Performance audit, Department of Administration, Financial Services Division

              PERFORMANCE AUDIT
DEPARTMENT OF ADMINISTRATION
FINANCIAL SERVICES DIVISION
Report to the Arizona Legislature
By the Auditor General
November 1995
Report # 95- 11
DOUGLAS R. NORTON, CPA
AUDITOR C- ENERAL
STATE OF ARIZONA
OFFICE OF THE
AUDITOR GENERAL
DEBRA K. DAVENPORT, CPA
DCPUTI IUDITOI OENEmAL
November 15, 1995
Members of the Arizona Legislature
The Honorable Fife Symington, Governor
Mr. Rudy Serino, Director
Arizona Department of Administration
Transmitted herewith is a report of the Auditor General, A Performance Audit of the
Department of Administration, Financial Services Division. This report is in response
to a May 5, 1993, resolution of the Joint Legislative Audit Committee. The
performance audit was conducted as part of the sunset review set forth in A. R. S. 5541-
2951 through 41- 2957.
This report addresses areas for improvement in two of the Financial Services Division's
three sections: General Accounting Office ( GAO) and Risk Management Section( RMS).
Our review of the General Accounting Office revealed that the potential for
improprieties and inaccuracies in the State's financial information exists under the
current Uniform Statewide Accounting System ( USAS). Moreover, we found that the
USAS has been unable to provide a complete representation of the State's financial
position, provide agencies with better budgeting information, and eliminate the need
for duplicate financial systems. These issues can be addressed and other important
financial activities achieved with the establishment of a Chief Financial Officer.
Currently, the State's General Accountant resides at a level too low within State
government to adequately perform important financial activities and to serve as an
equal participant with agency heads on financial matters, thereby placing the State in
a reactive position regarding financial management.
Our review of the Risk Management Section revealed numerous problems in the
property and liability unit's claims handling methods that expose the State to increased
claims settlement costs, inappropriate expenditures, and the potential for fraud. Many
of these problems can be resolved by following good claims management practices.
2910 NORTH 44TH STREET . SUITE 410 = PHOENIX, ARIZONA 85018 ( 602) 553- 0333 FAX ( 602) 553- 0051
Page - 2-
November 15, 1995
In addition, we identified the need for RMS to provide agencies with stronger
incentives to control losses.
My staff and I will be pleased to discuss or clarify items in the report.
This report will be released to the public on November 16, 1995.
Sincerely,
DO&.~& S R. Norton
Auditor General
Enclosure
SUMMARY
The Office of the Auditor General has conducted a performance audit of the Department
of Administration ( DOA), Financial Services Division, pursuant to a May 5,1993, resolu-tion
of the Joint Legislative Audit Committee. This audit was conducted as part of the
sunset review set forth in Arizona Revised Statutes ( A. R. S.) $ 541- 2951 through 41- 2957
and is the fifth of six audits scheduled on the Department.
The Financial Services Division is comprised of three separate units: the General Accounting
Office ( GAO), the Risk Management Section ( RMS), and the State Procurement Office
( SPO). This report focuses on two of these areas - the General Accounting Office and the
Risk Management Section. The State Procurement Office was not reviewed because it had
recently completed a study of its operations that recommends substantial change. Given
the magnitude of expected changes to the State's procurement process, we did not believe
it would be cost- effective to conduct a review at this time.
The Integrity of the State's Financial
Information Remains at Risk
( See pages 5 through 9)
The potential for improprieties and inaccuracies in the State's financial information exists
under the current statewide accounting system. When the State converted to a new Uni-form
Statewide Accounting System ( USAS) in July 1992, it went from a centralized, paper
transaction, accounting process handled by the DOA's General Accounting Office to a
decentralized, on- line system with agency staff responsible for all accounting transac-tions.
Unfortunately, the DOA has not provided an adequate internal control structure
for this new process ( i. e., agencies processing transactions on- line), leaving public funds
vulnerable to improprieties. Such improprieties have occurred in at least two instances in
the past three years when agency staff have manipulated the system in fraudulent schemes.
In a recent review of statewide internal controls, our Office found the potential for such
problems still exists.
Additionally, the DOA failed to provide agencies with the necessary training to properly
use the new accounting system. As a result, some agencies have had difficulty in process-ing
daily accounting transactions. For example, the GAO discovered ( at a small agency
that had virtually run out of appropriations) that an accounting technician I11 responsible
for processing receipts had not deposited approximately $ 150,000 in money orders and
checks because she did not understand how to process them.
The GAO will need to improve the system's internal control structure by assuming some
agencies' accounting responsibilities. Furthermore, it will need to develop a plan to deal
with the current training deficiencies.
The Statewide Accounting System
Unable to Readily Portray
Arizona's Financial Position
( See pages I1 through 17)
The statewide accounting system currently does not meet Arizona's financial manage-ment
needs. In fact, none of the primary goals for the system ( i. e., to provide a complete
representation of the State's financial position and to eliminate the need for duplicate
systems) have been achieved. For example, financial information such as cash on hand,
various bank and trust fund accounts, and short- and long- term liabilities must be ob-tained
from each state agency. In addition, the system is not integrated with procurement
transactions and payroll information is not transferred to the accounting system until one
week after the close of the pay period. This lack of system integration and timeliness may
result in misleading budget information. Finally, many agencies continue to maintain
their own financial systems, contending that USAS does not meet their day- to- day finan-cial
management needs.
To ensure USAS is able to meet its original expectations, several system improvements
will be required. For example, the GAO will need to determine if the system's current
software can be enhanced or if new software ( at an estimated cost of $ 1.1 million) is needed.
Also, the GAO must ensure the current plan to integrate procurement activities is com-pleted.
Additionally, the DOA will need to take the steps necessary to enable agencies to
maintain full financial information on the system, including assessing the additional needs
of the three largest agencies, equipping USAS to fulfill those needs and providing addi-tional
training or holding discussions with those agencies who are able to keep full infor-mation
on the system, but are currently not doing so.
The State Needs a Chief
Financial Officer
( See pages 19 through 26)
Despite its $ 11 billion budget, Arizona lacks a key management comp~ nenct ommon in
the private sector, and increasingly used in government - a Chief Financial Officer ( CFO).
A CFO in the public and private sectors takes a global view of the organization, monitor-ing
its financial position, and works in partnership with the Chief Executive Officer to
manage the organization's operations. The closest equivalent Arizona has to a CFO is the
State's General Accountant, who resides at a level too low within state government to
adequately perform important financial activities and to serve as an equal participant
with agency heads on financial matters. Lacking a high- level position with authority to
ensure that important financial activities are achieved, the State has been put in a reactive
position regarding the stewardship of public monies and financial management in gen-eral.
Arizona should follow the lead of other states and the federal government in prioritizing
the need for strong financial management by establishing a Chief Financial Officer posi-tion.
Further, the CFO should be given the statewide financial duties currently handled
by the DOA.
Risk Management's Property
and Liability Claims Unit Exhibits
Numerous Problems
( See pages 27 through 34)
During 1994, the State's risk management program experienced various management
problems. For example, it had high vacancies ( as high as 30 percent) at both the staff and
supervisory level, a high rate of top management turnover, and at least five separate
investigations that resulted in four employees being placed on administrative leave, four
contracts not being renewed, and an independent adjuster being indicted for fraud.
These difficulties and others have contributed to a number of claims- handling problems,
including delays in handling, poor documentation, and a lack of supervision. For ex-ample,
even though delays generally increase settlement costs, 35 percent of the open
claims we reviewed were not being actively adjusted. Similarly, despite its importance,
more than 50 percent of the claims lacked adequate documentation, such as billings sup-porting
the payments made. Likewise, most of the files we reviewed contained no evi-dence
of supervisory review. Also, at the time of our review, the RMS staff adjusters had
caseloads that were close to twice their recommended standard and the RMS payment
processing procedures have suffered from weak internal controls. All of these problems
can ultimately result in increased claims settlement costs, unnecessary expenditures, and
potential fraud.
To address these concerns, the RMS will need to implement or reintroduce basic claims
management techniques including supervision of all claims adjusters. Additionally, it
will need to assess the adequacy of its case management system and actively pursue fill-ing
its vacant positions.
The RMS Needs to Provide
Agencies with Stronger
Incentives to Control Losses
( See pages 35 through 38)
The RMS should give agencies stronger incentives to control losses. To encourage loss
control efforts, the state agency's insurance charges should be linked to its loss history
and its loss exposure. Although the RMS uses a cost allocation model to help assess state
agencies' insurance charges, this plan has been ineffective in providing the financial in-
centive necessary to encourage loss control. For example, in the past, the amount charged
to some agencies has fluctuated dramatically, due in part to changes in actuarial assump-tions
and the cost allocation model's failure to reflect actual loss experience because the
formula was old, complicated, and prone to errors. To address these concerns, the RMS
recently revised its cost allocation model with the overall goals of being simplistic, stable,
and responsive, and helping to encourage loss control efforts. Nevertheless, the current
method for budgeting for agency insurance costs also provides little incentiue. For ex- rr
ample, as an agency's insurance costs increase, so does the legislative appropriation to
cover the increased charge. As a result, an agency is not likely to feel the ramifications of
poor loss control behavior.
To give agencies stronger incentives to control losses, the Risk Management Section should
consider using additional tools such as deductibles and premium credits. These mecha-nisms
are widely used by other public risk management entities to increase agencies'
willingness to participate in loss prevention measures. For instance, several states impose
a $ 500 to $ 1,000 deductible on property claims. In addition, some states provide premium
reductions, premium credits, or recognition awards to reward agencies' loss control ef-forts.
Table of Contents
Introduction and Background .................................................................. 1
Finding I: The Integrity of the State's
Financial Information Remains at Risk .............................................. 5
Weak Internal Controls
Jeopardize System Security ........................................................................................... 5
Agency Personnel Do Not
Have Sufficient Knowledge to
Utilize the System .......................................................................................................... 7
Recommendations .......................................................................................................... 9
Finding II: The Statewide Accounting System
Unable to Readily Portray Arizona's
Financial Position ............................................................................... 11
USAS Goals .................................................................................................................. 1.1
USAS Does Not Provide
Important Financial Information ................................................................................. 12
Lack of Support and Resources
Contribute to USAS' Failure ......................................................................................... 14
Five Changes Needed to Ensure USAS
Meets Arizona's Financial Management Needs ......................................................... 16
Recommendations ......................................................................................................... 17
Table of Contents
Finding Ill: The State Needs
a Chief Financial Officer .................................................................... 19
Arizona's Current Organizational
Structure Is Not Conducive to Strong
Financial Management ................................................................................................. 19
Government Is Following
the Private Sector's Lead .............................................................................................. 2 3
Recommendations ......................................................................................................... 26
Finding IV: Risk Management's
Property and Liability Claims Unit
Exhibits Numerous Problems ........................................................... 27
Claims- Handling Problems Can
Result in Unnecessary Expenditures .......................................................................... 2. 7
The RMS Failed to
Address Deficiencies ................................................................................................... 3. 1
Immediate Action Is Needed
to Improve Claims Management ................................................................................ 3. 3
Recommendations ...................................................................................................... 3.. 4.
Finding V: The RMS Needs to
Provide Agencies with Stronger
Incentives to Control Losses ............................................................ 35
Programs Designed to Assist
Agencies in Reducing Losses ....................................................................................... 3 5
No Financial Incentives to
Increase Loss Prevention Efforts .................................................................................. 35
Table of Contents
Paqe
Finding V: ( con't)
Additional Tools Are Needed
to Encourage Loss Control Behavior ........................................................................... 36
Recommendations ......................................................................................................... 38
Area for Further Audit Work ................................................................... 39
Agency Response
Figure
Figure 1 Comparison of Financial Management Structures:
State of Arizona vs. Fortune 500 Company ................................ 21
vii
INTRODUCTION AND BACKGROUND
The Office of the Auditor General has conducted a performance audit of the Department
of Administration ( DOA), Financial Services Division, pursuant to a May 5,1993, resolu-tion
of the Joint Legislative Audit Committee. This audit was conducted as part of the
sunset review set forth in Arizona Revised Statutes ( A. R. S.) § § 41- 2951 through 41- 2957
and is the fifth of six audits scheduled on the Department.
