Cooperation between the accountant (auditor) and the actuary in relation to the auditing of financial information relating to insurance institutions

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1 Introduction 1. Both accountants and actuaries take into account codes of conduct when practising their professions. The activities of these professional practitioners in relation to insurance institutions results in various contacts and may give rise to questions in relation to the separate responsibility of each and in relation to the way in which they make use of each other's findings. Within both professions, it was deemed desirable to draw up a common modus operandi, 1 which sets out the rules governing cooperation between accountants and the actuaries. This modus operandi has been drawn up in consultation with the Platform Committee of Royal Nivra and the Dutch Actuarial Association. Terms and definitions Accountant 2. A person who is registered with the Register of Accountants maintained by Royal Nivra or with the Register of Accountants maintained by NOvAA, provided this contains an annotation in accordance with Section 36(3) of the Accounting Consultants Act [Wet op de Accountants- Administratieconsulenten], and who acts as the auditor of the insurance institutions. Actuary 3. A person who is a member of the Dutch Actuarial Association and acts as the actuary, in terms of Section V (Services relating to the annual accounts of an insurance institution) of the Code of Professional Conduct of the Dutch Actuarial Association. Insurance institutions 4. The holding company of insurance companies, an insurance company or a pension fund. Financial information 5. Financial information, as the object of an accountant's audit, includes both qualitative and quantitative information in written form which meets the following criteria: the information contains factual data; the purpose of the data is to account for the activities of the issuer thereof, whether or not due to an obligation imposed upon the issuer to do so; it must be possible to test the data by applying standards, in other words the data must be verifiable. Material importance and material accuracy 6. The (possible) variance between an item or a sum of items in the financial information shall be deemed to be of material importance if the knowledge thereof is essential in the assessment by users of the financial information. The term 'material accuracy' shall be understood to mean that no variances of material importance exist with a reasonable degree of certainty. Basic data 7. The entire range of information which is used by the insurance company to arrive at the correct provision for insurance liabilities/pension liabilities and which is used by the institution to assess the financial position and which, in addition, is of importance to the actuary in order to make the assessment required. 1 This modus operandi is contained in the separate regulations applicable to auditors and actuaries. In the case of auditors, the following applies: Accounting Standard 620 ("Using the Work of an Expert") provides general rules in relation to the auditor's use of the work of experts. By applying the rules stated therein, this practical guidance note regulates more specifically the cooperation between auditors and actuaries. The modus operandi included in this guidance note sets out the way in which this cooperation should be organised. This is developed in more detail in the annexes with the use of practical examples. 1

2 Justification 8. Within the framework of its operations, an insurance institution enters into obligations in respect of its policyholders or members. The obligations include making disbursements to the opposing party if the third party suffers a loss as a result of an uncertain occurrence or, alternatively, to pay out a benefit in the event of death or if the insured is alive on a certain date. These obligations are characterised by a certain degree of uncertainty. For instance, it is not certain in advance whether a benefit will have to be paid and in the case of non-life insurance it is often not certain what the level of the payout will be. The complexity is also increased by the fact that the period in which the liability is settled may be very long in many cases. This makes the estimation of future cash flows complex. In addition, as a result of this, there is the risk that possible inaccuracies and incompleteness in the recording of the obligations and inaccuracies in the setting of rates only come to the fore later, occasionally for the first time during the actual settlement. A lengthy settlement period also results in situations where the insurance institution holds funds, which are required in order to secure the later benefits, for a long period. In the financial information provided by insurance institutions, these liabilities are often determined with the use of actuarial techniques. Using the basic data, applying valuation policies, and using assumptions made by the management of the insurance institution, an estimate is made of the value of the liabilities as at the balance-sheet date. 9. The accountant obtains his or her expertise, for instance, through his or her training as a registered accountant or as an accounting consultant, through permanent education in the area of his or her expertise and through practical experience. The accountant who acts as the auditor of an insurance institution must have more than general professional knowledge of insurance institutions. The accountant bears final responsibility for his or her assessment of the truth and fairness of the insurance institution s annual accounts and other financial information in accordance with the Financial Supervision Act [Wet op het financieel toezicht] or the Pensions Act [Pensioenwet], or similar legislation and regulations applicable to insurance institutions. The accountant bears final responsibility for the auditing measures which enable him or her to form a final opinion. His or her expertise enables the accountant to form an opinion of the adequacy of the auditing framework which ensures that the basic data is administered correctly and comprehensively and is translated into a valuation of the liabilities. In practice, close cooperation with the actuary is indispensable, certainly in relation to this last aspect and with regard to the supplementing of this information. 10. The actuary obtains his or her expertise, for instance, through his or her training as an actuary, through permanent education in the area of his or her expertise and through practical experience. The actuary has specific professional knowledge of insurance institutions which enables him or her to form an opinion of the risks which are important in order to arrive at a correct evaluation of the insurance institution s liabilities. The actuary bears the responsibility, in accordance with relevant legislation, for making an assessment of the adequacy (Financial Supervision Act and the Pensions Act) of the provision for insurance liabilities/pension liabilities and the institution's financial position (Pensions Act). In determining the insurance liabilities and assessing its financial position, the institution makes use of a considerable quantity of information. In making his or her assessment, the actuary must be able to rely on the fact that these data are and complete. In practice, close cooperation with the accountant is essential in relation to this aspect. 11. Both the accountant and the actuary, each on the basis of his or her own responsibility, is involved in assessing the financial information of insurance institutions. In the light of the above, an assessment of the financial information of insurance institutions, which includes information containing actuarially determined elements of material importance, can only be made efficiently on the basis of good cooperation between the accountant and the actuary. 2

