Auditing of Insurance Companies

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					                                                        AUDITING


Auditing of General
Insurance Companies
P.S. PRABHAKAR
There are several areas in insurance
accounting and finance, both at the cor-
porate level and operational level that
need an auditor’s focused attention and
critical review. This article intends to
deal with some of the important ones.
                                             covering itself. It has become
        The Industry                         the cynosure of all discerning
General Insurance sector is next             eyes, with more than a dozen
only to the banking industry in terms        private companies sponsored
of importance among the economic             by the top industrial empires of
                                                                                       ceptible in late March and early April
barometers of the nation. While the          the country teaming up with some of
                                                                                       in connection with Bank Audits,
banking industry is creating assets          the best international names, have
                                                                                       their eagerness to get acquainted
and consequently national wealth,            sprung in the horizon to increase the
                                                                                       with the latest on NPA provisioning
the insurance industry is ‘protect-          size of the cake several fold and then
                                                                                       norms and their self-propelling atti-
ing’ such wealth to the tune of sev-         to take their due slices of it.
                                                                                       tude to attend the Bank Audit semi-
eral zillions of rupees. The industry           Accounts and Audit                     nars in huge numbers are all nor-
is also very unique in the sense that it                                               mally not very pronounced even
thrives in selling promises and mar-         The various stakeholders in the gen-      among those who get the insurance
keting uncertainties and making              eral insurance companies such as the      audit allotments. For some unfath-
good money in the process, cycling           Government (as the owners of the          omable reasons, the auditors do not
such money back in to the nation-            PSU companies), Indian shareholders       display any enthusiasm in acquiring
building process. Cash-rich, again           and the JV partners (in case of private   the necessary domain expertise of
next only to banking, it is also the         companies), policyholders, reinsurers     this industry, the financial concepts
only industry that is global, both by        who do business with the companies        of which are riddled with unique and
design and default, in its reach and         etc. consider the published financials    specialized concepts such as heavy
perspectives and hence its numbers           of the Insurance Companies as the         influence of the bottom lines by var-
are also massive.                            symbol of the strength and more so        ious estimations, statutory limitation
The industry, which was opened up            because such financials bear the attes-   on management expenses, relation-
for private sector participation with        tation of the Chartered Accountants,      ship between the capitalizations and
a defined limit of foreign equity,           who ‘audit’ the companies.                risk bearing capacities, protection of
after three decades of public sector              The      excitement       among      policyholders’ interests vis-à-vis
monopoly, is in the process of redis-        Chartered Accountants that is per-        expectations of stakeholders etc.
                                                                                       This lack of domain expertise some-
The author is a member of the Institute. He can be reached at psprab@vsnl.net          times leads to an auditor’s perform-



THE CHARTERED ACCOUNTANT                                       1318                                              JUNE 2004
                                                      AUDITING
ing his role in lesser dimension than       Companies) Regulations, 2000 sub-         to 50% for Fire & Misc and 100% for
he normally should.                         sequently replaced by Version             Marine, many insurers (and, after
     There are several areas in insur-      2002, was the one to govern the           nationalization, all PSU insurers)
ance accounting and finance, both           reporting and disclosure aspects of       took advantage of the same and so
at the corporate level and opera-           financials of the insurance companies.    provided]. Essentially, this meant that
tional level that need an auditor’s           Several financial concepts came         the companies recognized the rev-
focused attention and critical                under major revision and a sea          enue, by making adjustments for
review.                                       change not only in the reporting        URR in their Net Premium Income
     However, before embarking on             and disclosure requirements (as         (Premium less reinsurances), calling
the core area, let us briefly go over the     detailed below) but in the very         this as Net Earned Premium Income.
