Budget Issues: Budgeting for Federal Insurance Programs (Testimony,
04/23/98, GAO/T-AIMD-98-147).

GAO discussed: (1) current budget reporting and accrual-based reporting;
and (2) accrual budgeting and its specific application for insurance
programs.

GAO noted that: (1) the cash-based budget often provides incomplete or
misleading information about cost where cash flows to and from the
government span many budget periods, or where the government obligates
itself to make future payments or incurs losses well into the future;
(2) the use of accrual-based budgeting for federal insurance programs
has the potential to overcome a number of the deficiencies of cash-based
budgeting--if estimating problems can be dealt with; (3) the use of
accrual concepts in the budget has the potential to overcome the time
lag between the extension of an insurance commitment, collection of
premiums, and payment of claims that currently distorts the government's
cost for these programs on an annual cash flow basis; (4) accrual-based
reporting for insurance programs recognizes the cost of the government's
commitment when the decision is made to provide insurance, regardless of
when cash flows occur; (5) for federal insurance programs, the key
information is whether premiums over the long term will be sufficient to
pay for covered losses; (6) earlier recognition of the cost of the
government's insurance commitments under a risk-assumed accrual-based
budgeting approach would: (a) allow for more accurate cost comparisons
with other programs; (b) provide an opportunity to control costs before
the government is committed to making payments; (c) build budget
reserves for future claims; and (d) better capture the timing and
magnitude of the impact of the government's actions on private economic
behavior; (7) a crucial component in the effective implementation of
accrual-based budgeting for federal insurance programs is the ability to
generate reasonable, unbiased estimates of the risk assumed by the
federal government; (8) GAO reviewed three different approaches to
incorporating risk-assumed estimates into the budget: (a) under the
supplemental approach, accrual-based cost measures would be included as
supplemental information in the budget documents; (b) under the budget
authority approach, accrual-based cost measures would be included in
budget authority for the insurance program account and in the aggregate
budget totals; and (c) under the outlay approach, accrual-based cost
measures would be incorporated into both budget authority and net
outlays for the insurance program account and in the budget totals; and
(9) the complexity of the issues involved and the need to build agency
capacity to generate such estimates suggest that it is not feasible to
integrate accrual-based costs directly into the budget at this time.

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

 REPORTNUM:  T-AIMD-98-147
     TITLE:  Budget Issues: Budgeting for Federal Insurance Programs
      DATE:  04/23/98
   SUBJECT:  Accrual basis accounting
             Budget administration
             Cash basis accounting
             Future budget projections
             Budget outlays
             Insurance
             Budget obligations
             Budgeting
             Accounting procedures
             Government liability (legal)

             
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Cover
================================================================ COVER


Before the Budget Task Force, Committee on the Budget, House of
Representatives

For Release on Delivery
Expected at
10 a.m.
Thursday,
April 23, 1998

BUDGET ISSUES - BUDGETING FOR
FEDERAL INSURANCE PROGRAMS

Statement of Susan J.  Irving
Associate Director, Budget Issues
Accounting and Information Management Division

GAO/T-AIMD-98-147

GAO/AIMD-98-147T


(935270)


Abbreviations
=============================================================== ABBREV

  PBGC -

============================================================ Chapter 0

Mr.  Chairman and Members of the Task Force: 

I am pleased to be here today to discuss an idea that is clearly
worth exploring as a way to improve the information and incentives
for budget decision-making.  Before turning to the issue you asked me
to address--accrual budgeting and its specific application to
budgeting for insurance programs--I would like to talk a little about
budget reporting--the current cash-based reporting and a different
reporting basis, accrual-based reporting. 


   BUDGET REPORTING REFLECTS
   CHOICES ABOUT THE USES OF THE
   BUDGET
---------------------------------------------------------- Chapter 0:1

The federal budget is the primary financial document of the
government.  The Congress and the American people rely on it to frame
their understanding of significant choices about the role of the
federal government and to provide them the information necessary to
make informed decisions about individual programs and the collective
fiscal policy of the nation.  In practice, the budget serves multiple
functions--it is used to plan and control resources, assess and guide
fiscal policy, measure borrowing needs, and communicate the
government's policies and priorities. 

