PENSION COSTS ON 

DOD CONTRACTS

Additional Guidance 

Needed to Ensure 

Costs Are Consistent 

and Reasonable

Report to Congressional Requesters

January 2013

GAO-13-158

United States Government Accountability Office

GAO
United States Government Accountability Office

Highlights of GAO-13-158, a report to 

congressional requesters

January 2013

PENSION COSTS ON DOD CONTRACTS

Additional Guidance Needed to Ensure Costs Are 

Consistent and Reasonable 

Why GAO Did This Study

DOD contractors are among the 

largest sponsors of defined benefit 

pension plans in the United States and 

factor pension costs into the price of 

DOD contracts. Since the 2008 market 

downturn, these pension costs have 

grown—thereby increasing DOD 

contract costs—and recent changes in 

rules for calculating pension costs 

have raised the prospect of further cost 

increases. Given this possibility, GAO 

assessed how (1) contractor pension 

costs are determined; (2) DOD 

ensures the contractor pension costs it 

pays are appropriate; (3) DOD 

contractors’ defined benefit pension 

plans compare with plans sponsored 

by similar companies; (4) pension 

costs have affected DOD contract 

costs and the factors that contributed 

to these pension costs; and (5) the 

harmonization of CAS with ERISA will 

affect the amounts DOD will pay in 

pension costs in coming years. To do 

this, GAO analyzed defined benefit 

pension plans for the largest 

contractors; interviewed contractor and 

DOD officials; and reviewed relevant 

laws and regulations, including 

changes made to harmonize CAS with 

ERISA.

What GAO Recommends

GAO recommends that the Secretary 

of Defense clarify responsibility for and 

guidance on assessing pension 

reasonableness and determining 

discount rates for pension cost 

projections. GAO recommends that the 

CAS Board set a schedule for revising 

the parts of CAS that address the 

settlement of plan curtailments. DOD 

agreed with the recommendations to 

the Secretary of Defense, and OMB

said that when the CAS Board meets it 

will consider a schedule for revision.

What GAO Found

Labor costs are included in the prices contractors negotiate with the Department 

of Defense (DOD), and include pension costs as these are a normal element of 

employee compensation. Contractors make two sets of calculations for their 

defined benefit pension plans, following two sets of standards: (1) Cost 

Accounting Standards (CAS), which determine how pension costs are allocated 

to government contracts; and (2) Employee Retirement Income Security Act of 

1974 (ERISA), which establishes the minimum contribution required to fund 

plans. In 2008, revised ERISA rules altered the minimum funding requirements, 

causing CAS costs and ERISA contributions to diverge further apart. ERISA 

contributions have therefore greatly exceeded CAS pension costs reflected in 

contract prices. In December 2011, almost 4 years after ERISA changes took 

effect, the CAS Board, which is part of the Office of Management and Budget 

(OMB), made changes to CAS that harmonized them to ERISA in order to 

gradually reduce the difference between the two calculation methods.

DOD centralizes its technical expertise for management and oversight of defined 

benefit pension plans. DOD contracting officers at the corporate level negotiate

pension costs with contractors and receive technical support from a team of DOD 

actuaries. DOD audits projected and actual costs for contracts, including pension 

costs, to ensure they are allowable, allocable, and reasonable. The Federal 

Acquisition Regulation requires that employee compensation, including pensions, 

be reasonable. However, the pension costs used for compensation reviews can 

be affected not only by the value of benefits earned by employees, but also by 

factors such as asset returns and interest rates. Also, oversight processes do not 

clearly assign responsibility for assessing the reasonableness of pension 

benefits, including those for executives. 

GAO analyzed the defined benefit plans of the 10 largest DOD contractors and 

found that nearly all of the contractors—as well as a peer group of companies—

maintain some sort of tax-qualified, defined benefit plan for their employees. The 

largest contractors invest in similar types of pension plan assets as their peer 

group, and do so somewhat more conservatively. GAO also found that CAS 

pension costs reported by the contractors grew considerably over the last 

decade, from less than $500 million in 2002 to almost $5 billion in 2011, although 

not all of these costs were allocated to DOD contracts. Contractor CAS pension 

costs grew as the market downturn increased unfunded liabilities. 

Although pension cost projections are highly sensitive to economic assumptions, 

both contractors and DOD officials expect CAS pension costs to increase starting 

in 2014 due to harmonization. The CAS discount rates used to value liabilities will 

now be tied to the more volatile ERISA-based rates, making it harder to forecast 

future CAS pension costs and reducing the consistency of cost projections used 

in contract pricing. DOD issued limited guidance on projecting ERISA-based 

discount rates for CAS calculations, but lack of specificity in the guidance can 

lead to great variation among the rates contractors use. Moreover, when a 

contractor curtails a plan, DOD and the contractor must settle pension costs; 

however, the discount rates used for settlements were not updated as part of 

harmonization, meaning liabilities will be calculated differently under CAS and 

ERISA rules. A schedule has not been set for addressing this issue.

View GAO-13-158. For more information, 

contact Cristina Chaplain at (202) 512-4841 or 

chaplainc@gao.gov; or Charles Jeszeck at 

(202) 512-7215 or jeszeckc@gao.gov.
Page i GAO-13-158 Pension Costs on DOD Contacts

Letter 1 

Background 3

CAS and ERISA Rules Determine Pension Calculations but Have 

Diverged Over Recent Years 7

DOD Leverages Centralized Expertise Necessary to Provide 

Oversight but Lacks Full Picture of Defined Benefit Plan 

Reasonableness 16

The Largest DOD Contractors Maintain Their Defined Benefit Plans 

in Similar Ways to Peer Companies 25

CAS Pension Costs for Large DOD Contractors Have Increased in 

Recent Years Due to the Market Downturn 31

Harmonization Will Likely Increase the Magnitude and Volatility of 

Contractor Pension Costs 38

Conclusions 44

Recommendations for Executive Action 46

Agency and Third-Party Comments 46

Appendix I Objectives, Scope, and Methodology 49

Appendix II Comments from the Department of Defense 54

Appendix III GAO Contacts and Staff Acknowledgments 57

Table

Table 1: Changes Affecting ERISA and CAS Discount Rates for 

Liabilities 13

Figures

Figure 1: Types of Contract Cost 4

Figure 2: Effect of Different Discount Rates on the Current Value of 

a Future Payment 11

Figure 3: Hypothetical Development and Discharge of Prepayment 

Credits 14

Contents 
Page ii GAO-13-158 Pension Costs on DOD Contacts

Figure 4: Interactions and Information Flows between DOD 

Contractors and Providers of Pension Cost Oversight at 

DOD 17

Figure 5: Asset-Weighted Year-End 2011 Pension Investment 

Allocations of Large DOD Contractors and Their Peer 

Group 30

Figure 6: Total CAS Pension Costs for Largest DOD Contractors 

with Defined Benefit Plans 32

Figure 7: Defined Benefit Plan Costs Relative to Direct Labor for 

Selected Weapon Systems Programs 33

Figure 8: Defined Benefit Plan Costs Relative to Total Costs for 

Selected Weapon Systems Programs 34

Figure 9: Sources of Current Unfunded Liabilities for the Largest 

DOD Contractors (as of Beginning of 2011) 36

Figure 10: Breakdown of 2011 CAS Pension Costs for the Largest 

DOD Contractors (as of Beginning of 2011) 37

Figure 11: Effect of Different Discount Rates and Different Asset 

Returns on Plan Costs for an Illustrative Plan 40

Figure 12: Long-Term Cost Projections for an Illustrative Plan 

under Different Discount Rate Scenarios 41

Abbreviations

CAS Cost Accounting Standards

CIPR Contractor Insurance/Pension Review

DCAA Defense Contract Audit Agency

DCMA Defense Contract Management Agency

DOD Department of Defense

ERISA Employee Retirement Income Security Act of 1974

FAR Federal Acquisition Regulation

MAP-21 Moving Ahead for Progress in the 21st Century Act

OMB Office of Management and Budget

PBGC Pension Benefit Guaranty Corporation

PPA Pension Protection Act of 2006

This is a work of the U.S. government and is not subject to copyright protection in the 

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Page 1 GAO-13-158 Pension Costs on DOD Contacts

United States Government Accountability Office

Washington, DC 20548

January 22, 2013

Congressional Requesters

Department of Defense (DOD) contractors are among the largest 

sponsors of defined benefit pension plans in the United States, with more 

than $100 billion in pension assets.1

Given the possibility of increased contractor pension costs for DOD, you 

asked us to review contractor pension costs. As agreed, we assessed 

how (1) contractor pension costs are determined; (2) DOD ensures the 

contractor pension costs it pays are appropriate; (3) DOD contractors’ 

defined benefit pension plans compare with plans sponsored by similar 

companies that are not among the largest DOD contractors; (4) pension 

costs have affected DOD contract costs and the factors that contributed 

to these pension costs; and (5) the December 2011 harmonization of 

Cost Accounting Standards (CAS) with the Employee Retirement Income 

Security Act of 1974 (ERISA)

Contractors factor the cost of 

employee wages and fringe benefits, including defined benefit pension 

costs, into the price of contracts with DOD. These pension costs had 

been relatively low for a number of years, principally because of strong 

returns on pension assets. However, over the last decade, and 

particularly since the financial market decline of 2008 and 2009 reduced 

the value of major assets, these costs have grown—almost 90 percent 

from 2008 to 2011 for the largest contractors—and increased DOD 

contract costs. Concerns have been raised that recent changes in the 

government’s rules for calculating pension costs may lead to further cost 

increases in coming years.

2 will affect the amounts DOD will pay in 

pension costs in coming years.3

 

1

Defined benefit plans typically provide a specific retirement benefit often based on salary 

or years of service. 

2

29 U.S.C. § 1001 note.

3

CAS is a set of rules designed to ensure contractors consistently apply cost accounting 

practices to contracts with the government. ERISA sets certain protections for participants 

in defined benefit pension plans and minimum funding standards for pension plans 

sponsored by private employers.

 
 

Page 2 GAO-13-158 Pension Costs on DOD Contacts

To conduct analysis across all objectives, we analyzed defined benefit 

pension plans for the 10 largest contractors based on DOD contract 

obligations for fiscal year 2011, selecting for deeper analysis the 35 

defined benefit plans that together covered at least 90 percent of each 

contractor’s pension liabilities.4

Further, to understand how DOD oversees pension costs at smaller 

contractors, we reviewed seven publicly traded contractors that met 

criteria we set for DOD contract obligations, level of defined benefit 

pension plan assets, and amount of DOD business relative to non-DOD 

sales. To compare the pension plans of contractors to those sponsored 

by similar companies, we selected a peer group of 15 companies not 

among the largest DOD contractors and analyzed the peers’ and 

contractors’ audited financial statements for 2011. To identify trends in 

CAS pension costs, for the nine largest contractors we reviewed pension 

plan documents such as CAS valuation reports (generally certified by 

qualified and credentialed actuaries) and collected contractor data on 

incurred CAS pension costs from 2002 to 2011. To understand how 

pension costs make their way onto DOD contracts, we selected divisions 

at the five largest contractors and at each division selected a weapon 

system program, which together represent a mix of military services and 

platform types. For the five divisions and programs we collected 

contractor data on incurred pension costs from 2005 to 2011. To 

demonstrate the potential impact on CAS pension costs of CAS/ERISA 

harmonization and changing economic assumptions, we developed a 

model of an illustrative contractor defined benefit plan, based on a review 

of the model DOD uses, and reviewed by the Chief Actuary of the GAO 

for actuarial soundness. We also gathered contractor projections of CAS 

pension costs for 2012 to 2016. See appendix I for additional details on 

our scope and methodology.

At the 10 largest contractors, we 

interviewed officials whose responsibilities included benefits management 

and government accounting, as well as Defense Contract Management 

Agency (DCMA) and Defense Contract Audit Agency (DCAA) officials. 

We reviewed relevant laws, regulations, and DOD policy documents, in 

addition to reports written by the DCMA Contractor Insurance/Pension 

Review (CIPR) Center and DCAA that address contractor pension costs.

 

4

Of the 10 largest DOD contractors, one does not sponsor defined benefit pension plans 

for employees. Throughout this report when we refer to the “largest DOD contractors”, 

unless otherwise specified, we are referring to the nine largest DOD contractors based on 

DOD contract obligations for 2011 that also sponsor defined benefit pension plans.
 

Page 3 GAO-13-158 Pension Costs on DOD Contacts

We conducted this performance audit from December 2011 to January 

2013 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives.

