oversight

Death and Total and Permanent Disability Discharges of FFEL and Direct Loan Program Loans.

Published by the Department of Education, Office of Inspector General on 2005-11-14.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                     UNITED STATES DEPARTMENT OF EDUCATION
                                   OFFICE OF INSPECTOR GENERAL




MEMORANDUM	                                                                 11/14/2005

TO:	           Theresa S. Shaw
               Chief Operating Officer
               Federal Student Aid
               Lead Action Official

               Sally L. Stroup        

               Assistant Secretary for Postsecondary Education 


FROM:	         Helen Lew /s/
               Assistant Inspector General for Audit Services

SUBJECT:	 Final Audit Report
          Death and Total and Permanent Disability Discharges of FFEL and Direct Loan
          Program Loans
          Control Number ED-OIG/A04E0006

Attached is the subject final audit report that covers the results of our review of FFEL and Direct
Loan program loans discharged due to death during July 1, 2002, through August 27, 2004, and
total and permanent disability (disability discharges) from July 1, 2002, through June 30, 2004.
An electronic copy has been provided to your Audit Liaison Officers. We received your
comments on the draft report non-concurring with the recommendation for finding 1, non-
concurring with the finding and recommendation for finding 2, and concurring with the finding
and recommendation for finding 3.

Corrective actions proposed (resolution phase) and implemented (closure phase) by your offices
will be monitored and tracked through the Department’s Audit Accountability and Resolution
Tracking System (AARTS). ED policy requires that you develop a final corrective action plan
(CAP) for our review in the automated system within 30 days of the issuance of this report. The
CAP should set forth the specific action items, and targeted completion dates, necessary to
implement final corrective actions on the findings and recommendations contained in this final
audit report.

In accordance with the Inspector General Act of 1978, as amended, the Office of Inspector
General is required to report to Congress twice a year on the audits that remain unresolved after
six months from the date of issuance.
In accordance with the Freedom of Information Act (5 U.S.C. §552), reports issued by the Office
of Inspector General are available to members of the press and general public to the extent
information contained therein is not subject to exemptions in the Act.

We appreciate the cooperation given us during this review. If you have any questions, please
call Denise Wempe, Regional Inspector General for Audit, at (404) 562-6477.


Enclosure
            Death and Total and Permanent Disability 

       Discharges of FFEL and Direct Loan Program Loans 


                                   FINAL AUDIT REPORT 

Statements that managerial practices need improvements, as well as other conclusions and recommendations in this
 report, represent the opinions of the Office of Inspector General. Determinations of corrective action to be taken
                         will be made by the appropriate Department of Education officials.




                                            ED-OIG/A04E0006 

                                             November 2005 





Our mission is to promote the efficiency,                                           U.S. Department of Education
effectiveness, and integrity of the                                                   Office of Inspector General
Department’s programs and operations.                                                            Atlanta, Georgia
                                          TABLE OF CONTENTS


                                                                                                                       Page 


EXECUTIVE SUMMARY ...............................................................................................1 


BACKGROUND ................................................................................................................3 


AUDIT RESULTS .............................................................................................................5 


          Finding No. 1 - The Regulatory Three-year Conditional Discharge 

                          Period is Inadequate for Determining Eligibility 

                          of All Borrowers..........................................................................5 


          Finding No. 2 – Regulations That Excuse a Borrower from Paying Interest 

                          Should Be Reconsidered .............................................................8 


          Finding No. 3 – FSA Did Not Update NSLDS, As Required ...........................12 


OTHER MATTERS ........................................................................................................15 


OBJECTIVE, SCOPE, AND METHODOLOGY ........................................................16 


APPENDIX A – WRITTEN RESPONSE TO THE DRAFT REPORT.....................18 

Final Report
ED-OIG/A04E0006                                                                       Page 1 of 21



                              EXECUTIVE SUMMARY


The objective of our audit was to determine whether Federal Student Aid (FSA) has implemented
effective policies, procedures, and internal controls over the process for discharging William D.
Ford Federal Direct Loan (Direct Loan) and Federal Family Education Loan (FFEL) program
loans, based on the death or total and permanent disability of the borrower. The audit period for
our review of death discharges was from July 1, 2002, through August 27, 2004, and the audit
period for our review of discharges based on total and permanent disability (disability discharges)
was from July 1, 2002, through June 30, 2004.

We found that policies, procedures, and internal controls over the process for discharging loans
based on the borrower’s death were adequate. However, we identified problems with policies,
procedures, and internal controls established for disability discharges. Specifically, we found that

• 	 The regulatory three-year conditional discharge period is inadequate for determining eligibility
    of all borrowers. The three-year conditional discharge period begins on the date that the
    borrower became totally and permanently disabled as certified by a physician. In determining
    whether the borrower will receive the final discharge, the Department only considers the
    borrower’s earnings from employment or receipt of a new student loan during the conditional
    discharge period. If the borrower’s three-year conditional discharge period does not include
    the current date, the Department does not consider the borrower’s current income and loan
    status when making its determination. As such, the regulations allow loans to be discharged
    without an adequate determination of all applicants’ current disability status.

• 	 Regulations that excuse a borrower from paying interest should be reconsidered. We found
    that FSA reinstated (resumed collection on) 16,457 loans previously in a conditional discharge
    status, totaling nearly $172.4 million. These loans were reinstated because FSA’s controls,
    during the conditional discharge period, identified the borrowers as ineligible for disability
    discharges. Under current regulations, these ineligible borrowers are not required to pay the
    interest that accrued on the loans during the conditional discharge period. This benefit for
    ineligible borrowers should be reconsidered.

• 	 FSA did not update the National Student Loan Data System (NSLDS), as required. Until
    April 2005, FSA did not update NSLDS to reflect borrowers’ disability discharge status.
    Since schools cannot identify borrowers’ status without this update, 17 ineligible borrowers, in
    conditional disability discharge status, received new student loans totaling $270,975.

We recommend that the Chief Operating Officer for FSA and the Assistant Secretary for
Postsecondary Education revise Department of Education (Department) regulations to 1) allow a
consideration of a borrower’s current information when determining his or her eligibility for a
disability discharge and 2) require borrowers who are determined to be ineligible for a discharge
Final Report
ED-OIG/A04E0006                                                                   Page 2 of 21

to pay interest for the conditional discharge period. We also recommend that FSA ensure that
NSLDS reflects all borrowers’ conditional disability discharge status correctly.

