The Georgia Scroll
October 1997
Managed care arrangements, as well as health-care-sponsored managed care organizations, are growing all over the country-and in Georgia. Health care organizations are setting up their own HMO's and provider sponsored networks, as well as expanding their risk contracts through the hospital, physician and hospital organizations and other entities. As these type arrangements become more significant, the accounting and reporting requirements become more relevant.
A decision was made by the AICPA to defer additional guidance on the accounting and reporting requirements in the managed care area until after the healthcare audit guide was released. A task force has now been set up by the AICPA that includes representatives from the AICPA insurance committee, the AICPA healthcare committee, as well as representatives from the insurance and healthcare industries, to address the relevant accounting and reporting issues. A draft SOP is expected to be released for public review and comment during the summer or fall of 1997.
One of the overriding concepts that the task force has agreed to is that the accounting and reporting for managed care arrangements should be consistent, regardless of whether the activity is part of an insurance company or part of a health care organization. There are areas where health care organizations (whose accounting is governed by the healthcare audit guide, except for governmental entities who follow GASB Statements 10 and 30), and insurance companies (whose accounting is governed by SFAS No. 60, Accounting and Reporting by Insurance Enterprises), are accounting for similar transactions differently. Additionally, there is a concern that a diversity in application of existing authoritative guidance has developed throughout both industries as products have evolved to meet market needs.
Scope of the SOP
The scope of the SOP is intended to include all transactions where medical insurance risk of providing health care services is assumed or transferred, as well as transactions relating to the administration of the costs of providing health care services. Medical insurance risk relates to the risk from uncertainties about the frequency, severity, and health care costs of medical services rendered. Accordingly, per diem, DRG, fee for service, and various other payment arrangements would be excluded from the scope of the SOP because the risk of frequency of service is not assumed under these type of arrangements. The scope will include the traditional indemnity type insurance arrangements. It is also likely that governmental entities will be included in the scope of the SOP, which would be important to the Authority hospitals in Georgia.
Classification and Reporting of Revenues
The healthcare audit guide requires that premium revenues, where medical insurance risk is assumed or transferred, be separately displayed from patient revenues. Another issue is the extent that revenues for providing administrative services, or claims processing, should be segregated from premium and patient revenue. There are arrangements where the premium and claims processing revenues are combined and not clearly distinguishable. The SOP will provide guidance on separately reporting these revenue categories.
An additional issue relates to reporting of administrative services revenues and expenses. If no, or minimal medical insurance risk is assumed, it is unlikely the SOP will support a gross presentation of claims processed as revenues. Only the fees earned for performing administrative services would qualify as revenues.
Reinsurance
Insurance companies (under SFAS No. 60) and governmental entities (under GASB Statement No. 10) reduce premium revenues by the amount of ceded insurance. Stop loss premiums are required to be recorded as a medical expense by health care companies under the health care audit guide. Recoveries under stop loss arrangements are to be recorded as reductions of medical expenses. The ceding concept of insurance companies is very similar to stop loss insurance arrangements. It is likely that there will be a change proposed in the draft SOP to make the financial reporting for stop loss premiums more consistent with the insurance industry approach to ceding off levels of insurance. This approach would require stop loss premiums to be reported as a reduction in premium revenue with stop loss recoveries continuing to be reported as a reduction in medical expenses.
Loss Contacts
One of the more significant issues of the draft SOP relates to the measurement process to determine if a loss exists under a managed care contract or group of contacts. The healthcare audit guide requires that a loss be recognized when it is probable that expected future healthcare costs and maintenance costs under a group of existing contracts will exceed anticipated future premiums and stop loss insurance recoveries. The requirement is for all costs to be considered in that measurement process. All costs include fixed and variable, as well as direct and indirect. The insurance industry concept is that a premium deficiency (equivalent to loss contract) exists for a group on contracts when the sum of expected claim costs and claims adjustment expenses, expected dividends to policy holders, unamortized acquisition costs, and maintenance costs exceed related unearned premiums. Governmental entities use a definition similar to that of the insurance industry except that maintenance costs are not to be included in the calculation.
The task force has recognized that the pricing of managed care contracts does not always consider all costs. In many instances, the incremental costs of a single new contract may be substantially less than a full cost approach. The draft SOP will give more consideration to a definition of costs that vary with the contract or contracts, grouped for the purpose of determining if a loss exists. Accordingly, the grouping requirements will likely be more flexible than required by the healthcare audit guide, but will need to be consistent from period to period.
