REPORT DIGEST

ILLINOIS WORKERS’ COMPENSATION COMMISSION -
SELF-INSURERS SECURITY FUND

FINANCIAL AUDIT
FOR THE YEAR ENDED JUNE 30, 2016

Release Date:  January 11, 2018

FINDINGS THIS AUDIT:  3

CATEGORY:  NEW -- REPEAT -- TOTAL
Category 1:  3 -- 0 -- 3
Category 2:  0 -- 0 -- 0
Category 3:  0 -- 0 -- 0
TOTAL:  3 -- 0 -- 3

FINDINGS LAST AUDIT: 0

Category 1: Findings that are material
weaknesses in internal control and/or a
qualification on compliance with State laws
and regulations (material noncompliance).
Category 2: Findings that are significant
deficiencies in internal control and
noncompliance with State laws and
regulations.
Category 3: Findings that have no internal
control issues but are in noncompliance with
State laws and regulations.

State of Illinois, Office of the Auditor
General
FRANK J. MAUTINO, AUDITOR GENERAL

To obtain a copy of the Report contact:
Office of the Auditor General, Iles Park
Plaza, 740 E. Ash Street, Springfield, IL
62703
(217) 782-6046 or TTY (888) 261-2887

This Report Digest and Full Report are also
available on the worldwide web at
www.auditor.illinois.gov

INTRODUCTION

This digest covers the Fund’s financial audit
as of and for the year ended June 30, 2016.
The auditors expressed an adverse opinion on
the Fund’s basic financial statements.  The
Codification of Statements on Auditing
Standards (AU-C § 705.09) states auditors
“should express an adverse opinion when the
auditor, having obtained sufficient
appropriate audit evidence, concludes that
misstatements, individually or in the
aggregate, are both material and pervasive to
the financial statements.”  A compliance
examination of the entire Commission for the
two years ended June 30, 2017, will be
started later this year.

SYNOPSIS

• (16-01) The Commission did not exercise
adequate internal control over its financial
reporting.
• (16-02) The Commission had an inadequate
process to determine the claims liabilities
of the Fund.
• (16-03) The proper accounting treatment for
an insolvent self-insurer’s security
collected by the Commission is not
determinable due to two different
irreconcilable interpretations of the
Workers’ Compensation Act.

EMPHASIS OF MATTER

During our audit, we noted the Self-Insurers
Administration Fund’s expenses have exceeded
revenues recognized for a significant period
of time.

FINDINGS, CONCLUSIONS, AND RECOMMENDATIONS

INADEQUATE FINANCIAL ACCOUNTING AND REPORTING

The Illinois Workers’ Compensation Commission
(Commission) did not exercise adequate
internal control over its financial reporting
for the Self-Insurers Security Fund (Fund).

Material and Pervasive Misstatement

During testing, the auditors noted the
Commission had an inadequate process to
determine the claims liabilities of the Fund.

Material and Pervasive Inability to Obtain
Sufficient and Appropriate Evidence

During testing, the auditors noted the proper
accounting treatment for an insolvent self-
insurer’s security collected by the
Commission is not determinable due to two
different irreconcilable interpretations of
the Workers’ Compensation Act (Act).

Basis for an Adverse Opinion

As a result of (1) the Commission not
adopting a more robust process to determine
the estimated claims liabilities of the Fund
and (2) our inability to obtain sufficient
and appropriate audit evidence regarding the
proper accounting treatment for an insolvent
self-insurer’s security under the Act, the
auditors expressed an adverse opinion on the
Fund’s financial statements as of and for the
year ended June 30, 2016.

Other Noted Errors Corrected by the
Commission

In addition to the foregoing conditions that
resulted in an adverse opinion on the Fund’s
financial statements as of and for the year
ended June 30, 2016, we noted other financial
reporting problems that were corrected in the
Fund’s final financial statements by the
Commission.  Some of the more significant
matters included the following:

• The Commission changed the Fund’s
methodology for calculating claims accruals
by eliminating a 20% markup and additional
reserve for claims. The auditors determined
the Commission did not have (1) a reasonable
basis for the markup or (2) documentation to
support why the 20% markup was included
within its claims accrual methodology. This
change resulted in the Fund recording a prior
period adjustment of $796,388 and a current
period adjustment of $133,610.