All of these uses are important, but they can lead to conflicting
criteria for judging a budget.  For example, the budget should be
understandable to policymakers and the public yet comprehensive
enough to fully inform resource allocation decisions.  Since no one
method of budget reporting can fully satisfy all uses, choosing a
reporting method ultimately reflects some prioritization of the
various uses--and a judgment about the quality of information and
what an acceptable degree of uncertainty might be. 

When I refer to reporting methods, I mean how things are measured in
the budget.  Spending can be measured on different bases, such as
cash, accrual, or obligation.  The basis of budget reporting
influences decision-making because the way transactions are recorded
affects our understanding of the relative cost of different
activities, the way critical choices are framed, and how the deficit
(or surplus) is measured. 

For a simple example, suppose the government extends insurance for
which it collects $1 million in premiums in the first year but
expects total losses of $3 million in future years.  If the primary
objective of the budget is to track cash flows, then it is
appropriate to show the $1 million cash inflow as a reduction in the
deficit or increase in the surplus in the first year and to show the
payouts as outlays when they occur.  But if we want the budget to
show the full cost of a decision, then it might be more appropriate
to record a net cost of the present value of $2 million in the year
the insurance is extended.  Both numbers provide useful information
and can be tracked over time.  However, they provide very different
information to policymakers and may lead to different decisions. 
Although a comprehensive understanding of this hypothetical program
requires knowing both numbers, generally only one has been the
primary basis upon which budget decisions are made. 


   CASH IS APPROPRIATE FOR MOST
   PURPOSES
---------------------------------------------------------- Chapter 0:2

Historically, government outlays and receipts have been reported on a
cash basis, i.e., receipts are recorded when received and
expenditures are recorded when paid, without regard to the period in
which the taxes or fees were assessed or the costs incurred. 
Although this has the advantage of reflecting the cash borrowing
needs of the government, over the years, analysts and researchers
have raised concerns that cash-based budgeting does not adequately
reflect either the cost of some programs or the timing of their
impact on economic behavior. 

As a general principle, decision-making is best informed if the
government recognizes the costs of its commitments at the time it
makes them.  For many programs, cash-based budgeting accomplishes
this.  And, as noted earlier, because it reflects the government's
actual borrowing needs (if in a deficit situation), it is a good
proxy for the government's effect on credit markets. 

In general, then, the arguments for cash-based budgeting are
convincing and deviations should not be lightly undertaken.  The
cash-based budget, however, often provides incomplete or misleading
information about cost where cash flows to and from the government
span many budget periods, and/or where the government obligates
itself to make future payments or incur future losses well into the
future.  This is true for federal credit, insurance, and retirement
programs.  The Federal Credit Reform Act of 1990 addressed this
mismatch between budget reporting and cost for credit programs.  This
act changed the budgetary treatment of credit programs by requiring
that the budget reflect the programs' costs to the government on a
net present value basis.  This means that, for example, rather than
recording a cash outlay for the full amount of a direct loan, the
budget records an estimate of what will ultimately be lost, taking
into account repayments, defaults, interest subsidies, and any other
cash flows on a net present value basis.\1 Such accrual-based
budgeting is also being done for the government's contribution to
pensions for civilian employees covered under the Federal Employees
Retirement System and for military personnel.  Accrual-based
reporting recognizes the cost of transactions or events when they
occur regardless of when cash flows take place. 

