[Federal Register Volume 61, Number 184 (Friday, September 20, 1996)]
[Notices]
[Pages 49534-49550]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-24091]
[[Page 49533]]
_______________________________________________________________________
Part II
Office of Management and Budget
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Office of Federal Procurement Policy
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Cost Accounting Standards: Post-Retirement Benefit Plans Other Than
Pension Plans Sponsored by Government Contractors; Notice
Federal Register / Vol. 61, No. 184 / Friday, September 20, 1996 /
Notices
[[Page 49534]]
OFFICE OF MANAGEMENT AND BUDGET
Office of Federal Procurement Policy
Cost Accounting Standard Relating to the Treatment of Costs of
Post-Retirement Benefit Plans Other Than Pension Plans Sponsored by
Government Contractors
ACTION: Notice.
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SUMMARY: The Office of Federal Procurement Policy, Cost Accounting
Standards Board (CASB), invites public comments concerning a Staff
Discussion Paper on the treatment of costs of post-retirement benefit
plans other than pension plans sponsored by Government contractors.
DATES: Comments must be in writing and must be received by December 19,
1996.
ADDRESSES: Comments should be addressed to Eric Shipley, Project
Director, Cost Accounting Standards Board, Office of Federal
Procurement Policy, 725 17th Street, NW, Room 9001, Washington, D.C.
20503. Attn: CASB Docket No. 96-02.
FOR FURTHER INFORMATION CONTACT: Eric Shipley, Project Director,
(telephone: 410-786-6381) or Rein Abel, Director of Research, Cost
Accounting Standards Board (telephone: 202-395-3254).
SUPPLEMENTARY INFORMATION
A. Regulatory Process
The Cost Accounting Standards Board's rules, regulations and
Standards are codified at 48 CFR Chapter 99. Section 26(g)(1) of the
Office of Federal Procurement Policy Act, 41 U.S.C. 422(g), requires
that the Board, prior to the establishment of any new or revised Cost
Accounting Standard, complete a prescribed rulemaking process. The
process generally consists of the following four steps:
1. Consult with interested persons concerning the advantages,
disadvantages and improvements anticipated in the pricing and
administration of Government contracts as a result of the adoption of a
proposed Standard.
2. Promulgate an Advance Notice of Proposed Rulemaking.
3. Promulgate a Notice of Proposed Rulemaking.
4. Promulgate a Final Rule.
This proposal is step one of the four-step process.
B. Background and Summary
The Office of Federal Procurement Policy, Cost Accounting Standards
Board, is releasing a Staff Discussion Paper on the treatment of the
costs of post-retirement benefit plans other than pension plans under
Government contracts. Section 26(g)(1) of the Office of Procurement
Policy Act, 41 U.S.C. 422(g)(1), requires that the Board, prior to the
promulgation of any new or revised Cost Accounting Standard, consult
with interested persons concerning the advantages, disadvantages, and
improvements anticipated in the pricing and administration of
Government contracts as a result of the adoption of a proposed
Standard. The purpose of the Staff Discussion Paper is to solicit
public views with respect to the Board's consideration of the treatment
of the costs of post-retirement benefit plans other than pension plans.
This Staff Discussion Paper identifies 10 major topics, but respondents
are welcome to identify and comment on any other issues they feel are
important. This Staff Discussion Paper reflects research accomplished
to date by the staff of the Cost Accounting Standards Board in the
respective subject area, and is issued by the Board in accordance with
the requirements of 41 U.S.C. 422(g)(1)(A).
The Cost Accounting Standards Board has received numerous public
comments recommending that it establish a case concerning the
measurement, allocation and period assignment of the costs of post-
retirement benefit plans other than pension plans. These letters have
come from Federal Government agencies, Government contractors, law
firms, trade associations and other respondents. The Board has
recognized the need to establish a case addressing post-retirement
benefit issues. Accordingly, this Staff Discussion Paper was developed
to identify the cost accounting issues related to post-retirement
benefit plans.
Post-retirement benefit plans have existed for many years,
sometimes as an adjunct to a company's pension plan, but they generally
received little attention until 1979 when the Financial Accounting
Standards Board (FASB) decided to examine the potential liabilities and
costs of these plans. After seeking public comments through an exposure
draft and a field test of a proposed standard, the FASB issued
Statement No. 106 (SFAS 106) in December of 1990.
SFAS 106 exposed the substantial unfunded liabilities associated
with post-retirement benefit plans. The costs and liabilities of post-
retirement benefit plans often equal or exceed those of a company's
pension plan. Over the last two decades, the growth rate of these costs
and liabilities has exceeded general economic growth. During this same
time period, some companies have looked for ways to either lower or
control their post-retirement benefit liabilities by eliminating,
curtailing, or otherwise limiting the benefit promise made to retirees.
Companies have also been searching for tax-advantaged means of funding
these liabilities. The efforts to limit, control, and fund post-
retirement benefit liabilities continue to evolve, but few standard
practices or solutions have yet emerged.
This Staff Discussion Paper identifies the following ten (10) major
topics that the CASB staff believes should be considered in order for
the Board to proceed with its rule-making process in this area. These
topics as they relate to post-retirement benefit costs are:
A. Applicability of generally accepted accounting principles and
existing Cost Accounting Standards.
B. Choice of accounting method or methods for measurement and
period assignment.
C. Validity of the liability as a prerequisite for accrual
accounting.
D. Choice of actuarial cost methods to measure and assign costs to
periods for accrual accounting purposes.
E. Assignment of unfunded actuarial liabilities to accounting
periods for accrual accounting purposes.
F. Actuarial considerations if accrual accounting is used.
G. The need, if any, to substantiate accruals by funding.
H. Cost determination for segments.
I. Accounting for plan terminations, liability settlements, and
benefit curtailments.
J. Adjustments for segment closings.
The balance of the Staff Discussion Paper comprises short
discussions of each topic highlighted above. The CASB staff is
requesting comments and information regarding these 10 major topics.
The staff also invites comments and information on any other post-
retirement benefit issues which respondents believe should be
considered. The staff continues to be especially appreciative of
comments and suggestions that attempt to consider the concerns of all
parties to the contracting process.
C. Public Comments
Interested persons are invited to participate by submitting data,
views or arguments with respect to this Staff Discussion Paper. All
comments must be in writing and submitted to the
[[Page 49535]]
address indicated in the ADDRESSES section.
Richard C. Loeb,
Executive Secretary, Cost Accounting Standards Board.
Accounting for the Cost of Post-Retirement Benefit Plans Other Than
Pension Plans Sponsored by Government Contractors
This staff discussion paper represents the results of research
performed by the staff of the Cost Accounting Standards Board, and is
issued by the Board in accordance with the requirements of 41 U.S.C.
422(g)(1)(A). The statements contained herein do not necessarily
represent the position of the Cost Accounting Standards Board.
In response to the Cost Accounting Standards Board's continuing
research, the Board has received a number of comments recommending that
a case concerning the costs of post-retirement benefit plans other than
pension plans under Government contracts be established. These letters
have come from Federal Government agencies, Government contractors, law
firms, trade associations and other respondents. In addition, a recent
General Accounting Office report, Cost Accounting Standards Board--
Little Progress Made in Resolving Important Issues (GAO/AIMD-94-88),
also commented on the need for a Standard in this area. The Board has
recognized the need to establish a case addressing post-retirement
benefit issues, but because of the similarities between post-retirement
benefits and more traditional pension plans, it was decided to defer
commencement of this case until the pension case was completed.
The pension case was completed when the amendments to Cost
Accounting Standards 9904.412 and 9904.413 were published as a final
rule on March 30, 1995, 61 FR 16534. At its February 24, 1995 meeting,
the CAS Board directed the staff to begin preliminary work on a Staff
Discussion Paper addressing the accounting treatment of costs of post-
retirement benefit plans.
Background
Post-retirement benefit plans have existed for many years,
sometimes as an adjunct to a company's pension plan, but generally they
received little attention until 1979 when the Financial Accounting
Standards Board (FASB) decided to examine the potential liabilities and
costs of these plans. After seeking public comments on a proposed
financial accounting standard through an exposure draft issued on
February 14, 1989 and after an examination of the practical
implications of the proposed standard through a study performed by
Coopers and Lybrand, the FASB issued Statement No. 106 (SFAS 106) in
December of 1990.
Companies adopting SFAS 106 have disclosed substantial unfunded
estimated liabilities associated with post-retirement benefit plans.
The costs and liabilities of post-retirement benefit plans often not
only equal or exceed those of a company's pension plan, but the growth
rate of the liability for some post-retirement benefits exceeds that of
general economic growth. Furthermore, the volatility of some of the
rates and trends, coupled with the informality of many post-retirement
benefit plans, mean there is a great degree of uncertainty in the
estimates of the liabilities, especially the liability for retiree
health care benefits.
During the 1980s and early 1990s, some companies looked for ways to
either lower or control their post-retirement benefit liabilities by
eliminating, curtailing, or otherwise limiting the formal and informal
post-retirement benefit arrangements made with employees and retirees.
Companies have also been searching for tax-advantaged means of funding
these liabilities. The efforts to limit, control, and fund post-
retirement benefit liabilities continue to evolve, but few standard
practices or solutions have yet emerged.
When the CAS Board undertook to write Standards for pension costs,
a relatively mature body of standards and practice had already evolved.
Pension plans had been around since the early 20th century and had
exploded in prominence during World War II when pension benefits were
granted in lieu of salary increases, which had been frozen as a part of
the war effort. The American Institute of Certified Public Accountants
began examining post-retirement benefits with Accounting Research
Bulletin Number 47 (ARB 47) in 1956. ARB 47 was superseded by Opinion
Number 8 of the Accounting Principles Board (APB 8) in 1966. APB 8
addressed pension benefits and permitted a variety of accepted
practices. Meanwhile, the economic and political environment of the
1960s and 1970s led to the enactment of tax incentives to encourage the
establishment and funding of pension plans. In 1974, the Employee
Retirement Income Security Act (ERISA) was passed to protect pension
plan participants against abuses that had developed, to enhance
controls on tax-deductible contributions, and to establish a benefit
guarantee buttressed by minimum funding requirements.
In 1985, the FASB issued Statements 87 and 88 (SFAS 87 and SFAS 88)
which replaced APB 8 with a more rigorous and standardized measurement
of pension costs and liabilities intended to achieve fuller disclosure
and better comparability of pension costs in financial statements. SFAS
87 and 88 were able to build upon the accrual accounting concepts of
APB 8.
To complete the effort begun with ARB 47, the FASB then used
concepts and principles from SFAS 87 and 88, where appropriate, to
develop SFAS 106, ``Employers' Accounting for Postretirement Benefits
other than Pensions''. SFAS 106 addresses non-pension post-retirement
benefits and is intended to achieve fuller disclosure and better
comparability of post-retirement benefit costs in financial statements.
However, post-retirement benefits are often granted to an employee as
an entitlement to a service, or reimbursement of the expenses of a
service, so that the amount of benefit may not be determinable at
retirement by either a formula or an account balance. Sometimes the
promise is open-ended. Furthermore, the actual amount of benefits paid
to or for an individual often depends upon that individual's morbidity
after retirement rather than their service or salary during their years
of employment. So, despite the similarities with pensions, the
entitlement nature of many post-retirement benefits makes them very
distinct from pension and other deferred compensation benefits.
Post-Retirement Benefits Defined
SFAS 106 defines a post-retirement benefit as any benefit, other
than retirement income, that is deferred until after retirement and
promised by an employer in exchange for current service. For SFAS 106
purposes, the post-retirement benefit promise arises from the written
documents and established practices that comprise the ``substantive
plan''. The most common forms of post-retirement benefits are retiree
health care insurance 1 and retiree life insurance. Examples of
other forms of post-retirement benefits are retiree discounts, legal
services, adult day care, housing subsidies, and tuition assistance.
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\1\ For purposes of this Staff Discussion Paper, the phrase
``retiree health care insurance'' can include hospitalization,
medical, dental, vision, and prescription drug benefits, as well as
Medicare Part B premiums.