• The Commission recorded a prior period
adjustment of $235,416 for a loss exposure
recorded in the prior year that did not meet
the requirement that a liability must have
been incurred as of the date of the financial
statements.

• The Commission changed its longstanding
accounting policy for claims liabilities to
include claims liabilities for insolvent
self-insurers whose unpaid claims were less
than the security collected by the Commission
from those self-insurers. This policy change
resulted in the Fund recording a prior period
adjustment of $2,799,100 and a current period
adjustment of $207,060.

• The Commission recorded a prior period
adjustment of $100,000 to increase the Fund’s
beginning net position and reduce its
unearned security deposits liability account.
This adjustment was needed to reflect a
refund previously incorrectly recorded as an
operating expense during a prior year as
opposed to a reduction to the unearned
security deposit liability account.

• The Commission recorded a current period
adjustment of $508,000 to reduce the Fund’s
current operating expenses and unearned
security deposits liability account. This
adjustment was needed to reflect refunds
incorrectly recorded as an operating expense
as opposed to a reduction to the unearned
security deposits liability account.
(Finding 1, pages 23-28)

We recommended the Commission, in conjunction
with the Self-Insurers Advisory Board, take
action to:
1) adopt written accounting policies which
conform to accounting principles promulgated
by the Governmental Accounting Standards
Board for enterprise funds;
2) develop an appropriate process to estimate
the claims liabilities of the Fund based upon
sufficient and reliable evidence;
3) seek a formal, written opinion from the
Attorney General regarding the treatment of
an insolvent self-insurer’s security under
the Act, or seek a legislative remedy; and,
4) identify financial reporting problems and
make any necessary adjustments to the
financial statements and related notes prior
to the post audit process.

The Commission agreed with this
recommendation.

INADEQUATE PROCESS TO DETERMINE CLAIMS
LIABILITIES

The Commission had an inadequate process to
determine the claims liabilities of the Fund.

Background

The Self-Insurers Advisory Board (Board)
within the Commission was established by the
Workers’ Compensation Act (Act) to provide
oversight of self-insurers, ensure the
employees of insolvent self-insurers continue
to receive their benefits due under the Act
and the Workers’ Occupational Diseases Act
(together, the “Acts”) by administering the
Fund, and determining the assessments to levy
against all private self-insurers to ensure
resources are available to continue paying
benefits due to employees of insolvent self-
insurers.

If a self-insurer becomes insolvent and can
no longer pay its workers’ compensation
obligations, the Board assumes the
outstanding obligations under the Acts of the
insolvent self-insurer and takes action to
collect, recover, and enforce all of the
various forms of security provided by the
insolvent self-insurer.  The Board then
directs the Commission to deposit resources
derived from the security into the Fund.

The Fund will continue to pay, in full, the
insolvent self-insurer’s obligations due
under the Acts as long as the insolvent self-
insurer’s employees remain disabled. Due to
the nature of workers compensation claims,
these costs can extend out over several
decades and remain subject to a wide variety
of factors impacting the actual cost of the
obligation due to the employees, including
necessary medical procedures, cost inflation,
and each employee’s life expectancy.

Review of Accounting Principles Generally
Accepted in the United States

Governmental Accounting Standards Board
Statement No. 34 requires the presentation of
proprietary funds, such as the Fund, under
the accrual basis of accounting and the
economic resources measurement focus.
Further, Governmental Accounting Standards
Board Statement No. 34 notes transactions
occur when something of value passes between
two or more parties. Additionally, National
Council on Governmental Accounting Statement
No. 1 states that under the accrual basis of
accounting, transactions are generally
recorded when the transaction occurs,
regardless of when cash is received or
disbursed.

Also, Governmental Accounting Standards Board
Statement No. 62 requires estimated losses be
accrued if both (1) information available
prior to the issuance of the financial
statements indicates it is probable a
liability has been incurred as of the date of
the financial statement and (2) the amount of
the loss can be reasonably estimated. If
either or both of these conditions cannot be
satisfied, Governmental Accounting Standards
Board Statement No. 62 requires the exposure
be disclosed in the notes to the financial
statements.

