business ethics - bkd · •a member shall not knowingly permit a person whom the member has the...

Business Ethics

Presented by: Thomas F. Wheeland, CPA, JD

• Who are we accountable to at work & home?

• Some behaviors may be ethically neutral but do not build trust or a sense of community

• Every corporate culture has its good & bad sides (Arthur Andersen)

• When our weaknesses are exposed, we can either confront them or continue down a path not worth venturing

• Document/ask why/seek counsel or Counsel

• Anyone can lead when things are going well

• Will our moment of pause/thought cause others to do so as well? In other words, someone may call & ask you to do something that makes you feel uneasy. If you pause & say “Let me think about that,” it may be enough for that person to do the same.

• Others in room may have similar standards. Parallels for all in audience.

• Who are our influencers? At work, home, family, spiritual lives, etc.

• HBR article on teamwork: internal self-awareness, external self-awareness, personal accountability

• Know your tendencies & strengths & weaknesses

Notes

• The code consists of principles & rules as well as interpretations & other guidance

• The principles provide the framework for the rules that govern the performance of the members’ professional responsibilities

• A member who departs from the interpretations shall have the burden of justifying such departure in any disciplinary hearing

• The term member, when used in part 1 of the code, applies to & means a member in public practice; when used in part 2 of the code, applies to & means a member in business; & when used in part 3 of the code, applies to & means all other members, such as those members who are retired or unemployed

Principles, Rules & Interpretations

• A member shall not knowingly permit a person whom the member has the authority or capacity to control to carry out on his or her behalf, either with or without compensation, acts that, if carried out by the member, would place the member in violation of the rules

• Further, a member may be held responsible for the acts of all persons associated with the member in public practice whom the member has the authority or capacity to control

• Even if the member is unable to control the actions or relationships of such persons or entities, the member’s independence may still be impaired

Application of the Code

• If a member identifies a breach of any other provision of this code, the member should evaluate the significance of the breach & its effect on the member’s ability to comply with the rules of the code

• The member should take whatever actions may be available, as soon as practicable, to satisfactorily address the consequences of the breach

Application of the Code

• The code uses certain drafting conventions to enhance the clarity of the interpretations & definitions

• For example, when the term “should consider” is used in connection with a specified procedure or action, consideration of the procedure or action by the member is presumptively required

• “Consider” is used when the member is required to think about several matters

• “Evaluate” is used when the member has to assess & weigh the significance of a matter

• “Determine” is used when the member has to come to a conclusion & make a decision on a matter

Drafting Conventions

• Membership in the American Institute of CPAs is voluntary

• By accepting membership, a member assumes an obligation of self-discipline above & beyond the requirements of laws & regulations

• The principles call for an unswerving commitment to honorable behavior, even at the sacrifice of personal advantage

Preamble

• In carrying out their responsibilities as professionals, members should exercise sensitive professional & moral judgments in all their activities

• Members also have a continuing responsibility to cooperate with each other to improve the art of accounting, maintain the public’s confidence & carry out the profession’s special responsibilities for self-governance

Responsibilities

• Members should accept the obligation to act in a way that will serve the public interest, honor the public trust & demonstrate a commitment to professionalism

• A distinguishing mark of a profession is acceptance of its responsibility to the public

o The accounting profession’s public consists of those who rely on the objectivity & integrity of members to maintain the orderly functioning of commerce

o Includes clients, credit grantors, governments, employers, investors, the business & financial community & others

The Public Interest

• In discharging their professional responsibilities, members may encounter conflicting pressures from each of those groups

• In resolving those conflicts, members should act with integrity, guided by the precept that when members fulfill their responsibility to the public, clients’ & employers’ interests are best served

• Those who rely on members expect them to discharge their responsibilities with integrity, objectivity, due professional care & a genuine interest in serving the public

The Public Interest

• To maintain & broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity

• Integrity can accommodate the inadvertent error & honest difference of opinion; it cannot accommodate deceit or subordination of principleo “Am I doing what a person of integrity would do?”

o “Have I retained my integrity?”

• Integrity also requires a member to observe the principles of objectivity & independence & of due care

Integrity

• A member should maintain objectivity

• A member in public practice should be independent in fact & appearance when providing audit & other attestation services

• The principle of objectivity imposes the obligation to be impartial, intellectually honest & free of conflicts of interest

• Regardless of service or capacity, members should protect the integrity of their work, maintain objectivity & avoid any subordination of their judgment

Objectivity & Independence

• Continuing assessment of client relationships & public responsibility

• Although members not in public practice cannot maintain the appearance of independence, they nevertheless have the responsibility to maintain objectivity in rendering professional services

• Members must be scrupulous in their application of generally accepted accounting principles & candid in all their dealings with members in public practice

Objectivity & Independence

• A member should observe the profession’s technical & ethical standards, strive continually to improve competence & the quality of services & discharge professional responsibility to the best of the member’s ability

• Due care requires a member to discharge professional responsibilities with competence & diligence

• Competence is derived from a synthesis of education & experience

• In all engagements & in all responsibilities, each member should undertake to achieve a level of competence that will help assure that the quality of the member’s services meets the high level of professionalism required by these principles

Due Care

• Competence represents the attainment & maintenance of a level of understanding & knowledge that enables a member to render services with facility & acumen

• Each member is responsible for assessing his or her own competence of evaluating whether education, experience & judgment are adequate for the responsibility to be assumed

• Diligence imposes the responsibility to render services promptly & carefully, to be thorough & to observe applicable technical & ethical standards

• Due care requires a member to plan & supervise adequately any professional activity for which he or she is responsible

Due Care

• Each of these principles should be considered by members in determining whether or not to provide specific services in individual circumstances

• In some instances, they may represent an overall constraint on the nonaudit services that might be offered to a specific client

• No hard-&-fast rules can be developed to help members reach these judgments, but they must be satisfied that they are meeting the spirit of the principles in this regard

Scope & Nature of Services

• In the absence of an interpretation that addresses a particular relationship or circumstance, a member should evaluate whether that relationship or circumstance would lead a reasonable & informed third party who is aware of the relevant information to conclude that there is a threat to the member’s compliance with the rules that is not at an acceptable level

• The code specifies that in some circumstances no safeguards can reduce a threat to an acceptable levelo For example, the code specifies that a member may not

subordinate the member’s professional judgment to others without violating the “Integrity & Objectivity Rule”

o A member may not use the conceptual framework to overcome this prohibition or any other prohibition or requirement in the code

Part 1 – Members in Public Practice

• Members should evaluate identified threats both individually & in the aggregate because threats can have a cumulative effect on a member’s compliance with the rules

• Identify threats – the existence of a threat does not mean that the member is in violation of the rules

Conceptual Framework Approach

• Evaluate the significance of a threat

o A threat is at an acceptable level when a reasonable & informed third party who is aware of the relevant information would be expected to conclude that the threat would not compromise the member’s compliance with the rules

o If the member evaluates the threat & concludes that a reasonable & informed third party who is aware of the relevant information would be expected to conclude that the threat does not compromise a member’s compliance with the rules, the threat is at an acceptable level, & the member is not required to evaluate the threat any further under this conceptual framework


• Identify & apply safeguards o If, in evaluating the significance of an identified threat, the

member concludes that the threat is not at an acceptable level, the member should apply safeguards to eliminate the threat or reduce it to an acceptable level

o In other cases, an identified threat may be so significant that no safeguards will eliminate the threat or reduce it to an acceptable level, or the member will be unable to implement effective safeguards

o Under such circumstances, providing the specific professional services would compromise the member’s compliance with the rules, & the member should determine whether to decline or discontinue professional services or resign from the engagement


• Adverse interest

• Advocacy

• Familiarity

• Management participation

• Self-interest

• Self-review

• Undue influence

Threats

• Safeguards that may eliminate a threat or reduce it to an acceptable level• Safeguards created by the profession, legislation or

regulation

• Safeguards implemented by the client [it is not possible to rely solely on safeguards implemented by the client to eliminate or reduce significant threats to an acceptable level]

• Safeguards implemented by the firm, including policies & procedures to implement professional & regulatory requirements

Safeguards

• The following are examples of safeguards created by the profession,

legislation or regulation

o Education & training requirements on independence & ethics rules

o Continuing education requirements on independence & ethics

o Professional standards & the threat of discipline

o External review of a firm’s quality control system

o Legislation establishing prohibitions & requirements for a firm or a firm’s professional employees

o Competency & experience requirements for professional licensure

o Professional resources, such as hotlines, for consultation on ethical issues

Safeguards

• Examples of safeguards implemented by the client that would operate in combination with other safeguards are as follows

o The client has personnel with suitable skill, knowledge or experience who make managerial decisions about the delivery of professional services & make use of third-party resources for consultation as needed

o The tone at the top emphasizes the client’s commitment to fair financial reporting & compliance with the applicable laws, rules, regulations & corporate governance policies

o Policies & procedures are in place to achieve fair financial reporting & compliance with the applicable laws, rules, regulations & corporate governance policies

o Policies & procedures are in place to address ethical conduct

o A governance structure, such as an active audit committee, is in place to help ensure appropriate decision making, oversight & communications regarding a firm’s services

o Policies are in place that bar the entity from hiring a firm to provide services that do not serve the public interest or that would cause the firm’s independence or objectivity to be considered impaired

Safeguards

• The following are examples of safeguards implemented by the firmo Firm leadershipo Policies & procedures that are designed to implement &

monitor engagement quality control o Policies & procedures that are designed to identify interests

or relationships between the firm or its partners & professional staff & the firm’s clients

o The use of different partners, partner equivalents & engagement teams from different offices or that report to different supervisors

o A means for informing partners & professional staff of attest clients & related entities from which they must be independent

Safeguards

• The following are examples of safeguards implemented by the firm

o Disclosures to the audit committee regarding the nature of the services that are or will be provided & the extent of the fees charged or to be charged

o The involvement of another professional accountant who reviews the work that is done for a client or otherwise advises the engagement team

o Rotation of senior personnel who are part of the engagement team

o A consultation function that is staffed with experts in accounting, auditing, independence, ethics & reporting matters who can help engagement teams

