North American Insurance Company

Report of the Examination of North American Insurance Company Phoenix, Arizona As of December 31, 2007 TABLE OF CONTENTS Page I. INTRODUCTION .................................................................................................................. 1 II. HISTORY AND PLAN OF OPERATION .............................................................................. 4 III. MANAGEMENT AND CONTROL ........................................................................................ 6 IV. AFFILIATED COMPANIES .................................................................................................. 8 V. REINSURANCE ................................................................................................................. 12 VI. FINANCIAL DATA .............................................................................................................. 13 VII. SUMMARY OF EXAMINATION RESULTS ....................................................................... 23 VIII. CONCLUSION.................................................................................................................... 29 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS.............................................. 30 X. ACKNOWLEDGMENT ....................................................................................................... 31 State of Wisconsin / OFFICE OF THE COMMISSIONER OF INSURANCE Jim Doyle, Governor Sean Dilweg, Commissioner Wisconsin.gov December 17, 2008 125 South Webster Street • P.O. Box 7873 Madison, Wisconsin 53707-7873 Phone: (608) 266-3585 • Fax: (608) 266-9935 E-Mail: ociinformation@wisconsin.gov Web Address: oci.wi.gov Honorable Sean Dilweg Commissioner of Insurance State of Wisconsin 125 South Webster Street Madison, Wisconsin 53703 Commissioner Dilweg: In accordance with the instructions of the Wisconsin Commissioner of Insurance, a compliance examination has been made of the affairs and financial condition of: NORTH AMERICAN INSURANCE COMPANY Phoenix, Arizona and this report is respectfully submitted. I. INTRODUCTION The previous examination of North American Insurance Company was conducted in 2003 as of December 31, 2002. The current examination covered the intervening period ending December 31, 2007, and included a review of such 2008 transactions as deemed necessary to complete the examination. The examination was conducted in accordance with the NAIC Financial Condition Examiners Handbook, which sets forth guidance for planning and performing an examination to evaluate the financial condition and identify prospective risks of an insurer. This approach includes the obtaining of information about the company including corporate governance, the identification and assessment of inherent risks within the company, and the evaluation of system controls and procedures used by the company to mitigate those risks. The examination also included an assessment of the principles used and significant estimates made by management, as well as an evaluation of the overall financial statement presentation and management’s compliance with statutory accounting principles, annual statement instructions, and Wisconsin laws and regulations. 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 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 2 examiner-in-charge. As deemed appropriate, reference is made in this report to the actuary's conclusion. 3 II. HISTORY AND PLAN OF OPERATION North American Insurance Company (NAI or the company), was incorporated as a stock company under the laws of Wisconsin on September 25, 1962. Its original name was Reliable Casualty Company. The Reliable Casualty Company received its certificate of authority and began operations on December 31, 1965. In 1968, the company changed its name to the Reliable Life and Casualty Company (RLCC). On August 31, 1981, the Dane County Circuit Court on petition of the Office of the Commissioner of Insurance (OCI) of the state of Wisconsin issued an order of rehabilitation on RLCC. A separate account was created into which substantially all of RLCC’s assets and liabilities were transferred. The Dane County Circuit Court placed this separate account in liquidation on October 1, 1981. On September 16, 1986, North American Group, Ltd. (NAGL), formerly known as the Reliable Investors Corporation, the parent of RLCC, applied for reinstatement of the company’s certificate of authority. An amended application for reinstatement was submitted on March 6, 1987. The Dane County Circuit Court released RLCC from rehabilitation on August 13, 1987. NAGL provided approximately $4,000,000 of recapitalization for the company. The company’s name was changed to the one presently used. NAI commenced the writing of business in September of 1987. On September 21, 1990, North American Insurance Company was purchased by a newly formed holding company, Encore Financial Inc. In November 1997, Oxford Life Insurance Company (Oxford), a wholly owned subsidiary of AMERCO, purchased all of Encore Financial’s capital stock. On December 31, 1997, Oxford contributed $2,400,000 through the purchase of a surplus note from NAI, at a rate of 8%. The note provided for interest only payments starting July 1, 1998, and principal payments of $350,000, plus interest starting July 1, 1999, all subject to the prior approval of OCI. The surplus note was paid off in full in 2002. 