West Central Mutual Insurance Company

Report of the Examination of West Central Mutual Insurance Company Whitehall, Wisconsin As of December 31, 2007 TABLE OF CONTENTS Page I. INTRODUCTION ............................................................................................................. 1 II. AFFILIATED COMPANIES.............................................................................................. 6 III. REINSURANCE............................................................................................................... 8 IV. FINANCIAL DATA ......................................................................................................... 10 V. SUMMARY OF EXAMINATION RESULTS................................................................... 15 VI. CONCLUSION ............................................................................................................... 32 VII. SUMMARY OF COMMENTS AND RECOMMENDATIONS ......................................... 33 VIII. ACKNOWLEDGMENT................................................................................................... 34 State of Wisconsin / OFFICE OF THE COMMISSIONER OF INSURANCE Jim Doyle, Governor Sean Dilweg, Commissioner Wisconsin.gov June 26, 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: In accordance with your instructions, an examination has been performed as of December 31, 2007, of the affairs and financial condition of: WEST CENTRAL MUTUAL INSURANCE COMPANY Whitehall, Wisconsin and the following report thereon is respectfully submitted: I. INTRODUCTION The previous examination of West Central Mutual Insurance Company (West Central or the company) was made in 2003 as of December 31, 2002. The current examination covered the intervening time period ending December 31, 2007, and included a review of such subsequent transactions deemed essential to complete this examination. The “Summary of Examination Results” contains elaboration on all areas of the company's operations. Special attention was given to the action taken by the company to satisfy the recommendations and comments made in the previous examination report. The company was organized as a town mutual insurance company on January 3, 1871, under the provisions of the then existing Wisconsin Statutes. The original name of the company was the Trempealeau County Farmers Mutual Fire Insurance Company. Subsequent amendments to the company's articles and bylaws changed the company's name to that presently used. During the period under examination, there were no amendments to the articles of incorporation or to the bylaws. The company is currently licensed to write property, including windstorm and hail, and nonproperty insurance. The company is currently licensed to write business in the following counties: Trempealeau Pepin Dunn Jackson Buffalo Eau Claire Clark La Crosse Monroe Vernon A review was made of the policy and application forms currently used by the company. The company issues approved policies with or without endorsements for terms of one, three, six or twelve months with premiums payable on the advance premium basis. Policy fees charged policyholders are retained by the company. Business of the company is acquired through 28 appointed agents, two of whom currently are directors of the company. Agents are presently compensated for their services as follows: Type of Policy All business - new and renewal Compensation 14% Agents do not adjust losses. The company has a salaried employee specifically for adjusting claims. Policyholders may participate in the management and control of the company by attending and voting at all annual or special meetings of the members. No member may vote by proxy. The annual meeting of the company for the election of directors and special meetings of the company are held in accordance with its articles of incorporation. Board of Directors The board of directors consists of seven members divided into three classes. One class is elected at each annual meeting for a term of three years. Vacancies on the board may be filled by the directors for the interim to the next annual meeting when a director shall be chosen for the unexpired term. 2 The current board of directors consists of the following policyholders of the company: Name Gary Monson Steve Hogden ** Betty Vold Daniel Lilla Danny Hanson Harlan Vold ** Dean Boehne Principal Occupation Farming Farming Jail Superintendent Farming Sales Retired Farmer Retired CPA Residence Strum, WI Galesville, WI Strum, WI Trempealeau, WI Alma, WI Osseo, WI Strum, WI Expiry 2008* 2010 2010 2009 2008* 2008* 2009 * Directors Monson, Hanson, and Harlan Vold were re-elected at the June 5, 2008, annual meeting. ** indicates the director is appointed as an agent for the company Members of the board currently receive $75.00 for each meeting attended, if a whole day is involved they receive $100.00, and they are reimbursed at the IRS-approved rate for mileage. Section 612.13 (1m), Wis. Stat., requires: (1) If a town mutual has fewer than 9 directors, no more than one director may be an employee or representative of the town mutual and; (2) Employees and representatives of a town mutual may not constitute a majority of its board. Harlan Vold and Steve Hogden are appointed as agents for the company, according to Agent Licensing records. Hogden has not written business for the company. Vold was employed by the company’s agency subsidiary; he received $9,856 in commissions for 2007 and is receiving commissions for 2008. Mr. Vold terminated employment with the company’s in-house agency in November 2007 but remains appointed as an agent for the company. The company at the time of the examination was in compliance with these requirements. There is additional comment in the section of the report captioned “Summary of Examination Results.” Officers Officers are elected by the board of directors from among its members and hold office for one year or until their successors are duly elected and qualified. Officers serving at the present time are as follows: 3 Name Harland Vold Gary Monson Dean Boehne Office President Vice-President Secretary/Treasurer 2007 Compensation $13,792 1,865 4,136 Reported compensation is the total compensation paid by the insurer for the year and includes salary, commissions, director fees and mileage as applicable. The Manager is Ellen Koxlien and her 2007 salary was $43,832. Committees of the Board The company's bylaws allow for the formation of certain committees