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[House Hearing, 106 Congress]
[From the U.S. Government Printing Office]

 
                 WASTE, FRAUD, ABUSE, AND MISMANAGEMENT

=======================================================================

                                HEARINGS

                               before the

                       TASK FORCE ON DEFENSE AND
                        INTERNATIONAL RELATIONS

                                 of the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             SECOND SESSION

                               __________

        HEARINGS HELD IN WASHINGTON, DC: JUNE 22 & JULY 20, 2000

                               __________

                            Serial No. 10-5

           Printed for the use of the Committee on the Budget

                               __________

                    U.S. GOVERNMENT PRINTING OFFICE
65-268                     WASHINGTON : 2000

                        COMMITTEE ON THE BUDGET

                     JOHN R. KASICH, Ohio, Chairman
SAXBY CHAMBLISS, Georgia,            JOHN M. SPRATT, Jr., South 
  Speaker's Designee                     Carolina,
CHRISTOPHER SHAYS, Connecticut         Ranking Minority Member
WALLY HERGER, California             JIM McDERMOTT, Washington,
BOB FRANKS, New Jersey                 Leadership Designee
NICK SMITH, Michigan                 LYNN N. RIVERS, Michigan
JIM NUSSLE, Iowa                     BENNIE G. THOMPSON, Mississippi
PETER HOEKSTRA, Michigan             DAVID MINGE, Minnesota
GEORGE P. RADANOVICH, California     KEN BENTSEN, Texas
CHARLES F. BASS, New Hampshire       JIM DAVIS, Florida
GIL GUTKNECHT, Minnesota             ROBERT A. WEYGAND, Rhode Island
VAN HILLEARY, Tennessee              EVA M. CLAYTON, North Carolina
JOHN E. SUNUNU, New Hampshire        DAVID E. PRICE, North Carolina
JOSEPH PITTS, Pennsylvania           EDWARD J. MARKEY, Massachusetts
JOE KNOLLENBERG, Michigan            GERALD D. KLECZKA, Wisconsin
MAC THORNBERRY, Texas                BOB CLEMENT, Tennessee
JIM RYUN, Kansas                     JAMES P. MORAN, Virginia
MAC COLLINS, Georgia                 DARLENE HOOLEY, Oregon
ZACH WAMP, Tennessee                 KEN LUCAS, Kentucky
MARK GREEN, Wisconsin                RUSH D. HOLT, New Jersey
ERNIE FLETCHER, Kentucky             JOSEPH M. HOEFFEL III, 
GARY MILLER, California                  Pennsylvania
PAUL RYAN, Wisconsin                 TAMMY BALDWIN, Wisconsin
PAT TOOMEY, Pennsylvania
                                 ------                                

           Task Force on Defense and International Relations

                CHRISTOPHER SHAYS, Connecticut, Chairman
MAC THORNBERRY, Texas, Vice          JAMES P. MORAN, Virginia,
    Chairman                           Ranking Minority Member
CHARLES F. BASS, New Hampshire       DAVID MINGE, Minnesota
JOSEPH PITTS, Pennsylvania           DARLENE HOOLEY, Oregon
JIM RYUN, Kansas                     TAMMY BALDWIN, Wisconsin
                                 ------                                

                           Professional Staff

                    Wayne T. Struble, Staff Director
       Thomas S. Kahn, Minority Staff Director and Chief Counsel

                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held in Washington, DC, June 22, 2000--Inefficiencies in 
  DOD's Health Care Claims Processing: The Need to Improve 
  Performance....................................................     1
    Statement of:
        H. James T. Sears, M.D., Executive Director, TRICARE 
          Management Activity, U.S. Department of Defense........    10
        Stephen P. Backhus, Director, Veterans' Affairs and 
          Military Health Care Issues, U.S. General Accounting 
          Office.................................................    16
        William J. Meyer, Senior Vice President of TRICARE, Blue 
          Cross-Blue Shield of South Carolina....................    22
    Prepared statement of:
        Hon. James P. Moran, a Representative in Congress from 
          the State of Virginia..................................     4
        Hon. Paul Ryan, a Representative in Congress from the 
          State of Wisconsin.....................................     5
        Hon. John M. Spratt, Jr., a Representative in Congress 
          from the State of South Carolina.......................     5
        Dr. Sears................................................    13
        Mr. Backhus..............................................    18
        Mr. Meyer................................................    25
                              ----------                              

Hearing held in Washington, DC, July 20, 2000--Pentagon Financial 
  Management: What's Broken, How to Fix It.......................    53
    Statement of:
        Hon. William J. Lynn, Under Secretary of Defense 
          (Defense) and Chief Financial Officer..................    56
        Robert J. Lieberman, Assistant Inspector General for 
          Auditing, U.S. Department of Defense...................    70
        Jeffrey C. Steinhoff, Assistant Comptroller General, 
          Accounting and Information Management Division, U.S. 
          General Accounting Office..............................    80
    Prepared statement of:
        Mr. Lynn.................................................    59
        Mr. Lieberman............................................    73
        Mr. Steinhoff............................................    83

  Inefficiencies in DOD's Health Care Claims Processing: The Need to 
                          Improve Performance

                              ----------                              

                        THURSDAY, JUNE 22, 2000

                  House of Representatives,
                           Committee on the Budget,
         Task Force on Defense and International Relations,
                                                    Washington, DC.
    The Task Force met, pursuant to call, at 10:05 a.m. in room 
210, Cannon House Office Building, Hon. Mac Thornberry (vice 
chairman of the Task Force) presiding.
    Members present: Representatives Thornberry, Shays, Buyer, 
Moran, Spratt, and McDermott.
    Mr. Thornberry. We are going to go ahead and get started. 
Mr. Moran is on his way and will join us shortly.
    Let me welcome our witnesses and guests. This is the eighth 
in a series of hearings held by the Budget Committee to 
identify management and financial improvements to make 
government agencies more efficient and effective. Of course, 
making the most out of each taxpayer dollar is important to all 
of us and I certainly appreciate Chairman Kasich's focus on 
those issues.
    Today, we are going to concentrate on improvements to the 
military health care system as part of an overall effort to 
improve quality of life for our military. Senior leadership at 
the Department of Defense and especially Chairman Shelton have 
committed themselves to making significant improvements in the 
TRICARE program. Unfortunately, the President's budget proposal 
this year did little to meet the full range of expectations 
which were created by the Chief's support.
    George Washington once said that the willingness with which 
our young people are likely to serve in any war, no matter how 
justified, shall be directly proportional as to how they 
perceive the veterans of earlier wars were treated and 
appreciated by their nation, and that, in sum, is the heart of 
the reason this issue concerns me, not just doing right by 
retirees but how we can get and keep top-quality people in the 
military.
    In May, the House passed a series of improvements in the 
Floyd Spence Defense Authorization Act to try to deal with a 
number of quality of life issues. Included in that was a 3.7 
percent pay raise, adding money for housing allowance, dealing 
with the food stamp issue, and a number of improvements dealing 
with health care. I am pleased today that on our panel the 
chairman of the Personnel Subcommittee of the Armed Services 
Committee, the gentleman from Indiana, Mr. Buyer, has joined 
us, because he is responsible for those improvements, as well 
as others which Congress has made over the past few years.
    Among other things, we learned during Chairman Buyer's 
hearings that inefficient claims processing and payment were 
among the most significant factors undermining the provider and 
beneficiary support of TRICARE. We also found that substantial 
savings could be gained by reducing the cost of processing 
military medical claims. It is a disturbing fact that the 
average cost to process a Medicare claim is $1.78 while the 
average cost to process a TRICARE claim gets close to $8. There 
are a variety of reasons for those differences we will be 
talking about today, but the bottom line is, we could save up 
to about $500 million over the next 5 years if we can improve 
the paperwork and processing costs.
    We are going to try to shed some light on the opportunities 
for those improvements and how managed care support contractors 
and DOD health officials can work together to reduce 
administrative requirements for TRICARE. I think the bottom 
line for all of us is that this money which is being used for 
administrative costs and paperwork could be used for health 
care, and that is certainly what we would prefer to have done.
    At this time, I would yield to the chairman of this task 
force, the gentleman from Connecticut, for any statement he 
would like to make.
    Mr. Shays. Thank you, Mr. Chairman. I also welcome our 
witnesses and guests.
    Last year, I sat down with a squadron of F-15 pilots at 
Hurlbert Air Force Base in Florida and asked what was on their 
minds. I expected to hear about spare parts shortages, distress 
at their high operational tempo, and the need for fighter 
aircraft modernization. But the conversation that followed was 
dominated, I have to say overwhelmed, by complaints about the 
Department's health care program, TRICARE. They described 
difficulties making appointments, confusing coverage rules, 
delayed payments, and denied claims. They described anguished 
late-night telephone conversations with spouses and children 
calling from the other side of the world, pleading for help 
navigating the torturous TRICARE bureaucracy.
    So when the task force vice chairman, Congressman 
Thornberry, suggested we focus our first hearing on 
inefficiencies in DOD health care, I concurred eagerly because 
wasted TRICARE dollars affect so much more than just the fiscal 
bottom line. Improving TRICARE claim processing and customer 
service improves the quality of life for millions of service 
members and their families. An efficient, responsive health 
care system contributes to military readiness and sustains 
morale. Military recruits need to be able to tell TRICARE 
success stories, not TRICARE horror stories.
    When a prospective volunteer in today's competitive job 
market says, how is your health care plan, how is the DOD 
health plan, according to the General Accounting Office [GAO], 
TRICARE is too complex, but reluctant to standardize coverage 
rules for fear of further alienating an already diminishing 
pool of providers. The price of excess complexity is paid in 
scarce health care dollars as paper claims clog the system and 
fraudulent vendors manipulate the byzantine payment process to 
their advantage.
    As the former chairman of an oversight subcommittee with 
jurisdiction over Federal health care programs, I am reluctant 
to cast the Medicare program as a role model of efficiency and 
responsiveness. In many ways, I think a comparison between 
claims processing costs in the two systems is apt, but TRICARE 
could emulate recent steps by the Medicare program to 
streamline claims through electronic processing, standardized 
vendor identification numbers, and systematically review high-
risk claims for fraud. DOD should also evaluate the benefits of 
joint purchasing and closer integration with the Department of 
Veterans Affairs, VA, health programs.
    I look forward to the testimony of our witnesses this 
morning on these important issues and also welcome our 
colleague, Mr. Buyer, who is clearly in the center of this 
issue, as well as Mr. Spratt, who has always been a 
constructive force on this Budget Committee.
    Mr. Thornberry. I now recognize the distinguished ranking 
member of the full committee and member of the Armed Services 
Committee, the gentleman from South Carolina.
    Mr. Spratt. Thank you, Mr. Chairman, and thank you for 
convening this important hearing. I would like to welcome our 
three distinguished witnesses, Dr. Sears from the Department of 
Defense, Steve Backhus from the GAO, and William Meyer, 
Palmetto Government Benefits Administrator--a long name, but a 
very important company with a very, very impressive record of 
insuring stewardship in the management of our health care 
assets, both in Medicare and in TRICARE.
    This particular hearing will focus on TRICARE, and I think 
that is extremely important. It is an important program that is 
not working as well as it should and must, and there are a 
number of problems with it and one is the cost of processing 
claims. The cost of processing claims for TRICARE exceeds the 
amount that we pay for Medicare and we need to know why. I 
think it has something to do with the implementation of the 
whole TRICARE program. I rather suspect that we have 
underestimated the cost of the TRICARE program providing the 
quality of care that our service members not only have a right 
to expect, they have earned the right to that kind of care.
    And furthermore, as we have tried to in the Congress 
improve TRICARE, we have probably increased the burdens, the 
demands upon this particular system. If the House proposal 
which we have passed in the defense authorization bill goes 
through or if the Senate proposal goes through, for example, in 
the Senate, they are proposing that all retirees have the 
option once they are in TRICARE, TRICARE Prime, of staying in 
TRICARE Prime past the age of 65. I think they should have that 
right. I think they earned that right. But if that happens, 
that is nearly two million additional retired service members 
who will be imposing additional demands upon the system and we 
need to know, are we adequately providing for the 
administration of this system? Why does it cost so much to 
process these claims?
    Mr. Meyer, I think you will tell the committee today that 
your organization at times has had its own substantial backup 
with the Department of Defense where you have processed 
numerous claims and had outstanding receivables for the payment 
of U.S. services that simply have not been paid in a timely 
fashion by the Department of Defense. We need to get to the 
bottom of this if we are going to get to the bottom of the 
problems of TRICARE, and I think this is critically important.
    I am delighted we are having this hearing. I have a much, 
much longer statement which I think is pertinent but I will not 
try the patience of the committee. Let us get on to the 
substance of it. Mr. Chairman, I would like to offer this for 
the record.
    Mr. Thornberry. Without objection, any written statement 
members would like to make will be made a part of the record.
    [The prepared statements of James Moran, Paul Ryan, and 
John Spratt follows:]

Prepared Statement of Hon. James P. Moran, a Representative in Congress 
                       From the State of Virginia

    Mr. Chairman, I want to thank you for scheduling today's hearing on 
TRICARE claims processing. I look forward to the testimony of our 
witnesses and greatly appreciate your willingness to allow me to submit 
my statement for the record.
    As you know from my involvement on this Committee and on the 
Defense Appropriations Subcommittee, providing quality, affordable 
health care for our nation's military personnel, their families and 
retirees is an issue I have followed closely during my years in 
Congress.
    It is especially important now as we grapple with difficulties in 
recruitment and retention of our military men and women. It is critical 
that this Congress not only provide adequate health care for our active 
duty personnel, but that we ensure that our nation's military 
retirees--especially the 1.4 million Medicare-eligible military 
retirees--have more health care options.
    In the past few Congresses, I have introduced legislation granting 
Medicare eligible military retirees the option of participating in the 
Federal Employees Health Benefits Program. I introduced the Health Care 
Commitment Act because I am deeply concerned that military retirees, 
particularly once they become eligible for Medicare, are being denied 
access to health care. Medicare-eligible retirees are denied access to 
CHAMPUS. They are prohibited from participating in TRICARE. They are 
also effectively shut out of military medical treatment facilities 
because they are placed last on the priority list for receiving care.
    In effect, we have created a system where military retirees, once 
they reach the point in life where they need health care the most, are 
given the least from their former employer. This does not happen in the 
private sector and does not happen to Federal civilian retirees. Having 
a large number of constituents who are military retirees, I am familiar 
with the enormous difficulties that many retirees experience in 
accessing affordable health care, especially at a time when they need 
it most.
    I have worked with Congressman Spratt, Shows, Norwood and 
Cunningham, among others, on a variety of legislation aimed at 
providing better care for military retirees over age 65. The budget 
resolution offered by House Democrats was the first vehicle considered 
on the House floor this year to address this issue and include $16.3 
bullion over 10 years to improve health care for Medicare-eligible 
military retirees.
    While we could spend an entire hearing on health care options for 
our nation's military retirees, this hearing will concentrate on 
TRICARE claims processing.
    In hearings held earlier this year by the Military Personnel 
Subcommittee of the House Armed Services Committee, there were several 
stories of unacceptable delays in TRICARE claims processing. In some of 
these cases, providers turned to the military beneficiary to seek 
payment for services rendered. This frustrates many service members and 
is a burden in particular for those that are deployed overseas. Even 
worse, as the service members tried to get TRICARE to pay and the bill 
went unpaid, the credit ratings of some service members suffered. So, 
prompt payment of claims is directly linked to quality of life and the 
morale of our troops.
    While today's hearing will touch on the quality of claims 
processing, it will mostly focus on the cost of TRICARE claims 
processing. The Military Processing Subcommittee received testimony 
that the average cost of processing a TRICARE claim was between $8.00 
and $15.00. Even the lower end of this range is substantially more than 
what it costs the Health Care Finance Administration to process 
Medicare claims.
    It is my understanding that we will hear testimony today that the 
delays in claims processing occurred primarily in the mid-1990's when 
TRICARE was first being established and that the most recent surveys 
indicate that TRICARE contractors are meeting or close to meeting the 
major deadlines for claims processing.
    While I expect that witnesses today will also testify that many of 
the criticisms of TRICARE processing costs are inflated or based upon 
unfair comparisons to less complex claims, it is my hope that we can 
all agree that more can be done and commit to making TRICARE more user 
friendly and efficient.
    Thank you for this opportunity to discuss such an important issue 
to our nation's 8.2 million active duty personnel, their dependents, 
and retirees. I look forward to hearing the testimony of our witnesses 
and any recommendations on how we can continue to improve the current 
system in order to achieve greater efficiencies and cost-savings.

Prepared Statement of Hon. Paul Ryan, a Representative in Congress From 
                         the State of Wisconsin

    Mr. Chairman, I would like to bring some inefficiencies of the 
TRICARE system to the attention of the members of the Task Force. Many 
of my constituents rely on TRICARE for their health care services--yet 
this program has repeatedly proven to be inefficient and ineffective, 
leaving my constituents and I with little recourse.
    TRICARE is a regionally managed health care program for active duty 
and retired uniformed service members and their families. According to 
their website, TRICARE is being implemented as a way to: provide 
faster, more convenient access to civilian health care; create a more 
efficient way to receive health care; and control escalating costs.
    In my experience with TRICARE, this has certainly not been the 
case. There have been a number of cases where I have assisted 
constituents who had problems with TRICARE, of which two took over 5 
months to resolve.
    The first case had over 20 claims submitted that were either paid 
incorrectly or not processed by TRICARE before the constituent 
contacted our office. When my office inquired as to why this was the 
case, TRICARE stated that clerical error was the cause of a number of 
the errors--for example, registering the health care expense as $10 
instead of $100. TRICARE could not explain why the remaining claims 
were not processed.
    Another case showing the inefficiencies of TRICARE included a 
situation where thousands of dollars in claims were processed 
incorrectly by TRICARE because Region 5 was not aware of changes in 
Federal law under the National Defense Authorization Act for FY '99. 
P.L. 105-261 was Federal law for more than a year prior to my inquiry. 
TRICARE repeatedly denied claims because of this--even during our 
inquiry.
    These are just two examples of how the current TRICARE system has 
let down constituents in Southeastern Wisconsin. I have dealt with this 
program in countless other cases and I have found similar results.
    I commend Chairman Shays and the Task Force for looking into this 
very real and pressing problem in our armed services today. Our 
military personnel deserve better health care than they are presently 
receiving and taxpayers should not be forced to pay for these 
inefficiencies.
    Our service men and women should not have to wait 5 months to 
settle their health care claims. I look forward to working with you, 
Mr. Chairman and members of this Task Force, to put an end to this.

  Prepared Statement of Hon. John M. Spratt, Jr., a Representative in 
               Congress From the State of South Carolina

    I want to thank you, Mr. Chairman, for convening this hearing, and 
welcome our three distinguished witnesses: Dr. James Sears, from the 
Department of Defense; Stephen Backhus, from the General Accounting 
Office; and William Meyer, of Palmetto GBA, from my own state of South 
Carolina.
    This hearing is about one aspect of DOD health care, but I want to 
use this opportunity to make a larger point: we must provide better 
health care for military retirees once they reach age 65. I serve on 
both the Budget Committee and the Armed Services Committee, and I hear 
a lot about how military retirees are no longer encouraging young 
people to enlist. This red-hot economy is making recruitment and 
retention difficult enough. We do not need more disincentives to 
military service. General Henry Shelton, Chairman of the Joint Chiefs 
of Staff, agrees. He testified that guaranteeing lifetime health care 
is important not only to keep the promises made to those who dedicated 
their careers to military service, but also to attract and retain good 
people today. Providing health care to military retirees age 65 and 
over is an issue this Congress should tackle this year.
    Today's hearing is on TRICARE claims processing. TRICARE is the 
Department of Defense's health care system. It is called TRICARE 
because it offers three options; an HMO option, a preferred-provider 
option, and a fee-for-service option. TRICARE uses a network of 
civilian health care providers to complement the DOD's own hospitals 
and clinics to provide health care to active-duty personnel and their 
dependents, and eligible military retirees and their dependents.
    Currently, TRICARE is not available to military retirees who are 
eligible for Medicare. So when military retirees turn age 65, they can 
no longer obtain TRICARE. Since the military has downsized and the 
population of military retirees has grown and is still growing, it is 
difficult for most retirees over age 65 to get treatment at military 
facilities, even on a ``space-available'' basis, which is the only 
health care option now open to them. These retirees spend much of their 
adult lives in the military health care system, and get to know the 
doctors at the base and in the network where they retire. Then they 
turn 65, and in most cases, they have to establish new relations with 
new doctors at an age when continuity of care is extremely important.
    The budget resolution offered by House Democrats was the first 
vehicle considered on the House floor this year to address this issue. 
We included $16.3 billion over 10 years to improve health care for 
Medicare-eligible military retirees. In part because of the impetus of 
the Democratic budget, the House and Senate Defense Authorization bills 
both propose extending DOD health care to military retirees, but do so 
in different ways. The House bill proposes expanding Medicare 
Subvention, where Medicare reimburses DOD for providing health care to 
Medicare-eligible military retirees, much as it reimburses private 
sector health care providers. Rep. Gene Taylor offered this provision 
as an amendment on the House floor. The Senate bill would allow 
military retirees age 65 and older to stay enrolled in TRICARE.
    TRICARE is the successor to Civilian Health and Medical Program of 
the Uniformed Services, or ``CHAMPUS.'' It began in the mid-1990's, and 
frankly, it has had growing pains. One of the growing pains is claims 
processing. There have been stories of claims being held up for long 
stretches of time. In these cases, some providers have turned to the 
military beneficiary to seek payment for services rendered. This 
frustrates many service members, and if you are overseas on deployment, 
it can be a real headache to deal with. Even worse, as the service 
members tried to get TRICARE to pay and the bill went unpaid, the 
credit ratings of some service members suffered. So, prompt payment of 
claims is directly linked to quality of life, and when we have trouble 
recruiting and retaining our soldiers, sailors, airmen, and marines, 
this is important.
    Today we will likely receive testimony that there have been 
improvements in the quality of claims processing, and so we will focus 
even more on costs. There have been allegations that TRICARE is 
inefficient in processing claims in comparison to Medicare. In truth, 
TRICARE claims do cost more to process. This hearing will explore why 
that is, and what steps can be taken to reduce the cost of TRICARE 
claims management.
    This is important for several reasons. First, the less we have to 
spend on claims processing, the more we have to spend on health care. I 
am from South Carolina and I represent Shaw Air Force base. I can tell 
you that TRICARE has a hard time signing up providers in my state. If 
we had more money to offer, we could induce more providers into the 
TRICARE network. In addition, the more we can standardize forms to make 
them easier to process, and the better TRICARE is in making prompt 
payments, the more doctors we can attract. This will make life better 
for active duty troops, eligible military retirees, and the families of 
both. TRICARE processed 32 million claims in 1999; if we could save $2 
per claim, we could have up to $64 million more to spend on improving 
the TRICARE networks, particularly in areas like South Carolina.
    Second, we may end up adopting the Senate provision to open up 
TRICARE to military retirees age 65 and older, and their dependents. 
That would bring in about 1.4 million eligible beneficiarees into the 
TRICARE system, and with them, many more claims. We have to get TRICARE 
claims costs down and make that process more efficient if we open up 
TRICARE to all military retirees.
    The hearing today is just one subset of the DOD health care issue, 
but it is an important one. While claims processing has not gotten the 
attention that the question of health care for military retirees has 
gotten, it is part of the equation. If we can reduce costs here, it 
frees up resources sorely needed for our active duty troops and our 
military retirees. I look forward to the testimony of our witnesses.

    Mr. Thornberry. The chair would now recognize the 
distinguished ranking member on the task force, the gentleman 
from Virginia, Mr. Moran.
    Mr. Moran. Thank you very much, Mr. Thornberry. Nice to see 
you. I want to thank you for scheduling today's hearing, Mr. 
Shays, Mr. Thornberry, and thank you, Mr. Buyer, for being 
here, and, of course, our ranking member of the full Budget 
Committee, Mr. Spratt.
    This is an important issue. There are few more important 
issues than providing quality, affordable health care for our 
nation's military personnel, their families, and retirees, 
because unless we do it, the quality of our military capability 
is going to suffer greatly. This is one of the biggest issues 
in terms of recruiting quality personnel.
    It is especially important now as we grapple with 
difficulties in recruitment and retention because the viability 
of the TRICARE system is in question. I probably get more 
complaints about military health care and TRICARE and retirees' 
health care than anything else. Now, that may partly be a 
function of my district, but I suspect that it cannot be a 
unique problem. There are 1.4 million Medicare-eligible 
military retirees and the Congress's attempt to provide 
adequate health care for them that is accessible and affordable 
has been one of the more controversial issues we have had to 
deal with.
    In the past few Congresses, I have introduced legislation 
granting Medicare-eligible military retirees the option of 
participating in the Federal Employees Health Benefits Plan. I 
introduced a Health Care Commitment Act because I was concerned 
the military retirees, once they become eligible for Medicare, 
are being denied access to health care, given the fact that 
they do not have CHAMPUS available to them any longer. They are 
prohibited from participating in TRICARE and they are 
effectively shut out of the military medical treatment 
facilities because they are on the very bottom of the priority 
list for receiving care.
    In effect, we have created a system where military 
retirees, once they reach the point in life where they need 
health care the most, are given the least from their former 
employer. We are the only large employer that does not provide 
health care as a benefit to its employees, that is, the 
Department of Defense military personnel.
    Having a large number of constituents who are military 
retirees, I can relate to their problems and I think it is 
something that we are ultimately going to fix, but it is going 
to cost a great deal of money. The bill that was most recently 
considered on the floor that was sponsored by Mr. Spratt, Mr. 
Shows, Congressmen Norwood and Cunningham, as well, would have 
cost $16 billion over 10 years.
    We can spend an entire hearing on health care options for 
retirees, but this is going to be primarily on TRICARE claims 
processing. There have been unacceptable claims in the claims 
processing for TRICARE. It has frustrated many service members 
and it is a particular burden for those deployed overseas. Even 
worse, as the service members tried to get TRICARE to pay and 
the bill went unpaid, the credit rating of many service members 
suffered. So prompt payment of claims is directly linked to the 
quality of life and morale of our troops.
    While today's hearing will touch on the quality of claims 
processing, it will also focus primarily on the cost of that 
processing. The Military Personnel Subcommittee received 
testimony that the average cost of processing a TRICARE claim 
was between $8 and $15. Even the lower end of this range is 
substantially more than what it costs the Health Care Financing 
Administration, HCFA, to process Medicare claims.
    It is my understanding that we are going to hear testimony 
today that the delay in claims processing occurred primarily in 
the mid-1990's, when TRICARE was first being established, and 
that the most recent surveys indicate that TRICARE contractors 
are meeting or close to meeting the major deadlines for claims 
processing. I suspect the witnesses are also going to testify 
that many of the criticisms of TRICARE processing costs are 
inflated or based upon unfair comparisons to less-complex 
claims.
    I hope we can all agree that more can be done and that we 
will commit to making TRICARE more user friendly and efficient. 
It is as important an issue as there could be to the 8.2 
million active duty personnel, their dependents, and retirees, 
and so I am glad we are having the hearing. With that, I will 
conclude my statement. Thank you, Mr. Chairman.
    Mr. Thornberry. Thank you.
    The chair recognizes the gentleman from Indiana, Chairman 
Buyer, for any comments you would like to make.
    Mr. Buyer. Thank you, Mr. Chairman, for the courtesy 
extended by inviting me to participate with you and other 
members during the examination of the cost of TRICARE claims 
processing. I also appreciate the kind remarks you extended to 
the Military Personnel Subcommittee of the House Armed Services 
Committee on the whole area of military health care benefits. 
There are very real and tangible benefits from the excellent 
bipartisan working relationship Mr. Abercrombie and I enjoy.
    With regard to comments by the ranking member, Mr. Moran, 
he is very accurate in describing the 1.4 million retirees. We 
have to be very careful, I would say, in our language about 
what occurred on the House floor with regard to Mr. Taylor's 
bill with Medicare subvention, because the reality is we only 
have so much limited space, we only double the number covered 
by the Medicare subvention program from 30,000 to 60,000. So 
there is this unreal expectation out there among the force that 
I am going to be deriving a very real benefit and it is not 
going to be there.
    We are going to work through this one, though. That is the 
good story here. And Mr. Spratt's comment about moving toward 
what the Senate has done, the Warner provision of saying when 
you turn 65, you really sort of stay in the TRICARE that you 
have, I am moving toward my own personal belief, having worked 
on these issues now for 8 years, that I do not believe anything 
magically should happen to a soldier when they turn 65. Now, I 
know that there are some members who are really concerned that 
we did not have this vote on FEHBP. We need to be very careful 
about how we conduct our business here.
    So, Mr. Spratt, I enjoyed your comments on that because I 
think that is probably where we will end up going. The more we 
telegraph to whoever the next administration is going to be 
that when we put our arms around this one, the key here is that 
in 2003 as we prepare for the 2004 budget, there is going to be 
a large bill that could be $8 to $10 billion. So I enjoyed the 
gentleman's comments.
    The defense health program represents over $17 billion of 
the Department of Defense budget. About $4.7 billion of that 
now purchases care in the private sector through the TRICARE 
program. Included in the cost of the private sector care is the 
cost of the claims processing, which is estimated at $270 
million.
    Mr. Chairman, despite the fact that we already spend $17 
billion a year on the Defense health program, the program is by 
some estimates underfunded, so I would say, Mr. Spratt, you are 
completely accurate. The GAO, even though the DOD does not like 
to admit it, they are saying that it is by at least $6 billion 
over the next 5 years, so that is a stunning number.
    As a matter of fact, I want to share this with the Budget 
Committee, and this is completely another hearing. I believe 
that there is a problem in the modeling that the Department of 
Defense uses for the estimates of what their budgets should be. 
We have told them that year after year, but we still have those 
problems. So I just wanted to bring that to your attention.
    We need to invest our resources in purchasing benefits, not 
unnecessary administrative costs. We should also ensure that 
savings we achieve should be plowed back into this chronically 
underfunded program. The TRICARE claims processing system has 
lagged behind the health insurance industry. It frustrates our 
TRICARE contractors. It also lags behind Medicare in moving to 
more efficient claims processing, as all of you have said in 
your statements.
    I had directed that copies of several white papers that I 
have requested from not only the TRICARE managed support 
contractors but also that of the director of the TRICARE 
management activity, who we will be receiving testimony here 
today, were made available to the committee. These papers 
describe the faltering claims process that is in great need of 
modernization. In fact, our analysis indicated we might be 
wasting over $100 million a year as a result of the inefficient 
claims processing systems.
    During our hearings on removing the barriers to TRICARE, we 
received testimony from TRICARE providers, claims processors, 
beneficiaries, managed care support contractors and the TRICARE 
management agency and lead agents. We learned in our hearings 
that there was a broad agreement among these different 
stakeholders that the system as it now exists is outdated and 
inefficient. Too many providers claim that they are not being 
paid in a reasonable period of time. The administrative 
requirements go far beyond what other governmental systems, 
like Medicare, require. As a result, far too many providers 
either never become participating providers or they end their 
active participation with TRICARE. The managed care support 
contractors have had to operate in a claims processing 
environment one of them has described during the committee 
hearing as ``the best Model-T money can buy.''
    Mr. Chairman, we can do better and I think the Fiscal Year 
2001 National Defense Authorization Act goes a long way in 
resolving some of these concerns. I will not use a lot of my 
time detailing all the specific actions that we have taken, but 
in summary, we directed several very specific actions to 
improve claims processing and other business practice 
improvements to streamline and make user friendly all the 
TRICARE administrative systems.
    One of the lessons we learned in the white papers is the 
cost per claim and chance for errors are increased whenever a 
claim is manually processed. The more these systems can be 
automated, the more efficient they become. As a result, costs 
and costly errors are reduced through the whole system. 
Therefore, most of our initiatives were designed to facilitate 
improving or expanding automated claims processing in TRICARE. 
You can imagine the example of a doctor who wants to track a 
particular claim. He actually speaks to a person, and the more 
that person handles it, the more time is invested and it just 
escalates the cost.
    Mr. Chairman, the Fiscal Year 2001 National Defense 
Authorization Act, we picked much of what I would call the 
lower hanging fruit in our efforts to improve the TRICARE 
claims processing. However, I am confident that there are more 
opportunities for improvement, so I applaud the Budget 
Committee for choosing this as one of your subject areas to 
investigate.
    Ferreting out waste or abuse wherever it can be found is 
wise. It is part of why we are here to serve, to make sure that 
we spend our limited resources in the right way and exercise 
good judgments to move toward good government principles. I 
appreciate the opportunity to participate in this hearing and 
look forward to continuing to exchange information with our 
witnesses we have here today, and let me extend compliments to 
them because I enjoy the working relationship which we have put 
together on the National Defense Authorization Act, and I yield 
back my time.
    Mr. Thornberry. I thank the gentleman for his statements.
    I trust the witnesses get a feel for the importance members 
place on the military health care system and some of the 
frustrations we feel if money is being used in a way that is 
not as efficient and not as it is intended to be used.
    Without objection, each of you can submit written 
statements or whatever written materials you would like and 
they will be made part of the record.
    We will first hear from the senior leadership of the 
Defense health program, Dr. James Sears, Executive Director of 
the Department of Defense TRICARE Management Activity. Then we 
will hear from Mr. Stephen Backhus, Director of Veterans' 
Affairs and Military Health Care Issues for the General 
Accounting Office. Then we will hear from Mr. William J. Meyer, 
Senior Vice President for TRICARE, Blue Cross-Blue Shield of 
South Carolina.
    Dr. Sears, you may proceed.

   STATEMENT OF H. JAMES T. SEARS, M.D., EXECUTIVE DIRECTOR, 
       TRICARE MANAGEMENT ACTIVITY, DEPARTMENT OF DEFENSE

    Dr. Sears. Thank you, sir. Your concerns are ours.
    Mr. Chairman, distinguished members of the task force, I 
appreciate the opportunity to be here today to discuss the 
Department's progress in improving claims processing, 
timeliness, and accuracy, while at the same time implementing 
initiatives to reduce the costs associated with adjudicating 
claims.
    Before I address the issues, I want to acknowledge the 
support and positive working relationship we have with the 
House Armed Services Committee, with Mr. Buyer and his 
committee members, some of whom are on this task force. I also 
want to thank Representative Moran for his support as a member 
of the Defense Appropriations Committee.
    Oftentimes, the cost of adjudicating TRICARE claims is 
compared to that of Medicare. Unfortunately, the two programs 
are not comparable entities. By definition, Medicare is a 
single fee-for-service program. TRICARE is a triple-option 
managed care program. Managed care, by definition, is designed 
to assure the efficient use of health care dollars. Ensuring 
this, however, requires the expenditure of administrative 
dollars. Perhaps an example will help.
    We recently discovered in one of our regions a rate for 
caesarian sections that was six times the national average. 
Through effective utilization management techniques, including 
preauthorization and retrospective clinical claims review, we 
have successfully changed practice patterns and improved the 
quality of care for this procedure in that region, while 
concurrently reducing health care costs by approximately 50 
percent. This, however, minimally increased our administrative 
cost to conduct these clinical reviews.
    On the other hand, our work simplification and claims 
reengineering initiatives revealed that the utilization 
management effort associated with prenatal ultrasounds 
associated with these deliveries were resulting in the 
verification that these procedures were, in fact, being 
delivered appropriately. This led to our elimination of the 
government requirement to clinically review ultrasounds and the 
savings of associated dollars.
    Other differences between TRICARE and Medicare include the 
sheer number of citizens served by Medicare compared to the 
relatively small number of TRICARE beneficiaries. While 
Medicare processes nearly 900 million claims a year, TRICARE's 
32 million claims annually do not provide the economies of 
scale Medicare enjoys. Our relatively small volume, especially 
as compared to Medicare, and far more comprehensive program, 
inhibits our ability to dictate the business practices of the 
provider community.
    The volume differences between TRICARE and Medicare also 
significantly impact our ability to achieve the same level of 
electronic submissions as Medicare. Our providers typically 
submit fewer than 10 TRICARE claims a month. Conversely, 
Medicare typically accounts for as much as 50 percent or more 
of a provider's income. There is simply no return on investment 
for small volume providers to invest in systems capable of 
submitting TRICARE claims when over 95 percent of our claims 
are paid within 30 days. Again, HIPAA, once implemented, will 
eliminate this issue and result in a dramatic increase in the 
receipt of electronic claims.
    Over the last 2 years, the Department has been actively 
involved both independently and with the assistance of our 
contractors in reviewing the government's processes for 
adjudicating claims, with an eye toward balancing customer 
service with costs. These initiatives began with an effort we 
called work simplification. Through this process, the 
government partnered with our current contractors, who 
identified roadblocks to prompt and efficient claims 
processing. We identified a considerable number of impediments, 
including mandated medical reviews, paper documentation, and 
other program complexities that inhibited the processing of 
claims.
    We have issued two comprehensive changes as a result of 
this initial effort that remove the vast majority of these 
impediments and that, when fully implemented, will allow claims 
to adjudicate without human intervention. We used caution when 
implementing these initiatives. Each impediment to claims 
processing was weighed against the potential impact on health 
care dollar expenditures.
    For example, removing medical review requirements and the 
requirement for the associated documentation subjects the 
government to excessive utilization and expenditure of finite 
health care dollars and the potential for fraud and abuse.
    Conversely, our overemphasizing review processes increases 
the cost and time involved with processing of a claim. Working 
with our contractors, we are carefully reviewing every aspect 
of the health care financing and delivery system to determine 
where statistical sampling is more appropriate than individual 
case review, where case review is resulting in no savings, and 
where profiling will identify instances where the Department 
can focus on a very limited number of procedures or providers 
to ensure that health care dollars are not unnecessarily 
expended.
    In conjunction with these efforts, the government is moving 
forward to implement the electronic submission of as many 
claims as possible. This is being done through the 
implementation of web-based technology and an emphasis on 
electronic claims submission, using Medicare's electronic 
submission requirements and encouraging our providers to submit 
their claims electronically in all of our education and 
marketing materials.
    Electronic submission can gain us several benefits, 
equating to approximately $2 per claim. More importantly, 
electronic submission is a tremendous benefit to our providers 
in that simple clerical errors are detected immediately and 
corrected without delay. These electronic submissions also feed 
the provider's business systems to reduce the doctors' 
administrative costs.
    From a claims processing perspective, these systems 
eliminate the need for our contractors to retype information. 
They eliminate keying errors. They substantially increase the 
number of ``clean claims,'' and they allow claims to process in 
a fully electronic environment. While these substantial 
benefits accrue to the government, we also recognize savings in 
the area of filing and storage the vast amount of paper 
associated with manual claims processing.
    Unfortunately, these efforts are not the panacea and we 
have much work left to be done before achieving a position 
where all provider-submitted claims are electronic. TRICARE 
alone has achieved an electronic submission rate that is 
nearing 50 percent. However, the Congress in legislating the 
Health Insurance Portability and Accountability Act, has 
provided the health insurance industry with the single most 
important tool for reaching our goal of 100 percent electronic 
claims submission. This tool, a standardized format for the 
data elements and the transmission format, will unify the 
entire industry and make the electronic submission of claims 
the only practical business process available to the provider 
community.
    We are looking forward to the publication of the HIPAA 
rules by HHS and the mandated effective date 2 years hence. In 
the interim, we are working very closely with our contractors 
and have implemented the first phase of web-based technology. 
These current systems allow our beneficiaries online access to 
their claims status and history. Each electronic web-based 
inquiry eliminates the need for a telephone call, including the 
associated staffing facility and infrastructure costs. We are 
rapidly expanding this technology and anticipate including 
physician access in the very near future as security and 
privacy issues are resolved.
    As we are able to open these communication pipelines to all 
of our clients, our client satisfaction will increase while the 
government cost per claim will decline in future contracts.
    Shifting gears, I would like to briefly address the issue 
that some of our beneficiaries are being pursued by collection 
agencies. While the number is extremely small, we are very 
concerned with each and every instance. All of our TRICARE 
contractors have established special units designed 
specifically to resolve collection issues. In addition, at each 
of our lead agents, we have created positions solely 
responsible for assisting our beneficiaries with whatever they 
require. We have expanded this function and created similar 
positions at each of our military treatment facilities to 
provide dedicated onsite assistance. I recognize that we can 
never guarantee that a single beneficiary will not be subject 
to collection. However, DOD is now in the position of being 
able to provide dedicated personal assistance and resolution to 
any problem that arises.
    Finally, I wish to conclude with a word of caution. The key 
to reducing claims costs is to pay claims without human 
intervention. This is not without cost. We must carefully 
balance fully electronic claims payment with ensuring that 
taxpayer dollars are only expended for medically necessary and 
appropriate care, and as we progress in these efforts, claims 
costs will be reduced, but they will continue to contain those 
costs associated with ensuring the proper expenditure of 
government resources. We must also never forget service to our 
military men and women and the doctors who provide their care. 
This, too, is not without cost. However, the value of serving 
our beneficiaries cannot be understated.
    I sincerely appreciate the time this task force has 
provided for me to briefly explain TRICARE claims and claim 
costs. I am at your disposal to expand on my comments and 
answer any other questions that you have.
    Mr. Thornberry. Thank you, Dr. Sears.
    [The prepared statement of H. James T. Sears, M.D., 
follows:]

  Prepared Statement of H. James T. Sears, M.D., Executive Director, 
                      TRICARE Management Activity

    Mr. Chairman, distinguished members of the committee, I appreciate 
the opportunity to discuss the Department's progress processing TRICARE 
health care claims in the Military Health System.
    My testimony today will focus on the steps we have taken to reduce 
the costs associated with processing TRICARE claims. First, I would 
like to report on two standards that have helped the Department make 
significant progress in claims processing timeliness.
    Beginning in October 1999, TRICARE removed barriers to electronic 
claims submission and moved to claims processing timeliness standards 
similar to those used by Medicare. The new standards, effective October 
1999, require our Managed Care Support Contractors to process 95 
percent of accurately submitted claims within 30 calendar days from the 
date of receipt of the claim and payment errors may not exceed 2 
percent. We have exceeded this standard in five of the last 7 months 
(in December 1999 and January 2000, 2 months where the standard was not 
met, the average was 94.4 percent). Our most recent information for 
March and April 2000, shows that our contractors exceeded the 95 
percent standard by processing 97.5 percent of all accurately submitted 
claims within the 30-day standard.
    The second standard requires contractors to process 100 percent of 
accurately submitted claims within 60 days of receipt. We continue to 
strive to meet this standard, however, for the most recent 2 months, we 
processed 99.6 percent of claims within 60 days. This extremely high 
level of performance will result in an ever-increasing number of 
satisfied providers who will submit more accurate claims either by mail 
or electronically. Accurate paper and electronic claims significantly 
reduce the manual intervention required in the adjudication process and 
equate to reductions in the overall cost of processing a claim.
    These ongoing initiatives have resulted in dramatic increases in 
the prompt adjudication of claims mentioned previously and, as 
improvements continue to be realized, will result in further reductions 
in the cost of adjudicating TRICARE claims. We will continue our 
efforts to simplify requirements and reduce costs. When comparing our 
claim costs to those of Medicare, it is important to remember that 
there are significant differences between the two programs. Claim costs 
for TRICARE include a number of functions that are not included in 
Medicare claim costs. TRICARE claim costs include additional functions 
such as appeals, customer service, beneficiary and provider education, 
and coordination of benefits. In addition, for most Managed Care 
Support Contracts, the prime contractor uses the claims processing 
subcontractor's enrollment and utilization review systems, and those 
costs are reflected in the claim rate. There are also statutory 
requirements that increase complexity (and therefore cost). These 
include the three-tiered benefit structure for TRICARE (Prime, Extra, 
and Standard), differing copayments and catastrophic caps depending on 
rank or service status. They also include mandated special programs 
such as the Continued Health Care Benefits Program, TRICARE Senior 
Prime, and Base Realignment and Closure (BRAC) pharmacy benefits.
    Further, while we expect that managed care will reduce health care 
costs overall, there are additional administrative tasks that accompany 
these reduced health care costs. These include the more extensive use 
of pre-authorizations and referrals that must be coordinated with 
claims. There is also significantly more effort in maintaining provider 
data. For example, the claims processor must track who is in the 
network and what the negotiated rate is for each service. This may vary 
even within provider groups or clinics, and network tracking and 
updates requires significant effort.
    An example of managed care's impact on health care costs is the 
Pharmacy Data Transaction System (PDTS). The database will incorporate 
prescription data from retail networks, from the Department's National 
Mail Order Pharmacy program, and from pharmacies at Military Treatment 
Facilities. Each of these prescription sources will have an electronic 
connection to the national database.
    PDTS will allow instantaneous checks for adverse drug reactions or 
duplicate prescriptions. It will also help prevent over-utilization and 
drug abuse by giving visibility of prescription drug usage across the 
Military Health System. The PDTS checks will occur at Point-of-Sale, 
allowing immediate patient intervention and education.
    We expect to begin implementation of PDTS this summer, starting 
with the Managed Care Support Contractors' retail networks.
    Over the past few months, the health care industry, like other 
industries, has been moving toward changing the way health care 
business is conducted. Health plans, providers, employers, health care 
consumers, and other health care-related businesses are adopting and 
applying new electronic technologies at great speed. Congress 
recognized the efficiencies and cost-savings that can be realized 
through electronic data interchange (EDI) and the application of 
standards in conducting health care business electronically, and passed 
the Health Insurance Portability and Accountability Act of 1996 
(HIPAA). The HIPAA statute requires the Secretary of Health and Human 
Services to adopt standards for financial and administrative 
transactions to enable health information to be exchanged 
electronically. These standards apply to the entire health care 
industry including the Military Health System. The first of these 
standards, those applying to electronic transactions and code sets, is 
expected to be published in a final rule in August, 2000. If published 
as expected, the standards become effective in August 2002. The TRICARE 
Management Activity is committed to and actively working toward 
achieving full compliance with all HIPAA standards within the required 
time frames.
    While the health care industry awaits the publication of the HIPAA 
standards and requirements, it is not waiting to develop and implement 
other e-commerce and web-based business applications and solutions. 
TRICARE isn't waiting either. The Department is actively reviewing all 
facets of its business practices and operations and is identifying 
those that can be moved to and performed on the Internet. Managed Care 
Support Contractors and their claims processing subcontractors are 
developing web sites on which beneficiaries and providers will be able 
to look up the status of their claims, submit enrollment applications, 
update addresses and other demographic data, submit health care 
questions, request authorizations and referrals, and conduct other 
health care related business. The Department has been working on the 
development of the electronic health care record with new versions of 
Defense Eligibility and Enrollment Reporting System (DEERS) and the 
Composite Health Care System (CHCS) which should ultimately allow for 
greater access by providers, beneficiaries, the Military Health System, 
and TRICARE business partners and contractors. The development of 
TRICARE data warehouses and of powerful data mining applications should 
provide DoD with valuable new health care information on which business 
decisions can be made and health care delivery improved for our 
beneficiaries.
    The speed with which technology is evolving and being adopted by 
the health care industry requires that organizations evaluate and re-
think how business is conducted. Health care consumers, our 
beneficiaries, are becoming computer-savvy and are demanding the kind 
of improved health care services that can be delivered today. The 
Department is actively working toward meeting their expectations and 
the expectations of the health care industry as a whole. The result of 
electronic commerce is the elimination of high cost human intervention 
which directly correlates to reduced claims processing costs.
    The Department has developed TRICARE Encounter Data (TED) records 
to replace Health Care Service Records (HCSRs). These records are 
simply processed claims data that are submitted to TMA in a 
standardized format. The TED record has evolved from the Health Care 
Service Record (HCSR) to a more streamlined and ``user friendly'' 
format. Claims processors use proprietary systems for processing 
TRICARE claims. The outputs from these claims processing systems are in 
different formats and contain different data elements and values. The 
Military Health System needs a centralized database of processed claims 
and encounter data for financial and program management purposes. In 
order to centralize the data and incorporate it into a single database, 
it must come into the Department in a consistent format. The TED record 
prescribes a much easier standardized format for contractors to submit 
claims data that will further reduce administrative costs when adopted.
    TED records allow us to apply rules and edits that help ensure that 
the claims and encounter data being submitted is accurate and reliable. 
Without the ability to establish rules and apply edits, financial and 
other important business decisions may be based on erroneous 
information with significant financial consequences.
    As an alternative to TEDs, The Department is evaluating contractor 
proposals to eliminate TEDs altogether. Under this proposal, 
contractors would submit claims data to their own data warehouses to 
which they would allow DoD access. As part of our evaluation, we are 
looking at overall program costs to shifting from TEDs to a raw claims 
data-warehousing model.
    For now, TED records should reduce costs over those previously 
associated with HCSRs and permit us to perform audits and monitor 
contractor performance. They can be used in bid price adjustment 
calculations and allow the development of reliable claims volume 
projections for procurements. They enable us to identify and recoup 
duplicate claims payments where one claim is paid by a contractor and 
the same claim is paid by another. They will continue to enable us to 
identify, account for and audit at-risk and not at-risk claims 
payments. Until a viable and even more cost-effective alternative 
emerges, TED records will support TRICARE management and provide better 
and easier access to claims data across the enterprise at reduced cost.
    I am extremely pleased with the significant progress that has 
occurred over the last 2 years as a result of the joint efforts of the 
Managed Care Support Contractors, TMA, the Lead Agents, and the 
Surgeons General to reduce claims costs and complexities. Working 
together, we have removed thousands of Government specified claims 
reviews, such as the clinical review of oxygen, ultrasounds, and CT 
scans. We eliminated prescriptive controlled development requirements, 
simplified the provider certification process and now permit the use of 
commercial best practices for utilization management. Soon, we plan to 
simplify requirements for coordination of benefits and for third party 
liability collections. By removing Government mandated reviews, we have 
not only complied with the President's acquisition reform initiatives, 
but have created a 21st century environment that allows our contractors 
to employ their best commercial practices to the processing of TRICARE 
claims while concurrently reducing cost.
    These initial claims improvements were complemented by a study the 
Department commissioned by First Consulting Group (FCG). FCG applauded 
the work completed to date and offered additional suggestions for 
enhancements. These included allowing our contractors to accept the 
Medicare provider number on electronically submitted claims and 
assisting the Department and our partners in the utilization of new 
world wide web based technology. These initiatives, when fully 
implemented, will eliminate much of the need for human intervention, 
the highest single cost factor in claims adjudication.
    Improving the TRICARE claims processing environment is a continuous 
quality improvement process. Our MCS contractors continue to submit 
suggestions for improving performance and implementing new 
technologies. Working together, with all of our partners, we will 
persist in our efforts to obtain state-of-the-art processes and systems 
that achieve the highest quality of performance at the most reasonable 
and effective cost to the Government.

