Audit Considerations for Insurance Companies

What makes insurance audits different

The balance sheet is dominated by estimates. A manufacturing company might have 5% of total assets in estimates. An insurer might have 60% or more.

Claims provisions (the liability for claims incurred but not yet settled and claims incurred but not yet reported) are management estimates under ISA 540.2, and they’re built on actuarial models that require specialist knowledge to evaluate. This concentration of estimation risk changes your audit strategy fundamentally. ISA 540.13 requires you to understand management’s process for making accounting estimates, the relevant controls, and how management addresses estimation uncertainty. For an insurer, “management’s process” includes the actuarial function, the reserving methodology, the assumption-setting process, and the governance framework around reserve approvals. Understanding these isn’t background reading. It’s the core of your risk assessment.

The second difference is regulatory. Insurance companies operate under Solvency II in the EU, which imposes its own reserving requirements separate from the financial reporting framework. The actuarial function holder produces two sets of calculations: one for Solvency II regulatory reporting and one for IFRS 17 financial statements. These use different methodologies and often produce different numbers for what appears to be the same liability. Your audit covers the IFRS 17 numbers, but the Solvency II calculations provide a useful benchmark for analytical review. The Dutch central bank (De Nederlandsche Bank, or DNB) supervises insurers and publishes findings that are relevant to your understanding of the control environment.

IFRS 17 and what it means for your audit file

IFRS 17 replaced IFRS 4 for reporting periods beginning on or after 1 January 2023. The shift is material for your audit approach.

Under IFRS 4, many insurers continued using local GAAP measurement for insurance liabilities. IFRS 17 imposes a standardised measurement model with explicit requirements for discount rates, risk adjustments, the contractual service margin (CSM), and the unit of account for grouping contracts. IFRS 17.40 requires the entity to measure groups of insurance contracts using one of two models: the general measurement model (GMM) or the premium allocation approach (PAA). Most non-life insurers with contract periods of one year or less use the PAA (IFRS 17.53), which is simpler but still requires estimation of the liability for incurred claims under IFRS 17.55. Don’t confuse “simpler measurement model” with “simpler audit.” The PAA simplifies the measurement of the liability for remaining coverage but does not simplify the measurement of the liability for incurred claims. That liability still requires actuarial estimation.

For your audit, this means you need to understand which measurement model the client uses, verify that the eligibility criteria for the PAA are met (IFRS 17.53 requires that the PAA would not produce materially different results from the GMM), and then focus your substantive procedures on the liability for incurred claims, which is where the estimation risk concentrates.

The discount rate is a new audit area under IFRS 17 that didn’t exist under IFRS 4 for many non-life insurers. IFRS 17.36 requires the use of discount rates that reflect the time value of money, the characteristics of the cash flows, and the liquidity characteristics of the insurance contracts. For a non-life insurer with short-duration claims, the discount rate effect may be immaterial. For a liability insurer with long-tail claims (professional indemnity, environmental liability), the discount rate is a significant assumption. Your procedures need to cover both the rate selection and the sensitivity of the claims provision to changes in the rate.

How to audit claims provisions under ISA 540

Claims provisions split into two components: the provision for reported claims (case reserves) and the provision for incurred but not reported claims (IBNR). Case reserves are set by claims handlers on individual claims. IBNR is set by the actuary using statistical models.

ISA 540.13 requires you to obtain an understanding of the nature of the estimate, including what gives rise to the need for the accounting estimate and the relevant requirements of the financial reporting framework. For claims provisions, “what gives rise to the need” is straightforward: the insurer has an obligation for claims that have occurred but haven’t been fully settled. What’s less straightforward is the estimation methodology.

For case reserves, your procedures are closer to traditional substantive testing. Select a sample of open claims, examine the claim file, compare the case reserve to supporting documentation (loss adjuster reports, legal opinions, repair estimates), and evaluate whether the reserve is reasonable given the evidence. ISA 500.8 applies: you need sufficient appropriate audit evidence. A case reserve based solely on a claims handler’s judgment without supporting documentation isn’t sufficient.

