oversight

Financial Management: Review of VA's Actuarial Model for Veterans' Compensation Benefits

Published by the Government Accountability Office on 1999-01-29.

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

                 United States General Accounting Office

GAO              Report to the Secretary of Veterans
                 Affairs



January 1999
                 FINANCIAL
                 MANAGEMENT

                 Review of VA's
                 Actuarial Model for
                 Veterans'
                 Compensation
                 Benefits




GAO/AIMD-99-46
                   United States
GAO                General Accounting Office
                   Washington, D.C. 20548                                                                            Leter




                   Accounting and Information
                   Management Division                                                                               Leter




                   B-281738

                   January 29, 1999

                   The Honorable Togo D. West, Jr.
                   The Secretary of Veterans Affairs

                   Dear Mr. Secretary:

                   In our report on the fiscal year 1997 consolidated financial statements of
                   the U. S. government issued on March 31, 1998,1 we noted that the
                   Department of Veterans Affairs' (VA) estimated liability for veterans'
                   compensation benefits was materially understated primarily because it did
                   not include estimates for anticipated changes in disability ratings and for
                   incurred claims not yet reported. Given such limitations, VA's methodology
                   for computing the liability did not comply with Statement of Federal
                   Financial Accounting Standards (SFFAS) No. 5, which prescribes
                   accounting standards for liabilities of the federal government. Prior to the
                   issuance of its own audited financial statements for the department on
                   April 30, 1998, VA revised its model to comply with SFFAS No. 5. Using the
                   revised model, VA's estimated liability as of September 30, 1997, in its
                   April 30, 1998 report was $466 billion--an increase of $270 billion over that
                   reported in the consolidated financial statements of the U.S. government
                   for fiscal year 1997, issued in March 1998.

                   The objectives of our review were to determine whether VA's revised
                   actuarial model complied with SFFAS No. 5 and whether future liability
                   estimates could be improved. This report discusses improvements that VA
                   has made to the model, and our recommendations for additional
                   improvements that should enhance the reliability of estimates produced by
                   the model.



Results in Brief   VA's revised model resulted in an estimate for fiscal year 1997 that was
                   much more consistent with SFFAS No. 5 than that previously used because
                   it included estimates for anticipated changes in disability ratings and for
                   incurred but not reported claims.

                   During our review we informed VA officials that the model needed further
                   refinements to comply more fully with SFFAS No. 5. Specifically, the


                   1
                     Financial Audit: 1997 Consolidated Financial Statements of the United States Government (GAO/
                   AIMD-98-127, March 31, 1998).




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             revised model did not include 1.5 million current active military personnel,
             some of whom have sustained injuries and may qualify for future benefits.
             Instead, it only included those who had separated from active military
             service as of September 30, 1997. In response, VA modified its model for
             fiscal year 1998 by including the current military population, which,
             according to VA officials, will further increase the liability estimate by
             about $12 billion. The VA Office of the Inspector General (OIG) is currently
             testing the underlying data used in the model as part of its audit of the fiscal
             year 1998 financial statements.

             Also, we noted certain limitations in the data used in the model to develop
             the estimated liability. VA's fiscal year 1997 liability estimate was based on
             1 to 3 years of experience for various data elements (e.g. beneficiary type,
             age, gender). Studying the experience over such a limited time period may
             not fully represent the universe of veterans and therefore could cause
             distortions in predicting future benefits. In addition, VA did not group
             claimants by conflict-related exposures, such as Agent Orange; therefore
             the model did not reflect the impact of such events on future benefits.
             Finally, VA's model did not consider the time lag between date of discharge
             and date of the initial award, although a veteran's likelihood of filing a
             claim decreases the longer he/she is out of the service. These data, if
             considered along with age and beneficiary type, would provide a better
             basis for predicting the likelihood that a veteran would seek a
             compensation award. With better experience data over a more extended
             period of time, VA's model would be more predictive, resulting in a more
             reasonable liability estimate.



Background   VA provides veterans or their dependents with compensation benefits if the
             veteran was disabled or died of military service-connected causes. In fiscal
             year 1997, 2.5 million veterans and survivors received compensation
             benefits of approximately $16 billion. VA calculates an estimated liability
             for compensation benefits expected to be paid in future years to veterans
             and, if applicable, their survivors, who have met or are expected to meet
             defined eligibility criteria.

