all you ever wanted to know about auditing but were afraid
TRANSCRIPT
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All you ever wanted to know about auditing but
were afraid to ask
David Brown and Rob Lewis
26 October 2018
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Disclaimer
This handout and presentation represents the personal views of the speaker who does not accept any liability for
reliance on it and make no warranty as to its content or accuracy.
This handout is not written advice directed at the particular facts and circumstances of any given situation and/or
data.
The materials contained in this presentation pack and any oral representation of it are explicitly outside the scope of
the TAS.
226 October 2018
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Agenda
1. Trust and Public Perception
2. Audit Insights
3. Some Important Audit Concepts
4. The Actuarial Side to Audit
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Trust and public perception
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Public Perception – Trusted People?
26 October 2018 5
https://twitter.com/MallowNews/status/1019523917529190400By John Cairns - The Bodleian Libraries, CC BY 4.0,
https://commons.wikimedia.org/w/index.php?curid=72687485
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Public Perception – Trusted Brands?
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https://lbbonline.com/news/the-uks-most-trusted-brands-who-tops-the-pile/
https://www.opinium.co.uk/most-trusted-companies-in-uk/https://www.campaignlive.co.uk/article/guardian-trusted-sun-
least-trusted-online-news-brand-pamco-reveals/1492881
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Public Perception – A Case Study (non-Actuarial)
• Volkswagen emission scandal in
September 2015
• Severe loss of public trust and large
share price crash
• Gained 40% since low point, but still
down from peak
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www.google.co.uk
Emissions scandal
Volkswagen Share Price
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Audit Insights
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Users of financial statements
Users Purpose
Equity investors (report addressee) Assess company’s performance
Debt investors Assessment of lending
Equity analysts Base point for future prospects
Rating agencies Informative for rating decisions
PRA and FCA Informative for understanding financial performance (albeit not Solvency II capital)
HMRC Starting point for corporation tax
Pension fund trustees Assess strength of pension covenant
Employees Share price performance
Trade unions Employee prospects
Consumer organisations Assess company stability to recommend to consumers
Financial press Reporting news, scandals, investigations
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Operating environment for audit firms
• Audits typically performed with unlimited liability.
• Tolerance for business failures post the Global Financial Crisis is low.
• Perception of huge rewards for directors in business and limited penalties for failure.
• Carillion and BHS two particularly high profile business failures subject to extensive scrutiny.
• Increased dialogue with both PRA and FCA – they expect a frank exchange of views from the
auditors and regular meetings on bipartite and tripartite basis.
• Routine inspection of work internally and by the Financial Reporting Council.
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Auditor responsibilities for statutory audit
Auditor’s responsibilities
• Obtain reasonable assurance about whether the financial statements as a whole are
– free from material misstatement, whether due to fraud, other irregularities (see below), or error, and;
– to issue our opinion in an auditor’s report.
• Reasonable assurance is a high level of assurance, but does not guarantee that an audit will always
detect a material misstatement when it exists.
• Misstatements can arise from fraud, other irregularities or error.
• Consideration is given to the materiality (defined later).
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Specialists in the audit
• Auditors need support across the audit, they can’t do everything!
• It is a multi-disciplinary team
• Specialists may include
– Actuarial
– Tax
– IRM
– Valuations
– Forensics
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Enforcement cases against actuaries
Case 1 Case 2 Case 3
Date 22 February 2017 22 February 2017 10 August 2017
Role Former Chief Actuary A former Actuary Consulting actuary to
Lloyd’s syndicate
Fine £101,500 £45,500 £75,200
Costs to be paid £11,000 £3,500 £400,000
Regulatory impact Ineligible for 3 years
for a practising
certificate
A Reprimand A Severe Reprimand
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Some Important Audit Concepts
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Key Terms and Definitions
• Materiality
– Materiality, Performance Materiality, Audit Misstatement Posting Threshold (“AMPT”)
• Estimate
• Error
• Professional scepticism
• Disconfirming evidence
• Benchmarks
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Materiality - concept
• The determination of materiality is a matter of professional judgement, and is affected by
our perception of the financial information needs of users of the financial statements.
• Users:
– a. have a reasonable knowledge of business and economic activities and accounting
– b. understand that financial statements are prepared, presented and audited to levels of
materiality
– c. recognize the uncertainties inherent in the measurement of amounts
– d. make reasonable economic decisions on the basis of the information
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Changes in estimates versus errors
• Prior period errors are:
• Omissions from, and misstatements in, the entity's financial statements for one or more
prior periods arising from a failure to use, or misuse of, reliable information that:
• (a)was available
• (b)could reasonably be expected to have been obtained and taken into account
• Such errors include the effects of mathematical mistakes, mistakes in applying
accounting policies, oversights or misinterpretations of facts, and fraud.
