Measuring the Costs of Federal Insurance Programs: Cash or Accrual?
In this report, CBO assesses the usefulness of cash and accrual accounting for several federal insurance programs—including deposit, flood, and pension insurance—and considers ways to increase use of accrual measures in the budget process.
Some federal insurance programs have long-term effects on the budget, and policymakers need complete and accurate measures of those effects to make informed decisions about such programs. The cash-based measures that are used for most programs in the federal budget process generally focus on a 10-year period. However, that period may not be long enough to accurately indicate some insurance programs’ expected net effects on the budget over the long term.
Accrual-based estimates, which consider long-term effects, can provide more complete information about some federal insurance programs. An accrual estimate summarizes, in a single number, the net budgetary impact that is anticipated at a particular time from a commitment that will affect federal cash flows many years into the future. Through such summarizing, accrual measures make it easier to compare the net costs of programs despite differences in the timing of their cash flows.
CBO currently produces two main types of accrual estimates for a limited set of federal activities: estimates prepared using the methodology specified in the Federal Credit Reform Act of 1990 (FCRA), which applies to most federal credit programs, and estimates prepared on a fair-value basis. The difference between FCRA and fair-value estimates lies in the treatment of market risk—the element of financial risk that is correlated with overall economic conditions and thus that cannot be eliminated by diversifying a portfolio. In general, FCRA-based estimates account for the time value of money (the fact that a dollar today is worth more than a dollar at some future date because it can earn interest in the interim), but such estimates do not reflect the full extent of financial risk that the government assumes. Fair-value estimates approximate the market value of an obligation. As such, they account for the time value of money and incorporate market risk, thereby providing a more comprehensive measure of expected costs.
This report looks at how an accrual treatment might differ from the current cash treatment for several federal insurance programs, including programs of the Federal Deposit Insurance Corporation (FDIC) to resolve troubled financial firms, flood insurance, and pension insurance. Besides the fundamental choice between cash and accrual measures, this analysis highlights two separate issues that policymakers could consider about the information provided by those measures: whether the measures should reflect limits on the amount of budgetary resources that insurance programs have available to pay claims and whether those measures should reflect the government’s exposure to market risk.
What Are the Key Advantages and Disadvantages of Accrual Measures for Federal Insurance Programs?
Accrual measures, whether prepared on a FCRA or a fairvalue basis, offer several advantages over cash measures for federal insurance programs:
- Accrual measures accelerate the recognition of longterm costs and could clearly display the net costs of the new insurance commitments that the government makes each year at the point when they are most controllable. By focusing on the net costs of new commitments and accounting for the time value of money, accrual estimates could help policymakers make more meaningful comparisons of the costs of competing programs that differ in the timing of their cash flows.
- Accrual measures would avoid mixing the costs of new and existing insurance commitments and thus could help to identify whether a program’s costs are rising or falling over time.
- Accrual measures summarize long-term net costs; that information could lead to a greater focus on risk when setting prices and reserve requirements in programs that insure against potentially large losses that have a small probability of occurring.
- Accrual measures can more readily incorporate market risk, using fair-value methods, than cash measures can.
- Accrual measures make it harder to alter estimates of the budget deficit by shifting the timing of federal payments or receipts without actually changing the inflation-adjusted value of those cash flows.
Accrual measures have several disadvantages, however:
- Accrual measures are less transparent and verifiable than cash measures because they are more methodologically complex.
- Accrual measures require judgments about appropriate methodology that could spark disagreements among analysts and policymakers, such as about what time horizon to cover and whether a federal commitment is certain enough to include in accrual estimates.
- Accrual estimates have a wider range of uncertainty and are more subject to change than cash-based estimates.
- Moving from cash to accrual measures in the budget would widen the difference that generally exists between the reported budget deficit and the actual change in outstanding federal debt in a given year. Such a change would also complicate budget reporting.
How Does CBO Assess Information Provided by Cash and Accrual Measures?
