Department of Energy: Progress Made Overseeing the Costs of Contractor Postretirement Benefits, but Additional Actions Could Help Address Challenges
Released: 2011-05-31T00:00:00

Letter

Background

DOE’s business model relies on contractors to carry out the bulk of the department’s mission activities through management and operating contracts and other site contracts for operations at DOE-owned facilities, while employing federal officials to set mission objectives and provide contract oversight. This business model dates from the Manhattan Project, when federal officials contracted with private companies and universities to develop and produce the atomic bomb. Under this business model, contractors manage and operate DOE facilities—including research laboratories, production and test facilities, and nuclear waste cleanup and storage facilities—located throughout the country. Generally, DOE requires these contractors to be corporate entities formed for the specific purpose of managing and operating a facility and requires the contractors to integrate their accounting systems and budget processes with those of the department. DOE also generally requires contractors that take over a contract to hire the existing contractor workforce at a facility. As a result, with the exception of top managers, the workforce at a facility generally remains in place despite changes in contractors. DOE oversees contractors’ activities through its headquarters program offices—primarily the National Nuclear Security Administration (NNSA), the Office of Environmental Management, and the Office of Science—and site offices located at each facility.

Under its business model, DOE reimburses contractors for the allowable costs of employee compensation, including benefits such as pension and other postretirement benefits. DOE is ultimately responsible for reimbursing its contractors for the cost of these benefit plans, and reports a liability or asset in its financial statements for the funded status—that is, plan obligations minus plan assets—of these benefit plans. When site contracts are recompeted or expire, it is DOE’s policy to ensure the continuation of these benefits for incumbent contractor employees and eligible retirees by, for example, requiring the transfer of benefit plan sponsorship responsibilities to a successor contractor or related company.

Although other federal agencies use contractors to operate facilities and reimburse those contractors for their allowable benefits costs, DOE is unique in the percentage of its budget that goes to site contractors. For example, while the National Institutes of Health funds a contractor- operated research facility and requires the facility contractor to assume sponsorship of existing employee benefit plans, the agency devotes only about 1.5 percent of its budget toward this contract. In contrast, 90 percent of DOE’s budget goes toward such contracts. As a result, a large increase in reimbursement costs for contractors’ employee benefits is more likely to have a significant impact on DOE’s budget than a similar increase would for agencies devoting a smaller percentage of their budget toward contracts for operating government-owned facilities.

DOE’s contractors sponsor pension plans for their employees, including both traditional pension plans, known as “defined benefit” plans, and 401(k) or similar plans, known as “defined contribution” plans. As of September 2010, DOE was responsible for reimbursing contractors for 50 defined benefit plans, including 40 qualified plans and 10 nonqualified plans. Of the qualified defined benefit plans, 37 are private-sector plans while 3 are public-sector plans. DOE’s contractors that sponsor private- sector pension plans must comply with the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (ERISA), which establishes minimum funding standards for the amounts that private- sector plan sponsors must set aside in advance to pay benefits when they are due. DOE’s current policy is to reimburse contractors for contributions made by the contractors to their qualified defined benefit plans and to reimburse contractors for their nonqualified plans on a pay- as-you-go basis. DOE reimburses contractors for their contributions to defined contribution plans as well.

DOE’s contractors also sponsor a variety of other postretirement benefits plans. Although these benefits can include dental and life insurance coverage, the majority of DOE reimbursement costs are for retiree health care benefits. As of September 2010, DOE was responsible for reimbursing 41 contractors for retiree health care payments, although the specific benefits offered to retirees varied across contractors. For these other postretirement benefits, DOE’s contractors typically do not set aside funds in advance because, in contrast to requirements for funding pension benefits, there are generally no requirements and few incentives to do so.

As a result, DOE reimburses contractors on a pay-as-you-go basis for the amount needed to meet the employer’s annual share of these costs, and these benefit obligations represent a continuing liability for DOE.

Since September 1996, DOE Order 350.1, Contractor Human Resource Management Programs, has set forth DOE’s policy for the oversight and reimbursement of contractor benefit plans. In particular, this order requires that DOE determine whether contractors’ benefit costs are reasonable and allowable and therefore reimbursable. To help make this determination, DOE Order 350.1 requires that contractors “benchmark” the value or cost of their total benefit package by conducting either a benefit value or cost study that compares the value or costs of this total benefit package to those of comparable organizations.

A small number of contractor pension plans account for a large percentage of DOE’s contractor pension liabilities. As shown in figure 1, 12 plans have liabilities—specifically, projected benefit obligations—that exceed $1 billion and account for $31.4 billion, or 86 percent, of the $36.7 billion in total liabilities represented by all DOE contractor qualified defined benefit plans. Within those 12 plans, pension liabilities are concentrated among a handful of contractor plans. NNSA oversees contractors that sponsor 6 of the 12 plans, including the 3 largest plans that, combined, account for over one-third of all DOE contractor pension liabilities.

