oversight

Year 2000: Insurance Regulators Have Accelerated Oversight, but Some Gaps Remain

Published by the Government Accountability Office on 1999-12-20.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                United States General Accounting Office

GAO             Report to the Ranking Minority
                Member, Committee on Commerce,
                House of Representatives


December 1999

                YEAR 2000
                Insurance Regulators
                Have Accelerated
                Oversight, but Some
                Gaps Remain




GAO/GGD-00-42
United States General Accounting Office                                                           General Government Division
Washington, D.C. 20548




                                    B-284237
                                    December 20, 1999
                                    The Honorable John D. Dingell
                                    Ranking Minority Member
                                    Committee on Commerce
                                    House of Representatives

                                    Dear Mr. Dingell:

                                    This report responds to your request that we provide an update to
                                    information that we presented earlier this year on the readiness of the
                                    insurance industry to meet the Year 2000 date change. Specifically, our
                                    objectives were to provide (1) an updated assessment, as of September 30,
                                    1999, of state regulatory oversight of the insurance industry’s Year 2000
                                    preparations and (2) the status of the industry’s Year 2000 readiness.

                                    Under a long-established division of responsibilities between federal and
                                    state regulators, state insurance regulators have primary responsibility for
                                                                                         1
                                    the regulatory oversight of the insurance industry. In March 1999, we
                                    reported that state insurance regulators were generally not as proactive in
                                    their oversight of the industry’s Year 2000 readiness as the banking and
                                                           2
                                    securities regulators. Of particular concern was the limited extent of
                                    regulatory attention given to validating the status of Year 2000
                                                                                  3
                                    preparedness among insurance companies. Specifically, we indicated that
                                    oversight efforts to validate the insurers’ self-reported Year 2000 readiness
                                    status generally began later and lacked the vigor demonstrated by bank
                                    and securities regulators. At that time, state regulators chiefly relied on
                                    surveys to obtain information on the Year 2000 preparedness of companies
                                    that were subject to their oversight, although examinations had been
                                    acknowledged as one of the primary means regulators could use to verify
                                    companies’ preparedness and validate their responses to surveys.

                                    In an April 1999 report, we also noted that the National Association of
                                    Insurance Commissioners (NAIC), which is a key coordinating group that
                                    serves to facilitate states’ oversight efforts, had been slow in providing
                                    1
                                        McCarran-Ferguson Act of 1945, 15 U.S.C. 1011-1015.
                                    2
                                     Insurance Industry: Regulators Are Less Active in Encouraging and Validating Year 2000 Preparedness
                                    (GAO/T-GGD-99-56, Mar. 11, 1999).
                                    3
                                     We use the term “insurance companies” in the broad sense to include all entities regulated by state
                                    insurance departments, not just life/health insurance companies and property/casualty insurance
                                    companies.




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                   information and guidance to state regulators about the appropriate Year
                                                           4
                   2000 regulatory activities to undertake.

                   Although both regulators and industry observers were generally confident
                   that the insurance industry was in reasonably good condition regarding
                   Year 2000 readiness, we cautioned in our April report that such
                   observations were based on information that was self-reported by
                   insurance companies and, for the most part, had not been validated.
                   Additionally, industry experts expressed concerns about insurers’ liability
                   exposures. Although it was too early to estimate the magnitude of costs
                   associated with claims and legal defenses for Year 2000-related mishaps,
                   evidence suggested that such costs could be substantial for some
                   property/casualty insurers. We concluded in the report that insurers would
                   continue to face uncertainties about their Year 2000-related liability
                   exposures until answers to key legal issues and actual claims for Year
                   2000-related matters began to materialize.

                   In the 8 months since our last report, NAIC stepped up its efforts to assess
Results in Brief   the insurance industry’s Year 2000 readiness by, among other things, (1)
                   issuing expanded guidance to state insurance regulators on how to
                   examine companies’ preparedness and (2) encouraging state regulators to
                   conduct on-site examinations of insurers with the greatest potential public
                   impact. Over the same period, some of the nation’s state regulators
                   increased their use of examinations that are aimed at verifying the Year
                   2000 readiness of their insurers, particularly for their nationally significant
                                                              5
                   life/health and property/casualty insurers. These insurers account for
                   approximately 86 percent of the premiums written and make up 27 percent
                   of the companies in these two industry segments.

                   Six of the 17 states we reviewed indicated that their goal was to conduct
                   Year 2000 readiness examinations for all of the insurance companies
                                             6
                   domiciled in their states. The remaining 11 states had set varying goals
                   regarding which companies were to be subject to Year 2000 examinations,
                   but most of these states attempted to cover their nationally significant
                   4
                    Year 2000: State Insurance Regulators Face Challenges in Determining Industry Readiness (GAO/GGD-
                   99-87, Apr. 30, 1999).
                   5
                    NAIC designates an insurance company as nationally significant if, in any of the past 3 years, its annual
                   gross premium writings was greater than $30 million for a property/casualty company or greater than
                   $50 million for a life/health company and the company is licensed in 17 or more states. NAIC uses this
                   designation in other processes, including a peer review of how states analyze the financial standing of
                   their insurers.
                   6
                   Insurance companies may sell insurance in one or more states. However, each company is chartered,
                   or domiciled, in one state. This state acts as the primary regulator for the company.




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insurers. At the time of our review, less information was available about
major life/health and property/casualty insurers that were not considered
nationally significant. In November, NAIC was still in the process of
systematically collecting information on companies in the other insurance
segments, such as health maintenance organizations (HMO) and health,
medical and dental indemnities (HMDI).

NAIC and state regulators remain confident about the insurance industry’s
Year 2000 readiness. In October 1999, NAIC’s Year 2000 Industry
                           7
Preparedness Task Force reported that the insurance industry is expected
to experience little disruption when 2000 begins, estimating that only 3
percent of the nation’s nationally significant companies had not made their
systems Year 2000 ready. State responses to a nationwide survey we
conducted indicated considerable confidence in the insurance industry’s
preparation for the Year 2000 date change. Responses indicated that 78
percent of the states’ domiciled insurance companies were considered to
be Year 2000 ready and making satisfactory progress in their contingency
planning activities as of September 30. An additional 17 percent had not
completed preparations for their mission-critical systems by September 30,
but were expected to be Year 2000 ready by December 31, 1999.

Uncertainties about the ability of the remaining 5 percent of the companies
to become fully Year 2000 ready were largely unresolved at the time of our
survey. Regulators indicated that they did not have adequate information
to determine the readiness status for 4 percent of the companies and
considered 1 percent to be at risk of not being ready by December.
Regarding the latter, 13 states identified 49 companies, consisting mostly
of small property/casualty insurers that they considered at risk of not
being ready by the end of the year.

In comparing the Year 2000 readiness of companies by type, we found that
states appeared to have a slightly lower level of confidence in the
readiness of HMOs and managed care organizations than those in other
insurance segments. According to a task force official, health insurers
represent one part of the industry that remains vulnerable because they
depend on hospitals and doctors’ offices becoming Year 2000 ready. Rating
companies and consultants we spoke with have generally remained
confident about the industry’s efforts to prepare for 2000. One rating firm
tempered the generally optimistic view of readiness in the industry by
7
 Formed in 1998, the Year 2000 Industry Preparedness Task Force is responsible for addressing
industry remediation, compliance and contingency planning, data confidentiality, and data sharing
among the regulators and working with peer regulators to most efficiently address the preparedness of
insurance companies.




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              reporting that 13 percent of the companies responding to its survey had
              made inadequate progress in their Year 2000 preparations.

              Industry observers continued to express uncertainty over potential costs
              associated with Year 2000-related liability exposures. Legal debates had
              yet to be resolved over insurance coverage for Year 2000-related mishaps
              as well as liability for costs that policyholders incur to avoid such mishaps.
              Rating companies we contacted in October 1999 indicated that it was still
              too early to tell how liability exposures might affect insurance companies,
              and, for this reason, the rating companies had not factored these
              exposures into their ratings.

              Each insurance company is chartered under the laws of a single state,
Background    known as its state of domicile. Although an insurance company can
              conduct business in multiple states, the regulator in the insurer’s state of
              domicile is its primary regulator. States in which an insurer is licensed to
              operate, but in which it is not chartered, typically rely on the company’s
              primary regulator in its state of domicile to oversee the insurer. Regarding
              Year 2000 issues, NAIC has emphasized this approach by encouraging each
              state to focus its Year 2000 oversight efforts on its domiciliary companies.

              In total, state-regulated insurance entities wrote an estimated $895.2 billion
                                                               8
              in direct premiums sold nationally during 1998. Life/health and
              property/casualty insurance companies represent the key industry
              segments, accounting for 85 percent of the total direct premiums written in
              that year. HMOs; HMDIs; and other entities, such as fraternal organizations
              and title companies, accounted for the remaining 15 percent.

