Defined contribution health and welfare plans differ from defined benefit plans. A defined contribution plan keeps a record of each participant’s account. Records are kept of each contribution, made both by the participants and their employers. Flexible spending arrangements, vacation plans, and HSAs may be included in such a plan.
A defined benefit plan,5 in contrast, specifies a particular benefit—perhaps a reimbursement to the covered participant, or a direct payment to providers or third-party insurers, for the costs of stipulated services. These plans provide participants with a specific benefit based on a formula provided in the plans themselves, whereas defined contribution plans provide benefits based on amounts contributed to an individual account.
5 Hicks, S.W. “Accounting and Reporting of Health and Welfare Plans.” Journal of Accountancy 174, no. 6 (1992).
Both types adjust values based on the following factors:6
6 FASB – 965-325-05-2, www.fasb.org.
- Investment experience
- Administrative expenses
Each type provides a benefit with value. Therefore, the defined benefit plan’s financial statements must provide financial information to aid in understanding and assessing its present and future ability to pay its benefit obligations once they become payable. To meet this requirement, a plan’s financial statements should provide information about its assets and benefit obligations, the results of transactions or events affecting its assets and liabilities, and all other pertinent information necessary for report users to analyze the information provided.
The different types of defined benefit plans (multiemployer and single employer) should separately report benefit obligations, including those for post-retirement.
Section 965 Explained7
7 In this part of the chapter, we are interpreting, adapting, and explaining relevant code sections (stating the relevant section) of FASB 965, www.fasb.org.
- Benefit payments (965-30-25-1): Health and wealth plans can process benefit payments directly, or the employer may utilize a third-party administrator (TPA) through an administrative service arrangement (ASA). Benefits are paid by either fully or partially self-funded plans.
- Premiums due under insurance arrangements (965-30-25-3): Premiums due, but not yet paid, should be part of the accounting in any obligation.
- Post-employment benefits (965-30-25-3): Plans for post-employment benefits must recognize a benefit obligation for current employees, based on amounts to be paid in future periods, if certain conditions are met. The conditions are as follows:
- The employee’s right to receive the benefit must be based on services already provided.
- The employees must have a vested benefit.
- There is a high probability of making the payment.
- The amount must be estimated accurately.
- An exception: All employees are provided the same benefits due to another event, such as medical benefits provided under a disability plan; in these plans, medical benefits are paid regardless of the length of service. These plans usually do not have a vesting provision.
- Disability benefits must be accrued from the starting date of the disability (965-30-25-4).
- Obligations for premium deficits (965-30-25-5): In fully insured experience-rated plans, experience ratings determined by insurance companies directly, or estimates developed by those companies, can result in deficits. Premium deficits must be included in the total benefit obligation, assuming the following criteria are met:
- It is probable that the deficit will be applied against the amounts of future premiums or future experience-rated refunds; the following must be considered:
a. To what extend the insurance contract requires deficit payments
b. The plan’s desire to transfer coverage to another insurance company
c. Whether the amount of the deficit can be estimated in a reasonable manner
- Recognition of employer contributions (965-310-25-1): If a formal commitment is made by the employer to make contributions, this must be documented. Sufficient evidence can include the following:
- The resolution of a governing body that has signed off on the commitment.
- Proof of a pattern of making payments after the end of a plan year; this must be made under a funding policy.
- Evidence of a deduction taken for federal tax purposes; this should be for periods ending on, or before, the financial statement date.
- Evidence of an accounting recognition as a current liability. It is insufficient to show in the balance sheet that there is accrued liability, or if the statement reflects that there is a liability amount that exceeds the plan’s assets.
- Recognition of premiums paid to insurance companies (965-310-25-2): This depends on if a premium is paid to an insurance company and also depends on whether the payments are for the transfer of risk or as a deposit. Analysis is necessary to determine the extent of the risk transfer. To mitigate this, insurance companies may require that a deposit is placed that can apply toward potential losses. These deposits must be reported as plan assets until they are used toward premiums. If these reserves are forfeitable when the insurance contract is terminated, this possibility should be considered when making asset calculations. If experience-rated premium refunds are expected, and if the policy year does not coincide with the plan, refunds due should also be reported as plan assets. Finally, it is assumed that all calculations can be reasonably performed (965-310-25-3).
