Taking a Fresh Look at Medical Malpractice Liabilities
At one point or another, it’s likely to happen to any healthcare organization: a patient files a medical malpractice claim. The first order of business is usually a call to your attorney and malpractice insurance carrier. But what about a call to your accounting department? Is there even an accounting implication when a malpractice claim is filed?
Before we answer that, let’s begin with…
A brief history of malpractice insurance . . .
Many years ago, in a very different health care world, most health care entities carried occurrence-basis medical malpractice insurance. These policies provide coverage for insured events occurring during the insurance contract period, regardless of the length of time that passes before the insurance company is notified of the claim. But over time, these policies became cost-prohibitive, and virtually all medical malpractice claims insurance policies became claims-made basis.
Under a claims-made policy, incidents are only covered if they are reported to the insurance carrier while the policy is in force (i.e., during the contract period for the policy). Claims-made basis policies are significantly less expensive than occurrence basis policies because the carrier’s risk is limited to only claims reported during the current contract period.
For purposes of this blog post, we’re going to assume that claims-made policies are in effect.
Is it necessary to record a liability for claims that have been filed?
Of course, it is – GAAP wouldn’t have it any other way. The FASB’s Codification states that “The ultimate costs of malpractice claims or similar contingent liabilities, which include costs associated with litigating or settling claims, shall be accrued when the incidents that give rise to the claims occur. A health care entity should evaluate its exposure to losses arising from claims and record a liability, if appropriate.” This seems straightforward. Especially for “known claims” (such as claims that have already been filed with the insurance carrier during the policy period). Simply:
- Obtain a supportable estimate of the expected liability for each claim (this usually comes from the attorney handling the claim or the insurance carrier)
- Make sure that the liability includes all anticipated expenses related to the claim (not just any amounts that may be payable to the plaintiff)
- Record the liability
See – it’s easy!
But wait! What about my insurance coverage?
GAAP addresses this as well. The FASB Codification notes that “The liability shall not be presented net of anticipated insurance recoveries. An entity that is indemnified for these liabilities shall recognize an insurance receivable at the same time that it recognizes the liability, measured on the same basis as the liability, subject to the need for a valuation allowance for uncollectible amounts.” Essentially, GAAP requires that entities evaluate the liability for the claim and the amount that is covered by insurance separately. So,
- First, record a liability for the total expected amount of the claim,
- Second, record a receivable for any amounts that are expected to be covered by insurance, and
- Third, evaluate the financial capacity of the insurance carrier to actually make good on its coverage (and record an allowance on the receivable if necessary).
Don’t forget . . . there are probably some unreported claims out there too
Due to the nature of the health care industry, many malpractice claims are not filed or made known until months – or even years – after the incidents giving rise to the claims have occurred. Do we need to worry about accounting for those claims? In a word: YES. The FASB Codification is clear on this matter. It requires that the malpractice liability include ” . . . an estimate of the losses that will result from unreported incidents, which are probable of having occurred before the end of the reporting period. All relevant information, including industry experience, the entity’s own historical experience, the entity’s existing asserted claims, and reported incidents should be used in estimating the expected amount of claims.” In other words, GAAP requires that health care entities also record a liability for incurred but not reported, or “IBNR” claims.
Estimating a liability for IBNR claims is clearly more complicated than estimating liability for a known claim. Although it’s not required, health care entities frequently engage actuaries or other consultants to help develop this estimate, especially if an organization has a large number of providers and service lines.
If you have any questions on the Medical Malpractice Liabilities, please contact our team today at (503) 697-4118.