Objectives, Scope, and Methodology

The Chairman of the House Committee on the Budget asked us to review the budget treatment of federal insurance programs to assess whether the current cash-based budget provides complete information and whether accrual concepts could be used to improve budgeting for these programs. Specifically, we were asked to (1) identify approaches for using accrual concepts in budgeting for insurance programs, (2) highlight trade-offs among different approaches, including the current budget treatment, and (3) discuss potential implementation issues, such as cost estimation. Key Information for Budget Decision-making— the Risk Assumed by the Government—Is Not Readily Available

As a general principle, decision-making is best informed if the government recognizes the costs of its commitments at the time it makes them. In most cases, the cash-based budget does not adequately reflect on a timely basis either the government’s cost or the economic impact of these programs because costs are recognized when claims are paid rather than when the commitment is made and when economic behavior is generally changed. Benefits of Accrual-Based Budgeting for Individual Federal Insurance Programs Will Depend on Several Factors

Although the use of accrual-based budgeting for federal insurance programs has the potential to overcome a number of the shortcomings of cash-based budgeting for these programs, a number of factors influence the extent to which the information and incentives for a particular insurance program would be changed. By recognizing the government’s cost in the budget deficit at the time decisions are made, the incentives for managing insurance costs may be improved. If premium rates were set to cover the long-term expected cost of the insurance extended, sufficient reserves could be established over time. The cash-based budget may misstate the cost of the government’s insurance commitments in any particular year because the time between receipt of program collections, the occurrence of an insured event, and the final payment of a claim can extend over several budget periods. The characteristics of the risks insured by the federal government, frequent program modifications, and the absence of sufficient data on possible losses have hampered the development of risk-assumed estimates. We believe that the potential benefits of an accrual-based budgeting approach for federal insurance programs warrant continued effort in the development of risk-assumed cost estimates. Supplemental reporting of these estimates in the budget over a number of years could help policymakers understand the extent and nature of the estimation uncertainty and permit an evaluation of the desirability and feasibility of adopting a more comprehensive accrual-based approach. The value of reporting risk-assumed estimates was also endorsed by FASAB in accounting standards it developed, which require disclosure of risk-assumed cost estimates as supplemental information for insurance programs beginning with financial statements for fiscal year 1997. Furthermore, OMB agreed that the challenges involved in bringing risk-assumed estimates into the budget are significant and that additional effort to improve estimation methods is required.
Why GAO Did This Study

Pursuant to a congressional request, GAO reviewed the budget treatment of federal insurance programs to assess whether the current cash-based budget provides complete information on the government's cost and whether accrual concepts could be used to improve budgeting for these programs, focusing on: (1) potential approaches for using accrual concepts in the budget for insurance programs; (2) trade-offs among different approaches, including the current cash-based budget treatment; and (3) potential implementation issues such as cost estimation.

What GAO Found

GAO noted that: (1) the cash-based budget does not adequately reflect the government's cost or the economic impact of federal insurance programs because generally costs are recognized when claims are paid rather than when the commitment is made; (2) in any particular year, the cost of the government's insurance commitments may be understated or overstated because the time between the receipt of program collections, the occurrence of an insured event, and the final payment of a claim can extend over many budget periods; (3) decisionmaking is best informed if the government recognizes the costs of its commitments at the time it makes them; (4) for insurance programs, accrual-based budgeting which would recognize the expected long-term cost of the insurance commitment at the time the insurance is extended offers the potential to overcome a number of the deficiencies of cash-based budgeting by improving cost recognition; (5) in most cases, the risk-assumed approach to accrual would be analogous to a premium rate-setting process in that it looks at the long-term expected cost of an insurance commitment at the time the insurance commitment is extended; (6) in practical terms, however, attempts to improve cost recognition occur on a continuum since insurance programs and insurable events vary significantly; (7) the challenges involved in bringing accrual-based estimates into the budget are significant and dictate beginning with an informational and analytic step; (8) development of models to generate reasonably reliable risk-assumed estimates is made difficult by the nature of the risks insured by the government, frequent program modifications, and the sufficiency of data on potential losses; (9) the potential benefits of accrual-based budgeting for federal insurance programs warrant continued effort in the development of risk-assumed cost estimates; (10) supplemental reporting of risk-assumed estimates in the budget as they are developed over a number of years would help policymakers understand the extent and nature of the estimation uncertainty and evaluate whether a more comprehensive accrual-based budgeting approach should be adopted; (11) supplemental reporting of risk-assumed estimates in the budget would parallel the new accounting treatment required under accounting standards developed by the Federal Accounting Standards Advisory Board (FASAB); and (12) in requiring the disclosure of risk-assumed estimates as supplemental information to agency financial statements, FASAB recognized the usefulness of these estimates to better inform budget decisions.