Department of Health and Human Services
DEPARTMENTAL APPEALS BOARD
Appellate Division
DATE: November 17, 1997
SUBJECT: Alabama Department of Finance
Docket No. A-93-25
Control No. A-04-90-00018
Decision No. 1635
DECISION
The Alabama Department of Finance (Alabama) appealed the decision of this Department's Division of Cost Allocation (DCA) to disallow $13,721,353, representing federal funding for insurance premiums maintained as reserve funds of the Alabama State Insurance Fund (SIF) and for interest charges on those funds. The SIF is a self-insurance plan maintained by Alabama to protect state and local properties against physical loss. Funds from various federal programs help support the premium payments that state and local agencies contribute to the plan. The SIF places any premium monies not used to cover casualty losses for a given period into its Reserve.
DCA's disallowance had three components. First, DCA disallowed what it determined was the federal share of approximately $43 million that the Alabama legislature transferred out of the SIF Reserve and then used for other purposes not contemplated by the federally funded programs. Second, DCA determined that Alabama was liable for interest on the federal share of the funds that the legislature had transferred out of the SIF Reserve from 1980 to 1987. Finally, DCA disallowed the federal share of a portion of the SIF Reserve that DCA characterized as excessive, as of the beginning of federal fiscal year 1991 (FY 1991).
Alabama argued that its accountability to the federal government for the funding of SIF premiums did not extend beyond the point at which the state and local agencies paid the premiums into the SIF plan, and that DCA therefore lacked authority to disallow federal funds based on how the SIF used the funds in its Reserve. Alabama argued, moreover, that the federal share of any funds transferred from the Reserve should not be the subject of a disallowance because the funds had merely been loaned from the SIF to the other state programs, and thus could still properly be viewed as part of the SIF Reserve. Alabama disagreed that it should be subject to charges for interest on the federal share of the funds transferred out of the SIF by the legislature. Alabama also argued that no portion of its SIF Reserve was excessive as of FY 1991. Finally, Alabama argued that in the event the Board upheld any part of the disallowance, the Board should not rely on DCA's standard estimates for determining the federal share of the Reserve funds, but rather on evidence developed in Alabama's own audit concerning the proper federal share percentages.
The record in this appeal consists of the parties' written briefs and motions, their extensive appeal files, their joint stipulations of fact, and their witness statements and deposition transcripts. This appeal was stayed for extensive periods of time while the parties participated first in settlement discussions, and then in negotiations that led to stipulations of fact and written witness testimony which the parties submitted in lieu of the in-person hearing that Alabama had requested. Beginning in December 1996, Alabama also filed six motions seeking dismissal of these proceedings and other relief, which we address at the end of our decision.
For the reasons explained below, we uphold a disallowance in an amount equal to the federal share of the Reserve funds removed from the SIF by the Alabama state legislature. Once the Alabama state legislature transferred the funds out of the Reserve, the funds could no longer be considered as having been applied to the costs of insurance premiums allocable to the original federally funded programs to which they were charged. However, we reverse the disallowance for the imputed interest on the transferred funds because DCA did not show that it had authority to recover interest not actually earned on grant funds received by a state. We also reverse the disallowance for the federal share of the SIF Reserve characterized by DCA as excessive, since we conclude that Alabama here demonstrated that its Reserve was within the range of reasonable reserves based on the particular circumstances of its SIF. In upholding the portion of the disallowance for the federal share of the transferred funds, we conclude that Alabama's computation of the federal share percentages attributable to the transferred funds was more probative of the actual circumstances in Alabama than DCA's estimates.
Background
The following statement of facts is based primarily on the parties' joint stipulations of fact.
The Alabama SIF is a self-insurance plan established by the Alabama legislature in 1923 to provide protection against damage to buildings, machinery and equipment owned by the state of Alabama and by local governments. Self-insurance is the practice of undertaking to absorb casualty and disaster losses internally, without buying insurance for such losses from an outside source. Pennsylvania Office of the Budget, DAB No. 1234 (1991), aff'd, 996 F.2d 1505 (3rd Cir. 1993), cert. denied, 510 U.S. 1010 (1993). Alabama's SIF insures all state-owned property in Alabama, and local governments are eligible to purchase insurance from the SIF as well. State and local entities insured by the SIF pay premiums for the insurance based on the value of the property covered.
The SIF premium levels are determined annually by the Division of Risk Management (DORM) of the Alabama Department of Finance. Under Alabama law, DORM sets premiums at not more than 60% of commercial insurance rates, described as the "ISO" rates. Alabama reported that 325 state and local agencies purchase insurance from the SIF. Alabama did not dispute DCA's determination that state-owned properties account for 49% of SIF premium payments and locally-owned properties account for 51% of the payments. Ala. Ex. 6, at 013365; DCA Brief (Br.) at 9-10. During the period covered by the U.S. Department of Health and Human Services (HHS) Office of Inspector General (OIG) audit, fiscal years ending September 30, 1977 - September 30, 1987 (FYs 1977-1987), the value of the property insured by the SIF rose from less than $2.2 billion to approximately $7.7 billion. The SIF provides coverage for the full replacement cost of insured property, without depreciation.