As shown in figure 2, DOE’s costs for reimbursing contractor pension and other postretirement benefits have grown since 2000 and are projected to increase in coming years. From fiscal year 2000 to fiscal year 2010, DOE’s annual costs for reimbursing contractor pension contributions ranged from a low of $43 million in 2001 to a high of $750 million in 2009. Although projections of future contributions are inherently sensitive to underlying assumptions and can change significantly over time, DOE estimates, on the basis of data provided by its contractors in November 2010, that necessary contractor pension contributions may rise markedly in fiscal year 2012—to almost $1.7 billion—in large part because of expected increases among plans with the largest liabilities. Although useful as an indicator of the financial pressures that could lie ahead, this projection is subject to much uncertainty because of factors that could result in changes in the size or timing of needed contributions to meet future years’ funding requirements. Specifically, projections are particularly sensitive to the future economic environment, especially with respect to future interest rates and asset returns, and also could be affected by legislative changes to funding rules. For example, an October 2009 DOE analysis showed that projected minimum required contributions among the 10 largest contractor pension plans could vary by $2 billion or more in any given year during fiscal years 2012 through 2019, depending on changes in interest rates. Although DOE’s reimbursement costs for its contractors’ other postretirement benefits have not fluctuated as widely as contractor pension costs, those costs have grown steadily since 2000 at an average annual rate of 8 percent and are currently projected to rise at a slightly higher rate of 9 percent over the next 5 years.

Within Its Current Business Model, DOE Has Limited Influence over Contractor Pension and Other Postretirement Benefit Costs

Under its current business model, DOE has limited influence over contractor pension and other postretirement benefit costs. Specifically, contractors sponsor the plans and therefore control the types of benefits offered employees and the investment strategies for allocating pension plan assets; they also determine the amounts paid into plans. In addition, external factors beyond both DOE’s and the contractors’ control, such as economic conditions and changes in statutory requirements, have significant effects on benefit costs incurred by contractors and, in turn, affect the amount of allowable costs that DOE reimburses contractors. Despite these constraints, however, DOE can exercise some limited influence over contractor pension and other postretirement benefit costs through its oversight efforts, reimbursement policy, and contract requirements.

Contractors, Not DOE, Sponsor and Manage Their Employee Benefit Plans

DOE has limited influence over contractor pension and other postretirement benefit costs under its current business model because contractors, not DOE, sponsor the plans. As shown in table 1, contractors control the types of benefits offered to employees and the benefit plans’ design. Moreover, contractors are responsible for managing those plans, including selecting strategies used to invest pension plan assets and determining, within statutory requirements, how much is paid into the plans. Because contractors control both the design and management of employee benefit plans, their decisions can significantly affect the magnitude of benefit costs and the volatility of pension contributions. Nevertheless, although DOE has limited influence over these decisions, the department is responsible for reimbursing its contractors for the allowable costs of providing pension and other postretirement benefits, including retiree health care, to current and former employees and their beneficiaries.

According to DOE documents and officials, contractors decide what type of benefits to provide to their employees and how to design benefit plans, and these decisions are part of an overall compensation strategy devised to recruit and retain the workers they need to fulfill their mission. With respect to pensions, contractors may offer defined benefit plans, defined contribution plans, or both, and the content of the plans may vary. For example, the contractor at DOE’s Oak Ridge National Laboratory offers both a defined benefit plan and a defined contribution plan to all employees, while the contractor at DOE’s Savannah River Site offers a defined benefit plan and a defined contribution plan to employees hired before August 1, 2008, but only a defined contribution plan to employees hired after that time. Contractors may change the pension benefits offered to employees, in accordance with ERISA, and many have been doing so, echoing the overall national trend from defined benefit to defined contribution plans. For instance, the contractor at Sandia National Laboratories changed its benefit package so that non-union employees hired after December 31, 2008, have a defined contribution plan, while existing employees remain participants in a defined benefit plan.

Contractors also determine other elements of plan design, such as eligibility and vesting requirements, within the parameters set by the Internal Revenue Code and ERISA. Moreover, in the case of defined benefit plans, contractors determine, among other things, the formula used to calculate benefits owed to employees, as well as additional provisions affecting costs, such as early retirement. In the case of defined contribution plans, they determine how much to match employee contributions and what investment options employees will have, among other things.

In addition to their control over pension benefits, contractors also control their offerings for other postretirement benefits, and they can change these packages as they deem appropriate, subject to DOE approval for reimbursement purposes. For example, at Sandia and Los Alamos National Laboratories, new hires receive access-only postretirement health care benefits, which means that, as retirees, they will have to pay the plan’s full benefit premiums. At DOE’s Savannah River Site, the contractor has steadily increased its retirees’ share of health care and dental costs since 2003, although the contractor continues to subsidize a portion of the premiums.

Contractors also manage the pension plans they offer, and they have a fiduciary responsibility to manage plan assets in the sole interest of the plans’ beneficiaries. The contractors’ fiduciary role takes precedence over their responsibility to DOE and therefore limits DOE’s influence over the plans and the associated costs. Plan management includes selecting investment strategies for defined benefit pension assets. In choosing strategies for investing defined benefit plan assets, contractors make a trade-off between risk and return. For example, bonds, because of their higher correlation to pension liabilities, can decrease the volatility in plan funding and potentially required contributions. On the other hand, equities generally come with greater risk, but also greater expected returns relative to bonds. Consequently, investment strategies relying relatively more on equity returns are likely to provide volatile plan funding and contributions.

The performance of contractors’ investment portfolios can affect the contributions contractors make to the plans and, in turn, their reimbursable costs. For example, declines in the fair market value of plan investments decrease the funded status of the plan. In such a situation, contractors may be required to increase their annual pension contributions over a period of years, which DOE may in turn be obligated to reimburse. Moreover, volatile investment returns can result in fluctuations in pension contributions from year to year. As a result, DOE ultimately bears the investment risk incurred by the contractor sponsoring the plan. DOE officials stated that the agency encourages contractors to make investment decisions that reduce volatility but—because DOE’s role is limited to oversight and contractors have the fiduciary responsibility for plan administration—does not provide guidance on how to do so, nor otherwise dictate how contractors should allocate plan assets.