▪ Assess issues when guidance is unclear or when the issues are highly technical or require a great deal of judgment

▪ Resist undue pressure from a client when the engagement team disagrees with the client about such issues

o Client acceptance & continuation policies

Safeguards

• An ethical conflict arises when a member encounters one or both of the following

o Obstacles to following an appropriate course of action due to internal or external pressures

o Conflicts in applying relevant professional standards or legal standards

• For example, a member suspects a fraud may have occurred, but reporting the suspected fraud would violate the member’s responsibility to maintain client confidentiality

• If the ethical conflict remains unresolved, the member will in all likelihood be in violation of one or more rules if he or she remains associated with the matter creating the conflict

Ethical Conflicts

• A member shall maintain objectivity & integrity, shall be free of conflicts of interest & shall not knowingly misrepresent facts or subordinate his or her judgment to others

• A member would be considered in violation of the “Integrity & Objectivity Rule” if the member cannot demonstrate that safeguards were applied that eliminated or reduced significant threats to an acceptable level

Integrity & Objectivity

• Providing corporate finance services to a client seeking to acquire an audit client of the firm, when the firm has obtained confidential information during the course of the audit that may be relevant to the transaction

• Preparing valuations of assets for two clients who are in an adversarial position with respect to the same assets

• A client asks the member to provide tax or personal financial planning services to its executives, & the services could result in the member recommending to the executives actions that may be adverse to the company

Integrity & Objectivity –Conflicts of Interest

Before accepting a new client relationship, engagement or business relationship, a member should take reasonable steps to identify circumstances that might create a conflict of interest, including identification of

a. The nature of the relevant interests & relationships between the parties involved &

b. The nature of the service & its implication for relevant parties


In cases where an identified threat may be so significant that no safeguards will eliminate the threat or reduce it to an acceptable level, or the member is unable to implement effective safeguards, the member should (a) decline to perform or discontinue the professional services that would result in the conflict of interest; or (b) terminate the relevant relationships or dispose of the relevant interests to eliminate the threat or reduce it to an acceptable levelWhen a conflict of interest exists, the member should disclose the nature of the conflict of interest to clients & other appropriate parties affected by the conflict & obtain their consent to perform the professional services


When a member serves as a director of an entity, such as a bank, the member’s fiduciary responsibilities to the entity may create threats to the member’s compliance with the “Integrity & Objectivity Rule” & the “Confidential Client Information Rule.” For example, an adverse interest threat to the member’s objectivity may exist if the member’s clients are customers of the entity or likely to engage in significant transactions with the entityNevertheless, if the member’s clients are likely to engage in significant transactions with the entity, it would be more appropriate for the member to serve as a consultant to the board

Integrity & Objectivity –Director Positions

When a member offers to a client or accepts gifts or entertainment from a client, self-interest, familiarity or undue influence, threats to the member’s compliance with the “Integrity & Objectivity Rule” may exist

Threats to compliance with the “Integrity & Objectivity Rule” would not be at an acceptable level & could not be reduced to an acceptable level by the application of safeguards & the member would be presumed to lack integrity in violation of the “Integrity & Objectivity Rule” in the following circumstances

a. The member offers to a client or accepts gifts or entertainment from a client that violate the member’s or client’s policies or applicable laws, rules & regulations; &

b. The member knows of the violation or demonstrates recklessness in not knowing

Threats are at an acceptable level when gifts or entertainment are reasonable in the circumstances

Integrity & Objectivity –Gifts & Entertainment

A member would be considered to have knowingly misrepresented facts in violation of the “Integrity & Objectivity Rule” if the member

a. Makes, or permits or directs another to make, materially false & misleading entries in an entity’s financial statements or records

b. Fails to correct an entity’s financial statements or records that are materially false & misleading when the member has the authority to record the entries; or

c. Signs, or permits or directs another to sign, a document containing materially false & misleading information

Integrity & Objectivity –Misrepresentation

Differences of opinion on technical issues may arise. If the member concludes that the position results in a material misrepresentation of fact or a violation of applicable laws or regulations, then threats would not be at an acceptable level. In such circumstances, the member should discuss his or her concerns with the supervisorIf unresolved, the member should discuss his or her concerns with the appropriate higher level(s) of management within the member’s organizationMay require communication with regulatory authorities or legal counsel & documentation is encouraged. Resignation may not be sufficient!

Integrity & Objectivity –Subordination of Judgment

The provision of nonattest services, such as tax & consulting services, could create an advocacy threat

Some professional services involving client advocacy may stretch the bounds of performance standards, go beyond sound & reasonable professional practice or compromise credibility, thereby creating threats to the member’s compliance with the rules & damaging the reputation of the member & the member’s firm

Seems a bit vague, but the purpose is to help ensure integrity, objectivity & independence

Integrity & Objectivity –Client Advocacy

Before disclosing confidential client information to a third-party service provider, the member should inform the client, preferably in writing, that the member may use a third-party service provider

A member is not required to inform the client when he or she uses a third-party service provider to provide administrative support services to the member

Integrity & Objectivity –Third-Party Providers

• A member should evaluate whether a relationship or circumstance would lead a reasonable & informed third party who is aware of the relevant information to conclude that there is a threat to either the member’s or firm’s independence, or both, that is not at an acceptable level

Independence

• Adverse interest – example would be threatened or pending litigation by member or attest client

• Advocacy – promoting of attest client’s securities for a IPO

• Familiarity – close relative in key position at attest client

• Management participation – designing internal controls for attest client

• Self-interest – preparing & reviewing tax provision• Undue influence – attest client threatens to replace

member or member’s firm over disagreement on application of an accounting principle

Independence – Threats

Example - E-Mail from CFO to Staff Accountant

Dear Mike,

I have heard good things about your work and it appears you are on the fast track. Hoping you can do me a solid. I know the policy for approving payments to new vendors can take time. My brother-in-law’s company has been providing IT consulting services as we were in a real bind because of turnover. The invoice attached is only for $5,000 and it would be great if you could facilitate its payment as soon as possible.

Thanks again and keep up your rockstar ways!

Chad


Example - E-Mail from Client to Audit Partner

Dear Kathy,

I know you have been working hard to resolve our conflict related to the tax return penalty that was caused by the deadline your staff missed. I am certainly willing to be reasonable and hope you can be as well.

The GAAP disclosure you described in yesterday’s meeting may be technically required, but it seems to border on “over disclosure” and could impact the company’s pending IPO. I would be more inclined to pass on the tax return issue if you could exercise some flexibility around the disclosure.

Let’s discuss!

Bob


Example - E-Mail from Client to Tax Partner

Dear Tara,

It was nice to meet you at the recent audit committee meeting. Welcome to the engagement. You probably thought your role would be limited to reviewing the tax provision. Surprise! Surprise!

We are in a pickle. Our sales and use tax person left suddenly. I need a staff person to prepare and file sales and use tax returns. No one here knows anything about these types of filings. So he/she will kind of be on their own. We need someone pretty responsible and motivated. They will also be allowed to approve checks to remit any taxes due.

Let me know how much it will cost. Be gentle as you have me at a severe disadvantage.

Kind regards,

Fritz


• Network firms

• Alternative practice structures

• Use of nonindependent CPA firms

• Firm mergers & acquisitions

o Personnel

o Nonattest services

• Client affiliates

Special Rules – Independence

• Reissued reports

• Contractual terms

• Unpaid fees (one year prior to the date of the current-year report)

• Financial interests o Mutual fund holdings

o Retirement & compensation plans

o Trusts & estates

o Benefit plans

o Bank & brokerage accounts

o Insurance policies (with or without investment options)

• Family members

• Former & subsequent employment by/with attest client

Special Rules – Independence

• Threatso Self-review

o Management participation

o Advocacy

• Timing of nonattest services & attest services o Assume nonattest services otherwise impair independence

o Independence not impaired if timing requirements met

• Cumulative effect guidanceo Individually, nonattest services do not impair independence

o Cumulative effect could impair independence

Independence – Nonattest Services

• Management responsibilities

o Assumption of management responsibilities for attest client

o No safeguards can reduce risk to acceptable level

o The member must determine that the attest client & its management agree to

i. Assume all management responsibilities as described in the “Management Responsibilities” interpretation,

ii. Oversee the service, by designating an individual, preferably within senior management, who possesses suitable skill, knowledge &/or experience. The member should assess & be satisfied that such individual understands the services to be performed sufficiently to oversee them. However, the individual is not required to possess the expertise to perform or reperform the services,

iii. Evaluate the adequacy & results of the services performed, &

iv. Accept responsibility for the results of the services

o Document understanding

Independence – Nonattest Services

Examples of advisory services provided at an acceptable level include

a. Providing advice, research materials & recommendations to assist management in performing its functions & making decisions,

b. Attending board meetings as a nonvoting advisor,

c. Interpreting financial statements, forecasts or other analyses, &

d. Providing management with advice regarding its potential plans, strategies or relationships

Independence – Advisory Services

• Factors to be considered includeo The level of subjectivity involved,

o The materiality of the results if the services, either individually or when combined with other such services

• Attest client musto Approve or determine all significant assumptions & matters of

judgment &

o Be in a position to have an informed judgment on, & accept responsibility for, the results of the service

• Provision of these services for other than financial statement purposes may be at an acceptable level

Independence – Appraisal, Valuation & Actuarial Services

• Factors to be considered includeo The level of management review

o Acceptance of responsibility or assumption of approval function

• Provision of these services for other than financial statement purposes may be at an acceptable level

Independence –Bookkeeping Services

• When a member provides hosting services, the member is maintaining the attest client’s internal control over its data or records

• Accordingly, the management participation threat to the member’s compliance with the "Independence Rule" would not be at an acceptable level, & could not be reduced to an acceptable level by the application of safeguards, & independence would be impaired

Independence – Hosting Services

• Threats to compliance with the “Independence Rule” would not be at an acceptable level & could not be reduced to an acceptable level by the application of safeguards, & independence would be impaired, if, for example, a member

a. Designs or develops an attest client’s financial information system,

b. Makes other than insignificant modifications to source code underlying an attest client’s existing financial information system,

c. Supervises attest client personnel in the daily operation of an attest client’s information system or

d. Operates an attest client’s network

Independence –Information Systems Design

• Threats would be at an acceptable level & independence would not be impaired, provided that the member does not have custody or control over the attest client’s funds or assets & the individual designated by the attest client to oversee the tax services

a. Reviews & approves the tax return & related tax payment

b. If required for filing, signs the tax return prior to the member transmitting the return to the taxing authority

• The following are not considered having custody or control over an attest client’s funds

a. Making electronic tax payments authorized by an attest client pursuant to a taxing authority’s prescribed criteria

b. Affixing the attest client’s depository account information on a tax return

c. Remitting an attest client’s check made payable to the taxing authority

Independence – Tax Services

• Does it result in a significant threat to independence?

