Corporation (WCMIC). The company was formed to provide liability and worker’s compensation coverages to municipalities and school districts. On November 26, 2003, the commissioner granted CIC the authority to also offer fire, inland marine and other property insurance pursuant to a change in the authority allowed under s. 611.11 (4) (b), Wis. Stat. In Wisconsin, municipalities and school districts have a limited exposure to large general liability and automobile liability claims due to “tort caps” of $50,000 on general liability and $250,000 on automobile liability pursuant to ss. 893.80 (3) and 345.05 (3), Wis. Stat. There is no “tort cap” for certain liability actions, such as civil rights actions based on federal law. During 2004, the company provided municipalities and school districts with the following coverages: • Liability insurance coverage with policy limits of up to $10,000,000 per loss occurrence. These coverages are written above deductibles, which ranged from $0 to $250,000 per municipality or school district. Worker’s compensation coverage with policy limits of the employer’s liability reaching $1,000,000 per accident for bodily injury by accident, and $1,000,000 per policy limit and per each employee for bodily injury by disease. The worker’s compensation portion of coverage is as prescribed by Wisconsin law. The company began to provide property coverage. Coverages were written above deductibles, which ranged from $1,000 to $1,000,000 per municipality or school district. Auto physical damage coverage was offered as an endorsement to its liability policies. All other property coverages, with the exception of auto physical damage, were offered as a property policy issued by the company. The coverage limits are discussed in the section of this report titled “Excess Property Coverage.” • • CIC also offers retroactive coverages to its policyholders. The retroactive coverages include errors and omissions for both municipalities and schools. The coverage is also extended for some municipalities to provide employee benefit coverage. As of the date of this exam, all schools have such coverage and 77 of CIC’s insured municipalities have such coverage. Some policies issued by CIC indicated the retroactive coverage extends as far back as 1987. The 3 retroactive coverage is made available to policyholders who had coverage on a “claims made” basis from previous insurance carriers rather than on an occurrence basis. The retroactive coverage is to cover claims that are first reported during the effective period of the CIC policy even though the occurrence date was prior to CIC offering the coverage. The retroactive coverage includes coverage for employment discrimination, sexual harassment and individual education plans required for special education students. CIC requires policyholders to establish a prefunded deductible escrow account for paying the deductible portion of their losses. The deductible deposit and premium are calculated using the insured’s ratable operating expenses (ROE) multiplied by the base rate and loyalty credit resulting in a gross amount. A factor is then applied to the gross amount, depending on the deductible option selected, to determine the deductible deposit amount. The gross amount is then reduced by the deductible deposit amount to determine the premium charged. The insured's deductible deposit earns interest at a rate that matches the average interest rate earned by the company on its investments. During the policy year, the company monitors and pays claims on behalf of its insureds. At the end of the third quarter, the self-insured portion of claims paid and percentage of outstanding reserves are compared with the deposit and the balance is settled before year-end. During 2004, municipalities participating in the liability and/or worker’s compensation programs included approximately 34 cities (18% of all Wisconsin cities), approximately 61 towns (5% of all Wisconsin towns), and approximately 48 villages (12% of all Wisconsin villages). CIC also offered liability and worker’s compensation to 8 other municipal entities (e.g., utilities, sanitariums, fire districts). In addition, there were approximately 114 school districts participating in the liability program (26% of all Wisconsin school districts). Of the school districts participating in the liability program approximately 25 also participated in the worker’s compensation program (6% of all Wisconsin school districts). The newly introduced property program had 7 municipal policyholders. 4 The following table is a summary of the net insurance premiums written by the company in 2003, as reported by the company. The growth of the company is discussed in the “Financial Data” section of this report. Direct Premium $3,491,001 2,420,859 1,311,849 $7,223,709 Reinsurance Assumed $0 0 0 $0 Reinsurance Ceded $ 836,810 695,569 414,513 $1,946,892 Net Premium $2,654,191 1,725,290 897,336 $5,276,817 Line of Business Worker’s compensation Other liability - occurrence Commercial auto liability Total All Lines CIC policies are marketed using an agency affiliated with Aegis Corporation (Aegis), its managing general agent (MGA), and an independent agency. The MGA is responsible for market conduct, agency appointments and field direction of the agency force. The company offers a one-year policy term. The major products marketed by the company include the following: Liability coverages Automobile liability Bodily injury and property damage Hired and non-owned Uninsured motorists Underinsured motorist Auto physical damage (comprehensive and collision) General liability Bodily injury and property damage products/completed operations Contractual liability Personal injury liability A broad definition of and coverage for discrimination Civil rights violations; and employment-related acts Libel, slander or defamation of character Law enforcement liability Jail operations Assault and battery and intentional acts Public officials errors and omissions including director and officer liability Health care institutions Municipal-owned airports Municipality or school district officials appointed to serve on other boards and commissions on behalf of the insured Nursing Home Liability 5 Worker’s compensation coverages Standard worker’s compensation Excess worker’s compensation, for self insured clients Property coverages Buildings, property in the open and personal property Contractors equipment and electronic data processing equipment and data Accounts receivable Valuable papers, fine arts, collectibles and museum collections Outdoor and refrigerated property Communication systems and equipment breakdown Business interruption and clean-up expenses Animal livestock 6 III. MANAGEMENT AND CONTROL Management CIC has no employees. The company contracts with outside vendors to provide standard services. The services include corporate management, general administration, claims administration, auditing, actuarial, and investments. The company initially entered into an agreement with Wisconsin Counties Association (WCA) to provide corporate management services. On June 20, 2002, the agreement was amended to replace WCA with its affiliate, WCA Services, Inc. (WCASI). The services to be provided per the agreement are summarized as follows: A. Manage and oversee all CIC’s service contracts, including, but not limited to, contracts for claims administration, general administration, risk management services and training, public relations, investment and reinsurance brokerage. WCASI shall review and approve the expenditure of funds associated with any service contract approved by the Corporation’s Board prior to the disbursement of such funds. B. Oversee investment of CIC’s assets. C. Provide customer services on behalf of CIC to municipalities and school districts. D. Coordinate board meetings. E. Arrange for legal services for the board. F. Arrange for insurance consultant services. G. Provide for and oversee marketing of CIC. H. Reimburse directors for personal travel expenses, subject to CIC reimbursement to WCASI. I. J. Pay expenses for CIC subject to reimbursement. Issue communications to policyholders. K. Prepare periodic financial reports on the corporate management services. L. Serve as staff for board. M. Provide legislative services at both the state and federal level. WCASI is owned by WCA, which has a similar corporate management services agreement with CIC’s parent, WCMIC. 7 WCASI is compensated according to the following schedule: Coverage Municipal Liability Municipal Liability and Property School Liability School Liability and Property Fully Insured Worker’s Compensation Excess Worker’s Compensation Compensation $0.50 per $1,000 of ratable operating expenses $0.625 per $1,000 of ratable operating expenses plus $0.005 per $100 of insured property values $0.50 per pupil $0.625 per pupil plus $0.005 per $100 of insured property values 3.75% of the worker’s compensation premium 2% of the standard worker’s compensation rate as established by the Wisconsin Compensation Rating Bureau As of the date of this report, the management agreement is effective from May 15, 2004, through December 31, 2007, and may be opened for amendment at any time upon mutual agreement of both parties. Either party may terminate the agreement upon 90 days written notice to the other party. The table below depicts the ratio of WCASI fees to gross premiums written (GPW) and net premiums earned (NPE) from 2002 through 2004. 2004 Mgt Fees* GPW NPE Fees/GPW Fees/NPE $ 542,923 10,413,029 6,611,604 5.2 8.2 2003 $ 381,803 7,223,709 4,389,221 5.3 8.7 2002 $ 168,427 2,872,000 948,320 5.9 17.8 * The reported figures exclude amounts paid to WCASI by the company to reimburse WCASI for board member expenses. Administration Since the company’s inception, significant administration services have been provided by Aegis, which is also the company’s managing general agent and, as of the date of this report, reinsurance intermediary-broker. A more detailed history of Aegis’ relationship with CIC can be found in the “Affiliated Companies and Key Service Providers” section of this report. The administrative services to be provided per the agreement are summarized as follows: A. Promote the corporation and solicit non-members. B. Maintain the appropriate records and procedures to comply with OCI regulations. 8 C. Coordinate with other service producers and administer a loss prevention program. D. Pay expenses as allowed or directed by CIC and provide a monthly accounting of all monies so expended. E. Issue insurance policies and/or certificates and issue all invoices; and collect amounts due and/or return amounts payable. F. Procure on behalf of CIC, at CIC’s expense, insurance and reinsurance coverages for protection of CIC’s coverage, limits and financial well-being, provided that such procurement will be at the direction and approval of CIC as approved (if required by law) by OCI. Aegis may receive a usual and reasonable fee for this service. G. Provide monthly accounting for all income and expenses of CIC. H. Maintain books and records in a manner consistent with the Statements of Statutory Accounting Principles. I. J. Compute the annual premiums, assessments and capital contributions to CIC. Procure actuarial support services in determining premiums, assessments, and capital contributions necessary on a continuing basis. K. Subject to board approval, do and perform such other, further and additional acts and duties as are generally done and performed. Aegis has a similar administration agreement with CIC’s parent WCMIC. Aegis is compensated according to the following schedule: Coverage Municipal Liability Municipal Liability and Property School Liability School Liability and Property Liability Claim Services Property Claim Services Fully Insured Worker’s Compensation Worker’s Compensation Claim Services Self-insured Worker’s Compensation without Services Self-insured Worker’s Compensation with Services Compensation $0.75 per $1,000 of ratable operating expenses $0.93 per $1,000 of ratable operating expenses plus $0.005 per $100 of insured property values $1.30 per pupil $1.55 per pupil plus $0.005 per $100 of insured property values $405 for all liability claims and $25 for files designated “Incident Only,” determined monthly $405 for all property claims or 4.7% of the actual loss, whichever is greater, determined monthly 10% of the worker’s compensation premium $210 for lost time claims, $210 for medical only claims, and $25 for incidental claims determined monthly Up to 2% of the standard worker’s compensation rate as established by the Wisconsin Compensation Rating Bureau based upon the premium and self-insured retention 2% of the standard worker’s compensation rate as established by the Wisconsin Compensation Rating Bureau 9 Fees for the worker’s compensation claim services were originally $280 for lost time claims, $75 for medical only claims and no charge for incidental claims. An amendment was made on December 5, 2003, to change the fees to that reported above. Beginning in 2004, Aegis took over administration of liability claims from an unrelated adjusting firm and also began to administer property claims. As of the date of this report, the agreement was effective from May 15, 2002, through May 14, 2007. The company may terminate the agreement with cause at any time upon written notice to Aegis or without cause by giving 120 days’ prior written notice. Aegis may terminate the agreement with cause at any time upon written notice to the company or without cause by giving 180 days’ prior written notice. The table below depicts the ratio of Aegis fees to gross premiums written (GPW) and net premiums earned (NPE) from 2002 through 2004. 2004 Adm Fees Claim Fees Brokerage Fees Aegis* Brokerage Fees AIMS, LLC* Total Fees GPW NPE Fees/GPW Fees/NPE $ 1,200,230 428,745 204,634 269,005 2,102,614 10,413,029 6,611,604 20.2 31.8 2003 $ 895,491 99,170 108,064 137,580 1,240,305 7,223,709 4,389,221 17.2 28.3 2002 $ 465,495 24,225 0 0 489,720 2,872,000 948,320 17.1 51.6 * Brokerage fees are paid to Aegis and AIMS, LLC, by the reinsurer for placing CIC’s business. Board of Directors The board of directors consists of seven individuals, five representing the counties and two representing municipalities. Directors are elected by the sole shareholder at the annual shareholder meeting. Each director shall serve for a period of two years. The terms of the directors are staggered. The directors currently receive $75 per diem and $0.375 per mile for travel expenses. One director is an insurance agent. The remaining directors’ experience in managing a property and casualty insurer derives primarily from their service as a director of CIC 10 and/or WCMIC. Certain board members have served on the board of directors of WCMIC since its inception in 1987. Currently the board of directors consists of the following persons: Name and Residence James Barrett1 Camp Douglas, WI Western District Patrick Brennand Oshkosh, WI East Central District Gerald Derr2 Columbus, WI Municipality James Gilligan Sheboygan, WI East Central District Robert Hoesly3 New Glarus, WI Southern District Erhard Huettl4 Wabeno, WI North Central District Vincent Marchetti Necedah, WI Municipality Principal Occupation Retired Business Owner - Manufacturing Term Expires 2005 Insurance Agent/Hired Hand 2006 Business Owner - Construction Materials 2006 Retired Manufacturing/Conservation 2006 Retired Farmer 2005 Farmer/Assessor 2005 Retired Construction Contractor 2005 During each year covered by the examination, up to two of the seven directors of CIC served as directors of WCASI and two directors served as directors of WCA. Further comment on this subject may be found in the “Summary of Examination Results” section of the report. 1 2 James Barrett was a director of WCASI during 2002, 2003 and 2004. Gerald Derr was a director of WCASI during 2004. 3 Robert Hoesly was a director of WCA during 2002, 2003 and 2004. 4 Erhard Huettl was a director of WCA during 2002, 2003 and 2004. 11 Officers of the Company Officers are appointed by the board of directors every other year. The officers appointed by the board of directors and serving at the time of this examination are as follows: Name James Barrett Robert Hoesly Erhard Huettl Mark O’Connell Jon Hochkammer Office Chairman Secretary/Treasurer Vice Chairman Assistant Secretary Deputy Assistant Secretary Officers are not compensated by the company for their services. As noted above, Erhard Huettl and Robert Hoesly serve on the WCA board of directors and James Barrett serves on the WCASI board of directors. Jon Hochkammer was employed by WCA as the Director of Insurance Operations in 2002, 2003 and 2004. Mr. Hochkammer was responsible for overseeing the performance of WCA’s and WCASI’s obligations under the management agreements with WCMIC and CIC. Mr. O’Connell was the Executive Director of WCA during 2002, 2003 and 2004 and the President of WCASI during 2002, 2003 and 2004. Mr. O’Connell was also the Registered Agent for WCMIC and CIC, and was Assistant Secretary of CIC in 2002 and 2003. The principal office for WCMIC and CIC is the WCA office. Committees of the Board The company's bylaws require the formation of certain committees by the board of directors. The committees at the time of the examination are listed below: Executive Committee Erhard Huettl James Barrett Robert Hoesly 12 IV. AFFILIATED COMPANIES AND KEY SERVICE PROVIDERS Community Insurance Corporation is a member of a holding company system with WCMIC, its sole shareholder. WCA and its subsidiaries, and Aegis and its subsidiaries, are key service providers. A brief description of WCMIC as well as CIC’s key service providers follows: Organizational Chart As of December 31, 2003 Wisconsin Counties Association Wisconsin County Mutual Insurance Corporation Aegis Corporation WCA Services, Inc. Community Insurance Corporation American Insurance Marketing Services, LLC Wisconsin Counties Capital Projects Commission American Insurance Marketing Solutions, Inc. 20.48% ownership WCA Group Health Trust Wisconsin County Mutual Insurance Corporation Wisconsin County Mutual Insurance Corporation was organized by member counties and WCA in 1987 under ch. 611, Wis. Stat., as an assessable municipal mutual. The company is only licensed in Wisconsin. On March 22, 1996, the commissioner approved WCMIC’s conversion to nonassessable status. During 2002, WCMIC formed CIC to provide liability and worker’s compensation coverages to municipalities and school districts of Wisconsin. The initial capitalization of CIC consisted of $2,000,000 in common capital stock and $1,000,000 in gross paid-in and contributed surplus. Since the initial capitalization an additional $7,000,000 has been 13 paid in and contributed to surplus. On November 26, 2003, the commissioner granted WCMIC and CIC the authority to also offer fire, inland marine and other property insurance. As of December 31, 2003, WCMIC's statutory annual statement reported assets of $49,306,604, liabilities of $26,695,654, and unassigned funds of $22,610,949. Operations for 2003 produced net income of $1,799,589. Key Service Providers Wisconsin Counties Association Wisconsin Counties Association was created in 1935 by an act of the Wisconsin Legislature as a nonprofit association organized for the purpose of protecting and furthering the interests and concerns of county governments. WCA is a quasi-government entity created under s. 59.52 (22), Wis. Stat., and is tax exempt on both the federal and state level. All 72 Wisconsin counties are WCA members. WCA lobbies the Legislature on matters of interest to Wisconsin counties. In recent years, WCA expanded its operations by providing services to its members such as: educational programming, employee benefits, and liability insurance. WCA charges additional fees to counties that participate in the service programs. As mentioned earlier in the report, WCA provides certain management services to WCMIC. Four of WCMIC’s twenty board members, including two of its officers, are also board members of WCA. Section 611.23, Wis. Stat., exempts WCMIC from ch. 617, Wis. Stat. Therefore, WCMIC is not required to file a consent to jurisdiction statement or a holding company registration statement with the commissioner. As of December 31, 2003, the financial statements of WCA were independently reviewed by a certified public accountant. WCMIC paid WCA $948,915 in management fees during 2003 that amounted to 31% of WCA’s revenue during that year. WCA Services, Inc. In order to provide additional services to counties, the WCA board of directors created WCA Services, Inc., a wholly owned subsidiary of WCA. The service corporation is involved in projects that benefit counties and offer potential cost savings, such as a county 14 purchasing directory, discounted office supplies, a grant locator and on-line auction services. WCASI has no employees of its own. Services offered are performed by employees of WCA. WCASI provides management services for CIC, providing services similar to the services WCA provides to WCMIC. As of December 31, 2003, the financial statements of WCASI were independently reviewed by a certified public accountant. CIC paid WCASI $381,803 in management fees during 2003 that amounted to 99% of WCASI’s revenue during that year. In 2003, WCMIC and CIC management fees provided WCA and WCASI revenue of $1,330,718, which amounts to 38% of WCA and WCASI’s combined revenue. WCA Group Health Trust The WCA Group Health Trust was established in 1991 by county officials to create an employee benefit program that would meet the needs of local governments. The WCA Group Health Trust serves Wisconsin county and municipal units of government and had 16 such members in 2004. WCA provides corporate management support services for the WCA Group Health Trust. Marketing and consulting functions are provided by Aegis. WCA Group Health Trust is governed by a 12-member board of directors, each serving three-year staggered terms. Members of the board are appointed by the President of WCA. Aegis Corporation Aegis Corporation was formed in 1992 to provide insurance brokerage, risk management, administration and educational services to municipalities and other businesses. Robert Wurtz and John Dirkse each own 50% of Aegis. WCMIC selected Aegis as its managing general agent on December 1, 1992. As of December 31, 2003, the financial statements of Aegis and its subsidiary American Insurance Marketing Services, LLC (AIMS, LLC), were independently reviewed by a certified public accountant. Fees paid to Aegis and AIMS, LLC, by WCMIC, CIC, and reinsurers for administering WCMIC’s and CIC’s business totaled $3,438,001 in fees during 2003; these include administration fees of $2,507,569, claim adjusting fees of $189,825, and reinsurance brokerage fees of $740,607. Fees paid to Aegis by WCMIC and CIC, and brokerage 15 commissions paid by reinsurers for placing WCMIC’s and CIC’s business amounted to 78.0% of Aegis’ and AIMS, LLC’s revenue during 2003. American Insurance Marketing Services, LLC On April 3, 1996, Aegis purchased all the outstanding shares of American Insurance Marketing Services, Inc., an Illinois corporation. Effective December 1, 1997, American Insurance Marketing Services, Inc., was reorganized as a Limited Liability Company (LLC) under the Wisconsin Statutes. AIMS, LLC, is an excess and surplus lines wholesale insurance broker and acts as a reinsurance intermediary. AIMS, LLC, and/or Aegis employed several individuals who had reinsurance intermediary licenses. In 2003, AIMS, LLC, collected approximately $415,268 in reinsurance brokerage fees from reinsurers for placing WCMIC’s and CIC’s business. American Insurance Marketing Solutions, Inc. American Insurance Marketing Solutions, Inc., (AIMS, Inc.) was organized originally as Principal Insurance Managers, Inc. In 1997, Aegis Corporation acquired a 20.48% interest in Principal Insurance Managers, Inc. Seven individuals, some of whom are or were Aegis or AIMS, LLC, employees, own the remaining shares of AIMS, Inc. In 2003, its name was changed to American Insurance Marketing Solutions, Inc. AIMS, Inc., is an insurance agency created to represent the risk management and alternative risk financing needs of public entities, including Wisconsin schools. In 2003, AIMS, Inc., collected approximately $187,980 from CIC in agent commissions. 