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Audit Criticizes Administration of Defense Base Insurance Program

A recent governmental audit of the workers’ compensation insurance program for U.S. government contractors working on Afghanistan reconstruction is highly critical of the program’s administration by the U.S. Army Corps of Engineers.

The Office of Special Inspector General for Afghanistan Reconstruction (SIGAR) found that the Corps failed to exercise strong oversight of the Defense Base Act insurance program in Afghanistan. The result was higher than expected insurance premium rates and instances in which contractors’ employees were either not insured or underinsured. The audit also found that up to $58.5 million in premium refunds had not been returned by contractors to the U.S. government.

The Defense Base Act, enacted in 1941, requires U.S. government prime contractors and subcontractors to provide workers’ compensation insurance for employees working overseas.

DBA insurance carriers provide disability and medical benefits for work-related injuries, and death benefits to eligible survivors for work-related deaths. The U.S. government reimburses contractors for the cost of their DBA premiums.

Chicago-based Continental Insurance Company (CNA) since 2005 has been the single DBA insurance provider in Afghanistan for contractors of the U.S. Army Corps of Engineers. U.S. Central Command Joint Theater Support Contracting Command (C-JTSCC) contracts were added in 2008. CNA has collected approximately $225 million in premiums for these contracts.

The audit found that the Corps agreed to higher premium rates sought by CNA, based on data that SIGAR criticized as being “not complete, accurate, or current.”

Under the DBA contract CNA’s premium rates are to be based on the loss ratio experienced in the program. “In July 2009, CNA reported a loss ratio of 5.2 percent for the base year of the October 2008 contract,” the report states. “However, during negotiations with [the Corps], CNA officials argued that their loss ratio was actually 57.7 percent based on a standard insurance industry definition of loss ratio. They, therefore, requested that their DBA rates for the option year be set at the above 50 percent loss ratio tier.”

While the Corps’ contracting officer disagreed with CNA’s rate evaluation, the higher rates than would have been set for a 5.2 percent loss ratio were ultimately approved “because they fell within the range of appropriate rates set through open market research. These rates have given CNA $9.9 million more in premiums than it would have collected had the contract definition of loss ratio been used.”

CNA has defended its rates and its methodology for developing them. The company retained independent actuarial science expert, Dr. Richard Fein, to review CNA’s rating process, says Katrina Parker, a spokesperson for CNA. Dr.Fein, Parker says, “reviewed all the data and concluded that the methodology and the loss ratio and the reserving practices that we used to price the program were all consistent with sound actuarial science and reasonable industry practices.”

She added that CNA “didn’t receive any premiums in excess of amounts to which we were entitled under the contract.”

Indeed, the report acknowledges that the rate negotiation was “permissible because the selection of the rates was to be based on final agreement by the government and the insurance carrier.”

The problem, according to SIGAR, is that the Corps agreed to the higher premiums and “did not take all of the oversight measures it could to verify CNA’s loss figures.”

“We obviously take very seriously our responsibility to provide the DBA and continue to adhere to industry best practices in doing so,” CNA’s Parker says. “There’s no question that the DBA is very complex compensation coverage. We worked very efficiently and transparently with the SIGAR audit team to try to educate them about the insurance process related to the DBA. We’re just very confident in the way we handled our claims and our business practices.”

Uninsured, Underinsured, Unreturned Refunds

U.S. contractors and subcontractors must purchase DBA insurance when working for the U.S. government overseas. SIGAR found, however that many contractors and subcontractors had either not purchased the required coverage or had purchased an insufficient amount. It asserts that contracting officers for the Corps and the C-JTSCC often failed to ensure that contractors were purchasing the correct amounts of insurance.

The process of tracking premium refunds was also found to be inefficient.

“Each contractor submits a self-administered audit at the end of each policy year,” the report states. “If, in total, the contractor overestimated its labor costs more than it underestimated them, the contractor receives a refund [from the insurance carrier] for the difference. The extent to which the U.S. government has a right to obtain the refund depends on how the original contract was written.”

The problem has been, according to the report, that because of inefficiencies and lack of oversight, premium refunds to contractors have not consistently been returned to the U.S. government.

As March 2011, CNA had refunded a total of $58.5 million to contractors, the audit found. While the report concedes that “it is unlikely that all of the $58.5 million in refunds are due the U.S. government,” if the full amount is due and no refunds are returned, the government will “have paid nearly $283.5 million for DBA coverage that should have cost $225 million.”

Recommendations

The report includes recommendations to improve the DBA program going forward. As it relates to the contract with CNA, the report recommends the following:

  1. Modify the current contract with CNA to require that an invoice be provided for each contract showing the final amount paid for DBA insurance for that contract.
  2. Determine whether the possible Purpose Statute violation [which relates to whether funds from different goverment sources were co-mingled] also constitutes an Anti-Deficiency Act violation and, if so, follow the reporting requirements set forth in the Act and in Office of Management and Budget guidance.
  3. Modify the current contract with CNA to clarify and make explicit the requirement that incurred losses exclude claims identified for reimbursement under the War Hazards Compensation Act (WHCA). Specifically, it should stipulate who identifies the claims for reimbursement, when they are to be removed from the loss report, how much time CNA has to remove them, and how cases with claimants outside the United States should be handled.
  4. Modify the current contract with CNA to require an independent actuary review of reserve adequacy particular to the claims covered under the contract with U.S. Army Corps of Engineers and to submit the review to Corps on an annual basis.

“We’re definitely willing to and will be working with the Army Corps of Engineers to address a lot of the concerns and recommendations not only found in this report but anything to improve the DBA program,” says CNA’s Parker. “We definitely are doing that and certainly are looking forward to doing that moving forward.”

The report also recommended ways to strengthen the DBA insurance program and take steps to recover any refunds.

The full audit report: SIGAR Audit 11-15, “Weaknesses in the USACE Defense Base Act Insurance Program Led to as Much as $58.5 Million in Refunds Not Returned to the U.S. Government and Other Problems,” may be found on the SIGAR Web site at http://www.sigar.mil/auditreports.asp.