Has Sarbanes-Oxley Made Insurance Riskier?

• Published in: Insurance Journal 2023-01
• Main Author: Lehmann, R J
• Format: Article
• Language: English
• Subjects: Accounting; Auditing; Conservatism; Financial reporting; Public companies; Solvency; State regulation
• ISSN: 0020-4714

Grace and Zhang focus on the impact that annual internal controls reports required both by Section 404 of SOX and the National Association of Insurance Commissioners' (NAIC) Model Audit Rule (MAR) have had on insurers' likelihood to adopt "conditionally conservative" accounting practices, in which unrealized losses are recognized more quickly than unrealized gains. Because both Section 404 and MAR create penalties for financial irregularities that can apply personally to chief executive officers and chief financial officers, it would be reasonable to assume that the rules would make regulated firms more likely to be conservative in their financial reporting. Under the NAIC's Statutory Accounting Principles, insurers must make annual updates to their estimates of incurred losses from a given accident year for each of their past 10 development years. Because not all claims are reported during the coverage period and reported claims may take years to settle, loss-reserve estimates will become more accurate over time as claims are paid and more information about the amount of "true" losses becomes known. In getting swept up in the post-Enron reforms, state insurance regulators may have too closely copied an auditing model that was designed to yield more accurate valuations of public companies, rather than one fit to purpose for their role as prudential regulators.