              To update our previous assessment of the regulatory oversight of the
Scope and     insurance industry’s Year 2000 readiness, we interviewed NAIC officials
Methodology   and reviewed documentation related to NAIC’s efforts to facilitate state
              oversight of the industry’s Year 2000 readiness. We also reviewed available
              state examination reports and executive summaries covering companies’
              Year 2000 preparations, which were available at NAIC. While we did not
              verify the accuracy of the reports, this review included well over 200
              reports and summaries prepared by or on behalf of 22 states. To the extent
              available through NAIC, we present updates pertaining to regulatory
              oversight through November 1999. In addition, we conducted follow-up

              8
               Direct premiums arise from policies or contracts issued by an insurance entity acting as the primary
              insurance carrier. Such premiums are defined as the contractually determined amount charged by the
              reporting entity to the policyholder for the effective period of the contract based on the expectation of
              risk, policy benefits, and expenses associated with the coverage provided by the terms of the contract.
              Direct premium figures do not include premiums related to reinsurance transactions.




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work of Year 2000 validation efforts at the same 17 state insurance
                                             9
departments on which we reported in April.

Our follow-up work for the 17 states included (1) a second survey
administered in July 1999 that covered their Year 2000 oversight activities,
                                            10
including examination efforts in the area; (2) site visits to 6 of the 17
states to interview regulatory officials and review guidelines for
conducting Year 2000-related examinations as well as available reports,
summaries, and workpapers covering companies’ Year 2000 preparations;
and (3) additional contacts in October 1999 with regulatory officials from
each of the 17 states for a final update of their Year 2000-related
examination efforts. The domiciliary companies of these 17 state insurance
departments collectively accounted for 76 percent of the insurance sold
nationally during 1998. See appendix I for a list of the 17 states and their
                                                11
respective domiciled insurers’ market shares.

Our review of examination-related documents was limited by restrictions
at two of the states we visited and at NAIC, which had examination report
summaries for the same two states. For one state, regulatory officials cited
an existing law that restricted access to its examination reports and
related workpapers by external parties. Regulatory officials for another
state explained that, under special agreements reached with insurers prior
to conducting Year 2000 examinations, their department was precluded
from sharing examination-related documents with other states or external
entities without the consent of the companies involved. Although one of
the two states provided some limited access to their examination
documents, we were unable to independently verify the adequacy of Year
2000 examination efforts for either state.

To determine the status of the insurance industry’s Year 2000 readiness,
we surveyed all 50 state insurance departments on the state of readiness of
their domiciled companies as of September 30 and the extent of the
departments’ on-site verification efforts. For each state, NAIC provided a
Year 2000 contact to assist us in this survey effort. Appendix II contains a
copy of the Year 2000 survey we administered to the states. With NAIC’s
assistance, we obtained a 100-percent response rate from the 50 states.

9
    GAO/GGD-99-87.
10
     We administered a similar survey in January 1999 during our initial review in the area.
11
   Market share information represents the proportion of total net premiums written nationally for all
types of insurance accounted for by all companies domiciled in a given state. NAIC provided this
information, which is based on 1998 financial data.




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                         To obtain updated insights regarding the industry’s Year 2000 outlook
                         pertaining to readiness and liability exposure issues, we contacted
                         representatives of key rating companies, including A.M. Best Company,
                         Standard and Poor’s, Moody’s Investors Service, and Weiss Ratings, Inc.
                         We also obtained and reviewed information from (1) the Gartner Group,
                         which is a business and technology advisory company that conducts
                         research on the global state of Year 2000 readiness; (2) the American
                         Academy of Actuaries, which is a public policy organization that presents
                         actuarial analyses, comments on proposed federal regulation, and works
                         with state officials on insurance-related issues; and (3) the Casualty
                         Actuarial Society, which is a professional organization to advance
                         knowledge of actuarial science applied to property, casualty, and similar
                         risk exposures. In addition, we spoke to representatives of Milliman and
                         Robertson, Inc., an actuarial and consulting firm, and the American Bar
                         Association.

                         We performed our work between June 1999 and December 1999 in
                         accordance with generally accepted government auditing standards. We
                         requested comments on a draft of this report from NAIC. Its written
                         comments, which are included in appendix III, are discussed near the end
                         of this letter.

                         Since March 1999, NAIC has stepped up its Year 2000 efforts by (1) issuing
NAIC and State           expanded guidance to state regulators on how to examine companies’
Insurance Regulators     preparedness and (2) encouraging state regulators to do on-site validation
Have Accelerated         reviews of companies with the greatest potential public impact. NAIC
                         reports that many of the nation’s state regulators have also made
Their Oversight of the   substantial progress in conducting Year 2000 validation reviews. They
Industry’s Year 2000     were projected to complete, by the end of November, on-site Year 2000
Readiness                reviews for 91 percent of the nationally significant companies that
                         accounted for about 84 percent of the direct premiums written by
                         life/health and property/casualty insurers in 1998, according to NAIC.

                         Despite this progress, uncertainties remain regarding the extent that on-
                         site validation reviews have been conducted for some states’ companies,
                         including some major health insurers and other segments of the insurance
                         industry, such as HMOs and managed care organizations. In November
                         1999, NAIC was still in the process of quantifying the extent to which on-
                         site verification was conducted at some of the major health insurers that
                         did not fall into the category that NAIC had designated as nationally
                         significant and at the larger managed care organizations, which had not
                         been specifically covered by NAIC’s earlier efforts.




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NAIC Has Stepped Up Its         After we reported on the insurance industry’s Year 2000 readiness in
                                March and April, 1999, NAIC stepped up its efforts to facilitate state
Efforts to Encourage States’    actions to verify insurers’ reported information on their Year 2000
Validation of Reported Year     preparations. For example, one undertaking involved NAIC’s provision of
2000 Information                expanded examination guidance for assessing companies’ Year 2000
                                preparations and related training. Another important part of NAIC’s
                                stepped up efforts has been its initiative that was aimed at prioritizing
                                companies for review and encouraging states to perform on-site validation
                                reviews. With only 9 months remaining before 2000 and 5,247 state-
                                regulated insurance companies to account for, NAIC developed a
                                pragmatic approach of focusing on the companies with the greatest
                                potential impact on the public if they were to experience major computer
                                problems. NAIC also worked with the states and encouraged them to
                                implement this focused approach.

Enhanced Guidance for           In April 1999, NAIC provided the states with an enhanced version of the
Examining Year 2000 Readiness   Financial Examiners Handbook, which provided additional guidance for
                                performing Year 2000 readiness reviews. According to NAIC, the guidance
                                was borrowed from audit programs developed by the Federal Financial
                                                                 12
                                Institutions Examination Council for federal examiners’ reviews of the
                                Year 2000 readiness of U.S. financial institutions and a few of the state
                                insurance departments that had been especially active in their Year 2000
                                oversight.

                                NAIC also contracted for the services of a national consulting firm to
                                develop and provide training to help state examiners better understand the
                                review procedures and assist them in incorporating the procedures into
                                their examinations. According to an NAIC official, this 2-day training,
                                which was provided during the latter part of April in Atlanta, Chicago, and
                                Denver, was attended by examiners representing almost 20 states.
                                Compared to the timing of guidance provided by the banking and
                                securities regulators, such Year 2000-related guidance and training would
                                be considered late. However, we were told that this training and guidance
                                were timely enough to be useful for some state insurance departments




                                12
                                  The Federal Financial Institutions Examination Council is an interagency body created by Congress
                                in 1979 to (1) prescribe uniform principles, standards, and report forms for federal examinations of
                                financial institutions and (2) make recommendations to promote uniformity in the supervision of these
                                institutions. The council’s membership is made up of the three federal bank regulators and the
                                regulators for credit unions and thrift institutions.




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                                                                                                                      13
                              because they did not start their targeted Year 2000 examination process
                              until mid-1999.

NAIC’s Year 2000 Initiative   In March, NAIC’s Year 2000 Industry Preparedness Task Force launched an
Focusing on Nationally        initiative that was intended to (1) encourage states to perform on-site
Significant Companies         validation reviews and (2) determine the extent to which the states had
                              verified the insurance industry’s Year 2000 readiness. The initiative
                              focused on life/health and property/casualty insurance companies that
                              NAIC had designated as nationally significant. This designation included
                              1,161 companies, located in 44 states and the District of Columbia, that
                              were responsible for almost $650 billion in total premiums written during
                                    14
                              1998.

                              According to NAIC information, the insurance industry is relatively
                              concentrated, with nationally significant companies representing
                              approximately 86 percent of the premiums written for the life/health and
                              property/casualty segments in 1998 and 27 percent of the 4,325 companies
                              in the two insurer segments. It is also noteworthy, however, that many
                              insurers that far exceeded NAIC’s criteria for the level of direct premiums
                              written were not considered nationally significant because they did not
                              meet the second criteria of being licensed in 17 states or more. These
                              companies tended to conduct a significant amount of business on a more
                              localized rather than national basis. We noted, for example, that 36
                              life/health insurers and 195 property/casualty insurers that each wrote
                              more than $100 million in direct premiums during 1998 were not covered
                              by NAIC’s nationally significant designation.

