Defense Base Act Insurance: State Department Should Evaluate Its Open Market System and Incorporate Leading Practices into Any Future Single Insurer Solicitation
Released: 2015-01-06T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: DBA requires U.S. government contractors to buy workers' compensation insurance for most employees working overseas. The cost of this insurance, if allowable under federal regulations, is generally reimbursable under government contracts. From 1992 until 2012, State had a contract with a single insurer to supply all State's contractors working overseas with DBA insurance. In July 2012, State's single insurer program ended after State unsuccessfully sought to solicit a new DBA single insurer agreement and State transitioned to a system requiring its contractors to obtain DBA insurance on the open market. However, concerns were raised about the transition and its impact on State's costs and on small businesses' competitiveness. To address these objectives, GAO was asked to review State's transition.

This report assesses (1) State's management of the transition to an open market system, (2) the change's effect on contractors' premium rates, and (3) the change's effect on small businesses. GAO analyzed State documents; reviewed federal and State contracting regulations; analyzed premium rate data and federal contracting data; and interviewed officials from State, the insurance industry, and contracting firms.

section_title: What GAO Found
paragraphs: The Department of State (State) did not follow leading acquisition practices in transitioning from a single insurer Defense Base Act (DBA) program to an open market system. Leading practices emphasize adequately documenting market research, allowing enough time to complete a solicitation, and collecting and analyzing data to select among alternatives, but State took limited measures to document the market research it performed and had little time to complete its 2012 solicitation. State included provisions in the solicitation to which insurers strongly objected, received no offers, and had to cancel the solicitation 3 days before its existing single insurer contract was to expire. As a result, State had to quickly transition to an open market system without weighing the relative costs and benefits to determine which insurance system best served its needs. Until State conducts such an evaluation, it cannot be assured that the open market system is the better alternative, and unless State incorporates leading practices into any future single insurer solicitations, it risks a similar outcome.

GAO found that State contractors' DBA premiums increased following the transition, but the increases were in a range similar to those likely to have occurred if State had continued its single insurer program. For example, median DBA premium rates increased by $1.98 per $100 of payroll. GAO analysis also shows that the increase in DBA premium rates after the transition was in a range comparable to the increase in DBA premium rates requested by State's single DBA insurer, which said it had lost money under the prior contract.

Existing data do not show a clear effect on small businesses resulting from State's transition to an open market system, but insurers and contractors have expressed concern that the change has had or could have an adverse effect. GAO analysis of federal procurement data from fiscal years 2009 through 2013 found a decrease in the percentage of contracts awarded to small businesses, but GAO could not link this to State's transition. Information GAO gathered from insurance industry officials and contractors shows that there is a potential for adverse effects, for example, denial of coverage and higher effective premium rates. State's policy is to maximize opportunities for small businesses, but it has not assessed whether its transition to an open market DBA system is affecting those opportunities. Without such an assessment, State cannot be assured that it is meeting its policy goal of maximizing opportunities for small businesses.

section_title: What GAO Recommends
paragraphs: State should (1) determine whether an open market system best suits its needs, (2) incorporate leading practices into any future single insurer solicitation, and (3) assess the effects of its transition on small businesses. State concurred with GAO's recommendations.

section_title: Letter
paragraphs: The Defense Base Act (DBA), as amended, requires U.S. government  contractors to provide employees working overseas—including, in many  cases, foreign nationals—with uniform levels of workers’ compensation  insurance. The cost of the premiums paid for DBA coverage, if allowable  under the Federal Acquisition Regulation (FAR), is generally reimbursable  under government contracts. According to a September 2009  Department of Defense (DOD) report, with the increase in U.S. military  and civilian engagement throughout the world, the cost to the U.S.  government for DBA insurance premiums sharply increased during the  past decade; total premiums paid to the four largest DBA insurance  providers increased from approximately $18 million in 2002 to  approximately $400 million in 2007. Although more recent and  comprehensive data on the total cost for DBA premiums are not available,  data on the cost of DBA claims to the insurance industry suggest that  DBA premium costs have continued to rise. According to Department of  Labor (DOL) data, between 2002 and 2013, the total number of claims  rose from 430 to 14,705, and the total amount of DBA benefits paid to  claimants working for U.S. government contractors rose from about $9.5  million to about $666 million in inflation-adjusted dollars. Figure 1 shows  the trends in the total amount of DBA benefits paid in inflation-adjusted  dollars and in the number of claims paid from 2002 to 2013.

From 1992 until 2012, the Department of State (State) had an exclusive  contract with a single insurer to supply all of its contractors with DBA  insurance. However, in July 2012 State’s single insurer program ended  after State unsuccessfully sought to select a new DBA single insurer  through a competitive source selection process. State now requires its  contractors to obtain DBA insurance on the open market from 1 of 38  insurers authorized by DOL.

You asked us to review State’s transition to an open market DBA  system. This report assesses (1) how State managed the transition from  a single insurer program to an open market system, (2) the extent to  which this change affected DBA premium rates paid by State’s  contractors, and (3) the extent to which this change affected small  businesses.

To examine State’s transition to an open market system, we reviewed  federal and State Department acquisition regulations, internal controls,  and leading acquisition practices as reported previously by GAO. We also  reviewed reports about DBA insurance issued by the State, U.S. Agency  for International Development (USAID), and DOL Offices of Inspector  General (OIG) as well as the Special Inspector General for Afghanistan  Reconstruction (SIGAR). In addition, we reviewed contract and  correspondence files from State and other agencies, and interviewed  officials from State and DOL as well as officials from insurance  companies, insurance brokers, contractors, and small busineses  (hereafter referred to as insurers, brokers, contractors, and small  businesses). The U.S. Army Corps of Engineers (USACE) made a similar  transition from a single insurer program to an open market system in  October 2013, and we compared how State and USACE managed their  transitions to an open market system.

To determine the extent to which State’s transition affected DBA premium  rates paid by State contractors, we obtained data on DBA premiums and  premium rates from a random sample of 71 State contractors who  obtained contracts through State’s Office of Acquisitions Management  and who performed work throughout State’s transition to the open market  (fiscal years 2012 to 2013) in Afghanistan, Iraq, Pakistan, Thailand, and  South Africa. We identified the set of countries by analyzing country  summary reports of contract actions for State and USAID in federal  procurement data for fiscal years 2010 through 2013, identifying the top  10 countries for each agency in terms of number of contract actions, and  choosing the countries that appeared in the top 10 list for both agencies.

Results from analyzing this sample are generalizable to the population of  164 contractors that meet these selection criteria. We also conducted  interviews with insurers, brokers, contractors, and small businesses. We  compared the open market premium rates paid by the contractors in our  sample with rates that would have been charged by a single insurer in  two hypothetical scenarios under which State might have continued its  single insurer program. The hypothetical scenarios were calculated from  pricing information contained in State’s most recent single insurer  contract, signed in July 2008, as well as official documents and  correspondence between State and its single insurer during the course of  that contract. Data on contractors’ DBA premiums and payroll were self- reported.

To examine the extent to which State’s transition to an open market  system affected small businesses, we analyzed federal procurement data  and interviewed officials from State, insurers, brokers, and contractors,  including small businesses and representatives of a national association  that represents government contractors. Because we used federal  procurement data to assess the effects of State’s transition to an open  market system on small businesses, we assessed the reliability of these  data. We determined that the data were sufficiently reliable for our use.

We conducted this performance audit from March 2014 to January 2015  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe the  evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives. See appendix I for a more  complete description of our scope and methodology.
subsections: section_title: Background
paragraphs: Congress enacted DBA in 1941 to provide workers’ compensation  protection to employees of government contractors working at U.S.  defense bases overseas. Subsequent amendments to DBA extended  coverage to other classes of employees. DBA insurance provides  covered employees with uniform levels of disability and medical  benefits—or in the event of death provides benefits to their eligible  dependents. DOL administers DBA, ensuring that workers’ compensation  benefits are provided for covered employees and overseeing the claims  process, among other things.

Under DBA, U.S. government contractors and subcontractors are  required to obtain DBA insurance for all employees, including foreign  nationals, unless DOL issues a waiver. The cost of DBA insurance  premiums, if allocable and reasonable, is generally reimbursable under  government contracts. Under the War Hazards Compensation Act, the  government also reimburses insurers for DBA benefits paid if the injury or  death is caused by a “war-risk hazard,” provided that the insurer did not  charge its customer a war-risk hazard premium. In addition to disability  and death payments, war-risk hazard benefits include funeral and burial  expenses, medical expenses, and reasonable costs necessary to process  the claims.

