oversight

Contractor Pension Plan Costs: More Control Could Save Department of Defense Millions

Published by the Government Accountability Office on 1977-05-19.

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

                          DOCUMENT RESUME
 02331   - [A1452459]

Contractor Pension Plan Costs: More Control Could Save
Department of Defense Millions. PSAD-77-100; B-146991. May 19,
1977. 83 pp.

Report to the Congress; by Elmer B. Staats, Comptroller General.
Issue Area: Federal Procurement of Goods and Services:
    Reasonableness of Prices Under Negotiated Contracts and
    Subcontracts (1904).
Contact: Procurement and Systems Acquisition Div.
Budget Function: National Defense- Department of Defense -
    Procurement   Contracts (058); Income Security (600).
Organizaticn Concerned: Department of Defense; Cost Accounting
    Standards Board.
Congressional Relevance: House Committee on Armed Services,
    Senate Committee on Armed Services; Congress.
Authority: Employee Retirement Income Security Act of 1974. P.L.
    91-379. Internal Pevenue Code of 1954, as amended.

          The Government incurred pension plan costs that were
 inequitable and too high because the Department of Defense
 permitted actuarial assumptions or unjustified changes in
actuarial cost methods. Findings/Conclltsions: Government
controls and surveillance over contractors' pension plan
practices were not adequate considering the costs involved.
Establishing effective controls and surveillance over these
practices could save the Government millions of dollars.
Department of Defense auditing and contracting activities also
lacked personnel with actuarial skills to evaluate pension plan
costs. Properly implementing the existing requirements of the
Cost Accounting Standards Board and the proposed standard on
pension plan costs should prevent the increased costs.
Recommendations: The Secretary of Defense should have the Armed
Services Procurement Regulation (ASPR) revised to require that
pension plan costs charged to the Government () are equitably
distributed between Government and commercial work when
different actuarial cost methods are used, (2) reflect
allocation of pension fund assets in proportion to
contributions, and (3) are allocated by using assumptions based
on division or cost center experience instead of companywide
experience. The ASPR should also be revised to require that any
changes in the policies and procedures affecting allocation of
pension plan costs be completely disclosed. (Author/SC)
                  REPORT TO THE CONGRESS
re
      1)



     . .''     BY THE COMPTROLLER GENERAL
.?j          , OF THE UNITED STATES




                 Contractor Pension Plan Costs:
                 More Control Could Save Department
                 Of Defense Millions
                 The Government incurred pension plan costs
                 that were inequitable and too high because it
                 permitted questionable actuarial assumptions
                 or unjustified changes in actuarial cost meth-
                 ods.
                 Government controls and surveillance over
                 contractors' pension plan practices were not
                 adequate considering the costs inveoved.
                 Establishing effective controls and surveil-
                 lance over these practices could save the
                 Government millions of dollars.
             -   Properly implementing the existing require-
                 ments of the Cost Accounting Standards
                 Board and the proposed stbndard on pension
                 plan costs should prevent the increased costs.




                 PSADn77100                                       MAY 19, 1977
                COMPTROLER GNRAL OP THE UNIrED &TA'I
                           WASIINTON.   D.C. II




B-146991




To the President of the Senate and the
Speaker of the House of Representatives

     This report is the first of a series of reports on the
Government's controls and surveillance over contractors'
pension plan practices and costs reimbursed under Government
contracts. It describes instances where the Government has
incurred excessive and inequitable amounts of pension plan
costs. Our review was undertaken because of the nationwide
concern over pensions and the large amount of pension plan
costs reimbursed to contractors by the Government.

     Our review was made pursuant to the Budget and Account-
ing Act, 1921 (31 U.S.C. 53), the Accounting and Auditing
Act of 1950 (31 U.S.C. 67), and the authority of the Comp-
troller General to examine contractors' records, as set
forth in 10 .S.C. 2313(b).

     Copies of this report are being sent to the Director,
Office of Management and Budget; and the Secretary of
Defense.




                                 Comptroller General
                                 of the United States
COMPTROLLER GENERAL'S               CONTRACTOR PENSION PLAN COSTS:
REPORT TO THE CONGRESS              MORE CONTROL COULD SAVE
                                    DEPARTMENT OF DEFENSE MILLIONS


        D I G E S T

       The Department of Defense has relied on
       actuaries selected by contractors to cal-
       culate, on the basis of factors developed
       by them and the contractors, the pension
       plan costs allocated to Government contracts.

       Nine Department of Defense prime contractors
       had over $100 million (see app. II) of ques-
       tionable pension plan costs, excluding pro-
       fits, that were, or may be, charged to
       Government contracts because

       -- unrealistic actuarial assumptions were used
          in computing annual pension plan contribu-
          tions, resulting in higher costs when pen-
         sion plan contributions were reimbursed
         by the Government (see p. 9);
        --allocation of pension plan costs between
          Government and commercial business was
          inequitable to the Government (see p. 26);
       -- changes in actuarial cost methods have
          increased the cost of Government procure-
          ment (see p. 36);
          and
       -- Department of Defense auditing and con-
          tracting activities lacked personnel with
          actuarial skills to evaluate pension plan
          cost. (See p. 43.)
       The actuarial cost method selected in deter-
       mining pension plra contributions has no effect
       on long-range plan contributions. However,
       pension plan costs of an accounting period
       can vary greatly with the method selected.
       Some methods will generate the highest ac-
       counting period cost in the early life of
       a pension plan. Other methods will project
       costs so that greater contributions are re-
       quired toward the latter part of the plan.
       Still other methods tend to level annual
       pension plan costs over the entire plan life.

       up-   Imun,   en
                      afe
cW*~dis bend hW.            t   i          PSAD-77-100
OtZher important factors in determining
annual pension plan costs are the actuarial
assumptions about future events, such as
annual increases in employee salaries, invest-
ment income, and employee turnover rates. The
choice of assumptions can have a tremendous
effect on periodic pension plan costs.
The regulations of the Cost Accounting'Stand-
zrds Board on consistency in accounting
practices and the standards on pension plan
cost practices it has issued or proposed
should help (1) prevent increased costs, re-
sulting from use of questionable assumptions
or unjustified changes in actuarial cost methods,
from recurring (see pp. 24 and 41) and (2) make
sure that pension plan costs will be equitably
assigned to accounting periods and cost
centers. (See p. 26.)

GAO recommends that the Secretary of Defense
have the Ar;ed Services Procurement Regulation
revised to
-- require that pension plan costs charged to
   the uvvernment (1) are equitably distributed
   between Government and commercial work when
   different actuarial cost methods are used,
   (2) reflect allocation of pension fund as-
   sets in proportion to contributions, and
   (3) are allocated by using assumptions based
   on division or cost center experience in-
   stead of companywide experience (see p. 35);
-- require any changes in the policies and
   procedures affecting allocation of pension
   plan costs to be completely disclosed.
   (See p. 35.)

