††††† 806 KAR 3:170. Annual audited financial reports.

 

††††† RELATES TO: KRS 304.1-050, 304.2-065, 304.2-210-304.2-290, 304.3-120, 304.3-125, 304.3-240, 304.3-241, 304.17A-820, 304.32-210, 304.35-040, 304.37-010, 304.37-020, 304.36-140, 304.42-150, 304.45-030, 304.45-040, 304.48-110, 304.49-070(2), 304.49-080, 304.49-090, 304.50-060, 304.50-075, 18 U.S.C. 1961, 1968

††††† STATUTORY AUTHORITY: KRS 304.2-110, 304.3-240, 304.49-140

††††† NECESSITY, FUNCTION, AND CONFORMITY: KRS 304.2-110 authorizes the Commissioner of the Department of Insurance to promulgate administrative regulations necessary for or as an aid to the effectuation of any provision of the Kentucky Insurance Code as defined in KRS 304.1-010. KRS 304.3-240 authorizes the commissioner to promulgate administrative regulations concerning the publication of financial statements. KRS 304-49-140 authorizes the commissioner to promulgate administrative regulations relating to captive insurance companies that are necessary to enable the commissioner to carry out the provisions of KRS 304.39-010 to 304.49-230. This administrative regulation establishes requirements concerning the annual filing of audited financial reports by insurers.

 

††††† Section 1. Definitions. (1)(a) "Accountant" and "independent certified public accountant" mean an independent certified public accountant or accounting firm in good standing with the American Institute of Certified Public Accountants and in all states in which they are licensed to practice.

††††† (b) For Canadian and British insurers, "accountant" means a Canadian-chartered or British-chartered accountant.

††††† (2) "Affiliate" or "affiliated" is defined by KRS 304.37-010(4).

††††† (3) "Audit Committee" means a committee, or equivalent body, established by the board of directors of an entity for the purpose of overseeing the accounting and financial reporting processes of an insurer or group of insurers and audits of financial statements of the insurer or group of insurers.

††††† (4) "Audited financial report" means those items specified in Section 4 of this administrative regulation.

††††† (5) "Commissioner" is defined in KRS 304.1-050(1).

††††† (6) "Controlling person" is defined in KRS 304.37-010(8).

††††† (7) "Department" is defined in KRS 304.1-050(2).

††††† (8) "Group of Insurers" means those licensed insurers included in the reporting requirements of KRS 304.37-020, or a set of insurers as identified by management, for the purpose of assessing the effectiveness of internal control over financial reporting.

††††† (9) "Insurer" is defined by KRS 304.1-040.

††††† (10) "Internal control over financial reporting" means a process affected by an entityís board of directors, management, and other personnel designed to provide reasonable assurance regarding the reliability of the financial statements and includes those policies and procedures that:

††††† (a) Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets;

††††† (b) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements and that receipts and expenditures are being made only in accordance with authorizations of management and directors; and

††††† (c) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements.

††††† (11) "SEC" means the United States Securities and Exchange Commission.

††††† (12) "Section 404" means Section 404 of the Sarbanes-Oxley Act of 2002 and the SECís rules and regulations promulgated under Section 404.

††††† (13) "Section 404 Report" means managementís report on "internal control over financial reporting" as defined by the SEC and the related attestation report of the independent certified public accountant.

††††† (14) "SOX Compliant Entity" means an entity that either is required to be compliant with, or voluntarily is compliant with, all of the following provisions of the Sarbanes-Oxley Act of 2002:

††††† (a) The preapproval requirements of Section 201;

††††† (b) The audit committee independence requirements of Section 301; and

††††† (c) The internal control over financial reporting requirements of Section 404.

††††† (15) "Work papers" mean the records kept by the independent certified public accountant of the procedures followed, the tests performed, the information obtained, and the conclusions reached pertinent to the independent certified public accountants audit of the financial statements of an insurer. Work papers may include audit planning documentation, work programs, analyses, memoranda, letters of confirmation and representation, abstracts of insurer documents, and schedules or commentaries prepared or obtained by the independent certified public accountant in the course of the independent certified public accountants audit of the financial statements of an insurer and which support the independent certified public accountants opinion of the financial statements of an insurer.

 

††††† Section 2. Purpose and Scope. (1) This administrative regulation shall be to improve the department's surveillance of the financial condition of insurers by requiring:

††††† (a) An annual audit of financial statements reporting the financial position and the results of operations of insurers by independent certified public accountants;

††††† (b) Communication of internal control related matters noted in an audit; and

††††† (c) Management's report of internal control over financial reporting.

††††† (2) Every insurer shall be subject to this administrative regulation. Insurers having direct premiums written in this state of less than one (1) million dollars in any calendar year and less than 1,000 policyholders or certificate holders of direct written policies nationwide at the end of the calendar year shall be exempt from this administrative regulation.

