oversight

The Department of Education has an Opportunity to Improve its Management of the Default Aversion Program.

Published by the Department of Education, Office of Inspector General on 1998-09-23.

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

       THE DEPARTMENT OF EDUCATION HAS AN
    OPPORTUNITY TO IMPROVE ITS MANAGEMENT OF
         THE DEFAULT AVERSION PROGRAM


                                 FINAL AUDIT REPORT




                                 Audit Control Number 05-80007
                                        September 1998




Our mission is to promote the efficient                          U.S. Department of Education
and effective use of taxpayer dollars                            Office of Inspector General
in support of American education                                 Chicago, IL
                                 NOTICE

Statements that management practices need improvement, as well as other
 conclusions and recommendations in this report, represent the opinions of
 the Office of Inspector General. Determination of corrective action to be
taken will be made by appropriate Department of Education officials. This
 report may be released to members of the press and general public under
                      the Freedom of Information Act.




                                 MEMORANDUM

                                                            September 23, 1998

TO:       Dr. David A. Longanecker
          Assistant Secretary for Postsecondary Education



FROM:     Richard J. Dowd
          Regional Inspector General
          for Audit - Region V
SUBJECT:       The Department of Education has an Opportunity to Improve Its
               Management of the Default Aversion Program (Audit Control Number 05-
               80007)

Attached is our subject final report that covers the results of our audit of the Default Aversion
Program. We incorporated the comments you provided in response to our draft audit report.

Please provide us with your final response to each open recommendation within 60 days of the
date of this report indicating what corrective actions you have taken or plan, and related
milestones.

In accordance with Office of Management and Budget Circular A-50, we will keep this audit
report on the OIG list of unresolved audits until all open issues have been resolved. Any reports
unresolved after 180 days from the date of issuance will be shown as overdue in the OIG’s
Semiannual Report to Congress.

Please provide the Supervisor, Post Audit Group, Financial Improvement, Receivables and Post
Audit Operations, Office of the Chief Financial and Chief Information Officer and the Office of
Inspector General, Planning, Analysis and Management Services with semiannual status reports
on promised corrective actions until all such actions have been completed or continued follow-up
is unnecessary.

In accordance with the Freedom of Information Act (Public Law 90-23), reports issued by the
Office of Inspector General are available, if requested, to members of the press and general public
to the extent information contained therein is not subject to exemptions in the Act. Copies of this
audit report have been provided to the offices shown on the distribution list enclosed in the report.

We appreciate the cooperation given us in the audit. If you have any questions or wish to discuss
the contents of this report, please contact me at 312-886-6503. Please refer to the above audit
control number in all correspondence relating to this report.


Attachment
Table of Contents
The Department Of Education Has An Opportunity To Improve Its
Management Of The Default Aversion Program
Audit Control Number 05-80007


Transmittal Memorandum

Executive Summary                                                1


Audit Results

     Develop and monitor a plan to assess program performance    2

     Develop additional policy guidance                          5

     Improve communication in the loan subrogation process       9

     Require supplemental explanations on ED Form 1189          11

Appendix A - Background                                         13

Appendix B - Purpose, Objectives, Scope, and Methodology        16

Appendix C - Statement on Management Controls                   18

Auditee’s Response to Draft Audit Report                        19
                             Executive Summary
Effective July 1, 1996, Great Lakes Higher Education Corporation (Great Lakes) and the U.S.
Department of Education (ED) entered into a Default Aversion Agreement (Agreement). The
Agreement implements an experimental program whereby Great Lakes agreed to support ED’s
efforts to reduce defaults in the Federal Family Education Loan (FFEL) Program by accepting an
alternative method for payment of the costs of preclaims assistance, claim payment, and
collections. The alternative payment method is designed to provide an incentive to Great Lakes
to avoid defaults by borrowers and limit Great Lakes’reliance on post default collections as a
method for financing operations. ED’s experiment with Great Lakes significantly revised
payments for default avoidance and collection fees. (See Appendix A for additional background
information.) The objectives of our audit were to determine if (1) ED, Great Lakes, and student
borrowers are benefitting from the new program, (2) additional improvements can be identified,
and (3) the Agreement would be useful for other guaranty agencies.

