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Pension costs to add billions to contracts

Mar. 5, 2012 - 11:13AM   |  
By SARAH CHACKO   |   Comments
A new federal accounting rule will require the government to increase reimbursements to contractors for their employee pension costs. At the Defense Department, additional costs "could be billions of dollars, conceivably," Pentagon Comptroller Robert Hale said.
A new federal accounting rule will require the government to increase reimbursements to contractors for their employee pension costs. At the Defense Department, additional costs "could be billions of dollars, conceivably," Pentagon Comptroller Robert Hale said. (DEFENSE DEPARTMENT)

Agencies face billions in additional contracting costs because of a new federal accounting rule that requires the government to reimburse contractors for a greater portion of employee pension costs.

"From what we have seen, [agencies] don't know exactly how much to set aside for this reimbursement," said Tom Schatz, president of Citizens Against Government Waste. "When you take it across government, the future liability is tens of billions of dollars. It's real money, but apparently it's not on the top of their priority list."

At the Defense Department, additional costs "could be billions of dollars, conceivably," Pentagon Comptroller Robert Hale said on Feb. 23.

"I'm hoping that our vendors realize in tight fiscal times that they need to work with us to hold down weapons costs," Hale told "This Week in Defense News." "We think there may be modest added cost ... but we are going to have to start budgeting for them, and it is a question I'm asking internally as we look into our next budget plan."

A Veterans Affairs Department spokeswoman said VA has not looked at how its contracts would be affected by the new accounting rule. The Department of Homeland Security and General Services Administration deferred to the Office of Management and Budget for answers.

It is impossible for anyone to calculate costs with certainty since market conditions will likely change between now and 2014, when more contractor pension costs will start being added to contract rates, said Richard Loeb, former executive secretary of the Cost Accounting Standards Board, which issued the rule change. The five-member board is run by OMB and consists of both federal and non-federal executives. The rule, which would apply only to new contracts starting in 2013, speeds up the time in which agencies have to reimburse contractors for their pension plan payments.

"This was not a rule that was designed around the budgetary process, as the costs have to be paid anyway," Loeb said. "It is merely a matter of timing of the payments."

If the market improves and pension fund investments earn money, the amount that agencies will pay in contract prices may decrease, he said.

However, if investments do poorly and pension funds become further underfunded, affected contractors would be forced to make bigger payments to cover those liabilities, pension experts said. And those costs will be passed on to the government.

Some agencies already impacted

Between 2010 and 2011, for example, liabilities outpaced assets for the pension plans of three major contractors Boeing, Lockheed Martin and Raytheon.

The new rule comes as agencies are already seeking to hold down procurement costs because of tighter budgets. It also comes as Congress is cutting the government's costs for federal employee pensions. The extension of last year's payroll tax cut and unemployment benefits, signed by President Obama last month, will nearly quadruple pension contributions for newly hired or rehired federal employees, from 0.8 percent to 3.1 percent of their pay, starting in 2013. Other bills that have been introduced would reduce or even end defined-benefit pensions for federal employees.

The government's responsibility for contractor pensions has only recently drawn attention. Sens. Carl Levin, D-Mich., and John McCain, R-Ariz., tasked the Government Accountability Office in December to examine contractor pension costs at the Defense Department. They asked how much the department paid for shortfalls in contractor pension plans over the past 10 years, what the department may have to pay in the future, and if it is possible to limit reimbursements to defined-contribution plans, such as 401(k)s.

In addition, Citizens Against Government Waste released a study Feb. 9 showing the government paid $3.3 billion to the pension programs of 18 of the biggest federal contractors in 2010. It is pressing lawmakers to stop reimbursing contractors for defined-benefit pension plans for new employees and instead reimburse them only for defined-contribution plans.

Some agencies are being hit particularly hard by costs they must bear for their contractors' troubled pension plans.

The Energy Department, for example the most contractor-reliant department in government started reimbursing its contractors for all of their pension costs in 2008 because its contracts are not subject to Cost Accounting Standards. The department saw these pension reimbursement payments swell from $43 million in 2001 to a projected $1.7 billion in 2012, the GAO report said.

In 2009, contractor pension costs at Energy hit $750 million and forced the department to redirect nearly $400 million in funding that was targeted for the National Nuclear Security Administration and Environmental Management programs, according to the Senate Appropriations Committee.

NASA is in similar trouble. It sought $548 million from Congress for this year to fully fund a pension plan for employees of its largest contractor, the United Space Alliance a joint venture of Lockheed Martin and Boeing before the plan's assets are transferred to new trustees that will offer retirees a lump-sum distribution or annuity. That's because the plan's assets have lost value and now can cover only about half of what workers are owed.

Congress ultimately appropriated $470 million of that amount. If that is not enough, NASA may have to defer some of its Space Shuttle transition program until 2013, according to NASA budget documents.

How the new rule will work

The new accounting rule stems from the 2006 Pension Protection Act, which set new accounting standards for companies to use in calculating their pension fund liabilities. The law anticipated a conflict with federal cost accounting standards and so directed the Cost Accounting Standards Board to fix the problem.

Late last year, the board issued the new rule, which requires the government to recognize more costs that contractors pay into their pension plans as reimbursable. The rule allows contractors to recoup all pension costs over four years, starting in 2014. That year, contractors can bill the government for an additional 25 percent of the difference between what they are required to pay under the Pension Protection Act and what they can charge the government under cost accounting standards. The percentage of additional costs that can be charged increases to 50 percent in 2015, 75 percent in 2016 and 100 percent in 2017.

Take the example of a contractor required to pay $120 million to its pension fund under the Pension Protection Act, and yet federal cost accounting rules recognize only $100 million of that as reimbursable by the government. In 2014, the contractor would be able to add a quarter of the $20 million difference $5 million to what it can charge the government, for a total of $105 million. Under the same circumstances, the contractor by 2017 could bill the government $120 million.

The cost accounting rule change also shrinks from 15 years to 10 years the amount of time contractors have to pay for past unfunded accrued liabilities. That change would be reflected in 2013 costs, pension experts said.

Contractor competitions affected

Contractors should figure their rates under the new rule to be applied on their proposals for contracts in 2013, said Joel Rich, senior vice president of Sibson Consulting.

The difference could over time affect a company's ability to compete, especially if the company is bidding against contractors with lower or no pension costs, he said.

Lockheed Martin spokesman Chris Williams said cost increases to the government will vary based on company-specific rates and the type of work being done. Rates may be higher, for example, if a contract is labor intensive and requires the work of employees who are pensioned, he said.

Lockheed phased out its pension plan for new hires starting in 2006 and put new employees on a retirement plan similar to a 401(k), he said.

"We do not anticipate the impact to competition to be significant, as pension costs overall are a relatively insignificant component of total contract cost," Williams said.

Bart Jansen, who reports for the Gannett Washington Bureau, contributed to this report.

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