In providing for DBA coverage, agencies mainly use one of two  approaches: a single insurer program or an open market system. For  instance, USAID has a single insurer program. DOD has generally  employed an open market system. USACE, however, had a single insurer  program from 2005 to 2013, and then transitioned to an open market  system. State adopted a single insurer program in response to a 1991  report by its OIG, which among other things, estimated that State could  save approximately 40 percent of its DBA cost by moving to a single  insurer program.

Under a single insurer program such as the one implemented by State,  an agency selects one insurer to provide DBA insurance through a  competitively selected multiyear agreement. The resulting agreement sets  premium rates for the agency’s contractors. The agreement may stipulate  that rates will remain fixed during the entire term of the agreement, or that  the rates may be adjusted up or down by mutual consent of the agency  and the single insurer. To obtain DBA insurance, the agency’s contractors  contact a broker specified by the single insurer. The broker obtains the  contractor’s statement of work, assigns the contractor to a service  category (for example, security), and collects premiums based on the  contractor’s payroll and the premium rates for the service category. Under  State’s single insurer program, DBA insurance was listed as a separate  line item on the agency’s contract with each contractor.

Under an open market system, contractors must independently obtain  DBA insurance coverage from an insurer licensed by DOL to underwrite  DBA insurance, and they usually do this through a broker. In this system,  agencies do not play a role in setting premium rates. Each contractor’s  selected insurer issues a DBA insurance policy that fixes premium rates  generally for 1 year; after that, the rates and corresponding premiums can  move up or down based in part on the insurer’s assessment of the  contractor’s risk. The initial premium rate can vary by contractor based on  the insurer’s assessment of the contractor’s risk. Contractors with a  history of few or no claims can see a reduction in their premiums when  renewing their DBA insurance, while contractors with a history of many  claims can see an increase. To reduce the likelihood of claims,  contractors can sometimes participate in a risk assessment and reduction  program sponsored by their DBA insurer. According to State guidance  issued in August 2012, it is no longer required that DBA insurance be  identified as a separate line item on the agency’s contract with each  contractor. Depending on the type of contract, a contracting officer may  include the cost of DBA insurance separately. Figure 2 provides a  process map of the two approaches.

section_title: State Did Not Follow Leading Practices in Its Transition from a Single Insurer Program to the Open Market
paragraphs: In 2008, State entered into a multiyear contract with a single DBA insurer.  In September 2011, State and its single insurer agreed that the DBA  contract would expire in July 2012. In June 2012, State posted a  solicitation seeking to select a single insurer through a competitive source  selection process. After State received no offers in response to its  solicitation, it withdrew the solicitation 3 days before its existing contract  expired and transitioned to a system requiring contractors to obtain DBA  insurance on the open market. Leading acquisition practices emphasize  the importance of allowing enough time to complete a solicitation,  adequately documenting market research, and collecting and analyzing  data, among other things. We found that State did not follow these  leading practices. Specifically, State (1) had little time to complete the  process of designating a DBA single insurer, (2) did not conduct a  lessons learned assessment after agreeing to terminate its existing DBA  contract, (3) did not adequately document market research, and (4) did  not provide sufficient information to insurers. As a result, State had to  quickly transition to an open market system without evaluating the relative  costs and benefits involved. According to officials of insurers, brokers,  and some contractors, after transitioning, State did not communicate its  change in a timely manner to insurers, brokers, and contractors, which  caused confusion among contractors and left some with little time to  replace their expiring DBA policies.
subsections: section_title: State Transitioned to an Open Market System in July 2012
paragraphs: Within State’s Bureau of Administration, its Office of the Procurement  Executive is responsible for maintaining State’s acquisition regulations  and procedures, and its Office of Acquisitions Management manages  most of the procurement for State domestically and overseas. The Office  of Acquisitions Management was in charge of the competitive source  selection processes for State’s single insurer program. In 2001, State first  signed a contract with its most recent single insurer to provide DBA  insurance to State contractors. In 2008, State signed a similar contract  with the same single insurer, this one a 5-year contract consisting of a  base year and 4 option years. The premium rates for the base year, or  year 1, were fixed, but the contract allowed for adjustments in the rates by  mutual agreement for years 2, 3, 4, and 5, with any adjustments to be  based on cumulative losses sustained by State’s single insurer since the  start of the contract. To ensure that contractors were appropriately  assigned a DBA premium rate based primarily on risk, the 2008 contract  provided that contractors would be assigned to one of four types of  service rate categories (listed here from highest to lowest risk): security  contractors involved in aviation-related work in defined hazardous areas  such as Afghanistan and Iraq, other security contractors working in the  same hazardous areas, construction contractors, and service contractors.  Figure 3 shows key dates and information related to State’s 2008 single  insurer contract.

Prior to the start of year 3 of the contract in July 2010, State’s single  insurer raised a concern about increasing DBA losses and the potential  for further increases in losses. Among other things, State’s single insurer  asked for an increase in premium rates for year 3. According to  documentation from State and State’s single insurer, the losses far  exceeded what the single insurer’s actuaries had anticipated and resulted  from several factors, including an increase in the number of claims from  State’s security contractors, many of which operated in hazardous areas.

The single insurer also cited an increase in the number of injured  employees that had not found suitable work upon release from their  contract because of poor economic conditions or the nature of their   State  injuries, which could include post-traumatic stress disorder.acknowledged that DBA losses had increased, but disagreed about the  extent of the losses and did not agree to allow the single insurer to  increase its premium rates. State also did not agree to the single insurer’s  request to obtain the services of an outside actuarial expert to validate the  losses sustained by State’s single insurer.

In May 2011, prior to the start of year 4 of the contract, State’s single  insurer requested a lump sum payment of approximately $27 million to  cover losses from year 3 of the contract as well as an increase in  premium rates for year 4 of the contract. by a warning of legal action. State’s single insurer concluded that it had  underestimated its 2010 losses and stated that a revised methodology it  used to estimate losses showed that it should have charged higher  premiums beginning with year 3 (July 2010-July 2011). State’s single  insurer also stated that its revised loss estimate methodology, which used  forecasted losses rather than actual sustained losses, was consistent with  insurance industry standards.

State’s single insurer termed the lump sum payment request a “request for equitable  adjustment.” rate increases raised numerous questions about how the insurer had  originally established its premium rates, along with other concerns.

State and its single insurer met to discuss the insurer’s requests and  exchanged correspondence but could not resolve their differences.  Because State and its single insurer could not agree on a solution, in  September 2011, State signed a memorandum with its single insurer  agreeing that State would not exercise its right to continue the program  through year 5, the final option year of the contract. Between then and  July 2012, a number of key events occurred. These are noted below:

September 12, 2011: State and its single insurer agreed that the DBA  contract would expire on July 21, 2012.

February 9, 2012: State posted a request for information containing a  DBA-related questionnaire to insurers, brokers, and contractors on a  federal procurement website. Nine responded by February 28, 2012.

June 14, 2012: Seeking to designate a single insurer through a  competitive source selection process, State posted a solicitation  requesting that insurers submit proposals by June 27, 2012.

June 14 through July 16, 2012: State twice extended the time frame  for the solicitation, ultimately setting the deadline as July 16, 2012.  Responding insurers stated that the solicitation contained  objectionable provisions. On July 16, 2012, one insurer filed a bid  protest with GAO.

July 18, 2012: Having received no offers in response to its  solicitation, State withdrew the solicitation.

According to State officials, while State and its single insurer agreed that the DBA  contract was to expire on July 21, 2012, the insurer also agreed to allow an extension of  some contractor policies until April 2014.

July 21, 2012: State’s existing single insurer program ended.

July 22, 2012: State transitioned to an open market system.

August 9, 2012: State issued a notice stating that as of July 22, 2012,  State no longer had a single insurer. The notice also stated that  contractors could purchase insurance from any insurer approved by  DOL to provide DBA insurance.

August 28, 2012: State formally notified its contracting officers that  they were required to inform contractors of the transition to an open  market system as DBA insurance policies expired.

section_title: State Did Not Follow Leading Practices during Its Transition to an Open Market System
subsections: section_title: State Lacks Specific Guidance for DBA Selections, but Officials Said They Followed Acquisition Regulations to the Extent Practicable
paragraphs: State officials said they lacked specific guidance for acquiring a new DBA  contract but followed acquisition regulations to the extent practicable. The  selection of a single provider of DBA insurance is not an acquisition  because it does not involve the use of appropriated funds. Therefore,  these selections are not subject to the FAR. State officials told us that in  the absence of guidance on how to execute a DBA selection, they looked  to the FAR and the Department of State Acquisition Regulation (DOSAR)  as their guidance to the extent practicable to conduct what the agency  labeled a “competitive source selection process.” For example, both the  2008 single provider agreement and the 2012 solicitation included  multiple references to the FAR, and State used certain provisions of the  FAR as criteria for determining whether to exercise options on the 2008  agreement.

