The EPIC Life Insurance Company

Report of the Examination of The EPIC Life Insurance Company Madison, Wisconsin As of December 31, 2006 TABLE OF CONTENTS Page I. INTRODUCTION .................................................................................................................... 2 II. HISTORY AND PLAN OF OPERATION ................................................................................ 4 III. MANAGEMENT AND CONTROL .......................................................................................... 6 IV. AFFILIATED COMPANIES .................................................................................................... 8 V. REINSURANCE ................................................................................................................... 11 VI. FINANCIAL DATA ................................................................................................................ 13 VII. SUMMARY OF EXAMINATION RESULTS ......................................................................... 22 VIII. CONCLUSION...................................................................................................................... 26 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS................................................ 27 X. ACKNOWLEDGMENT ......................................................................................................... 28 State of Wisconsin / OFFICE OF THE COMMISSIONER OF INSURANCE Jim Doyle, Governor Sean Dilweg, Commissioner Wisconsin.gov February 20, 2008 125 South Webster Street • P.O. Box 7873 Madison, Wisconsin 53707-7873 Phone: (608) 266-3585 • Fax: (608) 266-9935 E-Mail: information@oci.state.wi.us Web Address: oci.wi.gov Honorable Sean Dilweg Commissioner of Insurance State of Wisconsin 125 South Webster Street Madison, Wisconsin 53703 Honorable Alfred W. Gross Chair, Financial Condition (E) Committee, NAIC Commissioner of Insurance Commonwealth of Virginia 1300 East Main Street Richmond, Virginia 23219 Honorable Merle Scheiber Secretary, Midwestern Zone, NAIC Director of Insurance State of South Dakota 445 East Capitol Avenue Pierre, South Dakota 57501-3185 Commissioners: In accordance with the instructions of the Wisconsin Commissioner of Insurance, a compliance examination has been made of the affairs and financial condition of: THE EPIC LIFE INSURANCE COMPANY Madison, Wisconsin and this report is respectfully submitted. I. INTRODUCTION The previous examination of The EPIC Life Insurance Company (the company or EPIC) was conducted in 2002 and 2003 as of December 31, 2001. The current examination covered the intervening period ending December 31, 2006, and included a review of such 2007 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 Employees' Welfare and Pension Plans 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. Special attention was given to the action taken by the company to satisfy the recommendations and comments made in the previous examination report. The company 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 aggregate life and annuity 2 reserves, aggregate accident and health reserves, dividends to policyholders, asset adequacy analysis, and deferred life insurance premiums. 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. 3 II. HISTORY AND PLAN OF OPERATION The EPIC Life Insurance Company (EPIC) was organized in 1984 as a wholly owned subsidiary of Wisconsin Physicians Service Insurance Corporation (WPS), a Wisconsin health service insurance corporation. An examination of WPS and another affiliate, WPS Health Plan, Inc., were performed concurrently with this examination. As of December 31, 2006, the company is licensed in the following states: Arizona Arkansas Colorado Florida Illinois Indiana Iowa Kansas Kentucky Maryland Michigan Minnesota Missouri Nebraska Nevada North Dakota Ohio Oklahoma Oregon Pennsylvania South Carolina South Dakota Tennessee Texas Virginia West Virginia Wisconsin The company became licensed in Pennsylvania in 2007. In 2006, the company collected direct premium in the following states: Wisconsin Indiana Illinois Ohio Missouri All others Total $10,714,137 830,379 621,063 267,190 259,305 225,910 $12,917,984 82.9% 6.4 4.8 2.1 2.0 1.8 100.0% EPIC’s primary business is group life, dental, vision, and disability insurance as well as voluntary coverage for the same products and conversion policies to individuals. The company has targeted fully insured groups as well as offering administrative services contracts (ASC) products to large employer groups. Business is generated through independent agents and sales staff. The following chart is a summary of premium income as reported by the company in 2006. The growth of the company is discussed in the “Financial Data” section of this report. 