3 Obligations of the accountant and the actuary 12. As part of planning their schedule of activities, the accountant and the actuary will each year include coordination of the following matters: the outcomes of their initial risk analysis; the elements of information determined actuarially in respect of which certainty must be obtained; the proposed objective of the audit and approach to the audit; the auditing methods to be applied during the audit; the materiality which will be applied in this regard; the basic data; the way in which the actuary will be informed by the accountant of the reliability of the basic data; the valuation policies and proposed amendments thereto applied by the insurance institution; the planning of the activities and consultation on the findings of each. 13. The accountant and the actuary shall hold a concluding consultation in which the findings of each will be coordinated. In this coordination, the following matters will be considered: variances which have arisen in the approach to the audit compared to the earlier coordinated approach to the audit; the reliability of the necessary basic data (correctness and completeness); changes in the valuation policies which have arisen; the valuation policies and methods applied in determining the provision for insurance liabilities/pension liabilities; the findings resulting from the auditing of actuarially determined elements of information; the development of the financial position in the longer term and the risks which the insurance institution incurs in this regard; the technical analysis and organic statement of income and expenditure; the consequences of the findings for the tenor of the declarations to be issued in accordance with the Financial Supervision Act, the Pensions Act or, alternatively, similar legislation and regulations relating to insurance institutions. 14. The accountant and the actuary guarantee in their agreements with the insurance institution that they may hold the above-mentioned consultations without any reservations. Other reporting 15. In relation to financial information other than that described in Section 8 and other announcements in which accountants and actuaries are involved jointly in an auditing role, they still act in accordance with the purport of this modus operandi. 3

4 Annexes: Annex 1: Basic data...5 Annex 2: Materiality...7 Annex 3: Consultation within the framework of planning the schedule of activities...8 Annex 4: Consultation on the conclusions and exchange of information

5 Annex 1: Basic data The modus operandi includes a definition of the concept of "basic data". Further guidance is given in this annex with regard to this concept. The actuary is responsible for making an assessment of the adequacy of the provision for insurance liabilities/pension liabilities and with regard to the financial position (in the case of a pension fund). In determining the insurance liabilities and assessing the financial position, the institution makes use of basic data. The actuary must be able to rely on the fact that these data are correct and complete in making his or her assessment and, in doing so, will base his assessment on the accountant's assessment of these basic data. Section 12 stipulates that the accountant and the actuary should consult each other about the basic data and the way in which the actuary will be informed by the accountant about the reliability (correctness and completeness) of these basic data. The consultation with regard to the basic data is important in order to determine what the relevant basic data are in relation to the respective insurance institution and on which the accountant will report. On the one hand, this relates to information which is used in the primary determination of the balance-sheet provision for insurance liabilities/pension liabilities. In this regard, consideration must be given, in particular, to the data which indicate what the obligations are in relation to policyholders/members of the pension fund and what the insurance institution's rights are on the basis of the agreements which have been entered into. On the other hand, this relates to the identification of data which are of importance in carrying out a solvency test in relation to the insurance institution and in assessing the financial position. The following list of examples and items requiring attention is a non-exhaustive guideline with regard to the basic data are to be identified in the case of insurers or pension funds. Insurers: Correct and complete recording of agreements and claims data in the insurance administration, which includes: types of products and the number of policies per type of product/branch; insured risks and (where applicable) accompanying amounts; options in guarantees issued; the commencement date and the final date of the insurance or premium payments; the correct number of units or, alternatively, the correct savings balance in the case of unit-linked insurance; premiums and single premiums, and accompanying specifications; the date of birth and sex of the insured; disability percentages; data in relation to any administrative arrears; data in relation to reinsurance contracts: file-related provisions for reported claims (item-for-item reserves). The correct recording of technical insurance bases in the calculation systems including, for instance: mortality tables; disability and reactivity tables; interest rates; average amounts of claims. Relevant data for the capital adequacy test and solvency position including, for instance: cost allocation to products; run-off results for previous years per (sub)branch; payment triangulations; outcomes of empirical research carried out by the insurance institution (such as in relation to surrender frequencies, conversion into waiver of premium, company mortality, combined ratios); data in relation to the investment portfolio. Other data relevant to the assessment: 5

