GUARANTEE INSURANCE COMPANY - Florida Office of Insurance ... · Company’s administrative offices...
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REPORT ON TARGET EXAMINATION OF GUARANTEE INSURANCE COMPANY FORT LAUDERDALE, FLORIDA AS OF December 31, 2007 BY THE OFFICE OF INSURANCE REGULATION
Transcript of GUARANTEE INSURANCE COMPANY - Florida Office of Insurance ... · Company’s administrative offices...
REPORT ON TARGET EXAMINATION
OF
GUARANTEE INSURANCE COMPANY
FORT LAUDERDALE, FLORIDA
AS OF
December 31, 2007
BY THE
OFFICE OF INSURANCE REGULATION
TABLE OF CONTENTS LETTER OF TRANSMITTAL……………………………………………………….
-
SCOPE OF ENGAGEMENT………………………………………………………….
1
MANAGEMENT………………………………………………………………………
2
ORGANIZATIONAL CHART..………………………………………………………
5
ACCOUNTS AND RECORDS……………………………………………………….
6
FINANCIAL STATEMENTS PER EXAMINATION..………………………………
6
COMMENTS ON FINANCIAL STATEMENTS.……………………………………
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SUMMARY OF FINGINGS…………………….……………………………………
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CONCLUSION………………………………………………………………………... 71
Tallahassee, Florida August 26, 2008 Kevin M. McCarty Commissioner Office of Insurance Regulation State of Florida Tallahassee, Florida 32399-0326 Dear Sir: Pursuant to your instructions, in compliance with Section 624.316, Florida Statutes, and in accordance with the practices and procedures promulgated by the National Association of Insurance Commissioners (NAIC), we have conducted a target financial examination as of December 31, 2007, of the financial condition and corporate affairs of:
GUARANTEE INSURANCE COMPANY 401 E. LAS OLAS BLVD, SUITE 1540
FORT LAUDERDALE, FL 33301 Hereinafter referred to as the “Company’. Such report of examination is herewith respectfully submitted.
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SCOPE OF EXAMINATION
In March 2008, Buttner Hammock & Company, P.A. (BHC) was engaged by the Florida Office
of Insurance Regulation (the Office) to conduct a target financial condition Examination (target
examination) of Guarantee Insurance Company (the Company) in accordance with Section
624.316, Florida Statutes and the National Association of Insurance Commissioners (NAIC)
Financial Condition Examiners Handbook, the NAIC Accounting Practices and Procedures
Manual and Rule 69O-138, Florida Administrative Code. This target examination was
conducted to the extent and in the manner directed by the Office.
The scope of BHC’s target examination was to review the compliance by the Company with the
findings in the Report on Examination as of December 31, 2006, which was dated August 10,
2007, and the directives in Consent Order #93640-07-CO, dated March 11, 2008, (Consent
Order).
Planning for BHC’s examination began on March 1, 2008. The field work commenced on
March 31, 2008 and concluded on August 20, 2008. This target examination includes any
material events occurring subsequent to December 31, 2007 and noted during the course of the
target examination.
The target examination included a review of certain reports and work papers of examinations of
the Company conducted by insurance regulators, the Company’s corporate and financial records,
independent audit reports, and the audited financial statements as of December 31, 2007 which
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were prepared by BDO Seidman, LLP (BDO), and BDO’s audit work papers for the audit for the
year ended December 31, 2007. The Company maintains its principal operations in Fort
Lauderdale, Florida, where this examination was commenced. Most of BHC’s target
examination work was conducted off-site.
Management
The annual shareholder meeting for the election of directors were not held for the years 2006 and
2007 in violation of Section 607.1601 and 628.231, Florida Statutes.
Directors serving as of December 31, 2007 were:
Directors Name and Location Principal Occupation
Steven Michael Mariano CEO, Chairman of the Board, President Miami, Florida Guarantee Insurance Company
John Richard Del Pizzo Principal and Owner Newton Square, Pennsylvania Del Pizzo & Associates, PC
Ann L. Rodkey Vice President of Operations Sarasota, Florida Guarantee Insurance Company
Theodore G. Bryant (A) Secretary, Guarantee Insurance Company Weston, Florida Vice President, Suncoast Holdings, Inc.
Michelle A. Masotti (A) Vice President of Planning and Boynton Beach, Florida Development
Patriot Risk Management Timothy J. Tompkins General Counsel Traverse City, Michigan The Hagerty Group
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The following director was elected in June 2008.
Michael Sluka (B) Fort Lauderdale, Florida
Chief Financial Officer and Treasurer Guarantee Insurance Company
(A) Appointed effective January 4, 2007.
(B) Employed effective April 14, 2008.
Subsequent Events: Michael Grandstaff and Charlie Schuver were appointed October 13, 2008.
Ann L. Rodkey was removed October 24, 2008.
The Board of Directors, in accordance with Company’s bylaws, appointed the following officers:
Senior Officers
Name Title Steven M. Mariano Chairman of the Board/CEO Ann L. Rodkey Vice President, Operations terminated October 24, 2008 Paul V. H. Halter, III President/COO, employment terminated on April 15, 2007 James P. Chick, Jr. Executive VP/CFO, employment terminated on April 15,
2007 Charlie Schuver Chief Underwriting Officer ** Michael Sluka Chief Financial Officer, Treasurer, Vice President Michael Grandstaff Senior Vice President Theodore G. Bryant Senior Vice President, Secretary and General Counsel Greg Garber Senior Vice President John Travis Senior Vice President Alan Case Vice President, Claims Administration, employment
terminated August 1, 2008 Maria Allen Vice President, Client Services and Vice President, Claims
Administration Joyce Predmesky Vice President, Policy Services Kimberly Davis Vice President, Compliance, Assistant Secretary Stephen Kelly Vice President, Strategic Planning Paul Simeone Controller
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** Employment is expected to commence on June 2, 2008.
Following are the principal internal board committees of SunCoast, and their members as of
December 31, 2007:
Audit Committee
Investment Committee
Compensation Committee
John R. Del Pizzo1 Steven Mariano1 Timothy J. Tompkins1 Steven Mariano John R. Del Pizzo John R. Del Pizzo Timothy J. Tompkins Timothy J. Tompkins 1Chairman
There was an Executive Committee, however it stopped meeting in March 2007.
Organizational Chart The Company is a member of an insurance holding company system as defined by Rule 69O-
143.045(3), Florida Administrative Code. Holding company registration statements were filed
with the State of Florida on March 1, 2007 and March 1, 2008, as required by Section 628.801,
Florida Statute and Rule 69O-143.046, Florida Administrative Code. Amendment No. 1 to the
Company’s Holding Company Registration Statement was filed on March 25, 2008.
An organizational chart as of December 31, 2007 reflecting the holding company system, is
shown below. Schedule Y of the Company’s 2007 annual statement provided a list of all related
companies of the holding company group.
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Guarantee Insurance Company Organizational Chart (Including Name Changes)
December 31, 2007
• Name changed in 2008.
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Accounts and Records The Company’s accounting records are maintained on a computerized system and the
Company’s administrative offices are located in Fort Lauderdale, Florida, where this target
examination was conducted.
Balance sheet accounts were verified with the line items of the annual statement submitted to the
Office.
Financial Statements Per Examination During the course of this target examination, BHC identified several adjustments to the amounts
contained in the Company’s December 31, 2007 Annual Statement originally filed with the
Office.
The following pages contain the Company’s financial position at December 31, 2007, as
determined by the target examination.
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Guarantee Insurance Company
Admitted Assets December 31, 2007
As Reported in Guarantee 2007
Annual Statement
BDO Seidman
Audit Adjustments
Audited Balance at 12/31/07
Examination Adjustments
Examination Adjusted Balance
at 12/31/07 Bonds $ 55,169,895 $ 55,169,895
$ 55,169,895
Common stock 633,960 633,960
633,960
Real estate 255,785 255,785
255,785
Cash 5,040,972 5,040,972
5,040,972
Investment income due and accrued 542,380 542,380
542,380
Uncollected premiums 4,315,781 $ (446,656) 3,869,125
3,869,125
Deferred premiums 32,030,041 32,030,041
32,030,041
Amounts recoverable from reinsurers 4,502,022 4,502,022
4,502,022
Funds held by or deposited with reinsurance companies
2,370,194 179,599 2,549,793
2,549,793
Other amounts receivable under reinsurance contracts
179,599 (179,599) -
-
Current federal and foreign income tax recoverable and interest thereon
27,095 27,095
$ (27,095)
-
Net deferred tax asset 2,087,624 2,087,624
2,087,624
Electronic data processing equipment and software
125,346 125,346
125,346
Receivable from parent, subsidiaries and affiliates
-
-
Aggregate write-ins for other than invested assets 1,268,181 1,268,181 1,268,181
Total Admitted Assets $ 108,548,875 $ (446,656) $ 108,102,219 $ (27,095) $ 108,075,124
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Guarantee Insurance Company
Liabilities, Surplus & Other Funds December 31, 2007
As Reported in Guarantee 2007
Annual Statement
BDO Seidman
Audit Adjustments
Audited Balance at 12/31/07
Examination Adjustments
Examination Adjusted Balance
at 12/31/07 Losses $ 21,270,180 $ 21,270,180
$ 21,270,180
Reinsurance payable on paid losses and loss adjustment expense
404,018 404,018
404,018
Loss adjustment expenses 4,207,823 4,207,823
4,207,823
Commissions payable, contingent commissions and other similar charges
2,340,913 2,340,913
2,340,913
Other expenses 679,225 679,225
$ (34,475)
644,750
Taxes, licenses and fees 3,100,388 3,100,388
138,239
3,238,627
Current federal income taxes
66,808
66,808
Unearned premiums 14,196,989 14,196,989
10,097
14,207,086
Ceded reinsurance premiums payable 14,873,238 14,873,238
14,873,238
Funds held by company under reinsurance treaties
29,218,144 29,218,144
29,218,144
Amounts withheld or retained by company for account of others
887,624 887,624
887,624
Provision for reinsurance 753,063 753,063
753,063
Payable for parent, subsidiaries and affiliates 16,489 16,489
94,033
110,522
Aggregate write-ins for liabilities 1,787,901 1,787,901 1,787,901
Total liabilities 93,735,995 - 93,735,995 274,702 94,010,697 Common capital stocks 3,600,120 3,600,120 3,600,120
Surplus notes 1,253,000 1,253,000
1,253,000
Gross paid in and contributed surplus 102,948,223 102,948,223
102,948,223
Unassigned funds (deficit) (92,988,463) $ (446,656) (93,435,119) (301,797) (93,736,916)
Surplus as regards policyholders 14,812,880 (446,656) 14,366,224 (301,797) 14,064,427
Total Liabilities, Surplus & Other Funds $ 108,548,875 $ (446,656) $ 108,102,219 $ (27,095) $ 108,075,124
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Guarantee Insurance Company
Statement of Income December 31, 2007
As Reported in
Guarantee 2007 Annual
Statement
BDO Seidman
Audit Adjustments
Audited Balance at 12/31/07
Examination Adjustments
Examination Adjusted Balance
at 12/31/07 Premiums earned $ 23,815,030 $ (297,106) $ 23,517,924 $ (10,097) $ 23,507,827
Deductions:
Losses incurred 10,277,403 (120,134) 10,157,269
10,157,269
Loss expense incurred 6,855,980 6,855,980
6,855,980
Other underwriting expenses incurred 7,060,764 811,786 7,872,550
33,843
7,906,393
Total underwriting deductions 24,194,147 691,652 24,885,799 33,843 24,919,642 Net underwriting gain (loss) (379,117) (988,758) (1,367,875) (43,940) (1,411,815) Net investment income earned 954,281 954,281
954,281
Net realized capital gains 3,385 3,385
3,385
Net investment gain 957,666 -
957,666
-
957,666
Other income:
Net loss from agents or premium balances
charged off (88,979) (88,979)
(88,979)
Aggregate write-ins for miscellaneous income (19) (19)
(19)
Total other income (loss) (88,998) - (88,998) - (88,998)
Net income before taxes 489,551 (988,758) (499,207)
(43,940)
(543,147)
Federal and foreign income taxes incurred (662,316) 359,040 (303,276) (93,903) (397,179)
Net income (loss) $ (172,765) $ (629,718) $ (802,483) $ (137,843) $ (940,326)
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Guarantee Insurance Company
Comparative Analysis of Changes in Surplus
December 31, 2007 The following is a reconciliation of Surplus as regards policyholders between that reported by the Company and as determined by the examination. Surplus as Regards Policyholders December 31, 2007, per Annual Statement
$14,812,880
Per Company
Per Exam
Increase (Decrease) In Surplus
ASSETS: $108,548,875 $108,075,124 $(473,751)
LIABILITIES: $93,735,995 $94,010,697 (274,702)
Net Change in Surplus $(748,453) $(748,453)
Surplus as Regards Policyholders December 31, 2007, per Examination
$14,064,427
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Comments on Financial Statements
BHC reviewed the deficiencies and adverse findings documented in the 2006 Examination report
issued by the Office as of December 31, 2006 and conducted this target examination as of
December 31, 2007 and subsequent to determine if the Company corrected the 2006 deficiencies
and adverse findings. Each 2006 deficiency or adverse finding is noted below. BHC’s 2007
comments and findings immediately follow each 2006 deficiency.
