Audit and Enterprise Risk Services
Balance Sheet Presentation of a Claim Liability and the Related Insurance Recovery
Financial Reporting Alert 12-4
This alert applies to all entities that have certain claim liabilities (e.g., malpractice, workers’ compensation, and officers’ and directors’ claims, herein referred to as “claim liabilities”) and that have purchased insurance policies to protect against losses from those claims. We recommend that you consult with a professional adviser if you have any questions about the issues addressed in this alert.
Some noninsurance entities limit their exposures to certain claim liabilities by purchasing insurance to protect against potential losses from those claims. When an entity purchases insurance from a third-party insurer, it generally remains primarily obligated for a claim liability should such a claim arise; however, in such circumstances, the entity should carefully evaluate the contract and applicable laws. TIS Section 1200.121 describes the general accounting for a noninsurance entity that has an insurance policy with a third party but that has not transferred risk to the insurer such that the noninsurance entity remains the primary obligor:
A noninsurance enterprise amortizes the premiums over the contract period in proportion to the amount of insurance protection provided. If an insured loss occurs, and if it is probable that the policy will provide reimbursement for the loss and the amount of the loss can be reasonably estimated, the noninsurance enterprise records a receivable from the insurance enterprise and a recovery of the incurred loss in the income statement. If it is not probable that the policy will provide reimbursement, then the receivable and recovery are not recorded.
Right of Setoff for Claim Liabilities and Related Insurance Recoveries
Under U.S. GAAP, claim liabilities should not be presented in the balance sheet net of any related insurance recoveries unless the requirements of ASC 210-202 are met. The general principle of that guidance is that net presentation (“offsetting”) of assets and liabilities is only appropriate when a right of setoff exists. ASC 210-20-45-1 states that a right of setoff exists when the following four criteria are met:
a. Each of two parties owes the other determinable amounts.
b. The reporting party has the right to set off the amount owed with the amount owed by the other party.
c. The reporting party intends to set off.
d. The right of setoff is enforceable at law.
A right of setoff would not exist under ASC 210-20 because any insurance receivable and claim liability would be with different counterparties (i.e., the insurer and the plaintiff).
For many insurance policies that an entity may purchase from an unrelated third-party insurer, the purchasing entity remains the primary obligor for a claim made against the insurance policy by another individual or entity. Therefore, an entity would need to recognize, measure, and present the claim liability as an obligation without considering the potential insurance recovery. Separately, the entity would then record and present a receivable for the insurance recovery that it is entitled to receive. In some instances, the claim liability may be recorded in a period preceding the period in which the receivable is recorded (i.e., there is a rebuttable presumption3 that an asset should not be recorded if the insurer is contesting coverage). Consider the following example:
Transfer of a Claim Liability Resulting in the Insurer as the Primary Obligor
Laws in certain jurisdictions (especially certain state laws related to workers’ compensation) may dictate that when an entity purchases an insurance policy for certain claims, the entity is relieved from being, and the insurer has assumed the role of, the primary obligor. In such cases, the entity should carefully evaluate its individual facts and circumstances and should consider consulting with its professional advisers regarding the applicability of the relevant laws and regulations for legally transferring the obligation. When the entity concludes that a third-party insurer has become the primary obligor for a claim, the entity would derecognize any amounts on its balance sheet for the claim liability and related insurance receivable (if any). Consider the following example:
It is also common for a parent entity’s subsidiaries to be covered by an insurance policy held at the consolidated level (the parent entity will typically charge a fee to its subsidiary for the insurance). In these situations, entities should also carefully consider the financial reporting implications for both the consolidated financial statements and any of a subsidiary’s stand-alone financial statements. Specifically, even though an insurance policy is held at the consolidated level, the subsidiary may still be the primary obligor for a claim. When the subsidiary is determined to be the primary obligor for a claim, it should recognize, in its stand-alone financial statements, an associated claim liability as well as a receivable due from the parent entity for any insurance recoveries. In the absence of legal consent from the entity with the claim, it would typically not be appropriate for the subsidiary to transfer its obligation to the parent entity.
2 For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s “Titles of Topics and Subtopics in the FASB Accounting Standards Codification.”
3 See ASC 405-20-S99-1 for the SEC staff’s view regarding the rebuttable presumption.