Risk Indicators for Audit Committees

In determining the procedures to be performed for either an audit or proposed acquisition, the audit committee and management should generally be concerned with matters that could be material to the financial statements. Certain aspects of an insurance or managed care entity's operation are usually subject to a greater level of inherent risk than other areas. The size, complexity, products, and ownership characteristics of the entities have a significant influence on the risk environment. Answering the following simple questions can assist in assessing the level of risk.

• Can the company explain simply and concisely how it makes money?
• Is there an obsession with meeting earnings targets and expectations?
• Is there overly centralized control over financial reporting function?
• Does the company know its market?
• Do reinsurance, investment, or acquisition transactions lack economic purpose?
• Have company systems been updated to handle managed care transactions on a real-time net or gross basis?
• Is product development a formalized process whereby financial targets, product assumptions, and markets are identified and subsequently measured for success?
• Does the company measure the cost of large claims and impact of underwriting standards?
• What type of activities does management perform to review marketing practices?
• Is net income growing at a greater pace and far outstripping revenue growth?
• Do accounting policies rely heavily on management's judgment or appear too aggressive?
• Does the entity have a reputation for being unusually aggressive or taking inordinate risks?
• Is there a culture of arrogance or management entitlement?
• Do cash flows from operations trend with reported earnings?
• Has there been turnover of key management?
• Has the company grown through an undisciplined acquisition process?
• Is management's strategy more dependent on acquiring businesses and assets than making their existing ones perform properly?

The answers to these questions are a first step and strategy guide to your general assessment of inherent risks and controls to be addressed at your company. The next step is evaluating your internal control structure compared to the Committee on Sponsoring Organization of the Treadway Commission Internal Control Integrated Framework.