Plan management also includes making decisions about funding contractor pension plans. Contractors, not DOE, are responsible for determining, within statutory requirements, the amounts they pay into their benefit plans. Funding requirements vary among the defined benefit plans offered by DOE contractors, making it difficult to obtain a clear picture of pension contribution requirements across plans and over time. For example, three different sets of funding requirements apply to the range of DOE contractor pension plans. Additionally, three contractor pension plans, including the second largest plan, were eligible for special provisions from plan year 2008 to plan year 2010, which reduced their plan liabilities. Figure 3 illustrates the distribution of general funding requirement types among DOE contractor pension plans.

Contractors, according to the funding requirements applicable to their qualified pension plans, determine the minimum contribution they must make to the plans. A contractor’s minimum contribution is generally considered an allowable cost for reimbursement by DOE because the contractor incurs this cost to meet its contractual obligation with DOE to maintain the pension plan’s eligibility for favorable tax treatment under the Internal Revenue Code. While contractors are obligated to pay only the minimum required contribution, under DOE policy they can also ask the department to reimburse them if they contribute more than the minimum. A contractor might choose to contribute more than the minimum in the current year to, for example, avoid benefit restrictions that would otherwise come into effect on the basis of the pension plan’s funding level. In addition, a contractor might wish to contribute more than the minimum to build credit balances that it could use in future years to try to level the amount it budgets for pension contributions.

External Factors beyond DOE and Its Contractors’ Control Can Significantly Affect Benefit Costs

External factors over which DOE and its contractors have no control, including economic conditions and changes in statutory requirements, can significantly affect contractor reimbursement costs. For instance, changes in economic conditions can significantly affect necessary pension plan contributions, which are, in part, determined by actuarial assumptions about the future, and these assumptions are used to calculate the value of plan assets and liabilities, such as employee turnover, and compensation increases. Furthermore, minimum contribution requirements can vary from year to year as the result of fluctuations in the investment performance of plan assets. For example, the significant decline in value of the financial markets in 2008 caused a considerable drop in plan assets. In addition, changes in the interest rate can significantly affect contractor pension contributions. For instance, according to DOE officials, a drop in interest rates has contributed to increases in calculated plan liabilities, which, along with other factors, has led to a significant increase in contractor pension contributions. Officials further noted that, in part because of recent economic conditions, some contractors contributed to their pension plans for the first time in years. For example, a contractor at Oak Ridge National Laboratory told us that in fiscal year 2010, in part as a result of the recent financial market crisis and changing interest rates, it budgeted for the first contributions to the site’s defined benefit plan since 1984. The variability in investment returns and interest rates, which influences the calculation of plan contributions, also adversely affects DOE’s ability to accurately forecast the costs of pension contributions in its budget requests.

Changes in economic conditions can also affect other postretirement benefit costs. Changes in health care and other cost trends can influence the cost of these benefits and, in turn, the amount that must be reimbursed by DOE. For example, officials at DOE’s Savannah River Site explained that as health care costs increase nationally, the cost of providing retiree health care to their employees has also increased. Los Alamos National Laboratory officials attributed their rising health care costs to a variety of factors, including increases in emergency room and radiology costs.

Changes in statutory requirements can also have a significant effect on contractor benefit costs. For example, the funding requirements that govern a large majority of DOE contractor private-sector pension plans have been changed or significantly amended over the last 5 years. One of the most sweeping amendments to ERISA and the minimum-funding rules occurred with the passage of the Pension Protection Act of 2006. This act—prompted, in part, by the default of several large pension plans— increased the minimum funding requirements for pension plans and sought to strengthen the private pension system. Many of the funding rule changes for single-employer plans came into effect slowly, however, and included special rules that provided funding relief for certain plan sponsors. Additionally, almost as soon as the act began to take effect in 2008, the economy weakened, and further statutory and regulatory changes occurred that had the overall effect of reducing or delaying pension contributions that would otherwise have been required. The number and timing of statutory and regulatory changes since the enactment of the Pension Protection Act of 2006 makes it difficult to determine how much of an effect the law has had on contractor contribution requirements. During our site visits, some contractors reported an increase to their minimum required contributions since the act’s implementation, but these increases are the combined result of multiple factors, including economic and demographic experience and legislative changes. Contractor costs for other postretirement benefits can also be influenced by changes in statutory requirements. For instance, according to DOE documentation, passage of the Patient Protection and Affordable Care Act in 2010 may affect contractors’ other postretirement benefits in a variety of ways, such as by levying an excise tax on high-cost health plans.

and Contract Requirements

Despite the constraints posed by DOE’s current business model, our analysis of DOE documents—including department policy, budget documents, and contract provisions—indicates that the agency has several means—oversight efforts, reimbursement policy, and contract requirements—by which it can exercise some limited influence over contractor pension and other postretirement benefit costs (see table 2). While DOE will ultimately have to reimburse the cost of contractor pension benefits that have already been accrued, it can use these means to exert some influence over future benefit costs.

