It is no secret that the Government has been targeting contractor health care costs paid for ineligible dependents—e.g., overage children, divorced spouses. In August 2009, DCAA issued Audit Guidance directing auditors to disallow such costs, recommending the future imposition of penalties and asserting that auditors must be provided access to any third party service provider who performed eligibility reviews. In the field, DCAA auditors have made disallowing these costs a priority. In some instances, our clients have had all dependent health care costs disallowed because privacy laws prevented them from providing DCAA with proof of eligibility and DCAA refused to accept third party audit results. DCAA has also found internal controls inadequate, typically claiming that the contractor’s lack of oversight and failure to require certain types of documentation (e.g., birth certificates) demonstrated it had not acted reasonably. Compounding the problem is the fact that DCAA is so far behind in completing incurred cost audits, it is retroactively imposing more stringent 2012 industry dependent review standards upon open years as far back 2005.
The battle has now been joined by DoD. Shay Assad, Director Defense Pricing issued a memo dated February 17, 2012 to DCAA and DCMA stating that costs for ineligible dependent health care are unallowable “because it would be unreasonable to reimburse costs incurred due to invalid claims made by employees” and, therefore, “the contractor, not the Government, is responsible for the recovery of such improper costs.” The memo further encourages contractors “to voluntarily refund” any increase in the price of a fixed price contract they received as a result of including such costs in their proposals and suggests that some of these proposals may have resulted in defectively priced contracts (a dubious proposition, at best). The memo closes by acknowledging that the DoD will not currently pursue penalties, but that it is the DoD’s intention to amend DFARS to make future ineligible health care costs “expressly unallowable” and subject to penalties.
In our view, Assad’s memo oversimplifies the issue and expounds the wrong standard. The source of the problem, frankly, is employee dishonesty in identifying an ineligible person as a dependent. The practical question: What internal controls are required of a contractor to ensure that only eligible dependents incur health care costs? The DoD position is silent on this fundamental issue. As stands, it would require perfection by contractors—i.e., full, costly investigations of each employee’s personal life at multiple times, actions not warranted by the FAR and are in excess of comparable diligence undertaken by “prudent business men,” which is the measure of reasonableness. The memo also fails to address the mechanism for calculating the unallowable costs. To date, this has presented major complications for contractors. As noted above, privacy laws often prevent DCAA access to the personal information required to assess eligibility and DCAA has rejected compromise—reliance on independent third party eligibility reviews to determine questioned amounts. The contractor is thereby left with no alternative to demonstrate eligibility.