Manitowoc Mutual Insurance Company

Report of the Examination of Manitowoc Mutual Insurance Company Reedsville, Wisconsin As of December 31, 2005 TABLE OF CONTENTS Page I. INTRODUCTION .................................................................................................................. 1 II. HISTORY AND PLAN OF OPERATION .............................................................................. 3 III. MANAGEMENT AND CONTROL ........................................................................................ 5 IV. AFFILIATED COMPANIES .................................................................................................. 8 V. REINSURANCE ................................................................................................................... 9 VI. FINANCIAL DATA .............................................................................................................. 12 VII. SUMMARY OF EXAMINATION RESULTS ....................................................................... 21 VIII. CONCLUSION.................................................................................................................... 32 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS.............................................. 33 X. ACKNOWLEDGMENT ....................................................................................................... 35 State of Wisconsin / OFFICE OF THE COMMISSIONER OF INSURANCE Jim Doyle, Governor Jorge Gomez, Commissioner Wisconsin.gov November 15, 2006 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: MANITOWOC MUTUAL INSURANCE COMPANY Reedsville, Wisconsin and this report is respectfully submitted. I. INTRODUCTION The previous examination of Manitowoc Mutual Insurance Company (Manitowoc or the company) was conducted in 2002 as of December 31, 2001. The current examination covered the intervening period ending December 31, 2005, and included a review of such 2006 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. 2 II. HISTORY AND PLAN OF OPERATION The company was organized in 1874 as Manitowoc Rapids Farmers’ Mutual Insurance Company, a town mutual insurance company. The company changed its name to Manitowoc County Mutual Insurance Company through subsequent amendments to its articles and bylaws. Effective January 1, 1996, Manitowoc County Mutual Insurance Company converted from a town mutual insurance company to a limited assessable mutual insurance company and changed its name to that presently used; the company became non-assessable as of February 1, 2000. Hartland-Richmond Town Mutual Insurance Company merged into the company effective March 1, 1996; Eastern Mutual Insurance Company merged into the company effective October 1, 1996; and Liberty Grove Mutual Insurance Company merged into the company January 1, 1997. Mishicot Town Mutual Insurance Company merged into the company effective January 1, 2000; and Crystal Lake-Utica Mutual Insurance Company merged into the company effective February 1, 2000. On March 10, 1997, Manitowoc created an agency subsidiary company, Pine Insurance Agency, Inc. Further discussion of the agency is made in the section of the report captioned “Affiliated Companies.” The company is only licensed to conduct business in Wisconsin. In 2005, the company wrote direct premium in 46 counties of the state. The major products marketed by the company include farmowner’s, homeowner’s, commercial multiple peril, fire, and allied lines. Business is currently produced by an independent agency force. The company has 378 independent agents from 74 agencies throughout Wisconsin. Agents are compensated at a rate of 15% on all types of business. The company also offers an incentive commission plan to its agents. Incentive commission is dependent on the agent’s average loss ratio during the three prior calendar years. In 2005 incentive commission was based on the following determinants: 3 Minimum net written premium requirement: $30,000 Loss Ratio 0-15% 15-25 26-35 36-45 46-55 Incentive Commission 5% 4 3 2 1 Effective January 1, 2006, the incentive commission agreement was revised to reduce the loss ratio brackets and percentages by 5 percentage points. Effective January 1, 2007, the minimum premium requirement will be increased to $50,000. The following table is a summary of the net insurance premiums written by the company in 2005. The growth of the company is discussed in the “Financial Data” section of this report. Direct Premium $ 201,440 201,440 1,851,093 2,290,160 753,311 $5,297,444 Reinsurance Assumed $0 0 0 0 0 $0 Reinsurance Ceded $ 51,387 51,387 472,212 584,218 192,169 Net Premium $ 150,053 150,053 1,378,881 1,705,942 561,142 $3,946,071 Line of Business Fire Allied lines Farmowner’s multiple peril Homeowner’s multiple peril Commercial multiple peril Total All Lines $1,351,373 Manitowoc does not intend to expand from its current lines of business marketed. The company’s goal is to further establish its presence in the marketplace in order to increase surplus and diversify its risk exposure. The company believes that it can achieve its goal by acquiring additional companies, expanding its business to all counties of the state, maintaining quality underwriting and handling claims fairly and efficiently. 