By Huggins Actuarial Services, Inc.
- Historical Loss Experience Method- using the healthcare entity’s own loss experience. This method may result in difficulties if the entity’s loss experience is not credible enough to be used to derive an estimate of the gross losses for which the entity is liable.
- Increased Limits Factor Method – gross layers are estimated by relying on the estimated losses in the retained layer and using an increased limits factor (ILF) to apply a theoretical increase for losses above the retained limits. Depending on the limits purchased by the entity and the factors available (usually from industry data), the ILF may have to be estimated, increasing the uncertainty of the estimate.
- Commercial Premium Method- using the commercial premium charged by the excess carrier or reinsurer and removing the profit, expenses, contingencies, and risk loads to arrive at the pure losses (pure premium) in the layer. This method may result in varying estimates depending on the commercial data used, since carriers tend to target differing types and locations of business and provide different debits and credits depending on the loss history and size of the risk. In addition, since current premiums are a function of past loss experience, two different companies rating the same risk could produce different estimates even if the other factors are identical.
Introduction
In August 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-24, Health Care Entities (Topic 954): Presentation of Insurance Claims and Related Insurance Recoveries. Under existing authoritative guidance, a health care entity could net its estimated liabilities from malpractice or similar claims against the estimated insurance recoveries. ASU 2010-24 no longer permits netting of the recoveries and estimated liabilities. Instead, the health care entity will be required to present the full estimated liability in its financial statements, as well as an asset for the estimated receivable for the amount covered by insurance policies. This accrual also includes claims that had occurred but had not been reported as of the fiscal year-end (IBNR claims) if there is coverage under a claims-made insurance policy, as there is no guarantee that the policy would be renewed and be in force when the claims were reported in the future. ASU 2010-24 is effective for fiscal periods beginning after December 15, 2010 (i.e. December 2011 and June 2012 fiscal year-ends).
As a result of ASU 2010-24, health care entities must now recognize on their balance sheets the full estimated liability to be incurred as a result of malpractice claims that have occurred as of the date of the financial statement. A receivable will also be recognized on the balance sheet to reflect the estimated insurance recoveries from the coverage purchased by health care entities. For most health care entities, this new method of accounting will result in a “gross up” on its balance sheet and not impact the statement of operations. However, in some instances, ASU 2010-24 will result in a different net amount between the related assets and liabilities. For example, if the total amount of claims for a given year exceeds the aggregate amount of coverage available under the entity’s insurance policy.
The implementation of ASU 2010-24, while potentially achieving greater consistency in financial reporting, will likely raise a number of questions:
- What is the expected impact on the healthcare entity’s financial statements?
- What are the potential challenges of implementing ASU 2010-24?
- How can the gross liability and anticipated recoveries receivable be estimated?
Involving Actuaries When Evaluating the Impact of ASU 2010-24
Under ASU 2010-24, actuaries will need to estimate the recoverable asset. Although the method the actuary uses is the ultimate choice of the actuary, the following methods can be employed:
In order to calculate the gross value of malpractice liabilities for a healthcare entity, it is important to provide the actuary with a complete loss run as of the desired evaluation date, with a listing for each claim, including companion claims. Each record should contain the following information:
a. Insured
b. Claimant (or some other form of identifier)
c. Line of Business (GL, IPL or HPL)
d. Accident Date
e. Report Date
f. Paid-to-date Losses
g. Paid-to-date Defense and Cost Containment (Legal) Expenses
h. Current Loss Reserve
i. Current Defense and Cost Containment Expense Reserve
j. Claim Status (Open, Closed)
The actuarial report under ASU 2010-24 will be different from the prior reports that may have been presented to the healthcare entity. Since the new report includes calculations of both the total liability and the previously calculated net liability, there will be an additional item for management to consider in setting the reserve level for their financial statements. In addition, since an actuarial report typically provides a range of reasonable results for each liability item in the analysis, the entity will need to discuss with their external auditors whether the selected levels of reserves are acceptable. Once management has decided on the carried level of gross reserves and reserves net of reinsurance (or self-insurance, as appropriate), they can determine the offset for reserves covered by insurance, taking into account the considerations discussed above and below.
While the discussion above has focused on liabilities related to Medical Professional Liability, the new accounting standard applies to all liabilities of a healthcare entity that could be covered by insurance. This means that in addition to malpractice, the entity should also consider the potential effect on its financial statements of claims under the following types of insurance:
· Workers’ Compensation Insurance
· Commercial Auto Liability Insurance
· Aircraft Insurance
· Accident and Health Insurance
Conclusion
When FASB issued ASU 2010-24, the intent was to address diversity in accounting for insurance claims and related recoveries for health care entities compared to other entities. However, as with most changes in accounting, other factors are raised when adopting ASU 2010-24 that health care entities may not have considered in the past. Consulting with their actuaries prior to the year-end closing, as well as discussing the significant factors with the entity’s auditors, will help prevent additional adjustments to the financial statements.
Meet The Experts
Review articles and blog posts by our list of insurance experts!
Click Here For Participating Firms
VIEW RATINGS FOR INSURERS
Enter name of Insurance Company and press GO button.