Mike Grillaert, Partner Casualty Loss Reserve Seminar September 24, 2002
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Transcript of Mike Grillaert, Partner Casualty Loss Reserve Seminar September 24, 2002
Actuaries Supporting the Financial Audit:
Independence Issues and the Impact of the Sarbanes-Oxley Act
Mike Grillaert, PartnerCasualty Loss Reserve Seminar
September 24, 2002
Overview of Presentation
Provisions of the Sarbanes-Oxley Act:
– New oversight board
– Changes to certain professional standards
– Audit partner rotation
– Conflicts of interest
– Duties of audit committees
– Management’s assessment of internal controls
– Non-audit services
Standards
Board not responsible for accounting standards
Expected that the SEC and the Board will initially adopt current standards – including the SEC independence rules
Significant guidance on the new provisions of the Act will need to be released in the form of regulations and interpretations
Department of Justice will provide guidance concerning matters that fall under criminal law
To which clients does Sarbanes-Oxley apply?
The Act applies to “Issuers”, and it defines Issuer as follows:– The term “issuer” means an issuer, the securities of which
are registered under section 12 of that Act, or that is required to file reports under section 15(d), or that files or has filed a registration statement that has not yet become effective under the Securities Act of 1933, and that it has not withdrawn.
This does include foreign registrants We believe that the current definitions in the SEC
rules for affiliates will continue to apply to the independence provisions of the Act.
Effective Dates
7/30/02 10/28/02 1/26/03 4/26/03 10/23/03
Board members in place within 90 days of law Board must be functional on or before 270 days* of law Audit firms registered on or before 180 days* after SEC
determines that Board is functional Non-audit services provisions effective 180 days* after SEC
determines that Board is functional
Law
si
gned
Boa
rd n
amed
Boa
rd fu
nctio
nal *
Firm
reg
istr
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Non
-aud
it sv
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ffec
tive
*
* Outside limits
SE
C r
egs.
on
Inde
pend
ence
Conflicts of Interest
The Act prohibits registered public accounting firms from auditing issuers whose CEO, CFO, or chief accounting officer (or equivalent positions):– was employed by the accounting firm, and– participated in the audit of the issuer in any
capacity
during the one year period prior to the initiation of the audit
Duties of Audit Committees
Audit Committee is “directly responsible for the appointment, compensation and oversight” of the auditor– Auditor reports directly to the audit committee
Act establishes independence definition for audit committee members– No fees to members other than for board service– May not be an “affiliated person” of the issuer or any
subsidiary
SEC to require disclosure that the audit committee has at least one financial expert, or if not, why not
Audit Committee Financial Expert
Financial expert to be defined by the SEC considering the following elements– Public Accountant or Auditor– CFO, Controller, CAO or similar– Understanding of GAAP and financial statements– Experience in
• Preparation or auditing of financial statements of similar issuers
• Accounting for estimates, accruals and reserves
• Internal controls
– An understanding of Audit Committee functions
Management’s Assessment of Internal Control
The Act requires that an issuer’s annual report contain a report from management on internal control
External auditor required to attest to management’s assertion concerning its assessment of internal control as part of audit
What are Non-Audit Services under the Act?
Sarbanes-Oxley includes a definition of “non-audit services”, as follows:
– The term “non-audit services” means any professional services provided to an issuer by a registered public accounting firm, other than those provided to an issuer in connection with an audit or a review of the financial statements of an issuer.” (emphasis added)
Act has the force of “law” – makes it “unlawful” to do certain things – including providing certain “non-audit services” to an issuer
Non-Audit Services – Prohibited Activities
The Act identifies eight categories of “Prohibited Activities”– Bookkeeping and related services– Financial information systems– Appraisals & valuations– Actuarial services– Internal audit outsourcing– Management functions or human resources– Broker, dealer or investment advisor services– Legal services & expert services
In addition, the Board may adopt regulations prohibiting other services
Actuarial Services
“Actuarial Services” are not defined in the Act. SEC is charged with developing implementation rules
for the Act within 180 days of July 31. 60 day comment period.
Current SEC rules already define “actuarial services”. No changes are anticipated.
In the event of a change, it would not be effective until 2003 or later.
Preapproval of Services
Act requires pre-approval of audit and “other non-audit services” by the audit committee
We believe that where XYZ CPA Firm is providing auditing services, the services of all XYZ member firms are included
Audit committees may delegate preapproval to one or more independent members, however the full committee needs to approve at the next scheduled meeting
Non-audit Services Disclosure Requirement
The Act requires Audit Committees to disclose all approved non-audit services to be performed by the auditor to investors in periodic reports required by section 13(a) (i.e. 10-K & 10-Qs)
May be annual or more frequent – depending on Board’s interpretation
Appraisals & Valuations
Current Rules Sarbanes-Oxley
Not permitted if amounts are material to f/s or if results will be audited
??
Contribution-in-kind reports may be permitted (case-by-case basis)
Specifically included in the law; ??
Fairness opinions not permitted
No change
Actuarial Services
Current Rules Sarbanes-Oxley
Generally prohibited for insurance company reserves and related accounts
No change
May assist management in other cases/situations
No change
Employee benefit information generally permitted
??
Questions?