                              Over the past several months, NAIC’s Year 2000 initiative focusing on
                              nationally significant companies has involved an ongoing, interactive
                              process with the individual state insurance departments. In April, NAIC
                              administered a survey to all 50 states and the District of Columbia to
                              develop preliminary baseline information on state efforts to conduct on-




                              13
                                 Targeted Year 2000 examinations focus exclusively on reviewing companies’ Year 2000 preparations
                              and their corresponding status of readiness.
                              14
                                According to NAIC information, when all types of insurance companies are included (not just
                              life/health and property/casualty), there were 5,247 companies that wrote over $895 billion in direct
                              premiums in 1998. While the companies designated as nationally significant represented only 22
                              percent of the nation’s state-regulated insurance companies, they wrote approximately 73 percent of
                              the direct premiums written in 1998.




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site examinations of companies’ Year 2000 compliance status, particularly,
                                                   15
the compliance of nationally significant companies.

From June through August, 1999, NAIC also facilitated a series of
conference calls that included members of the Year 2000 Industry
Preparedness Task Force and, successively, representatives from each of
the 50 states. According to NAIC officials, these conference call
discussions focused on each state’s general approach to overseeing the
industry’s Year 2000 preparations as well as its efforts to conduct on-site
examinations to verify the Year 2000 compliance status of its domiciled
insurance companies, particularly its nationally significant companies.
These conference calls were a key mechanism that NAIC used to
encourage states to conduct more on-site verification reviews and
facilitate critical Year 2000 information-sharing among the participating
states regarding, for example, licensed companies that wrote a large
amount of insurance in a state but were domiciled elsewhere. Finally,
these conference calls with each of the states enabled NAIC to quantify on
a national basis the extent of the states’ on-site verification reviews of their
nationally significant companies.

To document its Year 2000 initiative, NAIC has maintained a summary
schedule of all nationally significant companies with information on,
among other things, whether each company had been subject to an on-site
Year 2000 verification review. A company was considered to have been
subject to an on-site verification review if the state of domicile, or another
state where the company was licensed and doing business, indicated to the
task force that a review had been completed or was scheduled to be
completed by the end of September. A company was also considered to
have been subject to an on-site verification review if it had been indirectly
covered or would have been covered by the end of September through an
on-site review of an affiliated company with which its computer system
was fully integrated.

On the basis of information obtained from the conference calls that were
completed in August 1999, NAIC reported that 1,037 nationally significant
           16
companies were to have been subject to an on-site Year 2000 review, 106
were not to have been subject to an on-site review, and the remaining 18
discontinued operations during 1999. The task force directed additional

15
 Another stated objective was to develop quantifiable information on the industry’s readiness for us in
connection with our Year 2000 reviews.
16
 These nationally significant companies included three for which NAIC believed the nature and scope
of reviews conducted by a state’s vendor were equivalent to an on-site review.




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                             attention to certain companies that were viewed to be of particular
                             concern. In a few cases, for example, NAIC officials noted that a state
                             reconsidered its original position that an on-site verification was not
                             needed. In one situation, NAIC provided financial assistance to facilitate
                             the Year 2000 examination of a few key nationally significant companies in
                             a particular state. In another case, a state agreed to conduct a targeted
                             Year 2000 examination for a company domiciled in another state that had
                             no plans to conduct on-site verification of the company.

                             By November 1999, NAIC reported that the number of companies that
                             would be subject to an on-site Year 2000 review by the end of November
                             had increased to 1,059 companies, and it reported that the remaining 84
                             companies would not be subject to an on-site review. NAIC officials
                             explained that, for the most part, the task force was satisfied with the level
                             of information available on the remaining nationally significant companies
                             that were not to be subject to on-site verification. NAIC has also taken the
                             position that some comprehensive surveys were thorough enough to be
                             equivalent to an examination. As we stated in our April 1999 report and
                             continue to believe, the use of Year 2000 examinations is a principal
                             mechanism for verifying self-reported information and providing
                             assurances pertaining to the Year 2000 progress and readiness of regulated
                             institutions. The ability to provide such assurances is particularly
                             important for the industry’s nationally significant companies and others
                             that do a substantial amount of business.

                             In total, the number of companies that were to be subject to an on-site
                             Year 2000 review by the end of November represented 98 percent of the
                             direct premiums written by nationally significant companies. Regarding
                             the total life/health and property/casualty insurer segments, the identified
                             coverage through NAIC’s initiative suggests that companies that accounted
                             for at least 84 percent of the direct premiums written during 1998 had been
                             or were to have been subject to an on-site Year 2000 review by the end of
                             November. The extent of on-site validation for the rest of the industry
                             (including large HMO and HMDI companies), which accounted for an
                             additional $137 billion in direct premiums written during 1998, was still
                             unknown as of November 1999.

NAIC’s Current Focus on      In October 1999, NAIC reported that the Year 2000 Industry Preparedness
Managed Care Organizations   Task Force had recently expanded the scope of its review process to
                             include the nation’s largest managed care organizations together with all of
                             the Blue Cross and Blue Shield Plans, which represented some of the




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                                                                                                                                    17
                                        major health care insurers not designated as nationally significant. NAIC
                                        estimated that the companies that fall into this category represent about 80
                                        percent of the direct premiums written for all HMOs and HMDIs in 1998.
                                        The first task force conference to collect and summarize information on
                                        the status of on-site Year 2000 reviews for these managed care
                                        organizations was held in November 1999. NAIC officials acknowledged
                                        that with the Year 2000 deadline close at hand, the task force’s main
                                        objective was to quantify the extent of on-site verification that had been
                                        completed and identify any companies that may be of regulatory concern.

State Insurance Regulators’             During 1999, most of the 17 state insurance regulators we reviewed
                                        increased their efforts to conduct targeted examinations that were aimed
Efforts to Validate Industry            at verifying companies’ Year 2000 readiness. In the beginning of the year,
Year 2000 Readiness                     10 of the 17 states were in the process of conducting targeted
Through Targeted                        examinations or were planning to conduct such examinations, and the
Examinations Increased                  remaining 7 states were either not planning to conduct such examinations
                                        or were uncertain whether they were going to conduct them, as shown in
During 1999                             table 1. By June 1999, the 17 states were either in the process of
                                        conducting targeted examinations or indicated that they planned to
                                        conduct them. Some states that started targeted Year 2000 examinations in
                                        the middle of 1999 used expedited approaches, such as suspending their
                                        regular financial examination process to devote their examiners solely to
                                        targeted Year 2000 examinations or hiring one or more private consultants
                                        to conduct such examinations in a short period of time.

Table 1: Status of Targeted Year 2000
Examinations to Validate Company                                                                                As of       As of          As of
Readiness in 17 States                  Status                                                                1/31/99     6/30/99        9/30/99
                                        Fieldwork for planned targeted examinations                                 0           0              9
                                        completed and reports finalized
                                        Targeted examinations in progress                                            8        13              8
                                        Targeted examinations planned but not                                        2         4              0
                                        started
                                        State expressed uncertainty regarding the                                    3         0              0
                                        need for targeted examinations
                                        No plans to conduct targeted examinations                                    4         0              0
                                        Total                                                                       17        17             17
                                        Source: GAO interviews with state officials.


                                        By the end of September, all of the 17 states we reviewed had either
                                        completed or were in the process of completing their targeted Year 2000
                                        examinations. Specifically, eight states had finished the fieldwork for over
                                        one-half of the companies that were targeted to be examined, but
                                        17
                                             These health care insurers tend to be concentrated in one or a few states.




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                                corresponding reports for many of these examinations were still pending.
                                We were told that one state was waiting for the completion of all its
                                examination fieldwork before issuing a single summary report for all of its
                                domiciled companies, rather than issuing separate reports for each
                                company. A few states projected that they would not complete their Year
                                2000 examination process until the end of November, leaving little time for
                                correcting identified deficiencies before the date change.

                                In conducting targeted Year 2000 examinations, the states generally said
                                they used the enhanced guidance that NAIC provided in April or guidelines
                                developed by contractors, or in some cases both guidance, to improve the
                                quality and consistency of their validation efforts. Our review of guidelines
                                provided by the six states we visited indicated that they covered all key
                                                                                                18
                                areas of Year 2000 conversion cited in our Assessment Guide as well as
                                those areas cited in the federal banking regulator examination guidelines.
                                In turn, our review of reports available for 22 states’ targeted Year 2000
                                examinations indicated that the reports systematically addressed all major
                                guideline components, and that they gave a particular emphasis to
                                                                           19
                                companies’ contingency planning efforts.

Coverage of Companies Through   Like the banking industry, insurers depend on date-sensitive calculations
On-site Examinations            involving, for example, annuities, policy renewals, and claims processing.
                                Recognizing their industry’s high level of date sensitivity, the nation’s
                                banking regulators have completed multiple rounds of on-site
                                                                                                     20
                                examinations for all financial institutions under their jurisdiction.
                                Although 6 of the 17 states we reviewed indicated that their overall goal
                                was to conduct 1 round of targeted examinations for all of their domiciled
                                insurance companies, the remaining 11 states had established varying
                                goals regarding which and how many companies would be subject to
                                targeted Year 2000 examinations. These states’ goals were to cover from 6
                                to 76 percent of the domiciled companies within their jurisdictions. For the
                                most part, these goals attempted to cover the states’ nationally significant
                                companies. Two exceptions were states that had not planned to conduct
                                on-site examinations for more than one-half of their nationally significant
                                companies. One state official explained that a decision was made at the
                                commissioner’s level that the limited time and staff resources available

                                18
                                     Year 2000 Computing Crisis: An Assessment Guide (GAO/AIMD-10.1.14, Sept. 1997).
                                19
                                     These reports were reviewed at five of the six states we visited and at NAIC.
                                20
                                   Federal financial regulators report that they have conducted Year 2000 examinations in each insured
                                financial institutions at least twice or, in some cases, three or more times. On the basis of such
                                oversight efforts, the chair of the Federal Deposit Insurance Corporation has assured the public that,
                                as of September 30, only 15 of the nation’s 10,292 insured banks were not ready for the Year 2000.




