Internal Audit’s Guide to Planning, Managing and Addressing Risks

As time passes and the modern-day enterprise evolves, so does the role of the internal auditor. What was once a function that was perceived as rule enforcers and compliance police is expanding into one that is a trusted advisor within the business. The last several years have introduced an enormous amount of change, but the proliferation of technology within the enterprise is accelerating every aspect; from operations to decision making.

The progressive steps organizations are taking as a result of the digital age present a bevy of benefits, but in turn, create a slew of challenges and risks. Subsequently, the internal audit function has been forced to adapt along the way, assuring key stakeholders in the business that risks have been identified, but above all, addressed and mitigated.

While identifying and managing risks tied to the business fall on management, it’s internal audit’s responsibility to focus on closing the loop. That’s why our second article focuses on the effective audit follow up, in addition to outlining the how and when tied to escalating risks.

A DYNAMIC AND ITERATIVE PROCESS

The COSO Internal Control – Integrated Framework (2013) provides that a “risk assessment involves a dynamic and iterative process for identifying and assessing risks to the achievement of objectives.” (emphasis added). To be effective, internal audit should be aware of and responsive to changes in known risks and additionally the emergence of new ones.

A purpose for the traditional (i.e., annual risk assessment) is to allow internal audit to develop a planning horizon which is understood by stakeholders and, in particular, executive management and the audit committee as a basis for the risks identified. In this process there can also be a push to finalize the internal audit “plan” so that budgets, schedules and staffing can be arranged.

With the emerging concept of “risk velocity”—measuring how fast a risk may affect an organization—is recognition that the typical risk assessment process is one that is not dynamic and iterative nor responsive to change in real time. Change does not occur on an annual basis. The move to a continuous and dynamic audit plan is significant for most internal audit departments. Some departments are already moving on this path and have had to adjust from a static process focused on listening to management on a seasonal basis to monitoring business objectives and risks that are rapidly changing.

Tony Redlinger, internal audit director with IHS Markit, observes the difficulties of the timely capture of risks as “asking the pertinent questions often without the broader knowledge of what the business is getting into, where the technology often advances much faster than the controls.”

BEYOND THE TYPICAL INTERNAL AUDIT RISK ASSESSMENT

What approaches internal audit functions can take to ramp up the process to achieve more dynamic audit planning?

One technique is to increase the frequency of the process and design a rolling service of assessments and audit planning. If existing processes can be made more streamlined and efficient, the time trajectory can be intensified to occur more frequently. Potentially, a concerted effort can result in an audit plan being updated every six months instead of annually. Since the risk identification process ideally is ongoing, management should be encouraged to implement a schedule to periodically review risks, while reserving the ability to accelerate reviews if a company objective changes, or risk factors increase.

For example, if management is considering an acquisition in a new jurisdiction, it could require the reevaluation of risk factors to determine how the decision could impact operations. Such processes can be formally linked into internal audit planning. Of course, existing sources of risk information should be identified and integrated into internal audit planning.

Other assessment processes including Enterprise Risk Management activities, department self-assessments and other functionspecific reviews in high-impact areas depending on industry (e.g., environmental hazards, cybersecurity threats, etc.), should connect and feed into internal audit processes.

Internal Audit 1

TECHNOLOGY TOOLS AND REALISM ABOUT SURVEYS

In the typical risk assessment, preparatory materials are provided and participants are asked a series of questions during sessions with audit staff. This process is expected to produce information to guide the allocation of resources and activities within internal audit so as to optimize the match between the company’s greatest risks and the corresponding mitigation efforts. The availability of sophisticated technology tools such as online surveys can seem to make it cheap and easy to gather voluminous data from a larger population, and to conduct statistical analysis of that data.

Dr. Hernan Murdock, vice president of the audit division at MISTI, finds surveys and questionnaires to be a technique to collect information. “[Questionnaires] promote risk and control awareness, while encouraging transparency and accountability,” he says.

Potentially, this means we can conduct a much larger assessment with the same resources. There is definitely a place for crowdsourcing risk as well as casting a wide net for particular fact patterns of concern, such as use of third-party sales intermediaries or collection of consumer personal data. Still, more data is not always better data. The essence of a good risk assessment is not popular opinion, mechanically sliced and diced; it is informed opinion and expert judgment applied to the facts. Be careful with gathering far more data than can be followed up on or that can be analyzed meaningfully which can result in human-judgment bottlenecks in the process.