In the absence of specific State guidance for solicitations involving DBA   we looked to leading  selections and in light of the use of federal funds,practices set forth in the FAR and DOSAR, as well as in other State  acquisition guidance to evaluate State’s management of the DBA  transition. Moreover, in accordance with federal requirements, State has  internal control standards that apply to competitively sourced  acquisitions.internal controls apply to all State operations and administrative functions.  In addition, GAO has in past reports discussed a number of other leading  acquisition practices that are applicable to competitively sourced  acquisitions.

section_title: State Had Little Time to Complete Its June 2012 Single Insurer Solicitation and Communicate Its Decision to Transition to an Open Market System
paragraphs: State had little time to complete its 2012 single insurer solicitation, and  when it received no offers, State had to withdraw its solicitation only 3  days before its existing DBA contract was due to expire. We have  reported on the need for agencies to establish time frames for acquisition  planning, including measuring lead times for presolicitation and   In addition, State guidance used by the Office of  solicitation activities. Acquisitions Management states that sufficient time must be allowed to  perform the many steps involved in the acquisitions process. State  officials told us they began planning for the June 2012 single insurer  solicitation well in advance; however, they did not issue the solicitation  until about a month before their existing single insurer program was due  to expire. The timeline in figure 4 shows how compressed State’s single  insurer solicitation process became. Because State compressed its  contracting efforts, it had little time to complete the solicitation process. In  2007, State did not complete the solicitation process in time to obtain a  DBA single insurer; however, in that instance, State was able to reach an  agreement with its single insurer to extend the contract for 6 months—an  option that it did not have in this instance since it had already agreed with  its single insurer that the existing contract would expire on July 21, 2012.

State officials told us that their decision to transition to an open market  DBA system primarily resulted from the lack of bids on its single insurer  solicitation rather than from a policy assessment and decision based on  an analysis of the costs and benefits of both approaches. State officials  also told us that their decision to transition to an open market system was  heavily influenced by discussions with DOL, which had included a  proposal in its fiscal year 2014 budget to reform DBA by creating a  government-wide self-insurance program. As a result, State officials said  they viewed the transition to an open market system as a temporary  measure. However, DOL officials told us that they decided to reevaluate  whether a self-insurance program would be cost-effective after they had  submitted their fiscal year 2014 budget proposal.

In addition, State had little time to communicate with stakeholders,  including contractors, its decision to transition to an open market system.  State transitioned to an open market system on July 22, 2012, but did not  formally communicate this internally or externally until August 9, 2012— about 3 weeks after the transition had occurred. According to an official of  a national association that represents government contractors, and  several contractors we interviewed, after State transitioned to an open  market system, contractors raised a number of concerns regarding the  transition, but State provided insufficient information to them. For  example, according to the association official, contractors were initially  unclear about whether and how long State’s single insurer would continue  to honor existing policies and whether contractors that had submitted bids  using an estimate of DBA insurance costs based on State’s single insurer  program would be allowed to revise their bids. In general, officials of  insurers, brokers, and some contractors told us that contractors were  surprised and confused because State did not communicate its decision  to transition to an open market system in a timely manner. These officials  also said that State’s late communication left some contractors with little  time to replace their expiring single insurer policies. In addition, while  State’s own contracting officers were tasked with informing contractors of  State’s decision to use an open market system to provide DBA insurance,  most of the contractors we spoke with did not learn of the change from  State. State formally notified its contracting officers of its decision to end  its single insurer program and transition to an open market system  through a procurement bulletin issued on August 28, 2012—over a month  after the transition had actually occurred. The bulletin required contracting  officers to notify contractors that State no longer had a single insurer  program and that contractors had to obtain future DBA insurance from a  list of insurers approved by DOL. However, all but 2 of the 10 contractors  we spoke with said that State’s contracting officers did not notify them of  the change to an open market system. Most said they learned about the  change from their insurance brokers.

section_title: State Did Not Conduct a Lessons Learned Assessment or Adequately Document Market Research to Inform Its 2012 Solicitation and Transition to the Open Market
paragraphs: State did not conduct a lessons learned assessment to inform its 2012  DBA solicitation, as suggested by leading practices, and though it  conducted market research, it took limited measures to document the   analysis and conclusions. State’s and GAO’s internal control standards  maintain that significant events and information need to be clearly  documented to ensure that management directives are carried out and to  inform future decision making. One way agencies may meet this standard is through conducting a lessons learned assessment and market  research for future competitive source selections.

State encountered serious difficulties in implementing its 2008 single  insurer contract but did not prepare an assessment detailing the lessons  learned from the implementation of that contract. In 2004, 2008, and  2011, we reported that a knowledge base of important lessons learned  from the acquisition process can help program and acquisition staff plan  future acquisitions. In addition, when conducting procurements, agency  heads prescribe procedures to ensure that knowledge gained from prior  acquisitions is used to further refine requirements and acquisition  strategies. While State’s Office of Acquisitions Management has  developed suggested guidance for documenting and incorporating  lessons learned from previous acquisitions into preparations for future  solicitations, it did not do so until August 2013 after it issued its 2012 DBA  solicitation. This guidance states that lessons learned should be noted  and provided to contracting officials. It also states that lessons learned  documents need not be extensive but should be developed when  appropriate.

U.S. Army Corps of Engineers’ (USACE)  Transition to an Open Market System for  Providing Defense Base Act (DBA)  Insurance  In October 2013, USACE transitioned from a  single insurer program to an open market  system. We found that, in contrast to State,  USACE did follow some key aspects of  acquisition guidance and leading practices.   First, USACE allowed time for a transition to  an open market system. In October 2012, it  prepared a decision paper to justify its  transition to the open market. It also prepared  a business case assessment weighing the  advantages and disadvantages of an open  market system. On the basis of its analysis,  USACE concluded an open market system to  be more cost-effective for itself and for  contractors than a single insurer program.   Second, USACE adequately documented its  market research. For example, it documented  the data collection and analysis methods  used, dates when research was conducted,  analysis of vendor capabilities, and a  conclusion based on that analysis.   Third, USACE communicated its decision in a  more timely manner than State. Officials said  they developed a communication plan to  guide the transition, including an August 23,  2013, letter informing contractors that after  October 1, 2013, they would no longer obtain  DBA insurance through USACE’s single  insurer. USACE officials also said they sent  notices to overseas contractors notifying them  of the change. frames when staff used them, an analysis of potential sources, and a  conclusion based on that analysis.

In preparing for its June 2012 solicitation, State took some steps to  conduct market research. State posted a request for information in  February 2012 on a U.S. government website that publicizes federal  procurement opportunities valued at over $25,000 to insurers, brokers,  and contractors asking, among other things, whether State should  continue its single insurer program, whether insurers charged minimum  premiums, and whether small businesses would be adversely affected by  a decision to transition to an open market system. Nine insurers, brokers,  contractors, and small businesses responded to the request for  information. State prepared a summary compilation of responses, but it  contained no analysis and no conclusion to inform decision making. By  contrast, USACE documented its market research, which included an  analysis and conclusions to support its October 2013 transition to an  open market system (see sidebar).

In addition, State did not use the February 9, 2012, request for  information to ask insurers to comment on two provisions that State later  included as part of the June 2012 solicitation. These two provisions, along  with the lack of certain data, were objectionable to insurers. State  extended the deadline and responded to insurers’ questions regarding  these concerns. The two provisions are described below.

An “opt out” provision allowed contractors to obtain DBA insurance on  the open market instead of through the single insurer if the contractor  could demonstrate that it could purchase DBA insurance on the open  market at a lower cost. Insurers expressed concern to State that this  opt out provision would encourage larger contractors and those with  fewer claims to opt out of the program, leaving the single insurer with  a pool of contractors representing a much higher level of risk. During  the solicitation process, insurers asked State to withdraw this  provision. State acknowledged that insurers wanted this provision  withdrawn, but during the solicitation process State did not agree to  the insurers’ request. State officials told us this provision was included  as a result of information, obtained through the request for information  and other sources, indicating that some contractors could save money  by purchasing insurance on the open market, and that it would allow  contractors dissatisfied with the performance of the designated insurer  to seek competitive alternatives if available.

