Texas Office of the Governor, DAB No. 1608 (1997)

Department of Health and Human Services

DEPARTMENTAL APPEALS BOARD

Appellate Division

SUBJECT: Texas Office of the Governor

DATE: January 30, 1997
Docket No. A-96-30
Decision No. 1608

DECISION

The Texas Office of the Governor (Texas) appealed the
decision of the Division of Cost Allocation (DCA) to
disallow $14,143,444, representing the federal
contributions to a reserve fund of approximately $98
million accumulated as of September 1, 1992 by the health
insurance plan that Texas operates for its state
employees. DCA took the disallowance because Texas, on
that date, enrolled in the health insurance plan some
55,000 employees from insurance plans maintained by state
colleges and universities. Texas, however, did not
authorize any additional reserve funding for the new
members. DCA determined that the reserve fund had
accumulated for the benefit of the original programs and
activities (which included federally funded programs and
activities) to which its costs had been charged since its
creation. DCA further determined that, following the
enrollment of the new members, the pre-existing federal
contributions to the reserve fund improperly benefited
the programs and activities of the state colleges and
universities because those programs and activities had
not made any contributions to the reserve fund. DCA
determined, as a consequence, that the entire federal
share of the reserve fund should be disallowed.

The record in this appeal consists of the parties'
written submissions and the transcript of a hearing held
by the Board. For the reasons explained below, we
conclude that the applicable cost principles require an
adjustment in the federal funding for the existing
reserve fund as of the enrollment date of the higher
education employees because the higher education
employees improperly benefited from the existing federal
contributions to the reserve fund. We further conclude,
however, that Texas is liable to DCA for only a
proportionate share of the federal contribution to the
reserve fund balance and not the entire amount of the
federal contribution as DCA had determined. Finally, we
conclude that we must remand the disallowance to DCA for
further proceedings since the current record is
insufficient to enable us to compute what part of the
reserve fund should be returned to the federal
government. If Texas disputes DCA's amended computation
of the disallowance amount, it may return to the Board on
that issue alone within 30 days after receiving DCA's
determination.

Background

This disallowance concerns federal financial
participation in the reserve fund maintained by the
Uniform Group Insurance Plan (UGIP), Texas' health
insurance plan for its state employees. UGIP was created
by the Texas Legislature effective September 1, 1976,
bringing together approximately 100,000 Texas employees
and retirees ("state employees") who had previously been
covered under some 60 health insurance plans maintained
by individual or groups of state agencies. Texas
initially considered but rejected including higher
education employees in UGIP at the time of its creation
in 1976. Transcript (Tr.) 166-69. UGIP is funded
through contributions by Texas and by its employees, who
pay uniform contribution rates and receive a uniform
schedule of benefits. Many of the Texas state agencies
administer federal grants and are thus entitled to have
some of their employer contributions to UGIP reimbursed
by the federal government.

The UGIP contribution rates are determined yearly by the
Board of Trustees of Texas' Employees Retirement System
(ERS), which oversees UGIP, and are set to provide
adequate revenue to cover the coming year's projected
claims and expenses. A portion of the year's
contribution rate may also be used to assure an adequate
reserve fund. The reserve fund generates investment
income and protects UGIP against unforeseen funding
shortfalls, such as could be caused by underestimating
upcoming employee health care claims. A sufficient
reserve fund benefits members of the health plan by
allowing lower contribution rates than would otherwise be
required. The ERS Board of Trustees determines the
amount of the reserve fund based on certain parameters,
such as a Texas legislative requirement that the fund
balance be at least 10 percent of the following year's
projected expenses, a 1986 Board resolution targeting a
balance of at least 35 percent of the total annual
contributions, and a recommendation by the U.S. General
Accounting Office that the health insurance program for
federal employees maintain a reserve equal to two months'
benefits and expenses. Tr. 220-24; Texas Exhibit (Ex.)
E. The federal government participates in the reserve
fund to the extent that Texas' employer contributions to
UGIP are eligible for federal reimbursement under various
federal programs for which Texas receives funding.