Because of their nature, self-insurance funds require that a reasonable fund balance or "reserve" be carried over from year to year. Pennsylvania. The Alabama SIF maintains a Reserve fund to cover potential extraordinary property damage claims. The SIF also purchases "reinsurance," which is commercial insurance that is intended to pay for potential losses above a certain threshold level.
Funds in the SIF Reserve are invested by the DORM, and the size of the SIF Reserve affects the level of premiums: if the Reserve falls to too low a level, premiums must be increased to build up the Reserve; high Reserve levels on the other hand mean that premiums can be reduced. Instead of reducing premiums, however, the Alabama legislature in 1980 and 1986 authorized the transfer of up to $50 million from the SIF Reserve to the state's general fund, to be used to finance Alabama's Medicaid program, its Department of Mental Health and Retardation, and its Department of Public Health, and for other purposes. A total of $43,260,00 was transferred from 1980 through 1987. Although the legislature provided that the money could be repaid with 8% interest when it was determined that sufficient funds were available, it is undisputed that no funds were ever returned to the SIF.
The DORM has the responsibility for setting the Reserve levels as well as the annual premium rates. Alabama reported that, over the years, the DORM has commissioned actuarial studies which have produced recommendations of appropriate Reserve levels. Alabama submitted the reports of the actuarial firms with its appeal file. One firm, the Wyatt Company, prepared several reports beginning in 1982. Wyatt recommended Reserve levels ranging from $48.2 million for 1980 to $110 million for 1990. Ala. Exs. 92-94, 96; Joint Stipulations of Fact 35-40. Another firm, Anistics, concluded in 1991 that the required Reserve level ranged between $29 million and $79 million, depending upon the extent to which the SIF utilized commercially available reinsurance for 1991. The DORM Risk Manager stated in November 1996 that, as a result of these actuarial reports, the SIF tried to maintain Reserve levels between $79 and $110 million. Alabama argued generally that a reserve within these levels was necessary because there was a substantial risk that commercial reinsurance could become unavailable, or because the SIF might decide to forego using commercial reinsurance. The auditors retained by OIG determined that the SIF Reserve had a fund balance of $30,170,086 as of September 30, 1987 (not counting the approximately $43 million transferred out of the SIF by the legislature), and DCA subsequently reported that this amount had increased to $49,189,551 as of September 30, 1990. Ala. Exs. 6, 9. The DORM risk manager reported that the SIF Reserve had a balance of about $52 million in 1990 not including the transferred funds, which were treated as a loan receivable. Ala. Ex. 147.
Many of Alabama's state and local government agencies administer federal grant programs and are thus entitled to have a portion of the SIF premiums on property used in the administration of those programs reimbursed by the federal government. Generally, the SIF premiums are charged to various federal programs using a cost allocation plan (CAP), which specifies the allocation of administrative costs among the various programs administered by state agencies. HHS is the cognizant federal agency responsible for the negotiation, approval, and audit of a CAP submitted by the state. In this capacity, this Department acts on behalf of all other federal agencies. Office of Management and Budget (OMB) Circular A-87, Attachment (Att.) A, . J.4. This disallowance thus involves federal funds provided to all Alabama state agencies for insurance premiums, not just those provided under HHS programs.
OIG Audit and Determination of the Disallowance Amount
This disallowance resulted from a review of Alabama self-insurance funds for FY 1977 to 1987, conducted by a CPA firm under contract with OIG. Their report (the Carmichael Report) determined that the SIF had accumulated reserves in excess of levels allowable under federal cost principles, that $43,260,000 had been transferred out of the SIF to the Alabama Medicaid Agency, Department of Public Health, and the Department of Mental Health and Mental Retardation, and that as of September 30, 1987 approximately $12,460,793 in interest had been lost to the SIF as a result of the transfers. Ala. Ex. 6.
The Carmichael Report noted that as of September 30, 1987, Alabama had a reinsurance policy, purchased with SIF funds, that protected it against all claims in excess of $5 million. The auditors thus concluded that any SIF reserves over $5 million were excessive, and recommended that the federal share of the excess reserves be refunded. Accordingly, the auditors recommended that Alabama return the federal share of $80,890,879, the amount of the "adjusted reserve fund balance" less the allowable level of $5 million. (The $85,890,879 adjusted reserve fund balance as of September 30, 1987 consisted of the $30,170,086 in the SIF Reserve, the $43,260,000 in transferred funds, and $12,460,793 in interest that the auditors reported was lost because of the transfers. Ala. Ex. 6.). The auditors determined the federal share of the excess Reserve balance to be $9,990,023, and recommended that Alabama refund that amount. Ala. Ex. 6. Calculation of the federal share was based on DCA's determination that federal funds paid for 20% of SIF premiums received from state government agencies, and 5% from local governments. Ala. Ex. 6, at 013365. The parties referred to these percentages as the "standard estimates."