A “blanket coverage” provision required the single insurer to provide  coverage to all subcontractors, regardless of whether they were  explicitly identified or not in State’s contract with the prime contractor.  State officials said they included this provision to ease the work of  contracting officers, who would otherwise have to obtain proof of DBA  coverage from individual subcontractors. In contrast, insurers  expressed two concerns. One expressed concern that the provision  contradicted applicable DOL regulations, making it harder for DOL to  process claims. Authorized DBA insurers are required to report to  DOL the names of every employer to which they have issued a DBA  insurance policy. According to one insurer, if a covered employee is  injured and reports the injury to DOL, DOL must identify the insurer  that is required to provide benefits to the employee; however, this is  difficult or impossible to do in the absence of information about which  contractors and subcontractors are covered under the DBA policy.  Additionally, insurers also expressed concern that not explicitly  identifying all covered subcontractors could expose the insurers to  unanticipated liabilities.

Because State did not develop a lessons learned assessment,  adequately document market research, and use the February 2012  request for information to ask insurers to comment on the “opt out” and  “blanket” provisions, State did not have sufficient information about the  provisions in its solicitation that insurers would find objectionable. This  explains in part why State’s single insurer solicitation received no offers  and motivated one insurer to file a bid protest with GAO citing among  other things a lack of information necessary for bidders to compete  intelligently and on an equal basis. In addition, State did not have analysis  to enable it to determine whether an open market system best fit its  needs.

section_title: State Did Not Provide Sufficient Information to Enable Insurers to Fully Assess Risks in State’s 2012 Solicitation
paragraphs: As part of its June 2012 solicitation, State provided some claims and  premium data, but insurers expressed concern that the data were  insufficient to enable them to reliably analyze State’s DBA insurance  needs and estimate future claims and losses as a foundation for  proposing premium rates.

When conducting procurements, agencies acquire and provide sufficient  data to potential service providers in order to ensure that contract  requirements are clear and potential service providers have sufficient  information to compete on a level playing field. Under the terms of the  2008 contract, State had required its single insurer to provide premium  data quarterly and claims and premium data in semiannual, and annual  reports. For the June 2012 solicitation, State provided prospective  insurers with two spreadsheets—one providing data on historical  premiums and the second providing data on claims. According to  insurance industry officials, these data were needed to enable  prospective insurers’ actuaries to propose premium rates. However,  according to four different insurers, both spreadsheets were missing  some key data such as payroll or claims data for certain years. In our  review of the solicitation, we also observed that some premium data were  missing. During the solicitation process, insurers asked State to supply  the missing data, but State responded that it had provided all available  data. Officials of two insurers we spoke with expressed concern that not  providing these data gave an unfair competitive advantage to State’s  previous single insurer, since only that insurer had access to the  complete claims and premium history data.

section_title: DBA Premiums Rose in the Open Market, but Increases Were in a Similar Range of Those Likely Had State Continued Its Single Insurer Program
paragraphs: Our analysis of a sample of State contractors’ DBA rates during the  transition from a single insurer program to an open market system  showed that the rates increased as State moved to the open market  system, but the increases fell in a similar range of those that were likely to  have occurred if State had continued its single insurer program. Because  State does not collect and analyze data on DBA costs in the open market  system, we collected and analyzed data on DBA premiums and payroll  from a random sample of State contractors active in fiscal years 2010  through 2013. We found that in our sample of contractors, effective DBA  premium rates—rates that incorporate minimum premiums—increased for  the median contractor by $1.98 per $100 of payroll as State transitioned  from the single insurer program to the open market system. Our  analysis also showed that the increase in effective DBA premium rates  after the transition was comparable to the increase in effective DBA  premium rates requested by State’s single DBA insurer, which said it had  lost money under the prior contract.
subsections: section_title: Effective DBA Premium Rates in a Sample of State Contractors Increased as State Moved to the Open Market System
paragraphs: The dollar amount basis of  a claim for damages under  the terms of an insurance  policy. From the claimant’s  perspective, a loss is the  monetary benefit the  claimant is entitled to  receive. terms).system, State’s contractors may be required to pay a minimum premium  set by their insurer, which is the minimum dollar amount the insurer  requires to write coverage for a contractor. DBA insurance industry  representatives told us that minimum DBA premiums can range between  $5,000 and $25,000 per policy. Hence, open market minimum premiums  can effectively increase the price of insurance, as measured in dollars per  $100 of payroll (i.e., the effective premium rate), particularly for smaller  contractors with fewer contracts.

The minimum dollar  amount necessary to  receive coverage under an  insurance policy.  the premium rate multiplied  by payroll or (2) the  minimum premium.

Total premium divided by  $100 of payroll. Because of  the minimum premium, the  effective premium rate may  be higher than the  premium rate.

The increase in effective rates varied across contractor characteristics.  We compared effective rates in the single insurer program with those in  the open market across three sets of contractor characteristics: business  size, contractor category (i.e., the nature of work performed by the  contractor), and country, finding a statistically significant increase across  many of these contractor characteristics. For example, for larger  contractors in our sample, effective rates increased from $6.23 to $11.15  per $100 of payroll, on average; for small businesses in our sample,  effective rates increased from $4.53 to $7.71 per $100 of payroll, on  average. We did not find a larger increase in effective rates for small  businesses compared with rates for larger contractors; this may be  explained in part by differences in the type of work performed by small  versus large contractors. For example, security contractors had a larger  increase in effective rates compared with rates for services and  construction contractors, and, as we discuss below, most of the security  contractors in our sample were larger contractors. Table 1 shows the  increase in the median effective premium rates for contractors in each  contractor category as State transitioned from the single insurer program  to the open market. Table 2 shows the increase in the median effective  premium rates by country. The difference in rates shown in tables 1 and 2  suggest that State’s transition to the open market may have led to  variations in DBA rates according to the level of risk associated with the  contractor’s category and geographic location. For example, according to  State and insurance industry officials, security contractors are exposed to  greater levels of DBA risk, which could explain why the median rate for  security contractors increased more than for other contractors in our  sample.

section_title: Our Sample Data Suggest That Increases in DBA Rates Were in a Similar Range of Those Likely If State Had Continued Its Single Insurer Program
paragraphs: An increase in DBA rates for State contractors was likely to occur  regardless of whether State had continued its single insurer program  because State’s single insurer reported it was losing money under the  2008 DBA contract. According to e-mails and other documents provided  by State, State’s single insurer repeatedly communicated to State that the  insurer was operating at a loss under the terms of the 2008 DBA contract.  Our analysis shows that the increase in State contractors’ DBA premium  rates following the open market transition was comparable to the increase  in DBA premium rates requested by State’s single insurer. We compared  open market premium rates paid by our sample of State contractors with  the rates we calculated that they would have paid under two hypothetical  scenarios in which State continued the single insurer program for an  additional year. The hypothetical scenarios are as follows:  In the highest contract rates scenario, State and the single insurer  continue the single insurer program, with the insurer charging all  contractors the highest rates allowable in State’s 2008 single insurer  contract. The 2008 DBA contract between State and its single insurer  allowed for three tiers of premium rates, varying by State contractors’  total DBA loss experience. In the contract, higher losses would result  in higher DBA premium rates. During the actual lifespan of the 2008  contract, State’s single insurer requested that the highest tier of  premium rates be charged in years 3 and 4 of the contract; however,  these requests were not granted because of the disputes between  State and its single insurer discussed previously.

In the renegotiated rates scenario, State and the single insurer  continue the single insurer program but renegotiate premium rates.  The single insurer charges security contractors a higher, renegotiated  security rate.

For most of the contractors in our sample, the effective rates they paid in  the open market were comparable to the effective rates they would have  paid under the hypothetical scenarios described above. Figure 5 shows  that there was a high degree of overlap between the likely ranges for the  median open market effective rate calculated from our sample data and  the likely ranges for the median effective rate in the two hypothetical  scenarios. For services and construction contractors—48 of the 56  contractors in our sample—our analysis did not reveal a statistically  significant difference between the median effective rate paid by  contractors in the open market and the median effective rates that they  were likely to have paid if State had continued the single insurer program.  For the 8 security contractors in our sample, our analyses showed that  open market effective rates were significantly lower than effective rates  under the hypothetical scenarios. Open market premium rates for security  contractors in our sample could have been lower than the rates calculated  for them under the hypothetical scenarios in part because insurers in the  open market may choose to insure only security contractors with a good  loss history; in other words, contractors in our sample may have benefited  from the open market to an extent that may not hold across all security  contractors. Brokers told us that the open market allowed insurers to be  selective about the customers they choose to insure. Additionally, the  security contractors in our sample were larger contractors that may have  been able to pool the risk of security contracting alongside work with  lower risk exposure to reduce their DBA premiums. Only 1 of the 8  security contractors in our sample was a small business, and 1 security  contractor told us that its payroll incorporated both security and clerical  employees. In appendix II we describe the methodology of the analysis  we conducted.