††††† (a) Unless the commissioner makes a specific finding that compliance is necessary for the department to carry out its statutory responsibilities, insurers shall be exempt during years in which the following conditions exist. The insurer has, at the end of the calendar year:

††††† 1. Direct premiums written in this state of less than $1,000,000; and

††††† 2. Less than 1,000 policyholders or certificate holders of direct written policies nationwide.

††††† (b) Insurers that have assumed premiums of $1,000,000 or more pursuant to contracts or treaties of reinsurance shall not be exempt from this administrative regulation.

††††† (3) Foreign or alien insurers filing the audited financial report in another state, pursuant to the other state's requirement for filing an audited financial report which has been found by the commissioner to be substantially similar to the requirements of this administrative regulation, shall be exempt from this administrative regulation if:

††††† (a) The following documents, which are filed with the other state, are filed with the commissioner in accordance with Sections 4, 11, and 12 of this administrative regulation:

††††† 1. A copy of the audited financial report;

††††† 2. Communication of internal control related matters noted in an audit; and

††††† 3. The accountant's letter of qualifications; Canadian insurers may submit accountants' reports as filed with the Office of Superintendent of Financial Institutions, Canada; and

††††† (b) A copy of any notification of adverse financial condition report filed with the other state is filed with the commissioner within the time specified in Section 9 of this administrative regulation.

††††† (4) Foreign or alien insurers required to file managementís report of internal control over financial reporting in another state shall be exempt from filing the report in this state if:

††††† (a) The other state has substantially similar reporting requirements; and

††††† (b) The report is filed with the commissioner of the other state within the time specified.

††††† (5) This administrative regulation shall not prohibit, preclude, or in any way limit the commissioner from ordering, conducting, or performing examinations of insurers under KRS 304.2-210 through 304.2-290, 304.17A-820, 304.32-210, 304.35-040, 304.36-140, 304.42-150, 304.48-110, 304.49-080, or 304.50-075.

 

††††† Section 3. General Requirements Related to Filing and Extensions for Filing of Annual Audited Financial Reports and Audit Committee Appointment. (1) All insurers shall have an annual audit by an independent certified public accountant and shall file an audited financial report with the commissioner on or before June 1 for the year ended December 31 immediately preceding. The commissioner may require an insurer to file an audited financial report earlier than June 1 with ninety (90) days advance notice to the insurer.

††††† (2) Extensions of the June 1 filing date may be granted by the commissioner for thirty (30) day periods upon showing by the insurer and its independent certified public accountant the reasons for requesting the extension and determination by the commissioner of good cause for an extension. The request for extension shall be submitted in writing not less than ten (10) days prior to the due date and contain sufficient detail to permit the commissioner to make an informed decision as to the requested extension.

††††† (3) If an extension is granted in accordance with subsection (2) of this section, a similar extension of thirty (30) days shall be granted to the filing of managementís report of internal control over financial reporting.

††††† (4) Every insurer required to file an annual audited financial report pursuant to this administrative regulation shall designate a group of individuals as constituting its audit committee. The audit committee of an entity that controls an insurer may be deemed to be the insurerís audit committee for purposes of this administrative regulation at the election of the controlling person.

 

††††† Section 4. Contents of Annual Audited Financial Report. (1) The annual audited financial report shall report the financial condition of the insurer as of the end of the most recent calendar year and the results of its operations, cash flows, and changes in capital and surplus for the year then ended in conformity with statutory accounting practices prescribed, or otherwise permitted, by the insurance supervisory authority of the insurer's state of domicile.

††††† (2) The annual audited financial report shall include the following:

††††† (a) Report of independent certified public accountant;

††††† (b) Balance sheet for reporting admitted assets, liabilities, capital, and surplus;

††††† (c) Statement of operations;

††††† (d) Statement of cash flows;

††††† (e) Statement of changes in capital and surplus;

††††† (f) Notes to financial statements as required by KRS 304.3-240 in accordance with KRS 304.3-241. These notes shall also include:

††††† 1. A reconciliation of differences, if any, between the audited statutory financial statements and the annual statement filed pursuant to KRS 304.3-240 with a written description of the nature of these differences; and

††††† 2. A summary of ownership and relationships of the insurer and all affiliated companies; and

††††† (g) The financial statements included in the audited financial report shall be:

††††† 1. Prepared in a form and using language and groupings substantially the same as the relevant sections of the annual statement of the insurer filed with the commissioner; and

††††† 2. Comparative, presenting the amounts as of December 31 of the current year and the amounts as of the immediately preceding December 31. However, in the first year in which an insurer is required to file an audited financial report, the comparative data may be omitted. The annual statement forms and instructions are those prescribed by the National Association of Insurance Commissioners as required by KRS 304.3-240.

 

††††† Section 5. Designation of Independent Certified Public Accountant. (1) Each insurer required by this administrative regulation to file an annual audited financial report shall, within sixty (60) days after becoming subject to this requirement, register with the commissioner in writing the name and address of the independent certified public accountant or accounting firm retained to conduct the annual audit set forth in this administrative regulation. Insurers not retaining an independent certified public accountant on the effective date of this administrative regulation shall register the name and address of their retained certified public accountant not less than six (6) months before the date when the first audited financial report is to be filed.

