Beginning with 2013 plan years, new federal cost accounting standards for how contractors can allocate their pension costs to government contracts start converging with the ERISA funding requirements that contractors have long used to determine pension contributions. The Pension Protection Act of 2006 amended the Employee Retirement Income Security Act to shorten funding periods and lower interest-rate assumptions for calculating assets and liabilities. That made projections more volatile than ever, especially for multiyear contracts.
Changes enacted last year provide only temporary relief from a growing gap between what contractors are required by law to contribute to their defined benefit plans and how much they can include in their government contract prices.
Unable to recoup all those costs under the federal cost accounting standards until now, contractors will use a shortened amortization schedule from 2013 and then phase in a liability measure similar to ERISA, starting at 25% in 2014 and gradually moving up to 100% by 2017, when both the accounting standard and ERISA will be more closely aligned, or “harmonized.”
“It's going to be a slow process,” said attorney Karen L. Manos, partner at Gibson Dunn & Crutcher, Washington, who represents defense contractors and is former chair of the National Defense Industrial Association's procurement division.
The next step, say GAO officials, is for the Pentagon to provide more guidance on how contractors should determine discount rates and project their pension costs.
“It's not really clear what rates you should use going forward,” said Charlie Jeszeck, director of education, workforce and income security at the GAO. Defense Department officials “need to be clear how they expect their contractors to calculate. If interest rates are bouncing around, we're going to have to start budgeting for it. I'm hoping our vendors realize that.”
Ms. Manos and others worry that guidance, unlike legislation, provides little opportunity for contractor input. “You have to wait until the government audits somebody's contract, which could be years from now. If you're a risk-averse contractor or don't want to deal with it, one way is doing away with DB. It's sad that the government itself is doing that.”
Her clients are also concerned that the GAO report calls for the Defense Department to scrutinize the “reasonableness” of contractor pensions. “That's something that should be looked at,” said Mr. Jeszeck of GAO. “They really haven't been looking at the generosity of pension plans and variation of formulas.”
Adding the question of reasonableness “is going to give auditors one more reason to question the costs,” said Ms. Manos. “It will come down to paying less or fighting the government. Over time, what's happens if you're continually fighting about these things, it's one more reason for these companies to no longer offer DB plans. If it's a choice between building the next nuclear submarine or offering a DB plan, the weapons are going to win out.”
Ms. Manos also worries about having the Defense Department set a discount rate instead of contractors and their actuaries.
GAO officials say they will be working with Congress on possible legislation to address the contractors' pension affordability concerns.
“It's a very complicated issue that we don't understand,” said a top Senate aide who did not wish to be identified. “If it affects overall affordability, just like fuel prices or other cost increases, it squeezes out other things. We're always getting pressure to reduce costs. We just have to deal with it.”