16 V. REINSURANCE The company's reinsurance portfolio and strategy is described below. Included is a list of the companies that had reinsurance in force during the year under examination and have reinsurance in force at the time of the examination. The summary includes the form of the agreement, such as signed or unsigned agreements, or placement slips. There are additional comments on the reinsurance program in the “Summary of Current Examination Results” section of this report. 2003 Ceding Agreements 1. Type: Reinsurer: Form: Excess of Loss (T009622/23 – 03) SCOR Reinsurance Company Agreement signed by reinsured’s broker (Robert Wurtz) and reinsurer during April/May of 2004 General liability, automobile liability, errors and omissions coverage, and worker’s compensation $250,000 per loss occurrence plus 5% of each loss not to exceed $37,500 Second Layer: $1,000,000 per loss occurrence plus 5% of each loss not to exceed $200,000 First Layer: 95% of $750,000 excess of $250,000 per loss occurrence Second Layer: 95% of $4,000,000 excess of $1,000,000 per loss occurrence First Layer: Deposit premium of $1,115,606 payable in four equal installments on July 1, October 1, January 1, and April 1, 2003/04 Adjustable within 90 days after expiry, 16.7676% of gross written premium to original insureds less cancellations and returns Second Layer: Deposit premium of $559,383 payable in four equal installments on July 1, October 1, January 1, and April 1, 2003/04 Adjustable within 90 days after expiry, 8.4075% of gross written premium to original insureds less cancellations and returns Ceding commissions: 22.5% of ceded premium First Layer: Scope: Retention: Coverage: Premium: 17 Broker: Aegis Corporation; payments are to be made through American Insurance Marketing Services, Inc., per the agreement July 1, 2003 July 1, 2004 On March 10, 2005, during examination fieldwork, after the execution of the agreement (April/May of 2004), the reinsurer signed a placement slip including the following changes: First Layer: Deposit premium of $1,439,492 payable in four equal installments, 90 days following the beginning of each quarter at July 1, October 1, January 1, and April 1, 2003/04 Effective date: Termination: Note: Second Layer: Deposit premium of $721,784 payable in four equal installments, 90 days following the beginning of each quarter at July 1, October 1, January 1, and April 1, 2003/04 Commissions: 0% ceding commission; 22.5% brokerage commission On March 14, 2005, during examination fieldwork, after the execution of the agreement (April/May of 2004), an addendum was made including the following changes: First Layer: Deposit premium of $1,439,492 payable in four equal installments, 90 days following the beginning of each quarter at July 1, October 1, January 1, and April 1, 2003/04 Second Layer: Deposit premium of $721,784 payable in four equal installments, 90 days following the beginning of each quarter at July 1, October 1, January 1, and April 1, 2003/04 Commissions: 0% ceding commission 2. Type: Reinsurer: Form: Excess of Loss (Agreement shared with WCMIC) Lloyds Syndicates Agreement not signed by reinsurer nor reinsured. Placement slip signed by the reinsurer’s broker. Worker’s compensation $5,000,000 per loss occurrence $5,000,000 excess of $5,000,000 per loss occurrence Under this agreement the reinsurer’s aggregate liability is $10,000,000 Scope: Retention: Coverage: 18 Premium: Deposit premium of $200,000 payable in four equal installments on January 1, March 1, July 1, and September 1, 2003 Adjustable at expiry, 3.64% of gross written premium to original insureds less cancellations and returns One full reinstatement is permitted for additional premium equal to a pro rata portion of the annual premium Commissions: Placement slip indicated 5% broker commission; agreement shows no commission American Insurance Marketing Services, Inc. January 1, 2003 January 1, 2004 Broker: Effective date: Termination: 2003 Direct Insurance Policies From January 1, 2002, through January 1, 2004, WCMIC and CIC provided excess liability insurance coverage that exceeded the normal policy limits through an endorsement stating the excess risk would be written with The Insurance Company of the State of Pennsylvania (ICSP). This direct insurance policy is written between ICSP and identified members of WCMIC and policyholders of CIC. 1. Type: Insured: Insurer: Scope: Excess of Loss Identified members of WCMIC and policyholders of CIC The Insurance Company of the State of Pennsylvania County and municipality general liability, automobile liability, and errors and omissions coverage $5,000,000 per loss occurrence $5,000,000 excess of $5,000,000 per loss occurrence Flat fee of $117,500, in addition to increases in premium for endorsements made after the effective date January 1, 2003 January 1, 2004 Retention: Coverage: Premium: Effective date: Termination: 19 2. Type: Insured: Insurer: Scope: Excess of Loss Identified members of WCMIC and policyholders of CIC The Insurance Company of the State of Pennsylvania Schools general liability, automobile liability, and errors and omissions coverage $5,000,000 per loss occurrence $5,000,000 excess of $5,000,000 per loss occurrence Flat fee of $125,000, in addition to increases in premium for endorsements made after the effective date July 1, 2003 July 1, 2004 Retention: Coverage: Premium: Effective date: Termination: 2004 Ceding Agreements 1. Type: Reinsurer: Form: Excess of Loss (T009622/23 – 04) SCOR Reinsurance Company Agreement signed by reinsured’s broker (Robert Wurtz) and reinsurer during February/March of 2004. General liability, automobile liability, errors and omissions coverage, and worker’s compensation $250,000 per loss occurrence plus 5% of each loss not to exceed $37,500 Second Layer: $1,000,000 per loss occurrence plus 5% of each loss not to exceed $200,000 First Layer: 95% of $750,000 excess of $250,000 per loss occurrence Second Layer: 95% of $4,000,000 excess of $1,000,000 per loss occurrence First Layer: Deposit premium of $1,244,880 payable in four equal installments on July 1, October 1, January 1, and April 1, 2004/05 Adjustable within 90 days after expiry, 17.29% of gross written premium to original insureds less cancellations and returns Second Layer: Deposit premium of $653,220 payable in four equal installments on July 1, October 1, January 1, and April 1, 2004/05 First Layer: Scope: Retention: Coverage: Premium: 20 Adjustable within 90 days after expiry, 9.0725% of gross written premium to original insureds less cancellations and returns Ceding commissions: Broker: Effective date: Termination: None American Insurance Marketing Services, Inc. July 1, 2004 July 1, 2005; agreement terminated January 1, 2005, upon addendum signed March 14, 2005 On December 28, 2004, during examination fieldwork, after the execution of the agreement (February/March of 2004), the reinsurer signed a placement slip including the following: Commissions: 22.5% brokerage commission Note: 2. Type: Reinsurer: Excess of Loss (Agreement shared with WCMIC) Aspen Re (16% participant) Lloyds Syndicates (84% participants) Agreement signed by reinsured’s broker (Robert Wurtz), not signed by reinsurers Worker’s compensation $5,000,000 per loss occurrence $5,000,000 excess of $5,000,000 per loss occurrence Under this agreement the reinsurer’s aggregate liability is $10,000,000 Form: Scope: Retention: Coverage: Premium: Deposit premium of $200,000 payable in four equal installments on January 1, March 1, July 1, and September 1, 2004 Adjustable at expiry, 3.448% of gross written premium to original insureds less cancellations and returns One full reinstatement is permitted for additional premium equal to a pro rata portion of the annual premium Ceding commissions: Broker: Effective date: Termination: None American Insurance Marketing Services, Inc. January 1, 2004 January 1, 2005 21 3. Type: Reinsurer: Excess of Loss (Agreement shared with WCMIC) Lloyd’s Underwriters (57.5% participants) Aspen Re (27.5% participant) Converium Limited (10% participant) Placement slip signed by reinsurer’s broker General liability, automobile liability, and errors and omissions coverage $5,000,000 per loss occurrence plus 5% representing the unsubscribed cessions $5,000,000 excess of $5,000,000 per loss occurrence (95% subscribed) Deposit premium of $600,000 payable 50% at July 1, 2004, and 50% at October 1, 2004. Adjustable at expiry, 5.45% of gross written premium income for the underlying primary $5,000,000 policy issued to each insured One full reinstatement is permitted for additional premium equal to a pro rata portion of the annual premium Form: Scope: Retention: Coverage: Premium: Ceding commissions: Effective date: Termination: 4. Type: Reinsurer: None January 1, 2004 January 1, 2005 Excess of Loss (Agreement shared with WCMIC) Lloyd’s Underwriters (75% participants) Aspen Re (25% participant) Placement slip signed by reinsurer’s broker Worker’s compensation $10,000,000 per loss occurrence $10,000,000 excess of $10,000,000 per loss occurrence Deposit premium of $175,000 payable in four quarterly installments of $43,750 each in advance Adjustable at expiry, 3.276% of gross written premium to original insureds less cancellations and returns One full reinstatement is permitted for additional premium equal to a pro rata portion of the annual premium Form: Scope: Retention: Coverage: Premium: Commissions: 5% broker commission 22 Effective date: Termination: July 1, 2004 July 1, 2005 2004 Direct Insurance Policy WCMIC and CIC began writing property coverages during 2004. Aegis told examiners that it was intended that property insurance coverage in excess of $500,000 be provided to policyholders through a direct insurance policy written by Travelers Indemnity Company (Travelers). The Travelers’ policy provides excess coverage for amounts above the policy limits indicated on the WCMIC and CIC policies issued. The Travelers’ policy was not delivered to the insured counties and municipalities. A master policy was issued to CIC and was endorsed to name the specific policyholders covered under the master policy. Aegis inadvertently issued WCMIC and CIC property coverage with limits reflecting the total risk (property coverage ranging from $17 million to $83.4 million) rather than the intended coverage limit of $500,000. As a result of the examination, Aegis subsequently issued CIC endorsements to affected policyholders clarifying that coverage in excess of $500,000 was provided on a direct basis by Travelers pursuant to a master policy issued to CIC. AIMS, LLC, acts as an agent for Travelers and received a commission for sale of the Travelers’ policy. Further comment on this is found in the “Summary of Examination Results” section of the report. Type: Insured: Insurer: Scope: Excess of Loss Identified members of WCMIC and policyholders of CIC Travelers Indemnity Company Buildings, personal property, property in the open, contractors’ equipment, money and securities, livestock, accounts receivable, and auto physical damage $500,000 per loss occurrence Risk coverage per endorsements (ranging from $2,100,000 up to $85,000,000) excess of $500,000 per loss occurrence Premiums charged are based on a per risk basis, which ranged from $863 up to $41,827 January 1, 2004 Retention: Coverage: Premium: Effective date: 23 Termination: The insured may cancel by giving advance written notice. The insurer may cancel by giving advance written notice of 10 days prior to the effective date of the cancellation due to non-payment of premiums and 60 days prior written notice for any other reasons. 24 VI. FINANCIAL DATA The following financial statements reflect the financial condition of the company as reported to the Commissioner of Insurance in the December 31, 2003, annual statement. Also included in this section are schedules that reflect the growth of the company, NAIC Insurance Regulatory Information System (IRIS) ratio results for the period under examination, and the compulsory and security surplus calculation. Adjustments made as a result of the examination are noted at the end of this section in the area captioned "Reconciliation of Surplus per Examination." 25 Community Insurance Corporation Assets As of December 31, 2003 Net Admitted Assets $12,479,172 716,482 614,518 131,014 Assets Bonds Cash Short-term investments Investment income due and accrued Premiums and considerations: Uncollected premiums and agents' balances in course of collection Total Assets $12,479,172 716,482 614,518 131,014 Nonadmitted Assets $0 31,722 $13,972,908 $0 31,722 $13,972,908 Community Insurance Corporation Liabilities, Surplus, and Other Funds As of December 31, 2003 Losses Loss adjustment expenses Other expenses (excluding taxes, licenses, and fees) Unearned premiums Advance premium Ceded reinsurance premiums payable (net of ceding commissions) Amounts withheld or retained by company for account of others Total Liabilities Common capital stock Gross paid in and contributed surplus Unassigned funds (surplus) Surplus as Regards Policyholders Total Liabilities and Surplus $ 2,000,000 8,000,000 (2,432,101) 7,567,899 $13,972,836 $ 2,521,678 1,104,538 46,570 1,837,705 27,820 815,662 50,964 6,404,937 26 Community Insurance Corporation Summary of Operations For the Year 2003 Underwriting Income Premiums earned Deductions: Losses incurred Loss expenses incurred Other underwriting expenses incurred Total underwriting deductions Net underwriting gain or (loss) Investment Income Net investment income earned Net investment gain or (loss) Other Income Write-ins for miscellaneous income: Miscellaneous Income Total other income Net income (loss) before dividends to policyholders and before federal and foreign income taxes Dividends to policyholders Net Loss $4,389,221 $2,901,535 1,567,528 1,364,902 5,833,965 (1,444,744) (63,465) (63,465) 2,076 2,076 (1,506,133) 18,999 ($1,525,132) 27 Community Insurance Corporation Cash Flow For the Year 2003 Premiums collected net of reinsurance Net investment income Miscellaneous income Total Benefit and loss related payments Commissions, expenses paid, and aggregate write-ins for deductions Dividends paid to policyholders Total deductions Net cash from operations Proceeds from investments sold, matured, or repaid: Bonds Total investment proceeds Cost of investments acquired (long-term only): Bonds Total investments acquired Net cash from investments Cash from financing and miscellaneous sources: Capital and paid in surplus less treasury stock Other cash provided (applied) Net cash from financing and miscellaneous sources Reconciliation Net change in cash and short-term investments Cash and short-term investments, December 31, 2002 Cash and short-term investments, December 31, 2003 $6,092,576 58,008 2,076 6,152,660 $ 945,792 2,039,077 18,999 3,003,868 3,148,792 $1,110,000 1,110,000 7,820,082 7,820,082 (6,710,082) 4,000,000 79,163 4,079,163 517,873 813,055 $1,330,928 28 Community Insurance Corporation Compulsory and Security Surplus Calculation December 31, 2003 Assets Less liabilities Adjusted surplus Annual premium: Lines other than accident and health Factor Compulsory surplus (subject to a minimum of $2 million) Compulsory surplus excess (or deficit) $13,972,908 6,404,937 7,567,971 $5,257,818 20% 1,051,564 2,000,000 $ 5,567,971 Adjusted surplus (from above) Security surplus: (140% of compulsory surplus, factor reduced 1% for each $33 million in premium written in excess of $10 million, with a minimum factor of 110%) Security surplus excess (or deficit) $ 7,567,971 2,800,000 $ 4,767,971 29 Community Insurance Corporation Reconciliation and Analysis of Surplus For the Two-Year Period Ending December 31, 2003 The following schedule is a reconciliation of total surplus during the period under examination as reported by the company in its filed annual statements: 2003 Surplus, beginning of year Net income Capital changes: Paid in Surplus adjustments: Paid in Surplus, end of year $ 5,093,030 (1,525,132) $ 2002 0 (906,970) 2,000,000 4,000,000 $ 7,567,898 4,000,000 $5,093,030 Note: Amounts reported in 2002 represent only six months of insurance operations. In May 2002, initial capitalization consisted of $2,000,000 in common capital stock and $1,000,000 paid in and contributed to surplus. In December 2002 an additional $3,000,000 was paid in and contributed to surplus. In December 2003, $4,000,000 was paid in and contributed to surplus. 30 Community Insurance Corporation Insurance Regulatory Information System For the Two-Year Period Ending December 31, 2003 The company’s NAIC Insurance Regulatory Information System results for the period under examination are summarized below. Unusual IRIS results are denoted with asterisks and discussed below the table. Ratio Gross Premium to Surplus Net Premium to Surplus Change in Net Writings Surplus Aid to Surplus Two-Year Overall Operating Ratio Investment Yield Change in Surplus Liabilities to Liquid Assets Agents’ Balances to Surplus One-Year Reserve Development to Surplus Two-Year Reserve Development to Surplus Estimated Current Reserve Deficiency to Surplus 2003 95% 70 178* 0 135* 0.0* 49 46 0 5 999* 15 2002 56% 37 999* 0 160* 0.0* 999* 26 0 0 0 0 #1 #2 #3 #4 #5 #6 #7 #8 #9 #10 #11 #12 Several IRIS ratios are calculated using prior year data. The company commenced business during 2002; therefore, it had no prior year data, which created exceptional results for ratios #3 and #7 in 2002 and #11 in 2003. In addition, ratio #3 was exceptional for 2003 due to WCMIC municipal business being written by CIC upon renewal. Most of WCMIC’s business is written on a calendar-year basis; therefore, CIC did not begin writing the business until January of 2003 causing the exceptional ratio #3. Ratio #5 measures the profitability of the company operations over a two-year period. The company began operations during 2002, therefore, the ratio is only based on one year. During 2002 the loss ratio was 63%, the loss adjusting expense ratio was 51%, the expense ratio was 35%, and investment yield was negative 11%. During 2003 the loss ratio was 66%, the loss adjusting expense ratio was 36%, the expense ratio was 26%, and investment yield was negative 1%. The 2003 results were combined with the 2002 results to determine the 2003 two-year overall operating ratio. The loss adjusting expense ratio is higher than typical for both years which may be a result of improper allocation of expenses. Investment income usually has a positive impact on the overall operating ratio. The company’s negative investment yield increased the 31 overall ratio due to improper allocation of expenses. Allocation of expenses is discussed further in the “Summary of Examination Results” section of the report. Ratio #6 measures the average return on the company’s investments. The exceptional ratios were attributable to the company’s investment expenses being greater than investment income earned which resulted in a negative investment yield. (The NAIC IRIS ratios report a negative investment yield as 0.0%.) The allocation of investment expenses is discussed in the “Summary of Examination Results” section of the report. In addition, the company’s bond portfolio consisted of low interest yielding government securities. 32 Growth of Community Insurance Corporation Surplus As Regards Policyholders $7,567,899 5,093,031 Year 2003 2002 Admitted Assets $13,972,908 6,860,360 Liabilities $6,404,937 1,767,329 Policyholder Dividends $18,999 0 Net Income $(1,525,132) (906,970) Year 2003 2002 Gross Premium Written $7,223,709 2,871,788 Net Premium Written $5,276,817 1,898,429 Premium Earned $4,389,221 948,320 Loss And LAE Ratio 101.8% 114.6 Net Expense Ratio 31.1% 70.5 Combined Ratio 132.9% 185.1 Loss ratios have not been favorable during the first two year of business, largely a result of the worker’s compensation line of business. WCMIC made capital contributions to the company since its incorporation: $4,000,000 in 2003 and $3,000,000 in 2002. The net expense ratio for 2002 was higher due to the company commencing business that year. There are many start-up costs in initiating an insurance company, including legal fees, that are not a factor in business going forward. During 2002, fees paid to service carriers were based on a full year’s written premium but the company only earned half a year’s premium because policies were written beginning July 1, resulting in an unusually high expense ratio. 33 Reconciliation of Surplus per Examination The following schedule is a reconciliation of surplus as regards policyholders between that reported by the company and as determined by this examination: Surplus December 31, 2003, per annual statement Increase Uncollected premiums and agents' balances in course of collection Deferred premiums Losses Loss adjustment expenses Commission payable Other expenses Unearned premiums Dividends declared and unpaid Ceded reinsurance premiums payable Amounts withheld or retained by the company for the account of others Net increase or (decrease) Surplus December 31, 2003, per examination Decrease $7,567,898 $ 93,364 $ 6,210 135,763 26,693 28,229 56,365 154,961 579,217 32,777 1,530 $127,671 $987,438 (859,767) $6,708,131 34 VII. SUMMARY OF EXAMINATION RESULTS Compliance with Prior Examination Report Recommendations This is the first examination report on the company. Consequently, there are no prior examination recommendations to report on. 35 Summary of Current Examination Results Articles of Incorporation and Bylaws Section 3.16 of the bylaws, Standing Committees, was reviewed. This section states, in part, that the board of directors shall appoint the following standing committees of directors, on nomination of the chairman: claims, loss prevention, investment, underwriting and worker’s compensation. On June 20, 2002, the board approved counsel to research the feasibility of retaining WCMIC’s committee structure for CIC. There were no further actions taken by the board concerning committees. The board of directors has not appointed standing committees of directors in compliance with its bylaws. Section 3.16, Standing Committees, also states, in part, that the directors who are members of the claims committee shall constitute the executive committee of the claims committee and shall have authority to approve payment of less than $25,000 to settle any claim against an insured of the corporation. The board of directors shall have sole authority to approve payment of $25,000 or more to settle any claim against an insured of the corporation, except that if action is necessary to approve payment in any amount to settle any claim against an insured of the corporation before the next scheduled meeting of the claims committee, the board of directors or the executive committee may approve the settlement of the claim. Examiners found examples of noncompliance with this bylaw. First, the examiners noted a claim payment CIC made in excess of $25,000 for which there was no evidence of approval from the board of directors to settle this claim. Secondly, the board of directors has not appointed a claims committee for CIC; therefore, all claims less than $25,000 are not being approved according to CIC’s bylaws. The practice has been for WCMIC’s claims review committee to act as the claims review committee for CIC; however, the WCMIC claims committee did not discuss every CIC claim under $25,000. The WCMIC claims review committee currently has only one member that is a director of CIC. Records indicate that WCMIC’s claims review committee only discussed CIC claims five times in 2003 and only once during 2004, and only some of CIC’s claims were reviewed. It appears that Aegis is authorizing payment for the majority of the company’s claims without proper approval by CIC. 36 It is recommended that the company follow its bylaws or amend them. Conflict of Interest The examiners reviewed conflict of interest questionnaires submitted by the directors during the period under examination. The review indicated one director failed to disclose, as a potential conflict of interest, the fact that the director also served on the board of directors for one or more of the WCA entities. This relationship is a potential conflict of interest because CIC