oversight

Financial Audit: Federal Crop Insurance Corporation's Fiscal Year 1988 Financial Statements

Published by the Government Accountability Office on 1990-04-18.

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

United States General Accounting   Office
Report    to   the   Congress




FINANCIAL                          AUDIT
Federal Crop
Insurance
Corporation’s Fiscal
Year 1988 Financial
Statements
United States
General Accounting  Office
Washington, D.C. 20648

Comptroller   General
of the United States

B-114834

April 181990

To the President of the Senate and the
Speaker of the House of Representatives

This report presents our opinion on the Federal Crop Insurance Corpora-
tion’s financial statements for the fiscal year ended September 30, 1988.
The Corporation’s financial statements present fairly, in all material
respects, its financial position, the results of its operations, and its cash
flows. This report also includes our reports on the Corporation’s system
of internal accounting controls and on its compliance with laws and reg-
ulations. We conducted our audit pursuant to 31 U.S.C. 9105 and in
accordance with generally accepted government auditing standards.

Our opinion on the Corporation’s financial statements emphasizes its
continued losses, which are due to claims exceeding premiums, and the
need for additional government capital to sustain operations. Claims
have exceeded premiums every year since enactment of the Federal
Crop Insurance Act of 1980, with 1988 losses amounting to $617 million.
The Corporation’s accumulated deficit for 1988 amounts to about $1.8
billion. Without significant changes in insurance program operations,
the Corporation’s ability to pay its losses will depend on additional gov-
ernment assistance.

Our report on internal accounting controls discusses weaknesses regard-
ing (1) the Corporation’s oversight of reinsured companies and (2) con-
trols over processing and payment of administrative expenses. Our
report on compliance with laws and regulations discloses that the Cor-
poration complied with the provisions of laws and regulations for the
transactions we tested.

We are sending copies of this report to the Director of the Office of Man-
agement and Budget, the Secretary of the Treasury, the Secretary of
Agriculture, and the Board of Directors of the Federal Crop Insurance
Corporation.




Charles A. Bowsher
Comptroller General
of the United States


Page 1                           GAO/AFhUWO4    Federal   Crop Immmnce   C!mpore.tion
Page 3   GA0/AFMB90-43   Federal   Crap Inmmme   Corpomtlon
                    B114J334




                    Since 1984, the Corporation’s accumulated deficit has more than tripled,
The Corporation’s   increasing from $516 million to about $1.8 billion by 1988. This can be
Financial Outlook   attributed to the continuing effects of several factors. First, the Federal
                    Crop Insurance Act of 1980 considerably expanded the role of the Cor-
                    poration. The act included provisions for increasing coverage (1) from a
                    limited number of states to nationwide availability, (2) from a limited
                    number of events to “all-risk” coverage for a wide variety of crop dam-
                    age, (3) from a few agricultural crops to any agricultural commodity the
                    Corporation’s Board of Directors decides to insure. According to the
                    1980 act and its legislative history, the increased coverage provided by
                    the act was intended to replace the federal disaster program which had
                    been administered by the Agricultural Stabilization and Conservation
                    Service. In 1988, all-risk crop insurance was available in over 3,000
                    counties with policies covering 50 different commodities. The 1980 act
                    also authorized the Corporation to request funds from the Commodity
                    Credit Corporation to cover losses in excess of premiums.

                    Second, recent widespread drought conditions have also contributed to
                    the Corporation’s deficit. In 1988, the United States suffered a drought
                    which was among the worst in the twentieth century. Consequently, the
                    Corporation experienced a record high $1 billion in claims for crop
                    losses which exceeded premiums by $617 million, resulting in a net loss
                    of $626 million. This experience was the worst in the Corporation’s his-
                    tory. The Corporation estimated that, due to continued drought condi-
                    tions, fiscal year 1989 will result in a new high of about $1.2 billion in
                    claims.

                    Claims have exceeded premiums every year since nationwide expansion
                    of the insurance program as a result of the 1980 act. However, the Cor-
                    poration h&s not established premium rates that adequately cover losses
                    on insured crops and that would enable it to build a reasonable reserve
                    against unforeseen losses, as authorized by the act. The Corporation’s
                    position is that higher premium rates would reduce producer participa-
                    tion in the crop insurance program.

                    To overcome these deficits, the Commodity Credit Corporation has pro-
                    vided $1.7 billion of capital contributions from its appropriations since
                    1984, as authorized by the 1980 act and the Food Security Act of 1985.
                    Also, in response to the severity of the drought conditions in 1988, the
                    Congress authorized about $3.4 billion in disaster payments in addition
                    to the insurance claims paid by the Corporation.




                    Page 6                          GAO/AFMD.SO43   Federal   Crop Insurance   Corporation
Page 7   GAO/AFM@Bl%43   Federal   Crop Insmce   Corporation
                      Our study and evaluation, made for the limited purpose described in the
                      second paragraph, would not necessarily disclose all material weak-
                      nesses in the system. Accordingly, we do not express an opinion on the
                      Corporation’s system of internal accounting controls taken as a whole or
                      on the categories of controls identified in the second paragraph.

                      In our prior reports since 1984, we have reported material weaknesses
                      relating to internal controls over reinsurance loss adjustments, adminis-
                      trative expenses, reconciliation of subsidiary records to control
                      accounts, and an accounting system which did not provide all informa-
                      tion on insurance losses and premiums required for fair financial report-
                      ing by fiscal year. The results of our fiscal year 1988 audit showed that
                      the Corporation had improved its internal control procedures relating to
                      reconciliation of subsidiary records and the accounting system.

                      However, our study and evaluation disclosed that further improvements
                      are needed with respect to two conditions which we noted in our fiscal
                      year 1986 financial audit and a 1987 report. These two conditions,
                      which we believe could result in errors or irregularities in amounts
                      material to the Corporation’s financial statements and not be promptly
                      detected, relate to (1) insufficient oversight over reinsured companies
                      and (2) the lack of accounting controls over administrative expenses. We
                      considered these conditions in determining the nature, timing, and
                      extent of our audit tests. We extended our audit tests sufficiently to con-
                      clude that these conditions would not require qualification of our opin-
                      ion on the Corporation’s financial statements for the year ended
                      September 30, 1988.