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Like pensions, post-retirement benefits are paid to or on behalf of
the employee after retirement. Post-retirement benefits also have
attributes of employee insurance; e.g.,
[[Page 49536]]
hospitalization, medical, dental, prescription drug, and death
benefits, and deferred compensation, adult day care allowances, housing
subsidies, legal services, and tuition assistance.2 It is
important to bear in mind that post-retirement benefits share the
attributes, issues, and problems of employee insurance and deferred
compensation as well as pensions.
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\2\ This Staff Discussion Paper addresses the accounting, that
is, the measurement, assignment to periods, and allocation to cost
objectives, of post-retirement benefit costs. This paper does not
address the allowability of the costs for a particular category of
post-retirement benefits.
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Actuaries practicing in the field of post-retirement benefits
indicate that about 80% of the liabilities are for health care
benefits; i.e, medical, hospitalization, dental, vision, and
prescription benefits, and about 19% are for life insurance. All other
forms of post-retirement benefits only account for about 1% or 2% of
the liability.
Accounting for Post-Retirement Benefits Under SFAS 106 and Related
Standards
SFAS 106 generally requires that the estimated liability for post-
retirement benefits be recognized on an accrual basis during the years
of service prior to the date an employee is first eligible for
benefits. The unit credit actuarial cost method is used to assign the
estimated liability 3 to these years of employment as an annual
expense. The portion of the liability assigned to periods prior to the
initial date of adoption of SFAS 106 is called the ``Transition
Obligation''. The ``Transition Obligation'' may be fully recognized in
the period in which SFAS 106 is first adopted or may be amortized over
the employees' average remaining years of service, but not more than 20
years. Increases in the estimated liability due to plan amendments are
always amortized over the employees' average remaining years of
service. On the other hand, decreases in the estimated liability due to
plan amendments are offset against any existing unrecognized prior
service liability before being amortized. Experience gains and losses;
i.e., the deviation of actual asset and liability values from amounts
that were actuarially predicted as well as changes in the liability due
to assumption changes, are recognized immediately. Only that portion of
the gain or loss amount falling outside of a defined corridor is
amortized over the employees' average remaining years of service.
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\3\ The SFAS 87 and 106 references to period attribution are
analogous to the concept of period assignment as used in the Cost
Accounting Standards.
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In addition to the FASB's actions, the Governmental Accounting
Standards Board (GASB), which establishes accounting principles for
State and local governments, and the National Association of Insurance
Commissioners (NAIC), which sets forth statutory accounting principles
for insurance companies, have recently issued accounting standards for
post-retirement benefit costs. Generally these standards follow the
concepts of SFAS 106, but with some important exceptions. Statement 12
of the Government Accounting Standards Board (GASBS 12) requires that
costs of advanced-funded post-retirement benefit plans be actuarially
determined, but unlike SFAS 106, does not limit the choice of actuarial
cost method. On the other hand, for purposes of statutory accounting by
insurance companies, the measure of estimated liability only considers
current retirees and those active employees who are currently vested or
eligible for benefits. The annual service cost for statutory accounting
only considers retirees, active employees eligible for benefits, and
active employees who are or who may become vested during the year.
These are relatively recent promulgations. The recognition of post-
retirement benefit plan costs does not have the framework, consistency
of operational practice, nor history of funding that existed for
pension plan costs when the CAS Board embarked on the pension project.
Some believe that the budget deficits of the 1990s will preclude the
creation of tax incentives to encourage the establishment and funding
of post-retirement benefit plans. State and Federal legislators and
policy makers are looking for ways to reduce or control the growth of
retiree health care costs, including Medicare, through cost
containment, managed care, and program re-design. The future of retiree
health care costs, the largest and fastest growing category of post-
retirement benefit cost, is uncertain.
The Need To Address Post-Retirement Benefit Accounting Issues
First, most Government contractors have now become subject to SFAS
106 and are disclosing for financial reporting purposes large estimated
liabilities for post-retirement benefits, similar in magnitude to those
of pension liabilities. Second, the procuring agencies and contractors
are already struggling with the sometimes conflicting goals of
consistency between periods, uniformity between contractors, and the
substantiation of costs.
Finally, as some companies leave Government contracting as the
defense industry downsizes, there is a question of the Government's
responsibility for the large unfunded estimated liability for post-
retirement benefits earned by workers with a long history of service
under prior Government contracts. These three factors convinced the
Board that issues pertaining to cost accounting, i.e., measurement,
allocation and period assignment, for post-retirement benefits should
be explored and addressed.
Therefore, through the issues raised in this Staff Discussion
Paper, the Board is seeking information and comments regarding two
central themes:
(1) On what basis should the Government determine; that is,
measure, assign, and allocate, post-retirement benefit plan costs to be
included in the prices of negotiated Federal contracts?
(2) To what degree, if any, should Government contract cost
accounting of post-retirement benefit plan costs differ from generally
accepted accounting principles?
An additional general issue will be whether any resolution of these
issues should be addressed through an Interpretation, an amendment to
existing Standard(s), or, through a new Cost Accounting Standard. The
staff is aware that both procuring agency and contractor
representatives have urged caution to avoid adding any unnecessary
accounting requirements to an intrinsically complex and technical
subject.
Preliminary Research
In developing this Staff Discussion Paper, the staff has solicited
preliminary comments from certain interested and knowledgeable
organizations and individuals from both the procuring agencies and
contractor communities. The staff also sought comments from
organizations and individuals from the accounting, actuarial, and legal
professions. They were asked for assistance in identifying existing
guidance and operational practices which should be explored. The staff
would like to thank all the organizations and individuals who responded
to the preliminary request for information. Their input and comments
were very important in preparing this Staff Discussion Paper, which is
the first step towards the possible promulgation of an Interpretation,
an amendment to existing Standard(s), or a new Standard.
Issues concerning financial and Government contract cost accounting
for post-retirement benefits are topics which have been treated in some
detail
[[Page 49537]]
in accounting and actuarial literature. 4 The interplay between
accountants and actuaries, which has produced issues that may affect
cost accounting for post-retirement benefits, has also been discussed
in accounting and actuarial literature. 5 To the extent that these
articles have aided with the drafting of this paper, the staff would
like to thank the authors.
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\4\ For example, the article ``Post-Retirement Benefits:
Accounting for and Recovering the Cost of Health Care for Retirees''
(Public Contract Law Journal, Vol. 24, No. 3, Spring 1995), written
by Brian Mizoguchi, gives an excellent overview of the subject and
associated cost accounting issues.
\5\ For a discussion of the tension between the accounting and
the actuarial professions concerning responsibility for the
measurement of Post-retirement benefit liabilities, see ``Impact of
the Actuarial Profession on Financial Reporting'' (Accounting
Horizons, Vol. 9, No. 3, September 1995) by Timothy J. Fogarty and
Julia Grant.
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Post-Retirement Benefit Issues
This Staff Discussion Paper identifies ten (10) major topics for
consideration by the Board during its deliberations of any
Interpretations, amendments to existing Standards, or a new Standard.
Respondents are encouraged to identify other topics that they believe
the Board should consider. The topics as identified in this Staff
Discussion Paper are:
A. Applicability of generally accepted accounting principles and
existing Cost Accounting Standards.
B. Choice of accounting method or methods for measurement and
period assignment.
C. Validity of the liability as a prerequisite for accrual
accounting.
D. Choice of actuarial cost methods to measure and assign costs to
periods for accrual accounting purposes.
E. Assignment of unfunded actuarial liabilities to accounting
periods for accrual accounting purposes.
F. Actuarial considerations if accrual accounting is used.
G. The need, if any, to substantiate accruals by funding.
H. Cost determination for segments.
I. Accounting for plan terminations, liability settlements, and
benefit curtailments.
J. Adjustments for segment closings.
The balance of the Staff Discussion Paper comprises short
discussions of each topic. Following the discussion of each topic,
specific issues are identified. The staff is requesting comments and
information regarding these issues. When responding to these issues,
the staff would appreciate explanations of the reasoning that supports
each comment. Where subparts of the issues are presented, the
respondents are asked to address the main issue as well as each of the
subparts. The staff invites comments and information on any other post-
retirement benefit issues that respondents believe should be
considered.
In writing this Staff Discussion Paper, the staff attempted to
avoid any preconceptions or conclusions about the proper accounting
treatment of post-retirement benefit plans for Government contract
costing purposes. In particular, the staff has not presumed that either
SFAS 106 or CAS 9904.412 should be the starting point. 6 In fact,
one of the difficulties in addressing Government contract cost
accounting for post-retirement benefits is that post-retirement
benefits share attributes with pension, insurance, and deferred
compensation plans. During its consideration, the Board may find that
different types of post-retirement benefits may require different
accounting treatments.
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\6\ This paper addresses many issues similar to those
considered in the March 30, 1995 amendments to CAS 9904.412 and
9904.413. The fact that issues are raised in this Staff Discussion
Paper on post-retirement benefit costs does not imply changes will
be made to the pension Standards.
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The CASB staff presumes that the readers of this Staff Discussion
Paper are familiar with the provisions of CAS 9904.412, 9904.413,
9904.415, and 9904.416, as well as the Federal Acquisition Regulation
(FAR) provisions regarding the award and administration of CAS-covered
contracts. In addition, a familiarity with the FAR cost principles, in
particular, FAR 31.205-6(o), is presumed.
In undertaking this project the Board is not constrained by nor
confronted with conflicts in outside standards and practices as it was
in the recent pension case. In this instance, except for the recent
promulgations of the FASB, GASB, and the NAIC, there is a paucity of
established common practice and efficient funding mechanisms, other
than the use of pay-as-you-go financing, limited use of Voluntary
Employee Benefit Association (VEBA) trusts, and some creative insurance
products.
Topic A. Applicability of Generally Accepted Accounting Principles and
Existing Cost Accounting Standards.
It is unclear whether post-retirement benefits are, or should be,
covered by any of the existing Cost Accounting Standards. Before taking
any action to interpret, amend, or expand the Standards for post-
retirement benefit costs, the Board would have to determine that
adequate guidance is not provided by generally accepted accounting
principles for the measurement and assignment to periods and by
existing Standards for allocation to intermediate and final cost
objectives for Government contract cost accounting purposes. One
possibility is for the Board to adopt or specify SFAS 106 as the
accounting standard for post-retirement benefit costs. Or, the Board
could adopt SFAS 106 but limit or modify any provisions or accounting
treatments that may be inappropriate or inadequate for cost accounting.
Although the primary benefits provided through post-retirement
benefit plans are retiree health care and life insurance benefits, the
FASB developed SFAS 106 on post-retirement benefits using the concepts
and techniques of SFAS 87 and 88 on pensions. Thus, since one of the
concepts adopted by the Board is to follow generally accepted
accounting principles wherever practicable, CAS 9904.412 and 9904.413
would seem to be the analogous Cost Accounting Standards to serve as
the starting point for post-retirement benefit plans. However, the only
specific reference to retiree insurance is found at CAS 9904.416-
50(a)(1)(v). At first, many in the procurement community expressed a
belief that post-retirement benefits were another form of pension
benefits and were therefore subject to CAS 9904.412 and 9904.413. In
response to an inquiry from the Financial Executives Institute, the
Administrator of the Office of Federal Procurement Policy (OFPP) and
Chairman of the CASB, stated: ``[E]xisting CAS pension or insurance
coverage does not appear to offer a basis for treating PRB costs. In
fact, the post-retirement benefit nomenclature barely existed at the
time of the earlier Board.'' 7 However, this statement represents
guidance from the Administrator of OFPP and is not an official
interpretation by the Board.
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\7\ Letter dated November 25, 1991 from Dr. Allan V. Burman to
Messrs. Fuqua and Hogg of the Aerospace Industries Association and
the National Security Industrial Association, respectively.
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The confusion increased as some individuals in the accounting
profession expressed a belief that the CAS Board intentionally included
post-retirement health care benefits in the pre-March 30, 1995 version
of CAS 9904.412-50(a)(9) which stated: ``If a pension plan is
supplemented by a separately-funded plan which provides retirement
benefits to all of the participants in the basic plan, the two plans
will be considered as a single plan for the purpose of this Standard.''