As I will discuss, cash-based budgeting is misleading for insurance
programs.  Federal insurance programs are diverse, covering a wide
range of risks that the private sector has traditionally been unable
or unwilling to cover.  The risks include natural disasters under the
flood and crop insurance programs and bank and employer bankruptcies
under the deposit and pension insurance programs.  The federal
government also provides life insurance for veterans and federal
employees, political risk insurance for overseas investment
activities, and insurance against war-related risks and adverse
reactions to vaccines.  The face value of all of this insurance--the
total amount of insurance outstanding--is around $5 trillion, but
this dollar amount overstates the potential cost to the government
because it is very unlikely that it would ever face claims from all
outstanding insurance.  The fiscal year 1997 Consolidated Financial
Statements of the United States Government reported a $14.6 billion
liability for insurance programs--payments already owed by the
government because of past events.\2 The financial statement records
liabilities incurred for events that have already happened.  But
budgets are forward-looking documents.  Decisionmakers need to make
decisions about future commitments as they debate them--before
insurance is extended.  Therefore, a different measure may be more
appropriate--the expected net cost to the government of the risk
assumed by extending the insurance commitment (i.e., the "missing
premium"), which is the difference between the full premium that
would be charged based on expected losses and the actual premium to
be charged the insured. 


--------------------
\1 Similarly, loan guarantees are no longer shown as having no cost. 
Rather, the budget records the estimated amount that the government
will lose over the life of the loan on a net present value basis,
including estimated defaults, interest subsidies, and other payments
to and from the government. 

\2 This amount does not include the government's life insurance
liabilities for federal employees or veterans.  In addition, we
attempted to audit these statements but were unable to express an
opinion on their reliability.  See Financial Audit:  1997
Consolidated Financial Statements of the United States Government
(GAO/AIMD-98-127, March 31, 1998). 


   CASH-BASED BUDGETING GENERALLY
   PROVIDES INCOMPLETE INFORMATION
   ON THE COST OF FEDERAL
   INSURANCE PROGRAMS
---------------------------------------------------------- Chapter 0:3

At the request of the Chairman, we reported last September on the
shortcomings of cash-based budgeting for federal insurance programs
and the potential use of accrual concepts in the budget for these
programs.\3 In general, cash-based budgeting for insurance programs
presents several problems.  Its focus on single period cash flows can
obscure the program's cost to the government and thus may (1) distort
the information and incentives presented to policymakers, (2) skew
the recognition of the program's economic impact, and (3) cause
fluctuations in the deficit unrelated to long-term fiscal balance. 

With the current cash-based reporting, premiums for insurance
programs are recorded in the budget when collected and outlays are
reported when claims are paid.  This focus on annual cash flows
generally does not adequately reflect the government's cost for
federal insurance programs because the time between the extension of
the insurance, the receipt of premiums and other collections, the
occurrence of an insured event, and the payment of claims may extend
over several budget periods.  As a result, the government's cost may
be understated in years that a program's current premium and other
collections exceed current payments and overstated in years that
current claim payments exceed current collections.  These distortions
occur even if the collections and payments for an insurance
commitment are equal over time.  This is similar to the problem with
loans prior to the Credit Reform Act.  The budget showed direct loans
as costly in the year they were extended but then as profitable in
future years when repayments exceeded new loans being made. 

The reasons for the mismatch between insurance premium collections
and claim payments vary across the programs.  In the case of
political risk insurance extended by the Oversees Private Investment
Corporation, the length of the government's commitment can run for up
to 20 years.  Similarly, benefit payments for pension plans assumed
by the Pension Benefit Guaranty Corporation (PBGC) may not be made
for years or even decades after a plan is terminated.  This is
because participants generally are not eligible to receive pension
benefits until they reach age 65 and, once eligible, they receive the
benefits for many years.  In other programs, temporary transactions
or the erratic occurrence of insured events cause the mismatch
between collections and payments and distort the insurance programs'
apparent costs in the cash-based budget.  For example, during the
savings and loan crisis, large temporary cash flows from the
acquisition and sale of assets from failed institutions resulted in
the government's cost for deposit insurance never being clearly
presented in the annual budget.  In years when assets were acquired,
the full amount of cash required was recorded as an outlay; later,
when the assets were sold, the proceeds were recorded as income. 
Thus, the cash-based budget overstated the cost of the deposit
insurance in some years and understated it in others. 