• Communicating the breach internally & externally

• Significance of the breach & consequences

• Further communication with governance at attest client

What if There is a Breach?

In situations in which the lead attest engagement partner or an individual in a position to influence the attest engagement either (1) committed the breach or (2) knows of a breach & fails to ensure the breach is promptly communicated to or known by an appropriate individual within the firm as described in this interpretation, there is a rebuttable presumption the provisions of this interpretation would not be able to address the breach as the threats to the attest engagement team’s integrity, objectivity & professional skepticism & the threats to the appearance of independence would be considered so significant that no actions could be taken to satisfactorily address the consequences of the breach

Significance of Breach

• Promptly communicate the breach to an appropriate individual within the firm, for example, an individual or individuals with responsibility for the policies & procedures relating to independence, or the attest engagement partner (the responsible individual)

• The responsible individual should be satisfied that the interest or relationship that caused the breach has been terminated, suspended or eliminated & should address the consequences of the breach

• A consequence of a breach may be that termination of the attest engagement is necessary

Communicating the Breach

a. The nature & duration of the breach

b. The number & nature of any previous breaches with respect to the current attest engagement

c. Whether a member of the attest engagement team had knowledge of the interest or relationship that caused the breach

d. Whether the individual who caused the breach is a member of the attest engagement team or another individual for whom there are independence requirements

e. The role of the individual if the breach relates to a member of the attest engagement team

f. The effect of the service, if any, on the accounting records or the attest client’s financial statements if the breach was caused by the provision of a professional service

g. Whether a partner or partner equivalent of the firm had knowledge of the breach & failed to ensure that the breach was promptly communicated to an appropriate individual within the firm

h. Whether the breach involved solely an affiliate of a financial statement attest client & if so, the nature of the affiliate relationship

i. The extent of the self-interest, advocacy, undue influence or other threats created by the breach

Evaluating Significance of a Breach

• If the responsible individual determines that action can be taken to satisfactorily address the consequences of the breach, the responsible individual should discuss the breach & the action taken or proposed to be taken with those charged with governance as soon as practicable, unless those charged with governance have specified an alternative timing for reporting less significant breaches

• The responsible individual should communicate in writing with those charged with governance all matters discussed in accordance with the paragraph above & obtain the concurrence of those charged with governance that action can be, or has been, taken to satisfactorily address the consequences of the breach

• The responsible individual should communicate in writing with those charged with governance all matters discussed in accordance with the paragraph above & obtain the concurrence of those charged with governance that action can be, or has been, taken to satisfactorily address the consequences of the breach

Communicating to Governance

A member shall comply with the following standards

a. Professional Competence – Undertake only those professional services that the member or the member’s firm can reasonably expect to be completed with professional competence

b. Due Professional Care – Exercise due professional care in the performance of professional services

c. Planning & Supervision – Adequately plan & supervise the performance of professional services

d. Sufficient Relevant Data – Obtain sufficient relevant data to afford a reason

General Standards – Reminder

A member shall not commit an act discreditable to the profession, such as

• Discrimination & Harassment in Employment Practices

• Solicitation of Disclosure of CPA Examination Questions & Answers

• Failure to File a Tax return or Pay a Tax Liability

• Negligence in the Preparation of Financial Statements of Records

Acts Discreditable Rule

• Confidential Employer Information – confidential client information from previous employer vs. experience & expertise gained

• Confidential Client Information

• False or Misleading Marketing

• Transfer of Information upon Sale/Transfer of Member’s Practice

• Contingent Fees▪ Not appropriate for audit clients▪ Not appropriate for original or amended returns (exception if there

is a reasonable expectation of a substantive governmental review of return)

• Investment Advisory & Referral Fees

Other Areas of Focus

• Members may encounter various relationships or circumstances that create threats to the member’s compliance with the rules

• The rules & interpretations seek to address many situations; however, they cannot address all relationships or circumstances that may arise

• Thus, in the absence of an interpretation that addresses a particular relationship or circumstance, a member should evaluate whether that relationship or circumstance would lead a reasonable & informed third party who is aware of the relevant information to conclude that there is a threat to the member’s compliance with the rules that is not at an acceptable level

Part 2 – Members in Business

• Identify Threats

• Evaluate the Significance of a Threat

• Identify & Apply Safeguards


• Advocacy Threat – example would be drafting a prospectus or regulatory filing

• Familiarity Threat – supplier or subordinate is an immediate family member

• Self-Interest Threat – holding stock options or participating in bonus plan

• Self-Review Threat – internal auditor accepting own work performed in previous capacity

• Undue Influence Threat – aggressive or dominant personality of a boss

Threats

• Safeguards Created by the Profession, Legislation or Regulation• Education & Training Requirements• Threats of Discipline• Hotlines

• Safeguards Created by the Employing Organization• Tone at the Top• Audit Committee Charter• Internal Policies

Safeguards

• An ethical conflict arises when a member encounters one or both of the following• Obstacles to following an appropriate course of action due to internal or

external pressures• Conflicts in applying relevant professional & legal standards

• For example, a member suspects a fraud may have occurred, but reporting the suspected fraud would violate the member’s responsibility to maintain the confidentiality of his or her employer’s confidential information

• Before pursuing a course of action, the member should consider consulting with appropriate persons within the organization that employs the member

• If the ethical conflict remains unresolved, the member will in all likelihood be in violation of one or more rules if he or she remains associated with the matter creating the conflict

• Accordingly, the member should consider his or her continuing relationship with the specific assignment or employer

Ethical Conflicts

• In the performance of any professional service, a member shall maintain objectivity & integrity, shall be free of conflicts of interest & shall not knowingly misrepresent facts or subordinate his or her judgment to others

• A member would be considered in violation of the “Integrity & Objectivity Rule” if the member cannot demonstrate that safeguards were applied that eliminated or reduced significant threats to an acceptable level

Integrity & Objectivity

• A conflict of interest creates adverse interest & self-interest threats to the member’s compliance with the "Integrity & Objectivity Rule“

• Examples• Serving in a management or governance position with two

organizations with access to confidential information from one that could be used by the other

• Selection of a vendor who employs a family member• Approving an investment that will enhance the value of the member’s

personal holdings• Safeguards include

• Restructuring or segregating certain responsibilities & duties• Obtaining appropriate oversight• Withdrawing from the decision-making process related to the

matter giving rise to the conflict of interest• Consulting with third parties, such as a professional body, legal

counsel or another professional accountant

Conflicts of Interest

• Financial & Nonfinancial Information• Operating & performance reports• Decision support analyses• Budgets & forecasts• Information provided to the internal & external auditors• Risk analyses• General & special purpose financial statements• Tax returns• Reports filed with regulators for legal & compliance purposes

• Responsibilities• Representing the facts accurately & completely in all material

respects• Describing clearly the true nature of business transactions or

activities• Classifying & recording information in a timely & proper manner

Preparation & Presentation of Information

• The “Integrity & Objectivity Rule” prohibits a member from knowingly misrepresenting facts or subordinating his or her judgment when performing professional services for an employer or on a volunteer basis

• Self-interest, familiarity & undue influence threats to the member’s compliance with the “Integrity & Objectivity Rule” may exist when a member & his or her supervisor or any other person within the member’s organization has a difference of opinion relating to the application of accounting principles; auditing standards; or other relevant professional standards, including standards applicable to tax & consulting services or applicable laws or regulations

• Resignation may not relieve the member of his or her responsibilities

Subordination of Judgment

• The “Integrity & Objectivity Rule” requires a member to maintain objectivity & integrity in the performance of a professional service

• When dealing with an employer’s external accountant, a member must be candid & not knowingly misrepresent facts or knowingly fail to disclose material facts

• This would include, for example, responding to specific inquiries for which the employer’s external accountant requests written representation

Obligation to External Accountant

• Professional Competence• Due Professional Care• Planning & Supervision• Sufficient Relevant Data

General Standards

• Gifts & Entertainment• Educational Services• Pressure to Breach Rules• Acts Discreditable

Other Rules for Members in Business

• Part 3 of the code applies to members who are neither members in public practice nor members in business

• For example, members who are retired or not currently employed

• These members are subject to the “Acts Discreditable Rule”• Discrimination & Harassment in Employment Practices• Solicitation or Disclosure of CPA Examination Questions &

Answers• Failure to File a Tax Return or Pay a Tax Liability• Confidential Information Obtained From Former Employment• False, Misleading or Deceptive Acts in Promoting or Marketing

Services• Use of the CPA Credential

Part 3 – Other Members

Tom Wheeland | 314.802.0213 | [email protected]

The information contained in these slides is presented by professionals for your information only and is not to be considered as legal advice. Applying specific information to your situation requires careful consideration of facts & circumstances. Consult your BKD advisor or legal counsel before acting on any matters covered.