In issuing its disallowance determination, DCA did not adopt OIG's approach for determining acceptable reserve levels. Instead of allowing a $5 million reserve based on the amount not covered by reinsurance, DCA determined that a reasonable reserve would be sufficient to cover up to three years' worth of potential losses to SIF property not covered by reinsurance. DCA determined that over the previous 15 years, property covered by the SIF had experienced an average annual loss not covered by reinsurance of 0.06% of total value. DCA applied this figure to the $8.2 billion value of SIF property as of 1991 to determine potential annual losses. Based on these calculations, DCA determined that $14,760,000 was an acceptable reserve balance, whereas the SIF had an adjusted reserve fund balance as of September 30, 1990 of $125,864,076. By that time, the adjusted reserve balance consisted of $49,189,551 in the SIF Reserve, the $43,260,000 in transferred funds, and the interest thereon, which had grown to $33,414,525. Accordingly, DCA disallowed the federal share of the $111,104,076 difference, which it determined was $13,721,353, based on DCA's standard estimates. Ala. Exs. 7,9.
Analysis
1. Transferred funds
The first issue raised by this disallowance is whether DCA properly disallowed the federal share of the portions of the SIF Reserve, totalling $43,260,000, that were removed from the SIF by the Alabama legislature from 1980 through 1987. Although these transfers were characterized by the legislature as loans, it is undisputed that no funds have ever been returned to the SIF, nor has the legislature ever authorized interest payments to the SIF based on the transfers.
The allowability of costs claimed for reimbursement by Alabama in its administration of federal grant and contract programs is governed by OMB Circular A-87. (The parties to this disallowance stipulated that the disallowance is based on OMB Circular A-87.) For claimed costs to be allowable under the Circular cost principles in effect during the applicable period, the costs must be: necessary and reasonable for the proper and efficient administration of the federal program, "allocable" to the program, and "net of all applicable credits." OMB Circular A-87, Att. A, .. C.1.a,g. Other provisions of Attachment A of OMB Circular A-87 address the requirement of allocability more specifically:
In addition to the cost principles, the various federal program statutes and regulations (and appropriation statutes) that authorize the use of federal funding for payment of administrative costs require that the funding be used only for the authorized programmatic purpose. For example, the Medicaid program limits reimbursement for administrative costs under that program to amounts "found necessary by the Secretary for the proper and efficient administration of the State plan." Section 1903(a)(7) of the Social Security Act. Similar provisions existed during the relevant period in other Social Security Act programs, such as the Aid to Families with Dependent Children (AFDC) Program (section 403(a)(3) of the Act) and the Title IV-E Foster Care and Adoption Assistance Program (section 474(a)(3) of the Act). It is also a general principle of federal appropriations law that federal funds be used only for authorized purposes. Moreover, the Board has repeatedly held that under the cost principles and Part 74, a grantee has the burden of documenting the allowability of costs charged to federal funds. See, e.g., Greater Philadelphia Health Action, Inc., DAB No. 1605 (1996); New Jersey Dept. of Human Services, DAB No. 1549 (1995); New York State Dept. of Social Services, DAB No. 1036 (1989).
When the federal government originally contributed to the SIF Reserve by funding its allocable share of the premium costs for insuring state property used in federal programs, the cost principles and other programmatic authorities required Alabama to use the funding for the authorized programmatic purpose. While Alabama did initially place federally funded premiums into the SIF system and ultimately the SIF Reserve, the Alabama legislature subsequently removed $43,260,000 from the SIF Reserve and used that funding to meet state-only commitments in various programs. The federal portion of the removed reserves represented both the original federal premium contributions and accumulated interest derived from those contributions while the contributions remained in the Reserve. From the point in time that these funds were removed from the Reserve, the funds no longer benefited the original contributing programs and no longer fulfilled the terms of the original authorizing legislation.
Alabama nevertheless argued that the federal contributions which were intended to fund the SIF premiums somehow lost their federal character when the state agencies that received the federal funds paid their insurance premiums to the SIF. However, the requirement that federal funds be used only for their originally authorized purpose (and not a different "state" purpose) did not terminate when Alabama transferred the premiums to the SIF system. Instead, the cost principles and the authorizing statutes and regulations created an ongoing obligation to account for these funds and to ensure that funds authorized to cover SIF premiums remained in and continued to benefit the programs which funded the SIF Reserve.
As the Board observed in Pennsylvania, the very nature of self-insurance funds requires that a fund balance be carried over from year to year (unlike accounts maintained for federal assistance programs such as Medicaid and AFDC). "The self-insurance funds are, in essence, contingency funds to be tapped, or disbursed, only when claims are filed against them and paid by the State." Pennsylvania at 9. Accordingly, to fulfill its burden as a grantee to document that federal funds were used for allowable program expenditures, Alabama was required to show that the federal funds used to pay SIF premiums were either maintained in the SIF Reserve, or used to pay property damage claims and other SIF-related expenditures. When the various agencies made their contributions to the SIF on behalf of federally-funded programs, those contributions were based on legislation authorizing the federal government to pay part of the costs of administering certain programs, including the costs of insuring for damages to state and locally-owned property. See Pennsylvania at 10. Alabama failed in its duty to use the federal funds for the costs of self-insurance when it removed them from the SIF Reserve and used them for other purposes.
