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    The Association between Actuarial Services and Audit...
    research summary posted September 17, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation 
    The Association between Actuarial Services and Audit Quality.
    Practical Implications:

    Involving two service providers, rather than one, conveys potential benefits similar to those argued for joint audits. Auditor independence is enhanced because each firm provides a reciprocal check on the diligence of the other, and the allocation of fees between providers reduces economic bonding between the client and any one firm. Regulators might consider requiring disclosure of the recipient of NAS payments for both the audit firm and other consultants to allow a more complete examination of the influence of NAS on audit quality in other settings.


    Gaver, J. J., and J.S. Paterson. 2014. The Association between Actuarial Services and Audit Quality. Auditing: A Journal of Practice & Theory 33 (1): 139-159.

    actuaries, auditor independence, insurance industry, knowledge spillover, non-audit services, reserve management
    Purpose of the Study:

    A challenge facing the accounting profession is the creation and maintenance of auditor independence from clients, both in fact and in appearance. The authors examine the association between non-audit services and audit quality among firms in the property-casualty insurance industry. Limiting the sample to insurance firms conveys benefits that provide a more powerful test of the audit quality-NAS relation than has been possible in prior studies. This setting allows the authors to focus on a specific non-audit service that is purchased by almost all firms in the industry. The insurance setting is unique because the non-audit service that the authors examine is purchased by all firms in the sample, and they can identify both the audit and non-audit service provider. This allows the authors to directly address the NAS separation issue while holding NAS quality constant.

    Since 1990, the National Association of Insurance Commissioners (NAIC) has required a "Statement of Actuarial Opinion" regarding the adequacy of the company's loss reserve to be submitted with the insurer's Annual Statement. Although auditing standards and SOX both prohibit the audit firm from determining insurance company policy reserves (the audit client must use its own actuaries or third-party actuaries to provide management with primary actuarial capabilities), it is acceptable for actuaries from the audit firm to review and certify reserves established by the client and to sign the Statement of Actuarial Opinion. The loss reserve is the largest liability on insurer balance sheets, and establishing comfort on reserve levels is a crucial aspect of an insurance company audit.

    Design/Method/ Approach:

    The sample consists of 3,261 insurer-year observations where both audit and actuarial services are provided by a Big N firm. The sample was derived from a property-casualty database of the NAIC during the years 1993 through 2006. In 2,977 cases, the services are obtained from the same Big N firm; in the remaining 284 cases, one Big N firm conducts the audit and a different Big N firm certifies the reserves.


    The authors find that when actuarial work is obtained only from Big N firms (NAS quality is constant), audit quality is higher when separate Big N firms provide audit and actuarial services. The implication is that separating audit and NAS functions between two quality providers is beneficial, compared to allowing one quality firm to provide both services.

    The results indicate that joint provision of services is related to significantly more over-reserving by healthy insurers, compared to the case where audit and actuarial services are obtained from two independent firms. Although over-reserving by financially secure insurance clients does not present the same risk of audit failure as does under-reserving by weak insurers, both findings suggest that reserves are more likely to be biased in the client's favor when multiple services are consolidated in one provider. Specifically, jointly provided audit and actuarial services are associated with a greater tendency for weak insurers to under-reserve and strong insurers to over-reserve.

    Audit Team Composition, Independence & Ethics
    Non-audit Services, Use of Specialists (e.g. financial instruments – actuaries - valuation)