††††† (2) The insurer shall obtain a letter from the accountant, and file a copy with the commissioner, stating that the accountant is aware of the provisions of the insurance laws of the insurer's state of domicile that relate to accounting and financial matters and affirming that the accountant will express the accountant's opinion on the financial statements in terms of their conformity to the statutory accounting practices prescribed or otherwise permitted by the insurance regulatory authority in that state, specifying any exceptions as the accountant may believe appropriate.

††††† (3) If an accountant who was the accountant for the immediately preceding filed audited financial report is dismissed or resigns the insurer shall:

††††† (a) Within five (5) business days notify the commissioner of this event;

††††† (b) Furnish the commissioner with a separate letter within ten (10) business days of the above notification stating whether in the twenty-four (24) months preceding the accountant's resignation there were any disagreements with the former accountant which, if not resolved to the satisfaction of the former accountant, would cause the accountant to make reference to the subject matter of the disagreement in connection with the opinion. These shall include disagreements:

††††† 1. Concerning accounting principles, financial statement disclosure, or auditing scope or procedure;

††††† 2. That have been resolved to the former accountant's satisfaction and those not so resolved; and

††††† 3. That occur at the decision-making level, that is, between personnel of the insurer responsible for presentation of its financial statements and personnel for the accounting firm responsible for rendering its report;

††††† (c) Request the former accountant to furnish a letter addressed to the insurer stating whether the accountant agrees with the statements contained in the insurer's letter, and, if not, stating the reasons for which the accountant does not agree; and

††††† (d) Furnish the responsive letter from the former accountant to the commissioner together with its own.

 

††††† Section 6. Qualifications of Independent Certified Public Accountant. (1) The commissioner shall not recognize any person or firm as a qualified independent certified public accountant if the person or firm:

††††† (a) Is not in good standing with the American Institute of Certified Public Accountants and in all states in which the accountant is licensed to practice, or, for a Canadian or British insurer, that is not a chartered accountant; or

††††† (b) Has either directly or indirectly entered into an agreement of indemnity or release from liability with respect to the audit of the insurer.

††††† (2) Except as otherwise provided in this administrative regulation, an independent certified public accountant shall be recognized as qualified if the independent certified public accountant conforms to the standards of the accounting profession, as contained in the statutes, administrative regulations, and codes of ethics and rules of professional conduct administered by the State Board of Accountancy of Kentucky in accordance with KRS Chapter 325 and 201 KAR Chapter 1.

††††† (3) The lead or coordinating audit partner having primary responsibility for the audit shall not act in that capacity for more than five (5) consecutive years. The person shall be disqualified from acting in that or a similar capacity for the same insurer or its insurance subsidiaries or affiliates for a period of five (5) years.

††††† (a) An insurer may make application to the commissioner for relief from this rotation requirement on the basis of unusual circumstances. Application shall be made at least thirty (30) days before the end of the calendar year. The commissioner may consider the following factors in determining if the relief should be granted:

††††† 1. Number of partners, expertise of the partners, or the number of insurance clients in the currently registered firm;

††††† 2. Premium volume of the insurer; or

††††† 3. Number of jurisdictions in which the insurer transacts business.

††††† (b) The insurer shall file with its annual statement filing the approval for relief from paragraph (a)1 of this subsection with the states that it is licensed in or doing business in and with the National Association of Insurance Commissioners. If the nondomestic state accepts electronic filing with the National Association of Insurance Commissioners, the insurer shall file the approval in an electronic format acceptable to the National Association of Insurance Commissioners via the Web site, https://www2.naic.org/servlet/Index.

††††† (c) The commissioner shall not recognize as a qualified independent certified public accountant, nor accept any annual audited financial report, prepared in whole or in part by any natural person who:

††††† 1. Has been convicted of fraud, bribery, or a conviction of the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. 1961, 1968;

††††† 2. Has been found to have violated the insurance laws of this state with respect to any previous reports submitted under this administrative regulation; or

††††† 3. Has demonstrated a pattern or practice of failing to detect or disclose material information in previous reports filed under this administrative regulation.

††††† (4) If an insurer disagrees with a determination made by the commissioner pursuant to subsection (3) of this section, it may request a hearing in accordance with KRS 304.2-310.

