How to Conduct an Internal Audit: A Step-by-Step Guide for Insurance Companies

Internal audits are critical for insurance companies to maintain regulatory compliance, manage risk effectively, and protect policyholders. Whether you're a small regional carrier or a growing MGA, a structured internal audit process helps you identify vulnerabilities before regulators do.

Why Internal Audits Matter for Insurance Companies

The insurance industry faces unique compliance challenges. State insurance departments, the NAIC, and federal regulators like the DOL (for employee benefits) all have specific requirements. A robust internal audit program helps you:

• Detect compliance gaps before regulatory examinations

• Identify operational inefficiencies that erode profitability

• Protect against fraud and financial misstatement

• Demonstrate good governance to stakeholders and rating agencies

• Reduce the likelihood of enforcement actions and fines

Step 1: Define Your Audit Scope and Objectives

Before you begin, clearly establish what you're auditing and why. For insurance companies, common audit areas include:

Underwriting and Pricing

• Are underwriting guidelines being followed consistently?

• Is pricing adequate for the risk being assumed?

• Are exceptions to underwriting standards properly documented and approved?

Claims Management

• Are claims being handled in compliance with policy terms and regulatory requirements?

• Is claims handling timely and adequately documented?

• Are reserves appropriate and regularly reviewed?

Premium Collection and Accounting

• Are premium payments being processed accurately and timely?

• Are trust accounts properly maintained and reconciled?

• Are unearned premium calculations accurate?

Regulatory Compliance

• Are rate filings current and approved in all operating states?

• Are policy forms compliant with state requirements?

• Are required reports submitted on time?

• Is producer licensing properly verified?

Information Security and Data Privacy

• Are customer data protection measures adequate?

• Do you comply with state data breach notification laws?

• Are systems protected against cyber threats?

Choose 2-3 focus areas for each audit cycle rather than trying to audit everything at once.

Step 2: Assemble Your Audit Team

Determine who will conduct the audit. Options include:

• Internal audit department - if you have one, they should lead

• Finance or compliance staff - for smaller companies without dedicated audit resources

• External consultants - bring objectivity and specialized expertise

• Cross-functional team - combine internal knowledge with independent oversight

The key is ensuring auditors have sufficient independence from the areas they're examining. The person auditing claims shouldn't report directly to the claims manager.

Step 3: Develop Your Audit Plan

Create a detailed work plan that includes:

Timeline: When will fieldwork begin and end? When is the report due?

Methodology: Will you review samples or conduct a comprehensive review? What sampling approach will you use?

Documentation Requirements: What records will you need to examine? Examples include:

• Underwriting files

• Claims files and adjuster notes

• Premium processing records

• Regulatory correspondence

• Producer agreements and commission statements

• Board and committee minutes

• Policy and procedure manuals

Testing Procedures: Specify exactly what you'll test. For example, "Review 30 randomly selected claims files from Q4 to verify compliance with claim handling procedures and state-specific requirements."

Success Criteria: Define what "good" looks like so you can measure performance objectively.

Step 4: Conduct Fieldwork and Gather Evidence

This is where the actual audit happens. Best practices include:

Document Everything: Take detailed notes, create testing workpapers, and maintain an audit trail. If you can't document it, you can't prove it.

Use Checklists: Develop standardized checklists for repetitive testing to ensure consistency and completeness.

Interview Key Personnel: Talk to underwriters, claims adjusters, and customer service staff to understand how processes actually work versus how they're supposed to work.

Test Controls: Don't just review transactions. Test whether control procedures (like supervisory reviews, dual signatures, or system edit checks) are functioning as designed.

Look for Patterns: A single error might be a one-off mistake. Multiple similar errors suggest a systemic problem.

Common Red Flags in Insurance Audits:

• Frequent underwriting exceptions without documented justification

• Claims files missing required documentation

• Delays in claims processing beyond state requirements

• Premium trust accounts not reconciled monthly

• Producers operating with expired licenses

• Rate filings used before regulatory approval

• Inconsistent application of underwriting criteria

Step 5: Analyze Findings and Assess Risk

Once you've gathered evidence, analyze what you found:

Categorize Findings by Severity:

• Critical: Regulatory violations, fraud indicators, or issues posing immediate financial or reputational risk

• High: Significant control weaknesses that could lead to material errors or compliance failures

• Medium: Process inefficiencies or minor compliance gaps

• Low: Best practice recommendations

Identify Root Causes: Don't just note that something went wrong. Determine why. Was it inadequate training? Unclear procedures? System limitations? Insufficient staffing?

Quantify Impact When Possible: If you found pricing errors, estimate the financial impact. If claims handling is slow, calculate how many files exceed regulatory timeframes.

Step 6: Draft Your Audit Report

Your audit report should be clear, actionable, and appropriate for your audience (board, management, regulators if required). Include:

Executive Summary: High-level overview of scope, methodology, and key findings

Detailed Findings: For each issue identified, document:

• What you found (the condition)

• What should have happened (the criteria)

• Why it matters (the impact/risk)

• Why it happened (root cause)

• What should be done (recommendation)

Management Response: Give the audited area an opportunity to respond to findings and propose corrective actions

Action Plan: Document specific remediation steps, responsible parties, and target completion dates

Positive Observations: Don't only focus on problems. Note areas of strong performance to encourage good practices.

Step 7: Follow Up on Remediation

An audit is only valuable if issues get fixed. Establish a follow-up process:

• Schedule status check-ins with management (30, 60, 90 days after the report)

• Track remediation progress in a centralized log

• Verify that corrective actions were implemented as promised

• Escalate to senior management or the board if deadlines are missed

• Consider follow-up testing in the next audit cycle for critical findings

How Often Should You Audit?

For insurance companies, consider this framework:

• High-risk areas (underwriting, claims, regulatory compliance): Annually

• Medium-risk areas (IT security, vendor management): Every 18-24 months

• Lower-risk areas (HR policies, facilities): Every 2-3 years

• Ad-hoc audits: Whenever there's a significant process change, system implementation, regulatory change, or suspected problem

Common Mistakes to Avoid

Scope Creep: Stay focused on your defined objectives. Don't try to audit everything at once.

Audit Fatigue: Spread audits throughout the year so operational areas aren't constantly disrupted.

Audit for Audit's Sake: Every finding should have a clear business purpose. Don't nitpick minor issues that don't create meaningful risk.

No Follow-Through: The most thorough audit is worthless if recommendations aren't implemented.

Poor Documentation: If you can't recreate your testing and conclusions, your audit won't hold up to scrutiny.

Getting Started

If you've never conducted an internal audit or want to strengthen your program, start small:

1. Choose one high-risk area for your first audit

2. Develop a simple but thorough checklist

3. Test a sample of transactions or files

4. Document findings clearly

5. Work with management to remediate issues

6. Learn from the process and refine your approach

Internal audits don't have to be intimidating or resource-intensive. Even a modest audit program is better than none, and you can build sophistication over time as your company grows.

Need help establishing an internal audit program for your insurance company? Our team specializes in helping carriers build practical, cost-effective audit and compliance frameworks tailored to their size and risk profile. Contact us to discuss how we can support your compliance objectives.