## MEMORANDUM 11/14/2005

**TO:** Theresa S. Shaw

Chief Operating Officer

Federal Student Aid

Lead Action Official

Sally L. Stroup

Assistant Secretary for Postsecondary Education

**FROM:** Helen Lew /s/

Assistant Inspector General for Audit Services

**SUBJECT:** Final Audit Report

> *Death and Total and Permanent Disability Discharges of FFEL and
> Direct Loan Program Loans*
>
> Control Number ED-OIG/A04E0006

Attached is the subject final audit report that covers the results of
our review of FFEL and Direct Loan program loans discharged due to death
during July 1, 2002, through August 27, 2004, and total and permanent
disability (disability discharges) from July 1, 2002, through June 30,
2004.  An electronic copy has been provided to your Audit Liaison
Officers.  We received your comments on the draft report non-concurring
with the recommendation for finding 1, non-concurring with the finding
and recommendation for finding 2, and concurring with the finding and
recommendation for finding 3.

Corrective actions proposed (resolution phase) and implemented (closure
phase) by your offices will be monitored and tracked through the
Department's Audit Accountability and Resolution Tracking System
(AARTS).  ED policy requires that you develop a final corrective action
plan (CAP) for our review in the automated system within 30 days of the
issuance of this report.  The CAP should set forth the specific action
items, and targeted completion dates, necessary to implement final
corrective actions on the findings and recommendations contained in this
final audit report.

In accordance with the Inspector General Act of 1978, as amended, the
Office of Inspector General is required to report to Congress twice a
year on the audits that remain unresolved after six months from the date
of issuance.

In accordance with the Freedom of Information Act (5 U.S.C. §552),
reports issued by the Office of Inspector General are available to
members of the press and general public to the extent information
contained therein is not subject to exemptions in the Act.

We appreciate the cooperation given us during this review.  If you have
any questions, please call Denise Wempe, Regional Inspector General for
Audit, at (404) 562-6477.

Enclosure

**Death and Total and Permanent Disability**

**Discharges of FFEL and Direct Loan Program Loans**

## FINAL AUDIT REPORT

Statements that managerial practices need improvements, as well as other
conclusions and recommendations in this report, represent the opinions
of the Office of Inspector General. Determinations of corrective action
to be taken will be made by the appropriate Department of Education
officials.

### 

### 

### ED-OIG/A04E0006

### November 2005

![](media/image5.png){width="0.7034722222222223in"
height="0.7076388888888889in"}

Our mission is to promote the efficiency, U.S. Department of Education
effectiveness, and integrity of the Office of Inspector General

Department's programs and operations. Atlanta, Georgia

# 

**TABLE OF CONTENTS**

**Page**

EXECUTIVE SUMMARY 1

## BACKGROUND 3

####### AUDIT RESULTS 5

> **Finding No. 1** - **The Regulatory Three-year Conditional
> Discharge**
>
> **Period is Inadequate for Determining Eligibility\
> of All Borrowers 5**

Finding No. 2 -- Regulations That Excuse a Borrower from Paying Interest

Should Be Reconsidered 8

#######  

> **Finding No. 3 -- FSA Did Not Update NSLDS, As Required 12**

## OTHER MATTERS 15

OBJECTIVE, SCOPE, AND METHODOLOGY 16

APPENDIX A -- WRITTEN RESPONSE TO THE DRAFT REPORT 18

**EXECUTIVE SUMMARY**

The objective of our audit was to determine whether Federal Student Aid
(FSA) has implemented effective policies, procedures, and internal
controls over the process for discharging William D. Ford Federal Direct
Loan (Direct Loan) and Federal Family Education Loan (FFEL) program
loans, based on the death or total and permanent disability of the
borrower. The audit period for our review of death discharges was from
July 1, 2002, through August 27, 2004, and the audit period for our
review of discharges based on total and permanent disability (disability
discharges) was from July 1, 2002, through June 30, 2004.

We found that policies, procedures, and internal controls over the
process for discharging loans based on the borrower's death were
adequate. However, we identified problems with policies, procedures, and
internal controls established for disability discharges. Specifically,
we found that

-   [The regulatory three-year conditional discharge period is
    inadequate for determining eligibility of all
    borrowers]{.underline}. The three-year conditional discharge period
    begins on the date that the borrower became totally and permanently
    disabled as certified by a physician. In determining whether the
    borrower will receive the final discharge, the Department only
    considers the borrower's earnings from employment or receipt of a
    new student loan during the conditional discharge period. If the
    borrower's three-year conditional discharge period does not include
    the current date, the Department does not consider the borrower's
    current income and loan status when making its determination.  As
    such, the regulations allow loans to be discharged without an
    adequate determination of all applicants' current disability status.

```{=html}
<!-- -->
```
-   [Regulations that excuse a borrower from paying interest should be
    reconsidered]{.underline}. We found that FSA reinstated (resumed
    collection on) 16,457 loans previously in a conditional discharge
    status, totaling nearly \$172.4 million. These loans were reinstated
    because FSA's controls, during the conditional discharge period,
    identified the borrowers as ineligible for disability discharges.
    Under current regulations, these ineligible borrowers are not
    required to pay the interest that accrued on the loans during the
    conditional discharge period. This benefit for ineligible borrowers
    should be reconsidered.