While our audit disclosed that Great Lakes generally administered the new program in accordance
with the Agreement, we found that ED (1) did not identify indicators of success needed to
monitor the experimental program’s performance, (2) lacked adequate policy guidance, (3) needs
to improve communication within ED offices and with Great Lakes, and (4) lacked adequate
financial reporting. As a result, we could not conclusively determine the merits of the
experimental program. Our limited scope audit, however, identified four areas where ED has an
opportunity to strengthen program administration and conclusively determine program merits.
ED should:

               1.    Develop and monitor a plan to assess program performance,
               2.    Develop additional policy guidance,
               3.    Improve communication in the loan subrogation process, and
               4.    Require supplemental explanations on ED Form 1189.

ED submitted a written response to our draft audit report that is attached (See pages 19 and 20).
ED concurred with recommendations for areas (3) and (4) above but did not concur with
recommendations for areas (1) and (2). We reviewed their response and have not changed our
recommendations. We paraphrased ED's comments and responded to them at the end of each
area.




FINAL AUDIT REPORT                             Page 1              ED-OIG-AS, Audit Control Number 05-80007
                             Audit Results

                            ED did not identify indicators of success needed to monitor the
 ED needs to develop and    program. Instead, Great Lakes developed its own evaluation
 monitor a plan to assess   model. The results of Great Lakes’model are favorable,
 program performance.       however, they are based on several estimates. We could not
                            determine the reasonableness of Great Lakes’estimates due to
                            the lack of historical data and the impact of merging the Ohio
                            guaranty agency’s portfolio. However, we reviewed the Great
                            Lakes model for fiscal year 1997 (October through September).
                            Based on our analysis, Great Lakes’model indicates that as
                            long as 18.5 percent of the accounts cured through preclaims
                            assistance do not default, ED will have a nominal cost savings.

                            ED needs to monitor the experimental program by developing
The experimental program
                            an evaluation process to determine its success or failure. One
needs to be monitored by
                            way to evaluate a program is to have measurable goals and a
having an evaluation
                            method to collect data. To measure program goals, you must
process.
                            identify and select data that are mission oriented, countable,
                            mutually exclusive, relatively uniform over time, and process
                            definable (readily defined so that the data can be evaluated for
                            potential improvements). Without a measurable goal(s) and a
                            method to collect the relevant data, assessing the success or
                            failure of the experimental program may be impossible.

                            The experimental program has two goals that need to be
                            measured and monitored. One goal is to provide proper
                            incentives for avoiding defaults. The second goal is to limit the
                            guaranty agencies’reliance on post default collections to
                            finance operations. ED did not instruct Great Lakes to measure
                            these goals so Great Lakes developed its own measure. Great
                            Lakes’measure does not specifically address the program’s
                            goals.

                            Great Lakes’model measures program success by estimating
                            the cost savings to ED as a result of avoiding a default. The
                            model does not address the impact of the Agreement’s
                            provisions to limit Great Lakes’reliance on post default
                            collections. When Great Lakes cures an account, it estimates

FINAL AUDIT REPORT                       Page 2               ED-OIG-AS, Audit Control Number 05-80007
                           ED will save the reinsurance on the average default amount
                           reduced by the net cost of the default avoidance fee and an
                           estimate of the Secretary’s share of post default collections.
                           Great Lakes also included a calculation that shows the effect if
                           as many as 50 percent of the accounts recycled and ultimately
                           defaulted.

                           Assuming the estimates in Great Lakes’model can be validated
                           over time, it may prove to be a useful performance measure. In
                           our opinion however, the model alone is not a sufficient
                           measure to assess the success of the entire Agreement. The
                           number of cures may be related to defaults avoided. However,
                           there is not a one to one correlation between the number of
                           cures and the reduction of defaults. Additional performance
                           measures such as Great Lakes’default rate, increased collection
                           revenue to ED, decreased operating and reinsurance costs, and
                           continued financial health of Great Lakes should be considered
                           to assess the success of the entire Agreement. Estimated cost
                           savings related to cures is only one of several relevant
                           performance measures needed to monitor the experimental
                           program.

                           An ED official stated that he made a conscious decision not to
The lack of a plan was a
                           develop a plan to assess the performance of the program
conscious decision by an
                           because he wanted to focus on changing the economic
ED official.
                           initiatives for a guarantee agency. The official also stated he did
                           not want many rules that would hinder the development of new
                           economic initiatives for Great Lakes. The official left the
                           development of a plan to accomplish the program up to Great
                           Lakes.

                           During the experiment, Great Lakes merged the Ohio guaranty
                           agency portfolio with its own. The inclusion of the Ohio
                           portfolio altered the baseline Great Lakes used to measure its
                           performance under the program. Had ED developed and
                           monitored a plan to assess performance, Great Lakes may not
                           have merged the Ohio portfolio with its own without
                           developing a separate tracking system.