Others believe this clause was added to address the total pension
benefit provided through the combination of a defined-benefit with a
[[Page 49538]]
defined-contribution plan, which were commonly referred to as ``floor-
offset plans'', or the combination of an ``excess benefit''
nonqualified plan with a qualified plan. Such combinations were
specifically being addressed by ERISA. There is no evidence that post-
retirement health care benefits were a consideration in the mid-1970s
when CAS 9904.412 and 9904.413 were originally promulgated. However,
this language does raise the question of whether separate accounts
within a qualified pension trust established for Internal Revenue Code
(IRC) Sec. 401(h) health care benefits should be considered as
providing an ancillary benefit that is an integral part of a pension
plan that covers the same population.
The first set of issues concerns how the case should evolve. Should
Government contract cost accounting for post-retirement benefit plans
be addressed through SFAS 106, a CASB Interpretation, an amendment(s)
to an existing Standard(s), or by a new separate Standard? At a
minimum, any consideration of amendments or additions to the Standards
would seem to require a review of the CAS 9904.416 provisions regarding
funded reserves for retirees.
CAS 9904.416 generally does not distinguish between various types
of insurance. However, there have been suggestions that employee
benefit coverages; that is, life, health care, and disability
insurance, should be separated from property, casualty, liability, and
workers compensation insurance. 8 Such separation is reflected in
the recent revisions to the CASB Disclosure Statement, DS-1. It may be
appropriate for the Board to consider whether 9904.416 is too broad
because it attempts to combine two similar, but unrelated, types of
insurance. The life and health insurance industry, through which most
employee benefits are provided, is governed by a separate set of state
laws and is represented by a separate industry association and
actuarial society from those of the property and casualty insurance
industry. But, because dividing 9904.416 into two Standards could
expand the scope of the instant case on post-retirement benefits, it
may be more feasible to address only the provisions of CAS 9904.416
relating to post-retirement benefits now and to identify the full
review of CAS 9904.416 as a potential subject of a future CASB case.
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\8\ Worker's compensation is a form of liability insurance that
covers a contractor's legal responsibility for injury for which it
is culpable.
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Issue 1: Does GAAP provide adequate guidance for the measurement
and period assignment of post-retirement benefits? Explain why or why
not and discuss the pros and cons. 9
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\9\ Throughout this Staff Discussion Paper, the staff requests
that respondents explain the reasoning for their conclusions.
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a. Does SFAS 106 provide sufficient guidance on the measurement and
period assignment of post-retirement benefit costs for Federal contract
costing purposes?
b. Identify any provisions of SFAS 106 that may be adequate or
inadequate for the measurement and assignment to periods of Government
contract costs. Discuss in detail the modifications or limitations that
may be necessary.
c. Are there other financial accounting standards; e.g., GASBS 12
or statutory accounting principles, that would provide more appropriate
guidance on the measurement and period assignment of post-retirement
benefit costs for Federal contract costing purposes?
d. If GAAP is used for measurement and period assignment of post-
retirement benefits costs, do existing Cost Accounting Standards
provide sufficient guidance on the allocation of such costs to Federal
contracts?
Issue 2: Should the Board issue an Interpretation specifying which
elements of post-retirement benefit costs are addressed by existing CAS
9904.412 and 9904.413 relating to pension plans, CAS 9904.415 relating
to deferred compensation plans, and CAS 9904.416 relating to insurance?
Issue 3: Should the Board establish specific accounting provisions
for the various elements of post-retirement benefit costs by
appropriately amending some or all of the four Standards that address
employee benefits, i.e., CAS 9904.412, 9904.413, 9904.415, and
9904.416?
Issue 4: Should the Board address post-retirement benefits through
a new, separate Standard?
a. To what extent should a new Standard draw on language already
found in CAS 9904.412, 9904.413, 9904.415, and 9904.416 to achieve
consistency with the concepts, definitions, and accounting provisions
of these four Standards?
b. To what extent do the issues unique to post-retirement benefits
require a different accounting treatment?
Issue 5: As part of this case, should the Board amend CAS 9904.416
to reflect the differences between life and health insurance and
property and casualty insurance?
Topic B. Choice of Accounting Method or Methods for Measurement and
Period Assignment
The CASB pension Standards and insurance Standard permit costs to
be assigned to cost accounting periods by use of any one of three
methods; cash accounting, terminal funding, or accrual accounting. The
less technically challenging CAS 9904.415 bases the cost of annual
deferred compensation awards on a single method; i.e., the present
value of the contractor's obligation for the award earned by that
year's service. Because of its focus on comparability between financial
statements, SFAS 106 mandates the use of accrual accounting based on a
specific actuarial cost method.
A primary consideration will be whether post-retirement benefits
should be accounted for using a single accounting method or if, and
when, alternative accounting methods would be appropriate. Any decision
in this area must find a balance between three different goals;
consistency in cost assignment between cost accounting periods, greater
uniformity among contractors in measuring their program costs, and
matching of cost to appropriate benefitting activities.
(i) Single versus multiple accounting methods
As with pensions, post-retirement benefit costs could extend over a
significant number of years, contracts, and programs. From this
perspective, predictability that is based on consistency of cost
assignment between cost accounting periods is desirable for forward-
pricing and program budgeting purposes. With possible reductions in
government contracting due to Federal budget restraint and the
reduction in the number of contractors due to mergers and acquisitions,
the importance of a level playing field for competitive pricing through
more uniformity in cost data determination among contractors has become
even more pronounced. Furthermore, because so many contracts and
programs are affected over the extended period of time during which
post-retirement benefits are earned, the proper matching of costs to
their benefitting activities is necessary for inter-program
consistency.
Several contractor representatives have noted that cash accounting
would satisfy the Government's primary desire for funding. With cash
accounting there is little question about the verifiability of the
cost, but cost recognition is deferred until the latest possible
moment. In most instances, the principle of matching cost with the
[[Page 49539]]
benefitting activities is clearly violated. Because a single cash
payment in the current period represents both liability liquidation and
cost recognition, there are no expenses for obtaining actuarial
valuations and most other administrative expenses are minimal. However,
the cost incurrence will be completely disconnected from the
benefitting activity because of this delay. Cash accounting is most
appropriate for obligations whose future payment is questionable or
which are difficult to estimate or quantify within reasonable limits.
With cash accounting there is a concern with the possible
recognition of the Government's share of any future estimated liability
not covered by current contract pricing. Many believe that Remington
Arms 10 suggests that the Government has a responsibility for any
unfunded post-retirement benefit liability in certain special
contractual relationships, such as a Government-owned contractor
operated (GOCO) facility. Some argue that in such cases the Government
may have encouraged the use of cash accounting in the past because it
benefitted from the resulting lower contract costs. If cash accounting
is permitted or mandated for Government contract costing purposes, this
issue may have to be addressed as part of any guidance on the final
settlement of contract costs if the contracting relationship ends. This
issue is discussed in more detail under Topic J.
---------------------------------------------------------------------------
\10\ Army Contract Adjustment Board (ACAB) Decision No. 1238
(1991).
---------------------------------------------------------------------------
Terminal funding is an improvement over cash accounting in that
cost recognition occurs somewhat closer to the incurrence of the cost.
But, under terminal funding the pattern of cost assignment is very
dependent upon the plan demographics and can produce very inconsistent
results from period to period, even for plans with large populations.
Moreover, terminal funding can be viewed as simply a subset of cash
accounting in which the cash outlays occur in lump sums at retirement,
rather than as periodic payments over the participants' retirement
years. Terminal funding generally shares the advantages and
disadvantages of cash accounting. However, the market for terminal
funding in the area of retiree health care benefits is virtually non-
existent. To improve consistency between periods, many contractor and
Government agency representatives believe that terminal funding, if
used to account for post-retirement benefit costs, should be subject to
an amortization requirement similar to the one at CAS 9904.416-
50(a)(1)(v)(C).
Accrual accounting provides the best matching of costs to
benefitting contracts and programs. Accrual accounting, properly
implemented, also enhances consistency between contract periods, and
thereby enhances predictability for forward-pricing purposes. However,
accrual accounting is only appropriate when the obligation is valid;
that is, reasonably expected to occur and can be reasonably
estimated.11 Accrual accounting for post-retirement benefits would
be based on expectations of long-delayed events and on actuarial
estimates of obligations that may not be fully liquidated for years, if
at all. And, there are significant administrative expenses associated
with these actuarial estimates and the necessary record keeping.
---------------------------------------------------------------------------
\11\ See Topic C for a discussion of the validity of post-
retirement benefit liabilities.
---------------------------------------------------------------------------
On the other hand, as the retiree proportion of post-retirement
benefit plans grows with the aging of the workforce and contractor
downsizing, pay-as-you-go (cash accounting) costs will sooner or later
exceed the accruals. Thus, from the perspective of a program manager,
the costs of post-retirement benefit plans might be more manageable in
the long run if accrual accounting is adopted now instead of facing
escalating pay-as-you-go costs in later years when many expect
procurement budget pressures to further increase.
Very different results are produced by accrual accounting, cash
accounting, and terminal funding, making it difficult to compare cost
or price proposals from competing contractors if several methods are
permitted for Government contract costing purposes. Besides the
differences in cost for the current period, one contractor may realize
lower costs from having adopted fully-funded accrual accounting earlier
while another contractor may achieve lower costs by avoiding current
accruals in favor of deferred cash payments. In such instances, there
would be little uniformity in the cost recognition patterns over time.
Contractor representatives who have shared information on how their
individual companies treat post-retirement benefits, indicate that
current contractor practices range from fully-funded accrual
recognition to traditional cash accounting. They note that terminal
funding is sometimes used for life insurance, but seldom or never for
retiree health care benefits. A contractor's choice of accounting
method is currently determined by many factors; such as, size of its
Government business base, type(s) of benefit, industry practice,
availability of tax-advantaged funding, and the type of covered
employee population; e.g., union or non-union, production or
management.
Issue 6: Should cash accounting be permitted for post-retirement
benefit costs of Government contractors?
a. If so, should cash accounting be mandatory if the post-
retirement benefit plan is unfunded?
b. Should cash accounting be mandatory if the post-retirement
benefit liability is not reasonably predictable?
Issue 7: Should terminal funding be permitted for post-retirement
benefit costs of Government contractors?
a. If so, should cost recognition be based on the terminal funding
payment made during the period?
b. Are there circumstances when the terminal funding payment should
be subject to amortization for cost recognition purposes?
c. Should the terminal funding payment always be subject to
amortization for cost recognition purposes?
Issue 8: Should accrual accounting be permitted for post-retirement
benefit costs of Government contractors?
a. Other than concern with the validity of the liability and the
possible need for funding which are discussed as subsequent topics, are
there certain criteria that must be met as a prerequisite for using
accrual accounting?
b. Should accrual accounting be mandatory if certain criteria are
met? If so, describe the criteria.
Issue 9: For uniformity between contractors, should measurement and
assignment of post-retirement benefit costs to periods be restricted to
a single accounting method? If so, identify that method.
Issue 10: If different accounting methods may be used by different
contractors, explain how and when each method should be used.
(ii) Different accounting methods for different benefit types
Although SFAS 106 treats all post-retirement benefits alike, the
CAS Board may wish to consider whether different accounting methods may
be appropriate for different types of benefits. Natural divisions seem
to be health care insurance, life insurance, and ``other'' benefits
(legal services, housing subsidies, adult day care). Similarly, the
Board may wish to consider whether a contractor should be permitted to
elect to use different accounting methods for different post-retirement
benefit plans or for different benefits within the same plan.
[[Page 49540]]
Contractor representatives and their actuaries have suggested that,
because of the added administrative and actuarial expenses, the
accounting treatment should not be separated by type of benefit. In
fact, they believe that benefits other than health care insurance and
life insurance are not sufficiently material to justify special
treatment since they only comprise about 1% or 2% of total post-
retirement benefit costs.
The Board will have to determine what constitutes a post-retirement
benefit plan. Under SFAS 106, a ``substantive plan'' may comprise a
formal plan document and trust agreement, an undocumented, but well
established practice, or a mere reference of intent in an employee
handbook. This definition of substantive plan is appropriate for the
SFAS 106 purpose of disclosing to investors, shareholders, and lenders,
an entity's potential liabilities. CAS 9904.412 and 9904.416 require
the purpose of a trust fund or reserve for retiree benefits be set
forth in writing as a precondition for accrual accounting. If the SFAS
106 definition of a post-retirement benefit plan is determined to be
inadequate for Government contract costing purposes, it may be
desirable to require that the obligation be evidenced in writing as a
precondition for the use of accrual accounting.