##### [FSA did not update the National Student Loan Data System (NSLDS), as required]{.underline}. Until April 2005, FSA did not update NSLDS to reflect borrowers' disability discharge status. Since schools cannot identify borrowers' status without this update, 17 ineligible borrowers, in conditional disability discharge status, received new student loans totaling \$270,975.

We recommend that the Chief Operating Officer for FSA and the Assistant
Secretary for Postsecondary Education revise Department of Education
(Department) regulations to 1) allow a consideration of a borrower's
current information when determining his or her eligibility for a
disability discharge and 2) require borrowers who are determined to be
ineligible for a discharge to pay interest for the conditional discharge
period. We also recommend that FSA ensure that NSLDS reflects all
borrowers' conditional disability discharge status correctly.

A draft of this report was provided to FSA and OPE for review and
comment.  In their joint response, FSA and OPE did not disagree with the
conditions or statistics with our Finding No. 1, but did not agree with
its recommendation; disagreed with our Finding No. 2; and agreed with
our Finding No. 3.  Where appropriate, we have incorporated into this
report summaries of FSA's and OPE's comments and our responses.  We
provide FSA's and OPE's response to our draft report, in its entirety,
as an Appendix to this report.  Although we have revised our findings
and recommendations slightly, for clarity, the substance of the report
has not changed.

**BACKGROUND**

Section 437(a) of the Higher Education Act of 1965, as amended (HEA),
requires the Department to discharge a borrower's FFEL Program loan if
he or she "dies or becomes permanently and totally disabled (as
determined in accordance with regulations of the Secretary)." This
provision also applies to the Direct Loan Program under Section
455(a)(1) of the HEA.

In 1998 and 1999, we conducted an audit to determine the nature and
extent of the Department's controls to ensure that FFEL Program loans
were discharged for reasons authorized by the HEA and the Department's
regulations. Our audit report identified control weaknesses in the
Department's system for determining borrower eligibility for death and
disability discharges, and we concluded that the Department improperly
discharged FFEL Program loans.[^1]

During the two-and-a-half-year period examined in the audit, the
Department discharged loans totaling over \$508 million: over \$216
million for borrowers who died and over \$292 million for borrowers
claiming total and permanent disability. We found that 708 (or 2
percent) of the borrowers who received death discharges, totaling over
\$3.8 million, were earning wages after the discharge, and we found that
9,798 (or 23 percent) of the borrowers who received disability
discharges, totaling over \$73 million, were earning wages after the
discharge.

In response to the findings in our audit report, the Department revised
its regulations for death and disability discharges, to improve the
process for evaluating applications for discharge. The Department's
revised regulations were proposed in a Notice of Proposed Rulemaking on
August 2, 2000 (65 FR 47634) and published as Final Regulations on
November 1, 2000 (65 FR 65678).

-   [Death Discharges]{.underline}. Under the Department's previous
    regulations, a FFEL Program lender was able to grant a death
    discharge based on a death certificate or other proof of death,
    acceptable under applicable state law. The Department's revised
    regulations restrict the evidence on which a death discharge may be
    granted. Specifically,

> A discharge of a loan based on the death of the borrower (or student
> in the case of a PLUS loan) must be based on an original or certified
> copy of the death certificate. Under exceptional circumstances and on
> a case-by-case basis, the chief executive officer of the guaranty
> agency may approve a discharge based upon other reliable documentation
> supporting the discharge request. (34 C.F.R. § 682.402(b)(2))

-   [Disability Discharges]{.underline}. Under the Department's previous
    regulations, a FFEL Program lender was responsible for reviewing and
    making the determination on a borrower's application for a
    disability discharge. If the lender determined that the borrower was
    totally and permanently disabled, the borrower's loan was
    discharged.

> Under the revised regulations, the FFEL Program lender and guaranty
> agency make determinations on whether the application supports the
> conclusion that the borrower meets the criteria for a total and
> permanent disability discharge. If they determine that the application
> supports that conclusion, the loan is assigned to the Department and
> the application and supporting documentation are forwarded to FSA's
> Conditional Disability Discharge Unit (CDD). If the CDD, on behalf of
> the Secretary, makes---
>
> . . . an initial determination that the borrower is totally and
> permanently disabled . . . the loan is conditionally discharged for up
> to three years from the date that the borrower became totally and
> permanently disabled, as certified by a physician. The Secretary
> suspends collection activity on the loan from the date of the initial
> determination of total and permanent disability until the end of the
> conditional period. If the borrower satisfies the criteria for a total
> and permanent disability discharge during and at the end of the
> conditional discharge period, the balance of the loan is discharged at
> the end of the conditional discharge period and any payments received
> after the date the borrower became totally and permanently disabled .
> . . are returned to the sender.
>
> \(ii\) A borrower satisfies the criteria for a discharge of a loan
> based on a total and permanent disability if, during and at the end of
> the three-year \[conditional discharge period\]---
>
> \(A\) The borrower's annual earnings from employment do not exceed 100
> percent of the poverty line for a family of two, as determined in
> accordance with the Community Service Block Grant Act; and
>
> \(B\) The borrower does not receive a new loan under the Perkins,
> FFEL, or Direct Loan programs, except for a FFEL or Direct
> Consolidation loan that does not include any loans that are in a
> conditional discharge status. (34 C.F.R. § 682.402(c)(1))

The Department also made similar changes to the regulations for death
and disability discharges in the Direct Loan Program, in 34 C.F.R. §§
685.212 and 685.213. The CDD processes disability discharges for both
FFEL and Direct Loan Program loans.