††††† (5)(a) The commissioner shall not recognize as a qualified independent certified public accountant, nor accept an annual audited financial report prepared in whole or in part by an accountant who provides to an insurer, contemporaneously with the audit, the following nonaudit services:

††††† 1. Bookkeeping or other services related to the accounting records or financial statements of the insurer;

††††† 2. Financial information systems design and implementation;

††††† 3. Appraisal or valuation services, fairness opinions, or contribution-in-kind reports;

††††† 4. Actuarially-oriented advisory services involving the determination of amounts recorded in the financial statements. The accountant may assist an insurer in understanding the methods, assumptions, and inputs used in the determination of amounts recorded in the financial statement only if it is reasonable to conclude that the services provided will not be subject to audit procedures during an audit of the insurerís financial statements. An accountantís actuary may also issue an actuarial opinion or certification on an insurerís reserves if the following conditions have been met:

††††† a. Neither the accountant nor the accountantís actuary has performed any management functions or made any management decisions;

††††† b. The insurer has competent personnel or engages a third party actuary to estimate the reserves for which management takes responsibility; and

††††† c. The accountantís actuary tests the reasonableness of the reserves after the insurerís management has determined the amount of the reserves;

††††† 5. Internal audit outsourcing services;

††††† 6. Management functions or human resources;

††††† 7. Broker or dealer, investment adviser, or investment banking services; or

††††† 8. Legal services or expert services unrelated to the audit.

††††† (b) A qualified independent public accountant shall not:

††††† 1. Function in the role of management;

††††† 2. Audit his or her own work; and

††††† 3. Serve in an advocacy role for the insurer.

††††† (6)(a) Insurers having direct written and assumed premium of less than $100,000,000 in any calendar year may request an exemption from subsection (5)(a) of this section.

††††† (b) To request an exemption, the insurer shall file with the commissioner a written statement discussing the reasons why the insurer should be exempt from these provisions.

††††† (c) If the commissioner finds, upon review of this statement, that compliance with this administrative regulation would constitute an organizational hardship upon the insurer, an exemption may be granted.

††††† (7) A qualified independent certified public accountant who performs the audit may engage in other nonaudit services, including tax services, that are not described in subsection (5)(a) of this section or that do not conflict with subsection (5)(b) of this section, only if the activity is approved in advance by the audit committee in accordance with subsection (8) of this section.

††††† (8)(a) All auditing services and nonaudit services provided to an insurer by the qualified independent certified public accountant of the insurer shall be preapproved by the audit committee.

††††† (b) The preapproval requirement shall be waived with respect to nonaudit services if:

††††† 1. The insurer is a SOX compliant entity or a direct or indirect wholly-owned subsidiary of a SOX compliant entity; or

††††† 2.a. The aggregate amount of all non-audit services provided to the insurer constitutes not more than five (5) percent of the total amount of fees paid by the insurer to its qualified independent certified public accountant during the fiscal year in which the nonaudit services are provided;

††††† b. The services were not recognized by the insurer at the time of the engagement to be nonaudit services; and

††††† c. The services are promptly brought to the attention of the audit committee and approved prior to the completion of the audit by the audit committee or by one or more members of the audit committee who are the members of the board of directors to whom authority to grant approvals has been delegated by the audit committee.

††††† (9) The audit committee may delegate to one (1) or more designated members of the audit committee the authority to grant the preapprovals required by subsection (8) of this section. The decisions of any member to whom this authority is delegated shall be presented to the full audit committee at each of its scheduled meetings.

††††† (10)(a)1. The commissioner shall not recognize an independent certified public accountant as qualified for a particular insurer if the following were employed by the independent certified public accountant and participated in the audit of that insurer during the one (1) year period preceding the date that the most current statutory opinion is due:

††††† a. A member of the board;

††††† b. President;

††††† c. Chief executive officer;

††††† d. Controller;

††††† e. Chief financial officer;

††††† f. Chief accounting officer; or

††††† g. any person serving in an equivalent position for that insurer.

††††† 2. This subsection shall only apply to partners and senior managers involved in the audit.

††††† 3. An insurer may make application to the commissioner for relief from the above requirements on the basis of unusual circumstances.

††††† (b) The insurer shall file, with its annual statement filing, the approval for relief from subsection (10)(a) of this section with the states that it is licensed in or doing business in and the National Association of Insurance Commissioners. If the nondomestic state accepts electronic filing with the National Association of Insurance Commissioners, the insurer shall file the approval in an electronic format acceptable to the National Association of Insurance Commissioners via the Web site, https://www2.naic.org/servlet/Index.

 

††††† Section 7. Consolidated or Combined Audits. An insurer may make written application to the commissioner for approval to file audited consolidated or combined financial statements in lieu of separate annual audited financial reports if the insurer is part of a group of insurers which utilizes a pooling or 100 percent reinsurance agreement that affects the solvency and integrity of the insurer's reserves and the insurer cedes all of its direct and assumed business to the pool. In these cases, a columnar consolidating or combining worksheet shall be filed with the report, as follows:

††††† (1) Amounts shown on the consolidated or combined audited financial report shall be shown on the worksheet;

††††† (2) Amounts for each insurer subject to this section shall be stated separately;

††††† (3) Noninsurance operations may be shown on the worksheet or a combined or individual basis;

††††† (4) Explanations of consolidating and eliminating entries shall be included; and

††††† (5) A reconciliation shall be included of any differences between the amounts shown in the individual insurer columns of the worksheet and comparable amounts shown in the annual statements of the insurers.