             The estimated liability for veterans' compensation benefits first became an
             area of focus in June 1993, when the Department of Veterans Affairs' Office
             of Inspector General (VA-OIG) gave an adverse opinion on VA's financial
             statements for the fiscal year ended September 30, 1992. The adverse
             opinion was due in part to the fact that VA did not record in the Statement
             of Financial Position the present effects of the probable future payments



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for compensation and pension benefits as required by Office of
Management and Budget (OMB) Bulletin 93-02.

VA subsequently entered into a contract with a consultant firm to develop a
model for calculating an estimate for the present value of future veterans'
benefits based on VA's definition of the liability. This model contained
numerous spreadsheets with basic assumptions or specific calculations
and beneficiaries were segregated according to age and type (veteran,
spouse, or child). Based on mortality assumptions and the age of the
beneficiaries, the model applied Cost Of Living Adjustment (COLA)
assumptions to the expected future benefits, assuming a disability rating
would not worsen. Using U.S. Treasury rates, the stream of future benefits
was then discounted back to September 30 of the fiscal year. VA continued
to use this model through fiscal year 1996.

As part of its annual financial statement audit, the VA-OIG separately
contracted with an independent public accountant (IPA) to review and
report on VA’s estimated liability for veterans’ compensation benefits.
Based on our review of the 1996 estimated liability, we determined that the
model used was limited in that it only considered those beneficiaries who
were on the payment rolls as of September 30 of the fiscal year. In order to
comply with SFFAS No. 5 the estimated liability must recognize veterans
who had experienced an event (injury) but had not yet filed a claim and for
increases in benefits other than COLAS. That recognition depends on
estimates of veteran and survivor mortality, analysis of probabilities of
future disability, and other predictions requiring actuarial expertise.

VA revised its model in an attempt to reflect each of these factors in its
liability estimate disclosed in its fiscal year 1997 consolidated financial
statements. Approximately 64 percent of the $270 billion increase over
what was reported in the consolidated financial statements of the U.S.
government can be attributed to the (1) inclusion of veterans not currently
receiving benefits but who had been injured while on active duty and
(2) inclusion of survivors of veterans, such as dependent children and
spouses, not currently receiving benefits but who are expected to. The
increase was also significantly affected by factors not exclusively related to
a specific cohort. These included factors such as changes in assumptions
relating to mortality projections, estimates of nondeath terminations such
as eligible veterans electing not to claim benefits or veterans being
institutionalized, and projected changes in the rate of new entrants in all
cohorts.




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              Both the old and revised model project beneficiary payments for 72 years
              and then discount them back to the present value. However, another major
              difference is the original model incorporated a perpetuity formula using
              assumptions from the 28th and 29th years of projection for years 30
              through 72, while the new model specifically projects based on
              assumptions for each of the 72 years.2



Scope and     This review was done as part of our audit of the fiscal year 1997
              consolidated financial statements of the U.S. government. To meet our
Methodology   objectives, we contracted with the Ernst & Young LLP (E&Y) Actuarial
              Services Group (contractor) to assess VA's methodology and the
              appropriateness of actuarial-based assumptions and other actuarial
              judgments applied to VA's calculation of the fiscal year 1997 estimated
              liability for veterans' benefits.

              Neither we nor E&Y audited the underlying data used in the model such as
              age, gender, and type of beneficiary (veteran, spouse, children, and
              mothers and fathers), and percentage of disability. These data come from
              compensation and pension systems within VA and external sources such as
              the Department of Defense and the Congressional Budget Office. The
              accuracy and completeness of the underlying data used in the model are
              equally important as the model. VA management is responsible for
              establishing, maintaining, and assessing the internal controls over the
              systems that produce such data. The OIG is currently reviewing the internal
              controls over the systems that produce the underlying data as well as
              obtaining assurance as to whether the data are accurate and complete as
              part of the audit of the fiscal year 1998 financial statements. Therefore, we
              are not reporting on whether the estimated liability reported in the
              financial statements is reasonable or reliable.

