Key audit matter

Investment valuation continues to be an area with inherent risk for certain level 2 and 3 investments that have unobservable or interpolated inputs. The risk is not the same for all investment types and is greatest for those listed below. These investments are more difficult to value because quoted prices are not always available and valuation requires complex valuation models:

• Fixed income securitised products
• Fixed income mortgage and asset-backed securities
• Private placements and infrastructure loans
• Private equities
• Derivatives
• Insurance-related financial products

How our audit addressed the key audit matter

We assessed and tested the design and operating effectiveness of selected key controls around the valuation models for level 2 and 3 investments, including the Company’s independent price verification process. We also tested management’s data integrity and change management controls relating to the valuation models.

In relation to the matters set out opposite, our substantive testing procedures included the following:

• Challenging the Company’s methodology and assumptions, in particular, the yield curves, discounted cash flows, perpetual growth rates and liquidity premiums used in the valuation models.
• Comparing the assumptions used against appropriate benchmarks and investigating significant differences.
• Engaging our own valuation experts to perform independent valuations of selected level 2 and 3 investments.

Based on the work performed, we consider the methodology and assumptions used by management in determining the valuation to be appropriate.

Key audit matter

Valuation of actuarially determined P&C loss reserves involves a high degree of subjectivity and complexity. Reserves for losses and loss adjustment expenses represent estimates of future payments of reported and unreported claims for losses and related expenses at a given date.

Furthermore, on a regular basis, the Company enters into large and/or structured transactions which often have material or complex financial reporting and reserving consequences. The reserving for such transactions is subject to increased risk of error due to the non-routine nature of transactions and the judgemental nature of reserving.

The Company uses a range of actuarial methodologies and methods to estimate these reserves. Actuarially determined P&C loss reserves require significant judgement relating to certain factors and assumptions. Among the most significant reserving assumptions are the A-priori loss ratios, which typically drive the estimates of P&C loss reserves for the most recent contract years. Other key factors and assumptions include, but are not limited to, interest rates, inflation trends, claims trends, regulatory decisions, historical claims information and the growth of exposure.

In particular, loss reserves for ‘long tail’ lines of business (for example, the Liability, US Asbestos and Environmental, Motor Liability and Workers’ Compensation portfolios) are generally more difficult to project. This is due to the protracted period over which claims may be reported as well as the fact that claim settlements are often less frequent but of higher magnitude. Long-tailed lines of business generally rely on many assumptions based on experts’ judgement.

Moreover, not all natural catastrophe events and significant man-made losses can be modelled using traditional actuarial methodologies, which increases the degree of judgement needed in establishing reserves for these events.

How our audit addressed the key audit matter

We assessed and tested the design and operating effectiveness of selected key controls relating to the application of the actuarial methodology, data collection and analysis, as well as the processes for determining the assumptions used by management in the valuation of actuarially determined P&C loss reserves.

In relation to the matters set out opposite, our substantive testing procedures included the following, which are applicable for both the standard reserving and large and/or structured transactions:

• Testing the completeness and accuracy of underlying data utilised by the Company’s actuaries in estimating P&C loss reserves.
• Applying IT audit techniques to analyse claims through the recalculation of claims triangles.
• Involving PwC’s internal actuarial specialists to independently test management’s estimates of P&C loss reserves, and evaluate the reasonableness of the methodology and assumptions used by comparing them with recognised actuarial practices and by applying our industry knowledge and experience.
• Performing independent projections of selected portfolios. For these portfolios, we compared our calculations of projected reserves with those of the Company taking into account the available corroborating and contrary evidence and challenging management’s assumptions as appropriate.
• Assessing the process and related judgements of management in relation to natural catastrophes and other large losses, including using our industry knowledge to assess the reasonableness of market loss estimates and other significant assumptions.
• Performing sensitivity tests to determine the impact of selected key assumptions.
• Evaluating the appropriateness of any significant adjustments made by management to P&C loss reserve estimates.
• Evaluating the appropriateness of the recognition, accounting, and disclosures for large and/or structured transactions.

Based on the work performed, we consider the methodologies and assumptions used by management in the valuation of actuarially determined P&C loss reserves to be appropriate.

Key audit matter

The Company’s valuation of liabilities for L&H policy benefits and policyholder account balances involves complex judgements about future events affecting the business. Actuarial assumptions selected by the Company with respect to interest rates, inflation trends, investment returns, mortality, morbidity, lapse in coverage, longevity, persistency, expenses, stock market volatility and future policyholder behaviour may result in material impacts on the valuation of L&H reserves. The methodology and methods used can also have a material impact on the valuation of actuarially determined L&H reserves.

Furthermore, on a regular basis, the Company enters into large and/or structured transactions which often have material or complex financial reporting and reserving consequences. The reserving for such transactions is subject to increased risk of error due to the non-routine nature of transactions and the judgemental nature of reserving.

The valuation of actuarially determined L&H reserves depends on the use of complex models. The Company continues to migrate actuarial data and models from legacy systems and/or spreadsheets to new actuarial modelling systems. At the same time, management is validating models to ensure that new models are fit for use. Moving from one modelling platform to another is a complex and time-consuming process, frequently taking several years. Any resulting adjustments to reserves need to be assessed in terms of appropriateness and classified as changes in estimates or as an out-of-period adjustment.

How our audit addressed the key audit matter

We assessed and tested the design and operating effectiveness of selected key controls relating to the application of actuarial methodology, data collection and analysis, as well as the processes for determining the assumptions used by management in the valuation of actuarially determined L&H reserves.

In relation to the matters set out opposite, our substantive testing procedures included the following, which are applicable for both the standard reserving and large and/or structured transactions:

• Testing the completeness and accuracy of the underlying data by vouching against the source documentation.
• Testing the migration of actuarial data from legacy systems and/or spreadsheets to the new actuarial systems for completeness and accuracy.
• Involving our life insurance actuarial specialists to perform independent model validation procedures, including detailed testing of models, independent recalculations and back testing.
• Challenging the Company’s methodology and methods, focusing on changes to L&H actuarial methodology and methods during the year, by applying our industry knowledge and experience to check whether the methodology and methods are consistent with recognised actuarial practices and reporting requirements.
• Evaluating the appropriateness of the recognition, accounting, and disclosures for large and/or structured transactions.

Based on the work performed, we consider that the methodologies and assumptions used by management in the valuation of actuarially determined L&H reserves to be appropriate.

Key audit matter

The Company is carrying a provision for uncertain tax items on its books. The valuations of these items are based on management’s estimates and management’s assessment whether deferred tax assets are more likely than not to be realised. Changes in the estimates of uncertain tax items have an impact (through income tax expense) on the results.

How our audit addressed the key audit matter

We assessed and tested the design and operating effectiveness of selected key controls in place to determine the completeness of the uncertain tax items and management’s assessment of the items for recognition and valuation.

In relation to the matters set out opposite, our substantive testing procedures included the following:

• Involving our own tax specialists to critically review management’s ‘more likely than not’ tax assessments to evaluate the Company’s judgements and estimates of the probabilities and the amounts.
• Assessing how the Company had considered new information or changes in tax law or case law, and assessing the Company’s judgement of how these impact the Company’s position or measurement of the required provision.
• Examining tax audit documentation to validate the appropriateness of releases of uncertain tax provisions.
• Evaluating the appropriateness of management’s assessment of completeness of the uncertain tax provisions.
• Examining material movements within the uncertain tax positions in each jurisdiction.

Based on the work performed, we determined management’s assessment of uncertain tax items to be appropriate.

Roy Clark
Audit expert
Auditor in charge

Frank Trauschke