NIA | In The News | Times Call for Increased Mutual Board Attention to Governance

Media coverage of corporate scandals at Enron, Global Crossing and Tyco - and even the incarceration of America's better-living diva Martha Stewart - have heightened public awareness of corporate governance issues. Couple this with regulations developed partly in response to these shortcomings, but already in the works before most scandals broke, and you end up with an environment that should strike fear - or at least diligence - in the heart of every corporate official.

According to Gregg Dykstra, NAMIC general counsel and senior VP-internal operations, and Tim Sullivan, NAMIC Insurance Company claims VP, it doesn't matter whether the companies are publicly traded or not. Good governance principles and the need for diligence apply equally to non-public companies, including mutuals.

Changes in the works

Corporate scandals are certainly nothing new, Dykstra said, "But they are receiving a lot more attention, and rightly so." Heightened scrutiny generated increased government and private sector responses. Sarbanes-Oxley legislation, for instance, addresses a range of governance issues. "Sarbanes-Oxley is one of the most expansive and important pieces of legislation, certainly at the federal level, in a long while," Dykstra said. While its provisions primarily apply to public companies, mutual company officers and directors are more subject to Sarbanes-Oxley than they realize, he added.

A survey, presented by the law-firm of Foley & Lardner at their National Directors Institute, highlighted the scope of private company response to the Act. "Seventy-seven percent of private firms have changed governance practices as a result of Sarbanes-Oxley, even though the Act doesn't apply specifically to them," Dykstra said. These firms are implementing changes in CEO/CFO financial statement attestation establishment of whistleblower protection, board approval for non-audit services, adoption of governance guidelines, and implementation of internal control audit by outside parties, he explained.

But it's not just Federal legislation driving change. Sarbanes-Oxley allows for - in fact, even encourages - - state initiatives to strengthen governance oversight. "Sarbanes-Oxley has a unique provision that authorizes state agencies to regulate non-registered public accounting firms, and those are the firms that are going to serve everyone," Dykstra said, citing one example. States don't usually differentiate between private and public firms when they act, he added.

"But there is another area that is not regulation, but it will impact all of us equally, if not more, and that is the area of litigation - court-based legislation if you will," he added. "The courts certainly aren't apolitical. They see what's going on in the world, and they know they have to be responsive -- and they have been. They're making decisions that will impact everyone."

One area where courts are acting relates to the so-called "Business Judgment Rule." The rule presumes directors acted with due care if they made business decisions in good faith, in the rational belief it was in the company's best interest, and in a disinterested manner on an informed basis. Dykstra noted that courts are not acting to expand the Business Judgment Rule, but to restrict it.

"Another element affected by court decisions is your ability as directors to rely on others to do your jobs," Dykstra said. "Courts expect directors and officers to be reasonable in their belief that people they rely on are qualified to give advice." Directors must be sure those giving advice are competent, independent and have no conflict of interest.

Dykstra believes mutual companies would be wise to consider the following:

Building on Dykstra's comments, Sullivan shared additional governance ideas for mutual company boards. Looking at why company boards exist, Sullivan said, "The simple reason is state law says we have to. But more importantly, in the context of mutual companies, they are the representatives of the policyholders." Insureds have placed considerable trust in their company boards, he said, "from the smallest companies to the largest."

But boards don't exist to handle day-to-day management responsibility, Sullivan said. "That's management's job. The board is there to set direction. That's why they call you directors." Specifically, Sullivan said, boards should be responsible for strategic planning - where the company plans to be in three, five or 10 years, for instance; setting policy; establishing corporate philosophy; and promoting the company.

One critical role for directors, Sullivan believes, is business planning. "Develop a business plan for your mutual," he said. "This is part of strategic planning." Sullivan said underwriters frequently ask companies what their business plan is, only to get a response along the lines of, 'We're going to sell a lot more insurance policies.' " That's not a business plan," he said. "Spend some time thinking about the business. Developing a business plan has become an important item for companies to show where strengths and weaknesses lie, and what the future holds."

How can directors know what to include in a business plan? For starters, Sullivan said, NAMIC Insurance Agency has a template available. In addition, he said, "I've found that state associations do a good job of giving directors opportunities to learn how. If a seminar is available, attend it. Learn from it." Other resources exist, as well. "Call your reinsurer," he said. "I promise you your reinsurer is running your numbers, whether you know it or not. They're probably in their computer."

Beyond planning, Sullivan explained that directors must oversee - but not replace - company management, and also must ensure regulatory compliance - not directly, but again, through management. They also must make sure crisis management is addressed; that succession planning is in place, for both board and management; and that annual reviews of company progress occur. "Every year there should be time set aside at a board meeting - or an entire board meeting - to say, 'What did we do last year? Was what we accomplished what we planned?' Sometimes you accomplish things you didn't plan. And that's okay. Flexibility is critical."

Knowledge, curiosity are key

According to Sullivan, management supports the directors by getting information to the board so it can execute policy. "Sometimes management will have tell you something you don't want to know," he told board members. "But if you don't have the information, you can't set proper policy or goals for the company."

Given potential Sarbanes-Oxley fallout and subsequent legislation and litigation, total board overhaul may be in order, Sullivan said. "If your board doesn't have an audit committee, you'll probably need one," he said. "The same holds true for nominating committees. Also, board members should step out of claims and underwriting; that's a major change. And director-agents should continue to decline in number." He said a new Wisconsin law that limits the number agent or employee directors, designed to promote outside directors, may find its way to other states.

Key advice to directors was to exercise diligence and common sense. "Become involved," Sullivan said. "Bring in required expertise. Have them explain concepts you don't understand." He cited a Massachusetts insurance department survey that showed insurance company directors didn't understand accounting, markets, technology or even product lines - something he called "alarming."

"Know the fundamental rules of your business," Sullivan told directors. "What products do you write? What geographic areas does your company cover? What opportunities exist for expansion and growth? Do you have the surplus to move into other counties? Should you be thinking about merger? What are the critical elements of your company's financial statements? What is surplus? What are loss reserves, and how do they affect the bottom line?"

These questions all play into a special duty for directors, which, Sullivan said, "sums up very nicely the essence of what we call the Corporate Governance Rule - that is, the Rule of Curiosity. It's not enough to be there. You have to be curious -- be involved. By that I don't mean pulling up the plant to see how the carrot is doing. Sitting back and saying a financial report is okay because the auditor did it isn't enough. Saying 'These things are okay because they're coming to us' isn't enough. Read them. You have a duty of curiosity to raise your hand and ask 'what did we do different?'" when changes appear.

Holding directorship in an era of increased scrutiny can be daunting. But for the sake of policyholders, employees and other business partners, it is critically important. The responsibility may seem overwhelming, but not nearly as overwhelming as having to pick up the pieces of an insurer brought down by directors' failure to knowledgeably, ethically, and yes, curiously, lead.

Dave Willis is a freelance insurance writer serving magazine, corporate and association clients. He can be reached at Dave@Willis.org.