First, DOE decides its degree of oversight over benefit costs, including the amount of detailed information related to these costs that it collects and reviews and the extent to which it communicates that information to department officials and congressional decision makers. While DOE’s oversight efforts do not control costs directly, according to department officials, they help increase awareness of cost management on the part of both the department and contractors and can encourage discussion between the two on ways to mitigate costs where appropriate. Specifically, DOE determines the amount of information contractors must provide about benefit costs and the frequency with which they must do so, the degree of departmental review, and how readily available that information is to decision makers. For instance, DOE policy requires contractors to periodically assess their benefit packages and submit the results of these evaluations to the department. Generally, the contractor must take corrective action if the value of the benefit package exceeds 105 percent of comparable companies’ plans. Moreover, DOE requires contractors to provide the department with cost projections and information on direct and indirect costs as they relate to pension and other postretirement benefits.

Second, through its reimbursement policy, DOE sets requirements that determine the extent to which contractor benefit costs qualify for reimbursement. In April 2006, in response to growing liabilities for contractor employee benefits, DOE issued Notice 351.1, which provided that the department would continue to reimburse contractors for the allowable benefit costs for incumbent employees and eligible retirees but limit reimbursement for new employees to the costs of “market-based” pension and health benefit plans. A pension plan was deemed market- based when, among other things, the plan was a defined contribution plan.

In June 2006, however, DOE suspended the notice, and in response to stakeholder and congressional concerns, subsequently decided not to reissue it. Although the policy change was ultimately reversed, it demonstrated that DOE can potentially use its reimbursement policy to exercise some influence over contractor benefit packages. Currently, DOE policy provides for reimbursement of a contractor’s minimum required pension contribution while giving program offices the discretion to approve higher reimbursement levels. In addition, in accordance with department policy, contractors must obtain DOE approval for any plan changes that can affect reimbursement costs. In asking to change a plan, a contractor must submit justification that, among other things, estimates savings or costs and provides the basis for this determination.

Third, DOE establishes contract requirements that determine the degree of flexibility contractors have in structuring and modifying their benefit packages and, through these requirements, can exercise some influence over contractor decisions on benefits. Although DOE cannot unilaterally alter an existing contract, it can negotiate with a contractor to include new provisions in an existing contract, as well as in a contract that is extended or newly awarded. By contractually obligating successor contractors to assume sponsorship of existing benefit plans, DOE has generally required that benefits be continued for existing employees and eligible retirees. Since 2005, however, the department has used a contract provision requiring contractors to provide market-based pension and health care benefit plans for new employees. As a result, some contractors have shifted from providing all employees defined benefit plans to offering new employees defined contribution plans, and some contractors have also stopped providing other postretirement benefits to new employees. For example, in 2006, the new contractor that assumed responsibility at Los Alamos chose to offer new employees only a defined contribution plan, while giving incumbent employees who worked at the site before the transition the option of participating in a defined benefit plan or the defined contribution plan. The contractor at Savannah River also closed its defined benefit plan to employees hired after 2009 and, in addition, ceased offering some other postretirement benefits to new employees. According to NNSA officials, NNSA is now exploring a further shift in contract requirements for sites it oversees, to allow successor contractors to alter existing employees’ benefit packages.

DOE Has Taken Steps to Enhance Its Management of Contractor Pension Costs but Has Not Comprehensively Reviewed Other Postretirement Benefits or Issued Complete Guidance

Since the economic downturn deepened in 2008, DOE has taken steps to enhance its management of contractor benefit costs—particularly for contractor pensions—but gaps remain in its approach. Before 2008, DOE had made some changes but had not exercised the full range of measures at its disposal. Since then, DOE has taken additional steps to address its approach to contractor benefit costs, but more could be done. Specifically, DOE has strengthened its oversight of contractor pension costs, but it has yet to review its approach to overseeing other postretirement benefit costs or to clearly inform Congress of those costs and their potential impact on mission work. As a result, DOE may be delayed in improving its oversight of those benefits, and potentially not provide important information to Congress that could inform annual funding decisions. DOE has, for the most part, continued to insert the same contract requirements since 2005 and use the same reimbursement policy since 1996, but it lacks clarifying guidance to ensure a consistent approach to evaluating contractor benefit costs. As a result, DOE is unable to ensure that program offices apply that policy consistently, and it continues to reimburse contractors for benefit packages that have exceeded its standard for a prolonged period.

DOE Has Strengthened Its Oversight of Contractor Pension Costs, but It Has Yet to Review and Clearly Communicate to Congress the Cost of Other Postretirement Benefits

DOE has strengthened its oversight of contractor pension costs by changing how it collects, analyzes, and communicates information on those costs. First, in a January 2010 memo, the department announced the creation of an annual review process to more systematically analyze the status of each contractor’s pension plan and the contractor’s strategy for managing the plan. Second, DOE created a central database in October 2010 to regularly collect and report information on contractor benefit costs. Third, DOE increased the information it communicates to Congress on contractor pension costs by adding an explanation of those costs to its fiscal year 2011 budget request. The department has done less on other postretirement benefit costs, however. DOE officials had stated that they expected to begin a review in spring 2010 of the department’s approach to other contractor benefits similar to the one done for contractor pensions, but as of January 2011, the department has not followed through with these plans. Moreover, DOE has not added information to its budget request on its contractors’ nonpension postretirement benefit costs. While contractor pension costs have risen sharply since 2009, the cost of other postretirement benefits is also significant and growing.