                      The Corporation’s oversight of reinsured companies’ loss adjustment
Oversight of          activities has improved, but further improvements can be made. In
Reinsured Companies   1987, we reported that reinsured companies had overpaid about 31 per-
Has Improved          cent of selected claims for crop years 1984 and 1985.’ Subsequent
                      reviews by us and one by the U.S. Department of Agriculture’s (USDA)
                      Office of Inspector General focused on claims adjusted by reinsured
                      companies for crop years 1987 and 1988 and found that improvements
                      had been made. For crop year 1987, we reported that the reinsured com-
                      panies’ overpayment rate was about 16 percent.z The Inspector General

                                                 of Claims by Private Companies costs the Govemment       Millions
                                    7, November 20,1987).

                                     Private Company Lass Adjusment   lmpro~    but Overpayment    Still High (GAO/
                           90-32, November 7,19S9).




                      Page 9                                GAO/-              Federal   Crop Insurance     Corporation
                       Our financial audit of fiscal year 1988 disclosed that the Corporation
Lack of Internal       did not have sufficient internal controls over the processing and pay-
Accounting Controls    ment of some administrative expenses. Specifically, the Corporation had
Over Adrninistrative   not established internal accounting control procedures to ensure that all
                       transactions sent to the U.S. Department of Agriculture’s National
Expenses               Finance Center (NFC) in New Orleans were accurately processed and
                       recorded. The audit of the Corporation’s 1987 financial statements
                       resulted in a disclaimer of opinion due to the Corporation’s lack of con-
                       trol over administrative expenses.

                       During fiscal year 1988, the Corporation sent a total of $232 million of
                       administrative expense vouchers to NET for processing and payment. NIX
                       functions as USDA'S central accounting office responsible for processing
                       and making administrative payments for all agriculture agencies, includ-
                       ing the Corporation. Approximately $177 million of expense vouchers
                       involving sales agents’ commissions, loss adjustors’ expenses, reinsur-
                       ante reimbursements, bad debt expense, and interest expense were
                       processed at the Corporation’s Kansas City headquarters Finance
                       Branch. We found that Finance Branch personnel performed appropri-
                       ate reconciliations of these transactions with NFCreports. However, we
                       found weak controls over the remaining $55 million of administrative
                       expenses, which involve salaries and other expenses processed by indi-
                       vidual Corporation cost centers.

                       GAO'S  Policy and Procedures Manual for Guidance of Federal Agencies,
                       Title 2, requires that general ledger balances be reconciled with subsidi-
                       ary accounts and records on a regular basis to ensure their accuracy.
                       Cost center personnel do not adequately reconcile expense vouchers for
                       salaries and other administrative expenses to ensure that they are prop
                       erly recorded. Individual Corporation cost centers (e.g., branches and
                       divisions) are responsible for submitting these administrative expense
                       vouchers to NFC.Each cost center receives a detailed transaction register
                       from MFCat the end of each month to show what was processed. Each
                       cost center maintains copies of the administrative expense vouchers
                       submitted to NIX, but cost center personnel do not compare these docu-
                       ments with the transaction register on a regular and systematic basis.
                       Cost center personnel may scan the monthly transaction register and
                       review copies of source documents for questionable items. However, this
                       procedure does not ensure that all transactions have been properly
                       recorded in the accounts and included in the Corporation’s financial
                       statements.




                       Page11
Report on ~mpliance With Laws
and Regulations

                 We have audited the financial statements of the Federal Crop Insurance
                 Corporation for the year ended September 30,1988, and have issued our
                 opinion thereon. We conducted our audit in accordance with generally
                 accepted government auditing standards. Those standards require that
                 we plan and perform the audit to obtain reasonable assurance about
                 whether the financial statements are free of material misstatement.

                 Compliance with laws and regulations applicable to the Corporation is
                 the responsibility of the Corporation’s management. As part of
                 obtaining reasonable assurance as to whether the consolidated financial
                 statements were free of material misstatement, we performed tests of
                 the Corporation’s compliance with the following provisions of laws and
                 regulations:

             l Federal Crop Insurance Act, as amended (7 USC. 1601-1620), and
               related regulations;
             l Anti-Deficiency Act (31 USC. 1341-1619);
             l Debt Collection Act of 1982 (31 USC. 3711-3719); and
             . Prompt Payment Act (31 U.S.C. 3901-3906).

                 The results of our tests indicate that, with respect to the items tested,
                 the Corporation complied, in all material respects, with the provisions
                 referred to in the preceding paragraph. With respect to items not tested,
                 nothing came to our attention that caused us to believe that the Corpo-
                 ration had not complied, in all material respects, with those provisions.




                 Page 13
-
                                                              Financial     statements




Statement of Loss and Changes in Accumulated Deficit

                                                FQfsFKxuyEARsENDm                    SEPlEuam       30.1988.       AND SEPTEMBER    30.1837
                                                                             (In ,hc”sa”ds  of dollars)



                                                REVENUFS                                   FtsALw=u3loe6                              FBCN     n=m      IS57

             Premium(note 2.b h ncte 3)
                Direct premium                                                                     961.963                                 362,876
                Reinsurance premium                                                                361.078           $423,041              269.095             9351.971



             Interest fnccme                                                                                              4,750                                     5.046
             Other                                                                                                        2,681                                     l?=-
                                     TOW Revenues                                                                     430.472                                    350.556




             Insuranm CIaims(note        2.c)
               Direct clams                                                                        154.058                                  75.184
               Reinsurance                                                                         aa%ata            1,039,876             338.835               414.119