4 In 2006, Encore Financial Inc. was merged with North American Insurance Company. NAI was the survivor, with Encore being dissolved. Descriptions of Oxford Life and AMERCO can be found in the “Affiliated Companies” section of this report. In 2007, the company collected direct premium in the following states: Wisconsin Indiana South Carolina Missouri All others Total $1,041,369 337,262 117,277 102,602 129,234 $1,727,634 60.3% 19.5 6.8 5.9 7.5 100.0% As of December 31, 2007, the company was licensed in the following states: Alabama Illinois Louisiana Minnesota New Mexico Oregon Texas Colorado Indiana Maryland Missouri Ohio Pennsylvania Wisconsin District of Columbia Kansas Michigan North Dakota Oklahoma South Carolina NAI primarily concentrates on Medicare supplement insurance, although it is currently not writing any new business. The following chart is a summary of premium income as reported by the company in 2007. The growth of the company is discussed in the “Financial Data” section of this report. Premium Income Direct Premium $ 9,222 (191,784) (120,020) 269,260 Reinsurance Assumed $ 0 0 0 0 0 $ 0 Reinsurance Ceded $ 0 0 0 0 Line of Business Ordinary life Credit life* Credit accident & health* A&H - Group A&H – Other (Med Supp) Total All Lines Net Premium $ 9,222 (191,784) (120,020) 269,260 1,799,703 $1,766,380 1,801,133 $1,767,810 1,430 $1,430 * The company is no longer actively writing any credit life or disability business. The negative premium balances are due to refunds being issued on existing policies. 5 III. MANAGEMENT AND CONTROL Board of Directors The board of directors consists of five members who are elected annually. 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 directors receive no compensation specific to their service on the board because all are employees of the AMERCO group. Currently the board of directors consists of the following persons: Name and Residence Mark A. Haydukovich Phoenix, AZ Don C. Smith Phoenix, AZ Jason A. Berg Phoenix, WI Rocky D. Wardrip Reno, NV Henry E. Martin Phoenix, AZ Officers of the Company The officers appointed by the board of directors and serving at the time of this examination are listed below. Listed compensation consists of 2007 gross earnings for services rendered to the AMERCO group as a whole. Name Mark A. Haydukovich Judith A. Pettit Eric N. Johansson Don C. Smith Gregory D. Morris* Michael D. Johnson Office President & Chief Executive Officer Chief Actuary Vice President & Chief Accounting Officer Vice President & Chief Marketing Officer Secretary Assistant Treasurer & Controller 2007 Compensation $223,082 138,496 120,769 109,831 102,285 69,423 Principal Occupation President & Chief Executive Officer Oxford Life Insurance Co Vice President & Chief Marketing Officer Oxford Life Insurance Co Chief Accounting Officer AMERCO Assistant Treasurer AMERCO Retired President Oxford Life Insurance Co Term Expires 2009 2009 2009 2009 2009 * Gregory Morris resigned as Secretary in August 2008. 6 Committees of the Board The company's bylaws allow for the formation of certain committees by the board of directors. The company currently has only an investment committee and members receive no compensation for their service. Below are the listed members of the Investment Committee: Investment Committee Mark A. Haydukovich – Chair Jason A. Berg Sam Briggs Rocky D. Wardrip 7 IV. AFFILIATED COMPANIES North American Insurance Company is a member of a holding company system. The organizational chart below depicts the relationships among the affiliates in the group. A brief description of the significant affiliates of North American Insurance Company follows the organizational chart. Organizational Chart As of December 31, 2007 AMERCO (NV) Republic Western Insurance Company (AZ) North American Fire & Casualty Insurance Company (LA) Affiliated Companies of U-Haul Rental Systems (AZ) Oxford Life Insurance Company (AZ) Christian Fidelity Life Insurance Company (TX) Dallas General Life Insurance Company (TX) North American Insurance Company (WI) Oxford Life Ins. Agency, Inc. (AZ) AMERCO AMERCO, a Nevada corporation, is the parent company of U-Haul International, Inc. (U-Haul), and Republic Western Insurance Company (RWIC). U-Haul was founded in 1945 under the name “U-Haul Trailer Rental Company.” From 1945-1974, U-Haul rented trailers and, starting in 1959, trucks on a one-way and in-town basis exclusively through independent dealers. Since 1974, U-Haul has developed a network of company managed rental centers (U-Haul Centers) through which U-Haul also rents its trucks and trailers and provides related products and services. On June 20, 2003, AMERCO filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court, District of Nevada. AMERCO continued to manage its properties and operate its businesses as “debtor-inpossession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable 8 provisions of the Bankruptcy Code. AMERCO improved its financial condition and emerged from Chapter 11 bankruptcy on March 15, 2004. As of March 31, 2008, AMERCO’s consolidated financial statements, as reported in its SEC 10-K filing, showed assets of $3.83 billion, liabilities of $3.07 billion, and stockholders’ equity of $758 million. Operations for the fiscal year ended March 31, 2008, showed net income of $54.8 million on revenues of $465 million. Oxford Life Insurance Company Oxford Life Insurance Company (OLIC) is a wholly owned subsidiary of AMERCO, domiciled in the State of Arizona. On November 21, 1997, OLIC purchased 100% of the shares of Encore Financial, Inc., which was the parent company of NAI until March 28, 2007, when Encore was merged with NAI. On November 13, 2000, OLIC purchased 100% of Christian Fidelity Life Insurance Company. OLIC is licensed in 48 states and the District of Columbia. Oxford directly writes and reinsures annuities, credit life and disability, single premium whole life, group life and disability coverage, and Medicare supplement insurance. OLIC also administers the self-insured employee health and dental plans for AMERCO. As of December 31, 2007, OLIC’s audited statutory financial statements reported total admitted