4 Premium Income Direct Premium $ 10,506 3,344,860 9,344,241 1,979 $12,701,586 Reinsurance Assumed $ 0 1,264,833 16,516 0 $1,281,349 Reinsurance Ceded $ 0 270,983 Line of Business Ordinary life Group life Accident and health: Group Other Total All Lines Net Premium $ 10,506 4,338,710 7,813,246 0 $12,162,462 1,547,511 1,979 $1,820,473 5 III. MANAGEMENT AND CONTROL Board of Directors The board of directors consists of seven members. All directors are elected annually to serve a one-year term. Officers are elected at the board's annual meeting. Members of the company's board of directors may also be members of other boards of directors in the holding company group. The board members currently receive $400 per meeting for serving on the board. Employees who are members of the board are not paid meeting fees. Currently the board of directors consists of the following persons: Name and Residence James Riordan, President Madison, Wisconsin Timothy Flaherty, M.D. Neenah, Wisconsin Timothy Heaton Oregon, Wisconsin William Bathke, Secretary Madison, Wisconsin Principal Occupation President WPS, EPIC and WPS Health Plan, Inc. Retired Physician Term Expires 2008 2008 Chief Operating Officer The EPIC Life Insurance Company Executive Vice President and Chief Operating Officer Wisconsin Physicians Service Ins. Corp. Retired Bank Vice President 2008 2008 Edwin Hill, Jr. Madison, Wisconsin Eugene Nordby, Chairman Madison, Wisconsin Leland Kauth Wisconsin Rapids, Wisconsin 2008 Retired Physician 2008 Retired Financial Consultant 2008 Officers of the Company The officers serving at the time of this examination are as follows: 2006 Compensation $667,435* 509,877* 309,776* Name James Riordan William Bathke William Beisenstein Office President Secretary Senior Vice President and Treasurer * This is total compensation paid by WPS, a portion of which is allocated to subsidiaries. 6 Committees of the Board The company's bylaws allow for the formation of certain committees by the board of directors. There were no committees appointed by the board at the time of the examination. 7 IV. AFFILIATED COMPANIES EPIC is a member of a holding company system. The ultimate parent is Wisconsin Physicians Service Insurance Corporation. The organizational chart below depicts the relationships among the affiliates in the group. A brief description of affiliates deemed significant follows the organizational chart. Organizational Chart As of December 31, 2006 Wisconsin Physicians Service Insurance Corporation The EPIC Life Insurance Company WPS Health Plan, Inc. Administrative and Technical Services, Inc. The Westwood Conference Center, LLC 30.1288% Share South Towne Office Park, LLC Wisconsin Physicians Service Insurance Corporation (WPS) WPS owns 100% of EPIC. WPS is a Wisconsin service insurance corporation offering hospital, medical, and dental coverage for groups as well as claims administration for self-insured employers. WPS assumes a portion of EPIC’s health business. Many of EPIC’s administrative functions are provided by WPS. As of December 31, 2006, WPS’s audited financial statement reported assets of $247,824,445, liabilities of $130,173,892, and capital and surplus of $117,650,553. Operations for 2006 produced net income of $11,580,796. Administrative and Technical Services, Inc. (ADTEC) ADTEC is a wholly owned subsidiary of WPS incorporated in 1979 and provides staffing services and contract programming services. As of December 31, 2006, the audited 8 financial statements of ADTEC reported assets of $3,552,696, liabilities of $335,984, and stockholders’ equity of $3,216,712. Operations for 2006 produced a net loss of $97,187. The Westwood Conference Center, LLC (Westwood) Westwood is a Wisconsin limited liability company operating the Westwood Conference facility in Wausau, Wisconsin. Westwood was established in 2004 and is 30.1288% owned by WPS. As of December 31, 2006, WPS’s share of the unaudited financial statements of Westwood reported total assets of $2,913,736, total liabilities of $1,675,280, and total partners’ equity of $1,238,456. Operations for 2006 produced net income of $133,529. South Towne Office Park, LLC South Towne Office Park, LLC, is a Delaware limited liability company which owns and leases commercial office space on property adjacent to the WPS home office. WPS is the sole partner of the limited liability corporation which was established in 2005. As of December 31, 2006, the unaudited financial statements of South Towne Office Park, LLC, reported assets of $4,039,453, liabilities of $1,713,369, and owner equity of $2,326,084. Operations for 2006 produced net income