Accounting, Funding and Tax Consequences

Dilatory funding practices by the employer

Plan supervisors should watch for signs of impending bankruptcy including: (1) dilatory funding practices, (2) marginal industries, (3) questionable financials, and (4) disparaging comments from brokers, bankers, participants, or providers. Most plan supervisors fail to get financial checks of prospective clients.

At net cost rather than gross cost

When a hospital maintains a self-funded plan and claims Medicare-allowable deductions, the cost of hospital services to its own employees is not a courtesy fringe benefit and may be treated as benefit plan costs. However, the costs of services must be includable at net rather than at gross costs.

6% per annum

The defense contract regulations state that reserves under an approved self-funded welfare plan are allowable expenses to the extent they are consistent with an insured plan. Benefit reserves that anticipate payments for periods in excess of one year, such as continuing disability, shall be discounted at a rate not less than 6% per annum.

Such costs are current income for the covered officers

The regulations specify that the costs of self-funded life insurance benefits for the officers of the employer are allowable only if such costs are current income for the covered officers. This ensures that the benefit is being reported as taxable compensation.

The AICPA Cost Accounting Standards Board, with administration by the General Services Administration

Regulations published by the General Services Administration provide guidelines for government-negotiated defense prime contractors that are self-funded. These guidelines are administered by the AICPA Cost Accounting Standards Board and also by the Department of Defense for other government nondefense agencies.

Items not directly affecting the plan supervisor's benefit administration, though benefit administration may be part of the audit

The course states that IRS audits are normally aimed at items not directly affecting the plan supervisor's benefit administration, but benefit administration may be part of the audit. Knowledge of such audits is useful in the administration of self-funded plans.

Because pegging reserves near the safe harbor limit suggests the employer is maximizing tax deductions rather than reflecting actual expected benefit costs

The course identifies the practice of pegging VEBA reserves near the 35% safe harbor limit as one that is often challenged during IRS audits. The implication is that employers may be using the safe harbor to maximize deductible contributions rather than setting reserves based on genuine actuarial need.

Because of a Supreme Court decision that ruled against using VEBAs for retiree reserves

The course notes that among typical IRS audit deficiencies related to VEBAs, a Supreme Court decision established that VEBAs are not suitable for retiree reserves. This is listed alongside other VEBA issues such as attempting to deduct accrued contributions and discrimination in favor of key employees.

50%

The course states that about 50% of DOL's audit resources are devoted to investigation of significant issues (areas with the highest potential for abuse). About 15% are devoted to fostering voluntary compliance, with the remaining 35% devoted to audits of plans with known or suspected violations, cross-section investigations, and criminal investigations.

Service providers to welfare plans and financial institutions that provide services to pension plans

Under the significant issue approach, 50% of DOL's fiduciary investigative time is devoted to abusive practices in two areas: service providers to welfare plans and financial institutions that provide services to pension plans. The remaining 50% is used to audit a cross section of the employee benefit plan universe and conduct criminal investigations.

Form 5500 annual reports

DOL targets its investigations from a number of sources including, most importantly, the Form 5500 annual reports. IRS enters the data from these reports and subjects it to comprehensive automated edit tests that identify deficient filings. Civil penalties of up to $1,000 per day may be assessed if deficiencies remain after three rounds of correspondence.

Up to $1,000 per day

The course states that civil penalties of up to $1,000 per day may be assessed if a Form 5500 deficiency remains after three rounds of correspondence. This is part of the DOL's automated edit check process for annual reports.

30%, which was an improvement from 39% in the 2015 study

The DOL's 2023 Audit Quality Study found that approximately 70% of audits fully complied with professional auditing standards or had only minor deficiencies. However, 30% contained one or more major deficiencies, which was an improvement from the 2015 study where 39% had major deficiencies.

The number of employee benefit plan audits performed by the CPA firm — firms performing more audits generally had higher quality

The study found a correlation between the number of employee benefit plan audits performed by a CPA firm and the quality of the audit work. Firms that performed more employee benefit plan audits generally had higher quality audits, suggesting that specialization and experience improve audit quality.