Division Overview
Under the direction of an assistant director, the Financial Services Division ( FSD) had an
authorized full- time staffing level of 280 for fiscal year 1995, and is comprised of three
separate sections: the General Accounting Office, the Risk Management Section, and the
State Procurement Office.
The General Accounting Oflice ( GAO) - The GAO provides statewide financial services
including accounting functions. Its mission is " to provide statewideflnancial services, man-agement
infmmation and technical assistance while ensuring compliance with related statutes and
rules." GAO's specific responsibilities include:
Preparing and distributing the statewide payroll;
Preparing and distributing payments to vendors and others receiving compensation
from the State for services rendered;
Providing financial information to state agencies, federal government agencies, finan-cial
institutions, and other interested public or private entities;
Maintaining the statewide automated financial system;
Preparing financial reports; and
Reviewing and revising financial policies and procedures.
The Risk Management Section ( RMS) - The RMS acts as the State's insurance carrier and
thus is responsible for protecting state assets, including property, personnel, and revenue
from accidental and unintended losses. For many years the RMS functioned as its own
division within the DOA. However, in 1993, due to a reorganization of the DOA, the risk
management function was brought into the Financial Services Division. This unit also
underwent another significant change in January 1994 when the state workers' compen-sation
function was brought in- house. cl)
The RMS mission is " to promptly provide high quality services fm cost- efective management of
state property, liability and workers' compensation exposures." To ensure assets are protected,
this program performs several functions:
W Provides insurance or self- insurance for all state agencies, boards, and commissions;
Investigates, mitigates, and settles all property and liability claims against the State;(=)
W Investigates and manages workers' compensation benefits for injured state employ-ees;
W Defends lawsuits and recovers monies from third parties who have injured the State;
4 Assists agencies in the development and administration of loss control programs; and
W Assists agencies in administering return to work programs in compliance with the
federal Americans with Disabilities Act ( ADA).
The State Procuranent Oflice ( SPO) - The Director of the DOA, primarily through the
SPO, acts as the centralized procurement authority. The SPO's mission statement reads:
" to promptly provide quality products and services at competitive prices, while at the same time
ensuring compliance with State Procurement statutes." The Director has the authority to del-egate
procurement authority, and currently many of the State's procurement activities are
largely decentralized. Therefore, the SPO concentrates its activities in the following areas:
W Conducting complex procurements, including statewide contracts;
W Managing the cooperative purchasing program for political subdivisions;
W Disseminating procurement information and training its procurement customers; and
W Administering bid protests and claims appeals on behalf of the Director.
In prior years, the State contracted with the State Compensation Fund to handle workers' compensa-tion
claims administration and legal representation.
( 2) The RMS has an office in Tucson as well as Phoenix to perform this function.
Budget
The Financial Services Division receives general fund appropriations, appropriations from
three other funds ( the Automation Fund, the Risk Management Revolving Fund, and the
Workers' Compensation Liability Loss Revolving Fund), and nonappropriated funds. For
fiscal year 1995 this Division received an estimated $ 74,253,800 in funding - $ 74,176,500
in appropriated funding and $ 77,300 in nonappropriated funding. The majority of the
funding is utilized by the Risk Management Section ( approximately $ 60,350,800) for the
payment of property, liability, and workers' compensation losses and expenses for ad-justing
these claims.
Audit Scope and Methodology
This audit focuses primarily on the General Accounting Office and the Risk Management
Section. Our work in the GAO centered on the implementation and usefulness of the
statewide accounting system. In the Risk Management Section we focused primarily on
one of the two claims sections - the property and liability section. The other section,
workers' compensation, was not reviewed in great detail because the Risk Management
Section has only been handling this function since January 1994, and this function is sub-ject
to outside monitoring by the Industrial commission of Arizona. Additionally, we did
not review the State Procurement Office. During our audit, the SPO had completed a
study of its operations that recommends substantial change to the State's procurement
process. Given the magnitude of expected changes in that Office, we did not believe it
would be cost- effective to conduct a review at this time.
Our report presents findings and recommendations in the following areas:
W The changes needed to improve the integrity of the statewide accounting system;
W The extent to which the statewide accounting system fails to meet the State's financial
management needs;
W The need for strong financial management in Arizona;
The need to improve the claims management function; and
W The need to give agencies stronger incentives to control losses.
In addition, we have included an Area for Further Audit Work on the State Procurement
Office. This section discusses proposed changes to the State's procurement function and
the need to evaluate the effect of those changes at a later date.
This audit was conducted in accordance with government auditing standards.
The Auditor General and staff express appreciation to the Director of the Department of
Administration, the Assistant Director of the Division of Financial Services, and their
staff for their cooperation and assistance throughout the audit.
FINDING I
THE INTEGRITY OF THE STATE'S FINANCIAL
INFORMATION REMAINS AT RISK
On October 21,1992, three months after the State implemented a new uniform
statewide accounting system, a local bank notified the State of unusual activity
in a personal checking account involving state warrants. An investigation sub-sequently
determined that an administrative service officer at a state agency
had entered transactions into the statewide accounting system to authorize the
issuance of 23 state warrants made payable to a phantom vendor and ultimately
misappropriated $ 1,878,688 in state monies.
To date, the integrity of the State's financial information remains at risk. Weak internal
controls within agencies continue to expose the State to additional improprieties. More-over,
agency personnel responsible for financial transactions do not have sufficient knowl-edge
to utilize the system. System changes and additional training are needed to improve
the system's reliability and security.
In July 1992 Arizona converted to a new Uniform Statewide Accounting System ( USAS)
to improve state financial management, budgeting, and reporting capabilities. Prior to
USAS, most agencies submitted paper financial transactions to the GAO for central pro-cessing.
This procedure required little computer or accounting knowledge on the part of
agency staff. Further, agency staff had only partial responsibility for processing financial
transactions. The new system shifted the emphasis from paper processing to computer-ized
accounting at the agency level. Today, agencies process their own financial transac-tions
and have on- line access to data, making computer and accounting skills and proper
internal controls essential.
Weak Internal Controls
Jeopardize System Security
When the State converted to USAS, it neglected to address fundamental internal control
issues at the agency level, jeopardizing system security and, in some cases, resulting in
outright fraud. Greater oversight and limited system access is needed to improve the
system's security.
Weak istternal costtrols - The DOA has failed in its obligation to provide an adequate
internal control structure for the State, leaving public monies vulnerable to future impro-prieties.
Internal controls are designed to prevent one person from gaining control over
processing accounting data and documents. Such controls became especially important
when financial transactions were decentralized and access to sensitive files was opened
to agencies. For example, the file that is essential to processing all state warrants, known
as the vendor file, is now accessible to agencies.(') Therefore, under the current system, if
proper controls are not in place at an agency ( such as " segregation of duties"), an em-ployee
could enter his or her name into the vendor file, enter a claim for payment, release
the claim for processing, and collect the warrant ( i. e., check) at the GAO.
Agencies became responsible for instituting proper controls for the automated system
when USAS was implemented, although the GAO is ultimately responsible for the system's
security. However, implementation of control procedures has not occurred to the degree
necessary. During a recent review of statewide internal controls, our Office found that
" financial assets were not adequately safeguarded against loss from unauthorized use or
disposition." For example, as of May 1995, ( nearly three years after USAS was imple-mented),
almost 30 percent of the persons using the system can still both enter a claim and
release it for payment. As a result, improprieties such as the one described in the first case
example on page 5 can still occur, as demonstrated in an incident last year:
In June 1994, a J. C. Penney employee contacted the State regarding three purchase
orders and three State of Arizona warrants he had received from a state worker for
store merchandise. This worker, an accounting technician from a small state agency,
issued state warrants totaling $ 29,100 for clothing, a new Ford Mustang, a car CD
player, and various college and insurance expenses. He had access to enter vendors
into the system, enter and release claims, and pick up warrants from the GAO.
Greater oversight and lilnited systerrz access is needed to improve internal controls -
System security will continue to be jeopardized until certain measures are taken to im-prove
the internal control structure of the State. First, the GAO may have to assume re-sponsibility
for the accounting functions of some agencies. For example, agencies that
repeatedly violate internal control policies should no longer be allowed access. In addi-tion,
while we recognize that it is difficult for some smaller agencies to appropriately
segregate duties due to limited staff, it does not negate the need for such controls ( or
alternative solutions). Therefore, smaller agencies that lack sufficient staff to adequately
implement internal control procedures may have to transfer their accounting functions
back to the GAO. However, the GAO has generally been unwilling to take control in
either of these instances because they feel they do not have the resources necessary to
perform these agencies' accounting functions.
Additionally, to reduce the possibility of financial inaccuracies and improprieties, system
( I) The vendor file contains the names of all vendors that conduct business with the State. To process a
state warrant, the vendor's name must be contained in this file.
access should be limited based on agency needs. Currently, all agencies have equal access
to the system's numerous accounting functions despite their accounting needs. Because
accounting needs vary significantly from small to large agencies, access that is linked to
agency needs could simplify interaction for basic users without restricting access for ad-vanced
users. More specifically, agencies that perform complex accounting ( such as those
that have to monitor multiple projects or report on federal grants) should be assigned
greater access and receive extensive training on system capabilities. For agencies that use
USAS primarily to pay bills and record receipts, access should be limited to the transac-tions
needed for daily operation.
These suggestions, if implemented, will likely result in GAO needing increased staff.
Although we did not verify this figure, agency officials estimate that three additional
staff would be needed to assume the financial accounting activities of smaller agencies.
Agency Personnel Do Not
Have Sufficient Knowledge
to Utilize the System
The integrity of the State's financial information is further compromised because agency
personnel lack adequate knowledge to effectively operate USAS. Although the new sys-tem
requires staff with substantially greater skills than the previous system, new skill
requirements were not addressed. In addition, inadequate training continues to impede
successful operation of USAS.
New skill requirements were not addressed - The skill level needed by agency staff to
operate the new accounting system was not addressed when USAS was implemented.
Highly skilled accounting staff at the agency level became critical when USAS shifted the
responsibility for the accuracy of financial data to the agencies. Because new skill require-ments
were never addressed, the staff who have the qualifications needed to operate in a
paper- driven environment are now responsible for the integrity of the State's financial
information under the new complex, automated system. For example, accounting techni-cian
III's, who are only required to have nine hours of accounting instruction or equiva-lent
experience, often find themselves responsible for million- dollar budgets. The GAO
managers state that, ideally, staff responsible for such duties as budget monitoring and
management reporting should have an accounting degree.
Some agencies have tried to resolve personnel problems by recruiting staff who exceed
the minimum qualifications. However, low pay impedes their ability to retain employ-ees;
hence, these efforts have been largely unsuccessful.
Inadeqzrate training - A knowledgeable user base has been further hindered due to
inadequate training. According to one DOA official, a minimum of 40 hours of training is
needed to understand how to enter common financial transactions and read reports. An
additional 40 hours of training is needed to grasp the system's overall structure. In con-
trast, when USAS was implemented, agencies received anywhere from 0 to 40 hours.
Furthermore, this training was a " one shot deal" and conducted at too technical a level for
the average accounting technician. By the GAO's own admission, the training must be
simplified and continuous, especially given the turnover among accounting staff at state
agencies. .
