Tag Archives: auditors

Why Workplace Safety Auditors Don’t Work

For decades, workplace safety has been about reactively auditing the work environment to pass a “tick box” exercise. This has not only led to high and sometimes fatal costs to businesses, but also higher expenses, more losses and a general inability to improve safety. But we are seeing changes – workplace safety puts loss prevention up front as a target, leading to lower loss ratios not just in regard to profits but more importantly for human life.

First things first: Let’s acknowledge that the auditor model does not work

Time and time again, studies have shown that workplace safety improves when you let business owners manage their own safety. The more involved owners, managers and the workers themselves are in monitoring safety measures, the higher the chances of success. In fact, empirical evidence shows that safety incidents are one-seventh as likely to happen with engaged worker-centric approaches. Conversely when third party auditors are involved, more often than not companies just put up an appearance of compliance to get through the audit. The results are lose-lose, disengaged workers, expensive auditors and no inherent increase in safety.

See also: Seriously? Artificial Intelligence?  

The smarter the device or building, the safer the worker

Today we have the tools to genuinely anticipate and prevent accidents, and one of the best tools is that thing everyone carries around these days, a mobile phone. The list of wearables that can bolster workplace safety is also growing longer every day as we progress toward an Internet of Things.

With a smartphone, workers can take a picture of any hazard (for example, an electrical fault) with augmented reality, and the GPS on the phone turns the hazard into a dynamic alert as opposed to being some static and often hidden document. So, even if it is not removed immediately, as it is unlikely to be in most cases, workers can be alerted as they approach it. (Note: The experts seem to call this contextual awareness.)

The smartphone is just the start; the building itself is now smarter, with sensors for temperature, smoke, moisture, electric current, humidity, noise, light measurements, etc. In the more industrial workplaces, helmets, wristbands and even gloves are being embedded with sensors, so they can send alerts to employees and their managers in real time, allowing them to take preventive measures if workers’ well-being is compromised or safety procedures are not being followed.

As safety data pours in, machine learning steps in to make the most of it

While augmented reality is great for short-term risk management, machine learning makes sense of all the safety data collected and helps in long-term risk management. Placing this data among financial, environmental, occupational and social data can result in a system that updates in real time and any time (and not just via third party audits) and gives users GPS coordinates, pictures and notes. For insurance companies, this combination of IoT data feeding into machine learning capability will help deliver more sophisticated risk prediction models and underwriting risk assessment tools than the industry has ever seen before.

See also: Digital Playbooks for Insurers (Part 4)  

There is no need to hide things from this auditor

Because it is self-audit!! But what does this mean to an insurance company? First, it means the focus now moves to loss prevention and subsequently, and carriers will have to lower premiums for worker-centric safety management. The lowering in top line premium is offset by lower expenses in using safety auditors and lower claims, leading to a better underwriting profit. This is not far-fetched; we have already seen this on the personal side and on the auto side with telematics. The trick this time around is combining with other data sources and machine learning for insights, which most humans could not comprehend in a traditional underwriting scenario.

I’ll leave you with a sobering fact – 4,836 fatal work injuries were recorded in the U.S. in 2015 itself. That’s 4,836 too many. It is time for insurers to lead the charge on eliminating (the right kind of eliminating) with worker-centric processes powered by augmented reality and machine learning.

Do Accountants Face Risk as Fiduciaries?

Outside accountants – including auditors, those providing other attestation and compilation services, tax preparers and even mere advisers – are increasingly facing allegations that they served their clients in a fiduciary capacity. These are not simply idle observations: In general, they are made by clients and third parties seeking to obtain monetary damages from the accountants as a result of, inter alia, errors in financial reporting, tax positions that are subsequently rejected by the IRS or other authorities and losses incurred by clients or third parties following advice presented by the accountants. The reason adverse parties seek to impute fiduciary obligations to the accountants is that this offers them the opportunity to seek larger settlements or court-imposed awards, if the defending accountants are found liable. Fiduciary duties pose major risk for accountants and for those writing insurance coverage for them.

Traditionally, accountants were not considered to be fiduciaries, and in some instances still cannot be held to be such, either because of the nature of the services being rendered or the character of the client organization. However, over time the threshold for finding (or, at least, being permitted to argue in litigation) that the accountants were de facto fiduciaries has been lowered by court rulings. The implications for the accountants are serious – and they warrant taking steps to mitigate, by use of appropriate engagement letter language, and by exercising greater caution in taking on clients and in performing services for them. Those underwriting accountants’ malpractice insurance should be equally concerned with how well, if at all, their insureds have dealt with this risk factor.