Auditors must determine whether the preconditions for an audit are present, including management's responsibilities and the auditor's ability to perform the audit

SAS 136 introduces several key requirements including engagement acceptance and continuance (determining audit preconditions), audit risk assessment and response, enhanced communication with those charged with governance, specific procedures for ERISA Section 103(a)(3)(C) audits, written representations from management, and revised reporting formats.

Whether the service provider has obtained SOC 1 and SOC 2 reports from an independent auditor

Each DOL service provider audit determines: (1) whether any legitimate service is being rendered, (2) whether the service is necessary to plan administration or payment of benefits, (3) whether the service is being duplicated by other providers, and (4) whether the cost is reasonable. SOC report verification is not listed as a standard DOL audit determination.

Sound and prudent business reasons, and as an early warning system for an external audit

The course states that the plan supervisor should have a regular program of internal audits for sound and prudent business reasons as well as for an early warning of an external audit. External audits routinely come from stop-loss carrier aggregate claim investigations, independent accountant audits for ERISA compliance, regulatory audits (IRS or DOL), or employer-requested audits.

Whether accumulations are accurate and whether dates are acceptable as to the terms of stop-loss contract types (12/12, 14/12, 12/15, etc.)

The internal audit checklist asks: Are there any errors with stop-loss benefits? Specifically, are accumulations accurate, and are dates acceptable as to terms of stop-loss (12/12, 14/12, 12/15, etc.)? This ensures claims are properly tracked against the correct contract parameters.

Effective date, COBRA dates, termination dates, change-of-status dates, age and hours requirements, and definitions such as dependent child

The internal audit checklist specifies that eligibility verification should consider: effective date, COBRA dates, termination dates, change-of-status dates, age and hours requirements, and definitions (dependent child, for example). This comprehensive check helps catch eligibility errors before they become costly.

IRS Revenue Procedure 98-22; the motivation is that self-discovery and correction of errors is far less costly than having errors found by a regulator

The course explains that the self-discovery of compliance errors is described in IRS Revenue Procedure 98-22. Self-funders are motivated to conduct compliance audits to assure themselves that they will not be subject to fines or penalties. The self-discovery and correction of errors is far less costly than having such errors found otherwise.

Whether all plan assets are held by either an insurance carrier or a trust

One of the key items examined in a compliance self-discovery audit is whether all plan assets are held by either an insurance carrier or trust. This is a fundamental ERISA requirement to protect participant assets from being commingled with employer general assets.

Errors in the 1-2% range

The course states that when employer-sponsored audits are conducted, errors of a procedural or payment nature are discerned, and most audits pick up errors in the 1-2% range. Three audit patterns are found: general assessment of performance, dollar value of errors, and selective or target audit.

Fully computerized systems have been found to have fewer errors compared to manual systems

The course notes that system efficiency is a key finding of employer-sponsored audits: fully computerized systems have been found to have fewer errors compared to manual systems. This highlights the importance of leveraging technology for accuracy and efficiency in claims processing.

The names of all covered dependents, not just the number of children

Audits have revealed that it is essential to have the names of all covered dependents, not just the number of children. This ensures accurate benefit administration and reduces errors related to eligibility verification and coordination of benefits.

The plan document and the Summary Plan Description (SPD)

The course identifies frequent inconsistencies between the plan document and the Summary Plan Description (SPD) as a common audit finding. This document consistency issue highlights the need for alignment and accuracy between the governing plan document and the summary provided to participants.

The clients' internal controls over financial reporting (ICFR)

A SOC 1 (System and Organization Controls 1) report focuses on a service organization's controls relevant to their clients' internal controls over financial reporting (ICFR). It is primarily used by service organizations to provide assurance to their clients and their auditors in the context of financial statement audits.

Type I evaluates design and implementation at a specific point in time, while Type II evaluates design, implementation, and operational effectiveness over a specific period

A SOC 1 Type I report evaluates the design and implementation of controls at a specific point in time. A SOC 1 Type II report evaluates the design, implementation, and operational effectiveness of controls over a specific period (e.g., six months or a year). Type II provides greater assurance because it demonstrates controls are working effectively over time.