A draft of this report was provided to FSA and OPE for review and comment. In their joint
response, FSA and OPE did not disagree with the conditions or statistics with our Finding No. 1,
but did not agree with its recommendation; disagreed with our Finding No. 2; and agreed with our
Finding No. 3. Where appropriate, we have incorporated into this report summaries of FSA’s and
OPE’s comments and our responses. We provide FSA’s and OPE’s response to our draft report,
in its entirety, as an Appendix to this report. Although we have revised our findings and
recommendations slightly, for clarity, the substance of the report has not changed.
Final Report
ED-OIG/A04E0006                                                                               Page 3 of 21



                                            BACKGROUND


Section 437(a) of the Higher Education Act of 1965, as amended (HEA), requires the Department
to discharge a borrower’s FFEL Program loan if he or she “dies or becomes permanently and
totally disabled (as determined in accordance with regulations of the Secretary).” This provision
also applies to the Direct Loan Program under Section 455(a)(1) of the HEA.

In 1998 and 1999, we conducted an audit to determine the nature and extent of the Department’s
controls to ensure that FFEL Program loans were discharged for reasons authorized by the HEA
and the Department’s regulations. Our audit report identified control weaknesses in the
Department’s system for determining borrower eligibility for death and disability discharges, and
we concluded that the Department improperly discharged FFEL Program loans.1

During the two-and-a-half-year period examined in the audit, the Department discharged loans
totaling over $508 million: over $216 million for borrowers who died and over $292 million for
borrowers claiming total and permanent disability. We found that 708 (or 2 percent) of the
borrowers who received death discharges, totaling over $3.8 million, were earning wages after the
discharge, and we found that 9,798 (or 23 percent) of the borrowers who received disability
discharges, totaling over $73 million, were earning wages after the discharge.

In response to the findings in our audit report, the Department revised its regulations for death and
disability discharges, to improve the process for evaluating applications for discharge. The
Department’s revised regulations were proposed in a Notice of Proposed Rulemaking on August
2, 2000 (65 FR 47634) and published as Final Regulations on November 1, 2000 (65 FR 65678).

      • 	 Death Discharges. Under the Department’s previous regulations, a FFEL Program lender
          was able to grant a death discharge based on a death certificate or other proof of death,
          acceptable under applicable state law. The Department’s revised regulations restrict the
          evidence on which a death discharge may be granted. Specifically,

                   A discharge of a loan based on the death of the borrower (or student in the
                   case of a PLUS loan) must be based on an original or certified copy of the
                   death certificate. Under exceptional circumstances and on a case-by-case
                   basis, the chief executive officer of the guaranty agency may approve a
                   discharge based upon other reliable documentation supporting the discharge
                   request. (34 C.F.R. § 682.402(b)(2))

      •    Disability Discharges. Under the Department’s previous regulations, a FFEL Program
           lender was responsible for reviewing and making the determination on a borrower’s

1
    Improving the Process for Forgiving Student Loans, issued June 7, 1999 (ACN A06-80001).
Final Report
ED-OIG/A04E0006                                                                        Page 4 of 21

       application for a disability discharge. If the lender determined that the borrower was
       totally and permanently disabled, the borrower’s loan was discharged.

       Under the revised regulations, the FFEL Program lender and guaranty agency make
       determinations on whether the application supports the conclusion that the borrower meets
       the criteria for a total and permanent disability discharge. If they determine that the
       application supports that conclusion, the loan is assigned to the Department and the
       application and supporting documentation are forwarded to FSA’s Conditional Disability
       Discharge Unit (CDD). If the CDD, on behalf of the Secretary, makes—

              . . . an initial determination that the borrower is totally and permanently
              disabled . . . the loan is conditionally discharged for up to three years from
              the date that the borrower became totally and permanently disabled, as
              certified by a physician. The Secretary suspends collection activity on the
              loan from the date of the initial determination of total and permanent
              disability until the end of the conditional period. If the borrower satisfies
              the criteria for a total and permanent disability discharge during and at the
              end of the conditional discharge period, the balance of the loan is
              discharged at the end of the conditional discharge period and any payments
              received after the date the borrower became totally and permanently
              disabled . . . are returned to the sender.
                        (ii) A borrower satisfies the criteria for a discharge of a loan based
              on a total and permanent disability if, during and at the end of the three-year
              [conditional discharge period]—
                        (A) The borrower’s annual earnings from employment do not
              exceed 100 percent of the poverty line for a family of two, as determined in
              accordance with the Community Service Block Grant Act; and
                        (B) The borrower does not receive a new loan under the Perkins,
              FFEL, or Direct Loan programs, except for a FFEL or Direct Consolidation
              loan that does not include any loans that are in a conditional discharge
              status. (34 C.F.R. § 682.402(c)(1))

The Department also made similar changes to the regulations for death and disability
discharges in the Direct Loan Program, in 34 C.F.R. §§ 685.212 and 685.213. The CDD
processes disability discharges for both FFEL and Direct Loan Program loans.

An FSA contractor, Affiliated Computer Services (ACS), performs CDD operations. From July 1,
2002, through June 30, 2004, the CDD processed 45,657 disability discharge applications.
Final Report
ED-OIG/A04E0006                                                                      Page 5 of 21


                                    AUDIT RESULTS


We found that FSA’s policies, procedures, and controls over the death discharge process were
adequate. However, we identified problems with FSA’s policies, procedures, and internal controls
for disability discharges. Specifically, we found that 1) the regulatory three-year conditional
discharge period is inadequate for determining eligibility of all borrowers; 2) regulations that
excuse a borrower from paying interest should be reconsidered; and 3) FSA did not update
borrowers’ outstanding principal balance in NSLDS, as required.

Finding No. 1 – The Regulatory Three-year Conditional Discharge Period is
                Inadequate for Determining Eligibility of All Borrowers
Under 34 C.F.R. §§ 682.402(c)(1)(ii) and 685.213(c), a borrower is eligible for a disability
discharge if, during and at the end of the three-year conditional discharge period, 1) his or her
annual earnings from employment did not exceed allowable limits, and 2) he or she did not receive
additional Title IV loans. Because a determination of a borrower’s eligibility under this method
does not always consider the borrower’s current condition, it does not ensure that only totally and
permanently disabled borrowers receive disability discharges.

