For Insurance Companies: The Current Perspective Thomas F. English New York Life Insurance Company Donald R. Stading Ameritas Life Insurance Corp. Stephen E. Roth Sutherland Asbill & Brennan LLP Cynthia M. Krus Sutherland Asbill & Brennan LLP 2005 Sutherland Asbill & Brennan LLP Introduction Despite the fact that there is no legal requirement to do so, there has been some recent movement within the non-public company sector of the insurance industry to adopt certain corporate governance best practices as set forth in the Sarbanes-Oxley Act of 2002 (SOX) and the various securities exchanges. The insurance industry is confronted with certain unique problems in applying governance principles. Any governance principles adopted by the insurance industry should be flexible enough to take into account the variety of insurers within its purview 2005 Sutherland Asbill & Brennan LLP Introduction Insurance companies should anticipate that the certain governance and disclosure reforms will become increasingly expected of them, especially in light of the NAICs proposed revisions to the Model Audit Rule incorporating certain aspects of SOX. Our outline discusses best practices for officers and directors of insurance companies to consider given the enhanced scrutiny inherent in todays environment. Obviously, one size does not fit all and the board of each company should tailor procedures to its own circumstances. 2005 Sutherland Asbill & Brennan LLP Tone at the Top Having the right tone at the top is one of the most important factors in ensuring that the board meets all its duties. The right tone at the top will establish the ethical culture of the corporation and permeate the corporations relationships with employees, the business community and regulators. The board of directors should participate in creating the right tone at the top and oversee how it is being communicated to all employees and constituents of the corporation. 2005 Sutherland Asbill & Brennan LLP Director Independence Companies will increasingly be expected to have a board of directors with at least a significant number, if not a majority, of independent directors. In general, independent directors are individuals who have no employment or other material business relationship with the company. Several corporate governance guidelines suggest that directors should be independent in both fact and appearance. Director independence is believed to enhance the objective exercise of independent business judgment by boards for the benefit of the companys shareholders and other constituencies. The determination of what constitutes independence should take into account the industry and regulatory structure that a company operates within. 2005 Sutherland Asbill & Brennan LLP Board Committees It is best practice for a board to have the following committees: an audit committee, a compensation committee, and a nominating/corporate governance committee. Each committee may formally establish a charter that specifies its responsibilities and the manner and frequency of meeting and reporting to the board of directors. There is no one size fits all template for board structures. When appropriate, smaller boards may opt to always meet as the full board with break-out sessions for independent directors to perform committee-type functions. 2005 Sutherland Asbill & Brennan LLP Self Assessments Boards and board committees of companies are increasingly expected to complete annual self assessments. The self evaluation is intended to serve as a useful tool for the board to assess its strengths and weaknesses. The Business Roundtable recommends that the independent directors periodically review the performance of the CEO and, together with the CEO, the performance of the remaining upper management. 2005 Sutherland Asbill & Brennan LLP Executive Sessions Companies will increasingly be expected to require non-management members of their board of directors to meet in executive sessions. These executive sessions should be viewed primarily as a safety valve to deal with problems and not as a forum for revisiting matters already considered by the full board. 2005 Sutherland Asbill & Brennan LLP Corporate Governance Guidelines Companies will increasingly be expected to adopt a set of basic board of directors governance policies to guide how their boards should govern themselves. Corporate governance guidelines typically describe the board of directors position on the following corporate governance guidelines: Director qualification standards; Director responsibilities; Director access to management and, as necessary and appropriate, independent advisors; Director compensation; Director orientation and continuing education; Management succession; and Annual performance evaluation of the board. 