Mr. Eric Shipley
Cost Accounting Standards Board
Office of Federal Procurement Policy
725 17th Street, NW, Room 9013
Washington, DC 20503
ATTN.: CASB Docket 96-02A
Via Facimile: (202) 395-5105
Dear Mr. Shipley:
Thank you for the opportunity to comment on the Cost Accounting Standards (CAS) Board's Advance Notice of Proposed Rulemaking (ANPRM) on "Accounting for the Costs of Post-Retirement Benefit Plans (PRBs) Sponsored by Government Contractors". The Project on Government Oversight (POGO) is a non-partisan, non-profit organization that has, for almost 20 years, investigated, exposed and worked to remedy abuses of power, mismanagement and subservience to special interests by the Federal government. As you may know, the activities of the CAS Board are currently a part of POGO's Defense Investigations Project. POGO has a strong interest in government contracting matters, especially those relating to the CAS Board.
POGO believes that the ANPRM is a good technical document that adequately reflects the application of accrual accounting concepts to the measurement, assignment, allocation and adjustment of PRB costs (primarily retiree medical). Nevertheless, while POGO understands, and is generally sympathetic to the application of accrual accounting concepts in accounting for costs under government contracts, we are very troubled by the criteria established for the recognition of a valid PRB liability under proposed Cost Accounting Standard 9904.419, particularly under the "Fundamental requirements" section, 9904.419-40.
The CAS Board's interest in this topic appears to stem primarily from Statement of Financial Accounting Standard No.106, "Employers' Accounting for Post-retirement Benefits Other Than Pensions" (SFAS 106). SFAS 106 is premised upon the accounting principle of conservatism and the probability of liquidation of the underlying PRB liability. SFAS 106 was designed to protect the investing public by exposing large, often unfunded corporate PRB liabilities to closer scrutiny and analysis; in other words, providing for transparency. In contrast, the same level of conservatism that underlies SFAS 106, leads to the potential overstatement of liabilities when used for the purposes of cash disbursal, such as that encountered in the cost-based government contracting environment.
Moreover, and perhaps even more importantly, estimating errors made under SFAS 106 can be easily adjusted on future corporate balance sheets and income statements. However, such debit and credit entries are not so easily corrected in the government contracting environment, even with the existence of adjustment provisions such as those contained in proposed CAS 9904.419-50(e) and (f). Government contractors have spent a great deal of time and effort, both on the political and legal fronts attempting to repeal, reverse or revise the requirements of CAS 9904.413, "Adjustment and allocation of pension cost". POGO believes that once paid in the form of cash, adjustments to previously determined PRB costs will be extremely difficult to credit to the taxpayers' benefit.
Recognition of the PRB Liability
POGO applauds the CAS Board's use of the "irrevocable right" to receive a benefit test and the associated PRB "vesting" requirements. However, we do not believe that these go far enough. It seems to us that one of the biggest unintended benefits that will inure to contractors under proposed CAS 9904.419 is enhanced cash flow; as well as the overall timing advantages associated with receiving cash disbursements from the treasury now, for liabilities that will be liquidated far into the future. By use of the phrase "timing advantage", POGO is not referring to the possible discounted value of future cash disbursements. POGO's concern is more fundamental. The principal "timing advantage" that will inure to contractors, is their ability to receive large sums of cash for the discounted value of future PRB payments. Even with agreement on the application of appropriate discount rates, it is readily apparent that it is much to a contractor's advantage to receive payment now, rather than wait until some future period for payment, when the PRB liability is actually liquidated.
We would caution the CAS Board that POGO is not advocating the use of cash accounting in this instance. Rather, our concern is that large sums derived from the public fisc will be transferred to contractors to do as they please for relatively extended periods of time. This is why POGO believes that in addition to the "nonforfeitability test" proposed by the CAS Board, there should also be a firm funding requirement associated with PRB costs. Ideally, such a funding requirement should be based as closely as possible on the principles embodied in the Employee Retirement Income Security Act (ERISA). Recognizing that the provisions of ERISA are generally unavailable to the funding of PRB costs, we would still urge the CAS Board to require contractors to fund all PRB costs; if necessary under provisions applicable to so-called non-qualified funding arrangements (such as "Rabbi trusts"). Failure to heed this relatively conservative approach will transfer billions upon billions of taxpayer dollars to contractors with little assurance that the funds will not be applied in some unintended manner to pursue other corporate purposes. We think this is unsound public policy.
