Insurance Regulation: Scandal Highlights Need for States to Strengthen
Regulatory Oversight (Testimony, 09/19/2000, GAO/T-GGD-00-209).

Despite being barred from the securities industry, Martin Frankel is
alleged to have anonymously acquired and controlled insurance companies
in several states and to have exercised secret control over a small
securities firm, using it to take custody of insurance company assets
and provided false documents on investment activity. He allegedly
diverted these assets to other accounts he controlled to support the
scam and his lavish lifestyle. Weaknesses in insurance regulatory
oversight, including inadequate analysis of security investments and
failure to detect misappropriate of assets, delayed detection of the
scam. GAO has noted regulatory weaknesses in regard to change of
ownership approvals, route financial analyses, and periodic on-site
examinations. Furthermore, the National Association of Insurance
Commissioners lacks effective interstate coordination oversight of
entities under holding companies and has gaps in control to prevent the
migration of unscrupulous securities brokers to other sectors of the
financial services industry. The Gramm-Leach-Bliley Act of 1999
underscores the importance of consultation and information-sharing among
federal financial regulators and state insurance regulators. Regulators
recognize the need to improve their coordination and have taken or plan
to take several measures. This testimony summarized the September
report, GAO/GGD-00-198.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-GGD-00-209
     TITLE:  Insurance Regulation: Scandal Highlights Need for States
	     to Strengthen Regulatory Oversight
      DATE:  09/19/2000
   SUBJECT:  Insurance regulation
	     Embezzlement
	     Fraud
	     Insurance companies
	     Internal controls
	     Interagency relations
	     Federal/state relations
	     Regulatory agencies

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GAO/T-GGD-00-209

United States General Accounting Office
GAO

Testimony

Before the House Subcommittee on Finance and
Hazardous Materials, Committee on Commerce

For Release on Delivery
Expected at
10:00 a.m., EDT
on Tuesday,
September 19, 2000
GAO/T-GGD-00-209

INSURANCE REGULATION
Scandal Highlights Need for States to Strengthen

Regulatory Oversight

Statement of Richard J. Hillman, Associate
Director
Financial Institutions and Market Issues
General Government Division

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Summary
Scandal Highlights Need for States to Strengthen
Regulatory Oversight
Page 2                           GAO/T-GGD-00-209
Martin Frankel, a banned securities broker who
allegedly migrated from that industry to the
insurance industry is under indictment for
embezzling more than $200 million in insurance
company assets over a nearly 8-year period. Mr.
Frankel has not yet been convicted in the United
States and others are currently under
investigation for assisting him.

This statement focuses on three issues:  (1) how
the scam happened, (2) the regulatory weaknesses
exposed by this scam, and (3) the crucial
importance of regulatory information sharing.

What happened?  Throughout the 1990s, Martin
Frankel, with assistance from others, allegedly
obtained secret control of entities in both the
insurance and securities industries. He is accused
of secretly purchasing 7 insurance companies in
several states. Using a securities firm as a
front, Mr. Frankel then allegedly took custody of
insurance company assets and provided false
documents on investment activity to disguise his
actual purpose.  Instead of managing these assets
in a prudent manner, he allegedly diverted them to
other accounts he controlled and used them to
support the ongoing scam and his lifestyle.

What are the regulatory weaknesses?  We observed
regulatory weaknesses in multiple states over
several years during key phases of insurance
regulatory oversight.  Specifically, we observed
inadequate measures for assessing the
appropriateness of buyers of insurance companies,
analyzing securities investments, evaluating the
appropriateness of asset custodians, verifying the
insurers' assets, and sharing information within
and outside the insurance industry.  We also found
some weaknesses in support services provided by
the National Association of Insurance
Commissioners (NAIC).

What improvements in the sharing of regulatory
information are needed?   Information sharing
failures existed between state insurance
departments and other state and federal
regulators, including state securities
departments, as well as among state insurance
department in different states.  As highlighted in
the Gramm-Leach-Bliley Act, the importance of
regulatory information sharing is greater than
ever before.  The fraudulent activities allegedly
perpetrated by Mr. Frankel further demonstrate the
need for heightened coordination of oversight
activities among regulators in cases where
affiliated entities exist.