6 accounting data used in the analysis of the results. Pension funds: Correct and complete recording of agreements and claims data in the insurance administration, which includes: the number of members, former members and persons entitled to pensions; accrued pension entitlements, benefits/pension entitlements in payment and insured latent pension entitlements; date of birth of the member, the former member, the person entitled to a pension, the partner entitled to a pension, latent orphans; date of marriage/divorce; date of death; date of commencement of membership; retirement date; income data: salary; part-time percentage; percentage disability; income limits (AOW offset, maximum income, etc.). Correct recording of technical insurance bases in the calculation systems including, for instance: mortality tables; disability and reactivity tables; interest rates; indexation. Relevant data for the capital adequacy test and solvency position including, for instance: data on the investment portfolio. Other data relevant to the assessment: accounting data used in the analysis of the results. The point of departure is that the basic data identified have been audited with regard to their correctness and completeness. The above-mentioned basic data need not necessarily be assessed in all cases by the accountant. It is of particular importance for the auditor and accountant to agree on which basic data are relevant, whether the accountant or the actuary will include these in his or her assessment activities and the way in which this will be done. Agreements may be reached between the accountant and the actuary, which result in a different division of activities. The following is an example of this. The accrued entitlements are important in determining the provision for pension liabilities in the case of a pension fund. These are audited by the accountant in accordance with the agreements. In the case of certain pension plans, it is conceivable that not the entitlements themselves, but the data which are used to determine the entitlements are registered and that the applicable entitlement is also calculated when valuing the liability. In this case, the accountant and the actuary could agree that in such a situation the registered data constitute the basic data and that the actuary also pay attention to the determination of the entitlements as part of his or her activities. With regard to data pertaining to the investment portfolio, depending on the nature of the assessment, these may include, for instance, the actual value of the investment portfolio or aggregations based on categories of investments, the duration of the fixed-interest investments, and the degree to which the interest risk, currency risk, credit spread etc. are hedged. In general, it is not easy to determine what information is required. For this reason, it is important that the accountant and the actuary determine this in consultation with each other. 6

7 Annex 2: Materiality Section 12 of the modus operandi refers to coordination by the accountant and the actuary as part of drawing up their schedule of activities within the framework of auditing the financial information of an insurance institution. One of the topics referred to in this section is the materiality applied in this regard. Materiality is not an absolute figure which results directly from a calculation, but a conclusion resulting from a technical, professional assessment. The accountant and the actuary, on the basis of their own technical, professional assessment, may make a different assessment of what is deemed to be of material importance in a specific case. For this reason, it is important that the professionals involved exchange ideas on this when drawing up their schedule of activities. The code of professional conduct of the Dutch Actuarial Association does not contain specific guidance in relation to the concept of 'materiality' or 'material importance'. The code of professional conduct of Royal Nivra includes the following provisions in accounting standard 320 of the Further Regulations for Auditing and other standards with regard to the way in which the accountant (auditor) deals with the concept of material importance and its relation to the risks associated with auditing. "'Material importance' or 'materiality' is the "framework for drawing up and structuring the annual accounts" contained in the Guidelines for Annual Reporting and is defined as follows: "Information is material if the omission or misstatement of such information could affect the economic decisions which users make on the basis of the annual accounts. The materiality of the item or the error depends on the size of this item or error, assessed in the light of the exceptional circumstances in which the omission or misstatement occurs. The concept of 'materiality' therefore serves more as a threshold or critical boundary than as a primarily qualitative characteristic which information must possess in order to be useful." The auditor must take into account the possibility that misstatements of relatively limited size may have a cumulative effect on the financial statements which is of material importance. For instance, an error in a monthly closure of accounts may indicate a potential error of material importance if this error is repeated each month. The auditor assesses the material importance both at the level of the financial statements as a whole, and in relation to the transaction flows, items in the financial statement and parts of the notes to the financial statement. The material importance may also be affected by legal and other regulations in relation to transaction flows, items in the financial statement and part of the notes to the financial statement, as well as their mutual interrelationships. This process may result in various levels of material importance, depending on the aspect of the financial statement which is assessed. The International Financial Reporting Standards also include a similar definition of materiality. Opmerking [JRE1]: Ik heb geen officiële vertaling hiervan van de NIVRA kunnen vinden Within the framework of their cooperation, the actuary and the accountant discuss the qualitative factors which they deem important in determining the materiality which will be applied in auditing the respective institution. In this regard, the importance of the information is considered from the perspective of the various possible stakeholders. As the outcome of their consultation, the accountant and the actuary document how the concept of 'material' is defined by the respective institution and, where relevant, in relation to the separate elements of information comprising the financial reporting. This provides them with a basis for taking into account the information requirements of the other professional within the framework of their own activities and the evaluation of their findings. 7