DOD frequently purchases products that are not available in the 

commercial marketplace. For example, DOD awards contracts for the 

development or production of weapon systems including fighter aircraft, 

submarines, and radars. In these situations, DOD typically negotiates the 

price it will pay based on the cost to deliver the desired product. In 

negotiating prices, DOD seeks insight into contractors’ costs such as for 

salaries, wages, and benefits, the last of which includes pensions. When 

a purchase occurs in the commercial marketplace, the price for a 

commercial product will include the sellers’ costs for materials and labor 

(including salaries, wages, and benefits) but the buyer has little insight 

into these costs.

Contractors’ labor costs include pension benefits, since such benefits are 

a normal part of compensation. These pension costs are an indirect cost 

spread across multiple contracts at a particular contractor business 

division, as opposed to direct costs such as those labor and material 

costs that can be associated with a specific contract (see figure 1). They 

are typically allocated to contracts based on direct labor costs. Pension 

costs are generally considered a fringe benefit, a category that includes 

costs associated with health benefits, group insurance, and other forms of 

nonwage compensation. In previous work, we found that of the three 

main types of employee benefits (health insurance, paid leave, and 

retirement benefits), health insurance is generally the most expensive, 

and retirement benefits the least.5

 

5

See GAO, Employee Compensation: Employer Spending on Benefits Has Grown Faster 

Than Wages, Due Largely to Rising Costs for Health Insurance and Retirement Benefits, 

GAO-06-285 (Washington, D.C.: Feb. 24, 2006).

Background 

Pension Costs Are 

Captured on DOD 

Contracts as Indirect Costs
 

Page 4 GAO-13-158 Pension Costs on DOD Contacts

Figure 1: Types of Contract Cost

Oversight of DOD contracts is primarily provided by two agencies:

1. Defense Contract Management Agency (DCMA), which includes 

contracting officers who, as part of their duties, negotiate and agree 

upon indirect costs applied to contracts awarded by DOD acquisition 

commands and other buying offices.

2. Defense Contract Audit Agency (DCAA), which audits projected and 

actual costs associated with DOD contracts to ensure they are 

allowable, allocable, and reasonable in accordance with CAS and 

Federal Acquisition Regulation (FAR) rules.

These indirect cost oversight processes are not limited to DOD, but apply 

to U.S. government contracts more broadly. DCMA and DCAA provide 

assistance related to indirect cost oversight for non-DOD agencies, such 

as the National Aeronautics and Space Administration (NASA) and the 

Department of Homeland Security. When DCMA, as the cognizant 

contract administration office, reaches an agreement on indirect costs, 

the agreement is applicable to all U.S. government contracts performed 

by that business unit.
 

Page 5 GAO-13-158 Pension Costs on DOD Contacts

DOD contractors, like other private sector companies, may sponsor 

traditional defined benefit plans, or defined contribution plans (such as 

401(k) plans) which provide individual accounts for employees and allow 

for employer and employee contributions.6 They may sponsor multiple

defined benefit plans, which typically cover different business lines or 

employee populations, such as salaried or hourly employees. Many 

defined benefit and defined contribution plans sponsored by DOD 

contractors are “tax-qualified” under the Internal Revenue Code.7 Tax 

qualification means the plans meet certain rules in the Internal Revenue 

Code, and have certain tax advantages. Minimum funding rules—that is, 

the amount required to be held in the trust fund to finance future benefit 

payments—are contained in the Internal Revenue Code and mirrored in 

ERISA, and apply to private sector “tax-qualified” defined benefit plans.8

Note that sponsor contributions to these plans are not the benefit 

payments themselves, but contributions that go into a trust fund, grow 

with investment returns, and eventually are paid out as benefits at a later 

date. These contributions are tax-deductible to the sponsoring company, 

investment returns on the trust fund is tax-deferred, and plan participants 

pay tax only as they receive benefits in retirement.9

DOD contractors also sponsor “nonqualified plans.”10

 

6

Defined benefit formulas vary widely, but in 2005 GAO found that a typical defined 

benefit plan gave participants 1.5 percent of their final average pay, multiplied by years of 

service, as a lifetime benefit. See GAO, Private Pensions: Information on Cash Balance 

Pension Plans, 

These plans do not 

meet the applicable requirements for tax-qualification under the Internal 

Revenue Code. Sponsors of these plans typically do not have to satisfy 

laws and regulations capping maximum benefits or requiring a minimum 

level of contributions to the plan. They also do not have to meet certain 

reporting, disclosure, bookkeeping, and core fiduciary requirements. 

GAO-06-42 (Washington, D.C.: Nov. 3, 2005). Note that this finding could 

change if a similar survey were undertaken today, because of plan freezes and benefit 

formula reductions in recent years. Note further that a plan participant’s actual benefit 

would often be lower than what this base formula would produce, because of such factors 

as partial offsets for Social Security benefits and reduction for early retirement.

7

26 U.S.C. § 401-436.

8

26 U.S.C. § 430 and 29 U.S.C. § 1082, respectively.

9

Participants do not have to pay income tax on the employer’s contribution to the plan on 

their behalf or on the earnings to those contributions until benefits are received. 26 U.S.C. 

§ 404(a)(1) & (2).

1026 U.S.C. § 409 A.

DOD Contractors Sponsor 

Different Types of 

Retirement Plans
 

Page 6 GAO-13-158 Pension Costs on DOD Contacts

Nonqualified plans are typically designed for highly compensated 

employees or selected company executives. Nonqualified plans may be 

operated on a pay-as-you-go basis or may be prefunded. Nonqualified 

plans do not have a minimum ERISA contribution, and, for pay-as-you-go 

plans, the CAS pension cost will be the cost of the benefit payments to 

the participants.

Defined contribution plans shift investment risk away from the employer 

and onto employees, meaning that these plans have much more 

predictable yearly costs for the employer. While defined contribution plans 

often have employer matches which generally require annual 

contributions, we reported that from 1995 to 2002, very few sponsors of 

large defined benefit plans were required to make cash contributions to 

their plans.11 In terms of sponsor contributions, neither type of plan—

defined benefit or defined contribution—is inherently more or less 

expensive to a plan sponsor, nor more or less generous to plan 

participants, than the other. Expense and generosity depend on the 

particular provisions of the plan, among other factors. Costs associated 

with defined contribution plans are typically more straightforward for 

sponsors to calculate and project than defined benefit plan costs. Defined 

benefit plans require actuarial support and management of sponsor 

contributions and invested assets in order to fund liabilities. These 

considerations do not apply to sponsors of defined contribution plans.

 

11GAO, Private Pensions. Recent Experiences of Large Defined Benefit Plans Illustrate 

Weakness in Funding Rules, GAO-05-294 (Washington, D.C.: May 31, 2005). 
 

Page 7 GAO-13-158 Pension Costs on DOD Contacts

DOD contractors make two sets of calculations for each of their defined 

benefit pension plans, following two sets of standards. They calculate a 

CAS pension cost, which is the cost that serves as a basis for calculating 

what pension costs can be charged to contracts. This cost is allocated to 

contracts based on CAS rules. Like all plan sponsors, they also calculate 

the contribution they are required to make, or otherwise face penalties, 

under ERISA. Because the rules are different, the CAS pension cost is 

likely to be different from the required ERISA contribution.

A contractor’s total pension cost may also include costs that are not 

allocated to DOD or other U.S. government contracts, but instead 

allocated to commercial activities. Several large DOD contractors have 

significant commercial operations. For example, less than 20 percent of 

United Technologies Corporation’s sales are to the U.S. government, and 

approximately half of Boeing’s sales come from its commercial aircraft 

business.

The FAR requires that costs be allowable, allocable, and reasonable. 

When contract costs are established through negotiation, the CAS 

provides the framework contractors use to determine allocable costs. In 

particular, pension costs for DOD contracts are measured, assigned, and 

allocated to contracts according to rules in CAS 412 and 413. CAS rules 

are set by the CAS Board, part of the Office of Federal Procurement 

Policy within the Office of Management and Budget (OMB), which 

includes members from government and industry. CAS is designed to 

ensure uniformity across contractors in how they allocate costs on 

government contracts, linking the costs incurred on contracts to the 

benefits the government receives as a result of those costs.12

 

12CAS rules for determining federal contract costs and ERISA rules for determining 

pension contributions are distinct from generally accepted accounting principles (GAAP) 

and related standards that apply to public financial reporting by pension plans and their 

sponsors. 

CAS also 

CAS and ERISA Rules 

Determine Pension 

Calculations but Have 

Diverged Over Recent 

Years 

CAS Rules Define How 

Much Pension Cost Can Be 

Allocated to Contracts 

While ERISA Rules 

Determine Required 

Pension Contributions

Cost Accounting Standards for 

Pensions
 

Page 8 GAO-13-158 Pension Costs on DOD Contacts

provides a framework for assigning costs to discrete cost periods and 

aims to minimize the volatility of pension costs in the pricing of 

government contracts.

In addition to using CAS rules to measure pension costs incurred in a 

given year, contractors also use CAS rules to determine expected future 

pension costs, called “forward pricing projections.” Contractors use these 

projections when they negotiate contracts covering multiple years. These 

contracts may be firm fixed priced—with no adjustment to reflect actual 

costs under normal circumstances—or flexibly priced. Flexibly priced 

contracts provide for price adjustment.13

CAS 412 provides guidance to contractors and the government on how to 

determine and measure the components of pension cost for defined 

benefit plans in a given year. For most defined benefit plans, the 

components include:

When a regulatory change 

occurs—such as a change in the CAS—both fixed and flexibly priced 

contracts may be eligible for adjustments (also known as equitable price 

adjustments) to reflect the impact of the change.

1. Normal cost: pension cost attributable to the employee’s work in the 

given year.

2. Other pension costs: the costs that include payment for part of any 

shortfall in assets required to pay for pension costs that are 

attributable to past service (the shortfall is known as the unfunded 

liability).

Both of these components reflect actuarial present values, today, of 

benefits projected to be paid in the future, and not the actual benefits 

being paid today to plan participants.

Sources of any shortfall may include: differences between actuarial 

assumptions and actual experience such as worse-than-expected asset 

performance in a given year (the difference is known as an actuarial loss); 

changes in actuarial assumptions that increase liabilities such as 

projections of inflation, mortality, and retirement age; and changes in the 

rules used for benefit computation or other plan amendments that 

 

13Such contracts include fixed price incentive contracts, cost plus incentive fee contracts, 

and cost plus fixed fee contracts. 
 

Page 9 GAO-13-158 Pension Costs on DOD Contacts

increase liabilities. Plans with unfunded liabilities make installment 

payments to reduce these unfunded liabilities over a period of time that 

depends on the sources of the unfunded liabilities.

If a plan has more assets than liabilities in a given year, then the normal 

cost is offset by extra plan assets, and so overall CAS cost to the 

government is reduced by the excess assets, and can even be reduced to 

zero. Plans might have more assets than liabilities if, for example, assets 

perform more strongly than expected (the difference is known as an 

actuarial gain) or if changes in actuarial assumptions reduce liabilities, or 

if the plan sponsor reduces liabilities through plan amendments. Both 

actuarial gains and losses are incorporated into CAS pension cost in 

installments over a number of years.

Supported by in-house or external actuaries, DOD contractors calculate 

their CAS pension costs at least annually, and produce CAS valuation 

reports for plans.14

While forward pricing projects future costs for use in contract pricing, 

contractors also develop annual proposals for incurred costs including 

CAS pension costs. These are actual costs incurred by the contractor, 

which may differ from the projected costs used in the forward pricing 

process. These proposals are submitted to DOD and used as the basis 

The calculations provide the basis for projections of 

future CAS pension costs for use in forward pricing. These costs are then 

allocated to the various divisions of the contractor. Contractors use a 

range of methods such as payroll dollars or number of active participants 

to allocate CAS pension costs across divisions for application to 

contracts. Allocation methods are explained in required CAS disclosure 

statements, prepared at the corporate and division levels by contractors, 

and provided to DOD for review. At the division level, the combined cost 

of pension benefits with other employee benefit costs including health 

benefits and group insurance, is frequently referred to as the fringe 

benefit cost. The fringe benefit cost is projected over one or more future 

years based on factors such as estimated labor costs and the expected 

amount of future business. Projected fringe benefit costs are then 

submitted to DCMA officials at the division level for review.

