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Companies across different industries use various types of internal and external specialists to assist in developing accounting estimates needed in their financial statements. While performing financial statement audits of companies, auditors frequently make use of the work of the company specialists as audit evidence. For entities with significant retained insurance liabilities, these specialists often include actuaries who are responsible for estimating outstanding claim liabilities, which are typically the most significant liability on their balance sheet.
At the end of 2018, the Public Company Accounting Oversight Board (PCAOB) implemented several amendments to their existing standards. One of the changes strengthened requirements for evaluating the work of company specialists. Prior to the change, PCAOB guidelines did not expressly require auditors to evaluate the appropriateness of methods and assumptions used by company specialists. Auditors were merely required to obtain an understanding of the methods and assumptions used.
The amended guidelines now specifically state that when auditors use the work of a company specialist as audit evidence, auditors must perform procedures to evaluate the reasonableness and appropriateness of the specialist’s work. Procedures may include:
Obtaining an understanding of the work, reports or equivalent communications of the specialists and the related company processes and controls.
Evaluating the relevance and reliability of the data, significant assumptions and methods used by the specialist.
Assessing the knowledge, skills and ability of both the specialist and the company as well as the relationship between the two.
The potential increase in costs associated with meeting the new guidelines is a concern for many audit firms. In general, larger audit firms already employ internal specialists, while smaller firms tend to rely more on the work of the company specialists or partner with outside experts. With this change, audit firms without in-house expertise to review the work of company specialists may need to more frequently partner with outside experts to perform certain audit procedures.
Pinnacle regularly works with audit firms of both traditional and non-traditional insurance entities, such as captives and self-insurance programs. We have a systematic approach to audit support engagements that is firmly rooted in the Actuarial Standards Of Practice (ASOPs) promulgated by the Actuarial Standards Board. A typical audit support engagement involves the following steps:
Understand project requirement.
Early in the process, through discussions with the audit team, we agree on the scope, objective and timing of the project as well as the best way to communicate our findings.
Understand underlying exposure and internal/external factors that could impact outstanding claim liabilities estimates.
Develop a good understanding of (a) the type of policy and coverage offered by the company, (b) any reinsurance programs providing protection to the company and (c) any significant changes in the company’s operations or claim handling processes. Much of this can be found in the company’s actuarial report and statement of actuarial opinions. The company’s financial statement is also a good source of information.
Review data, assumption, procedures and methods used by the company actuary.
This is where we spend most of our time and effort. Generally, the data, methods, procedures and assumptions used to estimate the outstanding claim liabilities are documented in the company actuary’s report. Our approach applies a series of evaluation criteria to the actuary report regarding its content and form, as well as compliance to applicable professional standards. This allows us to objectively assess the assumptions and methods used and conclude on the reasonableness of the estimated reserves. Depending on the outcome of this evaluation, we may also perform sensitivity testing on key assumptions used and develop our own range of reasonable reserves. The extent of the review is always discussed with and agreed upon with the auditor team in advance.
Document and communicate findings with the audit team.
Once our review is completed, an actuarial report providing details about the approach taken and our findings is prepared and shared with the audit team. In addition to conclusions on the reasonableness of the indicated outstanding claims, we also document the reasonableness of the data, assumptions, procedures and methods used as well as any deviations from ASOPs. Finally, we discuss with the audit team any areas that could lead to future concerns.
While we approach all of our engagements with independence and objectivity, we believe it is also critical to approach audit support projects with an open mind. The role of an audit actuary is mainly one of peer review and, although we may have our preferred method for analyzing and estimating claims liability, it is not the objective of the audit to insist on any particular selection or method. The primary objectives in an audit support project are to determine the reasonableness of the overall reserve estimate and to make sure appropriate methods and actuarial principals are applied.
Although changes to the PCAOB guidelines are specific to public companies, applying similar guidelines to the audit process of other insurance entities can provide benefits to the audit team. This includes early detection of problems to come, reduction of material misstatement risk on the financial statements and decreasing the audit firm’s reputational risk.
While each audit support project is different, a systematic and consistent approach allows for an efficient and objective appraisal of another specialist’s work. If you would like to learn more about Pinnacle, and our audit support service, you can find us here.
Jing Liu is a Consulting Actuary with Pinnacle Actuarial Resources, Inc. in the San Francisco, California office. She has over 15 years of experience in the property/casualty insurance industry, in both actuarial and underwriting capacities. Her experience includes assessing reserve and funding adequacy for captives, managing a portfolio of reinsurance treaties as well as ratemaking and filings. Jing is a Fellow of the Casualty Actuarial Society and a Member of the American Academy of Actuaries.
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