The DOA's initial failure to recognize the importance of training to the successful opera-tion
of USAS continues to hinder the accounting system. The following examples illus-trate
how inadequate training has resulted in financial difficulties and inaccuracies:
In March 1993, an executive director of a small agency requested assistance from the
GAO relating to the processing of accounting transactions. This agency had virtually
" run out of appropriations" with three months remaining in the fiscal year. The GAO
discovered, among other things, that the accounting technician 111, responsible for
processing receipts, had not deposited money orders and checks totaling approxi-mately
$ 150,000 because she did not understand how to process them. The GAO fi-nally
had to revoke the agency's ability to release transactions because of repeated
problems. The GAO now reviews all financial transactions before they are fully pro-cessed.
During a financial audit, a GAO auditor reviewed the records of an agency that was
having year- end funding difficulties. The auditor found that agency staff did not know
how much money was available because they did not know how to use the system.
According to a GAO official, on average four agencies exceed their appropriation lim-its
every year. Such incidents are typically not discovered until the system rejects pay-roll
processing because of inadequate monies. This official attributes these problems
to lack of system and budgetary knowledge.
Additiotral training is needed - Additional training is needed to educate agencies on
proper system usage. A number of training needs have been identified by the GAO staff,
including agency- specific training for both the technician and management levels, con-tinuous
general training, and user- friendly manuals that emphasize how to process com-mon
financial transactions. Furthermore, to help address high turnover rates among ac-counting
staff, the GAO should require state agency staff to complete training as a condi-tion
of being given system access. This training should occur within a specified time-frame
from the employee's hire date.
The GAO officials indicated that its current USAS training group consisting of three FTEs
is not adequately staffed to provide comprehensive instruction to approximately 120 agen-cies.(')
The GAO estimates anywhere from two to eight additional staff members are needed
to provide the necessary training. However, as the GAO's training group has just recently
been established, it is difficult to determine if these numbers are appropriate. Moreover,
there is potential to use other staff who are knowledgeable on system capabilities to assist
in the training effort. For example, the GAO has five internal auditors and four systems
security staff in addition to the training group who could potentially coordinate efforts
and better utilize existing internal resources.
Subsequent to the completion of our fieldwork, the GAO implemented a three- year train-ing
plan beginning in July 1995. The GAO now offers formalized training classes and
publishes a training calendar to inform agencies of class availability. More emphasis is
needed, however, on formalizing the coordination between the security, internal audit,
and training groups.
RECOMMENDATIONS
1. The GAO should take measures to improve the internal control structure of the State
by:
Assuming data entry responsibilities of those agencies unable to implement proper
internal controls due to limited staff; and
Revoking access to those agencies that repeatedly violate internal control policies.
2. The GAO, after consulting with the affected agencies, should consider restricting sys-tem
access based on agency needs to facilitate system interaction and reduce the pos-sibility
of financial inaccuracies.
3. The GAO should require all users to complete training as a condition of having sys-tem
access. This training should occur within a specified timeframe from the employee's
hire date.
4. The GAO should ensure its training plan includes a discussion of how the training,
internal audit, and systems security groups can coordinate their efforts to best utilize
existing resources.
There is a fourth position in the training group that is dedicated to training on travel issues only.
9
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FINDING II
THE STATEWIDE ACCOUNTING SYSTEM
UNABLE TO READILY PORTRAY
ARIZONA'S FINANCIAL POSITION
The uniform statewide accounting system ( USAS) fails to meet Arizona's financial man-agement
needs. USAS is currently unable to provide both agency and statewide officials
with important financial information. It appears that system implementation suffered
from a lack of support and resources; factors that continue to hinder the system's capa-bilities.
Several system improvements are needed to ensure the system accurately and
readily provides the information necessary to manage the State's finances.
A good financial management system is a critical component in today's financial arena.
Its importance was recently illustrated in an article from Governing magazine comparing
and contrasting the financial successes of other Arizona governmental entities - the City
of Phoenix and Maricopa County. This article describes how in 1993, while the City of
Phoenix won an international award for its " management virtuosity," Maricopa County
was " busy spending itself to the brink of bankruptcy." Although many factors likely con-tribute
to the City of Phoenix's successes, the author is quick to point to one specific fac-tor:
" A sophisticatedfinancial system means the government of Phoenix knows nearly everything
about what it is doing, and it knows it very quickly. . . the most important thing it knows is how
it is spending its money. "
USAS' Goals
In July 1992, Arizona implemented an automated accounting system to improve its finan-cial
management. The primary expectations for the system were that it would:
Be a complete, fully integrated governmental accounting system that would provide a
fair and complete representation of agencies' and the State's financial position;
Provide agencies with better budgetary information and ad hoc reporting capabilities;
Eliminate the need for agencies to maintain duplicate financial systems; and
Process financial transactions in accordance with generally accepted accounting prin-ciples
for governmental units ( GAAP).
To date, USAS has been unable to fulfill these expectations making financial management
of the State's programs more difficult.
USAS Does Not Provide
Important Financial Information
Numerous problems currently prevent USAS from providing complete and accurate in-formation
at both the agency and statewide level. Our review found that important infor-mation
is missing from USAS, even though it is statutorily required. In addition, the sys-tem
is not integrated with procurement activities nor does it produce timely financial
information. Due in part to USAS current deficiencies, agencies continue to maintain
their own financial systems so they can determine the financial status of their own pro-grams.
Finally, financial transactions are not being entered in accordance with generally
accepted accounting principles ( GAAP) for governmental units.
Important financial information missing - Important components of financial informa-tion
are missing from the statewide accounting system, even though the DOA is statuto-rily
required to maintain such information. According to A. R. S. 535- 131, the DOA " shall
maintain complete, accurate and currentfinancial records relating to state monies . . . expended by
each budget unit, including bust monies or other monies not subject to appropriation . . ., in a
manner consistent with the unifarm state accounting system . . ." Without this information it
becomes difficult to prepare the State's Comprehensive Annual Financial Report ( CAFR).( l)
For example, such information as cash on hand, various bank and trust fund accounts,
receivables, and short- and long- term liabilities must often be obtained from each state
agency. c2) It takes several months for the GAO to compile this information. As a result, the
financial status of the State is really available only available once a year after the CAFR is
completed.
The amount of information maintained on USAS is greatly impacted by the State's three
largest agencies that represent nearly 50 percent of its expenditures: the Arizona Health
Care Cost Containment System, the Arizona Department of Transportation, and the De-partment
of Economic Security, who do not rely on USAS as their primary accounting
system. It appears that the State did not have adequate resources to accommodate the
specialized needs of these agencies, so they were not required to convert to USAS. Never-theless,
these agencies were expected to maintain complete information on USAS for re-porting
purposes. Although these agencies transfer some of their financial data to USAS,
significant information continues to be missing from the statewide system.
The CAFR discloses the State's financial status, and is often used by taxpayers, bond rating agencies,
and banking institutions.
Less than 50 percent of the information used to compile the CAFR is obtained from USAS.
System lacks integration and timeliness - Although USAS was intended to be fully
integrated with procurement activities and provide accurate and timely financial infor-mation,
these goals have not been achieved because:
USAS currently is not integrated with procurement activities; and
Payroll expenditures are not transferred to the accounting system until one week after
the close of the pay period.
As a result, information on the system, such as available appropriations, is exaggerated
and can result in both the agencies and the State spending monies that are not available
( i. e., monies that have already been committed). For example, if an agency procures the
services of a consultant, it has made a commitment to pay for those services; however, if
the monies needed for the consultant are not encumbered (" reserved) on the system they
may ultimately be spent by another agency official who is not aware of the commitment.
Although agencies are required by statute to encumber monies when expenses over $ 500
are incurred, our review indicates that compliance with this policy is poor. As mentioned
previously ( see Finding I, pages 5 through 9), overspending may not be discovered until
the system rejects payroll processing due to inadequate monies.
Agencies are frustrated by the lack of timely and accurate financial information. For ex-ample,
a common complaint cited in our agency survey was that USAS does not provide
agencies with adequate budget and/ or management information ( including reports)
needed to conduct day- to- day operations.(') Although GAO has created several manage-ment
information screens, their effectiveness is hindered by the lack of integration with
procurement activities and the delayed transfer of payroll information.
Iizcomplete and untirrzely infomzation contributes to agencies maintaining duplicate sys-teriss
- Although a primary intent for USAS was to eliminate the duplication of resources,
this goal has not been achieved. Under the previous system, many agencies maintained
their own financial systems because they did not have on- line access to the State's finan-cial
information. While USAS has allowed agencies on- line access, it has failed to provide
them with timely and complete information, requiring many agencies to continue using
their own systems. For example, 19 of the 22 agencies we contacted said they still main-tain
some form of internalaccounting system ranging from paper ledgers to fully auto-mated
accounting systems. A GAO employee confirmed that these results are representa-tive
of most small and medium- sized agencies. In addition, the largest agencies maintain
their own systems, which were in place prior to the implementation of USAS.
(') Using an agency listing provided by the GAO, we contacted 22 small, medium, and large agencies to
determine the system's ability to meet their financial management needs. This size classification is
based on the agency's utilization of the system including the number and type of transactions per-formed.
Agencies offered several reasons for why they maintain separate systems. While some
stemmed from misperceptions about USAS' capabilities due to poor training ( see Finding
I, pages 5 through 9), other concerns were based on USAS' inability to:
Provide timely, accurate, and user- friendly financial information;
Provide meaningful, timely, standardized reports and ad hoc reports; and
Facilitate the recording of receivables due to an inoperative billing system.
As discussed above, USAS is not integrated with other systems and therefore lacks timely,
complete information. Moreover, the GAO's reports that are available are frequently criti-cized
for being untimely and unreadable. These problems are due in part to USAS not
having a functional ad hoc reporting tool that would allow agencies to customize their
own financial reports, thereby reducing the need for the GAO to do so. Additionally, a
billing system is necessary to facilitate the recording of accounts receivable information
on USAS. Currently, approximately 40 to 50 percent of the State's agencies provide bill-able
services and rely on their own systems to process invoices and record accounts re-ceivable
information. Consequently, such information is missing from USAS.
Transactions not processed in GAAP fonnat - Although lack of integration has hin-dered
USAS' performance, the current accounting method practiced has also impeded
USAS' ability to meet the State's original expectations. For example, USAS was intended
to provide information in compliance with generally accepted accounting principles
( GAAP) for governmental units to facilitate the production of financial reports and to
enhance the quality of information available to policy makers. Although the system is
capable of processing such information, agencies generally do not enter information on a
GAAP basis. When financial transactions are entered on a GAAP basis, monies are basi-cally
committed on the system when the obligation to purchase is made rather than wait-ing
until the bill is paid. For the past several years our Office has recommended this
method as it provides a more accurate depiction of monies available.
Lack of Support and Resources
Contribute to USAS' Failure
Several factors may have contributed to USAS' current inability to meet Arizona's finan-cial
management needs. Although DOA consulted with other states and conducted a fea-sibility
study prior to installing the new accounting system, a lack of support and re-sources
may have contributed to its poor implementation and continue to hinder its suc-cess
today.
Lack of support and resources contribute to poor implementation - Although pre- plan-ning
for USAS is evident, its implementation does not appear to have received the sup-port
and resources needed for success. Prior to purchasing the new accounting system,
the State conducted a feasibility study to determine what functions it needed the new
system to perform. Nevertheless, the DOA appears to have underestimated the difficulty
in successful system implementation.
According to the Government Accountants Journal, key factors in any successful long- term
automation project include sufficient resources and securing top management and broad-based
support from stakeholders. It appears that the General Accountant, who was ulti-mately
responsible for system implementation, was unable to solicit the support and re-sources
necessary to successfully implement USAS ( perhaps due to a lack of authority -
see Finding 111, pages 19 through 26). For example, according to the GAO staff, the Gen-eral
Accountant submitted a proposal to the Assistant Director of the Financial Services
Division explaining the need to upgrade the DOA accounting positions with the advent
of USAS. The DOA officials denied the request and informed the General Accountant that
" the development of USAS must be within the existing resources."
