Department of Energy DOE Contractor Postretirement Benefits PRB Other than Pension

1
Department of Energy (DOE) Contractor
Postretirement Benefits (PRB) Other than Pension

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

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Objective

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

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Post Retirement Benefits Other than Pension

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

4
Importance of PRB Medical to Employees

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

5
Magnitude of PRB Liability

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

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Importance to Employers and to DOE

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

7
DOE Contractors PRB Liability

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

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Past Accounting Practice

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

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Major Issues Against PRB Accrual/Pre-funding

• Measurement of Cost
• Lack of generally accepted approach to vesting-
  no firm liability
• Lack of adequate tax incentives

10
Cost Accounting Practice Change

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

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FAR 31.205-6(o)

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

12
DOE Order 350.1

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

13
FAS 106 and the PRB Issues

• Measurement of Cost
• Prescribes actuarial assumptions and cost method
• Present value technique applied to
• actuarial assumptions and cost method

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FAS 106 and the PRB Issues

• Vesting/Firmness of Liability
• Not addressed
• Substantive plan is the basis for cost accrual
• Substantive plan presumes employer will continue
  to provide postretirement benefits ..

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FAS 106 and the PRB Issues.

• Lack of Adequate Tax Incentives
• Not Addressed
• Financial Issue

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FAR and the PRB Issues

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

17
FAR and the PRB Issues

• Vesting/Firmness of Liability
• FAR criteria for allowable and reasonable PRB
• Established practice
• Required by law
• Required by the terms of CBA
• Old criteria did nothing to sufficiently address
  the issue

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FAR and the PRB Issues

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

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Ideal Funding Vehicle

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

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

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

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Post-84TRA Treatment of VEBA Trust

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

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March 89 IRC Tax Relief

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

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Other Funding Vehicles

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

24
Contractors Major Disagreement with FAR
31.205-6(o)

• Legality of the new PRB cost principle was
  questioned
• FAR Council went too far Accounting Principles
  not within the purview of the FAR Council

25
Boeing Case

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

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Similarities SERP and PRB

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

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Government Assessment of Risk

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

28
Government/DOD Push for New PRB Cost Principle

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

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FAR Clause 52.235-39

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

30
Status Quo

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

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Current DOD Position

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

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Current DOE Practice

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

33
Proposed CAS 419

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

34
Proposed CAS 419 and the PRB Issues

• Measurement of Cost
• Adopted FAS 106 Assumptions and Cost Method with
  the following exceptions
• Measurement and accrual will based on the written
  plan

35
Measurement of Cost

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

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Measurement of Cost

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

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Proposed CAS 419 and the PRB Issues

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

38
Proposed 419 and the PRB Issues

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

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Permitted un-funded accruals

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

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Prepayment Credits

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

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Settlement of PRB Liability

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

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Settlement of PRB Liability

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

43
Settlement of PRB Liability During Segment
Closings

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

44
Considerations Under DOEFAR/Based CAS Covered
Contracts
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Pay-As-You-Go Vs Fas 106 Accrual of PRB Costs
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DOE FAR/CAS Covered Contract

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

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Questions/Comments

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