    Mr. Thornberry. Mr. Backhus, as I mentioned, your full 
statement will be made part of the record and you may proceed 
to summarize it.

 STATEMENT OF STEPHEN P. BACKHUS, DIRECTOR, VETERANS' AFFAIRS 
   AND MILITARY HEALTH CARE ISSUES, GENERAL ACCOUNTING OFFICE

    Mr. Backhus. Thank you, Mr. Chairman. Good morning, Mr. 
Chairman and members of the task force. I am pleased to be here 
today to discuss what DOD can do to reduce TRICARE claims 
processing costs, and as you requested, I will also briefly 
discuss the need for increased anti-fraud efforts and more 
joint purchasing of pharmaceuticals and medical supplies with 
the VA, both of which could reduce costs. Finally, I will 
discuss our ongoing study of the process beneficiaries use to 
make medical appointments. The information I am presenting is 
based on a substantial body of work we have undertaken over the 
past several years on TRICARE operations.
    Today, TRICARE has much room for improvement. Each claim 
costs an average of $7.50 to process, double the industry 
average and more than four times the $1.78 for Medicare claims 
processing costs. These higher costs are attributable to a 
number of factors.
    Over half of TRICARE's claims are manually reviewed, a rate 
significantly higher than the industry average of 25 percent. 
For example, claims submitted for electrocardiograms require 
manual review, but in every case so far, after review, these 
claims have been paid. Last year, for one TRICARE contract 
alone, there were almost 14,000 of these claims.
    Furthermore, claim inquiry rates average about one for 
every four-and-a-half claims, four times higher than Medicare 
inquiries. These inquires add substantial cost to the program.
    But perhaps most significantly is that less than 20 percent 
of hospital and professional claims are submitted 
electronically, compared to the Medicare average of about 85 
percent.
    Obviously, we believe there is potential for reducing 
claims processing costs. The initiatives that DOD has underway 
and planned, some legislatively directed, if implemented 
properly, should go a long way toward reducing such costs. 
These include reducing manual review requirements when they are 
unnecessary, promoting electronic claims submission, using 
automated voice response systems for provider inquiries, and 
adopting Medicare claims processing time limit standards. As a 
means of encouraging electronic claims submission, DOD is also 
permitting its contractors to delay payment of paper claims as 
long as overall time limit standards are met.
    I need to caution, however, that the cost reductions from 
these and other efforts are limited and cannot be expected to 
approach current Medicare costs, primarily because TRICARE and 
Medicare are vastly different programs in terms of the benefit 
structure and size. For example, TRICARE's fixed costs are 
spread over a much smaller claims base than Medicare's and the 
TRICARE triple-option managed care benefit requires greater 
administrative costs than Medicare's fee-for-service plan.
    I would now like to turn to opportunities for increased 
efficiencies in other TRICARE areas. DOD estimates that losses 
due to fraud and abuse could account for 10 to 20 percent of 
military health care expenditures. DOD could be more effective 
in combatting fraud and abuse if the contractors were more 
proactive in identifying and referring potential fraud cases. 
Out of over 40 million claims processed from January 1999 
through April 2000, only 17 potential fraud referrals from 
contractors have been accepted by DOD for investigation.
    DOD would also benefit financially through additional 
cooperative efforts with the VA to procure pharmaceuticals and 
through the use of VA's mail outpatient pharmacy for their 
refill workload. The expectation is that as the two agencies 
buy more of a particular drug, their leverage, particularly 
under competitively bid contracts, would permit them to obtain 
even greater discounts from drug manufacturers and save money 
for both departments. We believe that VA and DOD could 
potentially save between $150 to $300 million more each year by 
jointly purchasing medications. An additional $45 million could 
be saved annually if DOD used VA's mail outpatient pharmacy for 
their refills.
    In addition to cost efficiencies, we are currently studying 
ways DOD could increase beneficiary satisfaction through 
changes to its medical appointment process. For years, 
beneficiaries have expressed frustration and confusion over how 
to access the health care system, largely because of the wide 
variability that existed in the appointment making process. 
Recently, DOD has been moving toward a centralized system that 
beneficiaries call to schedule all their appointments.
    However, even this process appears to be confusing and 
frustrating to some beneficiaries because it is being 
implemented inconsistently. Some beneficiaries are transferred 
from the appointment center to a physician's office or clinic, 
some are told to call the office or clinic directly, and others 
get their appointments made as intended. Thus, what is meant to 
be a simplified, more user-friendly appointment process appears 
to still be a complex and confusing one, for beneficiaries are 
unsure who to call. We expect to be making recommendations at 
the conclusion of our work.
    Mr. Chairman, this concludes my statement and I will be 
glad to answer any questions you or other members of the task 
force may have.
    Mr. Thornberry. Thank you. I appreciate it.
    [The prepared statement of Stephen P. Backhus follows:]

 Prepared Statement of Stephen P. Backhus, Director, Veterans' Affairs 
       and Military Health Care Issues, General Accounting Office

    Mr. Chairman and members of the Task Force, I am pleased to be here 
today to discuss opportunities to reduce claims processing and other 
costs of TRICARE--the Department of Defense's (DOD) managed health care 
program. Today more than 8.2 million active-duty personnel, retirees, 
and their dependents are eligible to receive care under this $16 
billion-per-year health care system. As the costs of delivering health 
care continue to increase and as beneficiaries demand improved and 
expanded services, significant pressures have been placed on the 
system, and DOD continues to search for ways to address them.
    Since TRICARE's inception, we have reported on the challenges DOD 
faces in delivering health care. DOD considers health care to be one of 
its major quality-of-life issues important to maintaining a quality 
force. As a result, DOD has continually striven to deliver this health 
care benefit and to respond to suggestions made for improving its 
health care system. Currently, DOD is facing increasing pressures to 
improve customer service. Improvements in areas such as claims 
processing not only have the potential to make the health care system 
more user-friendly and efficient, but also to reduce costs.
    At your request, my testimony today will focus primarily on the 
cost of processing TRICARE claims. Additionally, I will briefly discuss 
two other opportunities that potentially can reduce costs and improve 
service to beneficiaries, namely increased antifraud efforts and more 
joint procurement of pharmaceuticals and medical supplies with the 
Department of Veterans Affairs (VA). You also asked that I discuss our 
ongoing study of the process beneficiaries use to make medical 
appointments. The information I am presenting is based on a substantial 
body of work we have undertaken over the past several years on TRICARE 
operations.
    In summary, processing TRICARE claims costs several times as much 
as processing Medicare claims--$7.50 compared to $1.78 per claim on 
average. However, much of the cost difference appears to be 
attributable to differences in program design and processing 
requirements. For example, TRICARE offers three different benefit 
packages, with reimbursement rates that are established for each 
provider, and a complex system of authorizations and referrals. The 
program also experiences frequent changes to coverage and operating 
policies that make it difficult to administer. Nonetheless, we and 
others believe that opportunities exist to reduce some of the 
approximately $225 million spent annually to process claims. In 
response to the House version of the fiscal year 2001 Defense 
Authorization bill, and through several of its own initiatives that 
mirror private-sector practices, DOD has adopted and is planning 
several actions to reduce claims processing costs, including increasing 
electronic claims submission and web-based services to reduce the costs 
of claims review and to deal with the large number of inquiries 
received by providers and beneficiaries.
    Beyond claims processing, we believe there are other opportunities 
to reduce TRICARE costs and improve services. For example, although DOD 
has efforts under way to combat health care fraud and abuse, these 
efforts have only been marginally effective. Additional opportunities 
exist to save potentially hundreds of millions of dollars that could be 
used to purchase care for military beneficiaries. Also, we believe that 
additional cooperation with the VA to procure pharmaceuticals and 
medical supplies could yield substantial savings. Lastly, different 
systems are in place throughout the military health system for making 
medical appointments, and beneficiaries sometimes are unsure as to how 
to make such appointments, leading to frustration with TRICARE. We are 
currently reviewing this process and anticipate making recommendations 
for improving it at the conclusion of our study.

                               BACKGROUND

    DOD's primary medical mission is to maintain the health of active-
duty service personnel and to provide health care during military 
operations. DOD also offers health care to non-active-duty 
beneficiaries, including dependents of active-duty personnel, military 
retirees, and dependents of retirees, if space and resources are 
available. The Army, Navy, and Air Force provide most of the system's 
care through their own medical centers, hospitals, and clinics, 
totaling about 580 treatment facilities worldwide. Civilian providers 
supply the remaining care. TRICARE is a triple-option benefit program 
designed to give beneficiaries a choice among a health maintenance 
organization (TRICARE Prime), a preferred provider organization 
(TRICARE Extra), and a fee-for-service benefit (TRICARE Standard).
    TRICARE is organized geographically into 11 health care regions 
administered by five managed-care support contractors. Among the 
contractors' many responsibilities are claims processing, for which all 
have subcontracted with one of two companies. DOD requires contractors 
to meet specific timeliness and accuracy standards when processing 
claims. The tasks required to process claims include claims receipt, 
data entry, claims adjudication, and claims payment or denial. During 
1999, contractors processed about 30 million health claims submitted by 
institutions, health care providers, and beneficiaries.
    To help safeguard against health care fraud and abuse in its 
system, DOD established a Program Integrity unit in 1982 to coordinate 
its antifraud activities. This unit is responsible for developing 
policies and procedures regarding the prevention and detection of 
TRICARE fraud and abuse. DOD's Office of Inspector General and the 
Department of Justice work together with this unit (and sometimes also 
with the Department of Health and Human Services) to investigate and 
prosecute alleged health care fraud and abuse. DOD's contracts with its 
five managed-care support contractors also require them to perform 
antifraud and abuse activities to help ensure that TRICARE dollars are 
used to pay only claims that are appropriate.

 PROGRAM COMPLEXITY IMPEDES CLAIMS PROCESSING EFFICIENCY; IMPROVEMENTS 
                               UNDER WAY

    Claims processing activities have generated a great deal of 
dissatisfaction among providers and beneficiaries, as well as among 
various congressional committees, and DOD recognizes that problems 
exist. Complaints and frustrations stem from perceived inaccurate and 
late payments; complex program rules, processes, and reporting 
requirements; and high costs. All agree that the claims adjudication 
system needs to be simplified and made more user-friendly, and that it 
could benefit from increased use of technology. A number of 
administrative and legislative actions are under way, which, if 
properly implemented, should reduce TRICARE claims processing costs.

 Program Complexity and Size Contribute to High Claims-Processing Costs

    In August 1999, at the request of the House Subcommittee on 
Military Personnel, Committee on Armed Services, we reported on the 
complexity of the TRICARE program and benefit structure.\1\ This 
complexity manifests itself in many aspects of claims processing such 
as high rates of manual review, low electronic submission rates, and 
high customer inquiry rates. These factors, in addition to the 
relatively small program size when compared with Medicare, increase 
TRICARE claims processing costs because fixed costs are spread over a 
smaller number of claims. Currently, TRICARE claims cost an average of 
$7.50 per claim to process--double the industry average and more than 
four times the $1.78 Medicare claims processing cost.
---------------------------------------------------------------------------
    \1\Defense Health Care: Claims Processing Improvements are Under 
Way but Further Enhancements are Needed (GAO/HEHS-99-128, Aug. 23, 
1999).
---------------------------------------------------------------------------
    Contractors told us that of the many programs they administer, 
including Medicare and private plans, TRICARE is the most complicated, 
contributing to claims processing difficulties and high costs. For 
example, each of TRICARE's three options has a different array of 
benefits, copayments, and deductibles. Claims require different 
adjudication procedures, depending on which option is involved, and 
contractual requirements for prepayment review further complicate the 
process. Complexities such as these are manifested as thousands of 
edits in the adjudication logic of the claims processing system. These 
edits result in claims being ``kicked out'' of the system for manual 
review, which extends processing time and increases administrative 
costs. Over half of TRICARE's claims are manually reviewed, a rate 
significantly higher than the industry average of 25 percent.
    Program complexities also contribute to numerous beneficiary and 
provider inquiries, which add considerably to the cost of processing a 
claim. TRICARE claim inquiry rates average about one for every 4.5 
claims--four times higher than Medicare inquiries. Documentation shows 
that beneficiaries frequently inquire about their benefits and cost 
shares because they do not understand the program. Providers inquire 
most often about payment issues primarily because the same services 
might be reimbursed at different amounts depending on which TRICARE 
option the beneficiary is using. TRICARE has thousands of unique fee 
schedules and contracts that change frequently. In contrast, Medicare 
reimbursement is more consistent because it has national standard 
physician and hospital payment methodologies. In addition, Medicare 
inquiries are handled almost entirely by automated systems.
    TRICARE's per-claim processing costs are higher than Medicare's 
also because TRICARE's fixed costs are spread over a smaller claims 
base. Medicare costs are spread over about 900 million claims per year, 
whereas TRICARE processes only about 30 million claims per year.
    Under TRICARE less than 20 percent of hospital and professional 
claims are submitted electronically, compared to the Medicare average 
of about 85 percent. Electronic claim submissions are faster, involve 
less chance of data input error, and are less expensive to process than 
paper claims. Paper-based claims require significant front-end handling 
in the mailroom, document preparation, imaging, data entry, and 
storage. However, because TRICARE is usually a small percentage of 
providers' income--often less than 5 percent--providers have no 
incentive to incur the expense of adapting their computer systems to 
permit electronic TRICARE claim submission. Furthermore, because 98 
percent of claims are paid within timeliness standards, the incentive 
to submit electronic claims is further reduced.
    Nevertheless, we believe that some opportunities exist to reduce 
the administrative costs associated with processing a TRICARE claim. 
One of the claims processing subcontractors reported that $4.46 of each 
claim processed--totaling about $125 million per year--is paid for 
services provided or processes required by the program above the costs 
of determining payment outcomes. For example, responding to TRICARE 
inquiries reportedly costs $1 per claim more than responding to 
Medicare inquiries. Other costs that we consider to be targets of 
opportunity include mailroom handling, document preparation, imaging, 
paper storage, data entry, and certain reporting requirements. A number 
of initiatives are currently under way or planned that may reduce these 
costs as described below.

    Initiatives Under Way to Improve Claims Processing Efficiencies

    Several legislatively directed and DOD-initiated efforts are under 
way to simplify the claims adjudication process, improve provider and 
beneficiary education, and increase electronic claims submission. If 
properly implemented, these actions should reduce TRICARE claims 
processing costs.
    For example, the House version of the fiscal year 2001 Defense 
Authorization bill would direct that the Secretary of Defense take 
action to require high-volume TRICARE providers to submit claims 
electronically, and increase the use of automated voice response 
systems for provider inquiries on claims status. Also, the bill would 
direct that certain administrative reporting requirements be reduced.
    With the assistance of a consultant, DOD has developed and is 
implementing a plan that calls for eliminating unnecessary or 
duplicative processes that interfere with optimal performance, 
emphasizing the use of commercial best practices and Medicare 
standards. For example, the plan calls for adopting Medicare's 
standards for processing timeliness and the elimination of DOD required 
edits that should help decrease the number of manually reviewed claims. 
According to one of the claims processing subcontractors, some of these 
edits are unnecessary while others should be modified or retained. For 
example, claims for electrocardiograms must be manually reviewed, but 
in every case so far, the claims have been paid after review. Last 
year, for one TRICARE contract, almost 14,000 claims for this procedure 
were submitted. While DOD has issued formal contract modifications for 
all the changes it wants to make, contractors have not yet had time to 
implement all of them.
    Additionally, DOD is pursuing the possible use of Medicare's 
provider identification numbers to encourage and facilitate electronic 
claims submission. Also, DOD now permits contractors to delay the 
payment of paper claims (as an incentive for providers to submit 
electronically) so long as the contractors continue to meet standards. 
This initiative mirrors Medicare's process for increasing the number of 
claims submitted electronically. Further, to reduce the number of 
manual reviews, DOD is encouraging contractors to limit prepayment 
review of certain types of claims if appropriate.
    DOD and the contractors are also looking at ways to use new 
technology on the World Wide Web to reduce administrative costs and 
increase provider and beneficiary satisfaction. Currently, TRICARE 
claims processing subcontractors have developed comprehensive Web sites 
containing information on policy and benefits, electronic claims 
submissions, and claim status.\2\ In addition, DOD and contractor 
officials are considering future use of the Internet as a means to 
submit claims for processing. This method, which is similar to that 
used for electronic claims, might provide a more expedient, less 
expensive means of handling claims. However, before this Web-based 
technology can be utilized, the government must define security 
requirements to ensure privacy.
---------------------------------------------------------------------------
    \2\One subcontractor's Web site (www.mytricare.com) allows 
beneficiaries to access claim status while the other subcontractor's 
site (www.wpsic.com) gives providers access. Both sites are designed to 
ensure the privacy of beneficiary information.
---------------------------------------------------------------------------
    Nonetheless, because TRICARE makes up such a small percentage of 
most providers' business, neither Web-based nor electronic claims 
submissions are likely to significantly increase in volume without 
specific incentives or mandates. However, mandates may increase 
providers' reluctance to participate in the program. In the future 
these problems may be mitigated as a result of industrywide 
requirements to adopt uniform standards for electronic health care 
transactions, including claims.\3\ Uniform standards for electronic 
claim submissions will enable providers to submit claims for any health 
insurance plan in the same filing format.
---------------------------------------------------------------------------
    \3\The Health Insurance Portability and Accountability Act of 1996 
(P.L. 104-191) requires the industrywide adoption of uniform standards 
for electronic transactions, including claims filing.
---------------------------------------------------------------------------

 DOD COULD SAVE HUNDREDS OF MILLIONS OF DOLLARS WITH A MORE EFFECTIVE 
                           ANTIFRAUD PROGRAM

    While DOD does not know the precise extent of fraud and abuse in 
its health care system, it estimates potential annual losses to its 
TRICARE program to be in the hundreds of millions of dollars. In 
addition to the financial loss, health care fraud and abuse also 
affects the quality of care provided and may cause serious harm to 
patients' health. Despite its responsibility to prevent and detect 
health care fraud and abuse, DOD has not been effective in doing so, 
recovering less than 3 percent of its estimated losses to fraud and 
abuse between 1996 and 1998. DOD has the opportunity to improve its 
antifraud efforts by developing clear and measurable goals and ensuring 
that contractors comply with the antifraud requirements in their 
contracts.
    DOD estimates that losses due to fraud and abuse could account for 
10 to 20 percent of military health care expenditures. These ranges are 
consistent with estimates of other public and private-sector 
organizations, such as the Health Care Financing Administration, the 
U.S. Chamber of Commerce, the Health Insurance Association of America, 
and the National Health Care Anti-Fraud Association. Given TRICARE's 
expenditure of about $2.9 billion for contracted civilian-provided care 
in fiscal year 1999, DOD could be losing between $290 million and $580 
million annually to fraud and abuse. DOD officials acknowledged that 
they could be more effective in combating fraud and abuse if their 
TRICARE contractors were more proactive in identifying and referring 
potential fraud cases. They also agreed that they should expedite the 
implementation of revised antifraud policies and requirements that 
place greater demands on contractors to identify and prevent fraud and 
abuse. However, although DOD provided contractors with antifraud 
software, not all contractors are using the software. Further, DOD 
required contractors to develop and submit antifraud plans, but most 
contractors' initial antifraud plans were deficient. Current statistics 
do not indicate any significant improvements in DOD's antifraud 
efforts. Out of over 40 million claims processed from January 1999 
through April 2000, only 17 fraud referral cases from the contractors 
have been accepted by DOD for investigation.\4\
---------------------------------------------------------------------------
    \4\These 17 cases all involved high dollars or had the potential to 
cause patient harm. In addition, contractors submitted numerous small 
dollar cases that DOD has returned, believing they should be handled as 
overpayments rather than as fraud.
---------------------------------------------------------------------------

  ADDITIONAL JOINT PROCUREMENT OF PHARMACEUTICALS WITH VA WOULD YIELD 
                          SUBSTANTIAL SAVINGS

    We recently testified that DOD and VA would benefit through 
additional cooperative efforts to procure pharmaceuticals and through 
the use of VA's Consolidated Mail Outpatient Pharmacy (CMOP) for DOD's 
prescription refill workload.\5\ As the largest direct Federal drug 
purchasers, the Departments already enjoy varying, though significant, 
discounts on their drug purchases. The expectation is that, as the two 
agencies buy more of a particular drug, their leverage--particularly 
under competitively bid contracts--would permit them to obtain even 
greater discounts from drug manufacturers and to save funds for both 
Departments. Currently, the two agencies have awarded 18 joint and 51 
separate national contracts representing 19 percent of their combined 
drug expenditures of $2.4 billion in fiscal year 1999. We believe that 
VA and DOD could potentially save $150 to $300 million more each year 
by jointly purchasing other medications they both use.
---------------------------------------------------------------------------
    \5\DOD and VA Health Care: Jointly Buying and Mailing Out 
Pharmaceuticals Could Save Millions of Dollars (GAO/T-HEHS-00-121, May 
25, 2000).
---------------------------------------------------------------------------
    Further, additional savings could be achieved by utilizing VA's 
mail-out pharmacy program to handle DOD's annual refill workload of 
about 23 million prescriptions. For example, VA has the capability for 
mail order refills through its CMOP and documentation shows that CMOP 
refills cost about one-half of DOD's current costs of refilling 
prescriptions at military pharmacies. CMOPs potentially could reduce 
military pharmacy refill dispensing costs by about $45 million 
annually.

    IMPROVING THE MEDICAL APPOINTMENT PROCESS WOULD LIKELY INCREASE 
                        BENEFICIARY SATISFACTION

    Since the inception of TRICARE, beneficiaries have complained about 
the difficulties they encounter in making appointments for health care. 
For years beneficiaries seeking to make appointments in military 
treatment facilities accessed care by calling the desired clinic 
directly. Over the past several years however, DOD has been moving 
toward a centralized appointment system. In some military medical 
facilities an appointment center has been created and beneficiaries 
call that center to schedule various types of appointments. In four 
TRICARE regions though, TRICARE contractors have established regional 
appointment centers which beneficiaries call to schedule appointments 
with physicians in military medical facilities. The contractors perform 
this function as part of their administrative tasks under their 
contracts with DOD. We are currently reviewing the appointment making 
process in TRICARE.
    We are finding that the lack of uniform appointment names and 
requirements for scheduling appointments has resulted in confusion for 
both appointment clerks and beneficiaries, with beneficiaries sometimes 
being transferred from the appointment center to the military clinic, 
or told to call the clinic themselves.
    Thus, what is meant to be a simplified, more user-friendly 
appointment process appears to be a complex and confusing process, 
where beneficiaries are unsure as to whether to call the contractor or 
the military medical facility to schedule appointments. We expect to be 
making recommendations at the conclusion of our work.
    Mr. Chairman, this concludes my prepared statement. I will be happy 
to answer questions you or other Task Force members may have.

    Mr. Thornberry. Mr. Meyer, we will go ahead and let you 
proceed with your opening statement. We do have a vote, so 
members may be coming and going. I think it is just one vote, 
so we will try to keep things going as best we can. You may 
proceed.

    STATEMENT OF WILLIAM J. MEYER, SENIOR VICE PRESIDENT OF 
       TRICARE, BLUE CROSS-BLUE SHIELD OF SOUTH CAROLINA

    Mr. Meyer. Thank you, Mr. Chairman, Congressman Shays, 
Congressman Moran, Congressman Thornberry, Congressman Spratt, 
Congressman Buyer. I thank you for the opportunity of inviting 
me here today and thank you for your interest in the experience 
of my company, Palmetto Government Benefit Administrators, a 
division of Blue Cross-Blue Shield of South Carolina.
    I appreciate your concern with the difference in processing 
costs between Medicare and TRICARE and welcome the opportunity 
to give you some information and ideas based on our experience. 
Blue Cross-Blue Shield of South Carolina, through its 
subsidiaries, is the largest claims processor in the country 
for both Medicare and TRICARE, so we have a thorough 
understanding of the administrative cost structures and program 
differences of both programs.
    The national average cost to process a Medicare claim in 
fiscal year 1999 was $1.78. The average cost to process a 
TRICARE claim at my company is just over $7.50. While on its 
face this is a large disparity, close analysis shows that there 
are reasons for it. The best way to understand the differences 
in these processing costs is to understand the differences 
between the two programs.
    The most important difference is the most basic. By 
definition, Medicare is a fee-for-service program while TRICARE 
is a managed care program. The whole concept of managed care is 
that managing health care to maximize its efficiency will 
result in increased administrative cost, but that resulting 
efficiency will save far more than its cost. A complex system 
of authorizations, referrals, and discounted provider networks 
means that the same service might get paid for in dozens and 
even scores of different ways. This acknowledged administrative 
complexity is far different from what we find in Medicare, 
where fees are set, regardless of the provider, and almost 
every claim is paid the same way.
    There is a propensity to look at claims processing costs 
without accounting for savings on the benefits side, but an 
accurate analysis of the cost of Medicare and TRICARE demands 
that you look at both. As an example, one reason processing 
TRICARE claims is more complex, thus more costly, is that 
physicians in the program are paid different amounts for the 
same procedures. That is because reimbursement rates are 
negotiated to get the most savings possible. You would save on 
processing if you make all the reimbursement rates the same, 
but you would lose whatever you are now saving by negotiating 
rates with providers. It is my strong belief that for many, if 
not most, of TRICARE's administrative costs, you will find a 
substantial savings on the benefit side.
    Another issue contributing to TRICARE's higher processing 
cost is the wide range of coverages available under the three-
tiered managed care benefit. While Medicare has one benefit 
package standardized nationwide, TRICARE beneficiaries choose 
from among the standard indemnity plan, a point-of-service 
network provider option, and an HMO-like option. Additionally, 
each prime contractor can offer its own unique menu of 
coverages in addition to the standard benefit.
    There are also, of course, enrolled and unenrolled 
beneficiaries with a seemingly infinite number of possible 
combinations of cost and benefits. These choices and options 
and the constantly evolving benefits make TRICARE more 
attractive to the user, but much more complicated to 
administer. Processing these claims accurately in a timely 
manner is much more labor intensive than processing the 
standard claims for Medicare benefits.
    This complexity also results in a tremendous number of 
inquiries from both beneficiaries and providers, primarily 
related to benefits, cost share, and claim payments. Inquiry 
rates are four times higher for TRICARE than for Medicare. In 
fact, we receive one inquiry for every 4.5 TRICARE claims. We 
are required to provide toll free numbers for these inquiries, 
which certainly seems to be a service that these beneficiaries 
deserve, but it adds significantly to the cost of processing 
claims. And while HCFA requires Medicare providers to use the 
contractor's automated response telephone system when checking 
on the status of claims less than 30 days old, there are no 
such restrictions on TRICARE providers.
    Another difference between Medicare and TRICARE is size. 
The cost difference here derives from the principle of economy 
of scale, with which I know you are familiar. Each program has 
certain fixed costs, including software development and 
maintenance costs, fraud and abuse detection, and EMC marketing 
costs. Medicare's fixed costs are spread over nearly 900 
million claims a year, about 30 times the number of TRICARE 
claims. The huge volume of Medicare claims reduces unit cost. 
For example, $10 million in fixed costs to Medicare translates 
to just over one penny per claim compared to more than 39 cents 
per claim for TRICARE.
    A major factor in claims costs is the use or lack of use of 
electronic media claims filing. The cost of handling paper 
claims is $2 or more higher than the cost of processing them 
electronically. Our Medicare division receives 85.5 percent of 
its medical and surgical claims electronically. We receive less 
than 20 percent of TRICARE medical and surgical claims 
electronically. If we could achieve the same 85.5 percent 
electronic rate, we would reduce our costs by 26 percent.
    There are multiple reasons for this disparity in electronic 
filing. The biggest reason is that TRICARE rarely represents 
more than 5 percent of a provider's income, while Medicare 
typically represents 35 to 60 percent of his or her income.
    Adding to this financial leverage Medicare has on a 
provider, HCFA has mandated that all paper claim submissions be 
held and not released until they are 27 days old. Compare that 
to TRICARE. Fifty percent of TRICARE providers submit ten or 
fewer claims per month. Ninety-eight percent of those claims 
are paid within 30 days, averaging 12 to 14 days. There is 
simply no financial reason for a provider to go through the 
additional hassle and expense of an electronic system for 
TRICARE.
    Much of what I have said today has stressed the differences 
between these two programs. It is difficult to compare with an 
eye toward reducing the claims processing cost of two programs 
whose concepts are completely different. I would like to 
suggest to you that you might want to compare TRICARE with the 
Federal Employees Health Benefits Program, FEHBP, which, as you 
know, is quite highly regarded in terms of both benefits and 
administration and which is much more like TRICARE than is the 
Medicare program. Both are managed care programs, while 
Medicare is a fee-for-service program. My research shows that 
FEHBP and TRICARE have almost identical costs for claims 
processing.
    Since we are comparing administrative costs for TRICARE 
with those of Medicare, however, let me quickly add that the 
General Accounting Office recently raised questions about the 
low administrative cost for Medicare. When cost is measured 
against future population growth in the Medicare age brackets, 
coupled with medical technology advancements and consideration 
of new mandates, William J. Scanlon, Director of Public Health 
Issues of the Health, Education, and Human Services Division of 
the GAO, testified before the Senate's Committee on Finance on 
May 4, 2000. Here is part of what he said, and I quote. 
``Contractor budgets for claims administration have been 
falling in proportion to the volume of claims they process. 
Relative to the size of private health insurers and their 
administrative budgets, HCFA runs Medicare on a shoestring.''
    Blue Cross and Blue Shield of South Carolina is eager to 
work with you on finding ways to reduce claims processing 
costs, and indeed, we are always working toward streamlining 
and improving our processes. I appreciate your interest in my 
testimony and I will be happy to answer any questions.
    Mr. Shays [presiding]. Thank you, Mr. Meyer.
    [The prepared statement of William J. Meyer follows:]

   Prepared Statement of William J. Meyer, Senior Vice President of 
           Tricare, Blue Cross-Blue Shield of South Carolina

    Congressman Shays, Congressman Moran, Congressman Thornberry, thank 
you for inviting me here today, and thank you for your interest in the 
experience of my company, Palmetto Government Benefits Administrators, 
a division of Blue Cross Blue Shield of South Carolina. I appreciate 
your concern with the difference in processing costs between Medicare 
and TRICARE, and welcome the opportunity to give you some information 
and ideas based on our experience. Blue Cross and Blue Shield of South 
Carolina, through its subsidiaries, is the largest claims processor in 
the country for both Medicare and TRICARE, so we have a thorough 
understanding of the administrative cost structures and program 
differences of both programs.
    The national average cost to process a Medicare claim in fiscal 
year 1999 was $1.78. The average cost to process a TRICARE claim at my 
company is just over $7.50. While on its face that is alarge disparity, 
close analysis shows that there are reasons for it. The best way to 
understand the differences in those processing costs is to understand 
the differences between the two programs.
    The most important difference is the most basic: By definition, 
Medicare is a fee-for-service program, while TRICARE is a managed care 
program. The whole concept of managed care is that managing healthcare 
to maximize its efficiency will result in increased administrative 
costs, but that the resulting efficiency will save far more than it 
costs. A complex system of authorizations, referrals, and discounted 
provider networks means that the same service might get paid for in 
dozens, or even scores, of different ways. This acknowledged 
administrative complexity is far different from what we find in 
Medicare, where fees are set regardless of the provider, and almost 
every claim is paid in the same way.
    There is a propensity to look at claims processing costs without 
accounting for savings on the benefit side, but an accurate analysis of 
the costs of Medicare and TRICARE demands that you look at both. As an 
example, one reason processing TRICARE claims is more complex-thus more 
costly-is that physicians in the program are paid different amounts for 
the same procedures. That is because reimbursement rates are negotiated 
to get the most saving possible. You could save on processing if you 
make all the reimbursement rates the same-but you would lose whatever 
you now save by negotiating rates with providers. It is my strong 
belief that for many, if not most, of TRICARE's administrative costs 
you will find a substantial saving on the benefit side.
    Another issue contributing to TRICARE's higher processing costs is 
the wide range of coverages available under the three-tiered managed 
care benefit. While Medicare has one benefit package, standardized 
nationwide, TRICARE beneficiaries choose from among the standard 
indemnity plan, a point-of service network provider option, and an HMO-
like option. Additionally, each prime contractor can offer its own 
unique menu of coverages in addition to the standard benefit. There are 
also, of course, enrolled and unenrolled beneficiaries, with a 
seemingly infinite number of possible combinations of costs and 
benefits. These choices and options, and the constantly evolving 
benefits, make TRICARE more attractive to the user, but much more 
complicated to administer. Processing these claims accurately in a 
timely manner is much more labor-intensive than processing the standard 
claims for Medicare benefits.
    This complexity also results in a tremendous number of inquiries, 
from both beneficiaries and providers, primarily related to benefits, 
cost share, and claims payments. Inquiry rates are four times higher 
for TRICARE than for Medicare claims. In fact, we receive one inquiry 
for every 4.5 TRICARE claims. We are required to provide toll-free 
numbers for these inquiries, which certainly seems to be a service that 
these beneficiaries deserve, but it adds significantly to the cost of 
processing claims. And while HCFA requires Medicare providers to use 
the contractor's automated response telephone system when checking on 
the status of claims less than 30 days old, there are no such 
restrictions on TRICARE providers.
    Another difference between Medicare and TRICARE is size. The cost 
difference here derives from the principle of ``economy of scale,'' 
with which I know you are familiar. Each program has certain fixed 
costs, including software development and maintenance costs, fraud and 
abuse detection, and EMC marketing costs. Medicare's fixed costs are 
spread over nearly 900 million claims a year, about 30 times the number 
of TRICARE claims. The huge volume of Medicare claims reduces unit 
costs. For example, 10 million dollars in fixed cost to Medicare 
translates to just over one cent per claim, compared to more than 39 
cents per claim for TRICARE.
    A major factor in claims costs is the use-or lack of use-of 
electronic media claims filing. The cost of handling paper claims is 
$2.00 or more higher than the cost of processing them electronically. 
Our Medicare division receives 85.5 percent of its medical surgical 
claims electronically. We receive less than 20 percent of TRICARE 
medical surgical claims electronically. If we could achieve the same 
85.5 percent electronic submission rate we would reduce our cost by 26 
percent.
    There are multiple reasons for this disparity in electronic filing. 
The biggest reason is that TRICARE rarely represents more than 5 
percent of a provider's income, while Medicare typically represents 35 
to 60 percent of his or her income. Adding to this financial leverage 
Medicare has on a provider, HCFA has mandated that all paper claims 
submissions be held and not released until they are 27 days old.
    Compare that to TRICARE. Fifty percent of TRICARE providers submit 
10 or fewer claims per month. Ninety-eight percent of those claims are 
paid within 30 days, averaging 12-14 days. There is simply no financial 
reason for a provider to go through the additional hassle and expense 
for an electronic system for TRICARE.
    Much of what I have said today has stressed the differences between 
these two programs. It is difficult to compare, with an eye toward 
reducing, the claims processing costs of two programs whose concepts 
are completely different. I would like to suggest that you also might 
want to compare TRICARE with the Federal Employees Health Benefit 
Program, which as you know is quite highly regarded in terms of both 
benefits and administration, and which is much more like TRICARE than 
is the Medicare program. Both are managed care programs, while Medicare 
is a fee-for-service program. My initial research shows that FEHBP and 
TRICARE have virtually the same costs for claims processing.
    Since we are comparing administrative costs for TRICARE with those 
for Medicare, however, let me quickly add that the General Accounting 
Office recently raised questions about the low administrative costs for 
Medicare, when cost is measured against future population growth in the 
Medicare age brackets, coupled with medical technology advancements and 
consideration of new mandates. William J. Scanlon, Director of Health 
Financing and Public Health Issues of the Health, Education, and Human 
Services Division of the GAO, testified before the Senate's Committee 
on Finance on May 4, 2000. Here is part of what he said, and I quote: 
``* * * contractor budgets for claims administration have been falling 
in proportion to the volume of claims they process. Relative to the 
size of private health insurers and their administrative budgets, HCFA 
runs Medicare on a shoestring.''
    Blue Cross Blue Shield of South Carolina is eager to work with you 
on finding ways to reduce claims processing costs, and indeed, we are 
always working toward streamlining and improving our processes. I 
appreciate your interest in my testimony, and will be glad to answer 
any questions.