2006 Deficiency or Adverse Finding: Shareholder Meetings
The annual shareholder meetings for the election of directors were not held for the years 2006
and 2007. We recommend the Company hold annual shareholder meetings to comply with
Sections 607.1601 and 628.231 Florida Statutes.
BHC Findings:
BHC reviewed the “Notice of Annual Meeting of Shareholders To Be Held March 3, 2008 at
10:00 a.m.” for the purpose of electing five persons nominated to serve as Directors of the
Company until their successors are duly elected and qualified. BHC reviewed the proxy electing
the following Directors:
• Stephen M. Mariano • Theodore G. Bryant • John R. Del Pizzo • Michelle A. Masotti • Timothy J. Tompkins
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Ann Rodkey was elected as a Director of the Company on September 15, 2007.
BHC considers the Company to be in compliance in 2007 through March 2008 with
Consent Order #93640-07-CO regarding holding annual shareholder meetings.
2006 Deficiency or Adverse Finding: Corporate Records
The recorded minutes of the Board did not adequately document its meetings and approval of
Company transactions and events in accordance with Section 607.1601, Florida Statutes,
including the authorization of investments as required by Section 625.304, Florida Statutes.
The Company did not maintain the minutes to clearly distinguish between Guarantee
transactions and SunCoast transactions as required by Rule 69O-143.047, Florida
Administrative Code.
A corporation shall maintain its records in written form or in another form capable of conversion
into written form within a reasonable time in accordance with Section 607.1601, Florida
Statutes. We recommend the Company comply with Sections 607.1601 and 628.231, Florida
Statutes, and Rule 69O-143.047, Florida Administrative Code, which requires the Company to
maintain its books, accounts and records of each party to all transactions to clearly and
accurately disclose the precise nature of the transactions and keep as a permanent record
minutes of all meetings.
The minutes should clearly document the following:
• Approval for the Company investments as required by Section 625.304, Florida Statutes; • Board of Director review of the examination report for the Company; • Approval of major agreements for the Company; • Appointment of the CPA for the Company as required by Section 624.424(8), Florida
Statutes.
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BHC Findings:
BHC reviewed minutes from the meetings of the Company’s Board of Directors and certain
affiliates held on the following dates:
January 4, 2007 December 4, 2007 February 2, 2007 December 17, 2007 June 6, 2007 February 18, 2008 June 7, 2007 March 3, 2008 September 13, 2007 March 12, 2008 December 2007 (no day specified) March 13, 2008
The minutes for the June, 2008 Board of Director’s meeting had not been prepared as of June 30,
2008.
BHC’s review noted that the Board minutes properly included approval of the Company’s
investments as required by Section 625.304, Florida Statutes, appointment of the independent
auditors as required by Section 624.424(8), Florida Statutes and approval of major agreements.
BHC considers the Company to be in compliance in 2007 through March 13, 2008 with the
Consent Order #93640-07-CO regarding corporate records.
2006 Deficiency or Adverse Finding: Accounts and Records
The following were noted during the review of the Company’s accounts and records:
• There was no automated interface between the FiServ system and the general ledger;
manual entries were required to enter the premium entries. We recommend the Company establish reconciliation procedures, procedures for reporting of premium information, and develop detail reports to support the reported balances to the general ledger in compliance with Rule 69O-143.047(d), Florida Administrative Code.
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• As a result of the IT review, the following was recommended:
1. The Information Systems Department should hold at a minimum, a monthly status
meeting to discuss current Information Technology (“IT”) issues and future IT plans, with senior management attending the meetings.
2. The Company should employ an internal auditor to perform periodic audits of information systems controls.
3. Conduct a test of the disaster recovery plan annually. Test results should be documented and directed to management with any failures immediately addressed.
We recommend that the Company establish procedures in accordance with the IT
recommendations.
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FiServ Interface
The Company’s Board minutes noted that the Company had experienced continued
dissatisfaction with the FiServ system and was considering potential replacements. The
Company’s plan was to continue to use FiServ until the contract expires in mid 2010. The
Company believes there was some value in developing a partial integration between FiServ and
the general ledgers, which was under investigation. The Company agreed to contact the Office
as the interface is developed. BHC believes that the Company’s plan regarding the FiServ
interface is reasonable. Since the interface was not completed, BHC reviewed the Company’s
development of appropriate reconciliation procedures and reports to insure that correct
accounting data from FiServ is manually entered into the general ledger noting that the
procedures and reports established are appropriate and appear to be functioning accurately at
December 31, 2007.
In 2008, the Company is implementing a new system, Eagle Wings, to create annual reports.
IT Steering Committee Meetings
As a result of the Office’s recommendation that the Company hold a monthly status meeting to
discuss current IT and future IT plans, the Company implemented the IT Steering Committee
Meetings. BHC reviewed the minutes of the IT Steering Committee for the following dates:
July 3, 2007 November 13, 2007 December 11, 2007 January 15, 2008 February 15, 2008 March 11, 2008
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These minutes included evidence that:
• Senior management was in attendance. • Current IT issues were reviewed. • Future IT plans were reviewed. • Short term objectives were reviewed. • Equipment and staffing issues were reviewed.
BHC considers the Company to be in compliance in 2007 through March 11, 2008 with the
Consent Order #93640-07-CO regarding IT coordination.
Internal Audit On March 28, 2008, the Company developed a strategy with respect to the internal audit
recommendation of the Office as follows:
Step 1 (By April 15, 2008). Engage a qualified independent third party (likely Deloitte &
Touche) to examine the Company’s systems and processes and interview key personnel in order
to:
a. Prepare a written assessment of the Company’s key exposure areas, b. Document the current controls in place to mitigate these risks,
c. Prepare detailed internal audit work programs designed to test the existence and
effectiveness of such controls, and
d. Evaluate and document the amount of time required for a Director of Internal Audit to
execute these internal audit work programs in a manner sufficient to ensure that the
Company is maintaining an appropriate system of internal controls.
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The Company noted that Step 1 would be done irrespective of plans for the Company to be a
subsidiary of a publicly-held insurance holding company subject to compliance with the
Sarbanes-Oxley (“SOX”) Act of 2002.
Step 2 (By June 30, 2008). Hire a Director of Internal Audit. Deloitte & Touche was requested to provide the Company with a proposal to assist in preparing
for SOX 404 compliance on or before December 31, 2009 (the currently contemplated
compliance requirement date), including the following:
• Assessing both the design and operating effectiveness of selected internal controls related to significant accounts and relevant assertions, in the context of material misstatement risks;
• Understanding and documenting the flow of transactions, including IT aspects,
sufficiently to identify points at which a misstatement could arise;
• Evaluating company-level (entity-level) controls, which correspond to the components of the COSO framework;
• Performing a fraud risk assessment;
• Evaluating controls designed to prevent or detect fraud, including management override
of controls;
• Evaluating controls over the period-end financial reporting process;
• Scaling the assessment based on the size and complexity of the company;
• Evaluating management’s competency and objectivity;
• Evaluating controls over the safeguarding of assets; and
• Concluding on the adequacy of internal control over financial reporting.
On June 23, 2008 BHC received an update on progress regarding the implementation of the
internal audit recommendation. The Company reports that prior to April 15, 2008, the Company
reassigned Mr. Stephen Kelly to the position of Internal Audit Director. Mr. Kelly was
previously an employee of the Company and has 20 years of insurance accounting and
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operations experience. Mr. Kelly’s appointment was confirmed by the Board of Directors in
June, 2008.
Since his appointment, Mr. Kelly has completed the following tasks:
• Submitted an Internal Audit Department Charter to the Board of Directors. • Submitted a process and procedure to the Audit Committee for review prior to
submission to all department heads.
• Completed the following audits (no report was issued):
Reconciliation for direct, ceded and net written premiums. Reconciliation of direct, ceded and net earned premiums. Reconciliation of direct, ceded and net paid loss. Reconciliation of direct, ceded and net incurred losses. Reconciliation of paid commissions.
In addition, Mr. Kelly was assigned the task of seeking and evaluating proposals from qualified
external vendors to perform COSO and SOC implementation and testing. PriceWaterhouse
Coopers and Sunera/IGF remain as finalist to fulfill this roll at Guarantee. Final selection is
expected by June 30, 2008 or shortly thereafter.
Disaster Recovery Plan
BHC reviewed a copy of the SunCoast Holdings, Inc. and Subsidiaries Business Recovery Plan,
dated January 15, 2008 (“the Disaster Plan”). The SunCoast Disaster Plan applies to Guarantee.
