1. (a) Definitions. The following words and terms, when used in this section, shall have the following meanings, unless the context clearly indicates otherwise.

   1. (1) Accountant--An independent certified public accountant or accounting firm that meets the requirements of Insurance Code, Article 1.15A, §12.
   2. (2) Audited Financial Report--The annual audit report required by Insurance Code, Article 1.15A.
   3. (3) Commissioner--The Commissioner of Insurance.
   4. (4) Department--The Texas Department of Insurance.
   5. (5) Examiner--Staff appointed by the Commissioner pursuant to Insurance Code, Articles 1.17 and 1.18.
   6. (6) Generally Accepted Accounting Principles (GAAP)--The conventions, rules, and procedures that define accepted accounting practice, including broad guidelines and detailed procedures, set forth by the Accounting Principles Board of the American Institute of Certified Public Accountants, which was superseded by the Financial Accounting Standards Board, and which principles are specifically defined by SAS Number 69 (AU §411.05).
   7. (7) Generally Accepted Auditing Standards (GAAS)--The standards adopted by the American Institute of Certified Public Accountants to conduct an audit and to ensure the quality of the performance by accountants who are engaged in an audit of financial statements.
   8. (8) NAIC--The National Association of Insurance Commissioners.
   9. (9) Statutory Examination--An examination performed by the Department's examiners or other persons or firms retained by the Department specifically for examination of insurers, corporations, or associations.
   10. (10) Work Papers--The records kept by the accountant supporting that accountant's audit opinion, including the audit records defined by Insurance Code, Article 1.15A, §17(a); the accountant's audit planning records; and any record of communications related to the audit between the accountant and the insurer pursuant to the Insurance Code, Article 1.15A, §17(b).
   11. (11) Material--An item of information that should be reported if it is significant enough to have an effect on the decision maker. Materiality is dependent upon the relative size of an item, the precision with which the item can be estimated, the nature of the item, and the dollar amount above which the auditor's perspective of the item will be influenced. An item is material for accounting purposes if the omission or misstatement of it, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatements.

2. (b) Hierarchy of Authority. The priority for determination of accounting standards is set out in paragraphs (1)-(3) of this subsection. For guidance on matters not specifically addressed by the resources set out in paragraphs (1)-(3) of this subsection, the Department shall first rely upon other NAIC handbooks, manuals, and instructions, and if further direction is needed shall rely upon GAAP. GAAP is prescribed to the extent not conflicting with the hierarchy of authority set out in this subsection.

   1. (1) Texas statutes.
   2. (2) Department rules and regulations.
   3. (3) Directives and orders of the Commissioner, and any examiner's handbooks, manuals, bulletins, and/or instructions adopted by the Department.
3. (c) Applicability. This section applies only to audited financial reports with audit dates as of December 31, 1995, or later. A foreign or alien insurer may be exempt from this rule if the foreign or alien insurer files an audited financial report in another state and the requirements for that state's audited financial reports are determined by the Commissioner pursuant to the Insurance Code, Article 1.15A, §6(a), to be substantially similar to the requirements in Insurance Code, Article 1.15A. A foreign or alien insurer is exempt from this rule if the foreign or alien insurer files an audited financial report in another state and the requirements for that state's audited financial reports have already been determined by the Commissioner pursuant to the Insurance Code, Article 1.15A, §6(a), to be substantially similar to the requirements in Insurance Code, Article 1.15A.
4. (d) Purpose. The Department recognizes that the Insurance Code, Article 1.15A, requires audited financial reports to be prepared, and that statutory examinations are periodically conducted pursuant to the Insurance Code. To improve coordination between the audited financial reports and statutory examinations, and to promote the utilization of work papers to the fullest extent during the conduct of statutory examinations, certain minimum standards, guidelines, and procedures must be incorporated by the accountant during the preparation of the work papers and the audited financial report. The purpose of this section is to establish those requirements.

5. (e) Conduct of audit. The annual audit required by the Insurance Code, Article 1.15A, shall be conducted in accordance with GAAS. It is not the department's intent to expand audit testing beyond the requirements of GAAS. To the extent not inconsistent with GAAS, consideration shall be given to the procedures and conventions set out in paragraphs (1)-(4) of this subsection, as follows:

   1. (1) audit procedures and format contained in the NAIC Examiners Handbook;
   2. (2) accounting treatments for the particular line(s) of insurance contained in the NAIC Accounting Practices and Procedures manuals and the NAIC Annual Statement Instructions;
   3. (3) valuation procedures contained in the NAIC Purposes and Procedures of the Securities Valuation Office manual; and
   4. (4) any order(s) of the Commissioner issued to a particular company.

