Interaction Between the Appointed Actuary and Auditor

1
Interaction Between the Appointed Actuary and
Auditor

• Casualty Loss Reserve Seminar

September 12, 2005
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SPEAKERS

• James C. Votta, Ernst Young
• Scott A. Trosset, Ernst Young
• Joseph A. Herbers, Pinnacle Actuarial
  Resources,Inc.
• Roy Morell, Liberty Mutual

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INDEX TO GUIDANCE

• 2004 Practice Note
• Data Testing Requirements
• Actuarial Guidance
• Sample Letter

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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

5
Interaction Between the Appointed Actuary and
Auditor

• Auditors Perspective
• Scott A. Trosset, Ernst Young

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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

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Coordination between Appointed Actuary and Auditor

• Financial Statement Audit
• SAP and/or GAAP
• Internal Control Audit
• Data Testing Requirement Annual Statement
  Instructions

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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

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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
• Timing typically test data and loss reserves
  prior to year end, with update at year end
• Historically, actuaries and auditors have
  coordinated data requirements related to
  financial statement audit

10
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

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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 managements
  opinion, one on auditors evaluation of internal
  controls

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Internal Control Audit

• Timing for review of managements 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 actuarys 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 QA)

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Interaction Between the Appointed Actuary and
Auditor

• Consulting Actuarys Perspective
• Joseph A. Herbers,
• Pinnacle Actuarial Resources, Inc.

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OUTLINE OF PRESENTATION

• New Requirements in 2004
• Substantive Questions
• ASOP 21
• ASOP 23
• Procedural Questions
• Feedback Loop

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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

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New Requirements in 2004

• Audit procedures should be applied to
• claim loss and defense and cost containment
  expense
• current calendar year activity

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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?
• AO v DCC
• Acc. Year / Report Year / Und. Year
• UPR for long duration contracts
• ERE reserves

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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

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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

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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?
• What if auditors data testing yields
  significant data discrepancies?
• Is AA obligated to disclose which data was
  tested by auditor?

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Interaction Between the Appointed Actuary and
Auditor

• Company Actuarys Perspective
• Roy Morell, Liberty Mutual

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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

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Significant Data items attributes

1. Data items include paid and case reserves for
   loss DCC, earned premium, claim counts, ULAE
   (AO) paid by calendar year
2. Key attributes include line, state, accident
   year, subline (indem v. med), policy type (FI v.
   LD), mass tort features

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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

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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)

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Voluntary Compliance with SOX

• Compliance PROS
• Consistent with companys ethical practice
• Enhances financial operational transparency
• Rating Agency implications
• The bar has been raised!
• Compliance CONS
• Distraction from strategic focus
• Cost Time and money

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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

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Interaction Between the Appointed Actuary and
Auditor

• Audit Support Actuarys Perspective
• James C. Votta, Ernst Young

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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

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REVIEW OPINIONS (AUDIT SUPPORT)

• Responsibilities of Reviewed Actuary
• Available and responsive
• Code of Professional Conduct
• SOP 36

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ISSUES

1. Timing
2. Reserve Estimate/Range
3. Reinsurance/Risk Transfer
4. Other

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Q A