What makes a party a fiduciary?

Fiduciary status is not well defined under the law, and this lack of precision has led, over time, to a creeping extension that now sometimes even reaches to outside accountants. A fiduciary relationship gives rise to fiduciary duties, the primary one of which is that of loyalty. As expressed more expansively in a number of key court decisions, “[a] fiduciary relationship carries with it the duty of candor, rectitude, care, loyalty and good faith.”[1]

Fiduciaries are required to hold their beneficiaries’ (i.e., clients) interests uppermost. Generally, fiduciary relationships are characterized as involving two parties, with the one (the fiduciary) acting on behalf of another (the beneficiary). The acting party exerts control over a critical resource that belongs to the other party – for example, the fiduciary invests funds belonging to the beneficiary, or controls the official filings (e.g., financial reports or tax returns) that are the obligation of the other party. The other party must have a relevant vulnerability (lack of investing expertise, technical knowledge, etc.) that places the beneficiary in what amounts to a subservient position vis-à-vis the fiduciary regarding the object of that relationship.

A fiduciary duty arises by either of two means: by operation of law or by application of legal factors. The first of these connotes a formal relationship between the parties, whereas the latter arises from informal relationships. Furthermore, in matters that have been elevated to the domain of litigation, there have been various ad hoc determinations that fiduciary obligations have attached, beyond those set forth in established law.

Examples of formal relationships to which fiduciary obligations will be ascribed include trusts, guardianships, agency arrangements, partnerships and joint ventures, corporations (regarding the duties of directors and officers) and counseling relationships (this being the most controversial). Counseling relationships may be those of attorneys and accountants and their respective clients, medical doctors and psychiatrists and their respective patients and even clergy and their parishioners. More generally, counseling relationships may include any others where the giving of advice in confidential settings is a central defining condition.

Informal relationships may also be interpreted as requiring the duty of loyalty. To rise to this status, there must be “trust” or “confidence” reposed by one person (or entity) in another, and there must be a resulting “domination,” “superiority” or “undue influence” of or over the other party (the putative beneficiary of the fiduciary relationship). It is important to stress that neither trust nor vulnerability alone suffice – it is widely held that both must be present to successfully assert that such an informal relationship creates fiduciary obligations.

More generally, if any person solicits another to trust her in matters in which she represents herself to be expert as well as trustworthy, and the other party is not expert and accepts the offer and reposes complete trust in that person, a fiduciary relation is likely established.

However, sharing expertise with another party is not, per se, enough: It is clear that not every expert is or can be held to be a fiduciary.[2]  There is a wide range of informal relationships, not all of which will connote fiduciary obligations. As the Restatement of Trusts notes, “Although the relationship between two persons is not a fiduciary relationship, it may nevertheless be a confidential relationship. Conversely, a fiduciary relationship may exist even though the parties do not enjoy a confidential relationship.” Thus, this is a grey area in the law, and this very ambiguity is what creates risk for the unwary.

For example, a financial reporting expert may advise a client on the various ways a particular transaction or event might be reported, or even opine that only a single approach would meet professional standards, but the ultimate decision remains that of the client, who may reject such advice or seek other opinions. The accountant does not dictate how the transaction or event has to be reported in the client’s financial report (although, if serving as independent auditor, the accountant may elect to render a less-than-unqualified opinion if the client elects an improper method of accounting having material impact on those financial statements).

As already noted, determinations establishing fiduciary obligations have been sometimes made on an ad hoc basis by the courts. Of greatest relevance to the present discussion, this tendency has increasingly brought accountants under the fiduciary duty umbrella, sometimes to the accountants’ great surprise and dismay. Most commonly, in the author’s experience as a practicing accountant, this has involved tax preparers who may rather casually offer investing advice to their clients. For example, upon noting a particular client’s high tax bracket, some tax preparers will make offhand comments about the virtues of, say, municipal bonds or real estate as investment options, or wax enthusiastic about a specific bond issue or mutual fund, which is more of a concern. More recently, this logic – applying fiduciary obligations to accountants offering investment counseling – has been extended to those offering a range of non-tax services, even if tradition and professional standards clearly prohibit the accountants performing those services from also serving in a fiduciary role.

What are the duties of a fiduciary?

Being defined as a fiduciary (whether or not a formal fiduciary relationship has been documented) brings with it a range of obligations. As noted, the most significant of these is the duty of loyalty. The interest of the principal (the beneficiary, or the client) must come first – even to the exclusion of the interests of the fiduciary. For example, if our hypothetical tax preparer suggests a certain class of investment to his client, it must be believed that this is an optimal investment strategy for the client, unrelated to the accountant’s own investment interests. Touting an investment in the hopes that, e.g., an increased demand will lift prices and thus benefit the accountant’s own holding of the same asset would clearly be a breach of this obligation.