In January 2010, DOE set up an annual review process for contractor pensions that allows the department to more systematically analyze contractor pension data and each contractor’s strategy for managing its plan. Specifically, DOE guidance requires each contractor to submit a standard report on its pension plans at the start of each year. This report must include information on the plan’s current funding status and the contractor’s estimates for how much it will need to contribute to the plan during the current fiscal year and the 4 fiscal years after that. In addition, the contractor must provide the key assumptions and methods used to develop its estimates. If the estimates indicate that a plan’s funding level could drop enough to force the contractor to impose benefit restrictions, the contractor must describe the impact of the benefit restrictions, the number of employees the restrictions might affect, the additional funds needed to avoid those restrictions, and whether it recommends contributing those funds to the pension plan. The contractor must also include an assessment of its pension plan’s investment management and the results of its current investment strategy. After contractors submit this report, DOE guidance requires contractor personnel to meet with department officials from headquarters and the field to discuss the contractor’s pension strategy and the reasons for any differences between its current pension contribution estimates and prior estimates. In addition, DOE officials and contractor personnel are to discuss how the contractor intends to increase the predictability of its pension contributions and contain current and future costs. According to DOE guidance, a goal of this annual review process is to improve the accuracy and predictability of DOE budget forecasting for funding its contracts by requiring contractors to provide their estimated contribution amounts to their pension plans, both for the immediate year and the subsequent years, on the basis of a range of actuarial assumptions. In addition, these discussions are meant to provide DOE with opportunities to increase its ability to share information concerning contractor costs with key stakeholders across the department.

DOE has also created a central database to regularly collect information on contractor benefit costs, which is intended to facilitate analysis, as well as ensure current reporting on those costs. DOE set up the database in October 2010 and is requiring contractors to regularly update information on their benefit plan costs and characteristics. Specifically, DOE guidance requires contractors to report on, among other things, their current pension assets and liabilities and 5-year budget projections for pension and other benefits. Before implementing the database, DOE relied on ad hoc data requests to contractors to collect information on pension plans and other postretirement benefits. For example, in 2010, DOE requested pension and other benefit data from each contractor and shared that information in the form of site-specific “snapshots” to all of its contractors and program offices. In contrast to these data requests, which DOE and contractor officials at several sites found redundant or time-consuming, DOE guidance explains that the database is intended to provide a structure for capturing information obtained through the annual pension review process, as well as to expand data collection to other contractor benefits and readily report information on those benefits. By scheduling regular data requests and storing information in a central system, DOE has taken actions that help to streamline the data collection process and facilitate analysis and up-to-date reporting on contractor benefit costs.

While DOE has reviewed its approach to overseeing contractor pension plans, it has yet to devote a similar level of attention to other postretirement benefits. While our analysis of DOE financial data indicates that other postretirement benefit costs have generally been less volatile than those of pension plans, these costs have steadily risen over the last 10 years, amounting to $385 million in fiscal year 2010. According to federal standards for internal control, federal agencies are to employ internal control activities, such as top-level review, to help ensure that management’s directives are carried out and to determine if the agencies are effectively and efficiently using resources to assess risks from both internal as well as external sources. Consistent with these standards, DOE has collected and analyzed some information on the risk it faces from other postretirement benefits. For example, in May 2010 DOE issued a summary of its analysis on contractor pension plan and other benefits, including postretirement health care benefits. But it has not comprehensively reviewed its approach to overseeing those benefits or correspondingly changed its policy on how it manages other contractor benefit costs. DOE officials had stated that they expected to begin a review of benefits other than pensions in spring 2010. As of January 2011, however, DOE had yet to begin its planned review, according to an agency official, because of the department’s continuing work on contractor pensions. This official stated that the department still planned to review its approach to other postretirement benefits, but it was not clear when the review would begin.

Without comprehensively reviewing its approach to overseeing other contractor benefits, including postretirement benefits other than pensions, DOE may be delayed in improving its oversight of those benefits and identifying policy options that might reduce or better address the growth of reimbursement costs. For example, in a 2004 report on this topic, we recommended that DOE incorporate into its oversight process a focus on the long-term costs and budgetary implications of decisions pertaining to each component of contractor benefit programs, especially pension and postretirement health benefits, which have budgetary requirements beyond the current year. DOE has taken steps to incorporate such a focus into its oversight of contractor pension costs through its annual review process, but it has yet to incorporate a similar focus on long-term costs and budgetary implications into its oversight process for other postretirement benefit costs. Further, while DOE reimburses other postretirement benefits on a pay-as-you-go basis, an option for addressing its liabilities is to reimburse contractors for prefunding some or all retiree benefits, particularly those associated with health care, before employees retire. By reimbursing contractors for prefunding these benefits, DOE may be able to reduce the unfunded liability reported in its financial statements and take advantage of the compounding effects of investment returns on plan assets. Nevertheless, while prefunding more effectively recognizes costs when the associated work is being performed, in the short term prefunding might require higher contractor contributions, which would in turn increase DOE’s short-term reimbursement costs. In addition, opportunities for prefunding other postretirement benefits and nonqualified pension benefits are more restricted than for tax-qualified benefits. By not comprehensively reviewing its approach to its contractors’ other postretirement benefits, DOE has yet to systematically weigh the advantages and disadvantages of these and other potential policy changes that might enhance its approach.

