806 KAR 3:170. Annual audited financial reports.

806 KAR 3:170. Annual audited financial reports.

RELATES TO: KRS 304.3-240

STATUTORY AUTHORITY: KRS 304.2-110

NECESSITY, FUNCTION, AND CONFORMITY: KRS 304.2-110 provides that the Executive Director of Insurance may make reasonable administrative regulations necessary for or as an aid to the effectuation of any provision of the Kentucky Insurance Code. KRS 304.3-240 authorizes the Executive Director of Insurance to require additional information to the annual statement filed by insurers. This administrative regulation requires annual filing of audited financial reports by insurers.

Section 1. Definitions. As used in this administrative regulation:

(1) "Audited financial report" means and includes those items specified in Section 4 of this administrative regulation;

(2) "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, and for Canadian and British insurers, mean a Canadian-chartered or British-chartered accountant;

(3) “Executive Director” means the Commissioner of the Kentucky Office of Insurance;

(4) "Office" means the Kentucky Office of Insurance;

(5) "Insurer" means an insurer authorized to do business in Kentucky by the executive director; and

(6) "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 accountant's examination 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 accountant's examination of the financial statements of an insurer and which support the independent certified public accountant's opinion of the financial statements of an insurer.

Section 2. Purpose and Scope. (1) The purpose of this administrative regulation is to improve the office’s surveillance of the financial condition of insurers by requiring an annual examination by independent certified public accounts of the financial statements reporting the financial position and results of operations of insurers.

(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 directly written policies nationwide at the end of the calendar year shall be exempt from this administrative regulation for years in which these conditions exist (unless the executive director makes a specific finding that compliance is necessary for the executive director to carry out statutory responsibilities), except that insurers having assumed premiums pursuant to contracts or treaties of reinsurance of one (1) million dollars or more shall not be exempt.

(3) Foreign or alien insurers filing audited financial reports in another state, pursuant to the other state's requirement of audited financial reports which has been found by the executive director to be substantially similar to the requirements of this administrative regulation, are exempt from this administrative regulation if:

(a) A copy of the audited financial report, report on significant deficiencies in internal controls, and the accountant's letter of qualifications which are filed with the other state are filed with the executive director in accordance with the filing dates specified in Sections 4, 11, and 12 of this administrative regulation respectively (Canadian insurers may submit accountants' reports as filed with the Canadian Dominion Department of Insurance); and

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

(4) This administrative regulation shall not prohibit, preclude, or in any way limit the executive director from ordering, conducting, or performing examinations of insurers under the Kentucky Insurance Code.

Section 3. Filing and Extensions for Filing of Annual Audited Financial Reports. (1) All insurers shall have an annual audit by an independent certified public accountant and shall file an audited financial report with the executive director on or before June 1 for the year ended December 31 immediately preceding. The executive director 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 executive director 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 executive director 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 executive director to make an informed decision as to the requested extension.

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;

(d) Statement of cash flows;

(e) Statement of changes in capital and surplus;

(f) Notes to financial statements. These notes shall be those required by the appropriate National Association of Insurance Commissioners Annual Statement Instructions and any other notes required by generally accepted accounting principles and 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 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 executive director, and the financial statement shall be 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, Life and Accident and Health (Form 1, 1990) and Fire and Casualty (Form 2, 1990), incorporated by reference and available from the Kentucky Office of Insurance, 215 West Main Street, Frankfort, Kentucky 40601, 8 a.m. to 4:30 p.m. (ET), weekdays.

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 executive director 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 executive director, 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 within five (5) business days notify the office of this event. The insurer shall also furnish the executive director 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 on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of the former accountant, would have caused him to make reference to the subject matter of the disagreement in connection with his opinion. The disagreements required to be reported in response to this subsection include both those resolved to the former accountant's satisfaction and those not resolved to the former accountant's satisfaction. Disagreements contemplated by this section are those 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. The insurer shall also in writing 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 the insurer shall furnish the responsive letter from the former accountant to the executive director together with its own.

Section 6. Qualifications of Independent Certified Public Accountant. (1) The executive directorshall not recognize any person or firm as a qualified independent certified public accountant that 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.

(2) Except as otherwise provided in this administrative regulation, an independent certified public accountant shall be recognized as qualified as long as the independent certified public accountant conforms to the standards of the accounting profession, as contained in the Code of Professional Conduct of the American Institute of Certified Public Accountants (January 12, 1988) and statutes, administrative regulations, and codes of ethics and rules of professional conduct administered by the State Board of Accountancy of Kentucky (1991), or similar code both incorporated by reference and available from the Kentucky Office of Insurance, 215 West Main Street, Frankfort, Kentucky 40601, from 8 a.m. to 4:30 p.m. (ET), on weekdays.