IBNR is where ISA 540 drives most of your work. The actuary applies statistical methods (chain-ladder, Bornhuetter-Ferguson, or frequency-severity models) to estimate the total ultimate cost of claims from prior accident years. The key assumptions include development factors (how much more the claims from a given year will cost as they develop), tail factors (how much development remains after the last observed data point), loss ratios (for the Bornhuetter-Ferguson method, the assumed ultimate loss ratio based on premium earned), and the homogeneity assumption within each accident year grouping.

ISA 540.18 gives four options for responding to assessed risks of material misstatement in estimates: test management’s process and the key assumptions, develop an independent estimate, use subsequent events to evaluate the estimate, or combine these approaches. For IBNR, most non-Big 4 firms test management’s process and key assumptions, supplemented by a review of subsequent claims development after the balance sheet date.

Testing key assumptions means asking specific questions. Why did the actuary select a 5-year development period when the portfolio includes long-tail liability classes? What data calibrated the development factors, and does it include only the client’s own data or also industry benchmarks? If the Bornhuetter-Ferguson method was used, where does the expected loss ratio come from, and how does it compare to the actual loss ratio of the most recent fully developed accident year? These questions require preparation, but they don’t require you to be an actuary.

Working with the actuarial report under ISA 620

ISA 620.7 requires you to determine whether to use the work of an auditor’s expert when audit evidence in a field outside accounting and auditing is needed. For insurance audits, the answer is almost always yes.

The question is how. Two paths exist. First, use the client’s actuary as a management expert and evaluate their work under ISA 500.8. Second, engage your own actuarial expert (an auditor’s expert under ISA 620). For smaller non-Big 4 firms auditing mid-sized insurers, the first path is common for business-as-usual years, with the second path used when a significant disagreement with the actuarial assumptions emerges or when the engagement is new.

If you rely on the client’s actuarial report, ISA 500.8 requires you to evaluate the competence, capabilities, and objectivity of the management expert. Does the actuary hold a relevant qualification (in the Netherlands, membership of Het Koninklijk Actuarieel Genootschap)? Does the actuary report to someone independent of the reserving decision (reporting directly to the CFO who sets reserve targets creates an objectivity risk)? Document this assessment in your file.

Then evaluate the methodology and assumptions. ISA 620.12 requires you to evaluate the adequacy of the expert’s work for audit purposes. This doesn’t mean reperforming the actuarial calculations. It means understanding the methodology sufficiently to identify whether the assumptions are consistent with the audit evidence you’ve obtained from other procedures. If claims development in the current year has been adverse (more claims settling above case reserves than expected), the development factors should reflect that. If they don’t, you have a discussion point with the actuary and potentially with management.

Your financial ratio analysis can help identify trends in loss ratios and combined ratios across reporting periods, which gives you a baseline for challenging actuarial assumptions.

Reinsurance: the accounts that hide estimation risk

Reinsurance arrangements create assets on the insurer’s balance sheet (reinsurance receivables and the reinsurer’s share of claims provisions) that mirror the gross claims provisions. IFRS 17.61 requires the entity to measure reinsurance contracts held separately from the underlying insurance contracts. The audit risk sits in the recoverability assumption: the reinsurance asset assumes the reinsurer will pay, but that recovery depends on contract terms being met and the reinsurer remaining solvent.

Test reinsurance recoverability in two stages. First, verify that the reinsurance contracts are in force and that the ceded claims fall within the contract terms. Quota share treaties are straightforward: a fixed percentage of all claims is ceded. Excess of loss treaties are more complex: recovery depends on individual claims exceeding a retention level, and aggregate deductibles may apply.

Second, assess the creditworthiness of the reinsurer. ISA 540.15 requires you to consider the sources of estimation uncertainty, and reinsurer credit risk is one of them. Check the reinsurer’s credit rating (AM Best, S&P) and whether any receivables are overdue.

The most common misstatement in reinsurance accounting involves timing. When the actuary increases the gross IBNR estimate, the reinsurance asset should be adjusted accordingly. If it isn’t, the net claims position is understated. Test the reconciliation between gross provisions and reinsurance assets at year-end, specifically looking for movements in the gross that weren’t reflected in the net.