    Mr. Shays. Other members are voting and they will be back 
to ask questions. My name is Chris Shays. I chair this 
committee along with Mr. Thornberry and I also chair the 
National Security Subcommittee that oversees all of DOD for all 
programs, including health care. While my Subcommittee on 
Government Reform has not really gotten into health care, we 
did get into health care issues when I chaired the Human 
Resource Subcommittee and it is an issue we are tremendously 
interested in.
    Dr. Sears, I would like to have you just kind of describe 
to me your perception as you would be listening to veterans of 
all the reasons why they do not find TRICARE as satisfactory as 
you would like or as I would like.
    Dr. Sears. When you say veterans, sir, do you mean----
    Mr. Shays. I do not mean veterans, I mean our military 
personnel.
    Dr. Sears. Yes. I think----
    Mr. Shays. I might say also that my subcommittee also 
oversees veterans' affairs and we have focused time on 
veterans' affairs, so I let it slip there.
    Dr. Sears. I was afraid you were getting out of my area----
    Mr. Shays. That is also my bias, that I eventually would 
like to combine both health care systems, too, so that is 
another issue.
    Dr. Sears [continuing]. Although many of our beneficiaries 
are veterans, obviously. As we track satisfaction, which, 
incidentally, has shown a trend of steady improvement since the 
beginning of TRICARE in each of the regions in studies and 
surveys done by outside consultants, clearly, the remaining 
challenge, the largest remaining challenge to us is the issue 
of access, and that revolves around the difficulties with 
telephone access, sometimes a problem of infrastructure in our 
military treatment facilities, particularly, and sometimes a 
problem with access to easy appointments and sometimes access 
to particularly acute care appointments.
    We have made tremendous progress in those areas, but as Mr. 
Backhus pointed out, this is an area they are studying. It is 
an area where we have done a lot of work and there are 
significant improvements in place and many that are going in 
place over the next few months. But we must solve the telephone 
access problem, moving toward the utilization of one TRICARE 
number nationally that downlinks, and looking at other issues.
    The biggest problem we face----
    Mr. Shays. You say one number. There is not one 800 number 
nationwide?
    Dr. Sears. No, there is not. There is an 800 number 
regionally----
    Mr. Shays. See, I would have trouble understanding that. I 
mean, given that our military fly everywhere and go everywhere, 
why would that not have happened yesterday?
    Dr. Sears. We are talking about a number to access claims, 
and currently, the way the contracts are set, we have different 
contractors in different regions who manage that central phone, 
so that you access it currently on a regional basis because you 
are enrolled in a particular region, so you get served by that 
region.
    Mr. Shays. But they all have their own number. I use my 
Visa card and I enrolled in one place but I can go anywhere in 
the world and I can use it.
    Dr. Sears. Yes, sir, and that is where we are moving as 
rapidly as we can. The banking card issue, or the USAA, which 
is what our members talk to us about, is exactly where we are 
moving. That will allow us, when we put that in place, and that 
is in the works, to have one number that downlinks to all of 
our regions for both advice and appointments and other 
information, as needed.
    Mr. Shays. If I said to my staff they are going to do 
something as rapidly as possible, I would like to know, what 
does that mean, and they have trained me to ask the same thing. 
What does as rapidly as possible mean?
    Dr. Sears. Well, we are in the process, first of all, of--
we have an IPT, a team that is working on this issue. They have 
now worked with a number of the folks who provide these sorts 
of services and they are looking to the establishment of a 1-
800 number capability sometime next fall.
    Mr. Shays. Not this fall?
    Dr. Sears. No, not this fall, next fall.
    Mr. Shays. That does not seem as rapidly as possible, then. 
That seems like on our own good time. You raised telephone 
access as a great aggravant--I did not, you did--and it would 
strike me that if that is the biggest problem, it is one of the 
easier parts of the problem to solve.
    Dr. Sears. There are several approaches to that, sir. One 
is through an improvement in our regional systems so that 
people can access that, and those initiatives, some of them are 
in place, some of them are going into place. But the larger 
problem of getting a downlink system that has the 
infrastructure and takes advantage of all the current 
technology is a longer process. We are striving to get that in 
place, obviously, as quickly as we can. We also have current 
contractual relationships in terms of some of those numbers 
that have to be modified. Contracts have to be modified to put 
that in place.
    Mr. Shays. Well, it just strikes me, and I would think the 
other members of the committee, that doing it in a year and 3 
months or so is not rapidly as possible.
    What would be others besides telephone access? When I go 
out and I am listening to our men and women, they do not just 
tell me telephone access.
    Dr. Sears. No. The other major problem that we have had and 
are in the process of solving in very short order, this fall, 
is the issue of standardized appointments across our system. 
Right now, with the three military services doing appointing in 
different ways, using different appointment types, different 
templates, using different business rules for their appointing, 
we really have had a hodge-podge of different ways to get 
appointments.
    We are putting in place now a standardized appointment 
system which reduces the number of appointment types from 
literally thousands in the past to a manageable number of eight 
or ten and building the templates that allow visibility of 
appointments to the folks who are doing the scheduling. If the 
appointing system is not properly structured, then even though 
you may have appointments available, they may not be obvious to 
the people who are making the appointments. That will be solved 
this fall.
    We also have put out a software package that allows each of 
our military facilities to determine how they are utilizing 
their templates. It is called the template analysis tool. It 
allows them to make corrections in the way they are setting up 
their appointments so that they can correct their problems and 
make sure that the appointment availability is fully utilized. 
So those are very dramatic changes which will improve that 
access.
    Now, as you know, under TRICARE, unlike CHAMPUS and our 
military health system before, we are guaranteeing our 
beneficiaries certain access availability. If you have an acute 
illness and need to be seen immediately, the guarantee is that 
you will be seen the same day. For routine appointments, we are 
guaranteeing a 7-day appointment standard. And for wellness 
visits and other consultations, up to 30 days.
    For the most part, we are generally meeting those 
standards, and in the TRICARE system, if those standards cannot 
be met within the direct care system, within the military 
system, our requirement is that they be referred into the 
network so that they can be seen in a timely way.
    Mr. Shays. Let me just, before, Mr. Chairman, yielding 
back, just be clear on one thing. Our military personnel are 
sometimes called at a moment's notice. Is there the flexibility 
to meet a change in their schedule quickly, because they may 
all of a sudden find they are going to be out to sea for a few 
days?
    Dr. Sears. Absolutely. Active duty folks have the highest 
priority, and certainly deploying units would have the highest 
priority for attention to their medical needs as they prepare 
for deployment.
    Mr. Shays. Thank you very much. Thank you, Mr. Chairman.
    Mr. Thornberry [presiding]. Mr. Spratt.
    Mr. Spratt. I will waive any questions.
    Mr. Thornberry. Let me ask, I guess, kind of a bottom-line 
question. We hear that the average cost to process a Medicare 
claim is $1.78. We hear that the average cost for the health 
insurance industry, I guess the private sector, is $3.50 to $4, 
ballpark maybe. And for TRICARE, it is nearly $8. You all have 
given a variety of factors that causes TRICARE to be higher. 
Some of those, I suppose, are factors we can fix and some of 
them are factors we cannot fix.
    What I would like to get a sense of is, what do you think 
the goal ought to be? Are we doing as well as we can do? Is $8 
or whatever it is as good as we can do, given the way that 
TRICARE is set up, or can we do better with electronic filing 
and other kinds of improvements? What should our goal be if 
things were running pretty well? Mr. Backhus, let me ask you to 
start.
    Mr. Backhus. We asked ourselves and two claims processors 
that question, as well as the organizations that they process 
claims for, the TRICARE support contractors. We have analyzed 
the costs currently incurred in TRICARE. We have not looked at 
FEHBP at this point, but have a little bit of information on 
that.
    It seems to me that the consensus around this is in the 
neighborhood of $3 or $4 per claim, which would be more like 
the industry average. There is $3 or so in costs per claim that 
are above and beyond the real cost of determining payment. Some 
of these costs like maintenance of information relative to who 
is using the system and to detect and deter fraud and abuse, 
are necessary expenditures.
    But there are so many different edits in the program that 
probably are not necessary, and there is so much opportunity 
with technology such as potentially using the Internet and 
other more state-of-the-art systems, that I think we are 
talking, in my judgment, about $3 to $4 per claim.
    Mr. Thornberry. Mr. Meyer, do you agree that we can save 
that much money if we get everything running right?
    Mr. Meyer. I think if we did everything possible, this 
program would cost at least $5 a claim because of some of the 
basic inherent differences, and if you will just give me one 
moment, I will give you the best example I can, and that is our 
largest volume provider, we have five of the seven regions. We 
process 82 percent of the TRICARE claims.
    The largest single provider we have across all five regions 
that does not submit claims electronically is the provider from 
the East Coast of North Carolina, a large group provider. They 
submit over 3,300 TRICARE claims per month, every month. They 
submit them all paper. We have been fighting to get these 
people to submit electronically.
    Their answer to us is that they give TRICARE--they are a 
TRICARE Prime provider. They give TRICARE a 15 percent discount 
off the TRICARE rate for all their services. They are taking a 
15 percent hit on the benefit dollars. Their electronic 
submitter is a company that charges them 35 cents a claim to 
submit claims electronically. Their paper TRICARE claims are 
getting paid in an average of 2 weeks.
    They said there is exactly no reason for them to ever 
submit those claims electronically to us because they will be 
damned if they are going to give us--even though that 35 cents 
does not go to us, that is another 35 cents they would have to 
cut and they do not need the money in less than 2 weeks.
    And that is the story over and over again. Once again, we 
could cut our costs 26 percent if we could get the same 
electronic rates as Medicare, and to say our electronic rate is 
50 percent is a little bit misleading because most of that is 
pharmacy claims. Almost all of our pharmacy claims come 
electronically, but the hard claims, the professional claims 
and the surgical claims, only 17 to 20 percent of those come 
electronically.
    Mr. Thornberry. I want to clarify that and get back to it 
in just a second, because I had that as a question, to resolve 
that difference.
    But Dr. Sears, what do you think? What ought to be our goal 
here that we could achieve if we get everything running right?
    Dr. Sears. I think Mr. Meyer has hit it pretty closely. 
Obviously, we want to get the cost as low as possible, but I 
think the $2 to $3 range is achievable.
    Mr. Thornberry. So we could save $2 to $3 per claim if we 
get everything going right?
    Dr. Sears. I think that is achievable with HIPAA, when 
HIPAA gets into place, when we complete all of our 
restructuring of edits and reviews and all of the 
simplification things that we are going through right now in 
our task forces that are looking at how to prevent rework of 
claims. I think further savings are achievable and should be 
striven for. The new technology, obviously, will also help 
significantly and it is in some ways hard to predict what cost 
savings can be achieved through the new technology.
    Mr. Thornberry. Do you agree with Mr. Meyer's point that if 
you just look at, set pharmacy aside and the rest of the 
claims, only 17 to 20 percent are filed electronically now?
    Dr. Sears. That is correct.
    Mr. Thornberry. And you, I think, said something about 50 
percent, but that is only when you include all the pharmacy?
    Dr. Sears. That is right.
    Mr. Thornberry. OK.
    Dr. Sears. That is correct.
    Mr. Thornberry. Now, it is a little puzzling to me why it 
takes so long and seems to be so difficult to get electronic 
filing done, because, as you mentioned, Congress passed a law 
several years ago to require everybody to move in that 
direction, and you all seem to be saying we have no tools at 
our disposal to get these providers to file electronically. Are 
we making electronic filing too difficult for them? Do we have 
such a separate system for TRICARE with unique fields to be 
filled in and such special requirements for our computers that 
it is too difficult?
    Dr. Sears. Mr. Meyer is the expert in this, but if I am a 
physician practicing and I see a Medicare patient or a TRICARE 
patient, we use the same forms, the HCFA-1500 for individual 
providers and the UV-92 for hospital providers, the same form 
obviously for TRICARE and for Medicare. We have built things 
into the system now that mean that those claims could be 
submitted and processed--the same claim that could be submitted 
to the HCFA claims processor can be submitted to Mr. Meyer's 
organization and be processed.
    Mr. Thornberry. OK. Mr. Meyer, if you are using the same 
form that you get anyway from Medicare providers, why can you 
not just use the same form and why can these doctors and 
providers not use the same form and e-mail it to somebody else 
other than----
    Mr. Meyer. The form is the same, Mr. Chairman, but the data 
on the form is not necessarily the same, the data required on 
the form. There are some additional things that have to be put 
on that form for a TRICARE claim that does not have to be put 
on that form for a Medicare claim.
    Mr. Thornberry. Are there some of those things we can get 
rid of?
    Mr. Meyer. No, not really. You need to know branch of 
service, you need to know--there are TRICARE particulars you 
have to have. But let me say that that is not a large 
impediment. For the most part, that is a one-time cost, to 
modify a system to accept it for TRICARE.
    The bigger impediment is, once again, more than 90 percent 
of the TRICARE claims we receive, excluding drug ones again, 
are coming from providers that submit less than ten claims per 
month. In other words, they are submitting 800 Medicare claims, 
three TRICARE claims. They say, we are not going to go through 
the expense of adjusting our automated system. It is going to 
cost us $400 to fix our automated system to accept TRICARE 
claims for three or four claims a month when you are paying 
them in less than 30 days anyway. There is no advantage for us 
to do that. We run into that over and over and over again.
    Mr. Thornberry. I am sure it is just my ignorance. I am 
just not quite understanding why it should be so much more 
difficult, if you are already submitting so many Medicare 
claims, to submit a TRICARE claim on the same form.
    Let me ask one last question and then see if my colleagues 
have questions. Mr. Backhus, you used the example of these 
electrocardiograms. Would you explain that to me? As I 
understand it, from one provider alone, 14,000 claims for 
electrocardiograms were all sent over here for manual review. 
Now, I presume that means somebody looking at each piece of 
paper and approving each of those claims manually, when none of 
them are ever denied. Can you explain that to me?
    Mr. Backhus. I will try. The history of this dates back to 
program requirements that preceded TRICARE. At a time when 
CHAMPUS was in place and the Department of Defense was, in 
fact, a direct payer of claims, there was a feeling that there 
was a need to screen claims for many different kinds of 
services, in other words require that claims for many different 
services be edited and reviewed for medical necessity. In this 
particular case, the requirement was for all electrocardiograms 
claims to be manually reviewed for that purpose.
    Now that TRICARE is here and the contractors have some 
fiscal responsibility for the costs, the responsibilities for 
determining medical necessity and appropriateness rests in many 
cases with them. However, technologies have changed and 
utilization has changed, and thus, in some cases, the need to 
review services in particular have changed.
    Electrocardiogram claims fall into that category, but the 
requirement did not change. It is outdated, probably needs to 
be--in fact, recently, a policy has been put into place, as I 
understand it, to permit the contractors now to remove that 
particular edit from the claims processing system. It is not in 
place at this point, but it should be within a few months.
    The other thing I would like to clarify is that the 14,000 
claims are from one particular TRICARE contract, one particular 
region.
    Mr. Thornberry. We do not want to make too much out of each 
individual instance, but I think it is helpful for us to get a 
feel for some of the problems that we are trying to sort 
through and why these costs are so much, because obviously if 
you have got to go through 14,000 pieces of paper, each one and 
every one gets approved, then that is an unnecessary expense in 
a variety of ways and it is one example.
    Mr. Spratt. Would the gentleman yield?
    Mr. Thornberry. I would be happy to yield to the gentleman.
    Mr. Spratt. With respect to your cost, I am not quite clear 
as to your testimony. You testified, Mr. Meyer, that in 
addition to just the direct cost of processing a claim, you are 
also handling the network, responding to provider inquiries, 
responding to patient inquiries, and trying to make this 
managed care network an efficient provider as opposed to just 
some fee-for-service situation where you pay whatever the 
charge says to pay.
    Are you saying that when you give us your per claim 
estimate of what it costs to settle one claim, pay one claim, 
you are dividing the number of claims into the total 
compensation you receive from managing this whole program?
    Mr. Meyer. That is correct, Congressman. Typically, claims 
processing costs in this program includes all the things you 
just mentioned, includes providing the telephone service, the 
toll-free lines, the responding to written inquiries, the 
management of the provider file and pricing files. It is all 
rolled together. The cost to actually process the claim with 
none of that itself is $2 and some odd cents.
    Mr. Spratt. So it is pretty close to Medicare, the actual 
claims management aspect.
    Mr. Meyer. Right. But in fairness, Medicare includes the 
cost of processing the inquiries and they are $1.78. So the 
$1.78 for Medicare and the $7.50 for TRICARE is as close as you 
can get to apples to apples for the different requirements.
    Mr. Spratt. But does the $7.50 include all of these other 
managerial responsibilities?
    Mr. Meyer. Yes, it does, and many of those, Medicare does 
not have. Medicare does not have to manage the one million 
provider file that I have to manage. It is very, very small 
compared to that.
    Mr. Spratt. To what extent do you have to nourish the 
network? Do you have to deal with providers and try to coax and 
persuade them to stay in the network? I know in South Carolina, 
which is under your purview, we have had a problem with the 
TRICARE network, first of all building it up and filling out 
different aspects of it, and then keeping some of those who 
signed up originally in the system.
    Mr. Meyer. Yes, we do that, Congressman. We have a very--it 
is probably 60 cents a claim that we spend on just maintaining 
those provider networks. It is classic, for example, for one 
doctor to belong to one group and be in the network in that 
group and belong to another group at the same time and not be 
in the network in that group, which is legal but not ethical. 
He can manage his fees that way. In other words, as a part of 
the network in this group, he is going to get paid $50 for a 
service, but in this other group, he can get paid $75 for the 
same service, so he will move over to that group to get that 
service done. We have to manage that. There are over one 
million individual providers on our provider file that we have 
to manage the pricing on those things and the complexity is 
just enormous, and that is 60 cents a claim that Medicare does 
not experience.
    Mr. Spratt. I thank the gentleman for yielding.
    Mr. Thornberry. I thank the gentleman.
    Mr. Buyer.
    Mr. Buyer. Thank you, Mr. Chairman. Back to the hearing 
that we had this past spring, of all the hearings that I have 
ever attended or chaired in Congress, as I look back at that 
one, it was 5 hours. It was a marathon hearing that we had, but 
it was also one of the most productive I think that I have ever 
participated in because we talked about TRICARE. No one could 
duck anything. They were all in the room. I was going through 
the white paper that one of the companies had submitted and I 
wanted to touch on a couple of things.
    If we were to, back to the chairman's initial questions of 
you, to get at it quickly, when you talk about--I would 
appreciate your testimony about what are the front costs and 
then discuss the inquiry rates and why is there such a 
differential in the inquiry rates between Medicare and TRICARE, 
and those are two huge cost drivers.
    Mr. Meyer. Absolutely. Let me take the inquiry rates first. 
We have, once again, we get more than five million telephone 
inquiries per year for our claim volume, one phone call for 
every four-and-a-half claims. One of the reasons why that is so 
different compared to Medicare, and it is an important point to 
make, is that our research has shown that 50 percent of our 
phone calls are people, mostly providers, calling to find out 
the status of the claim. Sixty percent of that 50 percent are 
phone calls on claims less than 30 days old.
    In Medicare, those phone calls must go through the 
automated voice response unit. In other words, a doctor cannot 
opt past the automated response unit to a human attendant. In 
TRICARE, there is no such prohibition. Virtually 100 percent of 
them go right past the automated response unit and come to an 
individual to answer. This usually inflates the volume of phone 
calls. I would go on a limb to say 30 percent of our phone 
calls could be eliminated if we required, as Medicare does, 
those providers to use the automated response unit for claims 
that are less than 30 days old.
    Once again, more than half the phone calls we get on claim 
status are claims for 8 days old, 10 days old, 12 days old. It 
is routine. We have the same providers call every Monday and 
they call on the list of every claim they have submitted. Even 
if the claim was submitted last Thursday, they are calling for 
the status on a Monday. They read off 50 claims and they want 
the same status.
    Mr. Buyer. What had been submitted to me was that--and I 
wish you would concur or not concur--that with regard to 
Medicare, you receive one inquiry per 18 Medicare claims.
    Mr. Meyer. That is correct.
    Mr. Buyer. TRICARE, it is one inquiry for 4.5 claims.
    Mr. Meyer. That is correct. That is the ratio.
    Mr. Buyer. That is almost five times the amount.
    Mr. Meyer. It is exactly four-to-one, right.
    Mr. Buyer. That is stunning, especially given the volume of 
Medicare claims you process versus TRICARE claims. So this 
issue of moving toward greater simplification----
    Mr. Meyer. It is a huge benefit.
    Mr. Buyer [continuing]. It is a huge benefit. Will you 
share with the committee a breakout of what you meant by front 
costs? If the front end costs were--front end costs are handled 
different ways.
    Mr. Meyer. Right.
    Mr. Buyer. Break that out. Define that for me.
    Mr. Meyer. That is the mailroom, the place that receives 
the 25 million claims that we receive. That is the cost for 
coding all those claims and data rendering all those claims 
into the system. That is the cost of passing the paper around, 
collecting the paper, and then, in fact, sending the paper off 
to storage places for that paper to be stored, because, 
frankly, the Federal records centers are all full so we have to 
absorb the cost of retaining 25 million claims and associated 
correspondence per year.
    Mr. Buyer. So you threw in mailroom, document preparation, 
imaging, distribution, data entry, paper storage, according to 
this white paper by your company, it could add up to $1.35 to 
$1.50 per claim.
    Mr. Meyer. Right, Congressman. Since we did that paper, we 
looked at it closer and it is actually closer to $2 per claim.
    Mr. Buyer. That is almost equivalent to the cost of 
Medicare alone, and that is just the front cost.
    Mr. Meyer. That is correct.
    Mr. Buyer. That is pretty stunning when you think about 
that.
    Mr. Spratt. Would the gentleman yield?
    Mr. Buyer. Yes.
    Mr. Spratt. Is some of this due to the fact that this is a 
new program, you are just getting accustomed to it, getting 
your providers in the groove, so to speak, and they therefore 
have more inquiries, they need more guidance?
    Mr. Meyer. The inquiries in this program--well, yes and no. 
For example, we get more inquiries on the newer contracts than 
we get on the more mature contracts. For example, we process 
claims for Regions 9, 10, and 12, which is the States of 
California and Hawaii and Alaska. The ratio of calls to claims 
there is lower than the ratio of calls to claims, for example, 
in the Mid-Atlantic region, which is one of the last regions to 
come up, where people are still getting used to the 
complexities of the TRICARE program and still do not understand 
what the benefit is and what the cost share is all the 
complexities associated with the program.
    Mr. Spratt. If you had electronic filing, do you avoid most 
of this front-end cost?
    Mr. Meyer. If you have electronic filing, you avoid all of 
the front-end cost.
    Mr. Spratt. Gee whiz. Do we give providers the software, or 
do they have to buy proprietary software?
    Mr. Meyer. We have a free product that we offer every 
single provider. We say, this is absolutely free to you, this 
software. As a rule, once again, they are already using another 
software package and they are using it primarily for Medicare 
or they are a large commercial carrier and they say they do not 
want to run two packages, even though it is free. They have a 
large vendor that does this for them and they do not want to 
run the second package, and thanks but no thanks.
    If there was a way to do it, we would eliminate that paper 
tomorrow. It would drop right down to our bottom line. There is 
no reason not to do it.
    Mr. Spratt. If the gentleman would yield still, does the 
software we provide free integrate easily with most operating 
systems?
    Mr. Meyer. Yes, it does. It is on a floppy disk. You pop it 
into your computer and away you go. We will have the capability 
within 1 to 2 months for anybody, any provider in the country 
to submit TRICARE claims across the web. All you need at that 
point is government permission to get past whatever security 
issues that they have. We believe we have that conquered and 
then 100 percent of all providers in the country can file 
electronically across the web free.
    But my prediction is they are still not going to do it, 
because once again there, they have thee large systems in place 
that they are submitting from Medicare, which is 50 percent of 
their income, and they are going to say, that is what I am 
using and that is all I am going to use. We may pick up some 
around the edges in the three or four claim per month providers 
that say, well, we can get them done this way.
    Mr. Spratt. Do most of these providers also have a separate 
software package for Medicaid in their particular State?
    Mr. Meyer. I could not answer that question for Medicaid. I 
can look it up for you. For Medicare, I know, but not for 
Medicaid. I would not know.
    Mr. Spratt. Blue Cross-Blue Shield, do you provide your 
PPOs and others who are approved providers, do you provide them 
with software for submission of electronic claims?
    Mr. Meyer. Yes, we do.
    Mr. Spratt. And is the acceptability rate there high?
    Mr. Meyer. Yes, it is, and once again the reason is the 
financial leverage on the doctors we have in the State of South 
Carolina. For the most part, we represent anywhere from 33 
percent to 80 percent of their income.
    Mr. Spratt. Again, it is market share.
    Mr. Meyer. Right.
    Mr. Buyer. We were very cautious when we did the defense 
bill not to place the mandate to electronic filing. We have Dr. 
Sears here and Mr. Backhus. Let us explore that for just a 
moment.
    Mr. Backhus, on page 7 of your written testimony, you 
indicate that one of the challenges in reducing the cost of 
TRICARE claims processing is increasing the number of providers 
who are submitting claims electronically. You indicate that 
this is not likely to happen without either incentives or 
mandates. I agree with your assessment that mandates might 
actually drive providers away from TRICARE.
    What kind of incentives can be used to encourage providers 
to make more use of electronic means of filing claims, to make 
sure that that does not happen? I mean, how do we work 
cooperatively here, DOD with contractors and providers, to make 
sure that does not happen rather than Congress coming in and 
saying, you cannot get it right. We are just going to mandate 
and we are going to micromanage.
    Mr. Backhus. First of all, if these HIPAA requirements do 
come to pass and data submissions are similar for every 
program, then that would go a long way toward providing 
incentives for people to do this that would not require their 
own separate systems and software packages.
    Secondly, you know, Medicare, as Mr. Meyer pointed out, has 
tried to provide incentives for electronic claims processing by 
permitting, or actually requiring, that the paper claims not be 
paid in less than 26 days, whereas electronic claims, of 
course, can be processed and paid much quicker. The same 
possibility exists here to do this. He says his company 
processes the paper claims in 2 weeks.
    Mr. Meyer. On average.
    Mr. Backhus. On average, and the standard is 30 days. It 
may not be popular, but it is possible that if paper claims 
were paid something closer to 30 days, it may offer these folks 
an incentive to submit electronic claims because they will get 
paid quicker. Now, as he says, if they are going to get paid in 
2 weeks with the paper claim, what reason do they have to 
change?
    There is another opportunity here that I think exists that 
is more technical in nature and Mr. Meyer can probably explain 
it better than I can, but, for example, there are opportunities 
for TRICARE to try to adopt the Medicare provider 
identification numbers. What this means simply is that when a 
TRICARE provider wants to file a claim, their unique 
identification number does not fit into the current TRICARE 
electronic formatting and contractors have to convert their 
systems to try to adapt if they want to file under TRICARE.
    There is a possibility to go ahead and allow these folks 
just to use their Medicare numbers, for the TRICARE system to 
recognize that, convert it over to whatever the particular 
network is that this TRICARE provider is associated with, and 
process the claim that way.
    Mr. Buyer. Mr. Chairman, may I be permitted a little 
latitude? Dr. Sears, would you please comment on what we have 
just heard from these two other gentlemen's testimony----
    Dr. Sears. Sure.
    Mr. Buyer [continuing]. Because you have some kind of 
responsibility here.
    Dr. Sears. Yes, sir. What you are hearing described is a 
delicate balance that we have, in part, in attracting providers 
and keeping providers in the network, and the service that is 
provided to the provider is very important both in terms of the 
ability to access information about inquiries and the ability 
to get paid in a timely way. And so often, we hear from 
provider groups that they are willing to stay, they do not like 
the reimbursement, but they are willing to stay because they 
are getting paid in a timely way and there is a customer 
service feature that has been helpful to them. So I think you 
can see the tension there between mandating, which, as has been 
pointed out, could drive people out of the system and the other 
approach.
    Again, Mr. Meyer is the expert here, but the government has 
given approval to the contractors to use the UPIN, the 
Universal Provider Identification Number, and we used to 
require that, I believe, the tax ID number and a sub-
identifier, but there is now an ability to crosswalk between 
the UPIN number and the tax ID number, so that should not be an 
issue.
    Mr. Spratt. Will the gentleman yield?
    Mr. Buyer. Yes.
    Mr. Spratt. Mr. Meyer, Mr. Backhus mentioned HIPAA and 
standardization, and I understand that your particular company 
has a problem with standardization. According to your 
experience, it turned out to be much more complex than it would 
seem and it is also going to be very costly. Would you care to 
comment on that?
    Mr. Meyer. Well, I think you just said it, Congressman 
Spratt, that our experience in our company is we do not--it is 
not that we disagree with HIPAA. We just feel that by the time 
the smoke clears on HIPAA, the cost for administration, for the 
implementation of HIPAA will probably be four times higher than 
what is currently being said. We think there is a huge cost to 
doing it and it is going to drag out over a protracted period 
of time. I have very little confidence that it is going to be 
in 2 years like they say it is going to be. The way the 
committees on that are progressing, they are just not 
progressing at all.
    Mr. Buyer. I want to switch gears for a second, because Dr. 
Sears, one item in your written testimony concerns me a great 
deal. You state the Department is evaluating contractor 
proposals to eliminate the TRICARE Encounter Data System as a 
replacement for the Health Care Service Record. The committee 
staff has worked closely with you and in the 2001 Defense 
Authorization Act, you specifically requested and we put in the 
bill $3.1 million to finish the work on TEDS. So what is up 
here?
    Dr. Sears. We are studying, as the testimony says, but our 
intention is moving to replace the HCSR, the Health Care 
Service Record, with the TRICARE Encounter Data, again----
    Mr. Buyer. You intend to finish the work on TEDS?
    Dr. Sears. We intend to implement that. We are always 
looking at ways to do business in a better way, and this has 
been a very strong demand from our contractors, to look at 
another way of doing this. So we are looking at that. We are 
working with them. But that has not impaired in any way our 
implementation or our switch from the HCSR to the TED.
    Mr. Buyer. OK. You see, we want to be helpful here and be 
responsive and that is the challenge we have made not only to 
you but under the contractors, and so if you have asked us to 
fund a particular system while you are also looking, we want to 
make sure we are casting good judgment.
    Dr. Sears. You are and it is appreciated and we are 
proceeding, and we appreciate the language in the bill this 
year that supports that.
    Mr. Buyer. Thank you, Mr. Chairman. I will have a second 
round of questions. I yield back to the chair.
    Mr. Thornberry. Mr. Shays.
    Mr. Shays. Thank you. I am still wrestling with something 
that is kind of silly, but I am still wrestling with it. If you 
are telling me the primary negative that your recipients have 
to health care is access and just finding a real live person or 
getting information, and you are telling me that you do not 
have a uniform number for people to call in this day and age, 
and then you are telling me they are going to do it as rapidly 
as possible and rapidly as possible means next September, not 
this September, I am just wrestling with the question mark as 
to why, if this is a serious problem, at least in terms of 
product satisfaction, it could not be done in a month or two.
    Why can they not call an 800 number? Why can the 800 number 
not know exactly where it is coming from and refer to the, I 
guess you have 11 regions, is that correct?
    Dr. Sears. Twelve regions.
    Mr. Shays. I mean, the average stay that a military person 
has in one area has got to be relatively small. So of all the 
organizations that should want to do this, I would think you 
would want to do it before almost any other organization. Mr. 
Meyer or Mr. Backhus, tell me why it would be a problem to do 
this sooner than 15 months from now. Why could it not be done 
sooner?
    Mr. Meyer. Congressman, I think there are actually two 
issues on the telephone that Dr. Sears is talking about. One is 
the phone system where people call to get appointments.
    Mr. Shays. Right.
    Mr. Meyer. And the other is the phone system they call if 
they have claims questions. I think one phone number could 
handle it for the claims questions and another phone number--
two phone numbers, one phone number for claims issues and 
another phone number for appointments and I think that could be 
done.
    Mr. Shays. In the private sector fairly quickly, correct?
    Mr. Meyer. I am sorry?
    Mr. Shays. In the private sector, fairly quickly?
    Mr. Meyer. Yes.
    Mr. Shays. Mr. Backhus, you made some specific 
recommendations that would be helpful and one of them was 
dealing with the perennial and daily problem of fraud. What I 
was struck with was your pointing out there are 40 million 
claims processed from January 1999 through April of 2000. Only 
17 fraud referral cases from the contractors have been accepted 
by DOD for investigation. That boggles my mind. I mean, that 
seems so tiny, and I would like you to just talk about it a 
bit.
    Mr. Backhus. OK. A year ago, or about a year ago, we looked 
at this issue extensively. While recognizing TRICARE is a 
different program than Medicare, and the two are hard to 
compare, we were struck by how relatively little activity there 
was at the contractor level in terms of the referrals that they 
were making to other parts of the Department of Defense 
involving potential health care fraud. We asked why and how 
this could be, and what would one expect out of a program this 
size. We learned that while there are requirements in the 
contracts for the contractors to have programs in place to do 
certain kinds of analyses of claims, to look for patterns and 
trends and things like that, they were very poorly staffed.
    Mr. Shays. And is the reason because they have no financial 
incentive?
    Mr. Backhus. No.
    Mr. Shays. In other words, it is not their money?
    Mr. Backhus. No, they do have incentives. This is the odd 
thing about it. They do have, in many cases, the incentive to 
do this because they are at risk for the health care costs that 
are incurred. It just did not seem to be something that they 
had yet pursued with the vigor that ultimately they ought to.
    Mr. Shays. Well, how much are they at risk and how much is 
the government at risk? What is their risk?
    Mr. Backhus. That is a complicated thing. I am not so sure 
I can give an easy answer to that question.
    Mr. Shays. Give me your best effort.
    Mr. Backhus. Essentially, the contracts are fixed price. 
The simple explanation is that for the population that the 
contractors are serving, they bid a fixed price for those 
services. If the costs exceed what they have bid on and were 
awarded in the contract and those costs are not attributable to 
unforseen circumstances, such as population shifts and things 
like that or inflation, unanticipated inflation, then they are 
at risk for a portion of those excess costs shared with the 
government.
    I am having trouble. I would have to provide for the record 
what that split is, but I think Dr. Sears probably has----
    Mr. Shays. Mr. Meyer, can you help me out here?
    Mr. Meyer. It is 80/20, Congressman Shays.
    Mr. Shays. So who has the 80?
    Mr. Meyer. The government does.
    Mr. Shays. And the contractor has 20? And we have a measly 
17 cases out of 40 million?
    Mr. Meyer. Congressman, once again, I am a little bit 
troubled by the numbers in that I know I have right now several 
thousand claims suspended for fraud investigation. So, you 
know, sometimes a case might involve 8,000 or 9,000 claims. I 
think you have got a little bit of apples and oranges here 
again. We talked about 40 million claims and 17 cases. Those 17 
cases can represent a whole lot more than one claim per case.
    Mr. Shays. I understand that, but if only 17 organizations 
or people were prosecuted--is that what I understand to be 
right, Mr. Backhus?
    Mr. Backhus. No, these are active cases.
    Mr. Shays. That would not strike fear in the hearts of 
someone who is seeking to get payment, if 17 out of--but the 
cases are 40 million, so your point is that there are not 40 
million vendors, obviously. But in our work with Medicare and 
when we recommended that we have health care fraud be both a 
Federal and State offense, that it would be both Federal as 
well as State so people could not go from one area to the 
other, I mean, we are capturing billions of dollars as the 
result of those changes.
    I guess what I am interested in is, what would you 
recommend, Mr. Backhus, to beef up this effort? I mean, I am 
going to make an assumption that I do not have to be a rocket 
scientist to, that between fraud and abuse, we have got 
billions of dollars at play.
    Dr. Sears. If I could answer that, sir----
    Mr. Shays. Yes.
    Dr. Sears. First of all, the 10 to 20 percent is really 
felt to be an inaccurate projection of what the fraud and abuse 
is. The National Health Care Anti-Fraud Association feels it is 
between 3 and 5. Now, I am not belittling the problem----
    Mr. Shays. But between 3 and 5----
    Dr. Sears [continuing]. I am just saying the magnitude of 
it is not as great as it may have been portrayed. We have 
probably the leading industry piece in terms of pre-pay edits 
and edits in the system that detect abusive claims, many of 
which are potentially fraudulent claims. So those are 
identified in the system before the claim is paid, and with the 
prepaid edits, that amounts to about seven million in claims 
saving a year, and in the software that detects inappropriate 
or potentially abusive or fraudulent claims, we save about $87 
million a year in that area.
    Mr. Shays. What is the total expenditure that we make, $8 
billion? Out of how much? I am trying to understand the overall 
billing.
    Dr. Sears. The total purchased care dollars that we expend 
is about $2.9 billion for purchased care in our system. We 
have, in the last year and a half, instituted what is called 
the Operation TRICARE Fraud Watch, which is a very aggressive 
approach to address many of the issues that Mr. Backhus raises. 
We have required, are requiring--it is not totally in place yet 
but it is going into place--artificial intelligence software 
that we have mandated that each of our contractors use to 
further identify potential cases of fraud that then can be 
identified.
    We make a major contribution through our national database, 
our TRICARE purchased care database, in support of HCFA, the 
FBI, the Defense criminal investigators----
    Mr. Shays. I am just going to interrupt you and let others 
ask questions.
    Dr. Sears [continuing]. How to do that.
    Mr. Shays. The bottom line is, there is 17 out of 40 
million.
    Dr. Sears. Yes.
    Mr. Shays. That is the bottom line, and the bottom line, 
that would suggest that there is not the aggressive effort.
    Dr. Sears. Yes. Now, that is not all the referrals that we 
get. Those are the referrals that we have gotten that we feel 
where there has been potential harm done to the patient or 
where there is significant recovery. There would be a number of 
other submittals to us that get returned to be investigated as 
abusive claims rather than fraudulent claims.
    But frankly, that is--I do not want to be misunderstood 
here. We think that is a low number also, and it has become a 
special interest item during our quarterly meetings with our 
contractors where we review their turning over to us for 
potential fraud cases, and we expect that to increase. In fact, 
we are seeing increases, not as dramatic as we had hoped, but 
we are seeing increases this year in referrals and anticipate 
with the utilization of the additional software piece and all 
of the other educational efforts--we have required the 
contractors to put on the explanation of benefits forms a fraud 
hotline number. The EOB is one of the great detectors of fraud 
and we think that is an effective way. We have established a 
web page that also identifies sanctioned providers and gives 
people the direction and providers the direction in terms of 
how to report fraud.
    Mr. Shays. Let me thank----
    Mr. Buyer. Would the gentleman yield to me for a moment?
    Mr. Shays. Sure.
    Mr. Buyer. I have listened to this and I am not completely 
satisfied that, despite what you have testified to, Dr. Sears, 
is completely responsive to Mr. Shays. That is my personal 
observation.
    What we have here is Mr. Backhus, with regard to his 
interest in the Department of Defense efforts to implement an 
effective system for identifying waste, fraud, and abuse, comes 
out and says, we have identified potential losses of up to $580 
million. Mr. Shays and the Budget Committee's reaction to that 
is appropriate. I think that is incredible. Then when you add 
to that and say that 17 cases of potential fraud were accepted 
from the managed care support contractors by the Department of 
Defense for investigation is stunning.
    So let me pause for a moment here, if I may, Mr. Shays, and 
let us turn to Mr. Backhus here and let us try to put the 
ketchup back in the bottle. Mr. Backhus.
    Mr. Backhus. I am not sure what you are asking me.
    Mr. Buyer. What I am asking here is, of the $580 million, 
what all is that and give us your judgments here or your 
observations about why the Department is giving the answers 
that they are giving here.
    Mr. Backhus. I suppose the first thing I need to say is 
that I doubt--I would say it would be impossible to ever, ever 
pinpoint or be precise as to what this upper limit is. The 
estimates that comprise or make up $580 million come from a 
number of different sources, from people in the business who 
are talking 10 to 20 percent. It is fraud, waste, and abuse, 
not just fraud, necessarily. It is important to distinguish and 
to make clear that it is not always criminal kinds of fraud but 
there are over-billings and things like that, possibly 
unnecessary care and things like that which are included in 
this. So that accounts for, I think, the difference, 
potentially, between 3 percent and something in the 
neighborhood of 10 to 20 percent. So we are talking about lots 
of things here.
    The activity--in response to the report that we wrote last 
year on this, the Department has been responsive in several 
ways. Giving it attention was the first order of business here, 
and there was at the time nothing in the way of strategic 
planning or emphasis, in terms of management attention, that we 
could see that existed. Since that time, there is now in place 
an emphasis that has been placed on this from the top. They do 
have prepayment edits. They identify over-billings in some 
cases and things like that.
    But in preparing for this hearing today what we tried to do 
was to find out exactly what has changed in the way of 
additional kinds of analysis, mostly in an automated way, that 
are being made of the claims that are submitted, either 
provider profiling, trending, patterns, billing practices, at 
the contractor level. This is a level above where Mr. Meyer 
works--the people that he contracts with to process claims.
    There is software available around to do this that matches 
claims together to determine potential issues involving fraud, 
mostly. The software is available. The Department of Defense 
has identified that software and wants their folks to use it, 
but as I understand it, this stuff is not going to be loaded by 
the contractors until the end of this fiscal year, sometime in 
the September-October time frame, and until that happens, I 
suspect that we are going to see much the same kind of----
    Mr. Buyer. Of the $580 million. So you have got the fraud 
side of it, you have got abuses of the systems, and then you 
have waste, and that is sort of what we are looking at here, is 
how we bring efficiencies to the systems.
    Let me shift gears for just a moment. This is a unique 
opportunity, so I have to ask this question. We conduct our 
hearings on the Armed Services Committee. We work with you. We 
sort of move toward solutions. Now you have an opportunity to 
examine what we have placed in the Defense Authorization Act. 
We chose not to give you an actual mandate, come in and 
mandate, and we talked about some of those concerns. But what 
we gave you was a goal, to move to 50 percent of the non-
pharmaceutical claims.
    Do you know what that sort of is? We are telegraphing 
exactly where we are coming from. We want to see if you can 
achieve the goal, because if you do not achieve the goal, you 
know exactly what Congress is going to do and it will be 
mandates. So my question to you is, how realistic will you be 
to achieve the goal so we do not micromanage? Dr. Sears.
    Dr. Sears. Are you asking if the goal is realistic?
    Mr. Buyer. I want to know if you can achieve the goal 
without Congress having to mandate electronic filing. Can you 
do it on your own?
    Dr. Sears. We certainly feel that that is achievable. As 
Mr. Meyer has pointed out, it is difficult, but we will 
certainly--I think the 50 percent level is going to be 
difficult and I would just be repeating what has been stated 
before in testimony, but we certainly have a full court press 
in terms of our attempts to convert, particularly as you stated 
in the legislation, that we would, identify the high-volume 
providers. We have directed the Secretary to identify the high-
volume providers in an attempt to get that level up to 50 
percent, and we will pursue that vigorously. I have----
    Mr. Buyer. Let us be specific. Full court to achieve, full 
court press to achieve is your quote. What is the date to 
implement a web-based system of open architecture? When is that 
going to happen? Give me an idea. It was supposed to have 
occurred by May. Is it going to happen? I mean, if you can say 
full press, that should have happened by now. When is this 
going to happen?
    Dr. Sears. As you know, our contracts are established and 
requirements are put in those contracts that are met. Changes 
in those change. Some of the web-based systems are currently 
online. They are in place. They are being utilized. In terms of 
looking up the status of claims and other enhancements will go 
on those.
    As Mr. Meyer mentioned, they are moving toward the 
utilization of web-based capability to submit claims. Those 
things are underway. We are supporting with our contractors 
discussions that may lead to other approaches to this. So there 
is activity, there are things in place, and this is 
progressing.
    But it will take new contracts to bring a total system 
across--a total approach across the system, which is one of the 
things that is difficult that we cannot move as rapidly as we 
would like to and as we see the right way to move. But in the 
meantime, things are going into place and in the new contracts, 
with the requirement that our contractors use best business 
practices, obviously, a good share of those things will be a 
part of those new contracts.
    Mr. Buyer. Mr. Chairman, may I have one more? I think this 
has been very helpful and productive and I want to thank the 
Budget Committee. We have talked about different pillars here 
relative to why it costs so much, whether it is front costs, 
inquiry costs, how we can reduce actually the human element in 
touching this administration.
    Mr. Meyer, I think your testimony was very helpful. The 
theme I received from your written testimony is about the 
complexity of the claims processing. I think the other pillar 
is the complexity of these claims versus Medicare. So in our 
system, you have got to look at it and you say, well, how do we 
move to data warehousing? Right now, you go, OK, a claim. Are 
they active, pending, TRICARE, standard, prime, senior, extra, 
how were the rates negotiated, portability, who pays what, 
competition between regions, not my responsibility.
    Mr. Meyer. Right.
    Mr. Buyer. Wow. So how do we move toward streamlining, all 
right, and I would be interested in your views here. Actually, 
for all of you gentlemen, how do we move toward streamlining, 
reduce the complexity without actually reducing the benefits at 
the same time?
    Mr. Meyer. I think the Department has begun to do that. I 
think the work simplification efforts in the past year are 
beginning to get away from the fact that 14,000 
electrocardiograms had deferred the year before for somebody in 
my shop to look at the paper and say it is appropriate and pass 
on. That is times 400 other deferrals just like that. That has 
begun. The Department has told us, do away with that. That does 
not make any sense. That is a carryover from the CHAMPUS days. 
So that is being done away with and that will simplify the 
program.
    I think Mr. Backhus discussed earlier today one of the big 
hangups on electronic claims has been our being unable to 
accept the Medicare provider numbers. The Department has now 
said, you can now accept the Medicare provider numbers. We have 
to build a crosswalk system behind it, but that is an 
impediment that is being blown away. So one by one, these 
things are coming away.
    I guess my caution is that nobody should believe that at 
the end of the day, when all of it goes away, we are going to 
be at $1.78, because we are not.
    Mr. Buyer. Mr. Backhus or Dr. Sears? Dr. Sears, then Mr. 
Backhus.
    Dr. Sears. Obviously, the example I gave in my opening 
statement about ultrasounds is another one of the examples. As 
we determine things that have no yield, that do not reduce 
health care costs or improve quality, those things are being 
removed. I could provide for the record, if you wish, a very 
extensive list of specific initiatives that are being 
undertaken to remove the complexity, unnecessary edits, and 
other approaches that we are using to simplify claims.
    Mr. Buyer. Mr. Chairman, Dr. Sears has offered it to the 
Budget Committee and I think it would be helpful, if you would 
so order.
    Mr. Thornberry. We will look forward to receiving that 
list. Thank you.
    Dr. Sears. Very fine.
    [The information of H. James T. Sears, M.D., follows:]

             Claims Processing Re-Engineering Status Report

    Improvements already implemented or in progress to address the need 
for process simplification, improved timeliness of claims processing 
and increased electronic claims submission include a work 
simplification contract modification, a comprehensive expert consultant 
review of the claims process, partnering with contractors to initiate 
improvement and investigation of e-commerce options.
    Work Simplification Initiatives: Fully implemented by Fall 2000, 
modifying current contracts to eliminate unnecessary or duplicative 
processes that interfere with optimal performance in claims processing, 
emphasizing the use of commercial best practices and Medicare 
procedures, where possible. Changes implemented were:
     Simplified Provider Authorization Process; implemented 
Summer 1999;
     Eliminated Prescriptive Controlled Development; 
implemented Summer 1999;
     Increased Claims Processing Cycle Time Standard; 
implemented Fall 1999;
     Allowed Commercial Best Practices for Utilization 
Management; implemented Spring 2000;
     Changed Third-Party Liability Collection Approach; Final 
Regulation and implementation Fall 2000; and
     Increased Transition Time (between award and start work 
date) to a minimum of 9 months (to be included in all future 
contracts).
    Consultant's Comprehensive Evaluation and Assessment 
Recommendations: Completed in November 1999, resulting in initiatives 
that will be implemented throughout 2000. The goal of these changes is 
to improve beneficiary and provider satisfaction through improved 
claims processing timeliness and reduction of deferrals or denial of 
claims. Initiatives identified include:
     Increase Electronic Claim Submission and Auto-
Adjudication;
     Improve Customer Service, Provider Education and 
Beneficiary Education;
     Enhance Management Reporting Capabilities and Program-Wide 
Data Quality;
     Improve Enrollment and Eligibility Process; and
     Enhance Fraud and Abuse Mitigation Capabilities.
    Partnering With Managed Care Contractors: One key strategy to 
implement recommended changes is ongoing partnering with the managed 
care contractors. Meetings were held in January and April 2000, 
focusing on improvements that could be implemented quickly and that 
would eliminate root causes of re-work, increase first-pass rates, 
remove barriers to EMC and Auto Adjudication, and decrease deferrals. 
Initiatives were approved in the following areas:
     Provider ID: An interim solution was developed, allowing 
the use of the Medicare Uniform Provider Identification Number for 
provider identification on TRICARE claims, with the claims processors 
developing the TRICARE ID (Health Care Provider Record) from internal 
resources. This change will facilitate electronic claims submission.
     Performance Reports Streamlining: Unnecessary reports have 
been eliminated, some reports have been placed on an ad hoc or annual 
basis and the routine monthly reporting has been reformatted and 
simplified.
     Health Care Service Records: Edits have been eliminated, 
where possible, and investigation is under way, in cooperation with the 
managed care contractors, to implement the new TRICARE Encounter Data 
system as soon as possible.
     Coding and Pricing Update Process: The annual processes 
for updating CMAC and DRG rates and for providing coding updates has 
been streamlined to ensure that claims are not delayed due to these 
processes.
     Performance Audit Process: Extensive changes and 
streamlining to this process have been undertaken with the goal of 
reducing the contractor's resource investment in auditing, while 
maintaining a strong TMA oversight of performance, allowing the 
contractor to refocus resources on claims processing.
     Claims Deferrals: Changes have been authorized to allow 
contractors to use their best business practices in determining the 
need for pre-pay review of claims. Examples include use of Durable 
Medical Equipment Regional Carriers' pricing where no CMAC exists and 
there is not sufficient data available to set a locality price, review 
of consultations versus office visit codes for specific provider 
specialties and annual rather than per claim review of MTF Durable 
Medical Equipment status. These changes improve auto-adjudication of 
claims, decreasing processing time and reducing costs by eliminating 
the need for manual intervention.
     Third Party Liability Handling: The regulation change 
necessary to implement this change has been finalized, and 
implementation is expected by the end of 2000. This change will 
eliminate delays in claims processing due to Third Party Liability 
issues.
    Implementation plans have been developed and changes will be 
implemented throughout 2000 and 2001. The next partnering meeting is 
planned for October 2000, focusing on implementation status for the 
initiatives identified in previous meetings, preparation for the Coding 
and Fee Schedule update process that will take place in early 2001, 
discussion of Web-based applications for beneficiary or provider access 
to information and web-based claims processing options. These meetings 
have been well received by the managed care contractors and will be 
continued throughout 2001.
    Electronic Claims Processing and Web-based Applications: 
Initiatives recommended by the managed care contractors are under 
investigation and internal strategy development has been undertaken to 
determine how available technology can be properly utilized to 
facilitate claims processing and customer service, in conjunction with 
implementation of national HIPAA standards.
    Debt Collection Assistance Officer Program: The Department is 
moving to rapidly implement a new program to assist our military 
families in addressing notices of debt collection. The Debt Collection 
Assistance Officer Program will provide a single point of contract for 
our service members for assisting in resolving debt collection issues. 
Assistance officers will be located at each Military Treatment Facility 
(MTF) and TRICARE Lead Agent office. Once contacted by a TRICARE-
eligible beneficiary, the debt collection assistance officer will 
intercede with all agencies involved, including military personnel 
offices, the MTFs, lead agents, network and non-network providers, the 
TRICARE Management Activity, managed care contractors, and debt 
collection agencies when appropriate, to resolve a collection issue 
arising from a TRICARE claim. The officer will research the claims 
history with the priority unit at the claims processor, and notify the 
beneficiary of the resolution. If appropriate, written documentation 
will be provided for use with national credit reporting companies in 
removing unwarranted adverse credit information related to TRICARE 
claims. Servicemembers in remote locations may contact any debt 
collection assistance officer who is convenient for them. An 
implementation team of representative from the TMA, the military 
Services, and the Lead Agents are currently working to define 
implementation parameters.