BKD, LLP is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: www.nasbaregistry.org.

http://www.nasbaregistry.org/

Tax UpdatesPresented by: Brandy Shy, CPA | Director | BKD CPAs & Advisors

Our Goals for Today

2

1 Impact of TCJA – A Recap

Recent Developments

What We Have Seen

2

3

What We Don’t Know4

General Corporate Provisions

3

TCJA Provisions – A Recap• Reduction in Federal Corporate Income Tax Rate to 21%

• Repeal of Alternative Minimum Tax (AMT)

• AMT Credit Utilization & Refund

• 50% of Excess Refundable in 2018 – 2020

• 100% of Excess Refundable in 2021

• Net Operating Loss (NOL) changes

• Reduction in Dividends Received Deduction

• 100% Bonus Depreciation & Expanded §179 Expensing

• Limitation on Deductibility of Business Interest

• Income Inclusion Rule

• Meals & Entertainment Limitations

• Qualified Transportation Fringe Limitations

• Pre- & Post-TCJA

NOL Comparison Chart

OLD LAW Years Carryback

Years Carryforward

% Offset

C-Corporations 2 20 100

Non-Life Insurers 2 20 100

Life Insurers 3 15 100

NEW LAW Years Carryback

Years Carryforward

% Offset

C-Corporations 0 ∞ 80

Non-Life Insurers 2 20 100

Life Insurers 0 ∞ 80

Non-Life Company Provisions

5

TCJA Provisions – A RecapLoss Reserves

• Changes in Interest Rate & Payment Pattern –Generally Reduced Tax Loss Reserves

• No Company Election

• Repeal of §847

Proration Percentage Increased from 15% to 25%

• Keeps the After-Tax Yield of Tax-Exempt Bonds Constant at 5.25%

• Narrows the Spread Between Taxable & Tax-Exempt Bonds

Retention of NOL Rules (2 Back/20 Forward)

Life Company Provisions

6

TCJA Provisions – A Recap• Life Reserves Capped at Greater of Net Surrender

Value or 92.81% of Tax Reserves (8 Year Phase-In)

• 70% Company Share/30% Policyholder Share (6.3% ETR on Tax Exempt Interest)

• Inclusion of Policyholder Surplus Account Balance in Income over 8 Years

• NOL/OLD Conformity

• Elimination of Small Life Insurance Company Deduction (SLICD)

Life Company Provisions

7

TCJA Provisions – A Recap§807(f) Changes Subject to §481 Rules

• 4 Year Spread for Reserve Decreases

• 1 Year Spread for Reserve Increases

DAC Capitalization

• 2.09% for Annuities (formerly 1.75%)

• 2.45% for Group Life (formerly 2.05%)

• 9.2% for Other Contracts (formerly 7.7%)

DAC Amortization

• Retains 60-Month Amortization

• Increases 120-Month Amortization Period to 180 Months

Recent Developments

8

TCJA Provisions – P&C Loss Reserves• Rev. Proc. 2019-06

• Provided proposed tax discount factors for the 2017 reserve reset & 2018 reserve calculations

• Based upon 3.12% annual rate

• Same factors apply to losses & salvage

• Reserve reset at 12/31/17 spread over 8 years

• Rev. Proc. 2019-31

• Revised factors issued

• Based upon a 2.94% rate

• Tended to increase reserves as compared to proposed factors

Recent Developments

9

TCJA Provisions – P&C Loss ReservesRev. Proc. 2019-30

• Provides “simplified” procedure for loss reserve & salvage accounting method changes

• Companies using “revised” factors for 2017 reset & 2018 reserves & salvage

• Spread reserve adjustment over 8 years

• Spread salvage adjustment over 4 years if taxable income or 1 year if tax deduction

• Companies using “proposed” factors for 2017 reset & 2018 reserves & salvage

• “Remainder” adjustment spread over 7 years

• “Supplemental” adjustment over 1 or 7 years at taxpayer’s election

Recent Developments

10

TCJA Provisions – Life Reserves & DACRev. Proc. 2019-34

• Provides “simplified” accounting method change guidance for life reserves & deferred acquisition costs (DAC)

• Life reserves under TCJA are greater of net surrender value or 92.81% of the tax reserve (tax reserve generally meaning CRVM or CARVM)

• Reset for life reserves spread over 8 years

• §807(c)(3) reserves – insurance & annuity reserves not involving life, accident or health contingencies – spread over 4 years if taxable income or 1 year if tax deduction

• DAC – cut-off method; thus, no adjustment to spread

BKD Observations

11

What We Have Seen• Many companies scrubbed the accounting for meals &

separated it from entertainment in trial balances

• Qualified transportation impacted most companies; calculations were difficult to complete based on limited guidance

• A small shift in life insurance company investment in municipal bonds

• Form 8990 (business interest expense limitation) was required for most insurance returns, but often did not result in a limitation of deductibility

• Some state proforma returns negatively impacted in a consolidated group setting

• Many companies did not change the method for dividend income based on the income inclusion rule

BKD Observations

12

What We Don’t Know

Pending Official IRS Guidance

How will refundable AMT credit work in a §382 fact

pattern?

NOL & AMT credit guidance in mixed group settings

• Will P&C companies with NOLs in 2018 &/or 2019

be required to calculate an AMT NOL?

• If a P&C insurer has an NOL in 2018 or 2019 &

creates an AMT liability in the carryback period,

how is the resulting credit refunded?

BKD Observations

13

NOLs & AMT Credits – P&CExample

• ABC Holding Company has $2 million in income & ABC Insurance Company, its wholly owned subsidiary, has a $(22) million loss for a consolidated loss of $(20) million

• $(20) million can be carried back to offset prior income of entire group

• May trigger AMT in 2016 or 2017 upon carryback

• Would necessitate an amended 2018 return to secure 50% refund of AMT credit

Brandy Shy, CPA | Director | 314.231.5544 | [email protected]

State & Local Tax Update

Mom-Approved SALTY Talk

Federal

H 3167 / Flood Insurance

▪ Would extend the National Flood Insurance Program for 5 years (through 9/30/2024)

▪ HR 4378 / S 1693 – Having failed several times to pass a disaster aid bill with a federal flood insurance reauthorization provision, Congress passed two temporary extensions of the National Flood Insurance Program, effective through 11/21/2019

S 604 / Income Tax

▪ The “Mobile Workforce State Income Tax Simplification Act” would set a 30-day threshold before states could tax income earned by nonresidents

VServ Global (P.) Ltd., In re [2018] 99 taxmann.com 253 (AAR -Maharashtra)

• India’s outsourcing services companies are worried that more of their business could be hit with an 18% goods & services tax

• Per the holding & a July tax circular, the government could decide on a case-by-case basis which services are taxable under the open-ended interpretation of what falls into the “intermediary category”

International

Multistate Trends

Domestic Surplus Lines

▪ Authorizes domestic surplus lines insurers & treats them the same as a nonadmitted insurer, including the surplus lines tax instead of the standard premium tax

➢ Iowa S 558 / Passed, effective 07/01/2019

➢ Nevada S 86 / Passed, effective 10/01/2019

➢ Vermont S 131 / Passed, effective 07/01/2019

Multistate Trends

Nonadmitted Reinsurance Reform Act (NRRA) Conformity

▪ Updates state surplus lines & self-procurement tax provisions to conform to the NRRA & generally eliminate the state requirements to collect & share tax at other states’ rates for purposes of the tax sharing pacts

➢ Hawaii S 19 / Passed, effective 10/01/2019

➢ New Hampshire S 189 / Passed, effective 01/01/2020

Multistate Trends

Travel Insurance

▪ Clarifies that travel insurance is classified as inland marine insurance (or health insurance as applicable) & imposes the premium tax on travel insurance sold to residents, certain primary certificate holders or certain blanket travel insurance policyholders, excluding any amount received for travel assistance services or cancellation fee waivers➢ Arkansas S 399 (Act 698) / Passed, effective 10/01/2019➢ North Carolina H 755 / Passed, effective 01/01/2020➢ Rhode Island H 5207 & S 256 / Passed, effective

10/01/2019➢ Texas H 2587 / Passed, effective 09/01/2019➢ Virginia H 2186 & S 1565 / Passed, effective 07/01/2019

Multistate Trends

Unclaimed Property Tax

▪ Establishes unclaimed property tax provisions related to policies with death benefits, including requiring insurers to identify deceased insureds via semi-annual comparison to the Social Security Administration’s Death Master File & submit unclaimed property accordingly

➢ California S 740 / Passed, effective 01/01/20120

➢ Kansas H 2209 / Passed, effective 05/01/2019

Multistate Trends

Model Life & Health Guaranty Fund Conformity

▪ Updates life & health guaranty fund provisions to conform to NAIC model statutes, which generally

1) Include HMOs as member insurers & permit them to recoup assessments via policyholder surcharges; &

2) Split assessments pertaining to LTC insolvencies 50/50 between life/annuity & health insurers

➢ Arkansas S 292 (Act 520) / Passed, effective 06/12/2019*

➢ Iowa S 556 / Passed, effective 03/29/2019*

➢ Kentucky H 382 / Passed, effective 6/26/2019

➢ Nevada S 87 / Passed, effective 01/01/2020

➢ North Dakota H 1116 / Passed, effective 01/01/2020

Alabama

H 360 / Premium Tax

▪ Authorizes the use of proceeds from county & municipal taxes not earmarked for other purposes, for the purposes of providing insurance to career firefighters

▪ Provides that funds received for these policies may not be subject to any premium taxes otherwise required by law

▪ Passed, effective 01/01/2020

Arizona

S 1485 / General Tax

▪ The School Tuition Organizations tax credit cap shall be increased from the previous FY by

➢ 15% for FY 2020–2021;

➢ 10% for FY 2021–2022;

➢ 5% for FY 2022–2023; &

➢ The greater of the percentage increase in the metropolitan Phoenix consumer price index or 2% for FY 2023–2024+


Arkansas

H 1724 (Act 850) / General Tax

▪ Authorizes the DOR to conduct administrative tax hearings by telephone, video conference or other electronic means


H 1800 (Act 855) / General Tax

▪ Creates the Major Historic Rehabilitation Tax Credit that may be taken against income & premium taxes

▪ The credit is equal to 25% of the total qualified rehabilitation expenses incurred in a certified rehabilitation in excess of $1.5m


Arkansas

S 345 (Act 457) / Premium Tax

▪ Reduces the maximum amount of salary credit against A&H insurance to

➢ For tax years starting January 1, 2021, the maximum offset is 70%;