contracts with WCASI for management services, and the payment to WCASI is not based on WCASI’s actual cost of providing the services. It is recommended that company directors who serve as directors and officers for one or more of the WCA entities disclose the affiliation in the conflict of interest statements. Board of Directors This section and other findings of the report demonstrate that the current board of directors is not structured such that the board can properly “manage the business and affairs of the corporation” as required by s. 611.51, Wis. Stat. The current members of the board have commendable backgrounds in county government and other occupations. However, few have any background in insurance company management other than that gained through oversight of the company and/or WCMIC. Board meeting minutes are approved by the board at the following meeting; however, the minutes are not signed by the secretary of the company, and they are retained electronically by WCA. Instances were noted in which WCMIC and WCA had difficulty readily determining which version of the minutes were meant to be the final authorized copy, and initially a full set of WCMIC minutes for the period under examination were not provided to examiners. Typically, companies have formal procedures to ensure minutes are readily available and identifiable, which include preparing, retaining and maintaining their own minutes. The lack of formal procedures may lead to difficulty properly documenting the actions of the board of directors. Because WCMIC had these problems and similar procedures exist for CIC, examiners are making a similar recommendation to both WCMIC and CIC boards. It is recommended that the company develop 37 formal procedures to ensure minutes are properly retained and available to document the actions of the board of directors. As of the date of this report, the board of directors had not appointed an investment committee for the company and the investment committee minutes of its parent, WCMIC, did not discuss CIC’s investments. An investment report was given to the board of directors once since the inception of CIC. It was also noted that the investment advisor reported the investment portfolios of WCMIC and CIC to the WCMIC board on one occasion. The investment policy, approved by the board, states that “Corporate Management [WCASI] shall quarterly submit an investment report to the Investment Committee and the Corporation’s Board of Directors.” It appears that the directors are not receiving a quarterly report from WCASI. The investment policy also states that an annual investment report shall be submitted to the company’s board of directors. The examiners did not note any receipt of an annual investment report during the review of board minutes. There does not appear to be any regular review of the company’s investment portfolio by the board of directors. The company has acquired $14.2 million in bonds and disposed of $1.5 million in bonds from June 26, 2002, through December 31, 2003. In addition, page 1 of the company’s investment policy under the heading “Delegation of Authority” states, in part, that “The management responsibility for the investment program is hereby delegated to Corporate Management [WCASI], which shall monitor and review all investments consistent with this investment policy.” It is recommended that the board of directors remove the delegation of investment management authority to WCASI from its investment policy. Committees of the Board of Directors The board has not fully complied with its obligations to manage the company, pursuant to ss. 611.51 and 611.67, Wis. Stat. In reviewing WCMIC’s underwriting committee minutes the examiners noted several discussions and decisions made on behalf of CIC. Of the seven underwriting committee members of WCMIC, two were directors of CIC. It appears that CIC’s board of directors did approve decisions made by WCMIC’s underwriting committee; however, the CIC board regularly approves and adopts the recommendations of the WCMIC underwriting committee but the minutes do not reflect the debate or discussion that occurred 38 among the board members. Review of the underwriting committee minutes under examination also showed that the committee regularly approves and adopts the recommendations made by Aegis. While there is the appearance that the board establishes guidelines for and oversees Aegis’ underwriting of business, claims handling, equipment purchases, etc., in fact, the board’s oversight of Aegis’ performance should be improved to identify and correct the violations and other findings in this report. Accordingly, the board would benefit from individuals with additional expertise in technical insurance management issues. It is recommended that the company submit a plan (Management Plan) required under s. 601.42, Wis. Stat., to the commissioner for approval within 30 days of the adoption of this report that includes all of the following: 1. An Operations Oversight Committee (Committee) with responsibility and authority to make timely recommendations with respect to management of the operations of the company, including, but not limited to, supervision and evaluation of functions performed by the managing general agent (Vendor Supervision), with respect to reinsurance placement and general administration and management services. The Committee shall include not less than two members (External Members) who: a. Are not board members; b. Have no conflict of interest, including no interest, directly or indirectly, in a vendor; c. Have significant expertise that is substantially related to the Committee's Vendor Supervision and reinsurance placement functions, such as reinsurance, actuarial, insurance accounting, insurance claim administration, underwriting and insurance company management expertise; d. Dedicate, and are compensated for dedicating, their time and resources sufficient to perform their functions on the Committee, including with respect to Vendor Supervision and reinsurance placement; and e. Are provided the resources and budget reasonably necessary to perform their functions on the Committee related to Vendor Supervision and reinsurance placement. 2. Provisions to address the management issues described elsewhere in this report, including, but not limited to, a budget and business plan process. 3. Provision for a reasonable Committee budget for the Committee's functions, including its Vendor Supervision and reinsurance placement functions. 4. Provision for a reasonable Committee budget to retain outside and independent professional services, including professional services reasonably required for the Vendor Supervision function and reinsurance placement function. 39 5. Provision for one or more of the External Members with appropriate expertise to actively participate in the negotiation and placement of company reinsurance and for the External Member or Members to make a recommendation to the Committee as to each such placement. 6. Provision for one or more of the External Members with appropriate expertise to actively participate in the review of the underwriting, reinsurance accounting, and claims processing operations of the company's managing general agent and for the External Member or Members to make a recommendation to the Committee as to each such review. It is further recommended that the company implement the Management Plan as approved by the commissioner. Management Agreement This examination reviewed the company’s relationship with WCA and WCASI. The 2003 CIC board of directors was compared to the 2003 board of directors roster for WCA and WCASI. The examiners noted that, as of December 2003, two of CIC’s seven directors, both of whom were officers, were active directors on the WCA board, and one of CIC’s seven directors, who was also an officer, was an active director on the WCASI board. The company’s deputy assistant secretary, Jon Hochkammer, was employed by WCA as the Director of Insurance Operations in 2002, 2003 and 2004. Mr. Hochkammer was responsible for overseeing the performance of WCA’s and WCASI’s obligations under their respective management agreements with WCMIC and CIC. Mr. O’Connell was the Executive Director of WCA during 2002, 2003 and 2004 and the President of WCASI during 2002, 2003 and 2004. Mr. O’Connell was also the Assistant Secretary of CIC in 2002 and 2003. In addition, the CIC board is dependent, in part, on WCASI to provide information concerning the company’s business operations as well as any matters pertaining to transactions between WCASI and the company. Section 600.03 (1), Wis. Stat., defines “affiliate” as a person “who controls, is controlled by, or is under common control with, the first person. A corporation is an affiliate of another corporation, regardless of ownership, if substantially the same groups of persons manage the two corporations.” Section 600.03 (13), Wis. Stat., defines “control” as “the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies 40 of a person, whether through the ownership of voting securities, by contract, by common management or otherwise. A person having a contract or arrangement giving that person control is deemed to be in control despite any limitations placed by law on the validity of the contract or arrangement.” This examination found the following relationships between CIC and WCASI: • the management agreement appears to delegate to WCASI management authority over CIC’s operations, including supervision of CIC’s administrator, with only periodic review by the board; CIC’s board includes three members in 2003, and four members in 2004, who are also directors or officers of WCASI or WCASI’s parent company, WCA; and CIC’s sole full-time paid officer is its Deputy Assistant Secretary, who is an employee of and paid by WCA; this officer is supervised by the WCA executive director. • • Based on the totality of factors cited above, WCA and WCASI could be viewed as “affiliates” of the company as such term is defined in s. 600.03 (1), Wis. Stat. The company’s position is that it was not intended to have an “affiliate” relationship with WCA and WCASI. While this examination does not reach any conclusions on this issue, it is recommended that the company implement measures to ensure no legal affiliation exists with respect to WCA and WCASI for purposes of Wisconsin insurance laws, including, but not limited to: 1. Amend the management agreement and CIC’s bylaws to remove any potential delegation of management authority to WCASI with respect to CIC’s business operations. 2. Amend the management agreement to prohibit WCASI from withdrawing its endorsement of WCMIC and CIC or endorsing any other insurance company with respect to insurance products offered by WCMIC and CIC for as long as the management agreement remains in effect and for a period of not less than two years after its termination, other than a termination for cause by WCASI. 3. Establish an Operations Oversight Committee, and involve that committee in reviewing and, when appropriate, providing recommendations with respect to (a) information prepared or provided by WCASI concerning the operations of the company, and (b) all transactions between CIC and WCASI. 4. Limit the number of company directors serving on the Operations Oversight Committee who also serve on WCA’s or WCASI’s board to no more than two individuals. 41 5. Preclude those directors who are also directors of WCA or WCASI from voting on WCA-related matters in accordance with s. 611.60 (2), Wis. Stat. The corporate management fees paid by WCMIC and CIC represented 38% of the total revenue of WCA and WCASI in 2003. The management agreement does not indicate any distinction between payment to WCASI for specific direct services rendered and payment for any intangible services provided by WCASI. To date, the company’s operations have been able to support payment of the corporate management fees. The fees payable to WCASI, like all costs and expenses, affect the company’s expense ratio and could someday affect the company’s financial strength and competitiveness. To ensure that CIC continues to maintain adequate financial strength, it should have the flexibility to terminate the management agreement on relatively short notice (or use this termination right as the basis to renegotiate compensation terms) if necessary to decrease its operating expenses. Accordingly, it is recommended that the company submit to the commissioner, within 30 days of the adoption of this report, a revised management agreement with WCASI. The revised management agreement shall provide all of the following: 1. Appropriate and reasonable transition provisions to protect the interests of the company, including its interest in data, systems, software, market and property, on termination of the contract. 2. Provision for termination of the contract without cause by the company on not less than 60 days’ notice. All renewed management agreements and amendments to management agreements were traced to the minutes of the board of directors to verify approval. The examiners noted that the agreement in effect during the period under examination and two amendments thereof were approved by directors of the company that were also directors of WCA or one of its affiliates; contrary to s. 611.60 (2), Wis. Stat., no potentially conflicted director abstained from voting on the WCASI agreement. It is recommended that directors who are also directors of WCA entities should abstain from voting on WCA-related matters, pursuant to s. 611.60 (2), Wis. Stat. According to the management agreement, WCASI is to manage and oversee all of CIC’s service contracts including, but not limited to, contracts for claims administration, general administration, risk management services and training, public relations, investment and 42 reinsurance brokerage. WCASI shall review and approve the expenditure of funds associated with any service contract approved by CIC’s board of directors prior to the disbursement of such funds. The examiners reviewed several cash disbursements of the company relating to service contracts and did not find evidence that WCASI reviewed or approved any of the disbursements. During the review of the company’s cash disbursements it was noted that several payments were made to WCA during 2003 and 2004. These payments were related to CIC’s board meeting expenses and general expenses, and such reimbursement should be made to WCASI. It is recommended that the company comply with the terms of its administrative agreement with WCA Services, Inc. The management agreement did not include proper indemnification clauses (e.g., WCASI should indemnify CIC for any liabilities resulting from WCASI’s services or recommendations). Also, the management agreement does not clearly define how fees are affected by return premium as a result of audit adjustments or policy cancellation. Aegis stated that the company’s practice is to recover fees paid to WCASI for audit adjustments or policy cancellations; however, there are no written procedures on this point. It is recommended that the company amend its management agreement with WCASI, to include proper indemnification clauses and to define how return premium would affect management fee payments. The examiners estimated the minimal amount of fidelity bond coverage the company should have in place in accordance with the NAIC Financial Examiners Handbook. The company’s suggested fidelity bond coverage was calculated to be between $175,000 and $200,000. Currently WCASI has a crime policy with a $50,000 limit. Since WCASI handles cash receipts and has authority to make transactions in all banking and investment accounts, the management agreement should require at least the suggested minimum fidelity bond coverage. Suggested amounts are not a substitute for the risk assessment that should be made by the company’s management in establishing a reasonable level of coverage. Management should also review internal controls which serve to mitigate the exposures covered by such insurance policies. It is recommended that the company amend its management agreement to require the greater of the suggested minimum fidelity bond coverage in accordance with the NAIC Financial Examiners 43 Handbook, or the results of the risk assessment, and provide evidence of such coverage to this office within 30 days after the adoption of this report. Business Plan/Budgeting The company does not prepare a comprehensive budget for operations. The company’s revenue budgets for the period under examination included certain budgets for premium including auto liability, general liability and worker’s compensation but not property premium. The company included a lump sum for reinsurance ceded and no budgeted amount for losses incurred. It was noted that the company did maintain a detailed budget for operation expenses. The company did not provide evidence of the board’s review of the budgets or discussions of variances between budgeted amounts and actual results. In addition, the company was not able to provide trend analysis by line of business over the last two years for premiums and losses. The company does not maintain its business plan. A business plan and budget should integrate the board and management’s vision of the company’s goals and how they will be achieved. The foundation of a company’s internal control environment is a system for forecasting the financial effects of a company’s intended operations and a system for comparing the actual results against those forecast. This would enable the company to follow up on those areas where intended results contrasted the greatest from those forecast. Causes can then be discovered and corrective action can be applied. Whether such procedures are in place can be the difference between a company that achieves positive results and a company that drifts into trouble. Lack of a comprehensive budget process and a business plan contributes to the company’s violation of s. 611.51, Wis. Stat. In order to obtain a certificate of authority, the company had to file a business plan with this office in accordance with s. 611.13 (2), Wis. Stat. The company has not developed procedures to periodically review its business plan or amend the business plan when changes are made. Pursuant to s. 611.28, Wis. Stat., within five years after the initial issuance of a certificate of authority, no substantial change, alteration or amendment may be made to the business plan and the insurer may not substantially deviate from it unless notice of the proposed change is filed 44 with the commissioner 30 days in advance of the proposed effective date and the commissioner does not prohibit the change. In reviewing the business plan filed with OCI, the examiners noted the following changes that were not filed with the commissioner: 1. The business plan reported CIC would be selling insurance on a direct basis, without outside insurance agents. CIC does have an independent agency force that is not affiliated with its MGA. 2. The business plan reported CIC would retain no more than $100,000 per loss. Currently the company retains $250,000 per loss. 3. The business plan reported that CIC will not cover general and medical liability exposures of hospitals and nursing homes. During the examination it was noted that CIC has provided general liability coverage for a nursing home. 4. The business plan reported that they have a management agreement with WCA. CIC changed their management service agreement replacing WCA with WCASI. 5. The business plan reported CIC would contract with the same actuary as WCMIC. Subsequent to the examination date, CIC changed its actuary to one that differs from WCMIC. 6. The business plan did not report CIC would offer retroactive coverages to its policyholders. The examiners found that CIC insured all schools and 77 municipalities with retroactive coverage for years as far back as 1987. Furthermore, there was no documentation that the board of directors approved this coverage. It is recommended that the company follow the business plan filed with the commissioner or file the proposed change with the commissioner 30 days in advance of the proposed effective date in accordance with s. 611.28, Wis. Stat. It is recommended that the company establish a comprehensive business plan and budget process, including quarterly board review. Disaster Recovery Plan The company had not completed a formalized disaster recovery plan. A disaster recovery plan identifies steps to be performed in case the company loses a key employee, is not able to access its computer, information on its computer was lost, or the office building was destroyed, to name a few contingencies. Once completed, the plan should be reviewed, updated, and tested on an annual basis. In addition, the company’s backup copies of data files and programs were not maintained in a locked, waterproof and fireproof storage area. It is recommended that the company develop a formalized disaster recovery plan and file it with this 45 office within 30 days after the adoption of this report. It is further recommended that the company store copies of data files and programs in a locked, waterproof and fireproof storage area. Administrative Agreement Aegis is a managing general agent for the company. The administrative agreement between Aegis and the company is subject to the MGA regulation set forth by ch. Ins 42, Wis. Adm. Code. Section Ins 42.02 (1), Wis. Adm. Code, states, in part, “No person, including, but not limited to, a natural person, may act as a managing general agent for an insurer with respect to a risk located in this state unless the person is licensed as a managing general agent under s. 628.04 or 628.09, Stats.” Robert Wurtz, 50% owner of Aegis, has an MGA license. However, Aegis Corporation has never held an MGA license in Wisconsin, despite acting as an MGA for the company since 2002. Aegis is required to be licensed as an MGA under ch. Ins 42, Wis. Adm. Code. It is recommended that the company contract for managing general agent services only with a person who is licensed as a managing general agent pursuant to s. 628.04, Wis. Stat. The administrative agreement includes language stating that the maximum annual premium volume shall be determined from time to time by the corporation’s board in accordance with s. Ins 42.03 (6), Wis. Adm. Code. The board made no such determination, according to the minutes of the board of directors. It is recommended that the company comply with s. Ins 42.03 (6), Wis. Adm. Code, concerning underwriting guidelines including the maximum annual premium volume. The administrative agreement also includes language stating that the maximum limit of liability on any policy should be $10,000,000 unless approved by the board of directors in writing and in advance. The company is writing property risks for several municipality members in excess of $10,000,000. The board of directors, according to its minutes, did not approve maximum limits in excess of $10,000,000. This is a violation of s. Ins 42.03 (6), Wis. Adm. Code, which requires that underwriting guidelines of the company are to include the maximum limits of liability. It is recommended that the company board of directors establish, and that the company require its MGA to comply with, underwriting guidelines set forth by the board of directors, including the maximum limit of liability, in accordance with s. Ins 42.03 (6), Wis. Adm. Code. 46 Aegis is to provide the company with “an independent financial examination” in accordance with s. Ins 42.05 (1), Wis. Adm. Code. During the period under examination Aegis provided an independent financial review for the year ended November 30, 2002, and an independent financial review for the year ended December 31, 2003. The reviews performed consist principally of inquiries of Aegis personnel and analytical procedures applied to financial data. These procedures are substantially less comprehensive in scope than an audit in accordance with generally accepted auditing standards. It is recommended that the company comply with s. Ins 42.05 (1), Wis. Adm. Code, by requiring its MGA to provide annual audited financial statements to the company and to amend its administrative agreement to include this requirement. At least semiannually, the company is to conduct an on-site