In addition, the amount of resources Arizona invested in system implementation was low
compared to other states with the same system.(') Three of the four states that also pur-chased
USAS provided cost estimates for system implementation ( for software, training,
consultants, and reprogramming) ranging from $ 12 million to $ 60 million. In contrast,
Arizona invested $ 3 million for these same items.
Many of the system deficiencies have been recognized by the GAO; however, when they
will be addressed is uncertain due to a lack of resources and other competing DOA pri-orities.
For example, GAO officials state they do not have the technical staff necessary to
perform the reprogramming required to make USAS more user friendly and efficient.
Currently, inefficient programming contributes to unnecessarily high system downtime
as well as cumbersome user screens. To correct such problems, the GAO must rely on
programmers who are located within the DOA's Information Services Division ( ISD).
However, these programmers are often reassigned to other competing statewide applica-tions.
Only 10 of the 14 programmers assigned to the statewide accounting system are
working on USAS ( 8 full- time and 2 part- time). The remainder are working on other
statewide applications. This leaves only enough staff to maintain USAS but not enough to
make badly needed improvements. Therefore, it is uncertain when these needs will be
addressed.
(') Maryland, Michigan, Oregon, and Texas all have the USAS system. All of these states, except Mary-land,
were able to provide us with cost figures for software, training, consultants, and reprogram-ming.
All of the figures cited are for initial implementation costs and do not include any costs for
additional enhancements.
Five Changes Needed to Ensure
USAS Meets Arizona's
Financial Management Needs
USAS could largely fulfill its original goals if actions are taken in five key areas.(')
First, additional software needs must be addressed. Software needs include a billing sys-tem
to facilitate the recording of accounts receivable information ( needed for GAAP- based
accounting methods) and an ad hoc reporting tool to allow agencies to produce custom-ized
reports. Both items will assist in eliminating the need for duplicate systems at the
agency level. The GAO should conduct feasibility studies to determine if the existing
software can be enhanced to meet agency needs or if new software is required. The GAO
estimates that new software would cost approximately $ 1.1 million ( this estimate includes
the cost of feasibility studies, but not additional equipment agencies may need to use the
new software).
Second, the DOA should perform the reprogramming needed to make USAS more user-friendly
and efficient. This can be accomplished either by transferring programmers to
the GAO or by committing adequate resources in the ISD to meet USAS' day- to- day main-tenance
needs and make additional enhancements. c2)
Third, to ensure the system provides accurate information, the DOA should ensure that
USAS is interfaced with procurement activities and payroll processing delays are mini-mized.
Although the State abandoned the original procurement system that was pur-chased
with USAS, another system has since been purchased. The DOA should make
efforts to accelerate this project. Likewise, delays in payroll processing should be ad-dressed
either through system changes or by utilizing accounting practices such as en-cumbering
(" reserving") payroll.
Fourth, to improve the quality and quantity of information kept on USAS, the DOA should
take the steps necessary to enable agencies to maintain full financial information on the
system as required by A. R. S. 535- 131. In the case of the three largest agencies that have
specialized needs that currently cannot be met by USAS, this will entail the DOA assess-ing
the additional system enhancements required to meet their needs. Then, as a long-term
goal, the DOA will need to equip USAS to fulfill these needs.
There are, however, many agencies who could, but do not, keep complete financial infor-mation
such as revolving funds and budgetary information on USAS. In some cases it
These recommendations are h i t e d to only those that would likely enable USAS to meet original
expectations. They do not address other items needed to enhance the system.
( 2) The GAO recently submitted a request to the DOA director to have programmers transferred from
ISD to GAO. However, the request was denied.
appears agencies do not keep full information on the system because of a lack of knowl-edge
about the system. Other agencies appear not to put all information on USAS as a
means of limiting outside scrutiny of this information. The DOA needs to address these
situations through better training and specific discussion with the agencies involved.
Finally, the State should consider requiring some agencies to enter financial data in accor-dance
with GAAP. Because this method is more complex than the current cash- based
method, it might be more cost- effective to convert only those agencies that comprise the
largest share of the State's revenues and expenditures. GAAP accounting methods would
enable the system to report the State's financial position continually throughout the year
rather than relying solely on the annual report. Moreover, this method does not preclude
the State from reporting on a cash basis if needed.
RECOMMENDATIONS
To improve the statewide accounting system, the DOA should take the following steps:
1. Conduct feasibility studies to determine if the current billing system and ad hoc re-porting
tool can be enhanced to meet agency needs or if additional software is neces-sary.
2. Reprogram the system to make it more user friendly and efficient.
3. Interface the system with procurement activities and address payroll processing de-lays.
4. Improve the quality and quantity of information on USAS by:
Assessing the additional system enhancements required by the three largest state
agencies to meet their needs, and as a long- term goal, equipping USAS to fulfill
those needs; and
Ensuring, through better training and specific discussion with agencies, that agen-cies
record complete financial information on the USAS system whenever pos-sible.
5. Consider converting those agencies that comprise the largest share of the State's rev-enues
and expenditures to GAAP basis accounting.
FINDING Ill
THE STATE NEEDS A
CHIEF FINANCIAL OFFICER
Arizona needs a chief financial officer ( CFO) to assist in statewide strategic planning and
to ensure strong financial management and public accountability. The need for strong
financial management is increasing, but DOA's current organizational structure is inad-equate
to handle the challenge. The private sector should serve as a model for Arizona as
it has for other governmental entities.
Although Arizona's $ 11 billion budget is similar in size to such Fortune 500 companies as
Intel, U. S. West, and Chase Manhattan Corporation, the State lacks a key component of
most private sector management teams - a Chief Financial Officer ( CFO). In the private .
sector the CFO works in partnership with the Chief Executive Officer ( CEO) and the Chief
Operating Officer ( COO) to manage company operations. The CFO takes a global view of
the organization, handling financial and strategic planning issues, while his or her staff
( including the controller) manages the daily financial operations. The closest equivalent
Arizona has to a CFO is the State's General Accountant who, as keeper of all funds, more
closely resembles the private sector's controller. Specifically, Arizona lacks an individual
whose primary role is to provide sound financial information to the budget offices and
other financial entities to assist with such policy questions as:
H Can we afford a tax cut?;
H How much revenue must we collect to pay for education reform?; and
H Will there be adequate resources in the future to fulfill bond obligations?
This void has put the State in a reactive position regarding the stewardship of public
monies and financial management in general.
Arizona's Current Organizational
Structure Is Not Conducive to
Strong Financial Management
The DOA's current structure is inadequate to handle the financial challenges facing the
State. Although Arizona's need for strong financial management is increasing, it contin-
ues to place responsibility for its finances at a much lower organizational level than the
private sector. As a result, important financial activities are difficult to accomplish.
The need for strong financial management is increasing - Several factors illustrate the
increasing need for strong financial management. First, over the past five years, Arizona
has experienced rapid budgetary growth. According to the Comprehensive Annual Fi-nancial
Report ( CAFR), the State's general fund revenue has increased by almost 70 per-cent
( from $ 4.2 billion to $ 7.1 billion) in the last five years.
Second, stricter professional standards, promulgated by the Governmental Accounting
Standards Board ( GASB) and the Single Audit Act, have been instituted since the mid-
1980s that require greater disclosure of financial information. The State has been unable
to meet several of these reporting requirements including financial disclosure of federal
grant information and general fixed assets. The inability to meet such standards could
ultimately result in the State receiving a lower Certificate of Participation ( COP) rating,
and thereby paying a higher interest rate to the State's investors.(')
Lastly, state and national initiatives such as the National Performance Review and the
Arizona Budget Reform Act illustrate the increasing demand for greater efficiency and
accountability in go~ ernrnent.( S~ tr) o ng financial management will increase the likelihood
that such goals are achieved by providing agencies with the financial data needed to
make sound fiscal decisions.
DOA's current organizational structure impedes strong financial management - The
DOA's current organizational structure suggests that strong financial management is not
a priority, thus leaving Arizona in a reactive position regarding financial management
and strategic planning. The current financial management team consists of the Director of
DOA, the Assistant Director of the Financial Services Division ( FSD), and the General
Accountant ( who is located in the General Accounting Office). According to A. R. S. 541-
732, ultimate responsibility to keep public accounts rests with the Director. However, this
statute enables him to delegate the duties associated with this task to the General Accoun-tant
of the State. Figure 1 ( see page 21) provides a comparison of the DOA's organization
structure with that of a typical large corporation.
(') COPS are a legalized form of debt issued as a mechanism to finance the construction or acquisition of
state facilities.
( 2) The National Performance Review is an initiative by the Clinton Administration to make government
" work better and cost less." The Budget Reform Act was passed in fiscal year 1993 by the Legislature
to move toward performance- based budgeting.
Figure 1
Comparison of Financial Management Structures
State of Arizona vs. Fortune 500 Company
State of Arizona
DOA- Personnel DOA- Financial DOA- Information
Assistant Director
State Procurement Risk Management
Fortune 500 Company
Chief Executive ORter
Ch! ef Flnanclal Officer
Comptroller
- Compliance with accounting - Cash 8 R i
poliiieslprocedures. financial ManagemenVlnvesbnents
reportinslaccounting systems
As illustrated on page 21, executive leadership over statewide financial matters resides at
a much lower level within state government than within the private sector.(') Not only is
the General Accountant four levels below the Governor, but the director and assistant
director positions above it are appointed. Consequently, individuals in those positions
are not necessarily required to have a financial backgro~ nd.( F~ u) r thermore, both posi-tions
experience significant turnover. For example, in the past five years, there have been
five directors and four assistant directors. Lastly, because financial management is one of
many responsibilities assigned to the Director, it often competes with other agency priori-ties.
( The DOA has four other divisions in addition to Financial Services. See Figure 1 on
page 21.)
Lack of authority makes important financial activities difficult - Although the statute
enables the Director to delegate the duties associated with keeping public accounts, the
General Accountant has not been given the authority to fulfill important financial respon-sibilities.
Currently, the General Accountant is responsible for, among other things, man-aging
the State's daily financial operations, maintaining the statewide accounting system,
and ensuring compliance with accounting policies and procedures. However, the Gen-eral
Accountant lacks the authority to adequately perform these functions and to serve as
an equal participant with agency heads on financial matters. For example:
Agencies continually fail to submit the financial information necessary to prepare the
State's Comprehensive Annual Financial Report ( CAFR) in a timely manner despite
requests from the General Ac~ ountant.( T~ h) e se delays ultimately contribute to the un-timely
production of the CAFR. The CAFR, which reports the status of the State's
finances, has been late every year since its inception ( in 1989) except this past year.
The CAFR became a priority this last year when the DOA Director was informed that
Arizona was ranked as one of the bottom five states for timeliness of financial report-ing.
When USAS was purchased, it included a procurement module that was subsequently
abandoned for another project described as " less effective." Our review indicates that
the decision to abandon the original module was made without the support or the
participation of the General Accounting Office ( GAO) which is responsible for the
operation of USAS. The purchasing module is critical to the success of USAS because
without it, the system reports misleading information ( see Finding 11, pages 11 through
17).
The CFO in the private sector reports directly to the CEO of the company.
(') The desired qualifications specified in the most recent recruitment for the DOA Director did not
include any reference to a financial background.
") The GAO must request this information annually from agencies because it is either not on the state-wide
system, or it is not in the proper format.
According to several persons involved in implementing USAS, the GAO expressed
concerns regarding the insufficient resources dedicated to the project. Having partici-pated
in the implementation of the previous accounting system, there was a concern
that similar mistakes were being repeated with the new system. Despite these con-cerns,
the DOA decided that the development of USAS had to be within the existing
resources. Therefore, no additional funding was provided for such items as training.