Ordinarily, risk assessments gather information from senior executives and managers, as well as a sample of senior operational personnel in the business units. To the extent that “risk owners” are not in these groups, they are usually sought out, and sometimes manager-level input is also requested.

Front-line workers should be considered as well. It’s usually those who are in the details on a daily basis that have the best perspectives on risks and low-hanging fruit when it comes to increasing operational efficiency.

THE RISK OF THE INTERNAL AUDIT RISK ASSESSMENT

Here we are not talking about the risk assessment that drives the audit plan. Rather, this is the risk that the internal audit function itself will not achieve its objectives as a result of the risk assessment. Should you perform this type of quality engagement as well? See IIA’s Standards for the Professional Practice of Internal Auditing 2120—Risk Management: “The internal audit activity must evaluate the effectiveness and contribute to the improvement of risk management processes.”

The internal audit function in this regard should consider risks such as:

  • The potential that the audit risk assessment is inaccurate or incomplete leading to an ineffective audit plan
  • Audit staffing that is insufficient in terms of quality and capacity to deliver useful results on every engagement
  • Changes in business and risk not promptly identified so that the audit plan can be updated
  • Audit communications failing to provide information organizational stakeholders need, when they need it
  • Governance roles not able to understand audit results and their implications for management of the organization

Internal Audit 2

Beyond Quality: The Four-Part Approach for Audit Efficiency and Effectiveness

STEP 1: PLAN FOR ORGANIZATIONAL GROWTH

While the concept of quality is uniform for internal auditors of different varieties and capacities, effectiveness and efficiency can vary from organization to organization. Accordingly, clear definitions for these terms—the expectations for your team—must be established and adopted to plan for growth.

Use these questions as guidance when defining exactly what effectiveness and efficiency mean for you and your team:

  • Are we equipped with the up-to-date tools needed to conduct the best work possible?
  • Do we have the right resources and skill sets required to deliver our audit plan?
  • Are we contributing to organizational improvement? If so, can others see this?
  • Have we obtained any validation of our team’s quality, such as notification from managers or executives?
  • Is feedback effectively distributed to team members, so they know what areas to improve?
  • What quantifiable metrics can we associate with these definitions?

While you and your team’s definitions of effectiveness and efficiency are crucial, it is also important to gain the approval of key stakeholders involved in internal audit.

A major reason that process improvement initiatives fail, according to one Harvard Business Review article is that the people whose work will be directly impacted are often left out of the process.

Accordingly, feedback from stakeholders at the helm of the financial success of your company should also be incorporated. Here are a few stakeholders who should weigh in on your definitions of effectiveness and efficiency:

  1. Internal stakeholders: Board of directors, audit committee, executives, senior management and department leads
  2. External stakeholders: Regulators, standard-setters, vendors, customers and external audit teams

STEP 2: DO THE WORK NEEDED TO SET EXPECTATIONS

The second step of this process continues to articulate the definitions of effectiveness and efficiency, and sets expectations for your team.

By this stage, you should have an internal definition of effectiveness and efficiency, and you have tempered that definition in the context of what key internal and external stakeholders need. To better set your organization up for success, make these definitions more actionable and specific through the assignation of qualitative and quantitative metrics.

As described in a Forbes article, Forrester reports 74 percent of firms say they want to be “data-driven,” but only 29 percent are actually successful at connecting analytics to action. Actionable insights appear to be the missing link for companies that want
to drive business outcomes from their data.

Make these definitions more actionable and specific for your team by assigning qualitative and quantitative metrics for each. To collect qualitative and quantitative metrics, try the following tactics:

  • Look back at past performance data to determine quantitative metrics:
    • How many audits were scheduled?
    • How many were completed?
    • How was staff utilized?
    • What were the budgeted hours as compared to the actual hours?
  • Go on a listening tour of departments impacted by your work to determine qualitative metrics:
    • What do clients think of your team’s performance?
    • What do other internal stakeholders think of your team’s performance?
    • Do they consider you and your team leaders in their role or order-takers?
    • Would they want to engage in future projects with your team?