CBO uses three criteria to assess the trade-offs between accrual measures and the 10-year cash measures now used for insurance programs in the federal budget process:
- Do accrual measures convey more complete and relevant information about a program’s budgetary effects? One key advantage of accrual measures is their ability to avoid timing-related distortions— particularly when a significant share of a program’s cash flows are expected to occur outside the 10-year budget window or when the timing of cash inflows and outflows does not coincide.
- Can a program’s underlying long-term cash flows be projected and discounted with enough accuracy and practicality to allow accrual measures to be used reliably in the budget process? All estimating is uncertain, but projecting insurance-related costs can be particularly challenging regardless of the basis of accounting used.
- Is the nature of the government’s commitment to provide future resources firm enough to justify recording future cash flows before they occur? Accrual measures may be most useful for commitments that are legally binding or otherwise firm and that do not require further Congressional action to ensure that programs have enough resources to pay claims.
Why Might Accrual Estimates for Federal Insurance Programs Include Market Risk?
Federal insurance programs expose the government to market risk if their claims are likely to be higher (or their income lower) than usual when the economy as a whole is performing poorly. For programs that face a significant amount of market risk, such as pension and deposit insurance, accounting for that risk would result in more comprehensive estimates of federal costs. However, including market risk might involve considerable analytical judgment and would cause those estimates to be more difficult to understand.
How Might Accrual Measures Be Useful for Certain Federal Insurance Programs?
Relative to 10-year cash estimates, accrual measures may be particularly useful for some insurance programs:
- For the FDIC’s resolutions of troubled financial firms, carried out through the Orderly Liquidation Fund (OLF) and the Deposit Insurance Fund (DIF), annual cash flows may not be a good indicator of the net costs of a given year’s transactions—especially during or after a financial crisis, when losses are large. For any particular year or 10-year period, a snapshot of cash flows may not capture all of the up-front costs of resolving troubled institutions (if those resolutions occurred before the projection period) or all of the offsetting income from fees assessed on the financial industry (particularly if those receipts are expected to occur after the projection period). Accrual measures would largely eliminate timing-related distortions for resolution activities and, if calculated on a fair-value basis, would provide a more complete estimate of expected costs. Alternatively, some of the drawbacks of cash measures for OLF and DIF could be lessened by keeping the cash budgetary treatment of losses and income but excluding transactions that involve working capital from estimates of the budget deficit.
- For federal flood insurance, 10-year cash estimates may be dominated (particularly in the near term) by costs that stem from past events. By focusing instead on expected losses and income related to the insurance commitments made during a given period, accrual measures might help to highlight the program’s structural imbalances. In addition, CBO’s current projections reflect legal constraints on the amount of budgetary resources that the program has available to pay claims and other expenses—and thus may understate the full amount due to policyholders. Projections that did not reflect resource constraints, whether prepared on a cash or an accrual basis, would provide more information about the full extent of programs’ costs.
- For the Pension Benefit Guaranty Corporation (PBGC), 10-year cash measures fail to convey the size of the imbalance between the agency’s resources and its liabilities for future claims. Because of the long timing lags that typically occur between inflows and outflows in PBGC’s pension insurance programs, cash-based projections currently show net savings from those programs. Accrual measures would present a more accurate measure of PBGC’s long-term commitments.
How Could the Government Increase the Use of Accrual Measures in the Budget Process?
A range of options exist for expanding the use of accrual measures for federal insurance programs. In all cases, policymakers would need to determine how such measures would factor into the framework of statutory requirements and Congressional rules that make up the federal budget process.
- Shifting fully to an accrual-based treatment for some insurance programs in the federal budget would change how those programs affect the budget and potentially alter how statutory mechanisms to enforce budget targets—namely, required cuts to budgetary resources—would affect different programs. Such measures would provide the most additional information for decisionmaking. However, such a change would require new account structures and periodic revisions to estimates.
- Using accrual measures only for enforcing Congressional budget rules, but not in the budget itself, would be less burdensome. Employing such measures in legislative cost estimates might be helpful for decisions about the allocation of resources, but it would create an inconsistency between the estimates used by the Congress and those used by the Administration.
- Using accrual measures as supplemental information, without changing budget enforcement procedures or budget execution, would be the least disruptive option but would give accrual estimates less prominence in Congressional deliberations.