oversight

Retiree Health Benefits at Selected Government Contractors

Published by the Government Accountability Office on 2003-02-27.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

United States General Accounting Office
Washington, DC 20548

          February 27, 2003

          The Honorable Carolyn McCarthy
          House of Representatives

          Subject: Retiree Health Benefits at Selected Government Contractors

          Dear Ms. McCarthy:

          Since World War II, some employers have voluntarily sponsored postretirement health
          plans as a benefit to their employees. According to government sources, these health
          plans constitute the primary source of health coverage for retirees aged 55 to 64 and
          supplemental coverage for nearly one third of retirees aged 65 or older with Medicare
          coverage. However, with costs already amounting to hundreds of millions of dollars for
          large employers and the baby boom generation nearing retirement age, employers are
          taking actions to control the costs of providing these benefits.

          In your letter of April 3, 2002, you expressed concerns that government contractors may
          be receiving undeserved financial benefits by reducing retiree health benefits that were
          paid for under government contracts. Because data limitations precluded us from
          determining whether a trend exists among government contractors to reduce
          postretirement health benefits, as agreed with your office we selected on a nonstatistical
          basis three of the largest government contractors to determine (1) what changes, if any,
          they had made to their retiree health benefit plans and (2) the extent to which
          government agencies oversee retiree health benefit costs.

          The three contractors we reviewed—Lockheed Martin Corporation, Northrop Grumman
          Corporation, and Raytheon Company—accounted for about 14 percent of all federal
          contracts awarded in fiscal year 2001 and collectively incurred about $756 million in
          postretirement health benefits-related costs between 1999 and 2000 (the 2 most recent
          years for which data are available). Because we selected the contractors on a
          nonstatistical basis, our results cannot be generalized to all government contractors.
          However, we obtained data on general trends in employer-sponsored retiree health
          benefits from two widely cited surveys—conducted by Mercer Human Resource
                                1
          Consulting (Mercer), and Kaiser Family Foundation and Health Research and
          Educational Trust (Kaiser/HRET). We determined what actions the government takes to
          oversee retiree health benefit costs at the selected contractors by interviewing officials
          from the Defense Contract Audit Agency (DCAA) and Defense Contract Management
          Agency (DCMA)—the two principal agencies responsible for overseeing the selected
          contractors—and reviewing various audit reports and analyses. For more on our scope
          and methodology, please see the enclosure.

          1
              Prior to April 2002, Mercer was known as William M. Mercer, Incorporated.



          Page 1                                                                          GAO-03-412R Retiree Health Benefits
Results in Brief

Each of the three contractors we reviewed had adopted various strategies to control
retiree health benefit costs, including restricting eligibility; increasing premiums,
deductibles and copayments; and limiting future commitments. These actions are
consistent with national trend data reflected in the Mercer and Kaiser/HRET surveys.
These surveys show decreases in the percentage of large employers2 offering retiree
health benefits and suggest that the erosion of such benefits will likely continue. For
example, the most recent Kaiser/HRET survey, issued in 2002, reported that about one-
third of large employers offer retiree health benefits—compared to almost half in 1991.
The surveys’ data do not distinguish between government contractors and those whose
business base is nonfederal in nature.

DCMA and DCAA closely monitored postretirement health benefits to ensure charges to
the government were made in compliance with federal regulations. As part of their
oversight efforts, the two agencies performed risk assessments and conducted regular
reviews of the contractors’ actual and projected postretirement health benefits costs and
the assumptions underlying future cost projections. For the 2 years covered in our
review, neither DCAA nor DCMA found any significant problems with the contractors’
actual or projected postretirement health benefits costs. For example, DCAA took no
exceptions to the projected costs reflected in the contractors’ pricing proposals and took
exception to less than 1 percent of the $756 million in postretirement health benefits
costs incurred by the contractors over the 2-year period.

Background

Government contractors offering postretirement health benefits are subject to various
standards and regulations that govern how benefit costs are to be accounted for, how
they are allocated among their business units, and what conditions must be met before
such costs will be reimbursed by the government. The Department of Defense (DOD)
has primary responsibility for ensuring that the three contractors we reviewed complied
with these various requirements. To assist DOD procurement officials, DCMA has a
specialized review unit—the Contractor Insurance/Pension Review Center—to provide,
among other services, technical assistance in reviewing contractor postretirement health
benefits plans. Similarly, DCAA provides auditing, accounting, and financial advisory
services in connection with the negotiation, administration, and settlement of contracts.
At contractors with both defense and nondefense government contracts, other federal
agencies often rely on DOD to ensure that their interests are protected.