The application that a borrower submits for a disability discharge includes a section that is
completed by the borrower’s physician. In this section, the physician certifies that the borrower’s
condition meets the Department’s definition of total and permanent disability. The physician also
provides the date that “the borrower became unable to work and earn money in any capacity.”
During the discharge process, this date is considered to be the borrower’s disability date. The
borrower’s three-year conditional discharge period begins on this disability date.

In many cases, borrowers’ disability dates occurred more than three years before their applications
for disability discharge were submitted. We compared borrowers’ disability dates to the earliest
possible date of application (July 1, 2002) for the 4,844 borrowers who received disability
discharges between July 1, 2002, and June 30, 2004. As Table 1.1 shows, about 54 percent of the
applications for borrowers who received disability discharges were received more than three years
after the disability date. As a result, for the discharges that FSA approved from July 1, 2002,
through June 30, 2004, about 54 percent were based on a three-year period that did not include
current income data.
Final Report
ED-OIG/A04E0006                                                                        Page 6 of 21

       Table 1.1—Discharged Borrowers With Applications Filed More 

                 Than Three Years After The Reported Disability Date 

         Application Time Periods                               No. Of         Percentage
         For Disability Application                            Borrowers       of the 4,844

         More Than 3, less than 6 Years                           1,322          27.29%

         From 6 to 10 Years                                        743           15.34%

         10 Years or More                                          528           10.90%

         Total                                                    2,593          53.53%

We were unable to review income data for each of the 2,593 discharged borrowers included in
Table 1.1, because we did not have access to the borrowers’ earnings records. As such, we could
not identify all borrowers who would have been ineligible for a disability discharge if the
discharge were based on their current earnings from employment. However, current income
information was available for the limited number of these borrowers who had submitted a
subsequent Free Application for Federal Student Aid (FAFSA). We found that 121 of the 2,593
borrowers completed a FAFSA after their reported date of disability, and we reviewed their
FAFSAs for award years 2003 through 2005. Of the 121 borrowers, 10 reported income over the
allowable regulatory limits.

When making a determination on a borrower’s eligibility for a disability discharge, FSA only
considers whether the borrower earned income over the allowable limit or received a new Title IV
loan during the three-year conditional discharge period, the three years after the borrower’s
disability date. If the date of a disqualifying event occurs after the end of the three-year
conditional disability discharge period, that information is not a basis to deny a borrower’s
disability discharge. As a result, a borrower who is not currently disabled may receive a disability
discharge, even when FSA has knowledge of the borrower’s current disqualifying income or loan
information.

By requiring borrowers to complete Internal Revenue Service (IRS) Form 4506-T (Request for
Transcript of Tax Return), FSA may gain access to IRS information about borrowers’ current
earnings from employment. Recent loan data information for borrowers is available to FSA
through NSLDS. However, neither of these sources of information is considered when
determining the borrower’s eligibility, if the borrower’s date of disability is more than three years
before the application date.

As we noted in the Background section, Section 437(a) of the HEA requires the Department to
discharge a borrower’s FFEL or Direct Loan Program loan if he or she “dies or becomes
permanently and totally disabled (as determined in accordance with regulations of the Secretary).”
The use of the three-year conditional discharge period, as established in the Department’s
Final Report
ED-OIG/A04E0006                                                                      Page 7 of 21

regulations, is ineffective for making this determination because it does not always allow the
Department to examine a borrower’s current earnings and loan information.

RECOMMENDATION

We recommend that the Chief Operating Officer for FSA and the Assistant Secretary for
Postsecondary Education

1.1 	   Revise the Department’s regulations to ensure that current income and Title IV loan
        information is considered when determining whether a borrower is totally and permanently
        disabled. One way of doing this would be to re-define the three-year conditional discharge
        period, to start the three-year period on the date the borrower submits his or her
        application, rather than the date the borrower became disabled.

FSA and OPE Response:

FSA and OPE did not disagree with the conditions and statistics in the finding. However, they
disagreed with our recommendations. FSA’s and OPE’s joint response stated
        The current regulations implement the Department’s response to an earlier OIG study that
        concluded that a one-time “snapshot” approach to determining eligibility for a discharge
        was inadequate. Current regulations, to which the OIG agreed despite the strenuous
        objections of the student loan community require monitoring borrower eligibility over a
        significant time period (three years) before granting a final discharge.

        The OIG does not define "current earnings." It is, therefore, unclear whether revising the
        regulations to provide for a three-year conditional period that begins on the date of the
        borrower's application for total and permanent disability discharge will address the concern
        that borrowers appear to be ineligible "based on their current earnings." Even if the three-
        year conditional period were prospective from the date of application, it would not include
        the borrower's "current" income because the conditional discharge would still be based on
        the three previous year's [sic] incomes. A borrower could still receive a discharge and then
        have income that exceeds the current regulatory income threshold. The report and finding
        should be revised to clarify this issue and whether the OIG believes this will eliminate the
        problem it has identified.

The response asked that OIG acknowledge amendments to the HEA proposed by H.R. 609
(Report No. 109-231), which would base the Department’s determination of a borrower’s
eligibility for a total and permanent disability discharge on medical determinations by the
Department of Veterans Affairs (VA) o r the Social Security Administration (SSA). OPE and
FSA stated that, if adopted, this amendment could render our recommendation moot and that they
“plan to make no regulatory changes in this area before the Congress completes action to amend
and extend the Higher Education Act.”
Final Report
ED-OIG/A04E0006                                                                        Page 8 of 21

OIG Comments:

Though the prior regulations were developed to address the control weaknesses identified in our
earlier report, the results of this audit indicate the need to revisit the regulations again. When the
regulations were last revised, neither the Department nor our office anticipated that the applicant
pool would be dominated by applications based on disabilities that arose more than three years
prior to the application date.