The inability of the cash-based budget to capture the cost of the
government's insurance commitments at the time decisions are made has
significant implications.  Cash-based budgeting for federal insurance
programs may provide neither the information nor incentives necessary
to signal emerging problems, make adequate cost comparisons, control
costs, or ensure the availability of resources to pay future claims. 

The shortcomings of cash-based budgeting for federal insurance
programs became quite apparent during the 1980s and early 1990s as
the condition of the two largest programs--deposit insurance and
pension insurance--deteriorated while the budget continued to show
positive cash flows and did not even recognize failures that had
actually happened.  Although we and others raised concerns at the
time about the government's rapidly accruing deposit insurance costs,
the cash-based budget was not effective in signaling policymakers of
the emerging problem because it did not show a cost until
institutions were closed and depositors paid.  This delayed
recognition obscured the program's, as well as the government's,
underlying fiscal condition and limited the usefulness of the budget
process as a means for the Congress to assess the problem.  At
approximately the same time, PBGC was facing growing losses and
sponsors of insured pension plans were coming under severe financial
stress, yet the cash-based budget showed large and growing cash
income for the program.  While the financial condition of PBGC has
improved considerably in recent years, the Office of Management and
Budget reported in the President's fiscal year 1999 budget that the
government's expected liability for current and future pension plan
terminations is approximately $30 billion. 

Because the cash-based budget delays recognition of emerging
problems, it may not provide policymakers with information or
incentives to address potential funding shortfalls before claim
payments come due.  Policymakers may not be alerted to the need to
address programmatic design issues because, in most cases, the budget
does not encourage them to consider the future costs of federal
insurance commitments.  Thus, reforms aimed at reducing costs may be
delayed.  In most cases, by the time costs are recorded in the
budget, policymakers do not have time to ensure that adequate
resources are accumulated to pay for them or to take actions to
control them.  The late budget recognition of these costs can reduce
the number of viable options available to policymakers, ultimately
increasing the cost to the government. 

For example, the National Flood Insurance Program provides subsidized
coverage without explicitly recognizing its potential cost to the
government.  Under current policy, the Congress has authorized the
Federal Insurance Administration to subsidize a significant portion
(approximately 38 percent) of the total policies in force without
providing annual appropriations to cover these subsidies.  Although
the flood insurance program has been self-supporting since the
mid-1980s--either paying claims from premiums or borrowing and
repaying funds to the Treasury--the program has not been able to
establish sufficient reserves to cover catastrophic losses and,
therefore, cannot be considered actuarially sound. 

In some cases, the cash-based budget not only fails to provide
incentives to control costs, but also may create a disincentive for
cost control.  Deposit insurance is a key example.  Many analysts
believe that the cash-based budget treatment of deposit insurance
exacerbated the savings and loan crisis by creating a disincentive to
close failed institutions.  Since costs were not recognized in the
budget until cash payments were made, leaving insolvent institutions
open avoided recording outlays in the budget and raising the annual
deficit but ultimately increased the total cost to the government. 

Cash-based budgeting also may not be a very accurate gauge of the
economic impact of federal insurance programs.  Although discerning
the economic impact of federal insurance programs can be difficult,
private economic behavior generally is affected when the government
commits to providing insurance coverage.  At this point, insured
individuals or organizations alter their behavior as a result of
insurance.  However, as I noted above, the cash-budget records costs
not at this point but rather when payments are made to claimants. 
These payments generally have little or no macroeconomic effect
because they do not increase the wealth or incomes of the insured. 
Rather, they are merely intended to restore the insured to his or her
approximate financial position prior to the insured event. 

The cash flow patterns of some federal insurance programs can result
in fluctuations in the federal deficit unrelated to the budget's
long-term fiscal balance.  As noted earlier, uneven cash flows may
result from both the erratic nature of some insured risks or
temporary cash flows, as in the case of the acquisition and
subsequent sale of assets from failed savings and loan institutions. 
In addition, insurance programs with long-term commitments, such as
pension and life insurance programs, can distort the budget's
long-term fiscal balance by reducing the aggregate deficit in years
that premium income exceeds payments without recognizing the
programs' expected costs. 