metamorphosis in the area of financial        area of concept of premium                   IRDA set out to change this. In
reporting and disclosure requirements         accounting.                             the first set of Regulations that came
of general insurance companies.               ✎ Revenue Recognition vis-              out in 2000, it was required that the
                                                à-vis URR provisioning.               companies recognized the Premium
  Pre – IRDA scenario                                                                 income over the contract period or the
                                              ✎ Premium Deficiency
                                              ✎ Investment Income bifurca-            period of risk. Which, simply meant,
      The provisions of The Insurance
                                                tion between Policyholders            proportionately. For example, if
Act, 1938 were governing the for-
                                                funds and Shareholders funds          Rs.3,650/- is collected for a vehicle
mats, reporting and disclosure
                                              ✎ IBNER (Incurred but not               insurance policy that commenced on
requirements. Besides the financial
                                                enough reported) Claims               18th Sept, 2003 to expire on 17th
statements in the pre-designed for-
                                              ✎ Cash flow under ‘Direct               Sept, 2004, the revenue recognisable
mats that were to be published for the
                                                Method’                               is Rs. 1,950/- for the financial year
benefit of the stakeholders, returns
                                              ✎ Adherence to Accounting               ending 31st Mar, 2004, as the policy
were prescribed for submission to the
                                                Standards with specific               runs its course for 195 days out of 365
Controller of Insurance. On national-
                                                modifications.                        days in the current financial year. The
ization of the general insurance indus-
                                              ✎ Concept of “Management                balance of Rs. 1,700/- is to be kept as
try, the de jure supervisory authority
                                                Report” to stress adequate            unearned premium, as it is attribut-
continued to be the Controller of
                                                disclosures                           able and allocable to the succeeding
Insurance but the de facto supervisory
                                              ✎ Auditors’ report – Revision           accounting period. Perhaps, the idea
authority was the General Insurance
                                                in Format.                            germinated from the perception that
Corporation of India. In fact, GIC’s
                                                                                      in the days of high-end computers
roles were multi fold. It was the hold-
                                                                                      and sophisticated methods of
ing company, the first reinsurer,
industry’s policy maker, supervisor,
                                             Premium accounting                       accounting, any percentage ad-
                                                                                      hocism in provisioning was not nec-
de facto regulator et al.                        Now, to see how the financials get   essary and that the revenue account-
                                            affected by the changes of (a) and (b)    ing could be almost realistic.
 Post – IRDA scenario
                                            above and how the auditors so far have         IRDA’s fresh set of regulations
    Came 1999, the IRDA was                 dealt with them can be seen below:        of 2002, possibly realising that the
born. Insurance Act was suitably                 For time immemorial, the pre-        earlier Regulations on this score were
amended to give IRDA the powers             mium accounting was done after pro-       found ‘complicated’ by the existing
to regulate the industry that was           viding the Unexpired Risks Reserve        and the new insurers alike, sought to
soon to be thrown open to private           at ad-hoc percentages indicated in the    grant an escape route by bringing
players. Among the many supple-             Solvency Margin requirements {Sec.        back the ‘adhoc regime’, by saying
mentary regulations that were               64V(1)(ii)(b)}, which were 40% for        that though the premium recognition
issued covering many aspects of             Fire, Marine Cargo & Misc and 100%        should still to be on ‘accrual’ basis,
functioning, the IRDA (Preparation          for Marine Hull of “Net Premium”.         the minimum of URR should be at
of Financial Statements and                 [However, as the Income Tax Act &         percentages prescribed.