by the board of directors. The committees at the time of the examination are listed below: Adjusting Committee Harlan Vold, Chair Danny Hanson Daniel Lilla Dean Boehne Form and Rates Committee Harlan Vold, Chair Daniel Lilla Danny Hanson Dean Boehne Underwriting Committee Harlan Vold, Chair Dan Lilla Betty Vold Dean Boehne Personnel Committee Gary Monson, Chair Steve Hogden Dan Lilla The Manager is a non-voting member of all standing and ad hoc committees. Audit and Investment Committee Harlan Vold, Chair Steve Hogden Betty Vold Dean Boehne Agency Committee Harlan Vold, Chair Daniel Lilla Gary Monson Steve Hogden Dean Boehne Executive Committee Harlan Vold, Chair Gary Monson Dean Boehne 4 Growth of Company The growth of the company since the previous examination as compiled from its filed annual statements was as follows: Net Premiums Earned $527,349 615,985 607,986 607,993 503,837 464,021 Policies In Force 1,216 1,299 1,448 1,457 1,428 1,397 Net Income $152,933 (84,712) 145,196 91,572 29,821 (24,686) Admitted Assets $2,201,724 1,947,276 1,889,074 1,586,387 1,170,986 1,147,209 Policyholders' Surplus $1,780,456 1,500,184 1,438,007 1,124,970 700,786 706,284 Year 2007 2006 2005 2004 2003 2002 The ratios of gross and net premiums written to surplus as regards policyholders since the previous examination were as follows: Gross Premiums Written $ 857,289 956,351 1,036,964 1,005,340 944,376 874,270 Net Premiums Written $524,602 600,115 617,773 605,889 536,758 483,622 Policyholders' Surplus $1,780,456 1,500,184 1,438,007 1,124,970 700,786 706,284 Writings Ratios Net Gross 29% 40 43 54 77 68 48% 64 72 89 135 124 Year 2007 2006 2005 2004 2003 2002 For the same period, the company's operating ratios were as follows: Other Underwriting Expenses Incurred $272,386 259,506 286,282 251,726 230,240 214,785 Year 2007 2006 2005 2004 2003 2002 Net Losses and LAE Incurred $199,873 577,685 204,073 307,086 335,648 373,163 Net Premiums Earned $527,349 615,985 607,986 607,993 503,837 464,021 Loss Ratio 38% 94 34 51 67 80 Expense Ratio 52% 43 46 42 43 44 Composite Ratio 90% 137 80 93 110 124 In 2007 and 2006 there was a decrease in business; the company said this is due in large part because of competition and from a soft market. Three agencies/agents moved their business or stopped writing for the company, related to the company’s requirements regarding agents performing inspections. The company lost 149 policies in 2006 and 83 policies in 2007. In 2006 claim losses increased greatly due to a severe hail storm. 5 II. AFFILIATED COMPANIES West Central Mutual Insurance Company is a member of a holding company system. It is the ultimate parent. The organizational chart below depicts the relationships among the affiliates in the group. A brief description of the affiliate follows the organizational chart. Holding Company Chart As of December 31, 2007 West Central Mutual Insurance Company West Central Insurance Services, Inc. West Central Insurance Services, Inc. West Central Insurance Services, Inc., (WCIS or the Agency) was created by West Central Mutual Insurance Company in 1994 as a means to market insurance products and service policies in the event West Central purchased a block of business from an independent agency. The initial capitalization of WCIS was to be $110,000 with West Central Mutual Insurance Company holding 100% of the outstanding shares; however, the company chose to issue only $20,000 in shares. WCIS currently has 200 issued and outstanding shares of common stock. WCIS was initially limited to property and casualty business but has since received OCI approval to write life and health business. The board of directors and the Manager for the company serve the same positions with WCIS. WCIS has purchased four blocks of business from agents of the company. All have been completely paid and amortized by WCIS. The President of the company worked as an agent for WCIS in 2006-2007, but terminated his employment in November 2007; WCIS did not purchase a block of business from the President. 6 WCIS currently has a service agreement with the insurance company. This is an agreement whereby WCIS will be provided administrative services, including accounting, data processing, receptionist and secretarial services, and other services to be agreed upon and paid based upon the actual time spent by such employees performing these duties. WCIS pays West Central a percentage of the company’s overall actual operating expenses. West Central uses the previous year’s expenses and has WCIS pay a flat amount for 12 months. If there are major changes in WCIS, expense adjustments are made as necessary. The Agency pays the company 33.3% of the company’s operating expenses. For 2007 the fee was $6,988.78 a month and for 2008 it is $8,444.38 a month. The service agreement was updated during the examination to reflect how the agreement is currently working. WCIS has been paying the monthly amount billed through the services agreement to West Central since the last examination. WCIS has also paid the amount that had accumulated prior to the last examination. WCIS no longer has an exclusive producer agreement with an individual agent, whereby the agent agrees to solicit proposals and bind and execute contracts of insurance in return for commissions as set forth in the producer agreement. At the current time, the agents are employees of West Central and provided to WCIS through the services agreement. No commissions are paid to employees. As of December 31, 2007, WCIS’s statutory equity was $175,020. The financial statements are reviewed by the CPAs but no opinion is issued by them. The CPA’s review for any errors and adjustments that might need to be made for the previous year-end results. WCIS is keeping a general ledger which is updated monthly. Statements are developed using the software QuickBooks. WCIS paid the company a $50,000 dividend in 2007. 