Security

SOC 2 reports are based on five trust services criteria categories: Security, Availability, Processing Integrity, Confidentiality, and Privacy. Security is mandatory for all SOC 2 reports, ensuring that the system is protected against unauthorized access and misuse. The other categories are optional based on the service organization's needs.

SOC 3 is a general use report that can be freely distributed, designed for users who need assurance but lack the knowledge to use a detailed SOC 2 report

SOC 3 reports are designed to meet the needs of users who need assurance about controls at a service organization relevant to security, availability, processing integrity, confidentiality, or privacy, but who do not have the need for or the knowledge necessary to make effective use of a SOC 2 report. Because they are general use reports, SOC 3 reports can be freely distributed.

An employer that self-funds, a plan that requires an accountant's statement, or a trust regardless of whether qualified or nonqualified

Service Organization Controls (SOC) audits apply when an audit is performed on the financial statements of: (1) an employer that self-funds, (2) a plan that requires an accountant's statement, or (3) a trust, regardless of whether governed by IRC §501(c)(9) (qualified) or by IRC §419A (nonqualified).

The effectiveness of their enterprise-wide cybersecurity risk management programs

The AICPA developed a cybersecurity risk management reporting framework that assists organizations as they communicate relevant and useful information about the effectiveness of their cybersecurity risk management programs. A CPA reports on an organization's enterprise-wide cybersecurity risk management program to help stakeholders gain a better understanding.

Billing errors (ministerial in nature) and substantive errors (e.g., medical practice issues)

The course states that the hospital bill audit seeks out two categories of difficulties: billing errors (ministerial in nature) and substantive errors (e.g., medical practice). In addition, charges for apparently not necessary, reasonable, and customary services will be looked for. When an audit is made, the employer/plan agrees to pay back any undercharges to the hospital.

Over $25,000 in charges

The course states that in deliberating whether an on-site audit is in order, one question to ask is: Is there enough money involved? The break point at minimum is over $25,000 in charges. Other considerations include whether the patient is still confined and whether questions can be resolved by telephone.

Lab tests done more often than daily

The course provides numerous examples of errors that might be discovered in hospital bill audits, including: lab tests done more often than daily, blood charges without credit for replacement, frequent or questionable therapies, excessive charges, services not consistent with diagnosis, charges not adequately described, and room and board charges less than 50% of total bill.

90% of the covered benefit

The guidelines for successful hospital bill audits state that despite a pending audit, payers should pay a minimum of 90% of the covered benefit upon receipt of a bill. The audit should not be used as a process to delay payment. Additionally, all audits should be completed within six months of submission of the bill.

Whatever the original purpose of the audit, all parties agree that any identified overcharges and undercharges will be recognized, recorded, and presented

The full reporting guideline addresses concerns raised in Senate hearings about the alleged failure of certain firms to report hospital overcharges if they were hired to identify undercharges. The guideline requires that whatever the original purpose, all overcharges and undercharges must be recognized, recorded, and presented.

$25,000 and over

The course states that when there is a stop-loss audit of any dollar consequence ($25,000 and over, for example) or when the stop-loss carrier has reason to be uncertain as to the practices followed by the plan supervisor, there may be a stop-loss audit.

Aggregate on-site audits are frequent; specific on-site audits are rare and usually done by home office review of the actual claim file

The course states that aggregate on-site audits are frequent, while specific on-site audits are rare and are usually done by the stop-loss carrier by home office review of the actual claim file. This is because an aggregate claim represents a significant risk for a small premium, making aggregate verification more important.

Large claims without medical case management

The course identifies several red flags that may prompt a stop-loss audit beyond an aggregate claim: large and unexplained increase in paid claims, large claims without medical case management, numerous credits and refunds directing payment errors, and excessive complaints regarding the plan supervisor's service.