In addition, to promulgate new accounting policies and procedures for the State, the Gen-eral
Accountant must first have the support of the Assistant Director and the Director
who, as previously mentioned, may not have a financial background.
Government Is Following
the Private Sector's Lead
To elevate the importance of financial management and fiscal policy decisions, Arizona
should establish a Chief Financial Officer position. National and state trends indicate that
strong financial management is becoming a priority in government. If a CFO position is
established in Arizona, it should be given statewide financial duties and be structured to
withstand the changing political environment commonly experienced in the public sec-tor.
National trends - The federal government has shown its commitment to financial man-agement
and accountability through The Chief Financial Officers Act of 1990. This act
gave the Office of Management and Budget ( OMB) broad new authority and responsibil-ity
for directing federal financial management, modernizing the federal government's
accounting systems, and improving financial reporting. Citing problems similar to
Arizona's, the federal government stated that this act was needed because the existing
financial practices did not provide adequate information to plan for current and future
operating costs ( such as future cash needs), or operate programs efficiently. The act pre-scribed
the establishment of critical financial positions ( all of whom are appointed by the
President and confirmed by the Senate) including:
Deputy Director for Management - This individual serves as the federal government's
CFO. He/ she sets universal financial management policies, monitors the resources
required to effectively operate, maintain, and enhance financial management systems,
and monitors the financial execution of the budget. In addition, the Deputy Director
oversees information and procurement policy, property management, and productiv-ity
improvement.
Comptroller(') - The comptroller heads the new Office of Federal Financial Manage-ment
in OMB. As in the private sector, this individual handles day- to- day accounting
operations to ensure universal compliance with financial policies and procedures.
Chief Financial Officers - CFO's were established in 23 major agencies. These indi-viduals
establish financial management and internal control policies, establish ad-equate
financial systems to produce useful, reliable, and timely financial data, and
integrate budget execution and accounting functions.
The federal government claims that the improved central coordination of internal con-trols
and financial accounting resulting from this act could significantly decrease the bil-lions
of dollars lost through waste, fraud, abuse, and mismanagement of programs. One
agency CFO stated that he has been able to accomplish important financial activities since
the act's passage. The Assistant to the Chief Financial Officer of the Department of Com-merce
stated that this act is enabling the department to implement a comprehensive fi-nancial
management system. The Assistant also noted that because the Secretary of Com-merce
has many other priorities, having a CFO has enabled them to provide more accu-rate
and meaningful information to managers and policy makers. Because accurate finan-cial
data is the CFO's primary responsibility, accountability has also improved.
State level - Events at the state level also suggest that strong financial management has
become a priority. We conducted a survey of states to gather information on their finan-cial
structures.( 2T) he term " chief financial officer" is not commonly used at the state level.
However, strong comptrollers serve in a similar capacity to CFO's in the private sector.
Out of the nine states we contacted, five had elevated or created a comptroller position
since the 1980s in an effort to prioritize financial management. Two of these five are strong
comptroller positions.( 3) The need for strong financial management and the results such
management can achieve are illustrated below:
H The Governor's Commission on Quality and Efficiency in the State of Kentucky rec-ommended
the establishment of a comptroller position to elevate financial manage-ment.
Several reasons supporting the position were presented to the Commission.
The terms l'comptr~ llera~ n~ d " controller" are often used interchangeably. However, the term con-troller
is more commonly used in the private sector.
The National Association of State Auditors, Comptrollers and Treasurers ( NASACT) provided us
with comptroller information they had obtained from a survey. We used this information to select
other states. Our selection was based on the type of appointment ( i. e., elected, appointed, civil service
exam) and the reporting structure.
0) According to literature provided by the State of Kentucky ( who elevated their comptroller position in
1993), approximately 15 states have a " strong comptrollership function."
They included the lack of a strong, independent, and credible source to assist agencies
with internal controls and the inability to report financial data accurately. Also cited
was the fact that the current organizational structure was not conducive to attracting
the skilled, technical employees needed to manage a large, complex financial manage-ment
system.
North Carolina established a strong comptroller position in 1986 that oversees not
only financial management activities but information resource management as well.
This State's comptroller reports that strong financial leadership has resulted in better
financial accountability and reporting, and the successful implementation of a state-wide
accounting system. The comptroller explained that prior to 1986, financial man-agement
was so poor that the budget office had to conduct an agency survey when-ever
the Legislature wanted specific information on expenditures.
Massachusetts also implemented a statewide accounting system under a strong comp-troller.
The system is truly comprehensive ( every agency is on line) and provides im-mediate
financial information such as cash on hand to state agencies and statewide
officials. Unlike USAS, this system maintains the data needed to produce the Compre-hensive
Annual Financial Report ( CAFR). As a result, the resources and time needed
to produce the report are significantly reduced. According to the state comptroller,
there are five professionals that work one " intensive" month to prepare the report. In
contrast, Arizona has 11 people who dedicate much of the year to the project.
A CFO in the public sector requires authority, independence, and longevity - To with-stand
the political instability commonly experienced in the public sector, a CFO should
have adequate authority, independence, and longevity. Information obtained from both
the private and public sectors indicates that an adequate level of authority for the Chief
Financial Officer ( or equivalent) is critical for the position. According to a management
consulting firm, CFOs in Fortune 500 companies always report to the Chief Executive
Officer ( CEO) and have authority that spans across division lines. The federal CFO Act
also emphasized the need for adequate authority. For example, the OMB required that
agencies illustrate through an organizational chart that the CFO reports directly to the
agency head. The OMB also stated the CFO should have responsibility for information
resource management ( IRM), or be a full participant in agency- wide IRM decisions, and
be able to appeal to the agency head on IRM decisions affecting financial management of
which the CFO disapproves.
Stability and independence from the political process are also important. To address these
concerns, North Carolina established a comptroller position that serves a seven- year term
and reports to both the Governor and the Legislature.(')
' ) This position is appointed by the Governor and confirmed by the Legislature.
If the State establishes a CFO reporting to its highest executive, it may require the creation
of a new financial management office to support the CFO position. All statewide financial
duties currently performed by the DOA should be transferred to this office.
Other considerations - While the establishment of a Chief Financial Officer is an impor-tant
step toward the improvement of overall state financial management, there may be
other elements in the State's financial arena that may also need to be considered. As men-tioned
earlier, a role of the CFO would be to provide sound financial information to bud-get
offices and other financial entities to assist with policy questions. As this scenario
suggests, the CFO would frequently work in conjunction with other state budgeting and
financial officers, such as the Joint Legislative Budget Committee, the Office of Manage-ment
and Budget, the State Treasurer, and the Department of Revenue. Therefore, further
study would be needed to determine how these entities would interact or whether any of
their roles or functions should be combined or consolidated with the CFO to ensure im-provement
of Arizona's financial management.
RECOMMENDATIONS
1. The Legislature should consider establishing a Chief Financial Officer ( CFO) position.
The CFO should be given the statewide financial duties that are presently associated
with the DOA. Consideration should also be given to structuring this position with
adequate authority, independence, and longevity.
2. If a CFO position is established, the Legislature should also consider further study of
the need for interaction between the CFO and other financial officers and whether any
of their roles and functions should be combined or consolidated.
FINDING IV
RISK MANAGEMENT'S PROPERTY AND
LIABILITY CLAIMS UNIT EXHIBITS
NUMEROUS PROBLEMS
Throughout 1994, the State's risk management program experienced various management
problems. For example, there were high vacancies ( up to 30 percent) at both the stafand
supervisory level and a high rate of management turnover - 3' risk managers within a 10-
month period. In addition, there were at leastfive investigations that resulted in four em-ployees
being placed on adnzinistrative leave, as many as four contracts not being renewed,
and an independent adjuster being indicted forfiaud.
These disruptions to the Risk Management Section's ( RMS) daily operations have under-mined
the Property and Liability Claims Unit's integrity. An array of claims- handling
problems limit the RMS' ability to safeguard monies set aside for the property and liabil-ity
program. Many of these conditions can be attributed to management's failure to re-solve
basic problems within their control. Fundamental changes are needed to ensure
state monies are well spent and loss exposure is controlled.
Claims- Handling Problems Can
Result in Unnecessary Expenditures
The RMS' claims- handling methods expose the State to increased claims settlement costs,
inappropriate expenditures, and the potential for fraud. Our review of property and li-ability
claims files found that the majority of these files exhibit at least one fundamental
problem. Claims- handling problems identified include inattention, poor documentation,
lack of supervision, high caseloads, and weak internal controls.
File review uncovers numerous problems - Numerous claims- handling problems exist
in the RMS' property and liability section.(') To help assess the adequacy of the RMS'
claims- handling methods, we reviewed 77 property and liability claims files ( 49 of these
(') The RMS' property and liability section receives over 6,000 claims per year. Claims are filed by state
agencies and the public. The claims received vary widely in terms of type and severity - everything
from broken windshields on state vehicles, to prisoner lawsuits and environmental claims.
27
files were open and 28 were closed).(') Over 80 percent of the files from the sample exhib-ited
at least one problem. Moreover, several problems such as inaccurate claims informa-tion
on the RMS' automated system, duplicate files, and files that the RMS was unable to
locate made the selection and review of the sample difficult and further raised concerns
about the extent to which problems exist.
Though individually the problems we identified in our review may not appear signifi-cant,
when combined they indicate the poor quality of the RMS' claims- handling process.
Inattention and delays in handling - Our review suggests that the RMS has no way of
ensuring that property and liability cases are properly adjusted. For example, 17 ( 35 per-cent)
of the 49 open cases contained no evidence of being adjusted, some being unat-tended
for periods from several months up to 4 years. The RMS attributes some of these
delays to not having the appropriate mechanisms in place to integrate outside adjuster
cases back into its own workload when contracts expire or are terminated.( 2) I n December
1994, the contract adjuster assigned to handle the medical malpractice claims was in-dicted
on six counts of fraud and theft for falsifying claims documents relating to his
contracted work with the RMS. It was not until 6 months after this indictment that the
RMS began reassigning approximately 64 claims to staff adjusters. Similarly, the RMS has
yet to reassign an estimated 64 claims that were previously handled by another indepen-dent
adjusting company, essentially leaving the files unattended in boxes for more than
13 months.
Our interviews with industry representatives indicate that the longer a case remains open,
the greater the costs will be to settle the claim.
Poor cloczrmentation - In addition, more than 50 percent of all reviewed cases lacked
adequate documentation. Since the claims process involves investigating and gathering
of documents to determine the State's liability, files should contain an array of documen-tation.
However, we found insufficient documentation to support many claims adjusting
activities. For example, cases lacked explanations for the settlement amount or why a case
We chose a judgmental sample from a March 31,1995, case summary report, with the intent of re-viewing
claims at various stages in the process. These files included both in- house adjusters and
contracted adjustment services provided by independent adjusters. Because some of the information
on the RMS' automated claims management system ( Risk Management Information System " RMIS")
is inaccurate, we selected alternate files when necessary.
( 2) The RMS contracts with independent adjusters to provide specialized knowledge, handle claims in
remote locations, and assist with peak workloads. They perform such services as appraisals, taking
accident scene photos, and interviewing claimants. The cost for these services typically range from
$ 35 to $ 49 per hour. In contrast, the RMS staff adjusters' salaries range from $ 12 to $ 18 per hour
( excluding benefits and overhead).
was denied, evidence of the claimant's signed release, and adequate documentation to
support the payments made to outside adjusters and legal counsel.( l)
Inadequate documentation can expose the State to future liabilities and cannot ensure
that expenditures are necessary or appropriate. For example, an independent adjuster
was hired to provide interim adjusting services for medical malpractice claims. A $ 12,430
bill was submitted and paid, representing two months' work ( individual billings ranged
from $ 307 to $ 959 per claim file). However, we were unable to find adequate support for
these billings, especially since we discovered some cases were essentially closed by the
previous adjuster and others contained no documentation to support that any work was
performed by the interim adjuster.
