Interaction Between the Appointed Actuary and Auditor

1. Interaction Between the Appointed Actuary and Auditor Casualty Loss Reserve Seminar September 12, 2005

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

3. INDEX TO GUIDANCE • 2004 Practice Note • Data Testing Requirements • Actuarial Guidance • Sample Letter

4. 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 Auditor’s Perspective Scott A. Trosset, Ernst & Young

6. 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

7. Coordination between Appointed Actuary and Auditor • Financial Statement Audit • SAP and/or GAAP • Internal Control Audit • Data Testing Requirement – Annual Statement Instructions

8. 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

9. 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

11. 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 management’s opinion, one on auditors evaluation of internal controls

12. Internal Control Audit • Timing for review of management’s 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)

13. 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

14. Data Testing Requirements • Required by annual statement instructions starting in 2004 • Auditor tests data identified by actuary as significant to the actuary’s 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 Q&A)

15. Interaction Between the Appointed Actuary and Auditor Consulting Actuary’s Perspective Joseph A. Herbers, Pinnacle Actuarial Resources, Inc.

16. OUTLINE OF PRESENTATION • New Requirements in 2004 • Substantive Questions • ASOP 21 • ASOP 23 • Procedural Questions • Feedback Loop

17. 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

18. New Requirements in 2004 • Audit procedures should be applied to: • claim loss and defense and cost containment expense • current calendar year activity

19. Substantive Questions What about other data elements viewed as significant? • Premium (and/or rate change activity) • Claim Counts • Salv/Sub Recoveries • Exposure • External data

20. Substantive Questions • Direct / Ceded / Net? • A&O v DCC • Acc. Year / Report Year / Und. Year • UPR for long duration contracts • ERE reserves

21. 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

22. 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

23. 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

24. Feedback Loop • What obligation does AA have in securing feedback on data testing? • What if auditor’s data testing yields significant data discrepancies? • Is AA obligated to disclose which data was tested by auditor?

25. Interaction Between the Appointed Actuary and Auditor Company Actuary’s Perspective Roy Morell, Liberty Mutual

26. 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

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

28. 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

29. 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)

30. Voluntary Compliance with SOX • Compliance PROS • Consistent with company’s ethical practice • Enhances financial & operational transparency • Rating Agency implications • The bar has been raised! • Compliance CONS • Distraction from strategic focus • Cost – Time and money

31. 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

32. Interaction Between the Appointed Actuary and Auditor Audit Support Actuary’s Perspective James C. Votta, Ernst & Young

33. 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

34. REVIEW OPINIONS (AUDIT SUPPORT) • Responsibilities of Reviewed Actuary • Available and responsive • Code of Professional Conduct • SOP 36

35. ISSUES • Timing • Reserve Estimate/Range • Reinsurance/Risk Transfer • Other

36. Q & A