In addition to making (or seeking to make) a hidden profit from advice given to the beneficiary, competing against the beneficiary (e.g., putting in a bid for property sought by the beneficiary, or “front running” an investment in securities), or simultaneously acting on behalf of another party whose interests are adverse to the beneficiary, would constitute breaches of the loyalty obligation. Because accountants typically have a large number of clients, there is a real risk that this prohibition could inadvertently be contravened.

A fiduciary also has a duty to disclose all relevant facts to its beneficiary. Again harking to the tax preparer/adviser situation, if the accountant is positioned to benefit if the client follows this investment advice (e.g., will obtain a referral fee or commission), this must be clearly communicated to the putative beneficiary. If an accountant is placed in the role of a fiduciary, the duties to exercise reasonable care and to maintain client confidences, found in the professional technical and ethical standards, must still be observed. Additionally, the fiduciary has a duty to maintain client confidences, which might carelessly be disobeyed even in the course of casual conversations with the accountants’ other clients.

Why is being held to be a fiduciary a risk for accountants?

Being held accountable as a fiduciary has one very crucial implication. Whereas assertions of failure to exercise due care (the normal standard to which outside accountants are held) lie within the domain of tort law, assertions of failure to meet the requirements of loyalty are found within fiduciary obligations. In the instance of allegations of breach of fiduciary duty, the burden of proof shifts to the respondent accountant, who must show, inter alia, that all material facts had been provided to the beneficiary and that all other fiduciary obligations have been satisfied.

In the event of a finding of failure to exercise ordinary due care, as defined in the professional standards with which the accountant is obligated to comply, damages are limited, typically, to actual damages suffered by the plaintiff, assuming that the tripartite required demonstrations of liability, reliance and damages have been achieved by the complaining party. In contrast, a failure to meet fiduciary obligations may result in punitive damages as well as the awarding of plaintiff’s legal fees, and thus presents a significantly greater financial risk for the accountants and for their insurers. The burden of proof, coupled with the potentially greater monetary damages, makes defending against well-founded accusations of having been a fiduciary and having breached associated duties to the beneficiary a much more serious concern.

The evolution toward fiduciary obligations for accountants has accelerated over the past few decades. During the 1970s and 1980s, claims against CPAs were commonly based on fraudulent misrepresentation and negligence (i.e., professional malpractice), as well as on contractual breaches (in the case of suits by clients against their accountants, who had purportedly failed to perform the assignment for which they had contracted). The 1990s witnessed an increase in claims made against CPAs that argued that they had served as financial advisers. This led to allegations of breach of fiduciary duty and a range of other assertions, such as functioning as an unlicensed investment adviser.

In the early 2000s, courts readdressed fiduciary duty claims, as they might pertain to CPA liability matters. In a seminal case, Miller v. Harris, decided in 2013,[3] a state appellate court reversed and remanded the trial court’s dismissal of a complainant’s breach of fiduciary duty claim against the respondent accountants. It found that contracts (such as that between the accountant and his client) between litigating parties do not control a claim for breach of fiduciary duty, because the latter are not based on contract law. This distinction is a vital one, establishing an important principle. Further, the court stated that a claim for breach of fiduciary duty must allege the existence of a fiduciary relationship and a breach of duties imposed as matter of law as a result of that relationship. The net effect of the Miller v. Harris appellate decision was to set a new, lower bar for fiduciary status by operation of law (i.e., for an informal relationship).

Given this decision and others, there is an enhanced likelihood that future actions against accountants will attempt to assert as fiduciary those relationships that, in the past, were not deemed to be such. Accountants, and their insurers, thus would be wise to give increased attention to this risk, and take steps to mitigate it, where possible.

What steps should be taken in actual practice to guard against this risk?

Although the record has been mixed, there has been some expansion of fiduciary duties over past decades to include accountants. Traditionally, of course, accountants generally had not been deemed fiduciaries. Indeed, their obligations to third parties and requirement for independence historically confirmed non-fiduciary status on accountants, inasmuch as duties to third parties could not coexist with loyalty to the client entity’s management.

