The Financial Reporting Council found, among other things, that BDO relied on the opinions of independent actuaries without taking sufficient steps to evaluate their work.
The Financial Reporting Council (FRC), which sets U.K. accounting and actuarial standards and conducts independent enforcement of accountants and actuaries, has fined BDO LLP 200,000 pounds and reprimanded one of its partners for their work on the fiscal 2014 and 2015 audits of AmTrust Europe (AEL). The FRC found a failure in documentation for the 2014 audit, and three separate breaches of accounting standards in the work on the 2015 audit.
In determining sanctions for BDO and its partner, the FRC took into consideration the partial admissions made by both parties with respect to the charges. The FRC also noted their good compliance records and disciplinary histories.
AEL is an insurance company with multiple lines of business across Europe, Asia-Pacific, and Canada. Its primary underwriting activities are in the areas of medical malpractice, legal expenses, special risks and warranty, and property and casualty. BDO served as AEL’s auditor from 2007 through 2015.
In its decision notice, the FRC noted that in 2014 and 2015 AEL’s most significant line of business was medical malpractice insurance for certain Italian hospitals. The technical provision for outstanding claims was the largest balance sheet item in AEL’s FY2014 and FY2015 financial statements.
2014 audit. The FRC’s adverse findings for the 2014 audit relate to the approach of AEL’s management to setting the technical provision for outstanding medical malpractice claims. Specifically, the FRC took issue with the documentation surrounding management’s compliance with the Association of British Insurers’ statement of recommended practice on accounting for insurance business (the ABI statement).
The BDO partner concluded based on an exchange of emails with independent actuarial experts that AEL had complied with the ABI statement. However, the email exchange was not placed in the audit file, and the evidence documented in the file did not record how BDO had considered whether (in light of the independent expert’s comments) the ABI statement had been complied with and how the auditor had reached a conclusion on that matter.
As a result, the FRC concluded that BDO and its partner failed to prepare adequate audit documentation recording a significant matter arising during the audit, the conclusion reached thereon, and significant professional judgment made in reaching that conclusion.
2015 audit. With respect to the fiscal 2015 audit, the FRC found breaches in three areas of audit work on provision for claims: the use of independent actuaries as auditor’s experts; the testing of management’s accounting estimate and the data on which it was based; and the evaluation of the method of measurement used by management.
The FRC said that in the 2015 audit, the pricing of medical malpractice insurance was of importance to AEL’s estimation of ultimate loss ratios and eventual setting of the provision for medical malpractice claims liability. The medical malpractice pricing index had an effect on three of the four alternative models considered by AEL in its estimation of ultimate loss ratios and, therefore, was an input into one of management’s significant accounting estimates, according to the FRC. However, the FRC found that neither the independent actuarial expert nor BDO and its partner in their audit work gave any detailed consideration to the pricing index or the data and assumptions on which it was based.
The FRC concluded that BDO failed to design and perform audit procedures that were appropriate in the circumstances for the purpose of obtaining sufficient appropriate audit evidence in relation to one of management’s significant accounting estimates by not directly testing the medical malpractice index. It also determined that BDO failed to test adequately how management made the accounting estimate and the data on which it was based or adequately to evaluate whether the method of measurement used was appropriate in the circumstances.
The FRC further determined that BDO failed, in relation to the pricing index, to make a sufficient evaluation of the adequacy of the auditor’s expert’s work by verifying the relevance, completeness, and accuracy of the source data used by the expert. The FRC added that BDO failed to prepare adequate audit documentation surrounding the decision not to perform any substantive work directly on the medical malpractice pricing index.
The enforcement action also was based on BDO’s inadequate communication with the independent actuarial expert. The FRC noted that BDO’s communication with the expert, following receipt of its draft report, was limited to a single brief telephone conversation, which was not documented. The FRC concluded, therefore, that BDO failed to hold discussions with the expert that were adequate for the purpose of gaining an understanding of the opinions of the expert as to whether management had appropriately applied the requirements of the applicable financial reporting framework relevant to the accounting estimate and whether management’s methods in making those estimates were appropriate and had been applied consistently.
BDO sanctions. In a related news release, the FRC outlined the sanctions against BDO. The firm was fined 200,000 pounds, but the FRC discounted it to 160,000 for admissions made by BDO. The firm was reprimanded and will be required to implement an appropriate training program designed to improve quality and consistency in the firm’s processes for obtaining and evaluating independent actuarial audit evidence, and in the documentation of those processes and of auditors’ key judgements.
The FRC said that, for a period of two years from the decision date, BDO must undertake a quality performance review of the work relating to obtaining and evaluating actuarial audit evidence from independent actuaries as auditor’s experts. The firm must report the results annually to the FRC.
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