The
Town Of Frostbite Self Insures For Some Of Its Liability Claims An
The Town of Frostbite self-insures for some of its liability claims and purchases insurance for others. In an effort to consolidate its risk management activities, the Town recently decided to establish an internal service fund, the Risk Management Fund. The Risk Management Fund’s purpose is to obtain liability coverage for the Town, to pay claims not covered by the insurance, and to charge individual departments in amounts sufficient to cover current year costs and to establish a reserve for losses. The Town reports proprietary fund expenses by object classification using the following accounts: Personnel services (salaries), Contractual services (for the expired portion of prepaid service contracts), Depreciation, and Insurance Claims.
The following transactions relate to the year ended December 31, 2012, the first year of the Risk Management Fund’s operations.
1. The Risk Management Fund is established through a transfer of $500,000 from the General Fund and a long-term advance from the water utility enterprise fund of $250,000.
2. The Risk Management Fund purchased (prepaid) insurance coverage through several commercial insurance companies for $200,000. The policies purchased require the Town to self-insure for $25,000 per incident.
3. Office Equipment is purchased for $10,000.
4. $450,000 is invested in marketable securities.
5. Actuarial estimates were made in the previous fiscal year to determine the amount necessary to attain the goal of accumulating sufficient funds to cover current-year claims and to establish a reserve for losses. It was determined that the General Fund and water utility be assessed a fee of 6 percent of total wages and salaries (Interfund premium). Wages and salaries by department are as follows: Public Safety $5,000,000; General Administrative Operations $1,500,000; Education $1,500,000; Water Utility $2,500,000; Total $10,500,000.
Cash received in payment of interfund premiums from the General Fund totaled $275,000, and from the Water Utility totaled $100,000.
7. Interest and dividends received totaled $27,000.
8. Salaries for the Risk Management Fund amounted to $200,000 (all paid during the year).
9. Claims paid under self-insurance totaled $150,000 during the year.
10. The office equipment is depreciated on the straight-line basis over 5 years.
11. At year-end, $190,000 of the insurance policies purchased in January had expired.
12. The market value of investments at December 31 totaled $456,000.
13. In addition to the claims paid in entry 9 above, estimates for the liability for the Town’s portion of known claims since the inception of the Town’s self-insurance program totaled $90,000.
Required:
b. Prepare a Statement of Revenues, Expenses, and Changes in Fund Net Assets for the year ended December 31, 2012, for the Risk Management Fund.
c. Prepare a Statement of Net Assets as of December 31, 2012, for the Risk Management Fund.
d. Prepare a Statement of Cash Flows for the year ended December 31, 2012, for the Risk Management Fund.
e. Comment on whether the interfund premium of 6 percent of wages and salaries is adequate.
Paper For Above instruction
Introduction
The Risk Management Fund established by the Town of Frostbite exemplifies a classic internal service fund within governmental accounting, aimed at managing liabilities related to self-insurance and related activities. This fund consolidates various risk management activities, including paying claims, purchasing insurance, investing reserve funds, and allocating costs to departments. Analyzing its financial statements provides insight into its operational efficiency, financial position, and fiscal adequacy, especially regarding its funding mechanisms such as interfund premiums.
Statement of Revenues, Expenses, and Changes in Fund Net Assets
The Statement of Revenues, Expenses, and Changes in Fund Net Assets (or Fund Activities) reflects the fund’s performance over the fiscal year. It begins with revenue sources—interfund premiums, investment income, and other income—and deducts operational expenses such as salaries, claims paid, depreciation,
and administrative costs.
Revenues primarily include:
- Interfund premiums ($275,000 from the General Fund and $100,000 from the Water Utility)
- Investment income ($27,000)
Expenses include:
- Salaries ($200,000)
- Claims paid ($150,000)
- Depreciation expense on equipment ($10,000 / 5 = $2,000 annually)
- Insurance expense for expired policies ($190,000 of policies expired during the year)
The net change in assets reflects the difference between total revenues and total expenses, indicating whether the fund gained or lost net assets during the year.
**Calculation:**
Total Revenues:
- Interfund premiums: $275,000 + $100,000 = $375,000
- Investment income: $27,000
- Total Revenues = $402,000
Total Expenses:
- Salaries: $200,000
- Claims paid: $150,000
- Depreciation: $2,000
- Insurance expense (expired policies): $190,000
- Total Expenses: $542,000
Net change:
- $402,000 - $542,000 = -$140,000
This indicates a decrease in fund net assets by $140,000, representing operational costs exceeding income.
Statement of Net Assets
The Statement of Net Assets reports the financial position at year-end, including assets, liabilities, and net assets.
Assets include:
- Restricted cash (initial transfer and subsequent cash balances): Starting with the initial investments and transfers, adjustments for claims liabilities, prepaid insurance, investments at fair value ($456,000), and equipment net of depreciation.
- Investments: $456,000, with an unrealized gain of $6,000 (from $450,000 to $456,000).
Liabilities include:
- Claims payable: $90,000 (known claims)
- Claims paid during the year: $150,000, accounted for as reductions in liabilities upon payment.
Net assets reflect the residual interest:
- Beginning net assets: this is typically zero or initial contributions
- Changes during the year: net assets decreased by $140,000 due to operations
**Assets calculation:**
- Cash and investments at year-end: $456,000
- Prepaid insurance: $10,000 (purchase) minus expired amount $190,000; however, since expired policies exceed the initial prepaid, adjustments must be made for the remaining prepaid balance.
- Office equipment net of depreciation: $10,000 - $2,000 = $8,000
**Liabilities:**
- Claims payable: $90,000
Net Assets:
- Total assets minus liabilities result in the net position at year-end, which would be adjusted for actual insurance and claims liabilities.
Statement of Cash Flows
The Statement of Cash Flows details cash inflows and outflows categorized into operating, investing, and financing activities.
**Operating activities:**
- Cash received from premiums: $375,000
- Claims paid: ($150,000)
- Salaries paid: ($200,000)
- Payments for insurance premiums, administrative expenses, and claims.
**Investing activities:**
- Purchase of investments: ($450,000)
- Proceeds from sale or mature investments are reflected in the change in fair value: unrealized gains of $6,000, increase in investment value.
**Financing activities:**
- Transfers from the General Fund and water utility: $500,000 + $250,000
- Purchase of office equipment: ($10,000)
The net cash position at the end of the year is derived from these inflows and outflows, considering accrued and unexpended amounts.
Adequacy of Interfund Premium
Assessing whether the 6% of wages and salaries adequately funds the Risk Management Fund involves comparing the premiums collected against actual claims, administrative costs, and reserve allocations.
Total wages are $10,500,000, and 6% of this yields $630,000. However, premiums received were $375,000, indicating a shortfall relative to the expected premium-based assessment. The premiums covered less than the calculated 6%, highlighting potential underfunding. The actual claims paid and
liabilities are higher than collected premiums, which suggests the rate may be insufficient. To ensure sustainability, the premium rate should be re-evaluated considering actual claims experience, reserve requirements, and administrative costs. An underfunded premium structure could compromise the fund's ability to cover future liabilities, especially considering the liabilities and claims estimates exceeding collected premiums.
Conclusion
The financial analysis indicates that the Risk Management Fund experienced a net decrease in assets during 2012, mainly due to claims and operational expenses surpassing revenue. Its current funding mechanism through interfund premiums at 6% appears inadequate based on actual claims and expenses. Addressing this gap requires revising premium assessments and strengthening reserve policies. Proper funding is vital to sustain self-insurance activities without reliance on external borrowing or additional transfers, ensuring the municipality’s risk management framework remains resilient and effective.
References
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