Conversions of Startup Loans Into Surplus Notes by Consumer Operated and Oriented Plans Were Allowable but Not Always Effective

CMS established loan agreements with Consumer Operated and Oriented Plans (CO-OPs) to provide startup and solvency loan funding. CMS issued a memo to the CO-OPs in July 2015 allowing the CO-OPs to convert startup loans into surplus notes. A surplus note is a bondlike instrument issued to provide needed capital. Under the terms of a surplus note, CO-OPs are not required to make any repayment on the surplus note that could lead to financial distress or default.

We determined that the CO-OPs complied with CMS guidance and applicable accounting principles when converting startup loans into surplus notes. However, CMS did not adequately document the potential impact of the conversions on the Federal Government's ability to recover the loan payments if the CO-OPs were to fail. Although the conversions provided increased levels of capital and surplus, 4 of the 12 CO-OPs approved for conversions ceased operations within 6 months after the conversion. Despite the conversions allowing CO-OPs to record the startup loans as capital and surplus instead of debt, risk-based capital percentages were at levels below the CMS requirement of 500 percent for four of the eight operational CO-OPs as of December 31, 2015.

We recommended that CMS perform the following steps prior to approving additional conversions of startup loans to surplus notes: (1) document any potential negative impact from changes in distribution priority and (2) quantify the likely impact on the Federal Government's ability to recover loan payments. CMS concurred with our recommendations.