Governmental Accounting Standards Series

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1 NO. 131-B FEBRUARY 1996 Governmental Accounting Standards Series Interpretation No. 4 of the Governmental Accounting Standards Board Accounting and Financial Reporting for Capitalization Contributions to Public Entity Risk Pools an interpretation of GASB Statements No. 10 and 14 Governmental Accounting Standards Board of the Financial Accounting Foundation

2 For additional copies of this Interpretation and information on applicable prices and discount rates, contact: Order Department Governmental Accounting Standards Board 401 Merritt 7 P.O. Box 5116 Norwalk, Connecticut Telephone Orders: Please ask for our Product Code No. GI04. The GASB website can be accessed at

3 Summary This Interpretation applies to capitalization contributions made to and received by public entity risk pools both with and without transfer or pooling of risk. This Interpretation requires entities to report capitalization contributions made to public entity risk pools with transfer or pooling of risk as deposits if a return of those contributions is probable. Otherwise, entities should report the contributions as prepaid insurance (an asset) to be allocated as expenditures/expenses over future periods (not to exceed ten years under certain circumstances) or, alternatively, in governmental funds, as expenditures in the period made. In neither case should entities report those capitalization contributions (or any participation in those pools) as equity interests in joint ventures. Furthermore, entities should continue to report capitalization contributions to public entity risk pools without transfer or pooling of risk as deposits or reductions of claims liabilities. This Interpretation also provides guidance for public entity risk pools that make capitalization contributions to other pools (such as excess pooling arrangements) in which they participate. This Interpretation requires public entity risk pools with transfer or pooling of risk to report capitalization contributions received as liabilities if a return of those contributions is probable. Otherwise, those pools should report the contributions as unearned premiums to be allocated as premium revenue over future periods (not to exceed ten years under certain circumstances). Public entity risk pools without transfer or pooling of risk should net capitalization contributions with other amounts and report assets or liabilities, as appropriate. The provisions of this Interpretation are effective for financial statements for periods beginning after June 15, Earlier application is encouraged. Unless otherwise specified, pronouncements of the GASB apply to financial reports of all state and local governmental entities, including general purpose governments, public benefit corporations and authorities, public employee retirement systems, utilities, hospitals and other healthcare providers, and colleges and universities. Paragraph 2 discusses the applicability of this Interpretation. i

4 Interpretation No. 4 of the Governmental Accounting Standards Board Accounting and Financial Reporting for Capitalization Contributions to Public Entity Risk Pools an interpretation of GASB Statements No. 10 and 14 February 1996 Governmental Accounting Standards Board of the Financial Accounting Foundation 401 Merritt 7, PO Box 5116, Norwalk, Connecticut ii

5 Copyright 1996 by Financial Accounting Foundation. All rights reserved. Content copyrighted by Financial Accounting Foundation may not be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the Financial Accounting Foundation. iii

6 Interpretation No. 4 of the Governmental Accounting Standards Board Accounting and Financial Reporting for Capitalization Contributions to Public Entity Risk Pools an interpretation of GASB Statements No. 10 and 14 February 1996 CONTENTS Paragraph Numbers Introduction... 1 Interpretation Scope and Applicability... 2 Accounting and Financial Reporting for Capitalization Contributions Entities Other Than Pools Capitalization Contributions Made to Public Entity Risk Pools with Transfer or Pooling of Risk Capitalization Contributions Made to Public Entity Risk Pools without Transfer or Pooling of Risk... 9 Public Entity Risk Pools Capitalization Contributions Made to Other Public Entity Risk Pools Capitalization Contributions Received Effective Date and Transition Capitalization Contributions Made Capitalization Contributions Received Appendix A: Background Information Appendix B: Basis for Conclusions Appendix C: Codification Instructions iv