7 III. REINSURANCE The examiners' review of the company's reinsurance portfolio revealed there is currently one ceding treaty. The treaty contained a proper insolvency clause and complied with s. Ins 13.09 (3), Wis. Adm. Code, concerning maximum wind loss. Company retentions of risk complied with s. Ins 13.06, Wis. Adm. Code. The coverages provided under this treaty are summarized as follows: Reinsurer: Effective date: Termination provisions: Wisconsin Reinsurance Corporation January 1, 2008 At any January 1 by either party giving 90 days’ prior written notice The coverage provided under this treaty is summarized as follows: 1. Type of contract: Lines reinsured: Company's retention: Coverage: Class A – Excess of Loss Reinsurance All nonproperty written by the company $8,000 per loss occurrence 100% of each and every loss occurrence, including loss adjustment expense, in excess of the company’s retention subject to the maximum policy limits of: a. $1,000,000 per occurrence, single limit or combined for bodily injury and property damage liability. b. $1,000,000 split limits, in any combination of bodily injury and property damage liability. c. $25,000 for medical payments, per person; $25,000 per accident. Reinsurance premium: 2. Type of contract: Lines reinsured: Company's retention: 50% of premiums written Class B – First Surplus Reinsurance All property business written by the company When the company’s net retention is $400,000 or more in respect to a risk, the company may cede on a pro rata basis up to $800,000 When the company’s net retention is $400,000 or less in respect to a risk, the company may cede on a pro rata basis up to 50% of such risk Coverage: Pro rata share of each and every loss including loss adjusting expense 8 Reinsurance premium: Pro rata portion of premiums corresponding to amount of each risk ceded plus 100% of the pro rata unearned premium applicable to business covered as of January 1, 2008 Commission allowance: 15% of the premium paid Profit commission: 15% of the net profit Class C-1 First Layer Excess of Loss All property business written by the company $35,000 per loss occurrence 100% of any loss including loss adjusting expenses in excess of company retention up to $65,000 10.13% of net premiums written with a minimum premium of 75% of the annual deposit premium or $56,036 Class C-2 Second Layer Excess of Loss All property business written by the company $100,000 per loss occurrence 100% of any loss including loss adjusting expense in excess of company retention up to $300,000 3.25% of net premiums written, subject to a minimum premium of 75% of the annual deposit premium or $17,978 Class D/E-1 – First Layer Stop Loss All business written by the company 60% of net premiums written 100% of net losses in excess of retention, up to 50% of net premiums written as defined in the contract Current year rate is 12.93% of net premiums written with a minimum premium of 75% of the annual deposit premium or $79,009 Class D/E-2 – Second Layer Stop Loss All business written by the company 110% of net premiums written 100% of aggregate net losses in excess of retention 3% of net written premium with a minimum premium of 75% of the annual deposit premium or $18,332 Ceding commission: 3. Type of contract: Lines reinsured: Company's retention: Coverage: Reinsurance premium: 4. Type of contract: Lines reinsured: Company's retention: Coverage: Reinsurance premium: 5. Type of contract: Lines reinsured: Company's retention: Coverage: Reinsurance premium: 6. Type of contract: Lines reinsured: Company's retention: Coverage: Reinsurance premium: 9 IV. 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. 10 West Central Mutual Insurance Company Statement of Assets and Liabilities As of December 31, 2007 Assets Cash in company's office Cash deposited in checking account Cash deposited at interest Bonds Stocks and mutual fund investments Real estate Premiums, agents' balances and installments: In course of collection Investment income accrued Reinsurance recoverable on paid losses and LAE Electronic data processing equipment Fire dues recoverable Reinsurance premium recoverable Other expense-related assets: Reinsurance commission receivable Cash surrender value Other nonexpense-related assets: Federal income tax recoverable Furniture and fixtures Totals $ Ledger 100 73,915 466,515 75,897 1,226,213 255,341 Nonledger $ Not Admitted $ Net Admitted $ 100 73,915 466,515 75,897 1,226,213 255,341 1,180 3,092 26,468 3,169 781 2,726 56 1,124 3,092 26,468 3,169 781 2,726 3,236 49,814 3,236 49,814 13,333 4,423 $2,203,111 $3,092 4,423 $4,479 13,333 0 $2,201,724 11 West Central Mutual Insurance Company Statement of Assets and Liabilities (cont.) As of December 31, 2007 Liabilities and Surplus Net unpaid losses Unpaid loss adjustment expenses Commissions payable Unearned premiums Amounts withheld for the account of others Payroll taxes payable (employer’s portion) Other liabilities: Expense-related: Accounts payable Accrued property tax Accrued vacation and sick pay Pension liability payable Nonexpense related: Premiums received in advance Total liabilities Policyholders' surplus Total Liabilities and Surplus $ 52,411 1,281 1,277 266,070 4,603 1,638 2,288 3,335 21,562 35,753 31,050 421,268 1,780,456 $2,201,724 12 West Central Mutual Insurance Company Statement of Operations For the Year 2007 Net premiums and assessments earned Deduct: Net losses incurred Net loss adjustment expenses incurred Other underwriting expenses incurred Total losses and expenses incurred Net underwriting gain (loss) Net investment income: Net investment income earned Net realized capital gains (losses) Total investment gain (loss) Other income (expense): Policy fees and miscellaneous income Net income (loss) before federal income taxes Federal income taxes incurred Net Income (Loss) $527,349 $ 99,749 100,124 272,386 472,259 55,090 67,355 348 67,703 66,724 189,517 36,584 $152,933 13 West Central Mutual Insurance Company Reconciliation and Analysis of Surplus as Regards Policyholders For the Five-Year Period Ending December 31, 2007 The following schedule is a reconciliation of surplus as regards policyholders during the period under examination as reported by the company in its filed annual statements: 2007 Surplus, beginning of year Net income Net unrealized capital gains or (losses) Change in nonadmitted assets Surplus, End of Year $1,500,184 152,933 126,899 440 $1,780,456 2006 $1,438,007 (84,712) 151,047 (4,158) $1,500,184 2005 $1,124,970 145,196 165,061 2,780 $1,438,007 2004 $ 700,786 91,572 306,573 26,039 $1,124,970 2003 $706,284 29,821 (55,720) 20,401 $700,786 Reconciliation of Policyholders' Surplus The examination resulted in no adjustments to policyholders’ surplus. The amount reported by the company as of December 31, 2007, is accepted. 