Government entities shouldn't run low on GAS 10

Risk Management, June, 1994 by Robert M. Bieber

Guidelines for reporting insurance, risk financing and loss funding transactions established by the Governmental Accounting Standards Board Statement #10 (GAS 10) apply to a wide range of government entities. Public entity pools have been required to comply with GAS 10 since January 199 1. In addition, individual entities with self-financed or commercially insured risks, or entities that participate in a public entity risk pool, must comply by June 15, 1994. But many are delaying compliance, which may affect their credit ratings.

Historically, government entities were major players in the risk management arena. They bought insurance through local brokers, paid the premiums, and were satisfied that most of their losses were covered. In the past 25 years, government entities have begun to see the advantages of the formal risk management programs used in the private sector. As government entities hired risk management professionals, the era of non-managed insurance programs faded. Then came the insurance crunch of the 1980s.

Overall, the insurance industry suffered from a severe combined loss ratio; individual carriers began cutting back on risks they covered. Many carriers didn't understand government exposures; they lacked detailed loss data, and chose to stop writing new government business and to drop existing government business. Unable to buy insurance, government entities began to self-fund losses and set up insurance pools.

The Financial Accounting Standards Board set accounting guidelines for private sector risk financing programs and insurance companies. These guidelines represent the model for GAS 10, the governmental standards for handling self-funded losses. The standards apply to numerous government entities, including: public entity pools; state and local governments; public and authorities; retirement systems; governmental utilities, hospitals, colleges, universities and special districts. GAS 10 identified risks and losses applying to the entities, including: torts; theft; damage to and destruction of assets; business interruption; errors and omissions; job-related illness or injury; acts of God; risks assumed under policies issued by public entity pools; and current employees group benefits.

Traditionally, public entities that self-financed losses and related expenses did so on a paid-loss basis, setting aside funds at the start of their budgetary year for expected loss payments. At the end of the budgetary year, the fund's balance was brought to zero whether or not any claim payments were made. However, public entities didn't know to - or know how to - estimate the future liabilities underlying a claim. The Governmental Accounting Standards Board (GASB) now requires losses and related expenses to be reported on an incurred basis. When a claim occurs, an actuarially sound estimate of the present and future liabilities of that claim must be made.

Claims not reported in the year they occur are known as Incurred But Not Reported (IBNR) losses. IBNR expenses must be estimated, and reserves must be established for those future liabilities. GASB allows reserves to be estimated, as long as the estimates are based on historical loss information and are actuarially sound. GAS 10 permits - but does not mandate - discounting reserves. Discounting claim settlement amounts that are structured with specific payouts over a set time, however, is mandated. GASB currently doesn't require funding reserves; although, reserves, whether funded or unfunded, must be reported as liabilities on the balance sheet.

Creating Funds

GASB allows the creation of two separate funds to pay for losses - a "general fund" to account for all financial transactions not properly accounted for in other funds, and an "internal service fund" to finance special activities performed by units of government for other units of the same entity. An example would be a cost allocation system where each department is charged for its share of loss costs. The use of an internal service fund requires that charges made by the fund must be calculated within GAS 10 guidelines. They must be based on historical information and the loss experience of the department being charged. Charges also must be determined based on an actuarially sound method. And, charges must be adjusted over a reasonable period of time so that the funds, revenues and expenses are roughly equal. GAS 10 indicates that investments used for risk financing (loss and expense recognition) must be identified and kept separately from the traditional entities investment portfolio.

Entities that commercially insure their risks must report premium payments as expenses. This does not represent a change in the way premiums should be reported on the balance sheet. In addition, all dividends received from insurance companies will be treated as a refund of unused premium and recognized as a reduction of the insurance expenditure.

Entities with "claims-made" policies must file claims within the policy period. They must also establish reserves for claims incurred during the policy period but not reported to the insurance company. Actuarially sound cost estimates of these claims/incidents must be established and reported on the balance sheet. For entities with Incurred Loss/Paid Loss Retrospectively Rated Insurance Programs, minimum premium deposits are treated as an expense over the policy period. Any estimated accrued losses that occur in the following years and exceed the minimum premium must be reserved for, and appear on, the balance sheet.