    Mr. Buyer. I did not mean to interrupt. Were you concluding 
you would provide it to us written?
    Dr. Sears. Along all these lines, there are tremendous 
efforts underway to move this along. There are certain very 
significant impediments that we face that make it difficult to 
simplify or do some of the things that we would like to do in 
the system, and the fact that we have open enrollment, or that 
we do not have all of our members enrolled, is a significant 
impediment to us, and there are other issues like that that 
make it difficult to negotiate. But where we can find 
solutions, where we can remove these impediments, that is being 
done right now.
    Mr. Buyer. Mr. Backhus.
    Mr. Backhus. Well, we have obviously taken the position 
that we have positive reactions to all the initiatives 
underway. We have been monitoring them but have not evaluated 
them up to this point in detail. But they are clearly the right 
things to do.
    The only concern I really have at this point is, I guess I 
am hearing the same thing from you, and that is how long is it 
going to take? I have seen a number of initiatives come and go 
in the past, so I will be looking here for sustained commitment 
to make these kinds of changes. I think, in many respects, 
these folks know what to do, but this bureaucracy sometimes 
just kind of makes it hard to do.
    Mr. Buyer. Thank you, gentlemen.
    I want to thank the Budget Committee for permitting me to 
sit with you here as we explore these issues. I think they are 
extremely important, and I also want to compliment you as you 
work in a bipartisan fashion. This is a really important issue 
to the troops out there because what happens is exactly what 
both of you had mentioned earlier, and in particular Mr. Moran.
    I do not necessarily agree with Dr. Sears' testimony 
earlier about that, well, all these payments are being made 
timely. They are not being made timely. Some of the contractors 
are not getting paid on time and then they take those bills and 
they drop them right on the soldiers and the soldiers do not 
have the money and then they end up with all of the bad credit 
ratings and, guess what, guys, they call us. So it is a system 
that begins a vicious circle. It is circuitous.
    So I think all this is very important, and the more light 
we shine on this, the more we can move to productive solutions. 
I want to compliment the Budget Committee. We from the House 
Armed Services Committee would enjoin and work cooperatively 
with you in the efforts toward moving toward a solution. Thank 
you, gentlemen, for the bipartisan effort.
    Mr. Thornberry. We appreciate the gentleman participating. 
He has added a lot in trying to get to the heart of the matter 
and we thank him for his time.
    Mr. Moran.
    Mr. Moran. I do not have anything further to add because I 
think the questions that needed to be asked have been asked. I 
just had one thing that I cannot figure out right away.
    You said that it costs on average $2 extra to do the 
processing the way that you feel you have to do and that the 
principal reason is because these providers, they just do not 
have enough claims to make automation make sense, to automate 
it completely, because it costs on average 35 cents per claim, 
or it would cost the providers 35 cents per claim to automate 
their system, as I understand it, on average, and why should 
they incur that expense.
    But why could you not incentivize it by saying, we will pay 
you, not only give you free software but we will give you 50 
cents a claim. So if it costs you on average 35 cents a claim, 
we will give you an extra half-buck per claim. So now you have 
no economic reason not to automate it and we are better off, 
the Defense Department, because we are saving $2 a claim. Can 
we not give them some of the money that we would save, or am I 
missing something?
    Mr. Meyer. You, in fact, can do that. That would be up to--
I am a subcontractor. That would be up to the prime contractor, 
because that money would have to come out of their pocket, to 
make that decision.
    One of the issues in making that decision is right now 
there are many providers who are paying for the service. So if 
I am paying for the service and the guy next door to me all of 
a sudden starts getting paid for the same thing, I just created 
chaos inside that network. I am just speaking frankly, what 
would happen. Everybody that is currently paying for the 
service the next day is going to say, I am not paying for it 
anymore. It might be a good thing to happen, but that is what 
would happen and there would be an interim period of time where 
there would be chaos going on because some guys are paying for 
something somebody else is being paid to do.
    Mr. Moran. But our interest is in reducing that $2 extra 
that is attributable to the non-automation.
    Mr. Meyer. Clearly.
    Dr. Sears. We pay claims at the maximum allowable rate, so 
theoretically, under the law, we could not add money to that 
rate.
    Mr. Moran. You cannot by law?
    Dr. Sears. We pay at the maximum allowable rate.
    Mr. Moran. Could the authorizing subcommittee do something 
there that would enable them to incentivize it so that it does 
not cost 35 cents, on average, a claim?
    Mr. Buyer. If the gentleman would yield.
    Mr. Moran. I would love to yield.
    Mr. Buyer. Obviously, it is worth looking at. I mean, no 
matter what the system is out there in government, whenever we 
can--whatever investments we also make to reduce costs and save 
money is smart business. You brought up something worth looking 
at. Thank you.
    Mr. Moran. Thank you, Mr. Buyer. Thank you, Mr. Thornberry, 
and thanks to the witnesses. I know you are trying to do as 
good a job as you can under the circumstances, and I do think 
that TRICARE, particularly TRICARE Prime, is going to get 
better as time goes on and that you are going to be able to 
automate more. I think that we all have the same objective. It 
just is frustrating to see this very high differential. You 
have explained why the differential exists, but it still is 
unacceptable in the long run and I trust that that gap will be 
narrowed because we are going to continue to be criticized for 
letting the system go on where the costs are so much higher 
than it costs HCFA. While we may understand that and may be 
sympathetic, it just lends itself to constant criticism and 
more and more GAO reports. But as you say, the process for 
automation is ongoing.
    Why were you smiling there, Mr. Backhus?
    Mr. Backhus. Dr. Sears got a chuckle out of more GAO 
reports. I agree.
    Mr. Moran. But do you not agree, until we narrow the gap, 
it is just easy pickings, and particularly for the Congress. 
But I know that the people involved are trying to do a good job 
and do the right thing. I do not have any sense that anybody is 
trying to rip off the system. And while we may have a lot of 
fraud, we have more fraud in HCFA, and I do not think fraud is 
the problem. I think we have a system that simply needs to be 
modernized and needs to be more subject to the information 
technology that is available. When you have small providers, 
you can understand why they just do not want to automate their 
system for a handful of claims. It does not make sense from 
their point of view.
    It has been useful. Does our colleague, the ranking member 
of the full committee, want to have a final word of wisdom?
    Mr. Spratt. I just wanted to, if I could take a second and 
ask Mr. Meyer what has been your situation recently with 
respect to your own receivables from the Department of Defense.
    Mr. Meyer. We have a problem there, Congressman Spratt. We 
are owed about $40 to $50 million in back payments.
    Mr. Spratt. At this point in time?
    Mr. Meyer. Yes.
    Mr. Spratt. Is that high or low relative to the past?
    Mr. Meyer. It is extremely high. We have two situations on 
two contracts where the government estimated claim volume came 
up way short of the actual claim volume and reasonable 
equitable adjustments were put forward. We have been working on 
them two to 3 years now. One of them did settle. The other one 
is still pending, and of that $40 million, most of it is 
wrapped up in that one settlement.
    Mr. Spratt. And was the fee that you, or the proposal that 
you made in the bidding for this contract predicated on a 
certain volume of claims processed?
    Mr. Meyer. Yes, sir. In all five contracts, the government 
provided the claims volume estimate and said, bid your staffing 
and your dollars on your receiving this number of claims.
    Mr. Spratt. And what was their estimate, claims volume?
    Mr. Meyer. It was different on each contract, but, for 
example, on the contract that is not resolved yet, the 
government estimate was five million claims per year.
    Mr. Spratt. And what did----
    Mr. Meyer. In fact, we got seven-and-a-half million.
    Mr. Spratt. So it is off by 50 percent?
    Mr. Meyer. Right.
    Mr. Spratt. Under by 50 percent.
    Mr. Meyer. Correct.
    Mr. Spratt. And has this been a continual frustration, or 
has the basis for bidding improved as experience has gone on?
    Mr. Meyer. The basis for the claims volume did improve in 
the last two contracts. In the last two contracts, the 
government actually asked us what we thought the volume would 
be and we jointly agreed on what the volume probably would be 
and, in fact, were right on the last two contracts. But it is 
the earlier contracts that still are not resolved that create 
the financial problem for us.
    Mr. Spratt. So does this indicate that in structuring this 
system, DOD underestimated what the administrative complexities 
and volume of claims processing was likely to be?
    Mr. Meyer. Well, certainly the claims volume was 
underestimated.
    Mr. Spratt. What about, since you participated in this, the 
difficulties building the network? Do you think that the 
assumptions going into this were a bit too facile about how you 
would build a network?
    Mr. Meyer. The problem that you have with this program with 
building the network is that the requirements are the same for 
100 percent of the geographic area of this country, although 
the practice of medicine and distribution of the physicians is 
not the same. So the requirement for numbers of doctors in a 
network, for example, in Portsmouth, Virginia, where there is a 
high concentration of military retirees and active duty 
military and their families, is the same as it is for Rock 
Hill, where there are not very many military retirees. So even 
though things are not the same, they are tried to force to make 
to look like the same.
    Mr. Spratt. Dr. Sears----
    Mr. Meyer. Dr. Sears has done a great job working with us 
in trying to get that resolved, and Dr. Sears, to his credit, 
in the resolution of the REA has been the single person who has 
been trying to push to get the thing resolved more than anybody 
else. We wish we could get that kind of initiative underneath 
Dr. Sears.
    Mr. Spratt. How is it your largest contractor, you are $40 
million in arrears on the payment of its account?
    Dr. Sears. I am pleased to be able to say that we are close 
to resolution of those REAs and the money for the prime that 
will be passed to the sub will be forthcoming.
    Mr. Spratt. Humana? You said the prime is--I may have 
misunderstood your----
    Dr. Sears. I did not say, but it is Humana.
    Mr. Spratt. Has this been a learning process for DOD? Do 
you think the Department underestimated the complexity of 
putting in place a national managed care network?
    Dr. Sears. There were many factors that--yes. As Mr. Meyer 
said, we are trying to put a uniform benefit in place across 
the country, and I worked actually for a contractor in 
California and it was very easy to build networks in San Diego 
and Los Angeles and San Francisco. It was very difficult to 
build networks in places like Monterey and to bring the same 
benefit and get the same advantages to the contractor and the 
government in those places.
    We also, as you know, have been going through some very 
significant changes in health care and in the military health 
care system. With the significant downsizing of military 
medical facilities, the conversions from hospitals to clinics, 
there are just a myriad of things that affected the--and the 
utilization, switching from a system where the beneficiary was 
the primary person who submitted claims to a system where the 
provider submits the claim in 97 percent of the cases. There 
were a number of factors that increased the number of claims 
over what the government projection was.
    So yes, there were lessons learned and the example that was 
just used was one of those lessons, talking to the claims 
processor about what their anticipated numbers were and sitting 
down together and figuring out what a more likely number was 
and then going forward with that. That has been a feature of 
the program. This is a program that came up essentially in 1995 
and is now worldwide and has had some growing pains, but 
tremendous progress has been made.
    Mr. Spratt. One final question. In our State with TRICARE, 
we have experienced--first of all, it took a while to fill out 
the network and now we are seeing repercussions to the rates of 
reimbursement of pay and there are pieces of the network that 
are sloughing off, providers pulling out, both hospitals and 
physicians. Is this a problem nationwide?
    Dr. Sears. It is a problem in some localities. As I say, 
where there are concentrations of providers, where there is 
some competition among providers, that is not an issue for us. 
In the communities where there are stand-alone providers or 
sole community hospitals, those sorts of things, it is more of 
an issue for us. The reimbursement rate, as you know, is at the 
Medicare level. CHAMPUS used to reimburse at higher levels than 
that. So we are experiencing some of the same things in terms 
of provider participation, actually, that Medicare is 
experiencing in terms of providers dropping out of the network.
    Mr. Spratt. So TRICARE rates equate to Medicare rates?
    Dr. Sears. We are required to have our rates at Medicare 
rates and that has been accomplished. There are a few of our 
rates that are somewhat higher, but those are for things that 
Medicare generally does not do, like deliveries and things of 
that nature. But yes, our rates are at the Medicare level.
    Mr. Spratt. Thank you very much.
    Mr. Thornberry. Dr. Sears, have you made a request for 
money or some authorities to help improve the efficiency of 
claims processing that has gotten stopped while going up the 
chain?
    Dr. Sears. As you know, funding for the DHP is an issue and 
there are funding----
    Mr. Thornberry. So you have made funding requests that 
basically get reduced before they get to the Congress?
    Dr. Sears. We do not have enough money to do all the things 
we want to do, yes, sir.
    Mr. Thornberry. I think that was yes. OK.
    I appreciate the testimony from all of you today. I think 
it certainly has been helpful. I am left a little bit with the 
feeling that we have a health care system that has some 
dissatisfaction among beneficiaries, some problems among 
providers, and to try to keep providers there, we are having to 
do things to try to be nice to them, paper filing in 2 weeks 
and the rest, that is more expensive and helps reduce care and 
puts further strain on the budget, which kind of gets to be a 
vicious circle. Hopefully, we can break out of that sort of 
thing.
    I think at a minimum, we have got agreement that we can at 
least save $3 a claim if we get everything right, and certainly 
if there are--you were talking about the incentives and the 
things that Mr. Moran was talking about. If there are other 
authorities that any of you see would be helpful in getting us 
to save that $3 or $4 quicker, well, then please let us know.
    If that is all, then we will call this hearing adjourned. 
Thank you all.
    [Whereupon, at 12:20 p.m., the Task Force was adjourned.]

      Pentagon Financial Management: What's Broken, How to Fix It

                              ----------                              

                        THURSDAY, JULY 20, 2000

                  House of Representatives,
                           Committee on the Budget,
         Task Force on Defense and International Relations,
                                                    Washington, DC.
    The Task Force met, pursuant to call, at 10:05 a.m. in room 
210, Cannon House Office Building, Hon. Christopher Shays 
(chairman of the Task Force) presiding.
    Chairman Shays. I would like to call this hearing to order, 
the Budget Committee Task Force on Defense and International 
Relations on Pentagon Financial Management: What's Broken, How 
to Fix It.
    I welcome our witnesses and I welcome our guests. As 
defenders of freedom and the instrument of U.S. policy when 
force is required, our military is unsurpassed. But as a 
steward of the public funds entrusted to it, the Department of 
Defense, DOD, enters the new century captive to the wasteful 
fiscal habits of the last.
    It seems the guardian of the new world order keeps accounts 
like a Third World banana republic. Audits have found hundreds 
of millions wasted on inefficient, duplicative information 
systems, billions in excess inventory and trillions of dollars 
in unsupported accounting adjustments.
    In 1999, DOD reported problem disbursements totaling more 
than $10 billion, more than half of which could not even be 
matched to a valid invoice or contract. The true extent of DOD 
overpayments can only be inferred from the $5.3 billion 
voluntarily returned by contractors between 1994 and 1999.
    A recent report disclosed the Pentagon has been 
miscalculating simple payroll withholding taxes for many 
civilian employees.
    Due to these and a myriad of other persistent systemic 
accounting problems, the Department is unable to comply with 
Federal laws requiring annual financial statements and other 
management controls. Sadly, these problems are not new and 
reforms spawn only more reforms, pushing promised solutions 
over the budgetary political horizon.
    We convene this Budget Committee Task Force hearing on DOD 
financial management practices this morning to discuss not just 
the extent, but the impact of these chronic problems, and what 
the Department is doing to get its fiscal house in order. In an 
enterprise as vast and costly as the Department of Defense, 
effective business systems are not peacetime luxuries that 
occupy lawyers and accountants. Today's generals, admirals, 
colonels, and captains rely on management information to 
support their core mission. The projection of global power 
requires the production of timely and accurate data on troop 
readiness, supply inventories, equipment performance and much 
more. The link between ledgers and lives is very real.
    The Government Reform Subcommittee on National Security, 
which I chair, recently heard sobering testimony from the DOD 
Inspector General on the prosecution of a company knowingly 
providing substandard protective suits for use against chemical 
and biological weapons. The IG found more than financial fraud. 
The lack of effective inventory controls prevented rapid 
segregation of the defective suits. Some were sent to deployed 
troops in high-risk areas. U.S. Forces were put needlessly at 
risk.
    This year the House authorized $306 billion for defense. 
Current projections call for increased defense spending in the 
years to come. Our constitutional obligation to provide for the 
common defense and our fiduciary obligation to protect public 
assets dedicated to the effort demand a system of modern 
financial and management controls that can account for those 
dollars from beginning to end and at every stop in between.
    That is not the case today, but DOD has plans to simplify 
current processes, eliminate incompatible data sets and 
standardize some transaction and inventory codes across 
programs and service branches. Our witnesses today have been 
asked to discuss these initiatives and the challenges still 
confronting the effort to transform last century's quaint 
bookkeeping into the modern business of defense.
    As I said before, we welcome their testimony. At this time, 
I would call on Ms. Hooley, the ranking member of the Task 
Force.
    Ms. Hooley. Thank you, Mr. Chairman, for convening this 
hearing--I should turn on my mike--Pentagon Financial 
Management: What Is Broken, How to Fix It.
    We have before us today three distinguished witnesses, Mr. 
Bill Lynn, Comptroller of the Department of Defense; Mr. Robert 
Lieberman from the Office of Inspector General of the 
Department of Defense; and Mr. Jeffrey Steinhoff from the 
General Accounting Office. I thank you for coming before this 
committee today and look forward to the testimony from all of 
you.
    Congressman Moran is the ranking member of this Task Force, 
but he is also ranking member of the District of Columbia 
Appropriations Subcommittee, which is in markup this morning. 
He sends his regrets that he will not be able to attend this 
important hearing.
    From the stories of overpriced hammers and toilet seats 
that garnered great attention in the 1980's to anecdotes we 
will hear today from our witnesses, it is obvious that the 
Department is still struggling to establish a fully reliable 
and accurate financial management system.
    To some extent we should not be surprised, because the 
Department is so large and complex. The defense budget 
represents about 16 percent of all Federal spending and is 
almost one-half of the entire discretionary budget. The Defense 
Department employs almost 3 million military personnel and 
civilians and has facilities in more than 100 countries. It has 
millions of items in its inventory, ranging from simple screws 
to the world's most complex weapons systems.
    The Department's system of financial management was born 
and raised during the Cold War when the threat of conflict with 
the Soviet Union took primacy over other considerations, 
including financial management. After the fall of the Berlin 
Wall and the end of the Cold War, both Congress and the 
Department started paying much closer attention to financial 
management issues.
    In 1990, Congress enacted the Chief Financial Officers Act, 
establishing a CFO for each of the 24 major agencies, including 
the Defense Department. The Government Performance and Results 
Act of 1993 and the Government Management Reform Act of 1994 
established statutory financial management standards for the 
Department of Defense and other agencies.
    Frankly, the financial management systems developed during 
the Cold War were overwhelmed by the standards of the 1990's. 
The Department is in the midst of revamping its financial 
management systems to meet today's standards. The Department 
has made progress, and I hope our witnesses will tell us about 
that progress that they have made to date, and by all accounts, 
the Department still has a long way to go.
    The issue before us today is not a partisan issue, but 
rather a long-standing and daunting problem that both 
Republican and Democratic administrations have struggled to 
overcome. I appreciate the title of today's hearing because not 
only should we know what is broken with the Pentagon financial 
management system, but more importantly, we need to discuss how 
to fix it.
    I look forward to the testimony of each of the witnesses.
    Thank you, Mr. Chairman.
    Chairman Shays. Thank you very much.
    At this time, I would call on Mac Thornberry, who is co-
chair of this Task Force and also serves on the Armed Services 
Committee.
    Mac.
    Mr. Thornberry. Thank you, Mr. Chairman.
    It is my opinion that defense is the first function of the 
Federal Government, and it is also my belief that we ought to 
spend whatever resources are necessary to do the job. But if 
defense is that high a priority, it makes it nearly even more--
it makes it even more disturbing to me that we have the 
continuing problems that we have in the Department of Defense; 
and I think, in a lot of ways, it makes it less forgivable.
    When we have such serious problems, which Mr. Lynn is well 
aware of, trying to come up with increased pay and benefits so 
that we can get and keep top quality people, when Congress has 
to put more money every year into the Department of Defense 
health care system, when we have shortages of a serious nature 
in research and development and other critical accounts, it is 
even more disturbing that we don't know where our money is 
spent, and we don't know how much of it is wasted and how much 
of it is spent on 30,000 accounting people and to try to deal 
with this cumbersome, outdated, indefensible system.
    I agree with Ms. Hooley; of course, it is a long-term 
problem, and it is not just one administration and it is not 
going to have just one fix. But it also seems to me that fixing 
the problem has not gotten priority from the top leadership at 
the Department, and that is--and it is going to have to have 
that.
    It also seems to me that we in Congress need to provide 
part of the solution, because big bureaucratic organizations 
are hard to change; and in the past, there have been several 
examples where it has taken an act of Congress to give the 
Department a nudge, or even a shove, into fixing the problems 
that need to be fixed. We did that with Goldwater-Nichols in 
reorganization. Congress did it last year with the Department 
of Education and the nuclear weapons complex. We mandated 
reorganization and changes. We may have to do some of that 
here.
    And so I look forward again not just to hear what the 
problems are, but what the answers are. We need to be part of 
that solution, but we have to have a solution and it needs to 
happen quickly.
    Thank you, Mr. Chairman.
    Chairman Shays. Thank you very much, Mr. Thornberry.
    Mr. Bass, do you have any comments?
    Mr. Bass. No statement.
    Chairman Shays. Thank you. Let me welcome all three of our 
witnesses, and I will announce them and then we will begin with 
the first individual I am introducing, William J. Lynn III, 
Under Secretary of Defense, Comptroller and Chief Financial 
Officer.
    We also have Robert J. Lieberman, Assistant Inspector 
General, Department of Defense.
    And then we will also have Jeffrey Steinhoff, Assistant 
Comptroller, General Accounting Office.
    And, Mr. Lynn, let me just say to you, I appreciate your 
appearing with the Department of Defense Inspector General and 
the Acting Assistant Comptroller General. Sometimes we just 
have the Department testify alone, but it will enable us to 
have a better dialogue. And also I realize that we basically 
have two who kind of examine the Department of Defense and are, 
in some cases, critics of the attempt to show how it can be 
approved. But we will welcome anybody else that you want to 
have respond to a question if you think they might be able to 
respond to it better.
    But at this time, let me welcome you, Mr. Lynn, and you 
have the floor.

  STATEMENT OF HONORABLE WILLIAM J. LYNN, UNDER SECRETARY OF 
         DEFENSE (DEFENSE) AND CHIEF FINANCIAL OFFICER

    Mr. Lynn. Thank you very much, Mr. Chairman. I appreciate 
the opportunity to be before the committee to discuss this 
important issue. I particularly appreciate, Mr. Chairman, your 
offer that I can call on help if I get over my head.
    I would ask that my formal written statement, more 
exhaustive treatment of the issue, be treated as part of the 
record.
    Chairman Shays. Let me just say that all the witnesses may 
ask unanimous consent that their entire statement be submitted 
for the record, if they want to just speak on part of it. And I 
also ask unanimous consent that all members be given, as well, 
5 days to submit written statements for the record.
    Without objection, so ordered. Sorry to interrupt.
    Mr. Lynn. Thank you, Mr. Chairman.
    Let me begin by respectfully disagreeing with Mr. 
Thornberry. Financial management reform has been a high 
priority of this Department in the two terms that I have been a 
part of it, and it has been a particularly high priority under 
Secretary Cohen. He has had long experience with this from the 
congressional side, and he has paid personal attention to these 
issues. And I would be happy to go into that in more detail if 
you would like.
    That said, there is--as Ms. Hooley indicated, substantial 
work to be done. I am encouraged by the substantial progress 
that we have made, the commitment that our people have toward 
that progress. But we indeed have much left to do.
    What I would like to give you today is a status report on 
our major initiatives and highlight the challenges ahead. While 
the Department has had notable successes in its financial 
management reform efforts, the reality is that it is impossible 
to overhaul our financial management operations overnight. The 
planned reforms will require several years to fully implement, 
as the chairman indicated, and nonetheless, though much remains 
to be done, we have made much solid progress.
    The analogy you might give here--the chairman, I think, 
indicated correctly that we inherited an accounting system that 
was not only outdated, but was intended for different purposes 
than it is being asked to do today. For 200 years, the 
accounting systems that we had were essentially to mark and 
track the obligation of funding along the lines that Congress 
appropriated it. Towards that end, the systems are actually 
quite strong and are able to do that.
    What we are trying to do today is to move into a more 
businesslike case where we can do accrual accounting, not just 
obligations and disbursements, but to do a business style 
accrual accounting. That is important in terms of estimating 
costs, in terms of trying to allocate costs toward decisions 
that understand the implications of the various far-reaching 
choices the Department is faced with.
    But it is a mammoth task. It is akin to driving a very 
large car at 60 miles an hour, and we are going to have to 
change all the tires and overhaul the engine, and we are not 
going to be able to stop the car. We still have to continue to 
do all of the things that we are doing, pay all of the people, 
pay all of the contractors to do all of the financial 
management of the Department, and at the same time overhaul it. 
So it is a very difficult process.
    The financial reform effort that Secretary Cohen has laid 
out has three major phases.
    The first phase is to consolidate our financial management 
operation. That phase is largely complete. We have consolidated 
over 300 finance and accounting field sites, scattered 
throughout the world, into 26 locations. That, in and of 
itself, has produced substantial savings, over $100 million a 
year. But more importantly, this organizational consolidation 
has enabled the second phase of financial management reform, 
the elimination of incompatible and noncompliant finance and 
accounting systems. This phase is well under way. The number of 
noncompliant finance and accounting systems has been 
significantly reduced.
    In 1991, just prior to this administration, we had 324 
systems, and none of them met today's accounting requirements. 
Today we are down to 96. By 2003, we will be at about 30 
finance and accounting systems. That is a 90 percent reduction 
in less than a decade, and we expect all those finance and 
accounting systems to be compliant with current accounting 
requirements.
    That leads to the third phase which we have recently 
initiated. The third phase involves upgrading the interfaces 
with the functional systems that feed data into the finance and 
accounting reports. A little-known fact is, more than 80 
percent of the data on DOD's financial statement comes from 
outside the finance and accounting systems. The data comes from 
personnel, acquisitions, medical, logistics and other systems 
necessary to perform the defense mission. Establishing a 
seamless connection between these so-called ``feeder systems'' 
and the accounting systems used to prepare the financial 
statements is the crucial final step in financial management 
reform.
    These steps were developed and put in--these systems, 
excuse me--were developed and put into service long before the 
promulgation of Federal accounting standards. They simply were 
not designed to produce business-type financial statements. 
Accordingly, much of our financial information has to be 
manually transferred from these systems into the accounting 
systems, and some of the information that the auditors insist 
upon is simply not available in these systems they were never 
designed for.
    Mr. Lynn. For example, most of our inventory systems are 
designed to maintain records on the latest acquisition costs. 
This is the data the logistics managers find the most critical. 
These systems, however, do not retain historical costs, which 
is the data the auditors would like to see.
    We are moving to upgrade our inventory systems to retain 
both historical and latest acquisition costs, but this is an 
expensive and laborious process. This type of effort can be 
repeated through the acquisition area, through the medical 
area, through all the logistics area; and that is what 
encompasses this third phase of financial management reform. It 
extends well beyond the financial arena to touch nearly every 
other function of the Department.
    To oversee this massive effort, to oversee the effort that 
is going to be needed to bring these areas into compliance with 
new accounting standards, we have established a Y2K-like panel. 
This panel will report to the Deputy Secretary of Defense 
through the Defense Management Council. The panel will 
establish milestones to move the 70 or so critical feeder 
systems into compliance with current accounting standards.
    In order to accomplish fundamental financial reform, we 
will have to complete this effort to establish interfaces with 
all the critical feeder systems. This will take a number of 
years and substantial new resources. In the interim, however, 
we believe that we can make substantial progress toward earning 
an unqualified audit opinion for the Department.
    Toward that end, we have collaborated with the 
organizations and the individuals represented at this table. 
They have helped us identify major obstacles that must be 
overcome for the Department to be successful. We have developed 
interim solutions to systemic problems, and we are applying 
accounting and auditing standards in ways that make sense for 
the Department of Defense.
    Major deficiencies which have prevented us from receiving a 
favorable audit opinion in the past have been identified. 
Strategies to deal with those deficiencies have been developed 
and coordinated. Details of these strategies are discussed in 
my written statement. I would be happy to go into them in 
questions.
    In sum, we have built a strong financial management reform 
foundation upon which those who follow us can build. We remain 
determined to have financial management reform so well advanced 
by the time the next DOD leadership team takes office that they 
will conclude that the job is not only wise but achievable.
    Our DOD leadership team has always been determined to keep 
foremost in our minds that the Department's primary mission is 
national security. Our reforms must support that mission, not 
burden the troops and support activities that aren't fulfilling 
it. We have been asked by Congress and the audit community to 
do things not previously required of the Department. Our 
challenge is to design such new procedures so they enhance, not 
diminish, the Department's management and leadership. We 
believe we have a plan to do just that.
    Thank you again, Mr. Chairman.
    Chairman Shays. Thank you, Mr. Lynn.
    [The prepared statement of William J. Lynn follows:]

Prepared Statement of Hon. William J. Lynn, Under Secretary of Defense 
   (Comptroller), Chief Financial Officer, U.S. Department of Defense

    Mr. Chairman and members of the Task Force, it is a pleasure to be 
here to discuss financial management within the Department of Defense.
    Today, I would like to summarize the comprehensive financial 
management reforms currently underway within the Department. In 
particular, I would like to highlight some of the major initiatives 
that are enhancing financial management throughout the Department 
while, at the same time, are supporting our forces at a high level of 
readiness and effectiveness.

                      FINANCIAL MANAGEMENT REFORM

    Financial management reform within the Department of Defense 
continues to be a very high priority. As we move into the 21st century, 
and chart a new financial management millenium, the Department's senior 
leaders are committed to improving financial management. As the Chief 
Financial Officer for the Department, this continues to be one of my 
highest priorities as well, and I remain encouraged by the commitment 
of the Department's personnel engaged in these improvement efforts.
    Reflecting the resolve of the Department's senior leaders, the 
Department is pursuing the most comprehensive reform of financial 
management systems and practices in the Department's history. Progress 
to date has been substantial, and the Department is determined to 
successfully complete this historically significant reform effort.
    The Department's pivotal agent for accomplishing needed financial 
management reforms is the Defense Finance and Accounting Service 
(DFAS). The DFAS has made remarkable progress since its formation in 
1991. Prior to the establishment of the DFAS, the Department compiled 
finance and accounting information through a series of vertical 
operations and organizations--information traveled up stove pipes but 
not across communities. Each Component had different processes and 
systems for its financial management, logistics, acquisition, and 
personnel activities. These processes and systems often did not share 
common data and could not effectively communicate with each other. 
Additionally, the processes and systems were not sufficiently flexible 
to respond rapidly to changing requirements.
    When the Department of Defense Components turned over their finance 
and accounting operations to the DFAS in 1991, they also turned over 
numerous problems. In response to these many problems, the Department 
undertook the most comprehensive reform of financial management systems 
and practices in the Department's history. Since 1991, financial 
operations have been consolidated, the number of noncompliant finance 
and accounting systems have been significantly reduced, standard 
systems have been designated, ambitious deployment schedules have been 
established and implemented, and business practices have been 
reengineered to adopt best practices from both the private and 
government sectors.

            CONSOLIDATION OF FINANCIAL MANAGEMENT OPERATIONS

    The DFAS has consolidated over 300 finance and accounting field 
sites scattered throughout the world into 26 locations, saving $120 
million annually. Through these consolidations, the Department has been 
able to eliminate redundancy and unnecessary management layers, 
facilitate standardization, improve the accuracy and timeliness of 
financial operations, enhance service to customers, increase 
productivity, and provide better financial management support to the 
Department's decision-makers. In short, the DFAS has taken what was a 
number of widely disbursed, costly and less effective nonstandard 
accounting operations and merged them into a smaller, more efficient 
and more effective operation. And it accomplished this goal almost 2 
years ahead of schedule.

            CONSOLIDATION OF FINANCE AND ACCOUNTING SYSTEMS

    To remedy the problem of numerous, incompatible and noncompliant 
finance and accounting systems the DFAS inherited from the Department's 
Components, the DFAS embarked on a major effort to streamline financial 
systems. As of May 2000, 95 finance and accounting systems were 
operating--down from 324 systems in 1991, a 70-percent reduction. 
Finance systems have been reduced from 127 to 15, with a goal of 
dropping to just nine by 2003. Accounting systems are down from 197 to 
80, with a goal of 22 or fewer by 2003. By the year 2003, the 
Department expects to account for and pay over 2 million service 
members, 2.2 million retirees and annuitants, over 700,000 civilian 
employees, and 200,000 contractors using just 31 finance and accounting 
systems--a 90-percent reduction.
    These consolidations have achieved genuine benefits and savings. 
For example, in bringing into a single system all of the Department's 
700,000 civilian payroll accounts, 26 separate systems were eliminated 
and 348 payroll offices closed. In 1999, a typical civilian payroll 
technician handled over 2,100 accounts, compared to just 380 accounts 
in 1991.
    The objective of the Department's initiative, however, is not 
simply to reduce the number of financial management systems. The 
consolidation, standardization, and modernization of the Department's 
financial management systems is intended to enable the Department to 
eliminate its outdated noncompliant financial management systems and 
substantially meet federal financial management system requirements, 
adhere to new applicable federal accounting standards, and use the 
United States Government Standard General Ledger at the transaction 
level. These efforts also are producing more accurate, timely, and 
meaningful financial management information for decision-makers.

                              EFFICIENCIES

    As a result of a number of initiatives, the DFAS has significantly 
reduced its personnel requirements and its operational costs, creating 
more efficient and economical operations while improving services 
provided to its customers.
    Between FY 1993 and FY 1999, personnel levels that the DFAS 
inherited from the Department's Components decreased by 37 percent, 
from 31,000 personnel in FY 1993, to 19,500 personnel at the end of FY 
1999. By FY 2003, the Department projects that DFAS personnel levels 
will decrease by another 2,000 personnel, to 17,500. Thus, over the 10-
year period from FY 1993 to FY 2003, the DFAS will have achieved a 44-
percent reduction in its personnel levels.
    In FY 2000 constant dollars, the DFAS cost of operations has 
decreased from approximately $2.0 billion in FY 1995 to $1.7 billion in 
FY 1999--a 15-percent reduction. These savings in operating costs have 
been achieved despite the assumption of additional missions. 
Admittedly, these savings are being offset, in part, by the need to 
invest in new systems and technology in order to meet today's new 
requirements and tomorrow's challenges. However, when compared to the 
operations of the Department as a whole, the DFAS budget equates to 
approximately six-tenths of one percent of the Department's budget. 
This is about one-half the private industry average of 1.2 percent.

                      PUBLIC-PRIVATE PARTNERSHIPS

    The Department has successfully used competition within the 
government and with the private sector to improve support services and 
save money. The Department recognizes that many finance and accounting 
functions can be competed without posing a significant risk to the 
Department's operations. The DFAS has recognized that approximately 85 
percent of its personnel perform functions that might be eligible to be 
outsourced on a competitive basis. To date, approximately one-third of 
the DFAS operations, measured in terms of costs, either have been 
outsourced, competed for outsourcing, or are in the process of an 
outsourcing competition. In addition, the DFAS has committed to study 
over 6,000 positions during the next 5 years.
    Changes implemented by the DFAS, as a result of competition 
studies, already have produced annual savings of $36.9 million through 
the streamlining of administration operations, facilities, and 
logistics; vendor payments; transportation accounting; depot 
maintenance accounting; and by consolidating debt and claims 
management. Within the financial community, the Department is using 
public-private competition--the A-76 process--to improve functions in 
other areas such as civilian and retiree/annuitant payroll and security 
assistance accounting.

                     FINANCIAL MANAGEMENT POLICIES

    The Department has replaced approximately 30,000 pages of separate, 
and sometimes conflicting, Defense organizational financial management 
regulations, policies, and procedures with a single standard 
``Department of Defense Financial Management Regulation'' (``DoDFMR 
''). In order to ensure the widest possible distribution of the 
policies contained in the ``DoDFMR,'' the ``DoDFMR'' has been made 
available on the Internet and on CD-ROM.
    In January 2000, the Department began to review the approximately 
40,000 remaining pages of financial management policy and procedures 
still in publication within the Department's Components. This effort is 
expected to result in the elimination, or merging into the ``DoDFMR,'' 
of many of those policies and procedures and create a single source of 
consistent financial management guidance for use throughout the 
Department.

                 INTERNAL CONTROLS AND FRAUD DETECTION

    To strengthen internal controls and elevate fraud awareness, the 
Department has implemented, and continues to implement, additional 
checks, balances, and approval requirements for transactions. Such 
internal controls minimize the Department's susceptibility to fraud, 
waste and abuse within its finance and accounting operations. In 
implementing adequate internal controls, the Department strives to 
incorporate appropriate levels of verification without requiring 
excessive resources or hampering the Department's ability to complete 
the mission. The DFAS and other Department of Defense organizations 
also continue to implement information assurance programs and fraud 
detection and protection measures. Some of the more significant 
internal control efforts include:
     Creating a centralized Fraud and Internal Review Office 
within the DFAS to better ensure that programs achieve intended 
results, laws and regulations are obeyed, resources are appropriate for 
a program's mission, data is reliable, and fraud is prevented;
     Enacting a 100-percent review of the Department's vendor 
pay systems to determine who has access and at what levels, and 
ensuring that the necessary separation of duties exists;
     Implementing an employee internal control responsibility 
training program;
     Strengthening in-house reviews to detect improper 
alterations of receiving reports; and
     Enhancing fraud awareness and prevention training for 
vendor pay employees.

                           OPERATION MONGOOSE

    Another internal control initiative was the creation of Operation 
Mongoose to identify potential erroneous, duplicative, or fraudulent 
payments, and to detect and correct potential internal control 
weaknesses. This initiative uses the combined efforts of the DFAS, the 
Defense Manpower Data Center, and the Department of Defense's Inspector 
General's Office, including the Defense Criminal Investigative Service, 
to develop fraud indicators that can be spotted by discrepancies 
between systems. This program collects and compares data throughout the 
Department, detects the presence of anomalies within the Department's 
systems and refers these anomalies to appropriate Department 
organizations for further review or investigation. If fraud is found, 
the Department vigorously pursues criminal charges against those who 
are responsible for the fraud. The objective of Operation Mongoose is 
to establish a permanent structure to detect and prevent fraud by 
reducing the opportunity for the concealment of crimes and actively 
seeking it out, rather than waiting for it to surface by chance, be 
identified by informants, or be detected by random reviews. Despite 
isolated occurrences, the Department is succeeding in firmly closing 
the door on fraud.

                 IMPROVING ACCOUNTING FOR DISBURSEMENTS

    Nearly all of the Department's payments are matched to recorded 
obligations at the time the payment is made or shortly thereafter. A 
small percentage of payments, however, require additional time and 
research to ensure that the transactions are recorded correctly in the 
Department's accounting records. This additional effort is required 
because, within the Department, separate offices and separate automated 
systems often are used to record the obligation of purchases in the 
accounting records, compute payment entitlements (i.e., determine how 
much should be paid and when), disburse funds (i.e., make payments), 
and then record the payment in the accounting system.
    This separation of duties reflects good internal controls. However, 
because the applicable entitlement, payment, and accounting systems are 
not fully integrated, some of the data required to process these 
transactions must be input manually into the Department's automated 
systems. This creates the potential for ``unmatched'' transactions as 
data flows between the different systems involved. For example, simple 
keystroke errors may occur during the process of manually inputting the 
same data into different systems. Such errors can result in data not 
matching when comparable information subsequently is transmitted 
between systems.
    These disbursement matching problems have been reduced by over 80 
percent in recent years. Although the Department considers this problem 
a matter to be taken seriously, almost all such expenditures connected 
with these disbursements were made only after a Department official 
confirmed that the goods or services were received and that the payment 
was in accordance with a valid contract.
    Prevalidation, the procedure of matching a disbursement to an 
obligation before (rather than after) a payment is made, has helped to 
significantly reduce accounting problems associated with disbursements. 
Thresholds for applying prevalidation are gradually being lowered until 
virtually all payments will be prevalidated.
    In addition to prevalidation, the Department also is implementing a 
system called the Defense Cash Accountability System (DCAS), through 
which disbursement voucher data is collected electronically under one 
central standard system and distributed electronically for posting to 
accounting systems. DCAS is expected to reduce the Department's 
accounting cycle for disbursements from over 90 days to approximately 
48 hours.

                       INFORMATION INFRASTRUCTURE

    The DFAS Corporate Information Infrastructure (DCII) is being 
implemented to help modernize DFAS finance and accounting systems and 
to establish the information environment needed to better support 
future financial activities. DCII will support the use of common 
standard data for the collection, storage, and retrieval of financial 
information. It also will simplify and standardize the Department's 
finance and accounting transactions. Included in DCII is an ambitious 
effort to standardize and share acquisition data. This will greatly 
improve the interactions between the Department's procurement systems 
and the financial systems that process and account for payments for the 
Department's procurements.

              ELECTRONIC EXCHANGE OF FINANCIAL INFORMATION

    The DFAS also is promoting the paperless exchange of financial 
information through a variety of other initiatives. One of the primary 
benefits of these initiatives is the elimination of manual processing 
of various documents and, thereby, significantly increasing the 
accuracy and timeliness of information. Another primary benefit is a 
reduction in the cost of processing data. Some examples of these 
initiatives include:
     Electronic Document Management (EDM) and World Wide Web 
applications. EDM and World Wide Web applications are enabling on-line, 
real-time access to documents needed to perform bill paying and 
accounting operations. Under this process, contracts, bills of lading, 
and payment vouchers can be stored in an electronic file and shared 
among DFAS activities. Another application eliminates the printing of 
reports by converting them into an electronic format for on-line 
analysis, reconciliation, and reporting. EDM technology also is being 
used to enhance the control and management of documents needed for bill 
paying operations, regardless of the format of the document, as well as 
to link to the Department's pay systems.
     Electronic Funds Transfer (EFT). EFT is being used to 
reduce the cost and improve the accuracy and timeliness of 
disbursements. Over 98 percent of the Department's civilian and 
military employees have their pay directly deposited into their 
personal bank accounts. The direct deposit participation rate for 
travel payments is now over 90 percent. In 1999, EFT accounted for 
about 90 percent of the total contract dollars disbursed by the 
Department.
     Electronic Data Interchange (EDI). The DFAS is using EDI 
to send remittance information directly to vendors and currently is 
processing EDI contracts and contract modifications into finance and 
accounting systems. The DFAS also is implementing a web-based invoicing 
system that provides industry with an economical method to submit 
electronic invoices.
     Web-based Central Contractor Registration (CCR). Through 
its Joint Electronic Commerce Program Office, the Department has 
fielded a web-based CCR program that provides our procurement and 
payment offices with a single source of valid and reliable contractor 
data. The CCR capability also helps the DFAS capture up-front 
contractor financial data that facilitates EDI and EFT payments.

                 FINANCIAL MANAGEMENT IMPROVEMENT PLAN

    The Department's long-term strategy recognizes that lasting 
effective financial management reforms require a Defense-wide 
management information overhaul. The long-term strategy is, through 
reengineering or replacement, to ensure that both the Department's 
financial and feeder systems can implement new federal accounting 
standards and that they are effectively interfaced or integrated. 
(Feeder systems are systems that support both financial management and 
other functions and pass, or ``feed'' information to accounting 
systems. For example, an inventory system may provide inventory 
managers information about the type, quantity and location of inventory 
while also ``feeding'' financial information to accounting systems for 
use in the preparation of financial reports and/or statements.)
    The Department has developed a comprehensive plan--the Financial 
Management Improvement Plan--to address planned changes to financial 
management operations. In October 1998, the Department submitted its 
first Financial Management Improvement Plan to the Congress. The 
Department updated the Plan in 1999 and intends to continue to update 
the Plan on an annual basis.
    In the Plan, the Department identifies its long-term strategy for 
improving its financial management operations, to include addressing 
various initiatives intended to reform the Department's financial 
management practices and systems. The Plan discusses the current 
financial management environment within the Department, addresses the 
Department's financial management concept of operations for the future 
and identifies the Department's proposed approach for transitioning to 
the future concept of operations.
    The Plan also summarizes and highlights the substantial progress 
the Department has made in improving its financial management 
operations to date. In addition, it presents information on the 
Department's systems--including the compliance status of systems, their 
noted deficiencies, proposed corrective actions with milestones, and a 
graphical representation of system interfaces. Details on policy and 
infrastructure initiatives also are provided. The Plan may be found at 
http://www.dtic.mil/comptroller/99FMIP/ on the Internet.

           Y2K-LIKE PROCESS FOR ACHIEVING SYSTEMS COMPLIANCY

    To aid in improving and/or replacing the Department's financial and 
feeder systems, the Department is initiating a ``Y2K-like Process.'' 
Similar to the efforts associated with the potential January 1, 2000 
computer problems, this ``Process'' provides for overseeing and 
monitoring progress on actions needed to better ensure that both 
financial and feeder systems meet federal financial management 
requirements. The ``Process'' consists of five phases with defined exit 
criteria and a governing body to provide oversight and guidance.
    The five phases of the process are awareness, evaluation, 
renovation, validation and compliance. The awareness phase includes 
identifying the Department's financial and feeder systems and then 
determining which of the systems are ``critical'' to financial 
management. This phase mostly has been completed. The evaluation phase 
includes identifying specific deficiencies and developing corrective 
action plans. The renovation phase involves implementing needed 
corrective actions and bringing the systems into compliance. During the 
validation phase, confirmation is obtained from an independent third 
party that the system is compliant with federal financial management 
systems and other applicable requirements.
    As the Under Secretary of Defense (Comptroller), I will chair the 
governing body which will provide oversight and guidance to the 
Military Departments, the Defense Agencies, and the Defense Finance and 
Accounting Service. While the Military Departments and Defense the 
Agencies will be responsible for executing the five phases of the 
``Process'' for each of their respective critical systems, they will be 
required to obtain approval from the governing body for each phase 
before proceeding to the next phase.

       FINANCIAL MANAGEMENT TRAINING AND PROFESSIONAL DEVELOPMENT

    The Department's financial management reform initiatives have 
focused on organizational structure, infrastructure, policies, 
processes and systems. However, the Department recognizes that sound 
financial management practices also demand well-trained and well-
qualified personnel.
    While the Department's current financial management workforce is 
well-qualified and highly motivated, its future workforce must be even 
better qualified. Accordingly, the Department needs to better prepare 
the next generation of its financial management leaders. To that end, 
an extensive workforce development program is underway within the 
Department. An agreement with the U.S. Department of Agriculture 
Graduate School has been reached to present a new 5-day class in 32 
locations to over 2,000 Department of Defense financial managers this 
calendar year. These classes will address financial management 
challenges that face the Department of Defense. This training is 
intended to better ensure that the Department's personnel ``know the 
rules'' that affect the administration of the Department's funds. The 
Department intends to continue presentation of these classes to over 
2,000 Department of Defense financial managers in each of the next 5 
years, and beyond.
    The Department's financial management senior leaders also are 
encouraging members of their financial management community to obtain 
appropriate professional certifications such as those of a Certified 
Public Accountant, Certified Government Financial Manager, Certified 
Internal Auditor, Certified Cash Manager, and other appropriate 
certifications. In addition to demonstrating professional competency, 
such professional certifications often impose a continuing education or 
training requirement to better ensure that once certified, the 
individual remains current with changes in financial management 
requirements and retains their proficiency.
    In addition, and in cooperation with the American Society of 
Military Comptrollers, the Department has initiated a new Certified 
Defense Financial Manager (CDFM) Program specifically geared toward 
Defense financial managers. The Department believes there is a benefit 
to having a Defense certification program because of the complexity of 
the Defense budget and its appropriations; the Defense Planning, 
Programming, and Budgeting System; the Department's accounting 
procedures; and related financial management policies and procedures. 
Eligibility requirements for the CDFM include a minimum of 3 years of 
relevant Defense financial management experience, or 2 years of 
relevant Defense financial management experience with an Associate or 
higher degree. Similar to other certification programs, the CDFM is a 
test-based program. Additionally, once certification is obtained, an 
individual must continue their professional education/training in order 
to retain their certification.
    The pursuit of desired professional standards for the Department's 
financial management workforce should help to better ensure that the 
Department can continue to produce high quality financial managers. It 
also should demonstrate the desired level of knowledge and capability 
of the Department's financial managers in an objective and measurable 
manner that is visible to the Department's leaders, the Congress and to 
the American public. In short, greater attention to professional 
training and development is good, not only for the Department's 
financial management community, but also for the Department as a whole.
    Employees outside of the Department's financial management 
community also must be, and are being, given appropriate financial 
management training. Senior leadership and management training courses, 
such as the Services' War Colleges, the National War College, and the 
Industrial College of the Armed Forces, all have incorporated financial 
management modules into their curriculums. In addition, many of the 
Department's courses for mid-level leaders and managers, such as the 
Command and General Staff Colleges and the Army Management Staff 
College, include financial management modules as well.
    The Defense Acquisition Workforce Improvement Act mandates training 
and certification of all of the Department's employees who serve in 
acquisition workforce designated positions. The training required for 
certification in some acquisition subspecialties includes elements of 
budget formulation, justification and execution; accounting and 
auditing principles; internal controls; and other financial management 
principals. As the Under Secretary of Defense (Comptroller), I am 
represented on the board that develops and periodically reviews and 
updates the training requirements for this career field, as well as 
assists in the oversight of courses and the quality of instruction.
    Additionally, the Department is in the process of developing 
training for its property managers and logisticians. This training not 
only is intended to reinforce accountability requirements, but also to 
emphasize financial management requirements to such personnel. The 
training is intended to instruct property managers and logisticians on 
how their management responsibilities impact the Department's efforts 
to accurately record and report property acquisition costs, acquisition 
and disposal dates, and depreciation. Property accountability modules 
within these training courses are intended to inform property managers 
and logisticians of the mandatory requirements for conducting physical 
inventories, the documentation requirements for such inventories, and 
the actions necessary to correct property accountability records and 
systems to reflect the results of physical inventories.

