House Panel Hits Defense Department, Insurers Over War Zone Insurance Costs

By | May 16, 2008

A House committee looking into defense contractors has alleged that the Department of Defense (DoD) has been lax in its management such that insurance companies providing workers’ compensation for civilian employees in Iraq and Afghanistan may have collected $585 million in excess profits over the past five years.

A report by the Democratic staff of the House Oversight and Government Reform Committee is highly critical of the DoD for not reforming its insurance contracting practices despite past warnings that taxpayers are being gouged and injured workers are not receiving promised benefits.

According to the committee, unlike the State Department, the U.S. Agency for International Development, and the Army Corps of Engineers that are also involved overseas, the DoD allows its contractors to negotiate their own insurance contracts, as opposed to selecting a single carrier to supply coverage. The report suggests this had led to inflated costs.

Under the Defense Base Act, all private contractors doing work overseas for U.S. government agencies are required to buy insurance policies to protect their civilian employees. The insurance costs are folded into the price the contractors charge the government.

DoD officials say its contractors work in very high risk areas, which can make it difficult to find even one insurer willing to write the coverage. However, DoD said it is reviewing the procedures.

The House panel report says that between 2002 and 2007, the four largest private insurers have made underwriting gains of 39 percent, or almost $585 million in profits, on about $1.5 billion in premiums.

Between 2002 and 2007, total premiums charged by the four insurers have grown from $18.1 million in 2002 to a high of $462 million in 2005, with premiums in 2007 estimated at $440 million.

It identifies the four insurers as AIG, ACE, CNA and Chubb — which it says combined control more than 99 percent of the DBA market in Iraq and Afghanistan, with AIG by far the biggest in controlling 80 percent.

AIG defended its pricing.

“AIG is confident that we price our DBA coverage as accurately and fairly as possible, given the inherent high risks of this insurance line in these regions, the uncertainties concerning the frequency and severity of future claims, and the obligation to pay claims for many years after the losses occur, including lifetime death and disability benefits,” said Chris Winans, vice president of media relations for AIG.

Winans also said the company has not “had time yet to review the documents supporting Sen. Waxman’s statement regarding AIG’s profitability on DBA programs.”

Chubb pointed out that its share of this business is very small.

“Of the total of $1.5 billion in premiums in question written by the four companies named over the 2002-2007 period, Chubb wrote only $8 million — one-half of one percent. This was a very small part of Chubb’s overall business, and we wrote it as an accommodation to customers for whom we wrote other business,” said Mark Schussel, Chubb public relations manager.

While other federal agencies have single insurance contracts or pooling arrangements for all of their contractors, the DoD has resisted doing this. Instead, it allows individual DoD contractors to negotiate their own contracts and then charge the government for the coverage.

The committee report also raises questions about payments made by insurers to one of the biggest private contractors, KBR, which negotiated insurance to cover its employees in Iraq and Afghanistan.

It cites an example involving KBR and insurer American International Group under which KBR received $8 million for negotiating the largest contract in Iraq, known as the Logistics Civil Augmentation Program (LOGCAP), a $284 million workers’ compensation package with AIG. Of this total $292 million in premiums and fees paid for insurance, $73 million was actually paid out to injured contractors, while AIG and KBR pocketed more than $100 million, according to the report.

“This is disgraceful. The taxpayer is paying nearly $300 million to deliver less than $75 million in benefits to injured contractors. Rube Goldberg could not design a more inefficient way to help employees wounded or injured in Iraq,” said House Oversight Committee Chairman Henry Waxman, D-Calif.

Waxman said that under the DBA, taxpayers, not the insurance companies, pay the costs when a contractor is wounded in action. The insurance companies only pay for the types of injuries that could occur at any worksite.

The federal government reimburses insurers for payments resulting from “a war-risk hazard,” but, the report says, it appears that the DBA insurers are charging extra premiums based on the “danger pay” workers receive for being exposed to these risks.

The committee report cites several previous government reports urging the DoD to alter its procurement strategy.

The committee refers to an Army Audit Agency report on the LOGCAP contract that found AIG made a $97 million profit on the deal and that AIG’s rates appear “unreasonably high” and “excessive.”

