**AUDIT OF ADMINISTRATION OF**
**INVESTED FUNDS FOR THE**
**SERVICEMEN'S GROUP LIFE**
**INSURANCE AND VETERANS' GROUP**
**LIFE INSURANCE PROGRAMS**
***VA needs more financial information in orderto more closely supervise administration of invested funds.***
**Report No.:  7R1-B12-002**
**Date:  October 23, 1996**
**Office of Inspector General**
**Washington DC  20420**
**TABLE OF CONTENTS**
**Page**
**Memorandum to the Director, Insurance Service(29)**     i
**RESULTS AND RECOMMENDATION**
VA needs more financial information from
The Insurer to more closely supervise
administration of invested funds     1
Conclusion     6
Recommendation     6
**APPENDIXES**
**I**OBJECTIVES, SCOPE ANDMETHODOLOGY     9
**II**BACKGROUND   11
**III**MONETARY BENEFITSIN ACCORDANCE 
 WITH IG ACT AMENDMENTS   13
**IV**MEMORANDUM FROM THEUNDER SECRETARY
 FOR BENEFITS   14
**V**FINAL REPORT DISTRIBUTION  17

**Memorandum to the Director, Insurance Service (29)**
**Audit of Administration of Invested Funds for the Servicemen'sGroup Life Insurance and Veterans' Group Life Insurance Programs**
1.  The Office of Inspector General conducted an audit of theadministration of invested funds for the Servicemen's Group LifeInsurance (SGLI) and Veterans' Group Life Insurance (VGLI) programs. SGLI and VGLI are programs supervised by the Department of VeteransAffairs (VA), Veterans Benefits Administration (VBA), and administeredby a major insurance company hereinafter referred to as The Insurer. During Calendar Years (CYs) 1993 and 1994, The Insurer reported$32 million and $40 million of program earnings from investments,respectively.  The purpose of the audit was to assess the accuracy,reliability, and sufficiency of The Insurer's financial informationregarding SGLI and VGLI investment funds, and to determine whetheropportunities exist to enhance the management of invested funds. This audit is one in a series of audits performed of the SGLIand VGLI programs.
2.  We concluded that more information needs to be obtained aboutprogram financial operations to assess whether opportunities existfor improvement.  Our audit of the Insurer's financial recordsand reports showed that:- Investment expenses were deducted from income, and funds weretransferred to The Insurer without being reported to VA. Invested amounts were misstated, and were not periodicallyreconciled to program reserves.Audits were conducted of special interest issues, but didnot attest to annual financial conditions and results of operations.
- Specific provisions were not established governing the insureds'equity in investments and program reserves.  
3.  Governing legislation and provisions of the group insurancepolicy did not require The Insurer to report this financial informationto VA.  However, its absence impeded VA management's ability tofully assess the accounting of invested funds and program reserves,and determine whether program investment earnings could be enhanced. As a result of the audit, The Insurer is considering a restorationof $3.8 million to invested assets and a reimbursement of lostincome to the SGLI and VGLI programs' reserves******of$3***.***2 million.  The amounts of these reimbursementsare subject to further review by Insurance Service management.
4.  VBA insurance program management indicated that they wereaware of The Insurer's investment methodology and considered itsuperior to other methods used in the insurance industry.  However,they were not informed of the source and use of invested programfunds, nor did they consider investment portfolio management asan appropriate function within their program oversight.  Managementdid review reported rates of return credited to the SGLI and VGLIprograms in comparison to average rates reported by commerciallife insurance companies.  Management also instituted independentaudits of certain segments of program administration.  While theseassessments were useful in evaluating program adherence to industry-widepractices and earnings, they did not address the potential forincreased earnings.
5.  We recommend that the Director, Insurance Service, obtainmore information about program financial operations, and takeaction to verify the accuracy of The Insurer's accounting of SGLIand VGLI investment funds, to include:- having the Insurer provide annual reports fully disclosingSGLI and VGLI programs' funds invested as distinguished from programreserves, and identifying the source of annual changes to thesefunds.  - providing independent audits of financial presentations ofcondition and operations of the SGLI and VGLI programs.  - clarifying provisions with The Insurer concerning the insureds'ownership equity in investments, program reserves, earnings andextraneous program transactions.  - reviewing financial information to assess whether opportunitiesexist to enhance program earnings.  - determining whether The Insurer's estimate of previous interbranchcharges to program funds, including those described as  **"** Dividendsto Stockholders **"** , is reasonable, and whetherthe Insurer's proposed $3.8 million restoration to invested assetsand $3.2 million reimbursement to program reserves are equitable.  