GAO also recommends that the Secretary of
Defense
--seek recovery or appropriate credit as soon
  as possible for pension plans overfunded due
  to unrealistic actuarial assumptions or




                     ii
   improper allocation of pension plan costs
   (see pp. 25 and 35);
-- determine if changes in actuarial cost
   methods (1) are justified, (2) are in ac-
   cordance with prudent business practices,
   and (3) will result in reasonable and
   equitable costs to the Government on future
   contracts (see p. 42);
-- reinstate the military services' and the
   Defense Contract Administration Services'
   reviews of contractors' pension plan prac-
   tices and costs (see p. 50);

-- obtain additional staff with actuarial
   skills to (1) help determine if pension plan
   costs are reasonable and equitably allocated
   to Government contracts and (2) determine
   compliance with the Armed Services Procure-
   ment Regulation and the Cost Accounting
   Standards Board guidelines (see p. 50); and

-- initiate training programs in pension plan
   accounting and computation to enable audit
   and contract personnel to review adequately
   the contractors' pension plan practices.
   (See p. 51.)
The Department of Defense stated that it had
known about many of the matters discussed in
the report and that action had been taken on
them. Defense also pointed out that a large
portion of the questioned costs was attribut-
able to one contractor. Although Defense
generally accepted the report findings, it
questioned GAO's interpretation of some provi-
sions of the Armed Services Procurement Regula-
tion and suggested that GAO should have con-
sidered certain offsetting factors hen
evaluating questionable pension plan costs.
(See pp. 58, 69 and 62.)
Nevertheless, the Department of Defense
stated that it will consider GAO's observa-
tions in future reviews of contractors'
pension plan practices. Defense also be-
lieved that current and proposed cost ac-
counting standards should improve management
in the pension area. However, it plans no



                     iii
further efforts concerning staffing at this
time, and believes its staffs are being suf-
ficiently trained to cope with these matters.
(See pp. 71, 75, 77 and 81.)
GAO points out that the report recognizes
corrective actions taken by the Department of
Defense but that there were other instances
where Defense did not act or failed to ade-
quately review contractor pension costs.
(See p. 46.) A large portion of the quen-
tioned costs was attributable to one con-
tractor; however, GAO believes that this is
not a true measure since the report also dis-
cusses instances where the dollar impact of
questionable pension plan practices was not
determined.  (See pp. 19, 23, 32, and 38.)

GAO is aware of the problems of interpreting
the Armed Services Procurement Regulation and
recommends clarification and improvements in
the regulation. On pages 15 and 16, GAO dis-
cusses a case where the Defense activities
agreed that their interpretation of the regula-
tion was limited and effected recovery of excess
pension plan contributions based on GAO's posi-
tion.

Where appropriate, GAO considered offsetting
factors in evaluating questionable pension
plan costs and in some cases found that the
offsetting factors obscured the increased costs
of changes in contractors' pension plan prac-
tices.  (See pp. 37 and 41.)

In view of the report findings, GAO still be-
lieves that the Department of Defense must
improve and extend its capability to review
contractors' pension plan practices.




                     iv
                  Con   tents


DIGEST
                                                          i
CHAPTER
   1       INTRODUCTION                                   1
               Brief history of pensions                  1
               Advance funding                            2
               Funding agencies                           2
               Computation of pension plan costs          3
               Role of the Accounting Principles
                 Board                                S
               Governmental policies and
                 procedures concerning
                 pension plan costs                   6
               Cost Accounting Standards Board        7
  2       UNREALISTIC ACTUARIAL ASSUMPTIONS CAUSED
            EXCESSIVE PENSION PLAN COSTS WITHOUT
            APPROPRIATE GOVERNMENT CREDIT             9
              Abnormal employee terminations          9
              Costs not reduced in accordance with
                reductions in employment levels      10
              Othez unrealistic actuarial assump-
                tions                                20
              Conclusions                            24
              Recommendations                        25
  3       REASONABLENESS AND ALLOCABILITY OF
            PENSION PLAN COSTS                       26
              Inequitable funding techniques         26
              Inequitable allocation of pension
                fund assets                          27
              Inequitable cost center allocation
                practices                            31
              Conclusions                            34
              Recommendations                        35
  4       NEED TO IMPROVE CONTROLS OVER THE
            SELECTION AND REVISION
            OF ACTUARIAL COST METHODS                36
              Costs to the Government
                increased by changes in
                actuarial cost methods               36
              Conclusions                            41
              Recommendation                         42
                                                       Page
CHAPTER

   5       NEED FOR THE DEPARTMENT OF DEFENSE TO
             INCREASE ITS EXPERTISE IN THE AUDIT,
             REVIEW, AND EVALUATION OF CONTRACTORS'
             PENSION PLAN COSTS                         43
               DOD reviews of contractors' pension
                 plan costs                             43
               Comments on DOD reviews of con-          45
                 tractors' plan costs
               Curtailment of DOD pen ion plan          46
                 rev'.aws
               Conclusions                              43
               Recommendations                          50

           SCOPE OF REVIEW                              52
   6
APPENDIX
                                                        53
   I       Summary of findings
  II       List of findings and questionable            54
             pension plan costs

 III       Actuarial interest assumption rates not
             in accordance with experience:              56
             Contractor G

   IV      Gains realized when actual employee
              terminations exceeded the assumed rate
              of terminations: Contractor G              57

       V    Letter dated October 21, 1976, from the
              Assistant Secretary of Defense
              (Installations and Logistics),
              Department of Defense                      58

   VI       Principal officials responsible for
              administering activities discussed
              in this report                             82
                 ABBREVIATIOtS
ASPR    Armed Services Procurement Regulation
CASB    Cost Accounting Standards Board
CWAS    contractor-weighted-average-share-
          in-cost-risk program
DCAA    Defense Contract Audit Agency
DCAS    Defense Contract Administration
        Services, Defense Logistics
          Agency
DOD     Department of Defense
ERISA   Employee Retirement Income Security
          Act of 1974
GAO     General Accounting Office
IRS     Internal Revenue Service
                         GLOSSARY
Abnormal               When an employee withdraws from a
forfeitures            pension plan or terminates employment
                       for reasons other than retirement or
                       death, employer contributions made to
                       that date on his behalf, plus inter-
                       est, are forfeited by the employee
                       to the extent that his benefits
                       are not vested. Abnormal forfeitures
                       are generated when the contractor
                       abruptly reduces his work force
                       by separating a large number of
                       employees who have not completed
                       their vesting requirements.
                       Abnormal forfeitures are a form of
                       actuarial gain resulting from actual
                       termination experience differing
                       from anticipated experience.
Actuarial               A prediction of future conditions
assumptions             affecting pension cost; for example,
                        mortality rate, employee turnover,
                        compensation levels, investment
                        earnings, etc.
Actuarial               A technique which uses actuarial
cost method             assumptions to measure the present
                        value o future pension benefits
                        and pension fund administrative
                        expenses, and which assigns the
                        cost of such benefits and ex-
                        penses to cost accounting periods.
Accrued-benefit
cost method       An actuarial cost method under which units
                  of benefit are assigned to each cost
                  accounting period and are valued as they
                  accrue--that is, based on the services
                  performed by each employee in the period
                  involved. The measure of normal cost under
                  this method for each cost accounting period
                  is the present value of the units of
                  benefit deemed to be credited to employees
                  for service in that period. The measure of
                  the actuarial liability at a plan's inception
                  date is the present value of the units of
                  benefit credited to employees for service
                  prior to that date. (This method is also
                  known as the unit credit cost method.)
Projected        Any of the several actuarial cost methods
benefit cost     which distribute the estimated total cost
method           of all the employees' prospective benefits
                 over a period of years, usually their
                 working careers.

     The principal projected methods are:

     1.   Individual-level cost method with supplemental
          liability. The most common form of this method
          is known as the entry age normal method. Nor-
          mal costs under this method are computed on the
          assumption that (1) every employee entered the
          plan at the time of employment or at the earliest
          time he would have been eligible if the plan had
          been in existence and (2) contributions have
          been made on this basis--from entry age to-the
          date of actuarial valuation. Thi annual contri-
          butions under this method consist of the level
          normal cost and an amount for past service cost.

    2.    Individual-level cost method without supplemental
           liability. The cost of each employee's pension
           is computed on the basis of funding from the
           inception date of the plan (or the date of his
           entry into the plan, if later) to his retire-
           ment date. Thus, past service cost is not com-
           puted separately, but is included as normal
           cost. In principle, this method is similar to
           an ordinary life insurance policy.