Employers have several options on how to account for their postretirement health
benefits costs. According to DCAA and DCMA officials, most contractors use the “pay-
as-you-go”—or cash—method. Under this method, contractors only record the actual
benefit costs they pay on their retired employees behalf. The other principal accounting
method used is accrual accounting. Under this method, contractors record the amount
of the benefits earned by current employees, even though the benefits will not be paid
until the employees retire. Under either method, contractors generally accumulate their
postretirement health benefits costs in an overhead account. These costs are then
2
 Large employers are much more likely to offer retiree health benefits. For example, a recent Kaiser/HRET study states that retiree
health benefits are offered by 34 percent of large firms (200 or more workers) compared to just 5 percent of all small firms (less than
200 workers). Mercer considers large employers as those firms having at least 500 employees.



Page 2                                                                             GAO-03-412R Retiree Health Benefits
allocated to their various business units and in turn to both government and non-
government contracts. As such, postretirement health benefits costs are not direct
contract costs; rather, they are considered an indirect expense.

Under the Federal Acquisition Regulation, the government will reimburse postretirement
health benefits costs if such costs have been properly charged to government contracts.
However, because contractors using the accrual method of accounting will not pay post-
retirement health benefits to current workers until they retire, the regulations require
contractors to deposit the amount they intend to claim for reimbursement with an
insurer or other trustee that maintains a separate account exclusively to provide benefits
to retirees. If contractors subsequently reduce or eliminate benefit programs and receive
funds back from these accounts, they must refund to the government a fair share of any
amount that had been paid for by the government.

Actions Taken at Selected Government Contractors to Control Benefit Costs
Mirror National Trends

The contractors we reviewed have taken a number of actions to control or manage the
cost of providing health benefits to their retirees. These actions—such as reducing
benefits; increasing premiums, deductibles, or copayments; or eliminating benefits for
new employees—were consistent with the actions taken by large employers, in general,
over the past decade.

The three contractors we reviewed have taken actions to manage and control
postretirement health benefits costs. These actions include the following:

    •    One of the 3 contractors decided in 1992 to impose a spending cap on its retiree
         health benefits payments. Implemented on January 1, 1999, this spending cap was
         equal to the actual cost the contractor incurred in 1998 and made retirees
         responsible for any additional premium increases. This contractor also eliminated
         postretirement health benefits for employees hired after 1992.

    •    Another of the 3 contractors stopped providing retiree health benefits to all newly
         hired employees in 1995. In addition, effective January 1, 2003, this contractor
         requires retirees covered by a health plan acquired through a merger to begin
         contributing to their plan premium.

    •    The third contractor increased retirees’ premiums, copayments and deductibles.
         For example, the copayment retirees must pay for an office visit on one of its
         plans doubled from $10 to $20.

These actions are similar in nature to those reported in surveys of large employers in
                                                        3
general. For example, in November 2001, we testified that the availability of employer-
sponsored retiree health benefits has declined over the last decade. Surveys conducted
by Mercer and Kaiser/HRET show decreases in the percentage of large employers
offering retiree health benefits and suggest that the erosion of such benefits will likely
continue. For example, the Kaiser/HRET survey reported that while 46 percent of large

3
 U.S. General Accounting Office, Retiree Health Insurance: Gaps in Coverage and Availability, GAO-02-178T (Washington, D.C.:
Nov. 1, 2001).



Page 3                                                                       GAO-03-412R Retiree Health Benefits
employers offered retiree health benefits in 1991, only 34 percent offered such benefits in
2002 (see fig. 1). Employers attempted to control their costs by (1) reducing benefits, (2)
increasing premiums, deductibles, or copayments, or (3) eliminating benefits for new
employees. These surveys’ data, however, do not distinguish between government
                                                                    4
contractors and those whose business base is nonfederal in nature.

Figure 1: Proportion of Large Employers Offering Retiree Health Benefits




    Notes: The Mercer data represent retiree health benefits offered by employers with at least 500 employees, whereas the Kaiser/HRET data
           represents employers with at least 200 employees.

           The Kaiser/HRET survey did not report on employer sponsorship of retiree health benefits in 1994 and 1996. KPMG Peat Marwick conducted
           the survey for the Kaiser/HRET between 1993 and 1997.