                      AUDITED FINANCIAL STATEMENTS

    With the passage of the Chief Financial Officers Act, the 
Government Management Reform Act, the Federal Financial Management 
Improvement Act and new federal-wide accounting standards promulgated 
by the Federal Accounting Standards Advisory Board, the federal 
government has been playing catch-up to comply with many new 
requirements to produce business-type auditable financial statements. 
The Department of Defense is no exception. It, too, is striving to 
comply with new statutory and other requirements.
    The Department previously has acknowledged that its financial and 
feeder systems were not designed to produce business-type financial 
statements. Quite the contrary. The Department's financial management 
systems were designed to perform budgetary accounting for the resources 
appropriated to the Department by the Congress. The Department's feeder 
systems, which generate the preponderance of business transactions 
within the Department, were designed to provide accountability over the 
Department's assets and perform other functions. These financial and 
feeder systems satisfactorily perform the missions that they were 
designed to perform. However, because these systems were not designed 
to provide financial information for business-type financial 
statements, it is not surprising that these systems do not do a good 
job of producing business-type financial statements that, until 
recently, the Department was not required to prepare. Nor should the 
difficulty in producing data for financial statements be misconstrued 
to mean that the Department does not do a good job of carrying out its 
stewardship and fiduciary responsibilities. In fact, the Department 
does a very good job.
    Most of the Department's financial and feeder systems were designed 
prior to the promulgation of new federal accounting standards. 
Information from these systems often is not collected in a way that 
complies with new federal accounting standards. Other information 
needed to meet some of the new reporting requirements is not collected 
in the Department's automated systems at all. Therefore, such 
information is manually entered into the accounting system at the end 
of the applicable fiscal year in order to facilitate the preparation of 
business-type financial statements. Although the use of estimates and 
the manual entry of data into accounting systems are acceptable 
practices, the Department is aggressively engaged in modernizing its 
financial and feeder systems and developing automated interfaces 
between its systems--both to minimize the use of estimates and to avoid 
the need to manually enter information. Thus, one challenge for the 
Department is to modernize both its financial and feeder systems to 
produce business-like financial statements.

           STRATEGIES FOR OBTAINING FAVORABLE AUDIT OPINIONS

    While system changes are the long-term solution, there is much that 
the Department can, and must, do now. Our short-term strategy 
recognizes that. We are developing interim methodologies that will aid 
the Department in achieving more acceptable results and will be 
sufficient to support more favorable audit opinions on the Department's 
financial statements.
    To succeed in this effort, the Department has fully engaged in a 
partnership with the Office of Management and Budget (OMB), the General 
Accounting Office (GAO) and the Office of the Inspector General (OIG) 
for the Department of Defense. We have worked, on a collaborative 
basis, to identify major obstacles that must be overcome for the 
Department to be successful; to develop interim solutions to the 
Department's systemic problems; and to apply accounting and auditing 
standards in ways that make sense for the Department of Defense.
    Major deficiencies that prevented the Department from receiving a 
favorable audit opinion in the past have been identified. Alternative 
methodologies to deal with these deficiencies have been developed and 
coordinated with the OMB, GAO, and OIG. To implement these 
alternatives, plans detailing short-term strategies for solutions to 
each of the deficiencies have been developed along with the 
identification of responsible parties and milestone dates needed to 
support accomplishment of the Department's goal. To better ensure that 
we stay on track, applicable organizations within the Department are 
being asked to report on their progress and, as appropriate, update 
their plans.
    Each of the implementation strategies is intended to address 
specific deficiencies previously noted by the audit community. When 
fully implemented, these implementation strategies are expected to 
allow the Department to attain a more favorable audit opinion on the 
Department's financial statements. Examples of some of the Department's 
more significant short-term implementation strategies include, but are 
not limited to, the following:

       VALUATION OF GENERAL PROPERTY, PLANT AND EQUIPMENT (PP&E)

    Recently approved accounting standards require PP&E to be reported 
at acquisition (i.e., historical) cost and depreciated. To validate the 
original costs, auditors want to see the original receipt or purchase 
document. However, the federal government's record retention policies 
are not consistent with such audit requirements.
    For example, the National Archives and Records Administration 
requires that most financial management documents and records be 
retained only for 6 years and 3 months. When the auditors attempt to 
audit assets that are older than 6 years and 3 months, they have 
difficulty finding documentation to support the reported values because 
the activities typically do not maintain documentation beyond the 
required retention period. This does not mean that the values reported 
by the Department are incorrect, rather it means that the auditors 
cannot verify the values reported.
    To address this situation, the Department engaged two of the 
largest and most prestigious public accounting firms in the world to 
provide a value for the Department's property that would be acceptable 
to the Department's auditors. Recently, the public accounting firm 
assessing the value of the Department's real property indicated that 
the values recorded by the Department were materially accurate for the 
Department's real property. The Department has not yet reached a 
similar milestone relative to its personal property. However, the 
Department continues to work with the contractor and the audit 
community in the pursuit of attaining a similar goal.
    Additionally, because the Department's accounting systems were not 
designed to capture, retain and depreciate the costs of PP&E assets, 
the Department is working with the audit community, and has asked 
public accounting firms to assist, in the development of guidance, 
processes and other changes needed to resolve existing systems 
deficiencies. This is an enormous undertaking for the Department 
because of the tremendous number of PP&E assets that the Department 
owns worldwide.

           ACCOUNTING FOR THE DEPARTMENT'S MILITARY EQUIPMENT

    The Department has an estimated $600 billion invested in, and 
spends significant amounts of funds annually for, military equipment. 
The Federal Accounting Standards Advisory Board (FASAB) has yet to 
determine the desired permanent accounting and reporting requirements 
for the Department's military equipment--which the FASAB refers to as 
National Defense Property, Plant and Equipment (PP&E). Obviously, once 
the FASAB issues its permanent accounting standard for National Defense 
PP&E, the standard will have a major impact on the Department's 
financial management processes. The FASAB is considering several 
accounting and reporting alternatives. This issue is a very complex 
matter and can be expected to have a major impact, not only on the 
Department of Defense's financial statements, but, potentially, also on 
the consolidated government-wide financial statements.
    Recently, the Department hired a contractor to perform a detailed 
and thorough analysis of each of the accounting and reporting 
alternatives being considered by the FASAB. The FASAB has agreed to 
consider, as part of its deliberations, such appropriate analysis as 
the contractor may complete, as well as other relevant information that 
the contractor may provide.
    The contractor--a well respected national Certified Public 
Accounting firm--will:
    (1) identify pros and cons of each alternative being considered, 
(2) provide an estimate of the costs for implementing each alternative, 
and (3) recommend timeframes for implementing each alternative. The 
Department will closely monitor the deliberations of the FASAB. 
Ideally, the FASAB will issue an accounting and reporting standard that 
meets the needs of external users of the Department's financial 
statements, is compatible with the manner in which the Department does 
business and supports internal decision-makers that might use such 
financial information.

                         VALUATION OF INVENTORY

    Similar to PP&E, the new accounting standards require a valuation 
of inventory based on historical cost (the amount paid) or latest 
acquisition cost (a revaluation of all items in stock to equal the 
amount paid for the last item purchased). When the latest acquisition 
cost is used, the difference between historical cost and the latest 
acquisition cost must be reported as an unrealized gain or loss--in 
effect resulting in latest acquisition cost equating to historical 
cost.
    Inventory values are not contained in the Department's financial 
systems. Instead, such information is included in logistical (feeder) 
inventory systems. These systems do an excellent job of ensuring that 
our troops have the parts they need, when they need them, at the place 
that they need them, and in the condition required to perform their 
mission effectively and efficiently. However, the systems were not 
designed to provide accounting data to support financial statements--
which became a requirement only beginning in FY 1998. Nor are the 
Department's logistics systems sufficiently integrated with the 
Department's accounting systems to pass, in an automated manner, 
information that is required by the new federal accounting standards. 
Additionally, these logistical inventory systems often value inventory 
at selling price--not historical cost or latest acquisition cost. As a 
consequence, the dollar value of inventory reported on financial 
statements is a calculated, vice a system driven, amount. These 
calculated amounts are determined by using a formula that adjusts the 
inventory values reported by logistical inventory systems to an 
approximation of latest acquisition cost and historical cost.
    The Department's logistics and financial communities are working 
together to improve the quality and reliability of the financial 
inventory amounts that are reported and are actively pursuing process 
improvements that will better comply with the new accounting standards. 
As inventory systems are renovated or replaced, new functionality that 
will better support audited financial statements will be added. In the 
meantime, the Department is working with its auditors to refine the 
formula used to calculate inventory values reported on the Department's 
financial statements, as well as to identify what specific sources of 
information would be most beneficial for use in such a calculation.

                    OPERATING MATERIALS AND SUPPLIES

    The current accounting standard allows for the use of two 
accounting treatments for operating materials and supplies--the 
consumption method and the purchase method. Under the consumption 
method, operating materials and supplies are recognized as assets when 
purchased, and are expensed when they are issued to an end user in 
normal operations. Under the purchase method, operating materials and 
supplies may be expensed when purchased.
    The Department is working in conjunction with the audit community 
to evaluate when the consumption method should be used and when the 
purchase method is appropriate, and to define ``end users.'' In those 
cases where it is determined that the consumption method is 
appropriate, the systems that would be used by the Department's 
Components to report operating materials and supplies primarily are 
logistics systems. These logistics systems were not designed to record 
and report historical cost, and logistics processes do not require 
retention of supporting documentation that meets the very stringent 
audit trail requirements necessary to support preparation of audited 
annual financial statements. The Department is working to define and 
develop functional requirements for logistics systems that better 
support accounting and valuation of operating materials and supplies, 
and to develop plans to update existing systems. While system changes 
will be required to institutionalize the automated reporting of 
accepted values for operating materials and supplies, the Department is 
working with the audit community to identify process or other changes 
that can be implemented in the interim to allow applicable values to be 
reported in a manner acceptable for financial statement purposes.

                       ENVIRONMENTAL LIABILITIES

    Current federal accounting standards require reporting the 
estimated costs of known and potential future environmental liabilities 
associated with the Defense Environmental Restoration Program (cleanup 
from past waste disposal practices at active and closed installations 
and formerly used defense sites); cleanup of closed, transferred, and 
transferring training ranges; preservation and management of active and 
inactive training ranges; and the future disposal of weapons systems 
(nuclear powered ships and submarines) and chemical munitions. Many of 
these costs will not be incurred until 20, 30, or even 40 or more years 
in the future.
    The Department reported approximately $34 billion in environmental 
liabilities for FY 1998. For FY 1999, the amount that was reported was 
$80 billion. The large increase in environmental liabilities reported 
for FY 1999 resulted primarily from the inclusion of amounts for future 
disposal of weapons systems and future efforts associated with the 
cleanup of training ranges. There also was an increase associated with 
reporting the estimated disposal cost of chemical munitions.
    However, some of the Department's future environmental liabilities 
have not yet been fully assessed. For example, it is likely that 
additional environmental liabilities associated with training ranges 
will be reported in future years. To report these additional amounts, 
the Department requires additional time to conduct inventories, surveys 
and site assessments, and to prepare cost estimates.

     MILITARY POSTRETIREMENT HEALTH BENEFITS AND CLAIMS LIABILITIES

    Military postretirement health benefits and claims liabilities are 
amounts that are estimated to be paid over a period that could be as 
long as the next 100 years. In reporting an actuarial liability for 
military postretirement health benefits and claims, historically the 
Department based its estimate on prior actual obligations. However, the 
new accounting standard requires that, to be acceptable estimates, 
these liabilities must be determined through the use of accrued costs 
instead of obligations.
    The Department is enhancing its ability to report such liabilities 
using factors that are more in accordance with the new accounting 
standards. The Department, in partnership with the GAO and the OIG, has 
formed a working group to evaluate the use of various cost data as a 
means to measure future military postretirement health benefits and 
claims liabilities. This data will be the baseline used to calculate 
estimated military postretirement health benefits and claims 

LIABILITIES FOR FUTURE FINANCIAL STATEMENT REPORTING PURPOSES.
                       FUND BALANCE WITH TREASURY

    The Department maintains its own checkbook. Private sector firms 
that maintain their own checking accounts reconcile the cash balance 
reported by the bank with the firm's check register. Similarly, cash 
balances shown on the Department's checkbooks should be reconciled with 
the cash balances on the books of the U.S. Treasury. In the past, the 
Department's financial statements reported the amounts provided by the 
U.S. Treasury instead of the balance reflected in the Department's 
financial records. Frequently, the account balances at the U.S. 
Treasury do not agree with the account balances on the Department's 
financial records. These differences primarily are caused by timing 
differences that result from (1) separate accounting and reporting 
systems that are not integrated, or (2) other agencies disbursing on 
behalf of, and charging such disbursements to, the Department of 
Defense.
    As approved by the OMB, the Department has discontinued reporting 
the cash balances reported by the Treasury and, instead, effective with 
its FY 1999 statements, reports the fund balance shown in the 
Department's ``Fund Balance With Treasury'' general ledger account. 
Differences between the amount reported by the Department and the 
balance in Treasury's account, if any, are reconciled and explained in 
the footnotes to the financial statements.

               IMPORTANCE OF FINANCIAL MANAGEMENT REFORM

    Sound financial management information is important for a variety 
of reasons. And the financial management reforms underway within the 
Department of Defense embrace that precept.
     Sound financial management practices provide greater 
visibility over costs. Having timely and accurate cost information aids 
decision-makers--both internal and external to the Department--in 
better allocating resources and in making business decisions.
     Sound financial management controls provide safeguards to 
better ensure that funds are used for intended purposes and to 
discourage and prevent fraud, waste and abuse.
     Dependable financial operations assure contractors and 
vendors with whom the Department does business that they will be paid 
accurately and in a timely manner. In turn, this better ensures goods 
and services will be available to the Department when and where the 
goods and services are needed.
     Reliable financial management operations support our 
troops. It instills confidence in our soldiers, sailors, airmen, 
marines, and our civilian employees, that their financial entitlements, 
as well as those of their families, will not be neglected even though 
they may be thousands of miles from home.
    Because sound financial management information is important, 
financial management reforms within the Department also are important. 
Reforming financial management practices will allow the Department to 
obtain better and more timely information to support better informed 
management decisions. And better management information also can be the 
foundation for even more reforms in the Department's business 
practices. Further, financial management reforms can be expected to 
increase the public's confidence in the Department by demonstrating, to 
those outside the Department, that the Department is, indeed, a good 
steward of the resources that the Congress, and the Nation, has 
entrusted to it.

        CONSTRAINTS ON THE PACE OF FINANCIAL MANAGEMENT REFORMS

    The Department's financial management reforms were designed to 
fulfill the financial management information needs of the Department's 
leaders, meet statutory requirements, and maximize efficiency and 
minimize fraud. However, these reforms are still a work-in-progress. 
While tremendous strides have been made, and there have been many 
notable successes, progress has been slow in some areas. The reality 
is, it is impossible to reverse decades-old problems overnight. These 
reforms will require several years to complete. Further, in pursuing 
such reforms, the Department has had to recognize, and accommodate, 
three unavoidable constraints.

             CONTINUATION OF DIVERSE, WORLD-WIDE OPERATIONS

    The size, complexity and diversity of the Department's ongoing 
operations make changes to the Department's financial management 
processes and systems a significant challenge. The Department manages 
over a trillion dollars in assets, including weapons systems, and 
maintains hundreds of bases in over 100 countries and territories 
throughout the world. It has over two million active duty and reserve 
component personnel as well as 700,000 civilian employees. The size of 
the three Military Departments--Army, Navy and Air Force--collectively 
dwarfs the largest organizations in the private sector as well as all 
other federal agencies.
    There is no other organization in the United States, perhaps in the 
world, that is as large and diverse as the Department of Defense. The 
Department operates 100,000 vehicles, from trucks to tanks, maintains a 
fleet of more than 22,000 aircraft and operates hundreds of oceangoing 
vessels around the world. Every month, the Department makes 920,000 
contract or purchase actions, fits troops with 50,000 pairs of boots 
and serves 3.4 million meals. On any given day, the Department buys 
enough fuel to drive a car around the world 13,000 times, maintains 
12,000 miles of waterways, operates 550 public utility systems--
including 24 percent of the nation's hydropower capacity, manages 232 
schools and provides day care for over 200,000 children.
    As the largest finance and accounting firm in the world, the 
Defense Finance and Accounting Service processes a monthly average of 
nearly 10 million payments to the Department's personnel; processes and 
pays 1.2 million commercial invoices; settles and pays 450,000 travel 
vouchers; issues 500,000 savings bonds; processes and pays over 100,000 
transportation bills of lading; and makes disbursements averaging 
approximately $24 billion.
    The Department cannot stop its financial operations while it fixes 
outdated business practices and flawed systems. The daily operating 
requirements of the Department impose a strong practical constraint on 
our plans for improving systems and business practices.

                      CONSENSUS AND COLLABORATION

    Lasting reform demands consensus and collaboration. Few solutions 
rest exclusively within the jurisdiction of the financial management 
community. It is estimated that most of the information needed for 
financial management reports and statements originates in systems that 
are not under the control of the Department's financial community. 
Rather, such information comes from feeder systems--most notably from 
acquisition, logistics, medical, and personnel systems. It is an 
enormous challenge to upgrade these feeder systems to produce the 
needed information and to improve their interfaces with the 
Department's financial systems--especially since the primary purpose of 
those feeder systems is to support the U.S. military forces defending 
our nation, not to produce financial data.
    The development of an infrastructure capable of providing more 
accurate and reliable financial management information and achieving 
auditable financial statements is a high priority of the Department. An 
infrastructure built around the integration and transfer of financial 
information between feeder systems and accounting systems is a 
Departmental goal and is necessary to enhance the sharing of 
information and to avoid redundant and sometimes conflicting data. The 
achievement of this objective is a Department-wide management challenge 
that requires a close cooperative working relationship among the 
Department's various functional communities. Therefore, much of our 
effort must, and does, involve working with other functional 
communities to upgrade their systems and to improve their interfaces 
with the Department's financial management systems. While this 
cooperative endeavor is well underway, much additional effort will be 
required to successfully complete the undertaking.

               CHANGING FINANCIAL MANAGEMENT ENVIRONMENT

    Legislation in the 1990s has changed the Federal Government's 
accounting requirements. More recent legislation requires audited 
financial statements from federal agencies. The Department's financial 
information must be collected and reported in accordance with new 
applicable Statements of Federal Financial Accounting Standards. These 
standards require more comprehensive accounting and reporting than the 
existing financial management systems were designed to accommodate. For 
the Department of Defense, this requires the Department to track 
financial data on items from their purchase to disposal in a more 
integrated process. No longer can we solely rely on separate systems 
monitoring separate categories. For example, if the Department 
purchased a patrol boat in 1975, we now must be able to identify when 
the boat was purchased; determine how much the Department paid for it 
and produce the original receipt; track where it is being used; or if 
it no longer is being used, determine if it has been offered for resale 
through the surplus property program, and, if so, when it was sold and 
for how much. And, we must have supporting paperwork for all these 
transactions, sometimes up to 18 months after the disposal or sale of 
the item. Obtaining a clean financial opinion requires an integrated 
and complete audit trail for millions of the Department's items, many 
purchased decades ago.
    Accommodating these three constraints--continuing operations, 
building consensus and collaboration, and implementing process and 
system enhancements in the face of ever changing financial management 
requirements--imposes an enormous challenge. But the challenge is not 
just a financial management challenge; it is a Department-wide 
challenge that requires the involvement of all communities within the 
Department. The Department has accepted this challenge and each of the 
Department's functional communities actively are engaged in 
implementing various aspects of the Department's financial management 
reform initiatives.

                                CLOSING

    In closing, Mister Chairman, I would like to thank you and the Task 
Force Members for providing me this opportunity to address financial 
management reform within the Department of Defense. The Department's 
financial management reforms are continuing to cut costs and improve 
effectiveness by exploiting the best of private and government 
practices. Especially productive are the extensive uses of 
consolidation, standardization, simplification, and advanced 
technology. During my tenure as the Department's Chief Financial 
Officer, I have witnessed substantial progress and an extraordinary 
transformation of the Department's financial activities, as well as 
other functional areas with which those activities must interact. 
Collectively, the initiatives addressed in this statement, as well as 
other initiatives underway within the Department, have built a strong 
financial management reform foundation upon which the Department can 
continue to build.

    Chairman Shays. Mr. Lieberman.
    Mr. Lieberman. Thank you, Mr. Chairman.
    Chairman Shays. Excuse me, Mr. Lieberman. I just want to 
point out that we are fortunate to have the ranking member of 
the full committee, John Spratt, here; and I welcome you to the 
meeting. Thank you.
    Mr. Spratt. Thank you.

 STATEMENT OF ROBERT J. LIEBERMAN, ASSISTANT INSPECTOR GENERAL 
            FOR AUDITING, U.S. DEPARTMENT OF DEFENSE

    Mr. Lieberman. Mr. Chairman and members of the Task Force, 
thank you for the opportunity to participate in this hearing 
this morning.
    You asked me in your invitation letter specifically to 
discuss the results of our financial statement audits. The 
first part of my written statement talks about basically how 
the Department ended up in the situation that it is in today, 
and I won't dwell on that in detail because references already 
have been made to it.
    For decades, as a decentralized operation, Defense, like 
most other government agencies, did not do a particularly good 
job of moving into the computer age on a controlled basis so 
that we would have systems that talk to each other and fully 
meet user requirements.
    During the 1990's, there has been a gradual but major 
transformation of the way the Department does business. There 
are several reasons for this. One is the advance of information 
technology. Particularly the Internet makes it much easier to 
move information among organizations and between locations more 
efficiently and faster than ever before. There has been a 
powerful example set by the U.S. private sector in how to 
harness modern information technology and use it to develop new 
business practices that are far more efficient than the 
practices of the '70's and the '80's.
    Also, there has been the stimulus of reform legislation, as 
previously mentioned, particularly the Chief Financial Officers 
Act of 1990 and related legislation. I would point to the 
Results Act and the Clinger-Cohen Act also as having had a 
profound influence on DOD financial management. But it is an 
enormous challenge.
    As Mr. Lynn said, DOD had somewhat over 300 finance and 
accounting systems in place when the CFO Act was passed, and 
none of them were capable of producing the kind of data needed 
to meet modern accounting standards. Also, there was no 
particular audit requirement related to financial reporting by 
the DOD, which in retrospect seems somewhat amazing, but was 
very true at the time.
    The DOD efforts to compile and audit the annual financial 
statements for the Department as a whole and for its nine 
subsidiary reporting entities have been massive, year after 
year, for 10 years. Unfortunately, the Department has never 
been able to overcome the impediments caused by poor systems 
and inadequate documentation of transactions and assets.
    In terms of opinions, the audit results again this year 
differ little from those of the past several years. A clean 
opinion was possible for the military retirement fund, but we 
had to disclaim the ability to render an opinion on any of the 
other reporting entities or on the Department's statements as a 
whole. In accounting terms, that means that the statements were 
unauditable.
    The scope of accounting adjustments to financial statements 
is perhaps one of the best indicators of how hard it has been 
for DOD to follow private sector financial reporting practices. 
When the financial reporting system of a corporation can't 
generate fully reliable financial statements, accountants 
sometimes make accounting entries, often as recommended by 
their external auditors, to complete or correct the statements. 
But making major entries or adjustments to override, correct or 
transfer data is not the preferred way of doing business; and 
there is considerable attention paid to any significant change 
to official accounting records before the contents of those 
records are disclosed in financial statements.
    The notion of accounting entries being made on a massive 
scale, in most cases to compensate for underlying system 
problems, is completely foreign to Corporate America, as is the 
prospect of any such adjustments being unsupported by clear 
audit trails. In fact, accounting adjustments are closely 
scrutinized by external auditors and the Security and Exchange 
Commission for fraud indicators.
    Unfortunately, the Defense Department has no integrated 
systems for compiling financial statements and relies on the 
patchwork of crosswalks, workarounds and what in the Army years 
ago we used to euphemistically call ``field expedients.''
    The audits of the fiscal year 1999 DOD financial statements 
indicated that thousands of accounting entries worth $7.6 
trillion were made to compile them. Of the $5.8 trillion worth 
of those adjustments that we audited this year, $2.3 trillion 
were unsupported by reliable explanatory information and audit 
trails or were made to invalid general ledger accounts.
    These huge amounts portray a massive, but fundamentally 
inefficient and largely futile, attempt to get the numbers 
right on the financial statements. We now clearly have the 
Department's attention in this particular problem; and, 
actually, we are pleased with recently announced initiatives to 
minimize unsupported changes. But, fundamentally, the number of 
adjustments is not going to come down appreciably until new and 
better systems are in place. CFO Act compliance is 
fundamentally a systems problem.
    The testimony of the other witnesses today provide good 
summaries of the other major deficiencies in the statements. So 
in my written statement I discuss just two examples of areas 
where I believe the rigor of better financial control would 
help the Department address persistent problems. Those are 
inventory and environmental cleanup. I would be happy to 
address any questions you have in either of those areas.
    It is particularly important, however, this morning to 
stress our concern about the long-standing lack of good ways to 
measure progress toward sound financial reporting and to focus 
on the long poles of the tent, which are the noncompliant 
systems.
    Audit opinions on the annual agency financial statements 
still are the only widely used way of measuring progress by the 
Federal Government toward accurate and, by implication, useful 
financial reporting. Unfortunately, this means that 
considerable improvement can be made within each of the huge 
DOD reporting entities without any appreciable effect on the 
overall audit opinion. A series of declarations that the 
statements are unreliable or unauditable tells you very little 
about what progress has been made and what remains to be done, 
especially in terms of replacing or fixing specific systems. 
Conversely, a favorable audit opinion can be misleading, too. 
We fully agree with the GAO that a clean audit opinion would 
not necessarily be synonymous with responsive financial 
information that enables sound decisionmaking.
    First, auditors can easily determine for you the accuracy 
of the numbers, but usefulness is more of a moving target. I 
don't think there has been enough dialogue between the Congress 
and the executive branch about what information in these 
financial statements would be useful.
    Secondly, audit opinions can be gamed. If the financial 
statements are put together using ad hoc procedures for 
bypassing the official financial systems and records that are 
relied on for day-to-day management information, the clean 
audit opinion can actually mask continued underlying serious 
problems with systems, records and actual operations. 
Therefore, I urge that the limitations of audit opinions per se 
be kept in mind as we assess DOD's performance.
    To help develop CFO Act compliance performance measures and 
to enhance management control, last year we recommended that 
DOD apply its highly successful Y2K management approach to the 
challenge of attaining CFO Act compliance. As was the case with 
the Y2K conversion, the CFO Act challenge is fundamentally a 
systems problem, which needs to be addressed with a clear, 
widely distributed plan that draws in all parts of the 
Department, not just the financial community. This is a problem 
that requires cooperation and resource expenditure by every 
single part of the Department--the acquisition people, the 
personnel people, the logistics people and what have you.
    There are several advantages to using the kind of 
individual system measurement terminology that we used for Y2K. 
The Department knows this approach works, managers and the 
Congress are familiar with the terminology, and it entails 
fairly simple and verifiable metrics to show progress in 
highlight risk areas.
    We are pleased that the Department has adopted this 
recommendation and concept, but, frankly, the implementation 
has been disappointingly slow----
    Chairman Shays. Let me give you about a minute more.
    Mr. Lieberman [continuing]. Yes, sir. I will finish in that 
time. And key Y2K process attributes are still missing.
    Similarly, the biennial financial management improvement 
plan still has holes in it. For example, although we have a 
fairly well-defined goal for when finance and accounting 
systems are going to be compliant, that is 2003, we do not have 
a sound, definitive goal for when all the feeder systems are 
going to be compliant. As Mr. Lynn said, they are absolutely 
critical.
    In closing, I would like to mention that in DOD we have a 
cooperative effort, a good relationship between the audit and 
finance communities. We have written lots of candid audit 
reports for 10 years taking the Department to task on these 
matters, and the Department in general has tried very hard to 
be responsive. This is, though, a massive task; and we think it 
is going to be several more years before you can look forward 
to clean audit opinions on the Department of Defense.
    Thank you, Mr. Chairman.
    Chairman Shays. Thank you, Mr. Lieberman.
    [The prepared statement of Robert J. Lieberman follows:]

Prepared Statement of Robert J. Lieberman, Assistant Inspector General 
                for Auditing, U.S. Department of Defense

    Mr. Chairman and members of the Task Force, I am pleased to have 
the opportunity today to discuss the efforts of the Department of 
Defense to account for its funds and physical assets, provide useful 
financial information to decision makers, and operate its huge payroll 
and contractor payment operations efficiently.
    I would like to begin by underscoring both the critical importance 
of sound financial management and the unavoidable complexity of finance 
and accounting operations in an organization as large as the DOD. It is 
useful to keep in mind that the Department is the largest holder of 
U.S. Government physical assets ($1 trillion), has the most employees 
(about 1,500,000 active military and 710,000 civilians), owns the most 
automated systems, administers the most complicated chart of accounts, 
and manages the most diverse mix of operating and business functions of 
any Government Agency.
    The average monthly finance and accounting workload includes 
cutting 5 million paychecks, taking 920,000 contract or purchase 
actions and reporting commitments, obligations, expenditures and other 
data for many thousands of accounts.

                PAST PRACTICES AND RESULTING CHALLENGES

    The Department's accounting systems and financial reporting 
practices mirrored its overall management philosophy during the 1950's 
through 1980's. Most DOD business processes--acquisition, inventory 
management, maintenance, training, and many others were decentralized; 
controlled in theory by elaborately detailed rules and regulations; 
developed unilaterally by organizations operating within their own 
functional ``stovepipe'' with insufficient coordination with other 
stakeholders; and often labor intensive despite the use of many 
thousands of automated systems.
    In the finance and accounting area, each Military Department 
operated dozens of systems; data element standardization was never 
effectively enforced; DOD accounting policies were enunciated in a 
Handbook whose precepts were not mandatory and therefore were widely 
ignored; and the primary focus of financial reporting was on funds 
control, not on providing the full range of financial data needed by 
managers. In retrospect, it is remarkable how infrequently the DOD 
accounting community was asked questions along the lines of how much 
does it cost to run a base, fill a requisition or operate a warehouse. 
To this day, when such cost information is needed, managers frequently 
must hire consultants to make estimates or use special data calls 
instead of relying on standard reports, often with questionably 
reliable results.
    During the 1990's, a combination of factors highlighted many 
longstanding DOD financial management problems and created new 
challenges for DOD. Those factors included:
     The centralization of most DOD finance and accounting 
functions into the Defense Finance and Accounting Service (DFAS) in 
1991 was a long overdue initiative to streamline the organizational 
structure in this area. Establishing a central organization is never 
easy, because users and customers are leery about the quality of 
service they will receive from offices they no longer directly control 
and some elements of the workforce resist change. In the case of DFAS, 
the usual problems were compounded by the compelling need to make deep 
workforce cuts rapidly and close many finance offices, as DOD sought to 
reduce its support costs. The downsizing effort was a major 
preoccupation for the first several years of DFAS' existence. In 
addition, DFAS was created at the same time the Department was 
expanding its revolving fund concepts to require users of services to 
pay for the total costs of those services. DFAS soon became immersed in 
arguments with customers over fees for services that previously had 
appeared free or cheaper from the users' standpoints. Some users 
continue to regard DFAS as a monopoly with inadequate incentives for 
cost reduction or service quality improvements.
     The Chief Financial Officers (CFO) Act of 1990 required 
preparation and audit of financial statements of revolving funds, trust 
funds and commercial-like functions throughout the Federal Government. 
Additionally, the Departments of the Army and Air Force were designated 
as pilot programs, requiring preparation and audit of financial 
statements for the General Funds of those Services. The Federal 
Financial Management Act of 1994 expanded the requirement for annual 
audited financial statements to all DOD funds, as well as Government-
wide financial statements. The DOD and many other Government agencies 
lacked the systems, controls and policies for complying with those 
requirements.
     The Federal Financial Management Improvement Act of 1996 
requires the head of each Federal agency to prepare a Remediation Plan 
if the agency's financial management systems do not comply 
substantially with Federal accounting standards, requirements for 
financial management systems, and the U.S. Government Standard General 
Ledger at the transaction level. The Department's systems cannot meet 
any of those standards and therefore the DOD is implementing a 
Remediation Plan.
     The National Defense Authorization Act of 1998 requires 
the Secretary of Defense to submit to Congress a biennial strategic 
plan for the improvement of financial management within DOD. The 
Biennial Plan is to address all aspects of financial management, 
including the finance systems, accounting systems, and data feeder 
systems that support financial functions. The Authorization Act also 
included additional detailed requirements for a statement of 
objectives, performance measures, schedules, and the identification of 
individual and organizational responsibilities for Special Interest 
Items. Because of other, similar reporting requirements, the Department 
now considers this to be an annual report.
     Previous Government accounting and auditing standards were 
inadequate for CFO Act implementation and private sector financial 
reporting methods cannot be adopted by the public sector without 
considerable modification. Therefore, over the past few years, the 
Federal Accounting Standards Advisory Board (FASAB) has issued 18 new 
accounting standards and 3 concepts. Each of these standards has 
generated very significant new workload requirements for the DOD 
managers who are trying to make systems ``CFO compliant,'' for the 
preparers of financial statements, and for the auditors. The standards 
also require further clarification and interpretation, as with any new 
set of policies.
     Because of its size, the DOD is required to prepare 
financial statements for both the overall Department and for numerous 
large component entities, such as each Military Department's General 
Fund. No other Federal Agency has an equivalent accounting and auditing 
workload. The annual financial audits alone consume about 400 staff 
workyears of my office and the Military Department audit organizations. 
The full cost of DOD CFO Act compliance effort has never been 
identified.

                   FINANCIAL STATEMENT AUDIT RESULTS

    Neither the full integration of DOD support operations, including 
financial management, nor the achievement of clean audit opinions on 
the consolidated DOD financial statements are feasible short term 
goals. The Department remains several years away from being able to 
achieve favorable audit opinions on most major financial statements, 
although breakthroughs on a few individual statements are likely over 
the next couple years.
    The DOD efforts to compile and audit the FY 1999 financial 
statements, for the Department as a whole and for the 9 subsidiary 
reporting entities, were massive. Nevertheless they could not overcome 
the impediments caused by poor systems and inadequate documentation of 
transactions and assets. In terms of opinions, the audit results 
differed little from the past several years. A clean opinion was again 
issued for the Military Retirement Fund, but disclaimers were necessary 
for all other funds, including the DOD-wide consolidated statements.
    The scope of accounting adjustments to financial statements is one 
of the best indicators of how difficult it has been for DOD to emulate 
private sector financial reporting practices. When the financial 
reporting system of a public or private sector organization cannot 
generate fully reliable financial statements, accountants sometimes 
make accounting entries, often as recommended by auditors, to complete 
or correct the statements. Making major entries or adjustments to 
override, correct or transfer data is not the preferred way of doing 
business and there is considerable attention paid to any significant 
change made to official accounting records. The notion of accounting 
entries being made on a mass scale, in most cases to compensate for 
underlying system problems, is completely foreign to Corporate America, 
as is the prospect of any such adjustments being unsupported by clear 
audit trails. In fact, accounting adjustments are closely scrutinized 
for fraud indicators.
    The audits of the FY 1999 DOD financial statements indicated that 
$7.6 trillion of accounting entries were made to compile them. This 
startling number is perhaps the most graphic available indicator of 
just how poor the existing systems are. The magnitude of the problem is 
further demonstrated by the fact that, of $5.8 trillion of those 
adjustments that we audited this year, $2.3 trillion were unsupported 
by reliable explanatory information and audit trails or were made to 
invalid general ledger accounts. About $602.7 billion of accounting 
entries were made to correct errors in feeder reports.
    I will discuss some of the other specific problems in the 
statements later in this testimony, but first I would like to mention 
our longstanding concern about measuring where the DOD CFO Act 
compliance effort stands.

                           MEASURING PROGRESS

    Audit opinions on the annual agency financial statements still are 
the sole widely used metric for quantifying progress by the Federal 
Government toward accurate and, by implication, useful financial 
reporting. Unfortunately, this means that considerable improvement can 
be made in each of the huge DOD reporting entities without any effect 
at all on the overall audit opinions. For example, the Air Force made a 
concerted effort to correct records and compile support for 
transactions so that a favorable audit opinion could be achieved on its 
Statement of Budgetary Resources (SBR), which is a key part of the Air 
Force General Fund financial statements. Notwithstanding these numerous 
improvements and corrections, the effort could not overcome the problem 
of an unreliable opening balance. Despite a relatively near miss, the 
Air Force SBR audit result for FY 1999 is scored as another failure for 
the Department, one of many disclaimed audit opinions, but this is only 
part of the story.
    Although the DOD deserves credit for the considerable effort made 
to improve its financial reporting, it seems that everyone involved--
the Congress, the Office of Management and Budget, the audit community 
and DOD managers--have at best a general sense of how much progress has 
been made, what is the planned pace of further action, how much remains 
to be done and how much risk exists in terms of meeting goals and 
schedules. Nor has it ever been clear, as previously mentioned, how 
much the various aspects of this effort have cost to date, how much 
more will be needed and whether the effort is sufficiently resourced.
    Ironically, although the Department annually compiles voluminous 
documents in response to statutory requirements for multi-year 
financial management improvement plans and other data, very little of 
that information is consistently updated, analyzed and used for day to 
day program management or frequent senior management oversight. Much of 
it has to be collected in annual data calls to the DOD component 
organizations. The various reports to OMB and Congress, the annual 
financial statement audits, and even supplementary audits cannot 
substitute for structured, readily accessible, meaningful and frequent 
internal management reporting. Current data on project performance, 
cost and schedule status should be routinely provided up a clearly 
defined program management chain and shared with external reviewers. 
What has been in place up until now has been a 1970's or 80's 
management model.

                   APPLYING YEAR 2000 LESSONS LEARNED

    In our November 1999 report, Deficiencies in FY 1998 DOD Financial 
Statements and Progress Toward Improved Financial Reporting, we 
recommended that DOD emulate its highly successful ``Y2K'' management 
approach to address the challenge of attaining CFO Act compliance. As 
was the case with the Y2K conversion, the CFO Act challenge has been 
designated by the Secretary of Defense as a high priority and it is 
fundamentally a systems problem. Therefore it can be addressed most 
effectively if there are goals, criteria and milestones set forth in a 
clear management plan that involves all DOD organizations and 
functional communities, because it cannot be overcome unilaterally by 
the Chief Financial Officer without the active assistance of the rest 
of the Department. Like Y2K compliance, CFO Act compliance needs 
extensive audit verification and testing, and the Congress, OMB and GAO 
are all strongly interested in measuring progress toward the goal. 
There would be several advantages to this approach. The Department 
knows it works, managers and the Congress are familiar with terminology 
related to defined phases and system status, and it entails fairly 
simple and verifiable metrics to show progress and highlight risk 
areas.
    Although the Department reports in its current Financial Management 
Improvement Plan that the Y2K concept has been adopted, implementation 
has been disappointingly slow and key Y2K process attributes are still 
missing. The Plan of September 1999 established March 31, 2000, as the 
milestone for completing the Assessment Phase for CFO Act compliance of 
168 critical systems, but we understand this milestone has slipped 
until later this year. Despite the Y2K program experience that initial 
system assessments and status reports often were overly optimistic, 
incomplete or inconsistent, audit community involvement in validating 
milestone status has been limited. This is in marked contrast to the 
Y2K conversion effort, which we supported on a massive scale and whose 
managers shared status reporting with the auditors on a virtually 
continuous basis. To help redress this weakness, we plan to issue at 
least one report this year on the Assessment Phase, based on a self-
initiated audit.
    The Biennial Plan did not identify an overall milestone to correct 
all system deficiencies and fully integrate the financial management 
systems. The Plan stated that compliant finance and accounting systems 
are expected to be in place by FY 2003, which likely is optimistic. 
Significantly, the Plan did not provide a specific date goal for 
correction of all feeder system deficiencies. Because the logistics, 
personnel, acquisition and other feeder systems provide from 50 to 80 
percent of all data, this is a crucial gap in last year's plan.
    We have identified feeder systems with intermediate target dates 
extended beyond the FY 2003 milestone for the finance and accounting 
systems. For example, the Army Standard Installation and Division 
Personnel System had a September 2005 milestone for improvements. It is 
important that there be a clear understanding of the plan for those 
feeder systems and intensive management of this vital segment of the 
overall effort. We will work with the Department this summer to 
strengthen management oversight and the next iteration of the plan. We 
consider it crucial that the Department act now to be able to provide 
the incoming Administration with a clear and realistic roadmap of what 
needs to be done to attain a new generation of fully capable systems 
and clean audit opinions on the output of those systems.

                         USEFUL FINANCIAL DATA

    In adopting the private sector practice of audited annual financial 
statements, the Congress clearly expected improved financial 
management. The lack of performance metrics and cost data, as 
previously discussed, handicap an assessment of whether the effort to 
attain auditable financial statements has been worthwhile. The more 
important question to be asked, however, is whether data produced in 
compliance with Federal Accounting Standards and validated in financial 
statement audits is useful to users--managers and the Congress. Because 
much of the data rolled up into annual financial statements is also 
provided to users in various reports and budget exhibits, frequently 
often during the year, the focus should be across the spectrum of 
financial information reported within and by the Department, in 
whatever form.
    We fully agree with the General Accounting Office that a clean 
audit opinion would not necessarily be synonymous with responsive 
financial information that enables sound decision making by program 
officials and resource allocators. This would be particularly true if 
the financial statements were formulated using ad hoc procedures for 
bypassing the official financial systems and records that are relied on 
for day to day management information.
    Questions on the usefulness of various financial reports can best 
be answered by the users, not auditors or accountants. Unfortunately, 
we are unaware of much feedback to the DOD CFO community along those 
lines from other managers or Congress. Hopefully this dialogue will 
expand in the future, so that the accounting community has the best 
possible idea of what managers and the Congress actually need, when and 
in what form.

                          ASSET ACCOUNTABILITY

    Accounting and auditing standards can be very arcane. In my view, 
some of the property valuation issues confronting the Department are 
marginally relevant in Government and will never have any impact on DOD 
decision making. However, other management information deficiencies 
identified by the financial statement audits have very practical 
implications. For example, inventory management has been a high risk 
area for DOD for many years. Having complete, accurate and timely data 
on inventory is essential for logistics readiness and for making good 
procurement and disposal decisions.
    Examples of inventory accuracy problems were highlighted in our 
report on Inventory Accuracy at the Defense Depot, Columbus, Ohio, 
February 27, 1997, and a follow-up report on Assuring Condition and 
Inventory Accountability of Chemical Protective Suits, February 25, 
2000. For the first audit, we observed an inventory count of chemical 
protective suits, which must be carefully controlled as a critical 
warfighting item. The audit disclosed major discrepancies between the 
Columbus Depot's records and the actual number of chemical protective 
suits on-hand. The audit indicated 423,062 fewer protective suits 
actually on-hand than in the records. At other locations on the 
premises that were not designated as containing protective suits, we 
found an additional 696,380 protective suits that were not on the 
inventory records. This loss of control was caused by poor management 
practices, rather than by problems with the automated inventory records 
system. Management took action to regain control of the chemical 
protective suits and temporarily corrected its records. Shortly 
thereafter, as part of efforts to consolidate overall supply depot 
operations, the protective suits were transferred to the Defense Depot 
at Albany, Georgia.
    Last year, we observed the physical inventory count for 158 items 
stored at the Defense Depot, Albany. One of the sampled items was one 
of the types of protective suits that we had addressed in 1997. We 
discovered that, instead of improving inventory management, the 
transfer of the protective suits had had the opposite effect. The 
inventory records were again materially inaccurate. Although the 
records indicated 225,202 protective suits on hand, the physical count 
was 31,277 less. We also reported that these suits had been involved in 
a criminal investigation by the Defense Criminal Investigative Service, 
were potentially defective, and should have been withdrawn from active 
inventory. This problem was not caused by the inventory record errors, 
but does illustrate that financial audits can have a variety of 
benefits and highlight problems other than poor accounting. The 
inventory records have again been corrected and the potentially 
defective suits have been designated as usable for training only.

            FINANCIAL LIABILITIES FOR ENVIRONMENTAL CLEANUP

    Another area where DOD financial statements have been materially 
deficient, and which involves controversy about the practicality of the 
new accounting standards, is the recognition of liabilities for 
environmental costs to dispose of equipment and clean up DOD 
installations. We were unable to verify the $79.7 billion reported for 
environmental liabilities on the FY 1999 DOD Agency-wide Balance Sheet. 
The reported amount, as large as it is, was clearly understated.
    The magnitude of DOD environmental cleanup requirements has been a 
matter of intense DOD and Congressional interest for many years, but 
information on costs is fragmented and often unreliable. It would seem 
logical that costs identified in budget exhibits, other DOD 
environmental program reports, Selected Acquisition Reports and 
financial statements should be as consistent as possible, reconcilable 
and supported. More work is needed to move toward that goal. 
Specifically, there are unresolved issues regarding when to recognize 
environmental disposal costs for other than nuclear powered weapon 
systems on financial statements. Also, the cost estimates for 
installation cleanup need improvement.
    For example, the $20.7 billion equipment disposal portion of the 
overall environmental liability estimate was clearly incomplete, 
although improved over previous years. The Air Force reported nothing. 
The Navy, in contrast, estimated $11.5 billion for nuclear-powered 
submarine and ship disposal.
    An open issue remains on when to recognize environmental disposal 
costs for most DOD weapon systems on the financial statements--as soon 
as estimates are made as part of initial weapon system life cycle 
costing or much later when disposal decisions are made. We are working 
with the Department and GAO to resolve the question of what the 
accounting standards require and how much flexibility the DOD has to 
distinguish between nuclear powered systems and others with different 
types of hazardous materials. Regardless of the decision, we have 
recommended more aggressive action by the Military Departments to 
ensure that acquisition program managers include hazardous waste 
handling and disposal costs in the total estimated ownership costs of 
their systems. Recent audits indicated commendable emphasis by program 
managers on reducing the amount of environmentally hazardous material 
that will require costly disposal, but virtually no emphasis on 
including disposal costs in life cycle cost estimates. Both Congress 
and DOD have stressed the importance of complete life cycle cost 
estimates for weapon systems, and stated that support costs are the 
most frequently understated category. Disposal costs are part of 
support costs.
    The DOD reported $34 billion as the liability for environmental 
cleanup of munitions residue at training ranges. Reporting this amount 
represents a significant improvement over FY 1998, when cleanup 
liabilities for training ranges were not recognized or reported at all. 
However, reporting was incomplete and some managers question the 
usefulness of collecting the data. Although final DOD guidance for 
reporting liabilities for cleanup of training ranges has not yet been 
published, it is expected in FY 2000. Also, we will issue a report next 
month on inefficiencies in the processes for collecting and disposing 
of range residue.