FINAL AUDIT REPORT                      Page 3               ED-OIG-AS, Audit Control Number 05-80007
                     We recommend that ED:
RECOMMENDATIONS
                     1. Develop and monitor a plan to assess program performance.
                        The plan should:

                        a. Identify the indicators of success. Some potential
                           indicators are (1) a reduced default rate, (2) increased
                           collection revenue to ED, (3) decreased operating and
                           reinsurance costs, and (4) continued financial health of
                           Great Lakes.

                        b. Define data needs.

                        c. Establish a process to collect and evaluate data.

                        d. Establish a schedule for periodic evaluation, either
                           monthly or quarterly.

                     2. Consider expanding the experimental program to other
                        agencies if ED’s analysis is consistent with Great Lakes’
                        analysis.

                     ED does not believe that the program has had sufficient time to
Auditee Comments
                     generate measurable results that can be extrapolated to the
                     industry. The baseline needed for performance measures was
                     altered when Great Lakes merged the Ohio portfolio with its
                     own. Great Lakes has created a conservative assessment plan,
                     in consultation with ED. Preliminary assessments by Great
                     Lakes suggest that the program may be (emphasis added)
                     effective at reducing defaults without adversely affecting the
                     guarantors’revenue as a result of the reduced collections
                     retention.

                     While we agree that the program may be effective, we could not
Auditor’s Response
                     make a conclusive determination based on Great Lakes’
                     assessment model. Great Lakes’assessment model is not
                     sufficient to cover the Agreement’s goals. Identifying
                     indicators for desired outcomes will clearly communicate the
                     desired outcomes to Great Lakes without dictating the methods
                     Great Lakes uses to achieve the outcomes. Also, data may not
                     be available if indicators and related data collection procedures
                     are not identified. We believe that in over two years since the

FINAL AUDIT REPORT                Page 4              ED-OIG-AS, Audit Control Number 05-80007
                               program’s effective date on July 1, 1996, enough time has
                               elapsed to expect to see at least preliminary results.


                               The Agreement does not adequately define the (1) number of
                               times or under what circumstances ED will pay the $60 default
 ED should develop
                               avoidance fee, (2) applicable cost principles for determining the
 additional policy
                               actual costs of post default collections, and (3) need to maintain
 guidance.
                               a baseline for performance measures when merging portfolios.
                               ED and Great Lakes could benefit from written policy guidance
                               to manage the experimental program.

 ED needs to further           The Agreement requires ED to pay the $60 default avoidance
 define the policies for the   fee if the lender does not file a claim during the 180 days
 default avoidance fee.        following the receipt of the preclaims assistance request.
                               However, this requirement does not prevent Great Lakes from
                               billing ED multiple times for the same borrower. Great Lakes is
                               billing ED for the $60 fee each time it receives a lender request
                               for preclaims assistance and cures the account. ED has no
                               written policies limiting the number of times it will pay the $60
                               fee and only a limited policy regarding under what
                               circumstances it will pay.

                               Great Lakes’internal policy limits the circumstances under
                               which it will request payment for the default avoidance fee.
                               Great Lakes does not request payment if the following
                               conditions occur:

                               1. The loan lost its guaranty,
                               2. The cure amount is less than $60,
                               3. A deferment, forbearance, or payment cured the loan before
                                  Great Lakes received the Request for Collection Assistance,
                               4. Non-sufficient funds or bounced checks,
                               5. Loan defaulted after running cure report,
                               6. Bankruptcy or loans that will default as a result of
                                  bankruptcy,
                               7. Death of the borrower,
                               8. Invalid cure, which includes loans that are usually not
                                  serviced by Great Lakes and have been cured in error or
                                  improper documentation such as deferment rejection by the
                                  servicer, and

                               9. Other, which may include any other unforeseeable problems.

FINAL AUDIT REPORT                          Page 5               ED-OIG-AS, Audit Control Number 05-80007
                             Allowing Great Lakes to bill ED for the $60 default avoidance
                             fee multiple times during a year increases costs to ED.
                             However, in some cases, ED may derive some benefit from
                             paying the additional fee. We reviewed a non-statistical sample
                             consisting of 49 borrowers judgmentally selected from two
                             months of fiscal year 1997 (November 1996 and August 1997)
                             billing reports. We researched these borrowers’accounts to
                             determine the nature of the preclaims actions Great Lakes took
                             to prevent the default and whether there were multiple
                             payments of the $60 default avoidance fee in one fiscal year.
                             Fifteen of the 49 (31%) borrowers went into delinquency and
                             were cured more than once in fiscal year 1997. Great Lakes
                             received a fee more than once in the fiscal year for these 15
                             borrowers. Most of these borrowers had two cures during the
                             fiscal year and Great Lakes performed additional work to cure
                             the accounts. The additional cure fees would have been higher
                             if Great Lakes had not implemented its own internal policy
                             limiting the circumstances under which it would request
                             payment.