While annual cash flows for federal insurance programs generally do
not provide complete information for resource allocation and fiscal
policy, the magnitude of the problem and the implications for budget
decision-making vary across the insurance programs reviewed.  For
example, the implications of the shortcomings of the current budget
treatment appear greatest for the largest programs, pension and
deposit insurance.  Because of their large size, incomplete or
misleading information about their cost could distort resource
allocation and fiscal policy significantly, making the limitations of
cash-based budgeting more pronounced than for other federal insurance
programs.  In addition, the limitations of cash-based budgeting are
most apparent when the government's commitment extends over a long
period of time, as with pension insurance, or when the insured events
are infrequent or catastrophic in nature, such as severe flooding or
depository losses.  Conversely, the implications for budget
decision-making may be less severe if relatively frequent claim
payments prompt policymakers to consider the financial condition and
funding needs of the program. 


--------------------
\3 See Budget Issues:  Budgeting for Federal Insurance Programs
(GAO/AIMD-97-16, September 30, 1997). 


   ACCRUAL CONCEPTS COULD IMPROVE
   THE BUDGETARY INFORMATION AND
   INCENTIVES FOR FEDERAL
   INSURANCE PROGRAMS
---------------------------------------------------------- Chapter 0:4

The use of accrual-based budgeting for federal insurance programs has
the potential to overcome a number of the deficiencies of cash-based
budgeting--if the estimating problems I discuss below can be dealt
with.  Accrual-based reporting recognizes transactions or events when
they occur regardless of when cash flows take place.  An important
feature of accrual-based reporting is the matching of expenses and
revenues whenever it is reasonable and practicable to do so.  In
contrast to cash-based reporting, accrual reporting recognizes the
cost for future insurance claim payments when the insurance is
extended and provides a mechanism for establishing reserves to pay
those costs.  Thus, the use of accrual concepts in the budget has the
potential to overcome the time lag between the extension of an
insurance commitment, collection of premiums, and payment of claims
that currently distorts the government's cost for these programs on
an annual cash flow basis. 

The use of forward-looking cost measures for federal insurance
programs could improve budget reporting.  As with the approach taken
for credit programs, accrual-based reporting for insurance programs
recognizes the cost of the government's commitment when the decision
is made to provide the insurance, regardless of when cash flows
occur.  For federal insurance programs, the key information is
whether premiums over the long term will be sufficient to pay for
covered losses and, if not, to identify the net cost to the
government.  The cost of the risk assumed by the government is the
difference between the full risk premium, based on the expected cost
of losses inherent in the insurance commitment, and the premium
charged to the insured (the missing premium).  Earlier recognition of
the cost of the government's insurance commitments under a
risk-assumed accrual-based budgeting approach would (1) allow for
more accurate cost comparisons with other programs, (2) provide an
opportunity to control costs before the government is committed to
making payments, (3) build budget reserves for future claims, and (4)
better capture the timing and magnitude of the impact of the
government's actions on private economic behavior.  It might or might
not change the premium charged--that is a separate policy decision. 
Rather, better information on cost would mean that decisions would be
better informed. 


   ESTIMATING THE COST OF THE RISK
   ASSUMED BY THE GOVERNMENT FOR
   INSURANCE COMMITMENTS IS A
   SIGNIFICANT CHALLENGE
---------------------------------------------------------- Chapter 0:5

A crucial component in the effective implementation of accrual-based
budgeting for federal insurance programs is the ability to generate
reasonable, unbiased estimates of the risk assumed by the federal
government.  Although the risk-assumed concept is relatively
straightforward, generating estimates of these costs is complex and
varies significantly across insurance programs.  While in some cases,
such as life insurance, generating risk-assumed estimates may not be
problematic, in most cases, the difficulties faced may be
considerably more challenging than those currently faced for some
loan programs under credit reform. 

