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Actuaries Supporting the Financial Audit: Independence Issues and the Impact of the Sarbanes-Oxley Act Mike Grillaert, Partner Casualty Loss Reserve Seminar.

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Presentation on theme: "Actuaries Supporting the Financial Audit: Independence Issues and the Impact of the Sarbanes-Oxley Act Mike Grillaert, Partner Casualty Loss Reserve Seminar."— Presentation transcript:

1 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

2 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

3 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

4 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filed a registration statement that has not yet become effective under the Securities Act of 1933, and that it has not withdrawn.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.

5 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 signed Board named Board functional * Firm registrations & Non-audit svcs effective * * Outside limits SEC regs. on Independence

6 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

7 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

8 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

9 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

10 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

11 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

12 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.

13 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

14 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

15 Appraisals & Valuations Current RulesSarbanes-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

16 Actuarial Services Current RulesSarbanes-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 ??

17 Questions?

18 The Current Role of Actuary on the Audit Terrence M. O’Brien Principal PricewaterhouseCoopers LLP Actuaries Supporting the Financial Audit CLRS – September 23, 2002

19 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

20 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

21 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

22 Covered Items  Assets and liabilities that: –Relate to insured risks –Involve future contingent events –Are not subject to precise determination

23 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

24 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

25 Reinsurance Policy Structure Issues  Assessment of transfer of risk  Interpretation of contract language and review of the associated accounting

26 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

27 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

28 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

29 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

30 Future Policy Benefits  May be relevant for discontinued lines of business

31 Expansion of the Actuary’s Role on the Audit Team Actuaries Supporting the Financial Audit CLRS – September 23, 2002 Jan Lommele, FCAS, MAAA Principal

32 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

33 Deep quantitative skill set 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 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

34 Expansion of the Actuary’s Role On 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 AssetsLiabilities Goodwill asset ALM/asset duration Capital Adequacy – RBC Unearned premium reserves Anticipated S&S Premium deficiency reserves

35 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

36  Balance sheet items –Loss reserves –Discounting –Retrospective premium reserves –Risk margins  Other items Expansion of the Actuary’s Role On the Audit Team Actuarial participation not limited to insurance company audits…… Non Insurance Company Audits

37  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 Non Insurance Company Audits – other items

38 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

39 Expansion of the Actuary’s Role On 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?


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