section_title: Available Data Do Not Allow for Conclusions as to Whether State’s Transition Affected Small Businesses, but Our Analysis Shows a Potential for Adverse Effects
paragraphs: Our analysis of existing federal procurement data did not show a clear  effect on contractors that are small businesses resulting from State’s  transition to an open market system, but insurers and contractors have  expressed concern that the change has had or could have an adverse  effect. State has not conducted an assessment of whether its 2012  transition affected small businesses’ competitiveness. Our analysis of  information provided by insurers, brokers, and contractors shows that  there is a potential for adverse effects. State’s policy calls for it to  maximize opportunities for small businesses. Without conducting an  assessment, State cannot be assured that it is meeting its policy goal of  maximizing opportunities for small businesses.
subsections: section_title: State First Adopted a Single Insurer Program in Part to Help Small Businesses’ Competitiveness, Consistent with Its Policy of Maximizing Opportunities for Small Businesses
paragraphs: Several audit reports, including State OIG’s 1991 and 1997 reports, as  well as DOD’s 2009 report, discussed the advantages and disadvantages  for small businesses when obtaining DBA insurance through a single  insurer program versus an open market system. Table 3 describes the  advantages and disadvantages based on our interviews with insurers,  brokers, contractors, and small businesses as well as our analysis of  State’s request for information in preparation for its 2012 single insurer  solicitation.

State’s policy calls for it to maximize opportunities for small businesses to  participate in the acquisitions process. State officials told us that State  first adopted a single insurer program for DBA in 1991 in part to make it  easier for small businesses to obtain DBA insurance. According to the  DOSAR, State is to provide maximum opportunities for U.S. small  businesses to participate in the acquisitions process. As required by  law, State has created an Office of Small and Disadvantaged Business  Utilization (OSDBU) to help small businesses participate in State  contracting.

State’s OSDBU also works to ensure agency compliance  with legal requirements contained in the Small Business Act (for example,  determining annual small business goals for the agency). State awarded  $2.1 billion in contracts to small businesses for work performed overseas  in fiscal years 2009 through 2013. Approximately one of every five  newly awarded contracts for work performed overseas during this period  was completed by small businesses, which provide State with a broad  range of services worldwide.

section_title: Federal Procurement Data Are Inconclusive as to the Effect of State’s Transition to the Open Market on Small Businesses
paragraphs: Our analysis of federal procurement data was inconclusive regarding the  effects of State’s transition on small businesses’ ability to obtain State  contracts, and the full effects might not be known for several years. We  analyzed State’s federal procurement data to track the percentage and  value of new awards that went to small businesses before and after the  shift to the open market DBA rate.  We found that for all State’s federally  procured work performed by U.S. contractors outside the United States in  fiscal years 2009 through 2013, the number of new contracts going to  small businesses (as a percentage of all new contracts) declined from 22  percent to 15 percent. For work performed during the same period in only  those countries affected by State’s transition to an open market system,  the decrease was nearly identical.decrease in fiscal year 2013, the first complete fiscal year after the  transition for which data are available. However, that decrease may be  part of the overall decline that we identified. In addition, when we looked  at contracts over $25,000 in value, we found that the percentage of  contracts going to small businesses actually increased by about 1 percent   There was a 2 percentage point  in fiscal year 2013. The major challenge in conducting this analysis is that  federal procurement data do not specify which awards required DBA  insurance. Therefore, we could not isolate those awards and examine  data on them before and after the transition to the open market.  Moreover, the full effects of the 2012 transition to the open market on  small businesses may not be apparent for several more years.

section_title: While State Had Not Observed an Effect on Small Businesses, Insurance Industry Officials and Contractors Noted a Potential for Adverse Effects
paragraphs: Cognizant State officials told us that they had not observed any impact of  the transition to an open market system on small businesses, nor had  they received complaints regarding DBA insurance after the transition  from either small or large businesses. As noted previously, State issued a  request for information in February 2012 and received responses from  two insurers, two brokers, and five contractors. Our analysis of the  responses showed that three of the four insurers and brokers responded  that transitioning to an open market could negatively affect small  businesses in two ways: (1) Insurers could deny them coverage and (2)  insurers could charge minimum premiums significantly higher than what  the small businesses paid under the single insurer program. The one  small business that responded to State also reported a potential for  adverse effects, citing difficulty obtaining coverage and higher premium  rates. State officials told us they reviewed the responses but did not  document their review or any conclusions they reached as a result of their  review.

Thus far, according to State officials, State’s primary way of assessing the  effects of its transition has been to informally monitor feedback received  from small businesses. State officials told us that they have not received  any complaints or concerns from small businesses about having to obtain  DBA insurance through an open market system. According to State, the  absence of complaints indicated that the transition to an open market  system had not adversely affected small businesses. However, State  officials also said that businesses may be reluctant to discuss  uncertainties about DBA costs with State personnel.

Industry officials noted that if the transition had not already had a negative  effect on small businesses’ competitiveness, it may in the future. Insurers,  brokers, and contractors told us that the existence of minimum premiums  under the open market system could have an adverse effect on small  businesses’ ability to perform work for State. As noted previously, we  found the same concerns prevalent among the responses that State  received for its February 2012 request for information. Data we reviewed  from a major DBA broker showed that several small businesses ended up  with a lower premium rate (per $100 of payroll) in the open market; for  example, one small service business saw its rate decrease by half.  However, the data also showed that in selected instances, small  businesses were charged substantially more for premiums after State  transitioned to an open market system. For example, one small service  business’ DBA premium was reported to have risen from $280 to $9,000.  Another small business reported that its premium rose from $883 to  $7,500. In both cases, the increase was due to minimum premiums.

While we cannot determine what effect State’s transition had on small  businesses based on our analysis of federal procurement data, our  discussions with insurance industry officials showed that there is a  potential for adverse effects. To learn more about those effects, we  interviewed a judgmentally selected sample of eight small businesses and  two large contractors that worked with small subcontractors. Four of the  small businesses reported experiencing no adverse effects. One small  business was able to retain its previous single insurer premium rate in the  open market system. Another small business told us that State’s  transition had no impact on it because the increase in its premium rate  was minor. However, six of the small businesses we interviewed  indicated a potential for adverse effects, two of which (minimum  premiums and difficulty obtaining DBA insurance) were raised by  respondents to State’s February 2012 request for information from  insurers, brokers, and contractors. After State’s transition to an open  market system, 3 of the 8 small businesses were required to pay  minimum premiums to their insurer that increased the cost of their DBA  coverage. Additionally, both of the larger contractors stated that small  businesses that they subcontract with may have difficulty obtaining DBA  insurance. In nearly all cases, the cost of DBA insurance (including  minimum premiums) is passed on to State. However, two small  businesses expressed concern that the additional costs imposed by  minimum premiums would negatively affect their competitiveness against  larger contractors who can more easily absorb higher DBA costs. Two of  the small businesses expressed concern that under a multiyear firm-fixed- price contract, if their DBA costs increased in the second or third year,  they would be forced to absorb the added cost. One small business said  that an increase in its DBA premium rate forced an early cancellation of a  multiyear State contract.

In our interviews, some small businesses expressed uncertainty about  whether State would reimburse certain DBA costs; however, State  officials stated that most DBA costs are reimbursable. For example, one  contractor told us that it had to absorb the increase in costs resulting from  State’s transition to an open market DBA requirement. In October 2014,  State officials told us that contractors’ concerns about reimbursement for  increases in DBA costs were unfounded because State reimburses the  cost of DBA insurance. As noted above, State officials said that  contractors may be reluctant to discuss uncertainties about DBA costs  with State personnel. However, State officials also said that in some  cases involving work on State posts overseas, contractors might not be  reimbursed for DBA costs. For example, one small construction firm was  required to purchase DBA insurance, which included a minimum  premium, in order to complete a site assessment at a State facility  overseas before bidding on the contract with State. In that instance, the  contractor would not have been reimbursed for the cost of DBA insurance  had it not won the contract.

section_title: Conclusions
paragraphs: DBA-required workers’ compensation insurance claims have increased  dramatically in recent years as the use of overseas contractors has  expanded. From July 2008 to April 2014, State expended over $212  million to reimburse contractors for the cost of DBA premiums. When  considering whether to adopt a single insurer program or an open market  system for DBA insurance—the two main approaches to providing this  coverage—agencies have a responsibility to conduct the acquisition  process in a way that adequately manages U.S. funds. State’s transition  from a single insurer program to an open market system was not the  result of a policy decision based on an analysis of costs and benefits of  both approaches but was required because its 2012 solicitation to select  a single insurer failed to yield any bids. State was unsuccessful in its  solicitation in part because it lacked guidance for how to conduct a  competitive source selection process that did not involve the use of  appropriated funds. Moreover, State did not make full use of relevant  leading practices, including its own standards for internal control and  federal and State Department acquisition regulations. Consequently,  State was forced into the open market system without knowing if that  system was better suited for the agency and its contractors. As a result,  State cannot be assured that its transition to an open market system was  in the best interest of the agency in a period when the number of DBA  claims and the amount of DBA benefits paid to claimants is at an all-time  high.

section_title: Recommendations for Executive Action
paragraphs: The Secretary of State should direct State’s Office of the Procurement  Executive to take the following actions:  1.  Evaluate whether a single insurer program or an open market system  best serves its needs.  2.  Incorporate leading practices into any future single insurer  solicitations by determining whether existing guidance could be used,  or by developing guidance based on leading practices in federal and  State Department acquisition regulations and State internal control  standards.  3.  Conduct an assessment to determine how State’s transition to an  open market DBA system is affecting small businesses.

section_title: Agency Comments
paragraphs: We provided a draft of this report for review and comment to the  Department of State, DOD, DOL, and USAID. In its comments (included  in their entirety in appendix III), State concurred with all three  recommendations. DOD, DOL, and USAID did not provide any  comments.