Moreover, although DOE has taken steps to improve its communication to Congress of key information concerning contractor pension costs, it has yet to provide similar information on the costs of other postretirement benefits and their potential impact on mission work. DOE expanded the information it provides to Congress in its fiscal year 2011 budget request by adding a discrete section explaining contractor pension costs. This section outlined contractor pension costs for the upcoming fiscal year and 2 prior years by program office and site. In addition, the section included a discussion of the challenges and risks DOE faces in managing contractor pension costs. The addition of this information is an improvement over prior budget requests, which included only isolated references to contractor pension costs and did not provide an agencywide picture of the magnitude of those costs. But DOE did not provide the pension information in a format consistent with the appropriation accounts that Congress uses to provide funding to the department. As a result, the information may be less useful to Congress than it otherwise could be.

Moreover, DOE did not include agencywide information on other postretirement benefit costs in its fiscal year 2011 request, nor did it add such information to its fiscal year 2012 request. Yet DOE reimbursements to contractors for other postretirement benefits have risen steadily from roughly $306 million in fiscal year 2005 to $385 million in fiscal year 2010. By not including an explanation of these costs in its budget request, DOE is not providing Congress with complete information on the full cost of its contractor retirement benefits and their potential impact on the resources DOE has available to accomplish its mission work. As a result, Congress lacks important information that could inform its annual funding decisions.

DOE Has Largely Continued Its Existing Contract Requirements and Reimbursement Policy but Lacks Clarifying Guidance to Ensure a Consistent Approach to Contractor Benefit Costs

DOE has, for the most part, continued to insert the same contract requirements since 2005 and use the same reimbursement policy from 1996, but it lacks complete guidance on how program offices should evaluate contractor requests to contribute more than the minimum required to their pension plans, and it also lacks a comprehensive timeline for modifying contractor benefit packages with values that exceed DOE standards. DOE has inserted language into new and renewed contracts that ties the reimbursement of contractor benefit costs for new employees to market-based benefit packages and increases how frequently contractors must assess their benefit packages. DOE Order 350.1 does not reflect these updated requirements, although DOE officials said the department plans to revise the order by removing certain sections and adding applicable provisions to its acquisition regulations. But because of procedural delays and the sensitive nature of the order’s content, officials stated they do not expect this revision of the order for some time.

Aside from a brief change in 2009, DOE has largely maintained its reimbursement policy for contractor benefits. The Office of Management and Budget’s implementing guidance emphasizes the need for agencies to develop policies that ensure the effectiveness and efficiency of their operations. In keeping with this guidance, DOE’s policy, as reflected in DOE Order 350.1, is to reimburse contractors for the minimum amount required by ERISA or more on a case-by-case basis. Also in keeping with Office of Management and Budget guidance, DOE reimbursement policy defines the reasonableness of reimbursement costs by requiring contractors to benchmark the value of pension and other benefits with those of comparable companies and to reduce the value of benefits if they exceed the overall benchmarked average by more than 5 percent.

Nevertheless, DOE lacks complete guidance on how its program offices should evaluate contractor requests to contribute more than the minimum required to their pension plans in order to carry out this revised policy. In particular, DOE has not outlined a standard process or criteria for evaluating requests to contribute more. Despite Office of Management and Budget criteria, DOE program officials we interviewed were not aware of any departmentwide guidance on factors to consider when deciding to approve or deny contractor requests to contribute more than the minimum. For instance, DOE does not specify whether program offices should place a higher priority on minimizing contribution volatility or reducing cost when evaluating contractor requests. As a result, DOE’s program offices use different evaluation procedures and may not consider the same factors when deciding whether to approve or deny contractor reimbursement requests.

By using different evaluation procedures, DOE program offices may implement DOE’s reimbursement policy inconsistently. For example, according to DOE officials, NNSA and the Office of Science have generally approved contractor requests to contribute additional funds to their pension plans for reasons such as leveling site or program office budget costs, while the Office of Environmental Management has generally denied such requests and instead directed those additional funds toward mission work. In particular, one site official stated that Environmental Management’s denial of a contractor request to contribute more than the minimum in 2010, with the intent of reducing future reimbursement costs, prompted the site to alter its planned budget allocations and mission work. Additionally, this denial resulted in a drop in the plan’s funding to a level at which plan restrictions went into effect for employees. In contrast, NNSA approved a similar request aimed at managing the anticipated rise in future pension costs. NNSA officials stated that in making these decisions, the office considers whether the contractor has made a compelling case that the higher contribution will reduce or level future budget costs. According to another DOE official, the Office of Science uses a set of criteria based on prior pension management performance, as well as an analysis of the contractor’s assumptions and investment strategies. An official from the Office of Environmental Management stated that, unlike NNSA and the Office of Science, the office will not reimburse pension contributions exceeding the minimum unless funding at the minimum level would restrict benefits. Without standard guidance for its program offices, DOE is unable to ensure that its offices are deciding on contractor requests on the basis of consistent criteria reflecting departmentwide goals for managing contractor pension costs. As a result, program offices may not systematically consider both near-term mission needs and potential spikes in future reimbursement costs when reaching their decisions.

In addition, DOE’s existing process is incomplete for correcting contractor benefit packages that exceed its reimbursement standard. Specifically, DOE lacks a comprehensive timetable for when a contractor must modify the value of its benefit package to fall within DOE’s reimbursement standard. DOE requires contractors to regularly assess whether the value of their benefit packages is reasonable relative to comparable companies and to take corrective actions if they do not meet that standard.

Specifically, DOE guidance requires contractors to implement corrective action plans if the assessments, known as value studies, show that the value of a contractor’s benefit package is more than 5 percent of the average value of 15 selected entities in similar lines of industry. DOE guidance stresses that the goal of the value study is to measure the relative worth of a contractor’s total benefits package, regardless of the actual payroll costs associated with the benefits.

