POINT: CODIFICATION— BENEFICIAL TO CONSUMERS, REGULATORS, AND INSURERS by Norris Clark, Chief of Financial Surveillance, California Insurance Department

The NAIC unanimously adopted (with one abstention) in March 1998 a comprehensive basis of statutory insurance accounting (the “Codification Project”) to be effective January 1, 2001. The goal of the Codification Project: create an accounting system based upon the concepts of conservatism, consistency, and recognition, which will be adopted by all states. Codification is based on statutory accounting practices and procedures which have been in effect for years; however, it is significantly more complete and coherent.

Why is Codification Project important? Because for an industry as sophisticated and important to the financial well-being of all of us, there exists no common regulatory basis of accounting for insurers. Insurers report their financial results on the basis of “accounting practices prescribed or permitted by their domiciliary states”, and those “practices” are not clearly understood or documented. For example, the financial statements filed by Prudential are not prepared on the same basis as those filed by Metropolitan Life. In other words, the financial statements of most insurers are not comparable. Astonishing! Imagine the SEC allowing General Motors to present its financials on a different accounting basis than those of General Electric. Clearly, a fix for current insurance accounting is necessary.

One of the most important elements of codification is a requirement to disclose the differences between an insurer’s financial results as reported under its domiciliary state’s “prescribed and permitted practices” and the NAIC codified accounting practices. This brings comparability.

What does Codification accomplish? It allows each state to maintain its own statutory accounting system for its domiciled insurers (under which insurers will report and be audited) while providing other state insurance departments with the information necessary to (1) understand the accounting bases upon which the financial statements are prepared and (2) compare financial results of insurers domiciled in all states. It provides a far better basis for regulators to determine insurer solvency. It provides a level accounting playing field, something that insurers want, at an affordable cost (insurers and CPAs agree on that point), and it provides added and useful information to consumers.

The overall benefits of the Codification far exceed any costs associated with its implementation. Codification deserves every State’s careful consideration and ultimate adoption.

COUNTER POINT: STATE AUTHORITY MUST BE PRESERVED by Michigan State Senator Michael Bouchard

The primary purpose of individual state governments is to respond to the needs of the state citizenry. Throughout history, Congress and the states have struggled in order to differentiate which authority has the power and/or responsibility to legislate in different areas. This power struggle persists due to the fact that, in many areas, it is not clear which authority is best suited to legislate in the best interest of the people. However, there are unique areas where Congress has expressly granted the states plenary authority to legislate. The motivation behind reserving legislative responsibility to certain authorities is to ensure that the public interest is protected by the authority best suited to respond to the needs and interests that arise in that area. Consequently, in 1945, with the passage of the McCarran-Ferguson Act, Congress unequivocally reserved to the individual state the authority to legislate the business of insurance. This broad reservation of legislative power authorizes the individual states to contemplate and implement legislation affecting the business of insurance without federal interference.

In 1871 the National Association of Insurance Commissioners (NAIC) was originally created purely for advisory purposes and to promulgate model solvency regulations. It was a creation of the states, within the control of the states. However, in recent years, the NAIC has assumed the stance of a federal legislative body and has designed model laws and regulations to assure compliance with its preferred methods. Specifically, with regard to Codification, the NAIC, along with the AICPA, another “industry association,” have integrated a forced regulatory scheme into their “codification of statutory accounting principles” that has the effect of eliminating prescribed and permitted individual state practices. Although certain state’s laws will continue to dictate the basis of accounting, companies, pursuant to SSAP 77, will be required to disclose “material” differences from Codification standards. To this point, the question of whether codification will become an accreditation standard has gone unanswered. In addition, the meaning of the word “material” has yet to be defined. Consequently, although not required to adopt the methods prescribed by Codification, companies will nonetheless be forced to comply with Codification standards.

Clearly, the NAIC has assumed a role and a responsibility that it was never intended to engage. Accordingly, individual state legislatures must demand that they retain their role and responsibility in dictating state insurance laws; a role that was never intended to be assigned to a national regulator or national legislative body. The states are best equipped to respond to individual state needs, and their purpose should not be simply to conform state needs to comply with national uniform standards. The idea of a national “legislative body” is in direct conflict with the express reservation to the states of the responsibility to legislate the business of insurance. Individual states and insurance regulators cannot simply defer the responsibility that Congress assumed the states would take seriously.

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