                             We believe that allowing Great Lakes to bill the default
                             avoidance fee multiple times as a result of granting forbearances
                             puts ED at risk. Great Lakes could grant a borrower repeated
                             forbearances and bill ED repeatedly for preventing a default. In
                             August 1997, Great Lakes cured 11,865 accounts, of which
                             2,506 (21%) were cured with a forbearance.

 ED has no policy            The Agreement allows Great Lakes to retain from collections
 regarding applicable cost   on defaulted loans its actual costs of post default collections.
 principles.                 Great Lakes is billing ED for all the direct costs of the
                             Collection Support units and for costs allocated for facilities
                             management, general administration, system support, systems
                             development, special projects, word processing, and records
                             maintenance in accordance with Attachment 1 to the
                             Agreement. However, Great Lakes did not have the actual
                             costs certified annually by a supplemental schedule to the A-133
                             audit as required by the Agreement.

                             The Agreement does not identify the cost principles to be
                             followed in determining Great Lakes’actual costs. The Office
                             of Management and Budget (OMB) Circular A-122 establishes
                             the cost principles for non-profit organizations. Great Lakes
                             has designed its own policy. Our audit disclosed that Great

FINAL AUDIT REPORT                        Page 6              ED-OIG-AS, Audit Control Number 05-80007
                           Lakes billed ED for costs that would reasonably be associated
                           with collection costs. However, we did not test for compliance
                           with OMB Circular A-122.

                           We believe that not having a policy in place regarding the
                           applicable cost principles for determining the actual costs of
                           post default collections puts ED at risk. Great Lakes created
                           two new non-profit corporations; Great Lakes Higher
                           Education Guaranty Corporation (GLHEGC) and Great Lakes
                           Higher Education Servicing Corporation (GLHESC).
                           GLHESC created and operates a wholly owned, for-profit
                           subsidiary, Great Lakes Educational Loan Services, Inc.
                           (GLELSI). To the extent that shared costs may not be
                           equitably allocated among the various corporations, there is a
                           risk that reserve funds could be used to finance non-guaranty
                           activities. The absence of a policy regarding applicable cost
                           principles increases the opportunity for abuse.

                           After Great Lakes and ED entered into the Agreement, Great
 There is a need to
                           Lakes merged the Ohio guaranty agency portfolio with its own
 maintain a baseline for
                           portfolio without providing for separate tracking. The Ohio
 performance measures.
                           merger altered the baseline used by Great Lakes to measure its
                           performance under the experimental program. ED told Great
                           Lakes to track the merged portfolio for Northstar separately
                           when Great Lakes subsequently merged with Northstar. If ED
                           expands the experimental program to other guaranty agencies,
                           the other agencies will need to maintain a baseline to accurately
                           measure their performance for preventing defaults.

                           The lack of guidance in these areas has affected the operation
                           and evaluation of the default aversion program at Great Lakes
                           and will likely cause inconsistencies if the program is expanded
                           to other agencies. The inconsistencies could include the
                           number of times and under what circumstances they bill ED for
                           the $60 default avoidance fee, how they bill for actual costs of
                           post default collections, and how they measure performance.
                           These inconsistencies may also result in increased costs to ED
                           and a lack of standardized performance measures that
                           accurately reflect the success of the experimental program.

                           The experimental program for default aversion and move
                           toward fee for service is new. Therefore, ED did not have
                           policies in place regarding the (1) number of times or under

FINAL AUDIT REPORT                      Page 7               ED-OIG-AS, Audit Control Number 05-80007
                     what circumstances it will pay the $60 fee, (2) applicable cost
                     principles for determining the actual costs of post default
                     collections, and (3) need to maintain a baseline for performance
                     measures when merging portfolios. The implementation of any
                     new program raises issues that were not anticipated.