4 III. MANAGEMENT AND CONTROL Board of Directors The number of directors serving on the company’s board varied greatly during the period under examination. The board currently has 8 directors as compared to 16 directors during the prior examination. The company’s changes in directors were as follows: 1 director was added in 2002; 4 directors did not renew their terms in 2003; 1 director passed away in 2004; 3 directors did not renew their terms in 2005; and in 2006 1 director did not renew his term. The number of positions was increased to 16, and later to 17 to accommodate four mergers that occurred in 1996, 1997 and 2000. In accordance with the company’s bylaws, the position of each director who resigns, retires, or otherwise is unable to serve because of death or disability is not to be filled, and the number of director positions shall be reduced by any of the above events until it reaches 9 positions. The company intends to bring the total number of directors to 9 members in 2007. Further comments on the number of directors can be found in the section of this report captioned “Corporate Records.” The directors currently receive a fee of $200 per meeting attended plus compensation for attendance at the following rates: Executive committee meeting Committee meeting District/Educational meeting Annual meeting $200 per meeting 100 per meeting 150 full day; $100 one-half day 200 per meeting The Board Chairman receives an annual fee of $4,000; the Board Secretary receives an annual fee of $1,000. The directors are also compensated for mileage when traveling to conventions or meetings other than regular meetings. The compensation is equivalent to the IRS rate, currently $0.445 per mile. 5 Currently the board of directors consists of the following persons: Name and Residence Russell Brandl Howards Grove, WI James Froelich Manitowoc, WI John Stangel Manitowoc, WI Caspar Wallrich Cecil, WI Bruce Deuchert Green Bay, WI Luther Olsen Ripon, WI Alan Tauchen Bonduel, WI Donald Risch Cato, WI Principal Occupation Insurance Agent Term Expires 2007 Retired Traffic Officer and Board Secretary 2007 Attorney 2007 Insurance Agent 2007 Insurance Agent and Corporate Secretary 2008 Mill Owner and State Senator 2008 Farmer 2008 Real Estate Salesperson and Board Chairperson 2009 Officers of the Company Officers are elected by directors at the board's annual meeting. The officers serving at the time of this examination are as follows: 2005 Compensation* $55,085 3,800 Name Robert Butters Bruce Deuchert Office President and Treasurer Corporate Secretary * Includes officer’s annual fee, meeting fees and mileage. The Secretary is also an agent writing for the company. In 2005, the Secretary received commissions of $44,710. Committees of the Board The company's bylaws allow for the formation of certain committees by the board of directors. Committees, with the exception of the Advisory Committee, must consist of at least three directors, with the Board Chairperson serving ex officio on all committees. The board of 6 directors appoints persons to serve on the Advisory Committee to advise the board on issues submitted by the board for review. The committees at the time of the examination are listed below: Executive Committee Donald Risch, Chair Bruce Deuchert John Stagel Jim Froelich Robert Butters Finance Committee Jim Froelich, Chair Lester Cherney Barb Lorrigan Bruce Duechert Donald Risch Bylaws Committee Bruce Deuchert, Chair John Stangel Luther Olsen Caspar Wallrich Donald Risch Advisory Committee Lester Cherney, Chair Otto Kral Merger Committee Lester Cherney, Chair Otto Kral Caspar Wallrich Russell Brandl Bruce Deuchert Donald Risch 7 IV. AFFILIATED COMPANIES Manitowoc Mutual Insurance Company is an owner of an agency, Pine Insurance Agency, Inc. (Pine). The organizational chart below depicts this relationship. A brief description of Pine follows the organizational chart. Organizational Chart As of December 31, 2005 Manitowoc Mutual Insurance Company Pine Insurance Agency, Inc. Pine Insurance Agency, Inc. Pine is wholly owned by Manitowoc Mutual Insurance Company. This agency was created to accommodate company agents writing business not offered by Manitowoc, such as umbrella liability and auto insurance. The company established Pine as a means to complement their insurance products and to help its agencies retain good policyholders. Currently very few policies are written through Pine and the company expects that the agency will cease to write business as of March 1, 2007. The company plans to keep Pine as a dormant company in case the need arises for an in-house agency structure. As of December 31, 2005, the agency’s unaudited financial statement reported assets of $1,418, liabilities of $0, and equity of $1,418. Operations in 2005 generated a net loss of $1,340. According to the terms of service and office lease agreements with Manitowoc, Pine is required to reimburse the company for the cost of administrative services at $1,000 per year; the postage, office supplies, and copier costs at $300 per year; and office rent at $300 per year. 8 V. REINSURANCE The review of the company’s reinsurance program revealed that there is currently one nonaffiliated ceding treaty. The treaty contains proper insolvency provisions and warranties the compliance with specific statutes and codes. Nonaffiliated Ceding Contracts Reinsurer: Effective date: Termination: Wisconsin Reinsurance Corporation January 1, 2006 By either party giving 90 days’ advance notice The coverages provided under this treaty are summarized as follows: 1. Type: Scope: Retention: Coverage: Exhibit A - Casualty Excess of Loss All casualty or liability business $10,000 of each and every loss 100% of each and every loss, including loss adjusting expense, in excess of $10,000 40% of net premium earned, subject to a minimum annual premium of $307,800 None January 1, 2006 By either party giving 90 days’ advance notice Exhibit B1 - First Surplus Reinsurance All property business $1,000,000 in respect to each and every risk Up to $800,000 on a pro rata basis when the company’s retention is more than $1,000,000 in respect to a risk. 50% of a risk when the company’s retention is less than $1,000,000 in respect to the risk. Pro rata portion of all premiums, fees and assessments Ceding commission of 15% of all premiums ceded under this exhibit Profit commission of 15% of the net profit to the reinsurer Premium: Commissions: Effective date: Termination: 2. Type: Scope: Retention: Coverage: Premium: Commissions: 9 Net profit to the reinsurer is calculated as follows: Premiums earned for the annual period less Ceding commission paid to the company on premium earned for the annual period less Losses and loss adjusting expenses incurred for the annual period less The reinsurer’s net loss, if any, from the preceding annual period 