             Administrative  Expenses
               Sales agent’s ccmm~sstc”s(ncte     2.e)                                               13.618                                 10.388
               Ctaims adjustment(note     2.~)                                                        7.M1                                   3.724
               Reinsurance administratlve(note    2.9                                              154,663                                 106.990
               Provision lor uncollectible acccunfs                                                   1.542                                  2,403
               Inter.61 expanse                                                                          34                                      43
               Salaries 8 other expenses(ncte    9)                                    --55,348-                                            56.760
                                                                                                                       232,644                                   180.308

                                     Total Expenses                                                           -I     1 272 520                                   584.427

                                  (Loss) from operations                                                              (842,048)                                 (235.871)

                                                QTHFR      FINAKING       SQ’JFICFS

             Operating   appropriations(note        2.g)                                                               215.675                                    175.341

                                  Net ,066 for the year                                                               (626,373)                                   (60.530)

             Credit arising from transfer of lnve8ted
               capital for depreciation on contributed         au~efs                                         -              249                                       271

                                  Loss transferred      tc accumulated     deficit                            __      @2%124)                                     W’259)
             Accumulated       Deficit. begInning    of fiscal year                                                 (,.142,g,t)                                (1.082.652)

             Accumulated       Debclt, end of trscal year
                                                                                                              =--- (S1,769.035)                            ($1.142.011)

             The acc.wnpany,ng       nctes are a,, integral part ct the sfa,eme”ts.




                                                                Page 16                                                   GAO/AFlKD90-43      Federal    Crop Insurance      Cmporation
Notes to Financial Statements


                                                            September      30,    1988 and 1987




                      (1)   Organization

                                    The Federal         Crop Insurance      Corporation     (FCIC) was established         with
                                    the Federal         Crop Insurance      Act (the Aztl,      which was enacted       as
                                     Title     V of the Agricultural         Adjustment    Act of 1938 (52 Stat.         721.
                                    FCIC manages an all-risk             crop insurance       program to assist      in
                                     stabilizing        and protecting      the farm sector       of the nation's
                                    economy.         The program was restricted         until     the Federal    Crop
                                     Insurance      Act of 1980 (Public         Law 96-3651 called       for expanding       it
                                     nationwide       to eventually      phase out the disaster         payment program
                                    which was authorized            by the Agriculture        Act of 1949, as amended.
                                     All-risk      crop insurance      is available     in over 3,000 counties          with
                                     policies      covering    50 different      commodities      in 1988.

                                    FCIC is a wholly-owned         Government corporation      within   the United
                                    States    Department    of Agriculture      (USOA). under the direction      and
                                    control    of a Board of Directors.          The Board of Directors     is
                                    appointed    by the Secretary       of Agriculture.     The accompanying
                                    financial    statements    include     only those operations      under the
                                    control    of the Board of Directors.

                      (2)   Sumnary     of    Significant         Accounting      Policies

                            (al       Basis    of    Accounting

                                              FCIC maintains       separate    accounts      for the insurance       program and
                                              for administrative        support.      however,      for financial     statement
                                              presentation      purposes,    the two sets of accounts             are combined
                                              and are presented        on the accrual        basis of accounting        following
                                              generally    accepted     accounting      principles.

                             (b)      Revenue       Recognition       Including      Federal   Premium   Subsidy

                                              Premiums (including         premium subsidies)        are recognized        as
                                              earned during      a fiscal     year based on a pro rata amount with
                                              respect    to each crop's        growing    season.    The portion      of premium
                                              not recognized      during     the fiscal      year is classified       as
                                              unearned.      FCIC's risk       of loss commences when the crop is
                                              planted    and continues       through    the respective      growing     season
                                              until   the crop is harvested,           destroyed,     or removed from the
                                              field.     Premiums are generally           collected    at the end of the
                                              growing    season when the crops are harvested.                 A provision      is
                                              made for federal        premium amounts expected           to be uncollectible
                                              based on historical         experience.
                           September      30,    1988 and 1987



(e)   Sales    and Service       Contractors'       Commissions     and Administrative         Expenses

              The 1988 crop       year coumtissions  and administrative        expenses were
              20% of direct       premium.    The 1987 crop year coamGssions         and
              administrative        expenses were 15% of direct       premium.

If)   Reinsurance       Administrative          Expenses   and Payables

              Section      508(e) of the Act, as amended, authorizes                 FCIC to enter
              into    reinsurance     agreements   with private    insurance           companies,
              under which FCIC assumes the majority             of the risk          of loss on
              crop insurance      written    by the reinsured     companies.

              The 1988 and 1987 standard         reinsurance     agreements   provided    for
              both proportional      and nonproportional        means by which the
              reinsured      may cede business     to FCIC.     The reinsured    company
              elects    the methods by which it intends          to cede business      to FCIC
              through     its plan of operations       which is submitted     with and
              becomes a part of the reinsurance            agreement.

              Proportional        reinsurance        provides      for a one-to-one     percentage
              exchange     of losses       and premium between the reinsured               company and
              FCIC.      The reinsured        company may not cede to FCIC, under the
              proportional       methods,       premium that exceeds           57% of its total      book
              of business.          Nonproportional          reinsurance     refers   to mandatory
              stop loss provisions            which apply to the reinsured's             entire
              retained     book of business           after     the cessions      made under
              proportional       methods.         Stop loss reinsurance           may be applied     on
              both a state        and national        level     based upon the ratio       of the
              reinsured's       retained      ultimate       net losses    to its retained       net
              book premium.          Limitations        under stop loss reinsurance           are
              dependent      upon the business            retained     and the ratio    of losses     to
              premium.