     3.   Aggregate-level cost with supplemental liability.
          This method has separate normal costs and supple-
          mental liability payments. Annual cost accruals
          are compiled for the plan as a whole rather than
          for the individual participants. The future
          benefits, excluding the supplemental liability,
          are funded on some form of level cost basis over
          the future working lives of the active employees,
          while the supplemental liability is amortized
          over a selected period not exceeding 40 years.
          When the supplemental liability is derived by
          assuming contributions from date of employment,
          this method is also referred to as the entry
          age normal method.
    4.    Aggregate-level cost without supplemental liability.
          A-ll projected enfi s are paid or-over the
          future working lives of the active employees.
            Costs are for the plan as a whole, and past
            service is not determined separately, but included
            as normal cost.

Actuarial gain    The effect on pension cost resulting from
and loss          differences between actuarial assumptions
                  and actual experience.

Actuarial         Pension cost attributable, under the act-
liability         uarial cost method in use, to years prior
                  to the date of a particular actuarial val-
                  uation. As of such date, the actuarial
                  liability represents the excess of the
                  present value of the future benefits and
                  administrative expenses over the present
                  value of future contributions for the
                  normal cost for all plan participants
                  and beneficiaries. The excess of the
                  actuarial liability over the value of
                  the assets of a pension plan is the
                  unfunded actuarial liability.

Actuarial         The process by which an actuary esti-
valuation         mates the present value of benefits to
                  be paid under a pension plan and calcu-
                  lates the amounts of employer contribu-
                  tions or accounting charges for pension
                  cost.

Actuary           A person professionally trained in the
                  technical aspects of insurance and related
                  fields, particularly in the mathematics
                  of insurance.

Advance           A financing policy under which contribu-
funding           tions are made to a pension fund during
                  the active service lives of employees
                  under one of several actuarial cost
                  methods.

Annuity           A contract that provides an income for a
                  specified period of time, such as a
                  number of years or for life. The person
                  receiving the payment is called an
                  annuitant.

Cost              As an actuarial term, it refers to con-
                  tributions for funding future benefit
                  payments specified in a pension plan.
              Determination of periodic cobts for
              accounting purposes may involve the
              same or differing considerations.

Fund          Used as a verb, it means to pay over to
              a funding agency. Used as a noun, it
              refers to assets accumulated in the hands
              of a funding agency for the purpose of
              meeting retirement benefits when they
              become due.
FunJing       An organization or individual, such as a
agency        specific corporate or individual trustee
(mediums)     or an insurance company, which provides
              facilities for the accumulation of assets
              to be used for the payment of benefits
              under a pension plan; an organization,
              such as a specific life insurance
              company, which provides facilities for
              the purchase of such benefits.

Investment    The return, earned or to be earned, on
income        funds invested or to be invested to pro-
              vide for future pension benefits. It
              includes interest on debt securities,
              dividends on equity securiiies, rentals
              on real estate, and realized and unreal-
              ized gains or (as ofLsets) losses on
              fund investments.

Liability     The term is used to describe the actuarial
              cost of a category of benefits and is not
              intended to suggest that there is neces-
              sarily any legal liability.
Normal cost   The annual cost assigned, under the
              actuarial cost method in use, to years
              subsequent to the inception of a pension
              plan or to a particular valuation date.
              (See past service cost, prior service cost.)

Overfunding   A pension plan is overfunded under IRS
              criteria if the value of the fund's
              assets exceeds the actuarial liability.

Participant   An employee, employer, or former employee
              or employer, who may becom- eligible to
              receive, or is receiving, benefits under
              the plan as a result of his credited
              service.
Past service    Pension cost assigned, under the actuar-
cost            ial cost method in use, to years prior to
                the inception of a pension plan. (See
                normal cost, prior service cost.)
Pay-as-you-go   An actuarial cost method under which
                pension costs are recognized only when
                benefits are paid to retired employees.
Pension plan    A deferred compensation plan established
                and maintained by one or more employers
                to provide systematically for the pay-
                ment of benefits to plan participants
                after their retirement (provided that
                the benefits are paid for life or are
                payable for life at the option of the
                employees). Additional benefits, such as
                permanent   id total disability and death
                            i
                payments a    survivorship payments to
                beneficiaries of deceased employees, may
                be an integral part of a pension plan.
Present value   The current worth of an amount or series
(actuarially    of amounts payable or receivable in the
computed        future. Present value is determined by
value)          discounting the future amount or amounts
                at a predetermined rate of interest. In
                pension plan valuations, actuaries often
                combine arithmetic factors representing
                probability (e.g., mortality, ithdrawal,
                future compensation levels) with arithmetic
                factors representing discount (interest).
                Consequently, to actuaries, determining
                the present value of future pension bene-
                fits may mean applying factors of both
                types.
Prior-service   Pension cost assigned, under the actuarial
cost            cost method in use, to years prior to the
                date of a particular actuarial valuation.
                Prior service cost includes any remain-
                ing past service cost. (See normal cost,
                past service cost.)
Qualified       A plan which the IRS approves as meeting
plan            the requirements of Section 401(a) of the
                1954 Code. Such a plan receives distinct
                tax advantages.
Service        Employment taken into consideration under
               a pension plan. Years o employment be-
               fore the inception of a plan constitute
               an employee's past service; years there-
               after are classified in relation to the
               particular actuarial valuation being made
               or discussed. Years of employment (includ-
               ing past service) prior to the date of a
               particular valuation constitute prior
               service; years of employment following the
               date of the valuation constitute future
               service.

Supplemental   The term for any liability treated as an
cost           element of actuarial cost separate from
               normal cost. Past service cost would be
               a supplemental cost.

germinal       An actuarial cost method under which
funding        funding for future benefit payments is
               made only at the end of an employee's
               period of active service.

Termination    The voluntary or involuntary withdrawal
(turnover)     of employees from the work force other
               than by death, disability, and retirement.

Unfunded       The excess of the actuarial pension
actuarial      liability, under the actuarial cost
liability      method in use, over the present value
               of the assets of a pension plan.

Vesting        A plan may provide that a participant
               will, after meeting certain requirements,
               retain a right to the benefits he has
               accrued, or some portion of them even
               though his service with the employer
               terminates before retirement. A par-
               ticipant who has met such requirements
               is said to have a vested right. Note
               that vesting is in the form of future
               annuity benefits, not the cash paid to
               purchase the benefits.
                            CHAPTER 1

                        INTRODUCTION
BRIEF HISTORY OF PENSIONS

     Private pension plans expanded in popularity during the
1930s and World War II. The idea was to provide employees
with retirement income to insure economic independence in
later years. As a corollary, employers hoped to generate
increased employee loyalty and goodwill, provide added in-
centives for quality work performance, and improve the ability
to recruit and retain qualified personnel.

     Statistics for 1974 show that private pension plans have
acquired assets of about $194 billion covering approximately
43 million active workers, or about one-half of the private
labor force. Annual private pension fund contributions are
currently about $26 billion, of which an estimated $1
billion is charged to Department of Defense (DOD) contracts.