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dictated that the state focus its on-site verification efforts on a select
                            21
number of key companies.

Some state officials believed that insurance companies had a clear
incentive to become Year 2000 ready to maintain their business in a highly
competitive industry and, therefore, did not require a great deal of
regulatory prodding in the area. Several state regulatory officials also
explained that they believed that available self-reported information from
companies was sometimes sufficient to satisfy regulatory needs, and that
this information obviated the need for an on-site verification review. We
found that the extent of such information available to state regulators
ranged from one department that had, among other things, access to
required quarterly reports of its companies’ Year 2000 progress since 1998
to one that relied primarily on company responses to a few Year 2000
surveys. The latter is of particular concern since the absence of
corroborating evidence obtained through on-site verification or multiple
contacts with companies to track their progress diminishes the extent of
regulatory assurances about Year 2000 readiness. A few state officials also
explained that some small companies were not sufficiently computer
dependent (e.g., a company may use a single personal computer to
conduct business) to experience major problems with the Year 2000 date
change and warrant the need for an on-site verification.

As we reported in April 1999, 2 of the 17 states we reviewed were
comparatively more active in their efforts to ensure that insurance
companies become Year 2000 ready. These states opted to forgo on-site
examinations for some of their domiciled companies because of a comfort
level that officials explained was derived from their close tracking of or
continuous interaction with certain companies over time. In some cases,
they chose instead to conduct targeted Year 2000 examinations for certain
insurance companies that were licensed to write business but were not
domiciled in the state. As of September 30, 1 of the 2 states had examined
as many as 378 such licensed companies, and the other state had examined
29. Some of the states of domicile for these companies, as well as the Year
2000 Industry Preparedness Task Force, ultimately ended up relying on
many of the targeted Year 2000 examinations conducted by the two
licensing states to verify their readiness.




21
 As of September 30, this state had conducted on-site verification examinations for six companies,
which represented 3 percent of the net premium volume written by the state’s domiciled companies.




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                            Information gathered by NAIC’s Year 2000 Industry Preparedness Task
Available Information       Force and responses to our survey of 50 states on U.S. insurers’ Year 2000
Continues to Suggest a      readiness indicate that regulators have considerable confidence in the
Positive Outlook for        insurance industry’s readiness for Year 2000. In October, NAIC estimated
                            that 3 percent of the nation’s nationally significant insurers had not made
the Industry, but Some      their systems Year 2000 ready. State regulators’ responses to our survey
Uncertainties Remain        indicated that 78 percent of all domiciled insurance companies were
                            considered to be Year 2000 ready and making satisfactory progress in their
                            contingency planning activities as of September 30. Of the remaining 22
                            percent of these companies, 17 percent, although not completed with their
                            preparations as of September 30, were expected to become ready by
                            December 31. Uncertainties about the status of the remaining 5 percent
                            were largely unresolved at the time of our survey.

                            With one exception, ratings companies and consultants we contacted were
                            generally optimistic about the insurance industry’s Year 2000 outlook.
                            However, some industry observers have raised questions about liability
                            exposure issues, such as the coverage of Year 2000 remediation costs.
                            They have also expressed concerns about insurance companies’ inability
                            to accurately report their potential Year 2000-related liability exposures on
                            their financial statements.

NAIC and State Regulators   In an October 1999 press release, NAIC’s Year 2000 task force reported
                            that information obtained from its initiative focusing on nationally
Remain Confident About      significant insurers indicates that the insurance industry is expected to
the Insurance Industry’s    experience little disruption when 2000 begins. The task force pointed out
Readiness for Year 2000     that state assessments of insurers’ readiness have identified a relatively
                            small number of insurers for follow-up and continued monitoring. It also
                            noted that regulators were expecting few problems in the new year,
                            estimating that only 3 percent of the industry’s nationally significant
                            companies had not made their systems Year 2000 ready. The task force
                            chairman further stated that efforts by individual states indicated that
                            most of the companies that were not designated as nationally significant
                            were also on schedule, but data on the extent of validation efforts
                            conducted for these companies had not been compiled at the time of our
                            fieldwork in November.

Our Survey of 50 States     Our review of the 17 states previously discussed was intended to provide
                            information on the status of regulatory oversight efforts. Separate from
                            this effort, we conducted a survey of all 50 state insurance departments to
                            obtain information on the Year 2000 readiness of insurance companies
                            domiciled in each state as of September 30. Appendix IV provides the
                            number of insurance companies by type of company identified by the 50



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                                           state respondents. For purposes of the survey, a company was to be
                                           considered Year 2000 ready if the regulator was satisfied that the company
                                           had made adequate efforts to complete Year 2000 remediation, testing, and
                                           implementation activities for all mission-critical systems in preparation for
                                           2000. Although our survey collected data on companies’ Year 2000
                                           contingency planning activities, we did not specify that companies should
                                           have completed such activities to be considered Year 2000 ready. This
                                           definition of Year 2000 readiness was consistent with NAIC’s industry
                                           expectation that the last 6 months of 1999 should be used by companies to
                                           focus on less critical applications and systems and develop contingency
                                           plans in the event of a failure.

                                           Individual states were to base their responses to our questions about
                                           companies’ readiness and contingency planning activities on information
                                           obtained through their Year 2000 oversight efforts. State oversight efforts
                                           pertaining to Year 2000 could include (1) surveys administered to obtain
                                           information on companies’ Year 2000 preparations, (2) required Year 2000
                                           disclosures with financial report filings, and (3) on-site verification reviews
                                           conducted as part of the state’s regular financial examination cycle or its
                                           targeted Year 2000 examination program. State responses to survey
                                           questions on the number of Year 2000 examinations conducted in 1998 and
                                           1999 indicated that states were engaged in varying levels of on-site
                                           verification. Table 2 shows the proportion of states’ domiciled companies
                                           that, as of September 30, had been subject to an on-site verification review
                                           of their Year 2000 readiness.

Table 2: Extent of On-site Verifications
Conducted by States                        Percentage of state’s domiciled
                                           companies that were subject to                                                            Number of
                                           on-site verification examinations                                                            states
                                           Less than 25 percent                                                                             11
                                           25 to 50 percent                                                                                 10
                                           51 to 75 percent                                                                                 18
                                           Greater than 75 percent                                                                          11
                                           Total                                                                                            50
                                           Note 1: Five states also indicated that, in some cases, they had relied on on-site verification
                                           examinations conducted by another state.
                                           Note 2: On-site verification examinations include Year 2000 coverage during regular examinations as
                                           well as targeted Year 2000 examinations conducted during 1998 and 1999 (through Sept. 30).
                                           Note 3: Information presented excludes companies whose Year 2000 readiness status was not
                                           viewed by the states as relevant, such as companies in liquidation, companies operating without
                                           computer systems, and shell companies with no business.
                                           Source: State responses to GAO survey.




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State Survey Responses                  Our survey indicated that state regulators had considerable confidence
Indicated Considerable                  about the adequacy of the insurance industry’s preparation for the Year
Confidence in the Industry              2000 date change. Seventy-eight percent of the states’ domiciled insurance
                                        companies were considered Year 2000 ready as of September 30 (see fig.
                                        1). State regulators also generally viewed these insurers as making
                                        satisfactory progress in their contingency planning efforts.

Figure 1: : Status of Insurance
Industry’s Year 2000 Readiness, as of
September 30, 1999




                                        Note: This total excludes companies whose Year 2000 readiness status was not viewed as relevant,
                                        such as companies in liquidation, companies operating without computer systems, and shell
                                        companies with no business.
                                        Source: State responses to GAO survey.


                                        The remaining 22 percent of the states’ domiciled insurance companies
                                        represented companies that were (1) not Year 2000 ready by September 30,
                                        but that were projected to be ready by December 31; (2) not subject to
                                        categorization due to the lack of adequate information to determine their
                                        readiness status; or (3) considered at risk of not being ready. Some
                                        uncertainties exist, specific to the companies included in the last two
                                        categories, about their ability to become fully ready by the end of the year.
                                        These categories are discussed in the following sections.