 

14CAS valuation reports reflect an actuarial valuation, as of the start of the plan year, of a 

contractor pension plan. They contain details of the plan’s CAS pension cost, assets and 

liabilities, as well as the plan’s actuarial assumptions. They are typically produced by 

actuaries, whether in-house or external.

Allocation of CAS Pension 

Costs to Contracts
 

Page 10 GAO-13-158 Pension Costs on DOD Contacts

for negotiating settlement of any cost differences when closing out flexibly 

priced contracts.

Congress enacted ERISA in 1974 to set certain protections for plan 

participants and minimum funding standards for pension plans sponsored 

by private employers.15 ERISA is designed to protect the interests of 

participants (and their beneficiaries).16 The administration of ERISA is 

divided among the Department of Labor, the Internal Revenue Service of 

the Department of the Treasury, and the Pension Benefit Guaranty 

Corporation (PBGC). According to PBGC, if sponsors are no longer able 

to fund or administer their plans, PBGC makes sure participants will get 

some or all of their promised benefits.17

The discount rate is a key part of determining both CAS pension costs 

and ERISA-required contributions.18 Pensions are promises to make a 

future stream of payments, and the discount rate determines the estimate 

of the present value of promises to pay a future benefit. As shown in 

figure 2, the higher the discount rate, the lower the liability today.

 

1529 U.S.C. § 1001 note.

1629 U.S.C. § 1001, 1001a and 1001b.

1729 U.S.C. § 1301-1461.

18DOD actuaries also refer to the discount rate as the valuation rate.

ERISA Rules for Pensions

Setting the Discount Rate 

Is a Key Decision in 

Calculation of Pension 

Contributions and Costs
 

Page 11 GAO-13-158 Pension Costs on DOD Contacts

Figure 2: Effect of Different Discount Rates on the Current Value of a Future 

Payment

Basic approaches to setting a plan’s discount rate include: (1) basing the 

discount rate on the expected long-term return on plan assets (which 

includes expected long-term stock market returns to the extent plan 

assets are so invested, and which, in recent years, often would produce 

discount rates between 7.0 and 8.0 percent), or (2) basing the discount 

rate on relevant interest rates in the bond market (which, in turn, could be 

based on either current market interest rates, or an historical average 

over some period, and which, in recent years, often would produce 

discount rates around 4.0 percent).19

The Pension Protection Act of 2006 (PPA), effective 2008, changed 

ERISA, strengthening the minimum funding requirements for defined 

The first approach will more often 

produce a higher discount rate than the latter approach.

 

19Use of the latter approach with short or no smoothing would have typically produced 

discount rates of around 4.0 percent in recent years.
 

Page 12 GAO-13-158 Pension Costs on DOD Contacts

benefit plans (although its provisions were altered by subsequent 

legislation).20 These changes required sponsors to use a measure of 

corporate bond interest rates to calculate their defined benefit plan 

liabilities instead of a discount rate based on the expected long-term rate 

of return on plan assets, which generally increased contributions.21 In 

contrast, CAS rules continued to use the expected long-term rate of 

return assumption as the discount rate, which would typically be higher 

than corporate bond interest rates. PPA mandated certain changes to 

CAS pension rules while delaying implementation of the new ERISA 

funding rules for several large DOD contractors until 2011.22

The recent changes in the ERISA discount rate basis meant major 

differences in the methodology for CAS cost and ERISA contribution 

calculations, but CAS and ERISA rules were not fully aligned even before 

these changes. CAS pension cost rules were once similar to the rules for 

determining minimum ERISA contributions. However, as Congress 

amended ERISA over the years, the CAS Board did not make changes as 

frequently. For example, prior to PPA taking effect in 2008, ERISA rules 

imposed additional funding charges for underfunded plans, which were 

not accounted for by the CAS rules. Table 1 summarizes recent changes 

to discount rates used for CAS and ERISA calculations, including the 

most recent changes enacted in the 2012 Moving Ahead for Progress in 

the 21st Century Act (MAP-21).

 

20Pub. L. No. 109-280. 

21PPA requires plan sponsors to discount expected benefit payments based on a 

corporate bond interest rate yield curve. This means that liabilities are discounted at 

different rates, depending on when a plan expects to make a given benefit payment.

22Until that time those contractors calculated liabilities under ERISA using a long-term rate 

of return assumption regardless of when benefit payments would be due. Companies 

required to delay implementation of the new funding rules were those whose primary 

source of revenue was derived from contracts with the U.S. government and whose 

revenue from such business in the previous fiscal year exceeded $5 billion. Several 

companies we reviewed delayed implementation under this provision (Section 106 of 

PPA) including BAE Systems, L-3 Communications, Lockheed Martin, Northrop 

Grumman, Raytheon, and General Dynamics.

Growing Divergence 

between CAS Costs and 

ERISA Contributions Has 

Generated Over $26 Billion 

in CAS Prepayment Credits
 

Page 13 GAO-13-158 Pension Costs on DOD Contacts

Table 1: Changes Affecting ERISA and CAS Discount Rates for Liabilities

Before 2008 After 2008 After February 2012 After July 2012

ERISA Equal to assumed long-term 

rate of return on plan 

assets.

Tied to recent corporate bond 

interest rates, per PPA; plans 

use rates that vary depending 

on when the actuary 

estimates the benefit 

payments will be made.

a

No change. Bounded recent bond interest 

rates by a longer-term 

historical average, expected to 

temporarily increase discount 

rates to provide funding relief 

to plan sponsors, per MAP-21.

CAS Equal to assumed long-term 

rate of return on plan 

assets.

No change. ERISA-based measures 

phase in gradually from 2014 

until 2017; new rates will only 

be used to extent they 

produce higher measures 

than under traditional CAS 

measures.

Change as ERISA discount 

rates change.

Source: GAO analysis of ERISA and CAS.

a

For a qualified pension cost to be recognized under CAS, a contractor 

must make a contribution in a given year to a plan’s trust fund. However, 

the past divergence of CAS and ERISA approaches is a driver of 

contractors contributing more to their pension plans than has been 

recognized under CAS and reflected in contract prices. This has 

generated CAS prepayment credits. In the future, the contractor can 

apply its CAS prepayment credits in lieu of a cash contribution to the plan 

in a given year. The largest DOD contractors had at least $26.5 billion in 

CAS prepayment credits as of the beginning of 2011. Figure 3 provides a 

hypothetical example of how a prepayment credit is generated and 

discharged.

Also contained an alternate calculation, tied since 2004 to recent corporate bond interest rates, that 

imposed an additional funding charge for underfunded plans.
 

Page 14 GAO-13-158 Pension Costs on DOD Contacts

Figure 3: Hypothetical Development and Discharge of Prepayment Credits

a

Prepayment credits affect how contractors calculate their unfunded 

liabilities. When comparing assets to liabilities, prepayment credits are 

subtracted from CAS assets. This creates a higher unfunded liability and 

thus a higher CAS cost.

The CAS prepayment credit would grow with the assumed rate of return on plan assets until 2013, 

after which time, it would grow with the actual rate of return on plan assets.

PPA required the CAS Board to harmonize CAS to ERISA by January 1, 

2010.23 The changes made by the CAS Board became effective in 

February 2012. However, the CAS Board did not make CAS rules exactly 

match ERISA, stating that this was not congressional intent, and 

recognizing that the two different systems have different goals. The CAS 

Board’s final rule phased in the liability calculated with the ERISA-based 

discount rate—from 25 percent in 2014 to 100 percent in 2017.24

 

23Pub. L. No. 109-280 § 106(d).

This 

means that closer alignment between CAS pension costs and ERISA 

24For example, in 2014 the liability would be a weighted average equal to 25 percent of 

the liability calculated under the current ERISA rules and 75 percent of the liability 

calculated under the traditional (pre-harmonization) CAS rules. Alternatively, if corporate 

bond interest rates rise high enough (the exact amount would vary by plan), there could 

be no additional harmonization-related cost because, per CAS rules, the ERISA-based 

discount rate calculation would not be applicable.

Harmonization of CAS to 

ERISA Aims to Gradually 

Reduce Differences 

between the Two 

Methodologies 
 

Page 15 GAO-13-158 Pension Costs on DOD Contacts

contributions will take several years. In addition to changes to the 

discount rate, the CAS Board also reduced the schedule of time to pay for 

actuarial losses (or get credit for actuarial gains) from 15 to 10 years, 

starting in 2013. This change aligns the CAS amortization schedule more 

closely with the 7-year amortization schedule mandated in the PPA. The 

CAS Board also designed harmonization so that if the cost calculation is 

lower under the new rules than the traditional rules, then the traditional 

rules would continue to apply.

The most recent change to ERISA minimum contribution requirements 

can also affect CAS pension cost. Congress effectively increased, on a 

temporary basis, the ERISA-mandated discount rate by applying a new 

methodology for calculating it via the MAP-21 legislation. Because the 

CAS harmonization rules say the ERISA discount rate is an automatically 

acceptable (“safe harbor”) rate, contractors that use the ERISA discount 

rate will see a matching change in their CAS discount rate.

CAS rules (CAS 413) specify that the contractor and the government 

must “settle up” under certain circumstances. For example, a settlement 

would be triggered if a contractor curtails a plan, meaning that no new 

benefits can accrue for participants.25 This means that DOD and the 

contractors calculate whether the government has over- or underpaid for 

CAS pension costs over the years, with the balance being settled via 

payment by the government or the contractor. These CAS settlement 

rules use the traditional long-term rate of return discount rate, instead of 

the ERISA-based corporate bond interest rates. This means that the CAS 

liability for settling up would be similar to the old CAS liability and would 

not reflect changes from the harmonization rule.

 

25CAS rules would also trigger a settlement for a business segment closure or a pension 

plan termination. For a pension plan termination, the liability is simply the amount needed 

to settle all benefit obligations. In the case of a curtailment, a company would retain the 

liability and assets.
 

Page 16 GAO-13-158 Pension Costs on DOD Contacts

Like contractors, DOD centralizes its technical expertise for management 

and oversight of defined benefit pension plans. DOD negotiates CAS 

pension costs with contractors at the corporate level. Figure 4 illustrates 

the range of interactions and information flows between large DOD 

contractors and those parts of DOD involved in pension cost oversight.

DOD Leverages 

Centralized Expertise 

Necessary to Provide 

Oversight but Lacks 

Full Picture of 

Defined Benefit Plan 

Reasonableness 

DOD Relies on Centralized 

Expertise for Management 

and Oversight of Defined 

Benefit Pensions
 

Page 17 GAO-13-158 Pension Costs on DOD Contacts

Figure 4: Interactions and Information Flows between DOD Contractors and Providers of Pension Cost Oversight at DOD

DOD oversight of CAS pension costs parallels the central management of 

these costs by the largest DOD contractors at the corporate level. The 

corporate-level DCMA contracting officer receives contractor submissions 

such as pension forward pricing and incurred pension cost proposals. The 

corporate-level contracting officer negotiates CAS pension costs and 

either comes to agreement with the contractor or recommends an amount 
 

Page 18 GAO-13-158 Pension Costs on DOD Contacts

of CAS pension cost that DCMA contracting officers at the division level 

can use in negotiations.

To monitor possible cost changes during contract performance, DCMA 

requires establishment of cost monitoring programs at contractor 

locations that meet certain government contracting cost and sales criteria. 

As contractors bill the government after contracts are awarded, DCMA 

cost monitors at the corporate level compare proposed costs with actual 

costs incurred. If actual costs diverge from the proposed costs, the cost 

monitor may recommend that an agreement be modified or even 

cancelled. This can affect the cost of fixed-price contracts awarded in the 

future and existing flexibly priced contracts.

The corporate-level contracting officer has two primary sources of 

technical expertise available to assist in determining that the contractor’s 

CAS pension costs meet CAS and FAR requirements that they be 

allowable, allocable, reasonable, and compliant: the DCMA CIPR Center 

and auditors from DCAA. The corporate-level contracting officer can use 

information from these two sources in negotiations with the contractor that 

result in either pension forward pricing agreements or recommendations.

The CIPR Center represents a key element in DOD’s oversight process, 

giving recognition to the complexity and highly technical nature of defined 

benefit pension plans. As DOD’s centralized source of actuarial expertise, 

it advises DCMA contracting officers on pensions as well as insurance, 

including review of forward pricing proposals. The CIPR Center assesses 

the reasonableness of actuarial assumptions, including the discount rates 

used to calculate liabilities. It also provides an independent measurement 

for projected pension costs. To test a contractor’s estimate of pension 

costs for future years, the CIPR Center has developed a model that 

generates an independent projection of the contractor’s CAS pension 

costs, which according to a CIPR Center official, is based on data and 

actuarial assumptions in CAS valuation reports. The CIPR Center 

compares the model’s output with the contractor’s proposal to evaluate 

whether the contractor’s projections are reasonable, and then issues a 

report that includes the CIPR Center’s methodology, calculations, and 

evaluation of reasonableness. For example, the CIPR Center has issued 

a recent report noting that a contractor’s assumed rates of return used to 

project CAS pension costs were unreasonable.