The Board has moreover held that the state as a whole must be viewed as the 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. The basis for this rule is amply illustrated here. A state cannot be allowed first to receive funding through one of its agencies for a specially authorized federal purpose, and then be able to simply transfer those funds to another agency within the state and thereupon lose all accountability for the funding to the federal government. When the Alabama legislature removed funds from the SIF Reserve, it abrogated not only its responsibility to the federal government but also the expectations of the various state entities that had funded the SIF premiums that any SIF reserves would be invested to pay for future damages, and to reduce future premium rates. See Testimony of Jerry Carpenter, Ala. Ex. 146. (Alabama law establishing the SIF provides that SIF premiums constitute a trust fund, and requires that the "unearned net premium computed on a pro rata basis shall be considered as a liability and carried as a reserve." Ala. Code .. 41-15-2, 41-15-10.) The actions of the legislature, moreover, demonstrated that Alabama could treat the SIF system as a fiction when it served the state's particular purposes. We find it illogical for Alabama to argue on the one hand that funds become permanently SIF funds and lose their federal character when they are transferred into the SIF and then argue on the other hand that the state legislature has residual authority to violate the rights of the premium-contributing agencies and use the Reserve funds for purposes totally unrelated to the SIF.
Alabama's removal of funds from the SIF Reserve not only caused federal programs to lose the benefit of a fully funded SIF Reserve, it also unquestionably required the SIF system to set future premiums at a higher level than would otherwise have been required if no funds had been removed from the Reserve. The SIF system contemplated that premiums not used to cover casualty losses within a particular period would be placed in the Reserve to cover extraordinary casualty losses in future years. As the SIF Reserve grew in size over time, the original contributing federal programs continued to benefit from their contributions to the Reserve because the Reserve enabled the SIF to maintain or even lower its premium rates. The removal of part of the Reserve, however, eliminated this benefit and unquestionably required contributing programs to pay higher premiums and correspondingly claim more FFP than would have been required if the funds had remained within the SIF Reserve.
Finally, we reject Alabama's argument that the transferred funds should be viewed as still remaining within the Reserve in the form of a loan (or an account receivable). The Board has held on numerous occasions that it has the authority to look behind paper transactions of federal grantees to determine their true substance. Economic Opportunity Council of Suffolk, Inc., DAB No. 679 (1985) (it is the substance of the transaction which matters, not the label it is given); North Carolina Dept. of Human Resources, DAB No. 361 (1982), aff'd, 584 F. Supp. 179 (E.D.N.C. 1984) (a grantee's accounting procedures cannot be used to mask the true nature of a transaction); see, e.g., Rural Day Care Association of Northeastern North Carolina, DAB No. 1384 (1993) (determination that a lease agreement was a less-than-arms-length transaction); Louisiana Dept. of Health and Hospitals, DAB No. 1109 (1989) (state did not have an actual expenditure for state sales tax on Medicaid items). Here, the legislature removed funds starting back in 1980 and has not yet taken any action to return the funds to the SIF. Moreover, if the transfers were truly to be viewed as loans, as Alabama argued, the legislature at the very least would have made appropriate interest payments to the SIF, which it has never done. Finally, it is noteworthy that only the Alabama legislature, and not any SIF entity, has the authority to determine when, if ever, these transfers may be returned to the SIF. Alabama did not show that the SIF could prudently operate in setting appropriate SIF premiums and Reserve levels by assuming that the transferred funds and any anticipated interest payments were actually part of the SIF Reserve when they in fact were not.
Accordingly, on the basis of the foregoing, we uphold the disallowance of the federal share of the portion of the SIF Reserve transferred by the legislature for use for other purposes.
2. Interest on the transferred funds
The second issue raised by this disallowance concerns Alabama's liability for interest on the $43,260,000 transferred out of the SIF by the Alabama legislature. DCA determined that Alabama should be charged for interest on the transferred funds, which it calculated to be $33,414,525 for the period beginning on the date of the first transfer and ending on September 30, 1990. DCA did not show that Alabama actually earned any interest on the funds removed from the SIF. Instead, DCA has argued that Alabama is liable for the amount the SIF would have earned in interest if the funds in question had not been removed, and had been invested with the rest of the Reserve funds at the annual rates received by the Reserve during the period in question.