review of the underwriting and claims processing operations of its MGA pursuant to s. Ins 42.05 (3), Wis. Adm. Code. WCA provided an annual review of Aegis to the WCMIC and CIC boards during 2003 and 2004. During 2002, one review of Aegis was performed after CIC initiated writing business. The examiners requested and obtained the reports associated with these reviews. WCA was also requested to provide all work papers associated with the reviews. The examiners found that no work papers were created for the reviews performed. WCA’s reports stated they performed a walk-through of Aegis’ operations and held conversations with office personnel concerning their responsibilities. WCA’s reviewer for 2002 is now an employee of Aegis. The WCA employee who performed the latest reviews of Aegis does not have an accounting background or a technical insurance background and was not provided with an audit guide to assist with a review. All of the reports included nearly identical paragraphs. The reports discussed Aegis’ claim reconciliation processes although there were no tests of the processes. The reports mentioned that they analyzed the underwriting practices and confirmed Aegis is following the policies established by the underwriting committee and the board of directors; however, there was no discussion or documentation of any tests performed. The reports did not discuss any analysis of claims processing. The company has violated s. Ins 42.05 (3), Wis. Adm. Code, by not conducting meaningful reviews as required by the rule. It is recommended that the company comply with s. 47 Ins 42.05 (3), Wis. Adm. Code, by performing a semiannual review of the underwriting, reinsurance accounting and claims processing operations of its managing general agent. The performance of such semiannual reviews may alternate between WCASI and a person independent of WCASI and the managing general agent, both of whom shall posses appropriate underwriting, reinsurance accounting and claims processing expertise. As discussed in the “Management Agreement” section of this report, the administrative agreement also does not clearly define how fees are affected by return premium as a result of audit adjustments or policy cancellation. It is recommended that the company amend its administrative agreement with Aegis to define how fees related to return premium are to be handled. The minimal amount of fidelity bond coverage the company should have in place was discussed in the management agreement section of this report. The company’s suggested fidelity bond coverage was calculated to be between $175,000 and $200,000. Currently Aegis has an employee dishonesty policy with a $25,000 limit. Since Aegis handles cash disbursements and performs all the administrative functions of the company, the administrative agreement should require at least the suggested minimum fidelity bond coverage. It is recommended that the company amend its administrative agreement to require the greater of the suggested minimum fidelity bond coverage in accordance with the NAIC Financial Examiners Handbook, or the results of a risk assessment, and provide evidence of such coverage to this office within 30 days after the adoption of this report. The administrative agreement requires that Aegis shall maintain professional liability insurance for errors and omissions, general liability, fidelity, and worker’s compensation. The agreement also states that each insurance policy shall contain an endorsement that it may not be cancelled without 60 days written notice to the company. The insurance policies reviewed provided the proper coverage but did not contain the 60-day notice requirement. It is recommended the company take measures to ensure that the insurance policies secured by the general administrator contain the agreed upon 60-day cancellation notice. 48 During the review of the administrative agreement, the examiners also noted that the company pays Aegis a sum of $405 for all member property claims or 4.7% of the actual loss, whichever is greater. This is a conflict of interest by creating an incentive for Aegis to settle a claim for a greater amount to receive a larger fee and could result in substantial fee overpayment for a large property claim (e.g., a maximum $500,000 property claim could result in a $23,500 adjusting fee to Aegis). This incentive is contrary to the company’s interest and violates s. 611.67, Wis. Stat. The examiners suggest that the fees paid for claims administration be based on an agreed upon amount considering severity and frequency factors rather than as a percentage of the claim. It is recommended that the company amend its administrative agreement to revise the fee schedule for claims administration so there is no potential conflict of interest. All renewed administrative agreements and amendments to administrative agreements were traced to board minutes to verify approval. The examiners noted that an amendment made to the administrative agreement dated December 5, 2003, was not approved by the board of directors. The amendment was to authorize Aegis’ takeover of claim adjusting from the outside claim service. Prior to the amendment, Aegis was responsible for overseeing the services of the outside claim adjustor. The board authorized the underlying selection of Aegis as the replacement claims processing firm; however, they did not approve the wording of the specific amendment to the administrative agreement reflecting this transfer. Amending the agreement without board approval is contrary to ss. 611.51 and 611.67, Wis. Stat. It is recommended that the company not allow amendments to agreements without approval from the board of directors. It was also noted that employees of Aegis attended all the board meetings and there was no indication that the board went into closed session to discuss Aegis’ duties and fees under the administrative agreement. It is recommended that the board of directors go into closed session when a conflict of interest arises between the parties attending the board meetings. According to the administrative agreement, Aegis is to maintain the appropriate records and procedures to comply with the regulatory requirements of the commissioner and to maintain books and records in a manner consistent with the NAIC Accounting Practices and 49 Procedures Manual. This report finds, as outlined in subsequent sections, that Aegis did not comply with this requirement. It is recommended that the company enforce the responsibilities of its managing general agent under the administrative agreement or terminate Aegis for noncompliance. Reinsurance Intermediary-Broker This section of the report discusses the company’s relationship with Aegis as its reinsurance intermediary-broker (as defined in ch. Ins 47, Wis. Adm. Code), and contains examples of noncompliance with ch. Ins 47, Wis. Adm. Code, including: Aegis’ appointment of AIMS, LLC, without the board of directors’ specific approval, Aegis’ failure to maintain and provide certain financial information to the board, and Aegis’ and AIMS, LLC’s lack of proper licensure as a reinsurance intermediary-broker. The administrative agreement states that Aegis is responsible for procuring reinsurance coverages and may receive a usual and reasonable fee for this service. According to s. Ins 47.03, Wis. Adm. Code, no insurer may enter into a reinsurance intermediary-broker agreement unless it includes the following clauses: 1. The insurer may terminate the reinsurance intermediary agreement at any time; 2. The reinsurance intermediary will render accounts to the insurer accurately detailing all material transactions, including information necessary to support all commissions, charges and other fees received by or, owing to the reinsurance intermediary, and remit all funds due to the insurer within 30 days of receipt; 3. The reinsurance intermediary will hold all funds collected for the insurer's account in a fiduciary capacity in a qualified United States financial institution; 4. The reinsurance intermediary will comply with s. Ins 47.04, Wis. Adm. Code, in regards to books and records they maintain; 5. The reinsurance intermediary will comply with the written standards established by the insurer for the cession or retrocession of all risks; and 6. The reinsurance intermediary will disclose to the insurer any relationship with any reinsurer to which business will be ceded or retroceded. The administrative agreement between the company and Aegis does not comply with any of the provisions set forth in s. Ins 47.03, Wis. Adm. Code. 50 In addition, Aegis does not act directly as an intermediary for the company’s business. An affiliate of Aegis, AIMS, LLC, acts directly as an intermediary and places the company’s business with reinsurers. AIMS, LLC, was initially organized as American Insurance Marketing Services, Inc. American Insurance Marketing Services, Inc., was reorganized to AIMS, LLC, in December 1997. However, in most reinsurance agreements the reinsurance intermediary-broker was referred to as American Insurance Marketing Services, Inc. Through inquiries with Aegis and the primary reinsurer and review of a producer’s agreement between Aegis and AIMS, LLC, the examiners concluded that the reinsurance agreements were never updated to reflect the current name, AIMS, LLC. The examiners were provided the producer’s agreement between Aegis and AIMS, LLC. According to the producer’s agreement, Aegis is to collect the ceded reinsurance premium from the company and forward it to AIMS, LLC. Aegis personnel issue CIC’s checks for reinsurance premiums that are signed by Aegis officials; some checks for reinsurance premiums were made payable to Aegis, others were payable to AIMS, LLC. The direct payments by the company to AIMS, LLC, are not in accordance with the producer agreement. It was also noted that over the last two years AIMS, LLC, was named as the intermediary under the “Intermediary Clause” of almost every reinsurance agreement. There is no evidence of a written reinsurance brokerage agreement between AIMS, LLC, and the company. Also, there is no record of Aegis telling the board that they were using AIMS, LLC, rather than Aegis as its intermediary. According to s. 47.03, Wis. Adm. Code, no reinsurance intermediary may continue an agreement for the reinsurance intermediary to represent the insurer as a reinsurance intermediary unless the reinsurance intermediary obtains written authorization from the insurer and complies with the provisions outlined above. Moreover, the arrangements described establish that the company violated ss. 611.51 and 611.67, Wis. Stat., by failing to establish adequate controls over its administrator. It is recommended that the company have a written reinsurance intermediary agreement with all entities that provide placement of business with reinsurers, that such agreements fully comply with s. Ins 47.03, Wis. Adm. Code, and that the company enforce the terms of the agreements. 51 None of the reinsurance agreements issued to the company indicated a brokerage fee payable to Aegis or AIMS, LLC, nor is there a separate agreement between the reinsurer and Aegis or AIMS, LLC. In some instances, placement slips were issued before the executed reinsurance agreement documenting a brokerage commission. A placement slip’s typical function is to outline a reinsurance agreement prior to the execution of an agreement. Once a reinsurance agreement is executed, the corresponding placement slip is typically no longer applicable. It is unclear what legal status a placement slip would have once a reinsurance agreement has been executed. Furthermore, at times a brokerage fee was collected by Aegis and AIMS, LLC, from the reinsurer when there was no evidence a fee was agreed upon. Brokerage fees paid by the reinsurers to Aegis and AIMS, LLC, for placing WCMIC’s business in 2003 and 2004 amounted to $245,644 and $473,639, respectively. For the company’s primary reinsurance agreements, brokers’ fees were 22.5% of ceded premium. Of this amount, 12.5% of the ceded premium was payable to AIMS, LLC, as a reinsurance brokerage fee and 10% of the ceded premium was payable to Aegis for providing placement support services. The primary reinsurer stated that its usual brokerage rates range from 5% to 10% with the average rate for 2004 being 5.11%. Again, as discussed above, the administrative agreement states Aegis may receive a usual and reasonable fee for this service. The compensation received by Aegis and AIMS, LLC, related to their placement of reinsurance is higher in comparison to the primary reinsurer’s average rate for 2004. Aegis explained the higher compensation to the primary reinsurer, regarding WCMIC, in an e-mail dated October 21, 2004, as follows: “Per our conversation, the brokerage to AEGIS / AIMS for Wisconsin County Mutual is 22.50% and the ceding commission to WCMIC is 10%. I realize this is different than ‘normal,’ but bear in mind that WCMIC has no employees. Aegis is the Program Administrators and we use the 22.50% ceding commission to (1) fund internal operations for Aegis for underwriting, policy issuance, etc., and (2) to pay brokerage to AIMS for marketing the reinsurance.” This explanation was unsatisfactory. As discussed above, Aegis is separately compensated by the company for underwriting, policy issuance, etc., as part of the administrative agreement. Moreover, there is no provision in the administrative agreement authorizing, and no documented disclosure to the company was found relating to, this additional AIMS, LLC, payment indirectly paid by the company. There is no record that Aegis informed the company of the full extent of the 52 brokerage fee or its nature. The board has not been informed of, or approved (according to the board minutes), this brokerage fee. This is a violation of s. Ins 47.03, Wis. Adm. Code. In one example, concerning 2003 coverage, a placement slip was issued on October 2, 2003, the agreement was executed on May 20, 2004, another placement slip was issued on March 10, 2005, and an amendment to the agreement was executed on March 14, 2005. This reinsurance agreement dated May 20, 2004, indicated a ceding commission payable to CIC of 22.5% of ceded premium which would have amounted to approximately $486,000. The company was never paid this commission; instead the amendment dated March 14, 2005, (after the termination of the agreement and during examination fieldwork) removed the commission clause from the agreement. The reinsurance agreement also did not indicate a brokerage commission but the placement slip dated March 10, 2005, documented a brokerage commission of 22.5%, which had been paid to Aegis and AIMS, LLC, during the effective period of the agreement. Aegis and AIMS, LLC, have not fulfilled their duty under s. Ins 47.03 (2), Wis. Adm. Code, to disclose and account for all “information necessary to support all commissions….” The company has violated ss. 611.51 and 611.67, Wis. Stat., by failing to exercise oversight over Aegis and AIMS, LLC, with respect to their compensation, including enforcing the requirement that Aegis and AIMS, LLC, maintain records under s. Ins 47.04, Wis. Adm. Code, and routinely auditing those records, including commission records. It is recommended that the company provide in any agreement for managing general agent services that the managing general agent shall not, and shall cause all of its affiliates, officers and agents to not: 1. Act as a reinsurance intermediary for the company as defined under ch. Ins 47, Wis. Adm. Code; or 2. Accept or solicit, directly or indirectly, any consideration or compensation relating to reinsurance negotiated for, or placed by, the company. This recommendation is not a restriction on the company compensating a managing general agent for providing advice relating to its reinsurance negotiations or placement provided that the managing general agent does not act as a reinsurance intermediary for the company. 53 Aegis issues and signs CIC’s checks for ceded reinsurance premium, made payable to Aegis and AIMS, LLC. A review was performed comparing the dates these payments were made by CIC to Aegis and AIMS, LLC, and the date the reinsurer received payment from Aegis or AIMS, LLC. Aegis and AIMS, LLC, held the ceded reinsurance premium, at times, for over nine months in their own accounts. Investment income on these funds were paid to Aegis and AIMS, LLC, not the company. Additionally, the payments made by Aegis or AIMS, LLC, to the reinsurer were regularly paid months after the due date specified in the agreement. CIC lost the opportunity to earn investment income. The examiners calculated lost investment income to exceed $57,000 during 2003 and 2004 using a modest interest rate of 3.46%. The interest income paid to Aegis and AIMS, LLC, while holding the company’s funds was not disclosed to, or reimbursed to, the company. WCASI is supposed to review and approve reinsurance payments made to Aegis. However, the board, according to board minutes, was not aware of the investment income paid to Aegis and AIMS, LLC, rather than to the company. There is no evidence that WCASI conducted audits that would identify the issue with respect to the timing of reinsurance premium payments or that Aegis and AIMS, LLC, disclosed this practice to the company. Aegis and AIMS, LLC, are required by s. Ins 47.03 (3), Wis. Adm. Code, to hold funds from the company in a segregated fiduciary capacity. Their failure to do so is a violation of s. 47.03 (3), Wis. Adm. Code. Failure to disclose loss of CIC’s investment income would be a violation of s. 628.34 (1), Wis. Stat. The company’s failure to oversee Aegis with respect to this matter is a violation of ss. 611.51 and 611.67, Wis. Stat. Section Ins 47.04, Wis. Adm. Code, states “A reinsurance intermediary-broker shall keep a complete record for each transaction for at least 10 years after expiration of each contract of reinsurance transacted by the reinsurance intermediary-broker showing ….” As a part of this requirement, Aegis is responsible to keep financial records and all related correspondence. Aegis did not have the past two years of financial transactions. The data had to be recreated by Aegis. Also, the examiners obtained WCMIC and CIC receipt and payment documentation from the primary reinsurer to compare with records provided by Aegis. Aegis’ records listed some ceded premium payments amounting to approximately $1.0 million and two losses recovered amounting 54 to approximately $1.0 million for WCMIC. However, the primary reinsurer’s records did not list these ceded premium payments or the loss recoveries. Aegis was requested to show the examiners correspondence to the primary reinsurer informing them of the ceded premium being netted against losses recovered. Aegis was not able to provide any record showing the primary reinsurer was informed of this transaction. Because WCMIC had these problems and similar procedures exist for CIC, examiners are making a similar recommendation to both WCMIC and CIC. It is recommended that the company require all reinsurance intermediaries to comply with the provisions of s. Ins 47.04, Wis. Adm. Code, and that the company enforce the provisions of its agreement with any managing general agent with respect to reinsurance functions. Section Ins 47.05, Wis. Adm. Code, provides, in part: 1. An insurer may not use the services of any person to act as a reinsurance intermediary-broker on its behalf unless the person is licensed as required by this chapter. 2. An insurer may not employ an individual who is employed by a reinsurance intermediary-broker with which it transacts business, unless the insurance intermediary-broker is under common control with the insurer …. 3. An insurer shall annually obtain a copy of statements of the financial condition of each reinsurance intermediary-broker with which it transacts business. 4. A reinsurance intermediary-broker required to be licensed under this chapter may not bind, and an insurer may not give the reinsurance intermediary-broker authority to bind, cede reinsurance on behalf of the insurer, …. Aegis and AIMS, LLC, are not licensed reinsurance brokers as required by s. Ins 47.05 (1), Wis. Adm. Code. Some individual Aegis-associated persons are licensed as reinsurance intermediarybrokers: Robert Wurtz, Blair Rogacki, and Peggy Shonkwiler. Aegis acts as the company’s MGA for all business. Aegis and its subsidiary AIMS, LLC, both act as the company’s reinsurance intermediary. This creates a potential conflict in the duties of the broker and does not comply with the intent of s. Ins 47.05 (2), Wis. Adm. Code. WCMIC and CIC have no employees; Aegis staff perform the function that company employees would typically perform relating to oversight and management of reinsurance. Aegis staff also perform the reinsurance intermediary functions. This creates a potential conflict. The company and the board did not review the financial condition of the brokers as required by s. Ins 47.05 (3), Wis. Adm. Code. Both brokers have bound reinsurance agreements contrary to s. Ins 47.05 (4), Wis. Adm. Code. In addition, the company 55 gave Aegis authority to bind and cede reinsurance on behalf of the company in violation of s. Ins 47.05 (4), Wis. Adm. Code. It is recommended that the company comply with the prohibited functions of a reinsurance intermediary-broker according to s. Ins 47.05, Wis. Adm. Code, and that these matters be addressed in the Management Plan. Reinsurance In an initial request sent to the company by OCI dated August 31, 2004, Aegis was asked to have available for examiners on November 8, 2004, “A copy of all reinsurance agreements currently in effect, including all amendments made to the agreements. We would request that we be provided the signed copies.” Aegis and AIMS, LLC, could not provide all executed reinsurance agreements under which the company had coverage. In some instances an executed reinsurance agreement did not exist; in other instances Aegis did not maintain an executed copy of the agreement. Aegis was still locating reinsurance agreements on April 8, 2005, seven months after the date of the initial request and five months after the due date. An appropriate recommendation has been made under the heading “Retention of Records.” The examiners provided the following summary of the company’s reinsurance coverages during the period under examination to indicate agreements that were not executed: Coverag e Year 2002 Effective Date 7/1/02 Date Executed 5/20/04 Coverage GL, AL, W/C and E&O First Layer ($900k x $100k) Second Layer ($4m x $1m) GL, AL, W/C and E&O First Layer (95% of $750k x $250k) Second Layer (95% of $4m x $1m) W/C $5m x $5m GL, AL, W/C and E&O First Layer (95% of $750k x $250k) Second Layer (95% of $4m x $1m) GL, AL and E&O $5m x $5m W/C $5m x $5m W/C $10m x $10m Form A 2003 A 7/1/03 5/20/04 A A 1/1/03 7/1/04 N/A 3/14/05 2004 PS A PS 1/1/04 1/1/04 7/1/04 N/A N/A N/A Key: Coverage GL=General Liability AL=Auto Liability W/C=Worker’s Compensation E&O=Errors and Omissions Form A=Agreement PS=Placement Slip 56 In some instances, there were executed agreements but they were not signed within nine months of the effective date of the agreement, per Statement of Statutory Accounting Principles (SSAP) No. 62, paragraph 23. A reinsurance agreement is not properly executed until both the company and the lead reinsurer (majority share/50% coverage) sign the agreement. Aegis provided the examiners with placement slips of reinsurance coverages when no executed reinsurance agreement existed. Placement slips are not reinsurance agreements; placement slips only outline the underlying reinsurance agreement. The underlying reinsurance agreements include critical clauses including insolvency clauses, right to offset, etc., while placement slips do not include such detail. The parties signing the placement slips do not receive full documentation of the agreements they are signing; therefore, placement slips alone do not demonstrate that the agreements are properly bound and finalized. It is recommended that the company ask its reinsurers to deliver signed copies of all reinsurance agreements entered into since its commencement date of writing business and in those situations where reinsurance coverage has been bound by placement slip, to properly sign