➢ For tax years starting January 1, 2022, the maximum offset is 60%; &

➢ For tax years starting January 1, 2023, the maximum offset is 50%

▪ Starting January 1, 2020, the total credit is also capped at $18 million


Arkansas

S 561 (Act 819) / Franchise Tax

▪ Transfers the administration of the franchise tax from the Secretary of State to the Department of Finance & Administration & authorizes them to adopt rules to implement & administer the tax

▪ Changes the due date to either remit with the corporation’s income tax return or May 1


California

A 101 / General Tax

▪ Permits $500 million in new state Low-Income Housing Tax Credits for calendar year 2020 & every year thereafter

▪ Authorizes developers to sell the credits to an unrelated investor

▪ Permits a taxpayer to make/revoke an election to sell, only once, at any time before the committee allocates a final credit amount for the project


California

A 115 / Premium Tax

▪ Revises the tax on health care service plans & managed care organizations to increase the tax per Medicaid enrollee, reduce the tax per non-Medicaid enrollee & end the premium/income tax exemption for plans that don’t serve Medicaid patients

▪ The applicable tax rates are➢ Medi-Cal taxing tier I (enrollment up to 4 million) – $40 for

2019–2020; $45 for 2020–2021; $50 for 2021–2022; & $55 for 2022–2023

➢ Other taxing tier II (enrollment between 4 million & 8 million) –$1 for 2019–2021; & $1.50 for 2021–2023

➢ Medi-Cal taxing tier II (enrollment greater than 4 million), other taxing tier I (enrollment up to 4 million) & other taxing tier III (enrollment greater than 8 million) – $0 for all years

▪ Passed, effective 09/27/2019 & operative 07/01/2019 (contingent upon federal approval)

California

Franchise Tax Board Notice 2019-01 / Income Tax

▪ The FTB has stated the principles of IRC §367 & associated regulations, which are generally applied to transfers to foreign corporations, will apply in cases involving the transfer of appreciated property to an insurance company, i.e., the built-in gain will be taxed to the transferor

▪ Issued 02/25/2019

Connecticut

H 7179 / Insurance Assessment

▪ Modifies the Healthy Homes surcharge to

➢Further define covered residences;

➢Specify that the surcharge is imposed on the first insured listed in the policy;

➢Provide that the surcharge must be paid in full when an insurance policy commences or renews;

➢Denies reimbursement of the surcharge even if the policy is cancelled; &

➢Imposes the surcharge on surplus lines policies to the broker


Connecticut

H 7424 / Pass-Through Entity Tax

▪ Reduces the credit for pass-through entity tax paid from 93.01% to 87.5% effective for tax years beginning on or after January 1, 2019

▪ Also establishes a payroll commission to evaluate the feasibility of a payroll tax & requires the DRS to collect the required data from employers


Connecticut

S 72 / General Tax

▪ Creates a credit against the corporation business tax or the insurance & health centers tax for 50% of the payments an employer makes that is applied to a qualified employee’s outstanding principal educational loan balance up to a maximum of $2,625 for any income year

▪ Qualified employees are Connecticut residents who earned their first bachelor’s degree within the last five years & are working full time at a corporation, insurer or health care center that is licensed in Connecticut & subject to the applicable tax


Delaware


▪ Creates the Delaware Health Insurance Individual Market Stabilization Reinsurance Program & Fund, which will be funded in part by a 2.75% annual assessment on entities that provide health insurance in Delaware

▪ The assessment excludes Medicare, Medicaid; Chapter 52 of Title 29 of the Delaware Code; or any other similar coverage under state or federal governmental plans, stand-alone dental insurance, standalone vision insurance, long term care insurance, disability income insurance & all accident-only insurance

▪ Passed, effective 06/20/2019 (contingent upon federal approval)

Florida

H 7127 / Income Tax

▪ Makes a variety of income tax revisions

➢ Updates IRC conformity to January 1, 2019 (currently 2018);

➢ Allows an income tax deduction for IRC §951A global intangible low-taxed income;

➢ Extends the automatic corporate income & franchise tax rate reduction if collections for those taxes exceed fiscal year forecasts through FY 2020–2021 (currently FY 2018–2019); &

➢ Requires information reporting of certain items impacted by the Tax Cuts & Jobs Act

▪ Passed, effective retroactively to 01/01/2019

Florida

Tax Information Publication No. 19C01-04 / Income Tax

▪ DOR announcement that the corporate income tax rate is reduced from 5.5% to 4.458% for taxable years beginning on or after January 1, 2019, but before January 1, 2022

▪ Issued 09/12/2019

Idaho

H 27 / Premium Tax

▪ Requires insurers to round to the nearest whole dollar any amount shown or required to be shown on any return, form, statement or other document submitted to the DOI for purposes of the premium tax

▪ Surplus line brokers are subject to the same rounding requirements


Illinois

S 687 / Income Tax

▪ Gov. J.B. Pritzker’s “fair tax proposal” potentially increases the corporate income tax rate from 7.0% to 7.99%

▪ Passed, effective 01/01/2021 if passed by 2020 November General Ballet

Illinois

S 689 / General Tax

▪ Authorizes dual tax amnesty programs running from October 1, 2019, through November 15, 2019, which exempt participants from all associated penalties, interest or civil/criminal prosecution

➢ For all taxes administered by the DOR for tax periods after June 30, 2011, & prior to July 1, 2018, &

➢ For franchise tax administered by the SOS for tax periods after March 15, 2008, through June 30, 2019

▪ Repeals the franchise tax by means of an increasing exemption for 2020 through 2023, with complete repeal in 2024


Illinois

Admin. Code 86 §§100.3370, 100.3380, 100.3600, 100.5220, 100.5270, 100.9700 / Income Tax

▪ Amendments to regulations explaining the computation of the combined apportionment factor for unitary businesses when members use different apportionment methods, which generally follow the gross-up method previously set forth by the DOR

▪ Effective 08/27/2019

Admin. Code 86 §210.126 / Income Tax

▪ Amends the regulation pertaining to the VDA program to reflect that the voluntary disclosure program is now administered the Problems Resolution Division instead of the Board of Appeals


Illinois

Trilisky v. Chicago, Ill. App. Ct., No. 1-18-2189, 09/26/2019

▪ Sales of real estate to & from Fannie Mae & Freddie Mac were held to be not exempt from Chicago property tax because the mortgage entities don’t qualify as exempt governmental bodies

Indiana

H 1001 / General Tax

▪ Increases the cap on the Scholarship Granting Organization Scholarship Tax Credit from $14 million to $15 million for FY 2019 & to $16.5 million for fiscal years beginning after June 30, 2020

▪ Establishes eligibility requirements for the Research Expense Income Tax Credit effective January 1, 2019


S 563 / General Tax

▪ Authorizes the Economic Development Corporation (or similar state agency) to enter into incentive agreements for amounts up to the incremental income tax withholdings collected from new employees


Iowa

H 278 / General Tax

▪ Would impose an additional tax added to public companies’ respective income tax, franchise tax or premium tax of 1% of CEO compensation

▪ Session adjourned, carryover to 2020

Kentucky


▪ Codifies the policyholder surcharge rate as $1.80 (statute currently states $1.50) per $100 of premium

▪ Requires that all future rate adjustments be codified by the General Assembly (previously the DOI could adjust the rate)

▪ Excess surcharges must be remitted back to the Association to reduce future assessments in the appropriate account


Kentucky

806 KAR 2:100 / Municipal Tax

▪ Amended regulation requiring that the policyholder surcharge is disclosed on all new & renewal policies; previously was optional on renewals


Revenue Procedure KY-RP-19-03 / General Tax

▪ Guidance on the DOR’s issuance of private letter rulings in a new format similar to the format used by the IRS

▪ Effective 10/01/2019 to supersede Revenue Procedure KY-RP-17-01

Louisiana


▪ The fee for an initial company appointment of an agent is increased from $20 to $30, & the renewal is set at $20. Initial & renewal of company appointment of an agency is $100

▪ Repeals the 1% assessment of direct premiums on each property & casualty insurer to fund expenses of the DOI


Maryland

H 173 / General Tax

▪ Extends the job creation tax credit sunset date from January 1, 2020, to January 1, 2022



▪ Extends the health insurance provider fee through calendar years 2020 through 2023 at the rate of 1.0%, only for products subject to the health insurer fee under the federal Patient Protection & Affordable Care Act


Maryland

S 581 / General Tax

▪ Creates the Opportunity Zone Enhancement Program which permits qualifying businesses within a zone enhanced income & premium tax incentives under the following tax credit programs

1) Job creation;

2) One Maryland Economic Development (provided a business hires at least 50 qualified employees);

3) Enterprise zone;

4) Biotechnology investment incentive;

5) Cybersecurity investment incentive;

6) More Jobs for Marylanders; &

7) Historic revitalization

▪ Passed, generally effective 01/01/2019

Massachusetts

830 CMR 63.39.1 / General Tax

▪ Amendments to the regulation on nexus to add a Wayfair type nexus standard

➢ C corporations are deemed to have nexus if they have $500,000 in annual sales or regular employee presence in state

➢ Financial institutions are deemed to have nexus if activities are conducted with 100+ residents, they have $10 million+ of assets or $500,000+ in receipts attributable to the state

➢ Insurance companies have a broad “when such entity meets the statutory jurisdiction” nexus standard

➢ A business corporation obtains flow-through nexus based on general or limited partnership operations


Minnesota

S 5 / Income Tax

▪ Omnibus tax bill makes a variety of income tax adjustments, including the awaited technical correction to the definition of includible insurance company for purposes of the income tax

▪ Specifically, only a "disqualified captive insurance company" can be included in a combined income tax return, defined as

1) A captive insurer licensed by any state or foreign country, or2) Derives less than 50% of its total annual premium for the tax

year from sources outside of the unitary business, &3) Pays less than 0.5% of its annual premium as premium tax, or

receives less than 50% of its annual receipts as premium

▪ Passed, effective 05/30/2019 & retroactively to 01/01/2017 for the insurance provision

Mississippi


▪ Authorizes the Windstorm Underwriting Association to levy recoupable & nonrecoupable assessments

▪ The maximum total of nonrecoupable assessments is the lesser of 6% of the year-end totals in force or $250m