In revising the regulations, the Department should ensure that the discharge is based on verified
income and Title IV loan information that is reasonably contemporaneous with the discharge
determinations. Starting the conditional discharge period on the application date and utilizing the
current practice of verifying annual income during the conditional discharge period through the
use of IRS Form 4506-T would be a reasonable approach.

Regarding legislative proposal, H.R. 609,
   • 	 There is no assurance that the proposed amendment to discharge requirements will be
       included in the legislation when it is enacted;
   • 	 It does not appear that the proposed amendment would apply to all borrowers, just to those
       who receive determinations by the VA or SSA; and
   • 	 The Department itself, when it was developing the final regulations issued on November 1,
       2000, considered using SSA determinations but found that “there is no documentation
       currently issued by SSA that would effectively establish that a borrower is totally and
       permanently disabled under the title IV standard” (65 FR 65683).

Although we did not change our recommendation, we have revised the example in the
recommendation, for clarity. We disagree with FSA’s and OPE’s intent to delay amending the
regulations. Due to the requirements in Sections 482 and 492 of the HEA, the earliest that any of
the regulatory changes can be implemented is July 1, 2007, and then only if the Department
initiates and completes negotiated rule-making and publishes final regulations by November 1,
2006. If the Department waits for Congress to complete re-authorization it may not be able to
meet the November 1, 2006, deadline, and effective corrective action would then be delayed until
July 1, 2008, at the earliest. While a brief delay may be appropriate to determine if changes to the
discharge regulations can be combined with post-reauthorization rule-making, the Department
should proceed with preparations to amend the discharge regulations by November 1, 2006, in the
event Congress does not complete reauthorization soon.

Finding No. 2 – Regulations That Excuse a Borrower From Paying Interest
                Should Be Reconsidered
If a borrower’s loans are placed in a conditional discharge status but the borrower is later
determined to be ineligible for a final discharge, the borrower’s loans are reinstated (FSA resumes
collection on the loans). The regulations provide that a borrower is not required to pay interest
that accrued on his or her loans during the conditional discharge.
Final Report
ED-OIG/A04E0006                                                                                     Page 9 of 21


We found that a substantial portion of applicants who receive a conditional discharge either do not
pursue their applications or do not qualify for a final discharge. Although we did not quantify the
amount of unpaid interest, we found that 36 percent (16,457 of 45,657) of the loans to borrowers
who applied for a disability discharge from July 1, 2002, through June 30, 2004, were reinstated.
These borrowers had loan balances totaling nearly $172.4 million.

Under 34 C.F.R. § 682.402(c)(16)

        If, at any time during the three-year conditional discharge period, the borrower does
        not continue to meet the eligibility requirements for a total and permanent disability
        discharge, the Secretary resumes collection activity on the loan. The Secretary does
        not require the borrower to pay any interest that accrued on the loan from the date
        of the initial determination . . . through the end of the conditional discharge period.

Similar requirements are provided for Direct Loans in 34 C.F.R. § 685.213(a)(3).

In the preamble to the final rule, the Department stated

        [B]orrowers suffer no negative consequences during the conditional discharge
        period. No collection activity or adverse credit reporting occurs during the
        conditional discharge period. If a borrower's situation changes during this period,
        we believe the borrower should be expected to repay the student loan. However,
        even if collection activity resumes on the loan, the borrower is not obligated to pay
        any interest that accrued during the conditional discharge period. (64 FR 65681)

The CDD reinstates loans from a conditional discharge for three reasons:

    1.	 No income verification form. After a year of the conditional discharge period has passed,
        the borrower is required to provide a signed Request for Transcript of Tax Return (Form
        4506-T). This is an IRS form that allows FSA to review the borrower’s annual earnings
        from employment and to verify the borrower’s eligibility for a disability discharge. If the
        borrower does not respond to FSA’s request, FSA makes three additional, monthly
        requests for return of the form. If the borrower does not respond within two weeks of the
        final notice, FSA reinstates the borrower’s loans. (FSA performs skip tracing if it becomes
        apparent that the borrower’s address is unknown.)2


2
  We did not survey borrowers to identify the reasons they failed to return the income verification form. However, we
examined the Department’s records for a random sample of 75 of the 1,552 borrowers with discharge claims
processed by the CDD during the month of June 2004, where the borrowers’ loans were reinstated because they failed
to return the income verification form. We found that 46 of the borrowers contacted FSA before or after their loan
reinstatement to find out what FSA needed to discharge the loan; 20 borrowers did not respond to the reinstatement; 8
borrowers provided the income verification forms late, after FSA had already reinstated their loans; and 1 borrower
had income over the poverty guidelines.
Final Report
ED-OIG/A04E0006                                                                       Page 10 of 21

   2. 	 Additional loans in NSLDS. To qualify for a disability discharge, a borrower may not
        receive a new loan, after his or her disability date, under the Perkins, FFEL, or Direct Loan
        program, except for a FFEL or Direct consolidation loan that does not include any loans
        that are in a conditional discharge status. (34 C.F.R. §§ 682.402(c)(1)(ii)(B) and
        685.213(c)(2)) FSA reviews NSLDS when the borrower begins a conditional discharge
        period and quarterly, thereafter, to ensure that borrowers meet this requirement. If a
        borrower does not meet this requirement, the borrower’s loans are reinstated.

   3. 	 Income in excess of poverty guidelines. FSA uses the authorizations that borrowers
        provide on IRS Form 4506-T to review IRS data on the borrowers’ annual earnings from
        employment. If a borrower’s earnings exceed the poverty guidelines described in 34
        C.F.R. §§ 682.402(c)(1)(ii)(A) and 685.213(c)(1), the borrower’s loans are reinstated.

Table 2.1 provides the number of borrowers, the number of loans, and the loan amounts
attributable to each reason for reinstatement:

             Table 2.1—Reinstated Loan By Reason For Reinstatement
                                            No. Of      No. Of     Loan Amount
    Reason for Reinstatement              Borrowers     Loans    (rounded in millions)

    No Income Verification Form                     14,650        32,400            $152.5

    Additional Loans in NSLDS                        1,745         4,676            $19.0

    Income in Excess of Poverty Guidelines             62           148              $0.9

    Total                                           16,457        37,224            $172.4

The 16,457 borrowers who were found to be ineligible for a disability discharge were not required
to pay the interest that accrued on their loans during the conditional discharge. Interest did not
accrue for up to a year and three months on $153.4 million, for borrowers who failed to return the
income verification form or who received income in excess of poverty guidelines. Interest did not
accrue for up to three months or more on $19 million, for borrowers who received additional loans
after their disability date, depending upon the speed with which NSLDS was updated with the
borrower’s new loan information.

