Adjusting to the new model of risk-based exams: carriers are in for big changes in the way regulators review their internal controls as examiners shift from rules to risk.

[ILLUSTRATION OMITTED]

Out with the old ... and in with the new, at last.

The next couple of years are bringing some big changes in the way examiners are going to look over the books of insurance carriers as regulators move from a rules-based to a risk-based methodology for reviewing the internal controls implemented by insurance companies.

Under the old system, insurance company examiners went strictly by the book: earnings, balance sheets, income statements, statutory filings, if the numbers looked clean, the company, it was assumed, was in good health. It doesn't quite work that way anymore.

Now examiners are taking a more flexible and holistic approach that takes into account the broader context in which carriers operate. They want to know how companies manage risk exposures, and what structures are in place to make sure a company does so. Numbers are not all that matter.

Who's going to benefit? Investors, for one, along with insurance buyers and their brokers, as examiners will be more likely to accurately evaluate the risks to which carriers are exposed. In theory, it's all good news for buyers as they'll get fair warning about whether a carrier is overexposed and could have trouble paying future claims.

The coming changes are important--perhaps even radical. We're not talking about changes in process. We're talking about a fundamental shift in the way insurance examiners interact with the industry they're supposed to be overseeing.

Take David G. DelBiondo, director of the Bureau of Financial Examination at the Pennsylvania Department of Insurance. DelBiondo practices his craft in a state that's seen its fair share of large insurance carriers--Legion and Reliance, for example--melt away into insolvency.

A decade ago, it was unheard of for a state examiner to sit in on a board meeting of a large or midsize insurance carrier. "I just couldn't imagine sitting on the board meeting of an insurance company in Pennsylvania," he said.

But in the next couple of years, C-suite insurance executives ought not be surprised if they hear a knock on their boardroom doors, only to find DelBiondo's smiling face on the other side.

In the past, when examiners would sometimes focus solely on a company's income statement or balance sheet, too often button-downed regulators would spend too much time on minor issues, approaching their tasks in "checklist" fashion, according to corporate comptrollers.

Those days--or should we say decades--are gone.

The changes come courtesy of the National Association of Insurance Commissioners, which ordered that state examiners obtain more information on insurance carriers beyond what was available in public filings.

Commissioners now expect examiners to have answers to questions such as, "How did companies use investments to manage and mitigate risks unique to that company?" said DelBiondo.

The NAIC ordered the changes in the wake of the Sarbanes-Oxley Act of 2002, which was passed in an attempt to inject more transparency and accuracy into financial accounting practices that previously allowed some companies to hide the real state of their balance sheets.

The accounting scandals led to a series of spectacular corporate collapses that cost investors billions of dollars, and investors and regulators blamed the audit profession for not revealing the pitiful state of some corporate balance sheets.

DelBiondo recommended that companies looking to prepare for their exams should engage senior management, the legal department, the risk management department, and the internal and external audit personnel and that managers involved in preparing for the visit should "meet early and often."