              The reinsurance         agreement    provides     that all premium written
              under the agreement           is remitted     to FCIC and that all losses        on
              claims     incurred     are paid by FCIC.         An annual settlement      is
              calculated       whereby the results        of the business      written   by the
              reinsured      companies      are determined      and an experience-rated       gain
              or loss computed.           If this annual      settlement     (which is
              calculated       monthly    during   the reinsurance       year on a cumulative
              basis)     results    in an underwriting        loss,   the reinsured     company




                         Pyle   19
                               September     30,    1988 and 1987



            however,       in fiscal    year 1988, the administrative             appropriation
            was short of actual           obligations.        Accordingly,    all
            administrative         and program expenses         have been reported         in the
            fiscal    year incurred         because of the premium deficiency              which
            existed      in fiscal     year 1988.        Excess expenses    of $14 million
            not covered         by appropriation        have been reported      in the
            Statement        of Operations       for the fiscal      year ended September
            30, 1988, and these expenses                have been paid out of the
             Insurance       Program Fund.         There were no excess expenses           not
            covered      by appropriation          for fiscal   year 1987.

(h)   Depreciation        of    Furniture      and Equipment   and Invested     Capital

             Depreciation       expense of $249,000 and $271,000 was recorded                    in
             fiscal    years    1988 and 1987.        Furniture    and equipment       is stated
             at cost and depreciated           using the straight-line          method over
             the estimated       useful  lives     of the related       assets,   ranging      from
             five   to nine years.        Invested     capital   is recorded      at the cost
             of furniture       and equipment      acquired,    as all furniture         and
             equipment      purchases   are paid for through           the annual operating
             appropriation       at the time of purchase.            Invested    capital     is
             decreased      by the amount of depreciation            for a fiscal      year.

(i)   Administrative           & Other

             The liability    for administrative      and other expenses    includes
             $2.1 million   for accrued      annual leave for fiscal   year 1988 and
             $2.2 million   for 1987.      This amount is not administratively
             funded by current    appropriation     from Congress.

(jl   Due to United         States       Treasury

             This amount represents    net adjustments     to the appropriation
             accounts  subsequent   to completion   of the year-end    closing
             statement  with the United   States   Treasury.

(kl   Cash Flow        Statement

             The Consolidated        Statement      of Cash Flows has been prepared        in
             accordance      with the direct        method as set forth    in Statement      of
             Financial      Accounting    Standards      No. 95 "Statement     of Cash
             flows"    (FASB 951.       The reconciliation      of Net Loss to Net Cash
             Outflow     from Operating      Activities     is as follows    (in thousands
             of dollars):




                          Page 21                                      GAO/AFMP90-42        Federal   Crop Inmmme   corporation
                            Financial      statements




                                    September      30,   1988 and 1987




                                                                         FISCAL   YEAR
                                                                1988                      1987

            Earned       Premium:
                     Producer                                 $318,910              $264,842
                     ;:",s,; dy                                104,131                 87,129
                                                                                    9J5l .YlT

            Unearned Premium:
                  Producer                                                            $44,535
                  ;I",;; dy
                                                                                      Iii&i


            The appropriated       premium subsidy      FCIC received     was $229 million     in
            fiscal  year 1988 and $136 million           in 1987.     This resulted    in $121
            million   in excess subsidy       earned for fiscal       year 1988 and $60
            million   for 1987.       This is reflected     in the liability       for unearned
            premium subsidy     of $181 million       on the September 30, 1988 Statement
            of Financial     Condition     and $60 million     for 1987.

            The subsidy      appropriation   of $229 million       for            fiscal    year 1988 and
            9136 million      in 1987 was based on a percentage                     of premiums
            estimated     for 1988 and 1987 crop years.          Since              1981, FCIC has
            received    a total     of 6866 million    in appropriations                 for premium
            subsidy,    of which $685 million       has been earned                 and Sl81 million   is
            unearned    as of September     30, 1988.

(41   Cash in   United     States       Treasury

            FCIC maintains         separate accounts   for the insurance    program and for
            administrative         support.  The administrative     account  can only be
            used to pay administrative          and operating   costs of FCIC as well as
            certain      program expenses,     and cannot be used to pay indemnity
            losses.       Cash maintained    in these Treasury     accounts  does not
            accumulate       interest.

(5)   Loan Payable       to United       States    Treasury

            On August 19, 1985, a promissory    note was executed                        between the
            Secretary   of Agriculture  and the Secretary of the                       Treasury  under
            the borrowing   authority  granted by section 516(d)                       of the Act.     The




                              Page 23                                         GAO/APMB2O-43        Federal   Crop Inmuance   Cmpomtion
                                        September      30,      1988 and 1987




                September        30, 1985.    As of September                   30, 1988,        FCIC has issued     all
                authorized        capital  stock as follows                   (in millions         of dollars):

                             Public     Law                  Issued                      Anount

                               97-103           December 23, 1981                         $250
                               97-370           December 18. 1982                          150
                               98-396           August 22, i984
                               99-088           August 15, 1985                              55:
                                                                                          zi5E
(81   Paid-In      Capital

                Unexpended        balance     of original             stock    issue

                The Federal    Crop Insurance      Act of 1980 directed         the Secretary       of
                the Treasury    to cancel      the original     $200 million      of outstanding
                capital   stock of the Corporation.            Cumulative    expenses    of $162
                million   were written      off against     the original     amount of capital
                 stock leaving    $38 million     which was transferred         to paid-in     captial.