6.  The Under Secretary for Benefits concurred with the recommendationand provided an acceptable implementation plan.  He plans to obtainadditional financial information from The Insurer, review thesedisclosures for opportunities to enhance program earnings, andimplement the other recommended improvements.  We consider allissues resolved and will follow up on the implementation of correctiveactions planned.
           For the Assistant Inspector General for Auditing
        [Signed]
       THOMAS L. CARGILL, JR.
      Director, Bedford Audit Operations Division
**RESULTS AND RECOMMENDATIONS**
**VA Needs More Financial Information From The Insurerto More**
**Closely Supervise Administration of Invested Funds**
More financial information needs to be obtained about the Servicemen'sGroup Life Insurance (SGLI) and the Veterans' Group Life Insurance(VGLI) programs' financial operations to enable the Departmentof Veterans Affairs (VA) to more closely supervise the administrationof invested funds.  Our audit of the Insurer's financial recordsand reports showed that:- Investment expenses were deducted from income, and funds weretransferred to The Insurer without being reported to VA. Invested amounts were misstated, and were not periodicallyreconciled to reserves.Audits were conducted of special interest issues, but didnot attest to annual financial conditions and results of operations.
- Specific provisions were not established governing the insureds'equity in investments and program reserves.  
Governing legislation and provisions of the group insurance policydid not require The Insurer to report this financial informationto VA.  However, its absence impeded VA management's ability tofully assess the accounting of invested funds and program reserves,and determine whether program investment earnings could be enhanced. As a result of the audit, The Insurer is considering a restorationof $3.8 million to invested assets and a reimbursement of lostincome to the SGLI and VGLI programs' reserves of $3.2 million. The amounts of these reimbursements are subject to further reviewby Insurance Service management.
**Background**
The SGLI and VGLI programs' group policy is the largest grouplife policy underwritten by The Insurer.  In policy year endedJune 30, 1993, the reserves held by The Insurer for the SGLI andVGLI programs ($344 million) far exceeded those reserves heldfor any other group policy***.*** Policy reserves area measure of the value of obligations to policyholders.  Mostassets held and invested by insurance companies support thesepolicy reserve liabilities.  In addition to policy reserves, thereare other liabilities for taxes, licenses, fees, etc.
Title 38 U.S.C., Chapter 19, Subchapter III, requires The Insurerto submit an annual accounting statement to VA.  That statementis to include the amounts of premiums actually accrued, the totalof all mortality and other claim charges, and the amounts of theinsurers' expense and risk charge.  In addition, the group policyrequires The Insurer to report the amount of premiums returnedto VA, and the amount of interest added to the Contingency Reserve. Neither Title 38 nor the provisions of the group policy providesdetailed guidance for VA's role of oversight in supervising TheInsurer's administration of the SGLI and VGLI programs' activitiesor programs' reserves.  The Insurer's responsibilities as programadministrator are based on the provisions of the above legislation,which include receiving premium payments, paying death claims,and submitting a Statement of Annual Accounting to VA.  Theseprovisions are also articulated in the group life insurance policyagreement with VA.  The Insurer's custody and investment of reservesand earnings are outlined in Article I, Section 7 of the policy,which states that the contingency reserve shall bear interestat a rate to be determined by The Insurer and approved by VA.
VA's selection of The Insurer, as prescribed in Title 38 U.S.C,Chapter 19, Subchapter III, is based on certain business volumeand financial size thresholds, without mandatory adherence togovernment procurement requirements.  Title 38 also provides thatVA will approve prospective interest rates for crediting to thecontingency reserve, as being consistent with rates generallyused by The Insurer for similar funds held under other group lifeinsurance policies.
