Richard C. Frese
Patrick J. Kitchen

At a Glance   

  • Financial reporting of medical malpractice self-insurance is evolving.
  • The Financial Accounting Standards Board Accounting Standards Codification Section 954-450-25 provides guidance for accounting and financial reporting for medical malpractice.
  • Discounting of medical malpractice liabilities has been reassessed in recent years.
  • Malpractice litigation reform efforts continue in several states.
  • Accountable care organizations could increase the frequency of medical malpractice claims because of patients' heightened expectations regarding quality of care.

Financial reporting of medical malpractice self-insurance continues to evolve. A program that started in the 1970s may not operate or report the same today.

How have things changed? Consider that before the 1960s and 1970s, the frequency of medical malpractice claims was low, due largely to the difficulty in suing physicians and people's lack of awareness of it as an option. Many healthcare entities were able to purchase guaranteed-cost coverage for the facility and physicians. In the mid-1970s, rules that had traditionally posed obstacles to litigation, such as charitable immunity and strict interpretations of the "locality rule," were starting to be overturned in courts. Other factors, such as changes in the law, advances in medicine, and more recognized standards of care, contributed to a medical malpractice crisis. Facing high insurance premiums, some states responded with tort-reform measures and creation of joint underwriting associations, special state patient compensation funds, and public reinsurance mechanisms, all with the goal of providing adequate coverage and filling in gaps in the underwriting market.

With the frequency and severity rate of medical malpractice claims growing in the 1970s, many hospitals began to self-insure medical malpractice losses to combat rising insurance prices. They also established trust funds mainly because Medicare reimbursement required actuarially certified funding for the self-insured expense to be considered an allowable cost. Later, excess insurers also began to look for trusteed assets supporting self-insurance programs. With the advent of trust funds, accounting practices for the fund investments and related investment income emerged.

During the 1980s, discount rates and trust fund investment returns were often in the mid-teens. Many self-insured healthcare entities were funding and recording the liability at a percentile, such as the 75th percentile. Many entities recorded liabilities at higher percentiles to offset the effect that higher discount rates had on the liability. Insurance premiums began to rise again in the mid-1980s, contributing to another medical malpractice crisis. Some insurance carriers, such as St. Paul Companies, began to offer a new type of coverage-claims-made coverage-as a way to reduce premiums, and they slowly discontinued offering occurrence coverage. Claim rates continued to climb in the 1990s, resulting in a third medical malpractice crisis in the early 2000s, and the few remaining carriers still offering occurrence coverage began to offer only claims-made coverage. The exhibit below summarizes the milestones of medical malpractice.

Since the 1970s, healthcare organizations have used many forms of self-insurance to promote loss control and battle rising costs during insurance market cycles, including pure self-insurance, risk retention groups, and captive insurers. Particularly during hard markets, when insurance prices rose, many healthcare organizations reevaluated the structure of their self-insurance programs to provide adequate coverage at a reasonable cost. Self-insured retentions have increased considerably (tenfold in some cases), in part due to natural inflation but mainly due to the insurance market not offering affordable excess or reinsurance at lower attachment points. Many hospitals also began to make use of captives to provide insurance to physicians, with the main goals of keeping insurance costs low and providing adequate coverage at a reasonable cost.



Current Financial Reporting Requirements

Accounting guidance has evolved in recent years, affirming some practices while modifying others.

The Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Section 954-450, Contingencies, provides current guidance for accounting and financial reporting for medical malpractice for nongovernmental healthcare entities. (Governmental healthcare entities should also consider the requirements of Governmental Accounting Standards Board Statement No. 10, Accounting and Financial Reporting for Risk Financing and Related Insurance Issues, as amended.) ASC 954-450-25 requires healthcare entities to accrue for the ultimate costs of malpractice claims, including costs to litigate or settle such claims, when the related incidents occur. To the extent that an entity has insured some or all of its medical malpractice liability, the entity should recognize the liability gross and a corresponding insurance receivable at the time it accrues the liability.

ASC 954-450-30 requires that estimated malpractice losses for both asserted and unasserted claims be accrued based on the best estimates of the ultimate costs of the claims. Such accrual should include an estimate of losses from unreported incidents that are likely to have occurred as of the reporting date (incurred but not reported [IBNR] claims). Although ASC 954-450-30 does not define best estimate, it indicates that the entity should use all relevant information, including the entity's historical and industry experience. Additionally, ASC 954-450-25 specifies that the liability accrued is independent of funding decisions, which may include adjustments to bring a funding requirement to a selected confidence level. From a financial reporting perspective, many healthcare entities consider the actuarial central estimate the best estimate. The actuarial central estimate represents the most likely estimate of loss.