Auditor’s Report of Insurance               Rules, allowed insurers to provide up          However, the problem is far



THE CHARTERED ACCOUNTANT                                    1319                                                 JUNE 2004
                                                      AUDITING
from over. First of all, there is an all-   only industry, where lower business         insurance companies are expected to
important point that has been missed        volume in a year can actually result        make the provisions based on the
by the rule-framers and not also            in higher profits because of the            available information and create a lia-
queried by rule-followers. The URR          ‘reserve release’ factor. Unless the        bility as on the date of closing of
provision, basically, is on the “Net”       auditors understand the tricks that         books. The sum total of such ‘direct’
basis. For this, only percentages,          can be played by the managements in         figures, tempered by the Reinsurance
however adhoc they may seem, can            this, it will not be possible for them to   recovery adjustments and added by
work. Pro-rata recognition of rev-          be true and fair to themselves let          the Outstanding Claims figures
enue is possible only on “Gross” pre-       alone to the shareholders.                  received from the Reinsurers, in
mium. This is, essentially because,              For the first time, a new concept      respect of ‘acceptances’ would be the
the Reinsurance programmes are not          called ‘Premium Deficiency’ was             total ‘net’ outstanding claims, which
policy wise, except for very major          brought in by IRDA. Again a mea-            will form the integral and major part
ones. They are, mostly, on treaty           sure for augmenting policyholders’          of the “Claims Cost”. However,
basis and the underwriting year for         funds, it mandated that if the sum of       these are based on estimations based
reinsurance markets will be blatantly       expected claims costs, related              on information in possession of the
different from the financial year           expenses etc. exceed the URR, the           insurance companies on the date of
basis that we might be following.           said excess is to be recognised as          closing the books. Such information
The actual manner in which the              Premium Deficiency. It is a fact that       could include surveyor’s assess-
whole premium accounting and RI             neither IRDA has attempted to               ments, spot survey reports, insurers’
cessions accounting works is too            explain the concept of this Premium         guesstimates based on the available
mind boggling to be wished away             Deficiency or the methodology of            documents and sometimes even sim-
with any simplistic solutions in the        providing the same nor any                  ply on the data given, not given or
name of bringing in any ‘seeming            Insurance Company really appeared           short given by the claimants them-
realism’. Many insurers, taking             to be unduly bothered on this. Some         selves in the claim forms. There are
advantage of the situation that             companies have opined that there            really no hard and fast rules on how to
‘actual accrual’ can never be worked        was no premium deficiency in their          make these provisions and it is left to
out correctly, simply continue adopt-       companies while some simply ‘dis-           the discretion and judgment of the
ing ad-hoc percentages, claiming            closed’ certain sums, even though           claims personnel as also pruning by
that they are the ‘minimum’.                the regulatory need was to recognize        the managements and hence unlike
     Now, there are myriad practical        the same in accounts. However, the          the URR, which will be a structured
problems that are encountered by the        interesting aspect is that in most          estimate, the provision for outstand-
companies in recognizing the rev-           cases, the auditors have looked the         ing claims will always be an unstruc-
enue but, the responsibility of audi-       other way on this issue or simply           tured estimate. This not only signifi-
tors is to see that the Regulation is       have gone by the averments made by          cantly influences (sometimes, even
followed scrupulously or if not fol-        managements in this regard.                 unduly) the bottomlines but also has
lowed, reported accordingly. If one                                                     the potential to distort the company’s
peruses the published annual reports             Estimation of                          liabilities in the Balance Sheet on a
of the insurance companies for 2002-          Outstanding Claims                        given date. The auditors’ responsibil-
03, it can be seen that most of the                                                     ity (both at operational office level
auditors have conveniently main-                The most pronounced drain of an         and at the central office level) is very
tained silence on this. What is worse,      insurance company’s resources is the        pronounced in this area. Only subject
some nationalized insurers have bla-        Claims cost (also known as Incurred         knowledge and experience can lead
tantly changed the rules of the game        Claims), which is the actual claims         auditors right in their ‘audit’ of this area.
to suit their convenience during            paid less adjustments for reinsurance
2001-02 and 2002-03, resulting in           recoveries on them and provisions for           Commissions and
huge difference to bottomlines, with-       claims outstanding as on the date of               brokerage
out eliciting any adverse comment           financial reporting. On the Direct
from the auditors. This is perhaps the      side, the operating offices of the               At the operational office level,



THE CHARTERED ACCOUNTANT                                     1320                                                      JUNE 2004
                                                    AUDITING
one of the major items of expense is      shares of his premium with other            perpetual legacy of lethargy.