An FSA contractor, Affiliated Computer Services (ACS), performs CDD
operations. From July 1, 2002, through June 30, 2004, the CDD processed
45,657 disability discharge applications.

**AUDIT RESULTS**

### 

We found that FSA's policies, procedures, and controls over the death
discharge process were adequate. However, we identified problems with
FSA's policies, procedures, and internal controls for disability
discharges. Specifically, we found that 1) the regulatory three-year
conditional discharge period is inadequate for determining eligibility
of all borrowers; 2) regulations that excuse a borrower from paying
interest should be reconsidered; and 3) FSA did not update borrowers'
outstanding principal balance in NSLDS, as required.

######### Finding No. 1 -- The Regulatory Three-year Conditional Discharge Period is Inadequate for Determining Eligibility of All Borrowers

Under 34 C.F.R. §§ 682.402(c)(1)(ii) and 685.213(c), a borrower is
eligible for a disability discharge if, during and at the end of the
three-year conditional discharge period, 1) his or her annual earnings
from employment did not exceed allowable limits, and 2) he or she did
not receive additional Title IV loans. Because a determination of a
borrower's eligibility under this method does not always consider the
borrower's current condition, it does not ensure that only totally and
permanently disabled borrowers receive disability discharges.

The application that a borrower submits for a disability discharge
includes a section that is completed by the borrower's physician. In
this section, the physician certifies that the borrower's condition
meets the Department's definition of total and permanent disability. The
physician also provides the date that "the borrower became unable to
work and earn money in any capacity." During the discharge process, this
date is considered to be the borrower's disability date. The borrower's
three-year conditional discharge period begins on this disability date.

In many cases, borrowers' disability dates occurred more than three
years before their applications for disability discharge were submitted.
We compared borrowers' disability dates to the earliest possible date of
application (July 1, 2002) for the 4,844 borrowers who received
disability discharges between July 1, 2002, and June 30, 2004. As Table
1.1 shows, about 54 percent of the applications for borrowers who
received disability discharges were received more than three years after
the disability date. As a result, for the discharges that FSA approved
from July 1, 2002, through June 30, 2004, about 54 percent were based on
a three-year period that did not include current income data.

**Table 1.1---Discharged Borrowers With Applications Filed More**

> Than Three Years After The Reported Disability Date

+-------------------------------------------+------------+------------+
| ## Application Time Periods               | **No. Of   | **         |
|                                           | B          | Percentage |
| ## For Disability Application             | orrowers** | of the     |
|                                           |            | 4,844**    |
+-------------------------------------------+------------+------------+
| ######### More Than 3, less than 6 Years  | **1,322**  | **27.29%** |
+-------------------------------------------+------------+------------+
| **From 6 to 10 Years**                    | **743**    | **15.34%** |
+-------------------------------------------+------------+------------+
| **10 Years or More**                      | **528**    | **10.90%** |
+-------------------------------------------+------------+------------+
| ###                                       | **2,593**  | **53.53%** |
|                                           |            |            |
| ### **Total**                             |            |            |
+-------------------------------------------+------------+------------+

We were unable to review income data for each of the 2,593 discharged
borrowers included in Table 1.1, because we did not have access to the
borrowers' earnings records. As such, we could not identify all
borrowers who would have been ineligible for a disability discharge if
the discharge were based on their current earnings from employment.
However, current income information was available for the limited number
of these borrowers who had submitted a subsequent Free Application for
Federal Student Aid (FAFSA). We found that 121 of the 2,593 borrowers
completed a FAFSA after their reported date of disability, and we
reviewed their FAFSAs for award years 2003 through 2005. Of the 121
borrowers, 10 reported income over the allowable regulatory limits.

When making a determination on a borrower's eligibility for a disability
discharge, FSA only considers whether the borrower earned income over
the allowable limit or received a new Title IV loan during the
three-year conditional discharge period, the three years after the
borrower's disability date. If the date of a disqualifying event occurs
after the end of the three-year conditional disability discharge period,
that information is not a basis to deny a borrower's disability
discharge. As a result, a borrower who is not currently disabled may
receive a disability discharge, even when FSA has knowledge of the
borrower's current disqualifying income or loan information.

By requiring borrowers to complete Internal Revenue Service (IRS) Form
4506-T (Request for Transcript of Tax Return), FSA may gain access to
IRS information about borrowers' current earnings from employment.
Recent loan data information for borrowers is available to FSA through
NSLDS. However, neither of these sources of information is considered
when determining the borrower's eligibility, if the borrower's date of
disability is more than three years before the application date.