assets of $535.8 million, total liabilities of $411.8 million, and capital and surplus of $124.0 million. Operations for the fiscal year ended December 31, 2007, showed net income of $13.6 million on revenues of $151.9 million. Christian Fidelity Life Insurance Company Christian Fidelity Life Insurance Company (CFLIC) is a wholly owned subsidiary of Oxford Life, domiciled in the state of Texas. Effective February 28, 2006, CFLIC acquired Dallas General Insurance Company. Prior to the acquisition, Dallas General reinsured all of its business other than Medicare supplement to a related company. In June 2006, CFLIC contributed $6.0 million of additional capital to Dallas General. CFLIC is principally involved in the direct writing of Medicare supplement insurance. CFLIC’s growth strategy includes the acquisition of insurance companies, expanded distribution channels and new product offerings. 9 As of December 31, 2007, CFLIC’s audited statutory financial statements reported admitted assets of $78.9 million, liabilities of $53.8 million, and capital and surplus of $25.1 million. Operations in 2007 resulted in net income of $4.1 million. Dallas General Life Insurance Company Dallas General Life Insurance Company (DGLIC) is a wholly owned subsidiary of CFLIC, domiciled in the state of Texas. DGLIC is principally involved in the direct writing of Medicare supplement insurance. After acquisition by CFLIC, DGLIC received approval to issue a final expense whole life insurance product. This product complements the Medicare supplement products DGLIC has historically offered to senior market clients. As of December 31, 2007, DGLIC’s audited statutory financial statements reported total admitted assets of $10.6 million, total liabilities of $6.4 million, and capital and surplus of $4.2 million. Operations in 2007 resulted in net income of $337,000. Affiliated Agreements 1. Tax Sharing Agreement with AMERCO—Effective April 1, 2003, NAI entered into and became part of the original Tax Sharing Agreement between AMERCO and Oxford Life Insurance Company, effective April 1, 1991, and the subsequent amendment effective June 30, 1994. NAI files a consolidated tax return with the group. NAI’s federal income tax liability or refund is limited to the separate company basis, and final settlement of federal income tax amounts due are made within 90 days of the filing of the consolidated AMERCO federal income tax return. 2. Administrative Services Agreement with Oxford Life Insurance Company (OLIC)—Effective January 1, 2008, OLIC and NAI entered into an administrative services agreement whereby OLIC authorizes NAI to act as an administrator for Medicare supplement and life insurance policies. Services provided include underwriting, claims processing, collection and remittance, and other administrative duties. NAI bears all the expenses incurred in the performance of this contract. OLIC pays a monthly base administrative fee for services rendered, as well as per transaction fees for claims on Medicare supplement and life Insurance, and for premiums on Medicare supplement. Fees are paid in arrears by the 15th of the month following the month for which fees are incurred. This agreement replaced the Policy Administration Agreement with OLIC dated January 31, 2001, and amended Jan. 31, 2002. 3. Investment Service Agreement with Oxford Life Insurance Company—Effective January 1, 2001, NAI entered into an investment service agreement with OLIC whereby OLIC provides investment services to NAI. NAI pays an annual fixed fee for services rendered, remitted in quarterly installments. 4. Management Services Agreement with Oxford Life Insurance Company—Effective January 1, 1998, NAI entered into a management services agreement with OLIC whereby OLIC provides payroll services to NAI directly or through affiliates or others, personnel assistance related to new employees and employee benefit plan administration, accounting services, actuarial services, and corporate services. NAI pays a monthly service fee for services rendered, paid in advance on the first business day of each month. 10 5. Administrative Services Agreement with Christian Fidelity Life Insurance Company (CFLIC)— Effective January 1, 2008, NAI entered into an administrative services agreement with CFLIC whereby CFLIC authorizes NAI to act as an administrator for Medicare supplement, life, and long-term care insurance policies. Services provided include underwriting, claims processing, collection and remittance, and other administrative duties. NAI bears all the expenses incurred in the performance of this contract. CFLIC pays a monthly base administrative fee for services rendered for Medicare supplement, life insurance, and long-term care, as well as per transaction fees for claims on Medicare supplement, life insurance, and long-term care, and for premiums on Medicare supplement and long-term care. Fees are paid in arrears by the 15th of the month following the month for which fees are incurred. 