Actuaries Supporting
the Financial Audit:
Independence Issues and
the Impact of the Sarbanes-Oxley Act
Mike Grillaert, Partner
Casualty 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 SarbanesOxley 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not withdrawn.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
 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
7/30/02
10/28/02
1/26/03
4/26/03
10/23/03
* Outside limits
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 “nonaudit 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 nonaudit 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-bycase 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
Actuaries Supporting
the Financial Audit
CLRS – September 23, 2002
Terrence M. O’Brien
Principal
PricewaterhouseCoopers LLP
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
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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, MAAA
Principal
Expansion of the Actuary’s Role
On 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
Expansion of the Actuary’s Role
On 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
Audit Team
Client
Deep quantitative skill set
• Data “gurus”
• Additional analytics
• Modeling capability
Specialized knowledge of
insurance and insurance products
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•
•
•
Risk assessment capability
• Insurance programs
• Current litigation
Industry benchmarking
Current events
Best practices
Early indication of problem areas
Expansion of the Actuary’s Role
On the Audit Team
Insurance Company Audits
In addition to loss reserves, there are a number of balance
sheet areas where actuarial involvement may be beneficial
Assets
Liabilities
Goodwill asset
Unearned premium reserves
ALM/asset duration
Anticipated S&S
Capital Adequacy – RBC
Premium deficiency reserves
Expansion of the Actuary’s Role
On the Audit Team
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 Role
On the Audit Team
Non Insurance Company Audits
Actuarial participation not limited to insurance company audits……
 Balance sheet items
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Loss reserves
Discounting
Retrospective premium reserves
Risk margins
 Other items
Expansion of the Actuary’s Role
On the Audit Team
Non Insurance Company Audits – other items
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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 Role
On 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 Role
On the Audit Team
? Other Things to Think About?
 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