     Spurred by citations of inadequate funding, vesting,
coverage, and fiduciary standards, pressure for pension
system reform grew and culminated in the Employee Retirement
Income Security Act of 1974 (ERISA). The provisions of ERISA
did not directly affect our review of the reasonableness of
pension plan csts charged to DOD contracts because the
costs were calculated before ERISA was passed. The act,
however, do¢c have a major impact on certain pension plans.
ERISA highlights include:
    -- Minimum age and service requirements for employees
       to be covered under retirement plans.
    -- Minimum acceptable periods during which participating
       employees must acquire vested interests in the
       benefits provided under such plans.
    -- An increase in plans' disclosure requirements re-
       garding conditions and operations and the addition
       of stringent standards for plan fiduciaries to insure
       that participants' pension interests are better pro-
       tected.
    -- Minimum funding standards for promised benefits
       under such plans.
     -- Tax incentives for those individuals not covered by
        an employer plan, to encourage them to save for
        retirement needs.
     -- An insurance program to a-'arantee that certain
        vested benefits are paic to participants of plans
        that are terminated.
ADVANCE FUNDING
     Most companies finance their pension plans by period-
ically making contributions to pension funds in advance of
actual payments to retirees. These funding arrangements are
generally preferred because (1) amounts set aside can be
listed as expenses for income tax purposes, within limitations,
(2) earnings of the accumulated fund are not taxed at the
time they are earned, (3) financing can be spread over a
period of years, (4) proper accounting generally requires
that costs be recognized at the time services are rendered
by the employees, and (5) they protect employees' benefits.
     In contrast, under pay-as-you-go and terminal funding
methods, pension plan costs were not recognized until
employees retired. Funding requirements of ERISA apparently
preclude the use of pay-as-you-go and terminal funding
methods.
FUNDING AGENCIES
     There are two types of funding agencies available for
private pension plans. A pension plan that uses a trust
as its funding agency is called a trust fund pension plan.
These plans are generally set up under an agreement between
an employer and a bank or trust company that is to act as
trustee. Cash and securities and the collection of income
and disbursements for trust purposes are usually handled by
the trustee.
     Under a trust fund plan, contributions are made to
the pension trust and earnings thereon reduce future con-
tributions. The fund's assets are used to provide pensions
or other benefits for employees. Retirement benefits and
expenses may be paid by the trust during the period of
retirement, or an annuity may be purchased for the employee
upon his retirement, thus transferring the obligation to
an insurance company.
     When an insurance company is used as an alternative
funding agency, this method of funding is called an insured


                             2
plan. Some pension plans are partly insured and partly
trust funded.

Pension Plan liabilities
     Generally, an employer's payments into the pension
fund are composed of three parts: normal costs which cover
benefits currently being earned by employees, periodic
payments which amortize the unfunded actuarial liability,
and adjustments for any actuarial gains and losses. Un-
funded actuarial liabilities can arise for a variety of
reasons, including benefit credits for service before the
effective date granted to employees when a plan is first
established, retroactive benefit increases, and changes
in actuarial assumptions.

     In all types of actuarial valuation, the existing
fund, future payments into the fund, and earnings of the
fund should be sufficient to pay future benefits. To
estimate future costs realistically, companies and actuaries
make assumptions regarding sucn items as employee turnover
and mortality rates, future wage increases, age at retire-
ment, and   e rate of return on pension fund assets.
Differences between these assumptions and actual events
result in actuarial gains or losses.

COMPUTATION OF PENSION PLAN COSTS

     Contractors generally hire a consulting actuary to
calculate the amount of the annual contribution to the
pension fund. To determine the amount, the actuary prepares
an estimate of the ultimate cost of the pension plan, which
is based on the total pension benefits expected to be paid
to employees during their retirement or on their behalf at
their death.l/ The present value of these benefits equals
the sum of the amount in the fund, the unfunded actuarial
liability, and the present value of future normal costs.
Future normal costs and the unfunded actuarial liability
can be distributed in various ways according to the actuarial
cost method selected.

     Pension cost determinations (using actuarial cost
methods and assumptions) are long range in nature. The
actuaries we spoke to emphasized that their most important


1/May not apply to the accrued benefit method because
  frequently no projection is involved.




                            3
concern was the overall financial position of the pension
fund over many years rather than the accuracy or equity of
a single year's contribution. Such pension plan cost
determinations often do not coincide with the objectives of
Defense contract cost principles, which are designed to
insure that costs assigned to Government work are reasonable
and as closely related as possible to the specific time
the work was performed.
     ettj*rial cost methods

     Of pri'y importance in making these computation   is
the actarl     vst method used, A number of acceptable
methods ha;    en developed to determine future annual
pension plan payments. Some of these ares
1.     Accrued benefit cost method.

2.     Projected benefit cost methods.

          a.   Individual-level cost method with supplemental
                 liability.
          b.   Individual-level cost method without supple-
                 mental liability.

          c.   Aggregate-level cost method with supplemental
                 liability.
          d.   Aggregate-level cost method without supple-
                 mental liability.
     The actuarial cost method selected to determine pension
plan contributions has no effect on the long-range cost of
a plan. However, pension plan costs of an accounting period
can vary significantly with the method selected. Some
methods will generate the highest accounting period cost in
the early part of the life of a plan. Other methods will
project costs so that greater contributions are required
later. Still other methods tend to level annual pension
plan costs over the entire plan life.
Actuarial assumptions
     Another important factor in determining pension plan
costs for an accounting period is the actuarial assumptions.
These assumptions amount to forecasts of future events, and




                                 4
any unrealistic assumptions can have a tremendous effect on
periodic pension plan costs.
     Actuarial assumptions deal with

     --annual increases in employees' salaries;
     -- investment income of the pension fund, including
        method of valuing assets;
     -- employee turnover rate;

     -- employee mortality rate; and

     -- employees' ages at retirement.

     Actual events seldom coincide with assumptions, and
differences result in actuarial gains or losses. As
conditions change, assumptions concerning the future may
become invalid and need to be revised to reflect actual
experience and reasonable expectations for the future.

     The choice of assumptions can materially affect pension
plan costs for any cven year. For example, a -percent
increase in the investment income assumption can reduce the
pension plan contribution by 20 percent or more, depending
on the specific circumstances.

ROLE OF THE ACCOUNTING PRINCIPLES BOARD
      Opinion Number 8 of the Accounting Principles Board,
American Institute of Certified Public Accountants, issued
in November 1966, clarified the accounting principles and
established the practices applicable to accounting for the
cost of pension plans. The opinion concerned determining
the pension plan cost for financial accounting purposes,
and recognized that the annual pension plan cost was not
necessarily the same as the amount to be funded for the
year.

     As part of the opinion, the Board

     -- identified acceptable actuarial cost methods;
     -- stated that the effect on cost of changes in methods,
        as well as other costs, should be applied pros-
        pectively to the cost of the current and future
        years; and




                              5
     -- stated that financial statements should disclose the
        nature and effect of significant matters affecting
        comparability for all periods presented, such as
        changes in accounting methods (actuarial cost method,
        etc.), changes in circumstances (actuarial assump-
        tions, etc.), or adoption or amendmenu of a plan.
GOVERNMENTAL POLICIES AND PROCEDURES
CONCERNING PENSION PLAN COSTS
Internal Revenue Service (IRS)

     The basic Federal tax requirement affecting private
pension plans is contained in the Internal Revenue Code of
1954, as amended, and the implementing income tax regulations
and rulings. The code provides certain tax advantages to
qualified plans. Employer contributions are deductible,
within limitations, as business expenses in the year in
which they are funded or paid and are nc taxable as income
to employees until benefits are received. Also, earnings
of the pension fund are tax free at the time they are
earned.

     To be qualified, several general requirements must be
met: (1) the plan must be in writing, (2) it must be commun-
icated to the employees, (3) it must not discriminate in
either contributions or benefits favoring officials or
highly paid employees, and (4) the employer's contributions
must be irrevocable.

     Under ERISA, IRS is required to certify the qualifi-
cations of plans with respect to participation, vesting,
and funding.
Department of Labor

     ERISA gave the Department of Labor the principal en-
forcement responsibilities in the areas of reporting,
disclosure, fiduciary standards, and protection of em-
ployee pension rights in the areas of participation,
vesting, and funding.
Department of Defense

     The Armed Services Procurement Regulation (ASPR) allows
payments to qualified pension plans to be charged to
Government contracts to the extent that the pension plan
cost, with all other compensation, is allocable and



                              6
reasonable in amount and is deductible for the same year for
Federal income tax purposes. Another ASPR provision requires
timely payments into pension funds. Normal costs of quali-
fied plans which are not funded in the year in which they
are incurred are not allowable in subsequent years.
Amortization of unfunded actuarial liabilities is allowed
if distributed over a period of 10 to 40 years and if
started after the effective date of the ASPR change.  (ERISA
requires the amortization period for new plans to be no
more than 30 years for single employer plans.)