The Department’s regulations should be changed to require borrowers who do not receive a final
discharge to pay the interest that accrued during the conditional discharge period due to the
substantial percentage of borrowers who either do not qualify for final discharge or fail to pursue
their applications. The intent of Section 437(a) of the HEA is to discharge a borrower’s FFEL or
Direct Loan Program loan if the borrower becomes permanently and totally disabled. However,
the decision to excuse interest provides a benefit to ineligible borrowers and to borrowers who fail
to pursue their applications.
Final Report
ED-OIG/A04E0006                                                                          Page 11 of 21

RECOMMENDATION

We recommend that the Chief Operating Officer for FSA and the Assistant Secretary for
Postsecondary Education

2.1 	   Revise the Department’s regulations to ensure that, if a borrower’s loans are reinstated
        from a conditional discharge status, the borrower is required to pay any interest that
        accrued on his or her loans through the end of the conditional discharge.

FSA and OPE Response:

FSA and OPE comment that our report “incorrectly states that the Secretary pays interest benefits
on behalf of borrowers during the ‘conditional discharge period.’” Their response points out that
the Department does not pay interest benefits to lenders during the conditional discharge period.

FSA and OPE do not agree that, when reinstated from a conditional discharge status, borrowers
should be required to pay interest that would otherwise have accrued. FSA and OPE state

        Such a retroactive assessment of accrued interest has the potential to discourage and
        ultimately penalize a borrower for applying for a discharge based on total and permanent
        disability. Moreover, it may result in the capitalization of the accrued interest, thus
        increasing the amount of the borrower’s debt. A retroactive assessment of as much as
        three years of accrued interest may also precipitate a default when the borrower returns to
        repayment. The OIG does not address in any way the possible negative consequences
        resulting from this change in treatment of borrowers or the OIG’s recommendations for
        dealing with them.

FSA and OPE stated that they “plan to make no regulatory changes in this area before the
Congress completes action to amend and extend the Higher Education Act.”

OIG Comments:

Our draft report did not state that the Secretary pays interest on behalf of borrowers during the
‘conditional discharge period.’” However, we have revised our finding, for clarity, by removing
the terms “interest benefits” and “interest waivers.”

We do not agree with FSA’s and OPE’s rationale for excusing borrowers from paying interest,
for the following reasons:

    • 	 We believe it is likely that most ineligible borrowers will be identified within the first
        year of the conditional discharge period, by the time the Department first verifies the
        borrower’s earnings from employment and receipt of new Title IV loans. As such, in
        most cases, accrued interest should not be an unreasonable burden.
Final Report
ED-OIG/A04E0006                                                                        Page 12 of 21

   • 	 It is unlikely that the possibility of repaying accrued interest would be enough of a
       disincentive to discourage eligible borrowers from applying for discharges. The only
       apparent disincentive would be for ineligible borrowers, who would be able to
       anticipate that their loans will be returned to repayment. Since such a large percentage
       of loans are being reinstated, a disincentive for ineligible borrowers would be
       appropriate and useful.

   • 	 Of the borrowers whose loans are reinstated, approximately 89 percent were ineligible
       because they failed to return an annual income verification form (see Table 2.1). This
       raises the question of the legitimacy of the borrowers’ initial applications and of
       compliance by the borrowers with rules for reporting increased earnings, under 34
       C.F.R. § 682.402(c)(14)(iv). Borrowers should not be excused from paying interest as
       the result of their non-compliance with discharge requirements.

   • 	 FFEL or Direct Loan Program loan borrowers are not excused from paying accrued
       interest if, after applying for other types of loan discharges or for teacher loan
       forgiveness, they are found to be ineligible and their loans are returned to repayment.

   • 	 A disabled borrower who is reinstated in error is not precluded from re-applying and
       receiving a discharge.

   • 	 If a borrower becomes unable to make payments on his or her loan as the result of
       accrued interest, there are other, more appropriate, methods to help the borrower avoid
       default. The borrower may request a deferment, a forbearance, income contingent
       repayment, or income sensitive repayment.

We disagree with FSA’s and OPE’s intent to delay amending the regulations, for the reasons we
stated in response to the comments in Finding No. 1. We did not change our recommendation.

Finding No. 3 – FSA Did Not Update NSLDS, As Required
Until April 2005, the CDD did not update NSLDS to identify loans in a conditional discharge
status. Schools could not identify borrowers in a conditional discharge status until CDD began
updating NSLDS. As a result, from July 1, 2002, through June 30, 2004, 17 borrowers in
conditional disability discharge status received new student loans totaling $270,975.

Under 34 C.F.R. §§ 682.201(a)(7) and 685.200(a)(1)(iv)(C), a borrower in a conditional discharge
must meet certain criteria before he or she is eligible to receive a new Title IV loan: 1) a physician
must certify that the borrower is able to engage in substantial gainful activity; 2) the borrower
must sign statements that neither the loans conditionally discharged nor the new loans the
borrower will receive may be discharged on the basis of a current impairment, unless that
impairment substantially deteriorates; and 3) the borrower must sign a statement acknowledging
that collection will resume on any loans in a conditional discharge period.
Final Report
ED-OIG/A04E0006                                                                        Page 13 of 21


For many borrowers in a conditional discharge, schools are required to review data in NSLDS
before disbursing Title IV funds. Under 34 C.F.R. § 668.19(a)(4), when a student transfers from
one school to another, schools must review data in NSLDS:

       Before an institution may disburse Title IV, HEA program funds to a student who
       previously attended another eligible institution, the institution must use
       information it obtains from the Secretary, through the National Student Loan
       Data System (NSLDS) or its successor system, to determine . . . [t]he outstanding
       principal balance of loans made to the student under each of the title IV, HEA
       loan programs . . . .