- Calculating plan benefit obligations (965-30-35-1): All obligations for single/multiemployer defined health and welfare plans should include the actuarial present value of the following:
- Claims payable.
- Claims incurred but not reported (IBNR).
- Premiums due to insurance companies for accumulated credits and for postemployment benefits. These should be premiums for retired participants, including beneficiaries and dependents, for other eligible participants, and for participants not yet fully eligible. Relevant information must be in the body of the financial reports rather than in footnote disclosures.
Claims Incurred But Not Reported
An important concept that affects both that actuarial valuations of plan assets and liabilities is the IBNR (claims incurred but not reported).8 According to www.healthdictionaryseries.com, an IBNR claim is a concept that signifies healthcare services have been rendered but not invoiced or recorded by the healthcare provider, clinic, hospital, or any other health service organization. IBNRs are usually an integral part of a risk-adjusted contract between managed-care organizations and healthcare providers. An IBNR claim refers to the estimated cost of medical services for which a claim has not been filed. These claims are normally monitored by an IBNR collection system or control sheet.
8 Adapted from a blog authored by Dr. David Edward Marcinko, “What is an IBNR medical claim?” Medical Executive Post…Insider News and Education for Doctors and Their Advisors, October 2008, http://medicalexecutivepost.com/2008/.10/07/what-is-an-ibnr-claim/.
More formally, an IBNR is the financial accounting of all services that have been performed but as a result of a time element or a “lag” have not been invoiced or recorded as of a specific date. The transactions covering medical services that were provided should be accounted for using the following accrued but not reported IBNR entry:
- Debit—accrued payments to medical providers or healthcare entity
- Credit—IBNR accrual account
An example of an IBNR in a hospital is a coronary artery bypass surgery for a managed care plan member. The surgeon and/or healthcare organization has to pay for all related services, such as physical and respiratory therapy, rehabilitation services, drugs, and durable medical equipment (DME), out of a future payment fund. These payments are contractual obligations, which is a liability.
The health plan might not be completely billed until several weeks, months, or quarters later, or even further downstream in the reporting year after the patient is discharged. In order to accurately project the health plan’s financial liability, the health plan and hospital must estimate the cost of care based on past expenses.
Since the identification and control of costs are paramount in financial healthcare management, an IBNR reserve fund (an interest bearing account) must be set up for claims that reflect services already delivered but, for whatever reason, have not been recorded by a particular deadline, nor yet reimbursed.
From the accounting point of view, the IBNR needs to be accrued as an expense and a short-term liability for each fiscal month or accounting period. Otherwise, the organization may not be able to pay the claim if the associated revenue has already been spent. The proper handling of these “bills in the pipeline” is crucial for proactive providers and health organizations. IBNRs are especially important with newer patients who may be sicker than prior norms. Amounts that hospitals hope to recover (recoverables) are posted as part of their reserve charges. In many cases, these recoverables will wind up being IBNR losses. They are recorded as IBNR claims on the balance sheet. Once these book losses start becoming actual losses, the hospital may look to the insurer to pay a part of the claim. This might end up being a disputable charge.
For self-funded plans, the IBNR cost should be measured at the present value of the plan’s estimated ultimate cost of settling the claims. Estimated ultimate costs should reflect the plan’s obligation to pay claims to or for participants (for example, continuing health coverage or long-term disability), regardless of employment status and beyond the financial statement date if stipulated. (965-30-35-1A)
Other Benefit Obligations
- Administrative expenses incurred by the plan can be recognized by including the estimated administrative expenses in the benefits expected to be paid or by reducing the discount rate. (965-30-35-2)
- Postretirement retirement benefit obligation should be measured as the actuarial present value of future benefits that are tied into the participant’s service performed as of the cost measurement date. The calculation should be reduced by projected future contributions from plan participants. The determined calculation represents the employer’s funding requirement and the accumulated plan assets. This calculation should also consider the following variables:
a. Continuity of the plan
b. That all assumptions made about future events for the calculation will indeed be met.
c. Any anticipated forfeitures and integration with other plans.
d. The discount rate used assumes a rate of return that matches high-quality fixed income investments.