As we noted in the Background section, Section 437(a) of the HEA
requires the Department to discharge a borrower's FFEL or Direct Loan
Program loan if he or she "dies or becomes permanently and totally
disabled (as determined in accordance with regulations of the
Secretary)." The use of the three-year conditional discharge period, as
established in the Department's regulations, is ineffective for making
this determination because it does not always allow the Department to
examine a borrower's current earnings and loan information.

######## RECOMMENDATION

We recommend that the Chief Operating Officer for FSA and the Assistant
Secretary for Postsecondary Education

1.1 Revise the Department's regulations to ensure that current income
and Title IV loan information is considered when determining whether a
borrower is totally and permanently disabled. One way of doing this
would be to re-define the three-year conditional discharge period, to
start the three-year period on the date the borrower submits his or her
application, rather than the date the borrower became disabled.

**FSA and OPE Response:**

FSA and OPE did not disagree with the conditions and statistics in the
finding. However, they disagreed with our recommendations. FSA's and
OPE's joint response stated

> The current regulations implement the Department's response to an
> earlier OIG study that concluded that a one-time "snapshot" approach
> to determining eligibility for a discharge was inadequate. Current
> regulations, to which the OIG agreed despite the strenuous objections
> of the student loan community require monitoring borrower eligibility
> over a significant time period (three years) before granting a final
> discharge.
>
> The OIG does not define \"current earnings.\" It is, therefore,
> unclear whether revising the regulations to provide for a three-year
> conditional period that begins on the date of the borrower\'s
> application for total and permanent disability discharge will address
> the concern that borrowers appear to be ineligible \"based on their
> current earnings.\" Even if the three-year conditional period were
> prospective from the date of application, it would not include the
> borrower\'s \"current\" income because the conditional discharge would
> still be based on the three previous year\'s \[sic\] incomes. A
> borrower could still receive a discharge and then have income that
> exceeds the current regulatory income threshold. The report and
> finding should be revised to clarify this issue and whether the OIG
> believes this will eliminate the problem it has identified.

The response asked that OIG acknowledge amendments to the HEA proposed
by H.R. 609 (Report No. 109-231), which would base the Department's
determination of a borrower's eligibility for a total and permanent
disability discharge on medical determinations by the Department of
Veterans Affairs (VA) o r the Social Security Administration (SSA).  
OPE and FSA stated that, if adopted, this amendment could render our
recommendation moot and that they "plan to make no regulatory changes in
this area before the Congress completes action to amend and extend the
Higher Education Act."

**OIG Comments:**

Though the prior regulations were developed to address the control
weaknesses identified in our earlier report, the results of this audit
indicate the need to revisit the regulations again. When the regulations
were last revised, neither the Department nor our office anticipated
that the applicant pool would be dominated by applications based on
disabilities that arose more than three years prior to the application
date.

In revising the regulations, the Department should ensure that the
discharge is based on verified income and Title IV loan information that
is reasonably contemporaneous with the discharge determinations.
Starting the conditional discharge period on the application date and
utilizing the current practice of verifying annual income during the
conditional discharge period through the use of IRS Form 4506-T would be
a reasonable approach.

Regarding legislative proposal, H.R. 609,

-   There is no assurance that the proposed amendment to discharge
    requirements will be included in the legislation when it is enacted;

-   It does not appear that the proposed amendment would apply to all
    borrowers, just to those who receive determinations by the VA or
    SSA; and

-   The Department itself, when it was developing the final regulations
    issued on November 1, 2000, considered using SSA determinations but
    found that "there is no documentation currently issued by SSA that
    would effectively establish that a borrower is totally and
    permanently disabled under the title IV standard" (65 FR 65683).

Although we did not change our recommendation, we have revised the
example in the recommendation, for clarity. We disagree with FSA's and
OPE's intent to delay amending the regulations. Due to the requirements
in Sections 482 and 492 of the HEA, the earliest that any of the
regulatory changes can be implemented is July 1, 2007, and then only if
the Department initiates and completes negotiated rule-making and
publishes final regulations by November 1, 2006. If the Department waits
for Congress to complete re-authorization it may not be able to meet the
November 1, 2006, deadline, and effective corrective action would then
be delayed until July 1, 2008, at the earliest. While a brief delay may
be appropriate to determine if changes to the discharge regulations can
be combined with post-reauthorization rule-making, the Department should
proceed with preparations to amend the discharge regulations by November
1, 2006, in the event Congress does not complete reauthorization soon.

Finding No. 2 -- Regulations That Excuse a Borrower From Paying Interest
Should Be Reconsidered

If a borrower's loans are placed in a conditional discharge status but
the borrower is later determined to be ineligible for a final discharge,
the borrower's loans are reinstated (FSA resumes collection on the
loans). The regulations provide that a borrower is not required to pay
interest that accrued on his or her loans during the conditional
discharge.

We found that a substantial portion of applicants who receive a
conditional discharge either do not pursue their applications or do not
qualify for a final discharge. Although we did not quantify the amount
of unpaid interest, we found that 36 percent (16,457 of 45,657) of the
loans to borrowers who applied for a disability discharge from July 1,
2002, through June 30, 2004, were reinstated. These borrowers had loan
balances totaling nearly \$172.4 million.

