We developed the conceptual framework for fiscal exposures in 2003, in order to facilitate the discussion of long-term costs and uncertainties that present risks for the federal budget in the future. Fiscal exposures vary widely as to source, extent of the government’s legal commitment, and magnitude. Figure 1 illustrates the range of the legal commitment. Fiscal exposures may be explicit in that the government is legally required to fund the commitment, or implicit in that an exposure arises not from a legal commitment, but from current policy, past practices, or other factors that may create the expectation for future spending. Some exposures present elements of both explicit and implicit exposures. Insurance programs are a key example. If an event occurs, some payment is legally required; this represents an explicit exposure. There may be an expectation that the government will provide assistance beyond the program’s total available resources or budget authority (e.g., flood insurance payments made in response to a major disaster): this expectation represents an implicit exposure. 10GAO-03-213. protect households or individuals against certain social risks including loss of income. In contrast to other federal insurance programs, these programs are generally viewed as transfer payments, which are benefits provided without requiring the recipient to provide current or future goods or services of equivalent value in return. In this respect, they are different from pension and other employee compensation that is provided in exchange for services. from 10 percent of GDP in 2010 to 13.6 percent of GDP by 2030, absorbing an increasing share of federal revenue and reducing future budget flexibility. Should the amounts of funding needed to cover future benefits exceed the amounts available in corresponding trust funds, there may be an expectation that the government will use federal funds to pay the difference, even though there would be no legal commitment on behalf of the government to do so. Significant information on the estimated future spending for Social Security and Medicare is available; in addition to our long-term fiscal simulations, the Congressional Budget Office (CBO) and the administration regularly publish long-term fiscal simulations, which illustrate the expected growth in spending for these programs. Future spending for other implicit exposures can be more difficult to estimate. For example, the frequency and magnitude of declared disasters has increased in recent decades, resulting in billions of dollars of supplemental appropriations. FEMA has obligated over $80 billion in federal assistance for disasters declared during fiscal year 2004 through 2011. The unpredictable nature of such events makes estimating future spending difficult. 12GAO, The Federal Government’s Long-Term Fiscal Outlook: Spring 2013 Update, GAO-13-481SP, (Washington, D.C.: Apr. 11, 2013). These figures also include spending for other federal health programs delivered through the states – the Children’s Health Insurance Program and the subsidies available to assist individuals to purchase insurance coverage through the American Health Benefit Exchanges. 13See Congressional Budget Office, The 2012 Long-Term Budget Outlook (Washington, D.C.: Jun. 5, 2012) and Office of Management and Budget, Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2014 (Washington, D.C., Apr. 10, 2013). losses if an event occurs in the future, the generally cash-based measures used in the budget do not reflect the magnitude of the government’s legal commitment of future resources at the time decisions are being made. If the full cost of a spending decision is included in the budget when the decision is made, then decision makers can consider the total costs when setting priorities, comparing the cost of a program with its benefits, or assessing the cost of one method of reaching a specified goal with another. Decision makers’ ability to make informed choices would be improved by increased transparency regarding the impact of policy decisions on the expected path of spending and revenue. Expected future spending arising from some exposures is recognized in the financial statements, which report costs on an accrual basis. Generally, under financial accounting standards, liabilities are recorded for probable and measureable outflows of resources arising from past transactions and events. Also, under accounting standards, the cost of claims for federal insurance programs that are deemed probable and measurable is considered a liability; reasonably possible losses are disclosed in the notes to the financial statements. Therefore, some measures reported in the government’s financial statements can be useful indicators of future spending arising from certain fiscal exposures. 14See appendix I for information on the extent and estimated magnitude of these fiscal exposures. government to the extent there is an expectation that the government would step in and cover losses beyond the program’s reserves. For some exposures, the extent of the government’s legal commitment has changed over time. For example, the fiscal exposure created by Fannie Mae and Freddie Mac changed in recent years as the government responded to the financial crisis. Prior to 2008, securities issued by Fannie Mae and Freddie Mac were explicitly not guaranteed by the federal government and the government had no legal responsibility to provide support to these GSEs. However, in response to the financial crisis, the government placed them into conservatorship and agreed to provide temporary assistance, creating a new explicit exposure. The budget does reflect some or all of the cost of the government’s legal commitment for some exposures. For example, for crop insurance, budget authority is provided to cover the cost of premium subsidies, claims payments, and administrative expense subsidies. For military and civilian pensions, agencies are required to make contributions out of current budget authority to cover some of the costs of civilian and military pension benefits earned by current employees. These contributions reduce the funds available to each agency to fund other activities. However, the recognition is incomplete because the contributions are not set to cover the full cost. In addition, we found that the budget provides incomplete information or potentially misleading signals about today’s legal commitments for some other exposures as well. Our selected fiscal exposures generally demonstrate one or more of the following characteristics: The full cost of commitments incurred today is not recorded in the budget until the corresponding outlays are made in the future. For example, for veterans compensation and civilian post-retirement health benefits, the budget reflects benefit payments in a given year, instead of capturing the cost of benefits earned today that will need to be paid in the future. 16The Federal Housing Finance Regulatory Reform Act of 2008 established the Federal Housing Finance Agency (FHFA), which was created to enhance authority over these GSEs and provide the Secretary of the Treasury with certain authorities intended to ensure the financial stability of these GSEs. Treasury entered into a Senior Preferred Stock Purchase Agreement (hereafter referred to as the agreements) with each GSE. The agreements, which have no expiration date, provide that Treasury will disburse funds to these GSEs if at the end of any quarter the FHFA determines that the liabilities of either GSE exceed its assets. 