Lack of supervision - In addition to cases not being adjusted in a timely manner or
properly documented, they are not receiving the necessary supervisory review. The RMS
claims staff and supervisors report, and our file review confirms, that virtually no super-visory
review takes place from the time a case is assigned until it is closed. This lack of
supervision applies to both the RMS' in- house adjusters as well as the independent ad-justers.
Most files contained no documentation indicating that a supervisor had ever re-viewed
the case. Moreover, 13 of 18 ( 72 percent) case assignments to independent adjust-ers
we reviewed did not receive the necessary supervisory approval.
The lack of supervisory review can ultimately result in inappropriate and unnecessary
expenditures. For example, we identified several cases that appeared to result in unnec-essary
costs:
A claim for a $ 200,000 embezzlement loss remained only partially resolved over an
18- month period because the RMS failed to initiate claims processing with its insur-ance
company.( 2T) here was no evidence of supervisory review during the 18 months.
The State now risks losing reimbursement of $ 100,000 from its insurance company
because of the negligent handling of this case.
An unapproved assignment for independent adjusting resulted in payment of $ 635 to
perform work over the phone and by mail; tasks which could have easily been done
by the RMS adjusters for considerably less cost. Payment on this case was made to two
separate adjusters, and there was no documentation in the file to support either pay-ment.
(') A signed release form is used to preclude future State liability when a claimant is paid. However, the
RMS has not developed adequate policies and procedures to ensure that signed release forms are
appropriately obtained.
( 2) The State is primarily self- insured. However, when it is available and affordable, the State purchases
insurance from private carriers. In this case, the State has a policy that covers losses in excess of
$ 100,000.
A local independent firm was paid to photocopy investigative materials for 21 hours,
charging $ 44 per hour, costing over $ 900. Similarly, another local independent ad-juster
was paid, at a rate of $ 35 per hour, nearly $ 1,000 for 28 hours of photocopying
materials.
High caseloads - High caseloads also impact the quality with which claims are handled.
Industry experts we interviewed indicated that there are no industry standards for opti-mal
caseload size because each risk management program has its own unique set of cir-cumstances.
Such factors as the types of claims, whether deductibles are in effect, the
deductible amounts, and seasonal fluctuations can affect optimal caseload size. There-fore,
if caseload guidelines are used, each individual entity has to develop its own case-load
standards based on the particular nature of claims and liability.
In 1990 the RMS developed adjuster workload standards. To develop these standards, the
RMS reviewed information from the private sector, considered the type and complexity
of cases handled by the State, and estimated the average number of hours needed to
adjust particular cases. However, since 1990 the RMS has not revised its workload stan-dards,
and for at least the past year the RMS adjusters have been operating with caseloads
more than double the RMS' standard of 120 to 140. For example, an analysis of the Phoe-nix
property and liability claims adjuster caseloads for May 1995 revealed caseloads aver-aging
270 cases per adjuster with one caseload of 491.(')
Operating with high caseloads may result in less thorough investigations. This in turn
may result in some cases being settled for less than if they were given more attention.
Similarly, heavy workloads may result in fraudulent claims going undetected, since ad-justers
can treat most cases in only a superficial manner.
Weak irrtental corztrols - Claims- handling problems also exist during the payment pro-cessing
stage, whereby weak internal controls expose the State to inappropriate expendi-tures
or even fraud. We found that despite a previous review from our Office citing the
RMS for employing inadequate segregation of duties, this problem had not been cor-rected
when our performance review began.@) F or example, each accounting clerk was
allowed to input claims data, release transactions for processing, and receive the war-rants
( i. e., checks). c3)
(') One staff person has a caseload of 815. However, the RMS officials contend this person handles
primarily small dollar property claims from Department of Corrections inmates and it is appropriate
to carry such a high caseload. This person's caseload was not figured in the average.
(') The problem was identified in our Fiscal Year 1993 Management Letter Report which is separately
issued to the agency. This Letter Report is issued in conjunction with the statewide single audit.
( 3) It was not until May 1995 that the RMS began segregating these duties.
Weaknesses in payment procedures further jeopardized the RMS' ability to safeguard
monies. Ideally, when a claim payment is processed it should include adequate taxpayer
identification information, such as a social security number, to enable the State to ad-equately
track the financial transaction. However, a February 1995 analysis by the RMS
accounting staff found that 21 percent of all payments processed during that month did
not contain this crucial identification information. Without this information simple error
detection becomes difficult and fraud detection nearly impossible. For example, we found
one case where the RMS' automated system indicated two payments were sent to a claim-ant,
though the claim file contains a copy of only one payment. The RMS was unaware of
the possibility that a duplicate payment occurred for this case. Moreover, when we tried
to verify whether a duplicate payment was made, the RMS explained that difficulties in
reconciling the RMS automated system with the statewide accounting system severely
limits their ability to determine if and when duplicate payment actually occurs.
In August 1995, subsequent to the end of our review, the GAO established a policy re-stricting
the use of the transaction code that allowed payments to be processed without
adequate taxpayer identification. The RMS furthered the intent of this policy by eliminat-ing
the accounting staff's access to that code.
The RMS Failed to
Address Deficiencies
The RMS has been remiss in addressing the deficiencies its program exhibits. The RMS
has not maintained or utilized essential management information. Further, it has not ad-hered
to established policies and procedures, and has not managed its contracts. Finally,
various staffing problems have contributed to the disorder of the claims management
function.
Failure to use marzagenlent information - The RMS has failed to fully utilize much of its
management information to adequately oversee its operations. The Risk Management
Information System ( RMIS) contains information pertaining to case assignment and sta-tus,
financial payment histories, and the use of outside adjusting services and counsel.
The RMIS provides regular reports to adjusters and management that can be used as a
tool to manage claims, gauge performance, and portray workload. However, our review
indicates the data is inaccurate in many instances. For example, the RMS continues to
show cases assigned to an independent adjuster who was indicted, a contractor whose
contract has expired, and to the category " unknown."
The RMIS also fails to capture additional data that could assist the RMS in managing its
claims operation. For example, the RMS is currently unable to determine the frequency
and reasons for using outside adjusting services.(')
Failure to follow policies on supemision - In addition, although the RMS has estab-lished
explicit policies and procedures regarding supervision, they essentially are not in
effect. For example, supervisors are required to review at least 20 cases from each adjuster
on a monthly basis. Despite this requirement, as illustrated earlier most cases are not
receiving any type of supervisory review. Further, supervisors are also required to con-duct
an annual review of the adjusters' work. However, the RMS staff state that these
ongoing monthly reviews have been neglected and annual reviews have not been con-ducted
for at least the past two years due primarily to time constraints.
The RMS attributes its failure to follow policies to turnover among upper management,
and the attention management has had to give to several investigations and management
projects over the past two years.
Poor contract management - Further, despite spending $ 1.7 million for contracted ad-justing
services during the past two years, the RMS has failed to properly manage these
contracts. For example, within the past 18 months, the RMS has encountered the follow-ing
problems:
Over a ten- month period, the RMS allowed staff adjusters to assign over $ 95,000 worth
of adjusting work to an independent company before discovering the company's con-tract
had expired and had not been reawarded during the previous rebidding process.
The RMS management hired a consultant at the cost of $ 43,000 to investigate an inde-pendent
firm suspected of overbilling for its services. Though the RMS management
ordered the independent firm to cease state contract work during the investigation,
our file review indicates that the RMS staff continued to send them work while the
investigation was underway.
The RMS has not developed specific policies regarding contract management, includ-ing
policies on potential conflicts of interest. For example, we found two employees
were granted authorization to perform adjusting services with independent adjusting
firms that held state contracts. Because these employees are in a position to assign
cases out to their secondary employer, the RMS cannot ensure that cases are being sent
out judiciously and in the State's best interest.
(') Subsequent to the completion of our fieldwork, the RMS began compiling some data on the use of
outside adjusting services.
32
Stafiing problems - Finally, staffing problems, including extended vacancies and high
turnover, have further contributed to the disorder of the claims management function.
For example, while the vacancy rate office- wide is relatively high ( 21 percent), the num-ber
of vacancies within the property and liability unit is even higher ( 30 percent). In addi-tion,
the majority of these vacancies have remained open for over nine months. According
to the RMS officials, these positions have not been filled for various reasons including the
RMS' involvement in several ongoing investigations and the organizational " turmoil"
resulting from such disruptions. Moreover, four employees ( including two managers and
a supervisor) had been placed on paid administrative leave during the various investiga-tions
previously mentioned, stifling the RMS' ability to fill certain positions.
The RMS has also had three different risk managers within a ten- month period, which
may have impacted its ability to make improvements in its operations.
Immediate Action Is Needed
to Improve Claims Management
Although the RMS claims management function suffers from numerous problems, many
of these can easily be resolved by following good claims management practices.
First, the RMS should follow its established policies and procedures. For example, the
RMS should regularly employ the supervisory activities it has already established and
that are common among other public risk management entities. Public risk managers that
we interviewed report that well- run claims operations require hands- on supervision, con-stant
monitoring of outside adjusting services, and routine audits ( i. e., bi- monthly, an-nual,
etc.). Most of these items are already addressed in the RMS manual and should be
followed. In fact, following the completion of our review, the RMS officials have indi-cated
they are re- establishing the continuous supervisory reviews. To help in this pro-cess,
the RMS has developed a supervisory checklist and plans to review 20 cases per
month, per adjuster.
Second, the RMS will need to determine what additional policies need to be developed.
For example, the RMS has a need for outside adjusting services yet lacks the necessary
guidelines to adequately oversee this process. Specifically, it needs to establish formal
procedures for case assignment, monitoring, billing documentation, and review. Public
risk managers that we spoke to stressed that oversight and supervision of contracted
adjusting staff is just as important as it is for in- house staff. Therefore, guidelines must be
established that specify assignment procedures, performance expectations, review and
audit mechanisms, and effective billing practices.
Finally, to enhance its ability to perform effectively and control costs, the RMS needs to
address deficiencies in its management information system. A first step in doing this
would be to conduct a thorough review of its caseload inventory and identify cases that
need closure. From there, the RMS could assess and prioritize its caseload. In addition,
the RMS should consider if additional management information should be captured. Pres-ently,
the automated system does not provide adequate management information to make
workload decisions or determine the appropriateness of certain expenditures. For instance,
an analysis of the cost per claim could assist the RMS in determining the need or cost
effectiveness of increasing either in- house staff or the use of outside adjusting services.
RECOMMENDATIONS
1. The RMS needs to immediately implement or reintroduce basic claims management
techniques to ensure the effective and efficient operation of its program by:
Requiring regular supervision of all adjusters, both in- house and contract, as well
as conducting continuous and annual reviews;
Revising its caseload standards so they can be used to help assess adjusters'
workloads;
Addressing current internal control weaknesses by employing adequate segrega-tion
of duties, and improving error detection capabilities; and
Establishing guidelines and procedures for the assignment and monitoring of out-side
claims adjusting services.
2. The RMS should assess the adequacy of its case management system by:
Performing a thorough analysis of RMIS, determining the reliability and accuracy
of claims data; and
Determining what additional management information is important to capture.
3. The RMS should actively pursue filling vacant positions.
FINDING V
THE RMS NEEDS TO PROVIDE
AGENCIES WITH STRONGER INCENTIVES
TO CONTROL LOSSES
The RMS should give agencies stronger incentives to control losses. While the Risk Man-agement
Section ( RMS) administers loss control programs designed to assist agencies in
reducing exposure to loss, agencies currently have no strong financial incentive to elevate
their loss prevention efforts. Similar to risk management programs in other state and
governmental entities, the RMS should implement additional mechanisms to increase
agency efforts at loss control and prevention.