DCA argued that since Alabama misappropriated the transferred funds and spent them for its own benefit, it should be obliged to pay for interest that the SIF Reserve would otherwise have earned during the disallowance period. DCA argued that permitting Alabama to convert the transferred funds to unauthorized uses for over ten years without requiring Alabama to account for lost interest would encourage states routinely to convert federal funds to their own uses. The states in effect would receive interest-free loans of government funds until the unauthorized use was discovered. DCA argued moreover that the interest calculated by it on the transferred funds was both an applicable credit and a "profit or other increment above cost" in violation of OMB Circular A-87. Citing New Jersey Dept. of Human Services, DAB No. 480 (1983), DCA argued that the Board has recognized the principle that a party retaining the use of money owed to another and to which it was not entitled may be required to pay interest. DCA also noted that the Alabama statutes authorizing the removal of the SIF funds called for 8% interest to be paid in the event that the funds were ever repaid to the SIF Reserve.
This Board and the courts have held in a variety of contexts that grantees may be held accountable for interest actually earned by them on investments of federal grant funds in their possession. See, e.g., Pennsylvania; Wisconsin Dept. of Health and Social Services, DAB No. 623 (1985); New York State Dept. of Social Services, DAB No. 588 (1984); New Jersey Dept. of Human Services, DAB No. 480 (1983), aff'd, Civil No. 84-2771 (N.J. Nov. 13, 1986); and North Carolina Dept. of Human Resources, DAB No. 361 (1982), aff'd, 584 F.Supp. 179 (E.D. N.C. 1984).
The Board has also held, however, that in the absence of express authority to recover imputed interest, the federal agency could not recover interest that could have been earned by the grantee but was not. Pennsylvania; New York State Dept. of Social Services, DAB No. 910 (1987). Although DCA briefed the interest issue extensively, it did not show that prior Board analysis of the interest question was incorrect. The cost principles cited by DCA, such as the rule on "applicable credits" in OMB Circular A-87, would require the recognition of a credit when the grantee actually received credit, for example, in the form of a payment of interest. DCA did not show that Alabama received such credit. Nor did DCA attempt to distinguish the situation here from the myriad of other disallowances of federal funding considered by the Board where the grantee was not found to be liable for imputed interest on disallowed funding in its possession, at least for the period prior to the issuance of the disallowance.
We agree with Alabama, moreover, that the record here does not establish that interest was actually earned because Alabama transferred funds out of the SIF Reserve. DCA did not dispute Alabama's assertion that the funds were immediately transferred to other programs to pay for expenses in those programs, as indicated in the Alabama legislation authorizing the transfers. DCA itself asserted that some of the transferred funds were used as Alabama's state share for costs in the Medicaid program against which additional federal funding was then claimed. Although DCA argued that Alabama's transfer of funds from the SIF Reserve potentially freed up other state funds that could have remained in investments earning interest, DCA did not establish whether any such interest-earning funds existed for the period at issue. Rather, the record suggests that the legislature transferred funds from the SIF Reserve for Medicaid and other program expenditures to make up funding shortfalls experienced by its state agencies.
It is also significant that while the legislation authorizing the transfers provided for the payment of 8% interest if the funds were ever in fact repaid, DCA acknowledged that none of the transferred funds had ever been repaid. If the transferred funds were ever repaid to the SIF Reserve with interest as provided in the legislation, it would appear that a portion of that interest would be attributable to the federal share of the transferred funds. DCA, however, may not impute interest based on this obligation where the legislature has never even repaid the transferred funds, much less the 8% interest.
Accordingly, on the basis of the foregoing, we reverse the part of this disallowance relating to interest charged for the transferred funds.
3. The excess reserves
The third issue raised by the disallowance concerns whether the federal share of the portion of the SIF Reserve which DCA characterized as "excessive" as of FY 1991 may properly be disallowed. In the Background above, we described the process by which DCA reached its amended determination that a portion of the SIF Reserve as of FY 1991 was excessive. Under DCA's amended determination, the excessive portion of the existing Reserve as of FY 1991 was computed by taking the actual Reserve and then subtracting DCA's computation of a reasonable reserve. Although DCA's computation of the Reserve included the $43,260,000 in funds the legislature transferred out of the Reserve as well as the interest DCA imputed on the transferred funds, we focus in this section only on the approximately $50 million in funds that DCA reported actually remained in the Reserve as of FY 1991.
DCA has changed its position several times on just how much of the Reserve as of FY 1991 was excessive. DCA initially abandoned the methodology in the Carmichael Report of limiting allowable SIF reserves to the $5 million not covered by reinsurance in favor of calculating potential losses over a three-year period, resulting in a $14,760,000 reasonable reserve determination.