17Budget authority is the authority to incur obligations and pay expenses. of an insured event, and the payment of claims may extend over several decades. Rather, the cost of pension insurance can be measured by the portion of risk assumed by the government that is not charged to the beneficiary—a “missing premium.” This subsidy is not recognized in the budget when the insurance is extended. The current budget treatment results in both incomplete information with regard to any missing premium, and in potentially misleading information about the program’s financial condition. For example, at the time budget decisions were being made for fiscal year 2013, the budget showed a positive budget estimate (i.e., net revenues) for PBGC of about $1.6 billion, suggesting that the program would help decrease the federal budget deficit that year. However, the financial reports available at the same time showed the program’s net position worsened by about $8 billion from the year before, principally as the result of incurred losses that are not yet reflected in the budget. These estimates provide significantly different pictures of the program’s health and its potential draw on future budget resources. While PBGC can legally only pay claims up to the amount of resources available in its revolving funds, in the face of major pension fund failures there might be an expectation that the government would pass legislation allowing PBGC to cover some or all of the gap. Dedicated resources are estimated to be insufficient to pay for the associated commitment. Some programs set aside amounts out of current budget authority to cover benefits earned today but payable in the future. For example, agency contributions and Treasury payments to cover military pension benefits accrued during the year are deposited in a budgetary trust fund; however, the trust fund balance is significantly less than expected future benefits payments, as measured by the accrued liability (see appendix I, figure 9). As such, the trust fund’s balance can provide a signaling function of future spending but does not necessarily represent the full cost of those legal commitments. Furthermore, some insurance programs do not have sufficient dedicated resources to cover expected costs. For example, the NFIP historically insured many properties at a subsidized rate. In addition, overall flood insurance premiums were designed to permit the program to cover losses and expenses in an “average historical loss year,” but not to cover high- loss years. Instead, the program was given the authority to borrow from the Treasury in such years, with the expectation that low-loss years would allow the program to repay any borrowed funds. With the exception of years involving catastrophes, annual losses and receipts have generally evened out since 1978, but NFIP has been unable to repay the amounts borrowed in response to catastrophic events, such as Hurricane Katrina in 2005. This funding structure is one of the reasons the program was added to our High Risk List in 2006. Increasing amounts of future spending may be required or expected based both on recent trends and events—and on the government’s response to those events. For example, weather-related events have cost the nation tens of billions of dollars in damages over the past decade. The exposure from weather-related events increases with changes in population density as well as increased frequency and severity of the events. This is one reason we added the federal government’s fiscal exposure created by climate change to our 2013 High Risk List. Through federal programs like flood and crop insurance, these events pose significant financial risks for the federal government. Questions, GAO-01-199SP (Washington, D.C.: Jan. 2001). the subsidized premiums be eliminated and actuarially sound premiums phased in. 20GAO, Federal Trust and Other Earmarked Funds: Answers to Frequently Asked 21The Biggert-Waters Flood Insurance Reform Act of 2012, Pub. L. No. 112-141, requires 22GAO, GAO’s High Risk Program, GAO-06-497T, (Washington, D.C.: March 15, 2006). 23GAO-13-283. Given the variation in fiscal exposures, when making budget decisions, a uniform, across-the-board approach to make fiscal exposures more apparent may not be appropriate. Several factors need to be taken into account in selecting an approach to better recognize fiscal exposures in the budget: the extent of the government’s legal commitment; the length of time until the resulting payment is made; and the extent to which the magnitude of the exposure can be reasonably estimated. We previously recommended to OMB and Congress two general approaches: reporting supplemental information in budget documents to increase attention to fiscal exposures, and incorporating costs into primary budget data to allow for better comparisons among programs. Supplemental reporting involves including information about the financial state of programs in addition to that which is available in primary budget data. Improved supplemental reporting in budget documents on fiscal exposures would make information more accessible to policymakers without introducing additional complexity and uncertainty directly into the budget. With a supplemental reporting approach, the current basis of reporting primary budget data would not be changed. Instead, the supplemental information would be used along with budget data to identify important signals that could be used to monitor fiscal exposures. For example, the Appendix Volume in the President’s budget includes a balance sheet for some federal insurance programs that shows the program’s net position (assets minus liabilities), providing valuable information about the program’s affect on future budget resources. For the Federal Crop Insurance budget account, a supplemental table includes the cost of the premium subsidy provided by the government. In 2003, we recommended that OMB create an annual report on fiscal exposures providing a concise list and description of such exposures, cost estimates (where possible), and an assessment of methodologies and data used to produce cost estimates for such exposures. We further recommended that OMB report estimated costs of certain exposures as a new budget concept—”exposure level”—as a notational item in the Program and Financing schedule of the President’s budget, though the recommendation was not implemented. In some cases, improving supplemental reporting in key budget documents may simply be a matter of expanding program analysis and making existing analytical work more readily available. For example, CBO regularly prepares 10-year budget projections for several programs in our review. While this time period is helpful for many programs, longer-term projections would be helpful for those programs—such as federal employee pensions and retiree health—where the time between the legal commitment and payments can extend over several decades. Further, significant changes in expected spending (or differences between actual and estimated spending) should prompt analysis, including consideration of the nature and source of the change. Identifying meaningful measures that would provide signals about the changing nature or magnitude of the exposure might offer another means to focus policymaker attention on fiscal exposures. For example, trust fund