Effective September 1, 1992, by which time UGIP's
enrollment had grown to approximately 139,000 members,
the Texas legislature enrolled in UGIP approximately
55,000 employees of Texas state colleges and universities
("higher education employees") previously covered by
different health plans. These employees brought with
them into UGIP none of the assets (including reserve
funds) or liabilities of their former health plans, which
continued to be responsible for claims incurred before
September 1, 1992. 1/ Nor did Texas provide funding to
increase the UGIP reserve fund balance at the time that
it enrolled the higher education employees.

In a letter dated June 26, 1995, the Acting Regional
Director of DCA sought repayment of the federal share of
the $98,409,713 reserve fund balance as of September 1,
1992, which was calculated as $14,143,444. Texas sought
reconsideration of that determination before the Regional
Director of the Department of Health and Human Services
(HHS), pursuant to 45 C.F.R. Part 75. The Regional
Director affirmed the disallowance in a decision dated
September 25, 1995, and Texas appealed to the Board.

Applicable Regulations

The allowability of costs claimed for reimbursement by
Texas in its administration of federal programs is
governed by Office of Management and Budget (OMB)
Circular A-87. 2/ To be allowable generally, costs
must be necessary and reasonable for the proper and
efficient administration of the federal grant program,
and must be "allocable" to the program. OMB Circular A-
87, Attachment (Att.) A, C.1.a. Other provisions of
Attachment A of OMB Circular A-87 address the requirement
of allocability more specifically:

C.2.a. A cost is allocable to a particular
cost objective to the extent of benefits received
by such objective.

C.2.b. Any cost allocable to a particular grant
or cost objective under the principles provided for
in this Circular may not be shifted to other Federal
grant programs to overcome fund deficiencies, avoid
restrictions imposed by law or grant agreements, or
for other reasons.

A state's employer contributions to health insurance
plans for employees who work on federally funded programs
are allowable as employee benefits under OMB Circular A-
87, Att. B, B.13.b. Such benefits must be granted
under approved plans and be distributed equitably to
grant programs and to other activities, and are subject
to basic requirements affecting allowability of costs set
out in the Circular. The federal government participates
in a state's contributions to health insurance plans for
employees working on federally funded programs, pursuant
to a cost allocation plan approved by HHS, which is the
cognizant agency on behalf of the federal government.
Texas Ex. DD.

Parties' Arguments

DCA argued that the cost principles require that UGIP's
$98 million reserve fund balance should only properly be
used to benefit those state programs and activities that
had funded it, including those that had received federal
reimbursement. When the 55,000 higher education
employees, who had not contributed to the reserve fund,
were transferred into UGIP, DCA argued, they diluted the
existing federal interest in the reserve. A portion of
the cost of conducting the activities of Texas' higher
education function was thus, in DCA's view, shifted to
those state programs and activities that had received
federal funding. DCA argued that the health insurance
costs of the higher education employees were thus
subsidized by the federal share of the reserve fund.

DCA argued that this cost shifting could have been
avoided if the higher education employees had brought
with them a pro rata equivalent reserve fund balance upon
their entrance into UGIP. DCA estimated that $32,864,000
should have been added to the reserve fund when the
higher education employees entered UGIP in order to
achieve "fund balance parity." Failing that, DCA argued,
fund balance parity could also have been achieved if the
existing UGIP membership, like the higher education
employees, had also brought no fund balance with them
when the higher education employees were enrolled in
UGIP. Accordingly, DCA disallowed the entire federal
share of the reserve fund, which it determined to be
$14,143,444. DCA also argued initially that transferring
the 55,000 higher education employees into UGIP was a
merger of the health plans and thus a change in Texas'
method of accounting for costs for which Texas had failed
to get prior approval as required under the terms of its
Statewide Cost Allocation Plan (SWCAP).

Texas denied that the costs of insuring the higher
education employees had been shifted to the federally
funded programs of the Texas state government or that
there had been any dilution of the federal interest.
Texas stated that the higher education employees proved
to be substantially less expensive to insure during their
first year of UGIP membership than the state employees,
generating a $38 million surplus for the reserve fund for
FY 1993. This positive claims experience enabled the
contribution rates for all UGIP members to be set lower
than they would have been in the absence of the higher
education members. Accordingly, Texas asserted, the
benefits that the higher education members enjoyed by
joining UGIP did not come at the expense of any other
employees or programs, and it was the higher education
employees who ended up subsidizing the state employees.
Texas argued that it did not make sense to look at the
UGIP reserve fund balance only as of September 1, 1992,
as this approach failed to disclose how the program
benefited by the admission of the higher education
employees.