     In DOD, the administrative contracting officer is
responsible for determining compliance with ASPR regulations
and contract provisions, including those related to pension
plans.
COST ACCOUNTING STANDARDS BOARD

     The Cost Accounting Standards Board (CASB) was estab-
lished by the Congress in August 1970 (Public Law 91-379),
to issue cost accounting standards designed to achieve uni-
formity in accounting practices and consistency in accounting
treatment of costs by contractors, Its standards, once
finalized, are published in the Federal Register and sent
to the Congress. The standards are generally applicable
to Defense contractors having individual negotiated contracts
in excess of $500,000.

     The law also authorizes the CASB to make, promulgate,
amend, and rescitnd rules and regulations for implementing
the standards. One regulation that CASB has issued requires
that contractors describe their cost accounting practices
by submitting a disclosure statement to contracting officers
and to the CASE and that they follow these practices uni-
formly for all covered contracts. This disclosure state-
ment includes a section dealing with pension costs which
provides, among other things, for a description of the
contractors' actuarial cost methods.

     On September 24, 1975, CASB promulgated a standard for
the composition anC measurement of pension plan costs
(standard 412) and proposed a standard on February 3, 1977,
on the adjustment and allocation of pension plar costs.
Standard 412 suggests that the amount of the pension
plan cost of a cost accounting period be determined by
the accrued benefit cost method or by a projected benefit
cost method, which separately identifies normal costs, un-
funded actuarial iabilities, and actuarial gains and




                             7
losses. The standard allows other cost methods as long as
the contractor aooumulates supplementary data for actuarial
gains and losses and develops an alternative computation to
disclose any overfunding.


      This report discusses the results of our review of
pension plan practices of nine DOD prime contractors and our
findings relative to questionable charges in excess of
$100 million paid or to be paid by the Government.   Some of
these contractors also had prime contracts with the National
Aeronautics and Space Administration.




                             8
                          CHAPTER 2
          UNREALISTIC ACTUARIAL ASSUMPTIONS CAUSED
             EXCESSIVE PENSION PLAN COSTS WITHOUT
                APPROPRIATE GOVERNMENT CREDIT
     Use of unrealistic actuarial assumptions in computing
annual pension plan costs has increased the cost of Govern-
ment procurement by many millions of dollars. Actuarial
assumptions should represent the best estimate of future
events, taking into account past experience and reasonable
expectations.
     Before the Cost Accounting Standards Board standard
for pension plan costs was issued on September 24, 1975, con-
tractors were not required to separately identify or justify
the actuarial assumptions used to compute their annual
pension plan cost. Actuaries for some of the contrac-
tors we reviewed acknowledged that certain assumptions, for
example, projected investment income and salary increase
rates, were unrealistic when compared to past xperience.
When we requested details on actual experience n prior years,
the actuaries either had no such data or said that it was too
difficult and costly to accumulate.
     Following is a discussion of cases involving abnormal
employee terminations and other unrealistic actuarial assump-
tions.
ABNORMAL EMPLOYEE TERMINATIONS
     One of the assumptions made by actuaries in computing
annual pension plan costs deals with the number of employees
whose employment will be terminated before earning a vested
right to receive retirement benefits. If actual termin-
ations exceed those projected, then the pension plan costs
will be higher than they should have been.
     The termination of employees who have not attained a
vested interest in the pension plan benefits releases the
employer's liability for their pension benefits. Conse-
quently, a pension fund surplus is created by funding the
pension liability on behalf of such employees. At five con-
tractors we reviewed, the Government had not received appro-
priate credits for at least $45.6 million of actuarial gains




                             9
resulting from terminations in excess of those estimated by
the actuarial assumptions used in the valuations.

     The contract cost principles section of the Armed Ser-
vices Procurement Regulation requires that abnormal forfei-
tures of pension rights due to significant and foresee-
able reductions in employment levels shall be reflected
by an adjustment in allowable costs. When abnormal forfei-
tures were not taken into account previously, that is,
forfeitures were unforeseeable or were foreseeable but
no cost reductions were made, ASPR requires an appropriate
credit to the Government. ASPR also states that the appli-
cable portion of any income, rebate, allowance, and other
credit relating to any allowable cost, received by or accru-
ing to the contractor, shall be credited to the Government
either as a cost reduction or by cash refund, as appropri-
ate.

COSTS NOT REDUCED IN ACCORDANCE WITH
REDUCTIONS IN EMPLOYMENT LEVELS
     At five of the contractors we reviewed, there were con-
siderable reductions in employment levels (terminations)
which were not adequately provided for by the contractors'
actuaries. As a result, the Government was charged excessive
amounts for pension plan costs, as summarized in the following
table.

               Employment      Estimated     Government share
             level before    net reduction   of excess pension
Contractor     reductions    in personnel       plan costs
                            Number Percent
                                                 (millions)

    G           29,500      24,000     81         $40.9
    J           31,146      21,780     70           3.5
    B            1,406       1,206     86           0.6
    E            3,849       2,266     59           0.6
    D            2,829       1,349     48           (a)
                68,730      50,601                $45.6
a/Termination gain not computed.

     A brief explanation of each case follows.




                             10
Contractor G
     Since 1963 contractor G's employment level has decreased
from 29,500 to 5,500 employees. By 1974 a cumulative gain of
about $42 million (about $41 million Government related) was
realized by the pension fund because of the forfeitures of
benefits by employees terminated without vested rights. No
changes were made in the turnover rates used in computing
annual pension plan costs during the 18-year period when ab-
normally high employee terminations occurred. Until 1969
Government participation in the company's pension plan costs
was about 99 percent. From 1969 to 1974 this participation
dropped to 86 percent.

     Since 1965 the DOD contract administration and audit
activities reviewing contractors' pension plan costs have
been critical of the low actuarial turnover and investment
income rates used, but apparently were unable to have the
contractor change the assumptions. The parent company
stated in its proxy statement when it acquired the remaining
stock in this contractor that the pension fund surplus might
be available to reduce pension plan costs of its other opera-
tions. Because of this, the administrative contracting of-
ficer notified the contractor in November 1972 that the sur-
plus had resulted from charges to DOD and other Government
contracts and that proper credits should be given to Govern-
ment contracts.
     The parent company contended that no contractual or
legal basis existed for a claim against the surplus simply
because some of the contributions were reimbursed under
Government contracts.  It also contended that the surplus
resulted from very favorable investment experience and from
an unforeseeable employment reduction--both of which are
presently reversing and reducing the surplus.

     In a November 1973 report to the administrative contrac-
ting officer, the Defense Contract Audit Agency (DCAA) resi-
dent auditor computed the amount of overfunding due the
Government through 1971 as $16.4 million. In November 1973
the administrative contracting officer advised the contractor
that the proposed agreement did not insure that the Govern-
ment would receive credit for its allocable share in the sur-
plus. He requested a direct refund or credit against cost
in the amount of $16.4 million pursuant to ASPR as the only
method for satisfying the Government's equitable right in the
surplus.




                             11
     In a December 1974 report to the administrative
contracting officer, the DCAA resident auditor stated that
since the overfunded condition was a direct result of contri-
butions made in the years when Government work comprised
nearly 100 percent of the contractor's business, the Govern-
ment should share in the credits at the same ratio. DCAA
recommended that the contractor and the Government negotiate
a refund for the excess funding. No formal action was taken
by the administrative contracting officer to resolve the is-
sues raised in the report.
      In February 1975 the contractor responded to the admin-
istrative contracting officer's demand letters of November
1972 and November 1973. The contractor proposed to continue
its present policy of not charging for pension plan costs
until the surplus funding was liquidated, with no foreseeable
plans to use any part of the surplus for any other of the
parent company's operations. However, the contractor is in
part dissipating the surplus by not making contributions for
pension plan costs of a commercial subsidiary acquired in
1972.