**Investment Operations and Fund Transfers Were Not Reportedor Audited**
Our review of The Insurer's financial records and reports indicatedthat critical financial information, including deductions fromincome and assets, was not reported to VA.  Invested assets andsome reserves were not reported, nor were differences betweeninvestments and reserves reconciled.  Audits of these investmentoperations were not performed, and provisions were not establishedgoverning the insureds' program equity.  Governing legislationand provisions of the group insurance policy did not require TheInsurer to report this financial information to VA.  However,these information gaps impaired management's and the OIG's abilityto make sound assessments of investment performance and opportunitiesto enhance earnings.- The Insurer Deducted Investment Fees from Program InvestmentIncome, But Did Not Inform VA   
The Insurer routinely deducted investment management fees fromprogram investment income and did not inform VA.  Although notrequired to be reported, VA management should be informed of thesedeductions as they directly affect program income.  These feesamounted to $1.3 million or 4 percent of reported earnings inCY 1993, and $3.2 million or 8 percent of reported earnings inCY 1994.  Management fees represented internally allocated costsof The Insurer for real estate transfer costs, investment companysalaries, rents, etc.  These charges were deducted from earningsreported to VA, but were not itemized as expenses or deductionsin any documents routinely provided to VA.- The Insurer Transferred Program Funds from SGLI and VGLIFunds, and Did Not Inform VA   
The Insurer's records indicated that a series of transfers occurredduring CYs 1991, 1993 and 1994.  These transfers involved additionsto and deductions from the SGLI and VGLI programs' capital andsurplus account, amounted to $18.3 million, and were not reportedto VA.  Additional funds may have been transferred in years priorto CY 1991, which we did not review.  In July 1995, we requestedthe Insurer to explain these deductions, which were identifiedas meeting various objectives including ***"***dividendsto stockholders***"*** and ***"***interbranchtransfers***"***.  The Insurer's officials respondedthat these transactions were transfers of surplus funds betweencorporate accounts and SGLI and VGLI programs' funds.  As a resultof the audit inquiry, The Insurer provided documentation regardinga proposed estimated $3.8 million restoration of invested assetsand a $3.2 million reimbursement of lost income to the SGLI andVGLI programs' reserves.  These reimbursements are subject toreview and approval by VA.- Other Deductions and Transfers Were Made from Program InvestedAssets, and Not Reported To VA   
Federal income taxes and capital asset losses were deducted fromprogram assets and not reported to VA.  The Insurer routinelydeducted ordinary federal income tax (FIT) payments from programinvested assets, which amounted to $3.5 million in CY 1993 and$.7 million in CY 1994.  These taxes are commonly paid by lifeinsurance companies, and are computed by The Insurer's tax departmentbased on the proportion of SGLI and VGLI programs' earnings. Although provisions for payment of FIT are included in the groupinsurance policy (i.e. Article I, Section 7), they were not itemizedas deductions from program invested assets in any documents routinelyprovided to VA for CY 1994 and previous years.
Losses from capital asset transactions were also deducted fromprogram assets, and not reported as such to VA.  These capitaltransactions amounted to a gain of $6 million in CY 1993 and anet loss of $11.6 million in CY 1994 representing a net loss of$5.6 million for the 2 years.  Although amounts of capital gainsand losses were listed in a separate schedule in annual reportssubmitted to VA, they were not shown as adjustments to investedassets, as would be done in a cash flow statement.- Invested Assets and Some SGLI and VGLI Reserves Were NotReported to VA, Not Reconciled, and Were Misstated in The Insurer'sRecords   
The Insurer did not report the amounts of SGLI and VGLI programs'assets invested and some amounts of program reserves to VA, orreconcile differences in these funds.  SGLI and VGLI program assetsare coinvested with other assets in The Insurer's group life andhealth portfolio.  The Insurer's overall corporate portfolio consistsof over 93******percent fixed income securities (e.g.bonds) and less than 7 percent equities (e.g. common******stocks). An internal process***,*** called the net cash availableprocess, is used to allocate investment income to various productlines (e.g. group life) of The Insurer, including distributionto the SGLI and VGLI programs.  The Insurer did not periodicallyinform VA management of the amount of SGLI and VGLI assets invested($404.9 million and $564.7 million in CYs 1993 and 1994 respectively).
We found $78.6 million in reserves (13 percent of reserves) heldby The Insurer in CY 1995 which were not reported to VA in theyear-end financial reports.  These reserves were held primarilyas "supplementary contracts" for future payments tobeneficiaries.  Insurance Service officials were unsure of thepropriety of considering these funds as liabilities of the programor The Insurer.  They planned to clarify the issue with The Insurer.