The CIPR Center is more likely to review proposed CAS pension costs 

annually for large contractors than for smaller contractors that also have 

significant defined benefit plans. From 2007 to 2011, the CIPR Center 
 

Page 19 GAO-13-158 Pension Costs on DOD Contacts

reviewed proposed pension costs for six of the nine largest contractors 

with defined benefit plans at least annually. Two other large contractors 

were reviewed in 4 of the 5 years from 2007 to 2011. The ninth large 

contractor, with relatively low CAS pension costs, had not been reviewed 

within the last 5 years. Four of the seven smaller contractors included in 

our review received CIPR Center reviews of proposed pension costs at 

least once between 2007 and 2011. Corporate-level contracting officers 

have the discretion to determine if the potential risk associated with CAS 

pension costs merits specialized review by the CIPR Center. One 

contracting officer at a smaller contractor noted that over recent years he 

had requested and received regular CIPR Center reviews of the 

contractor’s projected pension costs. Another contracting officer at a 

contractor whose pension plans have not received a recent CIPR Center 

review noted that he relied primarily on DCAA audits for insight into CAS 

pension cost issues, unless there had been significant pension plan 

changes such as a curtailment of benefits.

DCAA auditors at the contractor’s corporate office are responsible for 

reviewing other aspects of proposed pension forward pricing, such as 

previous CAS pension cost estimates to assess how close they were to 

actual CAS pension costs for those periods. DCAA employs technical 

specialists who provide auditors with additional support on pension 

issues. DCAA audits may question costs that they identify as not 

allowable, allocable or reasonable, which the contracting officer may 

incorporate into negotiations with the contractor. For example, DCAA 

audits have questioned costs in forward pricing proposals because 

estimated CAS pension costs were higher than the contractor’s historical 

cost trends or the calculation methods were not compliant with CAS.

Corporate-level contracting officers rely primarily on DCAA, and to a 

lesser extent the CIPR Center, to review contractors’ annual proposals 

representing actual corporate-managed costs incurred in the previous 

year, including CAS pension costs. DCAA audits incurred CAS pension 

costs reported by the contractor to determine whether they are allowable, 

allocable, and reasonable, as well as compliant with CAS. According to a 

CIPR Center official, contracting officers may also request additional 

support from the CIPR Center to ensure information in the incurred cost 

proposal reflects what is in the corresponding CAS valuation reports. 

They usually respond to these requests for support in a less formal 

manner than is the case with proposed forward-pricing requests, 

generally not issuing detailed reports. As with the forward-pricing process, 

the contracting officer may use the information from DCAA audits and 

CIPR Center reviews, including any questioned costs, when negotiating 
 

Page 20 GAO-13-158 Pension Costs on DOD Contacts

final indirect costs with the contractor. Once established, these costs are 

allocated to the divisions to form the basis of adjustments to flexibly 

priced contracts that can then be closed out.

Paralleling the contractor’s process, DCMA officials at the division monitor 

the incorporation of allocated pension costs into fringe benefit costs. 

Fringe benefit costs can also include defined contribution plan costs. 

Contractor and DOD officials we spoke with noted that it could be 

challenging to fully determine CAS pension costs applied to or incurred 

on a specific contract. For example, some CAS pension costs are 

captured among other indirect costs (such as shared service or corporate 

office costs).

DCAA is also responsible for reviewing the adequacy of contractors’ CAS 

disclosure statements at the corporate and division levels and 

determining their compliance with CAS and FAR. These statements 

contain information regarding how costs are allocated, and the corporatelevel disclosure statement in particular contains many details about 

allocation of the contractor’s pension plans.

In addition to overseeing CAS pension costs through the forward pricing 

and incurred cost processes, corporate-level contracting officers manage 

the process required by CAS for pension cost settlement when a 

contractor curtails a defined benefit pension plan. Curtailment under CAS 

means any situation where no new benefits can accrue for plan 

participants. When such a curtailment occurs, corporate-level contracting 

officers can receive assistance from the CIPR Center and DCAA to 

ensure that the related proposals submitted by the contractor are 

compliant with CAS.

When a contractor initiates a curtailment, it calculates the affected plan’s 

CAS pension costs to determine whether the plan is under- or overfunded 

and whether the government has over- or underpaid for CAS pension 

costs over the years. Based on the result of the calculation, one party 

may owe the other the balance of the difference in order to “settle up” the 

plan. The contractor submits a proposed settlement to the contracting 

officer, and the CIPR Center and DCAA provide support by reviewing the 

proposal in order to evaluate whether the calculations are correct and 

compliant with CAS. Both can issue reports which will help the contracting 

officer to negotiate a final settlement with the contractor. The resulting 

payment, whether from the contractor or the government, may either be 

DCAA and the CIPR 

Center Provide Additional 

Support for Contracting 

Officers during Settlement 

of CAS Pension Costs 

When a Pension Plan Is 

Curtailed
 

Page 21 GAO-13-158 Pension Costs on DOD Contacts

immediately charged or, when the contractor has other government 

contracts, amortized as pension costs over future years.

Settlements that resulted in potential payments to the contractor have 

resulted in litigation and long delays. According to DOD officials, three of 

the largest DOD contractors have pending settlements. Two of the 

smaller DOD contractors included in our review have settled cases within 

the last 4 years that resulted in payments to the government. DOD 

officials we met with noted that part of the reason for delayed settlements 

is the complicated nature of determining the appropriate government 

share of CAS pension costs, given that CAS rules on allocation of 

pension costs to contracts have changed over time. In response to court 

cases on the matter, DCAA and DCMA have issued joint guidance to 

address related issues.

The FAR requires that total employee compensation, which includes 

many components such as salaries and bonuses, fringe benefits like 

retirement benefits and health insurance, and other nonwage 

compensation, must be reasonable in order to be claimed by the 

contractor as a contract cost. However, as part of assessing the 

reasonableness of total compensation, DOD’s oversight processes do not 

clearly assign responsibility for assessing the reasonableness of the 

value of pension benefits to plan participants, focusing instead on the 

reasonableness of actuarial assumptions or fringe benefits as a whole.

Fringe benefits are examined as part of compensation reviews that DCAA 

auditors perform to determine reasonableness, often as part of incurred 

cost audits or reviews of compensation system internal controls. DCAA 

guidance for compensation reviews states that all cost components of 

employee compensation—including the value of fringe benefits, bonuses, 

and stock options as well as salary—are considered to be reasonable if 

they do not exceed the comparative value of those costs from market 

survey data by more than 10 percent.26

 

26Compensation costs established under “arm’s length” labor-management agreements

negotiated under certain statutes are generally considered reasonable if they are 

otherwise allowable.

Defined benefit pensions are 

generally part of that fringe benefit cost component, along with other 

benefits such as health and life insurance. Only if these collectively 

exceed the reasonableness threshold is an auditor instructed to review 

Pension Oversight 

Processes Do Not Address 

Reasonableness of Value of 

Defined Benefit Pension 

Plans
 

Page 22 GAO-13-158 Pension Costs on DOD Contacts

the individual cost components, such as pensions. In instances where 

questions arise about the reasonableness of pension costs, the auditor is 

instructed to turn to the CIPR Center as a resource for pension-related 

matters. Several auditors and DCMA contracting officers we spoke with 

also noted that if they had questions regarding the reasonableness of 

defined benefit plans, they would seek assistance from groups such as 

the CIPR Center or a centralized DCAA team that specializes in 

compensation issues, particularly those related to executive 

compensation.

Auditors are instructed to review fringe benefit costs as a whole when 

determining their reasonableness, but CAS costs for defined benefit 

pensions are an imperfect measure of the value of pension benefits 

participants earned in a year as part of their total compensation. Multiple 

factors drive CAS pension costs. For example, the pension cost could be 

zero in a given year due to strong asset returns, and this pension cost 

would not capture any of the value of the benefits earned that year by 

employees. Conversely, the pension cost could be higher in a given year 

than the value of the benefits earned that year by employees as a result 

of actuarial losses. While they may be aware of the CAS costs of defined 

benefit pensions, auditors do not know the value of these benefits to an 

employee in a given year. They lack guidance on how to measure this 

value (containing, for example, acceptable methodologies, assumptions, 

or data sources), and therefore are unable to get a complete picture of 

the reasonableness of total compensation for contractor employees.

Neither the CIPR Center nor DCAA’s compensation team currently 

assess the reasonableness of benefits offered through defined benefit 

plans. While officials stated that the CIPR Center did perform reviews of 

employee benefit offerings more than a decade ago, to the extent that the 

CIPR Center does evaluate reasonableness today, it does so only in 

terms of the measurements and actuarial assumptions used by 

contractors to calculate their CAS pension costs. It does not consider the 

relative value of benefits offered. For non-executive employees, the 

DCAA compensation team only reviews the reasonableness of salaries 

for direct labor. In essence, DOD assesses whether the CAS cost is 

appropriate from a regulatory and actuarial standpoint. Whether the 
 

Page 23 GAO-13-158 Pension Costs on DOD Contacts

liability reflected in the CAS cost stems from a generous pension plan is 

not considered.27

GAO reviewed the most prevalent final average pay formulas among the 

contractors that have these plans and found that contractors offer a wide 

range of benefit formulas and plan designs. This means that employees’ 

defined benefits can differ greatly from contractor to contractor. Plans 

offered by contractors include final average pay plans, which use a 

formula that considers a participant’s final average pay and years of 

service, as well as cash balance plans that use a hypothetical individual 

account to calculate benefits based on a percentage of a participant’s pay 

and a plan-specified rate of interest to be applied to a participant’s 

hypothetical account. The final average pay plans generally had a “base” 

accrual rate that granted between 1 percent and 2 percent of final 

average pay for each year of service with the company.28

In addition, these plans had a variety of features which affect a 

participant’s retirement benefit. For example, some plan formulas have 

the effect of reducing the base benefit by taking into account Social 

Security benefits to be received in the future. We noted other plan 

features, such as the presence or absence of a cost of living adjustment, 

which annually increases the benefit in retirement by a measure of 

inflation. Thus there was wide variation of plan designs across contractors 

and in the potential value of benefits to participants in different plans. 

However, neither DCAA corporate-level officials, the CIPR Center, nor the 

DCAA compensation team assessed the reasonableness of individual 

plans.

For example, 

two employees may have the same final average pay of $50,000 and the 

same 30 years of service. However, the employee with the “base” accrual 

rate of 2 percent would have an annual base benefit of $30,000 in 

retirement, whereas the employee with the “base” accrual rate of 1 

percent would have an annual base benefit of $15,000.

 

27A possible method to assess pension plan reasonableness would be to examine the 

present value of future benefits, with similar assumptions mandated across contractors.

28“Base” accrual rate refers to the fact that the accrual rate may be different for certain 

years of service; we use the term base to refer to the earliest years of service. Actual 

benefits could be reduced by taking into account Social Security benefits as well as for 

early retirement.
 

Page 24 GAO-13-158 Pension Costs on DOD Contacts

DCAA is responsible for reviewing executive compensation packages 

separately from compensation offered to other employees in order to 

evaluate whether these packages meet the FAR standard for 

reasonableness and do not exceed the dollar limitation specified in the 

FAR. However, defined benefit pension plans for contractor executives 

are not required to be included in these assessments.

Executive compensation reviews are usually done as part of incurred cost 

audits, although they can also be performed on audits of forward pricing 

proposals. DCAA auditors at contractor corporate offices have access to 

the DCAA compensation team for assistance with such reviews. While 

this team has developed a methodology for determining executive 

compensation reasonableness, it does not require examination of defined 

benefit pensions in the determinations, similar to its approach to pension 

plans in general. Compensation team officials told us they analyze the 

total cost of fringe benefits, and only look at individual benefits such as 

pensions if they deem the total fringe benefit cost to exceed that indicated 

by market survey data by more than 10 percent. In addition, the defined 

benefit components of the market surveys used by the team do not 

specify the use of CAS for their calculations, and thus may not be directly 

comparable to CAS-based pension cost. Compensation team officials 

noted that the most recent survey they use for this purpose was issued in 

2008, and only included self-reported pension cost. Executive 

compensation reviews we analyzed that addressed the reasonableness 

of total compensation and fringe benefits did not discuss the details of 

defined benefit pension plans.

