Best Practice for Captive Audit Preparation

This article originally was published on Captive.com and is reprinted here with permission.

We’ve all learned that death and taxes are inevitable, but captive owners also face another unnerving inevitability: their annual audit. Regulators mandate an annual GAAP audit for captive insurers established in their domiciles.

While traditional external audits largely protect investors, lenders and other parties, a captive audit protects the organization funding the captive by verifying its solvency.

The auditors ensure the captive meets its minimum capital requirements and has adequate internal controls in place. 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’ll check to see that the captive has all of the documentation required by the regulators, including executed contracts and agreements, as well as conflict of interest and code of ethics statements.

When a captive is being audited, the captive manager works as a liaison between the captive, its owner and the CPA firm performing the audit. Once the audit has been completed, the captive manager along with the CPA firm should report the findings and any recommendations to the company’s board of directors.

The ideal process should incorporate the best practices learned through working with a variety of captive types and domiciles. These practices ensure timely compliance with regulatory requirements, allowing the audit process to proceed quickly and efficiently, year after year.

Preparation is essential to ensure that all of the correct information is available to the auditor’s team early enough to allow sufficient time for the audit to be completed before the desired due date. If the captive audit must be completed before the parent company’s overall audit may proceed, scheduling becomes especially critical.

The best approach is to begin planning 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’s needed has been identified, the captive management team should work with the client to allocate resources to address the additional workload. 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), a good captive manager will brief them on the questions they can expect and accurate answers to those questions.

Be sure to 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 that committee duties and responsibilities are clearly defined and documented. 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.

The captive management team should substantiate that all bank reconciliations associated with the captive have been properly completed and executed, as have any of the checklists. If the previous audit identified any misstatements or exceptions, they should 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, review those controls to verify they align with the company’s policies and procedures. Be sure to 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 organization controls) reporting to meet legal or contractual requirements, use what’s detailed in that report as the framework for management to follow and ensure that actual activities reflect what’s been presented.

Deadline dates for these items and many more will be generated and compiled into an overall calendar that will both 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.

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 organizes information accordingly and everyone encounters fewer complications. Most of all, the process keeps the captive functioning effectively, year after year and audit after audit.

The above information does not constitute advice. Always contact your insurance broker or trusted advisor for insurance-related questions.