There was also no reconciliation of differences between reservesand invested assets. The Insurer disclosed there had been a $109million overstatement of SGLI and VGLI invested assets for CY1993 due to computer miscodings.  This error remained unreportedfor 2 years.  We also observed an additional $55 million differencebetween SGLI and VGLI programs' invested assets and reserves asof December 31, 1993.  The Insurer reconciled this differenceto within $2 million, but indicated it was not able to totallyreconcile this variance, since records prior to 1982 were notreadily available.  This remaining variance between program assetsand reserves would have been resolved had a reconciliation beenroutinely performed and reported to VA.- Audits Were Performed of Special Interest Issues But DidNot Attest To Programs' Financial Condition   
Audits of the SGLI and VGLI programs were initiated by programofficials in 1987, and focused on special interest issues, butdid not evaluate financial statements of condition or operations. Three independent audits focused on restricted aspects of theSGLI and VGLI programs' administration expenses which averagedabout 2 percent of invested assets.  The remaining audit focusedon the conversion pool, which was about $44 million (6.8 percentof assets invested in CY 1995).  Audits of financial conditionand results of operations would better serve management in resolvingunreported deductions from program funds.
In summary, The Insurer's financial investment operations werenot fully disclosed to VA for the SGLI and VGLI programs.  VAmanagement was not apprised of critical financial data includingdeductions from program funds, amounts of invested assets andsegments of program reserves.  Although these reporting omissionsdid not violate governing program requirements, they impeded VAmanagement's ability to improve the financial operations of theSGLI and VGLI programs.
**Provisions Were Not Established Governing The Insured's ProgramEquity**
We discussed with VA Insurance Service management what the residualSGLI and VGLI insureds' equity would be in the event of programdissolution or change of insurer.  For example, at the end ofCY 1995, SGLI and VGLI programs' reserves totaled $608 million,while invested assets totaled $630 million.  Management was initiallyuncertain of this residual equity amount.  This question was alsonot clarified in governing legislation or the group policy.  Afterdiscussing this matter with the Insurer, VA management agreedthat the insureds' equity would be the amount of existing reserves,as distinguished from the amount of invested assets.  Nevertheless,clear, written documentation of this agreement is needed to avoidpotential conflict and litigation upon program dissolution orchange of insurer, and to resolve ownership of all program relatedfunds including those associated with "supplementary contracts"as discussed above.
**All Financial Information Was Not Available for Supervisionof the Program**
While impeded from assessing several aspects of the programs'financial investment operations, VA management determined thatearnings were comparable to those experienced in the insuranceindustry.  Insurance officials indicated they were aware of TheInsurer's investment methodology and considered it superior toother methods used in the insurance industry.  However, they werenot informed of the sources and use of invested program funds,nor did they consider investment portfolio management as an appropriatefunction within their program oversight.- Invested Funds and Investment Rates of Return   
VA insurance management judged program earnings as comparableto the industry-wide average net rate of investment return forcommercial life insurance companies.  According to management,this comparison usually indicated the SGLI and VGLI rate of returnwas about average, when compared to other U.S. life insurancecompanies.  This statistic is computed by the American Councilof Life Insurance, and involves 2,391 reserve life insurance companies. As an indication of how representative this earnings statisticis of the population of respective insurance companies (2,391),we obtained the composite range of rates from the Program Director,Statistical Research, American Council of Life Insurance.  Therate of investment return for individual companies in CY 1995ranged from a loss of -54.6 percent of invested assets to a gainof 289 percent of invested assets and, in our opinion, representeda spectrum too broad to be an optimal measurement criterion.
As an alternative baseline for comparing investment return, weanalyzed earnings of the 14 largest American life insurance companieswhich met minimum legislative criteria to administer the SGLIand VGLI programs. Their average rate of return for CY 1994 (7.28percent) was closely aligned with the SGLI and VGLI rate of return(7.16 percent), representing an insignificant difference (.12percent).  A comparison for CY 1993 revealed similar results,thus supporting the VA's conclusions regarding the comparabilityof program and industry-wide earnings.- Earnings May Be Enhanced Through Full Disclosure Reporting   
VA management was not able to assess the validity of all deductionsfrom program funds, as this information was not fully disclosedto them by The Insurer.  In addition, the basis used in calculatingthe investment rate of return (i.e. average reserves or investedassets) was also not reported to VA.  We believe that additionalanalysis of unreported deductions as well as the components usedin calculating the rate of return may provide further understandingof reported earnings and the potential for enhanced program earnings.