DOD Agencies Closely Monitored Retiree Health Benefit Costs at Selected
Contractors

DCAA and DCMA closely monitored the contractors’ postretirement health benefits
costs at the contractors we reviewed to ensure that costs charged to the government
were in compliance with federal regulations. For the 2 years covered in our review,
neither DCAA nor DCMA found any significant problems with the contractors’ actual or
projected postretirement health benefits costs.

For the three contractors we reviewed, DCMA and DCAA performed risk assessments
and conducted regular reviews of the contractors’ actual and projected postretirement

4
 The contractors we reviewed had both federal and nonfederal customers, but each ranked among the top 5 of government
contractors based on dollars awarded in fiscal year 2001. Net sales to the U.S. government accounted for 78 percent of the
contractor’s calendar year 2001 business base at Lockheed Martin and at Northrop Grumman, and for 67 percent at Raytheon.



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health benefits costs and the assumptions underlying future cost projections. For
example, DCMA assessed the accuracy of the contractors’ actuarial projections of
postretirement health benefits costs, and assisted DCAA in evaluating forward pricing
               5
rate proposals. DCAA performed audits, annually or more frequently, of the contractors’
actual and projected postretirement health benefits costs and verified that the
contractors had made payments to appropriate trust accounts.

Our review of DCAA and DCMA postretirement health benefits-related reports found that
both agencies identified only minor problems with the contractors’ postretirement health
benefits costs. For example, DCAA took exception to less than 1 percent of the
$756 million in postretirement health benefits costs incurred by the contractors in
calendar years 1999 and 2000—the 2 most recent years for which DCAA had completed
audits. In addition, DCAA did not question any projected costs included in the
contractors’ forward pricing rate proposals. While DCMA questioned some of the
assumptions used to project future costs, it noted that the impact would be negligible.

Agency Comments and Our Evaluation

DOD officials notified us via electronic mail that they had no comments on the draft
report we provided to them.

                                                              --------

We are sending copies of this letter to the Secretary of Defense; the Director, Defense
Contract Audit Agency; the Director, Defense Contract Management Agency; and
interested congressional committees. We will also provide copies to others on request.
This letter will also be available at no cost on the GAO Web site at http://www.gao.gov.

If you have questions about this letter, please contact me on (617) 565-7500 or
Timothy DiNapoli at (202) 512-4841. Key contributors to this assignment were Kenneth
Patton, Ralph Roffo, and Jeffrey Rose.

Sincerely,




David E. Cooper
Director, Acquisition and Sourcing Management




5
    Forward pricing rate proposals are contractor estimates of indirect costs to be used in pricing government contracts.



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Enclosure                                                                       Enclosure

                                Scope and Methodology

To illustrate the type and nature of changes government contractors made to their
postretirement health benefits plans, we selected on a nonstatistical basis three of the
five largest government contractors, based on value of contracts awarded during fiscal
year 2001: Lockheed Martin Corporation, Northrop Grumman Corporation, and Raytheon
Company. We obtained information on each organization’s postretirement health plans
and discussed with cognizant officials the changes they made to their plans. Because we
did not select the contractors on a statistical basis, our results cannot be generalized to
all government contractors. However, we obtained updated information on the general
trends in employer-sponsored retiree health care benefits from publicly available private
sector consultant data.

To determine the extent of the government’s oversight of retiree health benefit costs at
these contractors, we interviewed officials from the Defense Contract Audit Agency
(DCAA) and Defense Contract Management Agency (DCMA). We discussed (1) how
actual and projected postretirement health benefits costs are reflected in government
contracts, (2) how they monitor and evaluate these costs, and (3) what actions they take
to protect the government’s interest. We also reviewed the most recent audit reports
relevant to the selected contractors’ postretirement health benefits plans, including those
concerning the contractors’ forward pricing agreements proposals and incurred cost
submissions. The incurred cost audit reports covered calendar years 1999 and 2000.
Forward pricing rate proposal audit reports covered up to 2006. We did not
independently assess the reliability or accuracy of the data relied on by DCAA and
DCMA during their audits. We also interviewed officials from the Departments of
Defense and Labor, respectively, and the Office of Federal Procurement Policy.

Our work was performed between August 2002 and January 2003 in accordance with
generally accepted government auditing standards.




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