Different contractors may provide similar benefit plans, but
package the benefits differently. Consider the following illustration.
Contractor X may have four formal documents covering all its employees;
one each for retiree medical benefits, retiree dental coverage, retiree
life insurance, and retiree discounts. Another contractor, Contractor
Y, may provide combined retiree medical, dental, life, and discount
benefits through two similar plans, each of which covers different
employee populations; i.e, union and non-union employees. If different
accounting methods are permitted for different benefits, could
Contractor Y elect different accounting for its retiree health care and
life benefits provided by the same ``plan'', or would such an election
only be available to Contractor X?
Even more problematic is when the same health care plan provides
the same benefits to active employees and retirees. Some contractor
representatives have expressed an interest in treating the two
participant categories; i.e, active and retired, as separate plans. If
permitted they would like to use cash accounting (based on premium
payments) for current retired employees while using accrual accounting
for the post-retirement benefits of the active population.
Issue 11: Is the SFAS 106 description of a post-retirement benefit
plan adequate for Government contract costing purposes?
a. If not, please describe any modifications or restrictions to the
SFAS 106 description that you believe are necessary.
b. Is there an alternative definition that the Board should
consider?
Issue 12: Should different accounting methods for different types
of post-retirement benefits be permitted when the benefits are provided
by the same contractor?
a. If multiple accounting methods are considered appropriate,
should the permitted accounting method or methods be dependent on the
type of post-retirement benefit provided by separate plans?
b. If multiple accounting methods are considered appropriate,
should different accounting methods be permitted for different benefits
provided through the same plan?
c. If multiple accounting methods are considered appropriate,
should different accounting methods be permitted for different groups
within the same plan population; e.g., union versus non-union, active
employees versus retirees?
Issue 13: Whether or not multiple accounting methods are considered
appropriate, should an administratively less burdensome form of cost
accounting be permitted for certain de minimis benefits; e.g., adult
day care, legal assistance?
a. Should cash accounting be permitted for de minimis benefits?
b. Should de minimis benefits, whose payment does not involve life
contingencies, be specifically subject to CAS 9904.415, deferred
compensation rules?
c. How should de minimis benefits be defined? Can that definition
be readily related to the CAS materiality criteria in 9903.305?
Topic C. Validity of the Liability as a Prerequisite for Accrual
Accounting
In considering whether accrual accounting is appropriate for the
measurement and period assignment of post-retirement benefit costs to
contracts, the CAS Board will have to assess the validity of the
estimated liability. A valid liability derives from an event which is
expected to occur and the cost effect of which can be reasonably
estimated. For purposes of this Staff Discussion Paper, a valid
liability is distinguished from a contingent liability for events whose
actual occurrence cannot be reasonably predicted or the cost effect
cannot be reasonably estimated.
As with pensions, use of any accrual accounting method for post-
retirement benefit plans could create an extended period of delay
between cost recognition and benefit payment. This delay raises
additional concerns about the validity of the liability. The
conservative nature of GAAP leads it towards accrual accounting for not
only contractual obligations, but also for informal, and possibly
unenforceable, benefit promises. The FASB is concerned that to not
disclose these liabilities would imply that no liability exists.
Therefore, the question is whether the recognition criteria of SFAS 106
are also applicable for accrual of the cost and the recognition of cost
in the Government contracting environment?
Furthermore, some companies have been actively amending, replacing,
and eliminating retiree health care plans to contain or eliminate post-
retirement benefits costs. The possibility of a retiree health care
benefit being greatly reduced or eliminated is much greater than that
for pension benefits which fall under the protections of ERISA. Also,
because there are limited tax-deductions available for funding post-
retirement health care benefits, some companies have been shifting
costs to participants through higher deductibles, co-payments, and caps
on employer-paid costs. Therefore, it seems that the validity of a
liability for a benefit that can be significantly avoided by the
unilateral action of a contractor could be questioned. The presumption
that a post-retirement benefit plan will continue has less certainty
than a comparable pension plan subject to ERISA.
In addition to the documentation requirements similar to those
found in CAS 9904.412 and 9904.416, there may be other criteria that
should be met before post-retirement benefit costs can be accrued for
Government contract cost accounting purposes. After retirement,
defined-benefit pension costs are dependent only on investment results,
mortality, and possibly a limited adjustment for general inflation.
Retiree health care costs are dependent not only on investment results,
mortality, and general inflation, but utilization, intensity, and
medical inflation rates. Unforeseeable changes, which are not
anticipated in the actuarial assumptions, such as future medical
advances, changes in delivery systems, new diseases, and increasing
health care provider competition will also affect future retiree health
care costs. Health care actuarial assumptions; e.g., utilization,
intensity, and medical
[[Page 49541]]
inflation rates, possess a much greater degree of uncertainty than the
economic and mortality assumptions used for pension plans. An important
issue concerns the degree of uncertainty that makes an event, or the
quantification of the effects of an event, a contingency rather than a
reasonable expectation.
Retiree health care plans are often integrated with Medicare, so
that after age 65, the benefit structure is that of a Medigap policy
that covers costs not paid by Medicare. Coupled with the uncertainty of
the assumptions, there are the widely disparate potentialities, over
the long-term, for either a complete third-party assumption of company
health care liabilities (e.g., a substantial increase in Medicare
benefits), which would eliminate or reduce contractors' retiree health
care costs, or, conversely, a revised Medicare program that would
increase contractors' retiree health care costs. The CAS Board may have
special concerns about the appropriateness of use of accrual accounting
for retiree health care costs as opposed to retiree life and other
benefits. Instead of valuing projected benefit levels, perhaps a
liability measurement based on current, that is unprojected, benefit
levels would be a more reliable, and therefore appropriate basis, for
determining the valid liability to be recognized in the current cost
accounting period. The effects of inflation on all benefits and the
effect on health care benefits due to changes in utilization and
intensity would have to be recognized in future periods as the cost
effects emerge.
Issue 14: Can post-retirement benefit liabilities be reasonably
estimated; i.e., is there a valid liability, given the degree of
uncertainty in projecting post-retirement benefit levels?
Issue 15: Because of the uncertainties in projecting retiree health
care benefits and trends, in particular long-term medical cost trends,
should accrual accounting for post-retirement health care benefits only
recognize current benefit levels?
Issue 16: Because of the uncertainties about future reductions or
other changes to the benefit promise, should accrual accounting for all
post-retirement benefits only recognize current benefit levels?
Issue 17: Should the validity of the liability be dependent on the
formality of the post-retirement benefit plan?
Issue 18: Are there other criteria that should be used to assess
the validity of the post-retirement benefit liability?
Topic D. Choice of Actuarial Cost Methods To Measure and Assign Costs
to Periods for Accrual Accounting Purposes
The current CAS Board, like its predecessor, believes that
generally accepted accounting principles should be used as a basis for
determining contract costs for a valid liability whenever practicable.
However, the Board has long recognized that GAAP concepts and methods
must be scrutinized, and possibly modified if otherwise acceptable, to
address the special needs of Government contracting because of its
emphasis on predictability of cost allocations between cost accounting
periods used for Government contracting purposes rather than the
stressing of current period comparability between companies that seems
to predominate financial accounting. In this case, one of the most
crucial determinations is how the estimated liability for post-
retirement benefits is assigned to cost accounting periods. Period
assignment is the foundation on which subsequent allocation to
intermediate and final cost objectives is based.
Many contractor and Government representatives have suggested that
the Board adopt GAAP, as represented by SFAS 106, only adding
safeguards truly needed to protect the Government's interests. Some
believe pure SFAS 106 accrual accounting, augmented with explicit
reversionary rights for the Government in case of an asset reversion,
may be sufficient. However, this use of SFAS 106 presumes that post-
retirement benefits are analogous to pensions. This presumption appears
to be reinforced by the prefatory section of SFAS 106 entitled,
``Similarity to Pension Accounting'', in which the FASB specifically
acknowledges that SFAS 106 is based on SFAS 87 and 88 pension
accounting principles.
CAS 9904.412 permits the use of any immediate-gain actuarial cost
method to apportion, that is, assign, the pension liability over the
employees' total years of service. The accrual pattern for a funded
pension plan, disregarding any funding limitation, can either be a
level amount in dollars or a level percentage of payroll; i.e., as
determined under the Entry Age Normal (EAN) actuarial cost method, or
can be generally increasing; i.e., as determined under the Accrued
Benefit Cost Method (ABCM) or the Projected Unit Credit (PUC) actuarial
cost method. CAS 9904.416 requires that the projected average loss;
i.e., the annual accrual, for advanced-funded retiree insurance
programs be actuarially determined and apportioned over the working
lives of the active population. 12 The CASB staff questions
whether contract cost determinations made under the projected average
loss methodology constitute accrual accounting. The projected average
loss method appears to be an actuarial smoothing technique applied to
cash accounting, especially considering that refunds and credits are
fully recognized when received.
---------------------------------------------------------------------------
\12\ If the population predominantly comprises retirees, then
the liability is apportioned over the average life expectancy of the
population.
---------------------------------------------------------------------------
For SFAS 87 pension accounting, the FASB mandated use of the unit
credit family of methods (ABCM and PUC) because the period assignment
is tied to the employment service by which benefits are incrementally
earned. Often, entitlement to post-retirement benefits is not earned
ratably, but occurs instantaneously when the employee meets an age and
service eligibility requirement. In such cases, the even apportionment
requirement of CAS 9904.416 might be more appropriate.
Issue 19: If accrual accounting is used independent of SFAS 106,
what actuarial method or methods should be used to assign the estimated
liability to cost accounting periods?
a. Should period assignment be limited to a single actuarial cost
method?
b. If the projected unit credit actuarial cost method is used,
should period assignment follow the benefit formula attribution method
or use ``project and prorate'' method? 13
---------------------------------------------------------------------------
\13\ Under the ``project and prorate'' method, the projected
liability at full eligibility age is apportioned over the employee's
years of service without regard to how benefits are actually
incrementally earned based on the benefit formula. Use of this
method is most common in instances where the benefit is not ratably
earned over years of employment.
---------------------------------------------------------------------------
c. If the plan population is predominantly composed of retirees
should costs be attributed to the future life expectancy of the retiree
population?
Issue 20: Is the projected average loss methodology of CAS 9904.416
an appropriate actuarial cost method for accrual accounting?
Issue 21: Are there other methods of period assignment that you
believe should be considered?
E. Assignment of Unfunded Actuarial Liabilities to Accounting Periods
for Accrual Accounting Purposes
If accrual accounting is used, post-retirement benefit costs will
be dependent on actuarial techniques and assumptions. Actuarial cost
methods measure and assign portions of the total liability to past,
current, and future
[[Page 49542]]
periods. When a post-retirement benefit plan is first established or
accrual accounting first adopted, the portion of the total liability
that the actuarial cost method assigns to prior years is identified as
the initial actuarial liability, which is sometimes known as the past
service liability. The portion of this liability that is not currently
secured by assets is the initial unfunded liability. Portions of the
total liability assigned to prior periods by the actuarial cost method
can also arise from subsequent changes in the benefit design, actuarial
cost method, and actuarial assumptions. 14 Actuarial practice
typically reassigns these previously unrecognized past service
liabilities to current and future periods through an amortization
process.
---------------------------------------------------------------------------
\14\ Changes in actuarial assumptions, actuarial cost method, or
underlying benefit promise may also constitute a change in
accounting practice, which is the subject of a separate CASB case
currently under consideration.
---------------------------------------------------------------------------
(i) Initial Unfunded Liability
SFAS 106, which considers the liability valid for financial
accounting purposes, permits the initial unfunded liability, which is
referred to as the ``Transition Obligation'', to be fully recognized in
the period in which SFAS 106 is adopted, to be amortized over the
average remaining years of service of the employees at the time of
adoption. Many have noted that amortization would minimize the
disruption of the forward-pricing and program budgeting processes by
spreading the recognition of this large, and long-neglected, past
service liability over many future years. Much of the large initial
unfunded liability can be attributed to prior periods when there may
have been very different levels of Government work performed by a
contractor. In such instances, amortization over the remaining years of
service would recognize the initial unfunded liability during future
periods of lower, or possibly further changing, Government
participation.