the ‘business procurement cost’. In       insurers, by way of co-insurance            However, in the matter of such non-
the pre-IRDA days, there were             (where the preference of the customer       reconciliation of balances, charity
agency commission payments at             plays a role) as well as by reinsurance,    does not begin at home itself. There
structured rates and though the sys-      both at home and abroad.                    are always transactions of (a) claims
tem per se was abused to the hilt by      Reciprocally, he also accepts risks         settled -mostly Marine Cargo &
the employees of the companies,           ceded to him. Wider the spread, better      Motor TP claims- by one office of the
nothing much could be done by the         it is for all. However, such transac-       company on behalf of the other and
auditors as everything used to be         tions between insurers (and reinsur-        (b) expenses incurred on behalf of
alright on papers. In the post-IRDA       ers) mostly take place by way of cor-       another office. There are eternal
scenario, the private insurance com-      respondence and accounting entries          issues of non-reconciliation between
panies resort to ingenious methods of     only. While the Balance Sheet items         offices of the same company and at
remunerating people, who help them        refer to the ‘net’ balances as on a date,   any point of time, significant amounts
procure business. Though there are        the relative effect should have gone to     stand wrongly ‘capitalised’ in these
official agents and brokers, the outgo    the revenue. There are always some          accounts, commonly called as Inter
towards procurement costs take dif-       transactions pending accounting for         Office Accounts.
ferent forms such as referral fee, con-   want of full information and espe-               Likewise, there is another item
sultancy fee etc. Unofficial rebating     cially when the number of transac-          called as Agents’ balances, both in
is also done to grease the palms of       tions is huge, there can be understand-     Current Assets and in Current
decision makers of the insureds. If       able differences in balances between        Liabilities. There is no official sanc-
auditors can be vigilant in this area,    entities having such transactions. If       tion in the Insurance Act or from
many such cases can be brought to         periodical reconciliations take place       IRDA that insurance companies can
light. The auditors, especially at the    and such pending items are accounted        have running balances with agents. In
operational offices, would do well to     in the way they should be, then there       fact, no agent is authorized to collect
analyse this account and seek clarifi-    will be some excuse in hiding behind        any money on behalf of the company.
cations on payments made to persons       the concepts such as going concern          At best, there can be one month’s
other than agents and brokers.            and consistency. But, in reality, such      commission dues that may stand as
                                          reconciliations never happen and bal-       credit balances. Or there could be
  Current assets and                      ances are always allowed to mount,          continuing aberrations of what has
                                          with differences ever swelling, result-     long since been prohibited viz., bal-
      liabilities                         ing in massive sums that should have        ances under Agents’ bank guarantees.
                                          found their rightful places in the rev-     But, the actual extents of such bal-
    When we come to Current Assets
                                          enue accounts and in P&L accounts of        ances defy such perceptions. Whether
and Current Liabilities, it will become
                                          the insurance companies being held          these balances are what they are really
necessary to put the concerned
                                          captive in “capital” accounts. (For         supposed to be or whether the head of
accounts under magnifying lens, to
                                          instance, a claim settled by company        account is a convenient parking place
understand what the individual bal-
                                          A on behalf of company B is debited         for several Para-revenue items, pend-
ances could broadly contain within
                                          to Company B without charging it off        ing (for ever?) accounting as revenue
them, as it is just possible that any-
                                          to Revenue and because full details         etc. are but kept as closely guarded
thing inconvenient could have been
                                          are not made available, even the com-       secrets, even from auditors, who will
parked in the hazy sub-headlines.
                                          pany B does not account it as Claim).       be constantly pressurized to complete
    For instance, every company will
                                          Though, every insurance company             the audits in the time frame set by the
show both in Current Assets and
                                          has such transactions with hundreds         managements. Yes, the only ‘recon-
Current Liabilities, the balances with
                                          of their counterparts across the globe      ciliation’ appears to be in the attitude
“other persons/entities carrying on
                                          and such problems are not unique to         of the statutory auditors, as it is seen
insurance business”. Insurance, being
                                          our country and our insurers alone,         that they are reporting this as noncha-
a global business by nature, is all
                                          certainly it is no excuse that “Due to /    lantly as possible year after year. As
about spread of risks far and wide and
                                          Due from Insurers” continues to be a        many of the readers of the financials
hence every insurer parts away certain



THE CHARTERED ACCOUNTANT                                   1321                                                  JUNE 2004
                                                     AUDITING
do not realize the impact, no serious      investments, provisioning and             ambit of functions of the IRDA, in
questions are asked from any quarters.     impairment norms, recognition of          terms of the regulations on prepara-
                                           income, disclosures forming part of       tion of financial statements and
        Other Issues                       financial statements etc. which           auditor’s report under the IRDA
                                           reflect the intention of the              Act. Here, the IRDA Act does not
     Some of the other important
                                           Regulators to bring in more trans-        make any distinction between
issues at the operational office level
                                           parency in presentation. Audit of         Public Sector and Private Sector
are verification of compliance of
                                           investments will have to be a very        Insurance Companies. (However, to
Sec. 64VB of the Insurance Act,
                                           detailed one and critical areas like      what extent the said Regulations
which deals with collection of pre-
                                           ‘investment in unapproved invest-         notified under the sanction given
mium prior to assumption of risk,
                                           ments’ (within the permissive lim-        under Sec. 114 A of the Insurance
bank reconciliations, operation of
                                           its), ‘disinvestments’ and ‘selling       Act, which in itself does not specifi-
Bank Guarantee Premium Control
                                           the traded securities’ etc. will have     cally state anything on auditors’
account, Cash Deposit Premium
                                           to be brought under careful scrutiny.     appointment, can overrule the provi-
Control account, refunds account-
                                                Reinsurance is a highly techni-      sions of Companies Act is not clear.)