BHC reviewed the Disaster Plan and has requested documentation of the update of the Disaster
Plan which was scheduled in May 2008. The Company reports that the scheduled update did not
occur and that the Company was in negotiations with Presidio/Comlanta to provide a hard
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facility with hardware and software that can be used in the event the Company’s current network
and computer facilities in Lake Mary, Florida are compromised. Negotiations are expected to be
concluded by July 15, 2008 and implementation by August 31, 2008.
BHC considers the Company’s Disaster Plan to be in compliance with the Consent Order
#93640-07-CO in regards to the Disaster Recovery Plan.
2006 Deficiency or Adverse Finding: Cash, Short Term Investments and Receivable for Securities
The Company reported $781,000, which represented receivable for securities under cash and
short term investments and also reported $500 under cash, which represented an error by the
Company. We recommend the Company correctly report account balances on all future annual
and quarterly statement filings as required by Section 625.012(1), Florida Statutes and the NAIC
annual statement instructions.
BHC Findings:
BHC obtained the BDO cash and short-term investment work papers for the Company at
December 31, 2007. These consisted of bank reconciliations, bank and investment account
statements and confirmations. BHC reviewed the bank reconciliation for reasonableness, agreed
appropriate cash balances to the year-end bank and investment statements and agreed the
reconciled balances to the Company’s general ledger and the Company’s 2007 Annual
Statement. BHC noted that the errors identified by the examiners during the 2006 Examination
did not reoccur at December 31, 2007.
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One exception identified by BHC concerns the reporting of $5,645,834 held in a Class 1 money
market account at December 31, 2007. The Company included the balance in cash on Schedule
E of the 2007 Annual Statement when the funds should have been reported as a short-term
investment in Schedule DA. The Company maintains a sweep account with the Bank of
America. Excess funds are swept into a Columbia Money Market Reserves account daily.
(Columbia is identified as a Bank of America company on the sweep account bank statement.)
The Columbia Money Market fund is listed as a Class 1 money market fund in the NAIC SVO
manual. BHC has notified Company management of this reporting error.
Except for the reporting error regarding the money market account discussed above, BHC
considers the Company to be in compliance with Consent Order #93640-07-CO at
December 31, 2007 in regards to cash and short-term investment balances. BHC
recommends the Company follow the procedures for reporting cash and short-term
investments as documented in SSAP #2, the instructions to the annual statement and the
NAIC SVO manual.
2006 Deficiency or Adverse Finding: Aggregate Write-ins for Assets
The amount reported by the Company was increased due to unreported deductible recoverable,
the use of deposit accounting due to a reinsurance agreement which did not transfer risk and was
decreased by the incorrect amount reported for an affiliated promissory note. We recommend
the Company correctly report account balances under aggregate write-ins for assets on all future
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annual and quarterly statement filings as required by SSAP No. 62, SSAP No. 75 and the NAIC
annual statement instructions.
BHC Findings:
Following is a comparison of the Aggregate Write-ins for Assets at December 31, 2007
compared to the final Office examination balance.
2007 Annual Per Office Statement Examination
Pg. 2 Line
23 2006 Funds Held NCCI $ 55,915 $ 55,915 Accounts receivable other 41,136 239,666 Deductible recoverable 871,130 1,589,691 Suspense acct. paid losses 300,000 5,159 Deposit premium - 2,629,605 $ 1,268,181 $ 4,520,036
The most significant difference results from an adjustment in 2006 for a reinsurance agreement
that did not pass risk to the reinsurer and is more fully discussed in the Reinsurance section of
this report.
BHC reviewed the BDO detail work papers supporting the deductible recoverable balance and
agreed the total to the 2007 general ledger. BDO selected 11 individual employer balances for
detail testing and noted no exceptions.
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BHC asked the Company to explain the balance reported in and the purpose of the Suspense
Account-Paid Losses. The Company responded that the Suspense Account–Paid Losses (balance
$300,000 at 12/31/07) “is used to hold claim check timing differences when there is a timing
difference between the Fiserv transaction and the actual check issuance. In the case at hand
$300,000 of LAE expense checks due to Patriot (Patriot Risk Services, an affiliate) were released
in advance of the Fiserv transaction going through”. BHC’s review of the BDO audit work
papers indicate the Company advanced Patriot $300,000 during 2007 in a series of cash transfers
beginning in March 2007. BHC questions the admissibility of this asset at December 31, 2007.
Based on the review procedures performed, except for the $300,000 balance reported in
Suspense Account-Paid losses as discussed above, BHC concludes that the balance of
aggregate write-ins for assets is properly stated at December 31, 2007, and considers the
Company to be in compliance with Consent Order #93640-07-CO at December 31, 2007.
2006 Deficiency or Adverse Finding: Aggregate Write-ins for Liabilities
The amount reported by the Company for unearned ceding commissions was increased due to
calculation errors. We recommend the Company correctly report ceding commission balances
on all future annual and quarterly statement filings as required by SSAP No. 62 and the NAIC
annual statement instructions.
BHC Findings:
The aggregate write-ins for liabilities totaled $1,787,901 at December 31, 2007 and consisted of
the unearned ceding commission for the Company’s treaty business and alternative market
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business. BHC has reviewed and tested BDO’s work papers supporting the unearned ceding
commission for the treaty business. BHC was able to reproduce this calculation without
exception using the appropriate ceded premium, ceded unearned premium and ceded commission
rates.
BHC also reviewed the BDO work papers supporting the unearned ceding commission for the
alternative market business. BDO calculated the unearned ceding commission using reinsurance
commission rates it obtained from various segregated cell reinsurance agreements and compared
its calculation to the Company’s calculation. BDO’s calculation methods appear proper and
resulted in a ceded unearned commission for the alternative market business that is $17,113
lower than the Company’s calculation. BDO passed on this audit adjustment due to
immateriality. BHC concurs with this judgment. However, the difference noted by BDO results
from the ceding commission rates used by BDO differing from the rates used by Guarantee.
Although the differing ceding commission rates could result in errors in calculating the
individual cell’s funds withheld balances, BHC believes the calculated balances are
generally correct in total. BHC considers the Company to be in compliance with Consent
Order 93640-07-CO at December 31, 2007 in regards to aggregate write-ins for liabilities.
2006 Deficiency or Adverse Finding: Uncollected and Deferred Premium
Uncollected and deferred premium were increased due to detail reconciliation items not recorded
in the general ledger. We recommend the Company correctly report account balances on all
future annual and quarterly statement filings as required by SSAP No. 6 and the NAIC annual
statement instructions.
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BHC Findings:
BHC reviewed the December 31, 2006 Examination work papers, noting that the Examiners
made adjustments to three individual sub-accounts of the Company’s uncollected and deferred
premium balance. Those sub-accounts and each corresponding December 31, 2007 balance in
those sub-accounts are as follows:
The deficiencies and adverse findings identified in the 2006 Examination were due to different
problems within each sub-account. Therefore, BHC’s testing at December 31, 2007 is by sub-
account individually.
Premium Receivable
The adjustment to premium receivable identified during the 2006 Examination resulted from the
Company’s general ledger balance being less than the supporting documentation. The Company
acknowledged the difference in 2006 and represented that the Company did not make an
adjustment to the general ledger and considered that the assets reported in the financial
statements were conservative.
BHC obtained and reviewed the Company’s premium receivable reconciliation schedule at
December 31, 2007 which reconciled the balances between the premium receivable general
ledger account and various FiServ reports. BHC obtained and reviewed the audit work papers of
General Ledger Sub-Account 12/31/07 Balance,
Per Company Premium Receivable $30,810,403
EBUB Premium Receivable $ 5,573,091
Premium Receivable - Nonadmitted $ (751,445)
25
BDO, which included copies of the FiServ reports as of December 31, 2007. BDO tested the
FiServ reports by verifying totals, selecting a sample of premium receivable accounts for
attribute testing, verifying cash received, and confirming a sample of individual PEO account
balances without exception. BHC reviewed and tested the BDO work papers, and the FiServ
reports, noting that the totals appeared to be calculated correctly and agreed to the premium
reconciliation schedule. BHC agreed the premium receivable balance on the reconciliation
schedule to the December 31, 2007 general ledger. BHC proposes no adjustment to the Premium
Receivable Balance as of December 31, 2007.
EBUB Premium Receivable
The adjustment to the “earned but unbilled (“EBUB”) premium receivable” identified during the
2006 Examination was due to errors in the underlying premium amounts that are part of the
calculation of EBUB.
BHC reviewed SSAP No. 53, noting the following:
“Reporting entities shall estimate audit premiums, the amount generally referred to as
earned but unbilled (EBUB) premium, and shall record the amounts as an adjustment to
premium, either through written premium or as an adjustment to earned premium. The
estimate for EBUB may be determined using actuarially or statistically supported
aggregate calculations using historical company unearned premium data, or per policy
calculation.”
In accordance with SSAP No. 53, the Company reports EBUB premium as an adjustment to
earned premium, and calculates EBUB using per policy data.
26
BHC obtained and reviewed the audit work papers of BDO, which included copies of FiServ
reports as of December 31, 2007. BDO obtained the earned premium totals from the FiServ
reports, calculated EBUB using a rate of 10% of earned premium, and reduced the resulting
amount by reinsurance ceded. BDO further tested the reasonableness of the 10% EBUB rate
based on documentation provided by the Company, and determined this percentage to be
reasonable. BHC reviewed and tested the BDO work papers, the FiServ reports, calculation
methods used by the Company and the EBUB rate. BHC proposes no adjustment to the EBUB
premium receivable at December 31, 2007.
Premium Receivable – Nonadmitted
The adjustment to “premium receivable – nonadmitted” identified during the 2006 Examination
was due to differences between the general ledger and FiServ Reports.
BHC obtained premium receivable aging reports from the Company identifying premium and
deductible balances that were over 90 days past due. These reports consisted of data from the
FiServ system and the Company’s summary of that data by PEO groups. Using ACL, BHC
verified the calculation of the total premiums due to the Company’s total. BHC tested the Fiserv
reports and agreed the balances over 90 days old to the summary sheet. BHC agreed the
premium receivable-nonadmitted balance at December 31, 2007 to Guarantee’s 2007 Annual
Statement.
BDO performed testing of the premium receivable balance, noting that the PEO balances over 90
days past due mainly consist of non-renewals in cancellation, that are offset by funds withheld
and collateral, essentially reducing over 90 day past due balances to zero.
27
BDO posted an audit adjustment to increase the balance in the premium receivable –
nonadmitted general ledger account by $446,656, which BHC has reviewed and accepted. BHC
proposes no additional adjustments to the premium receivable-nonadmitted balance at December
31, 2007.
Except for the increase to the premium receivable-nonadmitted balance at December 31,
2007, posted by BDO and accepted by BHC, BHC considers the Company to be in
compliance with Consent Order #93640-07-CO at December 31, 2007 in regards to
uncollected and deferred premium.
