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July 14, 2008

Insurance industry warns liability caps will not lower premiums

An insurance leader has warned a Europe-wide auditor liability cap will not lead to cheaper insurance for firms and could weaken the credibility of audit reports in the case of litigation. The EC last month fanned the auditor liability debate by recommending member states consider adopting up to three proposed models to cap liability.

Introducing the recommendation, Internal Market and Services commissioner Charlie McCreevy said the EC concluded unlimited liability combined with “insufficient” insurance cover is no longer tenable.

“It is a potentially huge problem for our capital markets and for auditors working on an international scale. The current conditions are not only preventing the entry of new players in the international audit market, but are also threatening existing firms. In a context of high concentration and limited choice of audit firms, this situation could lead to damaging consequences for European capital markets,” he said.

Artificial imbalance

But the recommendation, which was largely welcomed by the accounting profession, has come under attack by the European insurance and reinsurance federation (Comité Européen des Assurances – CEA). Federation vice-president Gérard de la Martinière told The Accountant liability caps would create an artificial imbalance between the liability of auditors and unlimited liability of management.

de la Martinière said he has seen no evidence of a lack of insurance coverage for audit firms, and believes auditors: “do not like to pay too much to get this coverage [but] claim that they need a cap to limit their spending”.

However, David Radley-Searle, a partner and director of the International Business Centre at Spanish firm Grant Thornton Audihispana, said there is ample evidence insurance premiums have risen in recent years and limiting liability should provide some relief on the cost of coverage.

“We have seen now clear signals in Spain that a limitation of liability would give rise in the short-time to lower premiums or better thought out insurance cover,” he said. “The market force is at play here and at the end of the day if insurance people realise that their risk is lowered due to [less] collateral risk [for] class actions or third parties, because the auditor is going to be liable for his or her actions, then it should lead to cheaper insurance.”

He suggested liability caps could even benefit the insurance industry by allowing more players to enter the audit firm market. Radley-Searle said limiting liability would benefit the mid-tier to a degree, as unlimited liability is a market entry barrier when pitching to larger quoted companies, but it would not influence the type of work or strategy firms pursue.

Out of the three models presented by the EC – applying a liability cap, introducing proportionate liability or allowing liability to be limited by contract – the Grant Thornton member firm prefers a model of proportionate liability where any damages should be proportional to the damage that has been caused.

de la Martinière admits steps should be taken to restrict the liability placed on auditors, which has spiralled out of control in recent years as regulators have imposed more rules and responsibilities on auditors in the wake of corporate failures such as Enron.

He is calling for an international approach to liability reform and believes legislators need to revise the scope of the auditor’s role and strip back certain functions and responsibilities.

However, he says there could be professional resistance to reducing the responsibility of the auditor’s role because expanding it “meant more fees, but on the other hand they do not like the liability which is associated to this extension of their role”.

LIABLILITY CAPS Choosing the right model

The European Commission has proposed member states follow one or more of the following methods:

(a) establishment of a maximum financial amount or of a formula allowing for the calculation of such an amount;

(b) establishment of a set of principles by virtue of which a statutory auditor or an audit firm is not liable beyond its actual contribution to the loss suffered by a claimant and is accordingly not jointly and severally liable with other wrongdoers;

(c) provision allowing any company to be audited and the statutory auditor or audit firm to determine a limitation of liability in an agreement. <

Source: European Commission

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