In May 2002, the Department issued Dear Colleague Letter GEN-02-03, which provides
operational guidance for reflecting a loan’s conditional discharge status in NSLDS:

       Upon assignment of a loan to the Department, the guaranty agency will report the
       loan to NSLDS by using a “DI” or “DS” [disability] code with a $0 balance . . . .
       The [CDD], after its initial determination of eligibility, will reenter in the NSLDS
       system the outstanding balance last reported on the loan or otherwise prevent
       deletion of the outstanding balance on the loan in the NSLDS system. (Dear
       Colleague Letter GEN-02-03, Attachment 3, Section (III)(B))

The Dear Colleague Letter further explains that a loan with a “DI” or “DS” disability code, a
positive outstanding principal balance, and a date of loan status on or after July 1, 2002, denotes a
loan in the conditional discharge period. The loan remains in the conditional discharge status until

   1. 	 A final discharge is granted, which is reflected by setting the outstanding balance 

        on the loan to zero; or 


   2. 	 The borrower loses eligibility for a final discharge and the loan is placed back into 

        repayment, which is reflected by reporting the loan with its previous NSLDS Loan 

        Status Code. 


FSA’s program manager for the disability discharge process said that FSA was aware of its failure
to update NSLDS and that there was a task order to modify NSLDS, to allow the CDD to adjust
the outstanding balances in NSLDS. In a discussion with FSA’s Director of Borrower Services,
we learned that the task order had been completed April 8, 2005, and that FSA is in the process of
running tests to ensure the data is correct.

We reviewed documentation and verified that FSA initiated the upgrade/modification to NSLDS.
According to FSA’s Director of Borrower Services, the request for the modification was made
during the original Conditional Discharge Loan Servicing contract, but NSLDS was unable to
support the changes to its system at that time. When the original contract expired on December
Final Report
ED-OIG/A04E0006                                                                       Page 14 of 21

31, 2003, and became part of the Common Services for Borrowers contract, FSA was able to
begin the required modifications to its NSLDS system.

Because FSA did not update borrowers’ outstanding principal balances in NSLDS before April
2005, borrowers in a conditional disability discharge status appeared to be eligible for new loans.
As a result, 17 borrowers in a conditional disability discharge status received new student loans
totaling $270,975. Although the conditionally discharged loans for these 17 borrowers were
reinstated based on the CDD’s NSLDS quarterly checks, these NSLDS checks did not prevent
borrowers from initially receiving the new loans. Schools were unable to correctly certify
borrowers’ eligibility based on information in NSLDS.

RECOMMENDATIONS

We recommend that the Chief Operating Officer for FSA

3.1 	   Review NSLDS to ensure that the records for all borrowers in a conditional disability
        discharge status from July 1, 2002, through April 8, 2005, were properly updated with the
        correct outstanding principal balance.

3.2 	   Continue to update the outstanding principal balance for borrowers in a conditional
        disability discharge status so that FSA complies with existing guidance in Dear Colleague
        Letter GEN-02-03, Attachment 3, Section (III)(B).

FSA and OPE Response:

FSA and OPE concur with our recommendations. Their response stated that the Conditional
Disability Discharge Tracking System (CDDTS) has been reporting to NSLDS on a monthly basis
since April 8, 2005. The most recent submittal, on August 2, 2005, included all loan information
in the CDDTS portfolio, including the correct outstanding principal balance as of the end of July
2005. FSA has confirmed that ACS is continuing to update the outstanding principal balances for
borrowers in the CDDTS.

OIG Comments:

We reviewed documentation and verified that FSA initiated the upgrade/modification to NSLDS
and that FSA’s most recent submittal to NSLDS, on August 2, 2005, included all loan information
in the CDDTS portfolio, including the correct outstanding principal balance as of the end of July
2005. FSA appears to have taken appropriate steps to respond to our recommendations
Final Report
ED-OIG/A04E0006                                                                        Page 15 of 21


                                   OTHER MATTERS


When making an initial determination that a borrower is totally and permanently disabled, and is
eligible for conditional discharge, the CDD contacts the physician who certified the application, if
the certification is incomplete or unclear. A CDD nurse told us that physicians are contacted for
approximately half of the disability discharge applications the CDD receives. According to CDD
staff, on three occasions in 2003, when physicians were contacted by fax for follow-up
information, the physicians stated that they had never signed the physician certification.

To ensure that borrowers are not perpetrating this type of fraud, we suggest that the Chief
Operating Officer for FSA implement a procedure, during the quality control review process, to
verify on a sample basis that physicians certifying borrowers’ applications actually examined the
borrowers.

FSA and OPE Response:

FSA’s and OPE’s response stated that FSA’s contractor, ACS, follows up with physicians for
approximately 70 percent of loan discharge applications received. This follow-up provides the
physician with an opportunity to indicate whether he or she believes the borrower forged his/her
signature or engaged in some other form of fraud. The response states, “FSA believes this
provides an on-going statistically representative monthly sample with which to monitor borrower
fraud.”

OIG Comments:

We acknowledge in our report that doctors are contacted frequently; however, the FSA contractor
selects the doctors judgmentally. Whether doctors are contacted for approximately half of
applications (as the CDD nurse told us) or 70 percent (according to the FSA and OPE response), a
statistical sampling is not used, so the results of the contacts are not representative and cannot be
projected to the universe of applications.

We have not changed our suggestion.
Final Report
ED-OIG/A04E0006                                                                                 Page 16 of 21


                OBJECTIVE, SCOPE, AND METHODOLOGY


The audit objective was to determine whether FSA has implemented effective policies,
procedures, and internal controls over the process for discharging Direct Loan and FFEL program
loans based on death or total and permanent disability. Audit coverage for our review of disability
discharges included the period July 1, 2002, through June 30, 2004, and audit coverage for our
review of death discharges included the period July 1, 2002, through August 27, 2004.

To determine FSA’s controls over the discharge processes, we
• 	 Interviewed officials responsible for oversight of the death and total and permanent disability
    discharge processes.
• 	 Reviewed current policies and procedures relating to the loan discharge process.