2005 Sutherland Asbill & Brennan LLP Code of Ethics Adoption and implementation of a code of ethics is one of the most common practices in corporate governance. It is increasingly expected that all companies will have a code of ethics in place to ensure that employees conduct themselves in a fair and ethical manner. Topics commonly addressed in a code of ethics are as follows: Conflict of interest; Corporate opportunities; Confidentiality; Fair dealing; Protection and proper use of company assets; Compliance with laws, rules and regulations; and Encouraging the reporting of any illegal or unethical behavior 2005 Sutherland Asbill & Brennan LLP Whistleblower Procedures Whistleblower procedures ensure that employees are able to report wrongdoing without the threat of retaliation. Section 301 of SOX requires audit committees of public companies to establish procedures for: The receipt, retention, and treatment of complaints received by the company regarding accounting, internal accounting controls, or auditing matters; and The confidential, anonymous submission by employees of the company of concerns regarding questionable accounting or auditing matters. Section 806 of SOX provides substantial protection to employee whistleblowers who report certain company misconduct. 2005 Sutherland Asbill & Brennan LLP The Model Audit Rule The NAICs proposed revisions to the Model Audit Rule would subject insurance companies to corporate governance rules similar to those mandated by SOX. The proposed revisions include: Creation of an independent audit committee; Designation of an audit committee financial expert; Prohibition of non-audit services; Pre-approval of audit and non-audit services; Rotation of lead audit partner; and Managements report on internal control over financial reporting. 2005 Sutherland Asbill & Brennan LLP The Model Audit Rule Audit Committee Independence Under the proposed revisions, each member of the audit committee would be required to be a member of the board of directors and independent of the insurer. In order to be considered independent under the proposed revisions, an audit committee member may not: Accept any consulting, advisory or other compensatory fee from the insurer other than in his/her capacity as a member of the audit committee, the board or any other board committee; or Be an affiliated person of the insurer or any subsidiary thereof. The number of independent audit committee members is based on direct and assumed premium volume: $0 - $25 million = no minimum, but encouraged $25 - $100 million = 50% or more >$100 million = 75% or more NOTE: The proposed revisions allow for an exception where domiciliary law requires participation by an otherwise non-independent member. The proposed revisions would permit the audit committee of the holding company to act on behalf of the subsidiaries. 2005 Sutherland Asbill & Brennan LLP The Model Audit Rule Audit Committee Financial Expert Pursuant to the proposed revisions, all members of the audit committee should be financially literate and at least one individual should qualify as an audit committee financial expert. An audit committee financial expert should have the following attributes: An understanding of generally accepted accounting principles or statutory accounting principles; The ability to assess the general application of such principles in connection with the accounting for estimates, accruals and reserves; Experience preparing, auditing, analyzing or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by the companys financial statements, or experience actively supervising one or more persons engaged in such activities; An understanding of internal controls and procedures for financial reporting; and An understanding of audit committee functions. 2005 Sutherland Asbill & Brennan LLP The Model Audit Rule Audit Committee Financial Expert An audit committee financial expert should have acquired such attributes through: Education and experience as a principal financial officer, principal accounting officer, controller, public accountant or auditor or experience in one or more positions that involve the performance of similar functions; Experience actively supervising a principal financial officer, principal accounting officer, controller, public accountant, auditor or person performing similar functions; Experience overseeing or assessing the performance of companies or public accountants with respect to the preparation, auditing or evaluation of financial statements; or Other relevant experience. 2005 Sutherland Asbill & Brennan LLP The Model Audit Rule Internal Control Over Financial Reporting The proposed revisions to the Model Audit Rule would incorporate the substantive requirements of the Section 404 of SOX. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles or statutory accounting principles. Under the proposed revisions, an insurer would be required to file a report prepared by management regarding managements assessment of the insurers internal control over financial reporting. 2005 Sutherland Asbill & Brennan LLP The Model Audit Rule Internal Control Over Financial Reporting Managements report on internal control over financial reporting would contain: A statement of managements responsibility for establishing and maintaining adequate internal control over financial reporting; A statement identifying the framework used by management to evaluate the effectiveness of internal control over financial reporting; Managements assessment of the effectiveness of internal control over financial reporting; A statement indicating that the independent certified public accountant that audited financial statements has issued an attestation report on managements assessment of internal control over financial reporting; Disclosure of any material change in internal control over financial reporting that occurred in the fourth quarter; and Disclosure of any material weaknesses.