Report 2000-132 Summary - March 2001
California Department of Veterans Affairs:
Its Life and Disability Insurance Program, Financially Weakened by Past Neglect, Offers Reduced Insurance Benefits to Veterans and Faces an Uncertain Future
Our review of the California Department of Veterans Affairs' (department) Life and Disability Insurance Program (insurance program) revealed that:
- Changes made in the insurance program to reduce its financial liabilities also reduced the program's benefits to veterans.
- Although within its discretion, the department's decision to use a substantial part of a refund from the 1983 cancellation of its contracts with previous insurance administrators mainly for the department's California Veterans Farm and Home Purchase Program (loan program) purposes contributed to the insurance program's lack of funds.
- It is currently seeking to increase the insurance program's benefits, but the long-term costs and funding for increased benefits are uncertain.
- In the short term, it could fund increased benefits for veterans by using a limited amount of loan program funds and a modest increase in the premium rates it charges to veterans.
- Improvements in its procedures are necessary to effectively manage the insurance program and safeguard its assets.
RESULTS IN BRIEF
The California Department of Veterans Affairs (department) currently helps about 34,000 veterans afford homes by offering low-cost loans through its California Veterans Farm and Home Purchase Program (loan program). In turn, the department's Life and Disability Insurance Program (insurance program) offers life and disability insurance to qualified veterans in the loan program so that injury or illness will not stop them from making loan payments and so their surviving spouses can pay off some or all of the mortgage. However, the financial health of this insurance program has been in jeopardy for over a decade because the department has regularly failed to pursue long-term strategies to financially stabilize the program. In 1996 the insurance program's funding for its estimated liabilities became so uncertain that the department purchased a group policy from a commercial insurer, resulting in reduced disability benefits for most veterans and higher life insurance premiums for some older veterans. The department is now working to improve California veterans' benefits by soliciting bids from other commercial insurers and examining funding alternatives. However, many solutions available to the department will be costly because the insurance program's liabilities for benefits to veterans are increasing as the population of veterans ages. For example, the estimated costs for options include an immediate cash contribution of $67 million to restore benefits over the next 30 years to veterans who were in the insurance program prior to June 1, 1996, and as much as $270 million to convert the insurance program from a commercial plan to a self-funded plan.
The financial problems of the department's insurance program are long-standing. As far back as 1986, the department's actuary reported a shortage of cash, pointing out that the premium rates that participating veterans paid were too low to sustain the program without other sources of money. At that time, the department chose a short-term solution: to sustain the reserve fund only through 1990 by covering an almost $10 million shortfall between cash and estimated liability. Over the next 10 years, the reserve fund's shortfall soared as the department repeatedly ignored consultants' advice that it was charging inadequate premiums and failing to maintain enough cash to cover the program's estimated liabilities. Also, the department decided not to cover the insurance program's growing shortfall with a 1984 refund from the cancellation of its contracts with previous insurance administrators. Although within its discretion, the department's decision to use this refund mainly for loan program purposes contributed to the insurance program's lack of funds.
By June 1996, facing a significant shortfall, the department made sweeping changes to its insurance program to avoid the large liabilities from future claims and restore the program's financial stability. Closing the existing self-funded insurance program, under which it was responsible for paying all veterans' claims, the department purchased a commercial group policy under which the commercial insurer is responsible for most future claims. Although the department's decision significantly lowered the disability premiums for veterans, life insurance rates for veterans age 60 and older doubled. Most veterans also experienced drastic reductions in how long they receive benefit payments from their disability insurance, and the amount of life insurance proceeds that go to beneficiaries of some veterans age 60 and older can be substantially lower than under the previous self-funded plan.
Presently, the department is exploring ways to improve veterans' benefits. Although the department plans to seek competitive bids from commercial insurers, the long-term costs of increased benefits are not predictable because these insurers generally will not contract to provide a group insurance policy for more than five years at fixed premium rates. The department has also established the Strategic Life and Disability Committee to advise it in selecting the best alternative for increasing the insurance program's benefits without greatly increasing the costs to veterans. The department's goal is to identify possible funding sources to pay for the increases and select the best option for the veterans and the future of the loan program by the end of 2001.
Finding the best option is complicated because future participation in the loan program is unpredictable for reasons that are out of the department's control, such as federal eligibility restrictions and uncertainties over funding. Because only veterans who qualify for the department's loan program can purchase the life and disability insurance, uncertainty in the loan program complicates the department's decisions on the future of the insurance program. Over half of the veterans now in the loan program are 50 to 59 years old, and the supply of funds for which younger veterans qualify is dwindling. The changing demographics of California's veterans and federal restrictions on the tax-exempt money available for home loans makes veterans' future participation in the loan and insurance programs unpredictable.
Further complicating the search for solutions, funding to cover increased benefits in the insurance program is scarce. The only ready source of funds now available within the department to subsidize the insurance program is the loan program's unrestricted funds. The department estimates it can transfer about $1.5 million each year in unrestricted funds to the insurance program for up to 10 years without adversely affecting its ability to meet the loan program's bond payments. Another source of funding for the insurance program is modest increases in veterans' premiums, increases the department has so far been unwilling to impose. In addition, when it implements recommendations from the report we issued in May 2000, the department could use the savings in its operational costs, as much as $1.3 million annually, as additional funding for the insurance program.
Finally, the department's administration of the insurance program contains flaws that weaken its ability to manage the insurance program and safeguard assets of the department and the veterans. For example, the department does not ensure that its contract practices comply with state guidelines. The department also needs to ensure adequate separation of duties for staff handling cash receipts for its insurance program. In the absence of adequate controls, the department cannot minimize the risk of errors or theft relating to veterans' premiums.
When choosing an option for the future, the department should establish a long-term strategy for the insurance program that does not adversely affect the loan program.
Further, any long-term strategy that it develops should include consideration of the following:
- The aging population of veterans in the loan program.
- The uncertainty of future funding for loans to younger veterans.
- The future costs of the insurance program beyond the five years any group insurance policy will cover.
- Continue exploring its options for transferring unrestricted funds to the insurance program.
- Consider increasing premiums at a modest, appropriate rate.
- Complete the implementation of recommendations from our May 2000 report and use the savings to improve the insurance program.
To adequately safeguard the cash receipts for its insurance program, the department should ensure it establishes and maintains an adequate system of internal controls as set forth in the State Administrative Manual.
The department believes the options and analysis presented in our report will be helpful in determining the future direction of the insurance program. It also agrees with our recommendations and is taking steps to comply.