To the extent that the compensation team does look specifically at 

defined benefit pensions, team officials told us that they evaluate the 

relative CAS cost of the pension. They do not examine the source of this 

cost, and therefore cannot identify whether, for example, a high relative 

CAS pension cost was largely driven by the generosity of pension plans 

or weak asset performance.

The FAR also contains a dollar limitation on the allowable annual 

compensation for certain contractor personnel, currently set at $763,029. 

The FAR describes the elements of executive compensation that should 

be considered against this limit. These include salary, bonuses, deferred 

compensation other than pensions, and employer contributions to defined 

contribution pension plans. However, the FAR does not include defined 

benefit pension plans as an element of compensation that should be 

considered against the limit.

Reasonableness 

Assessments of Executive 

Compensation Are Not 

Required to Include 

Defined Benefit Pensions
 

Page 25 GAO-13-158 Pension Costs on DOD Contacts

Accurately applying the cost of a defined benefit pension to an individual 

employee’s total compensation package is challenging due to the 

complexity and annual volatility of costs even if the value of the ultimate 

benefit does not change. DCAA compensation team officials noted that it 

is not clear how costs of a defined benefit plan should be evaluated. In 

addition, they lack current market survey data for defined benefit plans, 

and team officials noted that companies participating in these surveys do 

not consistently calculate and report their compensation costs.

Nearly all of the largest DOD contractors—as well as the peer group of 

companies we examined—maintain some sort of tax-qualified, defined 

benefit pension plan for their employees. As noted previously, the benefit 

designs of these plans can differ greatly, and we found variations among 

certain contractors’ final average pay plans. However, we were unable to 

compare the full range of plan designs across both contractors and their 

peer group.29

More generally, all of the largest contractors with defined benefit plans—

and the majority of their peer group—have frozen at least one of their 

plans in some way. A plan freeze is a plan amendment that closes the 

plan to new entrants and may limit future benefit accruals for some or all 

 

29Due, in part, to a lack of available data, we were unable to evaluate plan designs across 

both contractors and their peer group. As noted previously, the contractor “base” accrual 

rates for the final average pay plans we analyzed ranged between 1 percent and 2 

percent of participants’ final average pay multiplied by years of service as a lifetime 

benefit. Also as noted, a previous GAO report from 2005 found that a typical defined 

benefit plan gave participants a “base” accrual rate of 1.5 percent of final average pay 

multiplied by years of service as a lifetime benefit. Note that this finding could change if a 

similar survey were undertaken today, because of plan freezes and benefit formula 

reductions in recent years. Note further that a plan participant’s actual benefit would often 

be lower than what this base formula would produce, because of such factors as partial 

offsets for Social Security benefits and reduction for early retirement.

The Largest DOD 

Contractors Maintain 

Their Defined Benefit 

Plans in Similar Ways 

to Peer Companies

Many of the Largest DOD 

Contractors Have Frozen 

Defined Benefit Plans, As 

Have Companies in Their 

Peer Group
 

Page 26 GAO-13-158 Pension Costs on DOD Contacts

employees that are active in the plan. Under a freeze, the plan continues 

to be maintained by the sponsor.30 Specifically, a majority of the largest 

contractors and their peer group have “soft frozen” plans, that is, closed 

at least one of their plans to new entrants, while allowing existing 

participants to continue to accrue benefits.31

Some DOD contractors reported that when they froze their defined benefit 

plans they had either established a new defined contribution plan or 

changed the terms of an existing defined contribution plan for those 

employees who were no longer eligible to accrue benefits in a defined 

benefit plan. For example, one DOD contractor noted that employees not 

eligible for a defined benefit plan may receive a matching contribution 

under a defined contribution plan, whereas employees who are eligible for 

a defined benefit plan would not be eligible for such a match. In the short 

term, transitioning new employees to defined contribution plans may raise 

total costs since defined benefit plans generally are least expensive for 

young and new participants.

Furthermore, over 75 

percent of the contractors’ largest defined benefit plans were frozen in 

some way.

Defined benefit plans that remained open to new participants often 

included collectively bargained participants, and all but one of the largest 

DOD contractors had at least one plan that remained open to new 

participants. Open plans with collectively bargained participants were 

generally among the contractors’ smaller plans. Further, some DOD 

contractors said that they intended to close all of their defined benefit 

plans to new entrants and, subject to negotiation, they also expected 

plans with collectively bargained participants to be closed to new entrants 

in the future. For example, one DOD contractor noted that a number of its 

open plans were already “partially frozen,” or open only for certain 

bargaining units, while some, but not all, bargaining units had agreed to 

close the plan to new entrants going forward.

 

30A freeze should not be confused with a termination whereby a plan sponsor ceases 

maintaining the plan.

31In prior work, GAO defined a soft freeze as one which, at a minimum, closes the plan to 

new entrants. A soft freeze could include other changes that affect current participants. 

Throughout this report we use the term soft freeze to refer exclusively to the closing of a 

plan to new entrants. See Defined Benefit Pensions: Plan Freezes Affect Millions of 

Participants and May Pose Retirement Income Challenges, GAO-08-817 (Washington, 

D.C.: July 21, 2008).
 

Page 27 GAO-13-158 Pension Costs on DOD Contacts

Generally, the number of private-sector companies sponsoring defined 

benefit plans has declined substantially over the last 20 years or so. A 

prior GAO survey of 94 of the largest firms sponsoring defined benefit 

plans showed that many firms made revisions to their plan offerings over 

that last 10 years.32 For example, large sponsors have changed benefit 

formulas, converted to hybrid plans, or frozen some defined benefit 

plans.33 Moreover, in another GAO survey among a broader population of 

sponsors that included all plan sponsors with 100 or more total 

participants, 51 percent of those sponsors had one or more frozen 

defined benefit plans.34 A 2011 Aon Hewitt study of Fortune 500 

companies found largely similar results over time.35

Based on their fiscal year 2011 annual reports, members of the peer 

group were more likely than the largest DOD contractors to have 

instituted or planned to institute a “hard freeze” for one or more plans. 

With a hard freeze, the plan is closed to new entrants and also ceases 

accruals for existing participants. According to fiscal year 2011 annual 

reports, none of the contractors had reported current or planned hard 

freezes, whereas 4 of the 15 peers did. In interviews, however, one 

contractor told us that they implemented a hard freeze on December 31, 

2012, but none of the other large contractors told us they had hard frozen 

any of their largest plans.

For example, the 

study noted that 80 percent of Fortune 500 companies sponsored an 

open, defined benefit plan for salaried employees in 1995. However, as of 

2011, only 31 percent sponsored an open, defined benefit plan.

36

 

32See GAO, Defined Benefit Pensions: Survey Results of the Nation’s Largest Private 

Defined Benefit Sponsors,

According to several DOD contractors, hard 

freezing pension plans can present challenges such as triggering CAS 

rules, discussed previously, that require settlement between the 

contractor and the government. This may result in the government owing 

GAO-09-291 (Washington, D.C.: Mar. 30, 2009).

33Hybrid plans include cash balance plans, which are defined benefit plans that contain 

certain plan features that resemble defined contribution plans.

34GAO-08-817. 

35Aon Hewitt provides companies with services including retirement plan consulting.

36Other large DOD contractors had hard frozen smaller plans but not plans that were 

among the contractors’ largest plans (i.e., those that together covered at least 90 percent 

of each contractor’s pension liabilities). DOD contractors reported that these plans were 

“legacy” plans which had been replaced by another plan, or plans that were hard frozen 

prior to the contractor’s acquisition of the business divisions with those plans. 
 

Page 28 GAO-13-158 Pension Costs on DOD Contacts

the contractor or vice versa.37

However, the settlement-related challenges may not be the sole reason 

that a DOD contractor would avoid instituting a hard freeze. Indeed, one 

DOD contractor noted that instituting a hard freeze could damage 

employee relations and that in general with employees it is easier to 

justify closure of plans to new entrants. Other DOD contractors told us 

they continually evaluate their pension offerings against those of peers, 

and the competitiveness of their plans compared to those of peers is a 

driver of pension management decisions. A few DOD contractors noted 

that they want to provide pension plans that allow them to attract skilled 

employees, while remaining cost-competitive.

For example, according to a representative 

of one large contractor, one of the contractor’s plans that was settled in 

the late 1990s was determined to be overfunded on a CAS basis, but 

underfunded on an ERISA basis. This meant that the contractor owed the 

government money for settlement despite the fact that the plan was 

underfunded on an ongoing ERISA basis.

Nearly all of the largest DOD contractors and their peer group offer 

nonqualified defined benefit plans in addition to their tax-qualified defined 

benefit plans. In fact, all but one DOD contractor and one peer we 

reviewed maintained at least one nonqualified defined benefit plan.38

While the provisions of each nonqualified plan vary, in general, the most 

prevalent type that we found were “restoration” (or “excess benefit”) 

plans. These are plans that typically extend the benefits provided by a 

tax-qualified defined benefit plan by supplementing the portion of benefits 

that are in excess of limits prescribed by the Internal Revenue Code.39

 

3748 C.F.R. 9904.413-50(c)(12). Because interest rates used to calculate liabilities under 

ERISA funding calculations are currently lower than interest rates for CAS settlements, 

contractors may calculate lower liabilities under a CAS settlement than if the plan was 

ongoing on an ERISA basis. Thus, contractors’ plan liabilities and any recoveries from the 

government could be lower than under an ERISA valuation—leaving contractors 

responsible for what they may consider to be an inequitable share of any settlement. 

According to PBGC officials, CAS settlement would likely result in a significant 

underfunded liability for many plans on a PBGC termination basis, which could result in 

significant underfunded liability for the PBGC should it become trustee of the plan. 

For example, one contractor noted that its restoration plans could include 

38All large DOD contractors that maintain tax-qualified defined benefit plans also maintain 

nonqualified defined benefit plans. 3926 U.S.C. §§ 401(a)17 and 415. For defined benefit plans, these limits relate to the 

maximum annual compensation that may be counted towards benefit accruals and the 

maximum annual benefit that may be earned. 
 

Page 29 GAO-13-158 Pension Costs on DOD Contacts

certain highly-paid engineers. Some types of nonqualified plans we 

reviewed appeared to be offered only to certain senior executives.

Our review of the financial reports of the largest DOD contractors and 

their peer group shows that the DOD contractors invest in similar types of 

assets relative to their peer group. However, DOD contractors and their 

peer group employed a wide range of pension investment allocations 

between equities and fixed-income assets.40 For example, DOD 

contractors allocated as much as 64 percent or as little as 26 percent of 

pension investments to equity assets (i.e., stocks), while their peer group 

allocated as much as 74 percent or as little as 26 percent of pension 

investments to such assets. Similarly, DOD contractors allocated as much 

as 46 percent or as little as 32 percent of pension investments to fixedincome assets (i.e., bonds), while their peer group companies allocated 

as much as 51 percent or as little as 25 percent of pension investments to 

such assets.41

The DOD contractors’ pension investment allocations appear to be 

somewhat more conservative than those of their peer group when 

analyzed in the aggregate.42

 

40Asset allocations are from reported asset categories in 2011 annual financial reports and 

are for U.S. plans only. Also note that financial reports list investments of all funded U.S. 

pension plans in aggregate. For sponsors that maintain multiple plans, each plan may 

select a unique investment policy and set of allocations for each plan. Alternatively, 

sponsors may maintain a common trust, called a master trust, which may employ a 

common set of investment allocations across all sponsored plans.

Aggregating the year-end 2011 pension 

investment allocations of the DOD contractors and their peer group 

shows that contractors have allocated about 7 percentage points more of 

their investments to generally conservative assets, namely cash and 

fixed-income assets, than is the case with their peer group, as illustrated 

in figure 5. This means that, in the aggregate, the DOD contractors have 

a lower percentage of pension investments allocated to equities and 

41The DOD contractors’ cash allocations ranged from 0 to 10 percent, while the peer 

group allocated from 0 to 12 percent. “Other” asset allocations ranged from 0 to 24 

percent for the largest DOD contractors, while peer group allocations for such assets 

ranged from 0 to 38 percent. “Other” assets are assets that are not equities, fixed-income 

(i.e., bonds) or cash (or equivalents). Each contractor or peer may have different assets in 

the “other” category, but key asset classes in “other” include private equity, real estate, 

hedge funds, and commodities.