6. Marketing Service Agreement with Christian Fidelity Life Insurance Company—Effective June 1, 2001, NAI entered into a marketing services agreement with CFLIC whereby NAI, or through its affiliates, provides marketing services to CFLIC, to include agent customer service, marketing support, agent appointments, and other services. CFLIC pays a service fee for services rendered, paid on an annual basis in advance on the first business day of each year. 7. Policy Administrative Agreement with Christian Fidelity Life Insurance Company—Effective April 1, 2001, NAI entered into a policy administration agreement whereby NAI provides policy administration services for the Medicare supplement block of business to CFLIC. Services provided include customer services, underwriting, and claims processing. NAI bears all administrative expenses, including non-policy expenses, and any other expenses that are defined or treated as unusual expenses. CFLIC pays an administration fee of 7% net of premium received for services rendered, paid on a monthly basis as the premiums are received by NAI. 8. Administrative Services Agreement with Dallas General Life Insurance Company (DGLIC)— Effective January 1, 2008, NAI entered into an administrative services agreement with DGLIC, whereby DGLIC authorizes NAI to act as an administrator for Medicare supplement and life insurance products. Services provided include underwriting, claims processing, collection and remittance, and other administrative duties. NAI bears all the expenses incurred in the administration of policies. DGLIC pays a monthly base administration fee for services rendered for Medicare supplement and life insurance, as well as per transaction fees for claims on Medicare supplement and life insurance, and for premiums on Medicare supplement. 11 V. REINSURANCE The company's reinsurance portfolio and strategy are described below. A list of the companies that have a significant amount of reinsurance in force at the time of the examination follows. The contracts contained proper insolvency provisions. Ceding Contracts Life Insurance The company has a quota share reinsurance treaty with United Liberty Life Insurance Company (United Liberty), an unauthorized reinsurer, covering a block of pre-need life insurance assumed from Madison National Life under a 1993 assumption agreement. United Liberty is providing 75% coverage, subject to a maximum of $25,000 on any one life. This agreement was terminated with respect to new business, effective November 1, 1996. Credit Life and Credit Disability Reinsurance The company also had an automatic coinsurance quota share treaty with Lincoln National Reassurance Company of Fort Wayne, Indiana (Lincoln), covering the company’s Midwest business through 2001. Quota share percentages are based on the certificate issue dates. In 2002, the company’s quota share percentage was dropped to 0%. All reinsurance which had been placed in effect prior to the termination of the agreement remains in effect in accordance with the agreement. 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, 2007, 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 North American Insurance Company Assets As of December 31, 2007 Net Admitted Assets $19,939,854 32,040 3,472,803 4,530 220,911 Assets Bonds Preferred stocks Cash, cash equivalents, and short-term investments Contract loans Investment income due and accrued Premiums and considerations: Uncollected premiums and agents' balances in course of collection Reinsurance: Amounts recoverable from reinsurers Other amounts receivable under reinsurance contracts Net deferred tax asset Guaranty funds receivable or on deposit Electronic data processing equipment and software Furniture and equipment, including health care delivery assets Receivable from parent, subsidiaries and affiliates Health care and other amounts receivable Write-ins for other than invested assets: Premium tax refund receivable Prepaid expenses Total Assets $19,939,854 32,040 3,472,803 4,530 220,911 Nonadmitted Assets $ 0 7,915 86,175 5,119 509,842 15,107 8,490 39,577 566,745 76,629 202,861 6,259 $25,194,857 39,577 7,915 86,175 5,119 143,443 15,107 8,490 0 566,745 339 202,861 0 $24,706,332 366,399 76,290 6,259 $488,525 14 North American Insurance Company Liabilities, Surplus, and Other Funds As of December 31, 2007 Aggregate reserve for life contracts Aggregate reserve for accident and health contracts Liability for deposit-type contracts Contract claims: Life Accident and health Premiums and annuity considerations received in advance Contract liabilities not included elsewhere: Interest maintenance reserve Commissions to agents due or accrued General expenses due or accrued Taxes, licenses, and fees due or accrued, excluding federal income taxes Current federal and foreign income taxes Amounts withheld or retained by company as agent or trustee Amounts held for agents' account, including agents’ credit balances Remittances and items not allocated Miscellaneous liabilities: Asset valuation reserve Payable to parent, subsidiaries and affiliates Write-ins for liabilities: Uncashed checks pending escheatment Total liabilities Common capital stock Gross paid in and contributed surplus Unassigned funds (surplus) Total capital and surplus Total Liabilities, Capital and Surplus $1,747,800 5,222,383 8,584,594 $ 5,891,579 1,704,847 54,356 175,164 462,694 51,271 48,484 1,081 473,973 32,229 91,517 266 15,868 19,810 42,092 44,976 41,350 9,151,557 15,554,777 $24,706,334 15 North American Insurance Company Summary of Operations For the Year 2007 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: Policy administration fee Total income items Death benefits Annuity benefits Disability benefits and benefits under accident and health contracts Surrender benefits and withdrawals for life contracts Interest and adjustments on contract or deposit-type contract funds 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) General insurance expenses Insurance taxes, licenses, and fees excluding federal income taxes Increase in loading on deferred and uncollected premiums Total deductions Net gain (loss) from operations after dividends to policyholders and federal income taxes Federal and foreign income taxes incurred (excluding tax on capital gains) Net gain (loss) from operations after dividends to policyholders and federal income taxes and before realized capital gains or losses Net realized capital gains or (losses) Net Income $ 700,535 (16,939) 2,013,275 (284,033) 22,055 (3,933,789) (1,498,894) $ 1,766,380 1,528,390 22,277 32,674 6,989,928 10,339,649 (288,872) 