Contractors Charging the Federal Government for Pension Contributions is Not Corporate Welfare

By Karen L. Manos

In full election-year mode, news media have been awash in articles, blogs and reports urging Congress to stop the “corporate welfare” of reimbursing federal contractors’ pension costs.

They are expressing alarm about a new government contract accounting regulation that may add billions of dollars to the near-term cost of weapon systems and other government contracts. 

Citizens Against Government Waste published a report claiming, based on “limited data,” that the cost for reimbursing private contractors for underfunded plans has been estimated at $36.7 billion over 10 years. A November 2011 editorial in The New York Times urged Congress to “stop reimbursing the costs of pensions and other retirement benefits at huge, and hugely profitable, defense contractors.” 

Federal Times and Washington Technology ran stories under headlines proclaiming, “Pensions at Top 18 Contractors Cost Government $3.3B in 2010,” “Agencies Stuck with Tab for Federal Contractor Pensions, Taxpayer Group Says,” and “New Accounting Rule Could Cost DoD Billions.” Even The Wall Street Journal’s MarketWatch ran a story under the headline, “GM Reforms Pension Plan — Feds Should Do the Same.” 

While robust public debate is healthy, the underlying facts ought to be accurately stated.  
The new government accounting regulation should come as no surprise. It was specifically required by the Pension Protection Act of 2006, Public Law 109-280, which became effective on Aug. 17, 2006. 

Prompted by the terminations of several large, poorly-funded defined benefit pension programs and fears that future plan terminations could bankrupt the Pension Benefit Guaranty Corp., the Pension Protection Act was passed by large bipartisan majorities in both houses and requires employers to fund their pension plans more quickly than under prior law. 

Indeed, the House minority’s major criticism was that the legislation did not go far enough to protect the retirement security of more than 44 million workers, retirees and their families then participating in defined benefit pension plans. 

The Pension Protection Act requires employers to fully fund their defined benefit pension plans over a shorter, seven-year period, and calculate the plan’s assets and liabilities using actuarial assumptions and interest rates that are closer to market than previously required by the Employee Retirement Income Security Act of 1974. 

The net effect is that while the total cost per employee should be approximately the same over the life of the plan, for most employers, the short-term funding requirements increased significantly and became more volatile. Because of historically low interest rates over the past few years, Congress has already twice amended the Pension Protection Act to avoid enormous short-term increases in required pension contributions. In addition, the Pension Protection Act prohibits pension plans that are less than 80 percent funded from increasing benefits.

Although government contractors that sponsor defined benefit pension plans are required to comply with the Pension Protection Act funding rules, federal accounting regulations calculate pension costs at a lower rate. Consequently, there has been a growing deficit between the amount contractors are required by law to contribute to their defined benefit pension plans and the amount they are permitted to include in their government contract prices. 

Congress recognized the significant negative cash flow impact that the Pension Protection Act would have on government contractors. Section 106(d) of the Pension Protection Act required the Cost Accounting Standards Board — an independent organization within the Office of Management and Budget — to review and revise its accounting regulations to “harmonize the minimum required contribution under the Employee Retirement Income Security Act of 1974 of eligible government contractor plans and government reimbursable pension plan costs not later than Jan. 1, 2010.”

The Cost Accounting Standards Board missed the statutory deadline by almost two years, and finally published the “Cost Accounting Standards Pension Harmonization Rule” Dec. 27 (76 Fed. Reg. 81296). 

The Defense Department, meanwhile, turned a blind eye to the growing pension cost deficit, and steadfastly refused to allow contractors to begin including their increased pension contributions in the price of their government contracts. 

In December 2006, the Defense Department issued policy guidance that specifically said “contracting officers shall not include in the contract price or recognize as allowable any increased pension costs for anticipated changes to the [Cost Accounting Standards] into any contract or [Forward Pricing Rate], or include a re-opener clause that would allow adjustment to the contract at a later date.” 

The department repeated this injunction in an April 30, 2008 letter to the National Defense Industrial Association, and refused a request to temporarily waive the existing cost accounting regulations to deal with the looming deficit. Yet, according to press reports, even as late as Feb. 23, Pentagon Controller Robert Hale said the Defense Department has not yet budgeted for the additional pension costs, but estimated they “could be billions of dollars, conceivably.”

All of which brings us to the new “harmonization” regulation, 48 C.F.R. §§ 9904.412, 413, which took effect Feb. 27. 

Despite its name, the new regulation does not exactly “harmonize” the government accounting rules with the Pension Protection Act minimum funding requirements.   

Although the new regulation narrows the gap between what contractors are required to contribute to their pension plans and the amount that can be included in their government contract prices, most contractors will still be contributing more than they will be reimbursed for many years. 

Furthermore, the new regulation — rather than being corporate welfare — simply allows government contractors to gradually include in the price of their goods and services the contributions they are required by federal law to make to their defined benefit pension plans. When an airplane manufacturer sells a commercial airliner to United Airlines, the price of the plane includes costs of pension benefits for the manufacturer’s workers.  If the manufacturer sells an airplane to the federal government, there is no principled basis for insisting that the manufacturer remove such costs from its price. 

Refusing to reimburse contractors’ pension costs would be contrary to the Pension Protection Act, and inimical to the bipartisan congressional goal of enhancing American workers’ retirement security. Not reimbursing contractors’ pension costs could also cause contractors to freeze or terminate their defined benefit pension plans, which would likely result in even greater government liability. 

Government accounting regulations require a “settling up” when a contractor freezes or terminates its defined benefit pension plan. Just as the government is entitled to its share when there are surplus pension assets, contractors have a contractual right to recover their portion of a pension deficit. And retroactively changing these regulations would subject the government to breach-of-contract damages.

The new accounting regulation seeks to avoid these problems. It is a reasonable compromise between the requirements of federal procurement laws and regulations and the government’s budgetary concerns.

Karen L. Manos is a partner in the law firm of Gibson Dunn, and former chair of the American Bar Association’s Public Contract Law Section. Manos is the author of a three-volume book, Government Contract Costs & Pricing (2d. ed. 2009), published by Thomson-Reuters.

Photo Credit: iStockphoto

Topics: Defense Contracting, Defense Department, DOD Budget, DOD Policy

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