2006 Deficiency or Adverse Finding: Current Federal Income Tax Recoverable and Net Deferred Tax Asset
The amounts reported by the Company were decreased due to an understatement in income tax
provision. We recommend the Company correctly report account balances on all future annual
and quarterly statement filings as required by SSAP No. 10, SSAP No. 25 and the NAIC annual
statement instructions.
BHC Findings:
BHC obtained and reviewed the BDO audit work papers for current and deferred federal income
taxes. The calculation of the current year federal income tax provision appeared proper and
agreed to the amount reported in the Company’s 2007 Annual Statement. However, BHC was
unable to verify the current federal income tax recoverable of $27,095 reported in the
Company’s 2007 Annual Statement. BHC’s reconciliation of current income taxes resulted in a
current federal income tax liability of $66,808. The Company management has reviewed BHC’s
28
calculation and agrees with these findings. An adjustment to current federal income taxes
recoverable/payable of $93,903 is reflected in the examination financial statements.
The calculation of the net deferred tax asset of $2,087,624 appeared proper and agreed to the
amount reported in the Company’s 2007 Annual Statement.
During our examination, BHC identified the following errors or irregularities.
• In June 2007 the Company made an $850,000 federal estimated income tax payment. In
September and October it appears the Company was reimbursed $400,000 from SunCoast
Holding and $32,373 from Patriot Risk Service, respectively. These transactions are
reflected in the current income tax reconciliation discussed above and indicate that the
Company advanced funds on behalf of other members of the affiliated tax group in
violation of terms of the Tax Allocation Agreement.
• Based on the results of our procedures, BHC concludes that the Company is not in
compliance with Consent Order #93640-07-CO at December 31, 2007 in regard to
Current Federal Income Tax Recoverable. BHC concludes that the Company is in
compliance with Consent Order #93640-07-CO at December 31, 2007 in regard to
the Net Deferred Tax Asset.
2006 Deficiency or Adverse Finding: Receivable from Parent, Subsidiaries and Affiliates
(PSA)
29
The receivable from PSA was decreased due to improper reporting for this line item and amounts
over 90 days old. We recommend the Company correctly report receivable from PSA, federal
income tax receivable and the reinsurance transactions account balances on all future annual and
quarterly statement filings as required by Section 625.013(8), Florida Statutes, which does not
allow federal income tax refunds when a refund is not assured. According to NAIC annual
statement instructions, amounts related to intercompany reinsurance transactions were to be
excluded from the receivables from PSA. The Company should report reinsurance between
affiliated companies through the appropriate reinsurance accounts.
BHC Findings:
The balances due to/from PSA at December 31, 2007 are presented below:
Due to (from): Suncoast Holdings $ (49,412) Patriot Re International 120 Patriot Risk 32,751 Patriot Insurance Management 52
$ (16,489)
BHC has reviewed the detail activity recorded in the inter-company accounts during 2007 and
noted that the errors identified in the Office’s 2006 examination regarding federal income taxes,
reinsurance and balances over 90 days were corrected in 2007. BHC considers the Company
to be in compliance with Consent Order #93640-07-CO at December 31, 2007 with respect
to the exceptions identified in the 2006 examination.
The Company has a number of service agreements with affiliated companies. These include the
following:
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• Management Services Agreement with SunCoast Holdings effective January 1, 2004.
• Expense Reimbursement Agreement with Patriot Risk Management effective January 1,
2006.
• Managed Care Services Agreement with Patriot Risk Services effective January 1, 2006.
• Producer Agreement with Patriot Risk Services effective January 1, 2006.
• Reinsurance Brokerage Agreement with Patriot Re International effective January 1,
2006.
The Company has represented to BHC that the inter-company accounts are used when one
company pays expenses for other companies since some bills are processed for the consolidated
SunCoast group. These accounts are settled monthly within thirty (30) days of the end of the
month. BHC’s review of the inter-company account activity reasonably confirms this process.
The Company also represented to BHC that accounting for the various service agreements listed
above do not go through the inter-company accounts but are set up on Patriot’s books as
receivables and on the Company’s books as expenses and accruals. During BHC’s review of the
BDO audit work papers, BHC identified certain Patriot work paper schedules that noted
receivables being due from the Company at December 31, 2007. This includes $319,977 for bill
review service and $416,000 for on-site case management. It appears these balances have
accumulated during 2007 and are not just the December 2007 activity between the companies.
BHC asked the Company to demonstrate where the off setting liabilities are recorded in the
Company’s general ledger at December 31, 2007. The Company responded “the offsetting
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liabilities are all in individual case LAE reserves which may included other non-intercompany
LAE expense costs as well. Without looking at the entire inventory of individual claim file
reserves, we can not identify just the intercompany items”. Based on this response, BHC is
unable to verify if the intercompany liabilities discussed above have been accrued by the
Company at December 31, 2007.
BHC also identified an account titled Suspense Account-Paid Losses on the Company’s general
ledger with a balance of $300,000 at December 31, 2007. BHC believes this represents an
advance to Patriot for case management service. This account is included in Aggregate Write Ins
for Assets in the 2007 annual statement and is more fully addressed in the Aggregate Write Ins
for Assets section of this report.
2006 Deficiency or Adverse Finding: Losses and Loss Adjustment Expense (“LAE”)
The amount reported by the Company was unchanged. We recommend that the Company
strengthen reserves by booking amounts closer to the mid range rather than the low end of
the range of reasonable estimates.
BHC Findings:
BHC obtained and reviewed the Actuarial Opinion Summary (Revised) for the Company at
December 31, 2007, which was dated April 18, 2008. The Actuarial Opinion indicated the
following:
32
Net Reserves (000s) Low Mid High
Actuary's range of estimates $22,775 $27,836
Actuary's mid-range estimate $25,305
Guarantee's carried reserve 25,478 * 25,478 * 25,478 *
Difference between Guarantee's carried reserve and actuary's point estimate $2,703 $173 ($2,358)
*per Guarantee’s Annual Statement dated December 31, 2007.
At December 31, 2007, the Company has recorded reserves for loss and LAE in the amount of
$25,478,000 which is $173,000 above the actuary’s mid range estimate. BHC considers the
Company to be in compliance with Consent Order #93640-07-CO at December 31, 2007
regarding the recording of actuarial estimates for losses and LAE.
2006 Deficiency or Adverse Finding: Commissions Payable
The amount reported by the Company was increased due to the understatement of the
commission accrual. We recommend the Company correctly report commissions payable
on all future annual and quarterly statement filings as required by SSAP No. 5, SSAP No.
53 and the NAIC annual statement instructions.
BHC Findings:
The Company informed BHC that it is their practice to accrue commissions by applying an
average effective commission rate to the year-to-date written premium by category of business.
The Company noted that since commission payments made in the following month are based on
collected premium and not written premium, the total commission payable balance at any given
33
time is normally greater than the payments made in the month following the expense accrual.
BHC tested this assertion by reviewing supporting documentation for commission payments on
treaty and alternative market business in January 2008. Total commissions paid by the Company
in January 2008 equaled approximately $763,000, which was less than the December 31, 2007
Accrued Agents Commissions Payable balance of $1,664,000. The difference is apparently due
to the commission accrual being estimated based on written premium and the commission
payments being paid on collected premiums. However, it appears that the January 2008 payment
amount may not include all alternative market commission payments. If so, the December 31,
2007 commission payable may be understated.
BHC reviewed the Company’s general ledger as of December 31, 2007, noting that the
premiums, commissions, and other related accounts are recorded on a year-to-date basis at the
end of each month, with a reversal of this entry recorded at the beginning of the next month.
BHC reviewed the activity and the month-ending balances in the Accrued Agents Commissions
Payable general ledger account, and noted that the month-ending balances prior to June 30, 2007
appeared unusual and inconsistent, as noted in the following table:
Month Balance at month end DR (CR)
1/31/2007 $225,459.45 2/28/2007 $693,769.53 3/31/2007 ($1,829,942.55)4/30/2007 $1,554,728.18 5/31/2007 $2,003,670.65 6/30/2007 ($1,724,652.10)7/31/2007 ($1,944,375.88)8/31/2007 ($2,767,327.58)9/30/2007 ($2,564,835.06)10/31/2007 ($2,364,600.36)11/30/2007 ($1,736,984.61)12/31/2007 ($1,664,116.78)
34
BHC’s inquired of the Company’s Controller about the inconsistent balances, and the Controller
informed BHC that the Company did not properly close month-end balances in the Accrued
Agents Commissions Payable general ledger account from January through May 2007, except
for March 2007, which was corrected for quarterly reporting. The Controller further explained to
BHC that there was a cancellation and reissuance of a large policy for a short period of time
during August 2007, which led to a significant increase in the August 2007 month-ending
balance.
BHC also obtained and reviewed the audit work papers of BDO for commissions payable. BDO
performed a roll forward of the December 31, 2006 balance to December 31, 2007 and BDO
then selected two months in 2007 for detail testing of the payment activity in the account, and
obtained supporting documentation including (1) a schedule indicating how the commission was
calculated, (2) the invoice for the amount due, and, (3) a copy of the bank statement and a copy
of the check or wire transfer notification. BDO noted no discrepancies, or audit adjustments, and
concluded that commissions payable appears to be properly stated as of December 31, 2007.
BHC reviewed and tested BDO’s audit work papers as considered necessary and determined the
BDO procedures to be reasonably sufficient. BHC noted that the commissions payable account
in Guarantee’s 2007 Audited Statutory Financial Statements with the amount per Guarantee’s
December 31, 2007 general ledger and the amount per Guarantee’s 2007 Annual Statement.
BHC concludes that commissions payable is fairly stated at December 31, 2007, and
considers the Company to be in compliance with Consent Order #93640-07-CO at
December 31, 2007.
35
2006 Deficiency or Adverse Finding: Other Expenses
The amount reported by the Company was decreased due to reclassification to the appropriate
annual statement lines. We recommend the Company correctly report other expenses balances
on all future annual and quarterly statement filings as required by SSAP No. 35 and the NAIC
annual statement instructions.
BHC Findings:
BHC obtained and reviewed the work papers presented to BHC by the Company and the BDO
audit work papers for other expenses payable. This liability consists primarily of accounts
payable and accrued expenses. Based on the procedures performed, BHC presents the
adjustments summarized below which are included in the examination financial statements.
Other Expenses Payable As reported
$ 679,225
Adjustments: Accrue 2007 salary bonus 125,100 Over accrual 12/31/07 payroll (29,826) Expense reins. cell license fee 64,284 Reclassify intercompany fees (94,033) Reclassify examination fees (100,000) Corrected balance $ 644,750
• At December 31, 2007, the Company failed to accrue $125,100 in 2007 bonuses which
were paid out in March 2008 per BDO’s review of the ADP payroll report.