Texas also argued that DCA has never demanded that Texas
contribute a proportionate reserve fund balance in the
past when Texas hired large numbers of state employees to
work on new initiatives, including non-federal
activities. Texas noted that the lines of federal
funding are not as clearly demarked as DCA implied, in
that many state employees who are UGIP members do not
receive any federal funding support while a significant
number of the newly enrolled higher education employees
do. Texas argued that under DCA's analysis, a dilution
of the federal interest occurs every time a new employee
is hired to work on state-only activities, and that DCA's
position would require states to keep track of their
employees by funding source and make constant
contribution rate and fund balance adjustments for new
employees in order to stave off claims that one group of
employees is benefiting at the expense of another. Texas
cautioned that an onerous administrative burden would
result from sustaining DCA's position.

Texas also disagreed with DCA's methodology for
calculating the disallowance. Texas argued that even
assuming the validity of DCA's legal position, DCA should
be entitled to recover only a pro rata share of the
federal contribution reflecting the relative proportion
of the UGIP membership made up by the higher education
employees, rather than the entire federal share of the
reserve fund.

Analysis

In section one below, we discuss the cost principles
underlying the disallowance and conclude that these
principles require that the federal share of the UGIP
reserve be adjusted as of the time Texas enrolled the
higher education employees. We first discuss the basic
guidelines on allocability and the other requirements of
OMB Circular A-87 that would also support the
disallowance here. We then address Texas' arguments
concerning the cost principles, and finally DCA's
alternative basis for the disallowance. In section two,
we discuss why DCA is not entitled to recover the entire
federal share of the reserve fund, but only that portion
of the reserve allocable to the higher education
enrollees. In section three, we discuss why it is
necessary to remand the disallowance to DCA to enable the
parties to document how the required adjustment in the
disallowance should be computed.

1. The cost principles require an adjustment in the
existing federal share of the UGIP reserve fund.

A. The basic guidelines on allocability and other
requirements

OMB Circular A-87 provides as a "basic" guideline that a
cost must be allocable to the grant program in order to
be an allowable cost of that program. The Circular
further provides that a cost is allocable to a particular
cost objective of the grant program only to the extent of
benefits received by such objective. We here conclude
that Texas violated these provisions of the cost
principles when it enrolled the higher education
employees into the UGIP health insurance plan without
refunding to HHS a proportionate share of the UGIP
reserve fund balance that now benefits the higher
education employees and, concomitantly, no longer
benefits the federal programs that contributed to the
reserve fund in the first place. As we discussed above,
a wide range of federal programs contributed to the UGIP
reserve fund for a period of approximately 16 years prior
to the enrollment of the higher education employees.
This reserve fund could remain allocable to the
contributing federal programs only to the extent that the
reserve fund continued to benefit those programs in
proportion to their contributions. When Texas enrolled
the higher education employees without providing any
increase in the reserve fund, a proportionate share of
the existing reserve fund no longer benefited the
contributing programs and became allocable to the new
members. Since this proportionate share of the reserve
fund was no longer allocable to the contributing
programs, it may properly be disallowed under the cost
principles.

OMB Circular A-87 also forbids for any reason the
shifting of costs properly allocable to one or more
federal programs to other federal programs. This
provision prohibits the retention of costs as chargeable
to HHS' programs when those costs are no longer properly
allocable to those programs. Following the enrollment of
the higher education employees into the UGIP health
insurance plan, those employees received the benefit of a
proportionate share of the existing reserve fund of that
plan. The cost of that share of the fund is thus
properly allocable to the programs that support the
higher education employees and not to the programs that
had previously supported the employees in UGIP.
Paragraph C.2.b precludes the shifting of any of these
costs back to the federal programs that had traditionally
supported the UGIP employees since the costs are no
longer allocable to those programs. In its post-hearing
submission, Texas cited the language from paragraph C.2.b
which forbids shifting of costs "to overcome fund
deficiencies," and argued that there had been no
violation here because no fund deficiency was transferred
to UGIP. Texas Post-Hearing Brief (Br.) at 9. However,
the quoted sentence ends, "or for other reasons" and so
is reasonably read as forbidding shifting of costs to
federal programs regardless of motivation.