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Seventeen Percent of Companies          State responses indicated that 17 percent of their domiciled insurance
Were Not Year 2000 Ready by             companies were not Year 2000 ready by September 30 but were projected
September 30 but Were                   to be ready by December 31. These companies missed NAIC’s milestone
Projected to be Ready by                calling for all mission-critical systems to be Year 2000 ready by June 30,
December 31                             1999. States estimated that on average, 84 percent of the companies
                                        progressing toward becoming Year 2000 ready by December 31 were
                                        considered to be making satisfactory progress in their contingency
                                        planning efforts, which suggests that the remaining companies were not
                                        making adequate progress. This lack of adequate progress is of particular
                                        concern for companies that may be fully preoccupied with remediating
                                        their mission-critical systems during the last quarter of the year, leaving
                                        them little time to attend to their contingency plans. These companies
                                        would also have an increased likelihood of a system failure if any of their
                                        compliant mission-critical systems happen to be integrated with less
                                        critical systems that have not been fully remediated.

                                        Viable contingency plans are especially important for larger companies
                                        that may have complex systems that were not projected to be Year 2000
                                        ready until the end of the year. Survey responses indicated that while 887,
                                        or 83 percent, of the companies not ready by September 30, but projected
                                        to be Year 2000 ready by December 31, were small, the remaining 188
                                        companies each wrote $100 million or more in net premiums nationwide,
                                        as shown in table 3.

Table 3: Companies Projected to Be
Year 2000 Ready by December 31, 1999,   Type                                                  Large       Medium          Small       Total
by Type and Size                        Property/casualty                                         5            70          416         491
                                        Life/health                                              12            42          182         236
                                        HMOs (including managed care                              4            50          114         168
                                        organizations)
                                        Other (e.g., fraternal organizations,                      0              5         175           180
                                        title companies)
                                        Total                                                     21            167         887      1,075
                                        Note: Size is based the estimated net premiums written nationwide, with large companies writing
                                        more than $1 billion, medium companies writing $100 million to $1 billion, and small companies
                                        writing less than $100 million.
                                        Source: State responses to GAO survey.


Adequate Information Not                The states indicated that as of September 30 they lacked sufficient
Available for 4 Percent of              information to determine the Year 2000 readiness of 4 percent of their
Companies                               domiciled insurance companies. Specifically, 14 states placed 235
                                        companies in this category. Many of these states indicated that they had
                                        some self-reported information from these companies, such as responses
                                        to the state’s Year 2000 surveys or the company’s Management Discussion




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                                                                                 22
                                and Analysis Year 2000 disclosures. However, these states believed that
                                they could not determine their readiness from information that had not
                                been corroborated by an on-site verification review. One state official, for
                                example, explained that although survey responses did not indicate any
                                reason to question the prospective readiness of these companies, on-site
                                examinations had not been performed to verify survey information or
                                determine the companies’ readiness. On the basis of similar reasoning, an
                                official from another state noted that he was waiting for the results of
                                ongoing examinations at some companies before reaching any conclusions
                                about their readiness.

                                One situation involved a state where the insurance department was
                                responsible for monitoring the annual statements submitted by HMOs but
                                depended on another state department for survey and examination
                                information. The insurance department was told that a Year 2000 survey
                                had been administered to the HMOs, but their responses had not yet been
                                received. Therefore, the insurance department identified these HMOs as
                                companies for which it did not have adequate information to determine
                                their Year 2000 readiness.

One Percent of Companies Were   In response to our survey, the states reported that about 1 percent of their
Viewed at Risk of Not Being     domiciled insurance companies were viewed as at risk of not being Year
                                                                  23
Year 2000 Ready by December     2000 ready by the end of the year. Specifically, 13 states identified 49
31                              companies, consisting mostly of small property/casualty insurers, that they
                                considered at risk of not being ready by the end of the year, as shown in
                                table 4. Thirty-eight of the companies considered at risk were small, 9 were
                                medium, and the remaining 2 were large HMOs.




                                22
                                   Most state regulators required insurance companies to include a disclosure of their Year 2000 status
                                in the Management Discussion and Analysis section of their financial report filings.
                                23
                                   This figure is not necessarily inconsistent with NAIC’s estimate in October 1999 that 3 percent of the
                                nationally significant companies had not completed their Year 2000 preparations. The states’ responses
                                regarding companies that were not projected to be ready by December 31, 1999, included all
                                companies.




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Table 4: Companies Viewed at Risk of
Not Being Ready by December 31, 1999,   Type                                                  Large       Medium          Small       Total
by Type and Size                        Property/casualty                                         0            4            20          24
                                        Life/health                                               0            3             9          12
                                        HMOs (including managed care                              2            2             8          12
                                        organizations)
                                        Other (e.g., fraternal organizations,                      0              0            1             1
                                        title companies)
                                        Total                                                      2              9          38          49
                                        Note: Size is based on the estimated net premiums written nationwide, with large companies writing
                                        more than $1 billion, medium companies writing $100 million to $1 billion, and small companies
                                        writing less than $100 million.
                                        Source: State responses to GAO survey.


                                        On average, states estimated that 57 percent of these at risk companies
                                        had not made satisfactory progress in their contingency planning efforts as
                                        of September 30, 1999. Virtually all of the states that identified companies
                                        as at risk of not being Year 2000 ready by the end of the year noted that
                                        they would continue to focus on the adequacy of these companies’
                                        contingency plans during the last quarter of 1999.

                                        Other actions the states planned to take to deal with at risk companies
                                        included conducting management conferences and requiring monthly Year
                                        2000 progress reports. In a few isolated cases, a state had resorted to or
                                        was planning to resort to enforcement actions.

Regulators Have Slightly                In reviewing state survey responses regarding the Year 2000 readiness of
                                        companies by type, we found that states identified a slightly lower level
Lower Confidence in the                 proportion of HMOs considered to be Year 2000 ready when compared to
Year 2000 Readiness of                  insurers in other categories. As of September 30, 1999, 69 percent of the
HMOs                                    states’ companies classified as HMOs, including managed care
                                        organizations, were considered Year 2000 ready. Of the remaining 31
                                        percent, 23 percent had mission-critical systems that were not Year 2000
                                        ready as of September 30 but that were projected to be ready by December
                                        31, 6 percent were not subject to categorization due to the lack of adequate
                                        information, and 2 percent were considered at risk of not being ready by
                                        December 31. In contrast, 72 to 80 percent of insurers in the
                                        property/casualty, life/health, and other insurer categories were
                                        considered Year 2000 ready. Appendix V provides a graphic that compares
                                        the readiness status of companies by type of insurer.

                                        According to a task force official, health insurers represent one area that
                                        remains vulnerable because such insurers depend on hospitals and
                                        doctors’ offices becoming Year 2000 ready. A recent report issued by the
                                        President’s Council on Year 2000 Conversion states that many health care



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                             providers and managed care organizations continue to exhibit troubling
                                                 24
                             levels of readiness. The report refers to July/August survey data
                             indicating that (1) only 40 percent of the health care providers and
                             organizations reported that they were Year 2000 ready and (2) roughly 25
                             percent of the organizations did not have documented Year 2000 plans.

                             In July 1999, we reported that many surveys had been completed in 1999
                             on the Year 2000 readiness of health care providers, but none provided
                             sufficient information with which to assess the Year 2000 status of the
                                                               25
                             health-care-provider community. We later testified in September 1999 that
                             the Health Care Financing Administration, with assistance from a
                             contractor, performed a Year 2000 risk assessment of 425 managed care
                             organizations. This June 1999 risk assessment identified 22 percent of the
                             organizations as being high risk, 74 percent as medium risk, and 17 percent
                                          26
                             as low risk. During our fieldwork in November, we were told that NAIC
                             was in contact with the Health Care Financing Administration to
                             determine whether any of the managed care organizations assessed by the
                             agency overlapped with those that were regulated by the state insurance
                             departments.

Other Sources Are            The industry observers we contacted generally maintained a favorable
                             view of the insurance industry’s Year 2000 preparedness efforts, but they
Generally Positive About     continued to express uncertainty over potential costs associated with Year
Insurers’ Year 2000          2000-related liability exposures. With one exception, rating companies and
Preparedness Efforts but     consultants with whom we spoke have remained confident about the
Are Uncertain About          industry’s efforts to prepare and become ready for 2000. For instance, the
                             Gartner Group continues to place the insurance industry among the
Liability Exposure Impacts   industry leaders in becoming Year 2000 ready, on the basis of its August
                             report. Likewise, several rating companies we contacted, including
                             Standard and Poor’s; A.M. Best; and Moody’s, indicated that, as of October,
                             they had not downgraded any insurer’s rating due to Year 2000 readiness
                             issues.

                             One rating firm, Weiss Ratings, Inc., tempered the generally optimistic
                             view of readiness in the industry by reporting that 13 percent of the
                             companies responding to its survey had made inadequate progress in their
                             Year 2000 preparations. The response rate to this June 1999 survey was
                             24
                              Fourth Summary of Assessment Information, President’s Council on Year 2000 Conversion, November
                             1999.
                             25
                                  Year 2000 Computing Crisis: Status of Medicare Provider Unknown (GAO/AIMD-99-243, July 28, 1999).
                             26
                              Year 2000 Computing Challenge: HCFA Action Needed to Address Remaining Medicare Issues
                             (GAO/T-AIMD-99-299, Sept. 27, 1999).