**Conclusion**
We concluded that more information needs to be obtained aboutprogram financial operations to assess whether opportunities existfor improvement.  While The Insurer fully complied with the contractand all applicable legal provisions regarding financial reporting,our audit showed that:- Investment expenses were deducted from income, and funds weretransferred to The Insurer without being reported to VA. Invested amounts were misstated, and were not periodicallyreconciled to program reserves.Audits were conducted of special interest issues, but didnot attest to annual financial conditions and results of operations.
- Specific provisions were not established governing the insureds'equity in investments and program reserves.  
The absence of critical financial information impeded VA management'sability to fully assess the accounting of invested funds and programreserves, and determine whether program investment earnings couldbe enhanced.  As a result of the audit, The Insurer is consideringa restoration of $3.8 million to invested assets and a reimbursementof $3.2 million of lost income to the SGLI and VGLI programs'reserves.  These amounts are subject to further review by InsuranceService management.
**Recommendation**
We recommend that the Director, Insurance Service, obtain moreinformation about program financial operations, and take actionto verify the accuracy of The Insurer's accounting of SGLI andVGLI investment funds, to include:- having the Insurer provide annual reports fully disclosingSGLI and VGLI programs' funds invested as distinguished from programreserves, and identifying the source of annual changes to thesefunds. providing independent audits of financial presentations ofcondition and operations of the SGLI and VGLI programs.
- clarifying provisions with The Insurer concerning the insureds'ownership equity in investments, program reserves, earnings andextraneous program transactions.  - reviewing financial information to assess whether opportunitiesexist to enhance program earnings.  - determining whether The Insurer's estimate of previous interbranchcharges to program funds, including those described as  **"** Dividendsto Stockholders **"** , is reasonable, and whetherthe Insurer's proposed $3.8 million restoration to invested assetsand $3.2 million reimbursement to program reserves are equitable.  
The monetary benefit associated with this recommendation is shownin Appendix III, page 13.
**Under Secretary for Benefits Comments**
The Under Secretary for Benefits concurred with our findings andrecommendation.  While noting that The Insurer has fully compliedwith the terms of the contract and all applicable legal provisionsregarding financial reporting, he stated that they have agreedto supply additional financial information and have done so forCalendar Year 1995.  He further stated that the financial informationprovided by The Insurer was sufficient to allow effective programmanagement, which included increased SGLI and VGLI programs' coverage,and revised premium scales for both programs.
However, he concurred with the need for expanding The Insurer'sfinancial disclosures, and stated that The Insurer has agreedto provide a balance sheet and a statement of cash flows in additionto the statement of program operations, and has furnished thisinformation for Calendar Year 1995.  In addition, he indicatedhaving requested and received an investment exhibit disclosingprogram investment expenses and rate of return information.  Also,he indicated plans to:  have the accuracy of these financial presentationsaudited annually, clarify the insureds' equity in program funds,and review financial disclosures for opportunities to enhanceprogram earnings, without being involved in investment portfoliodecisions.
The Under Secretary for Benefits also stated that The Insurer'sreport on erroneous transfers was being reviewed to confirm whetherthe recommended funds restorations ($3.8 million) and reimbursements($3.2 million) were both reasonable and equitable.  (See AppendixIV on pages 14 through 16 for the full text of the Under Secretary'scomments.)
**Office of Inspector General Comments**
The Under Secretary concurred with the recommendation and providedan acceptable implementation plan.  He plans to obtain additionalfinancial information from The Insurer, review these disclosuresfor opportunities to enhance program earnings, implement annualaudits of these financial statements, clarify insureds' ownershipequity, and confirm whether reimbursements for erroneous interbranchtransfers of program funds are reasonable and equitable. The UnderSecretary reiterated statements by The Insurer's officials thatthey have fully complied with the terms of the contract and allapplicable legal provisions regarding financial reporting.  Weagree with this position and have revised segments of this reportto emphasize that the Insurer was fully compliant with governingfinancial reporting requirements.  We consider all issues resolvedand will follow-up on the implementation of corrective actionsplanned.
**OBJECTIVES, SCOPE AND METHODOLOGY**
**Objectives**
The purpose of this audit was to assess the accuracy, reliability,and sufficiency of The Insurer's financial information regardingSGLI and VGLI investment funds, and to determine whether opportunitiesexist to enhance the management of invested funds.  This auditis one in a series of audits performed of the SGLI and VGLI programs.