3. Type: Scope: Retention: Exhibit C1 - First Per Risk Excess of Loss Reinsurance All property business $75,000 in respect to each and every risk resulting from one loss occurrence $100,000, including loss adjusting expense, in excess of $75,000 in respect to each and every risk resulting from one loss occurrence 8.41% of the company’s net earned premium, subject to the minimum rate of 6% and maximum rate of 10% of the company’s net earned premium. Minimum annual premium is $269,393, None Exhibit C2 - Second Per Risk Excess of Loss Reinsurance All property business $175,000 in respect to each and every risk resulting from one loss occurrence $325,000, including loss adjusting expense, in excess of $175,000 in respect to each and every risk resulting from one loss occurrence 2.0% of the company’s net earned premium, subject to a minimum annual premium of $64,065 None Exhibit C3 - Third Per Risk Excess of Loss Reinsurance All property business $500,000 in respect to each and every risk resulting from one loss occurrence $500,000, including loss adjusting expense, in excess of $500,000 in respect to each and every risk resulting from one loss occurrence 1.0% of the company’s net earned premium, subject to a minimum annual premium of $31,628 None Coverage: Premium: Commissions: 4. Type: Scope: Retention: Coverage: Premium: Commissions: 5. Type: Scope: Retention: Coverage: Premium: Commissions: 10 6. Type: Reinsurer: Scope: Retention: Exhibit D1 - First Aggregate Excess of Loss Reinsurance Wisconsin Reinsurance Corporation All business 65% of the company’s net earned premium; estimated attachment point is $2,859,531 60% of the company’s net earned premium in excess of the company’s retention. Loss adjusting expenses recoverable under this exhibit are limited to the ratio of the loss recoverable under this exhibit to the total net incurred losses. 8% of the company’s net earned premium, subject to the minimum rate of 8% and maximum rate of 12%. Minimum annual premium is $263,957. None Exhibit D2 - Second Aggregate Excess of Loss Reinsurance All business 125% of company’s net earned premium 100% of all net losses incurred by the company during the annual period in excess of the company’s retention 2.70% of the company’s net earned premium, subject to a minimum annual premium of $89,086 None Coverage: Premium: Commissions: 7. Type: Scope: Retention: Coverage: Premium: Commissions: 11 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, 2005, 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." 12 Manitowoc Mutual Insurance Company Assets As of December 31, 2005 Net Admitted Assets $3,628,573 99,901 1,901,590 0 402,278 624,038 54,254 Assets Bonds Stocks: Preferred stocks Common stocks Mortgage loans on real estate: First liens Real estate: Occupied by the company 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 Net deferred tax asset Electronic data processing equipment and software Furniture and equipment, including health care delivery assets Write-ins for other than invested assets: Miscellaneous Total Assets $3,628,573 99,901 1,901,590 3,976 402,278 624,038 54,254 Nonadmitted Assets $ 0 0 0 3,976 0 0 0 148,963 0 148,963 617,781 23,729 511 333,864 17,038 31,540 0 0 0 258,864 3,850 31,540 617,781 23,729 511 75,000 13,188 0 613 $7,888,649 0 $298,230 613 $7,590,419 13 Manitowoc Mutual Insurance Company Liabilities, Surplus, and Other Funds As of December 31, 2005 Losses Loss adjustment expenses Commissions payable, contingent commissions, and other similar charges Other expenses (excluding taxes, licenses, and fees) Unearned premiums Advance premium Total liabilities Surplus as regards policyholders Total Liabilities and Surplus $ 669,203 20,362 280,635 57,891 2,634,485 75,808 3,738,384 3,852,035 $7,590,419 14 Manitowoc Mutual Insurance Company Summary of Operations For the Year 2005 Underwriting Income Premiums earned Deductions: Losses incurred Loss expenses incurred Other underwriting expenses incurred Total underwriting deductions Net underwriting gain (loss) Investment Income Net investment income earned Net realized capital gains (losses) Net investment gain (loss) Other Income Finance and service charges not included in premiums Write-ins for miscellaneous income: Miscellaneous income Total other income Net Income $3,680,789 $2,136,875 96,994 1,644,904 3,878,773 (197,984) 141,702 2,057 143,759 234,536 768 235,304 $ 181,079 15 Manitowoc Mutual Insurance Company Cash Flow For the Year 2005 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 Miscellaneous proceeds Total investment proceeds Cost of investments acquired (long-term only): Bonds Stocks Real estate 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 $ 3,838,324 161,606 235,304 4,235,234 $1,780,073 1,716,931 (101,245) 3,395,759 839,475 $ 587,614 195,750 (87,474) 695,890 1,555,869 219,385 2,173 1,777,427 (1,081,537) (20,869) (20,869) (262,931) 886,969 $ 624,038 16 Manitowoc Mutual Insurance Company Compulsory and Security Surplus Calculation December 31, 2005 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) $7,590,419 3,738,384 3,852,035 $3,946,071 20% 2,000,000 $1,852,035 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) $3,852,035 2,800,000 $1,052,035 17 Manitowoc Mutual Insurance Company Reconciliation and Analysis of Surplus For the Five-Year Period Ending December 31, 2005 The following schedule is a reconciliation of total surplus during the period under examination as reported by the company in its filed annual statements: 2005 Surplus, beginning of year Net income Change in net unrealized capital gains/losses Change in net deferred income tax Change in nonadmitted assets Write-ins for gains and (losses) in surplus: Mortgage in Default Surplus, end of year 2004 2003 2002 2001 $3,567,457 181,079 $2,743,677 210,625 $2,176,143 459,819 $2,920,960 (550,192) $3,474,513 (376,525) 125,608 (58,054) 35,945 279,818 (67,737) 401,074 58,905 (152,767) 198,208 (211,525) 240,495 (223,668) (82,369) 192,266 (279,506) 3,369 $3,852,035 $3,567,457 $2,743,677 73 $2,176,143 (7,419) $2,920,960 18 Manitowoc