14 V. SUMMARY OF EXAMINATION RESULTS Compliance with Prior Examination Report Recommendations Comments and recommendations contained in the last examination report and the action taken on them by the company are as follows: 1. Corporate Records—It is recommended that when the board wishes to change the number of members on the board that it do so by resolution according to Article III of the company’s articles of incorporation. Action—Compliance 2. Corporate Records—It is recommended that the board minutes reflect what committees are being assigned and list the members of each committee and the chairman of each committee. Action—Compliance 3. Corporate Records—It is recommended that the company divide the classes into more evenly distributed classes pursuant to s. 612.13 (1), Wis. Stat. Action—Compliance 4. Conflict of Interest—It is recommended that those directors who have indicated a conflict of interest abstain from voting when such a conflict exists pursuant to ss. 612.18 and 611.60, Wis. Stat. Action—Compliance 5. Fidelity Bond and Other Insurance Coverage—It is recommended that the company report the correct name of its Fidelity Bond insurer on the Annual Statement. Action—Compliance 6. Underwriting—It is recommended that the company develop a written performance standard for its agents and that the company develop a process to review agent performance, such process should include appropriate remedial action for those agents who do not meet the performance standard. Action—Compliance 7. Cash and Invested Cash—It is recommended that the company properly mark checks void and keep voided checks in a secure place. Action—Compliance 8. Cash and Invested Cash—It is recommended that the company properly accrue for unrecorded liabilities at year-end according to the Annual Statement Instructions. Action—Compliance 15 9. Agents’ Balances or Uncollected Premiums—It is recommended that the company nonadmit amounts in Agents’ Balances or Uncollected Premiums over 90 days pursuant to the Annual Statement Instructions. Action—Compliance 10. Net Unpaid Losses—It is recommended that the company properly report all losses unpaid as net unpaid losses on its annual statement. Action—Compliance 11. Net Unpaid Losses—It is recommended that the company estimate an IBNR for liability losses each year. Action—Compliance 12. Commissions Payable—It is recommended that the company require all agents to complete the Policy Renewal Underwriting Information Form. Action—Compliance 16 Current Examination Results Corporate Records The minutes of the annual meetings of policyholders and meetings of the board of directors and committees thereof were reviewed for the period under examination and also for the subsequent period. It was noted that the minutes do not show that the board of directors approves purchases and sales of investments. It is recommended that the board of directors’ minutes indicate approval of investments purchased and sold at each board meeting following the purchase or sale of investments. The WCIS board met in executive session in November 2007 to approve a transaction between WCIS and the President. The results of the executive session were not reported in the next official board minutes. Two of the seven directors are appointed as agents for the company. Section 612.13 (1m), Wis. Stat., states that if a town mutual has fewer than 9 directors, no more than one director may be an employee or representative of the town mutual. Director Hogden has been appointed as an agent for the company for many years, but he never wrote a policy for the company. A director would not be considered a “representative” or inside director for the purpose of compliance with the statute on inside directors until or unless a director writes a policy or performs any other “agent” action. Therefore, the company is determined to be in compliance with s. 612.13, Wis. Stat., based upon the above facts. A review of various agreements, procedures, and reports noted that they were not all current. The company corrected the items to show what is current after being pointed out during the examination. It is recommended that the company develop a procedure for the annual review of agreements, procedures, and reports to see that they are current and that the company make changes as needed. Some of the items noted were in the disaster recovery plan, the board of director’s policies and procedures manual (qualifications of a director), the business plan, the services agreement with WCIS, and the bank signature cards. 17 The board of directors on March 9, 2007, updated the board policy for qualifications, expectations and responsibilities of directors and officers. Among the qualifications to be a director for a mutual insurance company were that a person must: A. Never have pursued any claim or litigation against the company, any of its subsidiaries, any of its employees or directors at anytime in the prior five years. B. Not been employed by the company or any of its subsidiaries within the last five years. After correspondence with this office, the company was informed by letter dated May 22, 2007, that OCI request that the company not implement the above board policy at that time because the statutes allow any policyholder to run for the board, except for the limitations regarding inside directors in s. 612.13 (1m), Wis. Stat. The board minutes for May 23, 2007, indicate that item B on not being an employee for five years is suspended pending legal review. Item A was not discussed, according to the minutes. The Nominating Committee on May 23, 2007, reviewed the performance in the past of the individuals up for reelection as directors. On June 7, 2007, at the annual meeting “some of the qualifications that are looked for in a director” were reviewed. Both expiring directors were reelected, with no further nominations. During the examination the examiners noted that the board of directors’ policies and procedures manual also included items A and B for qualifications for a director. The board of directors at a meeting on May 20, 2008, removed item A. Thus both qualifications for a director that OCI requested that the company not implement have now been addressed. Biographical data relating to company officers and directors have been reported in accordance with the provisions of s. Ins 6.52, Wis. Adm. Code. The company has executed formal written agreements with its agencies. The contracts include language indicating the Agency will represent the company's interests "in good faith." Conflict of Interest In accordance with a directive of the Commissioner of Insurance, each company is required to establish a procedure for the disclosure to its board of directors of any material interest 18 or affiliation on the part of its