of $46,595. WPS Health Plan, Inc. WPS Health Plan, Inc., is described as a for-profit mixed model health maintenance organization (HMO) insurer, which markets both group and individual products. The HMO also markets an individual Medicare supplement product. The HMO uses a mixed distribution force consisting of selected agencies in the northeastern and north central Wisconsin areas. For the HMO’s Medicare supplement products a managing general agent is used, Informed Choice. As of December 31, 2006, the audited financial statements of WPS Health Plan, Inc., reported assets of $19,478,151, liabilities of $12,755,044, and surplus of $6,723,107. Operations for 2006 produced net income of $962,280. Agreements with Affiliates WPS has a service and supplies agreement with EPIC, ADTEC and WPS Health Plan, Inc., under which WPS provides management, investment, administrative, and other services and supplies. EPIC, ADTEC, and WPS Health Plan, Inc., reimburse WPS for the actual 9 cost of the services and supplies provided, including a reasonable allocation of overhead expenses. Settlement is to be made within 20 days after the invoice billing is exchanged but no less often than quarterly. WPS has tax allocation agreements with EPIC, ADTEC and WPS Health Plan, Inc. EPIC, ADTEC and WPS Health Plan, Inc., either pay or receive refunds on a calculation performed by WPS at the end of every month. Payments are to be made within 30 days or no later then each quarterly due date of the taxes. 10 V. REINSURANCE The company’s major reinsurance treaties in force at the time of the exam are summarized below. The contracts contained proper insolvency provisions. Affiliated Ceding Contracts The company has a 100% quota share agreement with WPS. EPIC cedes 100% of its accident and health coverages administered by the home office and defined as CORE business. CORE business is medical business. The company retains the business administered by the home office and described as Trustmark, WSE and Ancillary Health and the company also retains fully insured business administered by ABI Administrative Services Corporation. Non-Affiliated Ceding Contracts The company cedes group life and AD&D under an automatic excess of loss contract with Hartford Life & Health Insurance Company. The group life coverage is $400,000 in excess of $100,000 for each insured. The AD&D coverage is $500,000 with a retention of $100,000 for each insured. The retention can be a combination of life and AD&D coverages. The company carries catastrophic excess of loss coverage for its ordinary life, group term life and group AD&D polices, both written and assumed from TruAssure Insurance Company, with Sirius International Insurance Corporation. Coverage applies only to loss occurrences resulting in death or dismemberment caused by accident or accidental means to three or more persons. The reinsurer is liable to pay 100% of each loss occurrence in excess of the following retentions but not to exceed $5 million: $100,000 for EPIC policies and $125,000 for business assumed from TruAssure Insurance Company. The company has two excess of loss contracts with Allianz Life Insurance Company of North America. One contract covers all health business, excluding Medicare supplement. The other one covers medical stop-loss polices issued to self-funded groups. Each contract contains three layers as follows: 1) First layer is 90% of $800,000 in excess of $200,000 of any single loss. 2) Second layer covers 100% of $1 million excess of $1 million of any single loss. 3) Third layer covers $3 million excess of $2 million of any single loss. The limit on the contracts is the greater 11 of $5 million or policy limit per covered person per contract year. Both contracts contain some form of a profit-sharing arrangement. The company has a long-term disability quota share agreement through the American Disability Reinsurance Underwriters Syndicate (ADRUS) which is in run-off with only six claims left. EPIC retains 20% and ADRUS pays 80% of claims. A majority of the participating reinsurers in the ADRUS syndicate are rated A- or higher by A.M. Best. Non-Affiliated Assuming Contracts EPIC participates in a pool which provides catastrophic loss coverage involving group life insurance for the Wisconsin public employees under a contract with Minnesota Mutual Insurance Company. EPIC’s 2006 participation percentage in the pool was 2.4%. EPIC assumes 60% of TruAssure Insurance Company’s group term life and group term life combined with AD&D policies with a maximum retention of $150,000 per insured. In addition, EPIC assumes 50% of their group short-term disability policies not exceeding a maximum retention of $1,500. The life products have a maximum limit per insured individual of $500,000 and the short-term disability product has a maximum limit per insured individual of $1,500. EPIC assumes 100% of the claim liability for those lines in excess of the retentions. EPIC retrocedes amounts in excess of the maximum retention per insured individual. 