The insurance industry has recognized its
weaknesses and has proposed corrective actions.
This statement also contains a number of GAO
recommendations, which regulatory agencies
generally endorsed.

Statement
Scandal Highlights Need for States to Strengthen
Regulatory Oversight
Page 3                           GAO/T-GGD-00-209
Mr. Chairman and Members of the Subcommittee

We are pleased to be here to discuss with you our
report on insurance regulation that is being
released today.1  My testimony today focuses on
three issues. First, how did the scam allegedly
used by Martin Frankel to steal over $200 million
from several insurance companies across the
country operate?  Second, what are some of the
regulatory weaknesses exposed by the scam?  These
regulatory weaknesses allowed Mr. Frankel to gain
control of seven insurers domiciled or chartered
in six different states, and delayed detection of
the alleged theft for as much as 8 years-greatly
increasing the size of the loss.  Finally, we will
talk about the crucial importance of regulatory
information sharing-both in the context of the
failure to uncover the Frankel scam and in the
broader context of a world with affiliations of
financial firms across industry boundaries as
permitted by Gramm-Leach-Bliley.

I should note that Mr. Frankel, while currently
being held by German authorities and facing
extradition to the United States, has not yet been
convicted in the U.S. for any of the actions that
are attributed to him. At present, these actions
are alleged to have been committed by him.
Similarly, Mr. Frankel acted with assistance from
others.  A few of his associates have admitted to
roles in Mr. Frankel's alleged scam, and others
are under investigation.  As yet, the whole story
has not been told.

The Scam
In the 1980s Martin Frankel worked in the
securities industry.  He was permanently banned
from the securities industry by SEC in 1992.  Even
prior to his removal from the securities industry,
he was setting up the mechanism to move into the
insurance industry. He allegedly gained secret
control of a small securities firm called Liberty
National Securities (LNS), which in 1991, a year
before his ban from the securities industry, he
directed to become registered with the state
securities department in Tennessee.  The same
year, he allegedly anonymously established an
entity known as Thunor Trust, using the names of
nominee grantors as the apparent source of the
money.  Thunor Trust then applied for regulatory
approval from the Tennessee Department of Commerce
and Insurance, Division of Insurance, to purchase
the Franklin American Life Insurance Company, a
small, financially weak insurer.  This application
was subsequently approved.  In this and all
subsequent interactions with the insurers or with
regulators, Mr. Frankel's name was never used.  He
always operated by using aliases or through
fronts.  See figure 1 for a timeline showing the
actions of Mr. Frankel and Thunor Trust between
1985 and 1999.

Figure 1: Overview of the Scandal

Source: GAO.

Over the next 8 years, Thunor Trust purchased six
more insurance companies domiciled in five
additional states.  All of the insurance companies
owned by Thunor Trust were managed out of the
Franklin American headquarters in Franklin,
Tennessee, even though they continued to be
domiciled for regulatory purposes in the states of
Mississippi, Oklahoma, Missouri, Alabama, and
Arkansas.  The insurer bought by Thunor Trust in
Alabama was later redomesticated (moved) for
regulatory purposes to Mississippi, even though it
continued to be operated out of Tennessee.  Figure
2 provides an overview of the Thunor Trust
companies and their states of domicile when the
scam collapsed.

Figure 2: Simplified Structure of the Thunor Trust
Insurance Companies

Source: GAO summary of insurance regulatory data.

Mr. Frankel allegedly used the same scheme to loot
each of the insurance companies.  After purchasing
a company, Frankel removed the company's assets
from the control of the insurance company, using
LNS as a front. Shortly after Thunor Trust
purchased an insurer, the company's assets would
all be sold and apparently replaced with
government bonds purchased on the insurer's behalf
by LNS, acting under the direction of Mr. Frankel
who operated using an alias. None of this activity
involved the real LNS; rather, it was carried out
by a bogus LNS operated by Mr. Frankel out of his
mansion in Connecticut.

