# Presentation: 016430

## Department of Energy (DOE) Contractor Postretirement Benefits (PRB) Other than Pension

- Ellen I. Leyba, ME-63.1
- January 29, 2003

## Objective

- Provide an overview of PRB
- Importance of PRB
- PRB Issues
- Conflicting industry standard, federal laws and regulations
- Proposed CAS 419
- Potential Cost Impact: Conversion from DEAR to FAR/CAS Covered Contract

## Post Retirement Benefits Other than Pension

- FAR Definition: all non-cash and other welfare benefits payable during the period of after employees’ retirement including medical, dental, vision, life insurance, tuition assistance, day care, legal services and housing subsidies
- Over 90% of PRB cost: Medical

## Importance of PRB Medical to Employees

- A couple retiring at age 60 needs $200K in savings
- A couple retiring at age 65 needs  $160K in savings
- Source: Fidelity Investment White Paper

## Magnitude of PRB Liability

- Top 100 Fortune Companies
- Average Accumulated Postretirement Benefit Obligation
-               $1,312M

## Importance to Employers and to DOE ...

- Employer sponsored PRB medical:  an effective Human Resource recruitment and retention tool
- Unusual and significant health risk at DOE facilities
- PRB medical regarded as “legacy benefits”

## DOE Contractors PRB Liability

- 1994		$5.3B
- 1995		$5.6B
- 1996		$5.9B
- 1997		$6.0B
- 1998		$6.2B
- 1999		$6.4B
- 2000		$6.7B
- 2001		$7.0B
- 2002		$7.4B

## Past Accounting Practice

- Industry/Commercial contracts:  cash basis or pay-as-you-go (PAYG)
- DOD/Other Government Contracts:  PAYG except for major contractors who funded PRB prior to the Tax Reform Act (TRA) of 1984
- DOE Contracts:  PAYG

## Major Issues Against PRB Accrual/Pre-funding

- Measurement of Cost
- Lack of generally accepted approach to _vesting- no firm liability_
- Lack of adequate tax incentives

## Cost Accounting Practice Change

- FAS 106:  required disclosure of PRB liability on Annual Financial Statement
- Recognition of Transition Obligation
- Immediate Recognition: full cost
- Delayed Recognition: amortized cost

## FAR 31.205-6(o)

**Cash or pay-as-you-go (PAYG)**
**Actual benefits or premium paid **
**Terminal Funding basis**
**Cost is funded when employee retirees**
**Cost is allowable if amortized over 15 years**
**Accrual Accounting**
**Recognition of Transition Obligation: Delayed Recognition Method Only**

## DOE Order 350.1

- Maintained pay-as-you-go accounting for PRB cost
- Department disclosed the DOE contractors accrued PRB cost or accumulated post retirement benefit obligation on its Annual Financial Statement

## FAS 106 and the PRB Issues

- _Measurement of Cost_
- Prescribes actuarial assumptions and cost method
-   Present value technique applied to
- actuarial assumptions and cost method

## FAS 106 and the PRB Issues:

- _Vesting/Firmness of Liability_
- Not addressed
- “Substantive” plan is the basis for cost accrual
- Substantive plan presumes employer will continue to provide postretirement benefits ........

## FAS 106 and the PRB Issues.......

- _Lack of Adequate Tax Incentives__ _
- Not Addressed
-  Financial Issue

## FAR and the PRB Issues

_**Measurement of Cost**_
**Confusing/Conflicting**
**For Funding:**
**Measurement: FAS 106 Assumptions based on substantive language  **
**Assignment: FAS 106 Cost Method: Projected Unit Cost Method**
**Accrual: based on ASB Rules**
**   ****Measurement:  assumptions based on long-term funding **
**    ****Assignment:  Entry Age Normal Cost Method**

## FAR and the PRB Issues

- _Vesting/Firmness of Liability_
- FAR criteria for allowable and reasonable PRB
- Established practice
- Required by law
- Required by the terms of CBA
- Old criteria: did nothing to sufficiently address the issue