A grantee that receives funding for contributions to a
reserve fund in a health insurance plan does not have the
right to unilaterally make those reserves available to
programs that had not contributed to them. If the
federal government tolerates this type of manipulation,
it in effect permits violations of appropriations laws by
permitting states to shift costs intended for one purpose
to being used for another purpose. Texas' actions here
were the same as if it had removed the portion of the
reserve fund balance now allocable to the higher
education employees and used that funding for purposes
that were completely unrelated to the purposes of the
original funding programs.

The Board has long held that a grantee which receives
federal funds has the affirmative duty to document that
those funds were used for the purposes for which they
were awarded. Rural Day Care Association of Northeastern
North Carolina, DAB No. 1489, at 8 (1994); National Urban
League, Inc., DAB No. 289, at 2 (1982). The principle
that funds be used for the purposes of the programs under
which they were awarded is apparent from the general
requirement in OMB Circular A-87 that costs, to be
allowable, must be necessary and reasonable for the
proper and efficient administration of the grant program.
OMB Circular A-87, Att. A, C.1.a. See, e.g.,
California Dept. of Finance, DAB No. 1592 (1996); Texas
Dept. of Human Resources, DAB No. 617 (1985); Oregon
Dept. of Human Resources, DAB No. 493 (1983).
Additionally, a longstanding ruling of the Comptroller
General imposes on grantees the obligation to use grant
funds for the purposes of the grant, and holds that the
government has a reversionary interest in funds that are
expended for unallowable purposes. 42 Comp. Gen. 289,
294 (1962), cited in McLean Hospital, DAB No. 258 (1982).
Where, as here, the awarded funding is used to pay
health insurance costs, the affirmative duty to document
that funding was used to support the reserve fund
continues for the duration of the health insurance plan.

A health insurance reserve fund protects health insurance
plans against unforeseen funding shortfalls such as could
be caused by underestimates of employee health care
claims for a given period. Had Texas placed the higher
education employees in a new health insurance plan on
September 1, 1992, instead of enrolling them in UGIP,
Texas would have been required to make sure that these
employees had an adequate reserve fund, either by
creating a brand new reserve fund from its general
revenues or by setting the contribution rates high enough
to accumulate a reserve fund. 3/
Admission of the higher education employees to UGIP with
its substantial reserve fund eliminated the need to fund
a separate reserve for the higher education employees.
Texas and the higher education employees realized
substantial benefits and cost savings through the
existence of the UGIP reserve. Not only was Texas
protected from the costs of having to establish a new
reserve fund for higher education employees, it was also
protected from having to reassess the sufficiency of the
accumulated reserve fund balances of the existing higher
education health insurance plans. Texas' witnesses were
unable to provide the Board with any information as to
the amount of the accumulated reserve funds of those
plans or the ultimate disposition of those funds beyond
the payment of pre-existing claims incurred by the higher
education employees. Tr. 184-85, 282-83.

Moreover, the fact that Texas could add 55,000 employees
to UGIP without increasing the reserve is in effect an
admission that the reserve had excess amounts. This
suggests that prior UGIP contribution rates had been set
too high and that Texas thus claimed more federal funding
than was necessary for the proper and efficient
administration of the programs which provided funding for
UGIP and the reserve. See OMB Circular A-87, Att. A,
C.1.a. A statement of a DCA witness indicates that
Texas state agencies performing federal program
administration functions had in this instance been
allowed to charge health insurance costs greater than
necessary for the purpose of developing a contingency
reserve excess. Witness Statement of J.L. Myers, 5.
The evidence establishes that excess reserve funds may be
used to lower contribution rates. See n. 3. Had the
excessive UGIP reserves been so applied here, the amount
of federal funding claimed by Texas in its health
insurance costs would have been lower. 4/

Finally, the cost principles also require consistent
treatment of costs. 5/ The Board has found violations
of the consistency principles when the federal government
has been charged at a higher rate than the state paid on
similar cost items, such as pension funds. Indiana
Public Employees' Retirement Fund, DAB No. 314, at 7-9
(1982), aff'd, Board of Trustees of the Public Employees'
Retirement Fund of the State of Indiana v. Sullivan, 936
F.2d 988 (7th Cir. 1991), cert. denied, 502 U.S. 1072
(1992). These principles were violated here because the
funding sources of the higher education programs provided
no UGIP reserve funding, while other funding sources,
including federal funding sources, were required to bear
the entire cost of the UGIP reserve fund. Had the
reserves which had accumulated for the higher education
employees been applied to the UGIP reserve, as were the
reserve funds from the original UGIP members, the reserve
would have been even greater, which would have permitted
even greater reductions in contribution rates and thus
lowered claims for federal funding.

