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FINANCIAL CONDITION EXAMINERS HANDBOOK

d.

Affiliates But No Transactions

Sometimes two or more entities are under common ownership or management control, but do not transact business between or among themselves. The mere existence of common control may result in operating results or financial position significantly different from what would have occurred if the entities were autonomous. For example, two or more entities in the same line of business may be commonly controlled by a party with the ability to increase or decrease the volume of business done by each (i.e., the ability to exercise significant influence over the operations of each entity). e. Typical Examination Procedures

The following examination procedures typically are considered to identify afTtliates and afflliated transactions. The review and evaluation of internal accounting control and an understanding of the entity's business and operating environment should be sufficient to recognize whether significant transactions are occurring and are not being given accounting recognition. Examples: a company provides accounting and management services to an affiliate at no charge; a major shareholder absorbs corporate expenses. Determine and evaluate the entity's procedures for identifying and properly accounting for affiliated transactions. Determine and evaluate the entity's procedures, if any, that prohibit individual directors or other members of management from exercising significant influence over transactions in which that person is an affiliate.

One means used by many entities to preclude such significant influence is to prohibit a director or other member of management from voting or otherwise participating in any business decisions in which that individual is an affiliate. In some cases, an affiliate may have participated in a business decision and it may not be practical for the board to reconsider a previously approved transaction solely so that person can abstain from voting. In these instances, it usually is acceptable to obtain written representation from appropriate management and the affiliate that significant influence was not exercised, provided that by reference to the entity's minutes or otherwise, the examiners are able to satisfy themselves that the affiliate's vote does not influence the outcome of the board's decision (e.g., the resolution was unanimously approved). If examiners have been unable to satisfy themselves as to the absence of significant influence, or conclude that a relationship or transaction merits attention of the board of directors, they may recommend subsequent reconsideration of an issue by the board of directors, with any affiliates abstaining from voting. The following procedures provide an approach for detecting abuses that sometimes result from holding company or affiliated relationships. Potential abuses: (1) Misuse of insurance company assets through:
i.

ii.
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Shifting assets (particularly securities) from one affiliate to another for window-dressing purposes during examinations or at the fmancial statement date; Making unsecured loans or advances to afflliates;

PART 1 GENERAL

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iii.

iv. v. (2)

Maintaining compensating bank balances for the benefit of an affiliate; Making inappropriate loans to affIliates or purchases of affIliate securities; or, Pledging assets to secure loans for affiliates.

Siphoning of insurance company funds through: i. ii.

iii.

iv. v. (3)

Dividends; Management or service fees; Payment of exorbitant reinsurance premiums to affiliates; Inappropriate payment of the expense of affiliates; or, Misdirection of premiums or commissions to affIliate insurance companies or agencies.

Other forms of misrepresentation: i.

ii.

Creating nonexistent receivables due from affIliates for window-dressing purposes during examination, or at the financial statement date; Assuming the liabilities by/for an affiliate.

Techniques for deterring abuses:

(1) (2)

(3)

Examine affIliates simultaneously; Appoint an affiliate coordinator for large or diffIcult examinations. The coordinator should be an experienced examiner and capable of supervising others. The coordinator may be either the examiner-in-charge or, in the case of a very large group, an examiner appointed by the examiner-in-charge; The coordinator's duties include: i. Reviewing and verifying the propriety of all legal documents (supplied by management) supporting inter affIliate agreements or transactions (e.g., management or service contracts, guarantees or pledges of assets, intercompany loan agreements, agency contracts, inter affIliate reinsurance contracts, and current reports to the Securities Exchange Commission) ; ii. Where necessary, coordinating the investigation of intercompany transactions with the teams that are examining other affiliates; iii. Compiling a list of all entities that are affiliated with the company together with an organization (intercompany) chart - including: iv. Any company holding a controlling interest in the company being examined; Companies that are controlled by a common holding company; Companies in which a director or offIcer has a substantial interest; and, Companies controlled by the company being examined.

Supervising the examiners in the investigation of inter affiliate relationships.

(4)

Define the duties of the examiners which include:

i.

Develop a list of all significant inter affiliate transactions or balances encountered during the selection and evaluation of data used in the examination of the individual balance sheet accounts and evaluate compliance with appropriate insurance laws.
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