all reinsurance contracts received, and submit copies of those reinsurance agreements to this office within 90 days after the adoption of this report. In addition, the administrative agreement states that the MGA may not bind reinsurance or retrocessions on behalf of the company pursuant to s. Ins 42.03 (13) (a), Wis. Adm. Code. In some instances, the board of directors has given Aegis the authority to bind reinsurance agreements regardless of the administrative agreement and in violation of ss. Ins 42.03 (13) (a) and 42.05 (4), Wis. Adm. Code. For example, a report provided by Aegis to the underwriting committee for the June 8, 2004, meeting stated, “The General Administrator recommends that the committee recommend that the Board of Directors grant authority to the General Administrator to place this reinsurance [described in Aegis’ report] as proposed.” Aegis recommended action that violates the MGA rule, broker rule, and the administrative agreement, and the board approved Aegis’ recommendation. Pursuant to s. Ins 42.05 (4), Wis. Adm. Code, binding authority for reinsurance agreements shall rest with an officer of the insurer who is not associated with the MGA. The proper action would be to appoint a CIC officer to bind CIC’s 57 reinsurance agreements. This is an unlawful delegation of duties by the board of directors pursuant to ss. 611.51 (6) and 611.67 (2), Wis. Stat., and a violation of ss. Ins 42.03 (13) (a) and 42.05 (4), Wis. Adm. Code. It is recommended that the board of directors authorize all reinsurance agreements and properly have them bound by an officer of the company in accordance with ss. Ins 42.03 (13) (a) and 42.05 (4), Wis. Adm. Code. Some of the executed reinsurance agreements did not comply with SSAP 62, paragraph 8, in regards to requiring the company to provide reports of premiums, losses and payment of losses no less than on a quarterly basis to the reinsurer. In addition, when the company was only able to provide a placement slip for reinsurance coverage, the placement slip only stated in outline form that it included an insolvency clause. The examiners were unable to determine whether the actual insolvency clause was in compliance with SSAP 62, paragraph 8. It is recommended that the company only enter into reinsurance agreements that contain language in regards to reporting requirements and insolvency clause in accordance with Statement of Statutory Accounting Principles No. 62, paragraph 8, of the NAIC Accounting Practices and Procedures Manual. Some reinsurance agreements named both WCMIC and CIC as ceding companies. The shared excess reinsurance agreements do not establish how the companies are to divide the annual premium payments. The examiners did not determine whether the allocations made by Aegis would be considered fair and reasonable. The shared reinsurance agreements did include reinstatement clauses and aggregate reinsurance limits. However, there is no written agreement between WCMIC and CIC addressing these issues. There should be a written agreement in place between WCMIC and CIC to establish how the companies are to address the following for reinsurance agreements they share: 1. How to divide the annual premium payments; 2. How reinstatement premium would be allocated depending on the companies’ respective losses that triggered the reinstatement; and 3. In the event that WCMIC’s and CIC’s aggregate ceded losses exceeded the limit of the reinsurance agreement, how the recovery would be divided between WCMIC and CIC. It is recommended that the company establish a written agreement that addresses fair and reasonable allocation of reinsurance expenses and recoveries. 58 It was found that it is Aegis’ practice to submit a request to collect reinsurance recoverables on paid losses to the reinsurer only when the claim has been fully settled. In complex cases, insured by WCMIC, it has taken several years to completely settle a claim in which the recoverables amounted to over a million dollars. Failure to request prompt payment for paid losses may cause the company to lose the opportunity to earn investment interest income which is not in the best interest of CIC. It is recommended that the company reevaluate its procedures for collecting reinsurance recoveries. The examiners reviewed the 2002 through 2004 reinsurance agreements with SCOR Re to ascertain whether the agreements properly documented retroactive coverages CIC issued to its policyholders. It appeared the company had proper coverages for 2003 and 2004. However, there was no indication for 2002 that CIC was properly reinsured for the retroactive coverages. The examiner inquired with Aegis for the 2002 coverage; Aegis responded in an email dated July 12, 2005, that “it was not excluded in the CIC coverage but we are getting an addendum to clarify intent.” It is recommended that the company obtain proper reinsurance confirmations or endorsements to document that there is reinsurance coverage for its retroactive coverages for all years in which it wrote this product. Ceded Premium The company reported ceded premium on the 2003 annual statement as follows: first, they included half of the amount of ceded premium for policies with 2002 effective dates that had earned premium in January through June 2003 to which they applied the 2002 ceding premium rate, and, second, they included half of the amount of ceded premium for policies with 2003 effective dates that had earned premium in July through December 2003 to which they applied the 2003 ceding premium rate. The company should report premiums written and the respective premiums ceded at the time the policy and reinsurance agreement become effective, in accordance with SSAP 53 and SSAP 62, not when the premium was earned. In both 2002 and 2003 the company overstated net premium written by not including the full amount of premium ceded. It is recommended that the company recognize ceded premium at the inception of the 59 policy in accordance with Statements of Statutory Principles No. 53 and No. 62 of the NAIC Accounting Practices and Procedures Manual. Excess Property Coverage CIC began writing property coverages on February 1, 2004. The coverages the company offers includes flood insurance. During 2004, seven municipalities obtained property coverage from the company with risks of $25,200,000, $9,800,000, $7,600,000, $5,800,000, $2,400,000, $1,400,000, and $600,000, including auto physical damage. Aegis’ subsidiary, AIMS, LLC, also placed a master policy, excess of $500,000, written by The Travelers Indemnity Company (Travelers), effective February 1, 2004, for these insureds. AIMS, LLC, did not deliver the Travelers’ master policy to these insureds. Both the CIC and Travelers’ policies include standard language concerning “Other Insurance.” The “Other Insurance” provision defines the policy provisions when two insurers offer the same or similar coverage. Within the “Other Insurance” section applicable to the coverages provided by CIC and Travelers, the “Underlying Insurance” clause states (the same in both the CIC and Travelers policies), “Permission is granted to the Insured to purchase insurance on all or any part of the deductibles of this policy, and the existence of such underlying insurance will not prejudice any recovery otherwise payable under this policy. If the limits of such underlying insurance exceed the deductible which would apply under this policy, then the insurance provided by this policy will apply only as excess after the limits applicable to the underlying insurance, including that portion which exceeds such deductible, have been exhausted.” Aegis states its intent was to have the Travelers’ policy cover all losses exceeding $500,000, which is the amount of the deductible in the Travelers’ policy, and the CIC policy cover losses up to $500,000. However, Aegis inadvertently issued CIC property coverage with limits reflecting the total risk rather than the intended coverage limit of $500,000. Consequently, CIC arguably could be viewed as the primary insurer of the property up to the described policy limits, with no “reinsurance” in place, because the limits of CIC’s underlying insurance would exceed the $500,000 deductible which would apply under the Travelers policy. The CIC property policies issued have deductibles much less than $500,000, and the coverage limits of $600,000 to 60 $25,200,000 far exceed Travelers’ $500,000 deductible. Therefore, the CIC policy is considered the “Underlying Insurance.” The Travelers’ policy could be construed as an excess policy covering losses in excess of CIC’s policy limits stated above, not as the insurer of claims in excess of $500,000. It is Aegis’ responsibility, as the company’s underwriter, to have an understanding of the standard language of the “Underlying Insurance” provision included in the CIC and Travelers’ policies and to understand why this Travelers’ policy is not acting as “reinsurance” for claims above $500,000. Examiners contacted Travelers to obtain its interpretation of the coverage of the CIC and Travelers’ property policies. An attorney for Travelers indicated the “Underlying Insurance” clause would have the effect described above. The examiner contacted Aegis on June 28, 2005, regarding this matter and requested that Aegis provide its comments. Mr. Wurtz replied on the same date stating, “If the [Travelers] language is unclear, that is one problem but the intent was clear.” As a result of OCI raising this issue, Aegis reported that it issued endorsements to affected CIC policyholders clarifying that coverage in excess of $500,000 was provided on a direct basis by Travelers. Risk limitations pursuant to s. Ins 6.72, Wis. Adm. Code, states, in part, no single risk assumed by any insurance company shall exceed 10% of surplus as regards policyholders. The company’s risk limitation net of reinsurance at year-end December 31, 2003, would amount to $756,790. Prior to the issuance of clarifying endorsements, the company arguably exceeded retentions set by the board of $250,000 per risk. It is recommended that the company immediately obtain reinsurance for the property coverages it has issued and submit to this office verification of reinsurance coverages within 10 days of adoption of this report. The examiners’ review of the Travelers’ policy also noted that three of CIC’s property insureds were not separately named as insureds on the Travelers’ policy. Because of that omission, even if the Travelers’ policy would have functioned in the way Aegis and CIC intended, two of the three policies mentioned would still have exceeded risk limitations pursuant to s. Ins 6.72, Wis. Adm. Code, and all three would have exceeded retentions set by the board of $250,000 per risk. When the examiners expressed concern, Aegis proceeded to have the Travelers’ policy 61 amended to include one of the insureds on April 29, 2005, during examination fieldwork. The Travelers’ policy was later amended to include the other two insureds. It is recommended that when the company obtains proper reinsurance coverage for property coverages it clearly includes all insureds having risk greater than the retentions set by the board. Furthermore, it was noted that the Travelers’ policy was never issued to the individual policyholders as prescribed by ss. 631.05 and 631.61, Wis. Stat. This is a responsibility of Travelers not CIC. However, in correspondence with Travelers they indicated that it was not their practice to send a policy to each of the listed insureds. They send a copy of the policy to the agent (Aegis) with the expectation that the agent will distribute the policy as appropriate. Aegis failed to distribute copies of this Travelers’ policy to the policyholders, so those policyholders did not have the opportunity to learn about possible defects in their coverage. CIC insureds were likely only aware of the CIC policy and would expect to file claims up to the maximum policy limit with CIC. If Aegis would have obtained appropriate reinsurance coverage this issue could have been avoided. Excess Liability Coverage During 2003 and prior, CIC provided additional liability limits, $5,000,000 in excess of $5,000,000 coverage, to some municipalities, through a direct insurance policy written by another insurer, The Insurance Company of the State of Pennsylvania (ICSP). CIC indicated this excess coverage through an endorsement included in the insured’s CIC policy. The endorsement included in CIC’s municipality liability policy for the 2003 year stated, in part, “In consideration of an additional premium charge of $(varies) it is hereby agreed that an additional ($1,000,000 up to $5,000,000) in liability limits is provided through ‘The Insurance Company of the State of Pennsylvania,’ Policy #4603-3664.” Some municipalities named as insureds under the ICSP policy effective during 2003 are insured by WCMIC, and others are insured by CIC. It is not clear whether CIC’s insureds would be included under the ICSP policy, as the ICSP policy states that insureds are members of WCMIC. The amendment to the ICSP policy reads, “It is hereby agreed that the named insured is completed to read as follows: Wisconsin County Mutual Insurance Corporation Members [then 62 members are listed individually].” The examiners inquired with Aegis concerning coverage for CIC’s insureds in the ICSP policy. After the examiners’ inquiry, Aegis had the 2003 ICSP policy amended to include CIC as an insured on March 16, 2005. The amendment to have CIC included as a listed insured still does not completely address the issue as CIC and CIC’s insureds are not members of WCMIC. The company has a responsibility to their insureds to review all agreements for completeness and all coverage representations for accuracy. Aegis has the same responsibility. Aegis was unable to provide a comprehensive listing of municipalities that had the excess coverage under the ICSP policy effective during 2003. The examiners were therefore unable to determine if there are any municipalities that have an endorsement for this coverage on a WCMIC or CIC policy that are not named on the ICSP policy. Because CIC included the endorsement within the CIC policy, CIC could be responsible for the additional $5,000,000 in excess of up to $5,000,000 of coverage if a CIC policyholder was not properly included as a named insured on the ICSP policy, which would exceed the company’s risk limitations pursuant to s. Ins 6.72, Wis. Adm. Code. The declaration page of both the WCMIC and CIC policies for the municipalities states a liability limit of $5,000,000. The endorsement included in the policy issued by WCMIC or CIC changes the liability limit on the declaration page. The change in the liability limit could be interpreted in more than one way. It could be interpreted that WCMIC or CIC are increasing their direct coverage to $10,000,000 and the excess insurance provided is for $5,000,000 in excess of $10,000,000, or that the coverage between $5,000,000 and $10,000,000 is shared between the insurers. The ICSP policy does not provide for a range of coverage, it clearly states that the endorsed are provided for coverage of $5,000,000 in excess of $5,000,000. Aegis was unable to provide a reasonable explanation as to how its underwriters determined endorsement coverages of $1,000,000 to $5,000,000 for different municipalities when the ICSP policy provides $5,000,000 coverage for every named insured. 63 It is recommended that the company retain a competent insurance consultant and a law firm to ascertain the risks of the company concerning the endorsements included in its liability policies issued to municipalities and inform this office of the results within 60 days after the adoption of this report. During review of the ICSP policy issued during 2003 for the counties and municipalities it was also noted that some municipalities were charged an additional premium for the excess coverage and some were not. The initial insureds of the ICSP policy were not charged a premium; the amount was paid by WCMIC as a benefit. However, municipalities that were included as an amendment to the policy after the initial issuance were charged premium for the coverage. The fact that some municipalities were charged an additional premium and some were not constitutes a violation of ss. 628.34 (3) (a) and 625.11 (4), Wis. Stat., due to unfair discrimination. It is recommended that the company not discriminate against its policyholders by charging different premiums for the same coverage in accordance with ss. 628.34 (3) (a) and 625.11 (4), Wis. Stat. During 2003 and prior, CIC provided additional liability limits, $5,000,000 in excess of $5,000,000 coverage, to some schools through another direct insurance policy written by ICSP. CIC indicated this excess coverage through an endorsement included in the insured’s CIC policy. This endorsement for the 2003 year stated, in part, “In consideration of an additional premium charged (25% fully earned at inception), it is hereby agreed that an additional ($1 million up to $5 million) excess of $5 million in liability limits is provided through ‘The Insurance Company of the State of Pennsylvania,’ Policy #4603-4626.” One of CIC’s insured schools had an endorsement indicating they had excess coverage in the CIC policy, but this school was not included as a named insured on the ICSP policy. The examiners inquired with Aegis concerning the missing school. After the examiners inquiry, Aegis had the 2003 ICSP policy amended to include the school as an insured on March 18, 2005. They also amended the 2002 policy with ICSP to include the missing school as an insured. Because CIC included the endorsement within the CIC policy, CIC would have been responsible for the school’s $2,000,000 in excess of $5,000,000 coverage, exceeding risk 64 limitations pursuant to s. Ins 6.72, Wis. Adm. Code. An appropriate recommendation has been included to ascertain the risks of the company concerning the endorsements under this heading. Aegis was unable to provide a comprehensive listing of schools that had the excess coverage under the ICSP policy effective during 2003. The examiners were therefore unable to determine if there are any schools that have an endorsement for this coverage on a CIC policy that are not named on the ICSP policy. Again, because CIC included the endorsement within the CIC policy, CIC could be responsible for the additional up to $5,000,000 in excess of $5,000,000 of coverage if a CIC policyholder was not properly included as a named insured on the ICSP policy which would exceed the company’s risk limitation pursuant to s. Ins 6.72, Wis. Adm. Code. It is recommended that the company retain a competent insurance consultant and a law firm to ascertain the risks of the company concerning the endorsements included in its liability policies issued to schools and inform this office within 60 days after the adoption of this report. Service Carriers The company contracts for all services with outside parties. The board should periodically consider whether it would be in the best interests of the company to negotiate a costbasis contract or perform the services in-house. It is recommended that this be addressed in the Management Plan. Change in Actuary The company changed its opining actuary for year-end 2004. In a conversation with Aegis they noted two factors leading to the board’s decision to change their actuary. The first factor was that the actuarial tools and ratios used by the former actuary were based on industry averages nationwide, which reflect longer-tailed liabilities that normally resolve within 10 to 15 years. Aegis believes that the block of business written by CIC should be reviewed differently, that the liabilities associated with this block business are normally resolved within 6 years. Therefore, Aegis believes the former actuary’s numbers did not accurately reflect the company’s situation. The second factor was that the former actuary used a 95% confidence factor in their reserving methodology for the company, which the company believes is too conservative. The company believes it is more appropriate for an actuary to apply a 50% confidence factor in its 65 reserving methodology. OCI’s consulting actuary concluded that CIC’s December 31, 2003, reserves should have been $162,000 greater than the reported amounts (which were determined by the company’s former actuary). It is the opinion of OCI’s actuary that a 10- to 15-year resolution period and using a 95% confidence factor are more appropriate than the approach proposed by the company. Considering the likeliness of a significant change in CIC’s reserving methodology OCI felt it was prudent to have its consulting actuary review the year-end 2004 actuarial report prepared by the new actuary and discuss the reasonableness of the new actuary’s methods and how those methods differ from the prior year. The consulting actuary reported that CIC’s new actuary used the same methods that were used by the former actuary reporting for year-end December 31, 2003. However, the consulting actuary was not able to comment on the conclusions reached by the new actuary in their actuarial report for the following reasons: 1. The paid and incurred data triangles supporting the new actuary’s selected loss development factors were not updated through December 31, 2004. The latest diagonal of data was only updated through December 31, 2003. Also, the supporting data triangles were not included in the new actuary’s actuarial report. 