 

††††† Section 8. Scope of Examination and Report of Independent Certified Public Accountant. (1) Financial statements furnished pursuant to Section 4 of this administrative regulation shall be examined by the independent certified public accountant.

††††† (2) The examination of the insurer's financial statements shall be conducted in accordance with generally accepted auditing standards.

††††† (3) In accordance with SAS No. 109, "Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement" and SAS No. 110, "Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained", or their replacements, the independent certified public accountant shall obtain an understanding of internal control sufficient to plan the audit.

††††† (4) To the extent required by SAS 109 and SAS 110, for those insurers required to file a managementís report of internal control over financial reporting pursuant to Section 2 of this administrative regulation, the independent certified public accountant shall consider the most recently available report in planning and performing the audit of the statutory financial statements.

††††† (5) Consideration shall also be given to other procedures illustrated in the Financial Condition Examiner's Handbook of the National Association of Insurance Commissioners which the independent certified public accountant deems necessary.

 

††††† Section 9. Notification of Adverse Financial Condition. (1)(a) The insurer required to furnish the annual audited financial report shall require the independent certified public accountant to report, in writing, within five (5) business days to the board of directors or its audit committee any determination by the independent certified public accountant that the insurer has materially misstated its financial condition as reported to the commissioner as of the balance sheet date currently under examination or that the insurer does not meet the minimum capital and surplus requirements of KRS 304.3-120 and 304.3-125 as of that date.

††††† (b) An insurer which has received a report pursuant to this subsection shall forward a copy of the report to the commissioner within five (5) business days of receipt of the report and shall provide the independent certified public accountant making the report with evidence of this report being furnished to the commissioner.

††††† (c) If the independent certified public accountant fails to receive this evidence within the required five (5) business day period, the independent certified public accountant shall furnish to the commissioner a copy of its report within the next five (5) business days.

††††† (2) An independent certified public accountant shall not be liable in any manner to any person for any statement made in connection with subsection (1) of this section if the statement is made in good faith in compliance with subsection (1) of this section.

††††† (3) If the accountant, subsequent to the date of the audited financial report filed pursuant to this administrative regulation, becomes aware of facts which might have affected his report, the commissioner notes the obligation of the accountant to take the action prescribed in volume 1, section AU 561 of the Professional Standards of the American Institute of Certified Public Accountants.

 

††††† Section 10. Communication of Internal Control Related Matters Noted in an Audit.

††††† (1)(a) In addition to the annual audited financial statements, each insurer shall furnish the commissioner with a written communication as to any unremediated material weakness in its internal control over financial reporting noted during the audit.

††††† (b) The communication shall be prepared by the accountant within sixty (60) days after the filing of the annual audited financial report, and shall contain a description of any unremediated material weaknesses as of December 31 immediately preceding in the insurerís internal control over financial reporting noted by the accountant during the course of their audit of the financial statements.

††††† (c) If no unremediated material weaknesses were noted, the communication shall state that none were found.

††††† (2) An insurer shall provide a description of remedial actions taken or proposed to correct unremediated material weaknesses, if the action is not described in the accountantís communication.

 

††††† Section 11. Accountant's Letter of Qualifications. The accountant shall furnish the insurer in connection with, and for inclusion in, the filing of the annual audited financial report, a letter stating:

††††† (1) That the accountant is independent with respect to the insurer and conforms to the standards of the accountant's profession as contained in statutes, administrative regulations, and rules of professional conduct of the State Board of Accountancy of Kentucky set forth in KRS Chapter 325 and 201 KAR Chapter 1;

††††† (2) The background and experience in general, and the experience in audits of insurers of the staff assigned to the engagement and whether each is an independent certified public accountant. This administrative regulation shall not prohibit the accountant from utilizing staff as the accountant deems appropriate if use is consistent with the standards prescribed by generally accepted auditing standards;

††††† (3) That the accountant understands the annual audited financial report, that the accountant's opinion on it will be filed in compliance with this administrative regulation, and that the commissioner will be relying on this information in monitoring the financial position of insurers;

††††† (4) That the accountant consents to the requirements of Section 12 of this administrative regulation and that the accountant consents and agrees to make available for review by the commissioner, his designee, or his appointed agent, the work papers;

††††† (5) A representation that the accountant is properly licensed by an appropriate state licensing authority and is a member in good standing of the American Institute of Certified Public Accountants; and

††††† (6) A representation that the accountant is in compliance with the requirements of Section 6 of this administrative regulation.

 

††††† Section 12. Availability and Maintenance of Independent Certified Public Accountant Work Papers. (1) Every insurer required to file an audited financial report pursuant to this administrative regulation shall require the accountant to make available for review by department examiners all work papers prepared in the conduct of the accountant's audit and any communications related to the audit between the accountant and the insurer, at the offices of the insurer, at the department, or any other reasonable place designated by the commissioner. The insurer shall require that the accountant retain the audit work papers and communications until the department has filed a report on examination covering the period of the audit, but no longer than seven (7) years from the date of the audit report.