balances can serve as a signaling function for decision makers about underlying fiscal imbalances in covered programs. A gap between the projected fund balance and expected spending can signal that the fund, either by design or because of changes in circumstances, is collecting insufficient monies to finance future payments. Also, the repeated use of borrowing authority could be an indicator that the magnitude of the exposure has changed. Specifically, NFIP was expected to borrow in “above-average claim” years and repay that borrowing in “below-average claim” years. In years with extraordinarily high claims resulting from catastrophes like Superstorm Sandy and Hurricane Katrina, NFIP has used the borrowing authority repeatedly. The program currently has an outstanding debt to the Treasury of $24 billion. The program’s inability to cover claims in excess of premiums led to the passage of legislation in 2012 that altered the design of the program, including a key provision that NFIP raise premium rates to reflect true flood risk and make the program more financially stable. These signaling devices can provide policymakers with information regarding the full costs involved in budget decisions and enable those concerned about exposures to raise questions and challenges in the budget debate and to prompt action. 24GAO-01-199SP. 25Borrowing authority permits an agency to borrow money, usually from the Treasury, then 26Biggert-Waters Flood Insurance Reform Act of 2012, Pub. L. No. 112-141, § §100205, obligate against amounts borrowed. 100207. A second potential approach to improving recognition of fiscal exposures is incorporating full costs into primary budget data. This method would allow for better comparisons among competing priorities and between different methods for achieving program goals. In certain cases, including credit programs and government employee pensions, accrual accounting methods are already used to some extent in budgeting. For example, credit reform in 1990 permitted more accurate comparisons among direct loans, loan guarantees, and other types of tools for achieving a program’s objectives. Some other countries, such as Canada and Iceland, also use accrual budgeting selectively to increase recognition of future cash requirements related to service provided during the year; officials from these countries generally said that accrual budgeting contributed to improved resource allocation and program management decisions in these specific areas. We have recommended that Congress expand the use of accrual budgeting to other budget program areas where it would enhance upfront control, such as insurance and environmental liabilities. While it has not been expanded to these areas, proposals addressing broader budget process reform have included accrual budgeting. As seen in the implementation of credit reform, including estimates of full costs in primary data may also lead to the development of better estimates of future spending, though it would require the development of methodologies appropriate to the nature of the exposure. Because the cost to the government varies according to the specific program’s design and characteristics, different types of cost estimates could be incorporated into primary budget data in order to better recognize the government’s fiscal exposure. For example, Normal cost: For retirement benefit programs, such as pension or retiree health, the normal cost is the actuarial present value of the benefits to be paid in the future that are attributable to employees’ current year of service. As such, it is one measure of an accrual cost for a particular year. 27GAO-08-206. Other countries we reviewed—Australia, New Zealand, the Netherlands, and United Kingdom—use accrual budgeting more extensively to support broader efforts to improve the efficiency and performance of the public sector. However, none of these other countries used accrual budgeting for social insurance programs. Risk-assumed cost estimates: For insurance programs, key information is whether premiums will be sufficient to pay for covered losses under existing policies. The portion of risk assumed by the government that is not charged to the beneficiary—the “missing premium” or subsidy cost—is essentially the difference between some measure of the full premium and the actual premium charged to the insured. This cost measure has been used since 1991 for credit programs. All estimates of future spending introduce some degree of additional uncertainty into the budget and the ease of implementation differs. Some measures may already be used widely in other forms of reporting, whereas others are relatively new concepts for federal budget reporting and may involve developing new models and technical skills. Despite any implementation challenges, approximate estimates of the full cost to government may be preferable to some current measures that are incomplete or potentially misleading. Further, a requirement to produce estimates for budget reporting may help improve the quality of estimates by drawing more attention to them. Although using estimates may introduce uncertainty in primary budget data, it would result in earlier cost recognition in the budget. This would help reinforce up-front controls in the budget process. 28The risk assumed can be difficult to measure for many federal activities, but is most clearly identifiable in federal insurance programs. facing the federal government—would be an important first step toward enhancing control and oversight over federal resources and can aid in monitoring the financial condition of programs over the longer term. Incorporating measures of the full cost into primary budget data would provide enhanced control over future spending. This can both improve the nation’s fiscal condition and enhance the budgetary flexibility for responding to unexpected or emerging challenges. We provided a draft of this report to the Office of Management and Budget and the agencies responsible for administering the programs we reviewed. Those agencies are the Risk Management Agency (RMA) in the Department of Agriculture; the Federal Housing and Finance Administration; Department of Defense (DOD); Department of Homeland Security (DHS); Department of Veterans Affairs (VA); the Office of Personnel Management; and the Pension Benefit Guaranty Corporation (PBGC). RMA, DOD, PBGC, and the Federal Emergency Management Agency in DHS provided technical comments that were incorporated in the report as appropriate. The Chief of Staff of VA provided comments that are discussed below and reprinted in appendix II. VA generally agreed with our findings and stated that current budget reporting provides adequate information for determining the resources necessary to pay benefits for current veterans and survivors. While we agree that the budget records the outlays associated with benefits paid in a given year, we maintain that current budget reporting provides incomplete information about the costs incurred for benefits earned during the year that will be paid in the future. We are sending this report to relevant agencies and congressional committees. 