In actuality, the companies lost control of their
assets when the money was turned over to LNS.  Mr.
Frankel's bogus company, using the name of the
firm he secretly controlled-that is-the real LNS,
provided monthly statements to each insurance
company detailing a very active trading strategy
and showing the bonds that were supposedly bought
and sold that month by LNS as agent for the
insurer.  According to these statements, the bond
trading was profitable, and the profits were
returned to the company.  In fact, the securities
transactions shown on these statements did not
happen.  The statements were fabrications.  It
appears that Mr. Frankel actually used the
company's assets to (1) return phony profits to
the company, (2) purchase additional insurance
companies-a necessary step to continue the fraud,
and (3) support his own lavish lifestyle.
Ultimately, taxpayers, other insurers, and certain
policyholders will bear much of the losses
resulting from the scam.

Regulatory Weaknesses
Overseeing the financial health of insurance
companies can be broken down into three key
phases-change of ownership approval, routine
financial analyses, and on-site examinations.  We
observed regulatory weaknesses in each of these
phases in all the states where Frankel allegedly
purchased insurance companies, as well as with
certain support services provided to the states by
the National Association of Insurance
Commissioners (NAIC).  Table 1 summarizes the
weaknesses we identified in each of the phases of
regulatory oversight.

Table 1: Overview of Regulatory Weaknesses
Oversigh                                 Specific observations
t phase       Weakness
Change   Inadequate due      - Failure to act on "red flags" associated with
in       diligence performed trust managed by a sole and
ownershi on buyer              irrevocable trustee that left grantors with
p        application data    no control over money
approval                     - Inadequate questioning of prospective buyers
s                           

         Inadequate tools    - Inability to readily access regulatory
        and procedures to   history data
        validate            - Inability to access criminal history data on
        individuals'        individuals
        regulatory or       
        criminal            
        backgrounds
        
         Lack of             - Failure to exchange insurance regulatory
        coordination        concerns among states on a timely basis
        between regulators  - Absence of an industry "clearinghouse" of
        within and outside  insurer application data
        the insurance       - Inability to routinely access data from other
        industry            financial regulators
                            
Routine  Inadequate analysis - Inadequate state procedures and practices to
financia of securities       flag high asset turnover ratios and no
l        investments           use of thresholds to trigger additional
analyses                     scrutiny
                            - Lack of NAIC policies, procedures, or
                            practices to assess asset turnover
                            - Insufficient securities expertise exhibited
                            by insurance departments to question
                              unusual investment strategy
                            - Lack of NAIC consolidated financial analysis
                            of affiliated insurers in multiple states
                            
         Ineffective         - Inconsistent and ineffective policies
        mechanisms to       regarding appropriate asset custodial
        safeguard and         relationships
        monitor control of  - Failure of insurance regulators to require
        insurers'           from insurers sufficient information to
        securities held by    allow independent verification of legitimacy
        another entity      and appropriateness of new custodians
                            - Inadequate information collected annually to
                            understand who had control of the
                              insurers' assets
                            
         Inadequate          - Lack of expertise to assess the viability of
        securities-related  the insurers' investment strategy
        expertise and       - Failure to obtain securities-related
        information         expertise from state securities regulators or
        gathering           from
                              contracted assistance
                            - Lack of communication with state securities
                            regulators to verify the appropriateness
                              and legitimacy of the broker-dealer
                            
On-site  Failure to detect   - Failure of four completed exams on companies
examinat misappropriation of owned by Thunor Trust to identify
ions     assets                any material weaknesses
                             - Inadequate examination guidelines and
                            procedures to verify book-entry securities
                              that were not held by a depository
                            institution
                            - Inadequate assessment of highly unusual
                            investment activities
                            - Questionable ability of insurance examiners
                            to assess securities related activities
                            
         Inadequate          - Inadequate efforts to independently validate
        practices and       the identity and appropriateness of the
        procedures to         asset custodian
        verify the          - Improperly executed custodial agreements not
        legitimacy of asset detected
        custodians          
        