42This could alternatively be referred to as the asset-weighted average allocation.

The Largest DOD 

Contractors Invest in 

Similar Types of Assets as 

Their Peer Group and 

Generally Invest More 

Conservatively
 

Page 30 GAO-13-158 Pension Costs on DOD Contacts

“other” assets compared to their peer group. Equities and “other” assets, 

such as private equity, hedge funds, real estate, and commodities, are 

generally considered to be riskier than cash and fixed-income assets.43

Figure 5: Asset-Weighted Year-End 2011 Pension Investment Allocations of Large 

DOD Contractors and Their Peer Group

Note: “Other” assets include private equity, hedge funds, real estate, and commodities.

 

43Our analysis categorized and analyzed reported asset categories in 2011 annual

financial reports. However, sponsors define their asset categories in a variety of ways, and 

each asset category may encompass a wide range of risk.
 

Page 31 GAO-13-158 Pension Costs on DOD Contacts

CAS pension costs for the largest DOD contractors grew considerably 

over the last decade. Costs went from less than $420 million dollars in 

2002 (when most contractors reported at least one plan with zero costs, 

after a period when some plans were fully funded) to almost $5 billion 

dollars in 2011.44

 

44A contractor’s total pension cost may also include costs that are not allocated to DOD or 

other U.S. government contracts, but instead allocated to commercial activities.

While growth in total CAS pension costs was relatively 

small and gradual until 2008, as shown in figure 6, costs jumped by 

almost $1.5 billion from 2008 to 2009. They increased almost 90 percent 

in nominal dollars from 2008 to 2011, a substantial share of which was 

allocable to DOD contracts.

CAS Pension Costs 

for Large DOD 

Contractors Have 

Increased in Recent 

Years Due to the 

Market Downturn

CAS Pension Costs Started 

Relatively Low and Rose 

Significantly over the Last 

Decade
 

Page 32 GAO-13-158 Pension Costs on DOD Contacts

Figure 6: Total CAS Pension Costs for Largest DOD Contractors with Defined 

Benefit Plans

CAS pension costs are likely spread over thousands of contracts. All five 

weapon systems we analyzed showed an increase in defined benefit 

pension cost relative to labor cost from 2005 to 2011, as illustrated in 

figure 7.45

 

45For this analysis of CAS pension costs as a percentage of total direct labor cost, we 

included only defined benefit pension costs associated with direct labor on program 

contracts since this allowed for more comparability across programs. 

CAS Pension Costs at the 

Program Level 
 

Page 33 GAO-13-158 Pension Costs on DOD Contacts

Figure 7: Defined Benefit Plan Costs Relative to Direct Labor for Selected Weapon 

Systems Programs

For the five weapon systems programs, CAS pension costs as a 

percentage of direct labor showed the most growth from 2008 to 2009, 

corresponding to trends seen in aggregate costs across the largest DOD 

contractors. As these costs increased, contractors took several actions to 

control them. For example, as previously discussed, contractors were 

closing a number of defined benefit plans to new entrants and several 

adjusted benefit formulas.

CAS pension costs have also grown relative to total contract cost for the 

selected weapon systems programs. As shown in figure 8, average 

pension costs never exceeded 3 percent in any year—although this is still 

a significant dollar amount on large weapon systems contracts.46

 

46We included pension costs for both direct and indirect labor that was associated with 

each program, as the total program cost includes some indirect labor.

Until 

2009, average pension costs never exceeded 1 percent. However, note 
 

Page 34 GAO-13-158 Pension Costs on DOD Contacts

that this figure understates the impact of pension costs on programs since 

material costs—including the complex subsystems and components 

bought from subcontractors—may also include pension costs. Material 

costs for the systems we reviewed were as much as 81 percent of total 

program costs.

Figure 8: Defined Benefit Plan Costs Relative to Total Costs for Selected Weapon 

Systems Programs

Across this period, the trend for defined contribution plans differed. 

Defined contribution costs as a percentage of direct labor on the selected 

programs grew only slightly, and remained much steadier than the CAS 

pension costs for defined benefit plans. In 2005, defined contribution 

costs ranged between 0 and 6.9 percent for the five programs we 

examined. In 2011, the range was 0.6 percent to 7.0 percent.47

 

47To the extent that contractor defined contribution plans are largely either supplemental 

to defined benefit plans or cover relatively new employees, we would expect that defined 

contribution costs would generally represent a lower percentage of total program cost.

Defined 
 

Page 35 GAO-13-158 Pension Costs on DOD Contacts

contribution plan costs will generally be higher than defined benefit plan 

costs when defined benefit plan assets perform well, and gains offset a 

plan’s normal cost. Defined benefit plans will likely cost more than defined 

contribution plans when assets perform poorly, as the employer bears the 

investment risk. As demonstrated, defined contribution plan costs are 

generally more stable than defined benefit plan costs.

On a CAS basis (excluding prepayment credits), contractors’ plan assets 

at the beginning of 2011 were approximately $15.1 billion less than would 

be needed to pay their pension liabilities.48 This gap, known as the 

unfunded liability, is largely a result of losses incurred during the market 

downturn in 2008 and 2009.49

 

48If certain plans are less than 80 percent funded on an ERISA basis (and if they are also 

less than 70 percent funded using a different set of assumptions), they are considered “at 

risk.” While this review did not include analysis of ERISA funding reports, according to 

CIPR Center officials, no large contractors’ defined benefit plans were less than 80 

percent funded on an ERISA basis. 

Indeed, as illustrated in figure 9, 59 percent 

of this unfunded liability is attributed to losses from just those 2 years. 

The remainder of the unfunded liability came from other sources, such as 

changes in the contractors’ actuarial assumptions, other investment 

losses, and plan amendments (e.g., changes in rules for benefits 

computation).

49Investment losses are measured relative to the assumed rate of return. Thus, if the 

assumed rate of return was 8 percent, and assets actually lost 10 percent of their value, 

the loss would be approximately 18 percent.

CAS Pension Costs Grew 

as the Market Downturn 

Increased CAS Unfunded 

Liabilities
 

Page 36 GAO-13-158 Pension Costs on DOD Contacts

Figure 9: Sources of Current Unfunded Liabilities for the Largest DOD Contractors 

(as of Beginning of 2011)

The largest DOD contractors’ plans were, as of the beginning of 2011, 

about 87 percent funded in aggregate, based on how CAS directs 

contractors to calculate the level of plan funding; funded ratios ranged 

from 59 to 96 percent. The funded ratio (or percentage) is calculated by 

dividing plan actuarial assets by plan actuarial liabilities. CAS calculations 

subtract CAS prepayment credits from assets. When prepayment credits 

are included, the largest DOD contractors’ pension plans were 110 

percent funded at the beginning of 2011, in aggregate, with funded ratios 

ranging between 84 and 127 percent.

In aggregate, about half of the contractors’ CAS pension costs at the 

beginning of 2011 were a result of the need to pay installments on 

unfunded liabilities while half went to pay normal costs, which are the 

costs attributable to employees working an additional year. As shown in 

figure 10, about 24 percent of total 2011 CAS pension cost was payment 

on unfunded liabilities attributable specifically to plan losses in 2008 and 

2009, and approximately 25 percent was to pay for unfunded liabilities 

from all other sources such as plan amendments, investment losses from 
 

Page 37 GAO-13-158 Pension Costs on DOD Contacts

other years, and changes in actuarial assumptions. The remaining 51 

percent of CAS pension cost for 2011 was to pay normal costs.50

Figure 10: Breakdown of 2011 CAS Pension Costs for the Largest DOD Contractors 

(as of Beginning of 2011)

Note: Contractors calculated interest cost for the year (an adjustment to account for the fact that 

contributions are not made all at once on the valuation date) differently, and we included these 

adjustments exactly as the contractor included them. One contractor also had a small adjustment for 

a CAS curtailment, which was included in assets.

Under CAS rules, contractors have traditionally paid for incurred pension 

plan losses over the course of 15 years. As a result, the losses from 2008 

may contribute to plan costs until 2023 unless those losses are offset by 

future gains. Additionally, changes in actuarial assumptions and plan 

amendments can be recognized over many more years, which could 

potentially affect CAS pension costs for up to 30 years into the future, as 

contractors may elect to pay off these types of unfunded liabilities across 

as many as 30 years.

 

50Also included are any unusual adjustments or extraordinary payments that are paid for 

all at once instead of on a longer-term schedule.
 

Page 38 GAO-13-158 Pension Costs on DOD Contacts

Both contractors and DOD officials expect CAS pension costs to increase 

as discount rates used for CAS calculations fall to match the rates used 

for ERISA funding calculations. Indeed, in their 5-year pension cost 

forward pricing projections issued immediately following harmonization, 

large DOD contractors had estimated that CAS discount rates would fall 

by between 2.2 and 4.1 percentage points in 2014, depending on the 

demographics of the plan.51

Harmonization ties the CAS discount rate to ERISA rules, making it 

harder to project future CAS pension costs. On July 6, 2012, a few 

months after harmonization went into effect, Congress enacted MAP-21, 

which changed the methodology for calculating ERISA discount rates.

This drop would, in turn, increase costs 

because decreases in the discount rate raise pension liabilities and the 

normal cost. Increases in unfunded liabilities also increase CAS pension 

costs because of the need to pay down those unfunded liabilities in 

installments.

52

 

51The effective discount rate contractors will use is based on three segment rates 

published by the Department of the Treasury for benefit payments due in less than 5 

years, 5 to 20 years, and 20 years or more. These segment rates reflect 2-year averaging 

and the maximum and minimum segment rate as required by MAP-21. These durations 

reflect actuarial predictions about when plan participants will claim benefits based on 

participant demographics. We excluded one contractor from this summary because its 

assumptions and demographics lead to only a very slight decline in the discount rate, 

which was atypical.

Before MAP-21, ERISA discount rates were based on a 2-year average of 

corporate bond interest rates. Now, this 2-year average is bounded by a 

25-year average of corporate bond interest rates, and as a result, 

contractors now project their CAS discount rates will drop only 1.5 to 3.1 

52See § 40211(a) of MAP-21, Pub. L. No. 112-141, which adds § 430(h)(2)(C)(iv) to the 

Internal Revenue Code. This legislation also increased premiums that plan sponsors must 

pay to the PBGC.

Harmonization Will 

Likely Increase the 

Magnitude and 

Volatility of 

Contractor Pension 

Costs 

Projected Pension Costs 

Are Sensitive to Economic 

Assumptions 
 

Page 39 GAO-13-158 Pension Costs on DOD Contacts

percentage points, starting in 2014, to harmonize with ERISA.53

Costs under the new, harmonized CAS pension rules can vary 

dramatically based on small changes in the corporate bond interest rates 

used to discount liabilities. We modeled an illustrative pension plan’s CAS 

pension costs from 2014 to 2017, the period over which the new CAS 

discount rate rules will be phased-in. In our model, a 1.0 percentage point 

decrease in the discount rate (as determined by a measure of corporate 

bond interest rates) could increase CAS pension costs by 35 percent 

once the rule is fully implemented, and a 2.0 percentage point decrease 

could almost double CAS pension costs, as shown in figure 11. 

Furthermore, changes in this rate can have a greater effect on CAS 

pension costs than similar changes in plan asset returns.

However,

the effects of MAP-21’s ERISA funding relief are expected to have the 

greatest impact in the near term, and to diminish after 2015. Therefore, 

contractors still expect their CAS discount rates to be 2.0 to 4.0 

percentage points lower in 2016 than their pre-harmonization 2012 CAS 

discount rates.

54

 

53Note that CAS rules give contractors the option to use the ERISA interest rates for CAS 

calculations, but contractors could pick a different measure of the rate and use it 

consistently. None of the largest DOD contractors we spoke with used a rate other than 

the ERISA rates. 

54For example, even if a plan’s assets outperformed expectations by as much as 5.0

percentage points a year from 2014 to 2017, the reduction in cost would still be lower than 

a 1.0 percentage point increase in the discount rate using our illustrative model over the 

same period.
 

Page 40 GAO-13-158 Pension Costs on DOD Contacts

Figure 11: Effect of Different Discount Rates and Different Asset Returns on Plan Costs for an Illustrative Plan

Note: This plan is intended to illustrate the effect of changes in asset and liability returns. The starting 

discount rate is based on GAO analysis of expected effective rates following MAP-21. This illustrative 

plan has about $6 billion in liabilities and $5 billion in assets in 2014. The plan is also 90 percent 

funded in 2010 to show some costs from actuarial losses. The increases or decreases in asset 

returns are repeated for 2013 to 2017.

