Responding to Investments Commonly Encountered in an Employee Benefit Plan. Tricia A. Van Vliet, CPA Elliott Group CPAs, PLLC

Transcription

1 Responding to Investments Commonly Encountered in an Employee Benefit Plan Tricia A. Van Vliet, CPA Elliott Group CPAs, PLLC

2 The Game Plan Warming up with an overview of plan investments Playing by the rules know your position as plan auditor Anticipate the most common lineup of plan investments Situational Drills avoiding common auditor pitfalls 2

3 A Good Warm-up Overview of plan investments Plan investment portfolios continue to evolve with increased diversity & complexity but today we will focus on the most common investments you can expect to encounter Registered Investment Company Shares Common Stock Preferred stocks Bonds Insurance Company Guaranteed Contracts Swaps Collective Investment Funds Unitized Stock Funds Exchange Traded Funds Separately Managed Accounts Real Estate Funds & Partnerships Private Equity Funds Hedge Funds Insurance Company Pooled Separate Accounts Futures Funds of Funds Venture Capital Funds Commodity Funds Offshore funding vehicles Etc., etc., etc. 3

4 A Good Warm-up (continued) Proper planning and asking the right questions Funding vehicles vs. holdings (what does the plan own)? Who are the significant third party service providers? Who is responsible for custody / safekeeping of investments? How are investments valued? 4

5 Playing by the Rules Know your position example auditor vs. plan management responsibilities Management Auditor Establishing appropriate internal control; including monitoring & challenging of third party pricing services Determination of audit strategy based upon engagement scope and risk assessment; NO LIMITED SCOPE AUDIT BLINDERS Valuation and disclosure in accordance with applicable standards; including leveling within FV hierarchy Demonstrate comprehension of plan investments; Assess form & content of disclosures & conclude regarding adequacy in accordance with GAAP Assessment of trustee / custodian and plan filing requirements to determine scope of audit to properly engage independent auditor Understand management s process for fair value reporting & disclosure; assess management s knowledge, methodologies & assumptions 5

6 Playing by the Rules (continued) Limited vs. Full Scope Investment Procedures Limited Scope Audit Overview Certification Considerations Certifying entity bank, insurance company or trust company Custody & hold plan assets Execution of plan investments Certify completeness & accuracy; beware of qualifying language; entity s letterhead & manually signed by authorized personnel Responsibilities Obtain & read certification Agree certified investment information to information in the plan s financial statements, disclosures & schedules Assess form & content of investment information in financial statements, disclosures & schedules No need to audit certified investment information unless something comes to the auditor s attention Investment Information ONLY Although included in the statements certified by the qualified entity, limited scope exemption applies only to investments; all other audit areas (contributions, distributions, eligibility, etc.) are subject to full scope audit in accordance with applicable professional standards 6

7 Playing by the Rules (continued) Limited vs. Full Scope Investment Procedures Full Scope Audit Overview Internal Controls Design & implementation of significant controls Controls within the plan sponsor organization Controls within service organizations that handle investments & investment transactions, including valuation/pricing Tests of investments held, transactions & income Investment purchases & sales/redemptions Confirmation of existence Computation & recording of investment income (interest, dividends, realized & unrealized gains/losses) Investment fair valuation; use of management s or auditor s expert where necessary for Level 2 & 3 investments Presentation & Disclosure Review of subsequent events & transactions Impairment considerations Evaluation of presentation & disclosure in accordance with applicable standards 7

8 Anticipating the Most Common Plan Investment Lineup Registered Investment Company Shares (i.e., mutual funds) Bank common collective investment funds Insurance company separate account products Insurance company guaranteed investment products 8

9 Anticipating the Most Common Plan Investment Lineup (continued) Mutual Fund Characteristics Registered with & periodic reporting to the SEC Generally traded on a national exchange A professionally managed, collective investment scheme that pools money from many investors Periodic filing with the SEC; annual audited & semi-annual unaudited Daily net asset value per share published Established investment objectives for the fund 9

10 Anticipating the Most Common Plan Investment Lineup (continued) Bank Collective Fund Characteristics Must comply with IRC & meet ERISA requirements Not traded on a national exchange Common trust fund or collective investment funds A bankadministered trust that holds commingled plan assets Generally require audited financial statements Bank acts as fiduciary for fund & holds legal title to assets Resembles a mutual fund, but is not registered with the SEC 10

11 Anticipating the Most Common Plan Investment Lineup (continued) Insurance Company Separate Account Characteristics Not a distinct legal entity No audit requirement Not traded on a national exchange Variety of products offered by insurance companies Not publicly traded Insulated arrangements legally protect assets from general claims of creditors of insurance company Non-insulated arrangements do not protect assets in event of insurance company insolvency 11

12 Anticipating the Most Common Plan Investment Lineup (continued) Variable Separate Accounts Pool of assets Operate similar to mutual fund at investment level Contract-holder generally assumes investment risk (insurance may assume certain mortality & expense risk for a fee) Insurance company receives fee for investment management & certain admin expenses Ownership expressed as units Unit value fluctuates based on changes in value of underlying investments Cash flow in/out of Separate Account changes the number of units (but not unit value) Unit value assigned when the account is established Unit value also affected by dividends, capital gain distributions from & any impairment of the underlying investments 12