DOE guidance requires contractors to implement corrective action plans within 2 years, but the guidance does not include a defined timeline by when contractors must submit, and DOE contracting officers must decide whether to approve, contractors’ corrective action plans. As a result, some contractors with benefit package values exceeding 105 percent may spend several years developing corrective action plans. From our analysis of DOE data, of the 20 contractor benefit packages most recently assessed as exceeding the 105 percent standard, 3 were being corrected as of February 2010. Of those 3 benefit packages, one is expected to be reduced to below DOE’s standard, but another is expected to exceed DOE’s standard even after the contractor finishes taking its corrective actions, and it is unclear whether the third benefit package’s corrective actions will bring the score to below DOE’s standard. Contractors for 5 benefit packages that exceed DOE’s standard, some from as early as 2008, have yet to implement corrective action plans, either because the contractors are developing them or because DOE has yet to approve them. For example, one contractor whose August 2008 value study showed its benefits exceeding the threshold value does not yet have an approved corrective action plan, more than two and a half years after discovering its benefits were too high. According to a DOE document, the contractor submitted a corrective action plan that was disapproved by NNSA and, after analyzing different alternatives at NNSA’s request, decided to resubmit its original plan for reconsideration. As of February 2011, NNSA had notified the contractor that approval of its corrective action plan was being deferred pending the results of the contractor’s 2011 value study. In another instance, DOE directed a contractor to develop a corrective action plan in May 2010 after the contractor’s July 2009 value study exceeded DOE’s standard. According to a DOE document, the contractor submitted a corrective action plan in September 2010, but that plan has yet to be approved by NNSA because the plan, as submitted, was lacking in detail. As a result, only one contractor with benefit packages exceeding DOE’s standard for the most recent evaluation period is expected to bring its benefits in line with DOE’s requirements.

Furthermore, DOE guidance states that, on the basis of a contractor’s written justification, contracting officers may waive the requirement for contractors to develop a corrective action plan. But neither DOE policy nor guidance provide details on the process the contracting officers should use or the factors they should consider when deciding whether to waive the corrective action plan requirement. Moreover, the DOE headquarters offices with responsibility for overseeing contractor human resource management issues are not required to review the contracting officers’ decisions to issue waivers. In addition, a DOE official stated that the agency does not have departmentwide criteria for evaluating contracting officers’ rationale for waiving corrective action. As a result, DOE lacks assurance that contractor requests to waive corrective action plans are being consistently evaluated across the department or that decisions to allow benefit plans to remain above DOE’s standard— sometimes significantly—are based on departmentwide criteria. For the most recent value study, our analysis of DOE data showed that contracting officers issued waivers to eight contractors for a range of reasons, including marginal differences between DOE’s standard and the contractor’s score and recognition of a contractor’s previous efforts to reduce its score. Also according to DOE data, officials waived the requirement for one contractor whose score exceeded the DOE standard in part because of opposition from the site’s employee group. As a result, contractors whose scores exceed DOE’s standard may remain above that level for an undefined period and continue to accrue liabilities and be reimbursed for the cost of benefits that may not meet DOE’s standard.

Conclusions

Given DOE’s long history of using contractors to accomplish its mission and its growing unfunded liabilities for contractor pension and other postretirement benefits, it is important that DOE manage its contractual obligations associated with those benefits so as to ensure both the successful accomplishment of its mission objectives and the cost-effective use of government resources. While contractor retirement benefits are only one piece of total contractor compensation, in an era of federal budget constraints, DOE will likely continue to face significant challenges managing the costs of those benefits and mitigating their impact on funding available for the department’s mission activities. In particular, in some cases it will have to reimburse the costs of the substantial pension liabilities its contractors have accumulated over decades. While the volatility of pension contributions and the growth in other postretirement benefit costs are not unique to DOE’s contractors, the department’s extensive reliance on contractors and its limited influence over their benefit packages makes the department’s budget particularly sensitive to these factors. DOE’s recent review of contractor pension plans and the resulting oversight and transparency improvements are positive steps. Nevertheless, DOE has yet to comprehensively review its approach to managing other postretirement benefit costs as it has for contractor pensions, although the cost of these benefits is growing and could put pressure on the department’s budget in coming years. Without comprehensively reviewing its approach to managing other contractor benefit costs, DOE may miss opportunities to make policy changes that could improve oversight, enhance efficiency, and potentially reduce its reimbursement costs in the future.

Moreover, given the potential magnitude of contractor benefit costs, it is important that DOE keep Congress informed about amounts budgeted for all such costs, the factors that affect those costs, and the department’s plans for mitigating possible mission impacts if contractor benefit costs rise. DOE is collecting this information from its contractors but, with the exception of defined benefit plans, has yet to provide Congress with agencywide information on contractor benefit costs for use in annual budget deliberations. Without this information, policymakers will not have a full understanding of the context in which they are making funding decisions or of how benefit reimbursement costs might affect the department’s mission work in coming years.

It is also important that DOE consistently apply its policies for overseeing and reimbursing contractor benefit costs to ensure timely compliance by all contractors. Without consistent criteria for program offices to consider when evaluating contractor requests to contribute more to their pensions than the minimum required by law, department management lacks assurance that its offices are systematically considering both near-term mission needs and potential spikes in future reimbursement costs when reaching their decisions. Furthermore, without a defined timetable for when corrective action plans need to be in place or clear criteria for DOE contracting officers to use in deciding to waive corrective action, DOE will continue to have contractor benefit packages with values exceeding its standards and will accrue additional liabilities—which the department must ultimately reimburse—for an extended period of time. In addition, without headquarters review of contracting officer decisions to waive corrective action plans, DOE lacks assurance that contractor waiver requests are being evaluated consistently across the department.