Mutual Insurance Company Insurance Regulatory Information System For the Five-Year Period Ending December 31, 2005 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 #1 #2 #3 #4 #5 #6 #7 #8 #9 #10 #11 #12 #13 Gross Premium to Surplus Net Premium to Surplus Change in Net Writings Surplus Aid to Surplus Two-Year Overall Operating Ratio Investment Yield Gross Change in Surplus Net Change in Adjusted Surplus (first used in 2005) 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 2005 138% 102 18 0 93 2.3* 8 8 50 4 1 1 -4 2004 142% 93 9 0 87 1.8* 24 2003 174% 111 10 0 100* 2.5* 22 2002 205% 127 10 0 117* 2.4* -18* 2001 134% 86 -21 0 115* 3* -12* 50 4 1 0 3 58 5 0 0 -6 67 7 0 -3 -17 53 4 -2 -2 1 Ratio No. 5 measures the company’s profitability over the previous two-year period. The exceptional results reported in three of the five years under examination were due to the following factors: 1) a high loss ratio due to unusually severe storms in 2000 and 2001 resulting in numerous claims; 2) a high expense ratio; and 3) a low return on investments. Ratio No. 6 is net investment income earned as a percentage of the average amount of cash and invested assets during the year. The exceptional results in the years under examination were attributed to the current investment environment whereby a low investment yield was common and also to the fact that 12% of total cash and invested assets were represented by common stock in the company’s reinsurer, WRC, which has not paid dividends. Ratio No.7 measures the gross change in surplus from the prior year end. The exceptional results in 2001 and 2002 were due to net losses resulting from unusually severe storms that occurred in 2000 and 2001 and also due to substantial unrealized capital losses in value of the common stock WRC, the company’s reinsurer, whose operating results were 19 negatively affected by these storms. (Since 2002, WRC’s stock price has increased substantially, which is the major part of the unrealized capital gains reported in 2003-2005 in the table presented two pages ago.) Growth of Manitowoc Mutual Insurance Company Surplus As Regards Policyholders $3,852,035 3,567,457 2,743,677 2,176,143 2,920,960 Loss And LAE Ratio 60.7% 58.2 47.1 84.1 83.8 Year 2005 2004 2003 2002 2001 Admitted Assets $7,590,419 6,829,876 6,083,651 5,211,516 5,262,826 Gross Premium Written Net Premium Written $3,946,071 3,331,773 3,047,602 2,768,229 2,555,080 Liabilities $3,738,384 3,262,419 3,339,974 3,035,373 2,341,866 Net Income $ 181,079 210,625 459,819 (550,192) (376,525) Year 2005 2004 2003 2002 2001 Premium Earned $3,680,789 3,215,419 2,858,730 2,591,199 2,510,246 Expense Ratio 35.7% 36.9 38.6 38.4 37.7 Combined Ratio 96.4% 95.1 85.7 122.5 121.5 $5,297,444 5,068,599 4,776,547 4,471,409 3,923,688 As the above figures shows, the company has improved its financial position considerably in the last three years after it suffered from substantial losses resulting from severe hail and wind storms in 2000 and 2001. Both admitted assets and surplus have increased during the period under examination. Total admitted assets have increased 44%, and surplus has increased 32% compared to 2001. The company has reported premium growth since the last exam with rate increases being the most noticeable factor of that growth. Growth is evidenced by both gross and net premium written increases during the period under examination by 35% and 54%, respectively. The company reported net income in three of the last five years. 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, 2005, is accepted. 20 VII. SUMMARY OF EXAMINATION RESULTS Compliance with Prior Examination Report Recommendations There were 18 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. Corporate Records—It is again recommended that minutes for all committees of the board of directors be maintained and included with the minutes of the board of directors meetings. Action—Noncompliance. See comments in the summary of current examination results captioned “Corporate Records.” 2. Corporate Records—It is recommended that the company comply with s. 611.51(3), Wis. Stat., as regards the composition of its board of directors. Action—Compliance. 3. Agent Records—It is recommended that the company comply with s. 628.11, Wis. Stat; and accurately report its agent appointments and terminations to this office. Action—Compliance. 4. Conflict of Interest—It is again recommended that the company’s directors and officers disclose all potential conflicts of interest when completing the annual conflict of interest questionnaires. Action—Compliance. 5. Disaster Recovery Plan—It is recommended that the company update its disaster recovery plan to include the company’s strategy for a management succession plan. Action—Compliance 6. Holding Company—It is recommended that the company file an annual holding company report annually by June 1 of each subsequent year for the immediately preceding calendar year in accordance with s. Ins 40.03 (a), Wis. Adm. Code. Action—Compliance. 7. Holding Company—It is recommended that the company properly comply with all agreements between the company and the “agency” in accordance with s. Ins 40.03 (3) (c) 5, Wis. Adm. Code. Action—Compliance. 8. Cash and Short-term Investments—It is again recommended that the company report money market accounts on Schedule DA of the Annual Statement in accordance with the NAIC’s Annual Statement Instructions Property and Casualty. Action—Compliance. 21 9. Mortgage Loans—It is again recommended that the company accurately complete Schedule B of the Annual Statement in accordance with the NAIC’s Annual Statement Instructions Property and Casualty. Action—Compliance. 10. Mortgage Loans—It is again recommended that the company establish formal written underwriting guidelines for the acceptance of a mortgage loan which includes, but is not limited to, guidelines which do an extensive credit risk analysis for the potential mortgagee. Action—Not applicable – the company stopped investing in mortgage loans. 