Audit and Enterprise Risk Services

Balance Sheet Presentation of a Claim Liability and the Related Insurance Recovery

Financial Reporting Alert 12-4

June 26, 2012

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.

Background

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).

Editor’s Note: All entities should carefully evaluate the balance sheet presentation of any similar contingent liabilities with related insurance recoveries. Under ASC 210-20, the offsetting of conditional or unconditional liabilities with anticipated insurance recoveries from third parties is not permissible.

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:

Entity A purchases an insurance policy from Insurer Y, an unrelated party, that covers all losses up to the policy limit and does not include any deductible. Insurer Y deals with all aspects of any claim that is filed, including settlement, and pays any plaintiffs directly. Under the applicable contract and laws in this scenario, Entity A is still the primary obligor for the claim even though Insurer Y is handling and paying the claims and Entity A’s primary involvement is to pay its insurance premium (along with any amounts over the policy limit). Entity A would thus need to separately present the claim liability and related insurance receivable in its balance sheet.

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:

Entity B purchases an insurance policy (e.g., workers’ compensation) from Insurer Z, an unrelated party, that covers all losses up to the policy limit and does not include any deductible. Some states’ laws dictate that this type of insurance policy may only be underwritten by certain regulated insurance entities. In addition, in some states Entity B’s obligation to provide workers’ compensation benefits to its employees might be transferred to Insurer Z (when the criteria in ASC 405-20-40-1 are met). When Insurer Z is determined to be the primary obligor, Entity B would derecognize any amounts on its balance sheet for the claim liability and the related insurance receivable (if any) but would remain secondarily liable. Accordingly, Entity B would need to evaluate whether it is required to record a guarantee obligation in accordance with ASC 460 (see ASC 405-20-40-2). Entity B would also remain primarily obligated for any claims over the policy limit. When evaluating whether the primary obligation has been transferred to the insurer, Entity B should carefully evaluate the terms of its insurance policy and may need to also carefully consider (1) the laws in each state and (2) any law that may apply if Insurer Z filed for bankruptcy.

However, if there is no legal evidence that Entity B has transferred the primary obligation to Insurer Z, Entity B might not be able to assert that it has been legally released as the primary obligor and would continue to separately recognize and present its claim liability and a receivable for any insurance recoveries.

Related-Party Considerations

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.

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1 AICPA Technical Practice Aids, TIS Section 1200.12, “Accounting for Prospective Insurance.”

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.