                Transfers        of   funds   from    the     Cormnodity        Credit     Corporation      (CCC)

                At September     30, 1986, FCIC owed CCC, an affiliated            organization
                within   the USDA, $450 million        for funds advanced.        In September
                1987, the $450 million        was designated    by USDA as non-reimbursable,
                and consequently       has been classified     as additional      paid-in
                captial.    Additional     paid-in   captial   has been received         from CCC as
                shown in the following        summary (in millions      of dollars):

                                        Summary of          Paid-In       Capital                              Amount

                September        30, 1981         Balance   of           original        stock     issue      S      38
                September        30, 1986         CCC transfer                                                      450
                September        30, 1987         CCC transfer                                                      300
                  Balance        September     30, 1987

                September        30, 1988            CCC transfer                                                 900
                  Balance        September     30,    1988                                                    $LEg




                                Page 26                                                  GAO/AFMD90-43       Federal       Crop Insurance   Corporation
                                             September     30,    1988 and 1987



           (10)   Lease   Commitments

                          FCIC has entered,    at a total      rental    cost of $2.3 million,        into
                          operating   lease agreements      for certain        office facilities.       Rent
                          expense amounted to $545,000         in fiscal       year 1988.       Lease
                          commitments    on the rental    of office      facilities     at September     30,
                          1988 were as follows     (in thousands       of dollars):

                                                  Fiscal   1989       $ 568
                                                  Fiscal   1990         579
                                                  Fiscal   1991         591




(810078)                                Page 27                                    GAO/-               Federal   Crop Insurance   Corporation
                                                                                                .
         ,
     c




”\



                 Requests for copies of     GAO   reports   should be sent to:

                 U.S. General Accounting      Office
                 Post Office Box 6015
                 Gaithersburg, Maryland       20877

                 Telephone   202-275-6241

                 The first five copies of each report       are free. Additional   copies are
                 $2.00 each.

                 There is a 25% discount     on orders for 100 or more copies mailed to a
                 single address.

                 Orders must be prepaid by cash or by check or money order made
             l
                 out to the Superintendent of Documents.
                            PinanciaI    StJltementa




                                     September       30,    1988 and 1987




(9)   Employee   Benefits

             The majority          of FCIC's employees              are covered        by the Civil          Service
             Retirement        System (CSRS), which is currently                       two-tiered.           For
             employees       hired prior          to January        1, 1984, FCIC withholds
             .a~~~ximately           7% of,their         gross earnings,          which is matched by
                     . The amount withheld                from employees          is then remitted             to the
             Civil     Service       Retirement         Fund.      For employees         hired     on or after
             January      1, 1984, FCIC withholds,                  in addition        to Social        Security
             Withholdings,           approximately          1.3% of their         gross earnings,            but
             matches such withholdings                   with a 7% contribution,                as above.          This
             second employee             group will       receive      retirement        benefits       from the
             CSRS along with the Social                   Security       System to which they currently
             contribute.           By December 31, 1987, each employee covered                             by the
             CSRS made a decision               to remain under the CSRS or transfer                         to the
             new Federal          Employees Retirement              System (FERS).            Under FERS,
             employees       will     receive       retirement        benefits      from Social         Security,        a
             government        retirement         benefit      of 1 to 1.1% of "high-3"                 salary       base
             and benefits          from a defined           contribution         plan (thrift).            Under the
             contribution          plan,     an employee may contribute                  (tax deferred)             up to
              10% of their         salary     to an investment             fund.      The government           will
              then match this            amount up to 5%. Those employees                       electing       to
              remain under CSRS will                receive      the benefits         now in place,          plus they
             may contribute            (tax deferred)           up to 5% of salary            to the thrift
              plan, with no matching                amount to be contributed                 by the government.
              During the year ended September                      30, 1988, FCIC contributed                   51.6
              million     to the CSRS and $.OS million                     to the Social          Security
              System.       During the 1987 fiscal                year,      FCIC contributed            $1.7 million
              to the CSRS and S.08 million                    to the Social         Security       System.

             The value of vested and nonvestea               benefits,        assets     available      for
             benefits,    and unfunded     pension       cost related          to FCIC employees
             cannot be determined       as this       is a multiemployer            plan.      Although
             FCIC funds a portion        of pension       benefits       under the CSRS relating            to
             its employees     and makes the necessary               payroll     withholding        from
             them, it does not disclose           the assets         of the CSRS, nor does it
             disclose  actuarial      data with       respect      to accumulated         plan benefits
             or the unfunded      pension   liability         relative       to its employees.
             Reporting    of such amounts is the responsibility                     of the U. S. Dffice
             of Personnel    Management.




                             Page 26
                                      September      30,   1988 and 1987




                note allowed      the advance of no more than $113 million                   at any one
                time, with any outstanding           balance    originally        due January    1, 1988.
                 Interest    on the unpaid principal         balance       outstanding     is payable
                semiannually      on January    1 and July 1 at a rate equal to the current
                average market yield        on outstanding        obligations        of the United
                States    of comparable     maturities      during     the month preceding         the
                issuance     of such notes or obligations.

                 Interest,       however,       does not accrue unless FCIC's cash balance           with
                the U.S. Treasury             falls   below $113 million.       When this occurs,
                 interest      is calculated        on a daily   basis on the difference       between
                9113 million         and FCIC's cash balance.           No interest    expense was
                incurred       during     fiscal    year 1988 and 1987 as FCIC's cash balance
                with      Treasury    did not fall        below $113 million.       On October   15,
                 1987, the due date of this               note was extended     from January   1, 1988
                to January         1, 1990.

(61   Litigation

                FCIC is a defendant       in various    litigations        arising    in the normal
                course of business.         Damages claimed        in such litigations       exceed
                $100 million.       However,   approximately         $6 million    is considered    by
                counsel    to be a possible     loss as of September            30, 1988 and $8
                million    in 1987.

                Approximately          $6 million     in fiscal       year 1988 and $7 million               in 1987
                of potential         overpayments       to reinsured       companies       have been
                identified        by the Office       of Inspector        General,      the General
                Accounting       Office     and the FCIC Compliance             Division.         These
                overpayments         represent     potential       revenue    if collection          is
                ultimately       made.      tbwever,      these claims      are subject         to rebuttal       and
                appeal by       the reinsured        companies,       and collections         subsequent       to
                September       30, 1988 have been imnaterial.                  Realization        of this
                potential       revenue     is subject       to considerable         uncertainty        and,
                accordingly,         no receivable        accruals     were reflected         in the financial
                statements        for fiscal      year 1988 and 1987.