After Alabama filed this appeal, DCA sought actuarial advice and again increased the allowable SIF Reserve level. DCA first retained the services of an actuary, Glenn Walker, of B.L. Seamon & Associates, to review the actuarial evidence submitted by Alabama (the Wyatt and Anistics reports). Walker concluded that Wyatt used wrong actuarial procedures, committed calculation errors, and made vague judgments. Walker, however, adopted many of the conclusions of the Anistics report, but found that Anistics had overestimated the risk that commercial reinsurance would become unavailable. The Walker report concluded that it was more likely that the SIF would be faced with higher reinsurance premiums and deductibles. In his report, "Analysis of Funding Requirements - Alabama Self-Insurance Fund", May 25, 1993 (Walker Report), Ala. Ex. 102, Walker determined that a Reserve of $17.2 million was sufficient for 1991 if reinsurance is considered, a figure which Walker adjusted to $21.8 million to account for increasing property values. Walker also recommended allowing an additional $5 million to cover the event that the amount not covered by reinsurance increased to $10 million. While he disagreed with Alabama's position that reinsurance might become unavailable, he foresaw upcoming reductions in coverage. Ala. Ex. 102, at 06354-55. Assuming that no reinsurance was purchased, Walker recommended a Reserve of "about $80 million" as of December 1991. Id., at 060338.
DCA subsequently secured the services of another actuary, Nancy Watkins, of Watkins Consulting. She disagreed with the Anistics report as to the extent that reinsurance might become unavailable to the SIF. Watkins concluded that a reasonable SIF Reserve, taking into account the reinsurance that the SIF had utilized in the past, would range from $19.2 million to $24.2 million. "Review of Reinsurance Issues with Respect to Alabama State Insurance Fund," November 17, 1994. While the final disallowance on appeal found approximately $14 million to be an acceptable Reserve based on past losses, DCA once more modified its position in its final brief before the Board. DCA there said that it considers the range cited by Watkins as an acceptable Reserve, but left it to the Board to determine the specific, allowable Reserve balance. DCA 2d Supp. Br. at 14. DCA had also stated that if the Board were to find that reinsurance should not be considered, the appropriate fund balance would be the amount recommended by Anistics, or "the amount actually contained in the reserves" (not including the transferred funds). DCA Br. at 42.
DCA argued that the excess reserves were not "reasonable and necessary" administrative costs as required by OMB Circular A-87. A reasonable "cost" in the context of the SIF Reserve, according to DCA, was an amount of funds that would provide Alabama with reasonable protection for its property, not an amount that could be viewed as "needlessly sitting in the fund." DCA Br. at 17. DCA also argued that the excess reserves were in effect "contributions to a contingency reserve or for unforeseen events" which are also prohibited by the cost principles. OMB Circular A-87, Att. B, . D.2. DCA further characterized the accumulation of excess reserves as violating the prohibition on a "profit or other increment above cost," which is also in the cost principles. OMB Circular A-87, Att. A, . A.1.
We agree with DCA that the cost principles (and other authorities applicable to funding for administrative costs in federal programs as discussed in the first section of this decision) impose a "reasonableness" standard on the size of a reserve that may be held by a state in a self-insurance plan. This "reasonableness" standard, however, necessarily must encompass a range of possible reserve levels based on the particular circumstances of the self-insurance plan in question. There is nothing in the cost principles or other authorities relied upon by DCA that provides notice of a precise formula or methodology for determining what a reasonable reserve level must be. Moreover, the state as the administrator of the self-insurance plan (and as the primary source of the funding for the plan) must be permitted some discretion in determining a reasonable reserve level. The record in this appeal demonstrates that the determination of an appropriate reserve level for a self-insurance plan can be a highly complex decision, requiring a considerable amount of judgment concerning a number of unknowns.
In applying the foregoing standard of reasonableness to Alabama's SIF Reserve as of FY 1991, we conclude that Alabama established that its SIF Reserve of approximately $50 million was within a range of what could be considered to be a reasonable reserve. Our reasons are as follows:
4. Federal share of the transferred SIF Reserve funds
The sole remaining issue for us to decide concerns the computation of the federal share of the SIF Reserve funds the Alabama legislature removed from the Reserve and used for other purposes. DCA determined that federal funds comprised 20% of the SIF premiums contributed by Alabama's state agencies (which accounted for 49% of SIF premium payments), or $4,239,480 ($43,260,000 x .49 x .20) and 5% of the SIF premiums contributed by local governments, or $1,103,130 ($43,260,000 x .51 x .05), for a total disallowance attributable to the transferred funds of $5,342,610. DCA's standard estimates were not based on the circumstances particular to Alabama's SIF but were rather derived from a national estimate of the ratio of state and local funding to federal funding based on DCA's experience in a wide range of programs.
DCA reported that the auditors initially sought to determine federal participation in the SIF Reserve by calculating the average ratio of "total FFP to total Alabama expenditures" for FYs 1977 to 1987, which they determined to be 22.91%. DCA Br. at 10; Ala. Ex. 6, at 013368. However, auditors' work papers and agreed-upon procedures that Alabama submitted indicate that the auditors were attempting to determine the ratio of federal to total state revenues. Ala. Ex. 15, at 031418; Ala. Ex. 23, at 031944-46. The work papers indicate that while the auditors were in the process of compiling information needed to calculate the federal/state revenue ratio, they were informed that DCA preferred to use the 20% standard estimate. Ala. Ex. 23, at 031944-46. DCA reported that the 20% standard estimate was lower than the federal share calculations developed by the auditors retained by OIG, and lower than the 22.04% figure used to determine the federal share of an insurance fund in Pennsylvania. DCA argued that the standard estimates are commonly used in the "industry" of federal-state grants to determine the amount of federal participation in funds such as the SIF, and have been accepted by the Board as sufficient to support a disallowance.
