1. 2009 Seminar for the Appointed Actuary Friday September 18, 2009 MATERIALITY Colloque pour l’actuaire désigné 2009 2009 Seminar for the Appointed Actuary Friday September 18, 2009 MATERIALITY Colloque pour l’actuaire désigné 2009 Canadian Institute of Actuaries Canadian Institute of Actuaries L’Institut canadien des actuaires L’Institut canadien des actuaires

2. Page 1 Canadian Auditing Standards  CICA Handbook Section 5142-Materiality  Auditing Guideline-41-Applying the Concept of Materiality  A misstatement is material if it is probable that a financial statement user’s decision will be changed or influenced by the misstatement  Assumes user has a reasonable knowledge of business and economic activities  Misstatements arise from departures from generally accepted accounting principles including: ¯ Departures from fact ¯ Inappropriate determination of accounting estimates ¯ Omissions of necessary information  Misstatements may arise from error or fraud or the consequences of an illegal act 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009

3. Page 2 Users of financial statements/information  Auditor doesn’t know who they are or what their specific needs are  Therefore, materiality is ultimately a matter of the auditors’ professional judgment based on common needs of users as a group  No bright lines i.e. $1 over is material $1 under is not 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 Not Material May Be Material Material

4. Page 3 Qualitative vs. Quantitative Factors  Misstatements of relatively small amounts could have a material affect on financial statements  Illegal payment  Failure to comply with a regulatory requirement  Related party transactions  Judgments about materiality are made in light of surrounding circumstances and are affected by the size and/or nature of the misstatement 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009

5. Page 4 Auditors use materiality when  Determining the nature, timing and extent of audit procedures  Materiality for Planning Purposes  Evaluating the affect of misstatements  Materiality for Reporting Purposes  Materiality for Planning Purposes does not necessarily establish a threshold below which misstatements will be evaluated as immaterial 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009

6. Page 5 Fraud or Error  Distinguishing factor is whether the underlying action is intentional or unintentional  Errors are unintentional and include;  Mistakes in gathering or processing data  Incorrect estimates arising from unintentional oversight or misinterpretation of facts  Mistakes in the application of accounting principles 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009

7. Page 6 Materiality for Planning Purposes  A quantitative measure  Select an appropriate benchmark ¯ Income/earnings before tax ¯ Total assets or total revenues ¯ Equity or surplus  Apply an appropriate percentage (KPMG Audit Methodology) ¯ 3-10% for net benchmarks ¯ 0.5% - 2% for gross benchmarks ¯ (the lower end of these ranges are not floors and may be too high in certain circumstances)  Documented rationale, consistently applied 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009

8. Page 7 Materiality for Planning Purposes  Factors to be considered in identifying an appropriate percentage: ¯ Ineffective or partially effective control environment ¯ History of material weakness and/or a number of control deficiencies ¯ High turnover of senior management ¯ History of large or numerous misstatements ¯ Complex accounting issues and significant estimates ¯ Multi-location operations ¯ Regulatory requirements and thresholds ¯ Particular focus of financial statement users 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009

9. Page 8 Planning Thresholds for Insurance Companies  Focus on earnings for public companies  Focus on regulatory capital for non-public enterprises  Additional Factors: 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 FactorHigher PercentageLower Percentage Capital levels  Well capitalized entity  Significant margin over regulatory thresholds  No restrictions on dividend paying capacity  MCT/MCCSR/RBC close to regulatory actions levels  Limited dividend paying capacity Rating Agency Actions  High/Favourable ratings  Market is not reliant on favourable ratings  Entity with history of downgrades or being monitored for a potential down grade  Market is clearly reliant on favourable ratings Other sensibilities  Holding company is well capitalized  Holding company is dependent on dividends from the entity to fund cash flow/debt service

10. Page 9 Evaluation of Misstatements Identified  Auditor’s view is – they should be corrected  If management and the Audit Committee assess the misstatements as immaterial auditors options are;  Concur and issue an unqualified auditors’ report  Do more audit work to narrow the difference  Qualify the auditors’ report 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009

11. Page 10 Changes in Estimates Accounting Treatment  Changes in estimates based on new or better information that was not (and should not have been) available in prior periods are not misstatements  Changes in estimates are reported in the period they are identified Level of precision  The AA’s point estimate is always a specific number within a reasonable range  The level of precision (or the width of the range) varies from entity to entity based on the size and nature of it’s business  The level of precision (plus or minus 5% - 10%) may be higher than the auditors’ materiality  When the auditors’ actuary concludes that the entities recorded estimate falls within a reasonable range, there is no misstatement  However, movement within the range from one period to the next should have a robust rationale 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009

12. Page 11 Communication between Actuaries and Auditors  Required by Auditing Standards and Actuarial Standards  Should discuss both quantitative and qualitative factors affecting each others work 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009