Contract Acquisition Costs
Contract acquisition costs generally include costs such as broker's commissions or bonuses (or similar costs of employees that fill a similar function), governmental assessments based on premiums, and other costs relating to acquiring new managed care contracts. Those costs relating to initial losses of starting a new product, developing a health care network, or other costs relating to a start-up or pre-operating type situations are not considered contract acquisition costs. A separate draft SOP was issued by the AICPA in April of 1997 on -Reporting on the costs of Start-Up Activities+ that addresses the proposed accounting for these types of costs.
The healthcare audit guide requires that contract acquisition costs be expensed. SFAS No. 60 and GASB Statement No. 10 require that the insurance industry and governmental entities capitalize such costs and amortize them over the contract period. Further, examples of the types of costs capitalized by insurance companies included salaries of certain employees involved in the underwriting and policy issue functions.
The draft SOP will attempt to reconcile these two positions and provide an approach that could be applied consistently based on the type of transaction, rather than the type of industry performing the transaction. There is a good chance that both industry groups will require some change in the approach used in the past. However, contract acquisitions costs are probably much more significant with respect to indemnity type products than with HMO type products.
IBNR
The accrual of incurred but unreported claims for the insurance industry and the healthcare industry, for the types of products included in the scope of the draft SOP, may be determined using different conceptual approaches. It is difficult to make a generalization about these conceptual approaches. We do know there can be significant differences in the obligations required by the variety of managed care contracts. These differences can result from contract terms, legal requirements, or possibly the historical payment patterns of an organization providing health care services under managed care arrangements. The differences may be accentuated when comparing indemnity type contact to HMO type contracts.
The primary question centers around (1) what is the event that triggers a liability (such as diagnosis or hospital admission) and (2) when does that liability cease (such as when the patient is discharged from hospital or when the patient has completed all required medical treatment for the spell of illness), and does the obligation cease when the member discontinues paying premiums. If an organization has incurred a liability under a managed care contract, and it continues whether premiums are paid or not, those costs would qualify as IBNR whether you refer to guidance in SFAS No. 60, GASB Statements 10 and 30, or the healthcare audit guide.
The draft SOP will address this issue and propose an approach that will consider contractual, legal and customary practices relating to managed care contracts.
Financial Statement Display
There are at least two areas of financial statement display that will be addressed in the draft SOP. First, the issue of whether managed care organizations should present a classified balance sheet (i.e., current assets and current liabilities) or a non-classified balance sheet. There is support for a classified balance sheet because of the short duration of managed care contracts. The insurance industry presents its financial position on a non classified basis because long duration insurance contracts do not lend themselves to a current asset and liability classification based on a one year operating cycle. The health care audit guide requires a classified balance sheet.
The other issue relates to the statement of operations (income statement) and how much disclosure is required of health care costs applicable to premium revenue. The relationship between premium revenue and its applicable costs would be a meaningful disclosure. However, a health care organization would have difficulty breaking out separate healthcare costs applicable to premium revenue and patient service revenue. The draft SOP will address this issue and provide a recommended approach.
Applicability of SOP's
There are four AICPA Statement of Positions (SOP's) relating to insurance companies that could be related to managed care organizations. The SOP's are as follows:
The draft SOP on managed care will address to what extent the above SOP's will apply to managed care entities. It is expected that those managed care entities that are regulated by a state insurance department, or similar organization, will be expected to follow the SOP's.
SUMMARY
The healthcare industry is rapidly changing in many ways, including a greater concentration of managed care arrangements. The existing guidance in the health care audit guide (health care entities, including HMO's), GASB Statements No.'s 10 and 30 (governmental entities), and SFAS No. 60 (insurance entities) do not adequately address all of the current issues as they relate to financial reporting and accounting requirements. A draft SOP will be issued by the AICPA this year to address these financial reporting and accounting issues for managed care contracts, regardless of whether it is being handled by an insurance entity or a healthcare entity.
The process to finalize the SOP includes a public comment period and approval by the AICPA's AcSEC, the FASB and the GASB. The draft SOP should provide a good idea as to the potential new requirements relating to accounting and reporting for managed care arrangements. The extensive process involved in getting a final SOP issued could result in changes to the proposed approaches. Be sure and submit your comments when the draft SOP becomes available later in the year.
Terry is a partner with Arthur Andersen LLP and is presently serving on the AICPA's Healthcare Committee, as well as AICPA's managed care task force.