12 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, 2006, annual statement. Also included in this section are schedules which 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." 13 The EPIC Life Insurance Company Assets As of December 31, 2006 Net Admitted Assets $29,039,269 198,900 6,670,946 2,766,955 356,112 Assets Bonds Stocks: Preferred stocks Common stocks Cash, cash equivalents, and short-term investments Investment income due and accrued Premiums and considerations: Uncollected premiums and agents' balances in course of collection Deferred premiums, agents' balances, and installments booked but deferred and not yet due Reinsurance: Amounts recoverable from reinsurers Other amounts receivable under reinsurance contracts Amounts receivable relating to uninsured plans Electronic data processing equipment and software Furniture and equipment, including health care delivery assets Health care and other amounts receivable Write-ins for other than invested assets: Prepaid expenses Total Assets $29,039,269 198,900 6,670,946 2,766,955 356,112 Nonadmitted Assets $ 1,168,452 1,168,452 1,254 123,619 27,106 17,729 3,297 7,701 1,714 56,123 $40,439,177 57 7,701 184 56,123 $64,065 1,254 123,619 27,106 17,729 3,240 0 1,530 0 $40,375,112 14 The EPIC Life Insurance Company Liabilities, Surplus, and Other Funds As of December 31, 2006 Aggregate reserve for life contracts Aggregate reserve for accident and health contracts Contract claims: Life Accident and health Premiums and annuity considerations received in advance Contract liabilities not included elsewhere: Provision for experience rating refunds Other amounts payable on reinsurance Interest maintenance reserve Commissions to agents due or accrued Commissions and expense allowances payable on reinsurance assumed General expenses due or accrued Taxes, licenses, and fees due or accrued, excluding federal income taxes Current federal and foreign income taxes Net deferred tax liability Amounts withheld or retained by company as agent or trustee Remittances and items not allocated Miscellaneous liabilities: Asset valuation reserve Payable to parent, subsidiaries and affiliates Liability for amounts held under uninsured accident and health plans Total liabilities Common capital stock Gross paid in and contributed surplus Unassigned funds (surplus) Total capital and surplus Total Liabilities, Capital and Surplus $ 2,000,000 11,000,000 9,309,741 $ 990,553 352,583 455,057 827,893 414,933 11,911,144 1,091,953 35,378 89,463 43,494 474,847 (25,219) 154,618 164,597 24,737 205,762 769,372 78,718 5,488 18,065,371 22,309,741 $40,375,112 15 The EPIC Life Insurance Company Summary of Operations For the Year 2006 Premiums and annuity considerations for life and accident and health contracts Net investment income Amortization of interest maintenance reserve Commissions and expense allowances on reinsurance ceded Miscellaneous income: Write-ins for miscellaneous income: Miscellaneous income Total income items Death benefits Disability benefits and benefits under accident and health contracts Surrender benefits and withdrawals for life contracts Increase in aggregate reserves for life and accident and health contracts Subtotal Commissions on premiums, annuity considerations, and deposit-type contract funds (direct business only) Commissions and expense allowances on reinsurance assumed General insurance expenses Insurance taxes, licenses, and fees excluding federal income taxes Increase in loading on deferred and uncollected premiums Total deductions Net gain from operations before dividends to policyholders and federal income taxes Net gain from operations after dividends to policyholders and before federal income taxes Federal and foreign income taxes incurred (excluding tax on capital gains) Net gain from operations after dividends to policyholders and federal income taxes and before realized capital gains or losses Net realized capital gains Net Income $ $3,398,376 5,178,759 543 141,084 8,718,762 $12,162,462 783,873 62,392 161,211 15,854 13,185,792 504,017 53,631 3,037,227 217,767 12 12,531,416 654,376 654,376 215,305 439,071 167,216 606,287 16 The EPIC Life Insurance Company Cash Flow For the Year 2006 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 Federal and foreign income taxes paid (recovered) Total deductions Net cash from operations Proceeds from investments sold, matured, or