• At December 31, 2007, the Company over accrued salary by $29,826. BHC verified this
adjustment by reviewing the ADP payroll report.
36
• During 2007, the payment of $64,284 for a reinsurance segregated cell license fee was
processed through a liability account and not properly expensed. The Company concurs
with this adjustment and agreed to make this adjustment in its quarterly statement. BHC
has included this adjustment in the examination financial statements.
• After making the $64,284 adjustment discussed above, the balance in an account titled
Accrued Management Fee was $94,033. This liability represents management fees due
Patriot Risk Services, an affiliate. BHC tested this liability balance for reasonableness
and now proposes to reclassify this balance to amounts payable to parent,
subsidiaries and affiliates on the examination balance sheet.
• The Company included $100,000 in accrued expenses for examination fees at December
31, 2007. BHC proposes reclassifying this liability to taxes, licenses and fees in
accordance with the annual statement instructions.
Although the sum of the adjustments identified above is immaterial to the Company’s
overall financial position, BHC concludes that the Company is not in compliance with
Consent Order #93640-07-CO at December 31, 2007 in regard to Other Expenses
Payable due to the Company’s failure to properly account for and report liability
balances.
2006 Deficiency or Adverse Finding: Taxes, Licenses & Fees
The amount reported by the Company was increased due to under accrued liabilities. We
recommend the Company correctly report taxes, licenses & fees balances on all future
37
annual and quarterly statement filings as required by SSAP No. 5, SSAP No. 35, SSAP No.
53 and the NAIC annual statement instructions.
BHC Findings:
BHC obtained and reviewed the BDO audit work papers for taxes, licenses and fees. BDO’s
work papers included evidence that BDO reviewed and tested the annual expense calculations
for premium taxes, second injury fund assessments, workers compensation assessments and
guaranty fund assessments. BDO also reviewed the payments made to various states and tax
authorities to verify that the December 31, 2007 liability for taxes licenses and fees was fairly
stated. BHC’s examination work in this area included:
• Reviewing the 2007 premium tax returns for the states of Arkansas, Florida and Missouri
to verify the 2007 premium tax expense and the December 31, 2007 tax liability for these
states was fairly stated.
• Verifying the premium tax rate, second injury fund assessment rate and the worker
compensation assessment rate used in Guarantee’s calculations to independent third-party
documentation for various states.
• Verifying tax and assessment payments to copies of checks and wire transfers for
selected states to verify the liability for taxes, licenses and fees was fairly stated at
December 31, 2007.
During the course of this examination, BHC noted that the Company accrued $100,000 for
examination expenses at December 31, 2007. This liability was included as Other Expenses
on Page 3, Line 5 of the 2007 Annual Statement. This classification is not in accordance
38
with the annual statement instructions which require examination fees to be included in taxes,
licenses and fees in the annual statement. BHC has reclassified this liability to taxes,
licenses and fees in the examination balance sheet.
The Company did not properly accrue for the State of Florida corporate/franchise tax at
December 31, 2007. BHC estimates the state corporate/franchise tax for 2007 should be
approximately $107,139. The Company has represented that it made an estimated tax payment
of $68,900 (which was expensed) for tax year 2007. This would indicate the tax accrual at
December 31, 2007 is understated by $38,239. Company management concurs with BHC’s
findings. An adjustment for state income taxes of $38,239 is reflected in the examination
financial statements.
In October 2007 the Company paid $202,189 to the State of Florida for the Florida
corporate/franchise tax for tax year 2006. Based on BHC’s review of the Company’s 2006
taxable income this payment appears to be overstated by $163,954. BHC reviewed this finding
with the Company management who agreed that the 2006 payment represented a tax payment for
the entire tax group. An adjustment for $163,954 to reduce state tax expense and establish a
receivable from parent is reflected in the examination financial statements. BHC has non-
admitted this receivable balance in the examination financial statements. The payment of
$202,189 for the 2006 Florida corporate/franchise tax includes funds advanced by the Company
on behalf of other members of the affiliated tax group in violation of the terms of the Tax
Allocation Agreement.
39
Based on the results of our procedures, BHC concludes that the Company is not in
compliance with Consent Order #93640-07-CD at December 31, 2007 regarding the
accounting and reporting of taxes, licenses and fees.
Included in the liability for taxes, licenses and fees at December 31, 2007 is a $2,021,301
liability for Policy Fees Pass-Through Payable. BHC requested the Company to provide
documentation to support this liability, explain the Company’s method for billing and collecting
of the fees, provide documentation granting the Company authority to pass these fees on to
policyholders and demonstrate how and when these fees are paid to the taxing authority.
The Company was unable to provide supporting detail for this account.
In a conference call on July 8, 2008 the Company management explained that this liability
represented various state worker compensation taxes and assessments collected from
policyholders. Management further explained that the large increase in this liability ($157,976 at
December 31, 2006 to $2,021,301 at December 31, 2007) results from the states being slow to
send out the tax and assessment billing notices.
In an email from Mr. Ted Bryant dated July 15, 2008, the Company explained that the tax and
assessment pass-through primarily relate to the states of New York, New Jersey, Missouri and
Indiana. Mr. Bryant provided documentation from the NCCI for each of these states which
described the Company’s right to charge and collect various taxes and assessments directly from
policyholders.
40
BHC is concerned with the Company inability to control and reconcile this account and
recommends the Office consider reviewing the billing and collection of taxes and
assessments from policyholders during the next market conduct examination.
2006 Deficiency or Adverse Finding: Unearned Premium
The amount reported by the Company was increased due to errors in calculation, which resulted
in an overstatement and was due to reserve credit taken for reinsurance with no risk transfer. We
recommend that the Company correctly report unearned premium on all future annual
and quarterly statement filings as required by SSAP No. 53, SSAP No. 62, SSAP No. 75 and
the NAIC annual statement instructions.
BHC Findings:
BHC reviewed the December 31, 2006 Examination work papers, noting that the Office
Examiners made adjustments to four individual sub-accounts of the Company’s unearned
premium liability balance. Those sub-accounts and each corresponding December 31, 2007
balance in those sub-accounts are as follows:
The Company utilizes a Calendar Earned / Unearned (“CEU”) Report for tracking unearned
premiums, as well as inception-to-date, year-to-date, and month-to-date written and earned
General Ledger Sub-Account 12/31/07 Balance,
Per Company Unearned Premiums – Treaty Business $ (24,671,863)
Unearned Premiums - Alternative Market Business (4,149,159)
Ceded Unearned Premiums – Alternative Market (Quota Share) 3,178,749
Ceded Unearned Premiums - Treaty (Excess of Loss) $ 1,205,878
41
premiums for treaty and alternative market business. The CEU Report contains policy-level
detail in an Excel format and is a download from the FiServ system. Totals from the CEU report
are used in some capacity for testing of each of the four identified sub-accounts, so BHC
reviewed BDO’s work papers documenting BDO’s testing of the CEU Report.
BHC obtained and reviewed the audit work papers of BDO, which included a copy of the CEU
report as of December 31, 2007. BDO tested the CEU report by selecting a sample of premium
accounts from the report for attribute testing. BDO concluded that the amounts per the CEU
report agree to the FiServ system.
Unearned Premiums – Treaty Business and Unearned Premiums – Alternative Market Business
The adjustments to the “unearned premiums – treaty business” liability and the “unearned
premiums – alternative market business” liability identified during the 2006 Examination were
each comprised of the following two components:
1. The general ledger balance at December 31, 2006 was greater than the total balance for
treaty business as reported on Guarantee’s CEU Report. The Examiners posted an
adjustment to reduce the December 31, 2006 general ledger balance to equal the
CEU Report balance.
2. Negative unearned premiums appeared on the CEU Report due to errors generated in the
FiServ system, primarily because of the method that the FiServ system uses to process
the cancellations of self reporting accounts. The Examiners posted an adjustment to
42
increase the December 31, 2006 general ledger account balance by the amount of the
negative unearned premium balance.
BHC obtained and reviewed the Company’s CEU report for the period ending December 31,
2007. Using Audit Command Language (“ACL”) software, BHC summarized the unearned
premiums by type of business (treaty and alternative market), noting that the total unearned
premium for the treaty business and the alternative market business agreed to the corresponding
account balances in the Company’s December 31, 2007 general ledger. BHC proposes no
adjustment to the unearned premium – treaty business or the unearned premium –
alternative market business general ledger accounts as of December 31, 2007.
Using ACL, BHC identified 44 policies in the CEU report with negative unearned premium.
Thirty-nine of the policies had a negative unearned premium of 50 cents or less, which the
Company has explained as a rounding issue with FiServ. The remaining five policies had
negative unearned premium totaling $10,097 for treaty business. The Company has informed
BHC that negative unearned premiums should never occur. The Company researched the
negative unearned premiums and informed BHC that the problems were due to clerical data input
errors on transaction dates for three policy cancellation transactions, and two policy endorsement
transactions. Using the incorrect dates, the Fiserv system reduced the remaining unearned
premium by more than the actual balance. The Company informed BHC that they contacted
FiServ, who committed to placing an edit in their software to prevent this type of error from
occurring in the future. The Company informed BHC that Guarantee will monitor the CEU
Report on a weekly basis for negative unearned premiums.
43
BHC proposes no adjustment to the unearned premium – alternative market business
general ledger account as of December 31, 2007, and an adjustment to increase the balance
of the unearned premium – treaty business general ledger account as of December 31, 2007
by $10,097.
Ceded Unearned Premiums – Alternative Market (Quota Share)
The adjustment to the “ceded unearned premiums – alternative market (quota share)” liability
identified during the 2006 Examination was due to an error in the unearned premium –
alternative market balance compared to the CEU report, discussed above. An error in the direct
unearned premium – alternative market general ledger account balance would create an error in
the ceded unearned premium – alternative market general ledger account balance, as the ceded
unearned premium amount is generated by multiplying the direct unearned premium amount by
reinsurance percentages.
BHC’s exam procedures indicated that the unearned premiums – alternative market
balance as of December 31, 2007, was materially correct. Therefore, the ceded unearned
premiums – alternative market account balance would be materially correct as of
December 31, 2007.
BHC reviewed a calculation of the Company’s ceded unearned premium – alternative
market balance as of December 31, 2007 in the amount of $3,178,749, noting no exceptions.
44
Ceded Unearned Premiums – Treaty Business (Excess of Loss)
The adjustment to the “ceded unearned premiums – treaty business (excess of loss)” liability
identified during the 2006 Examination was due to improper reserve credits taken for a
reinsurance agreement that the Examiners determined did not transfer risk. A discussion of
reinsurance risk transfer testing is contained in the Reinsurance section of this report.
BHC obtained and reviewed a work paper that calculated the Company’s ceded unearned
premium treaty business balance of $1,205,878, as of December 31, 2007. BHC tested the ceded
unearned premium balance using the written and unearned premiums (tested previously by BHC
using ACL analysis) and the ceded premium reinsurance rates (BHC agreed these rates to the
reinsurance agreements) noting no exceptions.
