Statutory insolvency regulations and earnings management in the prepaid health-care industry

Abstract

SYNOPSIS AND INTRODUCTION: Although health-care reform has emerged recently as an important national priority, there has been little research on the effect of possible deficiencies in both accounting and auditing standards in the development of problems in this area. This study examines earnings management in the health maintenance organization (HMO) sectorof the prepaid healthcare industry. HMOs are a principal component of the managed health-care concept currently being promoted as important in controlling escalating healthcare costs. The study examines possible strategic behavior by HMO management in the accrual of incurred but not reported expenses (IBNRs). IBNRs are the costs of medical care provided to HMO enrollees during a given year but not yet reported to the HMO by the fiscal year-end. They consist primarily of five components: accrued inpatient hospitalization costs, accrued primary physician costs, accrued costs from medical specialists to whom HMO enrollees have been referred, accrued medical incentive pool payments, and other miscellaneous medical costs. Their accrual wasfirst recommended by the Health Maintenance Organization Task Force of the American Institute of Certified Public Accountants in an issues paper later published as an exposure draft (AICPA 1985). Itwas eventually released as SOP 89-5 entitled FinancialAccounting and Reporting by Providers of Prepaid Health Services in 1989 to be effective for fiscal years beginning on or after 15 June 1989 with earlier application

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