Alabama argued that the auditors' calculations showing a 22.91% federal share were inaccurate and tentative, that the federal/state revenue ratio did not approximate the federal share of funds in the SIF Reserve, and that DCA had provided no evidence to support its use of the 20% and 5% "standard estimates."
Among other points, Alabama argued that in the largest federal grant programs, such as AFDC, Medicaid and student loans, most of the federal money flows through states to recipients or third parties, and is not used to pay SIF premiums. For such large programs, Alabama argued, use of the standard estimates would overstate the federal share of SIF premiums. Alabama also asserted that most federal grants are to entities that pay only small amounts to the SIF, and that the state agencies that receive 90% of federal funds paid to Alabama pay only approximately 7% of the insurance premiums to the SIF.
Alabama also argued that the $43,260,000 transferred out of the SIF Reserve could have been composed of state funds. Alabama argued that the SIF had been started in 1923 with state-only funds and had been state-funded until 1960, at which time it had a reserve balance of $4.87 million. Alabama argued that this balance, with interest, amounted to a state-only share of at least $33.6 million by 1990. Alabama asserted that it was free to use the last-in, first-out "LIFO" accounting method, under which the state-only funds first deposited into the Reserve would be the last ones removed.
Additionally, Alabama argued that the auditors' calculations were deficient because the auditors admitted that they failed to adhere to applicable accounting standards, and instead used only procedures prescribed by HHS. Alabama asserted that the auditors thus violated Alabama's right to have the review conducted pursuant to procedures provided in the Inspector General Act and Single Audit Act.
DCA defended the auditors' calculations as final, not tentative, despite the difficulty they reported in obtaining needed information from Alabama. In response to Alabama's examples of agencies with low federal funding, DCA responded with examples of state agencies, such as Employment Security and Labor, which are 100% and 95% federally funded, respectively. DCA argued that reviews of 11 Alabama colleges and universities showed that the federal share of their revenues was 22.3%. DCA also argued that the failure to follow auditing standards does not mean that the information gleaned from the auditors' review is not evidence, and that relevant and material evidence is admissible regardless of whether it was collected in accordance with applicable standards.
In opposing the use of the standard estimates, Alabama contracted with the firm of David M. Griffiths (DMG) to discover the "actual federal share of the SIF's reserves." Ala. Br. at 80; Ala. Prehearing Br. at 75. DMG conducted a survey of state and local entities to determine what percentage of their SIF premiums, if any, were paid with federal funds. DMG attempted to trace SIF premiums charged to federal funds either directly or through indirect cost allocation plans. Ala. Exs. 26, 27, 33. DMG reported that 325 state and local agencies bought SIF policies, that 34 state agencies received no federal grants, and that for several of the largest state entities, none of the SIF premiums were paid by the federal government. DMG reviewed budgets and CAP agreements, conducted site visits, sent out questionnaires, visited or contacted the largest agencies, sent survey letters to the "remaining 272" state and local entities, and got 250 responses. Ala. Prehearing Br. at 75-77. DMG initially determined that federal funding comprised 7.31% of SIF premiums paid by state government agencies, and .32 % of SIF premiums paid by local government entities.
DCA presented OIG's criticisms of the DMG report. DCA stated that entities that did not respond to questionnaires were listed as having "0" federal participation. OIG reported visiting 18 entities and asserted that many did not understand or correctly fill out the form, with errors detected at 44% of the respondents. In response, DMG conducted a further review. As a result of that review, DMG concluded that the federal share of the Reserve from state sources was 7.75% and from local sources was .74%.
After considering the parties' positions, we conclude that Alabama's calculations are more probative of the proper federal share percentages than DCA's standard estimates because they attempt to trace federal funds actually received by state and local agencies and actually deposited into the SIF. They are thus more responsive to the particular circumstances confronted by Alabama's SIF for the period at issue than a standard estimate. We are also concerned that DCA has provided no evidentiary basis whatsoever in support of its 5% standard estimate for computing the federal share of SIF local government premiums. In particular, DCA failed to provide revenue ratios on a national basis to support this percentage.
DCA argued that the Board previously found standard estimates of total federal-to-state revenues to be sufficiently probative to support a disallowance, citing West Virginia Dept. of Administration, DAB No. 1465 (1994). DCA Reply to Ala. Motion to Dismiss for Failure to Adhere to Applicable Accounting Standards at 4; DCA 2d Supp. Br. at 32-33. West Virginia involved the disallowance of federal contributions to the pension funds for state employees. DCA reported that the 20% standard estimate employed in that decision was based on the average federal contribution to the pension funds of other states. The auditors there demonstrated the reasonableness of the 20% nationwide figure by comparing it to federal/state contributions actually made to West Virginia pension funds. Thus, the estimate employed in West Virginia had direct relevance to the particular fund that was the subject of the disallowance. In Pennsylvania, which was cited by DCA as employing a total FFP/state expenditure ratio (22.04%) higher than the standard estimate employed here, Pennsylvania did not specifically dispute DCA's calculations. Thus, standard estimates may reasonably be used in various contexts when there is no more probative evidence of the specific circumstances confronted by the parties.