B. Texas' arguments

Texas made several arguments as to why the cost
principles would not support a disallowance. We reject
these arguments for the following reasons:

o It is irrelevant to our analysis here that some of the
original programs contributing to the UGIP reserve may
not have received any federal funding or that some of the
programs supporting the higher education employees prior
to their enrollment in UGIP may have. This disallowance
only focuses on the federal funding contributed to the
UGIP reserve fund as of September 1, 1992. To the extent
that some of the participating UGIP employees may not
have been funded at all by federal programs prior to that
date, the reserve fund balance attributable to them would
not be affected by this disallowance. Moreover, while
some of the higher education employees may also have been
supported by federal programs prior to their enrollment
in UGIP, that funding obviously in no way contributed to
the funding balance at issue here. Texas asserted and
DCA did not dispute that many Texas colleges and
universities receive federal funding and that many of the
higher education employees work on programs eligible for
federal funding. What is critical here, however, is that
none of the federal funding for higher education
employees prior to their enrollment in UGIP ever became
part of the UGIP reserve fund. Even funding that may
have been applied to the reserves for the higher
education health insurance plans never became part of the
UGIP fund reserve because Texas did not authorize any
transfer of these reserves to the UGIP plan. Texas never
identified what became of those reserves beyond paying
the pre-existing claims of the higher education
employees.

o Texas' argument that no costs were shifted to federal
programs because the higher education employees as a
group had a positive claims history that generated
surplus reserve funds is an after-the-fact
rationalization and fails to focus on the point in time
at which the cost principles were violated. Texas and
the higher education programs received the benefits of
the UGIP reserve immediately upon their enrollment into
the plan and it was at that time that the applicable cost
principles were violated. The federal government was
entitled to seek recovery of the improperly allocated
reserve funds as of that time. Moreover, there was no
way of knowing at that time what the claims experiences
of the higher education employees would ultimately turn
out to be. Further, while the claims history of the
higher education employees has been initially positive,
that experience could change. There also is no basis
within the makeup of the plan for examining the claims
history of the higher education employees apart from
other members of UGIP. While different groups of UGIP
members may have variously different claims experiences,
they are treated uniformly through uniform contribution
rates and reap uniform benefits through the existence of
the reserve, without regard to the extent to which they
may utilize the reserve fund. Any differences in claims
among various groups of employees should not be a basis
to continually revisit the issue of the reserves that
arose at the time the higher education employees were
enrolled in UGIP.

o It has no bearing on this disallowance that DCA could
have but did not take disallowances for other UGIP
expansions. These expansions included employees engaged
in primarily state-funded activities, as with the 20,000
employees that Texas' witnesses reported were hired by
the Texas Department of Criminal Justice. Tr. 194-95,
238-39; Texas Ex. K. Those changes in UGIP membership,
as well as more routine expansions and contractions which
Texas warned would lead to further disallowances and
require the tracking of each employee based on funding
source and activity, are different from the instant facts
in both nature and scope. Changes in health plan
membership resulting from ongoing work force and
programmatic changes may be expected in the course of
state government operations. Such changes affect the
number of state agency employees covered by an existing
insurance plan, rather than, as here, the incorporation
into an existing plan of a substantial number of
employees who historically had been insured under other
health plans and accounted for in other cost centers.
The enrollment of the higher education members is also
distinguishable from the enrollment of new employees as
any reserves that remain in the new employees' former
plans benefit their successors in interest in those
plans, whereas here the higher education employees'
former health plan reserves covered only pre-existing
liabilities and were then dissolved.