7 Interpretation No. 4 of the Governmental Accounting Standards Board Accounting and Financial Reporting for Capitalization Contributions to Public Entity Risk Pools an interpretation of GASB Statements No. 10 and 14 February 1996 INTRODUCTION 1. When state and local governmental entities join to form a public entity risk pool or when those entities join an established pool, the pooling agreement may require capitalization contributions to meet initial or ongoing capital minimums established by statute, regulation, or the pooling agreement itself. Capitalization contributions generally take the form of cash. This Interpretation provides guidance on the accounting and financial reporting for these contributions. INTERPRETATION Scope and Applicability 2. This Interpretation clarifies the application of GASB Statement No. 14, The Financial Reporting Entity, paragraph 79, and GASB Statement No. 10, Accounting and Financial Reporting for Risk Financing and Related Insurance Issues, to capitalization contributions to public entity risk pools. This Interpretation applies to all state and local governmental entities. Accounting and Financial Reporting for Capitalization Contributions Entities Other Than Pools 3. An entity should not consider its capitalization contributions to, or participation in, a public entity risk pool (with or without transfer or pooling of risk) to be an equity interest in a joint venture 1 as defined in Statement Paragraph 74 of Statement 10 provides that entities that participate in risk-sharing pools under retrospectively rated policies or contracts should accrue additional premiums or refunds on the basis of the group s experience to date... (emphasis added). However, the recognition of these refunds is not equivalent to an equity interest and should not be construed as such. 1

8 Capitalization Contributions Made to Public Entity Risk Pools with Transfer or Pooling of Risk 4. A capitalization contribution to a public entity risk pool with transfer or pooling of risk should be reported as a deposit if it is probable that the contribution will be returned to the entity upon either the dissolution of or the approved withdrawal from the pool. An entity s determination that a return of the contribution is probable should be based on the provisions of the pooling agreement and an evaluation of the pool s financial capacity 2 to return the contribution. In governmental funds, fund balance should be reserved to indicate that the deposit is not appropriable for expenditure If it is not probable that a capitalization contribution will be returned as discussed in paragraph 4, that contribution should be reported in accordance with paragraphs 6 through 8. Proprietary funds 6. In proprietary funds, the contribution should be reported initially as prepaid insurance (an asset), and expenses should be allocated and recognized over the periods for which the pool is expected to provide coverage. The periods expected to be covered should be consistent with the periods for which the contribution is factored into the pool s determination of premiums 4 but should not exceed ten years if not readily determinable. Governmental funds 7. In governmental funds, the entire amount of the capitalization contribution may be recognized as an expenditure in the period of the contribution; reporting of prepaid insurance is not required. 5 Otherwise, the contribution should be reported initially as prepaid insurance (an asset), and expenditures should be allocated and recognized over the periods for which the pool is expected to provide coverage. The periods expected to be 2 See paragraph 70 of Statement NCGA Statement 1, Governmental Accounting and Financial Reporting Principles, paragraph 118, provides that use of the term reserve should be limited to indicating that a portion of the fund balance is not appropriable for expenditure or is legally segregated for a specific future use. An example of the former is the Reserve for Inventories, which indicates that the portion of fund balance represented by inventories is not available for appropriation and expenditure at a balance sheet date For purposes of this Interpretation, the term premiums includes required contributions, as defined in Statement NCGA Statement 1, paragraph 73(3), provides that expenditures for insurance and similar services extending over more than one accounting period need not be allocated between or among accounting periods, but may be accounted for as expenditures of the period of acquisition. 2

9 covered should be consistent with the periods for which the contribution is factored into the pool s determination of premiums but should not exceed ten years if not readily determinable. If prepaid insurance is reported, fund balance may be required to be reserved to indicate that the amount is not appropriable for expenditure. 6 Colleges and universities 8. In the unrestricted current funds of colleges and universities that apply the AICPA College Guide model, 7 the contribution should be reported initially as prepaid insurance (an asset), and expenditures should be allocated and recognized over the periods for which the pool is expected to provide coverage. The periods expected to be covered should be consistent with the periods for which the contribution is factored into the pool s determination of premiums but should not exceed ten years if not readily determinable. Capitalization Contributions Made to Public Entity Risk Pools without Transfer or Pooling of Risk 9. A capitalization contribution to a public entity risk pool without transfer or pooling of risk should be reported as a deposit or a reduction of claims liabilities. 8 Public Entity Risk Pools Capitalization Contributions Made to Other Public Entity Risk Pools 10. Some public entity risk pools ( participant pools ) participate in other public entity risk pools ( excess pools ), such as excess pooling arrangements. A participant pool that makes a capitalization contribution should apply the guidance applicable to proprietary funds in paragraphs 3 through 6. The participant pool also should apply pertinent reinsurance accounting guidance; 9 the participant pool may be required to net certain amounts related to the excess pool, or it may be required to treat certain amounts paid to the excess pool as a deposit. 6 See footnote 3. 7 See GASB Statement No. 15, Governmental College and University Accounting and Financial Reporting Models, paragraph 4. 8 See paragraph 71 of Statement See paragraphs 37 through 39 of Statement 10. 3