                     ED needs to:
 RECOMMENDATIONS
                     1. Implement policy guidance regarding:

                        a. The number of times or under what circumstances it will
                           pay the $60 default avoidance fee to the agency,

                        b. The applicable cost principles for determining the actual
                           costs of post default collections (OMB Circular A-122,
                           “Cost Principles for Non-Profit Organizations”), and

                        c. The need to maintain a baseline for performance
                           measures when merging portfolios.

                     2. Enforce the existing requirement in the Agreement for an
                        annual certification of actual costs of post default
                        collections in a supplemental schedule to the A-133 audit.

                     ED does not believe that additional policy guidance is necessary
Auditee Comments
                     or desirable. Great Lakes is encouraged to test various
                     approaches to default reduction. ED intentionally did not
                     develop extensive policy guidance for administering the
                     program. Part of the experimental program was to test new
                     approaches to regulating guaranty agencies. ED does not
                     believe that Great Lakes views the program simply as a way to
                     increase its Federal reserve funds. ED does agree that more
                     policy guidance must be developed before the program is
                     expanded to other guaranty agencies.

                     ED believes that additional policy guidance will hamper Great
Auditor’s Response
                     Lakes’flexibility in achieving the program’s goals. However,
                     we are not recommending extensive policy guidance but rather
                     minimal guidance to limit ED’s risk exposure. Minimal
                     guidance would limit ED’s risk exposure for multiple fee
                     payments, cost allocation, and facilitate assessment of the
                     program results.


FINAL AUDIT REPORT               Page 8               ED-OIG-AS, Audit Control Number 05-80007
                             Great Lakes was not able to meet the timelines in the
 ED should improve           Agreement for the defaulted loan subrogation to ED.
 communication in the        Subrogation of the defaulted loan portfolio is a major step in the
 loan subrogation process.   Agreement to reduce the costs incurred by guaranty agencies
                             and move toward a system based on a fee for service.

                             In the Agreement, Great Lakes agreed to subrogate to ED the
                             defaulted loans, beginning September 1, 1996, on which it paid
                             a default claim to a lender at least 2-years ago and on which it
                             has received no payments from the borrower. Great Lakes also
                             agreed to promptly negotiate with ED to agree to a schedule by
                             December 1, 1996, for subrogating all remaining defaulted
                             loans held by Great Lakes.

                             A Great Lakes official informed us that Great Lakes was not
Great Lakes experienced a
                             able to subrogate as many defaulted loans as it would like.
delay subrogating loans to
                             First, E-Systems (an ED contractor) was unable to accept them
ED.
                             because it had a backlog due to other agencies subrogating
                             large volumes and changes in the edit criteria. Second, IRS
                             offset, bankruptcy, and disability requirements reduced the
                             number of loans eligible for subrogation. Third, a Dear
                             Colleague Letter limited subrogation of accounts with certain
                             default dates. Therefore, Great Lakes needed permission from
                             ED to subrogate accounts with default dates up to September
                             30, 1995. In January 1998, ED gave Great Lakes permission to
                             subrogate accounts with default dates up to September 30,
                             1996.

                             When Great Lakes first attempted to subrogate a large number
                             of accounts E-Systems returned them because it could not
                             handle the volume. This caused additional work for Great
                             Lakes, since it had to reload the loan information on its system
                             and start working the account again. The approximate six
                             month period from the time Great Lakes sent the loans to E-
                             Systems until it reloaded the loans onto its system caused many
                             problems with the borrowers. This six-month delay could affect
                             the collectability of some loans. The subrogation delays also
                             affect ED’s efforts to reduce the costs incurred by guaranty
                             agencies in the FFEL Program and move toward a system based
                             on a fee for service.

                             After the initial delay, E-Systems informed Great Lakes it
                             would only accept tapes of 5,000 accounts per tape on a

FINAL AUDIT REPORT                        Page 9               ED-OIG-AS, Audit Control Number 05-80007
                      gradual basis so it could handle the volume. From fiscal years
                      1995 through 1997, Great Lakes subrogated 101,720 accounts
                      totaling $514,474,380 to E-Systems which has accepted 89,337
                      accounts totaling $332,864,883. Before E-Systems accepts the
                      subrogated accounts it performs edit checks. The 12,383
                      accounts not yet accepted are in the edit check process. In
                      addition, as of April 1, 1998, Great Lakes had approximately
                      28,375 accounts to subrogate.