With these actionable definitions in hand, the expectations for your team should be crystal clear. It is ultimately up to chief audit executives to hold their teams accountable for efficient and effective—along with quality—work.

STEP 3: CHECK PROGRESS AGAINST SET EXPECTATIONS

To check the quality, effectiveness, and efficiency of your team’s work, internal audit leaders should look at individual performance on an ongoing basis—not just an annual one. After all, it is easier and less problematic for leaders to reevaluate individual performance in small increments before it becomes a major issue.

In organizations of all sizes, a traditional once-per-year approach to employee reviews is fading away in favor of more ongoing ones. As a Washington Post article describes, today’s employees have come to expect instant feedback in many other areas of their lives, and performance reviews should be the same. Besides, the article states, one report found that two-thirds of employees who receive the highest scores in a typical performance management system are not actually the organization’s highest performers.

Chief audit executives should encourage the completion of self-appraisals. A Harvard Business Review article explains that an effective self-appraisal should focus on what you have accomplished and talk about weaknesses carefully, using language with an emphasis on growth and improvement, rather than admonishment. Highlight your team’s blind spots that they might not be aware exists.

In short, employees want more frequent and iterative assessments of their work, and internal audit leaders need to step up to deliver this and ensure quality, effectiveness, and efficiency at all stages.

STEP 4: ACT UPON WHAT YOU HAVE LEARNED

By this step, internal audit leaders have an array of tools at their disposal, including:

  • Actionable definitions of effectiveness and efficiency for their teams
  • Qualitative and quantitative metrics to bolster these definitions
  • Information gathered from self- and manager-guided evaluations
  • An understanding of how team members have performed along these guidelines

With this information in hand, many opportunities for growth are apparent—simply compare where you want your team members to be against where they are right now. By
implementing these fact-based changes into your internal audit processes, leaders set the stage for cyclical organizational and personal improvement.

According to a survey, this type of continuous improvement yields a positive ROI for organizations, helping increase revenue, along with saving time and money—an average annual impact of $6,000. Additionally, these improvements are designed to compound with each cycle.

Just as the approach to monitoring and improving audit quality is ongoing and cyclical—there are always improvements yet to be made—this approach to improving effectiveness and efficiency is fluid as well.

By weaving this four-part process into the fabric of your internal audit methodology, leaders can improve effectiveness and efficiency in their organizations.

 

Click here to access Workiva’s and MISTI’s White Paper

EIOPA: Peer review assessing how National Competent Authorities (NCAs) supervise and determine whether an insurer’s set­ting of key functions fulfils the legal requirements of Solvency II

The main task of the European Insurance and Occupational Pensions Authority (EIOPA) is to

  • enhance supervisory convergence,
  • strengthen consumer protection
  • and preserve financial stability.

In the context of enhancing supervisory convergence and in accordance with its mandate, EIOPA regularly conducts peer reviews, working closely with national competent authorities (NCAs), with the aim of strengthening both the convergence of supervisory practices across Europe and the capacity of NCAs to conduct high-quality and effective supervision.

In line with its mandate, the outcome of peer reviews, including identified best practices, are to be made public with the agreement of the NCAs that have been subject to the review.

BACKGROUND AND OBJECTIVES

Enhancing the governance system of insurers is one of the major goals of Solvency II (SII). The four key functions (risk management, actuarial, compliance and internal audit) as required under the SII regulation are an essential part of the system of governance. These key functions are expected to be operationally independent to ensure an effective and robust internal control environment within an insurer and support high quality of decision making by the management. At the same time it is also important that these governance requirements are not overly burdensome for small and medium-sized insurers. Therefore SII allows NCAs to apply the principle of proportionality in relation to compliance with key function holder requirements for those insurers.

Under SII, insurers may combine key functions in one holder. However, such combinations have to be justified by the principle of proportionality and insurers need to properly address the underlying conflicts of interest. Holding a key function should generally not be combined with administrative, management or supervisory body (AMSB) membership or with operational tasks because of their controlling objective. Thus, these combinations should rather occur in exceptional cases, taking into account a risk-based approach and the manner in which the insurer avoids and manages any potential conflict of interest.