**Scope and Methodology**
We audited SGLI and VGLI investment funds and related expenses,the adequacy of investment earnings, and the insureds' equityin invested assets and reserves.  The reserves amounted to $347million and $481 million in Policy Years ended June 30, 1993 and1994, respectively.
We evaluated the propriety of deductions (e.g. investment expenses,federal income taxes, and capital losses) by researching Title38 United States Code, and the SGLI and VGLI group insurance policy. We obtained and analyzed documents and reports concerning investmentrelated administrative expenses, federal income taxes, capitallosses, and transfers from SGLI and VGLI capital and surplus account. We tested the reliability of The Insurer's reports by comparingThe Insurer's internal reports of expenses/deductions to reportsroutinely provided to VA.  We compared the investment earningsof the SGLI and VGLI portfolio with the earnings of the life insuranceindustry as a whole, and also with the 14 largest life insurersin the United States.  We contacted the American Council of LifeInsurance in Washington D.C., and obtained information concerningrates of investment return.  We reviewed The Insurer's 'net cashavailable' method of allocating investment earnings, capital gainsand taxes.
We discussed these matters with responsible officials from TheInsurer, and The Insurer's investment company and tax department. We also discussed program equity with VA insurance and The Insurer'sofficials, and requested a reconciliation of SGLI and VGLI investedassets with SGLI and VGLI programs' reserves.
The Insurer appointed the SGLI and VGLI financial manager as theprimary point of contact during the audit to receive requestsfor information and provide explanations.  This contact obtainedinformation from primary sources within the company, and providedrequested information to us. Because of The Insurer's concernsabout safeguarding proprietary information and processes, we werenot afforded open access to, and we did not examine, primary sourcesof data, e.g. The Insurer's general ledger accounts, and the capitaland surplus account.  Because of this limitation, and the levelof reporting omissions which we noted during our examination,we are unable to provide assurance that we identified all materialtransactions which impacted SGLI and VGLI programs' reserves duringthe period of audit.  Nevertheless, nothing came to our attentionthat information was deliberately withheld.  Also, we did notperform actuarial studies to attest to the adequacy of the reserves.
The audit was conducted in accordance with generally acceptedgovernment auditing standards.
**BACKGROUND**
The Department of Veterans Affairs (VA), Veterans Benefits Administration(VBA), Regional Office and Insurance Center, at Philadelphia,Pennsylvania, supervises the administration of two life insuranceprograms by a major insurance company (The Insurer).
Effective September 29, 1965, the Uniformed Services-Group LifeInsurance Act (Public Law 89-214) established the Servicemen'sGroup Life Insurance (SGLI) program, which provided up to $10,000group life insurance to members on active duty in the uniformedservices (i.e., Army, Navy, Air Force, Marine Corps, Coast Guard,Public Health Service, and the National Oceanic and AtmosphericAdministration).  Over the years this coverage was broadened toinclude certain National Guard and Reserve personnel, and increasedto the maximum amount of $200,000.
The Veterans' Group Life Insurance (VGLI) program was establishedby the Veterans' Insurance Act of 1974 (Public Law 93-289) effectiveAugust 1, 1974, and currently provides 5-year term coverage, renewablefor life, in amounts ranging from $10,000 to $200,000.  This coverageis available to all veterans separated from active duty but onlyfor an amount equal to or less than their terminating SGLI programcoverage.  Beginning January 1, 1986, the VGLI program becameavailable to members of the Individual Ready Reserve and the InactiveNational Guard.
The SGLI program began and continues because service members wereunable to obtain life insurance from private companies with warfarecoverage at reasonable rates.  Additionally, Congress intendedto provide insurance benefits to service members' survivors anddependents especially during war time.  The intent of the VGLIprogram was to provide a low-cost life insurance policy to veteransduring their readjustment from military to civilian life.  TheInsurer administers the two insurance programs based on the provisionsof a group policy held by VA.  As of December 31, 1993, the SGLIand VGLI programs represented about 3 million and 335,946 insureds,respectively, with a face value of nearly $494.8 billion.  Premiumscollected for CYs 1993 and 1994 were $498 million and $486 million,respectively.  Death claims incurred were $519 million for CY1993 and $454 million for CY 1994.