(7)   Capital      Stock

                Section    504(a)   of the Act, as amended, directs   and authorizes
                capital    stock of $500 million   subscribed  by the United States      of
                America.      There has been no change in capital    stock issued    since




                             Page 24                                             GAO/~90.42             Federal    Crop Insurance   Corporation
                                                                                               I




                                       September      30,   1988 and 1987




                                                                                          FISCAL   YEAR

                                                                                1988                       1987

       Net Loss     Including    depreciation                              $(626,373'               S(60,530)

Depreciation          expense                                                      249                      271
Retirements         of furniture        and equipment,         net                 217                   1,149
Net book value of assets                contributed                            (9,DO:i                   1,191
Allowance        for uncollectible             accounts                                                 (3.5001
Increase      in unearned         premium                                      12,220                 (14,957)
Increase      in receivable          from reinsured        companies          (29,228'
                                                                               12,665                ‘y’6’
Decrease      in receivable          from producers
Decrease      in due to U.S. Treasury                                          (8,637)                    28:071
Decrease       in administrative              and other   receivables              972                    26,245
Increase      in losses       payable                                         544,317                     55,475
Increase       in accrued       loss adjustment          costs
        and coaxnfssions                                                       22,024
Decrease       in contingent         liabilities                               (1,900'                 (30Bg3?
Decrease in experience               rating       refund  due
       reinsured        companies                                             (16,893)                     6,893
 Increase      in premium subsidy                                             121,143                     25,242
Other,      net                                                                 (6,581)                   (4,196)

       Total   adjustments       to net    loss                               641,568                  (95,577'

       Net Cash Outflow         from   Operating      Activities          $    15.195               9(156.107)


 (3)      Federal     Premium    Subsidy

                    Section     508(b)(3)      of the Act, as amended, requires         FCIC to pay up
                    to 30x of each producers'             premium on any coverage      up to a maximum
                    of 65% of recorded           or appraised    average yield,    and provides
                    appropriation        for this    purpose.     FCIC's share of producers'        premium
                    is paid by this         subsidy,    which is recognized      as revenue   in the same
                    manner as premium paid by the producer.                 Premium earned from
                     subsidy    included     in the statement       of loss and accumulated     deficit
                    was $104 millfon         in fiscal     year 1988 and $87 million       in 1987.

                    A suaxnary of earned and unearned               premium,    showing both producer
                    premfum and the premium subsidy,                is shown in the following     table
                    for fiscal  years 1988 and 1987(in                thousands   of dollars):




                                Page 22
                                                       -                                                                       -
                      Filmmid statements




                            September   30,   1988 and 1987



            is required     to remit to FCIC the amount of the loss upon
             submission    of the monthly       accounting         reports    prior to filin
            the annual settlement         report.        In fiscal       year 1988 reinsure     i
            companies    incurred    losses      of $8 million         in excess of
            underwriting      gains;   however,      the net amount of $8 million              was
            not determined       and recorded      until     fiscal      year 1989.    If there
            is a gain, FCIC is required            to remit the gain to the reinsured
            company at annual settlement             time.       In fiscal     year 1987
            reinsured    companies     experienced         a gain,     so FCIC recorded      a
             liability   to refund     $17 million         to the companies.

            Total     1988 reinsurance       administrative       expenses were 37% of
             reinsurance       premium.    The 1988 reinsurance          agreement    provided
            for an expense reimbursement              equal to 34% of premium plus
            expense reimbursement          for premium taxes         (about   2% of premium)
            for policies        reinsured    under the agreement,         and another     1% of
            premium for additional           claim expenses       if warranted     by the
            companies      loss ratio.       These amounts aggregated          $155 million
             for fiscal      year 1988, of which $60 million             was shown as a
            payable      to reinsured     companies       at September    30, 1988.

            Total    1987 reinsurance     administrative        expenses    were 35% of
            reinsurance      premium.   The 1987 reinsurance           agreement  provided
            for an expense reimbursement           equal to 33% of premium plus
            expense reimbursement       for premium taxes          (about   2% of premium)
            for policies      reinsured   under the agreement.            These amounts
            aggregated     $107 million    for fiscal      year 1987 of which $44
            million     was shown as a payable         to reinsured     companies  at
            September     30, 1987.

(9)   Operating     Appropriations

            In addition         to the annual appropriation       for premium subsidy,
            FCIC also       receives      an annual appropriation     for administrative,
            operating,        reinsurance     and program expenses      except for
            uncollectible          accounts.

            The administrative          appropriation          is intended   to cover
            substantially        all expenses       other      than losses   incurred     and
            provision     for    uncollectible        accounts.       When the administrative
            appropriation        is sufficient        to cover applicable         expenses,   the
            Corporation's         accounting     policy      is to prorate     the
            appropriation        between fiscal         years     as premiums are earned.




                        Page 20                                        GAO/-                Federal   Crop Insurance   Corporation
                             September      30.   1988 and 1987



(c)   Claims      Recognition

               Liability      for claims        payable    and related          claims   adjustment
               expenses     is established          using estimates           of incurred      but unpaid
               claims    based on historical            experience         adjusted    for changes in
               crop growing       conditions.          Since the calculation             of claims
               payable    and claims       adjustment       expenses        payable    is necessarily
               based on estimates,            the ultimate       liability         may be more or less
               than the estimates.

               Commissions,      claim adjustment         expenses      and insurance
               administrative       expenses      are usually      covered    by operating
               appropriations;        however,     these expenses        may be paid from
               program funds if appropriated               funds are not sufficient        to pay
               these expenses.          Indemnity     losses    are paid from premium
               proceeds      when appropriations         are sufficient       to cover all other
               expenses.

