Employers and insurers will be required to account for their share of what could be billions of dollars in new liabilities on their balance sheets under a new auditing rule.

The rule, which was drafted by the American Institute of Certified Public Accountants and accepted by the Financial Accounting Standards Board, is designed to standardize how companies account for insurance-related assessments, such as the levies that support guaranty funds and state second-injury funds.

Employers, especially those that self-insure their workers compensation risks, also may incur substantial costs to annually hire actuaries to calculate their share of a second-injury fund's liabilities.

Most states levy second-injury fund assessments based on an employer's total workers compensation losses, though some use premium or equivalent premium. Guaranty fund assessments usually are based on premium.

In 1995, the most recent year for which statistics are available, total guaranty fund net assessments were $66.6 million, according to the National Conference of Insurance Guaranty Funds.

A figure for total second-injury fund liabilities is generally unavailable, but totals in the billions when unfunded liabilities are taken into account.

Employers and insurers account for the assessments either on a cash basis, reporting the liability as it is paid out, or on an accrual basis, in which the expense is recognized as it is incurred but may be before it has been paid. In addition, accrual methods often vary.

The new rule would require insurers and employers to report on an accrual basis estimable long-term liabilities of the relevant funds and their anticipated share of those liabilities.

As a result of the rule, several experts predict that employers that purchase workers comp insurance may have to pay more for coverage in states that eliminate their second-injury funds.

Insurance companies' loss expenses used to calculate rates currently are net of second-injury fund recoveries. To the extent those funds are eliminated, insurers expenses would be higher, said George Phillips-vp and actuary for the National Council on Compensation Insurance in Hoboken, N.J.

Theoretically, the rule also could result in lower capacity for lines of insurance subject to assessments.

That is because insurers will be reporting greater liabilities, which would limit policyholder surplus and the volume of business it writes.

"A lot of people are just waking up to the implications," said Bruce C. Wood, assistant general counsel of the American Insurance Assn. in Washington.

The new accounting rule, known as a "statement of position," was proposed by the American Institute of Certified Public Accountants of New York. The rule-formally known as "Accounting by Insurance and Other Enterprises for Insurance-related Assessments"-goes into effect for fiscal years beginning Dec. 15, 1998.

The Financial Accounting Standards Board in Norwalk, Conn., essentially accepted it in August, when the board did not object to the AICPA issuing it, said Dave Ficca, a FASB practice fellow. However, FASB requested that minor editing changes be made before a final draft is issued in December.

The purpose of the new accounting rule is to provide greater uniformity in the way insurers and self-insurers account for assessments they pay to support insurance-related funds, such as guaranty funds and second-injury funds, explained Elaine Lehnert, technical manager with the AICPA in New York.

Skyrocketing deficits in many second injury funds have resulted in changes to the funds in many states, as well as increased assessments for employers and insurers in some cases (BI, July 3, 1995).

For example, Florida's fund had a more than a $4 billion deficit when it was placed in runoff earlier this year, and employers and insurers are being assessed 4.5% of premium to pay claims incurred by the fund, said. John B. Lennes Jr., vp and director of workers compensation/health for the Alliance of American Insurers in Schaumburg, Ill.

Kentucky had an unfunded liability of $2 billion, when legislators voted to run it off over the next 20 years. As in Florida, Kentucky's unfunded liability is being paid off over time by assessments.

In all, 10 states have voted to run off their second-injury funds in recent years (BI, June 30).

The new accounting rule was designed to "improve disclosure and make it easier to compare the amounts disclosed for these types of assessments," said Ms. Lehnert of the AICPA.

Companies covered by the audit rule must comply with it to obtain a "clean" audit opinion, which is "very important," said Steve Broadie, vp-tax and finance for the Alliance.

Employers and insurers were concerned by FASB's failure to challenge the rule.

The National Council of Self-Insurers considers the new accounting rule "ridiculous," said Douglas Stevenson, a Chicago-based attorney who serves as executive director. "The accounting rule doesn't follow state laws which relieve employers and insurers from liability for pre-existing conditions," Mr. Stevenson said.

The NCSI also has "a serious question concerning how self-insurers could arrive at the figures required by the rule," Mr. Stevenson said.

Gross liability figures are "unattainable" for most funds, much less an individual self-insurer's pro-rated share of that liability, Mr. Stevenson said.

"Many of these (second-injury) funds can barely calculate what their cash-flow status is, much less their unfunded liability on an actuarial basis," agreed Eric Oxfeld, president of UWC Strategic Services on Unemployment and Workers Compensation in Washington.

In addition, merely having to hire actuaries to calculate such liabilities for assessments by second-injury funds and other insurance funds will drive up system costs, Mr. Oxfeld said.

The potential impact of the new rule raises several other questions.

The rule requires that there be a recognition of accrued losses of a second-injury fund or a related fund where the fund's assessment is based on paid losses, the AIA's Mr. Wood points out.

"If a state changes the assessment basis to a premium-based one, it eliminates the need to follow it," according to Mr. Wood's interpretation.

The rule's focus on paid losses inspired Montana to change how its second-injury fund assesses payers earlier this year, he said. Connecticut made a similar change when it began running off its second-injury fund in 1995, he added.

"I think it is fair to say there is suddenly increased interest among states" with second-injury funds with loss-based assessments to change to a premium-based assessment to avoid the effects of this accounting rule, Mr. Wood said.

However, he doesn't think that approach will help self-insurers.

"It is questionable how they could avoid the effects of the FASB rule by paying an assessment based on a contrived premium," he said.

However, the AICPA's Ms. Lehnert disagrees that the rule would not apply in states whose second-injury find assessments are based on premium.

There is guidance in the accounting rule for reporting liabilities from both premium-based and loss-based assessments, she said.

The Government Affairs Committee of the Risk & Insurance Management Society Inc. is currently reviewing the draft, said Paul Brown, director of government and legal affairs for the New York-based organization.