-Partners in Practice -

It came on little cat feet like the fog in the night. No one was paying attention. Suddenly it was there. It all started when the Defense Contract Audit Agency (DCAA) discovered what the rest of us have known since 1984. Professional liability insurance premiums were rising at an alarming rate.

The problem was that some of these costs were being passed on to the Government in the form of allowable overhead. Something had to be done to protect the Department of Defense from this unacceptable turn of events. DCAA's solution was a simple one. It decided to shift the costs to you.

In policy memorandum 86-PAD-145, dated September 9, 1986, DCAA instructed its regional offices as follows: "A pro-rata allocation of...professional liability insurance costs to all work does not appear to meet the causal beneficial test discussed in FAR 31.201-4, CAS 416.40(b), and CAS 418.40(c), namely 'The allocation of insurance costs to cost objectives shall be based on the beneficial or causal relationship between the insurance costs and the benefiting or causing cost objective."'

If you have trouble making sense of this, what it means in English is that DCAA has directed its auditors to find a way to disallow some or all of your professional liability insurance costs. How? First you will be asked to "require" your professional liability insurer to "...segregate its premium costs between commercial and Government risk exposures so that the relationships can be demonstrated and evaluated." Because there is no such differentiation in rates, this is a requirement that no professional liability insurer can meet.

Alternatively, DCAA auditors have been instructed to consider your own, individual loss experience on commercial and Government work in evaluating your "proposed" allocation of premium costs. In other words, the burden of justifying any such allocation falls on you. It does not appear to matter that what you pay to insure against losses on Federal work has nothing to do with the fact that you may have been fortunate enough to avoid such losses in the past.

How did DCAA come to the conclusion that the Federal Government ought somehow to be shielded from the cyclical nature of the insurance industry and the ravages of the tort liability system in the United States? Here is the reasoning it advanced in 86-PAD-145:

1. "Historically, A&E contractors have rarely incurred insurance claims or losses on its (sic) Government contract activity."

   This assertion has no basis in fact. Victor O. Schinnerer & Co. reports that, in the 30 year history of its insurance program for architects and engineers, it has never been able to establish a causal relationship between client type (i.e., Government vs. commercial) and the frequency and severity of claims. Of some concern, on the other hand, is the eventual impact of a 1977 General Accounting Office (GAO) report which recommended that Federal agencies more aggressively pursue the recovery of costs attributable to negligence in design. Either GAO's recommendations have been roundly ignored, or Government claims are actually on the increase.

2. "This problem is similar to the professional liability insurance carried by CPA firms....(in that) third parties do not use or rely on work performed by CPAs on Government contracts. Accordingly, the third party exposure...is minimal or non-existent...."

   Just how DCAA came up with this notion is beyond imagination. It is patently false. Contractors, subcontractors, workers on the job-site, and users, including Government employees, all have a legal right to rely on the services performed by architects and engineers on Government projects. They have not hesitated to assert that right in the past, and there is no reason to assume they will do so in the future.

3. Indemnification of architects and engineers is not an acceptable alternative to the reduction or elimination of professional liability insurance costs because, "...this alternative may expose the Government to substantial liability...."

   Probably, but more than anything else, this conclusion illustrates how hopelessly vague DCAA's guidelines are. An acceptable allocation of costs apparently falls somewhere between those associated with "substantial liability" and those associated with "rarely incurred insurance claims." The idea that either of these abstractions has anything to do with (or can reasonably be quantified on the basis of) the individual loss experience of a single firm borders on the ridiculous.

DCAA does not seem to be bothered by the fact that its rationale is unfounded and, for the most part, specious. It has taken the position that Department of Defense quality assurance procedures and its readiness to step forward with changes to the construction contract to correct design deficiencies significantly reduce the risk of loss on Government work. Therefore, in its view, a pro-rata allocation of insurance costs is inappropriate. DCAA has produced no data to support this contention, and it does not appear to be willing to do so. It has expressed an unsubstantiated opinion aimed at reducing Government costs, and it has neatly shifted the burden to you.

DCAA must be called upon to account for its actions and to justify its position with something more than convenient assumptions. The seriousness of the problem calls for a response at the national level-one involving political action, if necessary. As an individual firm, you are likely to find yourself hopelessly overpowered when you seek to negotiate on your own behalf, and it makes little sense for the same battle to have to be fought a thousand times over on a thousand different fronts.

The Professional Services Management Association (PSMA) has established a task force to formulate a response to DCAA, and the National Society of Professional Engineers (NSPE) has initiated an effort to engage DCAA in a dialogue about the position it has taken. To this point, NSPE has been met with a solid wall of resistance. It may be that only a concerted effort involving all of the professional societies will provide the critical mass necessary to bring DCAA to the point at which it is willing to address the issue seriously and in good faith.

None of this will solve your immediate problem if you are engaged in projects which fall under DCAA's watchful eye. At your next audit, you are going to have to provide compelling evidence that whatever allocation of premium costs you have made is consistent with DCAA guidelines. Ask for a copy of 86-PAD-145, and do what you can to compile data from your own records to support your position. On new work, you might investigate the possibility of establishing an allocation agreement, in advance, under the provisions of FAR 31.109. This, at least, will let you know where you stand before you finalize your fee negotiations with the Government.

For inquiries or problems please contact us via e-mail at Earleen Thomas or call us directly at 800-705-7742.
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