Whereas at one time any attempt to attribute fiduciary status to accountants, for the purpose of alleging breach of fiduciary duty by them, would have been almost automatically dispensed with, today accountant defendants are very unlikely to obtain summary dismissal of breach of fiduciary duty claims. Instead, courts are holding this matter to be a fact issue to be resolved at trial. For the accountants, one important implication is that, even if the defense ultimately prevails, they will be forced to incur costs to defend against such claims. In litigation, even when you win, you often lose.

The existence of a fiduciary relationship is now defined to be a question of fact. If the facts support the assertion that an accountant acted as a fiduciary for the client, that accountant will be exposed to liability for breach of fiduciary duty, which may result in economic harm greater than in the situation of a garden-variety failure to exercise due care in a professional negligence suit, including the possibility of punitive damages and attorney’s fees being levied. The burden of proof is essentially placed on the defending party once the existence of a fiduciary relationship has been established by the complainant. Summary dismissals of fiduciary obligation claims against accountants are now unlikely to be obtained, meaning costs of defense must be borne even when ultimate exoneration is achieved.

Engagement letter limitation of damages language will often not be effective in precluding punitive damages, so this risk element cannot easily be protected against, if a fiduciary relationship can be established by the complaining party.

Contractual language defining the assignment as not implying fiduciary duties may not be sufficient to defend the suit. Nevertheless, having a well-crafted engagement agreement with clients remains an important defensive strategy – and such letters are mandated under professional standards for most ordinary accounting and auditing services. In the author’s opinion, the role of “adviser” should be avoided or severely constrained, if later allegations of breach of a fiduciary relationship-based obligation are to be averted.[4]

If advice is provided in circumstances in which the client can later plausibly claim to have been in a subservient role – thus, where the accountant was effectively making decisions for the client – there will be risk. Obtaining “informed consent” for recommendations made to the client would be one procedure providing some reduction in such risk. All recommendations should be couched in language that requires the client to consider and then independently conclude upon the matter, by either accepting and acting upon it, or rejecting it.

Finally, for both insureds and insurers, it would be wise to consult with a qualified attorney regarding the language used or proposed for accountants’ engagement letters for the various services being offered. Only in this way will risks, including that of being held accountable for breach of fiduciary duties, be most effectively addressed and, to the extent possible under evolving legal standards, contained.



[1]  See, e.g., Miller v. Harris, 2013 IL App (2d) 120512, ¶21; In re the Estate of Abernethy, 2012 Tex. App. LEXIS 4272; and Gracey v. Eaker, 2002 Fla. LEXIS 2662.

[2]  Burdett v. Miller, 957 F. 2nd 1375, 1381 (7th Circuit, 1992).

[3]  Miller v. Harris, Appellate Court of IL, Second District, 2013

[4]  Somewhat ironically, the trade association of public accountants, the AICPA, long promoted the catch-phrase “trusted (business) adviser” as a marketing tactic for CPAs to employ. It no longer does this, but a review of recent on-line articles and firm web sites reveals that this proclamation, or a close variant, continues in wide usage. Knowingly or not, many accountants are playing a dangerous game, wanting to tout their roles as adviser while rejecting status as fiduciaries.

Financial Reporting Of Medical Malpractice Self-Insured Losses

Healthcare entities, or groups of physicians (through a captive), may self-insure losses to better control the costs of medical malpractice insurance, particularly when insurance premiums rise. Self-insured losses are typically estimated by an actuary, who will provide an unbiased estimate of the loss reserves and can also forecast losses for the next policy period for purposes of budgeting and assessing the feasibility of self-insuring, while an auditor will ensure full compliance with accounting and financial reporting standards. The following will provide background information and points to be discussed with the actuary and auditor.

Common Coverages

In a self-insured program, losses are retained by the program up to the self-insured retention amount, while losses greater than the retention amount are the responsibility of the excess or reinsurance policy. A claims-made policy provides coverage for claims that are reported within the policy period; claims reported after the policy expiration date are not covered. Most programs continually purchase claims-made policies for reportings in subsequent years. Occasionally, when a program changes excess carriers, it may purchase a tail policy for prior acts that have yet to be asserted. Physicians that purchase commercial claims-made coverage may also purchase a tail policy when leaving an organization or ceasing to practice.

When following guidance in the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC), most of these same entities record the self-insured liability in their financial statements on an occurrence basis. An occurrence basis is determined by when the incident happens, or occurs, regardless of when it is reported. An occurrence year can also be viewed as the combination of claims-made losses and tail reportings for claims occurring during a year that are unreported. It is important to note that if the physicians are covered on an occurrence basis by an entity (hospital or captive), but the entity purchases claims-made coverage from a commercial carrier for its physicians, then the entity is liable for the tail reportings.

