Interaction Between the
Appointed Actuary and Auditor
Casualty Loss Reserve Seminar
September 12, 2005
SPEAKERS
 James C. Votta, Ernst & Young
 Scott A. Trosset, Ernst & Young
 Joseph A. Herbers, Pinnacle Actuarial Resources,Inc.
 Roy Morell, Liberty Mutual
1
INDEX TO GUIDANCE
 2004 Practice Note



Data Testing Requirements
Actuarial Guidance
Sample Letter
2
INDEX TO GUIDANCE
 Actuarial Standards of Practice
No. 9 – Loss Reserve Documentation
No. 21 – Responsibility to the Auditors
No. 23 – Data Quality
No. 36 – Review Opinions
No. 41 – Actuarial Communications
 Annual Statement Instructions
3
Interaction Between the
Appointed Actuary and Auditor
Auditor’s Perspective
Scott A. Trosset, Ernst & Young
OUTLINE OF PRESENTATION
 Coordination between Appointed Actuary
and Auditor
 Financial Statement Audit
 Internal Control Audit
 Statutory Reporting on Internal Controls
 Data Testing Requirements per Annual
Statement Instructions
5
Coordination between Appointed
Actuary and Auditor
 Financial Statement Audit
 SAP and/or GAAP
 Internal Control Audit
 Data
Testing Requirement
Statement Instructions
–
Annual
6
Financial Statement Audit
 SEC Requirements
 GAAP financial statements required by Exchange
Act of 1934
 Included in 10-K – due 60 days after end of fiscal
year (75 days for 2004 reporting)
 NAIC Requirements
 SAP financial statements required by Model Audit
Rule
 Due generally by May 31 or June 1 of subsequent
year
 Other – GAAP reporting for non-public companies
or subsidiaries of public companies – timing set by
company
7
Financial Statement Audit
 GAAP and SAP Audits - focus with respect
to loss reserves:
completeness, accuracy and integrity of
data underlying loss reserve evaluation
Reasonableness of loss reserve balances
– typically test data and loss
reserves prior to year end, with update at
year end
Timing
Historically, actuaries and auditors have
coordinated data requirements related to
financial statement audit
8
Internal Control Audit
 Required by Section 404 of the Sarbanes
Oxley Act of 2002
 Accelerated filers (“seasoned” issuers
with over $75 million public float) –
required for fiscal years ended on or after
11/15/04
 Non-accelerated filers and foreign private
issuers fiscal years ending on or after
7/15/06
 Some companies adopting voluntarily
 Timing – same as Form 10-K
9
Internal Control Audit
 Public Company Accounting Oversight Board –
Auditing Standard No. 2 – An Audit of Internal Control
over Financial Reporting Performed in Conjunction with
an Audit of Financial Statements
 Management to document and test internal controls
related to significant accounts and processes
 Management issues opinion on effectiveness of
internal control as of end of year
 Auditors evaluate process followed by management
and test internal controls
 Auditors issue 2 opinions – one on management’s
opinion, one on auditors evaluation of internal
controls
10
Internal Control Audit
 Timing for review of management’s documentation and
testing and auditor testing – generally same timing as
financial statement audit (integrated audit)
 Test controls prior to year end, update at year end
 Internal Control Deficiencies
 Material weaknesses – in opinion
 Significant deficiencies – to audit committee and
management
 Deficiencies – to management (inform audit
committee)
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Statutory Reporting on Internal
Controls
 Model Audit Rule – auditor to report on significant deficiencies
(including material weaknesses) in internal control in accordance
with Statement on Auditing Standard No. 60 Communication of
Internal Control Related Matters Noted in an Audit
 AICPA/NAIC Working Group - Definition of significant deficiency in
PCAOB AS 2 and SAS 60 are equivalent
 Reporting requirements: AS 2 – significant deficiencies that exist
as of year end; SAS 60 – significant deficiencies noted in audit
 AICPA/NAIC Working Group – only report significant deficiencies
that exist as of year end – 49 states concurred
 Reporting requirements in AICPA/NAIC May 2005 Statutory
Framework for Reporting Significant Deficiencies in Internal
Control to Insurance Regulators
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Data Testing Requirements
 Required by annual statement instructions starting in
2004
 Auditor tests data identified by actuary as significant
to the actuary’s loss reserve estimate
 Might or might not be consistent with data tested by
auditor as part of financial statement audit
 Objective – data fairly stated in all material respects
in relation to SAP financial statements as a whole
 Timing – prior to year end and/or at year end
 Coordinate with auditors – scope, timing, reporting
protocol (AAA guidance for sample communications
and Q&A)
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Interaction Between the
Appointed Actuary and Auditor
Consulting Actuary’s Perspective
Joseph A. Herbers,
Pinnacle Actuarial Resources, Inc.