     The administrative contracting officer advised us that
no further action was to be taken on the Government's inter-
est in the pension fund surplus. He stated that reducing the
pension fund surplus for future pension costs would insure
that the Government receives its appropriate credits.
     We believe that because the percentage of Government
business has declined in recent years, the Government may
not have shared the credits in the same proportion that the
pension costs were reimbursed. Furthermore, the continued
use of the surplus to reduce future pension plan costs
does not insure that the Government will share equitably
in future credits.

     In our opinion, the Government may assert a right to a
credit for both foreseeable and unforeseeable abnormal for-
feitures on the basis that the contractor has beneficially
received or accrued credits, income, or rebates. We believe
that under ASPR the contractor can be required to give the
Government an appropriate credit, either as a cost reduction
or as a cash refund.

Contractor and agency comments
    The contractor did not question these facts and submitted
    no formal reply.




                             12
     The Defense Contract Administrative Services (DCAS)
     stated that benefits from the surplus continue to accrue
     to the Government in that no contributions are being
     made to the pension funds by the contractor.
GAO comments

     The fact that no contributions have been made does not
necessarily mean that surplus is decreasing. The surplus
is so large and the actuarial assumptions are so unrealistic
that the interest earned on the surplus and the actuarial
gains are likely to be greater than the accrued pension cost.
In addition, the decreasing percentage of Government business
will result in the Government not receiving its fair share of
earlier overpayments.
     For the reasons previously stated, we are recommending
that the contracting officer establish the amount of credit
due the Government and recover it.

      Under the section Other Unrealistic Actuarial Assump-
tions," we discuss the contractor's use of unrealistic in-
vestment income assumptions and furnish additional comments
on the overfunded condition of contractor G's pension plan
fund.

Contractor J

     From 1969 through 1974, employment in one of contractor
J's divisions decreased from 31,146 to 9,366, a net reduc-
tion of 21,780. Because of the abnormal employee turnover
previously experienced and the anticipated future abnormal
employee terminations for the division, the Air Force Con-
tract Management Division requested in 1971 a modification
in the actuarial assumptions used in computing pension plan
costs to recognize the anticipated abnormal terminations.
ASPR provides that foreseeable abnormal forfeitures of
pension plan benefits because of employee terminations
should be reflected by an adjustment of otherwise allowable
costs.

      In response to the Air Force request, the contractor
used special actuarial assumptions in determining pension
plan costs for active employees at the division for the
3-year period 1971 through 1973 to reflect anticipated
employee terminations. This special valuation procedure
was discontinued in 1974 when the employee population stabi-
lized. A cinparison of pension plan costs under the special
and regula- valuation procedures indicated that the special


                            13
valuation procedures reduced pension plan costs by about
$11.7 million, of which the Government's share was about $9.6
million.
     The Air Force and the contractor took a forward-looking
approach in using a special valuation technique to recognize
the anticipated abnormal termination gains. However. we feel
that the amount of excess contributions the Government made
before 1971 was not recognized. Also, no consideration was
given to the lower proportion of Government work after 1971.
Our actuaries, using the contractor'o data, calculated that
the amount of the adjustment was $3.5 million less than it
should have been as of December 25, 1975. We believe that
the contracting officials should seek an appropriate contract
price adjustment.
Contractor comments
     The contractor does not agree with our position princi-
pally because

     -- the executed agreement between the contracting parties
        allowed special actuarial assumptions,

     -- it believed that GAO incorrectly interpreted the re-
        lated ASPR sections, and
     -- the fact that contributions based on actual employment
        data versus anticipated employment levels indicated
        that its pension plans were actually underfunded by as
        much as $4 million (during the period of the special
        valuation).

GAO comments
     On the first point, the Air Force Office of General Coun-
sel believes that the executed agreement is not binding. We
agree, and believe that equitable adjustments should be ob-
tained.  Regarding the second point, ASPR 15.205.6 states that

     "abnormal forfeitures, due to significant reduc-
     tion in the contractor's level of employment,
     that are foreseeable and which can be currently
     evaluated with reasonable accuracy, by actuarial
     or other sound computation, shall be reflected
     by an adjustment of costs otherwise allowable;
     where abnormal forfeitures were not taken into




                              14
    account previously, appropriate credit shall De
    given to the Government."
     We oelieve the circumstances noted in this case clearly
tall within the limit of this section of ASPR.
     Finally, our calculation of $3.5 million distributed the
large gain equitaDly between the contractor's commercial and
Government ousiness based on the respective contributions be-
fore the gain. In our calculations we gave full credit to
contractor J for the lower contributions made in 1971-73.

     The Air Force advised that our recommendation for appro-
priate contract price adjustment is under review.
Contractor B

     Two pension plans were created in 1970 for hourly em-
ployees--union and nonunion--at contractor B's facility re-
ferred to as plant 2 in chapter 3. (See p. 31.) For both
plans, the actuary used termination rates identical to those
being used for the contractor's basic hourly plan at other
plants. In recent years, however, the contractor had a
much largeL and more stable work force at other locations.

     We found that 1,251 hourly employees were terminated at
plant 2 etween September 1, 1970, and September 1, 1974, and
had not been reemployed by the latter date. Since the
facility was not established until early 1968 and vesting
occurs after 10 years of credited service, none of these
employees had acquired a vested right to a pension benefit.
Accordirgly, all contributions made on their behalf remained
in the pension fund.  Because the actual rate of terminations
was much higher than the assumed rate of terminations for
these years, both pension plans became overfunded. No cash
contributions were required in either pension plan for 1973
and 1974.

     During 1970-72, Government work at the facility ranged
from 96 to 100 percent. Since 1972, however, the work per-
formed for the Government has dropped considerably and is
expected to be about 50 to 60 percent during the 1975-77
period. If this condition continues, the Government will
not share in credits against future years' pension plan
costs in the same proportion that it absorbed the costs.
     We estimated tnat about $533,000 in abnormal forfeitures
reverted to the pension funds when the liabilities for the




                              15
1.251 plan participants were released by termination of
their employment. Considering the effect of interest at
the actuarially assumed rate of 5 percent, compounded an-
nually, this amount was increased to about $598,000 (Septem-
ber 1974), of which about $592,000 was aid for by charaes
to Government contracts during plan years 1970 through 1972.
     In 1972 DCAA advised the Army that the facility might
be closed and that a substantial pension fund surplus would
revert to the contractor. Based on DCAA's advice, the Army
and the contractor agreed that appropriate credit be given
to the Government should the facility be closed.
     Discussions with local DCAA and Army officials revealed
that they had never considered applying the ASPR provision for
abnormal forfeitures to an ogoing i, Tation even though they
were aware that substantial abnormal forfeitures had occurred
in the facility's hourly plans. These officials had appar-
ently interpreted the provision as being applicable only to
those situations in which both a plant closing and pension
plan termination occurred.
Contractor comments

     The contractor believes that the abnormal forfeitures
     provision of ASPR applies only when a plan or operation
     terminates.

GAO comments
     We believe that ASPR is quite clear, stating that

     "* * *abnormal forfeitures, due to significant
     reductions in the contractor's level of employ-
     ment * * * shall be reflected by n adjustment
     of costs* * *"

     This regulation applies to both major reductions in em-
ployment as well    to plant closures.

     The Army agreed with our position, and has recouped
$135,000 of these costs hrough disallowance of all pension
plan costs in negotiation of forward pricing rates for 1973
and 1974. The Army will continue this procedure in subsequent
years. We support this method of recovering termination
gains.




