July 2003

The Audit as Insurance Policy

A clean opinion issued by a CPA firm has evolved by legal precedent to serve a role similar to that of a primary insurance policy. The firm’s malpractice policy plays the role of reinsurance coverage. This means that the CPA’s audit report can be thought of as an insurance underwriting function where the auditing firm is like a “fronting” carrier.

Given this state of affairs, why not allow insurance carriers to acquire CPA firms? In such an arrangement, the auditing firm could refer consulting or nonattest work to the insurance carrier. The division of auditing net profits should not be difficult to resolve. The potential nonattest profits could be incorporated into the original purchase price. To the investing public, the insurance carrier’s net worth would represent a mark of the highest confidence. The liability of the insurance carrier would be an effective barrier to the undue exercise of improper influence by clients that might result from high consulting fees. The insurance carrier would undoubtedly spread its risk by accessing the reinsurance market.

Under this structure, I believe professional competence would rise and fees would decrease as the effect of high malpractice premiums would gradually but steadily dissipate.

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