2. The accident year 2003 earned premium used by the new actuary in the paid and incurred Bornhuetter-Ferguson methods was not the same accident year 2003 earned premium that was used in the former actuary’s and the consulting actuary’s December 31, 2003, reviews of loss and loss adjustment expenses reserves. Discussions between the consulting actuary and CIC’s opining actuary could not resolve these earned premium discrepancies. OCI did not inquire further as to statement #1 above. However, to gain an understanding of statement #2 above, on July 18, 2005, OCI requested that the new actuary check their work papers and respond whether they were using the premium numbers as reported by the company or if the firm made an error in regards to the premium discrepancies. On July 28, 2005, subsequent to the end of the fieldwork date, the new actuary responded that its firm made the error and the correction of the error would result in immaterial differences. An appropriate recommendation is made below. A change of CIC’s actuary within its first five years would be a material change of the business plan filed when it obtained a license in 2002, and CIC failed to request and obtain permission from OCI to change its business plan pursuant to s. 611.28, Wis. Stat., as discussed 66 earlier in this report. Considering this and the discrepancies the consulting actuary reported, the examiners made the following recommendation: It is recommended that the company employ the former actuary to issue an opinion on the reserves reported for year-end December 31, 2004. Furthermore, the company is to notify this office within 30 days of the board of directors’ action stating the reasons for the replacement of their opining actuary in accordance with the NAIC Annual Statement Instructions – Property and Casualty. Notification was not received by this office for the decision to change actuaries. It is recommended that the company properly notify the Office of the Commissioner of Insurance of changes in appointed actuaries in accordance with the NAIC Annual Statement Instructions – Property and Casualty. Recognition of Written Premium The company records written premium only for the installment amount billed, not for the full term of the policy. In accordance with SSAP No. 53, paragraph 3, written premium shall be recognized at the effective date of the policy for the full term of the policy, regardless of whether the premium is paid in full or in installments. Also, when endorsements are made to a policy the additional premium is included as written premium in the following month. The company’s methodology earns the premium for the endorsement over the remaining installment period, rather than earning it over the remaining fullterm period of the policy as prescribed by SSAP No. 53, paragraph 8. Additional premiums charged to policyholders for endorsements shall be recorded on the effective date of the endorsement and recognized as revenue over the period of risk in proportion to the amount of insurance protection provided. It is recommended that the company recognize written premium for the full term of the policy and properly earn premium on endorsements in accordance with Statement of Statutory Accounting Principles No. 53 of the NAIC Accounting Practices and Procedures Manual in all future statutory financial statements. Allocation of Expenses During the review of the Underwriting and Investment Exhibit, Part 3, of the annual statement it was noted that the company allocated expenses for lines 3 to 18 by using a constant 67 percentage: loss adjustment expenses - 35%, other underwriting expenses - 45%, and investment expenses - 20%. CIC’s use of WCMIC’s method for allocating expenses was developed when it began writing business. There were no studies or analysis that documented the allocations used by Aegis for this schedule for WCMIC or CIC. The allocation used appears to allocate too much expense to investments and loss adjusting and not enough to underwriting. This results in understating net investment income, overstating loss adjusting expense and understating the underwriting expense ratio. According to SSAP No. 70, allocation should be based on a method that yields the most accurate results. Specific identification of an expense with an activity that is represented by either loss adjusting expense, investment expense, or other underwriting expense will generally be the most accurate method. Where specific identification is not feasible, allocation of expenses should be based upon pertinent factors or ratios such as studies of employees’ activities, salary ratios or other analysis. It was also noted that the company did not disclose the method used for the allocation of management and service fees in the Notes to Financial Statements. It is recommended that the company develop and apply a method consistent with Statement of Statutory Accounting Principles No. 70 of the NAIC Accounting Practices and Procedures Manual for reporting expenses on the Underwriting and Investment Exhibit, Part 3. It is further recommended that the company disclose the method used for allocation of management and service fees in the Notes to Financial Statements. Investments The company had a custodial agreement with a bank that did not contain all proper indemnification language as prescribed by the NAIC Financial Examiners Handbook. The agreement did not include the following provision, “in the event of a loss of the securities for which the bank or trust company is obligated to indemnify the insurance company, the securities shall be promptly replaced or the value of the securities and the value of any loss of rights or privileges resulting from said loss of securities shall be promptly replaced….” It is recommended that the company amend its custodial agreement to include language regarding the prompt replacement of lost securities in accordance with the NAIC Financial Examiners Handbook. 68 In reviewing the notes to the financial statements of the company’s year-end annual statement, it was noted that the company reported that the amortization of bond premium and accrual of discount is calculated by the company using the straight-line method. SSAP No. 26, paragraph 6, states, in part, that “Amortization of bond premium or discount shall be calculated using the scientific (constant yield) interest method.” It is recommended that the company amortize bond investments using the scientific method according to Statement of Statutory Principle No. 26, paragraph 6, of the NAIC Accounting Practices and Procedures Manual. Subsequent to the examination date, the company had begun investing in foreign markets. The company is subject to investment restrictions governed by s. 620.03, Wis. Stat., that prescribes special investment restrictions for insurers during the first five-year period after obtaining a certificate of authority. These restrictions as described in s. Ins 6.20 (4) and (5), Wis. Adm. Code, do not allow the company to invest in any foreign markets. Furthermore, after the first five years, foreign investments are subject to certain investment restrictions as described in s. Ins 6.20 (8) (k), Wis. Adm. Code, which limits such investments to 2% of the insurer’s assets. As of December 31, 2004, the company had $937,892 invested in foreign markets, approximately 6% of assets of $16,401,201. It is recommended that the company comply with investment restrictions prescribed by s. 620.03, Wis. Stat., and s. Ins 6.20, Wis. Adm. Code. Cash Disbursements Aegis does not have adequate controls in place over CIC’s cash disbursements. Aegis is responsible for the issuance of all checks including commissions, administrative and corporate fees, reinsurance, legal and financial services, advertisements and membership fees. In discussions with Aegis it was found that there is not a control in place limiting the authorization of Aegis to disburse the company’s cash. Aegis stated some invoices, such as legal and financial services, are sent directly to WCA. Invoices received by WCA are to be approved and then forwarded to Aegis for payment. The examiners found one invoice for legal services for WCMIC that had no approval from WCA. According to the management agreement the company has with WCASI, WCASI is to review and approve the expenditures of funds associated with any services contract approved by 69 the board prior to the disbursement of such funds. It does not appear that WCASI is fulfilling their responsibilities per the management agreement. Other elements of this issue are discussed in this section under the heading, “Management Agreement.” Checks are issued by the same Aegis employee who performs the reconciliation of cash disbursements to the general ledger, which is a violation of critical segregation of duties. This employee can also process an invoice request and has access to accounts payable. The critical segregation of duties is the separation of the requisitioning function from the accounts payable and disbursement functions. If one individual can both process an invoice request and gain access to the accounting records, there is an increased risk that fictitious or improper cash disbursements will be made and recorded. It is recommended that the company place controls over cash disbursements, including establishing a limit for cash disbursements that require approval from a party independent of Aegis, and segregate duties appropriately to gain a more secure control environment. Information System Controls A review of the company’s password controls noted that the company did not require users accessing its data to periodically change passwords. Periodic changes of passwords help to secure the passwords’ effectiveness and can limit potential damage caused from prolonged unauthorized use. The NAIC Financial Examiners Handbook currently suggests password changes on at least a quarterly basis. It is recommended that the company require its users accessing its data to change passwords on at least a quarterly basis according to the NAIC Financial Examiners Handbook. The examiners noted that the company had not developed a comprehensive security policy. A formal security policy helps establish standards for asset protection by assigning responsibilities and providing basic rules, guidelines, and definitions for personnel within the organization to assist in protecting the company’s critical computer assets including electronic data and proprietary information. This helps to prevent inconsistencies that can reduce risks and serves as a basis for the enforcement of more detailed rules and procedures. It is recommended 70 that the company develop and implement a written security policy to assist in protecting its critical computer assets. Retention of Records Section Ins 6.80 (4) (a), Wis. Adm. Code, requires, in part, that “General ledgers shall be retained as permanent records” and “rate books, agents’ handbooks, underwriting manuals, specimen forms, and related actuarial material, as well as reinsurance contracts, shall be retained as long as the related insurance coverage remains in force.” Section Ins 6.80 (4) (b), Wis. Adm. Code, requires that “Records of insurance company operations and other financial records reasonably related to insurance operations for the preceding 3 years shall be maintained and be available to the commissioner.” Section Ins 6.80 (4) (c), Wis. Adm. Code, requires that “Records maintained under par. (b) may be in written form or any other form capable of being converted to written form within a reasonable period of time.” Aegis had difficulties providing the examination team with adequate data and documents pertaining to 2003 loss payment detail, expense payment detail and reserve detail in a prompt manner. There were two times where data files that were requested and obtained by the examiners were not usable due to irreconcilable differences that could not be explained by Aegis. The examination team spent an extensive amount of time trying to reconcile data files provided by Aegis to the 2003 annual statement, that Aegis staff later stated could not be reconciled. There was also an instance where a difference was noted between two data files which could be explained by Aegis personnel; however, the explanation was not provided in a prompt manner. Aegis failed to save the company’s year-end loss records in accordance with s. Ins 6.80, Wis. Adm. Code. Considerable delays were also experienced in obtaining adequate data and documents pertaining to premiums. On two occasions Aegis provided inaccurate or incomplete information. For example, written premium files provided at the beginning of the examination did not indicate payment frequency. The company incorrectly reported written premium as the amount billed for the next installment, and the company incorrectly reported zero deferred premium receivable on the 2003 annual statement. To examine the premiums, a listing of policies 71 including payment frequency was required. Aegis took in excess of a month to provide this report. Testing the completeness and accuracy of the report showed it was not reliable. The written premium recorded by Aegis included endorsements and duplicated these same endorsements separately on a number of occasions, therefore, overstating total written premium. Aegis failed to save the company’s year-end premium records in accordance with s. Ins 6.80, Wis. Adm. Code. For the review of cash disbursements, the examiners requested a listing of disbursements the company made during December 2003. Aegis provided a listing but when comparing the listing to a sample of checks written during December 2003 it was found that some checks were omitted. Aegis failed to save the company’s year-end cash disbursement records in accordance with s. Ins 6.80, Wis. Adm. Code. These records are all required to be maintained under the mandatory MGA contract provisions of s. Ins 42.03, Wis. Adm. Code. The company’s failure to detect and require correction of these record deficiencies establishes that it did not adequately perform the review required by s. Ins 42.05, Wis. Adm. Code, and is in violation of ss. 611.51 and 611.67, Wis. Stat. It is recommended that the company retain adequate records and documentation in accordance with s. Ins 6.80, Wis. Adm. Code, conduct a competent review that complies with s. Ins 42.05, Wis. Adm. Code, and provide such records and documentation to OCI in a timely manner in order to facilitate the examination process. Annual Statement Reporting Deficiencies CIC’s annual and quarterly statements filed with this office have frequently contained reporting deficiencies and reporting errors requiring follow-up correspondence with the company and subsequent amendment of the statements. Amendments were made to seven different schedules or other reporting sections of the original 2002 filings, nine for the 2003 filings and, to date, five for the 2004 filings. In addition, other reporting deficiencies or reporting errors, not mentioned elsewhere in this section of the examination report, were noted as follows: • The 2003 annual statement filed did not report that the company made changes to its bylaws in General Interrogatory, Part 1, #2.1. In addition, the company did not properly indicate new officers and directors on the jurat page with a “#” symbol. 72 • The 2003 annual statement filing made by the company did not include an answer for interrogatory #19.2. The company reported in interrogatory #19.1 that all the stocks, bonds, and other securities owned December 31 of the current year, over which they have exclusive control, were not in their possession. Interrogatory #19.2 is to elaborate on a “no” response for interrogatory #19.1 including full and complete information relating to owned securities not under their control. On Schedule F, Part 3, of the 2003 annual statement the company reported one reinsurance syndicate as a participating reinsurer. In fact, there were nine other participating reinsurance syndicates listed on the placement slip along with their corresponding participation percentages. The company is to report all reinsurers that assume business from the company during the year on Schedule F, Part 3. The company did not properly document the capital contributions received by WCMIC in note 10b in the Notes to the Financial Statements of the Annual Statement filed for yearend 2002. The 2002 annual statement filed with this office also did not indicate in the Notes to the Financial Statements that the company received a $3 million capital contribution from WCMIC which the board approved on December 6, 2002. Schedule DM of the annual statement summarizes the difference between aggregate statement value and the fair values of bond and preferred stock holdings and Schedule D, Part 1, of the annual statement reports all long-term bonds owned by the company. During the review of these schedules for year ended December 31, 2003, the examiners noted that Schedule DM reported the company’s bond holdings with a statement value of $12,479,172 and a fair value of the same amount, whereas Schedule D, Part 1, reported the company’s bond holdings have a statement value of $12,479,172 and a fair value of $12,724,413. These schedules should have agreed. The holding company filings made by the company for years ended December 31, 2002 and 2003, were filed on the behalf of WCMIC. CIC is required to make the filing, not WCMIC. General Interrogatory #25 asks for information about payments to any trade association, service organization, and statistical or rating bureau. A service organization is defined as every person, partnership, association or corporation that formulates rules, establishes standards, or assists in the making of rates or standards for the information or benefit of insurers or rating organizations. The company reported for year-end 2003 a total of $381,803 paid to WCASI. The company should also include fees paid to Aegis and fees paid to the Wisconsin Compensation Rating Bureau. In a quarterly filing made by the company for first quarter 2003, the analysis team discovered the company did not properly record net investment income earned, causing prior year-to-date net income earned, net income, and change in surplus to be reported incorrectly. The company did amend its records for net investment income earned but did not file the amended pages with OCI or with the NAIC. In reviewing the Management and Discussion Analysis (MD&A) the company filed for year ended December 31, 2003, the examiners noted the following deficiencies: 1. no discussions of two-year results - historical trends, 2. noting balance sheet changes from the prior year but few discussions on what caused the change, and 3. no discussion of any known demands likely to result in material increases or decreases in cash flow (e.g., obtaining authority to write property insurance). • • • • • • • 73 • Subsequent to the examination date, the examiners noted that the Third Quarter 2004 statement filed by the company did not include Schedule DB, Part F, Sections 1 and 2, relating to replicated asset holdings. When schedules to the statement do not relate to the company they are to be completed by stating “None” and filed with this office, not omitted from the filing. Under the administrative agreement, it is Aegis’ responsibility to prepare quarterly and annual statements in a manner consistent with SSAP. Aegis is responsible for the financial statement reporting errors as described above. It is recommended that the company properly complete the quarterly and annual statements in accordance with the NAIC Quarterly and Annual Statement Instructions – Property and Casualty, and the Statements of Statutory Accounting Principles. Internal Controls This section of the report describes reporting and clerical errors made related to insurance policies issued and the maintenance of financial data by Aegis. Overall, it was found that Aegis does not maintain sufficient documentation of policies and procedures that apply to processes used to compile financial information. Also, Aegis has not implemented sufficient audit procedures to prevent erroneous data from being entered into its systems. It is recommended that the company institute or enhance procedures to monitor the underwriting and record-keeping processes to ensure that controls are in place to prevent erroneous data from being included in its policies and/or entered into its software systems. The company received an unqualified audit opinion on its year-end 2003 financial statement, and there was no evidence of a management letter from the CPA firm that advised the board of any problems with the control environment. As discussed in this report, the examiners found numerous problems with the company’s annual statement and internal controls. Therefore, it is recommended that the Operations Oversight Committee regularly review the performance of the CPA firm, consider the firm’s experience with audits of property-casualty insurance companies and make appropriate recommendations to the board regarding the selection of auditors. Investment Income Due and Accrued Aegis was unable to explain how they calculated amounts for investment income due and accrued for all investments. The examiners noted clerical errors when Aegis employees input 74 information in Aegis’ computer system (e.g., incorrect interest payment dates). The examination performed a calculation of interest due and accrued on all securities owned by the company and compared the results to what was reported on the annual statement. The examination determined that overall the accrual was within a reasonable range and the reporting deficiencies caused by employee error did not result in an adjustment to surplus. However, an appropriate recommendation concerning internal controls of the company has been included in this section under the heading “Internal Controls” above. Uncollected Premiums and Agents' Balances in Course of Collection $25,512 The above balance reflects a decrease of $6,210 as a result of an examination adjustment. The examination’s review of this account found that the company included a deductible fund escrow balance in the amount of $7,554 in error. The examiners did verify that this amount was correctly included as amounts withheld or retained by company for the account of others. The company also included return premium payable in the amount of $1,345 within this account in error. The adjustment to this asset is reflected in the “Financial Data” section of this report under the heading, “Reconciliation of Surplus per Examination.” An appropriate recommendation concerning internal controls of the company has been included in this section under the heading “Internal Controls.” Deferred Premiums $93,364 The company reported $0 deferred premium. The above balance reflects a net increase of $93,364 as a result of an examination adjustment described in the following paragraphs. The adjustment to this asset is reflected in the “Financial Data” section of this report under the heading, “Reconciliation of Surplus per Examination.” As discussed in the section under the heading “Recognition of Written Premium,” the company did not correctly report written premium. The company should report installments that have not been billed and are not yet due as deferred premium. The examination determined at year-end 2003 the company had deferred premium in the amount of $180,855. It is recommended that the company properly report deferred premium in accordance with the NAIC Accounting Practices and Procedures Manual. 75 The company reported $0 for earned but unbilled (EBUB) premium as a part of deferred premium. According to SSAP, No. 53, paragraph 9, “Adjustments to the premium charged for changes in the level of exposure to insurance risk [e.g., audit premiums on worker’s compensation policies] are generally determined based upon audits conducted after the policy has expired. Reporting entities shall estimate audit premiums, the amount generally referred to as earned but unbilled (EBUB) premium, and shall record the amounts as an adjustment to premium, either through written premium or as an adjustment to earned premium.” The company did not have a written policy on how to record EBUB premium, although this accounting rule has applied since January 2001. The company provided the examiners a listing of actual and estimated audit results for policies effective during 2003 and prior for which amounts were not settled until after year-end 2003. The listing amounted to a negative adjustment of $87,491. It is recommended that the company properly estimate and report audit premium in accordance with the NAIC Accounting Practices and Procedures Manual in all future statutory financial statements. Losses $2,657,441 The above balance reflects an increase of $135,763 as a result of an examination adjustment. This office contracted an independent actuary to review the reserves established by the company. The consulting actuary suggested an increase to loss and defense and cost containment reserves in the amount of $135,763. The adjustment to this liability is reflected in the “Financial Data” section of this report under the heading, “Reconciliation of Surplus per Examination.” It is important for companies that are new such as CIC to estimate loss reserves conservatively due to the lack of credible experience of their own block of business. The examination also noted the company has not reported salvage and subrogation received separately on Schedule P, Part 1, Column 10, of the annual statement. The company explained that they do collect amounts for salvage and subrogation but due to materiality they do not include the amounts on Schedule P, Part 1. It is recommended that the company report all salvage and subrogation received in accordance with the NAIC Annual Statement Instructions – Property and Casualty. 