repaid: Bonds Stocks Total investment proceeds Cost of investments acquired (long-term only): Bonds Stocks Mortgage loans Total investments acquired Net cash from investments Cash from financing and miscellaneous sources: Other cash provided (applied) Net cash from financing and miscellaneous sources Reconciliation: Net change in cash, cash equivalents, and short-term investments Cash, cash equivalents, and short-term investments: Beginning of year End of Year $13,352,221 1,038,201 180,435 14,570,857 $8,235,020 3,888,226 95,814 12,219,060 2,351,797 $4,346,833 2,378,393 6,725,226 6,530,839 2,368,583 144,430 9,043,852 (2,318,626) 12,942 12,942 46,113 2,720,842 $ 2,766,955 17 The EPIC Life Insurance Company Compulsory and Security Surplus Calculation December 31, 2006 Assets Less liabilities Adjusted surplus Annual premium: Individual life and health Factor Total Group life and health Factor Total Compulsory surplus (subject to a $2,000,000 minimum) Compulsory surplus excess or (deficit) $40,375,112 18,065,371 22,309,741 $ 10,373 15% $ 1,555 12,222,314 10% 1,222,231 2,000,000 $20,309,741 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 of 110%) Security surplus excess or (deficit) $22,309,741 2,800,000 $19,509,741 18 The EPIC Life Insurance Company Reconciliation and Analysis of Surplus For the Five-Year Period Ending December 31, 2006 The following schedule is a reconciliation of total capital and surplus during the period under examination as reported by the company in its filed annual statements: 2006 Capital and surplus, beginning of year Net income Change in net unrealized capital gains/losses Change in net deferred income tax Change in nonadmitted assets and related items Change in asset valuation reserve Capital and surplus, end of year 2005 2004 2003 2002 $21,379,557 606,287 286,390 101,645 (15,305) (48,833) $20,631,323 943,099 15,515 42,141 42,292 (294,813) $19,953,711 639,262 310,150 5,647 68,394 (345,841) $18,952,419 919,238 $18,377,665 656,786 28,741 61,038 (7,725) 5,889 (75,572) (12,349) $22,309,741 $21,379,557 $20,631,323 $19,953,711 $18,952,419 The EPIC Life Insurance Company Insurance Regulatory Information System For the Five-Year Period Ending December 31, 2006 The company’s NAIC Insurance Regulatory Information System (IRIS) results for the period under examination are summarized below. Unusual IRIS results are denoted with asterisks and discussed below the table. Ratio Net change in capital and surplus Gross change in capital and surplus Net income to total income Adequacy of investment income Nonadmitted to admitted assets Total real estate and mortgage loans to cash and invested assets #7 Total affiliated investments to capital and surplus #8 Surplus relief #9 Change in premium #10 Change in product mix #11 Change in asset mix #12 Change in reserving ratio #1 #2 #3 #4 #5 #6 2006 4% 4 5 999* 0 0 0 0 12 1.1 0.1 -32* 2005 4% 4 8 999* 0 0 0 1 -2 1.0 1.0 56* 2004 3% 3 5 999* 0 0 0 1 -6 2.0 2.0 -49* 2003 5% 5 7 999* 0 0 0 1 -9 1.0 1.0 18 2002 3% 3 4 999* 1 0 0 -1 7 0.0 1.0 86* 19 Ratio No. 4 compares the net investment income to the increase in reserves from tabular interest. The exceptional results for Ratio No. 4 were due to the company being primarily a group health insurer. Because the company’s business is not written on a level premium basis like individual life insurance, there are no tabular reserves. Because of the nature of the company’s business, the exceptional results are not an indication of insufficient reserves. Ratio No. 12 measures the increase in aggregate reserves to net single and renewal premiums. The exceptions can be attributed to the small volume of individual life policies the company writes, causing small reserve changes to result in high percentages. Growth of The EPIC Life Insurance Company Year 2006 2005 2004 2003 2002 2001 Admitted Assets $40,375,112 37,779,004 36,525,051 34,475,771 32,706,172 26,055,368 Liabilities $18,065,371 16,399,447 15,893,728 14,522,060 13,753,753 7,677,703 Capital and Surplus $22,309,741 21,379,557 20,631,323 19,953,711 18,952,419 18,377,665 Net Life Premiums, Annuity Considerations, and Deposits Accident and Health Premiums $7,872,642 6,476,368 7,199,964 8,380,146 9,592,429 9,353,897 Year 2006 2005 2004 2003 2002 2001 Life Insurance Premiums $4,360,045 4,399,461 3,886,772 3,387,011 3,287,784 2,704,800 Annuity Considerations $0 0 0 0 0 0 Life Insurance In Force (in thousands) Gross Risk In Force $1,270,374 1,230,389 1,092,096 976,348 837,960 914,987 Year 2006 2005 2004 2003 2002 2001 Ceded $ 61,710 61,119 100,627 85,006 62,868 59,390 Net $1,208,664 1,169,270 991,469 891,342 775,092 855,597 20 Accident and Health Incurred Claims and Cost Containment Expenses* $5,193,475 