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) 512-6806 or irvings@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 III. Farming has always been vulnerable to risks from natural causes such as drought, excessive moisture, hail, wind, frost, insects, and disease. Farmers are also exposed to financial losses from price risk. The federal government helps mitigate the impact of these risks on farm income through the federal crop insurance program. Crop insurance is sold and serviced by 17 approved private companies. Under the provisions of these agreements, the private companies both bear a percentage of any loss and reap a percentage of any gain associated with the policies over the course of the year. The federal government subsidizes the premiums paid by farmers and acts as primary reinsurer for the private companies that underwrite the policies. The federal government also makes payments to insurance companies that are intended to cover administrative expenses for selling and servicing crop insurance policies. Federal crop insurance is not intended to be self-financing through premiums; a permanent, indefinite appropriation covers any payments that are needed to cover losses and other expenses. The government’s legal commitment to pay crop insurance policyholder claims when losses occur makes the program an explicit exposure. The amount of federal spending resulting from this exposure depends on the extent of losses incurred by farmers. The federal crop insurance program’s costs increased sharply in recent years. An indicator of the government’s exposure is the increase in appropriations drawn from the general fund,Figure 3 shows outlays and resources available to the program, the combination of the general revenue funds, and collections (primarily premiums) received. Outlays, which reflect claims payments and other associated costs, doubled from $3 billion in 2001 to $6 billion in 2008, and then doubled again in 2009 to $12 billion. Premiums received do not fully cover the program’s costs; general revenue funds make up more than half of the program’s available resources and are used in part to provide premium and administrative expense subsidies. Therefore, the full cost of the crop insurance subsidies and administrative costs is reflected in the budget. Anticipating the future budget exposure presented by crop insurance is complicated by the potential impact of climate change and changes in program design. Our March 2007 report assessing the financial risks to the Federal Crop Insurance Corporation (FCIC) found that its exposure to weather related losses had grown substantially. At that time, we found that little had been done to develop the kind of information needed to understand FCIC’s long-term exposure to climate change and that FCIC had not analyzed the potential impacts of an increase in the frequency or the severity of weather-related events on its operations. Since then, a study examining the potential impact of climate change on the federal crop insurance program was prepared for the Risk Management Agency (RMA), which administers the program. According to RMA officials, the overall impact of climate change is not clear, given the uncertainty of various climate change scenarios and the potential adaptive responses by growers and the crop insurance program. Reflecting these uncertainties and the significance of this issue, we included a discussion of the crop insurance program in a high risk designation related to the fiscal exposure of climate change in our High Risk List in 2013. The Federal Emergency Management Agency (FEMA) within the Department of Homeland Security operates the National Flood Insurance Program (NFIP) to provide flood insurance to residential and commercial property owners. Flood insurance is funded primarily through premium collections. The premiums were designed to permit the program to cover losses and expenses in an “average historical loss year,” but not to cover high-loss years. Instead, the program has statutory authority to borrow from the Treasury in such years with the expectation that low-loss years would allow the program to repay any borrowed funds. While not always the case, since 1978 annual losses have generally evened out with receipts over normal years but borrowing authority has been accessed and increased in recent years, in response to catastrophic events such as Hurricane Katrina in 2005. NFIP presents a range of exposures to the federal government. The government’s legal commitment to pay flood insurance policyholder claims when losses occur makes the program an explicit exposure. The amount of federal spending resulting from this exposure depends, in part, on the frequency of weather-related events and their severity. If total claims exceed amounts available from premium collections, NFIP may access available borrowing authority to cover excess claim amounts. To the extent there is an expectation that the federal government cover claims exceeding the amount that NFIP has been authorized to borrow from the Treasury, NFIP represents an implicit exposure. NFIP received increased borrowing authority in 2013 to cover loss claims related to Superstorm Sandy. Including the $16.8 billion NFIP borrowed to cover claims primarily from Katrina, the program’s reported total outstanding debt had increased to $24 billion as of March 31, 2013. One measure of the government’s exposure is the extent to which claims exceed available resources. One indicator of the exposure is NFIP’s net position—the residual difference between the program’s total assets and liabilities. Figure 4 also shows how the program is reflected in primary budget data. NFIP is reflected on a cash basis: premium collections are recorded as receipts in the year they are received and claims payments are recorded as outlays in the year they are made. The balance sheet for NFIP is also included in the budget as supplementary information. However, the budget has not reflected the subsidy cost—or “missing premium”— embedded in NFIP’s program design. The subsidy can be measured as the portion of risk assumed by the government that is not charged to the beneficiary. NFIP was first added to our High Risk List in 2006 because of concerns about financial solvency. The program was highlighted again in 2013 when we added the fiscal exposure of climate change to the High Risk List. GAO-13-283. AECOM, The Impact of Climate Change and Population Growth on the National Flood Insurance Program Through 2100, (June 2013). 6The Biggert-Waters Flood Insurance Reform Act of 2012, Pub. L. No. 112-141. Congress recently repealed section 4005(c) of the Employee Retirement Investment Security Act, which provided authority for the PBGC’s federal line of credit up to $100 million. See the Moving Ahead for Progress in the 21st Century Act (MAP-21), Pub. L. No. 112-141, § 40234 (a). One measure of the magnitude of the government’s fiscal exposure is PBGC’s net position, which represents the residual difference between PBGC’s total assets and liabilities. As figure 5 shows, PBGC’s net position generally declined from a $7.8 billion surplus in 2001 to a $34 billion deficit in fiscal year 2012. However, PBGC estimated that its financial risk for potential termination of underfunded plans sponsored by financially weak firms to be almost $300 billion. Although PBGC’s annual receipts currently exceed its outlays, its overall financial position is weaker than would be indicated by these annual receipts and outlays. PBGC is an example of a program for which cash-based budgeting provides potentially misleading information. Premiums are shown as receipts when they come into the Treasury and payments are shown as outlays when they are made; the time lag between these events means that an increase in PBGC premiums would appear in the budget as an increase in revenues. The budget does not reflect the “missing premium”—the portion of a full risk-based premium not charged to the insured, which could be a signal of the expected cost of the program. In 2013, we reported that plan terminations and insolvencies threaten PBGC’s ability to pay pension guarantees for retirees. In the event that the agency were to exhaust all of its assets and become insolvent, the agency would only have premium revenue to rely on to make its benefit payments. For further discussion, see GAO, Private Pensions: Timely Action Needed to Address Impending Multiemployer Plan Insolvencies, GAO-13-240, (Washington, D.C.: Mar. 28, 2013). 