76 Loss Adjustment Expenses $1,131,231 The above balance reflects an increase of $26,693 as a result of an examination adjustment. The consulting actuary hired by this office suggested an increase to adjusting and other reserves in the amount of $26,693. The adjustment to this liability is reflected in the “Financial Data” section of this report under the heading, “Reconciliation of Surplus per Examination.” It is important for companies that are new such as CIC to estimate fairly conservative loss adjusting expense reserves due to their inexperience. Commissions Payable $28,229 The above balance reflects a net liability of $28,229 as a result of an examination adjustment. The examination’s review of settlements made by the company after year-end disclosed commissions incurred prior to year-end for which an accrual had not been established. Commission is based as a percentage of premium written during the acquisition of new or renewal business. All acquisition costs, which include commissions, are to be expensed when incurred as described in SSAP No. 71, paragraph 2. According to SSAP No. 5, expense incurs when a policy becomes effective and if not paid as of the end of the reporting year should be reported as a liability. The agent agreement stipulates that agents are responsible for the return of any commission calculated on returned premium. The examiners reduced the amount of commission payable, $32,604, by $4,375 which represents 5% of the amount of negative EBUB the company returned to insureds related to worker’s compensation policies. The adjustment to this liability is reflected in the “Financial Data” section of this report under the heading, “Reconciliation of Surplus per Examination.” It is recommended that the company review its methodology for accruing liabilities and implement improvements to ensure that liabilities are properly reported in accordance with the NAIC Accounting Practices and Procedures Manual. Other Expenses $102,935 The above balance reflects an increase of $56,365 as a result of an examination adjustment. The examination’s review of settlements made by the company after year-end disclosed management and administrative fees incurred prior to year-end for which an accrual 77 had not been established. Management and administrative fees are considered a part of cost at the acquisition of new or renewal business. All acquisition costs are to be expensed when incurred as described in SSAP No. 71, paragraph 2. According to SSAP No. 5, expense incurs when a policy becomes effective and if not paid as of the end of the reporting year should be reported as a liability. The adjustment to this liability is reflected in the “Financial Data” section of this report under the heading, “Reconciliation of Surplus per Examination.” An appropriate recommendation has been included in this section under the heading “Commissions Payable” above. Unearned Premiums $1,992,666 The above balance reflects an increase of $154,961 as a result of an examination adjustment. As discussed in this section under the heading “Deferred Premiums,” the company did not account for installments that have not been billed and are not yet due as deferred premium. The unearned premium reported should be increased by the total deferred premium amount of $180,855. The adjustment to this liability is reflected in the “Financial Data” section of this report under the heading, “Reconciliation of Surplus per Examination.” It is recommended that the company properly report unearned premium in accordance with the NAIC Accounting Practices and Procedures Manual. The examiners’ review of unearned premium also noted clerical errors in the calculation of unearned premium. In performing the calculation for unearned premium the company overstated unearned premium on policies paying in two installments by the amount of $25,894. In addition, the unearned premium file provided to the examiners by the company did not indicate policy numbers. A policy number is a unique attribute, which helps to identify an individual policy and ascertain the completeness and accuracy of a data file. An appropriate recommendation concerning internal controls of the company has been included in this section under the heading “Internal Controls.” 78 Dividends Declared and Unpaid $579,217 The above balance reflects an increase of $579,217 as a result of an examination adjustment. The examiners’ review of the minutes of the board of directors noted that a worker’s compensation dividend was declared on August 21, 2003, for policies expiring from July 1, 2003, and later. In accordance with SSAP No. 65, paragraph 45, dividends to policyholders immediately become liabilities of the reporting entity when they are declared by the board of directors and shall be recorded as a liability. Aegis provided the examiners with a listing of dividends paid during 2004 and an estimate for dividends that had not yet been paid for policies with effective dates during 2003 in which a dividend was declared but not paid as of year-end 2003. The adjustment to this asset is reflected in the “Financial Data’ section of this report under the heading, “Reconciliation of Surplus per Examination.” An appropriate recommendation has been included in this section under the heading “Commissions Payable.” Ceded Reinsurance Premiums Payable $782,885 The company reported $815,662 ceded reinsurance premiums payable. There were two adjustments reducing this balance to $782,885. The adjustment to this liability is reflected in the “Financial Data’ section of this report under the heading, “Reconciliation of Surplus per Examination.” The balance reflects an increase to the liability of $50,022 as a result of an examination adjustment. As discussed under the heading “Deferred Premiums,” the company did not account for installments that have not been billed and are not yet due as deferred premium. The company should have also estimated ceded reinsurance premium by multiplying deferred premium by the ceded reinsurance premium rates. The adjustment to this liability is reflected in the “Financial Data” section of this report under the heading, “Reconciliation of Surplus per Examination.” It is recommended that the company properly report ceded reinsurance premium payable in accordance with the NAIC Annual Statement Instructions – Property and Casualty. Amounts Withheld or Retained by the Company for the Account of Others $49,434 The above balance reflects a decrease of $1,530 as a result of an examination adjustment. The examination’s review of the deductible fund escrow balance noted a difference 79 between the amount the company reported on the annual statement and the details the company provided the examiners. The company was unable to provide an explanation of the difference. The examiners tested the detail provided by the company for accuracy. The test resulted in no exceptions. The examiners relied on the detail provided by the company and adjusted the annual statement to reflect the change. The adjustment to this liability is reflected in the ‘Financial Data” section of this report under the heading, “Reconciliation of Surplus per Examination.” An appropriate recommendation concerning internal controls of the company has been included in this under the heading “Internal Controls.” Declaration of Dividends The board declared dividends on August 21, 2003, for policies expiring from July 1, 2003, and later. Section 631.51 (2), Wis. Stat., states, in part, that any insurer may distribute a portion of surplus attributable to policies in amounts and with classifications the board of directors determines to be fair and reasonable. OCI has issued two bulletins adding clarification to s. 631.51, Wis. Stat., one bulletin on June 2, 1998, and another on July 8, 1999. The June 2, 1998, bulletin noted that dividend declaration should only include policies that expired prior to the board of directors’ declaration. The bulletin stipulated that surplus cannot be attributed to policies that had not yet expired. The July 8, 1999, bulletin noted that OCI will not object to a declaration, which includes policies that have not expired prior to the board of directors’ declaration, provided that the declaration clearly indicates that the declaration is not effective until after policy expiration. The board of directors did not comply with s. 631.51 (2), Wis. Stat., by declaring dividends on policies that were effective that had not expired at the time of the declaration without clear indication that the declaration is not effective until after policy expiration. In addition, the company did not file a schedule explaining the basis for the distribution of dividends to the commissioner at least 30 days prior to the distribution as required by s. 631.51 (3), Wis. Stat. It is recommended that the company comply with s. 631.51, Wis. Stat., in all respects concerning dividends on policies. 80 Agent Appointments The examiners compared the listing of agent appointments the company provided to OCI’s agent database. The company’s listing of appointments included 37 persons acting as intermediaries on the company’s behalf, of which 10 are Aegis employees and the remainder are independent. Two of the 37 appointments were not reported to the commissioner. Section 628.11, Wis. Stat., requires that an insurer report to the commissioner all appointments, renewals of appointments, and all terminations of appointments of insurance agents. Furthermore, as reported in a prior section of this report, the company issued a business plan to OCI stating it would be selling insurance on a direct basis, without outside insurance agents. An appropriate recommendation has been made. It is recommended that the insurer report to the commissioner all appointments and terminations of insurance agents in compliance with s. 628.11, Wis. Stat. The insurer is required to annually file a report titled “Agent Commission on Wisconsin Business Annual Report” in accordance with s. 601.42, Wis. Stat. This report is to disclose the number of intermediaries the company has as well as commission rates and contingent commission rates used by the company for reimbursing its agents under listed lines of business. Aegis provided the examiners with the producer agreement used with a commission schedule attached. The commission schedule was compared to the “Agent Commission on Wisconsin Business Annual Report” filed for year ended December 31, 2003. The producer agreement documented different commission rates than the amounts reported to the commissioner at year end. It also appears that agents who are employees of Aegis are paid both a commission rate and a salary for being agents for the company. The company should report amounts of any fixed salaries if they are supplemented by commission, pursuant to s. 628.81, Wis. Stat. It is recommended that the company properly file the report titled, “Agent Commissions on Wisconsin Business,” pursuant to ss. 601.42 and 628.81, Wis. Stat., annually and after any major change. 81 Policy Forms The company provided the examiners with a listing of policy forms that are currently being used. The examiners created a listing from OCI’s data base showing all forms filed by the company, and compared the policy forms the company was using with those OCI had on file. Several forms being used by the company were not filed with this office, in violation of s. 631.20, Wis. Stat. The review also noted that the company was using two forms that did not include a form number; the forms were titled “Coverage Clarification Endorsement (Defense and Settlement)” and “Coverage Clarification Endorsement (Exclusion).” The company also used different form numbers for the same form. The form titled “Community Insurance Corporation Public Entity Property Plan Declarations” was indicated on one policy as form number CICP996 (11/03) and on another policy as form number CICP999 (11/03). A policy form number is a unique attribute to specifically identify a policy form. It is recommended that the company only use forms that have been filed with and approved by the commissioner in accordance with s. 631.20, Wis. Stat. In addition, each policy form should be identified using a unique policy number. The company is also using a blank form titled “General Endorsement” for its liability and property lines of business. The blank forms used were erroneously approved by this office. General endorsements or blank forms are permitted to be used once for a specific policy. The company is using this blank form for several different endorsements to most policies. If the same language is used more than once for more than one policyholder, the endorsement should be filed as a form for general use. In addition, while reviewing the policy forms delivered to this office, it was noted that Robert Wurtz is submitting the forms certifying that he is an officer of the company. Robert Wurtz is not an officer of the company; he is a 50% owner of Aegis Corporation, the company’s MGA. It is required by s. Ins 6.05, Wis. Adm. Code, that an officer of the company bind and obligate the company in filing policy forms. The officer is also to take the responsibility to ensure the policy forms filed are the following, in part: 82 1. In compliance with applicable provisions of the Wisconsin Statutes and administrative rules of this office; 2. Do not contain inconsistent, ambiguous, or misleading clauses; 3. Do not contain specification or conditions that unreasonably or deceptively limit the understood risk; 4. That the form(s) filed is (are) the only variation; and 5. The submitted form(s) is (are) in final printed format. It is recommended that an officer of the company certify all form filings delivered to this office. Liability Policy Forms The company's public entity liability policies, CIC-200 (5/02) and 410103 (5-02), Section IV. Limit of Insurance, A., and the deductible liability insurance endorsement, DED-CIC 102 (5/02), indicate the limit of liability applicable to each occurrence is inclusive of or will be reduced by the amount of the deductible. However, the declarations pages, CIC-202 (7-02) and 410105 (7-02), do not indicate that the limit per occurrence will be reduced by or is inclusive of the deductible. This is misleading pursuant to s. 631.20 (2) (a), Wis. Stat., in that the actual amount paid will not be the limit shown. The amount paid will be the limit minus the deductible. The company should revise its declarations pages, CIC-202 (7-02) and 410105 (7-02), by including wording that indicates the limit of liability will be reduced by the amount of the deductible in order to comply with s. 631.20 (2) (a), Wis. Stat. The company's deductible liability insurance endorsement, DED-CIC 102 (5/02), includes the term "deductible fund escrow" in bold print. The term is not defined in the endorsement nor in the public entity liability policy to which it is attached. This term is not commonly used and could be considered obscure. The commissioner may disapprove a form under s. 631.20 (2) (a), Wis. Stat., if it is found to be obscure. The company should include a definition for "deductible fund escrow" in its public entity liability policy in order to comply with s. 631.20 (2) (a), Wis. Stat. The company includes collision and comprehensive coverages for motor vehicles by attaching endorsements, CIC-220 (11/03) and CIC 230 (11/03), to its public entity liability insurance policy. These coverages are property coverages. It could be misleading to include 83 property coverages within a policy titled "Public Entity Liability Insurance." The commissioner may disapprove a form under s. 631.20 (2) (a), Wis. Stat., if it is found to be misleading. Also, both endorsements in the liability policy, Losses Excluded, 3, and Basis of Recovery, make references to the property policy. Section 631.13, Wis. Stat., states that no insurance policy may contain any agreement or incorporate any provision not fully set forth in the policy or in an application or other document attached to and made a part of the policy at the time of its delivery. The company should attach the collision and comprehensive coverage endorsements to its public entity property insurance policy in order to comply with ss. 631.20 (2) (a) and 631.13, Wis. Stat. Also, the endorsements require that the insured maintain an inventory listing of the motor vehicles to be covered. However, they go on to state that the inventory shall be provided to the company, if requested. The inventory listings were not included with the copies of the policies provided to the examiners and the examiners could not find where the company had filed with and received approval for an inventory listing form. In addition, there is no limit indicated on the declarations page or in the endorsements themselves for the collision and comprehensive coverages. If the company does not request the inventory listing, the company would have no knowledge of what exposure it has regarding the number or types of vehicles insured nor the values of those vehicles. It is recommended that the company request inventory listings from all insureds who are provided collision and comprehensive coverages for motor vehicles. It is further recommended that the company file its inventory listing form with this office and receive approval from the commissioner. It is recommended that the company revise its liability policy forms to comply with Wisconsin insurance laws. Property Policy Forms The public entity deductible property insurance endorsement, CICP997 (11/03), indicates the limit of liability applicable to each occurrence will be reduced by the amount of the deductible. However, the declarations page, CICP996 (11/03), does not indicate that the limit per occurrence will be reduced by the deductible. This is misleading pursuant to s. 631.20 (2) (a), Wis. Stat., in that the actual amount paid will not be the limit shown. The amount paid will be the 84 limit minus the deductible. The company should revise its declarations page by including wording that indicates the limit of liability will be reduced by the amount of the deductible in order to comply with s. 631.20 (2) (a), Wis. Stat. The deductible property insurance endorsement, CICP997 (related to insurance policies issued and the maintenance of financial data 11/03), includes the term "deductible fund escrow" in bold print. The term is not defined in the endorsement or in the public entity property coverage to which it is attached. This term is not commonly used and could be considered obscure. The commissioner may disapprove a form under s. 631.20 (2) (a), Wis. Stat., if it is found to be obscure. The company should include a definition for "deductible fund escrow" in its public entity property coverage in order to comply with s. 631.20 (2) (a), Wis. Stat. Also, the deductible property insurance endorsement, CICP997 (11/03), mentions bodily injury, property damage [third party], personal injury and errors and omissions liability coverages. The property policy does not include these coverages. It may be misleading under s. 631.20 (2) (a), Wis. Stat., to mention coverages that are non-existent under the policy. It is recommended that the company revise its deductible property insurance endorsement by eliminating any references to coverages that are not included within the property policy. The public entity property coverage general conditions, CICP000 (11/03), X. Subrogation and Subrogation Waiver, states that if any person or organization to or for whom the company makes payment under the policy has rights to recover damages from another, those rights are transferred to the company to the extent of such payment and does not state who must be made whole before keeping recoveries. The Wisconsin Supreme Court decision, Rimes v. State Farm Mutual Automobile Insurance Company, 106 Wis. 2d 263, provides that the company may only retain recoveries after the insured has been made whole. The company should revise its public entity property coverage general conditions to comply with Rimes v. State Farm Mutual Automobile Insurance Company, 106 Wis. 2d 263. The public entity property program supplemental coverage declarations, CICP998 (11/03), E. Valuation Provision, states that replacement cost applies as per WCMP008 and that roofs that are over 15 years old will be valued at "Actual Cash Value" as defined in WCMP005. In 85 reviewing the mentioned forms, WCMP008 does not mention replacement cost and WCMP005 does not mention actual cash value. Also, the endorsements mentioned have not been approved for use by this company. They are approved forms for Wisconsin County Mutual Insurance Company. It is recommended that the company amend its public entity property program supplemental coverage declarations to reference the correct endorsements and only endorsements approved for use by the company. The public entity property coverage joint or disputed loss agreement endorsement, CICP008 (11/03), is intended to be used to facilitate payment of insurance proceeds when both a boiler and machinery (BAM) policy and this company's property coverage are in effect, damage occurs that would be covered by both policies, and there is a disagreement between the insurers regarding whether coverage exists and/or the amount each will pay. The endorsement sets forth, if certain requirements are met, how each insurer will pay if there is a dispute. It is unclear how the provisions of the endorsement can be enforced upon another insurer, who is neither an affiliate nor subsidiary of the company. It is recommended that the company revise its property policy forms to comply with Wisconsin insurance laws and the Wisconsin Supreme Court decision as mentioned above in this report. Management Representation Letter This office requires domestic insurers to submit a management representation letter in which management attests to the accuracy and completeness of information provided the examination. On April 26, 2005, this office notified persons from WCA and Aegis that at the end of fieldwork this office would request the following individuals sign the attestation: James Barrett, Chairman Robert Hoesly, Treasurer/Secretary Mark O’Connell, WCA Executive Director Jon Hochkammer, WCA Director of Insurance Operations Robert Wurtz, Aegis President and Chief Executive Officer John Dirkse, Aegis Executive Vice President and Chief Operating Officer Richard Green, Aegis Vice President and Chief Financial Officer Examination fieldwork was completed on July 22, 2005. On July 25, 2005, this office followed up on the management representation letter by providing a template for the company to follow as well 86 as reiterating the individuals expected to sign the letter. This correspondence was provided to both WCA and Aegis individuals. On August 12, 2005, the office received the management representation letter that was signed by Jon Hochkammer, Robert Wurtz and John Dirkse. 87 VIII. CONCLUSION During the course of this examination it was noted that the company lacked certain oversight functions of the management of CIC and its Key Service Providers. CIC was unable to provide documentation, to the satisfaction of the examiners, that the company officers and board of directors had established proper oversight and controls over its Key Service Providers. The examiners concluded that contracts must include requirements for reporting conflict of interest situations and that formal action and review be performed and documented by the company officers and board of directors in response to such reports. A concurrent examination of WCMIC has also disclosed similar concerns. 88 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS 1. Page 37 - Articles of Incorporation and Bylaws—It is recommended that the company follow its bylaws or amend them. Page 37 - Conflict of Interest—It is recommended that company directors who serve as directors and officers for one or more of the WCA entities disclose the affiliation in the conflict of interest statements. Page 37 - Board of Directors—It is recommended that the company develop formal procedures to ensure minutes are properly retained and available to document the actions of the board of directors. Page 38 - Board of Directors—It is recommended that the board of directors remove the delegation of investment management authority to WCASI from its investment policy. Page 39 - Committees of the Board of Directors— It is recommended that the company submit a plan (Management Plan) required under s. 601.42, Wis. Stat., to the commissioner for approval within 30 days of the adoption of this report that includes all of the following: 1. An Operations Oversight Committee (Committee) with responsibility and authority to make timely recommendations with respect to management of the operations of the company, including, but not limited to, supervision and evaluation of functions performed by the managing general agent (Vendor Supervision), with respect to reinsurance placement and general administration and management services. The Committee shall include not less than two members (External Members) who: a. Are not board members; b. Have no conflict of interest, including no interest, directly or indirectly, in a vendor; c. Have significant expertise that is substantially related to the Committee's Vendor Supervision and reinsurance placement functions, such as reinsurance, actuarial, insurance accounting, insurance claim administration, underwriting and insurance company management expertise; 2. 3. 4. 