Another report, by the Government Accountability Office, found that the State Department and USAID paid about $2 to $5 for every $100 of salary cost for DBA coverage under their single contract arrangement while the DoD contractors were paying between $10 and $21.

“Audit after audit has said the Defense Department model doesn’t work, but still the Department won’t change. When Congress passed a law in 2006 requiring the Defense Department to rethink its approach, the Department reported that it would be too expensive to collect the necessary data and “there are no compelling procurement reasons for DoD to initiate any … efforts,'” Waxman said.

Some have questioned whether a single contract approach is an option for DoD and its contractors.

“It’s not clear that any insurance provider would be willing to underwrite insurance for all DoD contractors, or that contractors would be willing to participate on those terms,” Rep. Tom Davis, R-Va., told the committee.

The DoD says it has had good reasons for not adopting the single policy approach, although it is considering switching to it now.

Richard Gilman, DoD deputy director in charge of procurement, said the DoD has been aware of the high costs, especially since 9-11 and the war in Iraq and that it is currently reviewing the results from a pilot program to change its practices.

He said that DoD had in the past been concerned that the umbrella contracting approach did not provide an incentive for improving a company’s safety record. “There was no incentive for companies to be proactive about keeping rates down through better safety practices, as there are when high rates make a firm less competitive,” he said.

Also, although DoD would not pay higher premiums in high-risk areas, he said DoD was additionally concerned in 1996 that if a single contract with one rate were issued, it would also not be able to take advantage of the low premiums for the majority of areas to which it was sending contractors at that time.

After 9-11 and during the beginning of the Iraq war, however, he said DoD received complaints from companies doing business in Iraq over DBA insurance. Rates had increased significantly, rising from $4 to more than $20 per $100 of employee salary, and in some cases, the contractors said they could not obtain DBA insurance. Gilman said this difficult DBA market “hit small businesses particularly hard” because there was often a minimum premium of $15,000 to $25,000.

“In short, DoD started to experience in Iraq, DBA situations similar to what had occurred at USAID and DOS before they commenced their umbrella contracts,” he said.

So DoD ordered a single contract pilot program at the U.S. Army Corps of Engineers (USACE). Although the USACE pilot contract was competed on a full and open basis, he said only CNA International submitted an offer.

CNA’s initial contract established DBA insurance rates of $5 per $100 of employee salary for services and $8.50 per $100 of employee salary for construction. These rates were significantly below the range of $10 to $21 per $100 of salary cited for contract workers in Iraq in 2005. Also, CNA did not require minimum payments by the contractors for DBA insurance.

Based on these positive early results, he said USACE continued with the second year of its pilot program. For the subsequent contract in March 2007, CNA again was the only offeror. Its rates were reduced from the previous contract, from $5 per $100 of employee salary for services to $3.50, and from $8.50 per $100 of employee salary for construction to $7.25.

“While USACE found that several small and local business were now able to obtain lower DBA insurance rates for Iraq and obtain insurance where they were previously denied, USACE also discovered that in certain non-war zone areas, their umbrella DBA rates were sometimes higher than what individual contractors were previously obtaining,” Gilman said. “Of course, this is expected under the concept of risk-pooling, where lower risk areas would pay a higher premium than higher risk areas. ”

In April 2008, CNA and USACE agreed to a contract modification, setting up two additional labor categories for security and for aviation with materially higher rates. This occurred, Gilman said, because CNA was incurring such significant losses in war zones such as Iraq, that it could no longer continue contract performance at the current rates. USACE and CNA agreed to a $10.30 rate per $100 of employee salary for security, and a $17.50 rate per $100 of employee salary for aviation, which are similar to what the State Department pays.

In February 2008, USACE decided to make the pilot program permanent. Gilman said DoD is reviewing the experience to determine whether to expand use of the approach in the future.

Waxman said the high cost is only part of the problem. He said benefit payments to injured workers are too often delayed. The Department of Labor told the committee that the DBA insurers delay or deny payments on almost all claims submitted by injured contractor employees. The insurers lose 95 percent of the disputed claims that are brought before administrative judges, according to his committee’s analysis.

“What makes the situation even worse is the people this program is supposed to benefit —the injured employees working for contractors – have to fight the insurance companies to get their benefits. Delays and denials in paying claims are the rule,” Waxman said.

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