Few contractors used accrual accounting to price their Federal
contracts prior to the issuance of SFAS 106. Since most contractors
ignored the liability for post-retirement benefits prior to the
promulgation of SFAS 106, some believe that the Government has no
responsibility for these liabilities that have appeared only when the
prior practice of cash accounting was been abandoned. A practical issue
will be whether to, and how to, identify the Government's share, if
any, of the initial unfunded liability.
CAS 9904.412 provides for the recognition of the initial unfunded
liability, that is, the unfunded actuarial liability attributable to
prior periods when a pension plan is first established, by providing
that such initial unfunded liability will be reassigned to future
periods through an amortization process. An alternative treatment of
this initial unfunded liability would be to set it aside from other
portions of the unfunded actuarial liability being recognized for
Government contract costing purposes and treat it as a separate or
``exceptional'' item. If this treatment were adopted, the period cost
would comprise the normal cost or projected average loss, plus
recognition of gains and losses, and prospective changes to the plan,
actuarial assumptions, or actuarial cost method. This approach would
permit the Government and a contractor to establish a short term
relationship without having to adjust contract costs for liabilities
and assets accumulated, but not recognized, during prior
periods.15
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\15\ This discussion is focused on the recognition of prior
period costs at the time a contractor first becomes subject to a
Standard on post-retirement benefit costs. Topic J discusses the
recognition of prior period costs at the time a contracting
relationship ends.
---------------------------------------------------------------------------
Issue 22: To what extent, if any, should the initial unfunded
liability of post-retirement benefit plans be recognized for Government
contract costing purposes?
Issue 23: If the initial unfunded liability is recognized, should
it be fully recognized in the cost accounting period when accrual
accounting is adopted or should it be amortized? If amortized, what
should the amortization period be?
Issue 24: If the initial unfunded liability is recognized, should
there be some consideration of historical Government participation
levels in the allocation of the initial unfunded liability to current
and future contracts?
a. If yes, how should such a recognition be measured? Would
permitting accrual accounting as an optional election rather than a
mandated method affect your answer?
b. Alternatively, to better match the amortization installments
with the current level of Government contracting, should the SFAS 106
amortization method of level principal payment and declining interest
equivalents be used? What about using a shortened amortization period;
e.g., 10 years.
Issue 25: If the initial unfunded liability is not recognized,
should accrual recognition be further limited to the normal cost plus
recognition of experience gains and losses and assumption changes?
Issue 26: Are there alternative accounting treatments that the
Board should consider for the initial unfunded liability?
(ii) Changes in Unfunded Actuarial Liability Due to Experience Gains
and Losses
Actuarial assumptions are estimates of future conditions affecting
costs. For post-retirement benefits, the assumptions include future
trends affecting health care costs; e.g., medical cost inflation,
utilization, and intensity, in addition to the events considered for
pension costs. And, like pensions, actual experience will differ from
actuarial expectations. GAAP, as expressed in SFAS 106, favors current
period recognition of the experience gains and losses as they occur.
The Cost Accounting Standards are divided on this subject. CAS
9904.413, which is concerned with consistency between periods, requires
that experience gains and losses be amortized over a 15 year period.
CAS 9904.416-50(a)(1)(vi) would seem to require that experience gains
and losses; i.e., the difference between estimated and actual refunds,
dividends, and assessments, be recognized in the period that the
difference is first known.
In SFAS 106, the FASB limits the immediate recognition of gains and
losses to a corridor, which is related to the benefit liability and the
market value of any assets. Any gain or loss falling outside of the
corridor is amortized over the employees' average remaining years of
service. CAS 9904.413 requires that experience gains and losses be
amortized over 15 years to dampen the volatility of annual market
movements. For Government contract cost accounting of post-retirement
benefit plans, it may be desirable to use a shorter amortization period
so that the gain and loss recognition will be closer to the period when
the gain or loss occurred. Concerns with predictability and forward-
pricing would seem to argue for amortization. The Board may have to
seek a proper balance between early recognition and increased
volatility.
Issue 27: Should experience gains and losses be recognized in the
period of occurrence?
a. If yes, should the current period recognition be limited to a
corridor? How should that corridor be defined?
b. If generally no, is there some de minimis level of gain or loss
that should be recognized in the current period?
c. Are there certain recurrent gain or loss events that should be
recognized immediately?
[[Page 49543]]
Issue 28: Should experience gains and losses be amortized?
a. Should a longer amortization period; e.g., 15 or 20 years, be
used to enhance consistency between periods by dampening volatility?
b. Should a shorter amortization period; e.g. 5 or 10 years, be
used to keep recognition closer to the period in which the gain or loss
occurred?
c. Should the amortization period reflect the average remaining
years of service for the plan's active population? What if retirees
predominantly comprise the plan population?
Issue 29: Are there other methods of recognizing experience gains
and losses that should be considered?
(iii) Other Changes in Unfunded Actuarial Liability
In addition to experience gains and losses, the treatment of all
other changes in the liability must be addressed. The Board will have
to specifically address the cost accounting for changes in the
actuarial assumptions, the actuarial cost method, and the benefits or
plan design.
Because SFAS 106 promotes recognition of current conditions, the
effects of actuarial assumption changes are included with the
experience gain or loss. CAS 9904.412, which was modeled after APB 8
and ERISA, treats changes in liability due to changes in actuarial
assumptions separately from experience gains and losses. Under SFAS
106, the choice of the discount rate is restricted in that it must fit
certain criteria set forth in SFAS 106 as well as guidance from the
Securities and Exchange Commission. The discount rate, and certain
other actuarial assumptions, must reflect current conditions which are
assumed to be beyond a contractor's control. Therefore, it is
consistent to report the effects of changes to such assumptions as part
of the experience gain and loss. Conversely, CAS 9904.412 requires that
all actuarial assumptions reflect a contractor's long-term
expectations. Because the timing and degree of assumption changes is
generally under the control of the contractor, CAS 9904.412 does not
consider the effects of such changes to be experience gains and losses
from external forces 16.
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\16\ While a contractor can exercise certain freedom in
determining its ``best estimate'' of future trends, other factors,
such as historical trends, plan experience, industry trends, must be
considered.
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SFAS 106 does not address changes in actuarial cost method because
the cost method is mandated. If choice of actuarial cost method is
permitted for cost accounting, the recognition of the effect of an
actuarial cost method change on the liability estimate will have to be
addressed. Also, for consistency, any change in actuarial cost method,
if permitted, probably should be treated as an accounting practice
change as it has been with pensions.
Included in the CAS 9904.412 definition of actuarial cost method is
the asset valuation method. Both SFAS 106 and CAS 9904.413 permit the
use of actuarially determined asset values whereby single period
investment experience volatility is smoothed through an asset valuation
method. Such asset valuation methods typically amortize asset gains and
losses over a five (5) year period. To maintain reasonable values, CAS
9904.413 requires that the actuarial value of assets fall within a
specified corridor related to market value. If asset smoothing
techniques are not permitted, the CAS Board may wish to consider
whether amortization of experience gains and losses over the somewhat
extended 15 year period or average remaining years of service provides
adequately for current asset values, or whether amortization of asset
gains and losses over a shorter time frame; e.g., five years, should be
permitted, or even mandated.
As with experience gains and losses, SFAS 106 requires that
increases in the estimated liability (losses) due to plan amendments
are always amortized. On the other hand, decreases in the estimated
liability (gains) due to plan amendments are offset against any
existing unrecognized prior service liability before being amortized.
Under CAS 9904.412, the effects of plan changes are amortized
regardless of whether the liability increases or decreases. The Board
will have to consider the proper cost accounting for changes in
liability due to plan amendments.
Finally, for situations where the CAS Board determines that
amortization of the effect of a change is appropriate, the Board will
have to consider the appropriate amortization period. CAS 9904.412
permits a contractor to select, based on predetermined criteria, the
amortization period. The amortization period can range from 10 to 30
years and the criteria should consider materiality and the nature of
the change. SFAS 106 specifies that the amortization period be equal to
the employees' average remaining years of service. Factors the CAS
Board may wish to consider are consistency between periods, uniformity
between contractors, and the delay in the recognition of changes in the
estimated liability.
Issue 30: Should the effect of a change in actuarial assumptions be
treated separately from experience gains and losses?
Issue 31: Should the effect of a change in actuarial cost method,
including the asset valuation method, be treated separately from
experience gains and losses?
Issue 32: Should the use of actuarially determined asset values be
permitted for the recognition of some asset gains and losses that would
otherwise be treated as an experience gain or loss?
a. If yes, should the actuarially determined assets value be
related to the market value of the assets? If so, how?
b. What limits and criteria should apply to the actuarial
determination of the asset values; e.g., time period over which these
asset gains and losses are spread?
c. Should the asset valuation method be considered to be part of
the actuarial cost method?
Issue 33: Should the effect of a change in benefits or plan design
be treated separately from experience gains and losses?
Issue 34: Should the amortization period for recognizing changes in
the actuarial liability be specified?
a. If yes, what should the specified amortization period be? Should
the amortization period differ depending on the cause of the change in
actuarial liability; e.g., emerging experience gain or loss, change in
benefit or plan design, change in actuarial assumptions, change in
actuarial cost method?
b. Alternatively, should a contractor be permitted to select the
amortization period?
c. If a contractor may select the amortization period, what
criteria, if any, should be imposed on that selection?
d. If a contractor may select the amortization period, should the
amortization period be fixed once selected? If the period is not fixed,
how does one address changes in the amortization period?
Topic F. Actuarial Assumption Considerations if Accrual Accounting is
Used
The SFAS 106 criteria for selecting actuarial assumptions, some of
which are based on current market conditions, can produce volatility
which is counterproductive to consistency between periods, and
therefore to predictability for forward pricing purposes. To enhance
inter-period consistency, CAS 9904.412 requires that assumptions be
based on long-term expectations. Likewise, under CAS 9904.416,
projected average losses must
[[Page 49544]]
be actuarially determined on a long-term basis. Besides the concerns
for consistency, post-retirement benefit plans probably will have to be
based on long-term, ongoing commitments, in order for estimated
liabilities to be considered valid.
The pension Standards have always required that assumptions be
based on long-term, best-estimate, expectations. The recent amendments
to the pension Standards followed the lead set by SFAS 87 and ERISA by
requiring that each assumption be individually identified and
reasonable. The CAS pension and insurance Standards do not impose any
requirements on the selection of assumptions beyond that of long-term
reasonableness.17 The revised CASB Disclosure Statement, DS-1,
asks contractors to ``describe the events or conditions for which
significant actuarial assumptions are made for determining the cost
accrual.'' The elicited information is not the current numeric values
of the assumptions, but rather the accounting practice(s) used for
determining these numeric values. Conversely, SFAS 87 and SFAS 106 set
forth general guidance on the basis for selecting the discount rate. In
CAS 9904.414, ``Cost of money as an element of the cost of facilities
capital'', the Board requires that a contractor use ``interest rates
specified by the Secretary of the Treasury pursuant to Pub. L. 92-41
(85 Stat 97)''. CAS 9904.415 also requires that the present value of
deferred compensation awards be valued using the Treasury rate.
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\17\ Except where a loss has occurred but payment is deferred.
(See CAS 9904.416-50(a)(3)(ii)).
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There is ample precedent for the Board to consider mandating a
specific interest rate.18 Furthermore, there has been limited
funding of post-retirement benefit plans so that there are often little
or no assets from which to derive meaningful historical rates of
investment return or against which the reasonableness of the assumption
can be gauged. Most of the assets, if any, will be accumulated from
future contributions. There may be a need to set forth the basis for
selecting the interest assumption or even mandate the use of a specific
rate. If such a requirement is deemed desirable, the issue may be
whether the basis for determining the rate or the rate itself should be
prescribed. Possible candidates for a mandated rate could be the
contractor's internal rate of return or the CAS 9904.414-50(b) Treasury
rate. Another possibility is to reference a hypothetical bond portfolio
similar to the SEC's requirement for SFAS 87 disclosures that the rate
be based on a portfolio of bonds rated ``Aa'' or better.19
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\18\ For purposes of this Staff Discussion Paper, terms such as
``interest rate'', ``discount rate'', or ``investment earning rate''
are treated synonymously referring to the interest assumption,
except where the context clearly indicates otherwise. The interest
assumption is the rate used to reflect the time value of money in
present value calculations.