For insurance, the accuracy of estimated future claims is determined
by the extent to which the probability of all potential outcomes can
be determined.  Unfortunately, probabilities are not known for
certain for most activities more complex than the toss of a fair
coin.  However, for activities in which data on actual outcomes
exist, like the length of a human life, the underlying probabilities
can be estimated.  When the probabilities of future events can be
inferred, estimates are said to be made under the condition of risk
and the risk undertaken by the insurer can be measured.  However,
when underlying conditions are not fully understood, estimates are
said to be made under uncertainty.  This is the case for most federal
insurance programs due to the nature of the risks insured, program
modifications, and other changes in conditions that affect potential
losses. 

Lack of sufficient historical data for some federal insurance
programs also constrains risk assessment.  While private insurers
generally rely on historical data on losses and claim costs to assess
risk, data on the occurrence of insured events over sufficiently long
periods under similar conditions are generally not available for
federal insurance programs.  Frequent program modifications as well
as fundamental changes in the activities insured further reduce the
predictive value of available data and complicate risk estimation. 

These factors, which limit the ability to predict losses and the
potential for catastrophic losses, have been cited as preventing the
development of commercial insurance markets for risks covered by
federal insurance programs.  Many federal insurance programs cover
complex, case-specific, or catastrophic risks that the private sector
has historically been unwilling or unable to cover.  As a result,
private sector comparisons are generally unavailable to aid in the
risk estimation process.  Thus, the development and acceptance of
risk assessment methodologies for individual insurance programs vary
considerably.  For some programs, the development of risk-assumed
estimates will require refining and adapting available risk
assessment models while, for other programs, new methodologies may
have to be developed.  The degree of difficulty in developing
estimates and the uncertainty surrounding these estimates will likely
be greatest for programs--such as deposit and pension insurance--that
require modeling complex interactions between highly uncertain
macroeconomic variables and human behavior.  Even after years of
research, significant debate and estimation disparity exists in the
modeling for these programs. 

This means that in practical terms, attempts to improve cost
recognition occur on a continuum since insurance programs and
insurable events vary significantly.  The extent of improvement in
information when moving from cash-based to accrual-based information
would vary across programs depending on (1) the size and length of
the government's commitment, (2) the nature of the insured risks, and
(3) the extent to which costs are currently captured in the budget. 
The diversity of federal insurance programs also implies that the
period used for estimating risk assumed, the complexity of the
models, and the policy responses to this new information will vary. 


   APPROACHES FOR INCORPORATING
   ACCRUAL-BASED ESTIMATES IN THE
   BUDGET
---------------------------------------------------------- Chapter 0:6

In our report on budgeting for insurance programs, we looked at
several different approaches to incorporating risk-assumed estimates
into the budget,\4 ranging from the addition of supplemental
reporting to incorporation directly into budget authority, outlays,
and the deficit.  We concluded that although the potential for
improved information argued for a risk-assumed approach, the analytic
and implementation issues argued for beginning with supplemental
information.  I will describe the three approaches we explored and
then discuss our conclusion. 

Supplemental approach:  Under this approach, accrual-based cost
measures would be included as supplemental information in the budget
documents.  Ideally, the risk-assumed estimates would be reported
annually in a standard format along with the cash-based estimates. 
Showing the two together would highlight the risk-assumed cost
estimates at the time budget decisions are made and also increase the
likelihood that serious work on improving these estimates would
continue. 

This approach has some advantages, particularly that it would allow
time to test and improve estimation methodologies and increase the
comfort level of users before considering whether to move to a more
comprehensive approach.  It would highlight the differences in the
type of information provided on a cash basis versus an accrual basis
without changing the reporting basis of total budget authority, net
outlays, or the budget deficit or surplus. 

The disadvantage of the supplemental reporting approach is that it
may not have a significant effect on the budget decision-making
process because the cost information would not directly affect the
budget totals and allocations to congressional committees. 
Therefore, if this approach is selected, it would be important to
also create an incentive to improve cost estimates and risk
assessment methodologies.  For example, demonstrated congressional
interest and stated intentions to move toward greater integration
into the budget after a period of evaluation might help ensure that
agencies and the Office of Management and Budget actively pursue
improvements. 