                              16
Contractor E

     As previously noted, ASPR requires that abnormal
forfeitures due to significant reductions in employment
levels be reflected by an adjustment in allowable costs.
     Contractor E experienced a large number of employee
terminations at its two plants (referred to as plants 1
and 2) from 1969 through 1973. These plants had a net de-
crease of 749 and 1,517 personnel, respectively, or 2,266
combined.
     At our request, the contractor's consulting actuaries
calculated an actuarial gain of $667,000 for the salaried
plan employees at plant 1., but no gain for the hourly plan
employees at plant 2. We estimated the actuarial gain at
plant 1, allocable to the Government, to be $590,000, which
is being amortized over a 15-year period. As of January
1975 the unamortized amount allocable to the Government was
estimated to be $514,000. "here was no gain at plant 2 be-
cause the actuary correctly anticipated the terminations
in determining annual pension plan costs.

Contractor and agency comments
     The contractor does not believe that the Government is
     entitled to an immediate credit for the actuarial gain.
     but that the 15-year amortization of the actuarial gain
     is consistent with ASPR.
    The contractor also believes that the termination gains
    in question, including those arising from commercial
    op rations, are being appropriately credited to Govern-
    n_.t contracts. It was also suggested that we did not
    consider the business mix (commercial versus Government)
    at the plant discussed and the type of contracts involved
    (fixed price, cost reimbursement, etc.).  Following the
    receipt of formal comments, the contractor's actuary ad-
    vised us that the termination gain calculation considered
    all employees at this plant as being terminated, in-
    cluding a group being transferred to another plant. He
    also felt that if the continuing liability for pension
    benefits for the transferred employees had been con-
    sidered in the calculation, the termination gain would
    have been less.
     DCAS has taken the position that while the Government
     has a legal right to recover abnormal forfeiture gains,




                                 17
                                 gains from commercial plants
    it has participated in such          plants. Therefore,
    comparable to those from Government                 31,
                      to the Government  as of December this
    credits allocated                and DCAS considers
    1975, are considered equitable.
                               its follow-on insurance/pension
    case closed. However, in DCAS is again checking into
    review of this contractor,
                                 plan costs and the handling
    the allowability of pension
    of abnormal forfeiture gains.

GAO comments
                                           of termination gains
     We do not agree that amortizationsince these gains are
over a 15-year period is appropriate
                               shorter period. Requirementsand
usually generated over a much     on page 10 of this report
       the regulation are stated
under                               be credited to the Govern-
we believe that such gain should or as a cash refund, as appro-
ment either as a cost reduction           view, our computation
priate. Contrary to the contractor's
                                 the mix of business and types
of potential credit considered
of contracts.
                                             B on page 16, the Army
      As noted in the case of contractor gains through credits
                            termination
 is seeking recovery of the    funding requirements. We
                                                            believe
 offsetting subsequent years'
                                   be followed in this case.
 that such procedure should also
                                       by the contractor's actuary
      In view of the statement made
                               in computing actual termination
 about the possible oversight  be made to determine the appro-
 gain, a recalculation should     statement about Government
 priate credit, considering the
                              abnormal forfeiture gains.
 participation in commercial
 Contractor D
                                            has been the major part
       Historically, Government business                         and
                 D's total  sales.   However, through expansion
 of  contractor                     business in recent years,
 acquisition of more commercial from 73 percent in 1969 to 41
 Government sales have declined
 percent in 1973.
                                       actual number of termina-
       We noted a big difference inpredominant decreases in
                                 the
 tions among divisions, with          During 1969-73 the Government
                       divisions.
 Government-oriented
             experienced  a decline  of 1,349 people, while the
 divisions                           of 926.
  total company had a net decline
                                            companywide pension plan
        During the 5 years the basically                       to
       187 terminations  with  vesting and 146 retirees added
  had




                                  18
the statistics. Even if all 333 were employed in Government
divisions, there were 1,016 employees terminated from these
divisions without vesting. Therefore, the resulting termina-
tion gains should s applied to the Government divisions.
Since a single termination scale was used for the entire com-
pany and Government sales have declined, the Government has
not shared in the credits (gains) on the same basis as it
paid pension plan contributions in earlier years.

     These matters were discussed with the contractor's
actuary and officials, and we requested data regarding the
terminations by divisions during this time. We were advised
that although the data was available, it would be difficult
and expensive to compile. We found, however, that the cost
of making an actuarial study of another similar case was
relatively small when compared to the excess credit due the
Government.
Contractor and agency comments

     The contractor indicated that while emphasis has been
     given to the termination assumption, equal attention
     should be afforded to other assumptions, such as salary
     scale losses.
     DCAS stated that the situation of abnormal forfeitures
     (terminations) is not a deficiency in this case since
     employment levels increased rather than decreased. How-
     ever, in its next visit it will review the points made in
     our report and make appropriate recommendations.
GAO comments

     As previously stated and confirmed in the contractor's
reply, detailed supporting data for actuarial assumptions was
not provided for an analysis. In this connection, CASB
Standard 412, effective September 1975, requires that each
actuarial assumption represent the contractor's best estimate
but validity of the assumptions may be evaluated on an aggre-
gate basis. In addition, if the proposed CASB standard, dated
February 3, 1977, is adopted, it will require termination as-
sumptions to be representative of experience for each segment
(division). The purpose of this requirement is to insure
that termination gains remain in the division generating the
gain rather than subsidize plan costs of the contractor's
other operations, including commercial work.




                            19
     In our opinion, DCAS should seek an appropriate credit
if the Government did not share in termination credits on
same basis as it made pension plan contributions.         the

      Regarding the DCAS comment on employment levels, the
DCAS figures appear to be based on total employment data
                                                           while
our finding relates to those persons enrolled in the pension
plan.   In addition, the actuarial reports do not support the
DCAS position. In any case, even if an increase   in total
employment occurred, this does not by itself preclude the
possibil-, of a termination gain during the period in ques-
tion.

OTHER UNREALISTIC ACTUARIAL ASSUMPTIONS

Contractor G

       Previously we discussed contractor G's use of an unrea-
 listic actuarial assumption for employee turnover (termination)
 rates. We also found that the contractor used unrealistically
 low actuarial assumptions regarding investment income when
compared with historical data.    From 1952 to 1974, the actuar-
 ial investment income rate used was 2.5, 3.0, and 3.5  percent.
The actual investment yield ranged from 1.02 percent to
                                                           17.64
percent under the hourly plan and from 0.47 percent to 12.49
percent for the salary plan. During this period the excess
investment yield over interest rate assumptions amounted
                                                            to
about $53.8 million. During the same period, gains of $42.4
million were realized when actual employee terminations ex-
ceeded the assumed rate of terminations. (See apps. III
                                                            and
IV.) These gains contributed to a substantially overfunded
position in the pension plans.    A portion of these excess
funds has been offset by omitting pension plan contributions,
including the Government's share, since 1969. However,
                                                          as
of November 30, 1974, the pension plans were still overfunded
by about $26.2 million, resulting direct'y from excessive
pension plan contributions, the bulk of which was charged
to Government contracts.
Contractor and aeny comments
    Tne contractor did not formally reply to our preliminary
    report.  DCAS stated that since no pension plan costs
    were being charged to Government contracts, and have
    not been for several years, any change in actuarial as-
    sumptions would not affect Government contract costs.
    DCAS also felt that GAO computations did not show the
    following actions which reduced contractor contributions




                               20
     to the pension plan:  (1) commencing in 1960,
     contributions were reduced by prior year actuarial
     gains, i2) no contributions were made to the salary
     plan after 1965, and (3) contributions to hourly
     plan were reduced by 50 percent starting in 1966 with
     none after 1968. Therefore, GAO computations were
     grossly overstated.
GAO comments

     We agree with the DCAS position pending resumption of
Government contributions. In addition, our actuarial staff
made a special study of the hourly plan of contractor G. This
study revealed that the contractor could have made contribu-
tions equal to 44 percent of the actual contributions in
every year from 1952 to 1969, and the plan still would have
been fully funded in 1969 when actual contributions ceased.
In other words, 56 percent of actual contributions were un-
necessary. This study dramatizes the effect of unrealistic
actuarial assumptions that resulted in unreasonable contract
costs.
Contractor C

     Contractor C's pension plan costs were overstated by pro-
jecting investment income considerably lower than actual.
Until January 1, 1972, the contractor funded the pension plan
through an insurance company which guaranteed a minimum return
of 4.5 percent on investments. Actual earnings averaged more
than 6.2 percent for the 3-year period ended in 1973, but
the contractor continued to use the guaranteed minimum of 4.5
percent as its actuarial assumption.