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                           27
about 19 percent. While Weiss Ratings, Inc., considered a company’s
progress to be inadequate if its mission-critical systems were not
renovated and tested by August 1999, it also indicated that those
companies viewed to be making inadequate progress still had a good
chance of achieving Year 2000 compliance in the time remaining.

Considerable uncertainty remains concerning the potential magnitude of
insurers’ Year 2000-related liability exposures. In our April report, we
noted that insurers’ liability exposures could not then be reasonably
estimated because, among other factors, a claims history for the event did
not exist and questions about key legal issues that could affect insurance
policy coverage were still unresolved. Since then, the industry observers
we contacted have continued to express uncertainties.

The rating companies we contacted in October indicated that it was still
too early to tell how liability exposures might affect insurance companies.
For this reason, the rating companies had not factored liability exposures
into their ratings. One actuarial consulting firm estimated that costs from
Year 2000-related claims and legal expenses among U.S. property/casualty
insurers could range between $15 billion and $35 billion. The firm
acknowledged that its estimates were based on several assumptions
associated with claims and legal outcomes that have not yet been
         28
realized. The industry observers we contacted generally said that
insurance companies will not likely be in a position to report their
potential Year 2000-related liability exposures on their 1999 financial
statements, because their liability exposures are not yet reasonably
estimable due to uncertainties over claims and legal outcomes.

Legal debates over insurance coverage for Year 2000-related mishaps, as
well as for costs to avoid such mishaps, have yet to be fully resolved. Our
                29
previous report described some of the legal debates associated with
coverage for Year 2000-related problems and damages, including the
coverage-related issues of “fortuity” and “triggers.” For example, it is not
clear whether a Year 2000-related loss would be considered a fortuitous
event covered by insurance, rather than an expected event that may not be
covered. For some types of policies, coverage also depends on what event
triggers coverage. Specifically, questions arise when coverage was
27
   Weiss Ratings, Inc., administered its survey on June 30, 1999, to 5,654 insurance companies and
HMOs. From the survey results, it developed Year 2000 readiness ratings for respondent companies
that were separate from their financial safety ratings.
28
     “Putting a Price Tag on the Millennium,” Best Review, Milliman and Robertson, Inc., June 1999.
29
     GAO/GGD-99-87.




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              activated for a particular policy. Other debates focus on whether an
              insured party that takes remedial action to reduce its vulnerability to Year
              2000-related problems may recover remediation costs under a particular
              policy.

              The Y2K Act, enacted in July 1999, does not directly address many of the
              unresolved legal issues that could affect insurers’ potential liability
                          30
              exposures. The primary purposes of the act include facilitating alternative
              modes of dispute resolution, limiting certain liabilities for Year 2000-
              related claims, and providing pre-Year 2000 remedial measures aimed at
              reducing an insured’s vulnerability to Year 2000-related mishaps. The act
              also sets forth procedural requirements for class action suits and
              affirmative defenses for temporary noncompliance with certain federal
              standards caused by a Year 2000-related problem. The act, however, does
              not contain substantive standards to guide courts in deciding whether Year
                                                                               31
              2000-related mishaps or remediation costs should be covered. Such issues
              will principally be a matter of state law. Some current cases involving
              insurance coverage disputes and additional provisions of the Y2K Act are
              described in appendix VI.

              Since we first expressed concerns about the states’ regulatory oversight of
Conclusions   the insurance industry in March 1999, NAIC actively emphasized the value
              of state regulators’ validating insurance companies’ Year 2000 preparations
              through on-site examinations, particularly those undertaken by nationally
              significant insurers. We also found that, partly in response to this
              emphasis, some states have increased their efforts to conduct on-site
              examinations of their domiciled insurance companies’ Year 2000
              preparations. Even with this increased emphasis, however, not all of the
              nation’s insurance companies will be subject to an on-site verification
              review.

              Gaps in Year 2000 verification coverage of the insurance industry can be
              attributed to several factors. One factor has been the late start of some
              states in conducting on-site verification reviews and the resulting need for
              them to focus on the potentially higher impact companies rather than
              conducting examinations of all domiciled insurance companies. Another
              factor has been regulators’ belief that, in some cases, comprehensive
              surveys were acceptable substitutes for examinations. Differing regulatory

              30
                   Public Law No.106-37, 113 Stat. 185, July 20, 1999.
              31
                 The act does require that all written contract terms, including exclusions of liability and disclaimers
              of warranty, are to be strictly enforced unless those terms are contrary to any applicable law in effect
              as of January 1, 1999.




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perspectives have constituted yet another factor contributing to state
decisions to forgo on-site examinations for some companies. Such
perspectives ranged from satisfaction with the adequacy of off-site
monitoring in a few states that had closely tracked the progress of their
companies over the last few years to the view in a few other states that
Year 2000 readiness would likely be adequately covered by insurers
motivated to remain competitive without regulatory prodding. Finally,
insurance regulators have indicated that some small insurance companies
are not sufficiently dependent on computers to experience major problems
with the Year 2000 date change.

The strategy promulgated by NAIC to focus on nationally significant
companies appears reasonable given the large number of state-regulated
insurance companies subject to oversight and the limited time remaining
before 2000. However, states’ generally late start in assuming a more
proactive role regarding Year 2000 has affected their ability to complete
their regulatory oversight of all the insurers they supervise. As of mid-
November, for example, some states had not finished the planned on-site
validation process for their companies, and NAIC was still in the process
of collecting information about states’ regulatory assessments of the
nation’s largest managed care organizations and major health insurers not
designated as nationally significant.

In addition, uncertainties exist about the readiness outcome for the 4
percent of the companies for which regulators did not have sufficient
information, and 1 percent of the companies that regulators viewed at risk
of not being ready by December 31 but were closely monitoring. Although
they were projected to be ready by the end of the year, questions also
remain unresolved regarding whether all of the 17 percent of the insurance
companies that were not ready as of September 30, 1999, can complete all
conversion activities to become fully compliant within the remaining time.
Lastly, and arguably outside of the regulators’ control, uncertainties
regarding insurers’ Year 2000 liability exposures continue to represent an
area of concern that is being monitored by rating companies, and other
industry observers, that can affect the overall Year 2000 outlook of the
insurance industry.

In summary, the intensive regulatory activity of the past several months
provides additional support for the level of confidence that regulators
place on the insurance industry’s Year 2000 preparations and their belief
that most policyholders should not be concerned about their coverage.
However, as previously indicated, remaining gaps in the on-site verification
of insurance companies’ Year 2000 readiness and unfinished regulatory



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                      efforts in the area leave uncertainties about the self-reported status of
                      some companies’ readiness. As a point of comparison, banking regulators,
                      who have conducted multiple examinations of all their financial
                      institutions, can provide stronger assurances to support their assertions
                      that, with relatively few exceptions, all banks were Year 2000 ready as of
                      September 30, 1999. Insurance regulators, on the other hand, can say with
                      some conviction that most insurance is sold by companies that are Year
                      2000 ready or appear to be on course to become ready by the end of the
                      year. It remains true that a portion of the industry had not completed its
                      Year 2000 preparations by September 30, 1999, and that some of these
                      companies had not made satisfactory progress in contingency planning.
                      However, the welcome news is that most consumers, especially those
                      insured by nationally significant companies, can have greater confidence
                      that their insurers will likely provide uninterrupted services into the new
                      year.

                      NAIC provided written comments on a draft of this report. A reprint of
Agency Comments and   NAIC’s letter can be found in appendix III.
Our Evaluation
                      NAIC disagrees with a perceived assertion that because states have not
                      performed on-site verification of Year 2000 preparations of every insurance
                      company, it represents an inability of states to complete their regulatory
                      oversight of the industry. As noted on page 22, we attribute the inability of
                      states to complete their regulatory oversight of the industry to states’
                      generally late start in assuming a more proactive role regarding year 2000.
                      This late start, among other factors, has caused some states to forgo
                      conducting Year 2000 on-site verifications for some of their domiciled
                      companies which has, in turn, limited the level of assurances to support
                      regulatory assertions of their companies’ readiness.

                      We acknowledge on page 10 that, according to NAIC information, 98
                      percent of the direct premiums written by nationally significant companies
                      had been or were to be subject to an on-site Year 2000 review by the end of
                      November. However, the extent of on-site validation for the life/health and
                      property/casualty companies that were not nationally significant and the
                      other insurer segments, which together represent 27 percent of the total
                      direct premiums written by the industry as a whole, was unknown at the
                      time of our review. We continue to believe that most consumers, especially
                      those insured by nationally significant companies, can have greater
                      confidence that their insurer will likely provide uninterrupted services into
                      the new year. The same level of assurances, however, cannot be provided
                      for the portion of the industry that may not have been subject to an on-site
                      verification or for which the extent of on-site verification is unknown.