As discussed above, claims-made coverage has become the predominant form of medical malpractice insurance. As addressed in ASC 720-20-25 and ASC 450-20-25, entities that maintain claims-made coverage must accrue for IBNR claims and incidents as of the reporting date if the related loss is probable and reasonably estimable. These are also known as "tail claims."

If a healthcare entity discounts its malpractice liability, ASC 954-450-50 requires disclosure of the carrying amount of accrued malpractice claims and the interest rate(s) used to discount the claims. Chapter 8 of the American Institute of Certified Public Accountants (AICPA) Audit and Accounting Guide, Health Care Entities, acknowledges diversity in practice in discounting, and provides additional guidance regarding discounting, including the conditions that should be present to support discounting and selection of a discount rate.

 To discount a malpractice liability:

  • The amount of the liability must be fixed or reliably determinable
  • The amount and timing of cash payments for the liability, based on the healthcare entity's specific experience, must be fixed or reliably determinable
  • The expected insurance recoveries, if any, must also be discounted

ASC 450-20-50 requires disclosure of malpractice contingencies that are reasonably possible but are not accrued because they do not meet the recognition criteria of ASC 450-20-25-2, or because exposure to loss exists in excess of amounts accrued. Other disclosures required relating to medical malpractice liabilities include a healthcare entity's program of medical malpractice insurance coverages (ASC 954-450-50) and potential material near-term changes in estimated malpractice liabilities that are reasonably possible (ASC 275-10-50).

Future Trends

Although discounting of medical malpractice liabilities continues to be acceptable, the propriety of this practice has been reassessed in recent years. Specifically, in conjunction with the recent overhaul of the audit guide, the AICPA Health Care Audit Guide Task Force discussed with the AICPA Financial Reporting Executive Committee (FinREC) whether the amount and timing of payments for medical malpractice claims were sufficiently fixed and reliably determinable to support discounting. Ultimately, FinREC supported discounting if the criteria in chapter 8 of the audit guide described above are met. Discounting is a topic that warrants continued monitoring.

Malpractice litigation reform efforts, in particular placing caps on noneconomic damages, continue in a number of states. The Patient Protection and Affordable Care Act authorized $50 million for grants to states for demonstration projects to evaluate alternatives to current tort litigation for resolving medical malpractice claims for five years beginning in federal fiscal year 2011. If such reform efforts are successful and withstand legal challenges, their caps would generally have a significant effect on a healthcare entity's medical malpractice exposure and would need to be considered in developing estimated medical malpractice liabilities.

Another trend that warrants monitoring is the emergence of accountable care organizations (ACOs) and the impact that such organizations will have on medical malpractice claims. Among the primary goals of ACOs is to improve integration of care, which should ultimately contribute to a reduction in medical malpractice risk. What remains to be seen is how independent healthcare entities forming ACOs will choose to manage medical malpractice risk (e.g., risk pools, captive insurance arrangements) and coordinate defense of medical malpractice claims. Some also argue that ACOs might increase the frequency of medical malpractice claims because patient expectations regarding quality of care will be heightened.

As financial reporting guidelines continue to evolve in response to changes in the medical malpractice environment, a healthcare organization's management should consult the organization's independent auditors to understand their positions and to obtain assistance in monitoring emerging guidance. Management's actuaries will be able to forecast the impact on medical malpractice reserves and funding from any new guidance. Unless changes in facts and circumstances dictate a change, a consistent approach, guided by a written policy for establishing medical malpractice reserves, is usually best.

Richard C. Frese, FCAS, MAAA, is a consulting actuary, Milliman, Chicago (

Patrick J. Kitchen is a partner, McGladrey LLP, Chicago, and a member of HFMA's First Illinois Chapter (


Early History of Medical Malpractice  

Medical malpractice was recognized as early as 1374 in England, when Chief Justice John Cavendish on the Court of the King's Bench ruled on a civil liberty action against a London surgeon named John Swanlond for treatment of the crushed and mangled hand of Agnes of Stratton. In the mid-1800s, the legal environment in the United States began to form fundamental principles and opinions about medical education and knowledge, standards of care, and errors of judgment. Most early malpractice suits were orthopedic in nature, with suits arising from the treatment of amputations, fractures, or dislocations. Physicians of this time faced judgments as large as $3,000, about six times an average physician's annual income. Furthermore, these judgments were paid by the physicians, because malpractice insurance did not become available until the 1890s by carriers such as Medical Protective.

Publication Date: Thursday, November 01, 2012

Login Required

If you are an existing member, please log in below. Username and password are required.



Forgot User Name?
Forgot Password?

If you are not an HFMA member and would like to access portions of our content for 30 days, please fill out the following.

First Name:

Last Name:


   Become an HFMA member instead