         Limited sharing of  - Lack of proactive alerts to warn other states
        Information and     of examination concerns so as to deter
        coordination among    scam from spreading
        regulators          - Lack of communication with securities
                            regulators
                            - Lack of coordinated on-site examinations for
                            insurers in the same group
                            
Source:  GAO analysis of insurance regulatory
data.
In some cases, the identified weakness involved a
lack of the appropriate policies and procedures
for identifying problems in the Thunor Trust
insurers.  At other times, state insurance
regulators failed to follow existing policies,
procedures, or recommended practices.  Overall,
however, regulators did not act in response to
"red flags" raised by the actions of Thunor Trust,
the insurance companies, or the bogus LNS that
served as  "custodian" of the insurance company
assets. These red flags did not necessarily rise
to the level of illegality.  But individually, and
certainly collectively, they should have led
regulators to ask more and harder questions-the
answers to which very likely would have uncovered
the scam much sooner.  We believe that all
financial regulators, including state insurance
regulators, have a positive responsibility to act
with professional skepticism.  It is clear that
for many years, in this case, insurance regulators
did not.

Our report on the regulatory handling of the
insurance companies was requested by the Ranking
Member of the full Committee, Mr. Dingell, and was
released this morning.2  It provides considerable
detail on each of the regulatory weaknesses
identified in table 1.  In my statement today, I
would like to mention only a few of the more
egregious examples.

During the initial change of ownership process
when Thunor Trust applied to purchase its first
insurance company, Franklin American Life
Insurance Company, there is no indication that
Tennessee insurance regulators noted any of the
peculiarities or followed up with any detailed
information gathering about the potential buyer.
There were several unusual circumstances that
could have sparked additional regulatory scrutiny.
These included the fact that Thunor Trust was
newly created and had no track record in the
insurance industry. Moreover, the trust was
established in such a way that the grantors had no
control over how their money was to be used.  The
trust was managed by a single trustee, not one of
the grantors, whose authority was irrevocable,
even by the grantors, irrespective of performance.
In spite of these unusual circumstances, the three
grantors of the trust, those supposedly putting up
the money, were never questioned, nor did we find
any evidence that regulatory and criminal history
background checks were performed.

Each of these and other characteristics of the
trust arrangement should have raised red flags for
regulators exercising professional skepticism.
The federal indictment now alleges that Frankel
himself established the trust, using the names of
three acquaintances who never actually contributed
funds to the trust. As the sole purpose of the
trust,was to purchase insurance companies, had
regulators followed the money trail back to the
reported sources of origin and questioned the
grantors directly to validate their interests and
actual control of the trust, the scam could have
been uncovered at the very beginning.  Moreover,
there is no evidence that any state insurance
regulator pursued any of these questions with the
grantors of Thunor Trust when it subsequently
applied to purchase insurance companies in other
states.

Routine financial analysis is the analysis of
annual and quarterly financial statements provided
to regulators by insurance companies.  These
financial statements are extensive compilations of
data that are used by regulators to monitor the
condition and performance of insurance companies,
especially those companies for which a particular
state insurance department has primary regulatory
responsibility, that is, their domiciliary
companies.  Routine financial analysis is
particularly important because of the normal 3-5
year cycle for on-site examinations.

One of the peculiar characteristics of the scam
was the nature of the securities activities that
were reported by Thunor Trust insurers to their
regulators.  These activities supposedly consisted
of a very active trading strategy using U. S.
government bonds.  During our review, we found
little evidence that insurance regulators
recognized or acted on concerns about the massive
asset trading activity and the resulting
extraordinary asset turnover ratios being reported
by the Thunor Trust insurers.  NAIC, which
provides analytical assistance to states in the
form of ratio analysis and other tools, also did
not identify or address the companies' investment
strategy as a problem.   Similarly, the
consistently greater-than-normal returns on
government bond trading reported on the companies'
financial statements failed to generate any
regulatory skepticism or concern.