6. (f) Contents of audited financial reports. In addition to the contents specified in the Insurance Code, Article 1.15A, §10(a)-(c), audited financial reports shall contain the statements and reports set out in paragraphs (1)-(3) of this subsection.

   1. (1) Balance sheet assets shall be limited to only those assets satisfying the admissibility issues of verified title and ownership, possession, valuation, and limitation. Asset admissibility issues are to be measured by compliance with the appropriate provisions of the Insurance Code and the Texas Administrative Code. The balance sheet shall include reserve and other liabilities which have been computed in accordance with the Insurance Code and the Texas Administrative Code.
   2. (2) The statement of gain or loss from operations, statement of changes in capital and surplus, and the statement of cash flow prepared in accordance with the Texas Administrative Code and the NAIC Annual Statement Instructions.
   3. (3) In addition to the items that must be recorded in the notes to the financial statements as required by the Insurance Code, Article 1.15A, §10(c), any exceptions to compliance with the financial, investment, and holding company provisions of the Insurance Code or the Texas Administrative Code noted during the audit and a schedule and explanation of material non-admitted assets shall also be recorded in notes.

7. (g) Contents of work papers.

   1. (1) For those items subjected to detailed tests by the accountant during the course of the audit, the work papers shall contain notation of whether any material exceptions exist for each of the items set out in subparagraphs (A) and (B) of this paragraph.

      1. (A) For invested assets:

         1. (i) compliance as an authorized investment has been determined and does not exceed statutory limitations;
         2. (ii) ownership and possession have been verified; and
         3. (iii) securities are valued in accordance with the instructions of the NAIC Purposes and Procedures of the Securities Valuation Office manual.

      2. (B) For assets other than invested assets:

         1. (i) such assets are admitted in accordance with the appropriate provision of the Insurance Code or Texas Administrative Code; and
         2. (ii) such assets are valued in accordance with the Texas Administrative Code and the appropriate section of the NAIC Accounting Practices and Procedures manual.

   2. (2) If the regulated entity subject to the audit has any material reinsurance agreement or agreements, the work papers shall contain an outline addressing the items set out in subparagraphs (A)-(E) of this paragraph as follows:

      1. (A) summary of the insurer's overall reinsurance program;
      2. (B) explanation of relevant provisions by which liabilities are transferred to the reinsurer and any contingency provisions by which the reinsurer can cause the ceding insurer to reassume liabilities previously transferred to the reinsurer;
      3. (C) explanation about assets held in trust, depositories, or letters of credit by which any reserve liabilities are collateralized;
      4. (D) verification of any material reinsurance balance ceded or assumed; and
      5. (E) explanation of amounts recoverable from unlicensed reinsurers that are not collateralized, or disputed reinsurance recoverables.

   3. (3) The work papers of any audited entity shall contain:

      1. (A) any letters from the accountant to management commenting on or explaining internal management operating procedures;
      2. (B) computer-generated work papers;
      3. (C) audit program;
      4. (D) reports prepared by outside consultants;
      5. (E) for policy liabilities, a note that reserves are established in accordance with policy and statutory provisions, and that required payments were made pursuant to any contract provisions;
      6. (F) for all other liabilities, that all material liabilities of the company have been properly recorded; and
      7. (G) internal control work papers.

   4. (4) The work papers of any audited entity shall contain a notation that the accountant has determined that such entity met the requirements of subparagraphs (A) and (B) of this paragraph.

      1. (A) Filing requirements have been met of the Insurance Code, Article 21.49-1, §3 and §4, and the Texas Administrative Code, including but not limited to the requirements that all dividends have been reported to the Department within two business days after declaration and at least ten days prior to payment, and that all dividends have been declared to have been paid in accordance with the provisions of Insurance Code, Articles 3. 11, 21.31, 21.32, 21.32A, or 22.08, whichever statute is applicable.
      2. (B) Unencumbered assets have been maintained in an amount at least equal to reserve liabilities as required by Insurance Code, Article 21.39-A.
8. (h) Accessibility of work papers. The accountant shall provide all work papers to the examiner, whether during or after the preparation of the audited financial report. The examiner may obtain, if necessary, photocopies of work papers as provided by the Insurance Code, Article 1.15A, §17(c), so as not to burden the accountant if a statutory examination is occurring at the same time as an annual audit. Information obtained under this section is subject to the confidentiality standards imposed by Insurance Code, Articles 1.15, §8(b); 1.15A, §17(c); 1.18; and 21.49-1, §10.
9. (i) Noncompliance with this section may result in the Commissioner initiating action pursuant to Insurance Code, Articles 1.10, §7, and 1.15A, §12(d).

Source Note:The provisions of this §7.85 adopted to be effective July 13, 1995, 20 TexReg 4689.