Although the Pension Protection Act of 2006 (PPA) will require many federal contractors to significantly change the funding of their defined benefit pension plans, “such funding changes will not necessarily result in increased costs on negotiated contracts,” according to recent Defense Department internal guidance.

If a contractor proposes increased pension costs as a result of the PPA, the DOD contracting officer should consult with the administrative contracting officer (ACO) and Defense Contract Audit Agency auditor before determining whether to include any proposed costs relating to the PPA in the contract price or forward pricing rates (FPRs), Defense Procurement and Acquisition Policy Director Shay Assad instructed in a Dec. 22, 2006, memorandum to the military services and defense agencies.

The memo also instructed contracting officers not to allow increased costs in anticipation of Cost Accounting Standards (CAS) changes to implement the act, and not to agree to reopener clauses that allow contract price adjustment at a later date. This appears to leave contractors holding the bag for increased pension costs until the CAS Board--which currently is not in operation--changes the CAS pension standards (CAS 412 and 412), at which point contractors would then be able to seek an equitable adjustment.

Beginning in 2006, the PPA permits companies to voluntarily increase their pension contributions, and, “starting in 2008, the PPA may cause contractors to significantly increase their required minimum pension contribution for tax purposes,” Assad acknowledged.

However, application of the PPA changes is “complex, and will require review by DOD pension and cost accounting experts,” the DPAP head added.

Policy Guidelines Prohibit Reopener Clauses.

In the memo, Assad set out three general principles to be applied by DOD contracting officers in response to contractor requests for increased costs resulting from the PPA.

(1) When contractors propose increased pension costs based on the current CAS and the PPA, contracting officers should contact their cognizant ACOs and DCAA auditors for assistance in reviewing such proposals.

(2) Contracting officers shall not include in the contract price or FPR or recognize as allowable any increased pension costs for anticipated changes to the CAS, or include a reopener clause that would allow adjustment to the contract at a later date. “To do so would result in over-recovery of costs by the contractor,” Assad said.

“For contracts that are subject to full CAS coverage, any changes to CAS 412 and 413 promulgated by the CAS Board as a result of the PPA may entitle the contractor to an equitable adjustment for those contracts as of the effective date of any such amendment or other guidance issued by the CAS Board,” he added.

(3) For contractors subject to a mandatory delayed implementation of the PPA until Jan. 1, 2011, or until the effective date of the CAS/PPA harmonization rule that is to be issued under the act--that is, contractors whose government contracts revenue exceeded $5 billion last year--their proposed costs should not include any amounts resulting from the PPA revised minimum funding standards. As examples of such prohibited costs, the guidance identified seven-year amortization for funding shortfalls, interest rate assumptions based upon corporate bond rates of return, and any other revisions contained in Title I of the PPA.

Harmonization Effort Delayed Without CAS Board.

Meanwhile, the development of the CAS/PPA harmonization rule called for by the act is being held up until a functional CAS Board can be established. Because the CAS Board cannot operate without a chair, who by statute is the administrator of the Office of Federal Procurement Policy, the board has basically been out of business since David Safavian resigned as head of OFPP in September 2005.

Although Paul Denett was confirmed as OFPP administrator in August 2006, the board still lacks representatives from industry and the accounting community. Denett last September sought industry recommendations for candidates, but no selection has been announced for either the industry or the accounting slot.

Representatives from the Defense Department and General Services Administration are the public sector members of the board. DCAA Deputy Director April Stephenson has been named to represent DOD, but no GSA representative has been announced yet.

Guidance Problematic in Light of Delay.

Given the resulting delay in the promulgation of the CAS/PPA harmonization rules, at least one member of the government contract accounting community expressed “disappointment” with the guidance.

Accountants and lawyers generally have been advising their federal contractor clients that, given the delayed implementation of the act for large contractors, such contractors should seek to negotiate an advance agreement or a bilateral contract modification regarding pension costs, with a reopener clause to protect the government in the event the agreement or modification ultimately results in a windfall to the contractor when the harmonization rules are issued. However, the new guidance expressly prohibits that approach, which to this point was seen by many as a practical necessity, the contractor representative said.

In addition, the new DOD guidance leaves unresolved the “very real conflict” between pension calculations under the CAS and under the Employee Retirement Income Security Act (ERISA) as amended by the PPA. Because the PPA made significant changes in pension funding and accounting requirements, large contractors that have some contracts subject to CAS and others that are not CAS-covered will find themselves in a “regulatory no-man's land,” with pension calculations under the two regimes leading to two different, and incompatible results, the contractor representative told BNA.