Under 34 C.F.R. § 682.402(c)(16)

> If, at any time during the three-year conditional discharge period,
> the borrower does not continue to meet the eligibility requirements
> for a total and permanent disability discharge, the Secretary resumes
> collection activity on the loan. The Secretary does not require the
> borrower to pay any interest that accrued on the loan from the date of
> the initial determination . . . through the end of the conditional
> discharge period.

Similar requirements are provided for Direct Loans in 34 C.F.R.
§ 685.213(a)(3).

In the preamble to the final rule, the Department stated

> \[B\]orrowers suffer no negative consequences during the conditional
> discharge period. No collection activity or adverse credit reporting
> occurs during the conditional discharge period. If a borrower\'s
> situation changes during this period, we believe the borrower should
> be expected to repay the student loan. However, even if collection
> activity resumes on the loan, the borrower is not obligated to pay any
> interest that accrued during the conditional discharge period. (64 FR
> 65681)

The CDD reinstates loans from a conditional discharge for three reasons:

1.  [No income verification form]{.underline}. After a year of the
    conditional discharge period has passed, the borrower is required to
    provide a signed Request for Transcript of Tax Return (Form 4506-T).
    This is an IRS form that allows FSA to review the borrower's annual
    earnings from employment and to verify the borrower's eligibility
    for a disability discharge. If the borrower does not respond to
    FSA's request, FSA makes three additional, monthly requests for
    return of the form. If the borrower does not respond within two
    weeks of the final notice, FSA reinstates the borrower's loans. (FSA
    performs skip tracing if it becomes apparent that the borrower's
    address is unknown.)[^2]

2.  [Additional loans in NSLDS]{.underline}. To qualify for a disability
    discharge, a borrower may not receive a new loan, after his or her
    disability date, under the Perkins, FFEL, or Direct Loan program,
    except for a FFEL or Direct consolidation loan that does not include
    any loans that are in a conditional discharge status. (34 C.F.R. §§
    682.402(c)(1)(ii)(B) and 685.213(c)(2)) FSA reviews NSLDS when the
    borrower begins a conditional discharge period and quarterly,
    thereafter, to ensure that borrowers meet this requirement. If a
    borrower does not meet this requirement, the borrower's loans are
    reinstated.

3.  [Income in excess of poverty guidelines]{.underline}. FSA uses the
    authorizations that borrowers provide on IRS Form 4506-T to review
    IRS data on the borrowers' annual earnings from employment. If a
    borrower's earnings exceed the poverty guidelines described in 34
    C.F.R. §§ 682.402(c)(1)(ii)(A) and 685.213(c)(1), the borrower's
    loans are reinstated.

Table 2.1 provides the number of borrowers, the number of loans, and the
loan amounts attributable to each reason for reinstatement:

> Table 2.1---Reinstated Loan By Reason For Reinstatement

+----------------------------------+---------+---------+--------------+
| **Reason for Reinstatement**     | **No.   | **No.   | **Loan       |
|                                  | Of      | Of      | Amount**     |
|                                  | Borr    | Loans** |              |
|                                  | owers** |         | (rounded in  |
|                                  |         |         | millions)    |
+----------------------------------+---------+---------+--------------+
| #########                        | **1     | **3     | **\$152.5**  |
|                                  | 4,650** | 2,400** |              |
| **No Income Verification Form**  |         |         |              |
+----------------------------------+---------+---------+--------------+
| **Additional Loans in NSLDS**    | **      | **      | **\$19.0**   |
|                                  | 1,745** | 4,676** |              |
+----------------------------------+---------+---------+--------------+
| ###                              | **62**  | **148** | **\$0.9**    |
|                                  |         |         |              |
| ### **Income i                   |         |         |              |
| n Excess of Poverty Guidelines** |         |         |              |
+----------------------------------+---------+---------+--------------+
| ###                              | **1     | **3     | **\$172.4**  |
|                                  | 6,457** | 7,224** |              |
| ### **Total**                    |         |         |              |
+----------------------------------+---------+---------+--------------+

The 16,457 borrowers who were found to be ineligible for a disability
discharge were not required to pay the interest that accrued on their
loans during the conditional discharge. Interest did not accrue for up
to a year and three months on \$153.4 million, for borrowers who failed
to return the income verification form or who received income in excess
of poverty guidelines. Interest did not accrue for up to three months or
more on \$19 million, for borrowers who received additional loans after
their disability date, depending upon the speed with which NSLDS was
updated with the borrower's new loan information.

The Department's regulations should be changed to require borrowers who
do not receive a final discharge to pay the interest that accrued during
the conditional discharge period due to the substantial percentage of
borrowers who either do not qualify for final discharge or fail to
pursue their applications. The intent of Section 437(a) of the HEA is to
discharge a borrower's FFEL or Direct Loan Program loan if the borrower
becomes permanently and totally disabled. However, the decision to
excuse interest provides a benefit to *ineligible* borrowers and to
borrowers who fail to pursue their applications.

### **RECOMMENDATION**

We recommend that the Chief Operating Officer for FSA and the Assistant
Secretary for Postsecondary Education

1.  Revise the Department's regulations to ensure that, if a borrower's
    loans are reinstated from a conditional discharge status, the
    borrower is required to pay any interest that accrued on his or her
    loans through the end of the conditional discharge.