2,728,926 195,999 (2,368) 1,134,791 9,204,858 3,107,280 6,097,578 7,592 $ 6,105,170 16 North American Insurance Company Cash Flow For the Year 2007 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 Total investments acquired Net increase (or decrease) in contract loans and premium notes Net cash from investments Cash from financing and miscellaneous sources: Dividends to stockholders 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 $ 1,726,173 1,658,490 7,022,602 10,407,265 $ 2,773,793 2,818,188 3,709,546 9,301,527 1,105,738 $11,462,896 45,845 11,508,742 4,132,921 32,040 4,164,961 1,498 7,342,283 8,000,000 1,745 (7,998,255) 449,765 3,023,039 $ 3,472,804 17 North American Insurance Company Compulsory and Security Surplus Calculation December 31, 2007 Assets Less liabilities Adjusted surplus Annual premium: Individual life and health Factor Total Group life and health Factor Total Greater of 7.5% of consideration or 2% of reserves for annuities and deposit administration funds Compulsory surplus (subject to a $2,000,000 minimum) Compulsory Surplus Excess or (Deficit) $24,706,333 9,151,558 15,554,775 $1,776,285 15% $266,443 (50,145) 10% (5,015) 14,177 2,000,000 $13,554,775 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) $15,554,775 2,800,000 $12,754,775 18 North American Insurance Company Reconciliation and Analysis of Surplus For the Five-Year Period Ending December 31, 2007 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: 2007 Capital and surplus, beginning of year Net income Change in net unrealized capital gains or (losses) Change in net deferred income tax Change in nonadmitted assets and related items Change in asset valuation reserve Dividends to stockholders Write-ins for gains and (losses) in surplus: Net change Capital and Surplus, End of Year 2006 2005 2004 2003 $17,432,068 6,105,170 (649) (315,685) 293,095 40,799 (8,000,000) 0 (1,877,290) $16,150,147 6,197,823 69,537 (308,647) 329,139 (5,932) (5,000,000) 0 1,281,920 $14,441,960 3,075,898 (5,288) (25,035) 61,082 41,531 (1,440,000) 0 1,708,187 $12,517,477 1,717,835 (83,754) (493,982) 1,918,475 2,208 (1,250,000) 113,700 1,924,483 $10,541,088 3,338,094 349,567 23,107 (688,096) (81,265) (940,000) (25,018) 1,976,389 $15,554,778 $17,432,068 $16,150,147 $14,441,960 $12,517,477 North American Insurance Company Insurance Regulatory Information System For the Five-Year Period Ending December 31, 2007 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 2007 -11%* -11* 59 450 2 0 4 0 -73* 9.9* 0.7 -99* 2006 8% 8 47 479 2 0 3 -11 -56* 2.2 0.6 -99* 2005 12% 12 14 362 3 0 4 -8 -1 2.1 5.2* 2 2004 15% 15 7 304 3 0 5 -2 63* 9* 1.2 593* 2003 19% 19 12 353 10* 0 6 72* -19* 1.1 2.8 -99* 19 Ratio Nos. 1 and 2, gross/net change in capital and surplus, were both exceptional in 2007. This was mainly due to an $8 million dividend paid to the company’s parent in 2007. Ratio No. 5, nonadmitted assets to admitted assets, was exceptional in 2003 due to the company reporting $3.1 million of nonadmitted assets. The nonadmitted balance consisted mainly of $1.3 million of deferred tax asset, $800,000 of affiliated receivables and an $800,000 line of credit from AMERCO. Ratio No. 8, surplus relief, was exceptional in 2003. This was due to the company’s reliance on reinsurance to manage surplus strain from its credit and group health business. Surplus relief represents the company’s commission equity from certain quota share reinsurance agreements. This is no longer an issue as the company has since changed its business and reinsurance program. Ratio No. 9, change in premium, was exceptional in four of the previous five years, and Ratio No. 10, change in product mix, was exceptional in both 2004 and 2007. These were due to the change in company’s business and reinsurance program. The company changed its reinsurance program and, since 2005, has reduced its premium written by 83% due to the change in focus from credit life business to Medicare supplement business. Ratio No. 11, change in asset mix, was exceptional in 2005, due to a shift in the company’s investment portfolio from short-term investments to long-term bond holdings. Ratio No. 12, change in reserving ratio, was exceptional in four of the previous five years due to the company’s minimal level of life business. 20 Growth of North American Insurance Company Year 2007 2006 2005 2004 2003 2002 Admitted Assets $24,706,333 31,949,126 34,806,533 33,708,175 29,641,983 27,396,442 Liabilities $ 9,151,558 14,517,059 18,656,387 19,266,215 17,124,506 16,855,354 Capital and Surplus $15,554,776 17,432,067 16,150,147 14,441,960 12,517,477 10,541,088 Net Life Premiums, Annuity Considerations, and Deposits Life Insurance Premiums $ (176,945) 1,377,016 3,754,711 3,862,144 591,929 976,116 Annuity Considerations $0 0 0 0 0 0 Deposit-type Contract Funds $0 0 0 0 0 0 Year 2007 2006 2005 2004 2003 2002 Life Insurance In Force (in thousands) Gross Risk In Force $ 81,331 199,190 391,608 506,226 710,942 1,147,329 $ Year 2007 2006 2005 2004 2003 2002 Ceded 3,976 4,912 120,220 335,833 634,554 1,044,013 Net $ 77,355 194,279 271,388 170,393 76,388 103,316 Accident and Health Incurred Claims and Cost Containment Expenses* $ 1,346,105 1,964,286 4,596,635 5,334,989 6,823,780 10,404,181 Combined Loss and Expense Ratio 116.4% 83.2 116.9 133.7 132.9 138.1 Year 2007 2006 2005 2004 2003 2002 Net Premiums Earned $ 3,430,150 6,511,637 10,461,325 9,754,974 9,341,869 12,073,344 Commissions Incurred $ (68,473) 1,238,928 4,299,337 4,081,717 1,259,216 1,692,698 Other Expenses Incurred** $2,718,234 2,214,113 3,340,421 3,628,463 4,333,318 4,570,737 * Includes increase in contract reserves. ** Includes taxes, licenses, and fees. 21 During the period under examination, admitted assets decreased 9.8%, surplus increased 47.6% and net premiums earned decreased 84.2%. Since the prior examination, the company has changed its reinsurance program, as it is no longer actively writing any credit life or credit disability business and focusing on Medicare supplement business. Also, since 2005, it has reduced its premium written by 83% due to the change in focus from credit insurance to Medicare supplement insurance. All of the company’s premium is renewal Medicare supplement business, as it is currently not writing any new business. 