Session 607 Plan Audits

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Session 607 Plan Audits

• March 28,2006
• Presented by
• Bob Rietz and Art Conat

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Agenda

• Sarbanes-Oxley Act and 404 Audits
• Evolution of audit services
• SAS 73
• SEC and Assumptions
• Auditors and Materiality
• Letter to ABCD - Contingencies Article
• Case Studies

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Financial Statement Assertions

• Completeness
• Rights and obligations
• Existence (assets and liabilities)
• Occurrence (transaction)
• Valuation or measurement
• Presentation and disclosure

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Sarbanes-Oxley Act Section 404

An assessment of the effectiveness of internal
control over financial reporting must be
supported by evidential matter, including
documentation, regarding both the design of
internal controls and the testing processes.
This evidential matter should provide reasonable
support for the evaluation of whether the
control is designed to prevent or detect material
misstatements or omissions for the conclusion
that the tests were appropriately planned and
performed and that the results were
appropriately considered.
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Annual Audits

• Financial audit (traditional)
• Reasonableness of financial results
• 404 audit (Sarbanes-Oxley)
• Control environment
• Tone from the top
• Processes
• Transactions focus
• Movement through companys information system

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Companys Control Environment

• Managements integrity, ethics and behavior
• Control consciousness and operating style
• Commitment to competence
• Board of directors participation in governance
  and oversight
• Organizational structure
• Assignment of responsibility and authority
• Human resource policies and practices

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Companys Processes

• Ensure companys processes provide reasonable
  assurances
• Transactions are properly authorized
• Assets are safeguarded against unauthorized or
  improper use
• Transactions are properly recorded and reported
• Sufficiency of documentation

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Considerations and Documentationof Estimation
Transactions

• Data used to make estimate
• Relevant factors and assumptions used
• Techniques employed
• Collection and aggregation of data
• Frequency of the estimation
• Degree of subjectivity involved
• Qualifications of the personnel making the
  estimate

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SAS 73Using the Work of Specialist

• Auditors are not expected to be experts in all
  areas
• Auditor may encounter material matters which are
  complex or subjective
• An auditor may use the work of a specialist
  engaged by management as evidential matter to
  evaluate financial statement assertions

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SEC View of Reliance on Specialists
Lynn Turner, Chief Accountant, SEC, May
2001 Auditors must do more than merely agree the
numbers in the actuarial reports to the financial
statements and related footnotes. Auditors should
evaluate the qualifications of the actuary and
rigorously challenge the assumptions and methods
used in calculating the numbers included in the
financial statements.
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Auditors Decision to Use a Specialist

• Experience of the specialist
• Certification or recognition of competence
• Reputation amongst peers
• Objectives and scope of the work
• Relationship of the specialist to the client
• Specialist needs to be responsible for
  appropriateness and reasonableness of methods and
  assumptions

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When Using SAS 73, An Auditor

• Obtains an understanding of the methods and
  assumptions
• Tests the data used
• Evaluates whether the assertions are
  appropriately supported
• May employ another specialist for assistance or
  to perform additional tests

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Application of SAS 73 to FAS 87, 88, 112, 106
and 132(R)

• Actuarial credentials of report signatories
• Affirmative statement of
• Qualification Standards of American Academy of
  Actuaries to provide actuarial opinions on
  subject matter
• Compliance with applicable accounting standard
• Opinion on assumptions and methods

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An Actuarys Role in an Accounting Firm

• Employed by the auditor
• Maintains a focus in a particular area
  (retirement plan accounting)
• Becomes a part of a clients audit team
• Maintains a healthy skepticism
• Utilizes specialized knowledge
• Documents approach and results

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Actuarial Standards of Practice

• Apply to certain members of actuarial
  organizations including
• American Academy of Actuaries
• Society of Actuaries
• Conference of Consulting Actuaries
• Casualty Actuarial Society
• American Society of Pension Actuaries

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ASOP 27 Selection of Economic Assumptions

• Guides actuaries in selecting economic
  assumptions for defined benefit pension plans
• Does not apply when an assumption is mandated
  (called a prescribed assumption)
• Actuaries obligated to use prescribed assumptions
• Actuarys communication should state the source
  of any prescribed assumptions
• FAS 87 and 106 assumptions are prescribed

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ASOP 35 Selection of Noneconomic Assumptions

• Guides actuaries in selecting noneconomic
  assumptions for defined benefit pension plans
• Does not apply when an assumption is mandated
  (called a prescribed assumption)
• Actuaries obligated to use prescribed assumptions
• Actuarys communication should state the source
  of any prescribed assumptions
• FAS 87 and 106 assumptions are prescribed

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The Critical Link

• SAS 73 states that the assumptions need to be the
  responsibility of the specialist
• ASOPs 27 and 35 identify that FAS 87 and 106
  assumptions are prescribed by the client
• Thus, the actuary is not responsible for FAS 87
  and 106 assumptions and there is not complete SAS
  73 reliance

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Financial Audit Concern

• The plan sponsor has selected the assumptions
  used to disclose its retirement plans
• The assumptions may have significant financial
  impact on the plan sponsors financial statements
• The plan sponsor has a vested interest in the
  assumption selection

