Why Get An Independent Review?

Al Rhodes, ACAS, MAAA

There are many reasons an actuary may be engaged to complete an actuarial report, everything from due diligence to regulatory requirements. These engagements commonly involve review work which require the engaged actuary to review another actuary’s report for a large deductible program, captive submission, or NAIC reporting requirements.

Glenn Richards is a Partner at Crowe LLP whose role involves auditing financial statements for both private and public companies. Often, his assignments include assessing the qualifications of a company’s actuary and the audit risk associated with the matter covered by the company’s actuarial report. Frequently, he will work with an independent actuary to add an appropriate level of expertise to his review. Glenn has a few insights into using an independent actuary in the review process.

1. Why involve an independent actuary? Or, what triggers the need for an independent actuary?

An independent specialist is often engaged when an auditor encounters a situation requiring specialized knowledge or skills. An actuary is a type of specialist that is qualified to complete complex calculations for estimates such as workers compensation liabilities and pension obligations, among others. When companies have these types of liabilities, management will typically hire independent actuaries to help them estimate the liability to meet the requirements of GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards). Depending on the magnitude and risk factors associated with these liabilities, the auditor may be able to rely on the work completed by the company’s actuary.

In situations where the liability is large and/or particularly complex, auditors may directly engage an independent actuary to test the estimates completed by management’s actuary and assess whether the assumptions used by management’s actuary are reasonable. The auditor, through the use of their independent actuary, is in a better position to assess the assumptions used and the result because the independent actuary is better qualified to identify agreement provisions, assess assumptions and replicate calculations than the auditor. When the auditor completes this process, the risk of a material misstatement can be greatly reduced.

The factors that the auditor would consider in making the decision to employ his own actuary include, but are not limited to, the magnitude of the liability subject to valuation (relative to the balance sheet of the entity), the complexity of the calculation, and the potential impact and nature of sensitive or subjective assumptions in management’s calculations.

2. How do you handle any issues if the auditor’s actuary does not agree with the original actuarial report?

When the auditor’s actuary identifies differences between their calculation and the values calculated by management’s actuary, the source of those differences has to be identified. Unless there is a mathematical error, the difference must be caused by the use of assumptions or methodologies that are not identical. The auditor is required to assess whether or not management’s assumptions are reasonable and therefore reasonably account for any differences. Very often, a discussion between the two actuaries results in a quick identification of the differences in assumptions, the cause of those differences, and general consensus about which assumption is appropriate. This is where the auditor’s actuary serves a particularly valuable role in being able to challenge assumptions at a granular level. Even when no differences are ultimately identified, the auditor’s actuary serves an important role in vetting management’s assumptions.

3. What level of detail do you ask for from the reviewer? High level – where the review focuses on acknowledging that the methodology and assumptions are reasonable, or more in-depth – like a parallel study?

The nature and extent of the report provided by the auditor’s actuary can vary from engagement to engagement. An auditor’s responsibility in the audit of financial statements is to gather sufficiently appropriate evidence supporting the balances, transactions, and disclosures in the financial statements. Any report provided by the auditor’s actuary serves as one piece of evidence gathered in the course of the auditor’s work. It is possible for an auditor to engage an actuary to look at one assumption or issue within a valuation. However, most often, when the auditor uses an actuary, the auditor asks for a recalculation of the work completed by management’s actuary, and an assessment of the reasonableness of all material assumptions they used. The report from the auditor’s actuary will state the procedures completed, the inputs/data used, and the results of their work. Typically, this involves a narrative section, describing the work, as well as tables summarizing the conclusions.

4. What are the critical questions or factors you look at when evaluating and selecting an actuary for an independent calculation?

The auditor can only rely on the company’s specialist after becoming comfortable with the qualifications and objectivity of the specialist. The auditor must also consider qualifications and objectivity for an actuary they engage directly. The auditor will typically evaluate the actuary’s education and experience, as well as the professional reputation of the firm. Similarly, the auditor will assess the objectivity of the specialist. This assessment is typically made at the inception of each engagement, as significant issues with the actuary’s quality or objectivity could impact the auditor’s use of the actuary’s work as audit evidence.

Beyond the requirements above, the auditor may also consider their past history with the actuarial firm – such as how effective the actuary was in working with management, timeliness of their report, and other factors affecting the ease of working with the actuary.

We welcome your feedback by posting a comment or contacting us at support@SIGMAactuary.com.

© SIGMA Actuarial Consulting Group, Inc.

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