United States General Accounting Office

GAO Testimony

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

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

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

Page 1 GAO/T-AIMD-98-147
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

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

Page 2 GAO/T-AIMD-98-147
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).

Page 3 GAO/T-AIMD-98-147
Cash-Based Budgeting

Generally Provides

Incomplete

Information on the

Cost of Federal

Insurance Programs

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

3

See Budget Issues: Budgeting for Federal Insurance Programs (GAO/AIMD-97-16, September 30,

1997).

Page 4 GAO/T-AIMD-98-147
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

Page 5 GAO/T-AIMD-98-147
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.

Page 6 GAO/T-AIMD-98-147
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.

Accrual Concepts

Could Improve the

Budgetary

Information and

Incentives for Federal

Insurance Programs

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

Page 7 GAO/T-AIMD-98-147
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

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

Page 8 GAO/T-AIMD-98-147
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

Page 9 GAO/T-AIMD-98-147
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

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.

4

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

Page 10 GAO/T-AIMD-98-147
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

Page 11 GAO/T-AIMD-98-147
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

Page 12 GAO/T-AIMD-98-147
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.

Conclusion 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.

Page 13 GAO/T-AIMD-98-147
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.

Mr. Chairman, this concludes my written statement. I would be happy to

answer any questions you or your colleagues may have.

(935270) Page 14 GAO/T-AIMD-98-147
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