10 Capitalization Contributions Received 11. If it is probable that capitalization contributions will be returned as discussed in paragraph 4, a public entity risk pool with transfer or pooling of risk should report contributions received as a liability. 12. If it is not probable that capitalization contributions will be returned as discussed in paragraph 4, a public entity risk pool with transfer or pooling of risk should report the contributions as unearned premiums. Premium revenue should be allocated and recognized over the periods for which coverage is expected to be provided by the pool. The periods expected to be covered should be consistent with the periods for which the contribution is factored into the determination of premiums but should not exceed ten years if not readily determinable. 13. A public entity risk pool without transfer or pooling of risk should net a capitalization contribution with other amounts and report the net amount as an asset or a liability, as appropriate. 10 EFFECTIVE DATE AND TRANSITION 14. The provisions of this Interpretation are effective for financial statements for periods beginning after June 15, Earlier application is encouraged. Accounting changes adopted to conform to the provisions of this Interpretation should be applied retroactively, if practical, by restating financial statements for all periods presented. If restatement of financial statements for prior periods presented is not practical, the cumulative effect of applying this Interpretation, if any, should be reported as a restatement of beginning fund balance, retained earnings, or fund equity, as appropriate, for the earliest period restated. In the period this Interpretation is first applied, the financial statements should disclose the nature of any restatement and its effect. Also, the reason for not restating prior periods presented should be explained. Capitalization Contributions Made 15. On implementation of this Interpretation, capitalization contributions made in prior periods that had been reported as equity interests in proprietary funds should be reclassified to deposits or prepaid insurance, as appropriate. Beginning fund equity for the 10 See paragraph 51 of Statement 10. 4

11 earliest period restated should be adjusted for the effect of any pool net income or loss that had been recognized using the equity method On implementation, capitalization contributions made in prior periods that had been reported as equity interests in governmental funds should be reclassified to deposits or prepaid insurance, as appropriate, or beginning fund balance for the earliest period restated should be adjusted for the effect of capitalization contributions that would have been recognized as expenditures in prior periods, as permitted in paragraph 7. Beginning fund balance for the earliest period restated also should be adjusted for the effect of any pool net income or loss that had been recognized using the equity method On implementation, capitalization contributions made in prior periods that had been reported as equity interests in unrestricted current funds of colleges and universities that apply the AICPA College Guide model should be reclassified to deposits or prepaid insurance, as appropriate. Beginning fund balance for the earliest period restated should be adjusted for the effect of any pool net income or loss that had been recognized using the equity method. Capitalization Contributions Received 18. On implementation of this Interpretation, capitalization contributions received by pools in prior periods that had been reported as contributed capital (a component of equity) should be reclassified as liabilities. Beginning retained earnings for the earliest period restated should be adjusted, as appropriate, for the effect of any capitalization contributions received in prior periods that had been reported as revenue. The provisions of this Interpretation need not be applied to immaterial items. 11 See paragraph 73 of Statement See paragraph 74 of Statement 14. 5

12 This Interpretation was adopted by unanimous vote of the members of the Governmental Accounting Standards Board: Tom L. Allen, Chairman Robert J. Freeman Barbara A. Henderson Edward M. Klasny Paul R. Reilly 6