Mississippi

H 1613 / General Tax

▪ Creates the Children’s Promise Act, which authorizes a credit against income & premium taxes for voluntary cash contributions to eligible charitable organizations licensed by the Department of Child Protection Services

▪ The amount of the credit is limited to 50% of the total tax liability of the taxpayer & aggregate credits may not exceed $5 million

▪ Passed, effective 01/01/2019 & expires on 01/01/2025

Mississippi

S 2210 / Income Tax

▪ Creates the Endow Mississippi Program which permits a tax credit for charitable gifts to endowed funds held by community foundations

▪ The credit is 25% of such contributions from January 1, 2019, through December 31, 2023, with a maximum contribution of $200,000

▪ The total credits authorized must not exceed $500,000 per calendar year & will be awarded on a first-come, first-served basis


Mississippi

Reg. Section 35.I.04 / General Tax

▪ Amendment that requires e-file for all DOR administered taxes for taxpayers with assets of $250,000 (currently $5 million) or more for tax years beginning January 1, 2019


Missouri

Regs. Title 20 §200-3.010 / Premium Tax

▪ Amended regulation regarding premium tax on annuity contracts, to recognize that flexible payment deferred annuities differ from traditional fully guaranteed fixed premium policies; & requiring insurers to signify on their premium tax returns if they have switched from using a paid-in approach to using a pay-out approach, or vice versa (as originally elected on their 1975 tax return)


Nebraska

LB 610 / Incentives

▪ Employers can receive an incentive payment of 25% of the total matching contributions not to exceed $2,000 per contributing employee to the Nebraska educational savings plan trust


GIL 24-19-1 / Income Tax

▪ Revises prior guidance to reflect that no dividend deduction is permitted for net IRC §965(a) income

▪ For 2017, taxpayers must include the IRC §965(a) income in their sales factor denominator & exclude it from their numerator

▪ Issued 09/13/2019

Nevada

S 86 / Insurance Tax

▪ Doubles the annual fraud assessment; (sliding scale based on premium from $500 to $2,000 to $1,000 to $4,000)


S 497 / Commerce Tax

• Removes the requirement for business entities to file a commerce tax return if their Nevada gross revenue for a fiscal year is $4,000,000 or less

• Passed, effective 06/03/2019

New Hampshire

H 3 & H 4 / Business Profits & Enterprise Tax

▪ Compromise budget bill excluded any changes to the BET & BPT rates for 2019; however, revenue changes of +/- 6% in 2021 will have corresponding rate changes

▪ Additionally, updates conformity to the IRC as of December 31, 2018, imposes BPT on a portion of global intangible low-taxed income, adopts market-based sourcing for sales of nontangible property & moves to a single sales factor apportionment formula for BET/BPT for tax year 2023


New Hampshire

H 620 / Premium Tax

▪ Revises the failure to file &/or timely pay for all premium based taxes to be based upon the number of days (currently a flat 10%)

➢ 1-30 days late / 3% of the tax due;

➢ 31-60 days late / 6% of the tax due;

➢ 60+ days late / 12% of the tax due


New Hampshire

S 190 / Business Profits & Enterprise Tax

▪ Changes the method for sourcing service-based revenue & intangible income from a cost-of-performance to market-based sourcing & imposes a throwout rule for sales of tangible personal property

▪ Establishes a committee to study apportionment & monitor the laws of other states concerning market-based sourcing

▪ Passed, generally effective 01/01/2022

New Mexico

H 6 / Income Tax

▪ Requires unitary corporate income tax filings, but provides an exemption for insurers subject (or would be subject) to the premium tax in the state

▪ The original bill would have repealed the Medical Insurance Pool Assessment Credit against premium tax


New Mexico

H 162 / Premium Tax

▪ Applies the provisions of the Tax Administration Act to the premium tax. This includes repeal of the former premium tax specific $1,000 per month penalty for failure to file or late filing/payment & the specific premium tax SOL provision (general SOL remains 3 years)


New York

New York ex. rel. Raw Data Analytics LLC v. JPMorgan Chase & Co., N.Y. Sup. Ct., No. 100271/2015, 8/30/2019

▪ The court rejected JPMorgan Chase’s characterization of any duty to self-calculate & pay interest to the state as a flexible obligation as related to reporting unclaimed property tax

North Carolina

DOR Notice / General Tax

▪ Clarification that a disguised-sale determination or a transaction which would result in the technical termination of a partnership for federal income tax purposes would result in the DOR not recognizing a credit allocation as valid for state income tax purposes

▪ Issued 09/10/2018

North Dakota

H 1075 / Surplus Lines Tax

▪ Revises surplus lines provisions, including

➢ Changes tax filing from 60 days of the policy effective date to quarterly returns (annual reconciliation return continues);

➢ Eliminates the requirement to reflect the allocation of policy risk between other jurisdictions; &

➢ The surplus lines producer must directly return to the policyholder the tax amount on any portion of unearned premium that has been credited or refunded by the state to the surplus lines producer (previously, the provision referred only to tax credited by the state)


North Dakota

H 1106 / Premium Tax

▪ Creates an individual health reinsurance pool. The pool will be funded by assessments on health insurers (paid quarterly), which would be eligible for premium tax offset in the year paid

▪ Passed, effective 04/18/2019 & expires 12/31/2021

Ohio

Time Warner v. City of Cincinnati, Ohio Board of Tax Appeals, No. 2017-1448, 05/31/2019

▪ Cincinnati erred in disallowing a parent corporation from including in its consolidated municipal tax return all those affiliated entities that were included in its consolidated federal income tax return for the tax year at issue. The city had tried to impose a nexus combination on audit

Oklahoma

H 2665 / Income Tax

▪ Creates the Pass-Through Entity Tax Equity Act, providing for the election & computation of pass-through entity tax for tax years beginning on or after January 1, 2019

▪ Tax is imposed on member's Oklahoma distributive share at the highest marginal income tax rate for individuals, trusts & estates; 6% for corporations, pass-through entities & financial institutions; or the highest marginal income tax rate that would be applicable for exempt entities


Oregon


▪ Increases the Health Benefit Plan Assessment on insurers & HMOs to 2.0% (currently 1.5%) on the gross amount of health plan premium

▪ The assessment is extended until December 31, 2026 (currently 2019)


Oregon

H 3427 (augmented by H 2164 & S 116) / Corporate Activity Tax

▪ Establishes the CAT, with the following key elements

➢ Imposes tax at a rate of $250, plus 0.57% of the taxpayer's taxable business receipts over $1 million;

➢ Taxpayers may deduct 35% of labor costs or COGS from the tax base;

➢ This is an annual tax due April 15, with quarterly estimates;

➢ “Taxpayer” includes insurers;

➢ The tax is imposed on a full unitary basis; &

➢ Note that this is a distinct tax, filed separate & in addition to excise/income or premium tax

▪ Passed, effective & affirmed as of 01/01/2020

Oregon


▪ Clarifies that only authorized insurers of wet marine & transportation insurance pay a tax on underwriting profits & brokers for unauthorized insurers pay a tax equal to 0.75% of gross receipts

▪ Permits the DOI to collect taxes on 100% percent of gross amount of premiums if the insured’s home state is Oregon


Oregon

Portland Clean Energy Community Benefits Initiative (CES) / Municipal Tax

▪ The CES imposes a 1% tax on the Portland sales imposed on companies with $1 billion or more in total “retail” sales, with at least $500,000 taking place inside the city (new tax as of November 2018)

▪ A city legal analysis obtained by local media concludes the tax may apply to nearly any billion-dollar company with sales in Portland, including insurers

Puerto Rico

H 1635 (Act 60-2019) / General Tax

▪ The Puerto Rico Tax Incentives Code consolidated a number of tax laws & requires information reporting for insurers receiving premium payments, which must be reported to the client & the Treasury Department in an electronic format by February 28


Circular Letter 19-08 / Income Tax

▪ For tax year 2018, corporations will be required to e-file through a program certified by the PRTD

▪ Life insurers are excluded from the e-file mandate

▪ Issued 03/11/2019

South Carolina


▪ Provisions designed to reduce the operating deficit of the Medical Malpractice Liability Joint Underwriting Association➢ As of January 1, 2020, all medical malpractice insurers are subject to a

pro rata assessment of 20% of the Association’s accumulated deficit

➢ Beginning January 1, 2020, all medical malpractice insurers, surplus lines insurers & self-procured insureds are subject to an assessment of 2%–6% of DWP

➢ Imposes a 1% policyholder surcharge on medical malpractice premium

➢ Beginning January 1, 2021, an additional 1.0% policyholder surcharge (which increases 1% annual to a total of 10% & does not sunset)

➢ Provides that the surcharges levied are not considered premium

▪ Passed, effective 05/16/2019 & continuing until 12/31/2035

South Carolina

H 4257 / Municipal Tax

▪ Would prevent any nongovernmental entity from collecting municipal premium tax (including MASC) & would instead require that the DOI perform collection services for the localities

▪ Session adjourned, carryover to 2020

S 360 / Premium Tax

▪ Clarifies the premium tax base on bail bonds to exclude any amounts retained by a licensed bail bondsman for commissions, fees & expenses

▪ Also clarifies that the tax base is written premium (previously collected premium)


South Dakota

S 96 / Premium Tax

▪ Increases the premium tax credit to 100% of the contribution to a scholarship granting organization (currently 80%), but no credit is eligible for the tax on workers comp or fire insurance premium

▪ Also permits insurers to claim the credit against quarterly installment payments


Texas


▪ Revises the Texas Windstorm Insurance Association measures to

➢ Require emergency meetings if insurers may be subject to assessment;

➢ Clarify the cost of the reinsurance shall be paid by assessments; &

➢ Specify that a member of the association may not recoup an assessment paid through a premium surcharge or tax credit


Vermont

H 514 / Premium Tax

▪ Moves the administration of the fire safety insurance tax, the direct placement insurance tax & the surplus lines tax from the Department of Financial Regulation to the Department of Taxes


Washington

Excise Tax Advisory 3133.2019 & Special Notice / B&O Tax

▪ The DOR has withdrawn Determination 88-311A, a 1990 tax decision that “misapplied” the B&O tax exemption for insurance businesses

▪ The Special Notice elaborates on the new qualifications for the exemption: 1) must be a premium tax paying insurer & 2) activities must be directly related to an insurance business. The DOR provided nonexclusive lists of activities that qualify & those that do not qualify for exemption

▪ Issued 10/02/2019

Washington

Grp. Health Coop. v. Dep't of Revenue, Wash. Ct. App., No. 79091-9-I, 04/01/2019

▪ The Washington Court of Appeals reversed the trial court's decision & held that Medicare Advantage plan premiums were subject to the B&O tax under state law, but that federal law pre-empted the imposition of B&O taxes on those premiums

West Virginia

S 30 / Premium Tax

▪ Repeals the premium tax on annuity considerations

▪ Effective for considerations collected & received for taxable years beginning on or after 01/01/2021

Wyoming


▪ Imposes an assessment of 0.75% on health insurance premiums to fund air ambulance costs covered under Medicaid in the state


QuestionsMelissa Gasior / *[email protected] / 630.835.9510

Michael Palm / *[email protected] / 740.262.0816

The information contained in these slides is presented by professionals for your information only and is not to be considered as legal advice. Applying specific information to your situation requires careful consideration of facts & circumstances. Consult your BKD advisor or legal counsel before acting on any matters covered.