The Current Role of Actuary on the Audit
Terrence M. O’BrienPrincipal
PricewaterhouseCoopers LLP
Actuaries Supporting the Financial Audit
CLRS – September 23, 2002
Policies and Practices
Actuarial involvement on insurance entities has evolved from– In-house resource on select companies and issues– Recommended involvement with responsibility for
reserves– Required involvement with responsibility for contingent
liabilities and assets
Actuary is charged with responsibility to sign off on reserves
If actuary determines that reserves are outside an acceptable range, the issue is submitted to consultation
Policies and Practices
Recommended reliance on an actuary to identify and evaluated self-insured liabilities for non-insurance enterprises is limited to clients with certain features or larger clients
– Self insured losses– Deductible losses– Retrospective premiums – Exhaustion of coverage issues– Asbestos or pollution liabilities
Entities Covered by Policy for Insurers
Property & Casualty insurers Enterprises with captive insurance entities Non-insurance entities that have subsidiaries
that write third-party insurance coverage Blue Cross/Blue Shield organizations Life insurance entities that write accident and
health policies Other entities underwriting short-duration
contracts
Covered Items
Assets and liabilities that:– Relate to insured risks– Involve future contingent events– Are not subject to precise determination
Liabilities for Unpaid Loss and Loss Expenses
Typically the most significant item
The approach to testing reserves may vary by client– Review of client’s methodology– Sensitivity testing based on client
methodology– Independent development of a
corroborative range
Reinsurance Reserves
Approach to reserves is the same for direct or net reserves– Review of client’s methodology– Sensitivity testing based on client
methodology– Independent development of a
corroborative range
Reinsurance Policy Structure Issues
Assessment of transfer of risk
Interpretation of contract language and review of the associated accounting
Return Premiums under Retrospectively Rated Policies
Many companies develop return or additional premiums on an account level
Reserves reflect development of losses and specific provisions of the account’s program
Certain policyholder dividend reserves are developed in the same fashion
Computation of Premium Deficiencies
Under codification premium deficiencies are now required for statutory accounting
Deferred acquisition costs require a test of recoverability based on the profitability of the relevant segment of business
Often the most critical issue is the proper grouping of business into segments based on how business is sold and serviced
Reserves for Contingent Commissions
Contingent Commission arrangements may vary over time and by class of agent
While sensitive to loss, amounts may not vary directly with losses
Premium Reserves
Unearned premium reserves not based on pro rata calculations
Primarily warranty related policies with terms greater than 12 months– Requires the projection of future losses under
inforce policies– GAAP and Statutory may differ
Earned but unreported premiums– Variance in premium projections usually drives an
associated variance in loss and LAE reserves
Future Policy Benefits
May be relevant for discontinued lines of business
Expansion of the Actuary’s Role on the Audit Team
Actuaries Supporting the Financial Audit
CLRS – September 23, 2002
Jan Lommele, FCAS, MAAAPrincipal
Expansion of the Actuary’s RoleOn the Audit Team
Review of Actuary’s Current Role– Participate on audits with material
insurance balance sheet or other financial statement items
– Provide specialist “opinion” relating to loss reserve estimates
Deep quantitative skill set
Expansion of the Actuary’s RoleOn the Audit Team
Actuaries are a valuable addition to an audit team – the benefits of their knowledge and experience translate
into value added audit services for our clients
Client
• Data “gurus”• Additional analytics• Modeling capability
• Industry benchmarking• Current events• Best practices• Early indication of problem areas
• Insurance programs • Current litigation
Specialized knowledge of insurance and insurance products
Risk assessment capability
Audit Team
Expansion of the Actuary’s RoleOn the Audit Team
In addition to loss reserves, there are a number of balance sheet areas where actuarial involvement may be beneficial
Insurance Company Audits
Assets Liabilities
Goodwill asset
ALM/asset duration
Capital Adequacy – RBC
Unearned premium reserves
Anticipated S&S
Premium deficiency reserves
Insurance Company Audits – Other Items FAS 113 – risk transfer Review of reinsurance/retention levels Financial modeling (output and appropriateness of) Reinsurance collectibility Subsequent events EBUB Premium revenue recognition
Expansion of the Actuary’s RoleOn the Audit Team
Balance sheet items– Loss reserves– Discounting – Retrospective premium reserves– Risk margins
Other items
Expansion of the Actuary’s RoleOn the Audit Team
Actuarial participation not limited to insurance company audits……
Non Insurance Company Audits
Insurance costs Review of alternative risk structures/financing Data issues Policy language Identification of unique exposures and
risk assessment Confidence intervals/reserve position in range
Expansion of the Actuary’s RoleOn the Audit Team
Non Insurance Company Audits – other items
Expansion of the Actuary’s RoleOn the Audit Team
Examples of “non traditional” services provided to audit teams
Modeling
Credit Reform – CF Models
Review of insurance premiums charged by government contractors
Income Tax Issues
Expansion of the Actuary’s RoleOn the Audit Team
Your (and the audit teams’) awareness of accounting literature/ASB21/current events
Get clarity around scope (timing, fees, etc.) For non-insurance companies – determine audit expertise
around insurance Awareness of any potential independence issues Future scope of audit
? Other Things to Think About?