The Actuary’s Role in the Audit Process

1. The Actuary’s Role in the Audit Process The Actuary’s Responsibility to Auditors and Examiners CLRS – September 9th, 2003 Matt Carrier, ACAS, MAAA Senior Manager Deloitte & Touche

2. Agenda • The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds

3. The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Entities where Actuaries Support the Audit • Insurance Companies • Self-Insureds • Pure Self-Insured • Large Deductible / Retro Rated • Captive Insurance Co.

4. The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Entities where Actuaries Support the Audit • Additional situations • Asbestos / pollution • Product warranties • Member reward programs • Bad debt reserves on loans

5. The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Items Reviewed by Actuaries During an Insurance Co. Audit • Loss and loss expense reserves • Unearned premium reserves • Anticipated Sub & Sal • Premium deficiency reserves • Reinsurance / risk transfer • Discounting • Retrospective premium reserves • Other – 10K, Insurance Dept. questions

6. The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Items Reviewed by Actuaries During a Self-Insured Audit • Loss and loss expense reserves • Discounting • Risk margins / confidence intervals • Retention levels / risk transfer • Insurance policies

7. The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Objective for Actuary in Supporting Audit • Determine the reasonableness of entity’s position for items reviewed by actuary • For example: loss and loss expense reserves, unearned premium reserve, etc. • The approach to determine reasonableness may vary by client • Review of client’s methodology • Sensitivity testing based on client methodology • Independent development of a corroborative range

8. Insurance Co. Actuarial Statement of Opinion performed Data available / reliable Understands nature of risks Understands / accepts actuarial methods Credibility of the data Self-Insured Statement of Opinion typically not performed Often data issues Diversity of insurance knowledge Sometimes resistance to accept actuarial methods Incorporate external data • The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Insurance Co. Vs. Self-Insured Environment Purpose of actuary in audit is to evaluate management’s best estimates

9. Independent Testing Supplement entity’s methods / estimates Entity requests 2nd look Auditor request 2nd look Support State exams Focus on problem areas Review Strong analysis by entity Limited materiality of reserve balance Stability of results Predictable exposures Complexity of calculations Lack of data • The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Independent Testing Vs. Review Often some combination approach is taken on an Audit

10. Audit Support Current View (12/31/03) Mix of review and indep. testing Often several statutory entities combined Statutory and GAAP Net focus Going concern aspect State Exams Historic view (12/31/02) but can use subsequent data Greater use of indep. testing Single statutory entity Statutory accounting Gross and net focus Solvency based • The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Audit Support Vs. State Exams

11. Employee Actuary Review analysis Support data collection Discuss company changes Discuss company insurance programs Provide broad context and perspective Consulting Actuary Review analysis Given nature of relationships (i.e. client, consulting actuary, auditor) typically provide limited support in other areas • The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Reliance on Company’s Actuary: Employee Vs. Consultant

12. The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Discounting and discount rates for self-insureds • 30% to 50% of self-insureds discount some or all of their loss reserves • Issue of appropriate discount rate given economic conditions • Support risk free rates (i.e. T-bills) that match liability duration • Education of client and auditor

13. The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Appropriate Risk Margins • Often issue with self-insureds • Example: • Actuary provides self-insured hospital with estimate at 80% confidence level • Hospital booked millions > conf level number • Education of client and auditor

14. The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Communication/Interaction with Company • Request data • Discuss operations and changes • Collect and review data • Communicate conclusions • Education on process • Value added observations/trends

15. The Basics • Comparisons • Specific Situations / Issues • Education / Value Adds Education/Value Adds • Audit actuaries and consulting actuaries can add value through benchmarking against the industry • Audit process allows numerous opportunities to educate client (CFOs, Controllers, etc.) on actuarial concepts and the value it can generate • Same opportunities arise for company employed actuaries • We all need to use these opportunities…