11GAO, Pension Benefit Guaranty Corporation: Redesigned Premium Structure Could Better Align Rates With Risk From Plan Sponsors, GAO-13-58, (Washington, D.C.: Nov. 7, 2012) and Pension Benefit Guaranty Corporation, Excellence in Customer Service: Annual Report 2012, (Washington, D.C.: Nov.14, 2012). 12GAO-13-58. Congress established Fannie Mae and Freddie Mac as government- sponsored enterprises (GSEs) in the housing finance market to support the supply of mortgage loans; securities issued by these GSEs were not backed by the full faith and credit of the government. In 2008, in response to the financial crisis, Treasury entered into Senior Preferred Stock Purchase Agreements (the agreements) with Fannie Mae and Freddie Mac to preserve the assets and mitigate systemic risks that contributed to market instability. Under the agreements, Treasury would purchase these GSEs’ senior preferred stock and make funds available on a quarterly basis, to be recovered by redemption of the stock or by other means. While the initial funding commitment for each enterprise was capped at $100 billion, Treasury increased the cap to $200 billion per GSE in May 2009 to maintain confidence in these GSEs. In 2012, the caps were replaced with a formulaic cap allowing these GSEs to make quarterly draws based upon their net position, or if the liabilities of either GSE, individually, exceed its respective assets. The purchase agreements with Fannie Mae and Freddie Mac illustrate how an exposure can change over time. Prior to 2008, these GSEs represented an implicit fiscal exposure to the government because the securities they issued were explicitly not guaranteed by the full faith and credit of the U.S. government. The 2008 stock purchase agreements, while temporary, created a new explicit exposure for the federal government to provide immediate financial support to Fannie Mae and Freddie Mac. At the end of any quarter in which either Fannie Mae’s or Freddie Mac’s balance sheet reflects that total liabilities exceed total assets, the GSEs have 15 business days to request funds under the terms of the agreements. Treasury then has 60 days to provide the funds, as necessary, up to the maximum amount of the funding commitment. The federal government is not obligated to provide additional assistance beyond the scope of the agreements, but the government’s response may influence expectations related to future support. This expectation represents an implicit exposure. One measure of the magnitude of the exposure to the government is the liability reported in the 2012 Financial Report of the United States Government (Financial Report) of $9 billion, reflecting Treasury’s best estimate at the time of likely draws over the remaining duration of the agreements. The liability was significantly reduced in 2012 (see figure 6). This reduction was in part due to a revision to the agreements that is expected to reduce the amount of future draws, and also to the improved housing market, which contributed positively to the GSEs financial results. Another possible measure of the exposure is the remaining draw authority available to these GSEs, which was about $258 billion as of January 1, 2013. This represents the maximum amount of future spending under the current agreement. In considering the exposure under either measure, any amounts received related to the federal government’s investment in the GSEs’ stock—which had a reported fair value of $109.3 billion in the 2012 Financial Report— would reduce the federal government’s exposure. Figure 6 also shows the Treasury payments to these GSEs and draw authority balance at the end of the year as recorded in primary budget data. The Administration considers Fannie Mae and Freddie Mac to be outside of the budget; therefore payments to them are recorded as outlays. Since 2008, Fannie Mae and Freddie Mac have drawn a total of $187.5 billion and draws have decreased each year—from a high of $95.6 billion in fiscal year 2009 to $18.5 billion in fiscal year 2012. The draw authority balance remaining at the end of each fiscal year is reflected as an unobligated balance. Under the terms of the agreements, the cost of the government’s commitment is offset by dividend payments from these GSEs to Treasury.which record associated costs in the federal budget. The future structures of these two GSEs and the roles they will serve in the mortgage market must still be determined and will affect future decisions about budget treatment. 15Pub. L. No. 101-508. Under the Federal Credit Reform Act of 1990, the credit subsidy cost of direct loans and loan guarantees is the net present value of the estimated long- term cost to the government at the time the credit is provided of such programs, less administrative expenses. The act was intended to improve disclosures about the risks associated with government direct loans and guarantee programs and assist Congress in making budget decisions about such programs. Most federal civilian employees are covered by one of two pension plans, depending largely on when they began their federal service: those hired before 1984 are covered by the Civil Service Retirement System (CSRS) while most employees who entered federal service after 1983 are covered by the Federal Employee Retirement System (FERS). FERS has a small defined benefit portion—the FERS annuity—which supplements Social Security, and a voluntary defined contribution portion, the Thrift Savings Plan (TSP).portion of FERS—which constitutes the government’s exposure arising from the two civilian pension plans. Both agency and employee contributions toward CSRS and the FERS defined benefit annuity are paid to the Civil Service Retirement and Disability Fund (CSRDF), the trust fund in the budget dedicated to funding civilian pension benefits. The CSRDF also receives some payments from the Treasury’s general fund account (largely intended to amortize and pay interest on the previously accumulated CSRS liability) and the CSRDF is credited with interest (investment income) on the Treasury securities it holds. According to the 2012 Financial Report, other significant civilian pension plans include those of the Coast Guard, Foreign Service, Tennessee Valley Authority, U.S. Postal Service, and the Department of Health and Human Services. more CSRS employees retire and the vast majority of the civilian workforce is covered by FERS.contributions for FERS employees are based on annual calculations of the amount required to fully fund future benefits (normal cost) less the employee contribution rate. Employee contributions are calculated differently for FERS than for CSRS: FERS employees essentially pay the