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Estimates vs Ranges
• There can be differences between two point estimates, two actuaries will
probably take different views
• The actuarial audit team may calculate what they consider to be a reasonable
range
• The audit considers whether the company’s estimate falls within a reasonable
range
• But what is reasonable?
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Professional scepticism
• Auditors are required to exercise “professional scepticism”
– This does not mean mistrust
– But requires challenge and evidence rather than taking things on face value
• Professional scepticism is an attitude that includes a questioning mind
• When considering key judgements, higher levels of professional scepticism
are applied in assessing the reasonableness – including consideration of
historical reliability
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Disconfirming Evidence
• What is disconfirming evidence?
• How to handle two opposing conclusions for two different pieces of evidence?
– What to choose or rely on? How to record this?
• Consider the impact
• Actuarial examples:
– Anchoring bias
– Loss ratios significantly better than industry peers
– Inappropriate exclusion of outliers
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Benchmarking
• Information from sources independent of the entity that may be used as audit evidence.
• Benchmarks are a guide only.
• Being in or out of the middle does not necessarily mean good or bad.
• Need to consider any potential anomalies that arise out of the benchmarking exercise.
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0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
120.0%
Incurr
ed a
s %
of U
ltim
ate
Hurricane X - Incurred:Ultimate
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The Actuarial Side to Audit
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Overview
• Auditing is not part of the actuarial exams.
• Yet reserving and accounting failure attract more attention than pricing
failures.
• Actuaries must be part of the solution!
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Actuarial Audit Work
• Need to assist the auditors in forming a view on whether the accounts and
judgements are reasonable
• Reasonable doesn’t mean that everyone is the same:
– For example, signing off on two insurers with Ogden assumptions of -0.75% and 0%.
• We have to build up the overall view taking perspective across the business.
• Use a range of tests include quantitative and qualitative.
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Actuarial Audit Work (cont.)
• Governance, experience, competence
– Consider review process for setting reserves, who signs off
• Data
– Reconcile data to prior years etc, but critically liaise with audit team
• Process and methodology
– Review methodology to calculate large loss IBNR and/or controls around the process
• Judgements and assumptions
– Compare assumptions to results from data and market benchmarks, e.g. EL tail
• Alternative estimates
– Conduct projections on material lines of business with greater uncertainty
• Further tests
– Reserving diagnostics or RI ‘netting down’ to spot any unusual data features
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Actuarial Audit Work (cont.)
• No test is considered in isolation
• But combined and in aggregate to develop a view
• Findings in one test may require further work in another
– E.g. racy assumptions and poorly documented methodology may mean a greater number
of independent projections to gain comfort (or not) over the reserves
• The following slides will cover a few typical tests in more detail and a few of
the key areas we look out for…
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Group Task
• … but first, a group task!
• Each group will have different information on parts of the accounts and/or
actuarial work
• You should discuss in your groups whether the data indicates any risks or the
level of prudence in the reserves
• Assign a rating of 1 – 5, and justify!
– 1: Overly optimistic
– 3: Best estimate
– 5: Overly prudent
• In each case, consider what might the criteria be to not be
acceptable? Of it not, what further evidence could be gathered?
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Exercise 1 – Team
Team
Member
Role Experience
A Chief Actuary Has held the chief actuary role at
the company for 15 years
B Reserving Manager 5 years post qualification
experience. New joiner, previously
at a personal lines insurer
C Reserving Manager New qualified, joined 6 months
ago but spent 4 years in a similar
syndicate
D Analyst 1 year experience
E Analyst New graduate
• A Lloyd’s syndicate
• Stable and experienced senior
management
• Managers with experience, but limited
knowledge of the business
• Are there sufficient resources to carry
out all the actuarial work to
appropriate standards?
• Consider quantitative and qualitative
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Syndicate X
0
2
4
6
8
10
12
0 50 100 150 200
Siz
e o
f R
eserv
ing T
eam
Number of reserving classes
Team Size Benchmarking
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• Summary of recent bodily injury claims
settled
Exercise 2 – Methodology
• Ogden assumption for reserving was
1%
• Implied rate on settlement is
decreasing following the Lord
Chancellors announcement
• But consistently above 0%
• Is a trend forming?