Premium revenue recognition under IFRS 17

Under the PAA (which most non-life insurers use), premium revenue is recognised over the coverage period. IFRS 17.55 requires the entity to recognise insurance revenue for each period in which the entity provides coverage. For annual policies, this means pro-rating the premium over twelve months. The audit risk is concentrated in two areas.

First, the unearned premium reserve (UPR). This is a relatively mechanical calculation (proportional allocation of written premium to the unexpired coverage period), but errors accumulate in portfolios with non-standard policy periods, mid-term adjustments, and cancellations. Test the UPR by selecting a sample of policies, recalculating the earned and unearned portions, and comparing to the recorded amounts.

Second, the premium deficiency test. IFRS 17.57 requires the entity to recognise a loss on onerous groups of contracts. For the PAA, this means assessing whether the expected claims and expenses exceed the remaining unearned premium. If the combined ratio for a product line exceeds 100%, that product line may be onerous. The entity should perform this assessment at the group-of-contracts level, not in aggregate. A profitable motor portfolio doesn’t offset a loss-making liability portfolio for this purpose.

Your risk assessment should identify which product lines have combined ratios near or above 100% and focus your premium deficiency testing on those groups.

Worked example: auditing a Dutch non-life insurer

Client: Rijnveld Verzekeringen B.V., a Dutch non-life insurer with €65M in gross written premium. Product lines: motor (40% of premium), property (35%), and professional indemnity (25%). Reports under IFRS 17 using the PAA. Total claims provision (gross) is €48M, of which €31M is IBNR. Reinsurance programme includes a quota share treaty (25% cession on motor) and an excess of loss treaty (retention €500K per claim on professional indemnity). The actuary is an external member of Het Actuarieel Genootschap.

1. Set materiality and identify significant risk areas

Gross written premium of €65M provides the benchmark. Apply 1.5% for overall materiality: €975K. Set performance materiality at 60% (€585K), reflecting the high estimation uncertainty in the professional indemnity IBNR.

The significant risk areas are the IBNR provision (€31M, 65% of total claims provisions), the reinsurance asset recoverability, and the premium deficiency assessment for the professional indemnity line (where the combined ratio was 108% in the prior year).

2. Evaluate the actuary and the actuarial report

The external actuary holds AG membership and has ten years of experience with similar-sized non-life portfolios. The actuary reports to the CFO, who also approves the final reserve figures. Document the objectivity concern (ISA 500.8): the actuary’s recommendations could be influenced by the CFO’s reserve targets. Mitigating factor: the actuary’s report includes a range of estimates (best estimate and 75th percentile), and the board minutes record that the selected reserve falls within the actuarial range.

3. Test the IBNR provision

The actuary used chain-ladder for the motor and property portfolios (short-tail) and Bornhuetter-Ferguson for professional indemnity (long-tail). Review the development triangles for motor and property: the five most recent accident years show stable development patterns, and the selected development factors are consistent with the observed data.

For professional indemnity, the Bornhuetter-Ferguson expected loss ratio is 72%, based on the actuary’s view of the portfolio’s long-term performance. The actual loss ratio for the most recent fully developed year (2020) was 78%. Challenge this assumption: ask the actuary why the expected ratio is below the actual observed ratio and whether the improvement is supported by underwriting changes. If the actuary applied the actual 78% ratio instead of 72%, the IBNR would increase by approximately €780K (within performance materiality but significant enough to record as an unadjusted difference).

4. Test reinsurance recoverability

For the motor quota share (25% of €48M motor claims = €12M ceded), verify the treaty terms and the reinsurer’s credit rating. The reinsurer is rated A+ by AM Best. Test a sample of ceded claims against the treaty terms and the gross claims records.

For the professional indemnity excess of loss treaty, identify claims above the €500K retention. Two claims exceed the retention with gross reserves of €1.2M and €850K respectively. Verify that the reinsurance recovery has been correctly calculated (€700K and €350K) and that the reinsurer has acknowledged the claims.