difference between the CSRS employee contribution rate of 7 percent and the Social Security employee payroll tax rate, currently 6.2 percent, for an employee contribution rate of 0.8 percent. However, in 2012, the employee contribution was increased to 3.1 percent of pay for employees hired after December 31, 2012, effectively reducing the agency contribution. Benefit payments for both CSRS and the FERS defined benefit annuity are made from the CSRDF, which has permanent, indefinite budget authority to pay benefits. Agencies pre-fund employee pensions by deferring some of their budget authority to the CSRDF, where it remains available to pay pensions to retired workers. The Treasury credits the CSRDF with budget authority in the form of special-issue securities that are backed by the full faith and credit of the U.S. government that earn interest equal to the average rate on the Treasury’s outstanding long-term debt. These securities are then redeemed to make payments to retirees and survivors. Employee contributions to the CSRDF are recorded as receipts and count as revenue to the Treasury. Payments to retirees are recorded as outlays and affect the government-wide deficit. Agency contributions are made from their appropriations and so payments toward the normal cost are visible to the individual agency, but are not reflected in the government- wide deficit because agency payments to the CSRDF are intragovernmental—that is, they are recorded as outlays by one agency and receipts by the trust fund. Treasury also makes annual payments to the CSRDF from the general fund to amortize the previously accumulated unfunded liability and to fund the difference between the CSRS employee and agency contributions and the amount that would be required to fully fund future CSRS benefits. Since no cash actually leaves the government, both agency contributions and Treasury payments to the CSRDF do not affect the government-wide deficit. While the long-term exposure to the federal budget arising from civilian pension benefits is large, it is on a path to decline over time. This trend reflects both the transition from CSRS to FERS in the mid 1980s and the change to a defined contribution design and funding structure in FERS. Civilian annuitants are generally eligible to receive continued subsidized health benefits such as those received over the course of their working years. The Federal Employee Health Benefits program, implemented in 1960, is operated through two revolving trust funds: the Employees Health Benefits Fund and the Retired Employees Health Benefits Fund. The two funds are reported jointly as the Federal Employee Health Benefits (FEHB) account in the federal budget. Under the FEHB program, the federal government pays a share of the monthly premium. The government shares the cost of the monthly premium with employees. The government’s legal commitment to pay a share of the monthly premium for eligible retirees makes civilian post-retirement health benefits an explicit exposure. The magnitude of the exposure can be estimated by the accrued liability for civilian post-retirement health benefits, which at the end of fiscal year 2012, was estimated to be $328 billion. The liability is an estimate of the government’s future cost of providing post-retirement health benefits to current employees and retirees. Figure 8 shows the exposure generally grew through 2010 before declining in 2011 and 2012. As is the case with health care costs in general, estimates depend on many factors, including assumptions about utilization and health care costs far into the future and as a result, can be difficult to estimate. These variables in turn can vary with changes in covered services and participants’ choice of plans. 29After age 65, the retirees’ FEHB benefits are coordinated with Medicare benefits. 30The government’s share for annuitants and current employees is 72 percent of the weighted average of the premiums for all participating plans, with a cap of 75 percent of the total premium. The FEHB Program is classified as a mandatory program and is funded through a permanent indefinite appropriation. The budget reflects payments made in the current year for both active employees and retirees. Although active and retired employees pay premiums, they do not cover the full cost. Agencies make payments to the Employees Health Benefits Fund at OPM for their share of the FEHB premiums for current employees. However, with some exceptions, the budget does not reflect the estimated costs of future payments associated with the federal government’s active employees’ post-retirement health benefits. Federal health care spending as a whole has been growing faster than the economy and is expected to continue to do so. As such it will be important to find ways to minimize costs while maintaining quality for civilian employees and retirees. 31The U.S. Patent and Trademark Office is an exception; since 2005 it has made accrual payments to the FEHB fund associated with its active employees’ post-retirement health benefits. In addition, since 2006, the U.S. Postal Service is required to make scheduled prefunding contributions to the Postal Service Retiree Health Benefit Fund in the budget. However, the Postal Service has not made required payments of $11.1 billion due in fiscal year 2012. See GAO, U.S. Postal Service: Proposed Health Plan Could Improve Financial Condition, but Impact on Medicare and Other Issues Should Be Weighed Before Approval, GAO-13-658 (Washington, D.C., July 18, 2013) and U.S. Postal Service: Status, Financial Outlook, and Alternative Approaches to Fund Retiree Health Benefits, GAO-13-112 (Washington, D.C., Dec. 4, 2012). Members of the military are eligible for a defined benefit, noncontributory pension after 20 years of active service. Active duty personnel become eligible for retirement by completing 20 years of service, regardless of age. The military retirement system provides inflation-protected monthly compensation and other benefits after an active reserve or military career. The system does not provide for gradual vesting; service personnel who separate prior to completing the minimum 20 years of service generally receive no retirement benefits. reserve retired pay is not payable until age 60, with some exceptions. 32Members of the reserves may retire after 20 qualifying years of creditable service, but 33Since 2001, service members also have been eligible to participate in the federal Thrift 34The military retirement system applies to members of the Army, Navy, Marine Corps and Savings Plan, the defined-contribution plan available to civilian employees, although generally without any matching contributions from the government. Air Force. Most of the provisions also apply to retirement systems for members of the Coast Guard (administered by the Department of Homeland Security), officers of the Public Health Service (administered by the Department of Health and Human Services), and officers of the National Oceanic and Atmospheric Administration (administered by the Department of Commerce). 35Pub. L. No. 98-94 provided for accrual funding of the military retirement system and for the establishment of a Department of Defense Military Retirement Fund in 1985. payments to those receiving both military retired pay and disability compensation paid by the Department of Veterans Affairs (VA). The government’s legal commitment to pay benefits to those retirees who reach 20 years of active service makes military pension benefits an explicit exposure. From a government-wide perspective, the magnitude of the exposure can be estimated by the accrued liability for military pensions, which at the end of fiscal year 2012 was estimated to be $1.5 trillion, up from $708 billion in 2001 (see figure 9). 