From information provided in the company financial
statements filed with NAIC and the state insurance
departments, we performed a simple financial ratio
test structured to flag highly speculative trading
activity-also referred to as an asset turnover
test.  The results of this analysis, highlighting
the unusually high asset turnover activity, are
presented in table 2. 3

Table 2: Summary of Asset Turnover Ratios
Life insurance company            Time period   Asset turnover        Asset
(domicile state)              (calendar year)            ratio     turnover
                                                  (end of year        ratio
                                                      average) (end of year
                                                                     range)
Franklin American (TN)                1992-98               85       10-207
International Financial               1994-98               54       12-115
Services (MO)
First National of America                1998               27           27
(MS)
Franklin Protective (MS)              1995-98               89       30-124
Family Guaranty (MS)                  1994-98              113       30-193
Farmers and Ranchers (OK)             1994-98              119       29-204
Source: GAO analysis of insurer financial data in
the annual statements.

For perspective, an asset turnover ratio of 52
would equate to selling and buying the entire
value of the companies' assets weekly.   By
contrast, a mutual fund expert recently cited
concern about equity fund managers whose asset
turnovers now average about 0.9.4

In April 2000, NAIC officials advised us that new
ratio tests to flag possible speculative asset
investment activities had been developed and
implemented.  The threshold test for indicating
abnormal investment activity is now an asset
turnover of 0.25, about one-fortieth of the lowest
asset turnover ratio shown for the companies in
table 2.

On-site regulatory examinations of insurance
companies usually take place on a 3-to-5 year
cycle.  Over the years that Thunor Trust owned
insurance companies, the various state regulators
completed four examinations on several companies.
The states have told us that these examination
were done in accordance with NAIC's examination
guidelines.  In no case were any material
weaknesses identified, even though it is now
alleged that Frankel embezzled the insurers'
assets shortly after the companies were purchased
by Thunor Trust.  In every examination, the
principal weakness was the examination's failure
to independently verify that the companies had
control over their assets, or even that those
assets actually existed.  Similarly, the
examinations failed to independently verify the
identity and appropriateness of the asset
custodian reported by the companies.

Regulatory Information Sharing
At nearly every stage of the scam that we have
described for you today, regulators could have
exposed the fraud sooner and limited the damage if
there had been better and more consistent sharing
of regulatory information.  Information sharing
failures existed between state insurance
departments and other state and federal
regulators, including state securities
departments, as well as among state insurance
departments in different states.

For example, in the initial change of ownership
process, insurance regulators could have used
information on the disciplinary history of the
supposed grantors of Thunor Trust.  Even though
Mr. Frankel's name never appeared, one of the
grantors had a history of unfavorable incidents in
the securities industry.  This information was
available on the Central Registration Depository
(CRD) maintained by NASD.  The CRD entries would
not necessarily have been serious enough to
preclude the person's association with an
insurance company.  However, if insurance
regulators had talked to the grantors, regulators
may have learned that the grantors did not provide
any funds for the trust. This level of initial
regulatory follow-up could have aborted the scam
at its inception.

When questions concerning an insurer's investment
activities did arise, insurance regulators did not
generally seek regulatory data or expertise from
regulators in the securities industry.  A check
with state securities offices of basic information
on Liberty National Securities at any point
throughout the 1990s could have helped unravel the
investment scam.  However, during our review, we
did not find evidence that state insurance
regulators obtained information from state
securities offices during examinations completed
in the mid-1990s or while conducting their annual
reviews.  Nor did we find that NAIC guidelines
required such coordination.  During our review, we
collected information from several state
securities offices on the real LNS that revealed
major inconsistencies with the information that
insurance regulators had been provided on LNS by
their domiciled insurers. We reviewed information
from the state securities offices on the real LNS
through annual statements on file and information
contained in the CRD system.

The CRD information, which was available to state
insurance regulators through their state
securities offices during the entire period of the
scam, would have revealed that the real LNS was
located in Dundee, MI, contrary to the location on
the account statements insurers received from LNS.
Additionally, financial statements available in
state securities offices revealed that the real
LNS typically had reported assets of less than
$100,000 during the 1990s.  Such information alone
could have generated other red flags given the
high level of trading that was being reported in
the account statements that insurers were
receiving from LNS. In addition, a check into the
officers of the real LNS would have revealed an
inconsistency between those actually employed by
LNS and the name of an individual who was
supposedly signing the asset verification
documents used by state insurance regulators and a
CPA firm.