OUTLINE OF PRESENTATION
 New Requirements in 2004
 Substantive Questions
 ASOP 21
 ASOP 23
 Procedural Questions
 Feedback Loop
15
New Requirements in 2004
 Burden on Auditor is to:
 communicate
with Appointed Actuary
regarding which data elements the AA
identifies as being significant;
 design testing procedures; and,
 subject data to testing.
 Auditor is allowed to factor in judgment
and materiality in determining necessary
testing
16
New Requirements in 2004
 Audit procedures should be applied to:
 claim
loss and defense
containment expense
and
cost
 current calendar year activity
17
Substantive Questions
What about other data elements viewed as
significant?
 Premium (and/or rate change activity)
 Claim Counts
 Salv/Sub Recoveries
 Exposure
 External data
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Substantive Questions
 Direct / Ceded / Net?
 A&O v DCC
 Acc. Year / Report Year / Und. Year
 UPR for long duration contracts
 ERE reserves
19
ASOP 21 – Responding to or Assisting Auditors
or Examiners in Connection with Financial
Statements for All Practice Areas
 Actuary should be responsive to reasonable requests
regarding data and methods used, sources and basis
for assumptions
 Be prepared to discuss known circumstances that had
a significant effect on reserves (operating environment,
trend, product mix, methods, regulation, etc.)
 Disclosure of relationship to entity being audited
 Confidentiality
20
ASOP 23 – Data Quality
 Completely accurate, appropriate and
comprehensive data are frequently not available
 Disclose material data limitations and implications
 Consider data elements desires and possible
alternatives
 Selection of data
 Reliance on Data provided by Others
 Review of Data
 Use of Data
21
Procedural Questions
 Who initiates discussions?
 When will testing be performed?
 Is AA obligated to disclose which data was
tested by auditor?
 Who determines how testing gets done?
 sample size
 attributes tested
 frequency of testing
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Feedback Loop
 What obligation does AA have in securing
feedback on data testing?
if auditor’s data testing yields
significant data discrepancies?
 What
 Is AA obligated to disclose which data was
tested by auditor?
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Interaction Between the
Appointed Actuary and Auditor
Company Actuary’s Perspective
Roy Morell, Liberty Mutual
Two parts of audit firm interaction
1) The auditor concerned with integrity of the
data and overall financial statement
2) The actuary at the audit firm concerned
with the reasonableness of booked reserve
25
Significant Data items & attributes
1) Data items include paid and case reserves
for loss & DCC, earned premium, claim
counts, ULAE (A&O) paid by calendar year
2) Key attributes include line, state, accident
year, subline (indem v. med), policy type (FI
v. LD), mass tort features
26
Role of those setting reserves
Who sets reserves? Home Office or Business
Unit actuary, CFO, Senior Management?
Whoever sets the reserve needs to take an
active role in the interaction with the auditor
27
Be aware of ASOP #9
ASOP #9 Documentation and Disclosure
in … Loss Reserving
“An actuarial report is … presented fairly if it
describes the data, material assumptions,
methods, and material changes in these, with
sufficient clarity that another actuary, practicing
in the same field, could make an appraisal of the
reasonableness and validity of the report.”
(ASOP #9, January, 1991, Section 5.3)
28
Voluntary Compliance with SOX
 Compliance PROS
 Consistent with company’s ethical practice
 Enhances financial & operational transparency
 Rating Agency implications
 The bar has been raised!
 Compliance CONS
 Distraction from strategic focus
 Cost – Time and money
29
Key Role of Company Actuary
Ensure that the auditor is aware of key
operational issues that impact reserve
evaluation
Develop an approach to the interaction that is
cooperative partnership, rather than
adversarial
30
Interaction Between the
Appointed Actuary and Auditor
Audit Support Actuary’s Perspective
James C. Votta, Ernst & Young
REVIEW OPINIONS (AUDIT SUPPORT)
 Responsibilities of Reviewing Actuary
 Understand purpose and intended use
 Assess reasonableness of
—Data
—Methods & Assumptions
 Does not require independent projections
 Discuss differences with opining actuary
 Document material differences
32
REVIEW OPINIONS (AUDIT SUPPORT)
 Responsibilities of Reviewed Actuary
 Available and responsive
 Code of Professional Conduct
 SOP 36
33
ISSUES
1. Timing
2. Reserve Estimate/Range
3. Reinsurance/Risk Transfer
4. Other
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Q&A
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