36Concurrent receipt refers to the simultaneous receipt of military retired pay and VA disability compensation. Prior to 2004, the law required that military retired pay be reduced dollar-for-dollar by the amount of any VA disability compensation received (e.g. an offset). The 2004 National Defense Authorization Act (Pub. L. No. 108-136) authorized concurrent receipt of both amounts without a required offset for certain military retirees. Figure 9 also shows the Military Retirement Fund’s outlays and receipts as reported in primary budget data. Outlays reflect benefit payments to current retirees, which totaled $49 billion in 2012, up from $34 billion in 2001. Receipts to the trust fund capture the intragovernmental contributions from the services to fund future benefits earned today, Treasury general fund payments, and investment income on the Treasury Securities the fund holds. The Military Retirement Fund had assets of $376 billion as of September 30, 2012. Beginning in 1985, military pension costs have been partially visible to DOD since it makes contributions to cover the costs as they accrue, but the normal cost is not reflected in the unified budget because the payments are intragovernmental—that is, they are recorded as outlays by one agency and receipts by the trust fund. Since no cash leaves the government, there is no effect on the government-wide deficit. DOD’s military compensation system, including pension benefits, is an important tool to attract and retain the number and quality of active duty servicemembers it needs to fulfill its mission. Comprehensive information about the total cost of compensation, including benefits earned today that will be paid in the future, is important for future decisions about military compensation in a constrained fiscal environment. TRICARE is DOD’s managed health care system for active duty and retired uniformed service members and their families. TRICARE consists of multiple plan options, a number of which cover active duty personnel, their dependents, and retirees under age 65. Prior to 2001, TRICARE beneficiaries would lose their TRICARE coverage when they reached age 65, and Medicare—the federal health insurance program that provides medical benefits to elderly and disabled Americans—would become their primary health insurer. However, in 2001, the Congress expanded TRICARE by authorizing the continued provision of TRICARE benefits after age 65. The program is known as TRICARE for Life (TFL). TFL provides supplementary health care coverage for TRICARE beneficiaries who are eligible for Medicare (e.g. those aged 65 or older) and pays for many services that Medicare only partially covers. Non- Medicare-eligible military retirees are not eligible for TFL and are covered by one of the other TRICARE programs. Corps, U.S. Coast Guard, the Commissioned Corps of the Public Health Service, and the Commissioned Corps of the National Oceanic and Atmospheric Association. through several TRICARE options. 37The uniformed services include the U.S. Army, U.S. Air Force, U.S. Navy, U.S. Marine 38DOD provides health care benefits to its non-Medicare-eligible beneficiary population 39The National Defense Authorization Act for Fiscal Year 2001, Pub. L. No. 106-398 40While TRICARE beneficiaries over age 65 do not have to pay for their TFL coverage, established the Department of Defense Medicare-Eligible Retiree Health Care Fund, administered by the Secretary of the Treasury. they must be eligible for Medicare Part A and elect to carry Medicare Part B. Retired TRICARE beneficiaries are required to pay premiums for Medicare Part B, which covers certain physician, outpatient hospital, laboratory, and other services. TFL covers out-of- pocket costs incurred by beneficiaries for care over the sum of the amount paid for under Medicare. fund was started in reaction to rapidly rising health care costs. The Medicare-Eligible Retiree Health Care Fund (MERHCF) is financed through annual transfers from DOD for the future health care benefits earned by active military in that year (i.e., normal cost contributions); payments from the Treasury general fund toward the previously accumulated unfunded liability for past service; and any gains on investment income from Treasury Securities the fund holds. The government’s legal commitment to provide post-retirement medical benefits to eligible retirees makes the benefits an explicit exposure. From a government-wide perspective, the magnitude of the exposure can be estimated by the accrued liability for military post-retirement health benefits, which at the end of fiscal year 2012 was estimated to be $833 billion. The retiree health liabilities for military personnel, shown in figure 10 as the accrued liability, represents the estimated total cost of benefits earned to date for both non-Medicare eligible and Medicare-eligible retirees, as well as a portion of future benefits for those in active military service. Figure 10 also shows the balance of the MERHCF, which had assets of $176 billion at the end of fiscal year 2012. Beginning in 2003, current costs for Medicare-eligible military retirement benefits have been visible to DOD, since it makes contributions to cover the costs for those benefits as they are earned by current servicemembers, and the uniformed services reflect these normal cost contributions in their budgets. The Treasury also deposits funds towards the unfunded liability. Since no cash actually leaves the government from these contributions to the MERHCF, there is no effect on the government- wide cash deficit. Assets accumulating in the MERHCF are only used to pay benefits for Medicare-eligible retirees, and there is an effect on the government-wide deficit as benefits are paid from the MERHCF. In contrast, the cost of pre-Medicare-eligible post-retirement health benefits is not reflected in the uniformed services’ budget data as these benefits are earned. Rather, the cost of pre-Medicare-eligible health care is paid for on a cash basis from DOD’s annual Operations and Maintenance appropriation. We have highlighted a range of long-standing issues surrounding DOD’s Medical Healthcare System. As health care consumes an increasingly larger portion of the defense budget, DOD leadership has recognized the need to reduce duplication and overhead to operate the most efficient health system possible. In 2012, we reported that DOD had identified initiatives aimed at slowing its rising health care costs, but its ability to implement and monitor these initiatives and achieve related costs savings is limited. 