Executive Action

Energy take the following four actions:

Conduct a comprehensive review, similar to the review of contractor pensions, of the department’s approach to managing other contractor benefit costs, including other postretirement benefits, and evaluate options for improving oversight and better managing the cost of these benefits.

Expand the information provided to Congress during its annual budget deliberations to include, for example, nonpension postretirement benefit costs by site, program office, and appropriation account, as well as a discussion of factors that affect these contractor benefit costs and DOE’s plans for managing those costs in coming years.

Issue guidance to program offices overseeing contractors with defined benefit plans that defines criteria to be considered when evaluating contractor requests to contribute more than the minimum to their pension plans.

Clarify existing guidance on correcting contractor benefit packages that exceed DOE’s standard by: establishing a defined timeline by when contractors must submit corrective action plans to their DOE contracting officer if the value of their benefit package is determined to exceed DOE’s standard, as well as a timeline for when DOE contracting officers must reach a decision on such plans; developing criteria for contracting officers to use when deciding whether to waive a required corrective action plan; and requiring review of these contracting officer decisions by the responsible headquarters office to help ensure consistent application of the criteria across the department.

Agency Comments and Our Evaluation

We requested comments on a draft of this report from the Secretaries of Defense, Energy, and Health and Human Services, and from the Administrator of the National Aeronautics and Space Administration. The Secretaries of Defense and Health and Human Services and the Administrator of the National Aeronautics and Space Administration had no comments. On April 18, 2011, we received written comments from the Department of Energy, which are summarized below and reprinted in appendix I. In addition, DOE provided technical comments, which we incorporated in the report as appropriate.

In its written comments, DOE did not state whether it concurred with our findings. DOE agreed with three of our recommendations but disagreed with the recommendation that the Secretary of Energy issue guidance to program offices that defines criteria to be considered when evaluating contractor requests to contribute more than the minimum to their pension plans. DOE stated that more stringent guidance regarding the use of additional funds is not needed and that each program office is best suited for determining whether additional contributions are the best use of funds in a given year. We did not recommend that DOE issue more stringent guidance or that program offices should have less flexibility in deciding whether to approve or disapprove contractor requests. Rather, we noted that DOE lacks complete guidance to its program offices on the common factors that they should consider when making their decisions. We agree that program offices may reasonably come to different decisions given their particular circumstances. Nevertheless, we continue to believe that DOE should provide a consistent set of factors for program offices to consider when making those decisions. Without such criteria, DOE lacks assurance that program offices are systematically considering both near- term mission needs and potential spikes in future reimbursement costs when reaching their decisions.

As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies to the appropriate congressional committees; Secretaries of Energy, Defense, and Health and Human Services; Administrator of National Aeronautics and Space Administration; and other interested parties. The report will also be available at no charge on GAO’s Web site at http://www.gao.gov.

If you or your staff have any questions about this report, please contact me at (202) 512-3841 or gaffiganm@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 listed in appendix IV.

Appendix I: Comments from the Department of Energy

Appendix II: Status of DOE Contractor Defined Benefit Plans

The number of current Department of Energy (DOE) contractor defined benefit plans open to new entrants has been dropping over the last decade, particularly since 2005, while the number of frozen plans has increased.

Of the 40 tax-qualified defined benefit plans currently sponsored by DOE contractors, only 1 was frozen as of 2000 (see fig. 4). By 2006, about one- fourth (9) of currently sponsored tax-qualified DOE contractor defined benefit plans were frozen in some way. By 2010, of the 40 tax-qualified defined benefit plans sponsored by DOE contractors, 21 were frozen in some way, and 19 plans were open to new entrants. This trend in plan freezes over time is similar to the trend discussed in another report, which found that, among currently frozen plans nationwide, half of plan freezes were implemented after 2005.

Appendix III: Investment Allocation of DOE Contractors’ Defined Benefit Plans

Table 3 shows the investment allocations of each DOE contractor tax- qualified defined benefit plan by percentage and dollar values as of September 30, 2010. As noted in the report, contractors—not DOE—are responsible for selecting strategies used to invest pension plan assets. Each tax-qualified, DOE contractor defined benefit plan is unique in its investment allocations. For example, certain plans have as much as 73 percent of plan assets invested in equities, whereas a few plans have no equity investment. The overall mix of assets across DOE contractor plans is 58 percent equities, 33 percent bonds, and 9 percent other assets (see last row of table 3). An asset allocation of 60 percent equities and 40 percent bonds is often considered a “typical” asset allocation for many defined benefit plans.

Appendix IV: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

Other key contributors to this report were Kimberley M. Granger and Diane G. LoFaro, Assistant Directors; Charles Ford; David Marroni; Ken Stockbridge; Fatema Wachob; and Marie Webb. Important contributions were also made by Joseph A. Applebaum, Ellen W. Chu, Charles Jeszeck, Mehrzad Nadji, Robert Owens, Cheryl Peterson, Anne Rhodes-Kline, Christopher Ross, Cynthia Saunders, Kiki Theodoropoulos, Roger Thomas, Frank Todisco, Craig Winslow, Melissa Wolf, and William Woods.