8 Annex 3: Consultation within the framework of planning the schedule of activities Section 12 states that the accountant and the actuary, in planning their schedule of activities, consult each other with regard to the following topics: the outcomes of their initial risk analysis; the actuarially determined elements of information in relation to which certainty must be obtained; the proposed objective of and approach to the audit; the auditing methods to be applied during the audit; the materiality which will be applied in this regard; the basic data; the way in which the actuary will be informed by the accountant of the reliability of the basic data; the valuation policies and proposed amendments to these applied by the insurance institution; the planning of the activities and consultation in relation to each other s findings. The coordination will take place on the basis of a draft schedule of activities drawn up by the actuary and the accountant. The institution will be given the opportunity to be present when the coordination takes place. The discussion will focus on informing each other of the risk factors identified and the way in which the audit will be carried out. By discussing these elements, the accountant and the actuary can also take cognizance of expectations with regard to the activities which the other professional has and by doing so identify possible gaps in their combined approach in good time. This coordination is intended mainly to provide clarity with regard to the objectives and scope of the activities to be carried out by the accountant and the actuary. On the one hand, this ensures that activities are not carried out twice and, on the other hand, ensures that relevant auditing activities are omitted by both professionals. In the consultation, moreover, agreement can be reached in relation to specific areas requiring attention during the audits. On the basis of the coordination, in addition to agreements with regard to the concluding consultation, consideration will be given to reaching agreement on possible interim coordination or to determining what circumstances will give cause for interim coordination. It is advisable to make minutes of the meeting and for the parties to confirm the correctness of the minutes. Actuarially determined elements of information It is important that the accountant and the actuary have clarity with regard to the actuarially determined elements of information which are included in the financial information and in respect of which clarity must be obtained within the framework of certification. This includes identifying the insurance liability/pension liabilities which fall within the scope of actuarial certification. This also includes agreement with regard to which information should be included in the notes to the annual accounts and the certainty which must be obtained in relation to this information. This may include, for instance, the outcome of the capital adequacy test or the cost-effective premium, which may (or ought) to be included in the notes. Objective of and approach to the audit The accountant's activities in relation to the financial institution s financial reporting focus on issuing a declaration on whether the financial statements provide "a true and fair picture", in accordance with the applicable system of financial reporting. The key aspect in this regard is whether the financial statements comply with the applicable system of financial reporting in all respects of material importance. The actuary's activities focus on the issuing of a declaration from a legal perspective in relation to the technical provisions and, in the case of a pension fund, in relation to the financial position. With regard to the assessment of the provisions, the regulations governing the actuary's professional conduct provide the following guidance: The formulation of the assessment of the provision is based on the formulation stipulated in legislation relating to the assessment by the certifying actuary. In the case of pension funds, the actuary therefore declares that he or she has ascertained that the technical provision is adequate. The conclusion that the level of the technical insurance provisions, viewed in their totality, is "adequate" 8