\19\ See SEC letter dated September 22, 1993 to Mr. Timothy S.
Lucas of the FASB.
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Many other assumptions address the same contingencies as pension
assumptions. Often the same employee population is covered by both the
pension and the post-retirement benefit plan. It may be desirable to
require that population assumptions about events and conditions that
are common to both plans be the same, or at least consistent and
reconcilable. Similarly, there are economic and non-population
conditions and events, such as general inflation and plant closings,
that apply equally to both types of plans. Again, there should be
consistency between the assumptions used to measure pension costs and
post-retirement benefit costs.
Certain assumptions are unique to post-retirement benefit
plans.20 This is particularly true of retiree health care
benefits. One of the primary findings of the Coopers and Lybrand field
test of the SFAS 106 exposure draft was the lack of statistically
reliable benefit data. Most census data only identified the employee
and did not include information on spouses, children, and other
dependents. To further complicate matters, benefit payment records
often did not identify whether the recipient was active or retired, the
employee or the dependent, Medicare eligible or not. While the
situation has greatly improved as companies have upgraded their data
systems in response to SFAS 106, the newness of reliable databases
combined with frequent changes in the benefit structure limit the
usefulness of companies historical data for predicting future trends.
However, unlike the interest assumption, the CASB staff is unaware of
any alternative basis for projecting benefit payments.
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\20\ See paragraph 5.5.2 of Actuarial Standard of Practice No.
6, ``Measuring and Allocating Actuarial Present Values of Retiree
Health Care and Death Benefits'', for a partial list of possible
assumptions. As used in this statement, the term ``allocation''
refers to the process of assigning portions of the liability to
accounting periods. Actuarial standards of practice do not address
the allocation of costs to final cost objectives.
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A final consideration is the responsibilities of the actuary and
the contractor. Since the actuary is not a party to the Government
contract, CAS 9904.412 and 9904.413 have always imposed the
responsibility for selection of actuarial assumptions on the
contractor. The actuary is a paid consultant of the contractor. The
contractor defines the scope of work and can thereby exercise
significant control over the actuary's work product. Nevertheless, some
have suggested that the actuary's post-retirement benefit cost and
liability measurements be subject to generally accepted actuarial
principles and practices as promulgated by the Actuarial Standards
Board (ASB), an independent body within the American Academy of
Actuaries. Thus, if a contractor instructs an actuary to value the
post-retirement benefit plan with assumptions that the actuary believes
are unreasonable, the actuary would have a professional obligation
under ASB principles and practices to disclose that fact, although
probably counter to the client's wishes.
A difficulty may arise when a contractor's ``best estimate''
materially differs from his professional actuary's ``best estimate'',
but falls within a range the actuary can accept. Legitimate differences
in expectations concerning the future should not pose a problem. But,
procuring officials and auditors have expressed concern that a
contractor, rather than designating use of its ``best-estimate''
assumptions, has selected assumptions advantageous to maximizing cash
flow or for creating artificially low costs to be used in competitive
negotiations. This concern is greater with retiree health care benefit
liabilities that can be more sensitive to minor changes in assumptions.
The CASB staff notes that SFAS 106 and Actuarial Standard of Practice
Number 6 both require a sensitivity analysis of the assumptions used
for post-retirement benefit costs.
Issue 35: Should actuarial assumptions for on-going post-retirement
benefit plans be based on long-term, ``best-estimate'', expectations as
they are for pensions?
Issue 36: Should a change in the basis used to set actuarial
assumptions be treated as a change in cost accounting practice?
Issue 37: Should the Board require a certification that the
actuary's selection of assumptions, measurement of the liability, and
assignment of cost to periods are in compliance with generally accepted
actuarial practices and principles as promulgated by the Actuarial
Standards Board?
Issue 38: Should the CAS Board require a sensitivity analysis of
the assumptions?
a. If yes, should there be specific pass/fail criteria?
b. If no, what criteria, if any, should be used to evaluate the
validity of an actuarial assumption?
[[Page 49545]]
Topic G. The need, if any, to Substantiate Accruals by Funding
As with pension costs, there is an extended delay between the cost
assignment of and the actual payment of the benefit liabilities. Unlike
pensions, there is a greater degree of uncertainty in the estimation of
the liability and there are fewer opportunities to prefund post-
retirement benefit costs on a tax-advantaged basis.
Once the concern of what is a post-retirement benefit plan for cost
accounting purposes is settled and criteria for accrual accounting are
established, the Board will have to address an even more difficult
topic--the need, if any, for a funding requirement. Post-retirement
benefit plans are more comparable to nonqualified than to qualified
pension plans, and therefore the Board may have to address many of the
issues that arose in the pension case in the case of post-retirement
benefit costs, as well. The Board's decisions in this area will have to
be consistent or reconciled with the decisions regarding nonqualified
pension plans.
(i) The Need To Substantiate
Several contractor representatives have opined that no action on
post-retirement benefits is preferable to a funding requirement and
noted that they had been able to negotiate equitable agreements with
Contracting Officers concerning accounting for post-retirement benefit
costs. But such individual arrangements with contractors defeats the
goal of uniformity. Another concern is the effect of a funding
requirement on competition, since the ability to use tax-advantaged
funding could vary greatly between contractors and because some
contractors who have been funding their post-retirement benefits will
have much lower costs.21 Many in the contracting community believe
that post-retirement benefit liabilities are valid liabilities and
therefore a funding requirement is not needed. They note that there
would be substantial administrative expenses associated with
establishing and maintaining a fund. They do concede it is reasonable
to have an adjustment mechanism so that the Government can recover any
prior period post-retirement benefit costs, which were priced into
contracts, whenever a post-retirement benefit plan is terminated.
---------------------------------------------------------------------------
\21\ The concern with contract cost difference due to cash
accounting versus funded accruals is related to the topic of
permitting multiple accounting methods previously discussed under
Topic B.
---------------------------------------------------------------------------
Many procuring agency representatives firmly believe that funding
is still necessary to protect the Government's interest, especially
given the dollar magnitude of post-retirement benefit plan costs, the
degree of uncertainty, and, as with pensions, the extended delay
between the employment service that creates the liability and the
benefit payment that liquidates the liability. From an accounting point
of view, the need to substantiate long-term liabilities applies to
post-retirement benefits as much as it does to accrued pension costs
under CAS 9904.412 and to prefunded retiree insurance costs under CAS
9904.416. There is also the question of public policy that suggests to
many a careful scrutiny of any funds advanced to contractors through
accrual accounting of post-retirement benefit costs on an unrestricted
basis.
At first blush, it would appear that consistency with the pension
Standards could be achieved using the tax-rate complementary funding
requirement for nonqualified plans, which are most similar to post-
retirement benefits. However, some Government representatives are still
not comfortable with the tax-rate complementary funding concept for
nonqualified pension plans, but have accepted the notion because these
nonqualified plan liabilities are still relatively small compared to
those of qualified pension plans. They might find the tax-rate
complementary funding approach difficult to accept for estimated
liabilities of the magnitude associated with post-retirement benefits.
Some actuaries with clients who are Government contractors observe that
there has been little interest in using complementary funding for
nonqualified pension plans. Many express a belief that complementary
funding adds an element of complexity without utility.
In addressing the funding issue, it may be advisable to avoid any
direct connection to the Internal Revenue Code (IRC). Unlike pensions
where the bulk of the liability is associated with qualified pension
plans whose trusts are tax-exempt and whose contributions are tax-
deductible, the opportunities for tax-advantaged funding of post-
retirement benefit plans is essentially limited to VEBA trusts and IRC
Sec. 401(h) separate accounts. Considering that the tax-advantages of
non-union VEBA trusts were drastically reduced in the early 1980s and
that the tax-advantages of qualified pension plans have been somewhat
reduced, any funding requirement that is tied to the IRC would have to
be flexible enough to handle possible future restrictions as tax policy
changes. In fact, it remains arguable whether tax-consequences should
be a concern in developing an accounting standard.
Although at present there is only limited funding, if any, of post-
retirement benefit plans, any imposition of a funding requirement might
consider the need for a limit on the accrual of post-retirement
benefits similar to the CAS 9904.412 ``assignable cost limitation''.
Such a limitation would prevent over-funding once fully adequate assets
had been accumulated. And, to be consistent with the period assignment
rules for pensions, any assigned cost, and associated interest, that
was voluntarily not funded might be explicitly eliminated from contract
costs in future periods. Likewise, funding in excess of the assigned
cost might be carried forward, with interest, until needed in future
years.
Issue 39: Is funding necessary to substantiate accrual of costs for
the estimated liability for post-retirement benefits? If so, what level
of funding is necessary?
Issue 40: Because assets are an integral part of cost measurement
under most actuarial cost methods, how should the unfunded portion of
the cost accrual be accounted for if funding for all or some portion of
the accrued cost of a period is not required?
Issue 41: Should a Standard addressing Government contract costing
consider the tax consequences of its accounting rules? If so, should
the Board consider tax-rate complementary funding similar to that in
CAS 9904.412?
Issue 42: Should there be an ``assignable cost limitation'' similar
to that found in CAS 9904.412? Should such a limitation be defined
differently for post-retirement benefit costs?
(ii) Funding Vehicles
There are two types of VEBAs: union and non-union. The earnings of
a union VEBA are tax-exempt, but the earnings of a non-union VEBA, like
those of a ``rabbi'' trust, are subject to the unrelated business
income tax (UBIT). For consistency with the amendments to the pension
Standards, the Board may wish to consider treating UBIT taxes on the
earnings of a non-union VEBA trust as an administrative expense of the
fund.
Another issue is which investment vehicles should be recognized as
assets for funding purposes. Contractors and their actuaries report
that use of Trust Owned Life Insurance (TOLI) arrangements and
Corporate Owned Life Insurance (COLI) arrangements is rare for retiree
health care benefits. They indicated that use of ``rabbi'' trusts for
[[Page 49546]]
post-retirement benefits was somewhat rare and only knew of one
contractor who used a secular trust for post-retirement benefits. The
use of IRC Sec. 401(h) accounts and VEBAs in combination are somewhat
common. They did note that accruals for bargaining unit plans can often
be fully funded using a union VEBA. And, the larger the Government
business base, the more likely a contractor is to establish means of
funding post-retirement benefit costs in order to use accrual
accounting for contract pricing.
Any consideration of post-retirement benefit investment vehicles
should address the nature of IRC Sec. 401(h) accounts. ERISA permits a
qualified pension plan to provide retiree health care insurance
benefits through a tax-qualified trust provided that such benefits are
ancillary to the basic retirement benefit and the contributions for
401(h) health benefits are accounted for separately from other pension
benefits. It is noteworthy that ERISA does not impose this separate
accounting requirement for other ancillary benefits such as disability
income and life insurance. Many have suggested that this separate
accounting provision distinguishes post-retirement health care benefits
from benefits that can be considered to be ``an integral part of the
pension plan''. A decision may be desirable as to whether, for
Government contract cost accounting purposes, an IRC Sec. 401(h)
account is an integral part of a pension plan, and thereby subject to
CAS 9904.412 and 9904.413, or is a form of post-retirement benefit plan
asset subject to a Standard dealing with post-retirement benefits.
For both CAS 9904.412 and 9904.416 purposes, the funding
arrangement must be either in the form of a trusteed fund or a reserve
maintained by an insurer. For consistency, any funding provision for
post-retirement benefits probably should require that the assets be
maintained either by a trustee in a fund or an insurer in a reserve
established for the exclusive purpose of providing post-retirement
benefits. Also, given the abuses that have occurred in some qualified
pension trusts and the proprietary nature of insurance company
calculations, it may be desirable to require that the investments have
a definitely determinable fair or market value. Such a rule may not
have to apply to an insurer's statutory reserve associated with a bona-
fide group or individual insurance contract subject to state insurance
laws. The CAS 9904.416 provisions regarding captive insurers should
also apply to a fund or reserve maintained or trusteed by an insurer.
