Proposed CAS Rule and a Potential FAR Rule May Significantly Impact Allowable Costs for Defined Benefit Pension Plans, Requiring Close Attention to Forward Pricing Rates
On May 10, 2010, the Cost Accounting Standards Board (the “Board”) issued a proposed rule to harmonize Cost Accounting Standards (“CAS”) 412 and 413 with the Pension Protection Act of 2006 (“PPA”). See 75 Fed. Reg. 25982 - 26024 (May 10, 2010). This proposed rule reflects the CAS Board’s continued attempt to achieve the harmonization of the PPA and CAS, as Congress required. The proposed rule would impact contractors by requiring use of accounting practices that will result, in many circumstances, in increased allocable costs for defined benefit pension plans in the near term. At the same time, DOD is apparently considering modifying the FAR to eliminate the allowability of costs resulting from the amortization of actuarial gains and losses. Each of these potential rules create contractor risks regarding forward pricing rates.
The proposed CAS rule (75 Fed Reg. 25982-26024 (May 10, 2010)) addresses many cost accounting requirements relating to the cost of defined benefit pension plans. The two most important concepts are: (1) the recognition of “minimum actuarial liability” consistent with the PPA minimum contribution requirements; and (2) the assignment of actuarial gains and losses over a 10 year period rather than the current 15 year period. A full analysis of these and other proposed requirements, and the many proposed “technical corrections” to CAS 412 and 413 that are not intended to change the meaning or provisions of CAS 412 and 413 as currently published, is beyond what can be accomplished in this alert. See 75 Fed. Reg. 28982.
The significant point is that the harmonization rule is one step closer to becoming final. Thus, contractors need to ensure that their forward pricing rates, dealings with the cognizant administrative contracting officer and financial planning, are consistent with the likely impact of the final rule. There are several relevant considerations which require attention.
First, the proposed rule includes a specific transition method for implementing the harmonization and moderating its cost effects on the government. The proposed rule phases in the changes to CAS 412 and 413 over a 5 year period that approximates what the Board deems as the typical contracting cycle. The phase in requires that any adjustment to the actuarial accrued liability and normal cost based on recognition of the minimum actuarial liability and minimum normal cost be phased in at 20% per year, i.e. 20% of the difference will be recognized in the first year, 40% in the next year, then 60%, 80% and finally 100% beginning in the fifth year. This means that government reimbursements may well continue to lag behind what the PPA requires that the contractor contribute for years to come.
Second, the proposed rule includes an applicability date that, consistent with past Board practice, would depend upon the effective date of the final rule, when the contractor receives a CAS-covered contract after the effective date and the beginning of the contractor’s first accounting period after receipt of a contract subject to the changed CAS 412 and 413. This means that the date when the revised CAS 412 and 413 might become applicable to any contractor is currently unknown. This not only creates uncertainty, but given the slow pace of the Board’s actions, it also means that the 5 year transition might not begin for 2 or more years in the future.
Third, the comments to the proposed rule state that achieving compliance with the changes will represent a “single change in cost accounting practice.” 75 Fed. Reg 260023. Presumably, this means that any change in cost accounting practice needed to achieve compliance will be considered as part of one change that should entitle the contractor to an equitable adjustment under 48 C.F.R § 52.230-2(a)(4)(i). The proposed rule does not take a clear position on this issue, but it does state that: “CAS-covered contracts awarded and priced prior to the effective date, that priced or budgeted costs based on the existing CAS, may be eligible for an equitable adjustment in accordance with FAR 52.230-2. This includes contracts awarded on or after the publication date but before the effective date.” Id. at 26002.
The comments to the proposed rule, however, do state that any changes not directly required by the revised CAS 412 and 413 will be voluntary. Contractors are not entitled to recover increased costs for voluntary changes unless the changes are deemed “desirable.” 48 C.F.R § 52.230-2(a)(4)(ii) and (iii). Thus, audit issues will arise because auditors will attempt to identify any cost accounting change not clearly required by changes to CAS 412 and 413 as voluntary changes.
While the proposed CAS rule will create a number of complex issues relating to future pension costs, the FAR Counsel is considering promulgating a rule that may well disallow much of the cost increases that the proposed CAS rule would recognize. Specifically, the FAR Council is considering amending the FAR cost principles to disallow costs resulting from the amortization of actuarial gains and losses. A draft preamble of the rule questions the extent to which the government should continue bearing the costs of contractor investment and management decisions relating to pension plan assets. These costs, recognized as actuarial gains and losses, arise from the difference between expected asset investment performance and actual earnings performance. The FAR Counsel is concerned that the current rule does not incentivize contractors to make prudent investment and management decisions relating to pension investments. The rule, which is not yet in the proposed rule stage, would disallow costs that are attributed to contractor behavior and practices with respect to pension plan assets, including the contractor’s investment decisions and strategies, excessive fees, mismanagement of plan assets and liabilities and excessive benefits.
Costs of defined benefit pension plans are usually significant costs for a contractor. The proposed CAS rule and the potential FAR rule create significant new challenges for contractor management of such pension costs that must be considered when preparing forward pricing rates in order to avoid unforeseen losses. As a part of this management process, contractors should consider whether advance agreements or re-opener clauses make sense and are achievable. Absent direct protections of this nature, contractors must be ready to negotiate forward pricing pension costs aggressively because the government certainly will do so as the acquisition community realizes that costs of defined benefit pensions will become subject to new rules.
McKenna Long & Aldridge has volunteered to lead the effort to gather and provide comments relating to the proposed rule on behalf of the American Bar Association’s Government Contracts Accounting, Cost and Pricing Committee. Written comments are due to the Board by July 9, 2010. If you have any questions about the proposed rule, would like to participate in the comment process or would like to submit comments through the Committee, please contact us.
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