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, 2007, is accepted. 22 VII. SUMMARY OF EXAMINATION RESULTS Compliance with Prior Examination Report Recommendations There were 24 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. Management and Control—It is again recommended that the company amend its Articles of Incorporation to reflect the actual registered agent and registered office, and file any such amendment with the commissioner, pursuant to s. 611.29 (4), Wis. Stat. Action—Compliance. 2. Management and Control—It is recommended that the company comply with its Bylaws or amend them to reflect current membership and/or practices, and file any future amendments of its Bylaws with the commissioner, pursuant to s. 611.12 (4), Wis. Stat. Action—Compliance. 3. Disaster Recovery—It is again recommended that the company develop and institute a formal Business Continuation/Disaster Recovery Plan for all company facilities. Action—Compliance. 4. Fidelity Bond—It is recommended that the company obtain fidelity bond coverage in at least the amount suggested by the guidelines of the NAIC. Action—Compliance. 5. Cash—It is again recommended that the company establish procedures that will ensure that when checks clear the bank they are removed from the system in a reasonable amount of time. Action—Compliance. 6. Cash—It is again recommended that the company comply with ch. 177, Wis. Stat., regarding the treatment of unclaimed property and file the required unclaimed property reports with the State Treasurer. Action—Compliance. 7. Cash—It is again recommended that the company establish procedures for following up on stale checks with payees and then either reissue them or transfer the balances into a liability account for reporting to the appropriate state. Action—Compliance. 8. Cash—It is recommended that in future annual statements, the company exclude from the cash balance suspense items and other items that do not meet the definition of cash. Action—Compliance. 23 9. Cash—It is recommended that the company complete a thorough review of all bank reconciliations identifying and taking the necessary steps to clear reconciling items in a timely manner and nonadmit balances for which it is unable to substantiate that a future economic benefit exists. Action—Compliance. 10. Assumed Reinsurance—It is recommended that the company properly file all future affiliated agreements, or any amendments thereof, at least 30 days in advance of the effective date, in compliance with s. 617.21, Wis. Stat., and s. Ins 40.04 (2), Wis. Adm. Code. Action—Compliance. 11. Assumed Reinsurance—It is recommended that the company take the steps necessary to obtain its securities and close this account. Action—Compliance. 12. Ceded Reinsurance— It is again recommended that the company establish procedures for properly documenting its reinsurance program. Action—Compliance. 13. Ceded Reinsurance—It is recommended that in future annual statements, the company properly report reinsurance balances in accordance with the NAIC Annual Statement Instructions – Life, Accident, and Health and the NAIC Accounting Practices and Procedures Manual. Action—Compliance. 14. Affiliated Transactions—It is again recommended that the company settle accounts within a reasonable amount of time. Action—Compliance. 15. Affiliated Transactions—It is recommended that the company either find alternative sources for reimbursement or discontinue providing policy administration services to its affiliate, Encore Agency, Inc. Action—Compliance. 16. Affiliated Transactions—It is recommended that the company continue to charge affiliates fees for providing services for which it is entitled. Action—Compliance. 17. Affiliated Transactions—It is recommended that the company continue to apply any future dividends declared to past due affiliated balances until all overdue affiliated balances have been collected. Action—Compliance. 24 18. Affiliated Transactions—It is recommended that the company develop and implement procedures to ensure that deposits are made to the correct affiliates account to ensure compliance with s. 610.23, Wis. Stat. Action—Compliance. 19. Affiliated Transactions—It is recommended that the company either execute new or amend current agreements, to clearly and accurately disclose the nature and details of the various transactions amongst affiliates and for settlement of any outstanding balances that arise from providing the services, pursuant to s. 611.61, Wis. Stat. Action—Compliance. 20. Remittances and Items Not Allocated—It is again recommended that amounts that do not meet the definition of Remittances and Items Not Allocated as stated in the NAIC Accounting Practices and Procedures Manual be classified on appropriate lines in future annual statements. Action—Compliance. 21. Taxes, Licenses, and Fees—It is recommended that the company improve its methodology for estimating its future premium tax obligations, as well as controls over monitoring its obligation to ensure accurate reporting of both premium taxes payable and the actual expense. Action—Compliance. 22. General Expenses Due or Accrued—It is recommended that the company review its methodology for accruing liabilities and implement improvements to ensure liabilities are properly reported in accordance with the NAIC Accounting Practices and Procedures Manual. Action—Compliance. 