**FSA and OPE Response:**

FSA and OPE comment that our report "incorrectly states that the
Secretary pays interest benefits on behalf of borrowers during the
'conditional discharge period.'" Their response points out that the
Department does not pay interest benefits to lenders during the
conditional discharge period.

FSA and OPE do not agree that, when reinstated from a conditional
discharge status, borrowers should be required to pay interest that
would otherwise have accrued. FSA and OPE state

> Such a retroactive assessment of accrued interest has the potential to
> discourage and ultimately penalize a borrower for applying for a
> discharge based on total and permanent disability. Moreover, it may
> result in the capitalization of the accrued interest, thus increasing
> the amount of the borrower's debt. A retroactive assessment of as much
> as three years of accrued interest may also precipitate a default when
> the borrower returns to repayment. The OIG does not address in any way
> the possible negative consequences resulting from this change in
> treatment of borrowers or the OIG's recommendations for dealing with
> them.

FSA and OPE stated that they "plan to make no regulatory changes in this
area before the Congress completes action to amend and extend the Higher
Education Act."

**OIG Comments:**

Our draft report did not state that the Secretary pays interest on
behalf of borrowers during the 'conditional discharge period.'" However,
we have revised our finding, for clarity, by removing the terms
"interest benefits" and "interest waivers."

> We do not agree with FSA's and OPE's rationale for excusing borrowers
> from paying interest, for the following reasons:

-   We believe it is likely that most ineligible borrowers will be
    > identified within the first year of the conditional discharge
    > period, by the time the Department first verifies the borrower's
    > earnings from employment and receipt of new Title IV loans. As
    > such, in most cases, accrued interest should not be an
    > unreasonable burden.

-   It is unlikely that the possibility of repaying accrued interest
    would be enough of a disincentive to discourage eligible borrowers
    from applying for discharges. The only apparent disincentive would
    be for ineligible borrowers, who would be able to anticipate that
    their loans will be returned to repayment. Since such a large
    percentage of loans are being reinstated, a disincentive for
    ineligible borrowers would be appropriate and useful.

-   Of the borrowers whose loans are reinstated, approximately 89
    percent were ineligible because they failed to return an annual
    income verification form (see Table 2.1). This raises the question
    of the legitimacy of the borrowers' initial applications and of
    compliance by the borrowers with rules for reporting increased
    earnings, under 34 C.F.R. § 682.402(c)(14)(iv). Borrowers should not
    be excused from paying interest as the result of their
    non-compliance with discharge requirements.

-   FFEL or Direct Loan Program loan borrowers are not excused from
    paying accrued interest if, after applying for other types of loan
    discharges or for teacher loan forgiveness, they are found to be
    ineligible and their loans are returned to repayment.

-   A disabled borrower who is reinstated in error is not precluded from
    re-applying and receiving a discharge.

-   If a borrower becomes unable to make payments on his or her loan as
    the result of accrued interest, there are other, more appropriate,
    methods to help the borrower avoid default. The borrower may request
    a deferment, a forbearance, income contingent repayment, or income
    sensitive repayment.

We disagree with FSA's and OPE's intent to delay amending the
regulations, for the reasons we stated in response to the comments in
Finding No. 1. We did not change our recommendation.

**Finding No. 3 -- FSA Did Not Update NSLDS, As Required**

Until April 2005, the CDD did not update NSLDS to identify loans in a
conditional discharge status. Schools could not identify borrowers in a
conditional discharge status until CDD began updating NSLDS. As a
result, from July 1, 2002, through June 30, 2004, 17 borrowers in
conditional disability discharge status received new student loans
totaling \$270,975.

Under 34 C.F.R. §§ 682.201(a)(7) and 685.200(a)(1)(iv)(C), a borrower in
a conditional discharge must meet certain criteria before he or she is
eligible to receive a new Title IV loan: 1) a physician must certify
that the borrower is able to engage in substantial gainful activity; 2)
the borrower must sign statements that neither the loans conditionally
discharged nor the new loans the borrower will receive may be discharged
on the basis of a current impairment, unless that impairment
substantially deteriorates; and 3) the borrower must sign a statement
acknowledging that collection will resume on any loans in a conditional
discharge period.

For many borrowers in a conditional discharge, schools are required to
review data in NSLDS before disbursing Title IV funds. Under 34 C.F.R. §
668.19(a)(4), when a student transfers from one school to another,
schools must review data in NSLDS:

> Before an institution may disburse Title IV, HEA program funds to a
> student who previously attended another eligible institution, the
> institution must use information it obtains from the Secretary,
> through the National Student Loan Data System (**NSLDS**) or its
> successor system, to determine . . . \[t\]he outstanding principal
> balance of loans made to the student under each of the title IV, HEA
> loan programs . . . .