13 Appendix A BACKGROUND INFORMATION 19. There has been diversity in the accounting for capitalization contributions to public entity risk pools, which may be made to provide start-up capital (or seed money ) or to assist in meeting ongoing capital needs. Specifically, there have been questions as to whether participants may report their capitalization contributions to, or participation in, risk-sharing pools in a manner similar to equity interests in joint ventures. 20. Statement 14, paragraph 69, defines a joint venture as a legal entity or other organization that results from a contractual arrangement and that is owned, operated, or governed by two or more participants as a separate and specific activity subject to joint control, in which the participants retain (a) an ongoing financial interest or (b) an ongoing financial responsibility.... Furthermore, paragraph 72 of that Statement provides: For financial reporting purposes, there are two types of joint ventures: (a) joint ventures whose participants have equity interests and (b) joint ventures whose participants do not have equity interests. An equity interest in a joint venture is manifest in the ownership of shares of joint venture stock or by otherwise having an explicit, measurable right to the net resources of a joint venture that is usually based on an investment of financial or capital resources by a participating government. An equity interest may or may not change over time as a result of an interest in the net income or loss of the joint venture. An equity interest is explicit and measurable if the joint venture agreement stipulates that the participants have a present or future claim to the net resources of the joint venture and sets forth the method to determine the participants shares of the joint venture s net resources.... [Footnote reference omitted.] 21. Paragraph 79 of Statement 14 discusses whether pools are joint ventures: A pool is another multijurisdictional arrangement that has the characteristics of a joint venture but has additional features that distinguish it, for financial reporting purposes, from the traditional joint venture defined in paragraph Entities participating in a public entity risk (insurance) pool should follow the accounting and reporting guidance provided in Codification Section C50, Claims and Judgments. 7

14 22. GASB Codification Section C50 13 consists of guidance for entities other than pools from Statement 10 and other Statements. Statement 10 does not specifically address joint venture accounting or accounting for an equity interest in a pool, nor does it specifically address capitalization contributions. However, paragraph 69 of that Statement provides that an entity participating in a pool with transfer or pooling of risk (a risk-sharing pool) should report its premiums as insurance expenditure/expense. Paragraph 71 provides that an entity participating in a pool without transfer or pooling of risk (a non-risk-sharing pool) should measure and record its own claims liabilities; payments to the pool should be recorded as deposits or reductions of claims liabilities. Statement 10 also provides for refunds from certain retrospectively rated policies and contracts (paragraph 74) and for dividends from pools and commercial insurers. History of the Project 23. In September 1993, the Board added a project to its technical agenda to provide guidance on certain risk financing issues related to Statement 10. These issues were identified during the preparation of the Guide to Implementation of GASB Statement 10 on Accounting and Financial Reporting for Risk Financing and Related Insurance Issues (Implementation Guide) but could not be addressed in that document, which is limited to clarifying, explaining, or elaborating on the standards in Statement 10. The results of the project are this Interpretation and a separate pronouncement, GASB Statement No. 30, Risk Financing Omnibus. A task force provided valuable input on the alternatives that the Board considered in both documents. 24. In August 1995, the Board issued an Exposure Draft (ED) of a proposed Interpretation, Accounting and Financial Reporting for Capitalization Contributions to Public Entity Risk Pools, which precedes this Interpretation. The Board received thirty comment letters on the ED, a large majority of which supported its provisions. Certain changes have been made to this Interpretation, however, as a result of respondent recommendations. 13 GASB Codification of Governmental Accounting and Financial Reporting Standards (Norwalk, CT: GASB, 1995). 8

15 Appendix B BASIS FOR CONCLUSIONS 25. This appendix discusses factors considered significant by Board members in reaching the conclusions in this Interpretation. It includes discussion of the alternatives considered and the Board s reasons for accepting some and rejecting others. Individual Board members gave greater weight to some factors than to others. Entities Other Than Pools 26. The Board believes that entities should not report their capitalization contributions to, or participation in, a public entity risk pool as an equity interest in a joint venture, whether or not that equity interest may change with net income or loss of the pool. The intent of Statement 14, paragraph 79, is that the joint venture provisions of Statement 14 do not apply to entities participating in a public entity risk pool. Most respondents to the ED agreed with the Board. Among other comments, respondents noted that reporting a share of a pool s equity that is subject to the uncertainty of future claims may be misleading to the readers of entities financial statements. Furthermore, reporting an equity interest effectively would allow some entities to recognize gain contingencies when a pool has net income for a period. Certain other respondents disagreed, however. They noted that, because of the manner in which they are established, certain pools are similar to joint ventures, as defined by Statement 14. Accordingly, they believe that reporting an equity interest is most appropriate. 27. The Board considered these comments and continues to believe that Statement 10 generally provides sufficient guidance on accounting for this participation (paragraphs 69 through 71) and on disclosure of the relationship between the participating entity and the pool (paragraph 77c). 28. Furthermore, entities participating in a risk-sharing pool share in the favorable claims experience of the pool through reduced premiums and through dividends. These participants also share in the adverse claims experience of the pool through increased premiums and through assessments. Accordingly, the Board believes it is inappropriate to attribute a share of a pool s net income to these entities. That is, the nature of a risksharing pool is such that its net income or loss does not accrue to participating entities 9