To evaluate the disability discharge processes, we
• 	 Visited the guaranty agency USA Funds,3 Indianapolis, IN; the Direct Loan Servicing Center,
    Utica, NY; the Atlanta Debt Collection office; and the Conditional Disability Discharge Unit
    (CDD), Utica, NY.
• 	 Interviewed officials responsible for processing disability discharges.
• 	 Reviewed and tested current policies and procedures relating to the disability discharge
    process.
• 	 Reviewed file documentation for a random sample of 69 of the 38,965 disability discharge
    claims contained in NSLDS that were processed by the CDD from July 1, 2002, through May
    5, 2004, to determine whether the CDD discharged only eligible applicants.
• 	 Reviewed file documentation for a random sample of 75 of the 1,552 discharge claims
    processed by the CDD during the month of June 2004 where the loans were reinstated because
    of no response to income verification requests.

To perform our analyses, we
• 	 Identified, in the Conditional Disability Discharge Tracking System (CDDTS), borrowers who
    had loans reinstated due to the NSLDS quarterly check and reviewed data in NSLDS for those
    borrowers to determine who received new loans while in a conditional discharge status.
• 	 Identified the 4,844 borrowers who received discharges and
    o 	Determined which borrowers applied more than three years after their date of disability,
       and
    o 	Determined which borrowers applied for new loans after a discharge and reviewed the
       income amount they reported on the FAFSAs they completed after the discharge.
• 	 Reviewed the Internal Revenue Service website to verify IRS income record retention policies
    applicable to the conditional discharge process.

3
 USA Funds had the highest concentration of FFEL loan discharges for all guaranty agencies. We also met with
officials at Sallie Mae, which is USA Funds’ contractor for its discharge processing.
Final Report
ED-OIG/A04E0006                                                                                   Page 17 of 21


To evaluate the death discharge processes, we
• 	 Visited the guaranty agency USA Funds, the Direct Loan Servicing Center, and the Atlanta
    Debt Collection office.
• 	 Interviewed officials responsible for processing death discharges.
• 	 Reviewed and tested current policies and procedures relating to the death discharge process.
• 	 Reviewed file documentation for a random sample of 65 of the 8,372 death claims contained in
    NSLDS that were processed from July 1, 2002, through May 5, 2004, at USA Funds, 50 of the
    266 death claims processed at the DLSC during the month of February 2004, and 50 of the 304
    death claims processed at the Atlanta Debt Collection Center during the week ending August
    27, 2004.4

During the audit, we relied on computer-processed data contained in the CDDTS. We tested
selected data from the CDDTS by reviewing support documentation corroborating 100 percent of
a listed population identified in the CDDTS Monthly Management Report. We also reviewed data
from USA Funds, Atlanta Debt Collection, DLSC, and CDD borrower files and used this data to
verify the accuracy of the CDDTS and NSLDS data. Based on these tests and assessments, we
concluded that the CDDTS and NSLDS data were sufficiently reliable for our use in meeting the
audit objective.

We performed audit work from June 2004 through September 2004 at FSA Headquarters, in
Washington, DC, and at the sites described above, in Indianapolis, IN; Utica, NY; and Atlanta,
GA. Subsequent audit work was performed through April 2005. An exit conference was held
with FSA officials on July 15, 2005. The audit was performed in accordance with generally
accepted government auditing standards appropriate to the scope of the review described above.




4
 Each week, the Atlanta Debt Collection office sends death claim documentation to Greenville, Texas, to be
warehoused; therefore at any time, it has a week’s worth of documentation on hand. We were able to review
documentation for the week ending August 27, 2004, before the Atlanta Debt Collection office sent that
documentation for warehousing.
Final Report
ED-OIG/A04E0006                                                                                              Page 18 of 21

Appendix A - Written Response to the Draft Report




                               UNITED STATES DEPARTMENT OF EDUCATION

                                            WASHINGTO N, D,C. 20202· _ _

                                               ~-Im



           TO:             Denise M. Wempe
                           Regional Inspector General for Audit
                           OrneI' of the Inspector Oeneml

           FROM:           Theresa S.  Sha~
                           ChiefOpcr:uing Omeer
                           Fedeml Student Aid

                           Sally L. Stroup  <;_~ S
                           Assistant Secretary for Postsecondary Education

            SUBJECT:       Dmft Audit Report
                           Death and Total and Pcmmnent Disability Discharges of FFEL and Direct
                           Loan Progmm Loans
                           ED-OIOfAD4-EOOO6

            Thank you for providing the Department with an opportunity to comment on the Omce
            of Inspector Geneml"s (010) Draft Audit Report dated July 21. 2005. The Dcpartment"s
            response to the findings and recommendations follow.

            Finding No.1 - The Regulatory Thre('-year Condilional Discharge Period is
            Inadequate for Determining Eligibility of All Borrowcn.

            Recom mendation 1.1 _ The Chief O IJerating Officer (COO) for Federal Student Aid
            (FSA) :lOd th e Assista nt Seeretary for Postsecondary Education (OPE) should revise
            regulations to ensure that current information is considered when de termining
            whether a borrower is totally and permanently dlSllbled.

            The Federal Family Education Loan (FFE L) and Direct Loan Program regulations
            stipulate that, in order for a borrower to establish eligibility for a loan discharge based on
            10lal and pemlanent disabilit y, the borrower's earnings cannot exceed allowable limits
            and the bolTower cannot receive additional Title IV loallS during a three-year conditional
            discharge period. This three-year condilional discharge period begins on the date the
            bolTOwer became pemlancntly and lotally diS:lbIed as certIfied by a physician. The OIG
            Slates Ih,LI approximately S4 percent of the bolTowers who applied fOT:l discharge based
            on tOlal and pennanenl disability applied marc than three years aner the reported
            disability date resul tin g in an immediate discharge based on outdated infOTll13tion. The
Final Report
ED-OIG/A04E0006                                                                                          Page 19 of 21




           DIG recom mends that the Department revise FFEL and Direct Loan Program regulations
           to re-define the three-year conditional discharge period as prospcctive from the date of
           application to ensure that "current" earnings arc considered when detemlining whether a
           bolTOwer is totally and pemlanently disab led. Such an approach would preclude a
           bolTOwer who is not currently disabled from receiving a disabi lity discharge.

           The current regulations implement the Department's response to an earlier OIG study that
           concluded that a one-time ··snapshot" approach to detemli ning eligibility fo r a discharge
           was inadequate. CUfTCnt regulations, to which the OIG agreed despite the strenuOUS
           objections of the student loan community, require moni toring bolTOwer eligibility over a
           significant time period (three years) before granting a final discharge.