Except for the negative unearned premiums discussed above, BHC considers the Company
to be in compliance with Consent Order #93640-07-CO at December 31, 2007 in regards to
unearned premium and ceded unearned premium.
2006 Deficiency or Adverse Finding: Reinsurance Risk Transfer
An adequate analysis of risk transfer was not identified in the documents provided for the
examination in 5 reinsurance agreements:
BHC 2007 Findings:
BHC Risk Transfer Testing Review
45
BHC identified each reinsurer assuming premium from the Company in 2007 as reported in the
2007 Annual Statement, Schedule F Part 3, Ceded Reinsurance. The Company ceded treaty and
alternative market business under 32 separate reinsurance agreements consisting of both quota
share and excess of loss agreements. BHC received and reviewed the reinsurance agreements and
risk transfer analysis for each of these contracts.
The Company’s independent auditors, BDO, engaged Pinnacle Actuarial Services (“Pinnacle”) at
year end 2006 and 2007 to perform risk transfer testing on selected reinsurance agreements. The
Company also performed in-house risk transfer testing for certain reinsurance agreements not
tested by Pinnacle as discussed below. BHC’s review of the Pinnacle risk transfer reports noted
that Pinnacle used the Expected Reinsurer Deficit (“ERD”) method. Certain reinsurance
agreements were written on a fiscal year and continuous basis in a prior period and remained
effective in 2007. The risk transfer testing for these agreements was performed in the appropriate
prior period as noted in the discussion below.
Treaty Market Business:
The Company ceded treaty market business under four reinsurance agreements during 2007. This
consisted of both quota share and excess of loss ($4 million xs $1 million) agreements. Pinnacle
performed risk transfer testing on three of these agreements at either year end 2006 or 2007 and
concluded that all three agreements passed risk to the reinsurer using the ERD method.
At year end 2006, BDO concluded risk transfer was self evident for one excess of loss agreement
and an actuarial analysis was not necessary.
46
Alternative Market Business: The Company ceded alternative market business under 26 reinsurance agreements consisting of
both quota share and excess of loss ($4 million xs $1 million) agreements. Pinnacle performed
risk transfer testing on 12 of these agreements at either year end 2006 or 2007 and concluded that
11 of these agreements passed risk to the reinsurer using the ERD method.
At year end 2006, Pinnacle determined a $4 million xs $1 million reinsurance agreement with
National Indemnity Insurance Company (“National Indemnity”) did not pass risk to the
reinsurer. The Company cancelled and commuted this agreement in 2007. The Company
entered into a new replacement agreement effective May 1, 2007. This new agreement was tested
by Pinnacle as part of the 12 agreements noted above using the ERD method.
The Company performed in-house risk transfer testing for five quota share reinsurance
agreements with effective dates in 2007. The Company concluded that each agreement passed
risk to the reinsurer. Six (6) reinsurance agreements effective prior to 2006 were tested in-house
by Guarantee for risk transfer. The Company concluded that these agreements passed risk to the
reinsurer. BHC obtained and reviewed the test calculations for these agreements and concluded
that these calculations are relatively simplistic and utilized only one simulation. BHC suggests
that the Company use multiple simulations in the future for in-house risk transfer analysis.
BHC did not review risk transfer for three reinsurance agreements with 2007 negative premium
totaling $62,009.
47
Treaty and Alternative Market Business:
The Company executed two excess of loss reinsurance agreements to protect itself from large
losses in the treaty and alternative markets. These included a $5 million xs $5 million agreement
and a $10 million xs $10 million agreement. Pinnacle performed risk transfer testing on each of
these agreements at year end 2007 and concluded that both agreements passed risk to the
reinsurer(s) using the ERD method.
As noted above, Pinnacle utilized the ERD method to test the risk transfer of certain reinsurance
treaties. BHC informed the Office that the ERD method was being used and the Office
instructed BHC to request the Company to provide risk transfer calculations using the 10/10 rule
which BHC requested on June 11, 2008. Subsequently, Pinnacle was requested by the Company
to perform new risk transfer calculations using the “10/10” Rule. The 10/10 Rule is a guideline,
that uses as the threshold for adequate risk transfer to qualify for reinsurance accounting, the
condition that the reinsurer should have at least a 10% probability of sustaining at least a 10%
loss on a reinsurance contract. The 10/10 Rule analysis is to be performed using the present
value of the cash flows for ceded premiums, ceded losses and LAE and ceding commissions.
The reinsurance contracts for which Pinnacle prepared detailed risk transfer analyses were
primarily Alternative Market quota share treaties (typically 90% quota share) which had loss
ratio caps on the losses ceded under the quota share, for the residual business not covered by the
primary quota share. These contracts also typically provided aggregate loss coverage above a
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specified attachment point, and with a limit based on a percent of gross premium, The ceded
premium was the quota share of the direct premium.
Following is our understanding of the operations of these reinsurance contracts, using SP 110 as
an example. The reinsurance treaty for SP 110 specified a 90% quota share with a loss ratio cap
of 87.5% for the 90% quota share. The remaining 10% of the subject business had aggregate
loss coverage for losses in excess of 67.5% with a maximum not to exceed 2% of annual gross
premium. The ceded premium was based on the 90% quota share and there was a 32.5% ceding
commission. If SP 110 had $1 million of direct premium, the quota share ceded premium would
be $900,000 and the ceding commission would be $292,500. Under the quota share agreement
the Company could recover losses at 90% of direct losses up to a limit of $787,500. For the
aggregate loss cover for the residual 10%, the Company could recover losses above the 67.5%
attachment point ($67,500), such recoveries limited to $20,000 (2% of annual direct premium).
The following is a summary of the contract parameters for the Alternative Market reinsurance treaties reviewed:
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Contract Parameters Quota Share Aggregate Loss Cover
Reinsurance Treaty
Treaty
Effective Date
Quota Share
%
Loss Ratio Cap
Quota Share
%
Loss Attachment
(Loss Ratio)
Limit % of AGP
Ceding Commission
Preferred Commercial
12/1/2006
80%
79%
46%
SP 104 12/15/2004 90% 100% 10% 55% 5% 45% SP 113 1/20/2005 90% 100% 10% 50% 5% 50% SP 117 2/15/2005 90% 105% 10% 55% 5% 45% SP 122 for PES 1/1/2006 90% 82% 10% 52% 3% 52% SP 122 for I-Core 1/1/2006 90% 82% 10% 52% 3% 47% SP 123 4/1/2005 90% 100% 10% 51% 4.9% 49% SP 125 1/1/2006 90% 100% 10% 50% 5% 50% SP 132 8/15/2007 90% 107% 10% 51% 5.6% 49% SP 110 1/1/2006 90% 87.5% 10% 67.5% 2% 32.5%
In performing the 10/10 risk transfer analyses Pinnacle utilized the same simulation model that
had been used for the ERD analysis. Pinnacle performed 10,000 simulations for each treaty.
Pinnacle assumed lognormal distribution of losses and assumed a mean loss ratio of 60%.
Pinnacle also used a standard deviation of 180% and a Coefficient of Variation of 3.0. BHC was
advised by Derek Freihaut of Pinnacle that the results of the simulations indicated that for each
of the treaties the 90th percentile direct loss ratio was approximately 130% to 135%. Therefore,
Pinnacles’ simulations indicate that there is a 10% probability that the direct loss ratio will
exceed 130% to 135%. For purposes of this analysis BHC used 130% as the Pinnacle threshold
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90th percentile loss ratio. Because Pinnacle used the same mean loss ratio and standard deviation
this 130% threshold would be applicable for all the alternative market treaties tested.
Because the Company contracts include loss ratio caps, the reinsurer’s loss maxes out well below
the 10% probable loss ratio. For each of the contracts BHC calculated the direct loss ratio that
results in a 10% present value loss to the reinsurer. BHC also determined the reinsurers p/v loss
at the direct loss ratio corresponding to the loss ratio cap in the reinsurance treaty. This
maximum reinsurer p/v loss also remains constant for all direct loss ratios above that point.
Reinsurance Treaty
Direct Loss Ratio that results in Reinsurer 10% loss
(Discounted)
Maximum Reinsurer Loss (P/V)
Direct Loss
Ratio for Maximum Reinsurer
Loss
Pinnacle Direct Loss
Ratio at 10% Probability
Pinnacle Reinsurer
NPV Loss at 10%
Probability1 Preferred Commercial
73.6%
-15.1%
79%
130%
-12.3%
SP 104 69.9% -45.1% 105% 13% -46.2% SP 117 69.7% -48.4% 105% 130% -44.9% Sp 122 for PES
62.7%
-29.2%
82%
130%
-27%
SP 122 for I-Core
67.7%
-24.3%
82%
130%
-22%
SP 123 67.6% -41.1% 100% 130% -37.5% SP 125 64.5% -45.3% 100% 130% -42.6% SP 132 69% -45.6% 107% 130% -36.7% SP 110 86.6% -10.9% 88% 130% -10.9%
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1 The percents in the column for all contracts except SP 110 are understated by 200 to 300
basis points. See discussion below.
From the preceding table it is apparent that for all of the reinsurance treaties reviewed, the direct
loss ratio that results in a 10% p/v loss to the reinsurer is well below the 90th percentile direct
loss ratio. The reinsurer’s loss at the 90th percentile loss ratio is greater than 10% for all of the
treaties, thus indicating that the 10/10 test was met.
Pinnacle’s initial submission related to the 10/10 test for reinsurance treaty SP 110 indicated a
7.7% reinsurance p/v loss at the 10% probable loss ratio – thus indicating that the 10/10 test was
not achieved. During BHC’s review it was determined that Pinnacle had used a discount rate for
the discounting of the payout of losses that was off by one duration. When this error was
corrected by Pinnacle the revised analysis for SP 110 indicated that the 10/10 guideline test had
been achieved.
Because of the discounting error the “Pinnacle Reinsurer P/V Loss at 10% Probability” values
for all treaties except SP 110 are understated by an order of the magnitude of 200 to 300 basis
points. Pinnacle has provided corrected schedules for only SP 110, however, BHC believes that
the discounting error does not change the conclusion as to the 10/10 Rule results for the other
treaties..
In reviewing the assumption used by Pinnacle, BHC is concerned that the assumed 60% mean
loss and ALAE ratio is unreasonably low and that the use of a standard deviation of 180% is
unreasonably high. For comparison purposes, BHC reviewed the U.S. Property and Casualty
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Insurance Industry Experience for Workers Compensation Insurance as published in Best’s
Aggregates and Averages (Best). The combined U. S. Industry experience from the 2004, 2005
and 2006 Combined Workers Comp Annual Statement Schedule Ps, according to Best, is as
follows:
Year of Annual Statement 2006 2005 2004
Lookback Period 1997-2006 1996-2005 1995-2004
Mean Loss and ALAE Ratio 81.9% 81.9% 80.1%
Standard Deviation of Loss &
ALAE Ratio 17.6% 15.7% 14.7%
Z Factor 1.282 1.282 1.282
10% Probable Loss and ALAE Ratio 104.5% 102% 98.9%
(Z Factor is the statistical factor for X Standard Deviation from the Mean at 90th percentile for a
normal distribution).