The SGLI and VGLI programs' reserves are those amounts which,together with future premiums and interest, are retained to payfuture claims.  Thus, reserves are liabilities and represent obligationsto policyholders which stem from that portion of premiums notused immediately to pay policy claims or expenses.  Reserves heldfor the SGLI and VGLI programs totaled $347******millionand $481 million in the Policy Years (PYs) ended June 30, 1993and 1994, respectively.  Some major components of reserves forPY 1994 were:  expected VGLI mortality costs reserve ($250 million),reserve for pending SGLI and VGLI program death claims ($86 million),and reserve for SGLI and VGLI programs' unreported death claims($56 million).  The SGLI and VGLI group policy specifies thesereserves will earn a minimum rate of return prospectively guaranteedby The Insurer, and subject to an increase adjustment at yearend, depending on investment performance.
SGLI and VGLI programs' premiums and interest income, not immediatelyused to pay claims and expenses, are invested by The Insurer'ssubsidiary investment company to support reserve liabilities. These investments are commingled with cash receipts from TheInsurer's other group life and health customers, and investedprimarily in fixed income securities.  The Insurer's 'net cashavailable' process allocates investment income, expenses, gainsand losses to various product lines (e.g. group life) of The Insurer,including distribution to the SGLI and VGLI programs.  Averageinvested assets allocated to the SGLI and VGLI programs were $405million and $565 million in CYs 1993 and 1994, respectively. Net investment income earned on these assets was $32 million inCY 1993 and $40 million in CY 1994.
**MONETARY BENEFITS**
**IN ACCORDANCE WITH IG ACT AMENDMENTS**
**REPORT TITLE:** Audit of Administrationof Invested Funds for the  Servicemen's Group Life Insurance andVeterans' Group  Life Insurance Programs
**PROJECT NUMBER:**4R1-142
**Recommendation Category/Explanation  Better Use   Questioned**
**Number****of Benefits****of Funds****Costs**
            1 Improved Use of    $3.8 million1
 Resources.  Insurer's
 estimate of funds from
 erroneous transfers to
 be restored to invested
 assets.
            1 Potential Recovery.    $3.2 million1
 Insurer's estimate of 
 lost income to be 
 reimbursed to program
 reserves.
1Insurer officials provided their analysis to VA aftercompletion of our examination.  These proposed reimbursementsare subject to review and approval by VA.
**MEMORANDUM FROM THE UNDER SECRETARY FORBENEFITS**Department of 
Veterans AffairsMemorandumDate:September 20, 1996
From: Deputy Under Secretary for Benefits (201)
Subj:Draft Report, Audit of Administration of Invested Funds for the 
Servicemen's Group Life Insurance and Veterans' Group Life Insurance Programs
To:Assistant Inspector General for Auditing (52)
1.  We have reviewed your draft report concerning the administration of invested funds for the Servicemen's Group Life Insurance (SGLI) and Veterans' Group Life Insurance (VGLI) programs.  We concur with your findings and your recommendation, but would like to clarify and elaborate on a few points.
2.  With regard to your recommendation, it should be noted that the Insurer has fully complied with the terms of the contract and all applicable legal provisions regarding financial reporting.  For your information we have attached a copy of the Insurer's comments to us regarding your report.  In their comments, they emphasize the point that they have been fully compliant with the group policy contract provisions.  They have agreed to supply us with the additional financial information, and have already done so for calendar year 1995.
3.  We would also like to put the scope of financial reporting into context.  That is, in recent years the CFO Act and similar legislation has required increased financial disclosure and accountability.  Nevertheless, the financial information provided by the Insurer has been sufficient to allow effective management of the program.  In each year since the origin of the program, the Insurer has provided us with a Statement of Annual Accounting, as required under the contract.  This is our primary source of financial information regarding program operations and program reserves.  It has enabled us to effectively manage the financial operations of the SGLI and VGLI programs.  In recent years, such management has included the quadrupling of SGLI coverage, the extension of the VGLI program from five year coverage to lifetime coverage, and the revision of premium scales for both the SGLI and VGLI programs.  The Statement of Annual Accounting also includes an investment exhibit and a schedule of capital gains and losses since the origin of the program.VA Form 2105
Mar 1989

**MEMORANDUM FROM THE UNDER SECRETARY FORBENEFITS**2.
Assistant Inspector General for Auditing (52)
4.  While the Statement of Annual Accounting has been the primary tool for the financial management of the group life insurance programs, we concur that it does not provide the extensive financial disclosure that the Comptroller General has required Government agencies to provide in their financial statements.  As is the case for most annual report presentations, including our internal CFO statements, the statement of operations should also be accompanied by a balance sheet and a statement of cash flows.  The Insurer has agreed to provide these statements and has furnished such for calendar year 1995.  In addition, an investment exhibit disclosing program investment expenses and rate of return information has been requested and provided.  We believe that the provision of these additional statements by the Insurer should satisfactorily address the first two findings in your report.
