A physician group carries a professional liability policy. Its books show the annual premium as expense and nothing else. There is no liability for open claims, none for incidents that have not yet been reported, and no insurance receivable. The bookkeeper reasons that the insurer will pay everything, so there is nothing to record. For a health care entity that reasoning is a departure from GAAP, and it misstates both sides of the balance sheet.
Revenue is the usual focus of health care audits, and it is covered in /us/blog/hospital-audit-net-patient-service-revenue-and-charity-care and /us/blog/healthcare-practice-audit-patient-revenue-and-contractual-adjustments. This guide covers the liability side: how ASC 954 treats malpractice claims, insurance coverage and the presentation that follows.
Who applies ASC 954?
ASC 954 applies to entities whose principal operations consist of providing or agreeing to provide health care services and that derive all or almost all of their revenues from the sale of health care services and related goods. It also covers entities whose primary activities are planning, organizing and overseeing such entities, such as parent or holding companies. In scope are clinics and surgery centers, continuing care retirement communities, health maintenance organizations, home health agencies, hospitals, nursing homes, rehabilitation centers and integrated delivery systems. Ownership can be investor-owned, not-for-profit or governmental.
Health care entities, including not-for-profit, business-oriented ones, classify assets and liabilities as current and noncurrent. A continuing care retirement community may instead sequence assets by nearness to cash and liabilities by nearness of maturity (ASC 954-210-45-1, FASB ASU 2016-14). The statement of operations of a not-for-profit, business-oriented health care entity includes a performance indicator (ASC 954-225-45-4, FASB ASU 2016-14). Liquid assets whose use is limited are reported separately from similar unrestricted assets, and these organizations distinguish internally designated funds from funds whose use is contractually limited by external parties or donors, either on the face of the balance sheet or in the notes (PwC).
When is a malpractice liability recorded?
The ultimate costs of malpractice claims or similar contingent liabilities, including the costs of litigating or settling claims, are accrued when the incidents that give rise to the claims occur (ASC 954-450-25-2, FASB ASU 2010-24). A health care entity that has not transferred risk to an external third party evaluates its exposure to malpractice losses and recognizes a liability, if appropriate. ASC 954-450-25-2 points to ASC 720-20-25 and ASC 944-40 for insurance claims costs, including incurred-but-not-reported claims, and to ASC 450-20 for loss contingencies. The larger an entity's volume of operations, the more likely it is that one or more unreported incidents occurred before the balance sheet date. It would be unusual to have no accrual for incurred but not reported (IBNR) claims.
Estimates rely on all available evidence, which can include industry experience, and many providers use actuaries when the liability is likely to be material (PwC). The costs of litigating or settling claims are part of the accrual, as the ASC text above says.
Estimates are reviewed at every reporting date, and changes are recognized in the period the estimate changes. Accrued unpaid claims expected to be paid within the normal operating cycle are current liabilities. The rest are noncurrent.
Can the liability be discounted?
Discounting of accrued claims is a policy area that needs support. PwC, summarizing the AICPA health care audit guide, describes discounting as appropriate only when the amount of the liability and the amount and timing of payments are fixed or reliably determinable, with any expected insurance recoveries discounted on the same basis. Where a provider discounts, read the disclosure of the carrying amount of discounted claims and the rates used.
How are insurance recoveries presented?
ASC 954-450-25-2, as amended by ASU 2010-24, is the key paragraph. The liability is not presented net of anticipated insurance recoveries. An entity that is indemnified for these liabilities recognizes an insurance receivable at the same time it recognizes the liability, measured on the same basis as the liability, subject to a valuation allowance for uncollectible amounts (FASB ASU 2010-24). The claim liability is determined without regard to insurance recoveries, and ASU 2010-24 ties the gross presentation to the ASC 210-20 offsetting guidance, which does not permit offsetting a liability against anticipated insurance recoveries from third parties. A fully insured claim therefore reports a liability and an equal receivable, and the net effect on expense is zero. PwC notes this holds even when the policy has first-dollar coverage or the carrier pays the plaintiff directly on the entity's behalf, because the entity remains the primary obligor if the insurer cannot pay.
The same presentation applies to similar contingent liabilities, since the paragraph covers malpractice claims or similar contingent liabilities, such as workers' compensation claims in PwC's reading.
Retrospectively rated policies
A retrospectively rated policy is one whose ultimate premium is based primarily on the entity's own loss experience. The entity expenses the minimum premium over the period of coverage and accrues estimated losses from asserted and unasserted claims in excess of the minimum premium, but not in excess of the stipulated maximum premium. Insurance recoveries under such a policy are not recognized until estimated losses exceed the stipulated maximum premium (ASC 954-720-25-1, FASB ASU 2010-24).
Self-insurance and trust funds
To the extent claims are self-insured, no insurance receivable is recorded. Estimated losses from asserted and unasserted claims are accrued, and the estimated losses are not based on payments to a trust fund (ASC 954-450-25-3, FASB ASU 2010-24). An entity that transfers its risk of loss by participating in a common trust fund and forfeits its rights to any excess funding expenses its contributions and accounts for the participation based on the type of coverage obtained, such as occurrence basis, claims-made or retrospectively rated (ASC 954-720-25-5, FASB ASU 2010-24). Assets held in a self-insurance trust for the entity's own claims stay on its balance sheet, and PwC notes that not-for-profit providers classify them as assets whose use is limited.