Application of the Accounting Literature to
the Fund’s Environment

As such, the Fund must develop an accounting
methodology to properly account for incurred
but not reported (IBNR) claims liabilities
and the associated administrative costs
necessary to continue processing the amounts
due to the employees over time as of the date
when it is both (1) probable a liability has
been incurred and (2) the amount can be
reasonably estimated or disclose the
situation in the Fund’s notes if one or both
conditions are not met. This is necessarily
an accounting estimate and impacts the
Board’s determination of assessments needed
to ensure the Fund has sufficient resources
to carry out its activities under the Act.

We noted the Commission’s current methodology
for its claims liability generally reflects
cash basis or modified accrual basis
accounting for the Fund’s unpaid medical
claims and unpaid administrative and legal
expenses. These liabilities must be reported
on the full accrual basis of accounting.

During the audit process, we recommended the
Commission adopt a claims reserve analysis to
properly estimate the Fund’s net unpaid
claims liability. This process would
calculate both known claims (such as
established rates for indemnity payments) and
IBNR claims where actuarial techniques are
used to calculate the total liability of each
individual claim from an insolvent self-
insurer’s employees and recognize that
expense in the period when it becomes
probable a liability has been incurred. When
these claims are ultimately paid from the
Fund, the Fund would reduce its already
recorded liability for unpaid claims.

A formula for determining the Fund’s net
claims liability from each claim is:

Add:	Gross Unpaid Indemnity Claims
	Gross Unpaid Medical Claims
	Gross Unpaid Administrative and Legal
	Expenses
Less:	Excess Insurance Recoveries
	Security Collected from Insolvent
	Self-Insurers
_________________________________
Recognized Net Unpaid Claims Liability

Material and Pervasive Misstatement

After extensive discussions between the
auditors and the Commission, the Board and
Commission ultimately did not adopt a claims
reserve analysis approach to calculate claims
liabilities in accordance with the accrual
basis of accounting. The Board and Commission
kept its prior claims methodology which did
not reflect the accrual basis of accounting.
(Finding 2, pages 29-33)

We recommended the Commission, in conjunction
with the Board, take action to ensure its
claims liabilities, including the Fund’s
unpaid medical claims and unpaid
administrative and legal expenses, are
properly presented in accordance with the
accrual basis of accounting.

The Commission agreed with this
recommendation.

UNCERTAINTY REGARDING STATUTORY
INTERPRETATION

The proper accounting treatment for an
insolvent self-insurer’s security collected
by the Commission is not determinable due to
two different irreconcilable interpretations
of the Act.

Background

An employer can apply to the Self-Insurers
Advisory Board (Board) within the Commission
to become a self-insurer under the Act.
During its review of the application, the
Board considers several factors – including
the applicant’s financial viability, number
of employees, the nature and hazard of the
types of work performed by its employees, and
claims experience factors – to reach its
decision to approve or deny the application.
If the Board approves the applicant, the
Board will determine if the self-insurer has
sufficient ability to adequately secure
payment for its financial obligations under
the Acts or require the self-insurer to post
a security. Typically, the Board requires the
self-insurer to post some form of security –
such as a surety bond, escrow agreement, or
letter of credit – to allow the Commission to
obtain resources to cover a self-insured
employer’s obligations under the Acts if it
becomes insolvent.

If a self-insurer becomes insolvent and can
no longer pay its workers’ compensation
obligations, the Board assumes the
outstanding obligations under the Acts of the
insolvent self-insurer and takes action to
collect, recover, and enforce all of the
various forms of security provided by the
insolvent self-insurer. The Board then
directs the Commission to deposit resources
derived from the security into the Fund.