Whether the disability is occupational or non-occupational, since this determines the applicable benefit program (workers' compensation vs. disability plan)

When disability benefits are audited, one of the key questions is whether the disability is occupational or non-occupational. This classification determines whether the claim falls under workers' compensation or the employer's disability plan, affecting benefits, funding, and tax treatment.

$720,000 paid plan costs plus the change in total claim reserves ($100,000 - $80,000) = $740,000

For Employer A, the general asset plan, the expense is $720,000 (paid plan costs) + ($100,000 - $80,000) = $740,000. The $100,000 is the total claim reserve at 12-31-X and $80,000 is the total claim reserve at 12-31-X-1. The change in reserves represents expense that has been incurred but not yet paid.

The tax deduction uses only the in-course-of-settlement reserve change ($40,000 - $30,000), not the total reserve change including IBNR

For Employer A, the GAAP expense is $720,000 + ($100,000 - $80,000) = $740,000, using total claim reserves. The tax deduction is $720,000 + ($40,000 - $30,000) = $730,000, using only the in-course-of-settlement reserves (reported, known claims). IBNR reserves are not deductible in a general asset plan.

30% of $2,800,000, which is $840,000

Employer B's proportionate share of the VEBA is presumed to be 30%. The VEBA's outgo is $2,700,000 + ($400,000 - $300,000) = $2,800,000. Employer B owes 30% of $2,800,000, which equals $840,000. This amount may be both expensed and taxable to Employer B.

The trust financials use IRC §419A claim reserves ($400,000) while the Form 5500 uses ASC 965 plan obligation reserves ($800,000), resulting in different liability figures

The VEBA trust financials show assets of $500,000 and liabilities of $400,000 (IRC §419A reserves), resulting in a $100,000 surplus. The Form 5500 shows the same $500,000 in assets but uses ASC 965 plan obligations of $800,000 as the liability, resulting in a deficit of $300,000. The Form 5500 is for disclosure purposes and has no impact on Employer B's earnings, balance sheet, or taxes.

Employer C must recognize the $140,000 liability shown on the trust's books because the trust is the employer's alter ego and exists only as a funding device

Employer C under general accounting theory will assume, and must recognize, the $100,000 (later $140,000) liability that is shown on the books of the trust. This is because the trust is Employer C's alter ego; it exists only as a funding device of the plan of Employer C, for which Employer C is the plan sponsor.

IRC §419A limits do not apply to a MEWA where there are both over 10 employers and no one employer contributes more than 10% of contributions, whereas they do apply to the VEBA

For the VEBA trust filing (IRS Form 990), the limits of IRC §419A apply. For the MEWA trust filing, the limits of IRC §419A do not apply where there are both (a) over 10 employers and (b) no one employer is contributing more than 10% of the contributions. Also, ASC 965 does not apply to a MEWA.

The employer's books are only affected indirectly by the VEBA or MEWA

The course states that for both the VEBA and the MEWA, the books of both Employer B and Employer D are only affected indirectly by the VEBA and MEWA. The employer's proportionate share and any surplus or deficit determination are matters of accountant judgment as to materiality and appropriateness.

$100,000 (the total claim reserve at year-end, including both in-course-of-settlement and IBNR)

For Employer A, the total claim reserve at 12-31-X is $100,000, consisting of $40,000 in-course-of-settlement and $60,000 IBNR. This $100,000 is shown as a liability on the employer's balance sheet at 12-31-X. The prior year reserve was $80,000, and the change drives the expense calculation.

The source of funds, the methods employed to obtain such funds, and the plan's short- and long-run financial needs

The DOL ruled in 1978 that the funding policy should disclose the source of funds, the methods employed to obtain such funds, and the plan's short- and long-run financial needs, ensuring plan fiduciaries can assess the plan's financial requirements.

Mandatory minimum funding levels for self-insured health plans based on actuarial projections

ERISA Section 43 under the SECURE 2.0 Act covers preemption of state laws, fiduciary responsibilities, plan documentation/reporting, and claims/appeals procedures for self-insured plans. It does not impose mandatory minimum funding levels based on actuarial projections for self-insured health plans.