BKD, LLP is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: www.nasbaregistry.org.

http://www.nasbaregistry.org/

December 2019Sohini Chowdhury PhD, Director

Global Economy Facing Headwinds

2

1. Economic Outlook and Risks

2. Regional Impact of Trade War

3. Flavor of the Next Recession

4. State of Household Finances

Agenda

3

-6

-4

-2

0

2

4

6

8

10

13 14 15 16 17 18 19 20 21 22 23

Net Exports GovernmentInventories InvestmentConsumption BaselineScenario 1 (10% Upside) Scenario 3 (10% Downside)

Consumers Continuing to Support the Economy…

Source: Moody’s Analytics

Contributions to % change in real GDP, % qtr/qtr annualized

4

0

5

10

15

20

25

30

01 03 05 07 09 11 13 15 17 19

Series3 Series6

Series1

The Job Market Continues to DeliverMillions

Sources: BLS, Moody’s Analytics

5

200

300

400

500

600

700

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19

Breakeven level* Actual

Initial Claims Remain FavorableInitial claims for unemployment insurance benefits, ths


*Level consistent with no monthly job growth

6

14

15

16

17

18

19

9

10

11

12

13

14

80 81 82 84 85 87 88 89 91 92 94 95 97 98 99 01 02 04 05 06 08 09 11 12 14 15 16 18

Debt Service Ratio (L)

Financial Obligations Ratio (R)

Household Debt Service Burdens Remain Low…

Sources: Federal Reserve, Moody’s Analytics

% disposable income

7

Warning Signs Are Emerging

But…

8

0

50

100

150

200

250

300

350

400

15 16 17 18 19

Monthly 6-mo MA 12-mo MA

Trend Job Growth Is Slowing but Still Solid Nonfarm employment, change, ths


9

0

10

20

30

40

50

60

70

80

90

100

92 94 96 98 00 02 04 06 08 10 12 14 16 18

Late-cycle expansion

Recession or at risk

Share of metro area GDP by business cycle status, %

Business Cycle Index Sends Warning Sign


10

State Business Cycle IndexStatus as of June 2019 data

Sources: Moody’s Analytics

Mid Expansion

Recession/ At Risk

Late Expansion

Recovery

11

State Business Cycle IndexStatus as of September 2019 data


Mid Expansion

Recession/ At Risk

Late Expansion

Recovery

12

Metro Area Business Cycle IndexStatus as of June 2019 data


Mid Expansion

Recession/ At Risk

Late Expansion

Recovery

13

Metro Area Business Cycle IndexStatus as of September 2019 data


Mid Expansion

Recession/ At Risk

Late Expansion

Recovery

14

-4

-3

-2

-1

0

1

2

3

4

5

6

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18

10 yr - 2 yr10 yr - 3 mo

Yield Curve Hardly Giving Conventional SignalsYield curve


15

0

20

40

60

80

100

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19

Financial variables

Economic variables

Recession Odds are Rising


Probability of recession in 12 mo, %, using only…

16

0

10

20

30

40

50

60

Economic variables Financial variables Yield curve (10yr/3mo)

Jun 2019 Jul 2019 Aug 2019 Sep 2019 Oct 2019

Economic Indicators Signaling Higher Recession RiskProbability of U.S. recession within the next 12 mo, based on…

Sources: Moody’s Analytics; See appendix for methodology

%

17

0

10

20

30

40

50

60

70

80

90

100

04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19

Recession

Next Recession

Recession Concerns Elevated…U.S. Google search term, 100=peak popularity

Sources: Google Trends, Moody’s Analytics

18

HKUS

Turkey

UK

China

South Africa

Brazil

Russia

Italy

JapanSpain

France

Canada

India

Indonesia

Germany

Israel

Chile

Saudi Arabia

Australia

Egypt

Expansion

SlowdownRecession

Recovery

Malaysia

Singapore

Thailand

Greece

South Korea

Vietnam

…Not Just DomesticallyGlobal business cycle, October 2019

19

30

35

40

45

50

55

60

65

05 06 07 08 09 10 11 12 13 14 15 16 17 18 19

Manufacturing Is in RecessionPurchasing Managers' Index, SA

Sources: Institute for Supply Management, Moody’s Analytics

Value below 50 indicates contraction

Value below 43 consistent with broader

recession

20

48

49

50

51

52

53

54

55

56

57

-4

-2

0

2

4

6

8

10 11 12 13 14 15 16 17 18 19

ISM sentiment (L)

ISM hard data (R)

Sentiment Will Play a Key RoleISM manufacturing index


21

-4

-3

-2

-1

0

1

2

3

4

03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19

MA business confidence indexConference Board consumer sentimentNFIB small business optimismUniversity of Michigan

Consumer Sentiment Holding Up…Z-scores

Sources: NFIB, The Conference Board, University of Michigan, Moody’s Analytics

22

-3

0

3

6

9

20

40

60

80

100

120

140

160

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18

Confidence, 3-mo MA (L) Real spending, % chg yr ago, 12-mo MA (R)

…But Not Translating into Spending

Sources: The Conference Board, BEA, Moody’s Analytics

23

Where Are the Flash Points?

24


25

0

50

100

150

200

250

300

350

97 99 01 03 05 07 09 11 13 15 17 19

Geopolitical Uncertainty is SurgingGlobal policy uncertainty index

Sources: Policyuncertainty.com, Moody’s Analytics

26

0

20

40

60

80

100

120

140

160

180

$34 bil $16 bil $200 bil Remaining

Capital goods

Intermediate goods

Consumer goods

Higher Tariffs will Pinch Consumers…SoonChinese imported goods subject to tariffs by round, $ bil

Sources: Commerce Department, Moody’s Analytics

27

Suffering is Across the BoardChina Trade War Exposure Index


>0.5 to 1.0

>2.0

≤0.5

>1.0 to 2.0

U.S.=1.0

28

Manufacturing Hubs Hurt by Indirect Costs

Sources: BEA, Moody’s Analytics

>0.75-1

>1.25

<0.75

>1–1.25

U.S. = 1.0

Economic impact of goods tariffs with China, U.S. = 1.0

29

Recession Tracker. What to Watch? www.economy.comIndicator Type Mo to Recession Threshold RiskUnemployment rate - NAIRU Leading 30 to 36 0 High

Financial stress index Leading 11 to 15 >1 Low

Housing permits Leading 10 to 12 Yr/Yr decline Low

Yield curve 10-yr minus 3 mo Leading 8 to 15 0 Moderate

Yield curve 10-yr minus 2-yr Leading 8 to 14 0 Moderate

TED spread Leading 7 to 8 >100 basis points Low

Consumer Confidence Leading 5 to 10 30 point decline from peak Low

Jobless claims Leading 4 to 5 >253k Low

S&P 500 Leading 3 to 9 20% correction Low

ISM Manufacturing index Leading 3 to 6 43.2 Moderate

Net % of banks tightening lending

standards on C&I Loans Leading 1 to 5 >20% Low

Hours worked for production workers Leading 1 to 10 Yr/Yr decline Moderate

Unemployment rate Coincident 0 Increase of 0.25% Low

Core capital goods orders Coincident 0 Yr/Yr decline Moderate

Industrial production Coincident 0 Yr/Yr decline Moderate

ISM nonmanufacturing index Lagging 1 49 Low

Employment Lagging 2 to 4 Yr/Yr decline Low

Real GDP Lagging 3 to 6 < potential growth Low

30

How Bad Will It Be? Next Recession Shouldn’t Be Severe


Recession Severity Index, composite of key indicators, Mar 2001 = 100

0

50

100

150

200

250

300

350

400

Nov-48 Jul-53 Aug-57 Apr-60 Dec-69 Nov-73 Jan-80 Jul-81 Jul-90 Mar-01 Dec-07 Sep-19 Oct-20

RSI - Actual RSI - Predicted

31

How Healthy are Consumer

Balance Sheets?

32

Debt Service Ratios Vary Across Geographies

Sources: Equifax, Moody’s Analytics

Total household debt payments, % of disposable income

2019Q2

33

4

5

6

7

8

80 83 86 89 92 95 98 01 04 07 10 13 16 19

Cons. DSR

Mtg. DSR

Debt Service Ratios Also Vary Across Products


Mortgage

Consumer

% disposable income

34

-20

-15

-10

-5

0

5

10

15

10 11 12 13 14 15 16 17 18 19 20 21

Mortgage Bankcard

Consumer finance Retail

Auto Student

Balances of open accounts, yr/yr % of $

Sources: CreditForecast.com, Moody’s Analytics

Household Debt Growth Diverging Across Products

35

No Housing Bust 2.0: Mortgage Lending Is Solid90-days delinquent, % of outstanding balance, 12-mo MA


0.0

0.2

0.4

0.6

0.8

1.0

07 08 09 10 11 12 13 14 15 16 17 18 19 20

First mortgage

HELOAN

HELOC

36

0.3

0.6

0.9

1.2

1.5

07 08 09 10 11 12 13 14 15 16 17 18 19 20

Retail card Bankcard Consumer finance

Unsecured Lending Expansion Bears Watching90-days delinquent, % of outstanding balance, 12-mo MA


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Moody’s Credit Outlook 38

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The Value of an Effective Internal Control Structure

Your Presenter

Courtney Reikofski

Senior Managing Consultant

[email protected] | 303.832.5705

https://keynet.bkd.com/Personnel/PhotosFull/18502.jpg

AGENDA

• Is Your Organization Proactive or Reactive?