Worked entries
All figures are illustrations.
Accruing claims with insurance. At year end a hospital estimates $1,000,000 for asserted claims and IBNR. Insurance covers $800,000 of that amount and the insurer is creditworthy.
| Account | Debit | Credit |
|---|---|---|
| Malpractice expense | 1,000,000 | |
| Estimated malpractice claims liability | 1,000,000 | |
| Insurance receivable | 800,000 | |
| Malpractice expense | 800,000 |
Net expense is the $200,000 retained.
Retrospectively rated premium. A hospital's policy has a $100,000 minimum premium and a $400,000 stipulated maximum premium, and the premium depends mainly on the hospital's own losses. The hospital estimates $300,000 of losses on claims. It pays the minimum premium and expenses it over the coverage period, then accrues the losses in excess of the minimum premium: $300,000 less $100,000, or $200,000, which stays below the maximum premium.
| Account | Debit | Credit |
|---|---|---|
| Prepaid insurance (expensed over the policy term) | 100,000 | |
| Cash | 100,000 | |
| Malpractice expense | 200,000 | |
| Estimated malpractice claims liability | 200,000 |
Total cost for the period is $300,000, the $100,000 minimum premium plus the $200,000 accrual. No insurance receivable is recorded unless estimated losses exceed the $400,000 maximum premium. PwC's health care guide illustrates the same policy type by expensing the minimum premium, carrying the experience-based payment as a deposit asset and accruing the estimated losses, so match the entity's presentation to the policy terms.
Funding a self-insurance trust.
| Account | Debit | Credit |
|---|---|---|
| Self-insurance trust assets (assets whose use is limited) | 300,000 | |
| Cash | 300,000 |
No expense is recorded for the funding, because the estimated losses are not based on payments to the trust fund. Expense stays tied to the accrual of estimated losses.
Disclosures
Health care entities disclose the program of malpractice insurance coverage: the nature of the coverage, such as claims-made or occurrence based; terms such as the self-insured retention and excess levels; and the expected insurance recoveries and the basis for the related loss accruals. They also disclose the carrying amount of discounted claims and the rates used.
Audit angle
- Completeness of claims. Obtain the claims log, incident reports and the loss run from the carrier. Compare to the legal letter responses. See /us/blog/legal-letters-attorney-inquiries-how-to-send-and-evaluate.
- IBNR. A zero IBNR for an operating provider is a lead. Ask for the actuarial report, test its data and assumptions, and consider whether the actuary is a specialist. See /us/blog/using-the-work-of-a-specialist-au-c-620.
- Gross presentation. Agree the liability and receivable to the policy terms. Confirm the liability is not shown net.
- Receivable recoverability. Confirm coverage with the broker or carrier, review reservation-of-rights letters, and test the allowance.
- Policy structure. For retrospectively rated policies, read the minimum and maximum premium terms and test the split between the premium expense and the accrual for losses above the minimum.
- Trust. Confirm trust balances with the trustee, test the classification of the assets, and test that expense follows the loss accrual and not the funding.
- Discounting. If the entity discounts, test the conditions for discounting, the rate, and that expected recoveries are discounted on the same basis.
- Disclosure. Compare the note to the policy.
Common misstatements: expensing premiums as the only recognition, no IBNR accrual, netting the recovery against the liability, expense recorded when a trust is funded, and the whole liability classified as noncurrent.
CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.
Sources
- FASB, ASU 2010-24, Health Care Entities (Topic 954): Presentation of Insurance Claims and Related Insurance Recoveries (text of ASC 954-450-25-2, 954-450-25-3, 954-720-25-1 and 954-720-25-5): https://storage.fasb.org/ASU2010-24.pdf
- FASB, ASU 2016-14, Not-for-Profit Entities (Topic 958) (text of ASC 954-210-45-1 and 954-225-45-4): https://storage.fasb.org/ASU_2016-14.pdf
- PwC Viewpoint, Health care entities guide (PDF), chapter 6.4 Loss contingencies and insurance coverage and chapter 1.1 Overview and scope: https://viewpoint.pwc.com/content/dam/pwc-madison/ditaroot/us/en/pwc/accounting_guides/health-care/asset/pwchealthcare0323.pdf
- PwC Viewpoint, Not-for-profit entities guide, 2.3 Presentation of assets and liabilities (classified balance sheet, assets whose use is limited): https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/not-for-profit-entities/Not-for-profit-entities/Nfp02_1/23_Presentation_of_assets_4.html
- PwC Viewpoint, Not-for-profit entities guide, 3.1 Statement of activities overview (statement of operations): https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/not-for-profit-entities/Not-for-profit-entities/Nfp03_1/31Overviewofthestatement.html
Part of CORAA University · US GAAP for private companies: related guides, calculators and templates.
AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error