A participant from one of our clients requested a loan. He had an
outstanding loan balance of $27,000 in December of 2002, the loan was then
paid off in March 2003. The participant then took another loan in April of
2003 for $13,000. Now he is requesting another loan and the amount being
calculated is being reduced by both highest outstanding balances
($27,000+$13,000 = $40,000) in the last year. Is this correct? Or should
the amount be reduced by only the highest outstanding balance ($27,000)?
How do we address this issue?

You may get differing opinions on this. I'd look at the outstanding balance on the DAY during the past year when it was highest. Since the 27,000 loan was paid off prior to the 13,000 loan being taken, the highest balance on any day would be the 27,000. FWIW, I would not use the 40,000 figure.

Maximum loan is equal to the lesser of:

a) 50% of the vested balance

b) $50,000 reduced by the highest o/s loan balance on any 1 day in the last 12 months.

You do not combine the highest o/s balance of each loan individually.

In your example, the highest total o/s balance during the last 12 months was $27,000. The maximum loan now available is $50,000 - $27,000 = $23,000, which must be reduced by the current o/s balance from the 2nd loan.