officers, directors, or key employees which conflicts or is likely to conflict with the official duties of such person. A part of this procedure is the annual completion of a conflict of interest questionnaire by the appropriate persons. The company has adopted such a procedure for disclosing potential conflicts of interest. Conflict of interest questionnaires were reviewed for the period under examination with no apparent conflicts being noted. Examiners found that one director is an insurance agent with appointments for at least one competing insurer, which should have been disclosed as a potential conflict of interest. It is recommended that directors disclose an agent appointment to a competing insurer as a potential conflict of interest. Fidelity Bond and Other Insurance The company is afforded coverage under the terms of the following bonds or contracts and has complied with s. Ins 13.05 (6), Wis. Adm. Code, which sets forth the minimum requirements for fidelity bond coverage: 19 Type of Coverage Fidelity bond Coverage Limits $250,000 Forgery $2,500 Deductible $250,000 Securities $2,500 Deductible $250,000 Trading Loss $2,500 Deductible Worker’s compensation: Employee injury Employers liability: Each accident Each employee Policy limit Professional and D&O insurance Identity fraud expense Building Personal property Accounts receivable, value papers and records, business income, and equipment breakdown Money and securities Statutory $100,000 By Accident $100,000 By Disease $500,000 By Disease $2,000,000 Each Claim $5,000 Deductible $2,000,000 Aggregate $25,000 per insured person for each identity fraud $506,200 $1,000 Deductible $50,000 $1,000 Deductible $100,000 blanket limit $10,000 on premise $5,000 off premise $2,000,000 Aggregate $1,000,000 Products $1,000,000 Personal and advertising $100,000 Fire damage $5,000 Medical expense Liability Underwriting The company has a written underwriting guide. The guide covers all the lines of business that the company is presently writing. The company has a formal inspection procedure for both new and renewal business. A sampling of new applications and renewal business is inspected by a company inspector who does not write insurance. Also, agents are to do inspections of property every three years. Agency Operations The company established an agency, West Central Insurance Services, Inc., which was described in the section of this report entitled "Affiliated Companies.” Establishing this agency subjected the company to ch. Ins 40, Wis. Adm. Code, Insurance Holding Company 20 System Regulation. In accordance with ch. Ins 40, Wis. Adm. Code, the company is required to make certain filings in relation to this subsidiary. This includes the annual registration statement, Form B, the summary registration statement, Form C, and any other filings which may be required by the administrative rule. The company has made the appropriate holding company filings since the last examination. As discussed earlier in this report, the company President worked for WCIS during 2006-2007. When the President terminated employment with the Agency in November 2007, the WCIS board approved (in Executive Session) an arrangement to pay the President 50% of the commissions for one year on the business the President had handled during his employment with the Agency. The company had reasonable business reasons for making this agreement; however, the company had not made this arrangement for any other Agency employee at termination. The arrangement was not recorded in the regular WCIS board minutes. Pursuant to ss. 612.18 and 611,60 (1), Wis. Stat., any material transaction between an insurer and one of its directors is voidable unless: (a) the transaction at the time it is entered into is reasonable and fair to the interests of the corporation; and (b) the transaction has, with full knowledge of its terms and of the interests involved, been approved in advance by the board; and (c) the transaction has been reported to the commissioner immediately after such approval. The company did not report this transaction to this office immediately after it was approved by the board. Although this transaction was done by the 100% owned agency subsidiary rather than the company, these companies are highly interrelated; the same persons comprise the board of directors and officers of the company and its agency subsidiary, and the Agency is largely dependent on the insurer’s commission payments and business. There may be the appearance that the use of the subsidiary was done to avoid the application of the statutes. It is suggested that in the future the company avoid the appearance of violating ss. 612.18 and 611.60, Wis. Stat., as regards transactions with directors and officers by complying with the procedures and reporting requirements of these statutes. 21 Claims Adjusting The company has an adjusting committee consisting of at least three directors as required by s. 612.13 (4), Wis. Stat. The function of this committee is to adjust or supervise the adjustment of losses. Accounts and Records The examiners' review of the company's records indicated that the company is not completely in compliance with s. Ins 13.05, Wis. Adm. Code, which sets forth the minimum standards for the handling of cash and recording of cash transactions by town mutual insurance companies. The examiners noted the following: 1. 2. 3. 4. 5. A proper policy register is not maintained. A proper cash receipts journal is maintained. A proper cash disbursements journal is maintained. A proper general journal is maintained. A proper general ledger is maintained. The policy coverage report and the unearned premium report do not show the correct effective or expiration dates for policies that have terms other than annual term. The reports only give accurate effective and expiration dates for policies that are for 12-month duration. The company writes policies that have terms of monthly, quarterly, and semiannual, in addition to annual. It is recommended that the company have a proper policy register and other reports that have the correct effective date (and expiration date) in compliance with s. Ins 13.05, Wis. Adm. Code. Some of the other reports noted were the policy coverage report, the unearned premium report, and the prepaid/deferred report. The company had new accounting software in 2007. An extensive review was made of income and disbursement items. Cash receipts were traced from source records and the proper recording and eventual