11. Mortgage Loans—It is again recommended that the company establish guidelines for the mortgage loan investment overall which includes, but is not limited to, the percentage of the company’s assets to be invested in mortgage loans, the terms allowable for loans, the interest rate determination, and the policy on refinancing or extending the mortgage loan. Action—Not applicable – the company stopped investing in mortgage loans. 12. Bonds and Stocks—It again recommended that the company accurately complete Schedule D of the Annual Statement. Action—Not applicable. See comments in the summary of current examination results captioned “Bonds and Stocks.” 13. Bonds and Stocks—It is again recommended that the company comply with the procedures of the NAIC’s Securities Valuation Office regarding its invested assets. Action—Compliance. 14. Bonds and Stocks—It is recommended that the company either follow its investment policy or amend the investment policy to reflect its current investment needs. Action—Compliance. 15. Premiums in Course of Collection—It is recommended that the company comply with the NAIC’s Financial Examiners Handbook, SSAP No. 6, paragraph 9, by properly nonadmitting uncollected premium balances over 90 days past due. Action—Compliance. See comments in the summary of current examination results captioned “Premiums in Course of Collection.” 16. Advance Premium—It is recommended that the company comply with the NAIC’s Financial Examiners Handbook, SSAP No. 6, paragraph 13, by properly excluding paid premium from the written premium or the unearned premium reserve. Action—Compliance. 17. Advance Premium—It is recommended that the company comply with s. Ins 6.80 (4) (c) 1, Wis. Adm. Code. The company should be maintaining all records of the company’s operations and other financial records related to insurance operations for a period of at least five years from the prior examination. Action—Compliance. 22 18. Underwriting—It is recommended that the company inspect all of its insured properties within the next three years. Action—Compliance. 23 Summary of Current Examination Results This section contains comments and elaboration on those areas where adverse findings were noted or where unusual situations existed. Comments on the remaining areas of the company’s operations are contained in the examination work papers. Management and Control The latest CPA management letter indicated a material weakness in the internal control structure due to the lack of segregation of duties. This condition is inherent with a company with few employees. The examiners reviewed the company’s control components related to the major accounting cycles and concluded that the company’s management undertakes adequate steps to mitigate this weakness. The steps undertaken by the company are listed below: • • • There is active board participation, especially in the area of loss payments. The board has established an annual detailed financial budget which is analyzed by members of the executive committee of the board. Management prepares a detailed financial summary of the company’s operations which is reviewed and discussed at board meetings. This summary includes a review of the company’s operating results, investment portfolio, agencies’ performance, and general expenses incurred by the company. Corporate Records The two most recent prior examinations recommended that the company maintain all committee minutes of the board and make them available for review. Under the current examination period, the examiner again noted that there were no minutes of meetings for some committees of the board. According to s. 611.51 (9) (am) 1, Wis. Stat., each mutual company should keep minutes of the proceedings of its policyholders, board of directors and committees having any authority of the board. Therefore, it is again recommended that minutes for all committees of the board of directors be maintained and included with the minutes of the board of directors in accordance with s. 611.51 (9) (am) 1, Wis. Stat. The examination review of the company’s organizational structure noted that the board of directors consisted of eight members. Three of these members were agents for the 24 company. This is a violation of s. 611.51 (2), Wis. Stat., which only allows one director who is an employee or representative of the company in cases where the company has eight or fewer directors. It is recommended that the company comply with s. 611.51 (2), Wis. Stat., as regards the composition of its board of directors. The review of the company’s bylaws revealed that the principal offices of the company should consist of a Chairperson, President, one or more Vice Presidents, Secretary and Treasurer. However, the company had neither a Chairperson nor any Vice Presidents. The company had two officers: one person held the offices of the President and Treasurer, and another person held the office of the Corporate Secretary. According to s. 611.12 (3), Wis. Stat., the principal offices shall be held by at least three separate individuals. It is recommended that the company’s principal offices be held by at least three separate individuals in accordance with s. 611.12 (3), Wis. Stat., and that the offices be designated in accordance with the company’s bylaws. In the course of the current examination it was noted that the company amended its articles of incorporation and bylaws effective October 2003. It was further noted that the company did not file the amended articles and bylaws with the commissioner. According to s. 611.29 (4), Wis. Stat., no amendment may become effective until the articles of amendment have been filed with the commissioner. It is recommended that the company file any amendment to its articles with the commissioner prior to the articles becoming effective in accordance with s. 611.29 (4), Wis. Stat. According to s. 611.12 (4), Wis. Stat., the bylaws of a domestic corporation and any amendment thereto shall be filed with the commissioner within 60 days after adoption. It is recommended that the company file any amendment to its bylaws with the commissioner