              In order to rely on the work of the contractor, we evaluated the
              qualifications and independence of the contractor's staff, reviewed and
              approved the contractor's approach plans and work programs, attended
              key meetings between the contractor and VA personnel, and reviewed the
              contractor's working papers to determine (1) the nature, timing, and extent
              of work performed, (2) the extent of quality control methods used, and
              (3) whether evidence in the working papers supported the contractor's


              2
                The actuary used 72 years, which is roughly the same as the period used by the Office of the Actuary of
              the Social Security Administration of 75 years.




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                          B-281738




                          conclusion concerning VA's methodology for calculating the reserve. We
                          briefed VA officials and made the contractor's results available to VA for
                          calculating the fiscal year 1998 estimate.

                          We performed our review of VA's actuarial model from September 1997
                          through November 1998 in accordance with generally accepted
                          government auditing standards. We requested written comments on a draft
                          of this report from the Secretary or his designee. The Secretary of Veterans
                          Affairs provided us with written comments, which are discussed in the
                          "Agency Comments" section and are reprinted in appendix I.



Model Expanded to         In our report on the fiscal year 1997 consolidated financial statements of
                          the U.S. government, we reported that VA's estimated liability for veterans'
Reflect Active Military   compensation benefits was materially understated because it did not
                          include estimates for anticipated changes in disability ratings and for
                          incurred claims not yet reported. Without including these estimates, VA's
                          methodology did not comply with SFFAS No. 5.3 VA revised its model to
                          comply with SFFAS No. 5 prior to the issuance of VA's audited financial
                          statements on April 30, 1998. Using the revised model, VA's estimate as of
                          September 30, 1997, was $466 billion--$270 billion more than the
                          $197 billion estimate that was reported in the consolidated financial
                          statements of the U.S. government.

                          While the revised model provides decisionmakers with significantly better
                          information about probable future obligations than the estimates produced
                          under the previous model, we found that the model needed further
                          refinements to conform with SFFAS No. 5. Specifically, VA's new model
                          did not account for the effect of active military personnel who--due to
                          events that occurred while on duty--will probably be eligible for disability
                          benefits upon leaving military service. This population needed to be
                          factored into the provision for claims incurred but not reported, which is
                          one of the elements required for a loss reserve.

                          Some of the 1.5 million active military personnel as of September 30, 1997,
                          had already experienced the event (injury) that would result in


                          3
                            SFFAS No. 5, Accounting for Liabilities of the Federal Government, became effective in fiscal year
                          1997. It requires recognition of an expense and the related liability for compensation benefits when a
                          future outflow or sacrifice of resources is probable and measurable on the basis of events occurring on
                          or before the reporting date.




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                       compensation benefits subsequent to leaving the service. Although the
                       total number of active duty personnel was only 6.6 percent of the
                       population of veterans not then collecting compensation or pension
                       benefits, historically the largest group of new beneficiaries are those
                       recently separated from military service. Thus, active military may be the
                       most significant population of potential new beneficiaries. We informed VA
                       that the estimated liability associated with these incurred but not reported
                       claims should be recognized and VA revised its model accordingly. VA
                       officials told us that the projection of estimates for this population will
                       increase the reported liability in its fiscal year 1998 financial statements by
                       about $12 billion.



Data Need to Reflect   VA’s model for estimating the future liability for veterans’ compensation
                       benefits needs to be further refined to include changes and developments
More Historical        in veterans' disabilities over an expanded period of time. In general, the
Experience             fiscal year 1997 liability estimate was based on the experience of the
                       compensation program only over the past 3 fiscal years when data were
                       available. For some components, only 1 or 2 years of data were available.
                       This was due in part to the fact that VA had just begun to compile these
                       data, some of which were not readily available, in an attempt to comply
                       with the requirements of SFFAS No. 5. For example, only 1 year of data
                       were available to predict future increases in veterans benefits, such as
                       changes in disability ratings.

                       Relying on such a short time period can cause distortions in predicting
                       future benefits. For example, if future benefits are predicted based on a
                       limited period that represents only the time frame immediately following a
                       conflict, when there may be an unusually large number of claims filed, the
                       resulting estimate will most likely be inflated. Conversely, if the time
                       period considered is during peacetime, when one would expect a low
                       number of claims filed, the liability estimate will most likely be
                       understated. Expanding the period over which experience is studied
                       increases the credibility of the underlying assumptions and identifies
                       trends and sensitivity to changes in economic conditions, resulting in more
                       reasonable estimates.