                  SIMPLIFYING ACCOUNTING REQUIREMENTS

    In the mid-1990's, we recommended that DOD and the Congress 
consider ways to reduce the burden on DOD accounting offices and the 
risk of errors by simplifying requirements. The Under Secretaries of 
Defense (Comptroller) and (Acquisition, Technology and Logistics) have 
pressed the DOD components to adopt measures to avoid the unnecessary 
use of multiple accounts on contracts and commingling of funds from 
different accounts on the same contract line item. Likewise, our office 
has periodically commented on the incredible complexity of the DOD 
chart of accounts, which is probably unique in the world because of its 
hundreds of thousands of accounting entities, and the absurdly long 
accounting codes that result. This multiplicity of ``colors of money'' 
is a root cause of the formidable DOD problems with the accuracy of 
accounting data, the complexity of contracts, the difficulty of 
properly managing disbursements and progress payments, the high 
overhead costs of DOD budget and accounting operations, and the 
considerable restrictions on the flexibility of managers to shift funds 
quickly to meet contingencies. Millions of documents must contain at 
least one, and in some cases, many accounting classification codes that 
typically have from 46 to 55 characters each. Compare 12 or 16 
characters used for a commercial credit card to a typical Navy fund 
cite:

    17x1611 1936 026 54002 3 068572 ID 000151 000560852000

    We believe that the DOD and Congress ought to reconsider the need 
for so many discrete appropriations, budget activities, line items, and 
other subaccounts. These kinds of issues are seldom considered in the 
context of management reform, but we believe that any streamlining of 
DOD accounting requirements would considerably assist managers in 
avoiding errors, improving data quality, and cutting overhead costs 
throughout the Department.
    Unfortunately, the budget and appropriation structures are 
difficult to change. The DOD must administer at least 1,200 open 
appropriation accounts at any given time. A single appropriation may 
have many hundred subaccounts. The main driver of complexity, however, 
is the business practice of the individual DOD component. The Army, for 
example, has resisted simplification of either contracts or its chart 
of accounts, in effect asserting that it wishes to continue trying to 
capture costs and control funds at extremely challenging levels of 
detail.

                             OTHER CONCERNS

    We have concerns about information assurance, fraud and management 
controls in finance operations, particularly vendor pay. We continue to 
view DFAS as a likely target for hackers and are working closely with 
the Department to reduce vulnerability to computer crime and other 
fraud. Conflicting priorities and constrained resources have minimized 
recent audit coverage of vendor pay and other high risk areas related 
to financial management. Nevertheless, the results of the relatively 
few audits performed recently on other than financial statement 
processes provide an insight into what kinds of issues require 
management attention. For example:
     Last November we reported that the Department's policies 
on the timely recording of fiscal obligations needed to be strengthened 
to ensure compliance with the intent of applicable laws. The Department 
has taken responsive actions.
     On June 5, 2000, we reported that DFAS had improved 
controls over vendor payments made for the Air Force using the 
Integrated Accounts Payable System, but more needed to be done to 
ensure that all payments were properly documented for compliance with 
the Prompt Payment Act. About 176,000 of 307,000 payments made from 
April through June 1999 lacked complete supporting documentation. 
Although we found no indication of widespread fraud, better compliance 
with prescribed controls would diminish the risk of fraud and non 
compliance with laws such as the Prompt Payment Act.
     On June 9, 2000, we reported that management controls over 
the National Drug Control Program funds received by DOD were 
reasonable; however, the manual process used to report the status of 
those funds to the Office of National Drug Control Policy was not 
linked to the official accounting records. As a result, we were unable 
to attest to the accuracy of the annual report for FY 1999 as required 
by Public Law 105-277, the Office of National Drug Control Policy 
Reauthorization Act of 1998. This is a good example of the current 
inability of DOD accounting systems to provide information needed by 
the DOD and Congress, necessitating special workaround measures.
     On June 16, 2000, we reported that the DOD had not 
rigorously applied the principles set forth in the Clinger-Cohen Act 
when approving the acquisition strategy for the Defense Joint 
Accounting System. The planning for this new system, currently intended 
to be one of four DOD systems for multi-organization general fund 
accounting, has been severely criticized by the House Armed Services 
and Appropriations Committees. The main concerns are the lack of a 
sound analysis of alternatives and the poor precedent involved in the 
combined Milestone I and II approval for the project despite the 
absence of that analysis.
     On June 29, 2000, we reported that controls needed 
improvement to ensure that payroll withholding for DOD civilians was 
accurate. A limited sample of withholding in 279 individual accounts 
indicated errors in 24 accounts and inadequate supporting records in 
DOD personnel offices. This is an example of a payment problem that is 
caused by erroneous input from feeder systems, not by errors in the 
finance office, but the tendency is to blame DFAS.

                               CONCLUSION

    Mr. Chairman, every time we testify on DOD financial management, we 
assert that sustained involvement by senior managers and the Congress 
are vital ingredients for progress. This remains very much the case and 
we urge the Task Force to continue its dialogue with the Department on 
these tough issues. Despite commendable progress, the DOD remains far 
from CFO Act compliance and continued measures will be needed over the 
next several years to achieve success. The DOD audit community, which 
has invested so much effort and resources in this area over the past 
several years, very much appreciates your interest in our activities 
and viewpoints. The titles of some of our reports that are applicable 
to this testimony are attached, for ready reference.
    Finally, I would be remiss if I did not mention that the DOD audit 
community has an outstanding relationship with the Department's 
financial managers and virtually all of our recommendations have been 
accepted over the past several years. Likewise, the advice of the 
General Accounting Office has been very helpful to us and we will 
continue working closely with them to provide DOD and Congress with a 
well rounded picture of DOD financial management issues. This concludes 
my statement.
   examples of fy 2000 inspector general, dod, reports and testimony 
                       related to this statement
No. 2000-030, Recording Obligations in Official Accounting Records, 11/
            4/99
No. 2000-041, Deficiencies in FY 1998 DOD Financial Statements and 
            Progress Toward Improved Financial reporting, 11/26/99
No. 2000-069, FY 1998 Department of Defense Agency-Wide Statement of 
            Budgetary Resources, 12/29/99
No. 2000-077, Testimony by Deputy Inspector General, DOD, to the House 
            Budget Committee on Defense Management Challenges, 2/17/00
No. 2000-086, Assuring Condition and Inventory Accountability of 
            Chemical Protective Suits, 2/25/00
No. 2000-091, Internal Controls and Compliance with Laws and 
            regulations for the DOD Agency-wide Financial Statements 
            for FY 1999, 2/25/00
No. 2000-120, Testimony by Assistant Inspector General for Auditing, 
            DOD, to Subcommittee on Government Management, Information 
            and Technology, House Committee on Government Reform 5/7/00
No. 2000-121, Hazardous Material Management for Major Defense Systems, 
            5/4/00
No. 2000-136, Reporting of Performance Measures in the DOD Agency-Wide 
            Financial Statements, 5/31/00
No. 2000-139, Controls Over the Integrated Accounts Payable System, 6/
            5/00
No. 2000-151, Acquisition of the Defense Joint Accounting System, 6/16/
            00
No. 2000-156, DOD Payroll Withholding Data for FY 1999, 6/29/00

    All reports and testimony listed above are available on the 
Internet at www.dodig.mil.

    Chairman Shays. Mr. Steinhoff.

   STATEMENT OF JEFFREY C. STEINHOFF, ASSISTANT COMPTROLLER 
 GENERAL, ACCOUNTING AND INFORMATION MANAGEMENT DIVISION, U.S. 
                   GENERAL ACCOUNTING OFFICE

    Mr. Steinhoff. Mr. Chairman, members of the Task Force, a 
pleasure to be here today.
    Mr. Chairman, as you said in your opening, DOD has an 
incredibly vast and complex worldwide mission that it carries 
on in a way that no other nation can match. Financial 
management must play an important role in carrying out that 
mission. The bottom line, DOD continues to make important 
progress in addressing its serious financial management 
weaknesses, as the other witnesses have said. At the same time, 
it has a long way to go. DOD's problems are pervasive, long-
standing, deeply rooted, widespread and complex in nature. My 
testimony today highlights some of the challenges DOD faces.
    As we have reported in the past, these weaknesses adversely 
impact on DOD's ability to control cost, to ensure 
accountability and to address pressing management issues which 
drain resources needed to carry out missions and to increase 
readiness. World-class organizations have found, private sector 
and government, that there is a great payoff from good 
financial management and the ability to efficiently and 
effectively manage day-to-day operations and to anticipate 
future costs and claims on the budget.
    What has been markedly different in DOD over the last 2 
years is we have seen for the first time a clear and 
demonstrated commitment to address these serious weaknesses. A 
number of important initiatives, both short and long term, are 
under way and planned; and we are seeing positive results. I 
applaud Bill Lynn and his top team for their efforts. As he 
mentioned before, they are facing systems and problems that go 
back decades and a culture that viewed these issues in a 
stovepiped manner and administrative versus viewing financial 
management at the fiber of managing.
    This commitment, though, must be sustained over a number of 
years to turn plans into reality. A big challenge remains, and 
the finish line is not yet in sight. For the short term, 
continuing efforts to standardize, streamline and simplify 
processes, reengineering will be critical to success. I can't 
overemphasize that. They have to change the basic processes 
they have in place today.
    Next, they have to strengthen and enforce existing 
controls. There is no lack of controls in Defense. In some 
areas there may be too many controls, but they oftentimes are 
not followed or enforced to ensure basic transaction processing 
which today is a major impediment as well as a cost that can be 
greatly reduced.
    As you will see in my detailed statement, there are a 
tremendous amount of adjusting entries--one of every three 
disbursement transactions, $51 billion last fiscal year was an 
adjustment. So they are entering transactions, and then 
reentering them to correct them. Some are corrected years 
later. This is a tremendous expense.
    The private sector and successful State governments have 
found that the key to having good finance operations is to 
reduce your backroom operations. You don't want to be spending 
a whole lot of time processing and reprocessing transactions. 
Have them processed one time at the source. You have tremendous 
economies, tremendous savings, you have richer data, and the 
data comes to you on a day-to-day basis.
    Next, they have to develop more reliable estimates of some 
of their future liabilities, which will be helpful in the 
budget process. They have to enhance human capital, and they 
have to oversee performance.
    At the heart of the long-term challenge--and I echo the 
other witnesses' views; this is a long-term challenge--is a 
financial system that needs to be overhauled. The system is not 
integrated or tied together and represents a patchwork of 
systems that individually have weaknesses, some very serious, 
and collectively simply do not get the job done. Information 
does not automatically flow from system to system, as the IG 
reported.
    To prepare its fiscal year '99 financial reports, DOD has 
had to make thousands and thousands of accounting entries and 
adjustments totalling $7.6 trillion.
    To give you some sense--this isn't the whole picture. This 
is some sense of the challenge that Bill Lynn and his folks 
face. Over at your left is an example of DOD's own depiction of 
the current system's environment for its payment system. They 
have got other systems and other operations; and, as you can 
see, this is overly complex. The system has been built up over 
decades. Around the outer edge are 22 payment systems that are 
fed by numerous other systems, systems that are generally not 
compatible or properly tied together and often do not use 
common data codes. In a nutshell, this tells a story as to what 
they are trying to fix.
    Compounding the challenge is that most of the information 
needed to prepare annual financial reports and, more 
importantly--I want to emphasize more importantly--to manage 
DOD's operations on a day-to-day basis comes from feeder 
systems--logistics, acquisition, personnel--that are not under 
the comptroller's control. He controls around 20 percent of the 
information. The other 80 percent comes in from the other 
systems.
    So to achieve the end game of the CFO Act, and that end 
game is systems that routinely provide reliable, useful, timely 
information for day-to-day management purposes, DOD faces a 
systems challenge that transcends the comptroller's operation. 
It is far beyond financial reporting, and it is at the fiber of 
the management system in DOD.
    The Y2K experience I think can be a great teacher. DOD 
lagged far behind on Y2K on a regular basis. Steve Horn was 
grading the Department as an F. But the Department recognized 
that fundamental changes had to be made. They successfully 
turned the Y2K effort around, and they passed that test with 
flying colors. They demonstrated that applying some of these 
concepts can get them to that finish line.
    First, DOD recognized that Y2K was a chief executive 
officer issue, not just a CIO issue. The Department Secretary 
took direct control, exerted strong overall leadership over 
Y2K.
    DOD's financial management challenge cuts across its 
operations similar to Y2K. It also has a host of initiatives 
ongoing in logistics and in the other functional areas to deal 
with systems; and given DOD's corporate culture, which tends to 
be stovepiped within services, tends within activities to be 
stovepiped, having a strong, direct, sustained leadership must 
come from the top. It must be at the corporate level, at the 
deputy level.
    I brought some copies today of our executive guide--
Creating Value Through World-Class Financial Management, which 
was just issued back in April. In performing this study we went 
to Boeing, Chase Manhattan, GE, Hewlett-Packard, Owens-Corning, 
Pfizer, and the States of Massachusetts, Texas and Virginia. We 
found in successful organizations, private sector and 
government, that financial management is an entity-wide 
priority for which the chief executive provides clear, strong 
leadership, including being actively engaged in systems 
development. They see this as the lifeblood of the company.
    Second, Y2K had a date certain. Financial management reform 
doesn't have the same type of date certain, but Y2K also had 
interim dates that you had to meet along the way to gauge the 
likelihood of meeting the January 1st date. And it also had 
periodic self-reporting.
    It gets back to what Mr. Lieberman said, have interim 
steps, have interim goals. Next year this time, probably DOD 
will not have a clean audit opinion again. I think you can 
expect that, but establishing interim goals, measuring DOD 
against how it is meeting those interim goals, and having the 
rigor of reporting back against those goals will be very 
important.
    Third, for Y2K, DOD followed a structured, disciplined 
approach. Given the tremendous complexity of this challenge, it 
will be very important that DOD fully adhere to the investment 
controls in the Clinger-Cohen Act.
    There have been other systems initiatives in DOD. They have 
been extremely problematic. Systems development--and I am 
talking about information technology systems--has been a GAO 
high-risk area since 1995. So they have a track record where 
developing systems has been difficult. Many other agencies are 
in the same boat, and the private sector, has problems as well. 
So a disciplined approach will be very important.
    Also, for Y2K, the IG was very much involved with 
validation, with interim reporting, with working with DOD on a 
real-time basis; and that kind of partnership will be 
important.
    In closing, the comptroller and his staff should be 
applauded for their efforts. They have a long way to go, a 
sustained, high-level commitment that transcends this 
administration. This is a multiyear effort and will be key to 
the ultimate success of DOD's reform efforts. Likewise, 
sustained congressional attention such as this hearing and the 
work of this group will be crucial to instilling the expected 
accountability in DOD.
    Mr. Chairman, members of the Task Force, this completes my 
summary remarks. I will be pleased to respond to any questions 
at this time.
    Chairman Shays. Thank you.
    [The prepared statement of Jeffrey C. Steinhoff follows:]

   Prepared Statement of Jeffrey C. Steinhoff, Assistant Comptroller 
     General, Accounting and Information Management Division, U.S. 
                      Government Accounting Office

    Mr. Chairman and members of the Task Force, I appreciate the 
opportunity to discuss financial management issues at the Department of 
Defense (DOD) and their implications for the budget process. We 
recently testified\1\ before the House Subcommittee on Government 
Management, Information and Technology on the status of DOD's efforts 
to address its long-standing pervasive weaknesses in financial 
management systems, operations, and controls. Material financial 
management deficiencies identified at DOD, taken together, continue to 
represent the single largest obstacle that must be effectively 
addressed to achieve an unqualified opinion on the U.S. government's 
consolidated financial statements. DOD's vast operations--with an 
estimated $1 trillion in assets, nearly $1 trillion in reported 
liabilities and a reported net cost of operations of $378 billion in 
fiscal year 1999--have a tremendous impact on the government's 
consolidated reporting.
    To date, no major part of DOD has yet been able to pass the test of 
an independent audit; auditors consistently have issued disclaimers of 
opinion because of pervasive weaknesses in DOD's financial management 
systems, operations, and controls. Such problems led us in 1995 to put 
DOD financial management on our list of high-risk areas vulnerable to 
waste, fraud, abuse, and mismanagement, a designation that continued in 
last year's update.\2\ Lacking such key controls and information not 
only hampers the department's ability to produce timely and accurate 
financial information, but also significantly impairs efforts to 
improve the economy and efficiency of its operations. Unreliable cost 
and budget information affects DOD's ability to effectively measure 
performance, reduce costs, and maintain adequate funds control, while 
ineffective asset accountability and control adversely affect DOD's 
visibility over weapons systems and inventory.
    DOD has made genuine progress in many areas throughout the 
department, both larger steps forward and smaller incremental 
improvements. We have seen a strong commitment by the DOD Comptroller 
and his counterparts in the military services to address the 
department's serious financial management problems. At the same time, 
DOD has a long way to go. Major problems remain--problems that are 
pervasive, long-standing, deeply rooted, and complex in nature. Our 
previous testimony outlined DOD's most difficult financial management 
challenges and described the many initiatives that are under way or 
planned to address them.
    Today, I will highlight certain of those ongoing challenges, with a 
focus on those that affect the reliability of budget execution data as 
well as other areas where accurate and complete financial management 
information could provide a useful perspective to decisionmakers 
related to budget requests, performance measures, costs, and other key 
decision points.
    Finally, I will discuss DOD's plans and actions to develop an 
integrated financial management system that complies with Federal 
system standards. To achieve what the Comptroller General has referred 
to as the ``end game"--systems and processes that routinely generate 
good financial information for day-to-day management purposes--will 
require a major systems and reengineering effort. Integrated financial 
management systems, along with marshaling the human capital needed to 
achieve results, have long been cited as major components to the final 
resolution of DOD's financial management problems. The successful Year 
2000 effort demonstrated that DOD can resolve complex, entitywide 
problems through top management leadership working across functional 
lines. Applying the Year 2000 lessons learned to the department's 
financial management system integration effort will require similar 
leadership and commitment to a disciplined systems development 
approach.

             RELIABILITY OF BUDGET EXECUTION DATA IMPAIRED

    As an integral part of an effective budget execution system, an 
agency is responsible for determining and maintaining its available 
fund balance. Treasury also has information about activity in the 
agency's accounts, and Treasury's and the agency's records must be 
periodically reconciled to determine the actual amount of funds 
available. This is analogous to reconciling one's personal checking 
account with the monthly bank statement. DOD weaknesses in accounting 
for its funds include (1) the inability to reconcile its balances to 
Treasury's, (2) frequent adjustments of recorded payments from one 
appropriation to another appropriation account, including to canceled 
appropriations, (3) problem disbursements--disbursements that are not 
properly matched to specific obligations recorded in the department's 
records, and (4) obligated balances that are incorrect or unsupported.
    As a result of these weaknesses, auditors have been unable to 
verify DOD's Fund Balance With Treasury and its major components--
obligated and unobligated balances. This means that DOD does not know 
with certainty the amount of funding that is available. This 
information is essential for DOD and the Congress to be able to 
determine the status of funds and if unobligated balances are available 
that could be used to reduce current funding requirements or that could 
be reprogrammed to meet other critical program needs.

      SIGNIFICANT DIFFERENCES BETWEEN DOD'S AND TREASURY'S RECORDS

    Although DOD has made some improvements in its accountability over 
its fund balance with Treasury, the amount of funds available at DOD 
remains questionable because (1) significant differences between DOD's 
and Treasury's records remain, (2) the reduction in differences between 
Treasury's and DOD's recorded fund balances may be, in part, a result 
of a change in policy rather than an actual reduction, and (3) items in 
suspense accounts, which cannot be identified with a specific 
appropriation account, may not be DOD transactions.
    DOD made the reduction of differences a high priority in its short-
term improvement plans last year. There was a drop in the amount of the 
unresolved differences from $9.6 billion at September 30, 1998, to $7.3 
billion at September 30, 1999. Although some of the differences may be 
due to the timing of transaction processing at Treasury versus DOD, an 
aging of the difference suggests that significant reconciliation issues 
remain. For example, of the $7.3 billion difference, $2.5 billion is 60 
days or older. Differences over 60 days old are generally not 
attributable to timing.
    At least some of the decrease in the total differences as of 
September 30, 1999, can be attributed to the practice of some Defense 
Finance and Accounting Service (DFAS) center staff to routinely adjust 
their records each month to match those at Treasury without first 
identifying whether the adjustment is proper. This practice results in 
fewer differences on the reports but does not necessarily mean that the 
reconciliation process has actually improved or that the causes of the 
differences, such as Treasury or DOD errors in recording transactions, 
have been addressed and resolved. For example, one Army disbursing 
station recorded $608 million in differences to a suspense account.\3\ 
At year-end, DOD charged the differences to Army's Operations and 
Maintenance appropriation, without documentation to support that these 
transactions should be recorded to this account. This resulted in 
financial reports to the Congress and OMB that show a reduction in the 
obligated balance in that account available for disbursement. However, 
DOD has little assurance that the charge should not have been properly 
assessed against, for example, some other Army appropriation or even to 
another entity's appropriation. Further, at the beginning of the next 
fiscal year, DOD reversed the Operations and Maintenance charges and 
returned the amounts to suspense accounts.
    Finally, DOD records show that an estimated $1.6 billion of 
transactions held in suspense accounts at the end of fiscal year 1999 
have not been properly reported to Treasury and may also affect the 
fund balance with Treasury amount. Until suspense account transactions 
are posted to the proper appropriation account, the department will 
have little assurance that appropriation balances are accurate, and 
that it has a right to any collections, that adjustments are valid, and 
that the disbursements do not exceed appropriated amounts. Moreover, 
the reported amounts in suspense accounts represent the offsetting 
(netting) of collections and adjustments against disbursements, thus 
understating the magnitude of the unrecorded amounts in suspense 
accounts. To illustrate the magnitude of this issue, we previously 
testified\4\ that audit work for fiscal year 1997 found that while the 
Navy had a net balance of $464 million in suspense accounts recorded in 
its records, the individual transactions--collections as well as 
disbursements--totaled about $5.9 billion.

                FREQUENT ADJUSTMENTS AFFECT RELIABILITY

    DOD frequently adjusts recorded payments to transfer the payment to 
another appropriation account, including to canceled appropriations. 
These adjustments raise questions about the reliability of amounts 
reported as obligated and available for disbursement in specific 
appropriations. In March 2000, we reported\5\ that about one of every 
two dollars in fiscal year 1997 contract payment transactions processed 
was for adjustments to previously recorded disbursement transactions. 
Although DOD reported that the number of adjustments has declined, it 
remains significant. During fiscal year 1999, DFAS data showed that 
almost one of every three dollars in contract payment transactions was 
for adjustments to previously recorded payments--$51 billion in 
adjustments out of $157 billion in transactions. Adjustments were often 
made to original entries that were recorded years earlier. A number of 
the adjustments selected during our review were made to canceled 
accounts.
    In the National Defense Authorization Act for Fiscal Year 1991, the 
Congress changed the government's account closing procedures. The 
intent of the changes was to impose the discipline of the 
Antideficiency Act\6\ and the bona fide needs rule\7\ to expired 
appropriations and to ensure that expired appropriations do not remain 
open on the government's books indefinitely.\8\
    Subsequent to the amendment of the account closing law, DOD 
requested that Treasury reopen hundreds of closed accounts to permit 
the posting of adjustments. Treasury asked us whether it had authority 
to correct reporting or accounting errors in closed accounts. In 1993, 
we determined that Treasury had authority to correct these errors.\9\ 
The decision concluded that Treasury may adjust the records of canceled 
appropriations to record disbursements that were in fact made before 
the cancellation. However, Treasury can make these adjustments only if 
DOD can establish that a disbursement was a liquidation of a valid 
obligation, recorded or unrecorded, that was properly chargeable 
against the account before it closed.\10\
    Adjusting disbursements previously recorded to current accounts by 
moving those transactions to canceled accounts can increase balances 
available for obligation in the current accounts. Since the 1991 
account closing law was enacted, DOD has requested that Treasury reopen 
333 closed accounts, totaling $26 billion. These accounts remained open 
as of September 30, 1999. By comparison, all other Federal agencies 
combined have requested that Treasury reopen 21 closed accounts, 
totaling $5 million. According to Treasury's records, DOD made $576 
million in net adjustments to canceled accounts in fiscal year 1999. 
DOD has indicated that it has controls in place to ensure that 
adjustments to canceled accounts are proper. Chairman Kasich and 
Chairman Horn recently asked us to review DOD's practice of making 
adjustments to canceled accounts, and our work has just begun.

                  DISBURSEMENTS NOT PROPERLY RECORDED

    Problem disbursements--disbursements that are not properly matched 
to specific obligations recorded in the department's records--continue 
to impede the department's efforts to improve its budgetary data. This 
situation can misstate DOD's reported obligated balances, undermining 
this important budgetary control. For example, when disbursements are 
not matched to specific obligations, an understatement of obligations 
and an overdisbursement of an account can occur. This situation occurs 
if the disbursement is for an item for which an obligation has not been 
recorded or if the amount of the recorded obligation is less than the 
recorded disbursement. Obligations are also understated in the case of 
in-transits, in which a disbursement has been made but documentation is 
insufficient to determine how the transaction should be recorded in the 
accounting records. The elimination of problem disbursements is one of 
the department's highest financial management priorities. DOD has 
reported progress in resolving problem disbursements. As of September 
30, 1999, DOD reported\11\ $10.5 billion in problem disbursements, 
including in-transits, as compared with about $17.3 billion in problem 
disbursements reported at the end of fiscal year 1998.
    Of the $10.5 billion, DOD reported that about $1.5 billion were 
problem unmatched disbursements and negative unliquidated obligations 
(NULOs)\12\ over 180 days old. DOD's problem disbursement policy 
requires that obligations be recorded for amounts paid that are 
unmatched to a recorded obligation or exceed recorded obligated 
balances after 180 days. However, the policy makes an exception if 
sufficient funds are not available for obligation. In that case, DOD's 
policy permits the department to delay recording an obligation or 
adjustment until the funds cancel--up to 5 years after expiration of 
the account. DOD believes that by delaying the recording of the 
obligation, funds will become available--for example, through de-
obligation--thus permitting the obligation to be recorded without 
raising an Antideficiency Act concern and ensuing investigation. If DOD 
had recorded this $1.5 billion after the transactions remained 
unmatched for 180 days, the related account balances would have 
reflected potential Antideficiency Act violations and required an 
investigation and report to the Congress if the appropriation is 
ultimately determined to be overobligated or overspent.
    An agency may not avoid the requirements of the Antideficiency Act, 
including its reporting requirements, by failing to record obligations 
or to investigate potential violations. To ensure sound funds control 
and compliance with the Antideficiency Act, an agency's fund control 
system must record transactions as they occur. We and the DOD IG have 
previously reported\13\ on this issue and recommended that DOD revise 
its problem disbursement policies and procedures to ensure that 
accurate and reliable balances are maintained.
    Finally, the process and control problems that result in the 
problem disbursement issues previously discussed also contribute to 
improper payments by the department. For example, our work continues to 
identify problems with overpayments and erroneous payments to 
contractors. For fiscal years 1994 through 1999, according to DFAS 
records, defense contractors returned over $5.3 billion to the DFAS 
Columbus Center, including about $670 million during fiscal year 1999, 
due to contract administration actions and payment processing errors. 
However, these amounts do not reflect the true magnitude of this 
problem because many overpayments are returned through billing offsets. 
We are currently working to estimate the scope of the overpayment 
problem, including these offsets.

           OBLIGATED BALANCES WERE INCORRECT AND UNSUPPORTED

    In their testing of obligated balances, DOD auditors found evidence 
of unsupported obligations and poor internal controls over obligations, 
as illustrated by the following examples.
     The Army Audit Agency found\14\ that internal controls 
over the recording of obligations were not adequate to ensure that 
reported obligated balances were accurate. In a sample of 60 1999 
transactions, the auditors found that 21 could not be supported.
     For fiscal year 1999, audit results\15\ show that the Air 
Force Working Capital Fund had $211 million of obligations out of 
approximately $1 billion tested, that is 700 out of 2,526 transactions 
that were incorrect, inadequately supported, or not supported. In 
addition, Air Force's general fund audit continued to identify 
inaccurate or unsupported obligated balances as of September 30, 1999. 
Specifically, Air Force auditors identified an estimated $1.3 billion 
in inaccurate or unsupported obligated balances, a significant 
improvement over the prior year when an estimated $4 billion in 
obligated balances were inaccurate or unsupported.
    In addition to auditors' reports, the Department of the Navy 
identified its unliquidated and invalid obligations as a material 
management control weakness in its fiscal year 1999 annual assurance 
statement issued pursuant to the Federal Managers' Financial Integrity 
Act.\16\ For example, the Navy reported that within the Operation and 
Maintenance--Navy appropriation, some activities were not verifying 
that only valid obligations were entered into the accounting system. As 
a result, funding may have been available but not used. In addition, 
the Navy had more than $1 billion in expired budget authority that was 
allowed to cancel at the end of fiscal year 1999, including more than 
$750 million that had been obligated but not disbursed. According to 
Treasury data, at the end of fiscal year 1999, the department had $3.8 
billion in expired budget authority that canceled.
    Accurate and reliable information would permit the Congress to 
review DOD year-end unobligated and unexpended balances and identify 
opportunities for possible funding reductions. For example, as a result 
of our analysis of unobligated balances in the military personnel 
appropriation, the House Appropriations Committee recommended a 
reduction of $96 million in the fiscal year 2001 request for this 
account. Since the military services' account data have shown a pattern 
of not spending all of their appropriated funds, the Committee 
concluded that the fiscal year 2001 military personnel budget request 
is overstated and can be reduced.

IMPROVED DATA ON ENVIRONMENTAL/DISPOSAL LIABILITY WOULD BE AN IMPORTANT 
                             OVERSIGHT TOOL

    Under federal, state, and international law, DOD faces a major 
funding requirement associated with environmental cleanup and disposal. 
These environmental costs result from the production of weapons systems 
and prior and current operations. Even when current operations are 
carried out in full compliance with existing environmental regulations, 
future cleanup costs for certain operations will still result due to 
the nature of these DOD activities. DOD has taken important steps to 
implement the Federal accounting standards\17\ requiring recognition 
and reporting of these liabilities and has made noteworthy progress. 
For example, DOD's reported estimated liabilities increased from $34 
billion in its fiscal year 1998 financial statements to $80 billion in 
fiscal year 1999. However, the full magnitude and timing of these costs 
are not yet known because (1) all potential liabilities were not 
considered in the reported estimates, (2) estimates were not based on 
the consistent application of assumptions and methodologies across the 
services, and (3) support for the basis of reported estimates continues 
to be inadequate.
    A reliable estimate of DOD's environmental liability would be an 
important factor in determining the cost of its operations and specific 
programs and for resource planning. To effectively, efficiently, and 
economically manage DOD's programs, its managers and oversight 
officials need reliable cost information for the following key decision 
points.
    Evaluating programs--Long-term liabilities that affect program 
costs must be accurately measured and considered in evaluating the 
status of programs. For example, the liability for disposal activity is 
part of the overall life-cycle cost of weapon systems and can 
contribute to the ongoing dialogue on funding comparable weapons. The 
National Defense Authorization Act for Fiscal Year 1995 required that 
the Secretary of Defense analyze the environmental costs of major 
defense acquisitions as part of the life-cycle costs of the programs. 
However, recent IG audits of several major weapons systems programs, 
including the Black Hawk helicopter and F-15 aircraft, have found that 
life-cycle cost estimates did not include costs for demilitarization, 
disposal, and associated cleanup.\18\ In addition, the Senate Committee 
on Appropriations has required that DOD develop disposal cost estimates 
for munitions.\19\
    Making current economic choices--DOD's decisions on whether to 
outsource specific functions require accurate and complete supporting 
cost data. Yet DOD, as well as other government agencies, has 
historically been unable to provide actual data on the costs associated 
with functions to be considered for outsourcing. For example, 
environmental and disposal costs must be considered in the department's 
plans to analyze its more than 2,000 utility systems for privatization. 
If these costs prove significant to DOD, they should be considered in 
any cost-benefit analyses developed by the department in deciding to 
retain or privatize these functions.
    Resource planning--Reliable information on the full extent of the 
environmental liability that DOD faces under current law and the likely 
timing of funding requests would enable DOD and the Congress to make 
informed judgments about DOD's ability to carry out those requirements. 
As the Comptroller General recently testified\20\ before the Senate 
Budget Committee, although we are currently enjoying a period of budget 
surplus, it does not signal the end of fiscal challenges. Long-term 
cost pressures from programs such as Social Security and Medicare will 
consume an ever-larger share of the economy and squeeze the resources 
available for other commitments and contingencies, such as Federal 
insurance programs and cleanup costs from Federal operations known to 
result in hazardous waste, including defense facilities and weapons 
systems. Accurate and complete information on the magnitude and timing 
of DOD's environmental liability would permit DOD and the Congress to 
strategically plan for this long-term liability and set realistic 
priorities among the competing challenges that we will face in the 
future. Further, quantifying this enormous liability and providing a 
breakdown of the costs by the approximate time periods the disposal 
costs are expected to be incurred would add an important context for 
congressional and other decisionmakers on the timing of resource needs, 
including those that are more near-term. For example, we estimated\21\ 
that approximately $1.6 billion of the $5.6 billion estimate for the 
disposal of nuclear powered submarines was for submarines that are 
already decommissioned and awaiting disposal.
    In summary, the most significant issues faced by the department in 
determining and verifying its environmental/disposal liability include 
incomplete estimates, inconsistent methodologies, and inadequate 
documentation.
    Incomplete estimates--To date, DOD has focused on what it expects 
will be its most significant liabilities, those associated with nuclear 
weapons and training ranges. It has not yet considered the magnitude of 
costs associated with other weapon systems, conventional munitions, or 
its ongoing operations, although these costs may also be billions of 
dollars. For example, the department's costs to dispose of 
conventionally powered ships would be at least $2.4 billion, based on 
applying the Navy's estimated average cost of $500 per ton of 
displacement used to estimate disposal costs for its inactive fleet. In 
addition, we previously estimated that the conventional munitions 
disposal liability for Army alone could exceed $1 billion.
    Also, the costs of cleaning up and disposing of assets used in 
ongoing operations may be significant. Significant environmental and 
disposal costs are required to be recognized over the life of the 
related assets to capture the full cost of operations. We are working 
with DOD to assess whether operations, such as landfills and utilities 
(including wastewater treatment and power generation facilities), will 
ultimately have significant environmental costs associated with 
closure. For example, Edwards Air Force Base officials provided us with 
a landfill closure cost estimate of approximately $8 million. This 
estimate excluded post-closure maintenance costs (such as monitoring) 
which are estimated to exceed $200,000 annually over 30 years. To 
provide some perspective on the potential scope of these operations, 
the Army alone reported 65 landfills that, based on the Air Force 
estimated cost data, could cost nearly $1 billion to close and monitor.
    Cost estimates should also be refined for changes in cleanup/
disposal schedules. For example, DOD reported a liability of 
approximately $8.9 billion in its fiscal year 1999 financial statements 
for chemical weapons disposal. Initial estimates to comply with the 
United Nations-sponsored Chemical Weapons Convention were based on a 
2007 completion date. However, we recently reported\22\ that while 90 
percent of the stockpile could be destroyed by the 2007 deadline, 
schedule slippages associated with the remaining 10 percent are likely 
to occur because of additional time required to validate, certify, and 
obtain approval of technologies to dispose of the remaining stockpile 
of chemical weapons. These schedule slippages will likely result in 
additional program costs. Historically, schedule delays have been found 
to increase costs such as labor, emergency preparedness, and program 
management.
    Inconsistent methodologies and inadequate documentation--Each 
military service independently estimated its liabilities with, in some 
cases, significantly different results, and the lack of documentation 
hampered auditors' ability to verify the estimates. For example, 
although the Air Force reported twice as many aircraft as the Navy, it 
has not yet reported environmental and disposal liabilities for its 
aircraft. The Navy's financial statements included an initial estimate 
of $331 million in fiscal year 1999 for its disposal of fixed- and 
rotary-wing aircraft. In addition, our limited analysis of DOD's first-
time effort to develop complete cleanup cost estimates for training 
ranges, which we view as an important step forward, showed that the 
reported amount of $34 billion was comprised primarily of cost 
estimates for active, inactive, and closed Navy/Marine Corps ranges of 
approximately $31 billion. The Navy reported this to be a minimum 
estimate based on assumptions of ``low'' contamination and cleanup/
remediation to ``limited public access'' levels, for uses such as 
livestock grazing or wildlife preservation but not for human 
habitation. Based on these assumptions, the Navy used a cost factor of 
$10,000 per acre. Although the Army also has significant exposure for 
training range cleanup liabilities, it reported only $2.4 billion for 
ranges on formerly used defense sites and closed ranges on active 
installations. The Army assumed one closed training range per base for 
the active installations. However, because the Army has not developed a 
complete range inventory nor recorded any liability for active or 
inactive ranges, this approach may have significantly understated its 
liability. To illustrate the potential magnitude of Army training range 
cleanup, applying the cost factor used by the Navy to estimated range 
acreage of the Army's National Training Center at Ft. Irwin, 
California, would result in a cleanup cost estimate of approximately $4 
billion for that installation alone.
    Further, DOD has had ongoing problems in adequately documenting its 
reported liability--an important control in ensuring its reliability. 
Last year, the DOD IG reported that the basis of estimates for 
significant recorded liabilities--primarily those related to 
restoration (cleanup) of sites contaminated from prior operations--was 
not adequately supported, and those problems persist. Military service 
auditors continue to find that significant portions of the reported 
restoration liabilities lack adequate support for the basis of cost 
estimates. For example, the Army Audit Agency found that the Army 
lacked support for its estimates and attributed it to the fact that 
recent guidance on documentation requirements was not properly 
disseminated to project managers and others preparing project cost 
estimates.

 BETTER ESTIMATES OF RETIREE HEALTH CARE BENEFITS COULD ASSIST DOD AND 
                              THE CONGRESS

    DOD and the Congress are looking at numerous options to provide 
more--and more cost-effective--health care to military personnel upon 
their retirement. Currently, there are several pilot programs underway 
to test the feasibility of providing additional health care benefits to 
retirees over 65 years, including the Medicare Subvention demonstration 
and the TRICARE Senior Supplement project.\23\ Congress is now 
considering expanding these pilot programs to cover greater numbers of 
retirees or extending the length of the trial periods. The Congress is 
also considering expanding coverage of certain benefits, such as for 
pharmaceuticals, to Medicare eligible retirees. Reliable financial and 
patient care data would enhance the ability of DOD and the Congress to 
consider medical care options.
    DOD estimates that, based on its current benefit programs, the cost 
of providing future health care benefits for military retirees and 
their dependents will be $196 billion;\24\ however, we have previously 
testified\25\ that this estimate is unreliable because DOD does not 
have accurate or complete cost and patient care information. DOD 
developed its estimate using an actuarial model that relies on 
historical information about the retiree population and the numbers, 
types, and costs of medical services provided to them. The model also 
uses economic, actuarial, and other assumptions, such as future 
interest rates and projected rate increases for medical costs.
    Improvements to the underlying data or assumptions can 
significantly change the liability estimate. DOD has made meaningful 
progress in improving the processes and underlying data on which its 
liability is based. For example, when better and more complete data 
about DOD's population, medical care costs, and outpatient clinic usage 
were used in the model in fiscal year 1999, the revised estimate was 
lower by $37.5 billion, or nearly 17 percent, than the fiscal year 1998 
estimate.
    DOD has used its health care model to determine the long-term 
impacts of some benefit changes; for example, DOD recently calculated 
the long-term change in the liability of a proposal to provide 
eligibility for purchased care to retirees over 65. With better 
underlying data and some refinements to its methodology, DOD's model 
could be a valuable tool to both the department and the Congress for 
estimating the short-term, as well as long-term, budgetary impacts of 
complex changes to the retiree health benefits program. DOD has been 
using a similar model to calculate its long-term liability for military 
retiree pensions for many years, and both DOD and the Congressional 
Budget Office rely on the model to analyze the impact of changes to the 
retirement program.
    As we testified in May 2000, DOD needs to improve the underlying 
data used by the model. First, DOD needs actual cost data for its 
military treatment facilities. DOD has been using budget obligation 
information as a surrogate; however, obligations do not reflect the 
full cost of providing health care because they do not, for example, 
include civilian employee retirement benefits that are paid directly 
out of the Civil Service Retirement and Disability Fund rather than by 
DOD. Nor do obligations include depreciation costs for medical 
facilities and equipment. In addition, DOD needs to improve the 
accessibility and reliability of its patient workload information. The 
DOD IG has reported\26\ that medical services could not be validated 
either because the medical records were not available or outpatient 
visits were not adequately documented. The DOD IG also reported that 
outpatient visits are often double counted and that many telephone 
consultations have been incorrectly counted as visits. An accurate 
count of patient visits by clinic and type is necessary for DOD to make 
the proper allocations of medical personnel, supplies, and funding. DOD 
has been working with the audit community on health care cost and 
workload data deficiencies and currently has several improvement 
efforts underway. DOD has been using examples of blatant data errors, 
such as negative costs for some surgery clinics and obstetric services 
provided to male patients, to stress to its own staff and to health 
care contractors the importance of its improvement efforts.
    We are currently working with a contractor to assess DOD's retiree 
health benefits estimation methodology, and preliminary results 
indicate several areas where the model could be refined. DOD is 
currently assessing the feasibility and impact of making the following 
types of refinements.
     Pharmacy costs for retirees are currently not segregated 
from those of non-retirees, even though preliminary evidence suggests 
that retirees use more outpatient pharmacy resources. Also, the future 
trend rate used by DOD for pharmacy costs is the same as that for 
general medical costs, even though we previously estimated that DOD 
pharmacy costs increased 13 percent from 1995 through 1997 while its 
overall health care costs increased only 2 percent for the same 
period.\27\
     In the past, DOD has assumed that numbers and types of 
clinic visits are adequate measures of outpatient health care usage for 
purposes of allocating health care costs to retiree and active duty 
populations; however, additional work may show that diagnosis related 
information is a better indicator of health resources usage because 
retirees may have more complicated diseases and therefore require 
longer and more resource intensive procedures.
     DOD's model currently does not calculate separate 
liabilities for retirees under and over 65 years old. DOD applies the 
same cost and economic assumptions to the two groups even though 
Medicare eligible retirees are offered different benefits than retirees 
under age 65 and therefore, their behavior, needs, and costs could be 
quite different.