Moreover, as Alabama argued, the vast portion of funding in many federal assistance programs such as AFDC and Medicaid is used to pay benefits to recipients, with only a relatively small fraction for administrative expenses, such as property insurance. For such programs, the only federal funds that might be deposited into the SIF would be those claimed as administrative costs related to state-owned properties that Alabama uses to administer the programs. DCA did not show why under the circumstances it was reasonable to use a percentage of total federal funds paid for those programs to approximate the federal share of SIF premiums paid by those programs. Although DCA argued that the 50% funding rate for administrative costs in the Medicaid program is higher than the 20% standard estimate, DCA did not take exception to Alabama's point that administrative costs in that program are only a small fraction of overall federal expenditures.
DCA, moreover, did not take issue with Alabama's examples of programs where the federal share of SIF premiums would be smaller than the 20% standard estimate. Although DCA cited instances of state agencies with federal funding percentages that were higher than the 20% standard estimate, DCA failed to substantiate whether the cited programs actually contribute large enough SIF premiums to outweigh the programs where the federal impact on the SIF is quite small.
DCA asserted that determining the federal share of SIF funds more accurately than it had here would require an audit of every recipient of a federal award that contributed to the SIF. While such an audit would certainly better assure complete accuracy, the lack of such an audit does not mean that DCA's figures are preferable to Alabama's. Alabama's calculations represent the only effort in the record to determine the federal percentage of SIF premiums paid by the various state and local government entities that pay SIF premiums. When DCA provided criticisms of the DMG report, Alabama attempted to respond to those criticisms by conducting a further review. DCA offered some additional criticism of the revised DMG study, noting in particular that the study was limited to only one year, 1990; however, that study remains the only evidence of record which has direct relevance to the SIF.
Alabama urged the Board to reject the standard estimates and adopt the DMG federal share figures as the best available evidence of the federal share. Ala. Prehearing Br. at 81. Accordingly, we apply Alabama's figures to determine the federal share of those funds that Alabama removed from the SIF Reserve without crediting the federal share.
5. Alabama's Motions
Beginning in December 1996, Alabama filed six motions seeking various relief in these proceedings: motion to dismiss for failure to establish legal standards; motion to dismiss or for partial summary judgment under the McCarron-Ferguson Act, 15 U.S.C. .. 1011-1015; motion to dismiss for failure to adhere to applicable accounting standards; motion in limine to preclude use of the standard estimates; motion to dismiss based on the failure to establish legal standards and to provide notice of the standards that have been applied to the SIF; and a motion to dismiss for lack of jurisdiction. Our analysis and holdings above effectively dispose of each of these motions.
The first five motions assail DCA's and OIG's methods for determining the appropriate SIF Reserve fund balance and the federal share of the SIF Reserve. Since we are using Alabama's own calculations of the federal share percentages instead of DCA's figures, and reversing that portion of the disallowance that was based on the finding that the reserves were excessive, these motions are moot. In its motion to dismiss for lack of jurisdiction, Alabama argued that OMB Circular A-87 applies only to funds provided on a "cost reimbursement" basis, and thus does not apply to a "significant portion" of the SIF Reserve. While Alabama pointed to programs where SIF premium payments might not be charged to federal funds in the same manner as in other programs, its argument is moot because the portion of the SIF Reserve here disallowed as the federal share is that portion identified by DMG. The DMG report which determined Alabama's federal share percentages states that DMG sought to identify whether "any of the property insurance billings had been directly charged to Federal agents (sic) or contracts, or if any of the billings were indirectly charged through indirect cost rates or cost allocation plans." Ala. Ex. 26, at 013340. The letters that DMG sent to state and local entities participating in the SIF as part of its revised study were intended "to identify insurance billed directly to federal funds, or included as indirect costs." Ala. Ex. 27, at 010238, 010240, 010242-43. Costs claimed directly to federal grants and contracts or claimed as indirect costs, as identified by the DMG study, are within the ambit of OMB Circular A-87. Alabama moreover did not argue that the facts asserted in its motion to dismiss for lack of jurisdiction would render unreliable the DMG figures that Alabama presented for calculating the federal share of the SIF Reserve.
Conclusion
On the basis of the foregoing analysis, we uphold a disallowance for the federal share of the Reserve funds which were removed from the SIF by the Alabama legislature and used for other purposes. We reverse the other two components of the disallowance. We conclude, moreover, that Alabama's computation of the federal share percentage attributable to the transferred funds was more probative of the actual circumstances in Alabama than DCA's standard estimates.
Judith A. Ballard
M. Terry Johnson
Donald F. Garrett
Presiding Board Member