GAO-01-164R DOD’s Sensitivity Analysis

United States General Accounting Office

Washington, DC 20548

October 31, 2000

Ms. Jeanne Fites

Deputy Under Secretary of Defense, Program Integration

Department of Defense

Ms. Gwendolyn Brown

Deputy Assistant Secretary of Defense, Health Budgets and Financial Policy

Department of Defense

Subject: DOD Retiree Health Benefits Liability: Evaluation of DOD’s Sensitivity Analysis

As part of our ongoing work with the Department of Defense (DOD) to prepare for auditable

financial statements, we have worked extensively with the Office of Actuary and with Health

Affairs on developing and reporting a reliable estimate for the postemployment health care

benefits due to military retirees, their dependents, and survivors. To calculate the military

retiree health care benefits liability, the DOD Office of Actuary has contracted with a private

sector firm of actuaries and consultants, Milliman & Robertson (M&R), which has

significant experience in estimating health related liabilities. M&R uses 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.

Using the M&R model, DOD estimated its military retiree health care benefits liability to be

$196 billion in its fiscal year 1999 financial statements.

To help DOD and its auditors focus their data improvement and audit efforts on the elements

that have the most significant impact on the resulting liability calculation, we asked the DOD

Office of Actuary to prepare a sensitivity analysis. A sensitivity analysis identifies key

elements—data and assumptions as discussed above—and varies a single element while

holding the others constant to determine what amount of change in that element is required to

raise or lower the resulting liability by a set amount. In this way, data and assumptions can

be risk-ranked for decision-making and auditing.

As agreed to, when the Office of Actuary completed the sensitivity analysis, we (1) evaluated

its completeness and accuracy and (2) reviewed the methodology used by M&R to calculate

the retiree health benefits liability, including the actuarial model and individual calculations.

Because of the technical nature of actuarial projections, we contracted with an independent

accounting firm, Ernst & Young LLP, to assist us in this work. Our contractor provided

actuarial expertise in reviewing documentation prepared by the Office of Actuary and by
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M&R regarding the sensitivity analysis, the actuarial model calculations, and data used in the

model to develop the liability estimate. This letter provides a high-level, nontechnical

summary of the contractor’s findings and includes our recommendation that the refinements

discussed in those reports be implemented.

In general, our contractor found that the sensitivity analysis prepared by the Office of

Actuary does a good job of identifying the factors that affect the military postretirement

health care benefits liability and of evaluating the relative impact of those factors on the

liability. However, the contractor did identify the following issues that should be addressed

in order to make the analysis more complete.

• The analysis does not provide an in-depth discussion of the independence or

interdependence of the relationship between the health care services provided by DOD

and those provided by Medicare for retirees over age 65. If DOD retirees choose care

provided by Medicare, or by the private sector, rather than by military treatment facilities,

the liability could be significantly affected.

• The analysis does not discuss in detail the rationale for the inflation factors, economic

assumptions, or retirement and death rates that are used in the calculation even though the

analysis found these factors to have the most significant impact on the resulting liability

estimate.

The contractor also identified areas where an additional break out of information is needed in

order for the Office of Actuary to adequately analyze the impact of those areas on the

liability calculation and to provide better information for decisionmakers.

• The under- and over-65 retiree populations are not currently reported separately even

though these groups receive different benefits and therefore may have different needs,

use patterns, and costs.

• The cost of providing pharmacy benefits has not been considered separately from other

health care benefits, even though pharmacy usage patterns and inflation rates could be

very different and therefore could significantly affect the resulting liability. For example,

there is some evidence that retirees use more outpatient pharmacy resources than

nonretirees. Furthermore, pharmacy costs have been increasing at a faster rate than other

medical costs, yet the same medical trend rate has been applied to all outpatient costs.

Finally, the contractor found that the methodology used by the Office of Actuary and M&R

to calculate the liability estimate is, in general, reasonable; however, the contractor did report

the following deficiencies.

• The Office of Actuary has not properly documented the liability approach, methodology,

and model. In addition to the benefit of good documentation realized by all users of the

model and its results, the process of preparing the documentation could clarify the Office

of Actuary’s and M&R’s understanding of their model and serve as an internal validation

mechanism to ensure that the model calculates what is intended.

• The contractor tested a sample of five calculations for accuracy and consistency with the

methodology of the model and found one to be in error. The erroneous calculation was
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corrected as soon as we reported the problem; however, not all calculations were tested,

so it is possible that other errors exist.

In order to make the analysis and the model more useful to DOD in evaluating changes in

health care benefits’ cost components and to the DOD auditors in planning future audit work

related to the health care liability estimate, the contractor’s reports recommend several

improvements that we believe should be implemented. We worked closely with the Office of

Actuary during the review and discussed all of the findings and desirable improvements with

the Chief Actuary. The Office of Actuary indicated its concurrence with the contractor’s

findings and stated that some of the contractor’s recommended improvements are already

being undertaken and that the remainder will be addressed in the near future.

We are providing you copies of our contractor’s detailed reports under separate cover. If you

have questions or comments regarding this letter or the contractor’s work or reports, please

contact me at (202) 512-9095 or Molly Boyle at (202) 512-9524.

Lisa G. Jacobson

Director

Financial Management and Assurance

(924014)