Unpaid Claim Liability And IBNR

The self-insured liability recorded in financial statements has two main components: 1) case reserves on known claims and 2) an incurred but not reported (IBNR) provision for unknown losses. The case reserves are determined based on the most current available information about the known claims while IBNR losses are usually estimated by an actuary. The IBNR losses account for case reserve development on known cases, pure late reportings, reopened cases, and pipeline claims (reported but not yet recorded in the system as a claim). Liability is simply losses that have occurred but are unpaid.

Actuarial Theory

Actuaries utilize models, centered on the theory of consistency and the assumption that the past is predictive of the future, in order to project losses of a program. This includes similarities in reserving strategy, payment philosophy, homogeneous risk management exposures (same types of procedures, same mix of specialties and maturities of physicians), and other program design characteristics. Any intentional change in a program by management should be reported to the actuary to avoid redundant or inadequate estimations.

Financial Reporting Discussion Points

Five key financial reporting items to discuss with both the actuary and the auditor are listed below.

  • Discounting
    Currently, guidance in the American Institute of Certified Public Accountants (AICPA) Audit and Accounting Guide Health Care Entities permits, but does not require, medical malpractice reserves to be recorded in the financial statements on a discounted basis. In order to discount a malpractice liability: 1) the amount of the liability must be fixed or reliably determinable; 2) the amount and timing of cash payments for the liability, based on the healthcare entity’s specific experience, must be fixed or reliably determinable; and 3) the expected insurance recoveries, if any, must also be discounted. If discounted reserves are presented, management must disclose the discount and be able to support the discount rate, which may include 1) the return on investments used to pay claims expected to be realized over the period the claims are expected to mature; 2) a risk-free rate; and 3) highly rated corporate bonds with maturities matching the average length of a malpractice payment, all of which may need to be periodically adjusted for future expectations.
  • Percentile
    Some healthcare entities record malpractice liabilities and fund for these losses with a contingency margin, such as at the 75th percentile, selected by management based on the nature and loss experience of the entity. ASC 954-450-25 provides that the liability recorded is independent of funding considerations. ASC 954-450-30 states that an entity should use all relevant information, including entity-specific data and industry experience, in estimating the liability.
  • Gross vs. net presentation
    FASB Accounting Standards Update (ASU) 2010-24, Healthcare Entities (Topic 954): Presentation of Insurance Claims and Related Insurance Recoveries, requires healthcare entities to report medical malpractice and similar liabilities on a gross basis, separately reporting any receivable relating to anticipated insurance recoveries. One of the outcomes of such gross presentation is to more clearly reflect the entity’s exposure to credit risk from the insurer, as the healthcare entity generally remains primarily liable for payment of claims until the insurer makes payments. ASU 2010-24 must be applied to all policies, including ground-up commercial policies, where the entity has a gross liability even though the net liability is $0.
  • Tail liability
    As addressed in ASC 720-20-25 and ASC 450-20-25, entities that maintain claims-made coverage must accrue for incurred but not reported claims and incidents as of the reporting date if the related loss is probable and reasonably estimable. Some believe the tail should be estimated based on an unlimited basis while others assume a limit based on the entities’ historical loss experience (also known as the “working layer”). Regardless of the limit assumed, the entity cannot assume that claims-made coverage will continue to be purchased in the future.
  • Conservatism in estimates
    Management should understand the amount of conservatism in the actuary’s estimate. Understanding the impact of large losses, where estimates fall within a range, and how actual loss experience is used compared to relying on industry information is important.

Working With The Actuary And Auditor

Management should set a goal to have frequent conversations and in-person meetings with both the actuary and the auditor. Although actuarial analysis and financial reporting can be complicated, it is critical for management to have a full understanding and the ability to effectively communicate its program and story. Finally, management should not be afraid to ask questions of both the actuary and auditor as this often leads to a better understanding for all parties and supports a collaborative working relationship between management, the actuary, and the auditor.

Authors

Richard Frese collaborated with Pat Kitchen in writing this article. Pat Kitchen is an assurance partner in the Chicago office of McGladrey LLP’s Great Lakes health care and not-for-profit practice. Pat leads McGladrey’s health care practice in Chicago and in its Great Lakes region. He has more than 24 years of experience serving a variety of health care organizations, including hospitals and health systems, specialty hospitals, academic medical centers and faculty practice plans, physician practices, and continuing care retirement communities. Pat assists clients with financial statement audits and reviews, compliance audits, accounting consultation, internal control reviews, acquisition-related due diligence, agreed-upon procedures and debt and equity financings.