                       For fiscal year 1997, the model grouped beneficiaries into cohorts4 by


                       4
                         Cohorts are identifiable groups within beneficiaries and potential beneficiaries. For example, 40-year
                       old veterans are considered a cohort.




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                   beneficiary type (veteran, spouse, child) and age. Future benefit payments
                  were projected for each beneficiary type. VA’s estimate relied on the
                  historical experience with older veterans who served in World War I, World
                  War II, and the Korean conflict and applied the result to younger veterans
                  who served in Vietnam or the Gulf War in projecting new entrants, deaths,
                  or other terminations. This methodology assumes that there are no more
                  recent conflict-related exposures that would affect the projections.
                  However, younger veterans had certain latent exposures that older
                  veterans did not. For example, the experience of World War II and Korean
                  War veterans would not have predicted some of the disabilities arising from
                  the Vietnam War, such as Agent Orange. If VA beneficiaries had also been
                  grouped by conflict, the model would have reflected the impact of conflict-
                  related exposures.

                  Additionally, VA's model does not consider the time lag between date of
                  discharge and date of initial benefit. This is an important consideration
                  because the likelihood of a veteran filing a claim decreases the longer he/
                  she is out of the service. For example, a 50-year old veteran who retired
                  from military service a year ago would have a higher probability of
                  receiving a disability benefit than a 50-year old veteran who was discharged
                  from military service 25 years ago. If these data were considered along
                  with age and benefit type, the model could better predict the likelihood of a
                  veteran securing a benefit rather than just grouping veterans by age and
                  beneficiary type.



Conclusions       By revising its model, VA has significantly improved the reasonableness
                  and reliability of its process for estimating its liability for veterans
                  compensation benefits. It can improve the model further by examining the
                  experience of more distinct groupings over an extended period of time.
                  This would give VA a better chance of finding trends in the data that would
                  lead to a more predictive and reasonable model.



Recommendations   We recommend that the Secretary of Veterans Affairs direct the Under
                  Secretary for Benefits to further improve its model for estimating VA's
                  liability for veterans' compensation benefits by:

                  • Refining the estimates by continuing to evaluate the actual experience
                    of the compensation programs and expanding the period over which
                    experience is studied.



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                  • Considering the impact of conflict-related exposures and the time lag
                    between discharge and date of initial award, in addition to age and type
                    of veterans and beneficiaries, as indications of the propensity for
                    veterans to secure compensation benefits.



Agency Comments   In written comments on a draft of this report, the Secretary of Veterans
                  Affairs concurred with our recommendations for improving the actuarial
                  model. VA plans to obtain a contractor's assistance to help it make the
                  improvements.

                  This report contains recommendations to you. The head of a federal
                  agency is required by 31 U.S.C. 720 to submit a written statement on
                  actions taken on these recommendations to the Senate Committee on
                  Governmental Affairs and the House Committee on Government Reform
                  within 60 days of the date of this report. A written statement also must be
                  sent to the House and Senate Committees on Appropriations with the
                  agency's first request for appropriations made more than 60 days after the
                  date of this report.

                  We are sending copies of this report to the Chairmen and Ranking Minority
                  Members of the House and Senate Committees on Veterans Affairs and the
                  Director of the Office of Management and Budget. We will provide copies
                  to others upon request. Should you or your staff have any questions, please
                  contact me at (202) 512-4476 or Alana B. Stanfield, Assistant Director,
                  Health, Education and Human Services, Accounting and Financial
                  Management Issues, at (202) 512-3197.

                  Sincerely yours,




                  Gloria L. Jarmon
                  Director, Health, Education, and Human Services
                   Accounting and Financial Management Issues




                  Page 8                                       GAO/AIMD-99-46 VA Actuarial Model
Appendix I

Comments From the Department of
Veterans Affairs                             AppenIxdi




             Page 9          GAO/AIMD-99-46 VA Actuarial Model
Appendix II

Major Contributors to This Report                                                                AppeInx
                                                                                                       Idi




Accounting and         Alana B. Stanfield, Assistant Director
                       W. David Grindstaff, Assistant Director
Information            Martin J. Eble, Senior Auditor
Management Division,
Washington, D.C.




(919274)      Letrt    Page 10                                   GAO/AIMD-99-46 VA Actuarial Model
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