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Without SAS 73 Reliance

• Evaluation of the findings must be more detailed
• Assumptions must be evaluated
• Results should be reasonable and follow from the
  data
• May verify the results using someone with
  familiarity with the subject matter

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Scott Taub, Deputy Chief AccountantMay 27, 2004
Presentation at USC

• rates being used are higher than the Aa bond
  index rate by between ¼ and ½ percent.
• Not necessarily a problem, if the registrant
  can support its assumed discount rate in some
  other manner.
• For example, by constructing a hypothetical
  portfolio of high quality instruments that mirror
  the pension obligation.
• These are insufficient responses.
• Reliance on actuarys advice
• Rates used by other registrants

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Jane Poulin, SEC Associate Chief Accountant,
December 6, 2004
We suspect that some plan valuations may be
based on 20 year old mortality tables, even
though more recent tables are available. In
addition to using the most recent tables, its
important that the mortality table used in
benefit plan computations be reflective of the
employee base covered under the plan.
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1983 Group Annuity Mortality Table

• Required by the IRS for certain minimum funding
  calculations
• IRS and SEC have different objectives and serve
  different constituencies
• Based on mortality experience of five employers
  in the mid-1960s
• The youngest annuitant in that study is either
  age 107 or is dead
• Surveys

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Case Study 1 Part I

• Traditional DB plan reviewed in conjunction with
  sponsors FYE audit
• DB disclosure information provided
• Brief email with spreadsheet attachment
• Spreadsheet contains schedules only
• Consideration of choice of discount rate
• Follow-up call identifies approach
• Yield curve developed by actuarys firm

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Case Study 1 Part II

• Consider following information
• Benefit payment projection (PBO based)
• Listing of the spot rates
• Write-up about the actuarys firm
• Write-up on the methods used to create the curve
• Acknowledgement of qualification to provide a
  prescribed statement of actuarial opinion
• Graph of yield curve
• Public literature on discount rate selection
  rules
• Listing of the bonds used to create the curve
• Which information should be provided to whom and
  why?

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Materiality

• A measure of significance to the financial
  statement
• Based on the accumulation of audit differences
• SAD Summary of Audit Differences
• Different thresholds for income statement and
  balance sheet
• Actuaries are not professionally qualified to
  attest to financial statement materiality

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Case Study 2

• Company sponsored many pension plans
• 5.72 was the maximum discount rate supported for
  one of the plans
• 5.75 used as the discount rate
• Total obligation for all plans 100 million
• Impact of 3 basis points200,000 additional
  minimum liability
• Amount was material to this companys balance
  sheet

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Facts and Circumstances

• Accounting and auditing firms are comprised of
  individuals
• Individual beliefs and approaches
• Professional differences occur
• One cannot generalize based on the results of a
  single set of facts
• Client confidentiality has a high priority
• Cannot use information for one client in the
  audit of another

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Letter to ABCD and Response

• Drafted by 8 consulting actuaries
• Published in November/December 2004 issue of
  Contingencies
• Discussed methods used by an actuary to select
  and support a discount rate
• Actuaries A and B had each constructed a
  hypothetical bond portfolio yielding X using
  high quality bonds
• Three questions to the ABCD

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Questions to the ABCD

• Did either actuary materially violate the code in
  the advice given to the client regarding the
  selection of the discount rate?
• Did either actuary materially violate the code in
  using the clients selected discount rate and
  describing it as a prescribed assumption?
• Did either actuary materially breach the code in
  attempting to convince the auditor of the
  appropriateness of a discount rate that was
  higher than the highest rate developed using
  methodology that was appropriate under actuarial
  and accounting standards?

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ABCD Letter Scenario 1

• Client selects and prescribes X 50bp
• Actuary provides results using prescribed
  assumption and discloses the discount rate as
  prescribed by the plan sponsor
• Actuary meets with the auditor and defends the
  appropriateness of X 50bp
• ABCD response
• Heavily dependent on facts circumstances
• Provided their likely approach to analyze case

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ABCD Letter Scenario 2

• Actuary suggests that the client could use a
  discount rate of X 50bp using several
  arguments
• Actuary meets with the auditor and defends the
  appropriateness of X 50bp
• ABCD response
• Heavily dependent on facts circumstances
• Provided their likely approach to analyze case
• Possibly a breach of Precept 1, 3 or 4

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Case Study 3

• Examination of a discount rate
• Company used a yield curve
• Yield curve developed by actuary
• Yield curve was approved for a different mutual
  client
• Yield curve not automatically approved
• Cannot share information from other clients
  workpapers
• Need to provide all appropriate information

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Case Study 4

• FAS 87 expense report contains
• Complete description of plan provisions and
  assumptions
• Appropriate representations for SAS 73
• Signed by an actuary with credentials
• FAS 87 disclosure report contains
• No plan provisions
• No assumptions other than required for disclosure
• No reference to expense report plan provisions
  and assumptions
• No representations for SAS73

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Case Study 5

• Company sponsors a defined benefit plan and a
  retiree medical plan, both containing heavy early
  retirement subsidies, covering all union
  employees
• Average retirement age
• Age 58 for FAS 87
• Age 63 for FAS 106
• Percent married
• 70 for FAS 87
• 40 for FAS 106

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Discussion

• QUESTIONS?
• THOUGHTS?
• REACTIONS?