Under certain scenarios, CAS pension costs could begin to decline back 

to previous levels over the next decade, but the outcome is sensitive to 

what actually happens in the economy. For example, as shown in figure 

12, projected CAS pension costs would begin to decline by the end of the 

decade and approach what they would have been under preharmonization CAS rules if discount rates rise to 6.5 percent by 2017 and 

stabilize at that level. However, if corporate bond interest rates do not 

stabilize and instead started to fall again after 2019, the discount rate 

would fall as well and CAS pension costs would then continue to rise. 

This example does not account for any asset gains or losses which could 

further raise or lower CAS pension costs.
 

Page 41 GAO-13-158 Pension Costs on DOD Contacts

Figure 12: Long-Term Cost Projections for an Illustrative Plan under Different 

Discount Rate Scenarios

Note: This plan is intended to illustrate how future discount rates can affect costs. The starting 

discount rate is based on GAO analysis of expected effective rates following MAP-21. This illustrative 

plan is 90 percent funded in 2010 to show some costs from actuarial losses. For the first CAS 

pension cost projection, we gradually increased the discount rate from 6.0 to 6.5 percent from 2014 to 

2019 to model the effects of an increase in corporate bond interest rates and then kept the discount 

rate at 6.5 percent. For the alternative, we modeled cost if corporate bond interest rates fell such that 

the discount rate declined to 6.25 percent in 2020. We picked 6.5 percent based on our judgment of a 

discount rate between recent traditional CAS discount rates and what post-harmonization CAS 

discount rates would be based on recent corporate bond interest rates.

As noted earlier, after harmonization went into effect in February 2012, 

the largest DOD contractors submitted new pension forward pricing 

proposals to DOD and projected significant rises in CAS pension costs by

2016. Overall, these updated projections showed large increases in CAS 

pension costs when compared to the pre-harmonization projections for 

the 2012 to 2016 period. Most contractors’ projections for 2012 and 2013 

showed little or no change but all contractors projected increases from 

2014 through 2016 as harmonization takes effect.55

 

55A few DOD contractors projected decreases in CAS pension costs in 2012 or 2013 due 

to changes separate from harmonization, such as changes to plan benefits.

After excluding the 

impact of changes such as changes to plan benefits to isolate the effects 

Even with Temporary 

Funding Relief, 

Contractors Anticipate 

That CAS Pension Costs 

Will Rise Due to 

Harmonization Starting in 

2014
 

Page 42 GAO-13-158 Pension Costs on DOD Contacts

of harmonization, these CAS pension cost increases for individual 

contractors ranged from 10 percent to 55 percent for 2014, relative to 

their proposals that do not reflect the impact of harmonization.

All of the large DOD contractors that submitted an updated pension 

forward pricing proposal after the enactment of MAP-21 still showed an 

increase in projected CAS pension costs, despite the temporary relief 

from ERISA funding requirements provided by the law. While MAP-21 

dampened the initial projected effect of harmonization, a few large DOD 

contractors noted that the impact of MAP-21 is likely to be temporary and 

that its long-term effect on discount rates and future CAS pension costs 

remain unknown. After taking into account MAP-21, projected CAS 

pension cost increases for individual contractors ranged from 7 percent to 

37 percent for 2014, due solely to harmonization, relative to their 

proposals that do not reflect the impact of harmonization. In aggregate, 

that represents a projected increase for 2014 of nearly $1.2 billion across 

the six contractors that submitted forward pricing proposals reflecting 

MAP-21. By contrast, the increase projected by those contractors in 

proposals prior to MAP-21 was almost $2 billion.

CAS pension costs for defined benefit plans at the divisions we reviewed 

are expected to rise as a percentage of direct labor costs. At all five 

divisions, post-harmonization projections that were the basis of 

negotiations for most of 2012 showed a rise in CAS defined benefit 

pension costs as a percentage of projected direct labor costs of between 

8 and 21 percentage points from 2012 to 2016.56 For those divisions, 

defined contribution costs stayed largely stable across the same period.

CAS rules are intended to provide consistent cost data for forward pricing 

of government contracts over future years for contracts implemented over 

multiple years. However, harmonization tied CAS discount rates to the 

more volatile ERISA-based discount rate, which can make CAS less 

consistent as a standard for generating pricing projections. DOD issued 

limited guidance to its acquisition organizations in March 2012 on 

projecting ERISA-based discount rates for CAS calculations, which 

indicates that contractors should increase their current ERISA-based 

 

56For four of the five divisions included in this review, these projections did not account for 

MAP-21 or changes in interest rates since submission of initial post-harmonization 

projections.

Harmonization Presents 

Challenges to Projection of 

CAS Pension Costs for 

Forward Pricing
 

Page 43 GAO-13-158 Pension Costs on DOD Contacts

rates for forward pricing to approach a 4- to 6-year historical average 

rate.57

Additionally, DOD indicated that in its final guidance, yet to be issued, 

forward discount rates would approach average rates drawn from 15 to 

20 years of historical data. Rates based on long-term averages would 

ensure more consistency in pricing because these rates would change 

less year-to-year than rates based on short-term historical averages. In 

the near-term, rates for forward pricing based on a long-term historical 

average would also very likely increase the contractors’ discount rates, 

reducing CAS pension costs. This final guidance may provide greater 

clarity about discount rates contractors could use to calculate pension 

costs for forward pricing purposes. However, in the absence of this 

guidance, there is likely to be a broad range of discount rates in use and 

thus large variation in forward pricing rates, even if contractors have 

similar participant demographics.

The guidance is not clear on the source for these rates or how 

quickly they should rise to historical averages. This lack of clarity can lead 

to great variation among the forward pricing rates of contractors, even if 

they have similar participant demographics, because small changes in the 

projected discount rate can create large changes in projected CAS 

pension cost.

Since harmonization was a mandatory regulatory change, contractors can 

ask for a contract adjustment to reflect the cost impact of the change. 

Although a general procedure exists that contractors can follow to seek 

any kind of adjustment, a March 2012 DOD memorandum stated that 

contracts would be eligible for adjustment if they were signed prior to 

February 27, 2012 and if their period of performance continues into 2014 

or later, when use of the ERISA-based discount rate begins to phase in. 

The memorandum indicated that DOD would eventually release more 

guidance on the matter but did not specify a timeline for completing the 

negotiation of contract adjustments. As of November 2012, DOD had not 

yet issued additional guidance.

The amount of additional CAS pension cost for DOD due to 

harmonization adjustments will depend, in part, on the number of 

 

57Department of Defense, Office of the Under Secretary of Defense, Memorandum: 

Subject: Guidance on Cost Accounting Standards Board (CASB) Final Rule to Harmonize 

CAS 412 and 413 with the Pension Protection Act (PPA) of 2006: March 27, 2012.

Adjustments to PreHarmonization Contracts 

Are Expected but Cost 

Impact Is Uncertain
 

Page 44 GAO-13-158 Pension Costs on DOD Contacts

contracts submitted by contractors for consideration, and this is yet to be 

determined. Some contractors said that a number of their contracts may 

be complete or no longer incurring costs by the time harmonization 

noticeably increases CAS pension costs. We reviewed four programs that 

have production or construction contracts that were both awarded before 

February 2012, and for which deliveries are scheduled in 2014 or beyond. 

These include large platforms with small quantities, such as Wideband 

Global SATCOM and Virginia Class Submarine; because satellites and 

submarines take several years to build, all the units on these contracts 

will be delivered in 2014 or later (as late as 2018 for the submarine). 

Therefore, substantial costs could be incurred in 2014 and beyond. In 

contrast, the bulk of costs on relevant contracts for F-35 Joint Strike 

Fighter aircraft and Tactical Tomahawk missiles will be incurred before 

2014 when the main provisions of harmonization take effect. Over 80 

percent of F-35 deliveries, and almost 60 percent of Tactical Tomahawk 

deliveries, are scheduled to take place before 2014. Several contractors 

stated that they were waiting for DOD to issue additional guidance before 

submitting their requests for adjustment and one contractor commented 

that it could be beneficial for DOD to wait for interest rates to rise, as that 

could negate the effect of harmonization and the need for adjustment on 

some contracts.

The CAS Board did not harmonize the discount rates used for settling up 

if a contractor curtails a pension plan, meaning that liabilities could be 

calculated differently under ERISA and CAS rules if a contractor 

terminates a plan or freezes new benefit accruals for all participants. In 

such an event, the liability would be calculated using the old (likely higher) 

assumed long-term rate of return, instead of the new (likely lower) 

corporate bond interest rates. In the current environment, that would 

make the measurement of liabilities lower for a plan being curtailed than 

would be the case if the plan continued with new benefits accruing.

According to CAS Board officials, the Board intends to begin a case on 

CAS 413 in the near future, although a schedule for such rule-making has 

not been created. The process of changing CAS rules can be timeconsuming. For example, while PPA, enacted in 2006, established a 

deadline for harmonization of January 1, 2010, the final ruling was not 

issued until December 2011, and not effective until February 2012.

DOD faces new challenges as a result of changes to rules governing 

contractor pension costs and the growth in these costs, especially since 

The CAS Board Did Not 

Update Rules for 

Settlement of Plan 

Curtailments as Part of 

Harmonization

Conclusions 
 

Page 45 GAO-13-158 Pension Costs on DOD Contacts

the market downturn that started in 2008. The regulatory structure for 

government contracting generally allows contractors to receive payment 

for normal business costs incurred while working on government 

contracts, including employees’ salaries and benefits such as pensions. 

DOD recognizes that understanding and overseeing pension costs 

requires highly specialized expertise, and has therefore centralized its 

pension oversight functions. However, while DOD processes ensure that 

contractors’ CAS pension costs have been calculated correctly and that 

actuarial assumptions are reasonable, these processes do not assign 

responsibility for reviewing and valuing the benefits that participants will 

receive. Additionally, CAS pension cost is an imperfect measure of the 

value of pension benefits participants earned in a given year. As a result, 

DOD has an incomplete picture of the reasonableness of the total 

compensation offered by contractors. Further, DOD’s assessment of 

executive compensation does not require inclusion of defined benefit 

pensions, and the assessment that does take place does not consider the 

value of benefits earned by participants. This could hamper DOD’s efforts 

to ensure the reasonableness of the total compensation offered to 

contractor executives.

CAS pension costs associated with defined benefit plans have grown 

substantially over the past decade, and can be expected to grow larger 

and more volatile with the harmonization of CAS to ERISA. We found that 

in this environment, DOD contractors, like their peer group, have limited 

employee entry to defined benefit plans. Defined benefit pension costs 

are highly sensitive to economic assumptions, and even a small change 

in conditions can have significant consequences. Increased volatility due 

to harmonization challenges the consistency of contract forward pricing. 

Under the previous rules, CAS discount rates were more stable and 

predictable, and therefore effective for consistent forward pricing. DOD 

has recognized the desirability of using long-term average rates in CAS 

calculations in order to smooth the impact of pension cost swings over 

time, and the need to provide more guidance to its acquisition 

organizations on the discount rates contractors should use. While DOD 

has stated that this guidance would be forthcoming, details are yet to 

emerge, and the longer it takes to issue the guidance, the longer DOD is 

likely to see a broad range of discount rates and large variation in forward 

pricing rates. Further, while harmonization changed how contractors will 

calculate their CAS pension costs, it did not update CAS 413 to 

harmonize the discount rates used for settling up in the event of a plan 

curtailment. The current interest rate environment means that a plan 

being curtailed would have significantly lower liabilities than if it had 
 

Page 46 GAO-13-158 Pension Costs on DOD Contacts

continued accruing new benefits, complicating settlements between 

contractors and the government.

We recommend that the Secretary of Defense take the following four 

actions:

• Assign responsibility for oversight of the reasonableness of pension 

plans offered by contractors, specifically the value of benefits earned 

by participants;

• Provide guidance on how to measure the value of pension benefits 

that participants earn in a given year to get a complete picture of total 

compensation for contractor employees;

• Provide guidance on the extent to which defined benefit plans should 

be included in assessments of the reasonableness of executive 

compensation packages; and

• Provide specific guidance to acquisition organizations, including 

DCMA and DCAA, on the discount rate or rates that would be 

acceptable for contractors to use in calculating pension costs for 

forward pricing purposes.