Programs Designed to Assist
Agencies in Reducing Losses
Because loss control and prevention are integral parts of any risk management program,
the RMS has established programs designed to assist agencies in their efforts to control
the frequency and/ or severity of their losses. The RMS' loss control programs include,
among other items, safety and loss prevention training, telephone and on- site consulta-tions,
and loss control grants. The RMS employs occupational safety consultants, indus-trial
hygienists, environmental specialists, and training officers to provide these programs.
However, the services and programs provided by the RMS are not mandatory, and not all
agencies have taken advantage of them.
No Financial Incentives to
Increase Loss Prevention Efforts
Currently, there are no strong financial incentives to encourage loss control behavior at
the agency level. Although the RMS charges agencies for insurance costs, its model for
allocating costs has been ineffective. Further, the budgetary process also provides little or
no link to loss control behavior.
Tlze RMS'cost allocatiorz model lzas been inefiective - Unlike the optional nature of the
RMS' loss control programs, all state agencies must financially contribute to the cost of
insuring against losses. To give each state agency the financial incentive to control its
losses, the amount each agency contributes to the cost of insurance should be linked to its
loss history ( i. e., how many losses it incurs) and its potential for loss ( i. e., its loss exposure
such as the number of employees). Although the RMS utilizes an actuarial formula ( known
as the cost allocation model) to arrive at agencies' insurance costs, it appears this formula
has not been effective in establishing the necessary financial incentive. For example, the
dollar amount some agencies have been charged for insurance appears to have fluctuated
dramatically in the past, sometimes for no apparent reason. The RMS indicates that these
fluctuations were due in part to changes in actuarial assumptions and in part to the cost
allocation model's failure to reflect actual loss experience because the formula was old,
complicated, and prone to errors. Nevertheless, from an agency perspective, these dra-matic
fluctuations can cause an agency to conclude there is no relationship between its
loss behavior and its insurance costs. This is especially true because the cost allocation
model was so complicated that the RMS staff could not explain to an agency why insur-ance
costs change.
To address these problems, during fiscal year 1995, the RMS requested its actuary to
develop a new cost allocation model. The revision to the model was a joint effort between
the RMS and both budget offices - the Joint Legislative Budget Committee and the
Governor's Office of Strategic Planning and Budgeting. The revised plan has the overall
goals of achieving more stable, simplistic, and responsive insurance costs and helping to
encourage loss control by linking insurance charges to actual loss experience and expo-sure
to loss. Thus, given no change in loss exposure, when actual losses decrease the
agency charge will decrease and when losses increase the agency charge will rise. How-ever,
because the plan is new, we were unable to assess its effectiveness in achieving these
goals.
Budgetanj process proviks little irrcentive - Regardless of the new cost allocation model's
success, the current method for budgeting for agency insurance costs provides little or no
link to loss control behavior. Once an agency's insurance costs are determined, these costs
are included as part of its other operating expenditures which are appropriated by the
Legislature. If an agency experiences an increase in its insurance costs ( even a dramatic
one) due to poor loss behavior, it is not necessarily reflected by a reduction in the subse-quent
year's operating budget. In other words, as insurance costs increase, so does the
legislative appropriation to cover the new insurance charge. As a result, an agency is not
likely to feel the financial ramifications of poor loss behavior, or the benefits of good loss
behavior. According to legislative budget staff, the current techniques may not give agen-cies
as much incentive to control losses as other techniques because their " operating base"
is not usually directly affected by their loss behavior.
Additional Tools Are Needed to
Encourage Loss Control Behavior
The RMS may need to implement additional techniques to strengthen agencies' willing-ness
to prevent and reduce loss costs and exposures. The RMS has attempted, unsuccess-fully,
to provide incentives for agencies to control losses. Therefore, it should consider
implementing additional techniques found in other risk management programs, such as
deductibles and premium credits.
Previous incentive attempts - The RMS attempt to establish a stronger relationship
between an agency's insurance costs and loss behavior has been ineffective. The State
established a $ 100 deductible for property claims in 1989. However, this tool is ineffective
in influencing agency loss behavior for two reasons: 1) the deductible amount is too low,
and 2) it is a " disappearing" deductible. Under this disappearing deductible, the agency
covers any property losses up to $ 100. When a loss exceeds $ 100 ( even $ 101), the deduct-ible
disappears and the RMS pays for the entire claim.
True deductibles and premium credits should be considered - The RMS may need to
implement additional techniques to increase agencies' willingness to participate in loss
prevention measures. For example, we contacted 15 states, the City of Phoenix, and the
City of Scottsdale, and found that the use of deductibles and premium credits is fairly
common:(*)
Deductibles - When a " true" deductible is in place, an agency must pay for a certain
amount of each loss. For example, with a $ 500 property claim deductible, an agency
would pay for the first $ 500 of each property loss. Nine out of the 15 states we con-tacted
use some form of deductibles for property, workers' compensation, and/ or
liability losses. For example, Nevada, Utah, and Oregon impose a $ 500 to $ 1,000 de-ductible
on property claims. Also, according to a RMS official, seven city and two
county programs in Arizona use property claim deductibles.
Credits - A premium credit rewards an agency's loss control efforts. If there is a
credit in place, an agency gets a reduction on the insurance premium they must pay.
An example of a premium credit in the private sector is a good driver or good student
discount whereby the individual's premium is reduced by a percentage, such as 5
percent. Six of the 15 states we contacted use premium reductions, premium credits,
or recognition awards as incentives. For example, Utah agencies that meet all the safety
criteria established by its risk management program receive a credit toward their pre-mium
for the next year. Likewise, Louisiana agencies receive a 5 percent premium
reduction if they are safety certified in all areas.
These and similar deductibles and credits have been used by other risk management
programs for years, some since the inception of their programs. Other state risk manage-ment
officials acknowledged that deductibles do provide an incentive for agencies to
(') The 15 states ( Alabama, Colorado, Florida, Georgia, Louisiana, Missouri, Montana, Nebraska, Ne-vada,
North Carolina, Oregon, South Dakota, Utah, Vermont, and Virginia) were chosen based on
similarities with Arizona's risk management program. For example, we looked at the type of insur-ance
offered, type of services provided, and type of functions performed.
control costs. Additionally, one state official commented that the use of deductibles seemed
natural since they are customary business practice for private insurance companies. Fur-ther,
deductibles can have the added benefit of reducing the number of small claims and
their administrative costs. As one state official noted, deductibles eliminate the need to
expand their claims department and allow them to concentrate on the bigger, more im-portant
claims.
Implementation of either a deductible or premium credit appears reasonable for Arizona's
risk management program. Our review indicates agencies are fairly receptive to the idea
of a deductible. In fact, the RMS has been contemplating increasing the use of deductibles
for quite some time. In January 1994, the RMS, along with agency representatives, re-searched
the idea of increasing the deductible to help promote loss control. While this
effort was put on hold, the RMS plans to address this issue in the near future. Increasing
the amount of the deductible, or implementing premium credits, would require a change
in the DOA's Administrative Rules. Under R2- 10- 106 the RMS has authority for only a
$ 100 deductible.
RECOMMENDATIONS
1. The RMS should ensure its new cost allocation model encourages loss control behav-ior
by linking insurance charges to actual loss experience and exposure.
2. The RMS should consider increasing the deductible and implementing premium credits
to help increase agencies' efforts to control loss costs and exposures.
AREA FOR FURTHER AUDIT WORK
During the course of our audit, we identified an area for further audit work that we did
not pursue due to time limitations.
Does fhe Sfafe Procuremenf Office ( SPO) adequately facilitate statewide purchases of
goods and services?
At the time of our audit, the SPO had recently completed a comprehensive review of its
operations. This project, referred to as business process reengineering ( BIR), was a col-laborative
effort for which the SPO sought input and assistance from other state agency,
local government, and private sector representatives. This project employed multiple tech-niques
such as surveys, focus groups, brainstorming sessions, and site visits to determine
whether the SPO was meeting the needs of its customers. The recommendations pro-posed
in the report, if fully implemented, are expected to fundamentally change the State's
procurement operation. H o w e ~ a, t the time of our review this BPR study was in draft
fOT . Subsequent to completion of fieldwork, the Director determined that additional
ana ysis was needed. Further audit work is needed to establish the outcome of the BPR
study and its impact on the SPO's ability to meet statewide procurement needs.
Agency Response
I
( FIFE SYMINOTON
Governor
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RUDY SERINO
Director
ARIZONA DEPARTMENT OF ADMINISTRATION
OFFICE OF THE DIRECTOR
1700 WEST WASHINGTON ROOM 601
PHOENIX, ARIZONA 85007
November 6, 1995
Mr. Douglas Norton
Auditor General
2910 N. 44th Street, Ste. 410
Phoenix, AZ 85018
Dear Mr. Norton:
Attached are the agency responses regarding the performance audit
of the Financial Services Division.
If you have any questions regarding these comments, please call Mr.
John Timko at 542- 0500.
Sincerely,
Director
RS: JT: wh
Attachment
CC: John Timko
Finding I - The Integrity of the Staters Financial Information
Remains at Risk.
Recommendations:
1. The GAO should take measures to improve the internal control
structure of the State by:
a. Assuming data entry responsibilities of those agencies
unable to implement proper internal controls due to
limited staff; and
Response:
Concur. Historically, the ADOA- GAO has provided such assistance to
agencies to the extent possible. The Department is always willing
to assist agencies with any difficulty they may have as long as
there are resources available to provide the assistance. We concur
that adequate resources should be provided to properly fulfill the
Auditor General recommendations.
b. Revoking access to those agencies that repeatedly violate
internal control policies.
Response:
Concur. The ADOA concurs with the recommendation, however, this is
a very drastic step which is taken only after all other avenues of
corrective measures have been explored. This is done at the time
when it becomes in the best interest of the state to revoke access.
The ADOA- GAO has revoked access in the past and will continue to do
SO as necessary.
2. The GAO, after consulting with the affected agencies, should
consider restricting system access based on agency needs to
facilitate system interaction and reduce the possibility of
financial inaccuracies.
Response :
Concur. The ADOA concurs with the recommendation and feels that
the system has those capabilities. The access is controlled
through a GAO security review prior to permitting any individual
access to the system, through the profiles established by the
agencies and the type of transactions authorized for any
individual, and through periodic system reviews. This process has
become more formalized since the implementation of the GAO Security
Group.
3. The GAO should require all users to complete training as a
condition of having system access. This training should occur
within a specified timeframe from the employee's hire date.
Response :
Concur. The training requirement prior to allowing system access
is reasonable. The establishment of a specific timeframe such as
6 months from hire with the stipulation that access will be
terminated unless the individual has attended training would be
ideal. We concur that with additional resources, the GAO could
schedule a variety of training classes and expand the number of
classes that are offered. To date the training group has conducted
a variety of classes on AFIS and travel policy which involved 1,162
state employees.
4. The GAO should ensure its training plan includes a discussion
of how the training, internal audit, and systems security
groups can coordinate their efforts to best utilize existing
resources.
Response :
Concur. Coordination between the training unit, internal audit and
system security is already happening within GAO. There are
frequent discussions regarding audit findings and security concerns
which are incorporated into the training modules to avoid future
problems and improve performance. Additionally, current personnel
are utilized as subject matter experts with whom the trainers
confer in the development of training modules.
Finding I - General Comments
While the ADOA concurs with all of the recommendations and has
already implemented each of the recommendations to the extent
possible within its funding constraints, ADOA does not agree with
many of the statements and most of the examples cited in this
finding.
For example, we disagree with the statement: " The DOA has failed in
its obligation to provide an adequate internal control structure
for the State, . . . I1. Good internal controls in a decentralized,
automated environment requires a combination of automated controls
and agency- level segregation of duties. The ADOA controls the
llsystemns ecurity in a variety of ways that are more than adequate
UNLESS the agency- level controlled assignment of incompatible
duties breaks down. Both the ADOA and the Auditor General have
committed significant resources to audit functions which detect and
report agency- level internal control weaknesses. It is the
responsibility of agency management to correct these problems. In
suggesting that ADOA is responsible for the solution to these
problems, the Auditor General misses the point. For example, in
the June 1994 example of fraud, the employee involved received his
access to the system through forged authorization documents.