5. d. Dedicate, and are compensated for dedicating, their time and resources sufficient to perform their functions on the Committee, including with respect to Vendor Supervision and reinsurance placement; and e. Are provided the resources and budget reasonably necessary to perform their functions on the Committee related to Vendor Supervision and reinsurance placement. 2. Provisions to address the management issues described elsewhere in this report, including, but not limited to, a budget and business plan process. 3. Provision for a reasonable Committee budget for the Committee's functions, including its Vendor Supervision and reinsurance placement functions. 89 4. Provision for a reasonable Committee budget to retain outside and independent professional services, including professional services reasonably required for the Vendor Supervision function and reinsurance placement function. 5. Provision for one or more of the External Members with appropriate expertise to actively participate in the negotiation and placement of company reinsurance and for the External Member or Members to make a recommendation to the Committee as to each such placement. 6. Provision for one or more of the External Members with appropriate expertise to actively participate in the review of the underwriting, reinsurance accounting, and claims processing operations of the company's managing general agent and for the External Member or Members to make a recommendation to the Committee as to each such review. 6. Page 40 - Committees of the Board of Directors— It is further recommended that the company implement the Management Plan as approved by the commissioner. Page 41 - Management Agreement— While this examination does not reach any conclusions on this issue, it is recommended that the company implement measures to ensure no legal affiliation exists with respect to WCA and WCASI for purposes of Wisconsin insurance laws, including but not limited to: 1. Amend the management agreement and CIC’s bylaws to remove any potential delegation of management authority to WCASI with respect to CIC’s business operations. 2. Amend the management agreement to prohibit WCASI from withdrawing its endorsement of WCMIC and CIC or endorsing any other insurance company with respect to insurance products offered by WCMIC and CIC for as long as the management agreement remains in effect and for a period of not less than two years after its termination, other than a termination for cause by WCASI. 3. Establish an Operations Oversight Committee, and involve that committee in reviewing and, when appropriate, providing recommendations with respect to (a) information prepared or provided by WCASI concerning the operations of the company, and (b) all transactions between CIC and WCASI. 4. Limit the number of company directors serving on the Operations Oversight Committee who also serve on WCA’s or WCASI’s board to no more than two individuals. 5. Preclude those directors who are also directors of WCA or WCASI from voting on WCA-related matters in accordance with s. 611.60 (2), Wis. Stat. 8. Page 42 - Management Agreement— Accordingly, it is recommended that the company submit to the commissioner, within 30 days of the adoption of this report, a revised management agreement with WCASI. The revised management agreement shall provide all of the following: 7. 90 1. Appropriate and reasonable transition provisions to protect the interests of the company, including its interest in data, systems, software, market and property, on termination of the contract. 2. Provision for termination of the contract without cause by the company on not less than sixty days notice. 9. Page 42 - Management Agreement—It is recommended that directors who are also directors of WCA entities should abstain from voting on WCA-related matters, pursuant to s. 611.60 (2), Wis. Stat. Page 43 - Management Agreement—It is recommended that the company comply with the terms of its administrative agreement with WCA Services, Inc. Page 43 - Management Agreement—It is recommended that the company amend its management agreement with WCASI, to include proper indemnification clauses and to define how return premium would affect management fee payments. Page 43 - Management Agreement—It is recommended that the company amend its management agreement to require the greater of the suggested minimum fidelity bond coverage in accordance with the NAIC Financial Examiners Handbook, or the results of the risk assessment, and provide evidence of such coverage to this office within 30 days after the adoption of this report. Page 45 - Business Plan/Budgeting—It is recommended that the company follow the business plan filed with the commissioner or file the proposed change with the commissioner 30 days in advance of the proposed effective date in accordance with s. 611.28, Wis. Stat. Page 45 - Business Plan/Budgeting—It is recommended that the company establish a comprehensive business plan and budget process, including quarterly board review. Page 45 - Disaster Recovery Plan—It is recommended that the company develop a formalized disaster recovery plan and file it with this office within 30 days after the adoption of this report. Page 46 - Disaster Recovery Plan—It is further recommended that the company store copies of data files and programs in a locked, waterproof and fireproof storage area. Page 46 - Administrative Agreement—It is recommended that the company contract for managing general agent services only with a person who is licensed as a managing general agent pursuant to s. 628.04, Wis. Stat. Page 46 - Administrative Agreement—It is recommended that the company comply with s. Ins 42.03 (6), Wis. Adm. Code, concerning underwriting guidelines including the maximum annual premium volume. Page 46 - Administrative Agreement—It is recommended that the company board of directors establish, and that the company require its MGA to comply with, underwriting guidelines set forth by the board of directors, including the maximum limit of liability, in accordance with s. Ins 42.03 (6), Wis. Adm. Code. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 91 20. Page 47 - Administrative Agreement— It is recommended that the company comply with s. Ins 42.05 (1), Wis. Adm. Code, by requiring its MGA to provide annual audited financial statements to the company and to amend its administrative agreement to include this requirement. Page 47 - Administrative Agreement—It is recommended that the company comply with s. Ins 42.05 (3), Wis. Adm. Code, by performing a semiannual review of the underwriting, reinsurance accounting and claims processing operations of its managing general agent. The performance of such semiannual reviews may alternate between WCASI and a person independent of WCASI and the managing general agent, both of whom shall posses appropriate underwriting, reinsurance accounting and claims processing expertise. Page 48 - Administrative Agreement—It is recommended that the company amend its administrative agreement with Aegis to define how fees related to return premium are to be handled. Page 48 - Administrative Agreement—It is recommended that the company amend its administrative agreement to require the greater of the suggested minimum fidelity bond coverage in accordance with the NAIC Financial Examiners Handbook, or the results of a risk assessment, and provide evidence of such coverage to this office within 30 days after the adoption of this report. Page 48 - Administrative Agreement—It is recommended the company take measures to ensure that the insurance policies secured by the general administrator contain the agreed upon 60-day cancellation notice. Page 49 - Administrative Agreement—It is recommended that the company amend its administrative agreement to revise the fee schedule for claims administration so there is no potential conflict of interest. Page 49 - Administrative Agreement—It is recommended that the company not allow amendments to agreements without approval from the board of directors. Page 49 - Administrative Agreement—It is recommended that the board of directors go into closed session when a conflict of interest arises between the parties attending the board meetings. Page 50 - Administrative Agreement—It is recommended that the company enforce the responsibilities of its managing general agent under the administrative agreement or terminate Aegis for noncompliance. Page 51 - Reinsurance Intermediary Broker—It is recommended that the company have a written reinsurance intermediary agreement with all entities that provide placement of business with reinsurers, that such agreements fully comply with s. Ins 47.03, Wis. Adm. Code, and that the company enforce the terms of the agreements. Page 53 - Reinsurance Intermediary-Broker— It is recommended that the company provide in any agreement for managing general agent services that the managing general agent shall not, and shall cause all of its affiliates, officers and agents to not: 1. Act as a reinsurance intermediary for the company as defined under ch. Ins 47, Wis. Adm. Code; or 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 92 2. Accept or solicit, directly or indirectly, any consideration or compensation relating to reinsurance negotiated for, or placed by, the company. This recommendation is not a restriction on the company compensating a managing general agent for providing advice relating to its reinsurance negotiations or placement provided that the managing general agent does not act as a reinsurance intermediary for the company. 31. Page 55 - Reinsurance Intermediary-Broker—It is recommended that the company require all reinsurance intermediaries to comply with the provisions of s. Ins 47.04, Wis. Adm. Code, and that the company enforce the provisions of its agreement with any managing general agent with respect to reinsurance functions. Page 56 - Reinsurance Intermediary-Broker—It is recommended that the company comply with the prohibited functions of a reinsurance intermediary-broker according to s. Ins 47.05, Wis. Adm. Code, and that these matters be addressed in the Management Plan. Page 57 - Reinsurance—It is recommended that the company ask its reinsurers to deliver signed copies of all reinsurance agreements entered into since its commencement date of writing business and in those situations where reinsurance coverage has been bound by placement slip, to properly sign all reinsurance contracts received, and submit copies of those reinsurance agreements to this office within 90 days after the adoption of this report. Page 58 - Reinsurance— It is recommended that the board of directors authorize all reinsurance agreements and properly have them bound by an officer of the company in accordance with ss. Ins 42.03 (13) (a) and 42.05 (4), Wis. Adm. Code. Page 58 - Reinsurance—It is recommended that the company only enter into reinsurance agreements that contain language in regards to reporting requirements and insolvency clause in accordance with Statement of Statutory Accounting Principles No. 62, paragraph 8, of the NAIC Accounting Practices and Procedures Manual.. Page 58 - Reinsurance—It is recommended that the company establish a written agreement that addresses fair and reasonable allocation of reinsurance expenses and recoveries. Page 59 - Reinsurance—It is recommended that the company reevaluate its procedures for collecting reinsurance recoveries. Page 59 - Reinsurance—It is recommended that the company obtain proper reinsurance confirmations or endorsements to document that there is reinsurance coverage for its retroactive coverages for all years in which it wrote this product. Page 59 - Ceded Premium— It is recommended that the company recognize ceded premium at the inception of the policy in accordance with Statements of Statutory Principles No. 53 and No. 62 of the NAIC Accounting Practices and Procedures Manual. Page 61 - Excess Property Coverage—It is recommended that the company immediately obtain reinsurance for the property coverages it has issued and 32. 33. 34. 35. 36. 37. 38. 39. 40. 93 submit to this office verification of reinsurance coverages within 10 days of adoption of this report. 41. Page 62 - Excess Property Coverage—It is recommended that when the company obtains proper reinsurance coverage for property coverages it clearly includes all insureds having risk greater than the retentions set by the board. Page 64 - Excess Liability Coverage—It is recommended that the company retain a competent insurance consultant and a law firm to ascertain the risks of the company concerning the endorsements included in its liability policies issued to municipalities and inform this office of the results within 60 days after the adoption of this report. Page 64 - Excess Liability Coverage—It is recommended that the company not discriminate against its policyholders by charging different premiums for the same coverage in accordance with ss. 628.34 (3) (a) and 625.11 (4), Wis. Stat. Page 65 - Excess Liability Coverage—It is recommended that the company retain a competent insurance consultant and a law firm to ascertain the risks of the company concerning the endorsements included in its liability policies issued to schools and inform this office within 60 days after the adoption of this report. Page 65 - Service Carriers—The board should periodically consider whether it would be in the best interests of the company to negotiate a cost-basis contract or perform the services in-house. It is recommended that this be addressed in the Management Plan. Page 67 - Change in Actuary—Considering this and the discrepancies the consulting actuary reported, the examiners made the following recommendation: It is recommended that the company employ the former actuary to issue an opinion on the reserves reported for year-end December 31, 2004. Page 67 - Change in Actuary— It is recommended that the company properly notify the Office of the Commissioner of Insurance of changes in appointed actuaries in accordance with the NAIC Annual Statement Instructions – Property and Casualty. Page 67 - Recognition of Written Premium— It is recommended that the company recognize written premium for the full term of the policy and properly earn premium on endorsements in accordance with Statement of Statutory Accounting Principles No. 53 of the NAIC Accounting Practices and Procedures Manual in all future statutory financial statements. Page 68 - Allocation of Expenses—It is recommended that the company develop and apply a method consistent with Statement of Statutory Accounting Principles No. 70 of the NAIC Accounting Practices and Procedures Manual for reporting expenses on the Underwriting and Investment Exhibit, Part 3. Page 68 - Allocation of Expenses— It is further recommended that the company disclose the method used for allocation of management and service fees in the Notes to Financial Statements. 42. 43. 44. 45. 46. 47. 48. 49. 50. 94 51. Page 68 - Investments—It is recommended that the company amend its custodial agreement to include language regarding the prompt replacement of lost securities in accordance with the NAIC Financial Examiners Handbook.. Page 69 - Investments—It is recommended that the company amortize bond investments using the scientific method according to Statement of Statutory Principle No. 26, paragraph 6, of the NAIC Accounting Practices and Procedures Manual. Page 69 - Investments—It is recommended that the company comply with investment restrictions prescribed by s. 620.03, Wis. Stat., and s. Ins 6.20, Wis. Adm. Code. Page 70 - Cash Disbursements—It is recommended that the company place controls over cash disbursements, including establishing a limit for cash disbursements that require approval from a party independent of Aegis, and segregate duties appropriately to gain a more secure control environment. Page 70 - Information System Controls—It is recommended that the company require its users accessing its data to change passwords on at least a quarterly basis according to the NAIC Financial Examiners Handbook. Page 70 - Information System Controls—It is recommended that the company develop and implement a written security policy to assist in protecting its critical computer assets. Page 72 - Retention of Records—It is recommended that the company retain adequate records and documentation in accordance with s. Ins 6.80, Wis. Adm. Code, conduct a competent review that complies with s. Ins 42.05, Wis. Adm. Code, and provide such records and documentation to OCI in a timely manner in order to facilitate the examination process. Page 74 - Annual Statement Reporting Deficiencies—It is recommended that the company properly complete the quarterly and annual statements in accordance with the NAIC Quarterly and Annual Statement Instructions – Property and Casualty, and the Statements of Statutory Accounting Principles. Page 74 - Internal Controls—It is recommended that the company institute or enhance procedures to monitor the underwriting and record-keeping processes to ensure that controls are in place to prevent erroneous data from being included in its policies and/or entered into its software systems. Page 74 - Internal Controls—It is recommended that the Operations Oversight Committee regularly review the performance of the CPA firm, consider the firm’s experience with audits of property-casualty insurance companies and make appropriate recommendations to the board regarding the selection of auditors. Page 75 - Deferred Premiums—It is recommended that the company properly report deferred premium in accordance with the NAIC Accounting Practices and Procedures Manual. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 95 62. Page 76 - Deferred Premiums—It is recommended that the company properly estimate and report audit premium in accordance with the NAIC Accounting Practices and Procedures Manual in all future statutory financial statements. Page 76 - Losses—It is recommended that the company report all salvage and subrogation received in accordance with the NAIC Annual Statement Instructions – Property and Casualty. Page 77 - Commissions Payable—It is recommended that the company review its methodology for accruing liabilities and implement improvements to ensure that liabilities are properly reported in accordance with the NAIC Accounting Practices and Procedures Manual. Page 78 - Unearned Premiums—It is recommended that the company properly report unearned premium in accordance with the NAIC Accounting Practices and Procedures Manual.. Page 79 - Ceded Reinsurance Premiums Payable—It is recommended that the company properly report ceded reinsurance premium payable in accordance with the NAIC Annual Statement Instructions – Property and Casualty. Page 80 - Declaration of Dividends—It is recommended that the company comply with s. 631.51, Wis. Stat., in all respects concerning dividends on policies. Page 81 - Agent Appointments—It is recommended that the insurer report to the commissioner all appointments and terminations of insurance agents in compliance with s. 628.11, Wis. Stat. Page 81 - Agent Appointments—It is recommended that the company properly file the report titled, “Agent Commissions on Wisconsin Business,” pursuant to ss. 601.42 and 628.81, Wis. Stat., annually and after any major change. Page 82 - Policy Forms—It is recommended that the company only use forms that have been filed with and approved by the commissioner in accordance with s. 631.20, Wis. Stat. In addition, each policy form should be identified using a unique policy number. Page 83 - Policy Forms—It is recommended that an officer of the company certify all form filings delivered to this office. Page 84 - Liability Policy Forms—It is recommended that the company request inventory listings from all insureds who are provided collision and comprehensive coverages for motor vehicles. Page 84 - Liability Policy Forms—It is further recommended that the company file its inventory listing form with this office and receive approval from the commissioner. Page 84 - Liability Policy Forms—It is recommended that the company revise its liability policy forms to comply with Wisconsin insurance laws. Page 85 - Property Policy Forms—It is recommended that the company revise its deductible property insurance endorsement by eliminating any references to coverages that are not included within the property policy. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 96 76. Page 86 - Property Policy Forms—It is recommended that the company amend its public entity property program supplemental coverage declarations to reference the correct endorsements and only endorsements approved for use by the company. Page 86 - Property Policy Forms—It is recommended that the company revise its property policy forms to comply with Wisconsin insurance laws and the Wisconsin Supreme Court decision as mentioned above in this report. 77. 97 X. ACKNOWLEDGMENT The courtesy and cooperation extended during the course of the examination by WCA and Aegis are acknowledged. In addition to the undersigned, the following representatives of the Office of the Commissioner of Insurance, State of Wisconsin, participated in the examination: Name Jerry C. DeArmond John E. Litweiler Rhonda R. Peterson Frederick H. Thornton Tim J. VandeHey Elena V. Vetrina Title Insurance Financial Examiner Advanced Loss Reserve Specialist Insurance Financial Examiner Insurance Examiner Senior Insurance Financial Examiner Advanced Exam Planning & Quality Control Specialist Insurance Financial Examiner Advanced Data Processing Audit Specialist Insurance Financial Examiner Respectfully submitted, Rebecca L. Easland Examiner-in-Charge 98 XI. SUBSEQUENT EVENTS Nearly five years have elapsed from the close of this examination period, and three years since this examination report was served upon the company. During this period, representatives of the company have worked with OCI to address the findings and recommendations contained in this report. The company’s subsequent actions are intended to improve the overall operations of the company going forward. The company, to its credit, has taken many actions in the past three years to respond to the findings and recommendations contained in this report. Some of these actions are included in this section of the report to document and acknowledge the company’s efforts; however, this office has not subsequently examined the company to verify its actions and to determine whether they have resolved the issues outlined in this report. In 2007, the company established an operations oversight committee comprised of both internal and independent external members to strengthen the management of the company. According to the company, this committee is being utilized to review all major business operations of the company and make recommendations to the board of directors. The operations oversight committee will also review and assist with implementing many of the recommendations in this report. The company expects the operations oversight committee to bring greater knowledge and insurance expertise, provide an additional level of corporate oversight, and improve overall management capabilities, all of which were cited as concerns in this report. The company has also amended its management agreement and general agency agreement to address various recommendations contained in this report. The company advised that its operations oversight committee will monitor ongoing performance under these agreements, especially with respect to those areas cited in this report. The company states it has also developed or supplemented various written policies and procedures, such as its disaster recovery plan, unclaimed property procedures, and written security policies. 99 Commencing in 2008, the company transferred its reinsurance placement functions to the operations oversight committee and other members of the board of directors with assistance from Aegis. The company has also demonstrated improvement in the preparation of its financial statements. This is reflected by the substantial reduction in the number of discrepancies identified by OCI in the company’s 2006 and 2007 annual statements. OCI is encouraged by the measures taken to date by the company to address the findings and recommendations contained in this report. Assuming the company continues to follow through on its proposed actions, OCI would expect fewer findings and recommendations in future examinations. 100