DOD Retiree Health Benefits Liability: Evaluation of DOD's Sensitivity
Analysis (Correspondence, 10/31/2000, GAO/GAO-01-164R).

GAO worked with the Department of Defense (DOD) on developing and
reporting a reliable estimate for the postemployment health care
benefits due to military retirees, their dependents, and survivors. In
order to do this, the DOD Office of Actuary has contracted with a
private sector firm of actuaries and consultants, Milliman & Robertson.
This report provides a non-technical summary of the contractor's
findings and includes GAO's recommendation that the changes discussed in
the reports be implemented. GAO found that although the analysis
prepared by the Office of Actuary does a good job of identifying the
factors that affect the military postretirement health care benefits
liability and of evaluating the possible impact of those factors, there
are still issues that need to be addressed. There are areas where an
additional break out of information is needed in order for the Office of
Actuary to properly analyze the impact of those areas on the liability.
The methodology used for the most part was reasonable, but some
deficiencies still remained.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  GAO-01-164R
     TITLE:  DOD Retiree Health Benefits Liability: Evaluation of DOD's
	     Sensitivity Analysis
      DATE:  10/31/2000
   SUBJECT:  Financial statement audits
	     Auditing standards
	     Retired military personnel
	     Employee retirement plans

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GAO-01-164R

October 31, 2000

Ms. Jeanne Fites

Deputy Under Secretary of Defense, Program Integration

Department of Defense

Ms. Gwendolyn Brown

Deputy Assistant Secretary of Defense, Health Budgets and Financial Policy

Department of Defense

Subject: DOD Retiree Health Benefits Liability: Evaluation of DOD's
Sensitivity Analysis

As part of our ongoing work with the Department of Defense (DOD) to prepare
for auditable financial statements, we have worked extensively with the
Office of Actuary and with Health Affairs on developing and reporting a
reliable estimate for the postemployment health care benefits due to
military retirees, their dependents, and survivors. To calculate the
military retiree health care benefits liability, the DOD Office of Actuary
has contracted with a private sector firm of actuaries and consultants,
Milliman & Robertson (M&R), which has significant experience in estimating
health related liabilities. M&R uses an actuarial model that relies on
historical information about the retiree population and the numbers, types,
and costs of medical services provided to them. The model also uses
economic, actuarial, and other assumptions, such as future interest rates
and projected rate increases for medical costs. Using the M&R model, DOD
estimated its military retiree health care benefits liability to be $196
billion in its fiscal year 1999 financial statements.

To help DOD and its auditors focus their data improvement and audit efforts
on the elements that have the most significant impact on the resulting
liability calculation, we asked the DOD Office of Actuary to prepare a
sensitivity analysis. A sensitivity analysis identifies key elementsdata and
assumptions as discussed aboveand varies a single element while holding the
others constant to determine what amount of change in that element is
required to raise or lower the resulting liability by a set amount. In this
way, data and assumptions can be risk-ranked for decision-making and
auditing.

As agreed to, when the Office of Actuary completed the sensitivity analysis,
we (1) evaluated its completeness and accuracy and (2) reviewed the
methodology used by M&R to calculate the retiree health benefits liability,
including the actuarial model and individual calculations. Because of the
technical nature of actuarial projections, we contracted with an independent
accounting firm, Ernst & Young LLP, to assist us in this work. Our
contractor provided actuarial expertise in reviewing documentation prepared
by the Office of Actuary and by M&R regarding the sensitivity analysis, the
actuarial model calculations, and data used in the model to develop the
liability estimate. This letter provides a high-level, nontechnical summary
of the contractor's findings and includes our recommendation that the
refinements discussed in those reports be implemented.

In general, our contractor found that the sensitivity analysis prepared by
the Office of Actuary does a good job of identifying the factors that affect
the military postretirement health care benefits liability and of evaluating
the relative impact of those factors on the liability. However, the
contractor did identify the following issues that should be addressed in
order to make the analysis more complete.

   * The analysis does not provide an in-depth discussion of the
     independence or interdependence of the relationship between the health
     care services provided by DOD and those provided by Medicare for
     retirees over age 65. If DOD retirees choose care provided by Medicare,
     or by the private sector, rather than by military treatment facilities,
     the liability could be significantly affected.

   * The analysis does not discuss in detail the rationale for the inflation
     factors, economic assumptions, or retirement and death rates that are
     used in the calculation even though the analysis found these factors to
     have the most significant impact on the resulting liability estimate.

The contractor also identified areas where an additional break out of
information is needed in order for the Office of Actuary to adequately
analyze the impact of those areas on the liability calculation and to
provide better information for decisionmakers.

   * The under- and over-65 retiree populations are not currently reported
     separately even though these groups receive different benefits and
     therefore may have different needs, use patterns, and costs.

   * The cost of providing pharmacy benefits has not been considered
     separately from other health care benefits, even though pharmacy usage
     patterns and inflation rates could be very different and therefore
     could significantly affect the resulting liability. For example, there
     is some evidence that retirees use more outpatient pharmacy resources
     than nonretirees. Furthermore, pharmacy costs have been increasing at a
     faster rate than other medical costs, yet the same medical trend rate
     has been applied to all outpatient costs.

Finally, the contractor found that the methodology used by the Office of
Actuary and M&R to calculate the liability estimate is, in general,
reasonable; however, the contractor did report the following deficiencies.

   * The Office of Actuary has not properly documented the liability
     approach, methodology, and model. In addition to the benefit of good
     documentation realized by all users of the model and its results, the
     process of preparing the documentation could clarify the Office of
     Actuary's and M&R's understanding of their model and serve as an
     internal validation mechanism to ensure that the model calculates what
     is intended.

   * The contractor tested a sample of five calculations for accuracy and
     consistency with the methodology of the model and found one to be in
     error. The erroneous calculation was corrected as soon as we reported
     the problem; however, not all calculations were tested, so it is
     possible that other errors exist.

In order to make the analysis and the model more useful to DOD in evaluating
changes in health care benefits' cost components and to the DOD auditors in
planning future audit work related to the health care liability estimate,
the contractor's reports recommend several improvements that we believe
should be implemented. We worked closely with the Office of Actuary during
the review and discussed all of the findings and desirable improvements with
the Chief Actuary. The Office of Actuary indicated its concurrence with the
contractor's findings and stated that some of the contractor's recommended
improvements are already being undertaken and that the remainder will be
addressed in the near future.

We are providing you copies of our contractor's detailed reports under
separate cover. If you have questions or comments regarding this letter or
the contractor's work or reports, please contact me at (202) 512-9095 or
Molly Boyle at (202) 512-9524.

[0x01 graphic]

Lisa G. Jacobson

Director

Financial Management and Assurance

(924014)

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GAO-01-XX DOD's Sensitivity Analysis

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GAO-01-164R DOD's Sensitivity Analysis
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