Likewise, the examples of " inadequate trainingM are more reflective
of complete management breakdowns at the agency level. Both the
training and individual assistance required to prevent these
Finding I1 - The Statewide Accounting System Unable to Readily
Portray Arizona's Financial Position
Recommendations:
The DOA should take the following steps to improve the statewide
accounting system so that it meets it s original expectations and
the DOA can fulfill its statutory mandate by:
1. Conducting feasibility studies to determine if the current
billing system and ad hoc reporting tool can be enhanced to
meet agency needs or if additional software is necessary.
Response :
Concur. The ADOA is currently pursuing enhancements to the system
encompassing these two areas to provide improved service to its
customers and meet the original expectations of the system.
Various modifications have been made to the system to improve on-line
reporting and we are exploringthe feasibility of implementing
one of several report writing tools which should fulfill the ad hoc
reporting requirements of agencies.
2. ~ eprogramming the system to make it more user friendly and
efficient.
Response :
Concur. The ADOA- GAO is continually modifying the system to
provide a more user friendly environment for users, however,
reprogramming the system totally is not practical or very feasible
due to our daily operational requirements.
3. Integrating the system with procurement activities and address
payroll processing delays.
Response :
Concur. Procurement activities currently interface with the USAS.
The procurement system " ASAP" provides USAS with an input tape that
has been checked for propriety before submitting to the USAS
system. The Department is continuing to pursue improvements to
this interface to provide more effective and efficient operation
for possible integration of the systems. As to the payroll delays,
it is the opinion of the GAO that there are no payroll delays. The
payroll is processed through HRMS on Wednesday and then processed
to AFIS on Friday the official payday of the State. This
processing is the customary and usual processing which is in line
with the official payday of the State. Therefore, there are no
processing delays between the State payroll system and the State
financial system.
4. Improving the quality and quantity of information on USAS by:
a. Assessing the additional system enhancements required by
the three largest state agencies to meet their needs, and
as a long- term goal, equipping USAS to fulfill those
needs; and
Response:
Concur. The ADOA is continuously assessing the requirements of the
three largest agencies and is constantly trying to meet those
needs. As we have in the past, ADOA is working with the agencies
and, as a result, five large agencies have substantially eliminated
their general ledger systems ( Education, Corrections, Juvenile
Corrections, Health Services, and Revenue) and are now using USAS
as their principal system. However, if the implication in this
recommendation is that the three largest agencies should disband
their internal systems and use USAS totally, this will not easily
happen due to the size and uniqueness of these agencies. To
accomplish a total integration of these agencies would take a major
statewide cooperative effort and a long- range plan for
implementation.
b. Ensuring, through better training and specific discussion
with agencies that agencies record complete financial
information on the USAS system whenever possible.
Response :
Concur. The recent implementation of AFIS Training has improved
the training of agencies. However, additional resources as are
recommended would speed the progress being made in the training
offered to agencies. The ADOA- GAO will continue to improve and
expand this new program as resources become available.
5. Considering converting those agencies that comprise the
largest share of the State's revenues and expenditures to GAAP
basis accounting.
Response:
Concur. GAAP basis accounting is more appropriate for financial
statement reporting purposes. However, the current budgetary
process and statutory requirement is cash basis and, therefore, a
total change to GAAP basis accounting requires a statutory change
and a re- education of ( the legislative and executive branches)
government personnel.
Finding I1 - General Comments
The ADOA concurs with all these recommendations. We also suggest
that the dedicated employees involved in this massive project
should be congratulated for their success to date, in spite of
serious lack of resources. As pointed out in the audit, other
states have spent four to twenty times what Arizona has spent. in
installing their systems. In our user group meetings with these
other states, we find that in spite of the funding discrepancy,
Arizona's system is on a par, or exceeds the capabilities of these
other states.
Finding I11 - The State Needs a chief Financial officer
Recommendation:
1. The Legislature should consider establishing a Chief Financial
Officer ( CFO) position. The CFO should be given the statewide
financial duties that are presently associated with the DOA.
consideration should also be given to structuring this
position with adequate authority, independence, and longevity.
2. ~ f a CFO position is established, the Legislature should also
consider further study of the need for interaction between the
CFO and other financial officers and whether any of their
roles and functions should be combined or consolidated.
Response :
ADOA does not agree that this finding and recommendation is proper
in a Performance Audit of the Financial Services Division. It does
not deal with our performance and we cannot implement the
recommendation. The Auditor General should use a different venue
to advance this proposal for a fundamental restructuring of state
government's financial system.
The finding fails to make the case for the need for such sweeping
changes and also fails to demonstrate that their proposed course of
action has had any measurable impact in the states which have tried
this approach. However, if the legislature decides to address this
recommendation, ADOA will be happy to comment and assist as
required.
Finding IV - Risk Management's Property & Liability Claims Unit
Plagued with Myriad of Problems.
Recommendations:
1. The RMS needs to immediately implement or reintroduce basic
claims management techniques to ensure the effective and
efficient operation of its program by:
a. ~ equiring regular supervision of all adjusters, both in-house
and contract, as well as conducting continuous and
annual reviews;
Response:
Concur. Risk Managements Property and Liability Claims Unit
currently has two supervisors and will be hiring a third within the
next 30 days. This provides for improved and more complete
supervision of 16 in- house adjusters, as well as oversight for the
assignments made to outside independent adjusters and private
investigators.
Claims supervisors are currently reviewing 20 files per adjuster,
per month and an audit review sheet is completed for the file.
Annual reviews are conducted on each adjuster at the appropriate
annual performance review period.
b. Revising its caseload standards so they can be used to
help assess adjusters8 workloads.
Response:
Concur. Caseload standards should be reviewed periodically. They
are one of several important workload measures used by management
to balance adjusters1 workloads. Since case volume and complexity
vary widely during the year, the judgement of experienced
supervisors in caseload assignment is more important than arbitrary
standards in assuring proper attention to the claims adjusting
process. As of this response, the average caseload per adjuster is
137 cases, within the 120- 140 case standard.
c. ~ ddressing current internal control weaknesses by
employing adequate segregation of duties, and improving
error detection capabilities; and
Response:
Concur. As noted in the footnote to the audit report, the issue
relating to segregation of duties has been resolved.
During August of 1995 we have instructed our accounting staff that
all claim payments have a taxpayer identification number, unless
the payee specifically refuses to furnish us with a taxpayer
identification number. During the first part of September 1995, we
have instituted a system control that effectively requires a
taxpayer identification number in order to process a payment.
d. Establishing guidelines and procedures forthe assignment
and monitoring of outside claims adjusting services.
Response :
Concur. Presently all independent adjustersf and investigatorsr
work is reviewed by the assigning RM adjuster, with selected follow
up review by the supervisor. All independent adjustersr and
investigatorsr billing is reviewed by the claims manager before
being submitted to accounting for payment.
2. The RMS should assess the adequacy of its case management
system by:
a. Performing a thorough analysis of RMIS, determining the
reliability and accuracy of claims data; and
Response :
Concur. There currently is an ongoing analysis of RMIS with regard
to its accuracy and reliability. As with any computer system that
has been in service for many years, our system is in need of
improvement. RM management is presently looking for ways to
improve upon or replace the current information system and will
continue to do so. The present system has never been purged and we
are preparing for a " clean up" of the system to free up more space
and allow for additional functions.
We have reconciled AFIS to RMIS as of October 1994. We are
currently working on reconciling July 1995, so that we can ensure
that the current year is reconciled, and at the same time we are
working on reconciling November 1994. All FY 1995 reconciliations
will be completed by November 30, 1995, and FY 1996 will be brought
current at the same time.
b. Determining what additional management information is
important to capture.
Response :
Concur. Our computer consultants are working with our management
to determine what additional information, reports, etc. are needed.
In FY 1995, 64 Requests for Service improvements were completed by
our computer support consultants. These improvements affected our
functionality and reliability of both the Workersr Compensations
side of RMIS as well as the Property and Liability side. This
fiscal year we are working on improvements to our system security
as well as the continuous reconciliation of the RMIS to AFIS
interface. We currently have 34 Requests for Service actively
being worked on by our computer support consultants. Within this
fiscal year we will have our RMIS system fully documented and up to
date.
3. The RMS should actively pursue filling vacant positions.
Response :
Concur. Beginning June 1, 1995, through the present, six vacancies
have been filled in the Property and Liability Unit. There are
three additional vacant positions. Hiring lists for these
positions are being reviewed and interviews are in process. These
remaining vacancies should be filed within 30 days. Of the seven
remaining vacancies elsewhere in RMS all are in active stages of
being filled. RMS is expected to be fully staffed no later than
December 19 9 5.
Finding IV - General Comments
While the ADOA concurs with these recommendations, we strongly
disagree with the text of the finding. The first three and one
half pages discuss the results of a sample consisting of 77 claim
files. The reader needs to search the footnotes to discover that
the sample is lljudgmentalltlh, a t is to say it is not statistically
valid and that the results of the sample should NOT be used for
drawing conclusions beyond these 77 claims or applying these
results to the entire population of 6,000 claims per year handled
by the claims unit. We feel this report unfairly encourages the
reader to do just that. We have expressed our concerns to the
Auditor General who has refused to amend the report in this regard.
Finding V - The RMS needs to Provide ~ gencies with Stronger
Incentives to Control Losses
Recommendations:
1. The RMS should ensure its new cost allocation model encourages
loss control behavior by linking insurance charges to actual
loss experience and exposure.
Response:
Concur. The primary purpose of our allocation module is to
apportion the total of estimated losses to individual agencies on
an equitable basis. However, another one of the goals is to
encourage good loss control behavior by linking insurance charges
to loss experience and exposure. Our new model achieves these ends
and others. It also embodies a structure which is widely regarded
in the insurance industry as " best practi~ e.~~
2. The RMS should consider increasing the deductible and
implementing premium credits to help increase agenciesf
efforts to control loss costs and exposures.
Response:
Concur. RMS is currently working on changing our deductible to a
" true" deductible and increase the dollar amount in graduated
amounts to $ 1,000.
Additionally, research is being conducted with input from other
states already working with a true deductible system.
We are also seeking information on premium credits from states
actively using a credit system.
It is anticipated that legislation and rule changes will be brought
up this year.
However, it must be noted that RM has been doing some very
successful loss prevention program and incentives for the past 4
years. They are:
a. Competitively selecting a Risk ManagerILoss Prevention
Coordinator of the year. As incentive we award to the
winner conference registration, air fare, hotel and
normal travel expenses to the Annual public ~ iskMa nager
Conference, ( PRIMA) .
b. RM issue one time loss prevention grants to agencies that
submit cost effective projects that will improve public
& employee safety thus producing a reduction in losses to
the state. Approximately $ 400,000 per year in grants are
budgeted for and funded by the legislature.
c. Every quarter RM sponsors and conducts an all day User
and Environmental meeting. These meetings convey current
changes going on in the risk management field. They
normally have a guest speaker and round table discussions
of current agency problems. Most large agencies are
represented as well as all three universities.
d. We are analyzing the past losses of major agencies and
working with them on an individualized basis to install
remedial action programs which will help prevent future
reoccurrence of incidents which have historically
resulted in the most expensive claims against the state.
e. We are redirecting our existing resources to deal more
effectively with areas of exposure which present the
greatest potential for losses -- eg, liability,
employment and environmental claims.
f. Various improvements have bene made in our Workersf
Compensation program. They have produced over $ 1,600,000
in annual cost savings, and have resulted in W. C. being
given the prestigious Governor's Award for Excellence.