                      Unforseen events, such as the closing of the Ohio and Northstar
                      guaranty agencies, caused some of the delay problems. ED
                      officials indicated they did not anticipate the large default loan
                      volumes subrogated by these agencies when they entered into
                      the Agreement with Great Lakes. However, we believe the lack
                      of communication within ED offices and with Great Lakes
                      caused some of the delay problems. Better communication
                      could have disclosed the changes in the edit criteria and the
                      need for ED approval to subrogate certain defaulted loans. The
                      increased communication would have made the subrogation
                      process more timely.

                      If ED expands the experimental program to other guaranty
 RECOMMENDATION
                      agencies, ED should improve its communication within ED
                      offices and with Great Lakes (or other guaranty agencies) to
                      ensure they carry the subrogation process out in a timely
                      manner.

                      ED concurred with the recommendation and stated it is working
Auditee Comments
                      with Great Lakes and E-Systems to resolve the difficulties that
                      have prevented the subrogation of the Great Lakes defaulted
                      loans.


                      The current ED Form 1189 does not facilitate accurate
 ED should require    reporting of default avoidance fees and actual post default
 supplemental         collection costs. According to Title 34 Code of Federal
 explanations on ED   Regulations (CFR) 682.414(b), guaranty agencies are required
 Form 1189.           to accurately complete and submit reports to the Secretary. ED
                      provides standardized forms for guaranty agency reporting.
                      The current ED Form 1189 is not designed to capture data
                      relevant to the experimental program. ED officials opted not to
                      change the ED Form 1189 during the experimental program


FINAL AUDIT REPORT                Page 10               ED-OIG-AS, Audit Control Number 05-80007
                     because of time and money issues and the need for OMB approval.

                     During the experimental program, Great Lakes is using the
                     supplemental preclaims assistance (SPA) line of the current ED
                     Form 1189 to report the net amount of cure fees and
                     adjustments for actual collection costs. ED users were not
                     aware that Great Lakes changed the data it is reporting on the
                     SPA line. For example, when discussing the ED Form 1189
                     reporting issue with ED officials from Accounting and Financial
                     Management Service, FFEL Program, they informed us they
                     were unaware of the new experimental program at Great Lakes.
                     The officials noted that Great Lakes’SPA amount went from
                     about $1.5 million in 1996 to about $6.5 million in 1997 but did
                     not know why.

                     We recommend that ED require Great Lakes to add footnotes
 RECOMMENDATION
                     or an attachment to the ED Form 1189 to explain the details
                     behind the amount reported on the SPA line. If ED expands the
                     experimental program to other guaranty agencies, we
                     recommend that it modify the ED Form 1189 to properly
                     account for the alternative method for reimbursement of
                     preclaims assistance and actual collection costs.

                     ED concurred with the recommendation and agreed to promptly
Auditee Comments
                     implement it.


                     We could not conclusively determine the merits of the
 Summary             experimental program. However, Great Lakes’assessment
                     model indicates that the experimental program appears to have
                     merit. Our limited scope audit identified areas where ED has an
                     opportunity to strengthen program administration and
                     conclusively determine program merits.

                     ED needs to develop and monitor a plan to assess program
                     performance. The program needs to be monitored by having an
                     evaluation process. ED needs to develop additional policy
                     guidance and improve its communication within ED and with
                     Great Lakes. ED should also require supplemental explanations
                     on ED Form 1189. Improvements in these areas will facilitate
                     the full implementation of the Agreement.



FINAL AUDIT REPORT               Page 11              ED-OIG-AS, Audit Control Number 05-80007
                     If the evaluation indicates the program is working as intended,
                     it should be gradually expanded to a few additional guaranty
                     agencies and evaluated to rule out the possibility that some
                     unique characteristic of Great Lakes is responsible for the
                     results. If the program is successful during the expanded test,
                     necessary legislative and/or regulatory changes should be
                     sought to expand the program to all guaranty agencies.




FINAL AUDIT REPORT               Page 12              ED-OIG-AS, Audit Control Number 05-80007
                                                                                       Appendix A


Background
Description of Great Lakes   Great Lakes Higher Education Corporation (Great Lakes) is a
                             nonprofit Wisconsin corporation that was established in 1967
                             for the purpose of guaranteeing student loans for Wisconsin
                             residents. Since then, Great Lakes has administered the FFEL
                             Program under several agreements with ED.

                             Great Lakes was reorganized as of September 30, 1996.
                             Pursuant to an internal restructuring resolution, Great Lakes
                             created two new Wisconsin nonstock, nonprofit corporations;
                             Great Lakes Higher Education Guaranty Corporation
                             (GLHEGC) and Great Lakes Higher Education Servicing
                             Corporation (GLHESC).