               In fiscal       year 1988, because claims             incurred       exceeded      the risk
               premium earned,          a premium deficiency           existed      as defined        in the
               Statement       of Financial       Accounting      Standards        No. 60 "Accounting
               and Reporting          by Insurance      Enterprises"        (FASB 60).
               Accordingly,         since the aggregated          loss ratio        for 1988 was 2.5
               (62.50 loss for every Sl.00 of premium),                      total      losses of
               $1,040 million          have been recognized          in the statement           of
               operations        and $71 million        of losses      have been carried            forward
               to fiscal       year 1989 to offset          the deferred        premium of $71
               million     carried      forward    to fiscal      year 1989.          In fiscal      year
               1987, $59 million           of premium and $46 million               of losses       and $13
               million     of related       insurance     adminstrative         expenses      were
               carried      forward     to fiscal     year 1988.

(d)   Acquisition        costs

               FCIC includes        only agents'      commissions     and reinsurance
               administrative         expenses   as acquisition       costs since they are
               the only expenses          that vary with,       and are directly       related to,
               acquiring      new and renewal        business.     FASB 60 requires
               insurance      companies      to capitalize      and amortize     deferred
               acquisition       costs    in proportion       to premium revenue
               recognized.         As of year-end,        FCIC did not have any deferred
               acquisition       costs because of the premium deficiency                 which
               existed      in fiscal     year 1988.




                     Page 18
Statement of Cash Flows




                                       16.1%                     (1M1.107,




                                        (2T7)                    -    -- 0

                                        (217)                           0




                          Page 16   GAO/AFMDBO-42   Federal   Crop Inwrance   Corpomtlon
Financial Statements


Statement of Financial Position




                                              sa37.7w
                                                 7.966
                                                 4.402
                                                60,388
                                                     0
                                                12.694
                                                 I.434
                                                71.074
                                            -  1a1,oao
                                                           S1,176,717

                                                             113.000
                                                               6.100

                                                            1.295.817




                                                             424,287

                                                           $1.720.104




                                  Page 14                GAO/AFMD9O-43   Federal   Crop Insurance   Corporation
                      We did not qualify our opinion due to this internal control weakness
                      because we were able to verify that transaction register entries were
                      properly supported by detailed records and the related amounts were
                      accurately recorded in accounts and included in the financial state-
                      ments. To make this determination, we (1) obtained computer tapes
                      from NFCshowing how Corporation salary and other expense transac-
                      tions were processed, (2) compared the tapes to the detailed transaction
                      registers received from NFCto validate that the transaction registers
                      accurately represented transactions processed by NFG,and (3) chose a
                      random sample of line items from the validated transaction registers
                      and compared them to source documents. We did not find any material
                      errors in the processing of our sample items.


                      Although the Corporation’s oversight of reinsured companies has
Conclusions           improved as indicated by a decrease in the overpayment rate, manage-
                      ment needs to continue to strengthen its oversight activities. The Corpo-
                      ration’s recent implementation of statistically valid sampling techniques
                      and efforts to develop criteria for evaluating reinsured companies’ loss
                      adjustment performance should result in improved oversight.

                      The Corporation still lacks adequate internal controls over certain
                      administrative expenses, a weakness we reported in our prior reports.
                      The Corporation needs a system to reconcile salary and other expense
                      transactions to NFC records to ensure that these transactions are prop-
                      erly processed and accurately recorded in its accounts.


                      We recommend that the Board of Directors direct the Comptroller to
Recommendation        develop procedures to be used by all cost centers for reconciling salary
                      and other administrative expense vouchers sent to NFC with the monthly
                      detailed transaction registers. The Comptroller should then ensure that
                      such procedures are followed to verify that all vouchers are properly
                      processed.


                      We provided a draft of this report to responsible Corporation officials
Comments of           for comment. They concurred with our findings and recommendation
Cognizant Officials   and indicated their commitment to correct the problems noted.




                      Page 12
reviewed crop year 1988 claims and found that the overpayment rate
was about 13 percent.3 We believe that the Compliance Division, which
was established in 1986, contributed to the decreased overpayment
rates by monitoring reinsured companies’ compliance with Corporation
standards, particularly those pertaining to loss adjustments. However,
our 1988 analysis indicated that the Compliance Division reviews did
not provide a reliable basis for conclusions about the overall quality,
and thus the acceptability, of a reinsured company’s loss adjustment
process.4 Further, we reported that the Compliance Division reviews
were (1) limited in scope, (2) not statistically valid, and (3) lacking
essential criteria to determine acceptable levels of performance. We rec-
ommended that the Corporation emphasize the use of statistically valid
sampling techniques and develop criteria to use in evaluating the results
of compliance reviews and for determining the acceptability of a rein-
sured company’s loss adjustment performance.

Corporation officials agreed with the recommendations in our October
1988 report. As part of our fiscal year 1988 audit, we reviewed the Cor-
poration’s progress in implementing the recommendations. Corporation
officials stated that they had implemented procedures designed to sta-
tistically sample and evaluate the results of compliance reviews. We
reviewed a judgmental sample of the Corporation’s audit reports and
found that the statistical sampling technique was used to assess rein-
sured companies’ loss adjustment performance.

As of September 15,1989, a Corporation task force had drafted criteria
for evaluating the results of compliance reviews and for determining the
acceptability of a reinsured company’s loss adjustment performance.
USLIA’s legal counsel and Corporation officials have approved the criteria
and have instructed Corporation staff who evaluate reinsured company
performance to use the criteria as a guide.




3FederdCmplnsuran~Co~rationCmpYear19881nsurance~                    With Claims, USDA Office
ot Inswctor Gmml, Audit Number OMOO-l-Te, September lQS9.

%TO~ Irwmnce      FCIC Needs to   ImproveItsOversight
                                                   of Reii   Cam-       (GAOIRcED8910,
October 19. 1988).




Page 10
Report on Internal Accounting Controls


                  We have audited the financial statements of the Federal Crop Insurance
                  Corporation for the year ended September 30,1988, and have issued our
                  opinion thereon. As part of our examination, we made a study and eval-
                  uation of the system of internal accounting controls to the extent we
                  considered necessary to evaluate the system as required by generally
                  accepted government auditing standards.