The Fund will continue to pay, in full, the
insolvent self-insurer’s obligations due
under the Acts as long as the insolvent self-
insurer’s employees remain disabled. Due to
the nature of workers’ compensation claims,
these costs can extend out over several
decades and remain subject to a wide variety
of factors impacting the actual cost of the
obligation due to the employees, including
necessary medical procedures, cost inflation,
and each employee’s life expectancy. As such,
the security collected by the Commission from
the insolvent self-insurer may or may not
ultimately satisfy the insolvent self-
insurer’s workers compensation claims. In
order to ensure the Fund can fulfill these
obligations if the collected security is
insufficient, the Act provides a procedure
for the Board to assess each private self-
insurer a pro rata share of the funding
reasonably necessary to ensure the Board can
fulfill its obligations to the insolvent
self-insurer’s employees.

At this point, two irreconcilable
interpretations of the Act exist with regards
to the proper treatment of the security
collected by the Commission from the
insolvent self-insurers.

Interpretation #1 – Liability Recognized Upon
Receipt
Interpretation #1 assumes the Act has two
separate and distinct refund criteria
codified for insolvent self-insurers when its
obligations have been satisfied and any
remaining self-insurers when all of the
Fund’s remaining obligations have been
satisfied.

Interpretation #2 – Revenue Recognized Upon
Receipt Interpretation #2 assumes the Act has
two separate refund criteria codified for
insolvent self-insurers when its obligations
have been satisfied and any remaining self-
insurers when all of the Fund’s remaining
obligations have been satisfied, but both
criteria only occur when the entire Fund
ceases operations and all obligations have
been fully satisfied. It is readily assumed
the complete cessation of the Fund is
extremely remote, as businesses voluntarily
choose to become self-insurers and
participate in the assessment process for
various economic reasons.

Within the finding, we analyzed both
interpretations and identified various
strengths and weaknesses for each
interpretation.  We also identified the
accounting treatments that would arise if
either Interpretation #1 or Interpretation #2
was adopted by the Fund.

Due to these two irreconcilable
interpretations of the Act, we were unable to
obtain sufficient, appropriate audit evidence
to conclude the Commission’s presentation of
the Fund’s financial statements complied with
the Act. According to Commission officials,
the implementation of the Interpretation #1
would result in the Fund reducing its
recognition of revenue in current and prior
periods of approximately $16.9 million, which
would result in the Fund showing a negative
net position of approximately $5.4 million.
(Finding 3, pages 34-44)

We recommended the Board and the Commission
seek a formal, written opinion from the
Attorney General regarding the treatment of
an insolvent self-insurer’s security under
the Act, or seek a legislative remedy.

The Commission agreed with the recommendation
to seek a legislative remedy.

We will review the Commission’s progress
towards the implementation of our
recommendations in our next financial audit.

EMPHASIS OF MATTER

The State of Illinois’ self-insurance program
administered by the Commission consists of
two funds: the Self-Insurers Administration
Fund and the Self-Insurers Security Fund.
Pursuant to the Act, the Self-Insurers
Administration Fund collects a $500
application fee from each private self-
insurer applying for or seeking renewal of
the self-insurance privilege, which is
available only for paying the salaries and
benefits of the employees and the operating
costs of the Self-Insurers Advisory Board
within the Commission. During our audit, we
noted the Self-Insurers Administration Fund’s
expenses have exceeded revenues recognized
for a significant period of time.  According
to the Commission’s most recent unaudited
accrual basis financial reports filed with
the Office of the State Comptroller, the
Self-Insurers Administration Fund’s net loss
was $157 thousand, $132 thousand, and $86
thousand during Fiscal Year 2015, Fiscal Year
2016, and Fiscal Year 2017, respectively.
Without operational changes and/or a
legislative remedy, the continuing negative
trend will eventually consume the remaining
net position, which the Commission’s
unaudited accrual basis financial reports
filed with the Office of the State
Comptroller reported was $304 thousand at
June 30, 2017.

AUDITOR’S OPINION

The auditors stated the financial statements
of the Fund as of and for the year ended June
30, 2016, are not fairly stated in all
material respects.

This financial audit was conducted by Adelfia
LLC.

JANE CLARK
Division Director

This report is transmitted in accordance with
Section 3-14 of the Illinois State Auditing
Act.

FRANK J. MAUTINO
Auditor General

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