                             Under an Assignment and Assumption Agreement between
                             Great Lakes, GLHEGC and GLHESC, the net assets and
                             personnel related to the activities traditionally conducted by the
                             Great Lakes Guaranty Division were assigned to GLHEGC and
                             the net assets and personnel related to activities traditionally
                             conducted by Great Lakes’Servicing Division were assigned to
                             GLHESC.

                             Great Lakes has retained certain controls over GLHEGC and
                             GLHESC through its rights as the sole corporate member of
                             each corporation. It also continues to provide certain support
                             functions for GLHESC and GLHEGC such as information
                             systems, facilities management, and accounting services.
                             GLHESC also created and operates a wholly owned, for-profit
                             subsidiary, Great Lakes Educational Loan Services, Inc.
                             (GLELSI), which is responsible for all alternative student loan
                             servicing activities. GLELSI was intended to be responsible for
                             all loan servicing activities for loans under the William D. Ford
                             Federal Direct Loan Program, until cancellation of the contract
                             between E-Systems and ED in 1997.




FINAL AUDIT REPORT                       Page 13               ED-OIG-AS, Audit Control Number 05-80007
Description of Default   Effective July 1, 1996, Great Lakes began participating in an
Aversion Program         experimental program with ED whereby Great Lakes agreed to
                         support ED’s efforts to reduce defaults in the FFEL Program by
                         accepting an alternative method for payment of the costs of
                         preclaims assistance, claim payment, and collections. The
                         alternative payment method is designed to provide an incentive
                         to Great Lakes to avoid defaults by borrowers and limit Great
                         Lakes’reliance on post default collections as a method for
                         financing guaranty agency operations.

                         The alternative method was to be implemented under the
                         following guidelines: (1) ED and Great Lakes agreed to test the
                         program from July 1, 1996 to December 31, 1996, unless
                         modified or terminated [later extended through June 30, 1998];
                         (2) ED agreed to pay Great Lakes $60 per default claim
                         avoided because of Great Lakes’efforts; (3) ED and Great
                         Lakes agreed to consider a default claim avoided if Great Lakes
                         received a preclaims assistance request from a lender after the
                         loan has been delinquent for 90 days and a default claim was
                         not paid on the loan during the 180 days following receipt of
                         the preclaims assistance request; (4) ED agreed to allow Great
                         Lakes to retain from collections its actual costs of post default
                         collections, calculated in accordance with Attachment 1 to the
                         Agreement and certified annually by a supplemental schedule to
                         the annual compliance audit; (5) Great Lakes agreed not to
                         retain a percentage of post default collections, except for the
                         actual costs as discussed in #4 above, and not to bill ED for
                         SPA.

                         Beginning September 1, 1996, Great Lakes agreed to assign to
                         ED the defaulted loans on which it paid a default claim at least
                         two years ago and on which no payments have been received
                         from the borrower. Great Lakes also agreed to set up a
                         schedule by December 1, 1996, for subrogating all remaining
                         defaulted loans.

                         Great Lakes agreed to return to ED $5 million in Federal
                         reserve funds maintained under 34 CFR 682.410(a)(1) as a first
                         step toward converting the guaranty agency financing system
                         from one based on the accumulation of reserve funds to a
                         system based on a fee for service competitively based working
                         capital cost reimbursement methodology. Subsequent to the


FINAL AUDIT REPORT                   Page 14               ED-OIG-AS, Audit Control Number 05-80007
                      Agreement, Great Lakes returned the $5 million in reserve
                      funds to ED.

Federal Regulations   Title 34 of the CFR, Part 668 and 682, govern the
                      administration of the FFEL Program. In addition, the FFEL
                      Program is subject to the provisions contained in Title IV of the
                      Higher Education Amendments of 1992 (Public Law 102-325).
                      The current regulations do not specifically address the default
                      aversion program. However, the Agreement does provide
                      requirements agreed to by Great Lakes and ED for the
                      administration of the experimental program.




FINAL AUDIT REPORT                Page 15               ED-OIG-AS, Audit Control Number 05-80007
                                                                                    Appendix B


Purpose, Objectives, Scope, and Methodology
Purpose, Objectives, and   The purpose of our audit was to determine if ED’s Agreement
Scope                      with Great Lakes is working as intended. The audit covered the
                           period October 1, 1995 through April 17, 1998.