4,264,648 5,057,824 6,693,406 7,595,894 6,315,971 Combined Loss and Expense Ratio 100.4% 101.2 109.7 105.9 105.7 99.4 Year 2006 2005 2004 2003 2002 2001 Net Premiums Earned $7,779,844 6,474,245 6,982,529 8,515,887 9,979,703 9,422,590 Commissions Incurred $ 199,581 7,717 194,926 289,238 541,149 1,247,482 Other Expenses Incurred** $2,411,698 2,279,529 2,410,067 2,033,864 2,413,573 2,044,560 * Includes increase in contract reserves ** Includes taxes, licenses, and fees Assets increased from $26,055,368 in 2001 to $40,375,112 in 2006. Liabilities increased from $7,677,703 in 2001 to $18,065,371 in 2006. Surplus increased from $18,377,665 in 2001 to $22,309,741 in 2006. Life premiums increased since the last examination and accident and health premiums decreased by about the same amount. Net in-force increased since the last examination. The combined ratio has ranged from a low of 99.4% to a high of 109.7%. The ratio in 2006 was 100.4%. Reconciliation of Surplus per Examination No adjustments were made to surplus as a result of the examination. The amount of surplus reported by the company as of December 31, 2006, is accepted. 21 VII. SUMMARY OF EXAMINATION RESULTS Compliance with Prior Examination Report Recommendations There were five specific comments and recommendations in the previous examination report. Comments and recommendations contained in the last examination report and actions taken by the company are as follows: 1. Executive Compensation—It is recommended that the company properly include all compensation amounts paid or accrued for when completing the Report on Executive Compensation (Form OCI 22-010). Action—Compliance. 2. Bonds—It is recommended that the company comply with the Purposes and Procedures Manual of the NAIC Securities Valuation Office and report correct designations for each security on future annual statements. Action—Compliance. 3 Bonds—It is recommended that the company comply with the Purposes and Procedures Manual of the NAIC Securities Valuation Office and maintain documentation for the provisionally exempt designated securities and make sure that any securities that no longer qualify for the provisionally exempt designation be filed within 120 days of such failure, as if the securities had never been provisionally exempt. Action—Compliance. 4 Commissions—It is recommended that the company properly accrue for commissions payable in future annual statements. Action—Compliance. 5 Reinsurance Contracts—It is again recommended that the company report the correct name of its reinsurers in Schedule S of future annual statements. Action—Compliance. 22 Summary of Current Examination Results This section 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. Financial Reporting The examiner reviewed the company’s 2007 audit engagement letter. It was noted that the letter contained an indemnification clause in violation of s. Ins 50.08 (1), Wis. Adm. Code. Prior to the end of examination field work the company and the external auditors amended the engagement letter to eliminate the indemnification clause. It is recommended that the company not sign engagement letters with indemnification clauses or other limitations on auditor liability in compliance with s. Ins 50.08 (1), Wis. Adm. Code. Unclaimed Funds The company reported unclaimed funds in the line “amounts withheld or retained on account of others.” According to the NAIC Annual Statement Instructions – Life, the escheat liability should be reported as a write-in. It is recommended that the company comply with NAIC Annual Statement Instructions – Life and report any escheat liability as a write-in. Beginning with the third quarter 2007, the company began reporting escheatable funds on the correct line. Custodial Agreement It was found that the custodial agreement was missing the following controls and safeguards: 1. An indemnification clause whereby the bank would indemnify the company for a loss of securities in the custodian’s custody due to negligence or dishonesty of the custodian’s officers or employees, or burglary, robbery, holdup, theft or mysterious disappearance, including loss by damage or destruction. 