                  The purpose of our study and evaluation was to determine the nature,
                  timing, and extent of the auditing procedures necessary for expressing
                  an opinion on the Corporation’s financial statements. For purposes of
                  this report, we have classified the significant internal accounting con-
                  trols into the following categories:

              l administrative expenses,
              l reinsurance,
              . cash,
              l direct insurance premiums and claims, and
              . financial reporting.

                  We tested all of the control categories listed above, except we did not
                  evaluate the internal accounting controls over all functions within any
                  of the categories because it was more efficient to expand our substan-
                  tive tests. Substantive audit tests can also serve to identify weaknesses
                  in internal control policies and procedures.

                  The Corporation’s management is responsible for establishing and main-
                  taining an effective system of internal controls. In fulfilling this respon-
                  sibility, estimates and judgments by management are required to assess
                  the expected benefits and related costs of control procedures. The objec-
                  tives of a system of internal accounting controls are to provide manage-
                  ment with reasonable assurance that (1) obligations and costs are in
                  compliance with applicable laws, (2) funds, property, and other assets
                  are safeguarded against waste, loss, and unauthorized use or misappro-
                  priation, and (3) assets, liabilities, revenues, and expenditures applica-
                  ble to agency operations are properly recorded and accounted for to
                  permit the preparation of accounts and reliable financial reports and to
                  maintain accountability over the Corporation’s assets. Because of inher-
                  ent limitations in any system of internal accounting controls, errors or
                  irregularities may nevertheless occur and not be detected. Also, projec-
                  tion of any evaluation of the system to future periods is subject to the
                  risk that procedures may become inadequate because of changes in con-
                  ditions or that the degree of compliance with procedures may
                  deteriorate.


                  Page 8                          GAO/AFMD9043   Federal   Crop Insurance   tirpomtion
B114634




In response to concerns about the plight of the Corporation, the Con-
gress established the Commission for the Improvement of the Federal
Crop Insurance Program in 1988. The Congress charged the Commission
with the task of providing recommendations to improve the Corporation
so as to lessen, if not eliminate, the need for additional disaster pay-
ments, while providing producers more equitable, efficient, and predict-
able protection from natural disasters. In July 1989, the Commission
issued its principal report to congressional agricultural committees and
to the Secretary of Agriculture. The report included recommendations
for increased responsiveness to producers’ needs, broadened producer
participation, program simplification, and improved program adminis-
tration. The Commission will continue to monitor the program and
report on the Corporation’s implementation of its recommendations
through 1990.

The Corporation anticipates that, due to continued drought conditions,
fiscal year 1989 will result in a net loss of about $600 million. Without
significant changes in insurance program operations, the Corporation
will continue to suffer losses, and its ability to pay them will depend on
additional assistance from the Commodity Credit Corporation or on
other sources of congressional funding.




Charles A. Bowsher            .
Comptroller General
of the United States

September 16,1989




Page 6                            GAO/AFMD-6043   Federal   Crop Inmrance   Cmporation
      United States
GAO   General Accounting  Office
      Washington, D.C. 20648

      Comptroller   General
      of the United States

      B-l 14834

      To the Board of Directors
      Federal Crop Insurance Corporation

      We have audited the accompanying statement of financial position of
      the Federal Crop Insurance Corporation as of September 30,1988, and
      the related statements of operations and of cash flows for the year then
      ended. These financial statements are the responsibility of the Corpora-
      tion’s management. Our responsibility is to express an opinion on these
      financial statements based on our audit. In addition to this report on our
      audit of the Corporation’s fiscal year 1988 financial statements, we are
      also reporting on our consideration of the Corporation’s system of inter-
      nal accounting controls and on its compliance with laws and regulations.

      We conducted our audit in accordance with generally accepted govem-
      ment auditing standards. Those standards require that we plan and per-
      form an audit to obtain reasonable assurance about whether the
      financial statements are free of material misstatement. An audit
      includes examining, on a test basis, evidence supporting the amounts
      and disclosures in the financial statements. An audit also includes
      assessing the accounting principles used and significant estimates made
      by management, as well as evaluating the overall financial statement
      presentation. We believe that our audit provides a reasonable basis for
      our opinion.

      The Corporation’s 1987 financial statements were audited by another
      auditor whose report, dated May 25, 1988, expressed a disclaimer of
      opinion. This occurred because the auditor was unable to verify whether
      the Corporation had adequate accounting controls over administrative
      expenses sent for processing to the U.S. Department of Agriculture’s
      National Financial Center. In order for us to express an opinion on the
      Corporation’s financial statements for fiscal year 1988, we expanded
      our audit tests to verify that entries in these accounts were adequately
      supported by detailed records.

      In our opinion, the 1988 financial statements referred to above present
      fairly, in all material respects, the financial position of the Federal Crop
      Insurance Corporation as of September 30,1988, and the results of its
      operations and its cash flows for the year then ended, in conformity
      with generally accepted accounting principles.

      The following section provides supplementary comments relating to the
      Corporation’s financial outlook in light of its continuing losses.



      Page 4                          GAO/AFMD-g&43   Federal   Crop Insurance   Corporation
Contents


Letter                                                                                            1

Opinion Letter                                                                                    4
Report on Internal                                                                                8
Accounting Controls    Oversight of Reinsured Companies Has Improved
                       Lack of Internal Accounting Controls Over
                                                                                                  9
                                                                                                 11
                           Administrative Expenses
                       Conclusions                                                               12
                       Recommendation                                                            12
                       Comments of Cognizant Officials                                           12

Report on Compliance                                                                             13
With Laws and
Regulations
Financial Statements                                                                             14
                       Statement of Financial Position                                           14
                       Statement of Loss and Changes in Accumulated Deficit                      16
                       Statement of Cash Flows                                                   16
                       Notes to Financial Statements                                             17




                       Abbreviations

                       NFC       National Finance Center
                       USDA      U.S. Department of Agriculture


                       p-2                            GAO/AFBlDW4   Federal Crop Insiuance CbwmUo~~