The Company is a relatively young company that writes, by the Company’s own admission, a
riskier clientele. Since the Company has limited loss experience it appears appropriate to assume
that the ultimate losses would not be more favorable that industry experience and that the
volatility could be greater than the industry volatility. Even if the indicated 90th percentile losses
from the combined U.S. Industry is used those loss ratios would be higher than the direct loss
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ratios which result in a 10% loss to the reinsurers. BHC recommends that the Office continue to
monitor the Company’s loss ratios and consider future results on Guarantee’s risk transfer.
The Company’s reinsurance treaties are funds held treaties. The reinsurers are required to
deposit collateral equal to the maximum losses (after excluding the ceded premium net of ceding
commissions). When the losses are completely paid out the reinsurer is to receive the balance of
the funds held account. The reinsurers cash flows thus occur at two points-in year one when the
reinsurer is required to deposit the collateral, and at the end of the contract when the fund
balance is paid.
For each of the reinsurance treaties tested BHC modeled the reinsurer’s cash flows assuming a
funds held structure. BHC used this model to determine the direct loss ratio which resulted in a
10% loss to the reinsurer (discounted basis). The results of this exercise are as follows:
Reinsurance Treaty
Direct Loss Ratio That Results in Reinsurer 10% Loss (Discounted) Funds Held Basis
Preferred Commercial 73.2%
SP 104 68.7%
SP 113 67.7%
SP 117 69.5%
SP 122 for PES 64.0%
SP 122 for I-Core 68.9%
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SP 123 69.8%
SP 125 66.1%
SP 132 71.7%
SP 110 87.3%
These results are not significantly different from the results achieved in the BHC analyses which
did not incorporate the funds held feature. For all of the contracts the direct loss ratio which
results in a 10% reinsurer p/v loss is well below the 10% probable loss ratio. In all cases it is
also below the direct loss ratio at which the reinsurers loss maxes out. Only SP 110 is close as
the 10% loss to the reinsurer occurs at a direct loss ratio of 87.3% and the reinsurer’s loss maxes
out at 87.5%. This indicates that SP 110 does meet the 10/10 risk transfer guidelines, but,
because of the existence of the loss ratio cap, there is no possibility the reinsurer loss will exceed
10.2%.
BHC reviewed the risk transfer analyses performed by the Company and Pinnacle (using the
ERD, the 10/10 Rule and in-house computations performed by the Company). BHC performed
independent analyses and calculations regarding the risk transfer analyses and has concurred
with Pinnacle’s and Guarantee’s conclusions as to the adequacy of risk transfer for the contracts
reviewed. BHC concludes that the Company is conducting risk transfer testing on a timely
basis and considers the Company to be in compliance with Consent Order #93640-07-CO
at December 31, 2007.
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2006 Deficiency or Adverse Finding: Reinsurance-National Indemnity Insurance
Company
The Company’s excess of loss agreement with National Indemnity did not transfer risk. In
accordance with SSAP No. 75, the deposit accounting method was used for this examination.
The Company had improperly utilized prospective reinsurance accounting on one excess of loss
agreement which did not transfer risk; and deposit accounting was required under SSAP No. 75.
BHC Findings:
The National Indemnity Insurance Company contract failing the risk transfer test at December
31, 2006 was a $4 million xs $1 million agreement covering alternative market workers’
compensation business. This agreement was cancelled and commuted in 2007 and replaced with
a new $4 million xs $1 million agreement effective May 1, 2007. As noted above, this new
agreement was tested for risk transfer by Pinnacle and found to transfer risk to the reinsurer. No
further procedures were considered necessary by BHC. In addition, BHC’s procedures noted
that Guarantee is accounting for reinsurance in accordance with SSAP No. 75 at December 31,
2007. BHC considers the Company to be in compliance with Consent Order #93640-07-CO
at December 31, 2007 regarding reinsurance accounting.
2006 Deficiency or Adverse Finding: Reinsurance –Receivable from Parent, Subsidiaries and Affiliates (“PSA”)
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The Company was improperly including reinsurance transactions in the net amounts receivable
from parents, subsidiaries and affiliates, which was not in accordance with the NAIC annual
statement instructions. The Company was unable to provide supporting documentation for some
transactions to clearly identify proper classification.
BHC reviewed all intercompany accounts for reinsurance transactions by reviewing the detail
transactions posted to the general ledger. Based on BHC’s review, the only reinsurance
transactions posted to intercompany accounts in 2007 were the reinsurance brokerage fees
between Guarantee and Patriot Re International which is governed by a Reinsurance Brokerage
Agreement between these companies. BHC considers the recording of these transactions in
intercompany accounts to be appropriate. Balances in the intercompany accounts at December
31, 2007 are presented as follows:
BHC’s review noted that no balances in the intercompany accounts exceeded 90 days past due.
BHC considers the Company to be in compliance with Consent Order #93640-07-CO at
December 31, 2007 regarding the recording of reinsurance transactions in intercompany
accounts.
Intercompany Balances December 31, 2007 Due to (from): Suncoast Holdings $ (49,412) Patriot Re International 120 Patriot Risk 32,751 Patriot Insurance Mgmt. 52 $ (16,489)
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2006 Deficiency or Adverse Finding – Reinsurance – Schedule F Errors
Errors were noted in the preparation and presentation of Schedule F, for which supporting
documentation was not provided.
BHC Findings:
BHC reviewed the Company's 2007 Annual Statement Schedule F concentrating on Schedule F
Part 3, Ceded Reinsurance. BHC agreed totals from all Schedule F Part 3 supporting working
papers to the general ledger without exception. BHC traced individual reinsurer totals from the
detail supporting work papers to the final Schedule F Part 3 without exception. BHC also agreed
the totals per the final Schedule F Part 3 to the appropriate pages, schedules and exhibits in the
2007 Annual Statement. BHC’s examination noted that the ceded loss IBNR per Schedule F-Part
3, Column 11 was $435,000 higher than the ceded loss IBNR reported in Schedule P-Part 1
Summary, Column 16. The Company’s management explained that this difference results from
reporting ceded reserves net of discount in Schedule P while the Schedule F Part 3 ceded reserve
is presented before discount. The Company’s explanation is considered reasonable. BHC
considers the Company to be in compliance with Consent Order #93640-07-CO at
December 31, 2007 regarding the accuracy of Schedule F.
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2006 Deficiency or Adverse Finding: Reinsurance – Recording of Ceded Deposit Premiums
The Company was improperly recording initial ceded deposit premiums as a contra-liability to
ceded reinsurance premiums payable; the Company did not recognize the expenses for minimum
ceded reinsurance premium on excess of loss agreements when incurred.
BHC Findings:
BHC reviewed all the excess of loss ceded premium calculations for 2007. This included the
following reinsurance agreements; $10 million xs $10 million, $5 million xs $5 million, $4
million xs $1 million, and $4.25 million xs $.750 million. BHC reviewed these calculations for
reasonableness, compared the ceding premium percentage rates to the reinsurance agreements
and compared the actual premiums ceded to the minimum premium required in the reinsurance
agreements to insure actual ceded premium equaled or exceeded the minimum. BHC also agreed
the actual ceded premiums to the general ledger and reviewed the reinsurance payable accounts
reconciliations for reasonableness. The only exception noted was an over accrual of ceded
premium of $56,578 under the $4 million xs $1 million alternative market excess of loss
agreement effective May 1, 2007. This adjustment was proposed and passed by BDO due to
immateriality. Except for this immaterial error, BHC considers the Company to be in
compliance with Consent Order #93640-07-CO at December 31, 2007 in regards to excess
of loss ceded premiums.
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2006 Deficiency or Adverse Finding: Ceded Reinsurance Premium Payable
The amount reported by the Company was increased due to reclassification for deposit
accounting and calculation errors. We recommend the Company correctly report ceded
reinsurance premium payable on all future annual and quarterly statement filings as required by
SSAP No. 75 and the NAIC annual statement instructions.
The most significant changes to the 2006 ceded reinsurance premium payable balance consisted
of the following adjustments.
• Correction to report reinsurance deposit accounting for one excess of loss reinsurance
agreement that failed to pass risk to the insurer. BHC has addressed this issue as it relates
to the December 31, 2007 financial statements previously in this report.
• Correction to properly report ceded premium for excess of loss reinsurance agreements.
BHC has addressed this issue as it relates to the December 31, 2007 financial statements
previously in this report.
• Correction to reclassify reinsurance funds withheld balances. BHC has addressed this
issue as it relates to the December 31, 2007 financial statements in the section below.
• Correction for ceded unearned ceding commission. BHC has reviewed BDO’s proposed
adjustment to ceded commission which results from differences in the alternative market
ceding commission for selected PEOs. BDO recalculated the commission using rates it
obtained from the reinsurance agreements and compared its calculation to GIC’s
calculation. The 2007 adjustment is immaterial and was passed by BDO. However,
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BHC has concerns that individual segregated cell commission calculations may be
incorrect. This could result in errors in calculating the individual cell’s fund withheld
balances.
• Correction to ceded reinsurance EBUB premium and commission. BHC has reviewed
BDO’s work papers related to the development of direct and ceded EBUB business.
BDO verified all calculations and was able to agree all balances to the December 31,
2007 general ledger.
BHC considers the Company to be in compliance with Consent Order #93640-07-CO at
December 31, 2007 in regards to ceded reinsurance premium payable.
2006 Deficiency or Adverse Findings: Funds Held Under Reinsurance Agreements
The amount reported by the Company was decreased due to a reclassification to ceded
reinsurance premiums payable. We recommend the Company correctly report funds held under
reinsurance agreements on all future annual and quarterly statement filings as required by SSAP
No. 62 and the NAIC annual statement instructions.
BHC Finding:
BHC reviewed the BDO work papers supporting the funds withheld balance for the alternative
market business. The grand total for all segregated cells agreed to the 2007 general ledger
balance at December 31, 2007. The funds withheld balance for the alternative market business
totaled $27.7 million which is 95% of the 2007 Annual Statement balance of $29.2 million.
BHC considers the Company to be in compliance with Consent Order #93640-07-CO at
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December 31, 2007 in regards to funds withheld balances. However, BHC did not examine
the development of the funds withheld balance for individual segregated cells and, as is
documented elsewhere in this report, is concerned that individual segregated cell balances
may be misstated.
2006 Deficiency or Adverse Finding – Reinsurance Accounting
We recommend that the Company establish procedures for its reinsurance accounting, implement
controls and review procedures to ensure compliance with SSAP’s regarding reinsurance
accounting and the NAIC annual statement instructions.