Issue 43: Identify types of trust arrangements; e.g., IRC
Sec. 401(h) accounts, VEBAs, ``rabbi'' trusts, secular trusts, that
should be considered? Is the Government's interest sufficiently
protected by these trust arrangements?
Issue 44: Identify what insurance arrangements; e.g., insurance
reserves, separate investment accounts, COLIs, TOLIs, should be
considered? Is the Government's interest sufficiently protected by
these insurance arrangements?
Issue 45: Should separate accounts established within a qualified
pension trust for IRC Sec. 401(h) health benefits be considered the
assets of a post-retirement benefit plan or the assets of an ancillary
benefit that is an integral part of the pension plan.
Issue 46: Can several types of funding arrangements be combined to
form the assets of a post-retirement benefit plan? If so, is there a
preference or priority order to the various types of funding?
(iii) Alternatives
Given the limited availability of efficient funding vehicles that
would sufficiently protect the Government's interest, the CASB staff
believes that an alternative means of substantiating the cost should be
explored. Although most alternatives will not be as secure as a
trusteed fund, the avoidance of administrative expenses and burdens may
be a compensating factor.
One possibility would be to permit a very limited form of accrual
accounting. This could be achieved by limiting or prohibiting
projections of benefit growth in actuarial calculations. Considering
the comments received by the CAS Board in response to the Staff
Discussion Paper on ``Accounting for Unfunded Pension Costs'', 56 Fed.
Reg. 27780, such an approach should recognize future vesting,
especially since vesting often does not occur until full eligibility
under many post-retirement benefit plans.
The Board may decide to not provide for the recognition of the
initial unfunded liability.22 If so, this may decrease annual
costs sufficiently to mitigate the Government's interest in ensuring
that the accrued costs are funded. This could be especially true if
this treatment is coupled with a somewhat restrictive measure of the
accrued cost.
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\22\ See Subtopic E(i).
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Another alternative may be to require that a contractor obtain a
surety bond to protect the Government's reversionary interests in the
case of a plan termination or segment closing. The CASB staff questions
whether such bonds are or would be available. Furthermore, if a
contractor's financial situation were to deteriorate, the contractor
may not be able to maintain the bond or afford the necessary premium at
the point in time when the Government's reversionary interest is most
at risk.
The alternatives set forth above are examples and are not intended
to set any limits on alternative approaches. The staff encourages
respondents to this Staff Discussion Paper to propose any other
alternatives that they believe should be considered.
Issue 47: Can restrictions be placed on the actuarial cost method
that would obviate the need to substantiate the accrual through a
funding requirement?
a. Would the accrual recognition be sufficiently restricted by the
use of the accrued benefit cost method?
b. Would the accrual recognition be sufficiently restricted if only
current, that is, unprojected, benefit levels are considered?
c. Are there other actuarial cost method restrictions that should
be considered as alternatives to a funding requirement?
Issue 48: If the initial unfunded liability is not recognized,
would the need to substantiate the accrual through a funding
requirement be obviated?
Issue 49: If all changes in actuarial liability are not recognized,
except for experience gains and losses, would the need to substantiate
the accrual through a funding requirement be obviated?
Issue 50: Would the purchase of a surety bond or other third party
guarantee adequately protect the Government's interests in lieu of a
funding requirement? Identify the types of guarantees that may be
available and appropriate.
Issue 51: Are there other alternatives to a funding requirement
that should be considered?
Topic H. Cost Determination for Segments
Once decisions are made on how to measure and assign to periods the
costs of post-retirement benefit plans, the staff believes a review is
needed of how such costs are determined at segments prior to their
ultimate allocation to final cost objectives. GAAP is not concerned
with the intra-period allocation of costs to cost objectives, so any
consideration of how post-retirement benefit costs are allocated to
segments needs to be addressed. Furthermore, the plan population or
experience of a segment may be substantially different from that of the
post-retirement benefit plan as a whole. In such instances there may be
a need to treat that segment separately
[[Page 49547]]
from the rest of the post-retirement benefit plan.
(i) Allocation of Post-Retirement Benefit Costs to Segments
Post-retirement benefit plans may be established and costs
accumulated at the corporate, home office, or segment level. Regardless
of whether post-retirement benefits are viewed as pensions, deferred
compensation, or insurance, if they are incurred at the home office
level those costs would seem to be a central payment or accrual for CAS
9904.403 purposes. Moreover, post-retirement benefit cost calculations
are based on employee census data so that portions of the home office
post-retirement benefit expense often can be readily associated with
the employees of individual segments. The fundamental requirement found
at CAS 9904.403-40(b)(4) and the illustration at 9904.403-60(c), both
of which specifically address pension and insurance costs, seem to
provide the basic guidance regarding how post-retirement benefit costs
could be allocated to segments. It can also be argued, however, that
following the concepts and principles found in CAS 9904.403-40(a)(1),
post-retirement benefit costs should be directly allocated to segments
on a bases that reflects the appropriate beneficial or causal
relationships.
The appropriate base used to allocate post-retirement benefit costs
from the home office to segments may differ from that used for pensions
or insurance. Post-retirement benefit costs often are not salary
related and the allocation base used for pensions or other insurance
may be inappropriate for post-retirement benefits. The CASB staff
believes that special guidance, similar to that used for pensions found
at CAS 9904.413-50(c)(1), may be needed to describe the appropriate
base or bases for allocating post-retirement benefit costs to segments.
Clearly any review of the allocation basis should consider both the
accounting method used to measure and assign costs and the relationship
of the benefits to the covered population. This review would have to
consider how costs for a plan providing both flat benefit health care
insurance and salary-related life insurance should be allocated. Note
that this allocation question is similar to the one raised under Topic
D concerning whether health care and life insurance benefits should be
treated separately.
Issue 52: Does CAS 9904.403 provide adequate guidance on the
allocation of post-retirement benefit costs from home offices to
segments?
Issue 53: In addition to the current guidance in CAS 9904.403, is
there a need for special guidance on the allocation of post-retirement
benefit costs from home offices to segments?
Issue 54: What allocation base(s) are appropriate for post-
retirement benefit costs?
Issue 55: Should the allocation base vary by type of post-
retirement benefit; e.g., health care insurance, prescription drug
programs 23, life insurance, retiree discounts?
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\23\ Prescription drug costs can represent a very significant
portion of the costs of a health care insurance program. It may be
appropriate to treat such coverage separately from other health care
benefits.
---------------------------------------------------------------------------
Issue 56: Does the accounting method; i.e., cash accounting,
terminal funding, or accrual accounting, affect the selection of the
appropriate allocation base?
(ii) Separate Calculation of Segment Post-Retirement Benefit Costs
CAS 9904.413 and 9904.416 both require that segmented accounting
24 may have to be used to isolate to a segment costs attributable
to that segment only. For consistency with the CAS pension Standards,
and more importantly, to follow the CAS 9904.403 concept of directly
allocating costs to the greatest extent practicable, a similar
provision may have to be made for post-retirement benefits. Therefore,
it may be desirable to require that when the demographics, risk factors
25, or experience of a segment are materially different from those
of the post-retirement benefit plan as a whole, post-retirement benefit
costs should be separately calculated, that is, measured, assigned, and
allocated at the segment level. In such cases, a segment's accrual
computations would also need to address the initial allocation of
assets to a segment and the subsequent annual asset valuations.
Certainly, if the population of a segment comprises the entire
population of a post-retirement benefit plan, it would seem to be a
basic requirement that costs be determined at the segment level. If
other than accrual accounting is permitted, such a requirement may have
to be extended so that cash accounting and terminally funded costs are
directly charged to a segment based on the population that retired from
that segment.
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\24\ As used in this Staff Discussion Paper, ``segmented
accounting'' refers to the process of measuring, assigning to
periods, and accumulating all or some elements of the cost at the
segment level rather than at the home office level.
\25\ There may be hazardous work performed at some Government
segments that is not found in other Government and commercial
segments.
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Issue 57: If the post-retirement benefit plan is established at the
home office or corporate level, should post-retirement costs ever be
separately calculated at the segment level?
Issue 58: If the post-retirement benefit plan covers only the
employees of a particular segment, should the costs of the plan
attributable to that segment be calculated, that is, measured,
assigned, and allocated at the segment rather than at the home office
or corporate level?
Issue 59: Should refunds and credits ever be accounted for at the
segment level? If so, please describe the appropriate circumstances.
Issue 60: Should experience gains and losses ever be accounted for
at the segment level? If so, please describe the appropriate
circumstances.
Issue 61: Should segmented accounting be required if plan
population or plan design factors affect one segment more or less than
other segments? If so, please describe the factors that should be
considered; e.g., mortality, morbidity, special benefit supplements,
state insurance law.
Issue 62: Should contractors be permitted to establish special
segments for retired or other inactive plan participants?
Issue 63: If funding is considered to be a prerequisite to accrual
accounting, should the methods described in CAS 9904.413 be used to
initially allocate assets to the segment and thereafter annually
updated?
(iii) Funding of Government Segments Only
Some have suggested that contractors be permitted to fund only the
post-retirement costs of their segments performing work under
Government contracts if the contractor uses segmented accounting. This
would permit contractors with predominately commercial business to
account for and operate their commercial segments as they determine
best for that environment.
Besides the concerns as to what constitutes a plan,26 a
practical problem would be how to design a trust document that would
reserve the assets for the exclusive use of only certain employees of a
plan. Pension and trust law generally view the trust fund as providing
assets for all participants of a plan. The CASB staff questions whether
any trust and plan arrangements could be developed that would permit
segmented accounting and funding, other than establishing and
maintaining a separate plan and trust for the
[[Page 49548]]
segment. Operating separate plans and trusts could be administratively
burdensome.
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\26\ See subtopic B(ii) ``Different accounting methods for
different benefit types''.
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In the preamble to the final rule on pension costing (61 FR 16534),
the CAS Board, in permitting segmented funding of qualified pension
plans, noted that while the assets of a plan are subject to the claims
of all plan participants, the funding requirements and protections of
ERISA would provide similar funding for all segments. However, the
segmented funding option is not available to nonqualified pension plans
because they lack the minimum funding requirements of ERISA. The
funding of post-retirement benefit costs is an act that provides the
plan participants with security and assurance that the deferred benefit
will ultimately be paid. Many post-retirement benefit plans cover
several segments so that all employees are eligible to earn the same
benefit regardless of whether a particular segment performs Government
work. However, the employees of segments performing Government work
would have a greater level of security if only those segments are
funded. Thus, there may be legal or employee relationship constraints
on the establishment and funding of only those segments performing
Government work.
Whether a separate trust is established for a given segment, the
funds in the trust would probably not be directly available to a
contractor if the Government is ever due a credit or other refund.
Therefore, as with pensions, any credit or adjustment would come from
general corporate resources. This use of corporate funds would be
offset by the trust assets which remain available for the funding of
benefits. Thus, the trust cannot directly provide the funds for any
adjustment covering the Government's rights. Nevertheless, it may be
possible for segmented funding of a plan-wide trust to be evidenced by
memorandum records and to use general corporate resources for the
adjustment. Because the plan assets are retained in the trust fund, the
subsequent recovery of these corporate funds would occur through lower
future post-retirement benefit contributions. If the use of such
memorandum records is adequate to protect the Government's interest,
then separate trust arrangements may not be necessary.
Others have pointed to CAS 9904.413-50(c)(9) and have suggested
that contractors be permitted to establish separate retiree segments.
Modeled after the insurance concept of a retired life reserve, a
retiree segment can be a useful device whereby retirees are fully
funded and removed from the active population that is performing work
under Government contracts. Furthermore, if the CAS Board permits
contractors to use different accounting methods for different plan
populations, then permitting separate funding arrangements for those
populations may be desirable. However, the concerns expressed above
about segmented funding would apply to different funding provisions for
different populations within the same plan.