Funding is Relevant to the Determination of the Validity of the Underlying PRB Liability
POGO believes that the CAS Board's prior pronouncements, affirming the importance of funding to the validation of the underlying liability are especially relevant in the case of PRBs. Both the CAS Board's 1995 amendments to CAS 412, "Cost accounting standard for measurement and composition of pension cost", as applied to non-qualified pension plans, as well as the original version and preamble to CAS 412 underscore this point. As the CAS Board has previously noted:
The Board believes that assigning pension costs to cost accounting periods on a cash basis is inappropriate from an accounting viewpoint and could lead to the improper assignment of pension costs among periods. The Board believes also that the concept which states that funding is unrelated to pension accruals is not appropriate for contract costing because, under such a concept, pension costs could be assigned to cost accounting periods and never be funded; yet such costs would be reimbursed by the Government.
(Note 11 to Preamble A of CAS 412.)
Those who argue that funding of PRB accruals are unrelated to the determination of the validity of the underlying liability seem to ignore the CAS Board's long-standing common-sense policy. In fact, during a 1998 Public Meeting of the Cost Accounting Standards Review Panel (at which POGO testified), we were amazed that a then-partner at a "Big Five" public accounting firm read from the above-stated Note 11, but disingenuously skipped over that part of the paragraph which states that funding of accruals is important. We would implore the CAS Board to watch for similar semantic "sleights-of-hand" in their review of public comments on the proposed PRB rule.
The "Tax Complement" Approach Used in CAS 9904.412 May Provide an Appropriate Solution to the Funding Issue
Faced with a similar situation in its consideration of the 1995 amendments to CAS 9904.412, the CAS Board adopted a "tax complement" funding approach. That approach requires a contractor seeking to accrue expenses under non-qualified defined benefit pension plans to establish a non-qualified funding device, and to fund such costs at the complement of the highest available marginal Federal corporate income tax rate. POGO believes that this approach at least assures equity to all parties by mitigating the effects of negative cash flows associated with a 100% funding approach, at least for those contractors who pay Federal income tax. For those contractors who do not pay Federal corporate income tax, or for those contractors who are able to construct qualified or partially-qualified funding devices for their PRB plans, the funding rate should be adjusted accordingly (to a maximum of 100%).
POGO accepts the obvious general superiority of accrual accounting concepts as applied to the determination of PRB costs. Such an approach has the primary benefit of assigning costs to those products and services which gave rise to the underlying liability. Permitting the accrual of PRB costs, like any cost, provides for the proper application of the "matching" concept. However, POGO cannot endorse the CAS Board's current proposal unless and until there is a substantial strengthening of the procedures associated with the funding of PRB costs, and the ability of Government agencies to appropriately be credited for adjustments made to previously determined contractor PRB costs. With regard to the adjustment issue for previously determined costs, POGO believes that strong PRB termination and/or curtailment procedures must be included in any final rule. Contractors are currently engaged in hard-fought litigation with the Government in order to have the "segment closing" adjustment provisions of CAS 9904.413, "Adjustment and allocation of pension cost" declared invalid. The corporate litigants: Teledyne, General Electric and Johnson Controls are defending themselves, in the aggregate, against billion dollar plus Government claims for surplus pension assets. That these companies would undertake such litigation, strongly underscores the need for the CAS Board to attach particular importance to the need for the Government to effect adjustments of previously determined PRB costs through the strongest possible crediting provisions. Unless the CAS Board acts in a firm and determined manner, the Government could end up reimbursing contractors for billions of dollars worth of PRB costs that will never be liquidated for the purposes intended (i.e., to pay beneficiary PRB bills). This would be a national scandal.
We have appended to our public comment, two articles from the October 28, 2000 edition of the Wall Street Journal. These articles concern corporate manipulation of PRB liabilities under SFAS 106. POGO believes that the CAS Board would be well-advised to consider these articles prior to proceeding further on this matter. As the articles make clear, it is not at all uncommon for companies that have made strong retiree medical care "promises" to their employees to "unload" their SFAS 106 liabilities when the opportune time arose. These companies then subsequently adjust their balance sheets, with the results flowing through to the income statement. But, of course, these are only "paper transactions". Does the CAS Board wish to promulgate a rule similar to that of SFAS 106 that might involve actual public cash disbursements of billions of dollars without the ability to recoup this money when companies failed to follow through on their "promises" or when adjustments to previously determined PRB costs are made?