within 60 days after adoption according to s. 611.12 (4), Wis. Stat. Board of Directors In the review of the board minutes for the period under examination, the examiners noted that the board members did not formally discuss or approve the investment transactions. The board has authorized the company’s broker to execute investment transactions without the 25 prior consent of the company according to the board approved investment policy. The broker’s authority is limited by the investment policies and guidelines specified in the policy. The company President reviews the broker’s compliance with the investment limitations imposed by the company and reports his findings to the board of directors. The board did not approve investment transactions but instead delegated its authority to the company’s broker. The investment transactions represent a significant part of the company’s operations and the decision-making power over the company’s investments should remain with the board. It is recommended that the company’s board of directors formally review and approve the investment decisions of the broker and not delegate its authority or responsibility to do so in accordance with s. 611.51 (6), Wis. Stat. Actuarial Opinion The company obtained approval from this office every year since 2001 to permit the company’s President to issue a statement of actuarial opinion. However, in the review of the board minutes for the period of the examination, there were no formal discussions or recording of the board’s approval for the President to be the appointed actuary in any year. It is recommended that the company’s board of directors approve the company’s appointed actuary and disclose the appointment in the board minutes. According to the NAIC Annual Statement Instructions, only an accredited actuary can sign the opinion. As noted above, the company received approval for a permitted practice allowing its President to prepare and sign the 2005 statement of actuarial opinion on behalf of the company. However, no disclosure was made in regard to the practice. According to the NAIC Accounting Practices and Procedures Manual, Statement of Statutory Accounting Principles (SSAP) No. 1, the company is required to disclose any deviation from the NAIC requirements along with any monetary effect resulting from the deviation. This disclosure should be made in a separate Summary of Significant Accounting Policies as the initial note in the notes to the financial statements. It is recommended that the company disclose a permitted accounting practice allowing the company’s representative to prepare and sign a statement of actuarial opinion on behalf of the company in accordance with SSAP No.1. 26 Custodial Agreement The review of the safekeeping agreement revealed that the agreement did not contain an adequate indemnification provision. According to the NAIC Financial Condition Examiner’s Handbook, a custodial or safekeeping agreement with a depository should contain satisfactory safeguards including provisions to indemnify the insurance company for any loss of securities in the custodian’s custody. It is recommended that the company amend its custodial agreement to include a provision that indemnifies the company in the event of the depository’s negligence or dishonesty in accordance with the NAIC Financial Condition Examiner’s Handbook. Bonds and Stocks The prior examination recommended that the company accurately complete Schedule D of the Annual Statement on all future annual statements. The recommendation was made based on the company’s failure to report call price and option date for callable bonds on Schedule D, Part 1, Column 7 and 8 of the Annual Statement. Although the examiner determined that the recommendation is not applicable to the current examination as regards callable bonds since the company did not report any such securities, the company did not correctly complete Schedule D of the Annual Statement. The company did not properly include the correct bond effective rate of interest on Schedule D – Part 1. The effective interest rate is a necessary component of the calculation of amortization of bond premium or discount and is required to be reported by the NAIC Annual Statement Instructions – Property and Casualty. It is recommended that the company properly report the effective interest rate on Schedule D – Part 1 in accordance with the NAIC Annual Statement Instructions – Property and Casualty. The review of bond amortization schedule revealed that the company used the straight-line method of amortization of bond premium or discount. The scientific method of amortization offers a more accurate measurement of interest expense and is required to be used by the NAIC Accounting Practices and Procedures Manual SSAP No.26, paragraph 6. Although the examiners did not attempt to estimate the monetary effect resulting from the use of the straight-line method, it is expected to be immaterial. Further, the examiners noted that the company incorrectly disclosed in the notes to the financial statements that the scientific interest 27 method was used. It is recommended that the company calculate amortization of bond premium or discount using the scientific interest method in accordance with SSAP No.26, paragraph 6, and correctly disclose the amortization method used in the notes to the financial statement. The review of the company’s investment portfolio revealed that the company held two bond issues that the examiners identified as being of foreign origin and, therefore, should be classified as foreign investments on the annual statements. It was determined that the company was in compliance with the investment limitation set forth in s. Ins 6.20 (8) (k), Wis. Adm. Code, as regards foreign investments. However, the company did not identify the foreign issues in column 4 of Schedule D - Part 1 and in Summary Investment Schedule as required by the NAIC Annual Statement Instructions – Property and Casualty. It is recommended that the company correctly identify foreign securities on the appropriate schedules