Date of
settlement
Amount Implied
Ogden Rate
01/11/2016 £ 300,000 2.5%
14/12/2016 £ 150,000 2.1%
10/03/2017 £ 1,000,000 3.0%
21/07/2017 £ 1,300,000 1.7%
03/08/2017 £ 750,000 1.8%
19/10/2017 £ 100,000 1.5%
05/11/2017 £ 250,000 0.9%
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Exercise 3 – Diagnostics
• Selected projection methodology only
considers the incurred
• Something has caused the paid to
speed up. Should we be worried?
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0%
20%
40%
60%
80%
100%
120%
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44
% D
evelo
ped
Development Quarter
Incurred Development as % of [Client] Ultimate
0%
20%
40%
60%
80%
100%
120%
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44%
Develo
ped
Development Quarter
Paid Development as % of [Client] Ultimate
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
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Exercise 4 – IELRs
• There is a consistent upward trend in IELRs over the initial development for
each UWY
• Recent IELRs may be optimistic both the trend and IELR<ULR, resulting in
under-reserving when using the BF method
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Table 1a - IELR Pick Development as at 31/12/2018 - Employers Liability
IELR selection at as at Date Projection
Method
ULR % Development to Ultimate
UWY YE13 YE14 YE15 YE16 YE17 YE18 YE18 Paid Incurred
2013 50.0% 52.5% 54.1% 54.6% 54.6% 54.6% Incurred CL 54.6% 50.2% 73.0%
2014 50.3% 52.8% 54.4% 54.9% 54.9% Incurred CL 54.9% 45.3% 65.9%
2015 47.2% 49.6% 51.1% 51.6% Incurred CL 51.6% 40.0% 56.6%
2016 50.3% 52.8% 54.4% Incurred BF 60.2% 34.7% 50.5%
2017 49.1% 51.6% Incurred BF 55.0% 17.1% 44.9%
2018 42.0% Incurred BF 47.9% 10.5% 23.1%
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Exercise 5 – Alternative Estimates
UWY Client
Ultimate
Auditor’s
Ultimate
Surplus /
(Deficit)*
2013 73 73 1
2014 74 72 2
2015 78 75 2
2016 79 79 0
2017 80 77 3
2018 89 98 (9)
2017 &
Prior
773 724 9
Total 822 822 (0)
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*small differences due to rounding
• Materiality £3m, total reserves £142m
• Overall, there is negligible difference
• But this is split looking CY vs PY
– CY has a £9m deficit
– PY has a £9m surplus
• This might be a case of optimistic
business plans or IELRs
• What would be the impact on pricing
or reserving for future years?
• What about the Solvency II impact?
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Exercise 6 – More Diagnostics
• Personal motor severity for small
bodily injury
• Marked change in the severity
development from notification post
April 2013
• Why? LASPO?
• Need to investigate if this has been
allowed for in the projections
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6,000
6,500
7,000
7,500
8,000
8,500
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43incurr
ed A
vera
ge C
ost per
cla
im (
inc n
ils)
Development Month
Incurred Average Cost per Claim (inc nils) - Small Bodily Injury
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
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Making the most of auditors
• Now you should have an insight into what the auditors do and are looking for
• How are they to be engaged?
– Two way communication
– Understand purpose of the work
• How can you help them?
– Provide evidence to back up assumptions and processes
– Propose changes in advance to get feedback on any remedial action required
• How can you get the greatest insight? How can they help you?
– Benchmarking against peers
– Supporting where there is pressure to reduce or increase selections
– Extra level of challenge to check areas you should be thinking about
– Help improve standards, c.f. upcoming IFoA peer review
– Testing robustness before presenting to audit committee
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Audit as an actuarial discipline
• Technical skills different to internal reserving
• TAS 200
• Learn different skills key to audit, those being: challenge, evidence based
review, documentation
• Market understanding
• Board exposure
• A skill set applicable beyond audit
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The views expressed in this presentation are those of invited contributors and not necessarily those of the IFoA. The IFoA do not endorse any of the views
stated, nor any claims or representations made in this presentation and accept no responsibility or liability to any person for loss or damage suffered as a
consequence of their placing reliance upon any view, claim or representation made in this presentation.
The information and expressions of opinion contained in this publication are not intended to be a comprehensive study, nor to provide actuarial advice or advice
of any nature and should not be treated as a substitute for specific advice concerning individual situations. On no account may any part of this presentation be
reproduced without the written permission of the IFoA or authors.
Questions Comments