41GAO, Defense Health Care: Applying Key Management Practices Should Help Achieve Efficiencies within the Military Health System, GAO-12-224 (Washington, D.C.: Apr. 12, 2012). The federal government provides benefits to eligible veterans and their survivors to compensate for the loss of potential earnings due to service- connected disability or death. Entitlement to compensation depends on the veteran’s disabilities having been incurred in, or aggravated during, active military service; death while on duty; or death resulting from service-connected disabilities. These benefits can be in place of (or in combination with) the DOD military retired pay. The government’s legal commitment to provide compensation to eligible veterans makes veterans compensation payments an explicit exposure. The magnitude of the exposure can be estimated by the accrued liability, which at the end of fiscal year 2012 was estimated to be $1.8 trillion. This measure reflects the present value of expected future payments to current veterans already receiving compensation payments, to veterans who are not currently receiving compensation but will in the future, and to a portion of those in active military service assumed by the VA to become eligible for compensation in the future. Figure 11 illustrates the growth in this exposure, which more than doubled between 2001 and 2012—from $692 billion to $1.8 trillion—and represents the fastest rate of growth among the compensation programs we examined in this report. The annual growth of the accrued liability, which averaged about $97 billion from fiscal years 2001 to 2012, reflects increases in the number of veterans as a result of wars and other conflicts, the aging of the veteran population, and changes in the benefits and services provided to veterans. payable for a veteran who, at the time of death, is qualified to receive compensation or pension, or whose death occurred in a VA facility. 42Burial benefits are also provided and include a burial and plot or internment allowance 43Prior to 2004, the law required that military retired pay be reduced dollar-for-dollar by the amount of any VA disability compensation received (e.g. an offset). The 2004 National Defense Authorization Act (Pub. L. No.108-136) authorized actual concurrent receipt, or the simultaneous receipt of military retired pay and VA disability compensation for certain military retirees. Veterans Compensation and Pensions annually receives no-year funds through regular appropriations. Figure 11 also shows the program’s annual outlays as reported in primary budget data. Outlays, which increased from $21 billion in fiscal year 2001 to $55 billion in fiscal year 2012, reflect payments made to current veterans. However, the budget does not reflect the estimated costs of future payments earned by current service. The VA’s Veterans Compensation and Pensions account funds one of the largest federal disability programs. In the years ahead, enrollment in the VA’s disability compensation program could increase given the conflicts in Iraq and Afghanistan and as more Vietnam veterans—a significant portion of the total veteran population—further age into disability-prone years. These trends directly affect the extent and magnitude of the government’s fiscal exposure arising from veterans compensation. Further, since 2003, veterans compensation and other federal disability programs have been on our High Risk List, due in part to challenges agencies face in keeping their criteria for evaluating disability and determining compensation consistent with advances in medicine, technology, and changes in the labor market and society. Modernization, GAO-12-846 (Washington, D.C.: Sept. 10, 2012). 44GAO, VA Disability Compensation: Action Needed to Address Hurdles Facing Program 45GAO-13-283. In addition to the contacts named above, Melissa Wolf (Assistant Director), Margaret McKenna Adams, Dean Campbell, Darryl Chang, Jeremy Choi, Robert F. Dacey, Felicia Lopez, Donna Miller, Susan Offutt, Frank Todisco, and Katherine Wulff made key contributions to this report.

Summary: The federal government's long-term fiscal imbalances are driven on the spending side by the effects of an aging population and rising health care costs on Social Security and major federal health programs. However, GAO identified a variety of other fiscal exposures--responsibilities, programs, and activities that may legally commit or create the expectation for future federal spending--that vary as to source, extent of the government's legal commitment, and magnitude. A more complete understanding of these other fiscal exposures can help policymakers anticipate changes in future spending and enhance control and oversight over federal resources. GAO was asked to provide information on risks facing the federal budget. This report (1) examines selected programs that create a fiscal exposure, including the extent and estimated magnitude of the government's legal commitment; and (2) assesses how fiscal exposures could be better recognized in the budget. Based on its review of budget and financial data, GAO selected nine programs, including federal employee benefit programs, insurance programs, and the stock purchase agreements with Fannie Mae and Freddie Mac, and drew upon previous work to discuss potential approaches for improving budgetary attention to fiscal exposures. Fiscal exposures may be explicit in that the federal government is legally required to pay for the commitment; alternatively, it may be implicit in that the exposure arises from expectations based on current policy or past practices. The nine programs GAO examined illustrate the range of federal fiscal exposures (see figure) and how they can change over time. Also, some programs may have elements of both explicit and implicit exposure. Federal insurance programs, for example, fall across the spectrum: if an event occurs, some payment is legally required--an explicit exposure. However, there may be an expectation that the government will provide assistance beyond the amount legally required--that is an implicit exposure. Prior to 2008, securities issued by Fannie Mae or Freddie Mac were explicitly not backed by the U.S. government. However, in response to the financial crisis, the government's agreement to provide temporary assistance to cover their losses up to a set amount created a new explicit exposure. The amount of future spending arising from federal fiscal exposures varies in the degree to which it is known and can be measured. For some exposures GAO found that the budget provided incomplete information or potentially misleading signals regarding the full cost of the commitments made today. A uniform across-the-board approach to make fiscal exposures more apparent when making budget decisions may not be appropriate given their varying characteristics. Several factors need to be taken into account in selecting an approach to better recognize fiscal exposures in the budget: the extent of the government's legal commitment; the length of time until the resulting payment is made; and the extent to which the magnitude of the exposure can be reasonably estimated. Expanding the availability and use of supplemental information, including measures that can signal significant changes in the magnitude of fiscal exposures, would be an important first step to enhancing oversight over federal resources and can aid in monitoring the financial condition of programs over the longer term. Incorporating measures of the full cost into primary budget data would provide enhanced control over future spending, which can help both improve the nation's fiscal condition and enhance budgetary flexibility. GAO is not making new recommendations but this analysis provides additional support for past recommendations to improve budget recognition of fiscal exposures by, for example, expanding the availability and use of information on expected future spending arising from commitments made today.