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NAIC believes that the draft report erroneously overemphasized statistics
based on the number of insurance companies verified or the number of
states performing on-site examinations and suggests that these statistics
should focus on information supplied by the NAIC and, more emphatically,
on premium-based statistics from our survey of the 50 states. Premium-
based information supplied by the NAIC can be found throughout this
report, but specifically on pages 2, 6, and 10 as it relates to the on-site
verification of nationally significant companies. We did not provide
premium-based statistics from our survey primarily because we found
inconsistencies when we compared responses from many of the states to
similar information provided by NAIC. For example, the total net premium
volume written nationwide reported by 15 states to have been subject to
an on-site verification was, on average, 126 percent more than the total net
premium volume written nationwide identified by NAIC for each of these
states. Such inconsistencies may have been the result of the states
reporting gross premiums rather than net premiums as our survey
requested or the result of duplicative counting for companies that may
have been subject to Year 2000 on-site verifications conducted during both
a regular and a targeted examination. Regardless of the reasons for such
inconsistencies, they rendered the survey responses on net premiums
subject to on-site verification unusable for reporting purposes.

NAIC also indicated that statistics based on the number of companies
impart an unnecessary negative bias because a significant number of
companies either write a very small amount of premiums, are so small as
to have no risk of Year 2000 failure, are dormant companies, or are
companies that have been acquired by or merged into other insurers since
1998. To help minimize this type of bias, we have made an adjustment to
the table on page 15 that shows the percentage of states’ domiciled
companies that were subject to on-site verification examinations.
Specifically, companies whose Year 2000 readiness status was not viewed
by the states as relevant were excluded; this covered, for example,
companies in liquidation, companies operating without computer systems,
and shell companies with no business. The effect of this adjustment on the
number of states falling into each category of on-site verifications
conducted was minor.

As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 10 days from its
date. At that time, we will provide copies to Representative Thomas Bliley,
Chairman, House Committee on Commerce, and Senator Robert Bennett,
Chairman, and Senator Christopher Dodd, Vice Chairman, Senate Special
Committee on the Year 2000 Technology Problem. We will also provide



Page 25               GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
B-284237




copies of this report to other interested parties and will make copies
available to others on request.

Key contributors to this assignment are acknowledged in appendix VII.
Please call me or Lawrence Cluff on (202) 512-8678 if you or your staff
have any questions.

Sincerely yours,




Richard J. Hillman
Associate Director, Financial Institutions
 and Markets Issues




Page 26              GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Page 27   GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Contents



Letter                                                                                        1


Appendix I                                                                                   30

Seventeen States
Reviewed and Market
Share of Their
Domiciled Insurance
Companies
Appendix II                                                                                  31

GAO Year 2000 Survey
Administered to the 50
States
Appendix III                                                                                 34

Comments From the
National Association
of Insurance
Commissioners
Appendix IV                                                                                  36

Universe of Domiciled
Insurance Companies,
by Type
Appendix V                                                                                   37

Status of Companies
by Type of Insurer, as
of September 30, 1999




                         Page 28   GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
                        Contents




Appendix VI                                                                                            38
                        Current Cases Involving Insurance Coverage                                     38
Current Court Cases     The Y2K Act                                                                    39
Involving Insurance
Coverage of Year 2000
Issues and Highlights
of the Y2K Act
Appendix VII                                                                                           42

GAO Contacts and
Staff
Acknowledgments
Tables                  Table 1: Status of Targeted Year 2000 Examinations to                          11
                          Validate Company Readiness in 17 States
                        Table 2: Extent of On-site Verifications Conducted by                          15
                          States
                        Table 3: Companies Projected to Be Year 2000 Ready by                          17
                          December 31, 1999, by Type and Size
                        Table 4: Companies Viewed at Risk of Not Being Ready                           19
                          by December 31, 1999, by Type and Size
                        Table I.1: States Reviewed and Market Share of Their                           30
                          Domiciled Insurance Companies
                        Table IV.1: Domiciled Insurance Companies, by Type                             36


Figures                 Figure 1: Status of Insurance Industry’s Year 2000                             16
                          Readiness, as of September 30, 1999
                        Figure V.1: Status of Companies by Type of Insurer, as of                      37
                          September 30, 1999




                        Abbreviations

                        HMDI          Hospital, Medical, and Dental Service Indemnity Corporation
                        HMO           Health Maintenance Organization
                        NAIC          National Association of Insurance Commissioners




                        Page 29              GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Appendix I

Seventeen States Reviewed and Market Share
of Their Domiciled Insurance Companies

                                        We focused part of our review on the same 17 state insurance departments
                                        visited during our previous review. These state departments’ domiciled
                                        insurance companies collectively accounted for almost 76 percent of
                                        insurance sold nationally during 1998. The departments represented the
                                        top 12 states, whose domiciled companies had combined market shares
                                        ranging from 3.4 percent to 14 percent, and 5 states with relatively smaller
                                        market shares ranging from 0.3 to 2.1 percent.

Table I.1: States Reviewed and Market
Share of Their Domiciled Insurance                                                                                        Market share of
Companies                                                                                                             domiciled insurance
                                        States reviewed                                                                        companies
                                        Illinois                                                                                    14.0%
                                        New York                                                                                      11.4
                                        Connecticut                                                                                    7.1
                                        Pennsylvania                                                                                   5.3
                                        California                                                                                     4.3
                                        Ohio                                                                                           4.3
                                        Wisconsin                                                                                      4.2
                                        Massachusetts                                                                                  3.9
                                        Texas                                                                                          3.7
                                        Indiana                                                                                        3.5
                                        Michigan                                                                                       3.5
                                        Delaware                                                                                       3.4
                                        New Jersey                                                                                     2.1
                                        Iowa                                                                                           1.8
                                        Arizona                                                                                        1.8
                                        Oregon                                                                                         1.0
                                        Utah                                                                                           0.3
                                        Total                                                                                       75.6%
                                        Note: Market share information of each state’s domiciled insurance companies represents the
                                        percentage of net premium volume written nationwide ($703 billion) for all types of insurance. A
                                        domiciled insurance company is one that is incorporated under the laws of the state in which it is
                                        doing business.
                                        Source: Data extracted from information provided by NAIC, based on its 1998 financial database.




                                        Page 30                      GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Appendix II

GAO Year 2000 Survey Administered to the 50
States




              Page 31   GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Appendix II
GAO Year 2000 Survey Administered to the 50 States




Page 32                 GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Appendix II
GAO Year 2000 Survey Administered to the 50 States




Page 33                 GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Appendix III

Comments From the National Association of
Insurance Commissioners




               Page 34   GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Appendix III
Comments From the National Association of Insurance Commissioners




Page 35                 GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Appendix IV

Universe of Domiciled Insurance Companies,
by Type

Table IV.1: Domiciled Insurance
Companies, by Type                                                                                  Number of      Percentage of
                                  Type                                                              companies        companies
                                                                                                              a
                                  Property/casualty insurers                                            2,830               46%
                                                                                                              b
                                  Life/health insurers                                                  1,477                 24
                                  HMOs (including managed care organizations)                              714                12
                                  Other (e.g., fraternal organizations, title companies)                 1,179                19
                                                                                                              c                d
                                  Total                                                                 6,200             101%
                                  a
                                      This number includes 692 companies designated as nationally significant.
                                  b
                                      This number includes 435 companies designated as nationally significant.
                                  c
                                  This total excludes 267 companies whose Year 2000 readiness status was not viewed by the states
                                  as relevant, such as companies in liquidation, companies operating without computer systems, and
                                  shell companies with no business.
                                  d
                                      Does not equal 100 percent due to rounding.
                                  Source: State responses to GAO survey.




                                  Page 36                        GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Appendix V

Status of Companies by Type of Insurer, as of
September 30, 1999

Figure V.1: Status of Companies by
Type of Insurer, as of September 30,
1999




                                       Note: The last bar graph labeled “Total” represents the same information shown in figure 1 of this
                                       report.
                                       Source: State responses to GAO survey.




                                       Page 37                     GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Appendix VI

Current Court Cases Involving Insurance
Coverage of Year 2000 Issues and Highlights
of the Y2K Act
                      As previously noted, our April report described some of the prevalent
Current Cases                                               1
                      issues involved in coverage disputes. Some recent court cases raised a
Involving Insurance   new issue involving businesses seeking to recover from their insurers
Coverage              remediation costs they have incurred in their efforts to help prevent or
                      reduce the costs of Year 2000-related mishaps. On the basis of an
                      interpretation of a provision commonly referred to as the “sue and labor”
                      clause, in some of the cases, the insured entities claimed that their
                      insurance policies cover remediation costs.

                      Some insurance policies, generally property/casualty insurance policies,
                      contain a sue and labor provision accompanied by language specifically
                      obligating the insurer to contribute to the expenses incurred by the insured
                      in acting under the provision. The sue and labor clause originated
                      centuries ago in ocean marine policies. Its purpose was to encourage or
                      require policyholders to prevent or minimize imminent potential loss or
                      damage covered by the policy without forfeiting recovery under the policy,
                      thereby reducing the insured loss. According to one commentator, the
                      classic example is the captain who orders the crew to jettison cargo to
                      prevent the ship from foundering in stormy seas. The value of the
                      jettisoned cargo is recoverable under the sue and labor clause.

                      At least three cases were brought in 1999 seeking coverage of remediation
                      costs under sue and labor provisions. The insured plaintiffs in those cases
                      reportedly sought to recover remediation costs of at least $400 million and
                      $183 million. Cases of this type contribute to the uncertainties associated
                      with insurers’ potential liability exposure.

