Thursday, January 8, 2009

The Liquidation Process in New York - Part V: The Legislative Cure – Masking the Disease?

Can you imagine a domestic New York insurer going to the Legislature with a proposed bill that would increase the insurers reporting requirements and expand its regulatory oversight? At the very least, one would expect the Legislature to look at the request with skepticism and seek to understand the motives behind the request. One would certainly not expect the Legislature to pass the bill or for the Governor to sign it without any significant airing of the problems and discussion of the proposed solution. That, however, is essentially what happened last year when the Liquidation Bureau presented the Legislature with a bill requiring annual audits of the Bureau and the estates under its management. The bill, as requested by the Bureau and without any significant public airing, was passed by the Legislature last June and signed into law in September [Laws of 2008, Chapter 540, amending §7405(g)].

So what could be so bad about requiring the Bureau to conduct annual audits? Why wouldn’t the revised law “provide greater transparency for policyholders and the public and to improve the Bureau’s fiscal accountability” as proclaimed by the Bureau’s August 7, 2008 press release? As Shakespeare wrote, let me count the ways!

A Failure to Provide an Oversight Function

First and foremost, providing for audits assumes that an oversight function already exists. It does not. As discussed in earlier installments of this series, the moment an order of rehabilitation or liquidation is signed, the superintendent of insurance becomes the receiver responsible for managing the estate and ceases to be its regulator – a void that is not addressed by the law. Providing for audits without providing for oversight responsibility, therefore, is placing the proverbial carriage before the horse.

Supporters point out that the new law provides that the audits be provided to the insurance department and the Legislature, therefore making them publicly available. But for what purpose and effect? Once an order of rehabilitation or liquidation is signed, the insurance department ceases regulating the insolvent company and has been given no charge – statutorily or otherwise – to conduct any review or analysis of the audited statements. Because the Court of Appeals has determined that the Liquidation Bureau is not a state agency, in large part because it does not involve the management or use of state funds, the state comptroller has no audit authority over it. It is also doubtful that the Legislature intends to assume any responsibility for the oversight of the estates or the Liquidation Bureau. And if members of the general public sought to fill this oversight void by challenging the reports or their methodologies, I suspect they would be ignored or summarily tossed for lack of standing.

Curiously, the law does not provide for submitting the reports to one entity with statutory authority over insolvent estates – the courts. In fact, the law does not provide for any regular reports or statements to be filed with the liquidation or rehabilitation court. And if the court were provided with the audited statements, it would most likely be quick to point out that its function is limited to ruling on matters put before them by the receiver, and not to act as the regulator of the estate or its managers.

A Failure to Address the Reporting Deficiencies

Secondly, the new law perpetuates and further imbeds the reporting deficiencies of the current law. Rather than following the §307 standard for all other licensed companies (filing statutory statements by March 1 with the statements audited by June 1 each year – see Part IV-A of this series), the current law allows statements to be filed for each estate subject to rehabilitation or liquidation “upon whichever standard the [estate] conducts its financial affairs.” Also, these statements do not have to be filed until the end of April, and are unaudited. These statements have proven to be of little value to policyholders, creditors, regulators, legislators, guaranty funds, investors or other interested parties, or even as a management tool to the Liquidation Bureau itself. Unfortunately, the new law not only fails to address these reporting deficiencies, it perpetuates them and wraps them in the protective cloak of an audit.

Most significantly:

• The new law dilutes the reporting requirements even further by allowing for combining the statements of the individual estates rather than requiring separate statements for each company in liquidation or rehabilitation. This combining is directly contrary to the whole receivership concept. Each estate is a separate entity with a distinct book of business under the supervision of a designated Supreme Court Justice. The idea of combining the results of these separate entities is new with the current administration and serves no useful disclosure purpose. Parties interested in one estate may have no interest in another estate, and reviewing combined statements would be of no help to interested parties in determining such things as the cost or effectiveness of the management of an estate, its success in marshalling assets, the likelihood of distributions to policyholders, guaranty funds or other creditors, or the prospects for new investor interest.