5.  The third issue concerns the formal auditing of these financial statements and exhibits.  We plan to address this issue by having the Insurer bring in an independent auditor to certify the accuracy of these financial presentations each year.  The audit report also expressed concern that further written clarification is needed concerning the insureds' equity in program funds in the event of program dissolution or change of insurer.  While we are confident that the Insurer and VBA officials had a clear understanding of this issue, we plan to provide such clarification as part of the next set of contractual revisions with the Insurer.  In the meantime, we will pursue an exchange of letters of understanding with the Insurer so that written documentation of our agreement will be available.
6.  With the additional financial disclosure that the Insurer has agreed to provide each year, we believe that we will be in a position to address that part of your recommendation that we review such information to determine whether opportunities exist to enhance program earnings.  This additional reporting will better enable us to review program asset allocation, as well as changes to such allocation resulting from program operations, capital gains and losses, federal income taxes and credits, and investment management expenses.  This type of review could lead to specific areas of investigation that may afford opportunities for improved program earnings.  We want to clarify, however, that does not mean that Insurance program managers should or will be involved in investment portfolio decisions.  We do not believe that is an appropriate function for program managers under the current statutory arrangement, which requires that the program's assets be invested similarly to the Insurer's other large group policies.

**MEMORANDUM FROM THE UNDER SECRETARY FORBENEFITS**
3.
Assistant Inspector General for Auditing (52)
7.  Regarding the final finding, on the guaranteed rate of return, although we agree that the Insurer did not disclose the basis of the guaranteed rate of return, we did not and do not consider that significant.  In fact, we have a unique agreement with the Insurer that benefits servicemembers.  Namely, instead of crediting the program with the guaranteed rate of return as they do with other group policies, the SGLI program receives the actual rate of return, which has always been higher than the conservatively calculated guaranteed rate of return.
8.  The final portion of your recommendation concerned some erroneous transfers that were made by the Insurer from program allocated assets in recent years.  The Insurer has investigated these transfers and has furnished us with a formal report of their findings.  This report recommends a restoration of $3.8 million in allocated assets and a reimbursement to the program of $3.2 million of lost investment income that resulted from these errors.  It appears that these figures are accurate and the Insurer has agreed to the restoration and reimbursement.  We are now reviewing these findings to confirm that their resolution of this matter is both reasonable and equitable.
9.  We appreciate your interest on behalf of the group life insurance programs.  Questions may be referred to Mr. Paul Koons, Assistant Director for Insurance, telephone (215) 381-3029.
      [Signed]
      Stephen L. Lemons
Attachment

**FINAL REPORT DISTRIBUTION**
**VA Distribution**
Secretary (00)
General Counsel (02)
Under Secretary for Benefits (20A11)
Assistant Secretary for Management (004)
Assistant Secretary for Policy and Planning (008)
Chief Financial Officer (24)
Deputy Assistant Secretary for Congressional Affairs (60)
Deputy Assistant Secretary for Public Affairs (80)
Director, Office of Management Controls (004B)
Director, Insurance Service (29)
**Non-VA Distribution**
Office of Management and Budget
U.S. General Accounting Office
**Congressional Committees:**
  Chairman, Senate Committee on Governmental Affairs
  Senate Ranking Minority Member, Committee on Governmental Affairs
  Chairman, Senate Committee on Veterans' Affairs
  Senate Ranking Minority Member, Committee on Veterans' Affairs
  Chairman, Senate Committee on Appropriations
  Chairman, House Committee on Appropriations
  Chairman, Subcommittee on VA, HUD, and Independent Agencies,Senate Committee
      on Appropriations
  Senate Ranking Minority Member, Subcommittee on VA, HUD, andIndependent
     Agencies, Committee on Appropriations
  Chairman, House Committee on Government Reform and Oversight
  House Ranking Minority Member, Committee on Government Reformand Oversight
  Chairman, House Committee on Veterans' Affairs
  House Ranking Minority Member, Committee on Veterans' Affairs