Two actions taken by Thunor Trust or its insurance
companies near the end of the scam clearly
illustrate the inadequacy of information sharing
between state insurance departments. These actions
were the purchase by Thunor Trust of Old Southwest
Life Insurance and a reinsurance transaction
between First National Life Insurance Company of
America and Settlers Life, a Virginia company.
Prior to the approval to purchase Old Southwest
Life in late February 1999, regulators in
Tennessee were warned that Franklin American Life,
the company that intended to purchase Old
Southwest, might have been looted of its assets.
However, this information was not conveyed to
regulators in Arkansas, who approved the Old
Southwest acquisition.  The insurer subsequently
experienced losses of over $5 million out of its
$6 million in total assets.  Similarly, other
insurance regulators were unaware of concerns that
regulators in Tennessee and Mississippi had with
insurers connected to Thunor Trust in early 1999.
In April 1999, Settlers Life in Virginia lost
approximately $45 million through a reinsurance
transaction with First National Life Insurance
Company of America.  If Virginia regulators had
known in February that an insurer owned by Thunor
Trust may have been looted of its assets, they
could have asked additional questions and warned
their domiciled insurers against entering into
transactions with an insurer(s) connected to
Thunor Trust without prior regulatory approval. In
all, over $50 million was lost because important
information concerning the solvency of an insurer
was not shared by Tennessee with other states.
After learning of the possible theft of assets
from its domiciled company, instead of notifying
other regulators, the Tennessee Department
notified the company that it had to return the
assets to a qualifying account within 60 days.
While $57 million was returned to Tennessee, it
was during that same period that $50 million was
stolen from companies in other states.

As highlighted in the Gramm-Leach-Bliley Act, the
importance of regulatory information sharing is
greater than ever before.  This is recognized by
the law through a requirement that banking and
insurance regulators share information about
insurance companies and banks that become
affiliated.  The fraudulent activities allegedly
perpetrated by Mr. Frankel further demonstrate the
need for heightened coordination of oversight
activities among regulators in cases where
affiliated entities exist.  Although the
legislation is recent, insurance and banking
regulators have recognized the need to improve
their coordination and have taken or plan to take
a number of actions.  Generally, the actions
consist of establishing formal agreements for
sharing of information and creating working groups
for periodic meetings to discuss matters of mutual
interest.  These regulatory actions are in their
infancy, but the expected continued blurring of
distinctions and separations in financial markets
will require an increased and continuing
commitment to enhanced regulatory cooperation in
performing oversight.

Insurance regulators and the Securities and
Exchange Commission (SEC) have also indicated a
desire to move toward more regulatory
coordination, although the Gramm-Leach-Bliley Act
does not specifically address coordination between
securities and insurance regulators.  However, SEC
officials specifically mentioned that, by statute,
they could not use regulatory information from
insurance regulators in determining eligibility to
license brokers.

In the aftermath of the scandal, we have observed
a desire by the states and NAIC to address both
the known regulatory and information-sharing
weaknesses associated with the scandal as well as
other areas of vulnerability.  Some corrective
actions have already been taken. The other
corrective actions proposed to date are also
commendable.  However, success in implementing
them will require continued commitment by NAIC and
the states, as some actions are expected to take
several years to implement.  In some cases,
corrective actions will require development of
model laws by NAIC, adoption of the new laws by
individual state legislatures, and the development
and implementation of new regulations by insurance
departments.  Insurance regulators will need to
apply the lessons learned from this scandal to
resolve existing regulatory weaknesses and
effectively coordinate with their banking and
securities counterparts as we enter a new
environment where the blurring of historical
differences in the financial sectors continues.