on all future financial statements in accordance with the NAIC Annual Statement Instructions – Property and Casualty. In the review, on a sample basis, of investment purchases and sales for the period under examination the examiners noted that the transactions were recorded on their settlement date and not on their trade date. This is contrary to SSAP No. 26, paragraph 4, for bonds, SSAP No. 30, paragraph 5, for common stock, and SSAP No. 43, paragraph 6, for loan-backed and structured securities. It is recommended that the company report investment acquisition or disposal on the trade dates, not the settlement dates, in accordance with SSAP No. 26, paragraph 4, for bonds, SSAP No. 30, paragraph 5, for common stock, and SSAP No. 43, paragraph 6, for loan-backed and structured securities. The company’s bond and preferred stock portfolios consist of securities that are monitored by at least one Nationally Recognized Statistical Rating Organization (NRSRO). The NRSRO ratings are shown in the investment summary statement provided by the company’s broker. The Purposes and Procedures Manual of the NAIC Securities Valuation Office (SVO Manual) sets forth filing exception provisions whereby certain securities rated by a NRSRO are assigned the equivalent of the NAIC 1 through 6 designation categories. Securities that are monitored by more than one NRSRO are required to be reported at the lowest rating. In the review of the company’s bonds and preferred stock quality designations, the examiners noted 28 one bond and three preferred stocks designated incorrectly. It is recommended that the company report its securities ratings in accordance with the SVO Manual. Premiums and Agents Balances in Course of Collection The prior exam recommended the company nonadmit any uncollected premium balances over 90 days past due. The examiners reviewed the company’s practices and procedures as regards monitoring and reporting uncollected premium amounts. The examiners were satisfied with the company’s procedures for reviewing and monitoring uncollected premiums and concluded that uncollected premiums were generally reported in accordance with the NAIC Accounting Practices and Procedures Manual, SSAP No. 6, paragraph 9. It was noted that premiums that were over 90 days past due were improperly admitted as a result of a clerical error rather than as a deficiency of the company’s monitoring process and the dollar amount of the error was insignificant. No recommendation was made in this situation. The examiners concluded that the company has undertaken adequate measures to comply with the prior exam recommendation. The examiners reviewed the Account Receivable – Direct Bill report and evaluated the company’s method of calculating the Uncollected Premiums and Agents’ Balances in Course of Collection amount. The report summarized all premiums that were billed as of the reporting date and included premiums billed for the policies with effective dates after December 31, 2005. In order to derive the Premiums in Course of Collection amount, the company subtracted the premium billed for policies with effective dates after December 31, 2005, from the total premiums indicated on the report. However, in the process of eliminating the premiums billed for policies effective in 2006, the company failed to eliminate the related policy fees included in the report. As a result, the Uncollected Premiums and Agents’ Balances in Course of Collection amount was overstated. The estimated amount of overstatement was not material to the company’s financial position therefore no adjustment to surplus was made. It is recommended that the company correctly report the Uncollected Premiums and Agents’ Balances in Course of Collection amount by not including any service charges related to the policies that had not become effective as of the reporting date. 29 Deferred Premiums In the course of review of the company’s premium records, the examiner recalculated a sample of deferred premiums. It was noted that the company included installment premiums that were billed but had not become due as of the reporting date as “Uncollected Premiums, Agents’ Balances In Course of Collection.” According to SSAP No.6, paragraph 7 (c), the due dates for installment premiums are governed by the contractual due date of the installments from the insured. The premiums that were due and not yet collected should be reported as “Uncollected Premiums and Agents’ Balances in the Course of Collection,” whereas the installment premiums that had not been due as of the reporting date should be reported as “Deferred Premiums, Agents’ Balances and Installments Booked and Not Due” in accordance with SSAP No. 6, paragraph 7 (c). It is recommended that the company report installment premium that is billed but not yet due as “Deferred Premiums, Agents’ Balances and Installments Booked but Deferred and Not Yet Due” in accordance with SSAP No. 6, paragraph 7 (c). Other Expenses In the review of the Other Expenses balance (Annual Statement Page 3, Line 5) it was noted that the company incorrectly included a guaranty fund liability estimated by the Wisconsin Insurance Security Fund as part of this balance. According to the NAIC Annual Statement Instructions – Property and Casualty, a liability for guaranty funds assessments that represent a charge imposed by the state to provide funds to cover policyholders’ obligations of insolvent reporting entities are to be reported in line 6 – Taxes, Licenses and Fees (Annual Statement Page 3, Line 6). It is recommended that the company correctly report guaranty fund liability as part of the Taxes, Licenses and Fees balance on all future financial statements in accordance with the NAIC Annual Statement Instructions – Property and Casualty. Claim Adjusting The examiners reviewed the company’s claim adjusting practices and noted that the company did not define the type and dollar amount of the claims that require signed proof of loss statements. A decision whether or not to obtain a statement depends on the adjustor’s discretion. However, as a general rule, the statements are required on all fire, theft and vandalism losses. In 30 the review of a sample of claims the examiners noted that not all of the claims classified in any of the categories mentioned above were finalized with a signed proof of loss. It is recommended that the company establish specific criteria as regards the type and dollar amount of claims that require signed proof of loss statements and follow these guidelines in its claim adjusting process. 