Issue 64: If funding is considered to be a prerequisite for accrual
accounting, is it desirable to fund only those segments performing work
under Government contracts?
Issue 65: Can a trust arrangement be restricted so that only the
benefits of plan participants of segments performing work under
Government contracts are funded?
Issue 66: Alternatively, could an arrangement be developed whereby
segmented funding is evidenced using memorandum records within a trust
established for the post-retirement plan as a whole? Would such
memorandum records be adequate to protect the Government's interests?
Issue 67: If separate funding is permitted, how should the assets
attributable to employees transferring between funded and unfunded
segments be treated?
Topic I. Accounting for Plan Terminations, Liability Settlements, and
Benefit Curtailments
Under paragraph 103 of SFAS 106, changes that a company voluntarily
makes to its post-retirement benefit plan that can be viewed as an
extraordinary event; e.g., plan terminations and benefit curtailments,
should be dealt with separately from normal modifications to the design
of an ongoing plan. Because the estimated liabilities of post-
retirement benefit plans can be dramatically affected by a variety of
factors, the CAS Board may wish to consider if such changes require
special treatment as some type of extraordinary event.
Although court decisions have somewhat limited a company's ability
to eliminate or reduce benefits, contractors can make substantial
changes to the benefits or even terminate a plan. GAAP, as represented
by SFAS 88, SFAS 106, and APB 30, views such major and infrequent
changes to the liability as extraordinary events.27 These events;
e.g., plan terminations and benefit curtailments, may require special
treatment under certain conditions. CAS 9904.413-50(c)(12) and
9904.416-50(a)(1)(vi) require that a credit be allocated in the current
contract period based on the amount that reverts; that is, is refunded,
from the trust fund or reserve. CAS 9904.413-50(c)(12) extends this
requirement to the gain that occurs when a plan is frozen or benefits
are curtailed.
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\27\ The termination of a plan, and possibly a major benefit
curtailment, is a change in the accounting basis for the cost
accrual; that is, the assumption that the plan is an ongoing,
permanent undertaking has been negated. The CAS Board uses the
9904.413-50(c)(12) adjustment mechanism, rather than a reference to
the CAS provision for accounting practice changes, because such an
event is equated to the GAAP concept of an extraordinary event
wherein the effect of the event on prior period costs must be fully
recognized in the current period.
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If benefits are curtailed or dramatically increased, as long as the
contracting relationship continues and costs are computed for the plan,
one possibility is to amortize the gain or loss as would be the case
for other experience gains or losses or plan changes. This approach
would cause the least disruption to the forward-pricing process.
However, such gains and losses can be quite large. In an environment of
a declining or an expanding defense business base, equity may be better
served by either immediate recognition or accelerated amortization. Any
proposed solution to large gains attributable to benefit curtailments
must also address the treatment of large losses due to benefit
improvements. Therefore, a company's post-retirement benefit liability
that is tied to Medicare, will have to be adjusted as Medicare benefits
change .
Because large changes in post-retirement benefit liabilities may
permanently reduce or increase the liability and costs of the post-
retirement benefit plan, it may be preferable to directly adjust
contract costs and prices. Otherwise, if a contractor's fixed-price
contract backlog was sufficiently great, the effect of a change which
is attributable to prior period costs being over- or under-estimated
because benefit changes could not be anticipated, may never be credited
or debited to the Government.
If a plan is terminated or frozen, then no further costs will be
computed for that plan against which an amortization installment can be
credited. As long as the contracting relationship continues, the
amortization installment credits could be reflected in ongoing contract
costs and prices. But, because there would be no further calculation of
costs for that post-retirement benefit plan, a mechanism to effect the
adjustment would have to be developed. If a replacement plan is
established, such a mechanism would prevent duplicate charges from
being made for the same
[[Page 49549]]
liability. Because there has been little funding of post-retirement
benefit plans, the CAS Board is aware that an immediate period
adjustment could result in a claim against the Government for a
substantial unfunded actuarial liability.
A third type of extraordinary event that may require special
treatment is that of a plant closing or major layoff. Post-retirement
benefits do not have the same vesting rights as pensions; i.e.,
benefits are often not vested until the participant is eligible to
retire. From an actuarial perspective, there could be a large
termination of employment gain when there is a plant closing or massive
layoff. However, the CASB staff presumes that such events would usually
coincide with a segment closing. Nevertheless, this presumption may
have to be examined further.
Finally, the CAS Board may wish to consider whether the gain or
loss from a liability settlement should be treated separately from
other asset gains and losses. Any special recognition or acceleration
of amortizations would have to be balanced with the treatment of asset
gains and losses and the treatment of terminal funding. In fact, since
the majority of post-retirement benefit plans are currently unfunded or
funded at minimal levels, these settlements are most analogous to
terminally funding a previously unrecognized cost.
Issue 68: Should there be special accounting treatment for the
effects of the termination of a post-retirement benefit plan? Should
the treatment methodology be dependent on whether assets revert to a
contractor?
Issue 69: Should there be special accounting treatment for the
effects of a post-retirement benefit curtailment?
Issue 70: Should there be special accounting treatment for the
effects of the settlement of post-retirement benefit liabilities?
Issue 71: Are there other non-recurring events that should be
considered for special accounting treatment?
Issue 72: What methodology; e.g., immediate recognition or
accelerated amortization, should be used for the special accounting of
these extraordinary events?
a. Should the special accounting treatment differ depending on
whether or not the contractual relationship with the Government
continues?
b. If the effect of the extraordinary event is treated as an
actuarial gain or loss, should the amortization of the gain or loss be
accelerated?
c. Should the special accounting treatment apply if only one type
of benefit is affected?
Topic J. Adjustments for Segment Closings
In the event a contractor closes a segment, issues regarding how
the Government should recognize such events arise. Further, the
resolution of this issue may influence how a contractor converts its
cost accounting practice for post-retirement benefits from a cash to an
accrual basis. Also associated with the issue of any adjustment for
segment closings is how the initial unfunded liability is treated.
For pension costing purposes the CAS Board has defined what
constitutes a segment closing (see CAS 9904.413). CAS 9904.413 has
historically contained a provision requiring an immediate period
adjustment of prior pension costs when a segment closing occurs. CAS
9904.416 focuses on typical insurance costs where the practice is to
determine costs based on the risk exposure for the upcoming period
only. CAS 9904.416 does not provide specific guidance on the
recognition of surplus assets accumulated through the advanced funding
of retiree insurance when a segment closes.
Any provision concerning treatment of post-retirement benefit costs
when a segment closes will have to consider similar questions to those
addressed in CAS 9904.413. These questions include: what constitutes a
``segment closing''; what is the appropriate adjustment method; and how
should the adjustment amount be measured. Any answers to these
questions should be consistent or reconciled with CAS 9904.413-
50(c)(12).
As previously discussed, there has been little or no funding of the
large liabilities of post-retirement benefits. If the concept, which is
found in the pension Standards, that segment closing adjustments should
cover both over- and under-funded plans is applied in the case of post-
retirement benefits, it could immediately create large claims against
the Government for unfunded post-retirement benefit liabilities
previously not included in costs charged to or priced into contracts.
Since neither contractors nor the Government sought the accrual of
post-retirement benefit liabilities prior to the promulgation of SFAS
106, there is a question as to the appropriate adjustment recognition
for such unfunded post-retirement benefit liabilities when a segment
closes. And, there is the practical question as to whether Federal
agencies would have budget appropriations available to fully cover
contractor claims for these large unfunded liabilities.
Some may argue that to the extent the Government benefited by not
recognizing the accrual of the liability and paid the lower costs that
cash accounting produced, the Government bears some responsibility to
see that funds are available to secure the benefits earned by long-term
government contract employees. Acording to many, in Remington Arms,
supra, the Government was held to a higher level of accountability than
in many other contracting relationships because the Government was the
owner and sole beneficiary of the operations at the GOCO. Furthermore,
the special nature of a GOCO arrangement would have allowed the
Government to influence the decision whether contract costs were
recognized on a cash or accrual basis. In most other cases, where there
has not been a long term special relationship and a contractor has made
an independent financial decision to use cash accounting, many believe
the Government has little, if any, responsibility for the unfunded
post-retirement liability.
If accrual accounting is mandated, a reasonable solution may be a
transition rule that phases in the recognition of these historically
neglected unfunded liabilities. The period of the phase-in should be
developed in coordination with provisions for the recognition of the
initial unfunded liability. Such a phase-in may provide a balance
between the Government's responsibility for increased costs for a
mandatory accounting change and a contractor's practice of not
recognizing these costs on an accrual basis in the past. The need for
special treatment of any unfunded liability derives from the cumulative
nature of post-retirement benefit liabilities and distinguishes them
from most other costs.
If a contractor is permitted a choice of accounting methods and
chooses cash accounting or terminal funding, many would argue that such
an election would preclude the contractor from making any claims that
the Government share in the unfunded actuarial liability when a segment
closes. On the other hand, if accrual accounting is not permitted, the
question then becomes what is the Government's responsibility, if any,
for the lack of accrual recognition. However, it is difficult to
imagine that accrual accounting for a valid liability would not be
permitted. And if the liability was not found to be valid, that fact
would seem to preclude any claim when a segment closes.
Several contractor representatives have asked that the CAS Board
[[Page 49550]]
specifically provide that any adjustment charge for unfunded post-
retirement benefit liabilities may be used as an offset to any CAS
9904.413-50(c)(12) adjustment credit for overfunded pension plans. The
CASB staff believes that this is not necessary. When a segment closes,
any adjustment amount measured for post-retirement benefit plans is to
be reported to the parties for consideration when negotiating the
overall settlement of costs and credits associated with the segment
closing. The parties are expected to negotiate an agreement on the
treatment of any post-retirement benefit segment closing adjustment and
the CAS 9904.413-50(c)(12) pension adjustment that is equitable based
on the facts and circumstances of the particular segment closing.
Finally, if it is decided that an initial unfunded liability is to
be excluded from Government contract cost recognition, then that
portion of the assets and liabilities which existed when accrual
recognition began should be adjusted for interest and excluded from any
segment closing adjustment. A similar, but more complicated, exclusion
would be needed if all past service liabilities are excluded from cost
recognition. The CASB staff notes that such exclusions could limit the
need for an adjustment to simply an accelerated, immediate period
adjustment of outstanding experience gain and loss amortization
installments. In fact, if the effect of the outstanding gain and loss
adjustment does not meet the materiality criteria in CAS 9903.305,
there may not be a need for a segment closing adjustment for post-
retirement benefits.
Issue 73: Should there be a segment closing adjustment for post-
retirement benefit costs? Please explain. Is your answer dependent upon
how the conversion, if any, from cash accounting to accrual accounting
is handled?
Issue 74: Except for GOCOs, what degree of responsibility does the
Government have, if any, for a contractor's past practice of not
accruing the costs for post-retirement benefit?
Issue 75: If the Government does have some degree of
responsibility, how should the Government recognize that
responsibility?
Issue 76: Independent of the Remington Arms decision, what degree
of responsibility, if any, does the Government have, if any, for a
GOCO's past practice of not accruing the costs for post-retirement
benefit?
a. How should the Government's responsibility in the case of a GOCO
be recognized in any phase-in provision for a segment closing
adjustment?
b. Are there any other special contracting relationships that
should be considered for similar treatment?
Issue 77: If accrual accounting is permitted, but not mandated,
would a contractor's election to use cash accounting or terminal
funding preclude the use of accrual accounting to determine the
adjustment for a segment closing?
Issue 78: If accrual accounting is not permitted, does the required
use of cash accounting or terminal funding preclude the use of accrual
accounting to determine the adjustment for a segment closing?
Issue 79: Should there be any explicit coordination between any
segment closing adjustment provision for post-retirement benefit costs
and the CAS 9904.413-50(c)(12) segment provision closing adjustment for
pension costs?
Issue 80: If accrual accounting is permitted, should the treatment
of the initial unfunded liability and other elements of past service
liability be coordinated with any segment closing adjustment provision?
If there is no Government contract cost recognition of the initial
unfunded liability, is a coordinated segment closing provision still
needed?
[FR Doc. 96-24091 Filed 9-19-96; 8:45 am]
BILLING CODE 3110-01-P