9 must be interpreted as follows: the level of the provisions is such that on the basis of realistic assumptions, it may be characterised as prudent. In the case of insurers, on the basis of the legislative texts, this leads to the opinion that it has been ascertained that the provision is adequate. As appears from the Memorandum of Amendment during the introduction of the Financial Supervision Act, "adequate" means that the provision has been determined in accordance with the regulations in this regard, in accordance with or pursuant to the Financial Supervision Act (Part Technical provisions and related legislation and regulations). In this regard, it should also be noted that the qualification "prudent" would incorrectly suggest that the actuary is only required to base his or her opinion on the prudence of the technical provisions. Within the framework of this guidance note, the qualification "adequate" is also understood to include the qualification "correct and adequate". The qualification of the balance-sheet valuation of the insurance liabilities as "adequate" also does not exclude the qualification "over prudent". The bases for the adequacy test with regard to the insurance liabilities, however, may not be over prudent (according to the Regulations in Relation to the Solvency Margin and Technical Provisions of Insurers [Regeling solvabiliteitsmarge en technische voorzieningen verzekeraars]). As appears from the guidance note, the objectives of actuarial certification are not the same as the objectives of an accountant's audit in all cases and vice versa. It is therefore important that the accountant and the actuary consult each other about the objectives of the individual audits before all the activities commence, so that they can identify where they differ and to what extent. To optimise the use of each other's activities, on the basis of this analysis it will be possible to ascertain how this affects the proposed approach to the audit. Auditing methods to be used in the audit With regard to the auditing methods applied, it is possible to exchange ideas on the extent to which the audit should focus on the system or the data and to what extent the audit should rely on internal audits. The consultation will also have to pay attention to the scope of the activities planned. This may include, for instance: discussing what activities are carried out by the actuary in relation to his or her view of the solvency position, as this may be important, after all, for the accountant's assessment of any additional notes to the annual accounts; discussing the activities which are carried out in relation to the assessment of the adequacy of the liabilities and the activities which are carried out in relation to assessing the actuarial correctness of the provisions and the adequacy test which has been carried out; determining the accountant's auditing activities in relation to investment data used in carrying out the solvency test. Method of providing information on the reliability of the basic data On the basis of the actuarially determined elements of information identified, the accountant and the actuary will determine in consultation with each other what the basic data are of which the accountant will inform the actuary. The actuary will also inform the accountant of the other information which he or she may include in making his or her assessment, for instance in relation to the assessment of the institution's financial position. This enables the accountant to evaluate whether from his or her perspective this requires measures to be taken with regard to his or her audit. As part of the consultation, a decision will also be taken with regard to the way in which the accountant will provide the actuary with information on the reliability of the basic data. In practice, various forms are applied. In general, use is made of an assurance report. An assurance report contains a conclusion reached by the accountant in relation to the audit which has been carried out. In a number of specific cases, use is made of a report of the actual findings because, for instance, this bears a better relationship in some cases to the division of activities between the actuary and the accountant. The actuary must realise that a report such as this does not contain a conclusion but reports on the findings of the activities coordinated beforehand. On the basis of this report, the actuary will have to draw his or her own conclusion as to whether the certainty required has been obtained. The accountant will also, in turn, have to determine whether the division of activities adhered to does not result in an 9

10 inadequate basis for a final assessment of the institution's reporting. In consultation with each other, a decision will be taken as to how an adequate basis can be guaranteed. Valuation policies and proposed amendments to these There may be a direct interrelationship between the valuation of the liabilities and that of other assets and liabilities. In this regard, it is important that the policies applied are discussed by the actuary and the consultant and that the effects of proposed amendments are evaluated. In coordinating the valuation policies applied by the insurance institution and any amendments to these, a discussion may also include the headings under which the liabilities are aggregated and the way in which the insurance institution explains the recognised liabilities in the annual accounts Planning the activities and consultation about each other's findings To guarantee the quality of the assessment and the efficiency of the cooperation process, it is important to reach agreement on the planning of the activities. In addition, it is relevant to reach agreement on a final consultation and on the interim coordination. Finally, the desirability of involving the insurance institution in certain discussions may be discussed. 10

11 Annex 4: Consultation on the conclusions and exchange of information The modus operandi stipulates that the accountant and the actuary will inform each other of their findings and conclusions. The point of departure for the consultation is that the accountant and the actuary have consulted the financial institution with regard to their findings of the audit, with regard to the factual correctness of these findings. In the consultation the focus will be on the exchange of these findings and discussing how particular findings effect the assessment. The effect of the findings on the assessment of the other professional could also be discussed. It is recommended that the insurance institution be given the opportunity to attend this meeting. Opmerking [JRE2]: Evt method of operation in alle gevallen. The final coordination of the findings should preferably take place on the basis of draft reports by the accountant (auditor) and the actuary. The concept of a 'technical analysis" must be interpreted broadly and may include, for instance, an analysis of the results, an analysis of the development (of the adequacy) of the liabilities, claims ratios et cetera. It is advisable to make minutes of the meeting and for the parties to confirm the correctness of the minutes. 11