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Captive Industry and Risk Retention Group Auditing Challenges Discussed

Company Rating
November 22, 2016

Editor's Note: Glenn Saslow, CPA, partner at Crowe Horwath LLP, recently shared a glimpse into his auditing experience with the captive insurance industry. Captive.com's interview with Mr. Saslow is presented below in a question-and-answer format (each of Captive.com's questions followed by Mr. Saslow's answers) to assure clarity and accuracy.

Question: What have been your experiences in dealing with captive managers while conducting a financial audit?

Answer: The majority of managers have a reliable process in place by which they provide the needed financial data and documentation. Their management and staff are generally knowledgeable and have a fundamental understanding of GAAP [generally accepted accounting principles] and statutory accounting.

Occasionally, we have had some difficulties in conducting an audit. Usually, it involves the application of accounting principles such as interpretations of GAAP and statutory accounting requirements. As a result, these items are detected during the audit, which results in adjustments to the financial statements and necessitates written communications regarding internal control deficiencies.

Other issues do arise, such as poor record keeping, lack of internal controls, and inadequate training of accounting staff. These issues result in inaccurate interim financial statements, which do not allow management to react timely to negative trends in financial performance.

Question: What is the most common cause that requires an auditor to issue a letter that identifies deficiencies in internal control?

Answer: Lack of internal controls that could potentially lead to a misstatement of financial statements. We are then required to issue a letter identifying the deficiencies in internal control and report it to the board of directors or the audit committee of the company and to the regulator in the state of domicile.

Question: When conducting an audit, do you review the actuarial loss reserve opinion?

Answer: There is a significant amount of work that is performed regarding loss reserves, which includes detailed testing of the actuarial report. If an insurance company engages an independent actuary to perform the actuarial analysis of reserve, the auditor is not required to have another actuary review their work product. With respect to captives and risk retention groups, it is imperative that the auditor determine that the actuary has full and complete understanding of the insurance program, and that the calculation of reserves is consistent with the structure of the insurance program. It is also critical that the auditor test the data used by the actuary and reconcile it to the company’s  internal loss data. In other words, if the data provided to the actuary is incorrect, the loss reserve opinion will also be incorrect.

Question: Among states of domicile, are there variations in what they request from audited financial statements?

Answer: Minimal. The reporting varies little from state to state and, generally, either GAAP or statutory financial statements are filed with the regulator; however, differences do exist. The use of permitted accounting practices by regulators can vary by domicile.  Another area that differs among domiciles is the process they utilize to conduct regulatory exams. While more mature domiciles have internal staff that conduct regulatory exams, it is not unusual for some states to subcontract with outside accounting firms to perform these exams. The issue arises in that the level of experience of the accounting firms can vary significantly. While the NAIC [National Association of Insurance Commissioners] has very stringent regulations governing regulatory exams of NAIC filers, the regulations are not as robust for non-NAIC filers. That being said, it would be beneficial for the captive regulators to consider more stringent requirements with respect to accounting firms performing regulatory exams of non-NAIC filers.

Question: What changes have you seen in the last 10 years?

Answer: There is much greater volume of regulatory oversight, including increased financial reporting and regulatory requirements. Auditors involved in the captive insurance industry need an in-depth knowledge of ERM [enterprise risk management], domestic and international insurance regulation, reinsurance markets, and governance standards. From a financial reporting perspective, the accounting rules and regulations are changing at the fastest pace ever, and it is critical that auditors have an in-depth knowledge of multiple bases of financial reporting (GAAP, statutory, IFRS [International Financial Reporting Standards], and the ever-changing audit standards).

Today, there are more parties that rely on auditors to determine the financial sustainability of a captive or risk retention group (RRG). As a result, auditing firms are finding that they carry a greater responsibility and risk as they perform their jobs.

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