This peer review assesses how NCAs supervise and determine whether an insurer’s setting of key functions fulfils the legal requirements of SII with a particular emphasis on proportionality. The peer review examines practices regarding:

  • combining key functions under one holder;
  • combining key functions with AMSB membership or with carrying out operational tasks;
  • subordination of one key function under another key function;
  • split of one key function among several holders;
  • assessment of the fitness of key function holders; and
  • outsourcing of key functions.

The period examined under the scope of this peer review was 2016 but also covered supervisory practices executed before 2016 in the preparatory stage of SII. The peer review was conducted among NCAs from the European Economic Area (EEA) on the basis of EIOPA’s Methodology for conducting Peer Reviews (Methodology).

Detailed information was gathered in the course of the review. All NCAs completed an initial questionnaire. This was followed by fieldwork comprising visits to 8 NCAs and 30 conference calls.

MAIN FINDINGS

The review showed that NCAs in general apply the principle of proportionality and that they have adopted similar approaches.

SUMMARY RESULTS OF THE COMPARATIVE ANALYSIS

  • Supervisory framework: Approximately half of NCAs use written supervisory guidance for the application of the principle of proportionality. Larger NCAs in particular use written supervisory guidance in order to ensure consistency of their supervisory practice among their supervisory staff.
  • Approach of NCAs: Most NCAs have a similar approach. NCAs assess the insurers’ choice of key function holders at the time of initial notification regarding the key function holder’s appointment. If any concerns are noted at this stage, for example regarding combinations or fitness, NCAs generally challenge and discuss these issues with the insurer, rather than issuing formal administrative decisions.
  • Combining key functions in one holder: This occurs in almost all countries. The most frequent combinations are between risk management and actuarial functions and between risk management and compliance functions. Combinations are most commonly used by smaller insurers but are also seen in large insurers. EIOPA has identified the need to draw the attention of NCAs to the need to challenge combinations more strongly, especially when they occur in bigger, more complex insurers, and to ensure that adequate mitigation measures are in place to warrant a robust system of governance.
  • Holding the internal audit function and other key functions: The combination of the internal audit function with other key functions occurs in 15 countries, although the frequency of such combinations is relatively low. Moreover, there were cases of the internal audit function holder also carrying out operational tasks which could lead to conflicts of interest and compromise the operational independence of the internal audit function. It is important to emphasise that the legal exemption of Article 271 of the Commission Delegated Regulation EU (2015/35) does not apply to the combination with operational tasks.
  • Combining a key function holder with AMSB membership: Most NCAs follow a similar and comprehensive approach regarding the combination of key function holder and AMSB member. In this regard, NCAs accept such cases only if deemed justified under the principle of proportionality. This peer review shows that two NCAs request or support combinations of AMSB member and the risk management function holder regardless of the principle of proportionality in order to strengthen the knowledge and expertise regarding risk management within the AMSB.
  • Combining key function holders (excluding internal audit function holder) with operational tasks: In nearly all countries combinations of risk management, actuarial and compliance key function holders with operational tasks occur, but such combinations generally occur rarely or occasionally. However, several NCAs do not have a full market overview of such combinations with operative tasks. Adequate mitigating measures are essential to reduce potential conflicts of interest when key function holders also carry out operational tasks. The most common combinations are the compliance function holder with legal director and the risk management function holder with finance director.
  • Splitting a key function between two holders: About half of the NCAs reported cases where more than one individual is responsible for a particular key function (‘split of key function holder’). The most common split concerns the actuarial function (split between life and non-life business). NCAs should monitor such splits in order to maintain appropriate responsibility and accountability among key function holders.
  • Subordination of a key function holder to another key function holder or head of operational department: This is observed in half of the countries reviewed. An organisational subordination can be accepted, but there needs to be a direct ‘unfiltered’ reporting line from the subordinated key function holder to the AMSB. In cases of subordination, conflicts of interest have to be mitigated and operational independence needs to be ensured including the mitigating measures concerning the remuneration of the subordinated key function holders.
  • Fitness of key function holders: Most NCAs assess the fitness of the key function holder at the time of initial notification and apply the principle of proportionality. Several NCAs did not systematically assess the key function holders appointed before 2016. These NCAs are advised to do so using a risk-based approach.
  • Outsourcing of key function holders: Most NCAs have observed outsourcing of key function holders. According to the proportionality principle, an AMSB member may also be a designated person responsible for overseeing and monitoring the outsourced key function. Eight NCAs make a distinction between intra-group and extra-group outsourcing and six NCAs do not require a designated person in all cases, which may give rise to operational risks.