                      Insurers opposing claims to recover remediation costs have raised several
                      arguments. For example, they contend that remediation costs are covered
                      only if they were incurred to protect against an insured loss, and that Year
                      2000 remediation costs are not insured losses. Among other things, costs
                      recoverable pursuant to a sue and labor provision typically involve
                      remedial measures to prevent or recover damage arising from covered
                      events, such as lightning, fire, or theft. Insurers contend that Year 2000
                      remediation costs arise from a defect or inherent limitation in a product
                      and not in connection with an insured event. In addition, insurers assert
                      that the majority of losses an insured business seeks to protect against
                      through remediation measures are not losses attributable to the physical
                      loss or damage of insured property, but instead are uninsured economic
                      losses, such as a decrease in market share, a loss of investor or consumer
                      confidence, or regulatory sanctions. Another argument is that the loss to
                      1
                          GAO/GGD-99-87.




                      Page 38              GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
              Appendix VI
              Current Court Cases Involving Insurance Coverage of Year 2000 Issues and Highlights of the
              Y2K Act




              be minimized or avoided must be actual or imminent. According to this
              argument, the Year 2000 event should not be considered imminent,
              because insured entities have been aware of it for several years and in
              many cases began remedial measures as early as the mid-1990s. Insurers
              argue that such remediation costs should be considered ordinary costs of
              doing business.

              The Y2K Act does not create any new causes of action. Instead, for “Year
The Y2K Act   2000 actions,” it modifies existing state or federal procedures and remedies
                                                                                       2
              concerning nonpersonal injury liability arising from Year 2000 failures.
              Among other things, the act (1) requires that notice of a Year 2000 claim be
              given to potential defendants before a “Year 2000 action” is filed; (2)
              establishes heightened pleading requirements; (3) sets caps and limitations
              on punitive damage awards; and (4) provides for the apportionment of
              damages, rather than joint and several liability, except in cases where it is
              found that the defendants acted with specific intent to injure the plaintiff
                                               3
              or knowingly committed fraud. The act applies to any “Year 2000 action”
              brought after January 1, 1999, for an actual or potential “Year 2000 failure”
                                                 4
              occurring before January 1, 2003. The following is an overview of some
              provisions of the act that could have a direct or indirect impact on the
              amounts for which insurance companies may be liable.



              2
               However, the new law does not preempt state laws that provide stricter limits on damages and
              liabilities or afford greater protection in Year 2000-related lawsuits.
              3
               While there will undoubtedly be additional litigation, the first court to examine whether insurance
              policies are subject to the Y2K Act decided that the act was not intended to apply to insurance
              litigation. American Guaranty and Liability Insurance Co. v. Xerox Corp., Index No. 603/69/99 (N.Y.
              Sup. Ct., N.Y. County, July 1,1999). Xerox, which had not provided notice within the time limits
              provided in the insurance contract, argued that the Y2K Act’s prelitigation commencement procedures
              prevailed over the insurance contract notice provisions. The court rejected this argument, reasoning
              that Congress did not intend to subject insurance litigation to the requirements of the Y2K Act. In the
              court’s view, the Y2K Act was aimed at litigation involving damages that directly result from Y2K
              failures. The court noted that many of the procedural requirements of the Y2K Act are directed at
              providing an opportunity for the parties to settle their differences by allowing a period for the
              manufacturer, software provider, or system operator to correct Y2K defects. The court viewed these
              provisions as meaningless in collateral actions involving insurance litigations.
              4
               A “Y2K action” is defined in the Y2K Act as “a civil action commenced in any Federal or State court . . .
              in which the plaintiff’s alleged harm or injury arises from or is related to an actual or potential Y2K
              failure, or a claim or defense that arises from or is related to an actual or potential Y2K failure.” A “Y2K
              failure” is defined in the Y2K Act as a failure by “any device or system . . . or any software . . . to
              process, to calculate, to compare, to sequence, to display, to store, to transmit, or to receive Year-2000
              date-related data.” Included in this definition are failures (1) “to deal with or account for transitions or
              comparisons from, into, and between the years 1999 and 2000 accurately”; (2) “to recognize or
              accurately to process any specific date in 1999, 2000, or 2001”; or (3) “accurately to account for the
              year 2000’s status as a leap year, including recognition and processing of the correct date on February
              29, 2000.” The Y2K Act does not apply to claims for personal injury or wrongful death.




              Page 39                       GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Appendix VI
Current Court Cases Involving Insurance Coverage of Year 2000 Issues and Highlights of the
Y2K Act




                                                                       5
Most of the Y2K Act focuses on the litigation process. Under the notice
provisions, prospective plaintiffs in a Year 2000 action (except for claims
for injunctive relief) must send a written notice to each prospective
defendant containing information about the pertinent event and including
the remedy sought. Within 30 days after receiving the notice, the
prospective defendant must provide each plaintiff with a written statement
describing what, if any, remediation measures or alternative dispute
resolution processes would be acceptable. If the defendant proposes a
plan to remediate the problem, the prospective plaintiff must allow the
prospective defendant an additional 60 days from the end of the 30-day
notice period to complete the proposed remedial action before bringing
suit. The purpose of this 90-day notice requirement is to create a procedure
that might facilitate the parties’ resolution of the problem through
voluntary efforts or through alternative dispute resolution.

The Y2K Act also contains rules for pleading affirmative defenses,
damages, warranty and liability disclaimers, proportionate liability, and
class actions. One purpose of the pleading requirements is to reduce the
potential for frivolous claims by requiring the plaintiff in a Year 2000 action
to articulate certain bases for the claim and remedy. Provisions of the act
for preserving warranties and contracts also are intended to discourage
frivolous lawsuits. As previously discussed, the act generally requires that
all written contract terms, including exclusions of liability and disclaimers
of warranty, are to be strictly enforced unless those terms are contrary to
any applicable state statute in effect as of January 1, 1999.

The Y2K Act limits liability exposure and damages. Some limitations
depend upon whether the lawsuit is a contract action or a tort action. For
example, in tort actions, the act provides for proportionate liability, except
with respect to certain suits brought by consumers. Generally, defendants
will be liable only for that portion of a judgment that corresponds to their
proportionate share of the total fault for the plaintiff’s loss, unless the
defendants are found to have committed fraud in connection with the Year
2000 problem or to have specifically intended to injure the plaintiff. Such a
finding would render the defendant jointly and severally liable.

Other limitations include the following: (1) elimination of strict liability,
(2) heightened proof requirements as a condition for recovering punitive
damages and a cap on the amount of such damages for individuals with net
5
 The Y2K Act also contains protections for homeowners who otherwise could be penalized should a
Y2K failure disrupt the country’s payment systems. If such an event were to prevent a homeowner from
timely making a mortgage payment, the homeowner would be protected from foreclosure unless
payment is not made within the time period contained in the act.




Page 40                     GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Appendix VI
Current Court Cases Involving Insurance Coverage of Year 2000 Issues and Highlights of the
Y2K Act




worth of less than $500,000 and small employers, and (3) limitations on the
recovery of certain “economic losses” of the plaintiff alleged in connection
with a tort claim. These losses, which include lost profits, business
interruption losses, and consequential and indirect damages, may be
recovered only if a contract provides for their recovery or the losses result
directly from damage to tangible real or personal property caused by the
Year 2000 failure. The limitation does not apply to claims of intentional
torts. For contract actions, no category of damages may be awarded unless
such damages are allowed by the contract expressly or, if the contract is
silent on the matter, under applicable state or federal law.

The act contains a special provision that excludes from damages the
amount the plaintiff reasonably could have avoided by utilizing any
available or reasonably ascertainable information “concerning means of
remedying or avoiding the Year 2000 failure involved in the action.”
Prospective plaintiffs are provided with an incentive to take reasonable
steps to limit their damages. This duty to mitigate is in addition to any such
duty imposed under state law. The duty is not absolute, however. Where a
defendant intentionally misrepresents facts concerning the potential for a
Year 2000 failure in the “device or system used or sold by the defendant”
that caused plaintiff’s harm, the plaintiff will be relieved from this
statutory mitigation duty.



Depending upon the effects of the settlement incentives and litigation-
related limitations contained in the Y2K Act, insurance liability exposure
could be less than would be the case if liabilities for Year 2000 actions
were determined under less limiting state laws. Whether an insurance
policy covers a particular Year 2000 event, however, could depend upon a
number of factors, including the extent to which state laws and cases
apply to insurance coverage litigation.




Page 41                  GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Appendix VII

GAO Contacts and Staff Acknowledgments


                  Richard J. Hillman, (202) 512-8678
GAO Contacts      Lawrence D. Cluff, ( 202) 512-8678



                  In addition to the persons named above, Evelyn E Aquino, Gerhard
Acknowledgments   Brostrom, Barry A. Kirby, May M. Lee, Alexandra Martin-Arseneau,and
                  Paul G. Thompson made key contributions to this report.




                  Page 42             GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
Page 43   GAO/GGD-00-42 Insurance Regulators Have Accelerated Oversight
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