deposit thereof ascertained. Negotiated checks issued during the period under examination were reviewed, test checked for proper endorsement, and traced to cash records. The verification of assets and determination of liabilities were made as of December 31, 2007. The company is audited annually by an outside public accounting firm. 22 EDP Environment Company personnel were interviewed with respect to the company’s electronic data processing environment. Access to the computers is limited to people authorized to use the computers. Company personnel back up the computers daily, and the backed-up data is stored off-site weekly. The company has manuals documenting the use of its software and outlining the steps to complete specific tasks. The manuals assist in the continuity of operations by providing instructions for seldom-used applications or when staff turnover occurs. Business Continuity Plan A business continuity plan identifies steps to be performed by a company in the event of business interruptions including, but not limited to, the inability to access its computer, the loss of information on its computer, the loss of a key employee, or the destruction of its office building. The company has developed a business continuity plan. The company’s business continuity plan appears to be adequate. Invested Assets Section 610.23, Wis. Stat., requires insurers to hold all investments and deposits of its funds in its own name except that: (1) Securities kept under a custodial agreement or trust arrangement with a bank or banking and trust company may be issued in the name of a nominee of the bank or banking and trust company; and Any insurer may acquire and hold securities in bearer form. (2) For securities not held under a custodial agreement or trust arrangement with a bank or banking and trust company, s. Ins 13.05 (4), Wis. Adm. Code, requires that: Non-negotiable evidences of company investments such as registered bonds, certificates of deposits, notes, etc., shall be maintained in a safe or vault with adequate safety controls or in a safety deposit box in a bank. Negotiable evidences of company investments shall be maintained in a safety deposit box in a bank. Access to a company safety deposit box containing negotiable securities shall require the presence and signature of at least 2 officers, directors or employees of the company. The securities are held under a safekeeping or custodial agreement with a bank. The company is considered to be in compliance with these requirements. 23 Investment Rule Compliance The investment rule for town mutual insurers allows a company to invest in common stocks, common stock mutual funds, and other higher risk investments (referred to as “Type 2”) provided that the town mutual has a sufficient amount of lower risk investments (referred to as “Type 1”). A town mutual may invest in Type 2 securities only if it already has sufficient Type 1 investments. Type 1 investments must equal or exceed the greater of items 1, 2, or 3. 1. Liabilities plus $300,000 2. Liabilities plus 33% of gross premiums written 3. Liabilities plus 50% of net premiums written 4. Amount required (greater of 1, 2, or 3) 5. Amount of Type 1 investments as of 12/31/2007 6. Excess or (deficiency) The company has sufficient Type 1 investments. The company was granted exceptions under s. Ins 6.20, Wis. Adm. Code, to hold Wisconsin Reinsurance common stock, Wisconsin Reinsurance preferred stock, NAMIC stock, West Central Mutual Agency (West Central Insurance Services) stock, and real estate. The company also was granted permission to hold up to 50% of its admitted assets in Wisconsin Reinsurance common stock and 5% of admitted assets in other common stock. The company is in compliance with the 5% limit when the stock value of the agency is not included. $721,268 704,173 683,569 721,268 723,301 $ 2,033 24 ASSETS Cash and Invested Cash The above asset is comprised of the following types of cash items: Cash in company's office Cash deposited in banks-checking accounts Cash deposited in banks at interest Total $ 100 73,915 466,515 $540,530 $540,530 Cash in company's office at year-end represents the company's petty cash fund. A review of the petty cash was made by the examiners during the course of the examination and the balance reconciled to year-end. Cash deposited in banks subject to the company's check and withdrawal consists of five accounts maintained in three banks. Verification of checking account balances was made by obtaining confirmations directly from the depositories and/or reviewing bank statements and reconciling the amounts shown thereon to company records. Cash deposited in banks represents the aggregate of deposits with 13 depositories. Deposits were verified by direct correspondence with the respective depositories, by an actual count and inspection of certificates and/or passbooks, or confirmation of brokered CDs held under the custodial agreement. Interest received during the year 2007 totaled $19,197 and was verified to company cash records. Rates of interest earned on cash deposits ranged from 1% to 5.4%. Accrued interest on cash deposits totaled $2,409 at year-end. Book Value of Bonds $75,897 The above asset consists of the aggregate book value of bonds held by the company as of December 31, 2007. Bonds owned by the company are located with the company’s brokerage firm under a custodial agreement with a bank. The statement from the company’s brokerage firm was reviewed by the examiners. Bond purchases and sales for the period under examination were checked to brokers' invoices and advices. The company's investment in bonds was in conformance with Wisconsin Statutes and the rules of the Commissioner of Insurance as regards investments made by town mutual insurers. 