Conclusions
Insurance companies in several states lost in
excess of $200 million through this investment
scam.  A fundamental aspect of the scam was the
concealment of a secret affiliation alleged to
exist between entities in the insurance and
securities industries, in which the interests
behind the ownership of the insurers as well as
the investment entity controlling the insurers'
assets were one and the same.  The role of Mr.
Frankel and others is presently the subject of a
federal criminal investigation as well as other
state criminal and civil actions.  Taxpayers will
ultimately bear much of the losses resulting from
the scandal, together with policyholders who are
not fully covered by their own states' insurance
guarantee programs.

Insurance regulators were not prepared to prevent
or detect a scam allegedly perpetrated among
several insurers for nearly 8 years by a rogue
broker who had migrated into the insurance
industry.  Although routine regulatory monitoring
and examination activities are not designed to
proactively look for fraud, there is a regulatory
responsibility to be alert for fraud.  Additional
mechanisms should be in place that are designed to
detect possible fraud-so called "red flags" that
trigger additional regulatory scrutiny.  In the
scam allegedly carried out by Mr. Frankel, these
red flags included peculiarities with the trust,
inconsistencies in regulatory data related to
asset custody and control, and the unusual
investment activities being reported by insurers.
Given these unusual activities and circumstances,
even though they were not specifically contrary to
law or regulation, insurance regulators could have
reacted to the warning signals by judiciously
asking additional questions.  In a number of
circumstances, those questions could have
unraveled the scam.  Clearly, in this particular
case, there was a lack of professional skepticism.

In addition, long-standing information-sharing
issues among federal and state financial services
regulators further exacerbated the negative
impacts of the scam.  Insurance regulators had
insufficient means for conducting background
checks and measures to safeguard and verify the
insurers' invested assets.  In addition, state
insurance regulators apparently did not have or
seek sufficient expertise in the area of
securities and investments to adequately
scrutinize the unusual investment activities being
reported to them by the Thunor Trust insurers.
Similarly, the most significant information-
sharing weakness observed was the inability or
failure of insurance regulators to access
regulatory information available from the
securities industry.  At each phase in the
oversight process, insurance regulators would have
benefited from information available through local
state securities regulators to further validate
the business transactions between the insurance
companies and other individuals and entities.
Accessing this information was neither suggested
nor required, either by the policies and
procedures of insurance departments or of NAIC.
Finally, once regulatory concerns finally
surfaced, the lack of information sharing among
state insurance regulators allowed the scam to
spread to other states.

We believe that it is too early to fully assess
regulatory oversight coordination efforts
emanating from the Gramm-Leach-Bliley Act.
However, it is clear that federal and state
regulators recognize the need to improve
coordination as they begin implementing the
financial services modernization legislation.
Insurance regulators' future fraud prevention
efforts will depend, in part, on the sharing of
regulatory data between themselves and the banking
and securities industries. Regulators in the
banking and insurance industries are taking steps
to formalize the coordination mechanisms through
memos of understanding and the establishment of
interagency working groups.

We also believe SEC and NAIC are correct in their
stated need to improve their coordination.
However, beyond the narrow issue of variable
annuities, we are unaware of any concrete actions
or plans for actions to strengthen coordination.
Although the Gramm-Leach-Bliley Act does not
specifically address coordination efforts between
insurance and securities regulators, we believe
that such coordination efforts will become
increasingly important as the lines distinguishing
the offerings of different financial sectors
continue to blur. Moreover, the movement of
undesirables from one industry to another would be
more easily controlled with better sharing of
disciplinary information. Overall, as illustrated
by the Frankel case, each of the financial
regulators needs to consider regulatory data from
other financial sectors to properly oversee the
business relationships and transactions between
institutions in different financial sectors.

Finally, we recognize the efforts of NAIC and the
states in proposing corrective actions.  These
actions represent an acknowledgment that the
weaknesses exposed by this scam need to be
corrected.  As these corrective actions are
implemented, the potential for a similar scam to
be successful should be substantially reduced.

Recommendations
As a result of the many weaknesses in regulatory
oversight and information sharing uncovered by our
work, we are making a number of recommendations in
our report.  These recommendations are repeated
here.