††††† (2) In the conduct of the periodic review by department examiners described in subsection (1) of this section, it shall be agreed that photocopies of pertinent audit work papers may be made and retained by the department. Reviews by the department examiners shall be considered investigations and all working papers and communications obtained during the course of shall be afforded the same confidentiality as other examination work papers generated by the department.

 

††††† Section 13. Requirements for Audit Committees. This section shall not apply to foreign or alien insurers licensed in this state or an insurer that is a SOX compliant entity or a direct or indirect wholly-owned subsidiary of a SOX compliant entity.

††††† (1) The audit committee shall be directly responsible for the appointment, compensation, and oversight of the work of any accountant, including resolution of disagreements between management and the accountant regarding financial reporting, for the purpose of preparing or issuing the audited financial report or related work pursuant to this administrative regulation. Each accountant shall report directly to the audit committee.

††††† (2) Each member of the audit committee shall be a member of the board of directors of the insurer or a member of the board of directors of an entity elected pursuant to subsection (5) of this section and section 3(4) of this administrative regulation.

††††† (3)(a) A member of the audit committee shall not, other than in his or her capacity as a member of the audit committee, the board of directors, or any other board committee;

††††† 1. Accept any consulting advisory or other compensatory fee from the entity; or

††††† 2. Be an affiliated person of the entity or any subsidiary.

††††† (b) Notwithstanding paragraph (a) of this subsection, if the law requires board participation by otherwise nonindependent members, that law shall prevail and the members may participate in the audit committee and be designated as independent for audit committee purposes, unless they are an officer or employee of the insurer or one of its affiliates.

††††† (4) If a member of the audit committee ceases to be independent for reasons outside the memberís reasonable control, that person, with notice by the responsible entity to the state, may remain an audit committee member of the responsible entity until the earlier of:

††††† (a) The next annual meeting of the responsible entity; or

††††† (b) One year from the occurrence of the event that caused the member to be no longer independent.

††††† (5)(a) To exercise the election of the controlling person to designate the audit committee for purposes of this administrative regulation, the ultimate controlling person shall provide written notice to the commissioners of the affected insurers.

††††† (b) Notification shall be made timely prior to the issuance of the statutory audit report and shall include a description of the basis for the election.

††††† (c) The election can be changed through notice to the commissioner by the insurer which shall include a description of the basis for the change.

††††† (d) The election shall remain in effect for perpetuity, until rescinded.

††††† (6)(a) The audit committee shall require the accountant that performs for an insurer any audit required by this administrative regulation to timely report to the audit committee in accordance with the requirements of SAS 114, "The Auditorís Communication With Those Charged With Governance", or its replacement, including:

††††† 1. All significant accounting policies and material permitted practices;

††††† 2. All material alternative treatments of financial information within statutory accounting principles that have been discussed with management officials of the insurer, ramifications of the use of the alternative disclosures and treatments, and the treatment preferred by the accountant; and

††††† 3. Other material written communications between the accountant and the management of the insurer, including any management letter or schedule of unadjusted differences.

††††† (b) If an insurer is a member of an insurance holding company system, the reports required by paragraph (a) of this subsection may be provided to the audit committee on an aggregate basis for insurers in the holding company system, provided that any substantial differences among insurers in the system are identified to the audit committee.

††††† (7)(a) The proportion of independent audit committee members shall meet or exceed the following criteria:

††††† 1. For prior calendar year direct written and assumed premiums between $0 and $300,000,000, no minimum requirements;

††††† 2. For prior calendar year direct written and assumed premiums over $300,000,000 to $500,000,000, fifty (50) percent or more of members shall be independent; and

††††† 3. For prior calendar year direct written and assumed premiums over $500,000,000; seventy-five (75) percent of members shall be independent.

††††† (b) Notwithstanding subsection (7)(a) of this section, the commissioner may require the audit committeeís board to enact improvements to the independence of the audit committee membership if the insurer:

††††† 1. Is in a risk-based capital action level in accordance with 806 KAR 3:190; or

††††† 2. Meets one or more of the standards of an insurer deemed to be in hazardous financial condition or otherwise exhibits qualities of a troubled insurer as set forth in KRS 304.2-065.

††††† (c) An insurer with less than $500,000,000 in prior year direct written and assumed premiums may structure its audit committee with at least a supermajority of independent audit committee members.

††††† (d) For purposes of subsection (7)(a) of this section, prior calendar year direct written and assumed premiums shall be the combined total of direct premiums and assumed premiums from nonaffiliates for the reporting entities.

††††† (8)(a) An insurer with direct written and assumed premium, excluding premiums reinsured with the Federal Crop Insurance Corporation and Federal Flood Program, less than $500,000,000 may make application to the commissioner for a waiver from the requirements of this section based upon hardship.

††††† (b) The insurer shall file, with its annual statement filing, the approval for relief from this section with the states that it is licensed in or doing business in and the National Association of Insurance Commissioners.

