We’re often asked, “Why do you have an insurance audit performed on your clients’ captives every year? It’s an added expense.” Our firm specializes in creating and managing captive insurance programs for “middle market” clients.
Yes, we do have an annual insurance audit performed for each and every one of our clients, and here’s why:
As managers, it’s our fiduciary responsibility. Simple as that: it’s the right thing to do.
All of our captive insurance programs make money. In these times of financial instability, our captive insurance and risk retention group owners are doing everything they know how to maintain profitable businesses, and their insurance structures are an added profit center. When our business owners go to their financial institutions for whatever financial transaction they’re making, that audited financial statement is just another financial tool that supports their businesses.
Many of our clients have health care-related businesses. They don’t just have IRS concerns. They don’t have just cash flow concerns. They receive Federal and State reimbursements and they have Medicare/Medicaid concerns. If their reimbursements are questioned, all reimbursements stop until the question is resolved. These clients cannot afford to have their insurance expenses called into question during an insurance audit. Their audited financial statements go one step further in validating their insurance company and protecting their reimbursements.
Insurance audits are primarily functions and procedures reviews. Although, they are beginning to look more and more like forensic audits due to the 2009 implementation of the International Financial Reporting Standards (IFRS) for Small- and Medium-sized Entities (SME). While these standards are less rigorous than those for public companies, their details become more and more time consuming. For example, it isn’t enough to supply confirmation from financial institutions with electronic or faxed signatures. All confirmations must be original signatures. We keep a receipt, of course! In this electronic age cyber risks cannot be ignored.
One of the primary functions of the IFRS during an insurance audit is to ascertain that the insurance structure is, in fact, an insurance vehicle and not just an investment tool. While this may be critical for the 831(b) rulings for small insurance companies, our clients are just as concerned about their insurance benefits as they are about the financial implications. The two are not separable.
In keeping with our fiduciary responsibilities as a manager, IFRS for SME requires all payments from the captive insurance program must be supported by a contract or approved invoice. As simple and straight-forward as this requirement appears, all our phone conversations must be documented by a follow-up e-mail, all our meeting notes must be approved by our clients, and everything must be verifiable. It’s as cumbersome for clients as for accounting departments.
Captive Insurance Investment Management
One of the biggest impacts for our clients is captive insurance investment management. While off shore venues tend to have broad guidelines for investments, the IFRS puts the captive manager in the spot of second-guessing its investment adviser by requiring additional verification of the values of investments held. Managers are responsible for ascertaining that the methods used to attribute a value to the securities are appropriate and reflect the fair value. So where in the past we relied on the professional expertise of our captive insurance program’s investment advisers and their monthly statements to account for our clients’ investments, we must now go to a third party source and validate our advisers’ work, not just on a monthly basis, but also at year end. We must know which sources our advisers’ used for valuation and find another pricing source to corroborate that for each security held. The expectation is that we, as managers, know that investments are properly measured and carried on the books.
TPAs and Actuaries
This oversight activity is not limited to investment advisers. Third Party Administrators and Actuaries are also meant to adhere to more rigorous standards for insurance audits. Managers are encouraged to use TPA’s who also have internal controls audits performed regularly. TPA’s are requested to confirm the details in their files of loss expenses paid, expenses payable, reserves and reserving methods, etc.
TPA’s work closely with Actuaries and it’s the Actuaries’ responsibility to take premium and loss data and make professional evaluations as to what the final payments and payout patterns will be based on mathematical probabilities. It’s a manager’s responsibility to make sure that the actuaries are licensed and that they specialize in the line or lines of coverage of the structure being audited. While this statistical process is a couple hundred years old and certain lines are more predictable than others, it’s still a professional estimation. When an actuarial firm submits a range of reserves from most aggressive to most conservative, auditors require written statements from captive owners as to why they might have chosen any number but the mid-point. There are as many reasons for maintaining a reserve number as there are for owners to decide to form a captive.
These meticulous procedures are intended to add value to the audit and ferret out unscrupulous managers and their clients. We, as managers, have every intention of providing a business solution that supports our clients’ risk transfer needs and improves the ability of those clients to maximize their company’s profits.