Make the audit add value
There is little discussion about pension plan auditors. This is surprising, given the number of times auditors in general have appeared in the headlines, mainly in connection with corporate scandals.
In recent years, managements of corporations in different countries have been accused of using overly creative or even fraudulent accounting methods. As a consequence, people have also been questioning the role and involvement of auditing firms, in particular their independence and certain of their business practices.
In contrast, auditors of pension plans seem to have a comparatively easy time. Not that pension funds as such had not been hit hard in recent years, but their problems and scandals have scarcely touched their auditors. In pension funds, when the numbers don’t square, the problems are normally caused by rising liabilities and poor investment returns, rather than incorrect or fraudulent accounting. Consequently, it is the actuaries and the investment advisers rather than the auditors that are in the firing line.
This may well change over the coming years. Just to give an indication: risk management and overall governance are increasingly acknowledged as areas of concern for pension plans everywhere. Such developments constitute new challenges for auditors, as they are likely to be asked to deliver more substantive and higher-aiming plan audits than in the past.
Cases of improper and fraudulent financial practices are, of course, not totally unknown to the pensions world (remember Robert Maxwell in the UK in the early 1990s). Furthermore, members of occupational pension plans are often heavily affected by corporate accounting and audit scandals (eg, Enron). No doubt, big risks are there. Nonetheless, auditors of pension plans still seem to be under comparatively low scrutiny.
The use of qualified and independent auditors has become obligatory in most countries. International institutions give very general guidelines on pensions accounting and audit.
For example, the EU pensions directive (2003) requires that the annual reports and accounts are ‘duly approved by authorised persons, according to national law’. The OECD Guideline for Pension Fund Governance 2002 stresses three key points:
q Independence: An auditor, independent of the pension entity, the governing body, and the plan sponsor, should be appointed … to carry out a periodic audit;
q Flexibility of national rules: The extent and frequency of the audit will vary depending on the nature, complexity, and size of the pension plan/fund;
q Whistle-blowing: The auditor should report promptly to the governing body (and the competent authorities in a second step) “wherever he or she becomes aware, while carrying out his or her tasks, of certain facts which may have a significant negative effect on the financial situation or the administrative and accounting organisation of a pension fund”.
As with all pensions regulation, the country-specific rules vary a lot. For example, not all pension arrangements need to have an auditor. Exemptions can relate to size (US small plans with fewer than 100 members) or type of scheme (fully insured in the Netherlands). Some countries demand a ‘board of auditors’ (closed plans in Italy), or specify requirements for internal auditors (Denmark). There are also other regulatory differences relating to:
q frequency of accounts and audits (normally annual);
q exact specification of duties;
q reporting requirements to the
q whistle-blowing to authorities;
q appointment (by trustees or sponsor) and dismissal.
The core role of the auditor is to audit and report on the annual accounts of the pension plan. Auditors assess whether the financial statements give a true and fair view of the financial transactions and assets of the scheme, and certify their compliance with law and regulation.
The accurate valuation of the assets is paramount but not always easy in the case of illiquid investments. It should be noted that things are a
bit different on the liability side: auditors typically look at ‘liabilities’ only through the rear-view mirror. It is the actuary’s, not the auditor’s, job to look at the future and to comment on the adequacy of the match between assets and liabilities.
Other core areas of activities include:
q checking the timely payment of contributions against schedules;
q assessing inherent risks in relation to financial statements;
q reporting any material weaknesses in the internal control systems.
However, such checks and reports would typically not take the form of a comprehensive assessment of a pension fund’s risk control systems and procedures. In fact, it is not unusual for pension fund trustees, and members, to have unrealistic expectations of what an auditor is strictly required to do under the regulation.
Confusion is perhaps less surprising when public expectations are raised to such high levels as in a recent US department of labour publication. “A quality audit will help protect the assets and the financial integrity of your employee benefit plan and ensure that the necessary funds will be available to pay…promised benefits to your employees.”
There are different views about what the auditors should actually do in practice. Some firms appear quite formalistic while others take a deeper and broader interest in substantive matters of the pension plan. There are, of course, two sides to this. Some pension boards prefer the auditors to stick to the limited brief given by law while others welcome the auditors’ comments on a wide range of issues.
For example, trustees may seek full reassurance about the quality of internal controls. Many pension plans encourage their auditors to make very thorough tests of systems and procedures. This may include checking the accuracy of membership numbers and records, the control of members’ transactions in defined contribution plans or the calculation of individual benefits. Also, the output of new computer systems needs particular attention.
Given the competitive nature of audit fees, big firms often offer a range of additional services. In practice, this means that they somehow ‘cross-sell’ additional advice, for example, on risk management, to trustees.
Most pension plans have longstanding relationships with their auditors. The advantages are clear. Auditors need to know their clients
well, including all the relevant paperwork, such as the trust rules, actuarial valuations and trustee minutes. Also crucial is a comprehensive understanding of the plan’s history and future plans, of the people in charge and of their advisers.
Occasionally, too much routine creeps into well-established relationships between plan management and auditors, which bears its own risks. This is the reason why newer governance codes propose a rotation of individual auditors and even audit firms.
As a matter of good governance, pension boards should in any case have a regular monitoring and assessment procedure for all their advisers, including auditors. Apart from all the other advantages, this reduces the risk of unnecessary irritations provoked by surprising ad hoc reviews.
Whether certain formalities are regulated or not, it is certainly good practice for trustees to have a good reading of audit appointment agreements and terms of engagement. Bigger plans should consider the constitution of an audit committee with clear terms of reference.
In terms of the annual audit process, it is advantageous for both sides to have a clear, agreed audit plan, describing the expected scope and conduct of the audit. Particularly in case of major changes to the pension scheme, it pays to have informative pre-meetings with the auditors.
Wise trustees also take this as an opportunity to get themselves updated on relevant regulatory changes.
Finally, pension trustees should look forward to the audit meeting with enthusiasm rather than boredom: it is a good chance to receive constructive criticism and recommendations for improvement from a hopefully knowledgeable outsider. Then the cost of audit can be of good value to your pension plan.
Georg Inderst is an independent consultant based in London