††††† (c) If the nondomestic state accepts electronic filing with the National Association of Insurance Commissioners, the insurer shall file the approval in an electronic format acceptable to the National Association of Insurance Commissioners, via the Web site, https://www2.naic.org/servlet/Index.

 

††††† Section 14. Conduct of Insurer in Connection with the Preparation of Required Reports and Documents. (1) A director or officer of an insurer shall not, directly or indirectly:

††††† (a) Make or cause to be made a materially false or misleading statement to an accountant in connection with any audit, review, or communication required under this administrative regulation; or

††††† (b) Omit to state, or cause another person to omit to state, any material fact necessary in order to make statements made, in light of the circumstances under which the statements were made, not misleading to an accountant in connection with any audit, review, or communication required under this administrative regulation.

††††† (2) An officer or director of an insurer, or any other person acting under the direction of the officer or director, shall not, directly or indirectly, take any action to coerce, manipulate, mislead, or fraudulently influence any accountant engaged in the performance of an audit pursuant to this administrative regulation if that person knew or should have known that the action, if successful, could result in rendering the insurerís financial statements materially misleading.

††††† (3) An officer or director of an insurer, or any other person acting under the direction of the officer or director, shall not, directly or indirectly, take any of the following actions to coerce, manipulate, mislead, or fraudulently influence an accountant with respect to the professional engagement period:

††††† (a) To issue or reissue a report on an insurerís financial statements that is not warranted in the circumstances due to material violations of statutory accounting principles as required by KRS 304.3-241, generally accepted auditing standards, or other professional or regulatory standards;

††††† (b) Not to perform audit, review, or other procedures required by generally accepted auditing standards or other professional standards;

††††† (c) Not to withdraw an issued report; or

††††† (d) Not to communicate matters to an insurerís audit committee.

 

††††† Section 15. Managementís Report of Internal Control over Financial Reporting. (1)(a) Every insurer required to file an audited financial report pursuant to this administrative regulation that has annual direct written and assumed premiums, excluding premiums reinsured with the Federal Crop Insurance Corporation and Federal Flood Program, of $500,000,000 or more shall prepare a report of the insurerís or group of insurersí internal control over financial reporting.

††††† (b) The report shall be filed with the commissioner along with the communication of internal control related matters noted in an audit.

††††† (c) Managementís report of internal control over financial reporting shall be as of December 31 immediately preceding.

††††† (2) Notwithstanding the premium threshold in subsection (1)(a) of this section, the commissioner may require an insurer to file managementís report of internal control over financial reporting if the insurer:

††††† (a) Is in any risk-based capital level event in accordance with 806 KAR 3:190; or

††††† (b) Meets one or more of the standards of an insurer deemed to be in hazardous financial condition in accordance with KRS 304.2-065.

††††† (3) An insurer or a group of insurers meeting the following requirements may file its or its parentís Section 404 Report and an addendum in satisfaction of the requirements of this section if those internal controls of the insurer or group of insurers having a material impact on the preparation of the insurerís or group of insurerís audited statutory financial statements were included in the scope of the Section 404 Report:

††††† (a) Directly subject to Section 404;

††††† (b) Part of a holding company system whose parent is directly subject to Section 404;

††††† (c) Not directly subject to Section 404, but is a SOX compliant entity; and

††††† (d) A member of a holding company system whose parent is not directly subject to Section 404 but is a SOX compliant entity.

††††† (4) Managementís report of internal control over financial reporting shall include:

††††† (a) A statement that management is responsible for establishing and maintaining adequate internal control over financial reporting;

††††† (b) A statement that management has established internal control over financial reporting and an assertion, to the best of managementís knowledge and belief, after diligent inquiry, as to whether its internal control over financial reporting is effective to provide reasonable assurance regarding the reliability of financial statements in accordance with statutory accounting principles;

††††† (c) A statement that briefly describes the approach or processes by which management evaluated the effectiveness of internal control over financial reporting;

††††† (d) A statement that briefly describes the scope of work that is included and whether any internal controls were excluded;

††††† (e) Disclosure of any unremediated material weaknesses in the internal control over financial reporting identified by management as of December 31 immediately preceding. Management shall not conclude that the internal control over financial reporting is effective to provide reasonable assurance regarding the reliability of financial statements in accordance with statutory accounting principles if there is one or more unremediated material weaknesses in its internal control over financial reporting;

††††† (f) A statement regarding the inherent limitations of internal control systems; and

††††† (g) Signatures of the chief executive officer and the chief financial officer.

††††† (5) Management shall document and make available upon financial condition examination the basis upon which its assertions, required in subsection (4) of this section, are made. Management may base its assertions, in part, upon its review, monitoring, and testing of internal controls undertaken in the normal course of its activities.

††††† (a) Management shall have discretion as to the nature of the internal control framework used, and the nature and extent of the documentation, in order to make its assertion in a cost effective manner and may include assembly of or reference to existing documentation.