We recommend that state insurance commissioners:

- develop and adopt the appropriate mechanisms to
adequately safeguard        and verify insurer
assets that are not in the physical possession of
the insurance company, including requirements for
ensuring the appropriateness of asset custodians;

- improve information-sharing by

 -- developing mechanisms for routinely obtaining
regulatory data on
        individuals and firms from other financial
services regulators; and

 -- implementing policies and procedures for
proactively sharing
        regulatory concerns with other state
insurance departments; and

 -- increase the level of securities expertise
available to their
       departments' staff and ensure that
insurance analysts and examiners
       have appropriate training, tools, and
procedures to analyze securities
       assets and to recognize unusual investment
strategies.

We recommend that the President of NAIC:

- ensure that the corrective actions identified by
the Ad Hoc Task Force on Solvency and Anti-Fraud
are implemented as quickly and fully as possible,
in particular those which NAIC can accomplish
unilaterally;

- ensure that the accreditation program requires
the states to have adequate controls for
safeguarding and verifying assets that are not in
the physical possession of the insurer and to have
access to securities-related expertise; and

- supplement existing guidance in financial
analysis and examiner handbooks reinforcing the
importance of reviewers exercising an appropriate
level of professional skepticism and due
professional care when indicators of fraud or
other irregularities surface.

We recommend that the Chairman, SEC and the
President of NAIC:

- increase the attention given to the development
of more routine processes and procedures for
sharing and communicating information to address
common regulatory oversight matters, including
efforts to help prevent the migration of rogues
between the securities and insurance industries.

We recommend that the United States Attorney
General, the President of NAIC, and state
insurance commissioners

- work together to establish a mechanism by which
state regulators can perform criminal background
checks on individuals for the purpose of meeting
insurance regulators' responsibilities under the
federal insurance fraud prevention provision, 18
U.S.C.  1033.

Matters For Congressional Consideration
In order to encourage and monitor progress by
insurance regulators, Congress may want to
consider requesting that NAIC periodically report
on the status of corrective actions recommended in
this report and by NAIC's Ad Hoc Task Force on
Solvency and Anti-Fraud, including a discussion of

- states' adoption of appropriate laws,
regulations, and processes to safeguard and verify
insurer's assets that are not in the physical
possession of the insurer;

- regulators' ability to access criminal history
data to meet the requirements of federal insurance
fraud prevention requirements, as identified in 18
U.S.C.  1033; and

- efforts and agreements between insurance
regulators and banking and securities regulators
to oversee insurance-related entities of
affiliated financial institutions, including
methods for safeguarding and verifying insurer
assets held by an affiliated institution and
mechanisms to access individual disciplinary data
from other financial services regulators.

Agency Comments
The state and federal agencies and other
organizations commenting on our report generally
concurred with the report's findings, conclusions,
and recommendations.

                                   --    --
--          --

Mr. Chairman, this concludes my statement.  My
colleagues and I would be pleased to respond to
any questions that you or other members of the
Subcommittee may have.

Contact and Acknowledgements

For further information regarding this testimony,
please contact Richard J. Hillman, Associate
Director, Financial Institutions and Markets
Issues, (202) 512-8678.  Individuals making key
contributions to this testimony included James R.
Black, Lawrence D. Cluff, Thomas H. Givens III,
Barry A. Kirby and Karen C. Tremba.

_______________________________
1  Scandal Highlights Need for Strengthened
Regulatory Oversight (GAO/GGD-00-198, Sept.19,
2000 ).
2 Scandal Highlights Need for Strengthened
Regulatory Oversight (GAO/GGD-00-198, Sept.19,
2000).
3 This calculation method consisted of the company
schedule showing assets acquired and sold each
year as the numerator and total company assets as
the denominator.  This method was selected for
illustration because it could be performed easily
(or roughly estimated by visual inspection) by
regulatory financial analysts.  The end of
calendar year numbers were used for six of the
insurance company submissions during the period
the companies were allegedly under Frankel's
control.  The remaining company, domiciled in
Arkansas, was acquired shortly before the collapse
of the scam, and regulators had not yet received a
quarterly statement for the period that the
insurer was under Thunor Trust.
4 Wall Street Journal, June 20, 2000.
*** End of document ***