(3) No partner or other person responsible for rendering a report may act in that capacity for more than seven (7) consecutive years. Following any period of service 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 two (2) years. The requirements of this subsection shall become effective two (2) years after the effective date of this administrative regulation.

(a) An insurer may make application to the executive director for relief from this rotation requirement on the basis of unusual circumstances. The executive director 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;

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

(b) The executive director 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, a conviction of the Racketeer Influenced and Corrupt Organizations Act, 18 USC 1961, 1968, or any dishonest conduct or practices under federal or state law;

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 executive director pursuant to subsection (3) of this section, it may request a hearing as set forth in KRS Chapter 304.2.

Section 7. Consolidated or Combined Audits. An insurer may make written application to the executive director 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% 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. Financial statements furnished pursuant to Section 4 of this administrative regulation shall be examined by an independent certified public accountant. The examination of the insurer's financial statements shall be conducted in accordance with generally accepted auditing standards. Consideration shall also be given to other procedures illustrated in the financial condition examiner's handbook of the National Association of Insurance Commissioners (1990), incorporated by reference and available from the Kentucky Officeof Insurance, 215 West Main Street, Frankfort, Kentucky 40601, from 8 a.m. to 4:30 p.m. (ET), weekdays, which the independent certified public accountant deems necessary.

Section 9. Notification of Adverse Financial Condition. (1) 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 executive director as of the balance sheet date currently under examination or that the insurer does not meet the minimum capital and surplus requirements of the Kentucky Insurance Code as of that date. An insurer which has received a report pursuant to this subsection shall forward a copy of the report to the executive director 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 executive director. 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 executive director a copy of its report within the next five (5) business days.

(2) It is not the intent of the commissioner that an independent certified public accountant 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 (1990), incorporated by reference and available from the Kentucky Office of Insurance, 215 West Main Street, Frankfort, Kentucky 40601, 8 a.m. to 4:30 p.m. (ET), weekdays.

Section 10. Report on Significant Deficiencies in Internal Controls. In addition to the annual audited financial statements, each insurer shall furnish the executive director with a written report prepared by the accountant describing significant deficiencies in the insurer's internal control structure noted by the accountant during the audit. SAS 60 communication of internal control structure matters noted in an audit (AU sec. 325 of the Professional Standards of the American Institute of Certified Public Accountants, (1990), available from the Kentucky Office of Insurance, 215 West Main Street, Frankfort, Kentucky 40601, 8 a.m. to 4:30 p.m. (ET), weekdays) requires an accountant to communicate significant deficiencies (known as "reportable conditions") noted during a financial statement audit to the appropriate parties within an entity. No report shall be issued if the accountant does not identify significant deficiencies. If significant deficiencies are noted, the written report shall be filed annually by the insurer with the office within sixty (60) days after the filing of the annual audited financial statement. The insurer is required to provide a description of remedial actions taken or proposed to correct significant deficiencies, if such actions are not described in the accountant's report.

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 the Code of Professional Conduct and Pronouncements of the American Institute of Certified Public Accountants (January 12, 1988) and statutes, administrative regulations, and rules of professional conduct of the State Board of Accountancy of Kentucky (1991), both available from the Kentucky Officeof Insurance, 215 West Main Street, Frankfort, Kentucky 40601, 8 a.m. to 4:30 p.m. (ET), weekdays, or similar code;

(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. Nothing in this administrative regulation prohibits the accountant from utilizing staff as the accountant deems appropriate where use is consistent with the standards prescribed by generally accepting 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 executive director will be relying on this information in monitoring and administrative regulation of 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 executive director, 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;

(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 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 office examiners all work papers prepared in the conduct of the accountant's examination and any communications related to the audit between the accountant and the insurer, at the offices of the insurer, at the offices of the office, or any other reasonable place designated by the executive director. The insurer shall require that the accountant retain the audit work papers and communications until the office 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 office 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 office. Reviews by the office 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 office.

Section 13. Exemptions and Effective Dates. (1) Upon written application of any insurer, the executive director may grant an exemption from compliance with this administrative regulation if the executive director 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 Chapter 304.2

(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, 1991, and each year thereafter unless the executive director 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 executive director permits otherwise:

(a) As of December 31, 1991, file with the executive director:

1. Report of independent certified public accountant;

2. Audited balance sheet; and

3. Notes to audited balance sheet.

(b) For the year ending December 31, 1991, and each year thereafter, these insurers shall file with the executive director all reports required by this administrative regulation. Foreign insurers shall comply with this administrative regulation for the year ending December 31, 1991, and each year thereafter, unless the executive director permits otherwise.

Section 14. 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 domiciliary 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 statement filed with the executive director 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. (18 Ky.R. 959; eff. 11-8-91; TAm eff. 8-9-2007.)