In order to better align with the harmonized CAS 412, we recommend that 

the CAS Board set a schedule for revising the parts of CAS 413 dealing 

with settlement of pension plan curtailments.

We provided a draft of this report to DOD, OMB, PBGC, the Department 

of the Treasury, and the 10 large DOD contractors covered by our review. 

We received formal written comments from DOD. DOD agreed with all 

four recommendations made to the Secretary of Defense. DOD also 

provided technical comments which were incorporated as appropriate. 

DOD comments are reproduced in appendix II.

OMB provided comments stating that the CAS Board, when it meets, will 

consider a schedule for a case to revise the parts of CAS 412 and CAS 

413 relating to defined benefit plan segment closings and curtailments. 

OMB also offered technical comments which were incorporated as 

appropriate.

We received comments from six contractors, who said that the report 

captures the complexities involved in determining pension costs. Four 

contractors indicated that they had no comments. Contractors also 

offered technical comments which were incorporated as appropriate. 

Recommendations for 

Executive Action

Agency and ThirdParty Comments 
 

Page 47 GAO-13-158 Pension Costs on DOD Contacts

Both the Department of the Treasury and PBGC provided technical 

comments which were incorporated as appropriate. 

We are sending copies of this report to appropriate congressional 

committees; the Secretary of Defense; the Acting Director, Office of 

Management and Budget; and other interested parties. In addition, this 

report will be available at no charge on the GAO website at 

http://www.gao.gov. 

If you have any questions about this report, please contact Cristina 

Chaplain at (202) 512-4841 or chaplainc@gao.gov, or Charles Jeszeck at 

(202) 512-7215 or jeszeckc@gao.gov. Contact points for our Offices of 

Congressional Relations and Public Affairs may be found on the last page 

of this report. Key contributors to this report are found in appendix III. 

Cristina T. Chaplain

Director

Acquisition and Sourcing Management

Charles A. Jeszeck

Director

Education, Workforce, and Income Security
 

Page 48 GAO-13-158 Pension Costs on DOD Contacts

List of Requesters

The Honorable Carl Levin

Chairman

Committee on Armed Services

United States Senate

The Honorable Kelly Ayotte

United States Senate

The Honorable John McCain

United States Senate

The Honorable Claire McCaskill

United States Senate
Appendix I: Objectives, Scope, and 

Methodology

Page 49 GAO-13-158 Pension Costs on DOD Contacts

Our objectives were to assess how (1) contractor pension costs are 

determined; (2) the Department of Defense (DOD) ensures the contractor 

pension costs it pays are appropriate; (3) DOD contractors’ defined 

benefit pension plans compare with plans sponsored by similar 

companies that are not among the largest DOD contractors; (4) pension 

costs have affected DOD contract costs and the factors that contributed 

to these pension costs; and (5) the December 2011 harmonization of 

Cost Accounting Standards (CAS) with the Employee Retirement Income 

Security Act of 1974 (ERISA) will affect the amounts DOD will pay in 

pension costs in coming years.

To conduct analysis across all objectives, we analyzed defined benefit 

pension plans for the 10 largest contractors based on DOD contract 

obligations for fiscal year 2011. Those contractors were:

• BAE Systems plc

• The Boeing Company

• General Dynamics Corporation

• L-3 Communications Holdings, Inc.

• Lockheed Martin Corporation

• Northrop Grumman Corporation

• Oshkosh Corporation

• Raytheon Company

• SAIC, Inc.

• United Technologies Corporation

For these contractors (with the exception of one that does not offer 

defined benefit plans), we selected for deeper analysis defined benefit 

plans that together covered at least 90 percent of each contractor’s 

pension liabilities (35 plans in total).

At the 10 largest contractors, we interviewed officials whose 

responsibilities included benefits management and government 

accounting, as well as a number of actuaries supporting those 

contractors. We also interviewed Defense Contract Management Agency 

(DCMA) and Defense Contract Audit Agency (DCAA) officials with 

responsibilities covering contractor costs at headquarters, and at a 

number of specialized centers such as the DCMA Contractor 

Insurance/Pension Review (CIPR) Center and Contract Disputes 

Resolution Center, and the DCAA Compensation Team. We also 

interviewed DOD officials with cognizance for negotiation and oversight of 

pension costs at the corporate level for each of the 10 selected large 

contractors, including the DCMA Corporate Administrative Contracting 

Appendix I: Objectives, Scope, and 

Methodology 
Appendix I: Objectives, Scope, and 

Methodology

Page 50 GAO-13-158 Pension Costs on DOD Contacts

Officer (CACO), and DCAA officials including regional audit managers, 

resident auditors, and pension technical specialists. We interviewed a 

representative of the American Academy of Actuaries, and also met with 

representatives of the Pension Benefit Guaranty Corporation (PBGC) and 

the Department of the Treasury.

We reviewed various federal laws (e.g., the Pension Protection Act of 

2006). We also reviewed key rules and regulations, such as relevant 

sections of the Federal Acquisition Regulation (FAR) (e.g., FAR section 

31.205-6, Compensation for Personal Services), the Defense Federal 

Acquisition Regulation Supplement (DFARS) (e.g., DFARS Subpart 

242.73, Contractor Insurance/Pension Review), and CAS (e.g., CAS 412, 

Cost Accounting Standard for Composition and Measurement of Pension 

Cost, and CAS 413, Adjustment and Allocation of Pension Cost). We 

reviewed DCMA documentation including guidance on forward pricing 

rates and final overhead rates, and reports written by the DCMA CIPR 

Center. We reviewed DCAA documentation such as relevant sections of 

the DCAA Contract Audit Manual (e.g., Chapter 8, Cost Accounting 

Standards), and audit reports that address contractor pension costs. We 

also reviewed prior GAO work concerning pensions.

Further, to understand how DOD oversees pension costs at smaller 

contractors, we selected publicly traded contractors that: fell between the 

11th and 50th places in terms of DOD contract obligations for fiscal year 

2011; had total defined benefit pension plan assets of at least $1 billion; 

and had fiscal year 2011 DOD contract obligations representing at least 4 

percent of total 2011 net sales.1

• Alliant Techsystems Inc.

The following seven contractors met 

these criteria:

• Computer Sciences Corporation

• Honeywell International Inc.

• ITT Exelis

• Navistar International Corporation

• Rockwell Collins, Inc.

• Textron Inc.

 

1

Selection of 4 percent as a minimum level of DOD business relative to total sales 

excludes companies that, while large contractors in terms of total contract obligations, are 

overwhelmingly engaged in commercial business.
Appendix I: Objectives, Scope, and 

Methodology

Page 51 GAO-13-158 Pension Costs on DOD Contacts

At the seven smaller contractors we interviewed officials with pension 

management responsibilities. We also interviewed corporate-level DCMA 

officials with cognizance for the seven smaller contractors, and where 

available collected recent DCAA audit reports and CIPR Center reports 

related to pensions at those contractors.

To compare the defined benefit pension plans of large DOD contractors 

to those sponsored by similar companies, we selected a peer group of 15 

companies not among the largest DOD contractors based on analysis of 

contractor audited financial statements. Many of the contractors list a 

peer group they use to benchmark executive compensation in their 

financial statements. These peer companies may be selected for 

generally comparability in terms of company size, industry, or operations 

as well as their overall competitiveness with respect to similar employee 

skill sets and talent. Eight of the largest DOD contractors publish lists of 

their peers and we selected the 15 most prevalent companies (not 

including the DOD contractors themselves) that appeared across all eight 

lists. For both the contractors and the peer group, we analyzed annual 

reports and proxy statements for fiscal year 2011 to identify the status of 

pension plans and understand how pension plan assets are allocated.

To identify trends in CAS pension costs, for the nine largest contractors

with defined benefit plans we reviewed pension plan documents such as 

CAS valuation reports (generally certified by qualified and credentialed 

actuaries), summary plan descriptions, and CAS disclosure statements. 

We collected contractor data on incurred CAS pension costs from 2002 to 

2011. Our analysis of CAS valuation reports identified sources of current 

unfunded liabilities and CAS pension cost, as well as the difference 

between ERISA-required contributions and what the contractors have 

calculated as CAS pension cost. Note that for one large contractor, we 

excluded most pension data associated with a business that was recently 

spun off, in which the transaction included parts of several defined benefit 

pension plans. This was done in order to make the contractor’s past and 

projected pension cost data more comparable. CAS pension costs 

provided by contractors may or may not reflect their PBGC premiums. 

Where we were able to identify the premiums separately from other 

pension costs, their relative size was insignificant.

To understand how pension costs make their way onto DOD contracts, 

we selected divisions at the five largest contractors based on DOD 

contract obligations for fiscal year 2011, and at each division selected a 

weapon system program, which together represent a mix of military 

services and platform types. This selection was a nonprobability sample, 
Appendix I: Objectives, Scope, and 

Methodology

Page 52 GAO-13-158 Pension Costs on DOD Contacts

and the findings from these programs are not generalizable to all 

programs. Those divisions and programs were:

• Boeing Space and Intelligence Systems—Wideband Global SATCOM

• General Dynamics Electric Boat—SSN 774 Virginia Class Submarine

• Lockheed Martin Aeronautics—F-35 Joint Strike Fighter

• Northrop Grumman Electronic Systems—AN/PED-1 Lightweight 

Laser Designator Rangefinder

• Raytheon Missile Systems—Tactical Tomahawk R/UGM-109E

At the divisions, we interviewed contractor officials whose responsibilities 

included contracting and development of forward pricing rates. We were 

also briefed on how pension costs are incorporated into rates at each 

division. We interviewed DOD officials with cognizance at the divisionlevel for the five selected divisions, including the DCMA Divisional 

Administrative Contracting Officer (DACO) and local auditors.2

To demonstrate the potential impact on CAS pension costs of 

CAS/ERISA harmonization and changing economic assumptions, we 

developed a model of an illustrative contractor defined benefit plan, based 

on a review of the model DOD uses, and reviewed by the Chief Actuary of 

the GAO for actuarial soundness. For additional insight into the potential 

impact of harmonization, we gathered from the nine largest contractors 

projections (prior to and following harmonization and the Moving Ahead 

for Progress in the 21st Century Act (MAP-21)) of CAS pension costs for 

2012 to 2016, where available. For the five selected divisions, we also 

gathered projections of pension costs for 2012 to 2016. We also 

interviewed the Project Director detailed to the CAS Board to lead the 

team that harmonized CAS with ERISA. We reviewed changes made to 

the CAS in December 2011 to harmonize it with ERISA. We also 

reviewed DOD policies related to CAS/ERISA harmonization, such as the 

Office of the Under Secretary of Defense for Acquisition, Technology, and 

Logistics memorandum providing guidance on harmonization.

For the 

five divisions, where available we collected contractor data on each 

division’s incurred pension costs from 2005 to 2011, and within each 

division, the individual programs’ incurred costs from 2005 to 2011. This 

period represents years for which data was generally available across 

selected programs.

 

2

For one division, duties similar to those of DCMA at other contractors were performed by 

the Supervisor of Shipbuilding, Conversion and Repair. 
Appendix I: Objectives, Scope, and 

Methodology

Page 53 GAO-13-158 Pension Costs on DOD Contacts

We conducted this performance audit from December 2011 to January 

2013 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives.
Appendix II: Comments from the Department 

of Defense

Page 54 GAO-13-158 Pension Costs on DOD Contacts

Appendix II: Comments from the Department 

of Defense
Appendix II: Comments from the Department

of Defense

Page 55 GAO-13-158 Pension Costs on DOD Contacts
Appendix II: Comments from the Department 

of Defense

Page 56 GAO-13-158 Pension Costs on DOD Contacts
Appendix III: GAO Contacts and Staff 

Acknowledgments

Page 57 GAO-13-158 Pension Costs on DOD Contacts

Cristina T. Chaplain, (202) 512-4841 or chaplainc@gao.gov; Charles A. 

Jeszeck, (202) 512-7215 or jeszeckc@gao.gov. 

In addition to the contacts named above, Karen Zuckerstein, Assistant 

Director; Kimberley Granger, Assistant Director; Robert Bullock; Robert 

Dacey; Charles Ford; Laura Greifner; John Krump; Gene Kuehneman; 

Kenneth Patton; David Reed; Matthew Shaffer; Roxanna Sun; Daren 

Sweeney; Aron Szapiro; Roger Thomas; Frank Todisco; and Jocelyn Yin

made key contributions to this report.

Appendix III: GAO Contacts and Staff 

Acknowledgments 

GAO Contacts

Staff 

Acknowledgments 

(121028)
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