ing, verification of fixed assets, cash,
                                           cal area and unless the auditors get      Accordingly, IRDA has started
policy stamps etc. The Audit pro-
                                           very well versed in verification of       compiling a panel of Chartered
gramme will have to factor in all of
                                           Bordereaux (a spreadsheet kind            Accountants and for the purpose,
the above issues for detailed scrutiny.
                                           statement detailing risks ceded /         has also prescribed certain exacting
      Investments &                        accepted, commissions, claims             parameters for such empanelment.
       Reinsurance                         etc.), checking of quarterly state-            Of course, in such parameters,
                                           ments of individual treaty reinsur-       the longevity, size etc. of a firm
    Audit of the investment as well        ers, profit commission statements         seem to be only given importance
as reinsurance activities happen           etc. it may not at all be possible to     rather than the specialized qualifi-
only at the Corporate Office levels        do justice in this area. The one          cations in the field or the domain
and here, the scope for auditors is        important thing that needs to be          expertise of the partners. This is
well defined by the relevant               borne in mind by the auditors is that     rather sad. An industry that is so
Regulations of IRDA. However, the          reinsurance transactions operate          unique and important cannot be
objective of the IRDA’s regulations        between companies at the interna-         ‘audited’ casually and generally,
on Investments is only the protec-         tional level based on a very high         when specialization is the order of
tion of policyholders’ funds. IRDA         level of trust (concept of utmost         the day. Realising the importance of
has stipulated that every insurer          good faith fortified) and the rein-       the need to create and develop
shall constitute an Investment             surers place heavy reliance on the        ‘domain expertise’ in this industry
Committee and shall draw up an             quality of the auditors who attest        that is all set to take a giant leap in
annual Investment Policy which             the financials of the Indian compa-       the years to come, our Institute has
shall be placed before the Board for       nies, which fact only increases the       newly introduced a specialized post
approval after being vetted by the         responsibility of the auditors.           qualification course on insurance
Investment Committee. The                                                            and risk management.
                                             Audit empanelment                            Providing assurance services
Investment Policy, as approved by
the Board shall also be filed with the         requirements                          to the people who are themselves in
IRDA. Schedule B of Regulation 3                                                     the business of assuring others is a
                                                Prior to the private sector entry,   serious affair and the responsibility
of The IRDA (Preparation of finan-
                                           the appointments of auditors for the      of the members of our profession to
cial Statements and Auditor’s
                                           four PSU companies were made by           provide comfort (by doing ‘an
Report of Insurance Companies)
                                           the CAG. In the current scenario          informed audit’) to the stakehold-
Regulations, detailing the account-
                                           where private insurers have begun         ers, regulator, reinsurers, tax
ing principles for preparation of
                                           operating, the appointment of audi-       authorities can hardly be overem-
financial statements provided for
                                           tors appears to have come within the      phasized.                             ■
the procedure for valuation of



THE CHARTERED ACCOUNTANT                                   1322                                                 JUNE 2004

				
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