We are sending copies of this report to the appropriate congressional  committees, the Secretary of State, the Secretary of Defense, the  Secretary of Labor, the Administrator of the U.S. Agency for International  Development, and other interested parties. In addition, the report is  available at no charge on the GAO website at http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202) 512-8980 or courtsm@gao.gov. Contact points for our Offices  of Congressional Relations and Public Affairs may be found on the last  page of this report. GAO staff who made key contributions to this report  are listed in appendix IV.

section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: Our review focused on the Department of State’s (State) transition from a  single insurer program to an open market system for the provision of  Defense Base Act (DBA) insurance. This report examines (1) how State  managed the transition from a single insurer program to an open market  system, (2) the extent to which this change affected DBA premium rates  paid by State’s contractors, and (3) the extent to which this change  affected small businesses.

To provide background and context for our analysis, we reviewed prior  GAO reports that discuss DBA insurance, as well as reports produced by  Offices of Inspector General of State, the Department of Labor (DOL), the  United States Agency for International Development (USAID), and the  Special Inspector General for Afghanistan Reconstruction. In addition, we  reviewed other documents from the Department of Defense (DOD), DOL,  and insurance industry experts that discuss the history of DBA insurance  and emerging trends in the DBA market. We also conducted interviews  with officials from insurance companies, insurance brokers, contractors,  and small businesses (hereafter referred to as insurers, brokers,  contractors, and small businesses).

To examine how State managed its transition from a single insurer  program to an open market system, we reviewed the Federal Acquisition  Regulation (FAR) and the Department of State Acquisition Regulation  (DOSAR). In addition, we reviewed State’s Foreign Affairs Manual (FAM),  Foreign Affairs Handbook (FAH), and acquisition source selection   GAO has issued a number of reports discussing leading  manual.acquisition practices, and we also reviewed these reports. We obtained a  number of State and insurance industry documents and met with  representatives of State, insurers, brokers, contractors and small  businesses, as well as a national association that represents government  contractors. We reviewed State’s 2008 DBA single insurer contract and  its 2012 solicitation. We compared the applicable regulations, guidance,  and leading practices with what we learned from the 2008 contract, 2012  solicitation, and other documentation. We met with officials from DOL to  discuss that agency’s role in the process. In October 2013, the U.S. Army  Corps of Engineers (USACE) also made a transition from a single insurer  program to an open market system, and we met with USACE officials to  discuss how they managed their transition. We also reviewed  documentation provided by USACE officials that shows how they  managed their transition to an open market system.

To examine the extent to which State’s transition affected the DBA  premiums and premium rates paid by contractors, we collected data on  DBA premiums under State’s single insurer program and in the open  market. To determine a sample of contractors for our analysis, we  obtained a list of State contracts with a principal place of performance  outside of the United States from fiscal years 2010 through 2013 from  State. We also obtained data from State on the contractors’ country of  location, the contracting officers’ determination as to whether the  contractors were classified as small businesses, and the contractors’  contact information. To determine the population of contractors for the  analysis, we applied the following selection criteria to the total dataset:  1.  included contractors active throughout State’s DBA policy transition  2.  included contractors who filed procurements through State’s Office of  3.  included contractors in Afghanistan, Iraq, Pakistan, South Africa, and  4.  excluded unnamed contractors (such as “Miscellaneous Foreign  Awardees”); and  5.  included the longest-performing contract per vendor in each country.

We identified the set of countries by analyzing country summary reports  of contract actions for State and USAID in the Federal Procurement  Database System-Next Generation (FPDS-NG) for fiscal years 2010  through 2013, identifying the top 10 countries for each agency in terms of  number of contract actions and choosing the countries that appeared in  the top 10 list for both agencies. After applying the above selection  criteria, the total population of contractors in the remaining dataset was  164; conclusions drawn from statistical tests on the resulting sample are  generalizable to the population of 164 contractors that meet these  selection criteria. Out of this population, we selected a simple random  sample of 111 contractors, asking for information on DBA rates,  premiums, and payroll during the single insurer program and during the  open market. We queried for country-specific contractor data by  requesting DBA information for a contract task order. Thirty contractors  did not respond to our inquiry. However, in total, we did not receive DBA  rate data from 40 contractors, as 10 contractors who provided responses  said that DBA did not apply to them for various reasons. Among  nonrespondents, 11 were in Afghanistan, 8 were in Iraq, 5 were in  Pakistan, 3 were in Thailand, and 3 were in South Africa; 11 were small  businesses and 19 were not. We did not see a clear pattern in the  geographical location or size of nonrespondent contractors. Table 4  provides the counts of the number of responses we received to our data  collection instrument.

We determined that it was most appropriate to use samples of contractors  that had different characteristics for the different analyses that we  conducted. In our analysis of the increases in effective premium rates  (defined as the total premium divided by hundreds of dollars of payroll)  from the single insurer program to the open market, we restricted the  sample to the 36 contractors who reported paying premiums and payroll  in both the single insurer program and in the open market. This was done  to control for contractor-specific characteristics in the pre-transition to  post-transition (pre-post) analysis. In our static analysis (i.e., we did not  look at pre-post differences) comparing open market effective rates to  effective rates that would have been charged in hypothetical single  insurer program scenarios, we were able to incorporate additional data  from a larger sample of contractors that reported paying premiums and  payroll in the open market. This increased the sample size for this  analysis to 56. For more details on our methodology, see appendix II.

We also conducted interviews with insurers, brokers, contractors, and  small businesses. To assess the reliability of the FPDS-NG data, we  interviewed knowledgeable officials and reviewed publicly available  documentation regarding the collection and use of the data. We  determined that the data were sufficiently reliable for the purposes of this  report. Contractor data on DBA premiums, premium rates, and payroll  were self-reported; however, we reviewed the data provided, performed  logical tests on it, conducted some follow-up with the contractors, and  determined they were sufficiently reliable for our analysis. Further  technical discussion of the data and analysis for this objective is provided  in appendix II.

To assess the extent to which State’s transition affected small  businesses, we interviewed officials from State, insurers, brokers, and a  contractors’ association that represents government contractors;  analyzed data contained in the FPDS-NG, and interviewed officials of 2  large contractors and 8 small businesses. To determine what regulations  and guidance State has regarding small businesses’ participation in  agency contracting, we examined the FAR, DOSAR, and FAH. To  determine the extent to which State received and acted upon information  indicating how its transition might affect small businesses, we spoke with  State officials from the Office of the Procurement Executive, Office of  Acquisitions Management, and Office of Small and Disadvantaged  Business Utilization (OSDBU). The director of State’s OSDBU, whose  duties include serving as an advocate for small business participation in  State contracting, told us that State is meeting its small business goals as  set by the Small Business Administration. However, we found the annual  Small Business Administration reports, which include measures of federal  agencies’ compliance with small business contracting goals, to be of  limited use because the measures are based on contract awards with a   In order to better understand how  U.S. principal place of performance.small businesses might be affected by State’s transition, we interviewed 5  of the 6 largest DBA insurers in the United States. These 6 insurers  processed almost all DBA insurance claims by U.S. contractors in 2013.  In addition, we interviewed 3 of the largest brokers that connect  contractors to insurers and a national association that represents  government contractors.