##  FAR and the PRB Issues

_**Lack of Adequate Tax Incentives**_
**Required funding**
**regardless of the limitations imposed by the Internal Revenue Code (IRC)**

**Notes:**
FAR 31.205-6(o)

## Ideal Funding Vehicle

**Tax deductible contributions**
**Tax free accumulation of reserve**
**Tax free benefits to employees and retirees**
**Investment flexibility**
**No discrimination rules or compensation limits**
**No separate accounting for key employees**
**No impact on other benefit plans**

## Pre-84: Internal Revenue Code (IRC) Section 501(c) , VEBA Trust

_**Advantage(s)**_
**Favorable tax treatment**
**VEBA Trust Investment Earnings are tax free**
_**Disadvantage(s):**_** **
**Contributions subject to account limitation**
**Future medical inflation not allowed in projecting cost for retirees.**

## Post-84:TRA Treatment of VEBA Trust

- Favorable tax treatment disappeared for VEBA trust that includes non-represented or salaried employees.
- Salaried Employees VEBA Trust’s investment earnings are subject the Unrelated Business Income Tax (UBIT)

## March 89 IRC Tax Relief

**401(h) account: a separate account within a  pension trust for the purpose of funding PRB**
**Contribution is limited to 25% of the maximum allowable pension contribution**
_***Not a feasible option if pension plan is over-funded***_

## Other Funding Vehicles

**Corporate Owned Life Insurance Policy (COLI)**
**Assets are accessible to the company**
**Trust/VEBA Owned Life Insurance Policy (TOLI/VOLI)**
**Contributions subject to  limitations**
**Secular Trust**
**Contributions: subject to limitations**
**Rabbi Trust**
**Assets are accessible to creditors**

## Contractors Major Disagreement with FAR 31.205-6(o)

- Legality of the new PRB cost principle was questioned
- FAR Council went too far: Accounting Principles _not_ within the purview of the FAR Council

## Boeing Case

- Supplemental Executive Retirement Plan (SERP)
- Original CAS: allowed accrual-based recovery of non-qualified pension cost
- Air Force Position/FAR:  cost limited to  amount actually funded or benefits that are compelled or liquidated
- ASBCA Ruling:  FAR Conflicted with CAS and the CAS is controlling

## Similarities: SERP and PRB

**Both are deferred compensation plans**
**Both are non-qualified retirement plans**
**Retirement plans are subject to CAS 412 and 413**
**Old CAS did not require funding of non-qualified retirement plans**
**Contractors proposes to accrue but not fund the PRB cost**

## Government Assessment of Risk

- Billions of Dollars for immediate settlement of PRB Liability for contractors who elected FAS 106 Immediate Recognition of Transition Obligation
- Lack of funding requirement will encourage plan termination
- Windfall profit to contractors

## Government/DOD Push for New PRB Cost Principle

- PRB not a pension plan
- Not subject to CAS 412 and 413
- PRB plan is an insurance plan
- Subject to CAS 416
- CAS 416 requires funding of insurance cost attributed to retirees

## FAR Clause 52.235-39

**Government has the right to an equitable share of any reversionary PRB assets**
**Contractor Counter Argument**
_**If Government has the above right, then Government has responsibility to share in the settlement of any un-funded PRB **_

## Status Quo

- No cost accounting standard for Accounting for PRB cost and
- No existing requirement to settle un-funded PRB liability

## Current DOD Position

- PRB liability may be transferred to a successor contractor; cost is allowable on future contracts
- No lump sum settlement of PRB liability at termination of the contract
- P.L. 85-804 Lump Sum Settlements for GOCO/M&O Contractors

## Current DOE Practice

**Transfer liability to successor contractor**
**Lump sum settlement of PRB liability allowed but requires funding**
**Lump Sum Settlement: CAS Violation**
**DEAR 970.5232-5, **_**Liability with Respect to Cost Accounting Standards**_**, indemnifies contractor from penalties resulting from a CAS violation if such violation is a result of contractor compliance with DOE policy.**