16 except through formal mechanisms such as premium adjustments, dividends, and assessments that are specified in pooling agreements. 29. The Board also notes that the provisions of this Interpretation do not amend the accounting for entities that participate in risk-sharing pools under retrospectively rated policies or contracts; the guidance in paragraph 74 of Statement 10 for those entities to accrue additional premiums or refunds on the basis of the group s experience to date... (emphasis added) still applies. However, the Board notes that the recognition of these refunds is not equivalent to an equity interest and should not be construed as such. 30. It was not the Board s intent in Statement 14 to preclude pool participants from reporting assets where they exist. The Board recognizes that these participating entities may be required to make capitalization contributions to establish a risk-sharing pool or to ensure a continuing, adequate capital base for a risk-sharing pool. These capitalization contributions may be distinct and separate from premiums and should be reported as deposits if it is probable that the contributions will be returned. Although reporting a deposit has the same effect as reporting an investment in pool, the Board believes that the deposit caption more clearly indicates the nature of the assets. Also, the Board believes that basing the determination of the probability of return on the pooling agreement and on the pool s financial capacity is consistent with Statement 10. Furthermore, requiring reservation of fund balance in governmental funds for qualifying capitalization contributions is consistent with NCGA Statement 1, paragraph When it is not probable that capitalization contributions will be returned, the Board believes the participants have, in effect, paid premiums in advance. Accordingly, these amounts represent prepaid insurance and should be recorded as assets and allocated as expenditures or expenses in future periods as risk coverage is provided. However, in governmental funds, the entire amount may be recognized as an expenditure in the period of the capitalization contribution. Respondents to the ED generally agreed with these provisions. 32. The Board believes that the periods over which risk coverage is provided are appropriate for the allocation and recognition of expenditures or expenses because this is consistent with and parallel to the manner in which premium revenue is to be recognized by pools in paragraphs 19 through 21 of Statement 10. Respondents to the ED generally agreed with this provision. Furthermore, the Board believes that the period for allocation and recognition can be determined by reviewing the pool s premium-setting provisions. 10

17 That is, if the pool charges reduced premiums because it includes the capitalization contribution when calculating amounts needed for claims, there should be some period of time over which the pool expects to provide services for that contribution. In addition, recognition may be accelerated if a pool does not have the capacity to return a contribution; the contribution (or any applicable portion thereof) should be treated as an assessment consistent with paragraph 69 of Statement The Board also agrees with certain respondents to the ED that believe that in some cases it may not be possible to readily determine the periods over which coverage is expected to be provided or for which capitalization contributions are being factored into future premiums. In those cases, the Board decided to limit the periods to a maximum of ten years. (When periods are readily determined, the ten-year maximum does not apply.) 34. The treatment of capitalization contributions to a public entity risk pool without transfer or pooling of risk is consistent with the guidance in Statement 10, paragraph 71, and does not create new guidance. However, the Board believes the guidance in paragraph 9 of this Interpretation is necessary to make it clear that the Board does not intend to modify guidance related to participation in these pools. Public Entity Risk Pools 35. The Board recognizes that public entity risk pools may be participants in other public entity risk pools, such as excess pooling arrangements. (Question 32 of the Statement 10 Implementation Guide addresses excess pooling arrangements.) The Board believes that pools should report capitalization contributions made to other pools in the same manner as is done by entities other than pools, adjusted for the reinsurance accounting requirements of Statement This Interpretation also addresses capitalization contributions received by pools. The Board believes that if the return of a capitalization contribution is probable, a pool should report a liability to recognize its obligation to return the contribution. If the return of the contribution is not probable, the pool should allocate and recognize premium revenue in a manner that is consistent with the premium revenue recognition guidance in paragraphs 19 through 21 of Statement 10. Respondents to the ED generally agreed with this provision. Many noted that the guidance for pools should parallel the guidance for participants in the pools. Consistent with paragraphs 32 and 33 of this Interpretation, the Board also believes that the period for allocation and recognition can be determined by 11