5. Assess premium deficiency on professional indemnity

The professional indemnity combined ratio was 108% in the prior year and is trending at 105% in the current year. IFRS 17.57 requires recognition of an onerous contract loss. Verify that the entity has performed the premium deficiency test at the product-line level. If the expected claims and expenses on unearned professional indemnity premium exceed the remaining premium, calculate the loss component.

Unearned professional indemnity premium at year-end: €4.2M. Expected claims (using the Bornhuetter-Ferguson 72% loss ratio): €3.0M. Expected expenses (16%): €672K. Total expected outflows: €3.7M. No deficiency at the 72% ratio. But at the actual 78% ratio: expected claims €3.3M, expenses €672K, total €3.9M. Still below the €4.2M unearned premium. No loss component needed, but the margin is thin (€300K). Document the sensitivity.

A reviewer examining this file finds a documented expert evaluation with an objectivity concern addressed, an IBNR challenge with quantified sensitivity, reinsurance testing linked to gross claims, and a premium deficiency assessment that shows the margin at the product-line level.

Practical checklist for insurance company audits

1. Confirm which IFRS 17 measurement model the client uses (GMM or PAA) and verify PAA eligibility under IFRS 17.53 before designing substantive procedures. The measurement model determines which accounts carry estimation risk and which are mechanical.
2. Evaluate the actuary’s competence, capabilities, and objectivity under ISA 500.8 at the planning stage. Document the reporting line, qualifications, and any threats to objectivity. Decide whether you need your own actuarial expert (ISA 620.7) before fieldwork begins.
3. Obtain the actuarial report and identify every key assumption (development factors, tail factors, expected loss ratios, discount rates). For each assumption, document what data supports it, whether it’s consistent with your other audit evidence, and the sensitivity of the provision to a change in that assumption (ISA 540.18).
4. Test reinsurance recoverability separately from gross claims provisions. Verify treaty terms, test a sample of ceded claims against the treaty, assess reinsurer credit risk using published ratings, and reconcile the reinsurance asset movement to the gross provision movement (IFRS 17.61).
5. Perform the premium deficiency assessment at the group-of-contracts level, not in aggregate. Identify product lines with combined ratios near or above 100% and test whether the entity has recognised a loss component where required (IFRS 17.57).
6. For long-tail claim classes, focus on the discount rate assumption. Obtain the entity’s discount rate methodology, assess whether it complies with IFRS 17.36, and quantify the sensitivity of the provision to a 50-basis-point change in the rate.

Common mistakes

• Relying on the actuarial report without evaluating the actuary’s objectivity. ISA 500.8 requires an assessment of competence, capabilities, and objectivity. The DNB’s 2023 findings on Dutch insurer governance specifically noted cases where the actuarial function lacked independence from the finance function.
• Testing IBNR only in aggregate without examining individual accident year development. A stable aggregate provision can mask offsetting movements (favourable development in old years masking adverse development in recent years). ISA 540.18 requires you to evaluate individual assumptions, not just the total output.
• Failing to perform the premium deficiency test at the product-line level. IFRS 17.57 applies at the group-of-contracts level. An insurer with a profitable motor book and a loss-making professional indemnity book still needs to recognise a loss component on the professional indemnity group.

Related content

Frequently asked questions

Further reading and source references

• IFRS 17, Insurance Contracts: paragraphs 40, 53, 55, 57, and 61 on measurement models, premium allocation, and reinsurance.
• ISA 540 (Revised), Auditing Accounting Estimates and Related Disclosures: the framework for testing claims provisions and actuarial estimates.
• ISA 620, Using the Work of an Auditor’s Expert: paragraphs 7 and 12 on engaging and evaluating actuarial experts.
• ISA 500, Audit Evidence: paragraph 8 on evaluating the competence, capabilities, and objectivity of management experts.
• IFRS 17.36 on discount rates for insurance contracts.
• Solvency II Directive (2009/138/EC): the regulatory framework that provides analytical benchmarks for IFRS 17 reserve testing.