## Proposed CAS 419

**Provides criteria: measurement, assignment, and allocation of cost**
**Defined contribution, defined benefit, insured plans **
**Provides for adjustment of previously determined PRB cost**
**Curtailment of PRB **
**Settlement of PRB obligation**
**Termination of PRB plan**
**Segment Closing**

## Proposed CAS 419 and the PRB Issues

- _Measurement of Cost_
- Adopted FAS 106 Assumptions and Cost Method with the following exceptions:
- Measurement and accrual will based on the _written plan_
- _     _

## Measurement of Cost

- health care trend may not exceed the expected long-term rate of return on plan assets or the prevailing Treasury Rate, Public Law 92-41, 85 stat 97

## Measurement of Cost

- The actual return on the fair value of plan assets shall _be increased_ by an interest equivalent on the accumulated value of  the _***permitted un-funded accruals***_ and _decreased_ by an interest equivalent on the accumulated value of _***pre-payment credits***_ using the prevailing Treasury Rate, Public Law, 92-41, 85 stat 97

## Proposed CAS 419 and the PRB Issues

_**Vesting/Firmness of Liability**_
**CAS Criteria for Accrual of PRB**
**Documented in writing**
**Legally enforceable**
**Communicated to employees**
_**Non-forfeitable once earned**_
**Plans containing a reservation of right to cancel, eliminate, or reduce benefits shall be accounted for PAYG basis**

## Proposed 419 and the PRB Issues

_**Lack of tax incentives**_
**Funding is not required to substantiate cost, **
**Criteria for accrual accounting is vesting/non-forfeitable benefits**
**Funding is an appropriate criterion to ascertain contractor’s commitment**
**Permit contractors to have different PRB plans for different types of employees to enable the use of different combinations of funding vehicles **
**Insurance products/reserves and other arrangements (COLI, VOLI/TOLI, secular, and Rabbi Trust) meeting the CAS definition of funding agency are allowable**

## Permitted un-funded accruals

- The difference between the CAS Assignable PRB cost and the amount actually funded for the year
- Cost is amortized over 10 years and allowable in future accounting periods

## Prepayment Credits

- The excess of the amount actually funded and the Assignable PRB cost for the year
- Cost is amortized over 10 years and assignable in future accounting periods

## Settlement of PRB Liability

_**Adjustment of previously determined cost**_
_***No adjustment or settlement allowed***_** for PRB Plans accounted for on PAYG basis:**
**PRB plans with no vesting provisions**
**FFRDC/State Sponsored PRB Plans**
**Defined Contribution plan under CAS**
**Purchased PRB medical and life insurance**

## Settlement of PRB Liability

_**Adjustment of previously determined cost during curtailment, settlement of PRB obligation, and termination of PRB plan**_
**No lump sum settlement allowed**
**Cost shall be amortized over a period of 10 years**
**Cost is allowable in future contracts, no adjustment allowed on current contracts.**

## Settlement of PRB Liability During Segment Closings:

**Discontinued Operation**
**Discontinued doing or actively seeking Government business**
**Sale of a segment**
**Lump sum settlement: allowed but limited**
**	****difference between the valuation assets and value of the accumulated **_**non-forfeitable**_** benefit obligation**
**No contract adjustment allowed if liability is transferred to a successor contractor**

## Considerations Under DOEFAR/Based CAS Covered Contracts

## Pay-As-You-Go Vs Fas 106 Accrual of PRB Costs

## DOE FAR/CAS Covered Contract

_**Accrual of PRB cost DOE Wide**_
**Estimated Increase: Over 230% **
_**Current Period/Pre-CAS 419**_
**Technical expertise needed to ensure PRB cost is reasonable**
_**Post CAS 419**_
**Three Accounting Records: for financial reporting, for funding, and cost accounting purposes**
**CAS: has the full force and effect the law**
**Technical expertise needed to ensure contractor compliance with CAS**

## Questions/Comments

- ?