- Any insurance premiums paid for plan participants who have accumulated enough eligibility credits or hours of employment. This is usually calculated by multiplying eligibility credits by the current insurance premium; and for self-funded plans, by using the average of all benefits per eligible participant. Mortality, expected employee turnover, and other required assumptions should be considered in the calculation.
- Any additional premiums as a result of the loss ratio exceeding present percentage.
- Additional payments to insurance companies resulting from stop-loss arrangements. (965-30-35-9 + 965-30-35-12)
Additional Obligations for Postretirement Health Plans
If a benefit is provided as part of a postretirement health plan, the estimated payments to participants needs to be a part of the accounting. These benefits usually trigger starting on the retirement date, but sometimes these benefits trigger at a certain age. The calculation of the estimated obligation as of a given date is based on an actuarial preset value of all future benefits that can be attributed to the participant’s period of employment. Benefit recipients should covered the following:
- A terminated employee, if benefits have been earned
- A beneficiary (or a covered dependent)
- Active employees, their beneficiaries, and any covered dependents
Benefit obligation calculations need to include the following assumptions and calculation elements:
- Appropriate discount rates to account for the time value of money
- Per capita cost of claims by age
- Healthcare cost trends
- Medicare reimbursement rates
- Retirement age
- Dependency status
- Salary progression
- Probability of payment calculation
- Participation rates
Benefit obligations should not include death benefits that might need to be paid during employees’ active service period. This benefit obligation is generally determined by applying current insurance premium rates or, for a self-funded plan, the average cost of benefits per eligible employee. In either case, the calculation should consider assumptions on mortality rates and the probability of employee turnover. (965-30-35-15 to 22)
Fair Value Measurement
Fair value, in the context of healthcare benefits, refers to “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participations at the measurement date” (FASB ASC 820-10-20). This concept is closely related to the accounting and reporting of these benefit plans. FASB ASC 820 defines fair value and establishes a framework to measure it as well as to set certain disclosure requirements.
To meet these requirements, a joint effort between management, custodians, investment fiduciaries, and plan auditors is required. Sponsors and administrators are responsible for ensuring that the proper valuation process and effective data are available to determine this fair value. They must also ensure that the measuring framework is conducted and that the proper disclosures are included.
The following is a summarized review of FASB ASC 820:
Noncash contribution must be recorded at fair value (FASB ASC 965-20-30-1). If this contribution is to be sold, the sale value will be set at the fair value minus the cost. Total assets, liabilities, and net assets available for benefits, as well as net assets reflecting investments at fair value, are presented in the statements available for the plan (FASB ASC 965-20-45-1). All accounting associated with these assets that reflect the investments in question need to ensure that the amounts are presented at fair value (FASB ASC 965-20-45-2-5). In terms of unusual or infrequent statements, or transactions made after the financial statement date, disclosures are required if these events or transactions significantly affect the efficiency of the financial statements. A significant change made to the fair value of plan assets is a required disclosure event (FASB ASC 965-20-50-1). Equity, debt securities, real estate, or other investments are required to be recorded, at their fair value, at the date of the financial statements (FASB ASC 965-320-35-1 / FASB ASC 965-325-35-1). Net appreciation, or depreciation, of the investments’ fair value must be disclosed in the notes for the financial statements (FASB 965-320-50-1). According to the Employee Retirement Income Security Act, insurance contacts must be presented at fair value, or at the amount determined by the insurance company (for instance, the contract value) (FASB ASC 965-325-35-3).
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