           The DIG does not define "current earnings." It is, Iherefore, unclear whether revising the
           regulations to provide for a three-year conditional period that begins on the date of the
           bolTOwer's application for total and pemanent disability discharge wil! add ress the
           concern that borrowers appear to be ineligible "based on their current earnings." Even i r
           the three-year conditional period is prospective from the date of application, it would not
           include the borrower's "current" income because the conditional discharge would still be
           based on the three previous year's incomes. A bolTOwer could still receive a discharge
           Ilnd then have income that exceeds the current regulatory income threshold. The report
           and finding should be revised to clarify this issue and whether Ihe D IG believes this will
           eliminate the problem it has identified.

           The final report should acknowledge that legislative proposals currently before the
           Congress, if adopted, could render the recommendations for regulatory changc moot.
           Under thc proposals contained in H.R. 609, a borrowcr's cligibility fo r a total and
           pcrmancnt disability dischargc could be based on a medical dctemlination made undcr
           the standards of the Department of Veterans Affairs or the Social Security
           Administration. Under this proposal, the Secretary would be prohibitcd from requiring
           any further documentation from a borrower in support of the borrower's eligibility for the
           discharge.

           We plan to make no regu latory changes in Ihis area before the Congress completcs action
           to amend and extend the Highcr Education Act.

           Finding No.2 - Regulation s that Provide Interest Benefits to Ineligible Borrowen;
           Sbould be Reconsidered.

           Recommendation 2.1 - The COO fo r FSA and th e Assistant Secretary for OPE
           should revise regulations to ensure tha t, ir a borrower·s loans are reinstated from a
           conditional discharge status, Ihe horrower is required to pay an y interest that
           acc ru ed 011 his or her loans throu gh the end of the conditional discharge period.

           The OIG incorrectly states thai the Secretary pays interest benefits on behalf ofborrowers
           during the "conditional discharge pcriod." Under the regUlations, if the loan holder
           makes a preliminary dClennination Ihat the borrower's medical condition suppons the



                                                        2
Final Report
ED-OIG/A04E0006                                                                                            Page 20 of 21




           borrower's eligibi lity for the discharge, the borrower's loans must be assigned to the
           Secretary. The Secretary then reexamines the borrower's eligibility and monitors the
           borrower's status over the three-year conditional discharge period. No payments are due
           from the borrower during tlus period. The Secretary does not pay interest benefits or
           subsidy payments to a lender during this period.

           The DIG recommends that all borrowers who fail to maintain eligibility for discharge
           during all or part of the three-year conditional period be held responsible for interest that
           would have otherwise accrued. The OIG believes that any portion orthe conditional
           period for which the borrower is not billed for interest prior to the borrower's
           disqualification represents an ineligible receipt of benefits. However. the OIG
           acknowledges that the current regulations do not require a borrower to Tepay such
           interest.

           We disagree. Such a retroactive assessment of accrued interest has the potential to
           discourage and ultimately penalize a borrower for applying for a discharge based on tOlal
           and pennancnt disability. Moreover, it may result in the capitalization of the accrued
           interesl, thus increasing the amount oflhe borrower's debt. A retroactive assessment of
           as much as ilrrce years of accrued interest may also precipitate a default when the
           borrower returns to repayment. The DIG docs nOi address in any way the possible
           negative consequences resulting from this change in treatment of borrowers or the OIG's
           recommendations for dealing with them.

           For these reasons, we plan to make no regulatory changes in this area before the Congress
           completes action to amend and extend the Higher Education Act.

           Find.ing No. J - FSA Did Not Update NSL DS, as Required.

           Recommendation 3. 1 - The COO of FSA should re\'iew NSlDS to ensure that the
           records for all borrowers in conditional disability discharge status fro m July I, 200:Z
           through April 8, :ZOOS were properly updilted with t.he correct outstanding principal
           balance.

           The Department concurs with the OIG's recommendation. The first Conditional
           Disability Discharge Tracking System (COOTS) submission to NS lOS was on April 8,
           2005 and included all loan information in the COOTS portfolio, including the correct
           outstanding principal balance as of the end of March 2005. Since then, COOTS has been
           reporting to NSLOS on a monthly basis. The mos t recent submittal was on August 2.
           2005 and included al1loan infonnation in the COOTS portfolio, including the corrCt;t
           outstanding principal balance as of the end of Jul y 2005.

           Recommendation 3.2 - The COO of FSA should continue to upd:lle the outstanding
           principal b:dance Jor borrowers in conditional disability discharge status so that
           FSA complies with the existing guidance in Dear COlleague Letter GEN-02-0J.
           Attac hment 3, Section (111)(8).




                                                         3
Final Report
ED-OIG/A04E0006                                                                                       Page 21 of 21




           FSA has con finned that Affiliated Computer Services (ACS) is continuing to update the
           outstanding principal balances for borrowers in the COOTS in compliance with FSA's
           existing guidelines described in Dear Colleague Lellcr GEN-02-03. Anachment 3.
           Section (UI)(B).

           Other Matters - To ens ure that borrowe~ are not s ubmittin g fraudul ent physicilln
           certifications, we suggest Ihat the COO for FSA implement II procedure, during the
           quality control rcview process. to \'erify on a sa mplc basis that physicians certifying
           Ihe borrowers' Ilpplications actually eXll min c the borrowers.

           FSA 's contractor. ACS. often rol1ows up with physicians during the medical evaluation
           thai comprises the initial determination of disability. This follow-up provides the
           physician with an opportunity to indicate whether he or she believes the borrower forged
           hislher signature or engaged in some other fonn of fraud . ACS reports that it perfomls
           follow-up with the physician for approximately 70 percent of loan discharge applications
           received. FSA belicvcs this provides an on-going statistically representative monthly
           sample with which to monitor borrower fraud.

           Should you have questions concerning our responsc to the Draft Audit Rcpon, please
           contact Denise Leifestc 3t202-3 77-3293.

           cc:    Helen Lew
                  Debra Wiley
                  Sue Szabo
                  Mati Fontana
                  Pat Howard




                                                       4