25 Interest received during 2007 on bonds amounted to $4,390 and was traced to cash receipts records. Accrued interest of $683 at December 31, 2007, was checked and allowed as a nonledger asset. Stocks and Mutual Fund Investments $1,226,213 The above asset consists of the aggregate market value of stocks and mutual funds held by the company as of December 31, 2007. Stocks owned by the company are located in the company’s safe. Stock certificates were physically examined by the examiners. There is no stock certificate for WCIS, the agency the company owns, so the examiners traced the ownership to other documentation. It was noted that the number of shares listed for WCIS on the annual statement was 2,000 when it should have been 200. The cost of the shares was correct. The value per share was thus also wrong. The annual statement market value was correct. The company agreed to correct these items in future annual statements. One mutual fund was with the company’s brokerage firm under a custodial agreement with a bank. Stock and mutual fund purchases and sales for the period under examination were checked to brokers' invoices and advices. The company's investment in stocks and mutual funds was in conformance with Wisconsin Statutes and the rules of the Commissioner of Insurance or permitted variances as regards investments made by town mutual insurers. Dividends received during 2007 on stocks and mutual funds amounted to $58,470 and were traced to cash receipts records. There were no accrued dividends at December 31, 2007. Book Value of Real Estate $255,341 The above amount represents the company's investment in real estate as of December 31, 2007. The company's real estate holdings consisted of its home office building. The required documents supporting the validity of this asset were reviewed and were in order. Adequate hazard insurance was carried on the real estate and contents as noted under the caption, "Fidelity Bond and Other Insurance." The company's investment in real estate and related items is in conformance with the Wisconsin Statutes and the rules of the Commissioner of 26 Insurance or permitted variances as regards investments made by town mutual insurers when depreciation is allowed. Real estate depreciation is calculated using the straight-line method. Premiums, Agents' Balances in Course of Collection $1,124 This asset represents the amounts due from policyholders which are not in excess of 90 days past due at year-end. A review of detailed premium records verified the accuracy of this asset. Investment Income Accrued Interest due and accrued on the various assets of the company at December 31, 2007, consists of the following: Cash at Interest Bonds Total Reinsurance Recoverable on Paid Losses and LAE $2,409 683 $3,092 $26,468 $3,092 The above asset represents recoveries due to the company from reinsurance on losses and loss adjusting expenses which were paid on or prior to December 31, 2007. This receivable had not been submitted to the reinsurer prior to the examination. A review of accountings with the reinsurer during the examination verified the above asset. Electronic Data Processing Equipment $3,169 The above balance consists of computer hardware and operating system software, net of depreciation as of December 31, 2007. A review of the listing of equipment and other documentation verified the balance. Non-operating system software was properly nonadmitted. Fire Dues Recoverable $781 This asset represents the amount overpaid to the State of Wisconsin for 2007 fire dues. The examiners reviewed the company's fire department dues calculation and found this asset to be correctly calculated. The actual amount paid was verified to the cash disbursement records. 27 Reinsurance Premium Recoverable The asset represents the net amount of the adjusted reinsurance premium $2,726 calculation of $39,966 due the company and reinsurance premium payable of $37,240 as of December 31, 2007. The examiners verified the balance with records from the reinsurer. Reinsurance Commission Receivable $3,236 The above asset represents the amount of reinsurance commissions that the company expected to receive as of December 31, 2007, under its contract with Wisconsin Reinsurance Corporation. Terms of the reinsurance agreement and year-end accountings with the reinsurer were reviewed. An estimated contingent commission of $2,131 based on the profitability of the business ceded was not supported by the reinsurer’s final calculation of the first surplus premium and losses, so the contingent commission was not collected. As the amount was not material, no change was made to the examination surplus. Cash Surrender Value $49,814 This asset consists of $49,814 of cash surrender value of life insurance on the company’s manager owned by the company at December 31, 2007. The above asset was confirmed by reviewing the applicable statement for the life insurance policy. This life insurance policy is intended to fund the company’s retirement obligation to the manager. Federal Income Tax Recoverable $13,333 This asset represents the balance receivable at year-end for federal income taxes incurred prior to December 31, 2007. The examiners reviewed the company's 2007 tax return to verify the accuracy of this asset. The overpayment was applied to the 2008 estimate of taxes. Furniture and Fixtures $0 This asset consists of $4,423 of furniture and equipment owned by the company at December 31, 2007. In accordance with annual statement requirements, this amount has been reported as nonadmitted asset, thus the balance shown above is $0. 28 LIABILITIES AND SURPLUS Net Unpaid Losses $52,411 This liability represents losses incurred on or prior to December 31, 2007, that remained unpaid as of that date. The examiners reviewed the reasonableness of this liability by totaling actual loss payments made subsequent to December 31, 2007, with incurred dates in 2007 and prior years. To the actual paid loss figure was added an estimated amount for 2007 and prior losses remaining unpaid at the time of the examination. The examiners' development of unpaid losses is compared with the amount estimated by the company in the following schedule. Company Estimate Incurred but unpaid losses Less: Reinsurance recoverable on unpaid losses Net Unpaid Losses $335,143 282,732 $ 52,411 Examiners' Development $263,557 229,057 $ 34,500 Difference $71,586 53,675 $17,911 An adjustment to the examination surplus was not made for the difference. The examination development for the IBNR reserves developed an adequacy of $9,500 which might not have been fully developed at the time of the examination. The adequacy of the case reserves of $8,411 is not considered material for purposes of this examination. The examiners' review of claim files included open claims, paid claims, claims closed without payment, and claims which were denied during the examination period. The review indicated that claims are investigated and evaluated properly and that payments are made promptly and in accordance with policy provisions upon the submission of a proper proof of loss. In addition, the review of claims handling procedures and files revealed the following: 1. 2. 