             CONTROL AND ACCOUNTABILITY FOR ASSETS IMPAIRED

    DOD relies on various information systems to carry out its 
important stewardship responsibility over an estimated $1 trillion in 
physical assets, ranging from multimillion dollar weapon systems to 
enormous inventories of ammunition, stockpile materials, and other 
military items. These systems are the primary source of information for 
(1) maintaining visibility over assets to meet military objectives and 
readiness goals and (2) financial reporting. However, these systems 
have material weaknesses that, in addition to hampering financial 
reporting, impair DOD's ability to maintain central visibility over its 
assets and prevent the purchase of assets already on hand. Overall, 
these weaknesses can seriously diminish the efficiency and economy of 
the military services' support operations. In addition, DOD's systems 
are not designed to capture the full cost of its assets, a major 
component in determining the total costs of its programs and 
activities. If reliable, such costs could be important tools for 
oversight and performance measurement.
    Significant weaknesses in accountability and cost information for 
DOD's three major categories of assets include the following.
    Weapons systems--The reported cost of this equipment in fiscal year 
1997--the last year for which such information was reported on DOD's 
balance sheet--was more than $600 billion. We have previously 
testified\28\ that many of the military services' logistics information 
systems used to track and support weapon systems and support equipment 
were unable to be relied on. DOD continues to experience problems in 
accumulating and reporting accurate information on its national defense 
equipment.
    For example, because the military services cannot identify all of 
their assets through a centralized system, each service had to 
supplement its automated data with manual procedures to collect the 
information. Items identified as a result of the fiscal year 1999 data 
call that were not included in the Army's centralized systems included 
56 airplanes, 32 tanks, and 36 Javelin command-launch units. In 
addition, the military services have historically been unable to 
maintain information on additions and deletions for most of their 
national defense assets. While some progress has been made toward 
improving this data, auditors found that much of it was still 
unreliable for fiscal year 1999. Reliable information on additions and 
deletions is an important internal control to ensure accountability 
over assets. Without integrated accounting, acquisition, and logistics 
systems to provide accounting controls over asset balances, this 
control is even more important. For example, property managers should 
be able to review information on additions to ensure that all assets 
acquired are reported in logistics systems. If such a control is not in 
place, DOD cannot have assurance that all items purchased are received 
and properly recorded.
    Because of the recognized problems with national defense asset 
information, the audit community in the past year focused on supporting 
and reviewing improvement efforts, rather than conducting any 
significant tests of data and systems. Under the National Defense 
Authorization Act for Fiscal Year 2000, the DOD Inspector General is 
required to review national defense asset data submitted to the 
Congress for fiscal year 1999. Such a review should help determine the 
success of DOD's improvement efforts so far, as well as identify those 
areas requiring further improvement.
    In addition, DOD has acknowledged that the lack of a cost 
accounting system is the single largest impediment to controlling and 
managing weapon systems costs, including costs of acquiring, managing, 
and disposing of weapons systems. Accurate information on the life-
cycle costs of weapon systems would allow DOD officials and the 
Congress to make more fully informed decisions about which weapons, or 
how many to buy.
    Properly accounting for the revenue associated with the sale of 
these assets has also been a significant financial management 
challenge. Since October 1998, we have issued four reports identifying 
internal control weaknesses in DOD's foreign military sales program 
that includes sales of national defense assets and services to eligible 
foreign countries. Most recently, on May 3, 2000, we reported\29\ that 
the Air Force did not have adequate controls over its foreign military 
sales to ensure that foreign customers were properly charged. 
Specifically, our analysis of data contained in the Defense Finance and 
Accounting Service's Defense Integrated Financial System as of July 
1999, indicated that the Air Force might not have charged FMS customer 
trust fund accounts for $540 million of delivered goods and services.
    In performing a detailed review of $96.5 million of these 
transactions, we found that the Air Force was able to reconcile about 
$20.9 million. However, of the remaining $75.6 million, the Air Force 
had either
     failed to charge customer accounts ($5.1 million, 22 
transactions);
     made errors, such as incorrectly estimating delivery 
prices ($44 million, 11 transactions); or
     could not explain differences between the recorded value 
of delivered goods and services and corresponding value of charges to 
customer accounts. ($26.5 million or 19 transactions).
    Inventory--DOD's inability to account for and control its huge 
investment in inventories effectively has been an area of major concern 
for many years. In its fiscal year 1999 financial statements, DOD 
reported $128 billion in inventory and related property. The sheer 
volume of DOD's on-hand inventories impedes the department's efforts to 
accumulate and report accurate inventory data. We reported\30\ in our 
January 1999 high-risk report on defense inventory management that the 
department needs to avoid burdening its supply system with large 
inventories not needed to support current operations or war reserves. 
For example, our analysis of approximately $63 billion of DOD's 
reported secondary inventory at September 30, 1999, showed that 58 
percent of the reviewed items, or an estimated $36.9 billion, exceeded 
these requirements. Further, during the fourth quarter of fiscal year 
1999, only 2 of the Defense Logistics Agency's (DLA) 20 distribution 
depots reported accuracy rates above 90 percent, and overall accuracy 
was reported at 83 percent, with error rates ranging from 6 percent to 
28 percent. DLA's goal is 95 percent accuracy. The lack of complete 
visibility over inventories increases the risk that responsible 
inventory item managers may request funds to obtain additional, 
unnecessary items that may be on-hand but not reported.
    Control weaknesses over inventory can lead to inaccurate reported 
balances, which could affect supply responsiveness and purchase 
decisions, and result in a loss of accountability. For example, during 
a December 1999 visit to one Army ammunition depot, we found weak 
internal controls over self-contained, ready-to-fire, handheld rockets, 
a sensitive item requiring strict controls and serial number 
accountability. As detailed in our recently issued report,\31\ we and 
depot personnel identified 835 quantity and location discrepancies 
associated with 3,272 rocket and launcher units contained in two 
storage igloos. The depot had more items on hand than shown in its 
records because of control weaknesses over receipt of items, and, in 
some cases, the records had location errors. Depot management responded 
immediately to our findings, and the depot subsequently accounted for 
and corrected the inventory records of all the rocket and launcher 
units. Regarding this problem, we identified potentially systemic 
weaknesses in controls and lack of compliance with Federal accounting 
standards and inventory system requirements and made recommendations to 
the Army to establish and verify operating procedures to help ensure 
that systemic weaknesses are corrected.
    DOD has long-standing problems accumulating and reporting the full 
costs associated with working capital fund operations that provide 
goods and services in support of the military services, its primary 
customers. The foundation for achieving the goals of these business-
type funds is accurate cost data, which are critical for management to 
operate efficiently, measure performance, and maintain national defense 
readiness.
    With regard to inventory cost information, Federal accounting 
standards require inventories to be valued based on historical costs or 
a method that approximates historical costs. However, DOD systems do 
not capture the information needed to report historical cost. Instead, 
inventory records and accounting transactions are maintained at a 
latest acquisition cost or a standard selling price. Inventory levels 
are also reported to the Congress at latest acquisition cost. Although 
latest acquisition cost data may be important for budget projection and 
purchase decisions, this information may not be appropriate for 
performance measurement. Latest acquisition cost can substantially 
differ from the cost paid for the item. To illustrate how this occurs, 
assume a military service had 10 items that cost $10 each, so each item 
would be valued at $10, or at $100 in total. However, if the service 
then purchased 1 new item at $25, all 11 items would be valued based 
upon the latest purchase price of $25, or $275 in total. The former 
Commander of Air Force Materiel Command testified in October 1999 that 
such valuation practices distort DOD's progress toward reducing 
inventory levels and impact Congressional funding decisions.\32\ The 
Commander stated the following.
    ``Part of the problem was accounting policy. * * * Each year, 
inventories of old spare parts were increased in value to reflect their 
latest acquisition price (the normal commercial practice is to deflate, 
not inflate, the value of long term assets). Many supply managers who 
faithfully disposed of unneeded inventory were surprised at the end of 
the year to see their total inventory value increase. As a result, they 
were subject to great pressure to further reduce inventory levels. * * 
* The new spares were needed but funding restrictions prevented 
purchase of these parts for several years.''
    Overall, the effect of increasing prices can be demonstrated by 
noting that the Air Force's $32.6 billion of inventory at latest 
acquisition cost is revalued to $18.3 billion to reflect estimated 
historical costs.
    Real and personal property--Audit tests of real property 
transactions, additions, deletions, and modifications that occurred 
during fiscal year 1999 indicated that DOD continues to lack the 
necessary systems and processes to ensure that its real property assets 
are promptly and properly recorded in its accountability databases. For 
example, Army auditors reviewed about $408 million in real property 
transactions recorded during fiscal year 1999 and determined that $113 
million of those transactions should have been posted in prior fiscal 
years. Army auditors also identified $43 million in unrecorded real 
property transactions.\33\ In addition, recent audits by the military 
service auditors have continued to find that while DOD regulations 
require periodic physical inventories and inspections--a critical 
control in safeguarding assets--they are not always performed as 
required. Air Force auditors reported that real property personnel did 
not perform required inventories at 34 of 99 installations audited in 
fiscal year 1999. To illustrate the benefit of physical inventories, 
while implementing the Navy's new accountability system, the number of 
assets recorded in the accountability database at one Marine Corps 
location alone increased by over 35 percent as result of wall-to-wall 
inventories.
    In addition, because DOD does not have the systems and processes in 
place to reliably accumulate costs, it is unable to account for several 
significant costs of its operations, including its facilities and 
equipment. Comprehensive and reliable asset financial information is 
necessary for determining the full cost of operations and can be useful 
for anticipating the need for additional budgetary resources.
    An analysis of reported asset balances and related depreciation\34\ 
can provide additional information to review specific budget requests. 
For example, the Navy reported that 85 percent, or approximately $1.2 
billion of its $1.4 billion of depreciated equipment reported on its 
fiscal year 1998 financial statements, was fully depreciated. If Navy's 
financial information accurately reflected asset accountability and 
utilization periods, this information could be used as a factor in 
analyzing Navy's funding requests. Specifically, if the Navy's fiscal 
year 1998 information were accurate, it would indicate that most of the 
Navy's equipment is at or beyond its anticipated utilization period. 
This type of information could help support a funding request or, 
absent such a request, could be used to question whether operations 
would be impaired by the lack of needed capital equipment.

                 DOD NET COST INFORMATION IS UNRELIABLE

    Our audit of the U.S. government's consolidated financial 
statements for fiscal year 1999 found that the government was unable to 
support significant portions of the $1.8 trillion reported as the total 
net cost of government operations. Federal accounting standards require 
Federal agencies to accumulate and report on the full costs of their 
activities.\35\ DOD, which represents $378 billion of the $1.8 
trillion, was not able to support its reported net costs. Although we 
have seen some improvements in DOD's ability to produce reliable 
financial information, as noted throughout this testimony and discussed 
in greater detail in my May 9, 2000, testimony, capturing and 
accurately reporting the full cost of its programs remains one of the 
most significant challenges DOD faces.
    DOD needs reliable systems and processes to appropriately capture 
the required cost information from the hundreds of millions of 
transactions it processes each year. To do so, DOD must perform the 
basic accounting activities of entering these transactions into systems 
that conform to established systems requirements, properly classifying 
transactions, analyzing data processed in its systems, and reporting in 
accordance with requirements. As I will discuss later, this will 
require properly trained personnel, simplified processes, modern 
integrated systems supporting operational and accounting needs, and a 
disciplined approach for accomplishing these steps.
    Because it does not have the systems and processes in place to 
reliably accumulate costs, DOD is unable to account for several 
significant costs of its operations, as discussed in this testimony. As 
I have highlighted today, the accuracy of the department's reported 
operating costs was affected by DOD's inability to
     complete the reconciliation of its records with those of 
the Department of the Treasury,
     identify the full extent of its environmental and disposal 
liability,
     determine its liability associated with post-retirement 
health care for military personnel,
     properly value and capitalize its facilities and 
equipment, and
     properly account for and value its inventory.
    In addition, DOD did not have adequate managerial cost accounting 
systems in place to collect, process, and report its $378 billion in 
total reported fiscal year 1999 net operating costs by program area 
consistent with Federal accounting standards.\36\ Instead it used 
budget classifications, such as military construction, procurement, and 
research and development, to present its cost data. In general, the 
data DOD reported in its financial statements represented disbursement 
data for those budgetary accounts, adjusted for estimated asset 
purchases and accruals. For financial reports other than the financial 
statements, DOD typically uses obligation data as a substitute for 
cost. As I stated earlier, DOD budget data are also unreliable.
    To manage DOD's programs effectively and efficiently, its managers 
need reliable cost information. This information is necessary to (1) 
evaluate programs, such as by measuring actual results of management's 
actions against expected savings or determining the effect of long-term 
liabilities created by current programs, (2) make economic choices, 
such as whether to outsource specific activities and how to improve 
efficiency through technology choices, (3) control costs for its 
weapons systems and business activities funded through the working 
capital funds, and (4) measure performance.
    The lack of reliable, cost-based information hampers DOD in each of 
these areas as illustrated by the following examples.
     DOD is unable to provide actual data to fully account for 
the costs associated with functions studied for potential outsourcing 
under OMB Circular A-76. We reported last year on a long-standing 
concern over how accurately DOD's in-house cost estimates used in A-76 
competitions reflect actual costs.\37\
     DOD has acknowledged that its Defense Reform Initiative 
efforts have been hampered by limited visibility into true ownership 
costs of its weapons systems. Specifically, the department cited 
inconsistent methods used by the military services to capture support 
cost data and failure to include certain costs as limiting the utility 
of existing weapons system cost data. As noted previously, DOD has also 
acknowledged that the lack of a cost accounting system is the single 
largest impediment to controlling and managing weapon systems costs, 
including costs of acquiring, managing, and disposing of weapon 
systems.
     DOD has long-standing problems accumulating and reporting 
the full costs associated with its working capital fund operations, 
which provide goods and services in support of the military services. 
Cost is a key performance indicator to assess the efficiency of working 
capital fund operations. For example, we recently reported\38\ that the 
Air Force's Air Mobility Command--which operated using a working 
capital fund--lacked accurate cost information needed to set rates to 
charge its customers and assess the economy and efficiency of its 
operations. We separately reported that Air Force depot maintenance 
officials acknowledged that they lack all the data needed to 
effectively manage their material costs.\39\ As a result, DOD is unable 
to reliably assess the economy and efficiency of its business-like 
activities financed with working capital funds.
    integrated financial management system using year 2000 approach
    Establishing an integrated financial management system--including 
both automated and manual processes--will be key to reforming DOD's 
financial management operations. DOD has acknowledged that its present 
system has long-standing inadequacies and does not, for the most part, 
comply with Federal system standards. DOD has set out an integrated 
financial management system goal. Further, the department is now well-
positioned to adapt the lessons learned from addressing the Year 2000 
issue and our recently issued survey of the best practices of world-
class financial management organizations\40\ and to use the information 
technology investment criteria included in the Clinger-Cohen Act of 
1996.

             INTEGRATED FINANCIAL MANAGEMENT SYSTEM NEEDED

    Establishing an integrated system is central to the framework for 
financial reforms set out by the Congress in the Chief Financial 
Officers (CFO) Act of 1990 and the Federal Financial Management 
Improvement Act (FFMIA) of 1996. Specifically, among the requirements 
of the CFO Act is that each agency CFO develop an integrated agency 
accounting and financial management system. Further, FFMIA provided a 
legislative mandate to implement and maintain financial management 
systems that substantially comply with Federal financial management 
systems requirements, including the requirement that Federal agencies 
establish and maintain a single, integrated financial management 
system.\41\
    The department faces a significant challenge in integrating its 
financial management systems because of its size and complexity and the 
condition of its current financial management operations. DOD is not 
only responsible for an estimated $1 trillion in assets and 
liabilities, but also for providing financial management support to 
personnel on an estimated 500 bases in 137 countries and territories 
throughout the world. DOD has also estimated that it makes $24 billion 
in monthly disbursements, and that in any given fiscal year, the 
department may have as many as 500 or more active appropriations. Each 
service operates unique, nonstandard financial processes and systems. 
In describing the scope of its challenge in this area, DOD recognized 
that it will not be possible to reverse decades-old problems overnight.
    DOD submitted its first Financial Management Improvement Plan to 
the Congress on October 26, 1998. We reported\42\ that DOD's plan 
represented a great deal of effort and provided a first-ever vision of 
the department's future financial management environment. In developing 
this overall concept of its envisioned financial management 
environment, DOD took an important first step in improving its 
financial management operations. DOD's 1999 update to its Financial 
Management Improvement Plan set out an integrated financial management 
system as the long-term solution for establishing effective financial 
management. As part of its 1999 plan, DOD reported that it relies on an 
inventory of 168 systems to carry out its financial management 
responsibilities. This financial management systems inventory includes 
98 finance and accounting systems and 70 critical feeder systems--
systems owned and operated by functional communities throughout DOD, 
such as personnel, acquisition, property management, and inventory 
management. The inclusion of feeder systems in the department's 
inventory of financial management systems is a significant landmark 
because of the importance of the programmatic functions to the 
department's ability to carry out not only its financial reporting but 
also its asset accountability responsibilities. The department has 
reported that an estimated 80 percent of the data needed for sound 
financial management comes from these feeder systems. However, DOD has 
also acknowledged that, overall, its financial management systems do 
not comply with the FFMIA Federal financial management systems 
requirements.
    DOD presently lacks the integrated, transaction-driven, double 
entry accounting systems that are necessary to properly control assets 
and accumulate costs. As a result, millions of transactions must be 
keyed and rekeyed into the vast number of systems involved in a given 
business process. To illustrate the degree of difficulty that DOD faces 
in managing these complex systems, the following figure shows for one 
business area--contract and vendor payments--the number of systems 
involved and their relationship to one another.

    In addition to the 22 financial systems involved in the contract 
payment process that are shown in figure 1, DFAS has identified many 
other critical acquisition systems used in the contract payment process 
that are not shown on this diagram. To further complicate the 
processing of these transactions, each transaction must be recorded 
using a nonstandard, complex line of accounting that accumulates 
appropriation, budget, and management information for contract 
payments. Moreover, the line of accounting code structure differs by 
service and fund type. For example, the following line of accounting is 
used for the Army's Operations and Maintenance appropriation.

   2162020573106325796.bd26fbqsupca200gre12340109003ab22wornaas34030

    Because DOD's payment and accounting processes are complex, and 
generally involve separate functions carried out by separate offices 
using different systems, the line of accounting must be manually 
entered multiple times, which compounds the likelihood of errors. An 
error in any one character in such a line of code can delay payment 
processing or affect the reliability of data used to support management 
and budget decisions. In either case, time-consuming research must then 
be conducted by DOD staff or by contractor personnel to identify and 
correct the error. Over a period of 3 years, one DOD payment center 
spent $28.6 million for a contractor to research such errors.
    The combination of nonintegrated systems, extremely complex coding 
of transactions, and poor business processes have resulted in billions 
of dollars of adjustments to correct transactions processed for 
functions such as inventory and contract payments. As stated 
previously, during fiscal year 1999, almost one of every three dollars 
in contract payment transactions was made to adjust a previously 
recorded transaction. In addition, the DOD IG found that $7.6 trillion 
of adjustments to DOD's accounting transactions were required last year 
to prepare DOD's financial statements.

                     DOD ADOPTS YEAR 2000 APPROACH

    As we testified last year, DOD has a unique opportunity to 
capitalize on the valuable lessons it has learned in addressing the 
Year 2000 issue and apply them to its efforts to reform financial 
management. The Year 2000 approach is based on managing projects as 
critical investments and uses a structured five-phase process, 
including awareness, assessment, renovation, validation, and 
implementation. Each phase represents a major program activity or 
segment that includes (1) specific milestones, (2) independent 
validation and verification of system compliance, and (3) periodic 
reporting on the status of technology projects. During the department's 
Year 2000 effort, DOD followed this structured approach and (1) 
established interim dates or milestones for each significant aspect of 
the project, (2) used auditors to provide independent verification and 
validation of systems compliance, and (3) periodically reported the 
status of its efforts to OMB, the Congress, and the audit community.
    To successfully adapt this structured, disciplined process to DOD's 
current financial management improvement initiatives, DOD must ensure 
that the lessons learned in addressing the Year 2000 effort and from 
our financial management best practices survey are effectively applied. 
In this regard, two important lessons should be drawn from the Year 
2000 experience--the importance of (1) focusing on process improvement 
instead of systems compliance and (2) strong leadership at the highest 
levels of the department to ensure the reform effort becomes an 
entitywide priority.

                   END-TO-END BUSINESS PROCESS FOCUS

    Establishing the right goal is essential for success. Initially, 
DOD's Year 2000 focus was on information technology and systems 
compliance. This process was geared toward ensuring compliance system 
by system and did not appropriately consider the interrelationship of 
all systems within a given business process. However, DOD eventually 
shifted to a core mission and function approach and greatly reduced its 
Year 2000 risk through a series of risk mitigation measures including 
123 major process end-to-end evaluations. Through the Year 2000 
experience, DOD has learned that the goal of systems improvement 
initiatives should be improving end-to-end business processes, not 
systems compliance.
    This concept is also consistent with provisions of the Clinger-
Cohen Act of 1996 and related system and software engineering best 
practices, which provide Federal agencies with a framework for 
effectively managing large, complex system modernization efforts. This 
framework is designed to help agencies establish the information 
technology management capability and controls necessary to effectively 
build modernized systems. For example, the act requires agency chief 
information officers to develop and maintain an integrated system 
architecture. Such an architecture can guide and constrain information 
system investments, providing a systematic means to preclude 
inconsistent system design and development decisions and the resulting 
suboptimal performance and added cost associated with incompatible 
systems. The act also requires agencies to establish effective 
information technology investment management processes whereby (1) 
alternative solutions are identified, (2) reliable estimates of project 
costs and benefits are developed, and (3) major projects are structured 
into a series of smaller increments to ensure that each constitutes a 
wise investment.
    The financial management concept of operations included in DOD's 
Financial Management Improvement Plan should fit into the overall 
system architecture for the department developed under the provisions 
of the Clinger-Cohen Act. In addition, the goal of DOD's Financial 
Management Improvement Plan should be to improve DOD's business 
processes in order to provide better information to decisionmakers and 
ensure greater control and accountability over the department's assets. 
However, we reported last year,\43\ the vision and goals the department 
established in its Financial Management Improvement Plan fell short of 
achieving basic financial management accountability and control and did 
not position DOD to adopt financial management best practices in the 
future.
    Although the 1999 improvement plan includes more detailed 
information on the department's hundreds of improvement initiatives, 
the fundamental challenges we highlighted last year remain. 
Specifically, a significant effort will be needed to ensure that future 
plans address (1) how financial management operations will effectively 
support not only financial reporting but also asset accountability and 
control, (2) how financial management ties to budget formulation, (3) 
how the planned and ongoing improvement initiatives will result in the 
target financial management environment, and (4) how feeder systems' 
data integrity will be improved--an acknowledged major deficiency in 
the current environment.
    For example, to effectively support accountability and control, 
DOD's plan needs to define each of its business processes and discuss 
the interrelationships among the functional areas and related systems. 
To illustrate, the plan should address the entire business process for 
property from acquisition to disposal and the interrelationships among 
the functional areas of acquisition, property management, and property 
accounting.
    In its 1999 Financial Management Improvement Plan, dated September 
1999, the department announced its intention to develop a ``Y2K like'' 
approach for tracking and reporting the CFO compliance of its financial 
management systems, including critical feeder systems. However, the 
department currently has hundreds of individual initiatives aimed at 
improving financial management, many of which were begun prior to the 
decision that a Year 2000 approach would be used for financial 
management reform. These decentralized, individual efforts must now be 
brought under the disciplined structure envisioned by the Clinger-Cohen 
Act and used previously during the department's Year 2000 effort. Doing 
so will ensure that further investments in these initiatives will be 
consistent with Clinger-Cohen Act investment criteria and that the 
department's financial management reform efforts focus on entire 
business processes and needed process improvements.
    Because of the extraordinarily short time frames involved for the 
Year 2000 effort, the department rarely had the opportunity to evaluate 
alternatives such as eliminating systems and reengineering related 
processes. DOD has established a goal of September 30, 2003, for 
completing its financial management systems improvement effort. This 
time frame provides a greater opportunity to consider all available 
alternatives, including reengineering business processes in conjunction 
with the implementation of new technology, which was envisioned by the 
Clinger-Cohen Act.

                   STRONG DEPARTMENT-LEVEL LEADERSHIP

    Lessons learned from the Year 2000 effort and from our survey of 
leading financial management organizations also stressed the importance 
of strong leadership from top leaders. Both these efforts pointed to 
the critical role of strong leadership in making any goal--such as 
financial management and systems improvements--an entitywide priority. 
As we have testified many times before, strong, sustained executive 
leadership is critical to changing the culture and successfully 
reforming financial management at DOD. Although it is the 
responsibility of the DOD Comptroller, under the CFO Act, to establish 
the mission and vision for the future of DOD financial management, the 
department has learned through its Year 2000 effort that major 
initiatives that cut across DOD components must have the leadership of 
the Secretary and Deputy Secretary of Defense to succeed. In addition, 
our best practices work has shown that chief executives similarly need 
to periodically assess investments in major projects in order to 
prioritize projects and make sound funding decisions.
    Improving DOD financial management is a managerial, as well as 
technical, challenge. The personal involvement of the Deputy Secretary 
played an important role in building entitywide support for Year 2000 
initiatives by linking these improvements to the warfighting mission. 
To energize DOD, the Secretary of Defense directed the DOD leadership 
to treat Year 2000 as a readiness issue. This turning point ensured 
that all DOD components understood the need for cooperation to achieve 
success in preparing for Year 2000 and it galvanized preparedness 
efforts.
    Similarly, to gain DOD-wide support for financial management 
systems initiatives, DOD's top leadership must link the improvement of 
financial management to DOD's mission. For example, DOD stated in its 
Defense Reform Initiative that improved business practices will 
eventually provide a major source of funding for weapon system 
modernization. This can occur through reductions in the cost of 
performing these activities as well as through efficiencies gained 
through better information. To ensure that this mission objective is 
realized will require top leadership involvement to reinforce the 
relationship between good financial management and improved mission 
performance. To build this support across the organization, many 
leading organizations have developed education programs that provide 
financial managers a better understanding of the business problems and 
nonfinancial managers an appreciation of the value of financial 
information to improved decision-making. As discussed below, DOD is 
taking these first steps in providing training to its financial 
personnel, and DOD officials have recently stated that their next 
annual financial management improvement plan will begin to address the 
need for financial management training for nonfinancial managers.

         STRATEGIC HUMAN CAPITAL INVESTMENT INTEGRAL TO REFORM

    An integral part of financial and information management is 
building, maintaining, and marshaling the human capital needed to 
achieve results. While DOD has several initiatives underway directed at 
improving the competencies and professionalism of its financial 
management workforce, it has not yet embraced a strategic approach to 
improving its financial management human capital. Our recently issued 
guide on the results of our survey of the best practices of recognized 
world-class financial management organizations shows that a strategic 
approach to human capital is essential to reaching and maintaining 
maximum performance.
    DOD's 1999 Financial Management Improvement Plan recognized the key 
role of financial management training in ensuring that the department 
has a qualified and competent workforce. The DOD Comptroller recently 
issued a memorandum to the department's financial management community 
emphasizing the importance of professional training and certification 
in helping to ensure that its financial managers are well-qualified 
professionals. Consistent with this recent emphasis, the department has 
begun several initiatives aimed at improving the professionalism of its 
financial management workforce. For example, DFAS contracted to have 
government financial manager training developed by the Association of 
Government Accountants provided to several thousand of its employees 
over the next 5 years. This training is aimed at enhancing 
participants' knowledge of financial management and can then be used to 
prepare for a standardized exam to obtain a professional certification, 
such as the Certified Government Financial Manager (CGFM)\44\--a 
designation being encouraged by DOD management.
    In another initiative, undertaken in conjunction with the American 
Society of Military Comptrollers, the department reports that it 
expects to have its own examination-based certification program for a 
defense financial manager in place in the near future. The department 
has contracted with the USDA Graduate School--a continuing education 
institution--to provide financial management training to an estimated 
2,000 DOD financial personnel in fiscal year 2000 and thousands more 
over the next 5 years. The department reports that this training will 
be directed at helping participants to develop sufficient knowledge so 
that they can demonstrate competencies in governmentwide accounting and 
financial management systems requirements as they are applied in the 
DOD financial management environment.
    The department is faced with a considerable challenge if it is to 
improve its financial management human capital to the performance-based 
level of financial management personnel operating as partners in the 
management of world-class organizations. While DOD's financial 
personnel are now struggling to effectively carry out day-to-day 
transaction processing, personnel in world-class financial management 
organizations are providing analysis and insight about the financial 
implications of program decisions and the impact of those decisions on 
agency performance goals and objectives. To help agencies better 
implement performance-based management, we have identified common 
principles that underlie the human capital strategies and practices of 
leading private sector organizations.\45\ Further, we have issued a 
human capital self-assessment checklist for agency leaders to use in 
taking practical steps to improve their human capital practices.\46\
    In closing, as we have noted throughout this testimony, DOD 
continues to make incremental improvements to its financial management 
systems and operations. At the same time, the department has a long way 
to go to address the remaining problems. Overhauling DOD's financial 
systems, processes, and controls and ensuring that personnel throughout 
the department share the common goal of improving DOD financial 
management, will require sustained commitment from the highest levels 
of DOD leadership--a commitment that must extend to the next 
administration.
    Mr. Chairman, this concludes my statement. We will be glad to 
answer any questions you or the other Members of the Task Force may 
have at this time.

                                ENDNOTES

    1. Department of Defense: Progress in Financial Management Reform 
(GAO/T-AIMD/NSIAD-00-163, May 9, 2000).
    2. High-Risk Series: An Overview (GAO/HR-95-1, Feb. 1995), High-
Risk Series: Defense Financial Management (GAO/HR-97-3, Feb. 1997), and 
Major Management Challenges and Program Risks: A Governmentwide 
Perspective (GAO/OCG-99-1, Jan. 1999).
    3. A suspense account is a temporary holding account for problem 
transactions involving both collections and disbursements--for example, 
those rejected because of system edit controls.
    4. Department of Defense: Status of Financial Management Weaknesses 
and Actions Needed to Correct Continuing Challenges (GAO/T-AIMD/NSIAD-
99-171, May 4, 1999).
    5. Financial Management: Differences in Army and Air Force 
Disbursing and Accounting Records (GAO/AIMD-00-2-, Mar. 7, 2000).
    6. The Antideficiency Act provides that an officer or employee of 
the United states Government may not ``make or authorize an expenditure 
or obligation exceeding an amount available in an appropriation or 
fund'' or enter into a contract or other obligation for payment of 
money ``before an appropriation is made.'' (31 U.S.C. 1341 (a)).
    7. The bona fide needs rule, based on 31 U.S.C. 1502(a), requires 
that agencies use appropriations available for obligation for a limited 
period of time to meet the legitimate needs of the agency arising 
during that period of time.
    8. Under the account closing law, 31 U.S.C. 1551-1558, agencies 
must continue to account for the obligated and unobligated balances of 
their appropriations for 5 years after the expiration of their period 
of availability. At the end of 5 years, appropriation balances, both 
obligated and unobligated, are canceled. After that time, they are no 
longer available for obligation, obligation adjustment, or expenditure 
for any purposes. Because these accounts are no longer available for 
disbursement, they are not reported as part of DOD's Fund Balance with 
Treasury or in the department's Status of Funds reports to OMB or the 
Congress.
    9. 72 Comp. Gen. at 343 (1993).
    10. 72 Comp. Gen. at 347 (1993).
    11. Defense Finance and Accounting Service reports to the DOD 
Comptroller on problem disbursements and in-transits as of September 
30, 1999.
    12. Negative unliquidated obligations (NULOs) are disbursements 
that have been received and posted to specific obligations by the 
accounting station, but the recorded disbursements exceed the recorded 
obligations.
    13. Financial Management: Problems in Accounting for Navy 
Transactions Impair Funds Control and Financial Reporting (GAO/AIMD-99-
19, Jan. 19, 1999) and Recording Obligations in Official Accounting 
Records (DOD IG Report No. D-2000-030, Nov. 4, 1999).
    14. Army's General Fund Principal Financial Statements for Fiscal 
Year 1999, Financial Reporting of Budgetary Resources (U.S. Army Audit 
Agency Report No. AA 00-223, Apr. 28, 2000).
    15. Opinion on Fiscal Year 1999 Air Force Working Capital Fund 
Financial Statements (Air Force Audit Agency Report No. 99068011, Feb. 
9, 2000).
    16. The Federal Managers' Financial Integrity Act of 1982 requires 
Federal agencies to annually assess controls and report on internal 
control and accounting system deficiencies, along with the status of 
related corrective actions.
    17. Statements of Federal Financial Accounting Standards No. 5, 
Accounting for Liabilities of the Federal Government and No. 6, 
Accounting for Property, Plant, and Equipment.
    18. Hazardous Material Management for the Black Hawk Helicopter 
Program (DOD IG Report No. 99-242, Aug. 23, 1999) and Hazardous 
Material Management for the F-15 Aircraft Program (DOD IG Report No. 
00-012, Oct. 15, 1999).
    19. Report on the Fiscal Year 1995 Defense Appropriations Bill 
(Senate Committee on Appropriations, Senate Report 103-321, July 29, 
1994).
    20. Budget Issues: Effective Oversight and Budget Discipline Are 
Essential-Even in a Time of Surplus (GAO/T-AIMD-00-73, Feb. 1, 2000).
    21. The Department of the Navy reported an estimated disposal 
liability for all nuclear submarines, both active and inactive and 
awaiting disposal, of $5.6 billion as of September 30, 1999. To 
determine the portion of the total reported $5.6 billion liability that 
applied to inactive submarines awaiting disposal, we divided the $5.6 
billion by the total number of active and inactive submarines reported 
in the Naval Vessel Register to arrive at an estimated disposal cost 
per submarine of about $49 million. Applying this average cost to the 
reported number of inactive submarines awaiting disposal, we estimated 
a cost of $1.6 billion to dispose of decommissioned submarines awaiting 
disposal.
    22. Chemical Weapons Disposal: Improvements Needed in Program 
Accountability and Financial Management (GAO/NSIAD-00-80, May 8, 2000).
    23. The Medicare Subvention demonstration allows retirees over 65 
to use their Medicare benefit to receive care from DOD and Medicare 
will reimburse DOD for a portion of the cost of that care. The TRICARE 
Senior Supplement project allows older retirees to use TRICARE programs 
to supplement their Medicare coverage, including coverage of 
prescription drugs.
    24. DOD's health benefits liability represents the present value 
cost of providing future health care benefits to current retirees and 
their dependents as well as to that segment of current active duty 
personnel and their dependents that DOD estimates will retire from the 
military. This estimate generally extends for the lifetimes or covered 
periods of eligible beneficiaries.
    25. Department of Defense: Progress in Financial Management Reform 
(GAO/T-AIMD/NSIAD-00-163, May 9, 2000).
    26. Data Supporting the FY 1998 DOD Military Retirement Health 
Benefits Liability Estimate (DOD IG Report No. 99-127, Apr. 7, 1999).
    27. Defense Health Care: Fully Integrated Pharmacy System Would 
Improve Service and Cost-Effectiveness (GAO/HEHS-98-176, June 12, 
1998).
    28. DOD Financial Management: More Reliable Information Key to 
Assuring Accountability and Managing Defense Operations More 
Efficiently (GAO/T-AIMD/NSIAD-99-145, Apr. 14, 1999).
    29. Foreign Military Sales: Air Force Controls Over the FMS Program 
Need Improvement (GAO/AIMD-00-101, May 3, 2000).
    30. Major Management Challenges and Program Risks: Department of 
Defense (GAO/OCG-99-4, Jan. 1999).
    31. DOD Inventory: Weaknesses in Controls Over Category I Rockets 
(GAO/AIMD-00-62R, Apr. 13, 2000).
    32. Statement of General George T. Babbitt, USAF, Commander, Air 
Force Materiel Command, Before the Subcommittee on Military Readiness, 
Committee on Armed Services, House of Representatives, October 7, 1999.
    33. Army's General Fund Principal Financial Statements for Fiscal 
Year 1999, Summary Audit Report (Army Audit Agency Report No. AA 00-
168, Feb. 9, 2000).
    34. Depreciation recognizes the cost of assets over the estimated 
period of time they are expected to be used in operations, rather than 
at the time of acquisition.
    35. Statement of Federal Financial Accounting Standards No. 4 , 
Managerial Cost Accounting Standards, requires accumulating the full 
cost associated with an entity's output through appropriate costing 
methodologies or cost-finding techniques.
    36. Statement of Federal Financial Accounting Standards No. 4, 
Managerial Cost Accounting Standards (July 31, 1995) and Internal 
Controls and Compliance With Laws and Regulations for the DOD Agency-
Wide Financial Statements for FY 1999 (DOD IG Report No. D-2000-091, 
Feb. 25, 2000).
    37. DOD Competitive Sourcing: Lessons Learned System Could Enhance 
A-76 Study Process (GAO/NSIAD-99-152, July 21, 1999).
    38. Defense Transportation: More Reliable Information Key to 
Managing Airlift Services More Efficiently (GAO/NSIAD-00-6, Mar. 6, 
2000).
    39. Air Force Depot Maintenance: Analysis of Its Financial 
Operations (GAO/AIMD/NSIAD-00-38, Dec. 10, 1999).
    40. Executive Guide: Creating Value Through World-class Financial 
Management (GAO/AIMD-00-134, Apr. 2000).
    41. Office of Management and Budget Circular A-127 defines an 
integrated financial management system as a unified set of financial 
systems and the financial portions of mixed systems encompassing the 
software, hardware, personnel, processes (manual and automated), 
procedures, controls, and data necessary to carry out financial 
management functions of an agency, manage financial operations of an 
agency, and report on an agency's financial status to central agencies, 
Congress, and the public.
    42. Financial Management: Analysis of DOD's First Biennial 
Financial Management Improvement Plan (GAO/AIMD-99-44, Jan. 29, 1999).
    43. Financial Management: Analysis of DOD's First Biennial 
Financial Management Improvement Plan (GAO/AIMD-99-44, Jan. 29, 1999).
    44. The Certified Government Financial Manager (CGFM) is a 
government financial manager professional certification awarded by the 
Association of Government Accountants.
    45. Human Capital: Key Principles From Nine Private Sector 
Organizations (GAO/GGD-00-28, Jan. 31, 2000).
    46. Human Capital: A Self-Assessment Checklist for Agency Leaders 
(GAO/GGD-99-179, Sept. 1999).