Budget authority approach:  Under this approach, accrual-based cost
measures--the full cost of the risk assumed by the government--would
be included in budget authority for the insurance program account and
in the aggregate budget totals.  Net outlays--and hence the budget
deficit or surplus--would not change.  Budget authority would be
obligated when an insurance commitment was made and would be held as
an interest-earning reserve.  Future claims would be paid from the
reserve. 

A key advantage of this approach is that it would provide earlier
recognition of insurance costs directly in the budget while
preserving cash-based reporting for net outlays and the budget
results.  This would incorporate cost estimates directly into the
budget debate without potentially subjecting outlays and the deficit
or surplus to the uncertainty of the risk-assumed estimates or
changing the nature of the outlay and deficit/surplus measure.  It
might also focus attention on improving the estimates since they will
be included in one of the key budget numbers.  There are problems
with this approach, however.  Since the estimates would not be
reflected in the deficit or surplus--the numbers that receive the
most attention and scrutiny--it is unclear how much more effect this
approach would have on the budget decision-making process than the
supplemental information approach.  In addition, the impact of this
approach would be limited by the fact that most insurance programs
are mandatory and thus any budget authority needed is automatically
provided. 

In our report, we discuss a variation of this approach that would
increase its impact.  For mandatory insurance programs, a
discretionary account could be created to record the government's
subsidy cost.  An appropriation to that account could be required to
cover the subsidy costs in the year the insurance is extended, unless
alternative actions were taken to reduce the government's cost, such
as increasing program collections or reducing future programs costs. 
Since the discretionary appropriation would be subject to Budget
Enforcement Act caps, decisionmakers would have an incentive to
reduce the government's costs.  However, such a change in budgeting
would also fundamentally change the nature of most federal insurance
programs and, by changing the locus of decisions to the annual
appropriation process, might change program operations. 

Outlay approach:  Under this approach, accrual-based cost measures
would be incorporated into both budget authority and net outlays for
the insurance program account and in the budget totals.  Thus, the
reported deficit or surplus would reflect the risk-assumed estimate
at the time the insurance is extended.  Since the government's
insurance programs generally provide a subsidy, the deficit would be
larger (or the surplus smaller) than when reported on a cash basis,
which could prompt action to address the causes of the increased
outlays. 

Without fundamentally changing the nature of most insurance programs,
the outlay approach is the most comprehensive of the three approaches
and has the greatest potential to achieve many of the conceptual
benefits of accrual-based budgeting.  It would recognize the
government's full cost when budget decisions are being made,
permitting more fully informed resource allocation decisions.  Since
the cost is recognized in the budget's overall results--the deficit
or surplus--incentives for managing costs may be improved.  Also,
recognizing the costs at the time the insurance commitments are made
would better reflect their fiscal effects. 

Conceptually, this approach has the appeal of taking the approach
currently used for credit programs and applying it to insurance. 
However, it is important to recognize that developing estimates of
the "missing premium" is much more difficult than developing subsidy
estimates for credit programs.  The uncertainty surrounding the
estimates of the risk assumed presents a major hurdle to implementing
accrual budgeting for insurance programs.  Risk-assumed estimates for
most insurance programs are either currently unavailable or not fully
accepted.  Even if they become more accepted, the Congress and the
President would need to be comfortable with the fact that recognizing
the risk-assumed estimate in outlays would mean that any reported
deficit would depart further from representing the borrowing needs of
the government. 

Choosing among the three approaches I have presented is further
complicated by the fact that the relative implementation
difficulties--and the benefits achieved--vary across federal
insurance programs.  The key implementation issue that I discussed
earlier is whether reasonable, unbiased, risk-assumed cost estimates
can be developed.  The programs for which the risk-assumed estimates
are perhaps most difficult to make--deposit and pension
insurance--are also the ones for which having the estimates would
potentially make the most difference in budget decision-making. 
While supplemental reporting of risk-assumed estimates would allow
time to evaluate the feasibility and desirability of moving to a more
comprehensive accrual-based budgeting approach for all insurance
programs, the Congress and the President could also consider whether
it would be reasonable to phase implementation by type of insurance
program over time.  If the latter approach were chosen, life, flood,
and crop insurance programs could be the starting points because they
have more established methodologies for setting risk-related premium
rates.  The methodology for life insurance is well established in
actuarial science.  For flood and crop insurance, some modifications
and refinements to existing methodologies and other implementation
challenges should be expected. 