††††† (b) The following shall have one (1) year following the year the threshold is exceeded to comply with the independence requirements in Section 6 of this administrative regulation, but not earlier than January 1, 2010. An insurer or group of insurers that, pursuant to Section 13 of this administrative regulation:

††††† 1. Is not required to have independent audit committee members or is required to have only a majority of independent audit committee members because the total written and assumed premiums is below the threshold; and

††††† 2. Subsequently becomes subject to one (1) of the independence requirements due to changes in premium.

 

††††† Section 16. Exemptions and Effective Dates. (1) Upon written application of any insurer, the commissioner may grant an exemption from compliance with any and all provision of this administrative regulation if the commissioner finds, upon review of the application, that compliance with this administrative regulation would constitute a financial or organizational hardship upon the insurer. An exemption may be granted any time and from time to time for a specified period or periods. Upon denial of an insurer's written request for an exemption from this administrative regulation, the insurer may request a hearing on its application for an exemption pursuant to KRS 304.2-310.

††††† (2) Domestic insurers retaining a certified public accountant on the effective date of this administrative regulation who qualify as independent shall comply with this administrative regulation for the year ending December 31, 2010, and each year thereafter unless the commissioner permits otherwise.

††††† (3) Domestic insurers not retaining a certified public accountant on the effective date of this administrative regulation who qualify as independent shall meet the following schedule for compliance unless the commissioner permits otherwise:

††††† (a) As of December 31, 2010, file with the commissioner an audited financial report.

††††† (b) For the year ending December 31, 2010, and each year thereafter, these insurers shall file with the commissioner all reports and communication required by this administrative regulation.

††††† (4) Foreign insurers shall comply with this administrative regulation for the year beginning January 1, 2010, and each year thereafter.

††††† (5)(a) The requirements of Section 13 of this administrative regulation shall be effective January 1, 2010.

††††† (b) An insurer or group of insurers that, pursuant to Section 13 of this administrative regulation, is not required to have independent audit committee members or only a majority of independent audit committee members because the total written and assumed premiums is below the threshold and subsequently becomes subject to one (1) of the independence requirements due to changes in premium shall have one (1) year following the year the threshold is exceeded, but not earlier than January 1, 2010, to comply with the independence requirements in Section 6 of this administrative regulation.

††††† (c) An insurer that becomes subject to one of the independence requirements as a result of a business combination shall have one (1) calendar year following the date of acquisition or combination to comply with the independence requirements in Section 13 of this administrative regulation.

††††† (6)(a) The requirements of Section 15 of this administrative regulation shall be effective beginning with the reporting period ending December 31, 2010 and each year thereafter.

††††† (b) An insurer or group of insurers that is not required to file an annual audit report because the total written premium is below the threshold and subsequently becomes subject to the reporting requirements shall have two (2) years following the year the threshold is exceeded, but not earlier than December 31, 2010, to file an annual audit report.

††††† (c) An insurer acquired in a business combination shall have two (2) calendar years following the date of acquisition or combination to comply with the reporting requirements in Section 4 of this administrative regulation.

 

††††† Section 17. Canadian and British Companies. (1) In the case of Canadian and British insurers, the annual audited financial reports shall be defined as the annual statement of total business in the manner filed by these insurers with their supervisory authority duly audited by an independent chartered accountant.

††††† (2) For Canadian and British insurers, the letter required by Section 5 of this administrative regulation shall state that the accountant is aware of the requirements relating to the annual audited financial report filed with the commissioner pursuant to Section 3 of this administrative regulation and shall affirm that the opinion expressed is in conformity with the requirements of Section 3 of this administrative regulation.

 

††††† Section 18. Incorporation by Reference. (1) The following material is incorporated by reference:

††††† (a) "Financial Condition Examinerís Handbook", 2008, National Association of Insurance Commissioners;

††††† (b) AU Section 561, "Subsequent Discovery of Facts Existing at the Date of the Auditorís Report", 1996 Professional Standards of the American Institute of Certified Public Accountants;

††††† (c) SAS 114, "The Auditors Communication With Those Charged with Governance", 2007, American Institute of Certified Public Accountants;

††††† (d) SAS 109, "Understanding the Entity and Its Environment and Assessing the Risks of material Misstatement", 2007 American Institute of Certified Public Accountants; and

††††† (e) SAS 110, "Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence", 2007 American Institute of Certified Public Accountants.

††††† (2) This material may be inspected, copied, or obtained, subject to applicable copyright law, at the Kentucky Department of Insurance, 215 West Main Street, Frankfort, Kentucky 40601, Monday through Friday, 8 a.m. to 4:30 p.m. This material is also available on the departmentís Web site at http://insurance.ky.gov. (18 Ky.R. 959; eff. 11-8-91; TAm eff. 8-9-2007; 35 Ky.R. 1304; 1831; 1765; eff. 3-6-2009; 37 Ky.R. 2746; 38 Ky.R. 37; eff. 9-2-2011.)