In May 2002, the Department issued Dear Colleague Letter GEN-02-03,
which provides operational guidance for reflecting a loan's conditional
discharge status in NSLDS:

> Upon assignment of a loan to the Department, the guaranty agency will
> report the loan to NSLDS by using a "DI" or "DS" \[disability\] code
> with a \$0 balance . . . . The \[CDD\], after its initial
> determination of eligibility, will reenter in the NSLDS system the
> outstanding balance last reported on the loan or otherwise prevent
> deletion of the outstanding balance on the loan in the NSLDS system.
> (Dear Colleague Letter GEN-02-03, Attachment 3, Section (III)(B))

The Dear Colleague Letter further explains that a loan with a "DI" or
"DS" disability code, a positive outstanding principal balance, and a
date of loan status on or after July 1, 2002, denotes a loan in the
conditional discharge period. The loan remains in the conditional
discharge status until

1.  A final discharge is granted, which is reflected by setting the
    outstanding balance on the loan to zero; or

2.  The borrower loses eligibility for a final discharge and the loan is
    placed back into

> repayment, which is reflected by reporting the loan with its previous
> NSLDS Loan Status Code.

FSA's program manager for the disability discharge process said that FSA
was aware of its failure to update NSLDS and that there was a task order
to modify NSLDS, to allow the CDD to adjust the outstanding balances in
NSLDS. In a discussion with FSA's Director of Borrower Services, we
learned that the task order had been completed April 8, 2005, and that
FSA is in the process of running tests to ensure the data is correct.

We reviewed documentation and verified that FSA initiated the
upgrade/modification to NSLDS. According to FSA's Director of Borrower
Services, the request for the modification was made during the original
Conditional Discharge Loan Servicing contract, but NSLDS was unable to
support the changes to its system at that time. When the original
contract expired on December 31, 2003, and became part of the Common
Services for Borrowers contract, FSA was able to begin the required
modifications to its NSLDS system.

Because FSA did not update borrowers' outstanding principal balances in
NSLDS before April 2005, borrowers in a conditional disability discharge
status appeared to be eligible for new loans. As a result, 17 borrowers
in a conditional disability discharge status received new student loans
totaling \$270,975. Although the conditionally discharged loans for
these 17 borrowers were reinstated based on the CDD's NSLDS quarterly
checks, these NSLDS checks did not prevent borrowers from initially
receiving the new loans. Schools were unable to correctly certify
borrowers' eligibility based on information in NSLDS.

###### RECOMMENDATIONS

We recommend that the Chief Operating Officer for FSA

1.  Review NSLDS to ensure that the records for all borrowers in a
    conditional disability discharge status from July 1, 2002, through
    April 8, 2005, were properly updated with the correct outstanding
    principal balance.

2.  Continue to update the outstanding principal balance for borrowers
    in a conditional disability discharge status so that FSA complies
    with existing guidance in Dear Colleague Letter GEN-02-03,
    Attachment 3, Section (III)(B).

**FSA and OPE Response:**

FSA and OPE concur with our recommendations. Their response stated that
the Conditional Disability Discharge Tracking System (CDDTS) has been
reporting to NSLDS on a monthly basis since April 8, 2005. The most
recent submittal, on August 2, 2005, included all loan information in
the CDDTS portfolio, including the correct outstanding principal balance
as of the end of July 2005. FSA has confirmed that ACS is continuing to
update the outstanding principal balances for borrowers in the CDDTS.

OIG Comments:

We reviewed documentation and verified that FSA initiated the
upgrade/modification to NSLDS and that FSA's most recent submittal to
NSLDS, on August 2, 2005, included all loan information in the CDDTS
portfolio, including the correct outstanding principal balance as of the
end of July 2005. FSA appears to have taken appropriate steps to respond
to our recommendations.

**OTHER MATTERS**

When making an initial determination that a borrower is totally and
permanently disabled, and is eligible for conditional discharge, the CDD
contacts the physician who certified the application, if the
certification is incomplete or unclear. A CDD nurse told us that
physicians are contacted for approximately half of the disability
discharge applications the CDD receives. According to CDD staff, on
three occasions in 2003, when physicians were contacted by fax for
follow-up information, the physicians stated that they had never signed
the physician certification.

To ensure that borrowers are not perpetrating this type of fraud, we
suggest that the Chief Operating Officer for FSA implement a procedure,
during the quality control review process, to verify on a sample basis
that physicians certifying borrowers' applications actually examined the
borrowers.

**FSA and OPE Response:**

FSA's and OPE's response stated that FSA's contractor, ACS, follows up
with physicians for approximately 70 percent of loan discharge
applications received. This follow-up provides the physician with an
opportunity to indicate whether he or she believes the borrower forged
his/her signature or engaged in some other form of fraud. The response
states, "FSA believes this provides an on-going statistically
representative monthly sample with which to monitor borrower fraud."

OIG Comments:

We acknowledge in our report that doctors are contacted frequently;
however, the FSA contractor selects the doctors judgmentally. Whether
doctors are contacted for approximately half of applications (as the CDD
nurse told us) or 70 percent (according to the FSA and OPE response), a
statistical sampling is not used, so the results of the contacts are not
representative and cannot be projected to the universe of applications.

We have not changed our suggestion.

**OBJECTIVE, SCOPE, AND METHODOLOGY**

The audit objective was to determine whether FSA has implemented
effective policies, procedures, and internal controls over the process
for discharging Direct Loan and FFEL program loans based on death or
total and permanent disability. Audit coverage for our review of
disability discharges included the period July 1, 2002, through June 30,
2004, and audit coverage for our review of death discharges included the
period July 1, 2002, through August 27, 2004.