We also analyzed FPDS-NG data to determine the extent to which the  proportion of small businesses hired by State changed after the transition.  Because the FPDS-NG does not indicate which contracts or contractors  are required to obtain DBA insurance, we imposed the following limits to  obtain relevant data for analysis. We (1) considered only new awards, (2)  considered only U.S. firms, (3) did not consider awards for work  performed in the United States, (4) distinguished between countries  where DBA applies and where DBA does not apply, and (5) distinguished  between contracts valued above and below $25,000. We performed a  number of other analyses, including subsets of contractors who  performed contracts valued above $25,000 in countries with a DBA  requirement, but the results were similarly inconclusive. There are  limitations on the data we used. For example, it is not possible to identify  which contracts contain a DBA requirement without examining the  individual contracts themselves. There is no requirement that agencies  include DBA-related data in their mandatory procurement data reporting  to the FPDS-NG, and State has not established a mechanism for  collecting data on DBA costs in an open market system. It is therefore not  possible to identify exactly which State contractors are affected, if at all,  by State’s transition. Moreover, a limited amount of time has passed since  the transition, so the window is small for observing effects. The transition  occurred on July 21, 2012, but the most recent FPDS-NG data extend  only to September 30, 2013. We determined that the FPDS-NG data were  sufficiently reliable for the purposes of this report.

We also interviewed a judgmental sample of 10 State contractors (8 small  businesses and 2 large contractors) to discover how, if at all, State’s  transition affected them and to uncover details that a quantitative analysis  of FPDS-NG data might not reveal. We selected 8 small businesses using  the judgmental selection criteria listed below. We limited our sample to  contractors that: were required to obtain DBA coverage for work performed overseas;  signed contracts with State both before and after State’s transition to  an open market system; performed work for State overseas in countries affected by the  transition to an open market system;represented a range of contract dollar values and type of work  performed (i.e., construction, security, or services); and were certified as small businesses by the Small Business  Administration.

We excluded contracts that were valued less than $25,000 in some of our  analyses because we judged those to be less likely to include a DBA  requirement because of the nature of the work performed. Because the  most recent FPDS-NG data are from fiscal year 2013, we developed a list  of contractors who were newly awarded State contracts in fiscal year  2013 and then searched FPDS-NG data from fiscal years 2010 through  2013 to determine whether they matched the criteria above. From the  resulting narrow pool of contractors, we judgmentally selected 8 small  businesses to interview. Since DBA premium rates varied in State’s single  insurer program according to one of four rate categories, we selected  contractors in different rate categories to approximate the representation  of service types and contract sizes among all State contractors.we intended to use these interviews to better understand the complexity   Because  and details of how small businesses experienced the transition and to  uncover any details potentially not revealed in our analysis of federal  procurement data—not to draw generalizable conclusions about all of the  small businesses that contracted with State—we determined that eight  interviews would be sufficient. To gain an additional perspective and  supplement the testimony of the 8 small businesses, we interviewed 2  large contractors that work regularly with small subcontractors. We  selected these 2, who meet the first 4 criteria listed above, because their  responses to our request for premium rate data indicated they had insight  into how the transition may have affected small businesses. The  interviews, which took place in person or by telephone conference, used  a standard set of questions, containing both open- and close-ended  questions that allowed contractors to share details of their experiences  both before and after State’s transition and allowed us to compare their  testimony. In all 10 interviews, we spoke with a representative whose job  duties required knowledge of DBA insurance requirements (for example,  a chief operating officer, accountant, or contract manager). Because this  is a nongeneralizable sample, results cannot be used to make inferences  about the entire population of small businesses that contracted with State  during the period covered by our review.

section_title: Appendix II: Technical Appendix for Analysis of Department of State Contractors’ Defense Base Act Insurance Premium Rates
paragraphs: To examine our second objective, the impact of the Department of State’s  (State) transition to the open market system on premiums paid by State’s  contractors, we collected data on contractors’ Defense Base Act (DBA)  insurance premiums, rates, and payroll during State’s single insurer  program and in the open market. Data on premiums, rates, and payroll  were collected from a simple random sample of contractors in  Afghanistan, Iraq, Pakistan, South Africa, and Thailand. We identified the  set of countries by analyzing country summary reports of contract actions  for State and the U.S. Agency for International Development (USAID) in  the Federal Procurement Database System-Next Generation (FPDS-NG)  for fiscal years 2010 through 2013, identifying the top 10 countries for  each agency in terms of number of contract actions and choosing the  countries that appeared in the top 10 list for both agencies. We identified  the population of contractors in each country by obtaining from State a full  list of State contractors whose principal place of performance was outside  the United States. We also requested data on the contractors’ country of  location, the contracting officers’ determination of whether the business  was classified as a small business, and the contractors’ contact  information. We restricted our analysis to contracts that were procured  through State’s Office of Acquisitions Management. We chose a random  sample of contractors in the 5 countries identified above and inquired  about the DBA premiums, payroll, and premium rates during the single  insurer program and in the open market system. When the task order was  from an indefinite delivery/indefinite quantity contract and the contractor  submitted DBA information for the overall indefinite delivery/indefinite  quantity contract, we applied the DBA data to the contractor in that  country. To assess the reliability of the FPDS-NG data, we interviewed  knowledgeable officials and reviewed publicly available documentation  regarding the collection and use of the data. We determined that the data  were sufficiently reliable for the purposes of this report. Contractor data  on DBA premiums, premium rates, and payroll were self-reported;  however, we reviewed the data provided, performed logical tests on them,  conducted some follow-up with the contractors and determined the data  were sufficiently reliable for our analysis.
subsections: section_title: Summary Statistics
paragraphs: In total, 46 contractors reported their total payrolls and total premiums in  the single insurer program, and 57 contractors reported their payrolls and  premiums in the open market system. 36 out of 81 contractors reported  paying premiums and payroll in both the single insurer program and the  open market system; 10 contractors reported paying premiums and  payroll in the single insurer program only. An additional 21 contractors  reported paying premiums and payroll in the open market system only. the premium rate multiplied  by payroll or (2) the  minimum premium.

Total premium divided by  $100 of payroll. Due to the  minimum premium, the  effective premium rate may  be higher than the  premium rate.

section_title: Histograms of DBA Rates
paragraphs: In this section we present a graphical depiction of the distribution of the  DBA premiums and effective premiums paid by our sample of State  contractors. Histograms (i.e., bar charts that show how frequently data  occur in certain intervals) are provided for the overall sample, as well as  disaggregated by contractor category. The histograms in figures 6  through 9 show that the distribution of premiums in both the single insurer  program and the open market are skewed toward higher values on the  right. As a result, we supplemented our analysis in the second findings  section of the report with statistical methods that are less sensitive to  skewed data. For example, we conducted two different tests for statistical  significance: (1) sign tests, which test for differences in medians and (2)  Wilcoxon signed ranks tests, which test for differences in overall  distributions and calculated confidence intervals for the median effective  rates. Because the original sample was not drawn from a stratified  random sample, some categories contain relatively fewer observations  than others.

section_title: Analysis of Hypothetical Scenarios
paragraphs: We analyzed trends in contractors’ DBA premiums before and after  State’s transition to an open market system, and examined how premium  rates varied by contractor category, country, and business size. We also  compared open market DBA rates to rates that would have prevailed in  two hypothetical scenarios in which State continued the single insurer  program. The two hypothetical scenarios are computed as follows:  1.  In the highest contract rates scenario, State and the single insurer  continue the single insurer program, with the insurance carrier  charging all contractors the highest rates allowable in the 2008  contract along with a lump sum amount to compensate the insurance  carrier for historical excess losses. This lump sum amount, which is  the same for all contractors, represents a retroactive adjustment of  approximately $27 million (divided equally amongst overseas  contractors), paid to the single insurer as compensation for performing  the second option year of the 2008 DBA contract at the lowest tier of  prices when, according to the insurer, the highest tier of rates should  have been charged.  2.  In the renegotiated rates scenario, State and the single insurer  continue the single insurer program, but renegotiate premium rates.  The single insurance provider charges security contractors the higher,  renegotiated security rate. The new rate is the average of the higher  rate requested by the single insurer, and a rate proposed by State as  its original negotiating position. All other contractors pay the same  rate they were paying in the third option year. All contractors,  regardless of contractor category, pay a lump sum to compensate the  insurance carrier for historical excess losses. The lump sum  represents the retroactive adjustment described in the scenario  above.

To determine whether premium rates in the hypothetical scenarios  described in the report differed from open market premium rates, we  conducted statistical tests of the difference between open market and  hypothetical rates, by contractor category. We conducted two different  tests: (1) sign tests, which test for differences in medians, and (2)  Wilcoxon signed ranks tests, which test for differences in overall  distributions. In table 8, we report results and p-values for each test. With  the exception of rates for security contractors, we were unable to detect a  robust, statistically significant difference between open market effective  DBA rates and effective rates under the hypothetical scenarios.

