Best practices for captive audit preparation

We all know that death and taxes are inevitable, but captive owners face another unnerving inevitability: their annual audit. Regulators mandate an annual Generally Accepted Accounting Practice (GAAP) audit for captive insurers established in their domiciles. 

Corporate audits are nothing new. The regular reviews of company financials ensure that investors, lenders and other parties can trust what the company says about its finances. But while traditional external audits are about protecting those outsiders, a captive audit is about protecting the organisation that operates the captive.

Captive audits are focused on verifying the solvency of the captive insurer. The auditors make sure the captive is meeting its minimum capital requirements and has adequate internal controls in place. It is more than a matter of just checking off the boxes: in addition to general oversight and reviews of the captive’s financial performance, auditors will perform testing on claims to verify that the amount and process of handling the claim(s) followed were in accordance with the plan. 

They will check to see that the captive has all the documentation required by the regulators and confirm that board meetings have been properly held, with minutes recorded. 

Other types of documentation to be reviewed include executed contracts and agreements, as well as conflict of interest and code of ethics statements.

Captive audits are typically conducted by Certified Public Accountant (CPA) firms that have earned the approval of the domicile. When a captive is being audited, a good captive management team works as a liaison between the captive, its owner and the CPA firm performing the audit. They typically submit the information requested by the auditors, which may include completing questionnaires or scheduling interviews of key stakeholders with the auditors. Once the audit has been completed, they will report the findings and any recommendations to the company’s board of directors.

The ideal model for overseeing and coordinating the audit process is designed to incorporate the best practices that a captive management team has learned through working with a variety of captive types and domiciles. These practices ensure timely compliance with regulatory requirements, and once they become embedded into the captive owner’s operations, they allow the audit process to proceed quickly and efficiently, year after year. 

With any type of audit, preparation is the key to meeting deadlines with less stress. It is essential to ensure that all the correct information is available to the auditor’s team early enough to allow sufficient time for the audit so it can be completed before the desired due date.

In some cases, that due date is based on direction from the domicile’s regulators, but much of the time, it is driven by the parent company’s overall audit. That is because the captive represents a significant investment by that company and its books need to reflect an accurate depiction of the captive and its financial health. If the captive audit must be completed before the parent company’s overall audit may proceed, scheduling becomes especially critical.

Plan early 

The best approach is to begin planning for the audit during the last quarter of the current fiscal year. The previous year’s audit provides the basis for the information needed to gather and submit. Once everything that is needed has been identified, a captive management team should work with their client to identify who will be responsible for obtaining and preparing information. 

“In smaller organisations it is not unusual for the entire board to act as the de facto audit committee.” Dawn Dinardo, Hylant

This process allows for determining the best way to allocate resources to address the additional workload, while navigating around any competing deadlines. It also makes it easier to monitor the audit preparation process and spot any issues before they threaten the timely completion.

Knowing that the audit team will expect to interview directors and other key stakeholders as part of their effort to verify the efficacy of oversight items (primarily the existence and awareness of processes and procedures to prevent fraud), the captive management team should brief the client on the questions they can expect and provide accurate answers to those questions. In most cases these interviews will target the board’s audit committee. In smaller organisations it is not unusual for the entire board to act as the de facto audit committee, so be sure that all directors are familiar and comfortable with this information.

Next, confirm that all executed agreements, engagement documents and conflict of interest or code of ethics attestations from the directors, officers and managers are on file and may be accessed by the auditor if necessary. Similarly, verify that all final drafts of minutes for the current year have been completed and any prior meeting minutes that may be needed have been executed. In addition, be sure to check that any committee duties and responsibilities are clearly defined and documented.

Teamwork

A good captive management team will verify that all bank reconciliations associated with the captive have been properly completed and executed, as have any of the checklists. If a captive participates in a reinsurance programme, ongoing reconciliations with the reinsurance fronting carrier on premium dollars that have been invested into the captive and claims that have been paid up through the end of third quarter will ensure the programme is in balance. 

That allows for heading off any potential issues regarding confirmations and ensuring everything is submitted to the auditor in a timely fashion. If the previous audit identified any misstatements or exceptions, be sure to double-check that those areas have been buttoned up and recorded properly so the auditor can approve them without exceptions. 

Internal controls are always a central element of audits. Before everything goes to the audit team, be sure to review those controls to verify they align with the company’s policies and procedures, and confirm that those policies and procedures, as well as any relevant operations manuals, have been properly documented. For companies that are expected to perform SOC 1 (system and organisation controls) reporting to meet legal or contractual requirements, be sure to use what is detailed in that report as the framework for management to follow and ensure that actual activities reflect what has been presented.

A thorough process

Deadline dates for these items and many more will be generated and compiled into an overall calendar that will guide the timing of the process and ensure that each item is properly completed. 

Executives who are completely accustomed to the annual audit process for their companies are often surprised by the additional scrutiny and checks and balances involved with an audit of a captive. Audits of insurance companies typically involve far more testing and time than the typical corporate audit. As an example, a good captive manager has to work not only with the company’s bankers to confirm account balances, but they are also usually required to send confirmations to legal firms, investment companies, reinsurance companies and the fronting carrier to ensure that what their records show mirrors what’s on the client’s books. 

While that complexity may seem to be a nuisance to some executives, there is value in the thorough captive audit process because it confirms the captive has been properly structured and funded and that it is being managed in ways that ensure it meets the parent company’s objectives. As companies become accustomed to the audit process, this level of preparation becomes a normal business process, the client’s team organises information accordingly and everyone encounters fewer complications. 

Most of all, the process keeps the captive functioning effectively, year after year and audit after audit.

• Captive audit planning checklist
• Plan ahead to perform audit prep in fourth quarter of current fiscal year.
• Be aware of deadlines for parent company audits.
• Set a timeline and plan for additional workload.
• Use prior-year audit as framework for submissions.
• Allocate resources and responsibilities to team members.
• Brief board/stakeholders on auditor interview questions.
• Confirm corrections to any prior-year misstatements or audit entries.
• Verify premiums and claims are in balance with fronting carrier.
• Prepare confirmations as early as possible for submissions to auditors.
• Ensure all executed agreements, engagements, consents, conflict of interest or code of ethics attestations from board managers/directors and officers are on file.
• Confirm final drafts of minutes for current year are complete and all prior meeting minutes have been executed.
• Ensure bank reconciliations and any checklists have been completed and executed.
• Review to ensure internal controls are in place and align with policies/procedures.
• Document policies, procedures and operations manual.
• Document committee duties and responsibilities.
• Add all deadlines and scheduling to calendar.

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