To determine FSA's controls over the discharge processes, we

-   Interviewed officials responsible for oversight of the death and
    total and permanent disability discharge processes.

-   Reviewed current policies and procedures relating to the loan
    discharge process.

To evaluate the disability discharge processes, we

-   Visited the guaranty agency USA Funds,[^3] Indianapolis, IN; the
    Direct Loan Servicing Center, Utica, NY; the Atlanta Debt Collection
    office; and the Conditional Disability Discharge Unit (CDD), Utica,
    NY.

```{=html}
<!-- -->
```
-   Interviewed officials responsible for processing disability
    discharges.

-   Reviewed and tested current policies and procedures relating to the
    disability discharge process.

-   Reviewed file documentation for a random sample of 69 of the 38,965
    disability discharge claims contained in NSLDS that were processed
    by the CDD from July 1, 2002, through May 5, 2004, to determine
    whether the CDD discharged only eligible applicants.

-   Reviewed file documentation for a random sample of 75 of the 1,552
    discharge claims processed by the CDD during the month of June 2004
    where the loans were reinstated because of no response to income
    verification requests.

To perform our analyses, we

-   Identified, in the Conditional Disability Discharge Tracking System
    (CDDTS), borrowers who had loans reinstated due to the NSLDS
    quarterly check and reviewed data in NSLDS for those borrowers to
    determine who received new loans while in a conditional discharge
    status.

-   Identified the 4,844 borrowers who received discharges and

```{=html}
<!-- -->
```
-   Determined which borrowers applied more than three years after their
    date of disability, and

-   Determined which borrowers applied for new loans after a discharge
    and reviewed the income amount they reported on the FAFSAs they
    completed after the discharge.

```{=html}
<!-- -->
```
-   Reviewed the Internal Revenue Service website to verify IRS income
    record retention policies applicable to the conditional discharge
    process.

To evaluate the death discharge processes, we

-   Visited the guaranty agency USA Funds, the Direct Loan Servicing
    Center, and the Atlanta Debt Collection office.

-   Interviewed officials responsible for processing death discharges.

```{=html}
<!-- -->
```
-   Reviewed and tested current policies and procedures relating to the
    death discharge process.

-   Reviewed file documentation for a random sample of 65 of the 8,372
    death claims contained in NSLDS that were processed from July 1,
    2002, through May 5, 2004, at USA Funds, 50 of the 266 death claims
    processed at the DLSC during the month of February 2004, and 50 of
    the 304 death claims processed at the Atlanta Debt Collection Center
    during the week ending August 27, 2004.[^4]

During the audit, we relied on computer-processed data contained in the
CDDTS. We tested selected data from the CDDTS by reviewing support
documentation corroborating 100 percent of a listed population
identified in the CDDTS Monthly Management Report. We also reviewed data
from USA Funds, Atlanta Debt Collection, DLSC, and CDD borrower files
and used this data to verify the accuracy of the CDDTS and NSLDS data.
Based on these tests and assessments, we concluded that the CDDTS and
NSLDS data were sufficiently reliable for our use in meeting the audit
objective.

We performed audit work from June 2004 through September 2004 at FSA
Headquarters, in Washington, DC, and at the sites described above, in
Indianapolis, IN; Utica, NY; and Atlanta, GA. Subsequent audit work was
performed through April 2005. An exit conference was held with FSA
officials on July 15, 2005. The audit was performed in accordance with
generally accepted government auditing standards appropriate to the
scope of the review described above.

**Appendix A - Written Response to the Draft Report**

![](media/image6.png){width="6.144444444444445in"
height="7.947916666666667in"}

![](media/image7.png){width="6.365972222222222in"
height="8.256944444444445in"}

![](media/image8.png){width="6.427777777777778in" height="8.3375in"}

![](media/image9.png){width="6.507638888888889in"
height="8.417361111111111in"}

[^1]: *Improving the Process for Forgiving Student Loans*, issued June
    7, 1999 (ACN A06-80001).

[^2]: We did not survey borrowers to identify the reasons they failed to
    return the income verification form. However, we examined the
    Department's records for a random sample of 75 of the 1,552
    borrowers with discharge claims processed by the CDD during the
    month of June 2004, where the borrowers' loans were reinstated
    because they failed to return the income verification form. We found
    that 46 of the borrowers contacted FSA before or after their loan
    reinstatement to find out what FSA needed to discharge the loan; 20
    borrowers did not respond to the reinstatement; 8 borrowers provided
    the income verification forms late, after FSA had already reinstated
    their loans; and 1 borrower had income over the poverty guidelines.

[^3]: USA Funds had the highest concentration of FFEL loan discharges
    for all guaranty agencies. We also met with officials at Sallie Mae,
    which is USA Funds' contractor for its discharge processing.

[^4]: Each week, the Atlanta Debt Collection office sends death claim
    documentation to Greenville, Texas, to be warehoused; therefore at
    any time, it has a week's worth of documentation on hand. We were
    able to review documentation for the week ending August 27, 2004,
    before the Atlanta Debt Collection office sent that documentation
    for warehousing.