Insurers and reinsurers need to prepare for changes to the audit regime applying from June 2016. In particular, requirements for the mandatory rotation of auditors will need to be planned for.
Other changes to the current regime are substantial, including tighter restrictions on non-audit services that can be provided by an auditor to an audit client and an overall limit on fees for those services. Unfortunately, considerable uncertainty remains about how the new legislation will apply in practice, not least because a number of Member State options, which may lead to different regimes applying across the EU, await decisions by national governments.
EU legislation, in the form of a Regulation and Directive, was published in the Official Journal of the European Union on 27 May 2014. Most of the changes will come into force in June 2016, although transitional provisions aim to allow the audit market to operate without too much disruption. The legislation derives from a mixture of concerns relating to the audit market and audit process which were highlighted during the financial crisis, particularly in relation to banks. As with many other reforms coming out of the crisis, they have been carried across to the insurance sector.
We consider briefly below how the changes apply to insurers and reinsurers. For a more detailed briefing looking at the impact of the EU measures on a wide range of companies, please click here.
- Most insurers and reinsurers are caught by the definition of "public-interest entities", which means that the statutory audit framework applying to them from 2016 will be more stringent than for most other types of company.
- Member State options within the legislation may cause difficulties for multi-national insurance groups who find themselves caught by more than one regime with differing requirements. In such cases, the only course available may be to apply the most stringent standards to the entire group, which seems to defeat the purpose of the Member State option.
- For insurance groups that have a non-EU parent, the changes raise additional concerns about the coordination of the audit process throughout the wider group. For example, will appointing new auditors within the EU be practicable without a change at the worldwide level too?
Application of the new rules to insurers
One of the main changes to the statutory audit framework introduced by the new regime is a split between public interest entities (PIEs) and all other entities that require a statutory audit. This has been achieved by dividing the legislation into:
- a Regulation (No 537/2014) which is directly applicable to relevant entities in EU Member States, without transposition into national law. This governs the statutory audits of PIEs; and
- a Directive (2014/56/EU) which amends the existing Statutory Audit Directive (2006/43/EC) and covers the statutory audit of all other entities, but also some specific PIE issues (for example on audit committees) and how auditors are regulated.
The definition of "public interest entities" includes insurance undertakings within the meaning of Article 2(1) of the Insurance Accounts Directive (91/674/EEC), which in turn means:
- undertakings within the meaning of Article 1 of the First Non-Life Directive (73/239/EEC), apart from those mutual associations which are excluded from the scope of that Directive by virtue of Article 3 but including those bodies referred to in Article 4(a), (b), (c) and (e) except where their activity does not consist wholly or mainly in carrying on insurance business;
- undertakings within the meaning of Article 1 of the First Life Directive (79/267/EEC), excluding those bodies and mutual associations referred to in Articles 2(2) and (3) and 3 of that Directive; or
- undertakings carrying on reinsurance business.
Article 2(1) of the Insurance Accounts Directive does not appear to have been updated to reflect more recent legislation in this area i.e. the Consolidated Life Directive (2002/83/EC), the Reinsurance Directive (2005/68/EC) or, indeed, the Solvency II Directive (2009/138/EC) which has now been finalised. Nonetheless, it seems clear that insurers and reinsurers that are currently within the scope of the Insurance Accounts Directive will also be regarded as PIEs for the purposes of the new statutory audit framework. This will include most EU-incorporated insurers and reinsurers.
Insurers and reinsurers will, therefore, be subject to the more stringent aspects of the new audit requirements, including the requirement for mandatory rotation of audit firms, as set out in our more detailed briefing.
Some issues for groups
Uncertainty surrounding implementation of the new framework, including how national governments will choose to exercise Member State options, makes it difficult for firms to prepare fully for June 2016. Multi-national insurance groups may, in particular, need to think carefully about how they respond to the changes if they find that different group companies are subject to different requirements.
For example, the default position on mandatory rotation of auditors will be that PIEs must change their statutory auditors after a maximum engagement period of 10 years. However, Member States can choose to extend this 10-year period up to another 10 years if public tenders are carried out and up to another 14 years in the case of a joint audit. They can also choose to make these time periods shorter. If a group includes insurers in two Member States, one of which opts for the full 10 year maximum engagement period and the other of which decides to limit engagements to seven years, the group will need to decide how best to satisfy both sets of requirements. In practice, it may have little alternative but to apply the seven year limit to all companies within the group and not just to those that are subject to the shorter limit.
Insurers that fall outside the Insurance Accounts Directive, including those based outside the EU, are not directly affected by the changes. Similarly, holding companies are out of scope irrespective of their location (unless they are caught by other provisions because they have a listing on an EU regulated market). For insurance groups that are headquartered outside the EU, consideration will need to be given to the implications of the EU regime for the broader group. For example, is it practicable to appoint a new set of auditors within the EU without making a change at the group level? Audit firms will, similarly, need to consider whether they could continue to act for the group in these circumstances.
Requirement for an audit committee
The Directive gives Member States the option of allowing unlisted PIEs not to have an audit committee. This is the same as the current position, in which case the relevant functions are performed by the full Board instead.
The Regulation contains many provisions, however, requiring specific activity by an audit committee (e.g. in relation to audit tenders) and it is not clear how these will work if the Member State has decided to allow unlisted PIEs to carry on without an audit committee. For example, it is possible that, if the tender process is not carried out using an audit committee, the ability to extend the length of tenure of an auditor from 10 years to 20 years may not apply.
Even if the exemption does continue, it is clear that the audit committee is now being seen as a key feature of a PIE's interaction with its auditors. This may make it worth companies reviewing again whether to move to establish an audit committee, although a final decision should probably wait until more detail is available about how each Member State intends to operate the regime under the new arrangements.
Uncertainty clearly remains about the practical implications of the new audit framework for insurers, reinsurers and other PIEs. Nonetheless, firms should begin to consider the impact of the changes now, in particular, in relation to audit tenders and auditor rotation.