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Audit Analytics in the Financial Industry
Split into six parts, contributors explore ways to integrate Audit Analytics techniques into existing audit programs for the financial industry. Chapters include topics such as fraud risks in the credit card sector, clustering techniques, fraud and anomaly detection, and using Audit Analytics to assess risk in the lawsuit and payment processes.
eBook
Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading
Accounting rules, through their interactions with capital regulations, affect financial institutions' trading behavior. The insurance industry provides a laboratory to explore these interactions: life insurers have greater flexibility than property and casualty insurers to hold speculative-grade assets at historical cost, and the degree to which life insurers recognize market values differs across U.S. states. During the financial crisis, insurers facing a lesser degree of market value recognition are less likely to sell downgraded asset-backed securities. To improve their capital positions, these insurers disproportionately resort to gains trading, selectively selling otherwise unrelated bonds with high unrealized gains, transmitting shocks across markets.
Journal Article
Accounting and litigation risk: evidence from Directors’ and Officers’ insurance pricing
We study whether and how financial reporting concerns are priced by insurers that sell Directors’ and Officers’ (D&O) insurance to public firms. As D&O insurers typically assume the liabilities arising from shareholder litigation, the premiums they charge for D&O coverage reflect their assessment of a company’s litigation risk. Using a sample of public firms in the 2001–2004 Tillinghast D&O insurance surveys, we document that firms with lower earnings quality or prior accounting restatements pay higher premiums after controlling for other factors impacting litigation risk. In addition, insurers’ concerns about financial reporting are most evident for firms with restatements that are not revenue or expense related, are greater in the period following the passage of the Sarbanes–Oxley Act of 2002, and are greater for firms with financial reporting problems that linger. Our results are consistent with past restatements being viewed as evidence of chronic problems with a firm’s financial statements. By analyzing archival data, we can also quantify the effects of other determinants of D&O premiums (such as business risk, corporate governance, etc.) identified by Baker and Griffith (Univ Chic Law Rev 74(2):487–544,
2007a
) through interviews regarding the D&O underwriting process.
Journal Article
Reserve Management and Audit Committee Characteristics: Evidence From U.S. Property-Liability Insurance Companies
We examine the relation between reserve management and a set of audit committee characteristics of property-liability insurers, using reserve errors as a proxy for reserve management. We find that insurers with three audit committee characteristics have more conservative loss reserve estimations: larger audit committee size and more members with accounting expertise, and more audit committee meetings. Our results also find that three recommendations of the 1999 Blue Ribbon Committee can make corporate audit committees more effective: a minimum audit committee size, a minimum level of accounting expertise, and a minimum number of audit committee meetings. These results were obtained when we controlled for board of director characteristics, firm-specific characteristics, and Sarbanes—Oxley. Some board composition variables (e.g., director ownership) also have an impact on reserve management during our study period. The evidence overall suggests that the audit committee and some board characteristics have an impact on reserve management (earnings management) even in a regulated environment such as the insurance industry.
Journal Article
Does Auditor Reputation Matter? The Case of KPMG Germany and ComROAD AG
We study the stock and audit market effects associated with a widely publicized accounting scandal involving a public company (ComROAD AG) and a large, reputable audit firm (KPMG) in a country (Germany) that has long provided auditors with substantial protection from shareholder legal liability. We use this event to study whether an auditor's reputation helps to ensure audit quality, a rationale for which recent literature and events provide scant support. Given the absence of a strong insurance rationale for audit quality, Germany permits a relatively clean test of whether auditor reputation matters. We find that KPMG's clients sustain negative abnormal returns of 3% at events pertaining to ComROAD, and that these returns are more negative for companies that are likely to have higher demands for audit quality. We also find an increase in the number of clients that drop KPMG in the year of the Com-ROAD scandal (mostly smaller, recently public companies that are similar to ComROAD). Overall, our results provide support for the reputation rationale for audit quality.
Journal Article
Fraudulent Claims and Nitpicky Insurers
Insurers have the reputation of being bad payers who nitpick whenever an opportunity arises. However, this nitpicking activity has a positive impact on their auditing strategy since auditing may prove profitable when claims are not fraudulent. We show that reducing the indemnity payments of audited claims induces a lower fraud rate at equilibrium and that some degree of nitpicking is socially optimal when insurance fraud is a concern. Its remains optimal even if it induces adverse effects on policyholders' moral standards.
Journal Article
Is tax aggressiveness associated with tax litigation risk? Evidence from D&O Insurance
This study uses directors’ and officers’ (D&O) insurance data to examine the relation between tax aggressiveness and tax litigation risk. D&O insurance covers litigation costs for tax-related cases. Thus D&O insurance premiums provide an independent and direct assessment of the risk in a firm’s tax aggressive strategies, which mitigates some of the challenges in studying tax risk. Based on pricing decisions, D&O insurers appear to view tax aggressiveness, as measured by industry- and size-adjusted cash effective tax rates (a measure where higher rates are associated with more aggressiveness), as increasing tax-related litigation risk. Regarding tax uncertainty, premiums increase (decrease) as unrecognized tax benefits (UTB-related settlements with tax authorities) increase. Finally, D&O insurers focus on firms with outbound tax haven activity when pricing tax aggressiveness. Overall, this suggests D&O insurers include aspects of both low taxes and tax uncertainty when pricing tax litigation risk.
Journal Article
Nonlinear Relationship Between Audit Quality and ESG Performance in Insurance Companies: New Evidence from the MENAT Region
This study examines the nonlinear connection between audit quality and insurance firm ESG performance based on a sample of 31 MENAT-region insurance companies from 2017 to 2022. Based on a fixed-effect model and quadratic regression, the main results support the presence of a curvilinear nexus between audit quality and ESG performance of insurance companies. This correlation shifts from positive to negative when it reaches a level of 51,7%. Given this, insurers and regulatory bodies should adjust audit quality to a balanced point where it optimizes ESG performance without excesses that would be needlessly costly and have reverse effects. Policy wise, proportionate rules should be established for the inclusion of ESG considerations in auditing, to prevent over-regulation and to achieve a balance between control and performance.
Journal Article