                           The specific objectives were as follows: (1) determine if the
                           Agreement has benefitted ED, Great Lakes, and student
                           borrowers, (2) determine if additional improvements can be
                           identified, and (3) assess whether the Agreement would be
                           useful for other guaranty agencies. Our specific objectives
                           included reviewing and evaluating management controls, the
                           accounting for the program, and adherence to provisions in the
                           Agreement.

Methodology                To achieve the purpose and specific objectives, we interviewed
                           key ED officials and Great Lakes management, reviewed
                           written policies and procedures, documents and accounting
                           records, and student financial assistance files pertaining to
                           preclaims assistance. Our review of student files consisted of
                           reviewing 49 borrowers judgmentally selected from two months
                           of fiscal year 1997 (November 1996 and August 1997) billing
                           reports. The universe for fiscal year 1997 was 108,985 cures.

                           We sampled 49 borrowers to determine what ED is paying for
                           when Great Lakes avoids a default and if ED has paid Great
                           Lakes multiple times for avoiding a default for individual
                           borrowers. We reviewed the histories of 21 borrowers from the
                           August 1997 preclaims supplemental allowance billing report
                           for the sample. We judgmentally selected three borrowers from
                           each of the following reasons for the default avoidance (cure):
                           deferment, forbearance, low delinquency, miscellaneous cure,
                           monetary update, paid in full, and payment posting. In addition,
                           we reviewed the histories of an additional 28 borrowers from
                           the November 1996 preclaims supplemental allowance billing
                           report. We judgmentally selected 4 borrowers from each of the
                           previous reasons for the default avoidance (cure).

                           We performed field work at the Guarantor and Lender
                           Oversight Service, Washington, D.C. and Great Lakes in

FINAL AUDIT REPORT                     Page 16              ED-OIG-AS, Audit Control Number 05-80007
                     Madison, Wisconsin from February 9, 1998 through April 17,
                     1998. We performed our audit in accordance with government
                     auditing standards appropriate to the limited scope of audit
                     described above.




FINAL AUDIT REPORT              Page 17             ED-OIG-AS, Audit Control Number 05-80007
                                                                                 Appendix C


Statement on Management Controls
Purpose of Assessment   As part of our review we assessed the system of management
                        controls including policies, procedures, and practices applicable
                        to ED’s administration of the experimental program. We
                        performed our assessment to determine the level of control risk
                        for determining the nature, extent, and timing of our substantive
                        tests to accomplish the audit objectives.

                        To make the assessment, we identified and classified the
                        significant management controls into the following categories:

                        " Program implementation

                        " Program monitoring

                        " Program evaluation

                        Because of inherent limitations, a study and evaluation made for
                        the limited purpose described above would not necessarily
                        disclose all material weaknesses in the management controls.
                        However, our assessment disclosed significant management
                        control weaknesses which adversely affected ED’s ability to
                        administer the experimental program. Our limited scope audit
                        identified weaknesses in controls needed to: (1) Develop and
                        monitor a plan to assess the performance of the experimental
                        program, (2) Develop additional policy guidance, (3) Improve
                        communication in the loan subrogation process, and (4) Require
                        supplemental explanations on ED Form 1189. These
                        weaknesses and their effects are fully disclosed in Audit Results
                        section of this report.




FINAL AUDIT REPORT                  Page 18              ED-OIG-AS, Audit Control Number 05-80007
FINAL AUDIT REPORT   Page 19   ED-OIG-AS, Audit Control Number 05-80007
FINAL AUDIT REPORT   Page 20   ED-OIG-AS, Audit Control Number 05-80007
                                     REPORT DISTRIBUTION LIST
                                   AUDIT CONTROL NUMBER 05-80007

                                                                                                No. of
                                                                                                Copies
Action Official
                  Dr. David A. Longanecker
                  Assistant Secretary for Postsecondary Education

Other ED Offices
              Deputy Secretary                                                                      1
              Deputy Assistant Secretary for Student Financial Assistance Programs                  1
              Service Director, Guarantor and Lender Oversight Service, SFAP                        1
              Service Director, Accounting and Financial Management Service, OPE (electronically)   1
              Office of Public Affairs                                                              1
              Secretary’s Regional Representative, Region V                                         1

ED-OIG (electronically)
              Inspector General                                                                      1
              Deputy Inspector General                                                               1
              Assistant Inspector General for Audit                                                  1
              Assistant Inspector General for Investigations                                         1
              Assistant Inspectors General for Operations                                       1 each
              Director, Advisory & Assistance, SFA                                                   1
              Director, PAMS                                                                         1
              Regional Inspectors General for Audit                                             1 each