3. A proper loss register is maintained. Claim files contained sufficient investigatory data and documentation to verify settlement payments or reserve estimates. Proofs of loss were properly signed. $1,281 Unpaid Loss Adjustment Expenses This liability represents the company's estimate of amounts necessary to settle losses which were incurred prior to December 31, 2007, but which remained unpaid as of year-end. The 29 methodology used by the company in establishing this liability is by taking 10% of the indirect unpaid expenses. The company uses mostly its in-house adjustor for claims adjusting. The examiners' analysis of expenses incurred in the current year related to the settlement of prior year losses, as well as estimates of amounts necessary to settle any prior losses remaining unpaid at the examination date, determined this liability to be adequately stated. Commissions Payable This liability represents estimated commissions payable to agents as of December 31, 2007. The examiners reviewed the company’s commission calculation and found the estimated liability amount for a contingency bonus was not paid as the agency did not earn the bonus. Since the amount is not material no change was made to the examination surplus. Unearned Premiums $266,070 $1,277 This liability represents the reserve established for unearned premiums in compliance with s. Ins 13.08 (3), Wis. Adm. Code. This reserve was established using a daily pro rata methodology. Amounts Withheld for the Account of Others $4,603 This liability represents employee payroll deductions of $3,440 in the possession of the company at December 31, 2007. It also includes $1,163 of premiums collected by the company on behalf of WCIS. Supporting records and subsequent cash disbursements verified this item. Payroll Taxes Payable $1,638 This liability represents the company's portion of payroll taxes incurred prior to December 31, 2007, which had not yet been paid. Supporting records and subsequent cash disbursements verified this item. Accounts Payable $2,288 This liability consists of unpaid expenses as of December 31, 2007. Verification was done through a review of subsequent payments. The company subtracted out the amount calculated for the unpaid loss adjusting expenses of $1,281 from the list of accounts payable of $3,569. No reclassification is being made. 30 Accrued Property Taxes $3,335 This liability represents property taxes owed by the company at December 31, 2007. Supporting records and subsequent cash disbursements verified this item. Accrued Vacation and Sick Pay $21,562 This liability represents the employees’ accumulated sick leave earned prior to December 31, 2007, which had not yet been paid. Employees receive 12 sick days per year and may accumulate up to 90 days. Upon termination the employee is paid half of the amount accumulated. Supporting sick leave records were used to verify this item. Pension Liability Payable $35,753 This liability represents the present value at year-end for a life insurance policy liability incurred prior to December 31, 2007, where the company is the policyholder and beneficiary. The examiners reviewed the company's calculation to verify the accuracy of this liability. The company computed this amount using the present value amount of the cash surrender value of the policy. Premiums Received in Advance $31,050 This liability represents the total premiums received prior to year-end for policies with effective dates after December 31, 2007. The examiners reviewed a 2007 prepaid premium report and cash receipt records to verify the accuracy of this liability. 31 VI. CONCLUSION West Central Mutual Insurance Company is a town mutual insurer covering ten counties. The company has been in business since 1871. Since the prior examination of December 31, 2002, the company’s assets increased 91% from $1,147,209 to $2,201,724 in 2007. Liabilities have decreased 4% from $440,925 in 2002 to $421,268. Surplus increased 153% from $706,284 in 2002 to $1,780,456 in 2007. Policy counts have decreased from 1,397 in 2002 to 1,216 in 2007, with the biggest decreases coming in 2006 and 2007. The company had decreases to gross and net premiums in 2007 and 2006. The company’s only net loss to income in the five years under examination was 2006. The company had underwriting gains in three of the last five years, with losses in 2006 and 2003. In 2006, the underwriting loss was $(221,206) and the loss to net income was $(84,712). Claims increased greatly in 2006 due to a severe hail storm. The company complied with the 12 recommendations from the previous examination report. The current examination report has 4 recommendations and a suggestion, and no adjustments to surplus. Examiners found some small errors related to collection of reinsurance on paid losses and on estimation of contingent commissions recoverable from the reinsurer. The company should improve controls over reinsurance transactions. The company should be mindful of statutes applicable to transactions in which directors or officers have an interest. 32 VII. SUMMARY OF COMMENTS AND RECOMMENDATIONS 1. Page 17 - Corporate Records—It is recommended that the board of directors’ minutes indicate approval of investments purchased and sold at each board meeting following the purchase or sale of investments. Page 17 - Corporate Records—It is recommended that the company develop a procedure for the annual review of agreements, procedures, and reports to see that they are current and that the company make changes as needed. Page 19 - Conflict of Interest—It is recommended that directors disclose an agent appointment to a competing insurer as a potential conflict of interest. Page 21 - Agency Operations—.It is suggested that in the future the company avoid the appearance of violating ss. 612.18 and 611.60, Wis. Stat., as regards transactions with directors and officers by complying with the procedures and reporting requirements of these statutes. Page 22 - Accounts and Records—It is recommended that the company have a proper policy register and other reports that have the correct effective date (and expiration date) in compliance with s. Ins 13.05, Wis. Adm. Code. 2. 3. 4. 5. 33 VIII. ACKNOWLEDGMENT The courteous cooperation extended to the examiners by the company's personnel is hereby acknowledged. In addition to the undersigned, DuWayne Kottwitz of the Office of the Commissioner of Insurance, State of Wisconsin, participated in the examination. Respectfully submitted, Andrew M. Fell Examiner-in-Charge 34