o The expansion of UGIP through enrollment of the higher
education employees was also of far greater scope than
the examples of programmatic expansions cited by Texas.
It resulted in an immediate increase in UGIP's membership
by almost 40 percent without any addition to the reserve
fund which had accumulated over 16 years for the benefit
of the existing programs which had funded it. Thus, this
was clearly a material change to the way Texas claimed
health insurance costs for federal reimbursement. In any
event, whether or not DCA acts in a consistent fashion
regarding other changes to UGIP membership is not
relevant here and not a bar to upholding this
disallowance.

o Finally, the situation here is materially
distinguishable from the routine enrollment of new
employees in UGIP. Texas' argument that it was not
familiar with any other instance of new enrollees in a
health plan bringing with them a reserve fund balance
misses the point entirely. Texas here had complete
control over the process by which the higher education
employees were removed from their previous health
insurance plans and enrolled in UGIP, and could have
provided funds for an equivalent reserve for the higher
education employees if it had wished to avoid any
adjustment in the existing federal contributions to the
reserve. Our decision does not require that every new
Texas employee be required to contribute to a reserve
fund upon enrollment in UGIP.

C. DCA's alternative basis for the disallowance

Texas also took issue with DCA's determination, contained
in its initial disallowance letter dated June 26, 1995
and in the final decision of the HHS Regional Director
dated September 25, 1995, that the enrollment of the
higher employees was a change in Texas' method of
accounting for costs claimed under its SWCAP for which
prior approval from HHS was required under the terms of
the plan. The provision in question requires prior
approval of the cognizant federal agency for "changes to
the method of accounting for costs which affect the
amount of reimbursement resulting from the use of the
statewide cost allocation plan" and advises that the
failure to obtain prior approval may result in cost
disallowances. SWCAP, Section II.B, Texas Ex. DD. Texas
argued that this provision was not applicable because
DCA, in invoking it, had erroneously characterized the
transfer of the higher education employees from their
former health plans into UGIP as a "merger" of the health
plans. Texas argued that the transfer of the higher
education employees from their former health plans into
UGIP was not a merger and did not represent a change in
its method of accounting for costs requiring prior
approval, because UGIP did not acquire any of the assets
or liabilities of the employees' former health plans.
Texas suggested that what occurred here was
indistinguishable from other instances of plan accretion
which could not reasonably be viewed as changes to the
method of accounting for costs.

Since we sustain the disallowance in principle on the
basis that Texas violated the provisions of OMB Circular
A-87 when it enrolled the higher education employees
without making an appropriate adjustment to the federal
government's contribution to the reserve fund, we do not
need to address DCA's initial determination that Texas
may have violated the provisions of its SWCAP. 6/ In
any event, DCA appears to have abandoned this position
during proceedings before the Board since its witnesses
conceded that the inclusion of the higher education
employees in UGIP was not technically a merger of the
health plans for accounting purposes, and DCA did not
argue that a merger occurred or cite this basis for the
disallowance in its brief or in its post-hearing
submission. Tr. 36-37, 111-12, 139-40.

2. Texas must only return the federal share of the
reserve fund allocable to the higher education
employees as of September 1, 1992.

As discussed above, we conclude that Texas violated
applicable cost principles by enrolling the higher
education employees in UGIP without providing an
appropriate adjustment to the federal government from the
UGIP reserve fund. However, we do not agree with DCA's
determination to disallow the entire amount of federal
funding in the $98 million reserve that had accumulated
as of September 1, 1992. DCA disallowed all federal
funding in the UGIP reserve so that the existing UGIP
membership would "start out" in the expanded UGIP on the
same level as the higher education employees with respect
to the reserve: that is, with no reserve. Tr. 39.
However, this remedy results in the same sort of shifting
of costs and benefits that led DCA to take the
disallowance in the first place. DCA complained that the
higher education activities benefited from a federally
funded reserve to which they had not contributed. As
Texas correctly pointed out, removing all federal funds
from the reserve would result in the federal programs and
activities benefiting from a UGIP reserve consisting
entirely of state funds. Instead of the higher education
activities being subsidized by the federal programs and
activities which contributed to UGIP, as DCA argued was
now the case, the federal funding sources would be
subsidized by the exclusively state funds remaining in
the reserve.