23. Loss Reserves—It is again recommended that the reserves for life policies be calculated and reported under the appropriate valuation standard. Action—Compliance. 24. Loss Reserves—It is recommended that the company report unpaid loss adjustment expenses in accordance with the NAIC Accounting Practices and Procedures Manual. Action—Compliance. 25 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. Disaster Recovery The prior two examinations noted that the company had taken major steps for disaster recovery backup; however, no formal Disaster Recovery Plan currently existed. During the period under examination, the company has developed a comprehensive business continuity plan but has not tested the plan in the last two years. It is recommended that the company test its disaster recovery plan annually to ensure the viability of its business continuity solution. Affiliated Transactions The prior examination noted the company had difficulty associated with timely collections and proper accounting for affiliated balances. The current examination noted continued problems with collecting and accounting for affiliated balances. The company has a marketing service agreement in effect with Christian Fidelity Life Insurance Company where Christian Fidelity Life Insurance Company is required to pay the company an annual fee of $10,000, payable in advance on the first business day of each year. This fee was not received from Christian Fidelity Life Insurance Company in 2007, and the company did not accrue for the fee. The company was not aware this agreement was in effect until after inquiry during this examination. The company also has a policy administration agreement in place with Oxford Life Insurance Company, which includes the US Able Medicare Supplement and Celtic Medicare Supplement blocks of business. Pursuant to the original contract effective January 1, 2001, the company was to receive an administration fee equal to 7% of premiums received. A subsequent amendment to the contract, effective January 1, 2002, changed the fee to 5% for the US Able Medicare Supplement and Celtic Medicare Supplement blocks of business. A review and recalculation of the transactions associated with this contract determined that the company was continuing to use the 7% rate to calculate fees for all blocks of business in 2007. The difference was not material for the purposes of this examination, and no adjustment was considered 26 necessary. It is recommended that the company properly calculate, accrue for, and collect all fees associated with executed affiliated agreements. The company has a policy administration agreement in effect with Dallas General Life Insurance Company that was not included on its 2007 Holding Company Registration Statement, Forms B and C. The company received $749,000 in policy administration fees associated with this contract. It is recommended that the company properly complete its annual Holding Company Registration Statement, Forms B and C, in compliance with s. Ins 40.11, Wis. Adm. Code. Loss Reserves As noted earlier, independent actuaries were engaged under a contract with OCI to review the adequacy of aggregate life and accident and health reserves, the accuracy of the deferred and uncollected premiums for life insurance, and for analysis of asset adequacy. The current examination found multiple problems with the company’s reserving procedures. During the consulting actuary’s testing of life reserves, the company was unable to provide sufficient information or reserve calculations for some of the samples selected for testing. The consulting actuary also tested the credit disability claim reserve by selecting a sample of contracts. The company could not document the reserve methodology or provide sample reserve calculations for some of the contracts selected for testing. The consulting actuary found that the reserves appear reasonable, however, recommends that the company document the assumptions and methodologies used in the claim reserve calculation. It is recommended that the company document the following items in accordance with s. Ins 50.79 (2), Wis. Adm. Code: • • • Reserve factors for pre-need life insurance; Credit life reserve methodology for joint life; Credit disability claim reserve methodology. The consulting actuary reviewed the company’s Actuarial Opinion Memorandum (AOM). The actuary was able to determine that overall the methodologies and results appear reasonable and no additional reserves were needed. However, the actuary found several areas where improved documentation was needed. The AOM did not clearly identify the December 31, 2007, liability segments that were analyzed using each of four methods. Additionally, the AOM contained several contradictory references, liabilities and reserves did not 27 reconcile and the table of assets was incorrect. It was also noted during the review of the AOM, there was no discussion of specific risks associated with the products tested. For items on which methods other than cash flow testing were used, the AOM provided no discussion or descriptions of the methods used to test the reserves/liabilities or the results of any analyses or conclusions relative to the suitability of the assets supporting these liabilities. The company also excluded a portion of the credit life contracts, a small block of traditional life contracts and a small block of Medicare supplement contracts from asset adequacy testing. It appears reasonable to exclude these blocks of business from the testing, however, the reasons why they were excluded should be documented. It is recommended that future Actuarial Opinion Memorandums include the following information, in accordance with s. Ins 50.79 (2), Wis. Adm. Code: • • • • An accurate table of actuarial liabilities as of the valuation date which identifies, discusses, and describes all methods used for asset adequacy testing; A discussion of the specific risks that the appointed actuary deems significant which are associated with the products tested; A discussion and description of all methods used other than cash flow testing and a presentation of results for the liability items tested using such methods; and Provide proper explanation for excluding any blocks of business. The consulting actuary also identified a number of other items that should be included in future AOMs. It is suggested that the following items be included in future Actuarial Opinion Memorandums: • • • • • • • • Tables of liabilities, including a breakdown by major item as of both the testing and valuation dates; Descriptions of the specific types of assets used to support the liabilities analyzed for all asset adequacy testing methods including the quality and distribution of such assets; Tables which show the amount of liabilities remaining at the end of the projection period for all base interest rate scenarios used in cash flow testing; Tables showing both market and book values of assets, liabilities and surplus for all years for each of the interest rate scenarios; Tables showing a reconciliation of the assets and liabilities in the AOM to the Annual Statement; Justification for Asset Adequacy Testing methodology used; A clear breakdown between the methods used and for the justification for testing certain methods and the way the final conclusion was drawn; and A clearer breakdown between the tested and not tested reserves. 28 VIII. CONCLUSION During the period under examination, admitted assets decreased 9.8%, surplus increased 47.6% and net premiums earned decreased 84.2%. Since the prior examination, the company has changed its reinsurance program and, since 2005, has reduced its premium written by 83% due to the change in focus from credit life business to Medicare supplement business. All of the company’s premium is renewal business as it is currently not writing any new business. The current examination determined that the company is in compliance with each of the recommendations of the prior examination. The current examination resulted in five recommendations and one suggestion, mostly regarding affiliated transactions and loss reserving methodology and documentation. The examination did not make any reclassification of account balances or adjustments to surplus as reported by the company in its year-end 2007 statutory financial statements. The examination determined that, as of December 31, 2007, the company had admitted assets of $24,706,333, liabilities of $9,151,558, and policyholders' surplus of $15,554,776. 29 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS 1. Page 26 - Disaster Recovery Plan—It is recommended that the company test its disaster recovery plan annually to ensure the viability of its business continuity solution. Page 27 - Affiliated Balances—It is recommended that the company properly calculate, accrue for, and collect all fees associated with executed affiliated agreements. Page 27 - Affiliated Balances—It is recommended that the company properly complete its annual Holding Company Registration Statement, Forms B and C, in compliance with s. Ins 40.11, Wis. Adm. Code. Page 27 - Loss Reserves—It is recommended that the company document the following items in accordance with s. Ins 50.79 (2), Wis. Adm. Code: • Reserve factors for pre-need life insurance; • Credit life reserve methodology for joint life; • Credit disability claim reserve methodology. Page 28 - Loss Reserves—It is recommended that future Actuarial Opinion Memorandums include the following information, in accordance with s. Ins 50.79 (2), Wis. Adm. Code: • An accurate table of actuarial liabilities as of the valuation date which identifies, discusses, and describes all methods used for asset adequacy testing; • A discussion of the specific risks that the appointed actuary deems significant which are associated with the products tested; • A discussion and description of all methods used other than cash flow testing and a presentation of results for the liability items tested using such methods; and • Provide proper explanation for excluding any blocks of business. Page 28 - Loss Reserves—It is suggested that the following items be included in future Actuarial Opinion Memorandums: • Tables of liabilities, including a breakdown by major item as of both the testing and valuation dates; • Descriptions of the specific types of assets used to support the liabilities analyzed for all asset adequacy testing methods including the quality and distribution of such assets; • Tables which show the amount of liabilities remaining at the end of the projection period for all base interest rate scenarios used in cash flow testing; • Tables showing both market and book values of assets, liabilities and surplus for all years for each of the interest rate scenarios; • Tables showing a reconciliation of the assets and liabilities in the AOM to the Annual Statement; • Justification for Asset Adequacy Testing methodology used; • A clear breakdown between the methods used and for the justification for testing certain methods and the way the final conclusion was drawn; and • A clearer breakdown between the tested and not tested reserves. 2. 3. 4. 5. 6. 30 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 Terry Lorenz Judy Michael Angie Romaker Victoria Chi Jerry DeArmond Title Insurance Financial Examiner Insurance Financial Examiner Insurance Financial Examiner Insurance Financial Examiner - Advanced Insurance Financial Examiner - Advanced Respectfully submitted, Stephen L Elmer Examiner-in-Charge 31