13 Anticipating the Most Common Plan Investment Lineup (continued) Fixed Return Separate Accounts Operate similarly to contracts backed by fixed rate General Account Some types provide for insulation, but if separate account assets exceed liabilities, they are owned by the General Account (i.e., insurance company) Synthetic GIC type arrangements are not insulated Plan may lose or gain more on the underlying investments than the rate credited to the plan participants & will need to lower or raise crediting rates to the participants based on the return of the underlying assets 13

14 Anticipating the Most Common Plan Investment Lineup (continued) Guaranteed Separate Accounts Guaranteed annuity product Assets that support the guarantees made under the contract are held in a Separate Account Contract-holders do not own units of the Separate Account Contract holders own a guarantee by insurance company of payment (similar to GICs or Evergreen GICs) Guarantee may have a secondary support from the insurer s general account if Separate Account assets are not sufficient Deposits from multiple plans may be comingled in a Separate Account 14

15 Anticipating the Most Common Plan Investment Lineup (continued) Separate Account GICs Guarantees supported by insurance company Separate Accounts, which own the underlying investments Generally provides for guaranteed crediting rates & a minimum floor crediting rate Contract value = sum of deposits to the contract withdrawals + interest at the net crediting rates in effect over time Crediting rates are influenced by actual performance of assets in Separate Account & actual plan & participant cash flow experience Structure greatly reduces general account credit risk but does not entirely eliminate it 15

16 Anticipating the Most Common Plan Investment Lineup (continued) Synthetic GIC Plan owns the underlying assets Also known as wrap contracts; stabilizes investment return (simulates performance of a traditional GIC) Generally, payments are made from the assets of the underlying fund Contract not required to pay until the fund it wraps runs out of assets or liquidity Crediting rates are determined by a formula Fees typically deducted from the gross crediting rate Value of the wrapper is the difference between the assets underlying the GIC and the value of the principal plus the guaranteed interest 16

17 Anticipating the Most Common Plan Investment Lineup (continued) Insurance Company Guaranteed Account Characteristics Plan holds a contract Insurance company s credit rating is key consideration Variety of contracts offered by insurance companies Contract backed by general assets of insurance company Contract satisfaction dependent upon insurance company s ability to pay 17

18 Anticipating the Most Common Plan Investment Lineup (continued) GIC Provides a guaranteed return on principal Plan owns the contract Individually negotiated terms specific to that plan Benefit responsive vs. non-benefit responsive Benefit responsive ability to transact at book value (principal + accrued interest); compliance with all criteria of standard necessary; evaluate on an individual contract basis Evergreen May be issued as individual or group contracts Allows reallocation under contract, but imposes limitations on plan s ability to remove amounts from guaranteed portion of contract Offers a guaranteed rate for a set period No specified maturity date; only specified interest crediting rate reset dates Contracts continue in-force until termination 18

19 Anticipating the Most Common Plan Investment Lineup (continued) DA Contributions applied to future participant benefits Resembles a money market account Promised rate of return (no specified benefit) No guarantee of sufficient funds to pay future annuities May or may not pay experience-rated dividends Most commonly used to fund defined benefit plans IPG Variation of a DA Contract Commonly used to fund defined benefit plans Two typical forms of contracts: Annuity purchased at retirement Pension payments made without purchase of annuity Hybrid DB Variation of IPG contract Commonly used to fund defined benefit plans Gives contract-holder more control over how assets supporting the income guarantees will be invested 19

20 Avoiding Common Auditor Pitfalls Changes in a client s portfolio Client overreliance on third party service providers Watching out for red flags and remembering your role as auditor Client requests that may indicate they need you to determine fair value measurements and/or appropriate leveling of investments within the fair value hierarchy Full Scope Price Testing - Identifying and investigating variances outside of an expected range 20

21 Avoiding Common Auditor Pitfalls (continued) Bank Collective Investment Funds Mutual Funds Unit Value Share Price/NAVPS Unit Value Portfolio holdings; generally marketable securities, but may invest in other collective investment funds or mutual funds No quoted market price; often valued daily to allow for daily purchases & sales Portfolio holdings Generally quoted market price; close of exchange Insurance Company Separate Account Products Portfolio holdings; may hold a single mutual fund or numerous securities No quoted market price Held in separate trust Held in separate trust An asset/liability of the insurance company Audited financial statements generally available Audited financial statements required to be filed with SEC & made publicly available May have audited financial statements; often unaudited 21

22 Understand Question Corroborate Avoiding Common Auditor Pitfalls (continued) Lack of Appropriate Professional Skepticism Set Expectations Challenge Conclude Document ALL of the above! 22

23 Avoiding Common Auditor Pitfalls (continued) The dreaded L Word Leveling within the fair value hierarchy Management s Policies Continue to evolve Avoid simply being thankful that one exists Looking for reasonable expectations rather than rules by investment category The Level 3 saga continues Debt Securities Resist the just bonds trap Biggest culprit for misclassification Found at Level 1, 2 and 3 Trading in exact security is less likely than you want to assume Most priced by 3 rd party pricing vendors use models that reflect Level 2 inputs 23

24 Avoiding Common Auditor Pitfalls (continued) Overreliance on service organization SOC 1 Reports Read entire report Understand what is covered vs. what you want or expect to be covered Look for and consider information that may contradict other evidence in your working papers 24

25 Put Me In Coach I m Ready to Play Game Time Decisions Made Easier Timing Confidence Knowledge Understanding Armed with the right questions Using All Available Resources 25

26 Questions 26

27 Tricia A Van Vliet, CPA Elliott Group CPAs, PLLC (616) tvanvliet@elliottgrouppllc.com 27