• Rather than seeking reporting consistency, such as by requiring reports to be filed on a basis consistent with other licensed companies under §307, the new law maintains the old reporting standard (“upon whichever standard each corporation conducts its respective financial affairs”). The new law, therefore, perpetuates the Liquidation Bureau’s open ended ability to prepare statements on some hybrid or mixed (or unknown) accounting basis, which has been one of the main reasons for the lack of meaningful and reliable information about the various estates and the Liquidation Bureau itself over the years.

• As stated before, there is no statutory requirement for the filing of any kind of regular, periodic report – financial or otherwise – with the liquidation or rehabilitation court.

• The new law provides for the filing of the audited statements by August 1 of each year without any explanation why auditors would need two more months than all other licensed companies are allowed under §307. By the time anyone can review and consider the consequences of these statements, they will be significantly out of date thereby diluting any value or insight they may have provided.

• The bill memorandum in support of the new law stated that the cost of the financial statements and audit opinions “will be below $300,000 annually.” That is for about 30 estates plus the Bureau itself – about $10,000 per audit. Based on the original engagement letters as posted on the Liquidation Bureau’s web site and subsequently removed, the cost of the 2006 audits was estimated to exceed $1.1 million and to be completed by Fall 2007. Those engagement letters were only for 2006, and the Bureau subsequently expanded the engagement to cover 2007 as well (although the engagement letters for 2007 were never posted). The 2006 audits were not completed until October 2008, and the 2007 audits, promised by year-end 2008, are still not completed. The full cost of these audits – all of which are fully borne by the creditors and policyholders of the estates – is unknown, but scary to anticipate. Believing that 30 plus audits can be done annually for “less than $300,000” is even scarier.

• The new law requires an audit of every estate “subject to liquidation or rehabilitation” no matter the size, age or status of the estate. There is no discretion or de minimus exception, which is likely to result in totally unnecessary and disproportionately costly audits for some estates, particularly those at the end of the liquidation process or with minimal remaining assets or exposure. Even §307 exempts small companies from the audit requirement.


Financial audits have their place and can be useful control and management tools. However, without having first established a meaningful oversight function; without having first established a consistent, recognized reporting standard; and without providing for timeliness of the reports; these audits are nothing more than a costly waste of estate assets for appearances sake – a rush to fix a problem without understanding the problem.

If there is a theme to this series of articles it is that the problems with the liquidation process in New York are systemic. The new law does not address these systemic problems. On the contrary, it protects the past through an audit of what is rather than an examination of what should be. The new law gives all the appearances of providing “greater transparency and accountability” while in fact it further imbeds the current deficiencies of the receivership system and makes the task of future, meaningful change that much more difficult to recognize and achieve.

Audit Endnote

On October 29, 2008 the Liquidation Bureau issued a press release proclaiming:

Bureau Receives Unqualified “Clean” Opinion from Auditor on its 2006 Financial Data”

The full 128-page report is posted on the Bureau’s web site, including the auditor’s opinion letters. Very impressive! The audit firm, Amper, Politziner & Mattia LLP, is a respected mid-level accounting firm and there is no reason to believe that they performed their review other than thoroughly, diligently and competently. Although the original engagement letters (posted and subsequently removed from the Bureau’s web site) were more akin to a review than an audit – primarily because the sampling and access to records was to be provided by Bureau personnel not the auditors – it is reasonable to assume based on the opinion letters that the scope of the engagement was expanded and changed before the completion of the audits.

One wonders, however, what the Bureau was seeking to convey by its proclamation of a “clean” 2006 audit. Without getting into a discussion of what constitutes a “clean” opinion, it is interesting to note that the “clean” year 2006 pre-dates the current administration, which has repeated castigated the prior Bureau leadership as having been fraught by incompetence, greed and corruption. If that was the case, how was it possible for the report to be “clean”? Yes, the current administration could take credit for cleaning up the mess created by their predecessors, but then the 2006 report would not have been “clean” – 2007 or 2008 maybe, but not 2006. Is it possible that their predecessors were not as evil as pictured? Is it possible that the problems with the Bureau are the system and not the personnel?

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