We recommend the Company develop procedures to monitor reinsurance transactions and follow
the appropriate NAIC guidelines, including SSAP’s, for the processing and reporting of
reinsurance.
BHC Findings: BHC’s review of reinsurance described above facilitated our review of the procedures for
reinsurance accounting. Based on our procedures, BHC considers the Company to be in
compliance with Consent Order #93640-07-CO at December 31, 2007 regarding
reinsurance accounting.
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Summary of Findings
The following includes target examination comments and recommendations for corrective
action:
Aggregate Write-ins for Assets
The Company has a Managed Care Services Agreement with Patriot Risk Services, Inc. (Patriot),
an affiliate, whereby Patriot provides certain managed care services to the Company for a fee.
During 2007, the Company advanced Patriot $300,000 in a series of cash transfers beginning in
March 2007. This advance was reported as an asset under Aggregate Write-ins for Assets in the
Company’s 2007 Annual Statement.
The Managed Care Agreement stipulates that service fees and payments be made within (30)
days of receipt of monthly invoices. There is no provision in the agreement addressing the
prepayment of fees or the advance of funds.
We recommend that the Company establish procedures to ensure that payments to
affiliates are within the terms of the underlying contracts and that advances to affiliates are
in accordance with Florida Administrative Code 69O-143.047 and Statement of Statutory
Accounting Principle No. 25.
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Aggregate Write-ins for Liabilities
The aggregate write-ins for liabilities at December 31, 2007 consisted of the unearned ceding
commission for the Company’s treaty business and alternative market business. The target
examination test calculation of the alternative market business unearned ceding commission
resulted in a difference which was immaterial to the Company’s overall financial position.
However, there were differences within individual alternative market cells which resulted from
the ceding commission rates used in the test calculations differing from the rates used by
Guarantee. This could indicate errors in the individual cells’ funds withheld balances. A detailed
analysis of individual cell balances was beyond the scope of this target examination.
We recommend that the Company establish procedures to ensure the alternative market
cells’ funds withheld balances are calculated in accordance with the terms of the
underlying reinsurance agreements.
Current Federal Income Tax
In June 2007 the Company made an $850,000 federal estimated income tax payment. In
September and October, 2007 it appears the Company was reimbursed $400,000 from SunCoast
Holding and $32,373 from Patriot Risk Service, respectively. These transactions indicate that
the Company advanced funds on behalf of other members of the affiliated tax group in violation
of terms of the Tax Allocation Agreement.
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We recommend that the Company establish procedures to ensure that payments on behalf
of affiliated companies are in accordance with the terms of the underlying contracts and
that advances to affiliates are in accordance with Florida Administrative Code 69O-143.047
and Statement of Statutory Accounting Principle No. 25.
Payables to Parent, Subsidiaries and Affiliates (PSA)
The Company has a number of service agreements with affiliated companies. These include the
following:
• Management Services Agreement with SunCoast Holdings (SunCoast) effective January 1,
2004.
• Expense Reimbursement Agreement with Patriot Risk Management effective January 1,
2006.
• Managed Care Services Agreement with Patriot Risk Services effective January 1, 2006.
• Producer Agreement with Patriot Risk Services effective January 1, 2006.
• Reinsurance Brokerage Agreement with Patriot Re International effective January 1, 2006.
The Company has represented that the inter-company accounts are used when one company pays
expenses for other companies since some bills are processed for the consolidated SunCoast
group. These accounts are settled monthly within thirty (30) days of the end of the month.
The Company has also represented that accounting for the various service agreements listed
above do not go through the inter-company accounts but are set up on Patriot’s books as
receivables and on the Company’s books as expenses and liability accruals. During the target
65
examination, the examiners identified certain Patriot work paper schedules that noted receivables
being due from the Company at December 31, 2007. This included $319,977 for bill review
service and $416,000 for on-site case management. It appears these balances have accumulated
during 2007 and are not just the December 2007 activity between the companies.
The examiners asked the company to demonstrate where the off setting liabilities were recorded
in the Company’s general ledger at December 31, 2007. The Company responded “the offsetting
liabilities are all in individual case LAE reserves which may include other non-intercompany
LAE expense costs as well. Without looking at the entire inventory of individual claim file
reserves, the examiners could not identify just the intercompany items”. Based on this response,
the examiners were unable to verify if the intercompany liabilities discussed above have been
accrued by the Company at December 31, 2007.
We recommend that the Company establish procedures to ensure transactions with
affiliated companies are properly recorded in the general ledger accounts and offsetting
receivable/liability balances due between affiliates are verifiable upon examination as
required by Florida Administrative Code 69O-143.047.
Taxes, Licenses & Fees
State income taxes:
In October 2007 the company paid $202,189 to the State of Florida for the Florida
corporate/franchise tax for tax year 2006. Based on a review of the Company’s 2006 taxable
66
income this payment appears to be overstated by $163,954. The examiners discussed this
finding with the Company’s management who agreed that the 2006 payment represented a tax
payment for the entire tax group.
The payment of $202,189 for the 2006 Florida corporate/franchise tax includes funds advanced
by the Company on behalf of other members of the affiliated tax group in violation of the terms
of the Tax Allocation Agreement.
We recommend that the Company establish procedures to ensure that payments on behalf
of affiliated companies are in accordance with the terms of the underlying contracts and
that advances to affiliates are in accordance with Florida Administrative Code 69O-143.047
and Statement of Statutory Accounting Principle No. 25.
Policy fees pass-through payable:
Included in the liability for taxes, licenses and fees reported in the Company’s 2007 Annual
Statement was a $2,021,301 liability for Policy Fees Pass-Through Payable. The examiners
requested the Company provide documentation to support this liability, explain the Company’s
method for billing and collecting of these fees, provide documentation granting the Company
authority to pass these fees on to policyholders and demonstrate how and when these fees will be
paid to the taxing authority.
67
The Company was unable to provide supporting detail for this account.
In a conference call on July 8, 2008 the Company’s management explained that this liability
represented various state worker compensation taxes and assessments collected from
policyholders. Management further explained that the large increase in this liability ($157,976 at
December 31, 2006 to $2,021,301 at December 31, 2007) resulted from the states being slow to
send out the tax and assessment billing notices.
In an email dated July 15, 2008, Company’s management further explained that the tax and
assessment pass-through primarily related to the states of New York, New Jersey, Missouri and
Indiana. Management provided documentation from the NCCI for each of these states which
described the Company’s right to charge and collect various taxes and assessments directly from
policyholders.
We are concerned with the Company’s apparent inability to control and reconcile this
account and recommends the Company establish or improve accounting controls over the
collection of policy fees and the payment of these fees to taxing authorities.
Unearned Premium
The examination identified 44 policies in the CEU report with negative unearned premium
balances. Thirty-nine of the policies had a negative unearned premium of 50 cents or less, which
the Company explained as a rounding issue within FiServ. The remaining five policies had
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negative unearned premium balances totaling $10,097. The Company represented to the
examiners that negative unearned premiums should never occur.
The Company researched the reason for the negative unearned premiums and informed the
examiners that the problems were due to clerical data input errors on transaction dates for three
policy cancellation transactions, and two policy endorsement transactions. By inputting
incorrect dates, the Fiserv system reduced the remaining unearned premium by more than the
actual premium balance. The Company informed the examiners that they contacted FiServ, who
committed to placing an edit in their software to prevent this type of error from occurring in the
future. The Company stated that it would monitor the CEU Report on a weekly basis for
negative unearned premiums.
We recommend that the Company establish procedures to identify coding errors,
implement system edits to detect these errors and establish procedures to review and
correct these errors on a timely basis.
Reinsurance Risk Transfer
The examiner team reviewed the risk transfer analyses performed by Pinnacle Actuarial Services
and in-house computations performed by the Company. The examiners performed independent
analyses and calculations regarding the risk transfer analyses and concurred with Pinnacle’s and
the Company’s conclusions as to the adequacy of risk transfer for the contracts reviewed.
However, the examiners identified the following areas of concern.
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• Pinnacle had used a discount rate for the discounting of the payout of losses that
was off by one duration. When this error was corrected the revised analysis
indicated that the 10/10 guideline test had been achieved for one reinsurance
agreement that had previously failed this test. The error did not have a material
impact on the other reinsurance agreements tested. We recommend that the
Company review all risk transfer calculation assumptions to ensure that
assumption errors do not have a material impact on the Company’s
conclusions regarding risk transfer in the future.
• In performing the 10/10 risk transfer analyses Pinnacle assumed lognormal
distribution of losses and assumed a mean loss ratio of 60%. The Office is
concerned that the assumed 60% mean loss and ALAE ratio is unreasonably low.
A review of the U.S. Property and Casualty Insurance Industry Experience for
Workers Compensation Insurance as published in Best’s Aggregates and
Averages (Best) indicates a combined U. S. Industry experience mean loss and
ALAE ratio of approximately 81% for the 2004, 2005 and 2006 periods. Since the
Company is a relatively young company with limited loss experience that writes,
by Guarantee’s own admission, a riskier clientele, it appears appropriate to
assume that the ultimate losses would not be more favorable that industry
experience. We recommend that the Company continue to monitor loss ratios
and consider future results on the Company’s risk transfer.
70
• The Company performed in-house risk transfer testing for five quota share
reinsurance agreements with effective dates in 2007 and six reinsurance
agreements effective prior to 2006. The examiners obtained and reviewed the test
calculations for these agreements and concluded that these calculations are
relatively simplistic and utilized only one simulation. We recommend that the
Company use multiple simulations in the future for in-house risk transfer
analysis.
Cash and Short Term Investments
One exception identified during the target examination concerns the reporting of $5,645,834 held
in a Class 1 money market account at December 31, 2007. The Company included this balance
in cash on Schedule E of the 2007 Annual Statement when the funds should have been reported
as a short-term investment in Schedule DA. The Company maintains a sweep account with the
Bank of America. Excess funds are swept into a Columbia Money Market Reserves account
daily. (Columbia is identified as a Bank of America company on the sweep account bank
statement.) The Columbia Money Market fund is listed as a Class 1 money market fund in the
NAIC SVO manual.
We recommend that the Company develop procedures to monitor the reporting of short-
term investments and follow NAIC guidelines for the preparation of the Company’s annual
statement.
71
Conclusion
The insurance examination practices and procedures as promulgated by the NAIC have been
followed in ascertaining the financial condition of Guarantee Insurance Company as of August
20, 2008, consistent with the insurance laws of the State of Florida.
Per examination findings, the Company’s Surplus as regards policyholders was $14,064,427 in
compliance with Section 624.408, Florida Statutes and Consent Order #93640-07-CO.
In addition to the undersigned, Buttner Hammock & Company, P.A. participated in the
examination.
Respectfully Submitted,
______________________________ Mary M. James, CFE, CPM Financial Administrator Florida Office of Insurance Regulation