BEST PRACTICES

Through this peer review, EIOPA identified four best practices.

  • When NCAs adopt a structured proportionate approach based on the nature, scale and complexity of the business of the insurer regarding their supervisory assessment of key function holders and combination of key function holders at the time of initial notification and on an ongoing basis. The best practice also includes supervisory documentation and consistent and uniform data submission requirements (for example an electronic data submission system for key function holder notification). This best practice has been identified in Ireland and the United Kingdom.
  • When an NCA has a supervisory panel set up internally which discusses and advises supervisors about complex issues regarding the application of the proportionality principle in governance requirements regarding key functions. This best practice has been identified in the Netherlands.
  • When assessing the combination of key function holder with AMSB member, EIOPA considers the following as best practice for NCAs:
    • To publicly disclose the NCA’s expectations that controlling key functions should generally not be combined with operational functions for example with the membership of the AMSB. Where those cases occur, NCAs should clearly communicate their expectation that the undertaking ensures that it is aware of possible conflicts of interest arising from such a combination and manages them effectively.
    • To require from insurers that main responsibilities as a member of the AMSB do not lead to a conflict of interest with the tasks as a key function holder.
    • To assess whether the other AMSB members challenge the key function holder also being an AMSB member.

This best practice has been identified in Lithuania.

  • When NCAs apply a risk-based approach for the ongoing supervision that gives the possibility to ensure the fulfilment of fitness requirements of KFHs at all times by holding meetings with key function holders on a regular scheduled basis as part of an NCA’swork plan (annual review plan). The topics for discussion for those meetings can vary, depending for example on actual events and current topics. This best practice has been identified in Ireland and the United Kingdom.

These best practices provide guidance for a more systematic approach regarding the application of the principle of proportionality as well as for ensuring consistent and effective supervisory practice within NCAs.

EIOPA NCA KFH

Click here to access EIOPA’s full report on its Peer Review

 

How the Distinct Roles of Internal Audit and the Finance Function Drive Good Governance

How the Distinct Roles of Internal Audit and the Finance Function Drive Good Governance

Effective governance involves many individuals and departments throughout an organization, including the Board of Directors, executive management, finance, and internal audit, among others. Yet each of these groups has a different set of skills and responsibilities. To successfully identify and manage risk, they must come together to create and maintain a sound system of corporate governance.

The insights shared here by 11 governance experts offer important perspective as to how finance and internal audit collaborate to support corporate governance, despite their distinct and separate missions.

Interviewees provided perceptions and experiences and shared best practices, as well as challenges, that they have encountered on their quest to achieve effective governance. These contributors come from organizations around the world that differ in size, industry, and management configurations. Several experienced governance from within both the finance function and internal audit.

A few shared perceptions include:

  • The Board of Directors is responsible for setting the proper tone for the organization;
  • It is critical to purposefully develop a consistent culture throughout the organization, driven by the CEO and senior management; and
  • Communication and coordination across complementary functions is vital.

Keys To Achieving Good Governance

There are many different definitions of governance. According to The Institute of Internal Auditors (hereafter The IIA), governance is “the combination of processes and structures implemented by the board in order to inform, direct, manage and monitor the activities of the organization toward the achievement of its objectives.

The International Federation of Accountants (hereafter IFAC) uses a slightly different definition which focuses more on the creation of strategic objectives and stakeholder value, “Governance is to create and optimize sustainable organizational success and stakeholder value, balancing the interests of the various stakeholders. It comprises arrangements put in place to ensure that organizations define and achieve intended outcomes.

Both definitions suggest that good governance and the achievement of organizational success are not the responsibility of the Board alone, but rather the outcome of a mosaic of organizational policies, processes, and cross-functional interactions.

When asked to provide the key objectives of governance, interviewees shared a number of different perspectives. Most frequently, good governance was defined as representing the interests of stakeholders by setting appropriate objectives and driving a culture that supports them.

Three LoD

Click here to acces IFAC and IIA’s detailed article