Disallowance of the entire federal portion of the UGIP
reserve fund is also not consistent with DCA's position
that the federal share of the UGIP reserve fund should
benefit only those operations and activities which
generated it. DCA Br. 7. The federal interest in the
reserve fund was diluted, not eliminated, by the entrance
of the higher education members, and the operations and
activities which generated the reserve fund continued to
benefit from it, although to a lesser extent.

We thus conclude that the full disallowance amount
proposed by DCA would not be authorized by the cost
principles supporting this disallowance. These
principles did not affirmatively require Texas to
increase or decrease the size of the reserve fund at the
particular time that Texas enrolled the higher education
employees. Texas had the discretion to reassess the
appropriate level of the reserve fund at that time by
looking at the needs of the health insurance plan as a
whole. The cost principles do, however, call for a
reassessment of the proper allocation of the costs and
benefits for the reserve fund's contributing programs
following Texas's decision. The appropriate disallowance
remedy following such a reassessment is not for Texas to
return the entire federal share of the reserve fund but
rather the federal share of that part of the reserve fund
as of September 1, 1992 that became allocable to the
higher education employees.

3. A remand is necessary to allow the parties to
complete the proper calculation of this
disallowance.

The computation of the disallowance in this appeal is a
three-step process. Based on the analysis in the
previous sections, the first step involves a computation
of the part of the existing reserve that would be
allocable to the higher education employees immediately
following their enrollment into UGIP. This amount can be
computed by completing the following formula using the
appropriate amounts as of September 1, 1992: the number
of the newly enrolled higher education employees divided
by the entire UGIP enrollment times the amount of the
reserve fund. The second and third steps in the
computation involve an isolation of the employer portion
of this part of the reserve fund from the employee
portion and then finally an isolation of the federal
share of the employer portion. While the parties have
provided some evidence for computing each of the three
steps and have stipulated as to the enrollment totals and
the proportion of the UGIP membership composed of higher
education employees, they have not reached precise
agreement concerning the results. 7/ They have,
however, indicated that they would be willing to
cooperate in attempting to develop an accurate
computation of an adjusted disallowance.

Accordingly, we are remanding this appeal to DCA so that
it can work with Texas in attempting to develop an
accurate computation of an adjusted disallowance
consistent with the analysis of this decision.

Conclusion

On the basis of the foregoing, we conclude that the cost
principles require an adjustment in the existing federal
share of the UGIP reserve fund at the time that the Texas
legislature enrolled 55,000 higher education employees
and failed to increase the size of the reserve fund to
reflect their newly acquired interest. We remand this
appeal to DCA so that it can work with Texas in computing
that part of the reserve fund that must be returned to
the federal government. If the parties are unable to


reach an agreement concerning the amount, Texas may
return to the Board within 30 days of receiving DCA's
determination of the amended disallowance amount.


Judith A. Ballard


M. Terry Johnson


Donald F. Garrett
Presiding Board Member


* * * Footnotes * * *

1. The parties described the number of higher
education employees transferred into UGIP on September 1,
1992 as ranging from 50-60,000 and subsequently
stipulated the number of employees as "some 55,000." The
parties also stipulated that there were approximately
139,000 UGIP members immediately prior to September 1,
1992. Joint Stipulation Nos. 1, 2. However, it appears
that this figure understates the UGIP membership. UGIP
enrollment figures supplied by Texas show that for fiscal
year (FY) 1991-92 there were 139,399 active UGIP members,
27,633 retirees and surviving spouses, and 1,314 "COBRA"
participants. Texas Ex. H.
2. The provisions of OMB Circular A-87 apply to
all federal agencies responsible for administering
programs that involve grants and contracts with state and
local governments. 46 Fed. Reg. 9548 (1981).
Regulations at 45 C.F.R. § 74.171(a) in effect at the
time applicable to this disallowance make the cost
principles of OMB Circular A-87 applicable to programs
administered by HHS; other federal agencies have similar
regulations. See current 45 C.F.R. § 74.27, 59 Fed. Reg.
43,760 (August 25, 1994). A revised version of OMB
Circular A-87 was published in the Federal Register on
May 17, 1995 (60 Fed. Reg. 26,484). Citations in this
decision are to the earlier version. The Board has held
that a state as a whole must be viewed as a single unit
responsible for the administration of grant funds. This
is apparent from the definition of "grantee" at 45 C.F.R.
§ 74.3. Oregon Dept. of Human Resources, DAB No. 1298,
at 14 (1992); Louisiana Dept. of Health and Hospitals,
DAB No. 1176, at 10 (1990). See current 45 C.F.R. § 74.2,
definition of recipient.
3. The evidence readily establishes that the
existence of a reserve fund affects rate setting and that
a sufficiently large reserve permits lower contribution
rates than if there is a small or no reserve fund
balance:

