Advisor rotation

This article is about whether audit and actuary rotation need to be items on a CRO’s agenda

Most insurance organisations have had the same auditing firm for many years. Very few audits are actually put out to tender. As far as we can tell, in only 3 countries is there a mandatory requirement to change auditors. Whilst there are good reasons to retain the existing firm, there is the risk that something important may be being missed which a fresh pair of eyes may identify. A similar argument may be made for third party actuarial advisors, as many companies often use the same firm for many years.

Why now?

Three factors make this something we believe CROs should be looking at seriously:

  • Solvency II, whenever it comes into law, has put the role and status of important outsource and other external providers on regulator’s agendas. This means that this aspect of firms’ governance could attract attention.
  • Lloyd’s, always in the vanguard of insurance industry developments, has suggested that it expects the boards of firms it oversees to show that they have considered every five years whether they should change the actuary providing their Statements of Actuarial Opinion (but possibly within the same firm). Expect others to follow suit.
  • Audit rotation (or an absence of it) has attracted increasing amounts of media coverage over the last few years, particularly following the banking crisis.

Who cares?

In the classic three lines of defence model, external audit forms part of the 3rd line of independent assurance (with the first line covering the application of risk management within business units, and the second line providing risk control and oversight). By contrast, the actuarial role is probably closer to the 2nd line of defence, although the position is not always clear-cut where actuaries work alongside statutory auditors.

Specifically the risk for the CRO to consider is that these elements of the 2nd and 3rd lines of defence do not work effectively.

Typically, the burden of selecting suitable actuaries and auditors has fallen squarely, although not universally, within the Chief Financial Officer’s remit. As the most significant stakeholder in the performance of external advisors, this is fair enough, however in our opinion, it should also be part of the Chief Risk Officer’s responsibility to provide effective challenge, and show that at least different options have been considered. This can be achieved by means of a recommendation each year made to the audit committee weighing up the advantages and drawbacks of change. This could involve a regular staged rotation of auditors and actuaries which would avoid excess disruption through a wholesale change in advisors.

What are the key arguments to include?

Here is our cheat-sheet with some key points for inclusion in an audit committee paper.

Arguments for change

A “fresh pair of eyes” – some evidence exists that suggests this can often identify weak accounting controls.

New perspectives avoid the peril of anchoring – it is potentially harder for an incumbent actuary to make the case for an early reassessment of an emerging issue.

A change can bring new ideas on how internal-control deficiencies or risks can be mitigated to the benefit of corporate boards, audit committees, and management.

Increased competition – as rotation becomes a wider market practice: quality, diversity and price-competition of external advisors will develop.

Avoid isolation – often problems arise in those firms where management and advisors have worked together over an extended period, with insufficient exposure to what competitors are doing. As we have seen, this risk blights firms and advisors large and small.

Arguments against change

Loss of corporate memory – there is the risk of a potential loss of knowledge built up by auditor and actuary over time. While this could be mitigated by hand-over processes, there will be an inevitable frictional loss arising.

The ministerial problem – Just as with ministers and civil servants, often a long relationship is the best way to keep management under control. Frequent advisor rotation can lead to an increased risk of fraud as new advisors get to grips with the firm.

Disruption and cost – The changeover period and subsequent on-boarding process will distract management and audit committees, and introduce costs as firms and advisors develop new systems and processes.

Better the devil you know. Not all auditing firms have the same level of relevant expertise or skill.