2. A provision that in event of such a loss the custodian is obligated to promptly replace the value of the securities and the value of any loss of rights or privileges resulting from said loss of securities. In addition, it appears that the agreement the company has is for pension type accounts and is not the custodial agreement normally used for insurers. It is recommended that the company fully comply with s. 610.23, Wis. Stat., by executing proper custodial agreements containing 23 satisfactory safeguards and controls in accordance with the NAIC Financial Condition Examiners Handbook. Bonds and Stocks The examiners found that the company did not appropriately designate many of its foreign securities on Schedule D as required by the NAIC Annual Statement Instructions – Life. It is recommended that the company designate foreign securities accurately in Schedule D of future annual statements as required by the NAIC Annual Statement Instructions – Life. Cash and Short Term Investments At year-end 2006 EPIC had a balance of $142,045 in a Cayman Island bank account. Since the company has no business in foreign countries that would require the use of foreign bank accounts, the company should reevaluate whether the use of foreign bank accounts is warranted. HIRSP Accrual The examination determined that EPIC did not properly accrue for the Health Insurance Risk-Sharing Plan (HIRSP) assessment. The company had received an assessment based on 2005 premium in August 2006 for the amount of $4,550. The company elected to pay this assessment in one installment resulting in no accrual for HIRSP for the 2005 premium assessment as of December 31, 2006. EPIC did not make an accrual for the HIRSP assessment based on its 2006 premium, which would have resulted in an additional $1,058. Statement of Statutory Accounting Principle (SSAP) No. 35, Guaranty Fund and Other Assessments, states that an accrual for assessments should be established when information is available prior to the issuance of the financial statements when it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statement and the amount can be reasonably estimated. Although the company did not receive notice of an assessment based on 2006 premium prior to the issuance of the financial statements, they could have estimated the assessment by taking the 2006 premium multiplied by the latest factor received in the last assessment. Since the assessment is based on premium as opposed to claims, the liability has been incurred once the company has written the premium. The additional accrual of $1,058 was not considered material. However, it is recommended that the company accrue for HIRSP 24 assessments in accordance with SSAP No. 35. It should be noted that beginning with year-end 2007 the company has begun to accrue for this liability in accordance with SSAP No. 35. 25 VIII. CONCLUSION The company is part of a holding company system in which the ultimate parent is Wisconsin Physicians Service Insurance Company. The three insurance companies in the group were examined concurrently. Surplus increased from $18,377,665 in 2001 to $22,309,741 in 2006. Life premiums increased since the last exam and accident and health premiums decreased by about the same amount. Net life insurance in-force increased since the last examination. The combined loss and expense ratio ranged from a low of 99.4% to a high of 109.7% during the period under examination. The ratio in 2006 was 100.4%. The company became licensed in Pennsylvania in 2007. The examination made recommendations regarding the CPA audit engagement letter, unclaimed funds, custodial agreement language, bonds and stocks and the HIRSP accrual. 26 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS 1. Page 23 - Financial Reporting—It is recommended that the company not sign engagement letters with indemnification clauses or other limitations on auditor liability in compliance with s. Ins 50.08 (1), Wis. Adm. Code. Page 23 - Unclaimed Funds—It is recommended that the company comply with NAIC Annual Statement Instructions – Life and report any escheat liability as a write-in. Page 23 - Custodial Agreement—It is recommended that the company fully comply with s. 610.23, Wis. Stat., by executing proper custodial agreements containing satisfactory safeguards and controls in accordance with the NAIC Financial Condition Examiners Handbook. Page 24 - Bonds and Stocks—It is recommended that the company designate foreign securities accurately in Schedule D of future annual statements as required by the NAIC Annual Statement Instructions – Life. Page 24 - HIRSP Accrual—However, it is recommended that the company accrue for HIRSP assessments in accordance with SSAP No. 35. 2. 3. 4. 5. 27 X. ACKNOWLEDGMENT The courtesy and cooperation extended during the course of the examination by the officers and employees of the company 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 Eleanor Oppriecht Angela Graff Andrew Fell Carmenza Rincon Victoria Chi Jerry DeArmond Title Insurance Financial Examiner Insurance Financial Examiner Insurance Financial Examiner Insurance Financial Examiner Insurance Financial Examiner—Advanced Insurance Financial Examiner—Advanced Respectfully submitted, David A. Grinnell Examiner-in-Charge 28