o Philip S. Dial, a consulting actuary who appeared as
a witness for Texas, stated that a reserve fund
balance removes the need for a margin to protect
against adverse experience and allows contribution
rates to be established at a level that is lower than
what otherwise would be required, and that an
excessive fund balance permits contribution rate
credits. Tr. 197, 263-64; DCA Ex. 3.

o The provision of the Texas Insurance Code requiring
a fund balance of at least 10 percent of the claims
expected to be paid in the following year also
requires that the contribution rates include
contributions to the fund balance if it drops below
that level. Texas Ins. Code, Art. 3.50-2, § 5(f), as
amended, Texas Ex. E.

o The report of the U.S. General Accounting Office
that Texas introduced reflects concern that reducing
reserves to one month's benefits would result in
larger annual premium (contribution rate) increases to
replenish the reserves in less time. Texas Ex. Q at
10.

o Language in the Texas Legislature's general
appropriations bill for FY 1992-1993 directs ERS to
use surplus UGIP funds to reduce the state's share of
UGIP premiums for FY 1992. Texas Ex. T at I-99.

o A letter dated April 21, 1992 from Philip S. Dial to
the ERS Board of Trustees states that excess income
earned on UGIP funds would reduce the contribution
rates charged to program members. Texas Ex. V at 2.

o Federal law governing federal employee health plans
provides that reserves accumulated by those plans may
be used, among other things, to reduce the
contributions of the government and the enrollees or
to increase the benefits provided by a plan. 5 U.S.C.
§ 8909(b); see also U.S. v. Littriello, 866 F.2d 713,
714 (4th Cir. 1989) (the balance of the fund is
examined when calculating the amount of the next
year's premium--the more money in the fund, the lower
the premium).
4. Texas also could reasonably be viewed as
having received a rebate of the amounts of excess
employer contributions which it should have treated as a
credit, applicable to the programs to which the original
employer contributions were charged. In effect, Texas
treated the excess reserve as available for its own
purposes -- to substitute for the reserves which
otherwise would have had to be maintained for the higher
education employees. Texas' actions are analogous to the
situation in California Dept. of Finance, DAB No. 1592
(1996), where the state used excess earnings on employee
contributions to a pension fund to pay its employer
contributions, in which federal funding was then claimed.
(That decision is currently being appealed.) Texas is
asserting ownership over an amount of funds by reason of
its role as employer, without recognizing the federal
share in the employer contributions that gave rise to the
funds.
5. Costs must be: consistent with policies,
regulations, and procedures that apply uniformly to both
federally assisted and other activities of the unit of
government of which the grantee is a part; and accorded
consistent treatment through application of generally
accepted accounting principles appropriate to the
circumstances. OMB Circular A-87, Att. A, C.1.d, e.
Employee fringe benefits must be granted under approved
plans and be distributed equitably to grant programs and
to other activities. Att. B, B.13.b.
6. The provision at issue merely states that
failure to obtain prior approval "may" result in cost
disallowances. A disallowance presumably may occur if
DCA subsequently determines as here that the changes
violated the cost principles or other applicable rules or
policies. Thus, the disallowance would not stem directly
from the prior approval requirement in the SWCAP but from
other authorities.
7. While the higher education employees would
appear to comprise 28 percent of total UGIP membership,
based on the stipulated UGIP enrollment figures of
139,000 UGIP members and 55,000 higher education
employees, the parties stipulated that the higher
education employees represented approximately 24 percent
of total participation in UGIP; witnesses referred to
this figure as 24.4 percent. Tr. 101-06; Texas Ex. U.
As noted above, however, the enrollment figures do not
accurately reflect total UGIP enrollment as reflected in
Texas' exhibits. Texas Exs. H, U; See n. 1.

(..continued)