Beyond generating estimates, there are other challenges that must be
addressed, such as the increased uncertainty accrual-based estimates
will inject into the budget.  For example, while one of the major
benefits of accrual-based budgeting is the recognition of the cost of
future insurance claims when programmatic and funding decisions are
being made, this recognition is dependent on estimates, which are in
turn dependent upon many economic, behavioral, and environmental
variables.  There will always be uncertainty in the reported
accrual-based estimates.  However, uncertainty in the estimation of
insurance program costs should be evaluated in terms of the direction
and magnitude of the estimation errors.  For budgeting purposes,
decisionmakers probably would be better served by information that is
more approximately correct on an accrual basis than they are by
cash-based numbers that may be exactly correct but misleading.  That
said, the estimation uncertainty will make periodic evaluation of the
risk estimation methodologies used to generate the estimates crucial. 

Other challenges to be addressed include how to establish and protect
loss reserves, how to handle reestimates, funding shortfalls,
previously accumulated program deficits, and administrative costs. 


--------------------
\4 Budget Issues:  Budgeting for Federal Insurance Programs
(GAO/AIMD-97-16, September 30, 1997). 


   CONCLUSION
---------------------------------------------------------- Chapter 0:7

To support current and future resource allocation decisions and be
useful in the formulation of fiscal policy, the federal budget needs
to be a forward-looking document that enables and encourages users to
consider the future consequences of current decisions.  The potential
benefits of an accrual-based budgeting approach for federal insurance
programs warrant continued effort in the development of risk-assumed
cost estimates.  The complexity of the issues involved and the need
to build agency capacity to generate such estimates suggest that it
is not feasible to integrate accrual-based costs directly into the
budget at this time.  Supplemental reporting of these estimates in
the budget over a number of years could help policymakers understand
the extent and nature of the estimation uncertainty and permit an
evaluation of the desirability and feasibility of adopting a more
comprehensive accrual-based approach. 

Supplemental reporting of risk-assumed cost estimates in the budget
has several attractive features.  It would allow time to (1) develop
and refine estimation methodologies, (2) assess the reliability of
risk-assumed estimates, (3) formulate cost-effective reporting
procedures and requirements, (4) evaluate the feasibility of a more
comprehensive accrual-based budgeting approach, and (5) gain
experience and confidence in risk-assumed estimates.  At the same
time, the Congress and the executive branch will have had several
years of experience with credit reform, which can help inform their
efforts to apply accrual-based budgeting to insurance.  During this
period, policymakers should continue to draw on information provided
in audited financial statements. 

If the risk-assumed estimates develop sufficiently so that their use
in the budget will not introduce an unacceptable level of
uncertainty, policymakers could consider incorporating risk-assumed
estimates directly into the budget.  While directly incorporating
them in both budget authority and outlays would have the greatest
impact on the incentives provided to decisionmakers, it would also
significantly increase reporting complexity and introduce new
uncertainty in reported budget data.  Thus caution is called for in
taking steps that move beyond supplemental reporting of risk-assumed
estimates.  One way to approach the incorporation of risk-assumed
estimates in the budget is to start with programs that already have
established methodologies for setting risk-assumed premium rates,
such as life, flood, and crop insurance. 

By drawing attention to the need to change the budget treatment of
insurance programs, this task force is moving the process in the
right direction.  As I have noted on other occasions, action and
effort are usually devoted to areas on which light is shined. 


-------------------------------------------------------- Chapter 0:7.1

Mr.  Chairman, this concludes my written statement.  I would be happy
to answer any questions you or your colleagues may have. 

*** End of document. ***