The U.S. Government Accountability Office (GAO) recently conducted a study of U.S. Department of Defense contractors and the defined benefit pension plans they sponsor.
According to the GAO it conducted the study because DOD contractors are the largest sponsors of defined benefit pension plans in the United States and pension costs are factored into the price of DOD contracts. The GAO set out to discover how contractor pension costs are determined; how the DOD ensures the contractor pension costs it pays are appropriate; how DOD contractors' plans compare with plans sponsored by similar companies; how pension costs have affected DOD contract costs; and the factors that contributed to these pension costs and how the harmonization of cost accounting standards (CAS) with ERISA will affect the amounts DOD will pay in pension costs in coming years.
What it found is that contractors make two sets of calculations for their DB pension plans, following two sets of standards, cost accounting standards, which determine how pension costs are allocated to government contracts and ERISA, which establishes the minimum contribution required to fund plans.
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DOD centralizes its technical expertise for management and oversight of defined benefit pension plans. DOD contracting officers at the corporate level negotiate pension costs with contractors and receive technical support from a team of DOD actuaries. DOD audits projected and actual costs for contracts, including pension costs, to ensure they are allowable, allocable, and reasonable.
The Federal Acquisition Regulation requires that employee compensation, including pensions, be reasonable. However, the pension costs used for compensation reviews can be affected not only by the value of benefits earned by employees, but also by factors such as asset returns and interest rates. Also, oversight processes do not clearly assign responsibility for assessing the reasonableness of pension benefits, including those for executives.
GAO analyzed the defined benefit plans of the 10 largest DOD contractors and found that nearly all of the contractors—as well as a peer group of companies—maintain some sort of tax-qualified, defined benefit plan for their employees. The largest contractors invest in similar types of pension plan assets as their peer group, and do so somewhat more conservatively. GAO also found that CAS pension costs reported by the contractors grew considerably over the last decade, from less than $500 million in 2002 to almost $5 billion in 2011, although not all of these costs were allocated to DOD contracts. Contractor CAS pension costs grew as the market downturn increased unfunded liabilities.
Although pension cost projections are highly sensitive to economic assumptions, both contractors and DOD officials expect CAS pension costs to increase starting in 2014 due to harmonization. The CAS discount rates used to value liabilities will now be tied to the more volatile ERISA-based rates, making it harder to forecast future CAS pension costs and reducing the consistency of cost projections used in contract pricing.
DOD issued limited guidance on projecting ERISA-based discount rates for CAS calculations, but lack of specificity in the guidance can lead to great variation among the rates contractors use. Moreover, when a contractor curtails a plan, DOD and the contractor must settle pension costs; however, the discount rates used for settlements were not updated as part of harmonization, meaning liabilities will be calculated differently under CAS and ERISA rules. A schedule has not been set for addressing this issue.
GAO recommends that the Secretary of Defense clarify responsibility for and guidance on assessing pension reasonableness and determining discount rates for pension cost projections. It also recommends that the CAS Board set a schedule for revising parts of CAS that address the settlement of plan curtailments.
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