    Chairman Shays. I am going to recognize Mr. Thornberry.
    I am just going to read one quote from your boss, 
Comptroller General Walker, who said before the Budget 
Committee, no part of DOD is able to pass the test of an 
independent financial statement audit. Many have trouble 
putting together a financial statement, much less having an 
audited financial statement. Continuing financial management 
problems have real consequences for program management and 
resource allocation. For instance, DOD cannot properly account 
for billions of dollars of basic transactions, leaving the 
agency vulnerable to the misuse of appropriated funds.
    Mr. Thornberry.
    Mr. Thornberry [presiding]. Thank you, Mr. Chairman.
    I appreciate the testimony from each of you.
    It is hard to discuss this subject for regular folks and 
not come away feeling like we are talking about accounting 
moves and tending to make one's eyes glaze over, but it does 
catch your attention when you talk about trillions of dollars 
of accounting entries. And, Mr. Lieberman, in your testimony 
you talked about as--in fiscal year '99, DOD financial 
statements, as they try to go through, as I understand there 
were $2.3 trillion worth of accounting entries that did not 
have adequate backup information, is that right?
    Mr. Lieberman. Yes, sir.
    Mr. Thornberry. Now, that is hard to understand in a way, 
because we only spend about $300 billion a year on defense. 
But, as I understand it, it gets back to something Mr. 
Steinhoff was talking about; and that is we don't enter this 
information right the first time. We reenter it and reenter it 
and reenter it, and you are talking about trillions of dollars 
by the time you add it all up. Is that how we get to such huge 
numbers?
    Mr. Lieberman. Yes, that is a gross number. That portrays 
how many adjustments are made to the automated record.
    Mr. Thornberry. And I assume at each step of the way there 
is room for error or mistakes--or at least confusion--if you 
have to reenter each of these entries so many times to end up 
to $7.6 trillion total in errors.
    Mr. Lieberman. Sure. What we need is a seamless system 
where the information moves from its source right into the 
financial statements without having to be moved between 
incompatible systems with some sort of jerry-rigged crosswalk 
process.
    Mr. Thornberry. Because I understand now one of the 
problems now is DOD's books do not reconcile. They don't add up 
with Treasury's books. So the Department of Treasury and 
Department of Defense don't have the same numbers as far as how 
much money they have got or how much money they spend, is that 
right?
    Mr. Lieberman. Yes, it is a chronic problem that actually 
has major implications for the government-wide statement that 
GAO audits.
    Mr. Thornberry. Mr. Steinhoff, I think everybody on the 
panel compares this situation with Y2K. And all of us were 
relieved at the way that Y2K worked out, and obviously it took 
an enormous effort. It took a fair amount of money by Congress. 
It took a lot of time and attention from the top folks at every 
Department. If you had to compare the magnitude of the 
challenge of Y2K for the Department of Defense and the problems 
we are talking about today for the Department of Defense, how 
do they compare?
    Mr. Steinhoff. I would say that this is a much greater 
challenge.
    Mr. Thornberry. How much greater?
    Mr. Steinhoff. Severalfold. Y2K was really addressing a 
specific aspect of the systems for which there was a big 
unknown. People didn't quite know how a system would work in 
that environment, and they had to go through and find out how 
that system would work through analysis and end-to-end testing. 
And they had to work with business partners.
    For DOD's current system challenge, you are really talking 
about revamping the entire management system. Mr. Lynn's plan 
is 900 pages long. We have had some issues with it. We have 
asked for more information. But he has a very comprehensive 
plan covering the accounting systems that he controls. In 
addition to that, you have all of the other systems, such as 
the logistics systems, for which there are major initiatives 
ongoing that must be integrated. This is a huge, huge 
challenge.
    Mr. Thornberry. Let me ask this--and I am just picking a 
number out of the air. If you assume that this challenge is 
three times bigger than the Y2K--and I am trying to be 
conservative--are we spending three times the effort and three 
times the money to solve the problem?
    Mr. Steinhoff. What will be important here is that the 
money be spent in a very wise manner. There have been literally 
billions of dollars spent on systems in DOD, and we have 
reported information systems development in DOD as a high-risk 
area. They had a major initiative back in the '80's, the 
corporate information management initiative where big dollars 
were spent without getting the expected result.
    I think that these efforts can be funded. But, it has to be 
done following a disciplined process where DOD ends up with a 
result from the money spent, that they don't go to point C 
before they get to point B, and that it not be solely date 
driven where you have to have it on line by a certain date 
regardless of the risk. Of course, people have to be 
accountable for meeting milestone dates, but it should be done 
in a way where there is a disciplined process. And under 
Clinger-Cohen and under the various investment guides, there 
are, in essence, proven approaches to design and put in modern 
systems, which is what DOD needs.
    Mr. Thornberry. Mr. Lynn, let me ask you, you heard the 
testimony that 80 percent of the problem of the information is 
outside of your direct control. It is in other systems 
throughout the Department that have to put the information in 
that feed in to the accounting systems. I would be interested, 
do you agree with that approximation? And, secondly, how are we 
going to solve the 80 percent of the problem that is outside 
your control and when are we going to solve it?
    Mr. Lynn. I actually gave you the 80 percent number, Mr. 
Thornberry. That is an accurate representation. We had set up a 
Y2K process. We have signed the organizing memo this week. It 
is going to require a cross-departmental process. I am going to 
have to bring in the logistics, the acquisition, the medical 
personnel people to solve this problem.
    More importantly than that, though, we are going to have to 
persuade them that solving the problem is going to help them do 
their job. To get them to do all this work and spend all of 
this money upgrading their systems, just to get a clean opinion 
in my world, is not going to be persuasive to a logistician. I 
have to persuade the logistician that the information that 
supports that clean opinion is going to help that logistician 
manage better. It is going to help him manage his inventory 
better. It is going to help him make better decisions. It is 
going to help him understand his costs. That is the crucial 
step.
    Mr. Thornberry. You talk about persuading him. It will help 
him do his job better. Do you also need a stick to go with that 
carrot? And I don't know exactly what it will be, but you don't 
get more money unless you do it the right way or something.
    Mr. Lynn. Being in charge of the Department's finances, I 
am not short of sticks, in fact. So we have ways. But I do 
believe this set of measures will help the logisticians, will 
help the acquisition managers of the Department. I think it is 
largely a matter of education and information. And indeed, not 
again to be disrespectful, but part of that has to come over to 
this side of the river in Congress.
    We had an unfortunate problem with the defense bill this 
year. Our major accounting system that we proposed for the Army 
and for the Defense Agencies to try and help reform this system 
was zero. We got no money. That is going to, frankly, set back 
our reform efforts. It is great that this committee is having a 
hearing. We need for, frankly, the other committees to take 
ownership of this issue as well. It has gotten very little 
notice, and we need for it to get more.
    Mr. Thornberry. Let me just say I agree. The difficulty you 
get is that either gets to be lack of confidence in the 
Department's plans to solve a problem and, with such tremendous 
other budget needs, then it becomes easier to take that money 
and apply it somewhere else, to health care or wherever it is. 
But this problem does have to be fixed, and we have to find 
some way to restore confidence that not just you but the whole 
Department from the very top all the way through is taking it 
seriously and will solve it.
    Mr. Lynn. And, Mr. Thornberry, that is exactly what we are 
trying to do by working collaboratively with the outside 
independent bodies, the GAO and the Inspector General. I think 
they both testified that we are working together 
collaboratively and making progress, and I hope that they would 
share that information with these other committees because the 
key to the solution is the systems. If we do not get these new 
systems on line, there is no work around that will work in the 
long run.
    Mr. Thornberry. I appreciate it.
    Ms. Hooley, would you like to go ahead? We have a vote on. 
We may have to be coming and going some.
    Ms. Hooley. I think a couple of people left to vote. I 
don't think I'll have time to finish my questioning, but let me 
at least start.
    Let me ask you a question, Mr. Lynn. As I read the 
information for today and looked at some of the problems, the 
fact that one out of every three transactions needs an 
adjustment, those are sort of alarming things. I also was 
struck by the fact--and let me make sure that I am right on 
this--that you had no audits before 1990, is that correct?
    Mr. Lynn. It is even later than that. This is a very new 
requirement.
    Ms. Hooley. This is really the first time we have opened 
the books and sort of discovered some of the problems that are 
occurring.
    Mr. Lynn. It is the first time we have looked at the books 
this way, I think is the right way to say it. The books have 
been treated for 200 years the way the Appropriations Committee 
look at them in terms of appropriations titles and, in term of 
obligations.
    Ms. Hooley. Right, but if you look at sort of the whole 
management and financial management, we have really not had a 
system, is that right?
    Mr. Lynn. The requirements for this kind of accounting are 
new in the last 5 to 10 years, that is right. Really, prior to 
this administration, very little had been done; and prior to 
this Congress in the early '90's very little had been done.
    Ms. Hooley. Let me ask you a question. I think the 
appropriation was $306 billion for defense. I mean, and you 
talk about trying to get that this year, Congress and the 
Defense Department had zero for financial management.
    Mr. Lynn. No, no, that is not true.
    Ms. Hooley. Well, what did they have for financial 
management?
    Mr. Lynn. It is hard to break the budget down, but just, 
simply put, the Defense Finance and Accounting Service, which 
is the central agency for finance and accounting, had a budget 
of about $1.7 billion.
    Ms. Hooley. But for some of the improvements----
    Mr. Lynn. That includes some of the improvements.
    Ms. Hooley. OK. Is there a way from--I mean, can you--out 
of this large of a budget, is there some way to peel off some 
money from some other areas to help make some progress?
    Mr. Lynn. That is exactly what we proposed. Unfortunately, 
the Congress didn't approve the major move, which was a new 
accounting system for the Army.
    Ms. Hooley. OK.
    Mr. Lynn. We proposed $46 million. Congress provided zero.
    Ms. Hooley. I am going to leave, so if I can come back with 
some questions. Thank you.
    Chairman Shays [presiding]. This is our only panel, so we 
will have some time to cover it pretty well.
    I would like to go back to that $7.6 trillion; and I know, 
Mr. Lieberman, you attempted to make some explanation. I just 
want to make sure--we are basically looking--we are looking at 
a total Federal budget of $1.7 trillion, a defense budget that 
is basically $306 billion, and I want to know if this number 
just represents all the transactions that take place in a $306 
billion budget. In other words, is it buying fuel at wholesale, 
moving it to different areas, then accounting it, going into 
the planes, going into the trucks and so on? Is it just taking 
that 306 and just saying there's so many transactions along the 
way?
    And what I would like, Mr. Lynn, for you to do is explain 
to me how you view those DOD bookkeeping adjustments. Are those 
mistakes, adjustments or just transactions, you know, 20 
transactions times your budget? Mr. Lynn.
    Mr. Lynn. Sure. Several----
    Chairman Shays. First off, do you agree with this?
    Mr. Lynn. I have no reason to question the audit.
    The chart you have up there, of course, is apples and 
oranges. You have bookkeeping adjustments on one side and the 
budget on the other. What you would have to do if you wanted to 
do an apples-to-apples chart is try and find the total number 
of bookkeeping adjustments in the U.S. economy and put that 
number--and it would be, I think, outstandingly high or the 
total bookkeeping adjustments and the total Federal budget 
would be similarly high. But I don't really think that is a 
fair way to look at it.
    Chairman Shays. Let us just look at it in terms of your 
budget, which is admittedly gigantic, but it seems like a 
tremendous amount of adjustments.
    Mr. Lynn. It is a very large amount of adjustments. And I 
think you were going in the right direction with your earlier 
comments that it is the multiple stops that the money takes, 
each one being recorded, that is the cause for the 
multiplication for $306 million up to $7.6 trillion. In 
addition to that, the financial statement includes long-term 
liabilities. It includes a hundred years of medical 
liabilities, a hundred years of environmental liabilities. 
Those are in the hundreds of billions of dollars as well. So 
that is outside of our $300 billion annual budget.
    In a financial statement you try and look at your long-term 
liabilities and make an assessment of those. You also look at 
the value of your property, which is in the neighborhood of a 
trillion dollars. Those, too, are included. So there is some 
very large numbers on the DOD financial statement, and some of 
them are on several times, which is how you get to that.
    I think the core of your question, though, goes to what is 
the meaning of the adjustments; and I think the meaning is the 
bottom line of all of our testimony. The fundamental cause of 
the adjustment is that we do not have a seamless system where 
the transaction gets entered at one end and goes through a 
series of automated steps to the financial statement. That is 
what you would like to have. That is what we aspire to have. It 
is the manual adjustments at each step that we have to now do 
as a substitute for that seamless system that is the cause for 
that adjustment. Achieving a seamless system is what we are 
about with this Y2K process.
    Chairman Shays. I would like both GAO and IG to make any 
comment in regards to how I should interpret $7.6 trillion in 
adjustments. I just want to know, is it mistakes or it is just 
transactions multiplied?
    Mr. Lieberman. Some of them are mistakes; some of them are 
corrections of mistakes. About $602 billion worth of that $7.6 
trillion represent adjustments made by the accountants in the 
finance centers that are responsible for getting these feeder 
reports from the field and putting them into the financial 
statements. They recognize what they consider to be errors in 
the incoming information and change it to try to fix it.
    Chairman Shays. Would it be like with my checkbook? At the 
end, I had my bank statement. I couldn't find the mistake. I 
just accept it and start from what the bank says and go from 
there.
    Mr. Lieberman. When we are talking about unsupported 
adjustments, yes, there are a lot of numbers plugged in to make 
things add up or force them to match other records; and there 
is no----
    Chairman Shays. So we don't know why they don't add up.
    Mr. Lieberman. No, we don't.
    Chairman Shays. We just know they don't add up. Doesn't 
that lend itself to tremendous potential for fraud?
    Mr. Lieberman. At the level we are talking about, these 
massive financial statements, I actually don't think that there 
is much fraud vulnerability involved. The fraud vulnerability 
is more worrisome in the inaccuracies and the records down at 
the local level, in the contracting offices, the payroll 
offices and, the personnel offices. If we are making payments 
that we shouldn't be making or out of accounts that are 
overdrawn and what have you, that is where the rubber hits the 
road. What we are talking about here are compiling these end-
of-year financial statements and their massive roll-ups of 
information.
    I do think, though, that it is not fair to say we are 
talking about comparing those bookkeeping adjustments to any 
other bookkeeping adjustments by anybody in the United States. 
What we are talking about here is this population of between 
17,000 and 20,000 changes which we believe were made to the 
end-year DOD financial statements. Now if you went to any of 
the large corporations in the United States and asked them how 
many adjustments they made on their end-year financial 
statements, the answer would be somewhere between zero and 
something that probably they could count on both hands.
    Chairman Shays. Let me ask you, if they had to count them 
on both hands, they would be severely criticized, wouldn't 
they?
    Mr. Lieberman. This is something they do indeed try to 
avoid, and they would go back and question why their systems 
were incapable of getting it right in the first place.
    Chairman Shays. Mr. Steinhoff.
    Mr. Steinhoff. I would agree with what has been said. A lot 
of the data comes from data calls where, because a system can't 
produce it, they call various activities and roll up the 
amounts. And you will have activities that will report a zero 
balance, and DOD will call to obtain the needed information. 
For example, you have adjustments that result from taking 
physical inventories and finding 35 percent more stock on hand.
    There are many errors. I had mentioned in my summary 
statement that out of $157 billion of payment transactions made 
in fiscal year '99 that $51 billion of those represented an 
adjustment to a previous transaction. Now those are outside 
these adjustments, but that gives you some idea of the number 
of changes they have to make because a system is very complex 
and doesn't work well and the fact that they really don't have 
accurate data on an ongoing basis. It really defies logic to 
have $7.6 trillion in adjustments, as you said, with a budget 
that is a small fraction of that.
    Chairman Shays. But, Mr. Lynn, since we have two kind of 
critiquing here, I don't mind you coming back if you have any 
comment you want to make in regards to this.
    Mr. Lynn. It is not really fair, two on one, is it?
    I don't really disagree with the thrust of what they are 
saying. I think what they are saying is that a bookkeeping 
adjustment is not a measure of the budget. It is a measure of 
the need for automation in the systems. It is also, I think, a 
measure of just how new this requirement is.
    I think the example I gave in my remarks was that when the 
logistics managers want to replace inventory, they want to know 
the latest acquisition cost. That is the number that is of the 
most relevance to them.
    That is not the number the auditors want. The auditors want 
a historical cost so they can depreciate it. The logistic 
manager is less interested in that. So the systems that we have 
had to do inventory, in general, don't do that. They don't 
record the historical costs. They can only keep one number. 
They keep the latest acquisition cost. It takes a manual 
adjustment, one of those adjustments, for a bookkeeper to look 
and try and estimate what the historical cost is for the 
financial statement.
    Now what we need to do, and what we are doing, is to change 
the inventory system so it records both numbers. That takes 
time and money, and we are putting both against it.
    Chairman Shays. Let me just say--Mr. Steinhoff, yes.
    Mr. Steinhoff. What also makes that more difficult is that, 
let us say the accounting wanted the latest acquisition, which 
is what they purport to have, oftentimes the items aren't on 
the system. So DOD has problems with recording all the assets 
it owns, and then it has problems with valuation, and those end 
up with a multiplicity of adjustments.
    Chairman Shays. Let me just say, Mr. Lynn, in terms of 
fairness, I have been with Mr. Steinhoff and Mr. Lieberman 
where they have been far more harsh, so I think they are trying 
to be very fair here. Because there is a lot you could say 
about this. Let me just----
    Mr. Lynn. Mr. Chairman, I am not suggesting they have been 
anything but fair.
    Chairman Shays. I just have one--let me just put up the 
chart on Social Security.
    A lot of people in the United States of America--and we do 
that with nine digits and, as near as you can--I can't count 
the bottoms of that. But it seems like there are 65 digits to 
an Army operation A&I maintenance code. I would love for you, 
Mr. Lynn, to explain to me why you think that is the case and 
what the logic is for doing it and what is going to happen to 
change it.
    Mr. Lynn. The logic--those two are not really comparable. 
The nine-digit code there for the Social Security number is 
intended to record one thing, which is the name of the 
individual. That is what is recorded. The 65 digits have to 
record multiple and overlapping requirements. The office that 
is managing that particular account wants to have management 
information to know how much they are spending on paper clips 
and how much they are spending on rubber bands, and so on, so 
they have better understanding of their cost structure.
    So some of the requirements come from the auditors. The 
auditors need to know certain things about the transactions, 
and those have to be recorded in those codes.
    Some of the requirements come from the Congress. The 
Congress wants to know what year, and what appropriations 
title, and various other things about the money so that we can 
track it and report it in great detail back to the 
Appropriations and Armed Services Committees.
    So each of those numbers has a purpose to report 
information to various entities who require it.
    Now that said, would I like to reduce that? Yes, I would. 
If I can just finish, Mr. Chairman. I would like to be able to 
reduce that number, but to do that I have to convince some of 
the people who are now demanding information--the Congress, the 
program manager, the auditors, my office--to reduce their need 
for information.
    I think the problem you are going for is when you have 65 
numbers, and somebody transposes two of those numbers, we have 
an unmatched disbursement. It doesn't mean we have spent money 
we shouldn't have. It just means we can't quite match it 
because we can't find it because of those two numbers.
    When you do that manually 5, 10, 15 times for an individual 
transaction, there is great opportunity for error. I would like 
to reduce the number, that number of digits, but, even more 
importantly, what I need is to automate the system so we only 
enter it once.
    Chairman Shays. Only entering it once would make sense. But 
I am told--I don't know if it is permutations. I am told, if 
you get to 65 digits, the variations are so extensive that you 
could provide lots more information. And it seems to be an 
indication that we are still thinking in terms of separate 
units, and they add their requirements and we end up with this 
mess, and the sense is that somebody central isn't taking 
charge and saying this shouldn't happen.
    Mr. Lynn. That is true. Because, as I say, I think we can 
reduce and try and eliminate overlapping. I am not really 
fighting you on that, but some of these I cannot reduce. I can 
try, but I won't succeed to reduce the requirements for 
providing Congress information.
    Chairman Shays. Mr. Steinhoff and Mr. Lieberman.
    Mr. Steinhoff. I have got a couple of thoughts on this. It 
is my understanding DOD now has 46 data elements. The 
transaction on your poster board from the Army includes 13 
different data elements. So they have 46 data elements, 271 
characters in all, that might be used in some combination.
    Also, if you had the same transaction in the Navy, you 
would have a different line there. In the Navy, you would have 
a total of 45 characters; and you would have 11 data elements 
covered.
    In the Air Force, you would have 41 characters and 14 data 
elements; and they are not all in the same order as the other 
services.
    So you have got each service, with a unique code, having a 
different number of digits and different number of data 
elements, all in a different order, in a stovepiped fashion, 
and then within a service you don't always have standard fiscal 
codes. So the Army itself might have different fiscal codes or 
different structures. So you have service unique transaction 
codes. You then have within service, nonstandard codes. It 
becomes extremely complex when you have all kind of data 
elements required by all types of parties.
    It is my understanding that DOD's goal is to reduce it to 
five to seven data elements, to greatly reduce the number of 
data element; and, therefore, the transaction code would be 
reduced. And, therefore, to have a standard entry, whether it 
is O&M in the Army or O&M in the Air Force, it should be the 
same way.
    Chairman Shays. I got you.
    Mr. Lieberman.
    Mr. Lieberman. The probability of people making the right 
choices to get everything correct when they have so many 
choices in all of these fields is not all that great. I mean, I 
may be the only person in here who started life as a GS-9 
budget analyst, but I used to be responsible for trying to make 
some choices on what number to put in about three-fourths of 
the way through that type of string. And I will tell you, the 
people in the field don't understand what the difference is, 
don't understand what the criteria is, and they just plug stuff 
in.
    So if we think that we are really shading things with this 
ultra degree of fidelity and getting back good information, I 
think we are, frankly, kidding ourselves.
    This whole situation reminds me very much of where Federal 
Acquisition Regulations were, say in the mid-'90's. Every 
single part of the FAR had a good reason behind it and had been 
put in there for some specific reason that made a lot of sense 
to somebody, but over the years it just got bigger and bigger 
and bigger, and it reached the point where it could not be 
administered efficiently anymore. And I think that is what we 
are saying here. The Department really needs to do a zero-based 
review of what is possible, particularly in this era right now 
where we know our systems are not particularly capable.
    Chairman Shays. I am struck by the fact that, with all the 
different things that need to happen, they don't have to wait. 
These changes can happen simultaneously, and I hope they do.
    Let me just say, Mr. Lieberman, you said you were a budget 
analyst number 9, but I was noticing from your bio that you 
also have a Bronze Star and have gotten other military awards, 
so your affection for the military goes before you got your 
budget analyst requirements.
    Mr. Spratt, I don't know whether to go back to Ms. Hooley--
would you like--OK. Ms. Hooley.
    Ms. Hooley. Thank you. Sorry I had to leave to go vote.
    Mr. Lynn, I just want to continue sort of with the 
questioning where we left off about when you look at your 
budget and look at your needs for financial management--I 
mean--and at least what I read, that we have a hard time 
keeping track of our inventory and so forth, is that right?
    Mr. Lynn. There are certainly issues with our inventory.
    Ms. Hooley. I mean, is it possible to not--to build one 
less tank or do something that would give you some money to put 
into your financial management?
    Mr. Lynn. We have done that. Inventory really is only a 
corollary to financial management. We need--within the 
inventory system--a module that would report the financial 
information to the finance and accounting systems, but what we 
need to do is do that as part of an overall upgrade to the 
inventory systems. We are doing that.
    We have an initiative. The phrase used in the logistics 
world is total asset visibility. What they are looking for is 
what most commercial operations had moved to and what we had 
partly moved to, is where you know where every piece of 
equipment is at every time, with barricades on the rest. That 
is the step we are trying to take in the inventory word.
    I am only tangentially related to that. I am basically 
trying to piggyback onto that by making sure we have the right 
financial module so I can report the financial information both 
accurately to the managers and in a way that is auditable for 
the financial statement.
    Ms. Hooley. But doesn't that all work together?
    Mr. Lynn. Absolutely.
    Ms. Hooley. I mean, when you have acquisition, it 
automatically goes into inventory and where it is so that you 
have some accounting?
    Mr. Lynn. Yes.
    Ms. Hooley. Part of that process--I mean, obviously, doing 
what you are trying to do isn't cheap. What do you need and 
what kind of goals do you have for next year, for 5 years from 
now that will get you to where, again, you have a system? And I 
am--I mean, I understand what audits do. They certainly point 
out some problems, but they don't solve all your problems. So 
that we at least get to the point that we know what we are 
doing and you don't have to reenter things three times and you 
don't have accounting for huge amounts of money that you know 
what you have in your inventory, when do we get there, how do 
we get there and what is it going to take?
    Mr. Lynn. Let me break that down a bit.
    In the finance and accounting world, which is one I am most 
directly responsible for, we are two-thirds of the way home. We 
have started, when we came into office, to try and reduce those 
330 systems that were all noncompliant, none of them met 
accounting standards. We are down below a hundred now. By 2003, 
we are on track to get it down to about 30.
    Just to give you a benchmark, at 300 we were way, way 
behind any kind of commercial operation. At 90 to a hundred, we 
are kind of in the middle of the pack of a major Fortune 500 or 
the top end of the Fortune 500 companies. That is about the 
number of finance and accounting systems they would have. When 
we get down to 30 and below, we will be in a world-class 
position. That will be in terms of the standards, and that is 
what we seek to achieve.
    As we have all testified, that is actually only 20 percent 
of the financial data. The other 80 percent is harder because 
it is in the other systems. We have set up a Y2K process to try 
and upgrade the financial modules. The first thing you do in 
Y2K is awareness and identification, try and understand what 
your systems are and where they stand. That is the process we 
are in now.
    We think there is about 70 systems right now, but we are 
refining that, that are critical. We will target those systems 
and try and upgrade those. And my personal target--this is more 
personal to me--is what I would like to do is, before I leave 
in this administration, is set up a system so that the next 
administration coming in will not push this problem aside, 
which will, frankly, be their temptation. If it looks too 
daunting and too expensive, they will push it aside because 
they are going to have to deal with strategy and weapons 
decisions and a whole series of other things. What I would like 
is, within the term of the next administration, that they could 
achieve a clean opinion.
    Ms. Hooley. So you are looking at the next four and a half 
years.
    Mr. Lynn. In the next four and a half years, if they could 
look at reasonably what has to be done and they could think 
that they may be able to get a clean opinion. Now to do that 
they are going to have make substantial progress on those 
feeder systems. That is the target I would lay out for you.
    Ms. Hooley. That is for the 20 percent of the systems.
    Mr. Lynn. The 20 percent we are on track.
    Ms. Hooley. It is bringing the other 80 percent----
    Mr. Lynn. It is bringing that other 80 percent in that is 
the key. I don't have fear as an administration change for the 
20 percent. They will continue along the lines we have. It is 
very well laid out, and everything is pretty well set. I want 
them to be in a similar position for the 80 percent so that 
they will see a process, they will see a plan, and they will 
understand the budget implications and, most importantly, they 
will think it is achievable. Nobody up until this point has 
thought that it was even within the realm of possibility DOD 
could achieve a clean opinion. I think we are now getting to--
we are not there, but I want to put it within reach of the next 
administration.
    Ms. Hooley. Well, I, frankly, think we have to make that 
happen.
    Mr. Lynn. I couldn't agree with you more.
    Ms. Hooley. It is not an option not to have that happen, at 
least having read the background information.
    I am going to change line of questioning for just a little 
bit and talk to Mr. Lieberman for a second, ask him some 
questions. There are a lot of expenditures for contractor 
services out there, and they certainly comprise a huge 
acquisition program in their own right. And, in fact, the 
largest subcategory of contracts for services was for 
professional, administrative and management support services. 
In fact, spending grew by 54 percent during these last fiscal 
years. And according to your testimony last March 16th before 
the House Subcommittee on Government Management, Information 
and Technology, spending on outsourcing will continue to grow 
as outsourcing initiatives expand. And I understand that last 
year you undertook a comprehensive audit to look at service 
contracts reviewing 105 Army, Navy and Air Force actions valued 
at $6.7 billion for a wide range of professional, 
administrative, and management support services amounting to 
about 104 million labor hours, about 50,000 staff years. Would 
you like to comment on the results of that audit?
    Mr. Lieberman. Yes. The results were dismaying. Every 
single one of the contract actions that we reviewed had major 
flaws in it--poor cost estimating, ignoring the rules for 
competition and a sundry other things. The Department has 
responded very positively to that audit. There has been no 
quibbling about whether there is a problem or not. Everyone 
recognizes that there has been a lot of acquisition reform 
emphasis on buying hardware, but next to none on buying 
services.
    You are right. We are now spending over $50 billion a year 
on services, so this is a gigantic acquisition program in its 
own right. The problem basically is contracting officers are 
not taught how to buy services. The contracting officers tend 
to gravitate toward buying hardware, that is where the career 
enhancement lies, not buying mundane things like computer 
maintenance or something like that. So we have had very poor 
training for them. We also need to look at improving policies 
and sharing more information.
    Corporations solve this by establishing centers of 
excellence in their contracting offices and having certain 
contracting people do just services contracts. So the 
Department has agreed with our recommendation that they ought 
to look at that concept.
    Ms. Hooley. Do you have--have they talked about when they 
think they can get this done?
    Mr. Lieberman. Well, they are working on enhanced training 
right now. I don't really have a sense for how long it will 
take to turn this around. We are talking about having to 
retrain thousands of people here, so it is going to take a 
while. And I really welcome your questions because I think this 
is an area that is terribly important and has been overlooked, 
in all the acquisition reform dialogue for the last several 
years.
    Ms. Hooley. And I think the monetary impact for these 
deficiencies have to be just enormous.
    Mr. Lieberman. Yes. There is no doubt we are making bad 
procurement decisions, paying too much for certain services or 
not getting what we are paying for in a lot of cases.
    Ms. Hooley. A lot of times--at least this is what I read or 
heard--that a lot of times as we contract out we also 
shortchange workers on their pay or benefits. When you talk 
about people that--I mean, our--first, there are problems with 
contracting out. Are we saving any money contracting out?
    Mr. Lieberman. Well, when we make a decision to contract 
out, there is a very rigorous process enshrined in Office of 
Management and Budget Circular A-76 that requires cost 
comparisons between the public and private sectors; and DOD 
policy is only to contract out when it is going to be cost 
effective to do that. The problem is, frankly, that with this 
being done on a mass scale and with cost data being rather 
unreliable, there really is completely inadequate follow-up, in 
my opinion, to see what the results of outsourcing have been. 
We have many things that look good on the front end, but down 
the road the cost picture could very well change, and we don't 
have a very good handle on whether the savings actually come to 
pass and are sustained or not.
    Ms. Hooley. Well, and my question is, also, do sometimes we 
save money because when we contract out they get less benefits 
or lower wages? And at a time of really high--I mean, we have--
employment is up, but we have very low unemployment. I mean, 
sort of the quality of people you get, too, if we are actually 
paying them less on contracted-out services.
    Mr. Lynn. If I might add, we have done some studies; and 
what we found is that we save when we do an A-76 competition. 
We save money regardless of how it comes out. We save 20 to 30 
percent regardless of whether the government wins the 
competition or the private sector wins the competition.
    On the government side, just the process of going through 
the most efficient organization and developing a more cost-
effective approach has been very effective; and we found that 
on about half the occasions the government does win the 
contract.
    Mr. Lieberman. But I agree the quality question is very, 
very hard to measure. Whether we are really getting sufficient 
quality when we contract out for services largely depends on 
how smart we are about writing the statement of work and then 
enforcing the contractual terms. With the downsizing of the 
acquisition workforce there is a whole lot less oversight on 
contracts, particularly on service contracts. So there is a 
very valid question about whether we are getting the same 
quality service as we had before.
    Ms. Hooley. Well, and I am looking for efficiency, saving 
money, but I also look for quality. And especially--I mean, if 
we want the strongest Defense Department, I want some quality 
there as well.
    Mr. Steinhoff. One of the issues, if I might add, and this 
was reported by GAO last July, is, going into many of these 
outsourcing studies, the baseline costs are estimated or 
anecdotal. They are not always fully fleshed out, and there is 
a difficulty then in really tracking the impact of changes. So 
the ability to have better metrics and to be able to really 
tell the result both financially and qualitatively is very 
important. That would get to your issue and get to really the 
bottom line: Is it qualitatively as good and is it costing 
less?
    Our work has shown that when DOD outsources it competes the 
government. It does reduce the cost, as Mr. Lynn said. The type 
of question you ask is a very good question. It gets right to 
the heart of the issue, and it gets to the heart of what a good 
financial management system would produce--not a financial 
accounting system, not a financial statement, but that end game 
I talked about. It would help you develop metrics and would 
tell your performance in a variety of ways.
    Ms. Hooley. I just want to finish up with Mr. Lynn this 
line of questioning. Do we collect any information when we 
contract out about what kind of pay or retirement benefits that 
the contracting out people have?
    Mr. Lynn. There are--I am going to be little bit out of my 
line on this. There are certain standards they have to meet, 
Davis-Bacon and others, that are legislative. And I would have 
to get back to you for the record whether we have--what 
processes we have beyond that.
    Ms. Hooley. OK. I am really interested in knowing; and, if 
you don't know now, if you could get back to me.
    Mr. Lynn. I understand the question. I just don't have it 
in my head.
    Ms. Hooley. OK. Thank you thank you very much.
    [The information referred to follows:]

     Mr. Lynn's Response to Ms. Hooley's Question About the Pay or 
           Retirement Benefits of the Contracting-Out People

    A key part of an A-76 competition is the requirement that each 
offeror submit a detailed cost proposal that identifies the proposed 
labor hours, by labor category, of the people who will perform the work 
under the contract. This includes the contractor's proposed 
compensation of those people, including their pay and retirement 
benefits. This is a necessary part of the overall cost comparison that 
leads to the decision regarding whether or not to contract out the 
requirement.

    Mr. Thornberry [presiding]. Mr. Spratt.
    Mr. Spratt. Thank you very much.
    Mr. Lieberman, you said you might be the only one here who 
started your career as a GS-9 budget analyst. I would like to 
introduce you to Hugh Brady, who started the same way, working 
for Mr. Nemfakos and--many years ago, so we should let him sit 
up and ask a few questions.
    Mr. Lieberman. I don't want to have to make any more 
confessions.
    Mr. Spratt. I went to work as a first lieutenant in the 
Army for Bill Lynn's predecessor, Bob Moot, who was the 
Assistant Secretary of Defense and Comptroller. Interesting 
case. Mr. Moot had grown up in the military system. He had been 
a warrant officer in the Second World War. His predecessor, who 
had polar, opposite training, was Robert Anthony. McNamara 
brought him down from Harvard Business School, and Anthony set 
up, to his credit, many of the things that we still live with 
today. To the extent we have program budgeting, that was his 
creation; and to the extent we have POMs and things like that, 
most of those were created in that period of time.
    One of the products of the little group that Anthony 
created was the SAR, Selected Acquisition Report. This was an 
effort at doing a variance report when we had none.
    I guess I state my thesis first. The problems we are 
talking about today have been with us for a long, long time; 
and while the progress you have made I think is commendable, 
some progress is being made, we have still a long way to go; 
and we shouldn't fool ourselves about that.
    The SAR is a good example. Mel Laird came up here to 
testify. This was in the peak of the Vietnam years, and there 
was a lot of procurement activity going on. Costs were going 
up, inflation was overtaking contracts, and there was no 
baseline. There was no good way to measure actual cost against 
promised costs, actual schedule against promised schedule, 
actual performance against the supposed performance when the 
system was originally authorized.
    And Mr. Laird told the Senate Armed Services Committee--Mr. 
Schweiker, I think, was then on the committee--don't worry 
about that. We have just had Booz-Allen-Hamilton come in, and 
we are setting up a variance reporting system--which, as it 
turned out, wasn't true. Not that he was misrepresenting it to 
the committee. He really didn't know that Booz-Allen had just 
come in and taken one or two or three systems that GAO was 
working on out of about 50 systems. But having said it the 
Department was bound to go ahead and create the selected 
acquisition report. That is how that was extracted from the 
Department of Defense almost inadvertently.
    When I came here in 1983, since this particular report had 
been kind of spearheaded and shepherded through the group that 
I worked in, the operations and analysis group, I went down to 
the committee where I had a seat. I was on the Armed Services 
Committee, still am, and I asked to see the selected 
acquisition reports. I wanted to see how much they had evolved 
between 1970 and 1983.
    I found, to my dismay, they hadn't evolved at all. They 
were still pretty static, and they weren't used--and that was 
the key to it. They weren't useful to the users and, therefore, 
there weren't these evolutionary improvements you would expect 
in a document that was used continually. And the users would 
say, gosh, it would be good to have this, and we don't need 
that, and gradually the system improves over time if it is an 
actively used accounting document for the purposes that it was 
intended, namely, a variance report.
    And I have to ask myself about a lot of this data that you 
are generating. Do you think within this complex realm of all 
these statements, all these source documents and entries, that 
you are really doing a lot of stuff that is not useful to 
anybody and that is part of the problem, that this is 
overcomplex and it could be streamlined, you could strip out 
some of this stuff and the users would never miss it?
    I put that question to all three of you.
    Mr. Lynn. It is a hard question. I think it is going to 
depend on where you sit. I think that you will never persuade 
the Deputy Assistant Under Secretary for Logistics that he does 
not need that data, and he will always insist that he needs 
that data to review the budgets to be able to understand what 
is going on in his area.
    And I think you might find a few things where people just 
aren't using the data any longer, no longer want it. I think, 
though, if you wanted to go the direction of true streamlining 
you would have to centralize the consideration and make a 
corporate judgment as to whether the value of the data would be 
something that is worth the cost of collecting it, and make 
that judgment. Right now, those two are divorced. The logistics 
guy does not pay, in general, to get that data.
    Mr. Spratt. Are the users really using these documents? Are 
the auditors simply using them to satisfy themselves with 
respect to issuing an opinion? Are these really management 
documents that users are resorting to to make sound management 
decisions?
    Mr. Steinhoff. Mr. Spratt, the audited financial statement 
is not the end game. It is one marker. It is one way to measure 
how a stewardship responsibility has been carried out. It is a 
way to pinpoint issues.
    One of the things that this process has done in DOD is to 
put some light on some of the major issues that have been there 
since your time at DOD and before, shone some more light on 
those problems.
    Financial reporting can be of use in a variety of ways. 
One, you want to know what are the cost of operations. Right 
now, DOD doesn't really know the cost of operations. You know 
how many obligations were incurred against the budget, but what 
was the cost of carrying out an operation? You want to know 
what are the some of the unfunded liabilities. Right now, the 
budget scenario is pretty good. We are running a surplus. Down 
the road, as the Comptroller General has testified, we face 
some very difficult challenges.
    You want to know what are the present and future 
liabilities, whether it be retiree costs or environmental 
disposal or medical costs going forward; and a financial 
statement can provide that to you. You want some assurance that 
they can reconcile their cash account. You want to know what is 
owed to them. You want to know what they own and the condition 
of their property.
    The financial report itself is not at all the panacea to 
DOD's management challenges. It is one mechanism. It is one 
measure. At a minimum, this is something that any organization 
should be expected to produce. And in the private sector they 
expect those reports to be out 4 to 10 days after the close of 
the year, close of the month. They expect them to be correct. 
They don't want to spend a lot of time on them, and the 
information flows immediately from the system.
    In the long term, what is important is that this 
Department, as well as others, have a financial management 
system in place that is far broader than a financial accounting 
system; a financial management system that provides to you 
rich, useful, relevant data. The key to the CFO Act is useful 
data that is relevant, timely, and reliable for the kind of 
decision you are making.
    Right now, the Department, as you are aware, is ordering 
inventory it doesn't need. At the same time, it is suffering 
from not having parts it needs.
    Mr. Spratt. Let me give you just an example from raw data, 
that gives rise to my question.
    Somebody in his testimony said that there was $7.6 trillion 
worth of entries in 1999. The defense budget in accrual terms 
that year--this is problematic because we don't think in those 
terms--was $378 billion. I think in cash terms it was probably 
300-, $270 billion. So right there you have got a complexity. 
You have got to have a cash set of books and an accrual set of 
books, if you want to do what you were talking about and keep 
tab of future liabilities you are incurring from present 
operations. But, in any event, $7.6 trillion of entries in a 
$378 billion budget. That means you are turning over that $378 
billion about 15 times, maybe 20 times--20 times.
    Mr. Steinhoff. I will defer to my colleague here. Those 
were actually the entries that were made to prepare the 
financial reports. There were more entries than that.
    Mr. Spratt. On a $378 billion budget you have got 20 
entries for every dollar.
    Mr. Lieberman. Well, that is the way the math works out. We 
still are comparing apples and oranges here, but fundamentally 
you are right. This is a massive administrative effort. Matter 
of fact, it is a heroic effort to try to satisfy these 
requirements. Obviously, it is costly. I don't know how much it 
costs to do it, but it soaks up lots of man hours and 
unfortunately right now is ultimately futile, because the end 
result still is not acceptable.
    Mr. Lynn. Mr. Spratt, if I could just add one thing. When I 
came into this position I was actually very skeptical of the 
need for a financial statement for the Department. No one reads 
it. It is not used. I mean I would guess no one in our 
authorizing appropriating committees has ever laid eyes on it. 
It is not a usable document for those purposes. Nor would you 
expect it to be. We are not a private corporation. We are not 
going to sell the place. We are not going to seek bonds. We are 
not looking for loans. So in the usual commercial reporting a 
financial statement is a very, very limited utility for the 
Department of Defense.
    What has persuaded me to pursue this is that I think--and 
particularly it is the collaboration with the IG and GAO is 
critical. Getting a clean opinion can, as Mr. Steinhoff 
indicated, be the report card that the management systems you 
have are providing the information to the managers that need to 
make decisions, that you understand your cost. And what we are 
trying to do is make sure that we modify the requirements so 
that--I think along the lines you are saying--they are 
producing appropriate data.
    For example, we don't need to depreciate M-1 tanks. That is 
not how we decide to make decisions. We use the threat and 
technology and a whole series of others things, not the 
depreciation value of the tanks. So that is not a useful set of 
information. It might be on a commercial set of books, but not 
for us.
    On the other hand, commercial depreciation of real property 
is of real value. Knowing how much we pay for property, as you 
have done in your earlier life, that is a critical component to 
figure out how much maintenance you ought to be doing on that 
property. That is useful data. What we are trying to do is work 
with the audit community to try and narrow down and get an 
achievable set of objectives that will allow us to get a clean 
opinion but, more importantly, produce the management 
information that our senior leadership needs.
    Mr. Spratt. In that regard, clearly you have got lots of 
formidable problems. I think you have made progress, but you 
have got lots of hurdles ahead of you.
    How much of your problems are tangible? By that I mean, due 
to outdated procedures and systems, both software and hardware? 
And how much of your problem is attributable to intangible 
causes such as the lack of really sharp and capable people to 
get the job done, particularly at the accounting helm?
    Mr. Lynn. We have made a transition at the start of the 
decade where we pulled all the finance and accounting 
organizations out of the individual military departments and 
set up the Defense Finance and Accounting Service. I think 
that, right now, that is an extremely strong organization; and 
I would hope in the next decade it will become a world-class 
finance and accounting center.
    We have just set up a new set of personnel standards, a 
certification process with the testing process so you can 
become a Certified Defense Financial Manager. This involves a 
whole series of courses prior to getting the certification, 
then continuing professional education afterwards. I think with 
that kind of initiative we have the talent that it takes. I 
think the critical and the overwhelming problem is upgrading 
the systems. The problem is with the systems at this point, not 
with the people.
    Mr. Spratt. Would the General Accounting Office care to 
comment on that?
    Mr. Steinhoff. I agree that they face a monumental--what I 
call world-class systems challenge--to address problems in all 
their business systems, with financial systems being an 
integral part of their general business systems. Also, human 
capital is going to be a very more important area.
    The Comptroller General has spoken about the crisis in 
government, the fact that government has to deal with human 
capital and look ahead. A large number of employees can retire 
soon. There are certainly other opportunities for them in this 
economy. The work that DOD is now doing to rebuild its staff 
and to provide training is important. The study we did a few 
years ago found that very few of the folks were being trained 
then. Now they have got a training program that is under way to 
better professionalize their staff.
    Mr. Spratt. Go ahead.
    Mr. Steinhoff. All agencies are going to have to prepare 
themselves for the technology age and the changes that will 
come as we actually get systems in place. So Defense is going 
to have to start planning for that era where they are not going 
to need as many accounting technicians, or people that enter 
the number of massive transactions. To the extent you can get 
away from transaction processing you are going to need a 
different type of person, a person with an analytical 
background, financial analyst, financial systems people; and 
you have to begin planning for that transition as you move into 
the technology age.
    Mr. Spratt. To give you an example, some years ago, when I 
was interested in doing some work with the Selected Acquisition 
Report and improving it, I was hiring a staffer to work for me 
in the defense area on the Armed Services Committee who had 
some background in this. I put that out in the RFP for possible 
employees and had a couple of applicants come to me and say, 
well, I have been working on such and such a SAR. And I said, 
how is that? Well, they worked for local consulting firms; and 
those firms were contracting agencies for doing this Selected 
Acquisition Report.
    It struck me that every program management office ought to 
be made to do the Selected Acquisition Report for two reasons: 
If they don't know how to fill out a Selected Acquisition 
Report, they aren't competent to manage the program; and, 
secondly, if they do it themselves, then they are going to have 
to dig into the data and understand it and be responsible for 
defending it if and when it goes wrong.
    Are we undercutting our own accounting efforts by 
outsourcing too much?
    Mr. Lynn. I don't think so. I actually would, in the area 
of audited financial statements, which is quite different than 
the SARs you are talking about, with the program offices I am 
actually looking to outsource more. We need more professional 
accounting help in terms of the remedial steps that are 
required to get a clean opinion than we have in-house. I think 
we only need it for a relatively short period of years. I 
wouldn't want to bring people on full time, but I think we are 
interested in, frankly, hiring Big Six accounting firms to go 
through with us what it is we need to change in terms of the 
system and set up a plan so we can get a clean opinion. So I 
think we are interested in using outsourcing in that sense.
    Mr. Spratt. What are the real--what are the worst--most 
intractable and difficult problems? For example, let me ask 
this. The number that you have got there for a Navy source 
reporting, that lengthy number in one of your testimonies, I am 
not sure, covers the whole width of the page. I have an old 
friend who was a captain who was in charge of trying to get the 
Navy's inventory control system and CINCPAC in working order; 
and his perennial and continual and final complaint was that 
the users riddled it by requiring that it be adapted to their 
own particular, peculiar and idiosyncratic needs and that there 
wasn't a czar sitting on top of the system saying, no, we are 
going to keep this thing streamlined.
    Has that been a problem? Are we suffering the consequences 
of that now, where we try to please the users too much and they 
proliferated some of our management systems to the point they 
are too complex?
    Mr. Lieberman. Yes. I think the capability of the 
technology that we have nowadays seduces people into thinking 
they can collect infinite amounts of information accurately. So 
managers don't really do very good planning, I think, in terms 
of figuring out the cost effectiveness of requiring this extra 
data, how much time is going to be involved in somebody 
plugging these numbers in and how much effort is involved in 
analyzing what the right number ought to be.
    Ultimately, we don't have any such thing as a sunset 
provision on these requirements; and so, over time, what is 
necessary to collect today may not be used any more. You 
mentioned the SARs, and you are right. There is very little 
feedback that I am aware of from the Congress nowadays. They 
get the SARs, and nobody knows whether they are being read or 
not. Many of our requirements in all of our databases were 
generated years ago by somebody who had some legitimate need at 
the time, I am sure, but we would be worlds better off if we 
were more efficient about regularly revisiting these things and 
making everybody rejustify the need for collecting the data.
    Mr. Steinhoff. As you are aware from your past experience, 
there is service-unique transaction coding and processing. Many 
things are nonstandard. Standardization is really a major 
issue. In order to achieve standardization, you really have to 
break down those stovepipes of each service doing its own 
things. People have to come together and agree to a standard 
approach, a standard system, a reengineered process that is 
much simpler, much more straightforward, and provides the basic 
data needed to provide fundamental accountability.
    There was a study done recently for the Air Force where the 
consultant found in one area that the service could reduce by 
78 percent the number of transactions it processes, a reduction 
of 155 million transactions, by changing its processes.
    A lot of economies are possible through standardization and 
simplification, which is a goal of DOD. A real challenge is to 
get past the culture that you saw with each service having its 
own unique approaches and each manager thinking they knew 
better how to do something; and that cultural challenge is hard 
to overcome.
    Mr. Thornberry. Mr. Spratt, if I could turn to Mr. Bass. It 
has been about 20 minutes or----
    Mr. Spratt. One final comment, if I could.
    Mr. Thornberry. Sure.
    Mr. Spratt. That is, you notice the Y2K effort had worked, 
and one of the reasons it worked is that senior management took 
it seriously. This was clearly an imperative. And I think we 
probably have to same kind of imperative attention to this, and 
that includes the Congress of the United States.
    I have been on the Armed Services Committee for 18 years. I 
have been on the Government Operations Committee. And we do far 
too little oversight into this very mundane but extremely 
important area. And I think if we gearing to expect success we 
have to have more hearings like this and we have to have sort 
of a common purpose between us where we all work and agree that 
this is a principal focus of our efforts.
    Thank you for coming and testifying. I think it has been a 
worthwhile hearing.
    Mr. Thornberry. I agree.
    Mr. Bass.
    Mr. Bass. Thank you, Mr. Chairman. I appreciate this 
hearing, and I agree with Mr. Spratt that it is important. We 
don't spend enough time on it.
    This hearing is entitled, Pentagon Financial Management, 
What's Broken and How to Fix It. You probably can't answer this 
question: Are you the three best possible people we could have 
up here--one from GAO, the two people in the Defense 
Department--that understand the most what is broken and how to 
fix it? Have we got the right guys here?
    Mr. Steinhoff. I hope so.
    Mr. Bass. OK. Two of the three of you aren't CPAs. Is that 
problematic or not? Does it matter? Let me qualify that for a 
second.
    Mr. Lynn, you are a graduate of Dartmouth, class of '76. I 
am Dartmouth class of '74. So you don't have a problem. You are 
well qualified.
    But, in all seriousness, I know that financial problems 
assailing the Department of Defense are far more than that 
which an accountant can address. And I am not an accountant, 
but I run a small business, but I don't handle the financial 
statements and the details of my business. I hire an accountant 
to do it. Maybe that is what you are doing yourself.
    And I don't want you to say that you still need to be 
accountants in order to handle the problems of the Defense 
Department, but we have had--I have been in a number of these 
hearings, and we get spiderwebs like that one over there. We 
don't seem to be making an awful lot of progress overall.
    I would suggest that maybe this has been tried 50 times 
already, that the DOD establish some sort of a Task Force of 
two or three of the best accountants in the country, perhaps 
two or three or one or two of the best management consultants, 
private management consultants, people that consult for 
governments, people that may consult for very large 
corporations, to try to pull their management and financial 
structures together and start by making them understandable.
    I am on the Intelligence Committee. I get acronyms 
constantly. Even Mr. Spratt had a few acronyms I had never 
heard of. And really try to get your arms around the bigger 
issues here. I don't understand most of the material that has 
been brought forth in this hearing, but I do know that we have 
severe systemic problems in the Department of Defense. We 
always have. And they don't seem to be getting an awful lot 
better.
    You guys have--any of you three have any observations about 
this? Mr. Lynn, just remember, you are all right. Dartmouth is 
OK. You are off the hook.
    Mr. Lynn. I have a couple of comments, if I could.
    You are absolutely right. We need accounting expertise. And 
in response to your question, you have the best people--
actually, the best person, from the Department's perspective, 
is sitting directly behind me, is Nelson Toye, who is the 
Deputy Chief Financial Officer. He is the one that honchos 
issues for the Department.
    We have the requisite expertise. What I would suggest is 
the problem in prior years has been that only the accountants 
understood the problems, and these are problems that affect 
management at the highest levels. This is information that 
needs to come to management, and if it stays below that we are 
not going to be able to solve the problems. So we need to pull 
nonaccountants, frankly, and it is not just myself but it is my 
colleagues in the logistics world, and the acquisition world, 
and the medical world. If we cannot pull them in and persuade 
them that they are going to have to make these upgrades, we are 
not going to succeed.
    Your suggestion of an outside panel I think is a good one, 
but I am pursuing it in a different way. I found, in general, 
that outside panels of observers are helpful in perhaps 
identifying a problem. They are almost never equipped to get 
seriously into the nitty-gritty of solving it. To do that, you 
have to pay people.
    Mr. Bass. I am not suggesting they be free. For the amount 
of money you are losing and so forth, this would be a drop in 
the bucket. You pay these guys lifetime salary.
    Mr. Lynn. And that is the direction where we are headed--I 
can't remember if you were in the room when I was discussing 
this with Mr. Spratt--is to hire Big Six accounting expertise 
to go through the specifics of what we need to do to upgrade 
our systems. We are in the process. The Defense Finance and 
Accounting Service and the Defense Logistics Agency have 
embarked on this. The other agencies in the Air Force--I am 
working on the Army and the Navy now--are working similarly.
    I do not think we have--and that is where I agree with 
you--I do not think we have enough in-house expertise to solve 
this problem, and we do need to go outside to do it. I do think 
it needs to go above the accounting expertise in the 
Department.
    Mr. Bass. Being an Under Secretary you are also a political 
appointee, right?
    Mr. Lynn. Completely.
    Mr. Bass. So another problem we have here is you are the 
top guy. There may be somebody else in your position next year 
at this time. Do you have a fixed term?
    Mr. Lynn. No, no. I serve at the pleasure of the President; 
and the President, obviously, will change on January 20th.
    Mr. Bass. Every 8 years or 4 years, you have a completely 
different person involved in the overall financial management 
of the Department of Defense.
    Mr. Lynn. That is absolutely right.
    In answer to Ms. Hooley's question, I indicated that one of 
the goals that I have, as the Department's Chief Financial 
Officer, is to leave in place a foundation that the next 
administration will want to pursue these initiatives because 
they are achievable within that time.
    Mr. Bass. Has your job been frustrating?
    Mr. Lynn. No, I actually enjoy my job quite a lot.
    Mr. Bass. How long have you been on the job?
    Mr. Lynn. In this particular job, since '97; and I was in 
the Pentagon prior to that for the first time in long-term 
planning.
    Mr. Bass. That is all the questions I have, Mr. Chairman.
    Mr. Thornberry. Thank you.
    Let me just have one final question for each of you.
    Part of the problem is--I think everybody has alluded to--
is you get down into the weeds of this thing and you are into 
territory that is kind of hard to pull together and make some 
sense in a larger sense. But, in essence, I think everybody 
agrees we can't really keep track of where all the money goes 
in the Department. We don't know everything we own. We have 
liabilities that it is hard to get a handle on. And it is 
because, in part, we have systems that started a long time ago, 
for a variety of reasons; and it is very hard to make change; 
and, at best, we are on track to fix 20 percent of the problem.
    What I want to get back to, I guess starting with you, Mr. 
Lynn, is, OK, you want to get in, to try to get--keep your 20 
percent going but also set things up for the rest of the 80 
percent to be solved, regardless of who wins the election. And 
the new administration is going to have to review strategy, 
they have got to figure out what fighter aircraft they are 
going to buy and what they are going to do with aircraft 
carriers, all these problems. In short, simple language, can 
you explain to me why the new administration ought to care 
about this other 80 percent and making sure we get it fixed? 
Why it is important that they focus on this issue?
    Mr. Lynn. In a single sentence, because the Department----
    Mr. Thornberry. It does haven't to be one sentence. It has 
to be short and simple so I can understand it.
    Mr. Lynn. The Department needs accurate, timely and 
reliable financial data. The key to that is--we have done two 
of the three steps that we need to produce that. First, we have 
consolidated all the finance and accounting operations. We have 
done it 2 years early. We have brought it down from hundreds of 
systems, from hundreds of sites, down to a couple--to two to 
three dozen. That is a major accomplishment, and that is the 
foundation on which any other reforms are going to proceed.
    The next step, as you indicate, and it is the hardest step, 
is to get the financial information that is produced outside 
the finance and accounting system into that finance and 
accounting system in a reliable way. This means a seamless 
automation from the logistics area to the finance area, from 
the acquisition area to finance area. That is the key. We have 
set up a process to do that. I think that that process will 
show that it can be successful within the next term; and I 
think, frankly, that is the biggest incentive. I think a new 
President and a new Secretary of Defense might well be the 
owners of a clean financial opinion before they leave office. 
That is the biggest incentive I can give them to try and pursue 
this.
    Mr. Thornberry. Mr. Steinhoff, if I am worried about what I 
am going to do with China and proliferation of missiles and 
terrorists and Middle East and drug trafficking, why should I 
care about this?
    Mr. Steinhoff. Defense is the largest, most complex entity, 
with worldwide reach; and as a steward or the head of that 
Department, I want to make sure I operate in an effective, 
efficient manner. I want to assure that I am fully accountable 
to the taxpayer for the money I have been given to carry out 
that mission. I want to make sure that the mission is carried 
out in the most effective way possible, that the troops have 
the items they need, that we do it at the least cost. And I 
want to have a high level of stewardship. I owe it to my 
Department. I owe it to the public.
    There is another side to this, too. I would want to leave a 
legacy for the next person that came in, that they weren't 
burdened with having to worry about the back room, that the 
back room is taken care of; and they would be able to focus on 
business decisions, such as resource allocation and spending, 
which is why they really take the job.
    When Mr. Lynn took this job, I don't think he took it to 
work in the back room, trying to reconcile these transactions. 
I think he took it trying to make decisions on the budget of 
DOD and the performance of DOD. So I would want to leave some 
kind of legacy that I, in fact, left a business process in 
place and the most complex operation, the most diverse, also 
had the finest financial operation.
    Mr. Thornberry. Mr. Lieberman.
    Mr. Lieberman. I have to agree with what was just said, and 
I would like to add one point. I don't think this problem is 
insurmountable, and we shouldn't make more out of it than it 
is. The most important thing that needs to be done is to fix, 
Mr. Lynn says, 70 systems. I think it may be a few more than 
that. Well, DOD has between 5 and 7,000 mission-critical 
information systems; and most of those are being modified or 
updated at any given time. So this is a small population of the 
Department's systems; and with sustained top-management 
attention, I don't think there is any particular reason why all 
those systems can't be made CFO compliant within a few years.
    Mr. Thornberry. Let me just suggest to you all that I think 
in some way this problem is like a virus on our defense 
efforts, because I think it weakens up--it weakens some of the 
support you get in Congress. You had some people voting against 
the defense appropriations bill yesterday because of the lack 
of confidence of how the money is being spent.
    I think it weakens our effort to make good decisions as we 
try to sort out where we are going, the outsource, or put into 
health care and various sorts of things. If you don't have good 
data, it makes it very difficult. And it is the kind of 
systemic problem that is not glamorous but has huge 
consequences. And I would hope----
    Mr. Lynn, there was a couple of questions related to zero-
based review, whether it deals with this number or whether it 
deals with some of the things Mr. Spratt was talking about. I 
would like for you to think about, during your last 6 months or 
whatever, coming to us or to the Department with 
recommendations--don't worry about what the logistics people 
think they need. You come to look at maybe some recommendations 
on how we can improve this system and leave that perhaps as one 
of your recommendations to your successors. And we want to try 
to help and support that effort, because we do bear part of 
this burden as well. It is a big problem, and I think it is 
important.
    I thank all our witnesses for being here; and, with that, 
the hearing is adjourned.
    [Whereupon, at 12:05 p.m., the Task Force was adjourned.]

                                
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