• How Is Risk Measured & Assessed?

• How Is Risk Mitigated?

• Fraud & the Relationship to Risk & Control

• Insurance Specific Example

PROACTIVE VS REACTIVE

ORGANIZATIONS

THE PROACTIVE APPROACH

Performing periodic risk assessments

Developing strong policies & procedures

Providing appropriate levels of training throughout the organization

Monitoring activities such as internal audit

Establishing a robust governance structure

WHAT IS RISK ANYWAY?

“A probability or threat of damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal vulnerabilities, & that may be avoided through preemptive action.”

HOW IS RISK MEASURED?

Inherent risk is the probability of loss or event arising out of circumstances or existing in an environment, in the absence of any action to control or modify the circumstances.

Residual risk is the probability of loss or event arising out of circumstances or existing in an environment, after considering any action that would mitigate the risk.

Control

Financial risk

Operational risk

Reputational risk

Fraud risk

Compliance risk

Technology risk

What types of risks are we looking at?

• A risk assessment involves the identification & analysis of relevant risks that threaten the achievement of an organization’s objectives & assists management in determining how those risks should be managed

Assessing Risk

THE RISK ASSESSMENT IS DONE. NOW WHAT?

How do we apply what we learned in our risk assessment process to the organization?

• Internal Controls• Entity vs. Transactional

• Manual vs. Automated

• Preventative vs. Detective

• The frequency/timing of the control activity

• Person or parties responsible (by title)

• The activity that is being performed (for example: review)

• The source of the information

How Is Risk Mitigated?

Analyzing if the control will mitigate the risk

Example• Risk: Payments go out from the organization without

proper approval• Control: All invoices are reviewed & approved by accounting

• Control: All invoices are paid by the due date


Analyzing if the control will mitigate the risk

Example: • Risk: Payments go out from the organization without

proper approval• Control: Invoices are approved prior to being released for

payment

• Control: Payment batches are reviewed for appropriateness & cash flow


Fraud Statistics

Figures from 2018 ACFE’s Report to the Nations on Fraud

How does that correlate to the insurance industry?

Insurance Fraud Statistics


• Scenario-Based

• Meant to measure management’s readiness to address possible fraud

• Maps existing control structure to understand where there may be missing controls

Fraud Risk Assessment

Detection


What caused the frauds from the Report to the Nations & how were they discovered?

The Importance of Internal Controls

• The primary internal control weakness that contributed to occupational fraud was lack of internal controls

• Management override & sufficient management review controls

• Code of Conduct

• Internal Audit Function/Surprise Audits

• Management Review

• Hotline/Anti-Fraud Policy

• Independent Audit Committee

• Job Rotation/Mandatory PTO

The Importance of Anti-Fraud Controls


NYPD Officer, 911 operators, nurses charged in $18 million insurance fraud scheme

• It is difficult to put sufficient controls in place to mitigate risk when collusion is present. Controls can be bypassed

• So what can you do? • Data analytics can give valuable

insight to organizations

• Red flags to further investigate things

Real-World Example

Courtney Reikofski | [email protected] | 303.832.5705

Insurance Data Security Model Audit Rule

Cybersecurity for Insurance

• National Association of Insurance Commissioners (NAIC) developed an act in Q4 2017

• Insurance Data Security Law

• The purpose & intent is to establish standards for

• Data security

• The investigation of & notification to the commissioner of a cybersecurity event applicable to licensees

• Also known as Model Audit Rule (MAR) 205

What is Model Audit Rule?

• Improve the state insurance departments’ surveillance of the financial condition of insurers

• The MAR modifications enhance provisions in three areas

• Internal controls over financial reporting

• External auditor independence

• Corporate & audit committee oversight

Purpose

Source: https://control-logics.com/model-audit-rule/

1. Provide regulators with greater confidence that their insurance entities have effective controls

2. Increase efficiencies of risk focused assessments; allow examiners to rely on the controls performed by the insurer

3. Enhance corporate governance by increasing management’s confidence in the internal controls environment

In Other Words…

Source: https://www.bakertilly.com/insights/the-model-audit-rule-best-practices-and-recommendations-to-improve-your-org

• Any individual or standalone nonpublic company that files an annual statement with their domiciliary state regulator. Includes

• Insurance companies

• Captive insurance companies

• Nonprofit insurers

• Health plans

Who is Affected?

• Licensee – any Person licensed, authorized to operate, or registered, or required to be licensed, authorized, or registered pursuant to the insurance laws of this State but shall not include a purchasing group or a risk retention group chartered & licensed in a state other than this State or a Licensee that is acting as an assuming insurer that is domiciled in another state or jurisdiction

• Authorized Individual – an individual known to & screened by the Licensee & determined to be necessary & appropriate to have access to the Nonpublic Information held by the Licensee & its Information Systems

Definitions

• Commissioner – the chief insurance regulatory official of the state

• Nonpublic Information – information not publicly available &

• Business-related information that would cause a material adverse impact to business, operations or security

• Consumer information (SSN, driver’s license, credit card, account numbers, biometric information, etc.)

Definitions

Source: MDL 668 – December 2017

• The New York Department of Financial Services (NYDFS) Cybersecurity Regulation requires covered entities to manage cybersecurity risk

• Covered entities

• Banks

• Insurance companies

• Other financial services institutions

• Built on core GLBA

Background

• Detail around the policies, procedures & safeguards that a covered entity must implement

• Based on risks & vulnerabilities identified during periodic cybersecurity risk assessments

• Expands the scope of covered data by defining “nonpublic information” to also include other data for which compromise poses a material risk to the business or its operations

• Requires breach reporting within 72 hours

What Makes This Unique?

• The South Carolina Insurance Data Security Act (“the South Carolina Bill”) was signed into law in May 2018 & became effective January 1, 2019

• Ohio became the second state to adopt a law based on the NAIC Model in December 2018. Ohio Senate Bill 273 (ORC §§3965.01-11) (“the Ohio Bill”) is enforceable on March 20, 2020

• Also in December 2018, Michigan became the third state to adopt with Michigan House Bill 6491 (MCL §500.550) (“the Michigan Bill”)

Other States Picking This Up

Requirements Under MAR

• A risk-based program

• Includes administrative, technical & physical safeguards to protect nonpublic consumer information & the licensee’s information systems

• Should be commensurate with the size & complexity of the business, as well as responsive to the risks identified during regular risk assessments

• Comprehensive program

Information Security Program

• Protect the security & confidentiality of nonpublic information

• Protect against any threats or hazards to the security or integrity of nonpublic information

• Protect against unauthorized access to or use of nonpublic information & minimize the likelihood of harm to any consumer

• Define & periodically reevaluate a schedule for retention of nonpublic information & a mechanism for its destruction when no longer needed

Objectives of Information Security Program

• Access limitations

• Multifactor authentication

• Encryption of nonpublic information during transit & on portable devices

• Intrusion detection mechanisms

• Audit trails

• Data retention & disposal practices

• Disaster recovery & business continuity plans

Appropriate Security Measures

• The licensee’s board of directors is ultimately responsible for overseeing the information security program

• Require the licensee’s executive management or its delegates to develop, implement & maintain the information security program

• The board must receive an annual report on

• The overall status of the security program

• Material matters related to the program

Oversight by the Board

• Require that these safeguards are checked at least annually

• Assess the effectiveness of the safeguards’ key controls, systems & procedures

• This broad language leaves room for variances at the state level for tighter time frames or more specific required testing

Planned Security Assessments

• Designate one or more employees, an affiliate or an outside vendor who is responsible for the information security program

• Identify reasonably foreseeable internal or external threats to nonpublic information that could result in

• Unauthorized access

• Transmission

• Disclosure

• Misuse

• Alteration or destruction

Risk Assessment

• Vet third parties prior to onboarding

• Contractually require third parties to implement appropriate administrative, technical & physical safeguards

• If a cyber event occurs within a vendor’s systems, licensees must launch an investigation to gather information about & document the event

Vendor Management

• Required to have a written IR plan

• Designed to promptly respond to & mitigate any cybersecurity incident

• Defined roles including those with decision making authority

• Managed internal & external communication

• Incident documentation

• Post-incident revisions & remediation

Incident Response Plan

• Licensees must provide security awareness training to employees

• Licensees are also responsible for monitoring legal & threat developments in the cybersecurity landscape & for updating their training program (as well as security safeguards) to reflect these developments

Training

• Annually certify compliance in accordance with the appropriate state law

• Certify with the state insurance commissioner

• Licensees must retain for five years all records, schedules & data supporting their compliance

Certify Annually

• If a licensee learns of an cybersecurity event, they must conduct a prompt investigation

• Can engage a thirdparty to do this on their behalf

• Must occur within 72 hours of discovery

• Must determine whether the event occurred

Reporting on Incidents

• Assess nature & scope

• Identify nonpublic information

• Perform or oversee reasonable measures to restore security of the compromised system

• Maintain records for five years

Reporting on Incidents

• Further regulation on cybersecurity compliance

• Increasing demand for privacy & data protection

• Other states will follow

• Organizations will need to show their due diligence in meeting these rules

What Does This Mean?

• Many of the principles from the MAR 205 have already existed in cybersecurity frameworks

• Tone at the top: executive management & boards play a role

• Conducting risk assessments required to know where an organization may be lacking

• Incident response plans can be dated; a tabletop exercise can help these refresh

• Validate that third-party partners also are maintaining their compliance

Next Steps

Rex Johnson | [email protected] | @RexSecurity

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