31 VIII. CONCLUSION The current examination finds that the company has improved its financial position since the last examination when the company was impacted by severe weather-related losses in 2000 and 2001. Since the prior examination, admitted assets have increased 44% to $7,590,419, direct premiums have increased 35% to $5,297,444, and policyholders’ surplus has increased 32% to $3,852,035. The company has had net income in three of the four years under examination. The prior examination resulted in 18 recommendations. The company has complied with 17 of the 18 recommendations. The current examination also resulted in 18 recommendations. The recommendations pertain to the board of directors, corporate records, the custodial agreement, the actuarial opinion, bonds and stocks, premiums in course of collection, deferred premiums, and other expenses. No adjustments to surplus were made as a result of this examination. 32 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS 1. Page 24 - Corporate Records—Therefore, it is again recommended that minutes for all committees of the board of directors be maintained and included with the minutes of the board of directors in accordance with s. 611.51 (9) (am) 1, Wis. Stat. Page 25 - Corporate Records—It is recommended that the company comply with s. 611.51 (2), Wis. Stat., as regards the composition of its board of directors. Page 25 - Corporate Records—It is recommended that the company’s principal offices be held by at least three separate individuals in accordance with s. 611.12 (3), Wis. Stat., and that the offices be designated in accordance with the company’s bylaws. Page 25 - Corporate Records—It is recommended that the company file any amendment to its articles with the commissioner prior to the articles becoming effective in accordance with s. 611.29 (4), Wis. Stat. Page 25 - Corporate Records—It is recommended that the company file any amendment to its bylaws with the commissioner within 60 days after adoption according to s. 611.12 (4), Wis. Stat. Page 26 - Board of Directors—It is recommended that the company’s board of directors formally review and approve the investment decisions of the broker and not delegate its authority or responsibility to do so in accordance with s. 611.51 (6), Wis. Stat. Page 26 - Actuarial Opinion—It is recommended that the company’s board of directors approve the company’s appointed actuary and disclose the appointment in the board minutes. Page 26 - Actuarial Opinion—It is recommended that the company disclose a permitted accounting practice allowing the company’s representative to prepare and sign a statement of actuarial opinion on behalf of the company in accordance with SSAP No.1. Page 27 - Custodial Agreement—It is recommended that the company amend its custodial agreement to include a provision that indemnifies the company in the event of the depository’s negligence or dishonesty in accordance with the NAIC Financial Condition Examiner’s Handbook. Page 27 - Bonds and Stocks—It is recommended that the company properly report the effective interest rate on Schedule D – Part 1 in accordance with the NAIC Annual Statement Instructions – Property and Casualty. Page 28 - Bonds and Stocks—It is recommended that the company calculate amortization of bond premium or discount using the scientific interest method in accordance with SSAP No.26, paragraph 6, and correctly disclose the amortization method used in the notes to the financial statement. Page 28 - Bonds and Stocks—It is recommended that the company correctly identify foreign securities on the appropriate schedules on all future financial statements in accordance with the NAIC Annual Statement Instructions – Property and Casualty. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 33 13. Page 28 - Bonds and Stocks—It is recommended that the company report investment acquisition or disposal on the trade dates, not the settlement dates, in accordance with SSAP No. 26, paragraph 4, for bonds, SSAP No. 30, paragraph 5, for common stock, and SSAP No. 43, paragraph 6, for loanbacked and structured securities. Page 29 - Bonds and Stocks—It is recommended that the company report its securities ratings in accordance with the SVO Manual. Page 29 - Premium and Agents’ Balances in Course of Collection—It is recommended that the company correctly report the Uncollected Premiums and Agents’ Balances in Course of Collection amount by not including any service charges related to the policies that had not become effective as of the reporting date. Page 30 - Deferred Premiums—It is recommended that the company report installment premium that is billed but not yet due as “Deferred Premiums, Agents’ Balances and Installments Booked but Deferred and Not Yet Due” in accordance with SSAP No. 6, paragraph 7 (c). Page 30 - Other Expenses—It is recommended that the company correctly report guaranty fund liability as part of the Taxes, Licenses and Fees balance on all future financial statements in accordance with the NAIC Annual Statement Instructions – Property and Casualty. Page 31 - Claim Adjusting—It is recommended that the company establish specific criteria as regards the type and dollar amount of claims that require signed proof of loss statements and follow these guidelines in its claim adjusting process. 14. 15. 16. 17. 18. 34 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 Gene Renard Jerry DeArmond Randy Milquet Title Financial Examiner Financial Examiner - Advanced Financial Examiner - Advanced Respectfully submitted, Elena Vetrina Examiner-in-Charge 35