Figure 10 shows confidence intervals for the median effective DBA  premium rates that State contractors reported having paid in the open  market and the median effective rates we calculated they would have  paid under two hypothetical scenarios. A confidence interval is a measure  of the reliability of an estimate. To calculate the confidence intervals  shown in figure 10, we ran quantile (median) regressions of effective  rates for subsamples of the data versus a constant term; the confidence  interval on the constant term represents the confidence interval for the  median effective rate. For services and construction contractors, our  analysis did not reveal a statistically significant difference between the  median effective rate paid by contractors in the open market and the  median effective rate that they were likely to have paid if State had  continued the single insurer program. For security contractors, our  analysis showed that open market effective rates were significantly lower  than effective rates under the hypothetical scenarios, which is reflected in  the complete separation of the confidence intervals for this contractor  category in figure 10. Open market premium rates for security contractors  in our sample could have been lower than the rates calculated for them  under the hypothetical scenarios in part because insurers in the open  market may choose to insure only security contractors with a good loss  history; in other words, contractors in our sample may have benefited  from the open market to an extent that may not hold across all security  contractors. Brokers told us that the open market allowed insurers to be  selective about the customers they choose to insure. Additionally, the  security contractors in our sample were larger contractors that may have  been able to pool the risk of security contracting alongside work with  lower risk exposure to reduce their DBA premiums: only 1 of the 8  security contractors in our sample was a small business, and 1 security  contractor told us that its payroll incorporated both security and clerical  employees. Further analysis with a larger sample of contractors would be  necessary to conclusively determine whether open market premium rates  differed from those under a single insurer program.

section_title: Analysis of DBA Premiums across U.S. Government Agencies
paragraphs: Although not discussed in the body of the report, an additional analysis  that we conducted compared DBA premium rates for State contractors  with those of other agencies with single insurer programs, namely USAID  and the U.S. Army Corps of Engineers (USACE). We found that for State  contractors active from fiscal year 2010 through fiscal year 2013, State  contractors’ effective DBA premium rates were generally higher than  those of contractors for USACE and USAID (see table 9). According to  agency officials and industry experts, the difference in premiums reflects  various factors, such as risk exposure, nature of work, and size of risk  pool. Over the same time period, the growth rate of State contractors’  DBA premium rates was higher than those of contractors for other U.S.  agencies, as USAID’s DBA rates remained fixed according to the terms of  its single insurer contract, and USACE’s DBA rates decreased for  services and construction contractors, and remained constant for aviation  and security contractors. However, as indicated in our analysis above, the  increase in State’s DBA rates were, in general, not statistically different  from the increases under two hypothetical scenarios in which State  continued its single insurer program.

section_title: Appendix III: Comments from the Department of State

section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
paragraphs: Michael J. Courts, (202) 512-8980 or courtsm@gao.gov.

section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Thomas Costa (Assistant  Director), José M. Peña, III (Analyst-in-Charge), Gezahegne Bekele,  Sonja Benson, Gergana Danailova-Trainor, David Dayton, Teresa  Abruzzo Heger, Martin De Alteriis, Mark Dowling, Etana Finkler, Jeff  Hartnett, Fang He, Julia Kennon, Ben Nelson, Kyerion Printup, John  O’Trakoun, Jerry Sandau, Christina Werth, and Timothy Young made key  contributions to this report.

section_title: Related GAO Products
paragraphs: Standards for Internal Control in the Federal Government. GAO-14-704G,  Washington, D.C.: September 2014.

Market Research: Better Documentation Needed to Inform Future  Procurements at Selected Agencies. GAO-15-8. Washington, D.C.:  October 9, 2014.

Iraq and Afghanistan: State and DOD Should Ensure Interagency  Acquisitions Are Effectively Managed and Comply with Fiscal Law.   GAO-12-750. Washington, D.C.: August 2, 2012.

Acquisition Planning: Opportunities to Build Strong Foundations for Better  Services Contracts. GAO-11-672. Washington, D.C.: August 9, 2011.

Department of Homeland Security Improvements Can Further Enhance  Abilty to Acquire Innovative Technologies Using Other Transaction  Authority. GAO-08-1088, (Washington, D.C.: September 23, 2008).

Defense Contracting: Progress Made in Implementing Defense Base Act  Requirements, but Complete Information Is Lacking. GAO-08-772T.  Washington, D.C.: May 15, 2008.

Defense Base Act Insurance: Review Needed of Cost and  Implementation Issues. GAO-05-280R. Washington, D.C.: April 29, 2005.

Homeland Security: Further Action Needed to Promote Successful Use of  Special DHS Acquisition Authority. GAO-05-136. Washington, D.C.:  December. 15, 2004.

Auditing and Financial Management: Standards for Internal Control in the  Federal Government. GAO-AIMD-00-21.3.1. Washington, D.C.:  November 1, 1999.


Question-summary annotations: questions: question: What did the Department of State not follow as it transitioned to an open market system?
answer: The Department of State (State) did not follow leading acquisition practices in transitioning from a single insurer Defense Base Act (DBA) program to an open market system.
child_questions: question: In what ways did they not follow leading acquisition practices?
answer: Leading practices emphasize adequately documenting market research, allowing enough time to complete a solicitation, and collecting and analyzing data to select among alternatives, but State took limited measures to document the market research it performed and had little time to complete its 2012 solicitation.
child_questions: question: How did insurers react to the provisions in the State's solicitation?
answer: State included provisions in the solicitation to which insurers strongly objected, received no offers, and had to cancel the solicitation 3 days before its existing single insurer contract was to expire.

question: How was the State negatively affected by not following the leading acquisition practices?
answer: As a result, State had to quickly transition to an open market system without weighing the relative costs and benefits to determine which insurance system best served its needs.

question: Why can the State not be assured that the open market system is the better alternative?
answer: Until State conducts such an evaluation, it cannot be assured that the open market system is the better alternative, and unless State incorporates leading practices into any future single insurer solicitations, it risks a similar outcome.

questions: question: Why is it unclear whether the DBA premium increases following the transition were significant?
answer: GAO found that State contractors' DBA premiums increased following the transition, but the increases were in a range similar to those likely to have occurred if State had continued its single insurer program.
child_questions: question: How did median DBA rates change?
answer: For example, median DBA premium rates increased by $1.98 per $100 of payroll.

question: What did GAO analysis reveal about the post-transition increase relative to the DBA premium rates requested by the State's single DBA insurer?
answer: GAO analysis also shows that the increase in DBA premium rates after the transition was in a range comparable to the increase in DBA premium rates requested by State's single DBA insurer, which said it had lost money under the prior contract.

questions: question: How have insurers responded to the State's transition to an open market system?
answer: Existing data do not show a clear effect on small businesses resulting from State's transition to an open market system, but insurers and contractors have expressed concern that the change has had or could have an adverse effect.

question: What did GAO's analysis from 2009 to 2013 reveal?
answer: GAO analysis of federal procurement data from fiscal years 2009 through 2013 found a decrease in the percentage of contracts awarded to small businesses, but GAO could not link this to State's transition.
child_questions: question: What sorts of adverse effects could there be due to the State's transition?
answer: Information GAO gathered from insurance industry officials and contractors shows that there is a potential for adverse effects, for example, denial of coverage and higher effective premium rates.

question: What is the State's policy in relation to small businesses?
answer: State's policy is to maximize opportunities for small businesses, but it has not assessed whether its transition to an open market DBA system is affecting those opportunities.
child_questions: question: Why is it unclear whether State is meeting its policy goal?
answer: Without such an assessment, State cannot be assured that it is meeting its policy goal of maximizing opportunities for small businesses.

questions: question: What must U.S. government contractors provide for most overseas employees?
answer: DBA requires U.S. government contractors to buy workers' compensation insurance for most employees working overseas.
child_questions: question: How can the contractors recover the money spent on this insurance?
answer: The cost of this insurance, if allowable under federal regulations, is generally reimbursable under government contracts.

question: How did State's contract operate from 1992 until 2012?
answer: From 1992 until 2012, State had a contract with a single insurer to supply all State's contractors working overseas with DBA insurance.
child_questions: question: How did this program change in 2012?
answer: In July 2012, State's single insurer program ended after State unsuccessfully sought to solicit a new DBA single insurer agreement and State transitioned to a system requiring its contractors to obtain DBA insurance on the open market.
child_questions: question: What concerns have arisen after the State's transition and how have they been responded to?
answer: However, concerns were raised about the transition and its impact on State's costs and on small businesses' competitiveness. To address these objectives, GAO was asked to review State's transition.