18 reviewing the premium-setting provisions of the pool. That is, if the pool charges reduced premiums because it includes the capitalization contribution when calculating amounts needed for claims, there should be some period of time over which the pool expects to provide service for that contribution. Similarly, when this period of time is not readily determinable, it should not exceed ten years. In addition, recognition may be accelerated if a pool does not have the capacity to return a contribution; the contribution (or any applicable portion thereof) should be treated as an assessment, consistent with paragraph 36 of Statement The Board believes that it is inappropriate to treat capitalization contributions as contributed capital, a component of equity. The Board notes that participants in certain pools may withdraw and receive a return of capitalization contributions; however, providers of contributed capital to proprietary activities generally do not expect a return of contributions. Most respondents to the ED agreed. 12

19 Appendix C CODIFICATION INSTRUCTIONS 38. The sections that follow update the June 30, 1995, Codification of Governmental Accounting and Financial Reporting Standards for the effects of this Interpretation. Only the paragraph number of this Interpretation is listed if the paragraph will be cited in full in the Codification. * * * CLAIMS AND JUDGMENTS SECTION C50 Sources: [Add the following:] GASB Interpretation 4 [Insert new paragraphs , including footnotes, as follows. remaining paragraphs and footnotes.] Renumber the [GASBI 4, 4 8] [Change cross-references. Insert the following additional footnote after the term capitalization contribution in the first sentence of new paragraph.130:] 8 When state and local governmental entities join to form a public entity risk pool or when those entities join an established pool, the pooling agreement may require capitalization contributions to meet initial or ongoing capital minimums established by statute, regulation, or the pooling agreement itself. Capitalization contributions generally take the form of cash. [GASBI 4, 1].135 [Revise the last sentence of the paragraph, which formerly was paragraph.130, as follows:] Payments to the pool, including capitalization contributions, should be reported either as deposits or as reductions of the claim liability, as appropriate. [GASBS 10, 71; GASBI 4, 9] * * * 13

20 ACCOUNTING FOR PARTICIPATION IN JOINT VENTURES AND JOINTLY GOVERNED ORGANIZATIONS SECTION J50 Sources: [Add the following:] GASB Interpretation [Replace the last sentence with the following:] Entities participating in a public entity risk (insurance) pool should follow the accounting and reporting guidance provided in Section C50, Claims and Judgments, paragraphs Entities should not consider participation in, or capitalization contributions to, a public entity risk pool to be an equity interest in a joint venture. [Insert footnote 4 at the end of the paragraph and change cross-references.] [GASBS 14, 79; GASBI 4, 3 and fn1] * * * COLLEGES AND UNIVERSITIES SECTION Co5.105 [Add the following after the last sentence:] Capitalization contributions to public entity risk pools should be accounted for in accordance with Section C50, paragraphs.130,.131,.134, and.135. [GASBS 10, 64, as amended by GASBI 4; GASBS 19, 4] * * * PUBLIC ENTITY RISK POOLS SECTION Po20 Sources: [Add the following:] GASB Interpretation 4 [Insert new paragraphs as follows, renumbering remaining paragraphs and footnotes:] Capitalization Contributions Made to Other Public Entity Risk Pools.136 [GASBI 4, 10 and fn9] [Omit the footnote reference and add its text as the last sentence of the paragraph. Change cross-references. Insert the following additional footnote after the term capitalization contribution in the second sentence:] 6 When state and local governmental entities join to form a public entity risk pool or when those entities join an established pool, the pooling agreement may require capitalization contributions to meet initial or ongoing capital minimums established by statute, regulation, or the pooling agreement itself. Capitalization contributions generally take the form of cash. [GASBI 4, 1] 14

21 Capitalization Contributions Received [GASBI 4, 11 12] [Replace the term public entity risk pool with transfer or pooling of risk with the term pool. Change cross-references.] [Revise the last sentence of paragraph.150, which formerly was paragraph.147, as follows:].150 Amounts collected or due from pool participants, including capitalization contributions, and paid or to be paid to settle claims should be netted and reported as an asset or a liability on an accrual basis, as appropriate. [GASBS 10, 51; GASBI 4, 13] 15