     In 1972 the contractor changed its funding for a large
portion of the pension benefits from an insurance arrangement
to a trust fund arrangement. One reason for the change, ac-
cording to the contractor's officials, was to increase in-
vestment income. Even though actual earnings under the in-
sured plan exceeded the guaranteed rate and the contractor
expected still higher earnings under the trust fund plan,
it continued to use 4.5 percent for valuation purposes.

     Because of the low-investment income assumption, the
contractor's annual pension plan costs were overstated,
resulting in increased costs to the Covernment.




                              21
Contractor comments

     The contractor advised us that interest rates used were
     common for pension plan valuations and that any favorable
     investment return was immediately credited to pension plan
     costs, reducing the expense allocated to Government con-
     tracts and, therefore, there has been no overstatement of
     pension plan costs.
GAO comments

     We do not concur. We believe that this conclusion was
reached because the operation of the actuarial cost method
used by the contractor's actuary was not fully understood.
Crediting of excess interest ompensates for the incorrect
interest assumption during that particular year. However,
the present value of future benefits for all following years
(the basic starting point of projected benefit actuarial
valuations) will still be significantly overstated. Con-
trary to the contractor's comment, a valuation using a 4.5-
percent interest assumption and with a 2-percent investment
gain will generally produce higher annual pension plan costs
than an actuarial valuation with a 6.5-percent interest as-
sumption and no actuarial gain for interest.

     The CASB standard on pension plan costs states that each
assumption should be separately identified and should repre-
sent the contractor's best estimates of anticipated exper-
ience, taking into account past experience and reasonable
expectations. The validity of the assumptions used may be
evaluated in the aggregate. If the actuarial assumptions
in the aggregate are not reasonable, the contractor should
identify the major causes for the resultant gains and losses
and the basis and rationale for retaining or revising each
such assumption.
Contractor D
     Contractor D, in a disclosure statement, reported that
the actuary kept all the data on calculations of pension plan
costs. The actuary expected that changes in the actuarial
assumptions would be recommended periodically as material
deviations were experienced or anticipated.  In 1973 the
contractor made important changes in the actuarial assumptions
which its actuary considered to be overdue.

     Since the overdue changes had the net effect of reducing
annual pension plan costs, it appeared that before 1973 the




                              22
actuarial assumptions were unrealistic and resulted in higher
   nsion plan costs. When requested to provide an analysis
of ctuarial gains and losses, the actuary stated that no
such records were kept even in the aggregate. He had no
information about the total gain or loss, nor about gains or
b0sses  broken down by types of assumptions.
Contractor     d agelcy ccmments
     The contractor advised us that the compelling reason for
     the change in assumptions was a revision in the basis for
     computing basic Letirement benefits from a career-average
     (total earnings divided by work years) to a final-average
     plan (average earnings during the last fw years before
     retiring). Although the contractor conceded that for
     a number of years ssumptions ere not realistic, it
     believed they were reasonable in the aggregate.
     DCAS also found that there was no analysis of actuarial
     gains and losses and that no such records were maintained
     even in the aggregate.   owever, it concluded that the
     assumptions used were reasonable when compared with
     those generally used in industry.

GAO comments
     As noted in the CASB standard 412. each assumption
     "* * * shall represent the contractor's best
     estimates of anticipated experience* * * taking
     into account past experience and reasonable
     expectations."
In our opinion, a benefit change is unrelated to the periodic
need to reconcile or adjust unrealistic assumptions. In ad-
dition, no disclosure of the effect of any individual assump-
tion was ever made by the contractor.
     We also question DCAS' basis for concluding that the con-
tractor's assumptions were reasonable by comparing them with
those used by industry. We believe that using industry aver-
ages of actuarial assumptions does not reliably indicate the
circumstances of an individual company, especially employee
termination rates and investment income assumptions.
     We were advised that DCAe ia currently conducting an
insurance/pension review at this contractor, and will assure
compliance ith applicable standards.



                               23
General agency comments
     DCAS stated that notwithstanding the above comments,
it agreed that Defense contractors should be required to
comply with standard 412 with respect to identifying and
justifying actuaiall assumptions. To that end, its insur-
ance/pension specialists have been evaluating compliance
with the standard since it became effective January 1, 1976.
In an overall comment, DOD felt that current and proposed
standards would improve management in the composition,
measurement. adjustment, and allocation of pension plan
costs.
CONCLUSIONS
     ASPR provides for cost adjustments n cases in which
employment reductions result in abnormal termination gains.
However, at five of the contractors we reviewed, the Govern-
ment had received neither an adjustment nor a credit for
about $46 million of such gains that were found.

     In our opinion, the Government is entitled to a credit
for large termination gains when estimated pension benefits
paid for by the Government will not be paid to employees
that performed work on Government contracts. We believe
that ASPR should be revised to furnish clear guidelines
for recovering DOD's share of gains caused by significant
employee reductions.
     While DCAS believes that the provision in ASPR on
abnormal forfeitures is reasonably clear, we believe that
ASPR should be revised to furnish clear guidelines for
recovering DOD's share of gains caused by significant
employee reductions. DCAS agreed, however, to consider
our comments.
     The CASB standard provides a means for the Government
to evaluate the propriety of the assumptions used by its
contractors and the mechanics to evaluate each assumption.
We believe that this standard should help prevent the
recurrence of the findings noted in this chapter.

     We conclude that, in the cases cited in this chapter,
the contractors and their actuaries increased pension plan
costs to the Government by using actuarial assumptions
which were unrealistic when compared to actual experience
or for which they had no documentation or rationale. We
believe that while actuarial assumptions should consider




                              24
reasonable expectations, they should be heavily influenced
by prior experience and should be documented to facilitate
reviews by contracting officials.
RECOMMENDATIONS

     We recommend that the Secretary of Defense determine in
the cases cited in this report the increased costs to the
Government resulting from abnormal forfeitures, and negotiate
appropriate credits for those pension plan contributions re-
imbursed under Government contracts which are now excessive.
We also recommend that ASPR be clarified to implement this
recommendation for application in all instances where con-
tractors experience abnormal terminations.

     The recoveries should be made as soon as possible
rather than permit amortization over a number of years,
since the gains are usually generated over a much shorter
period.

     In the case of contractor G, and in similar cases, we
also recommend that the Secretary of Defense determine and
obtain an appropriate credit for the Government, since use
of unrealistic assumptions resulted in unreasonable contract
costs. The amount to be recovered should be an equitable
share of prior overfunding, consistent with the funding
requirements of the Employee Retirement Income Security
Act of 1974.




                             25
                            CHAPTER 3
               REASONABLENESS AND ALLOCABILITY OF

                       PENSION PLAN COSTS
      The Armed Services rocurement Regulation (ASPR) states
that a cost is an allowable contract charge provided the
tests of reasonableness and allocability are met and that
generally accepted accounting principles are followed. A
cost is considered reasonable if it is one that would be
incurred by an ordinarily prudent person in the conduct of
a competitive business. Further, a cost should be allocated
between Government contracts and other work in reasonable
proportion to the benefits received.

     As mentioned previously, in September 1975 the Cost
Accounting Standards Board issued standard 412, and on
February 3, 1977, the Board proposed a second standard
that deals with the allocation of pension plan costs to
segments or divisions covered by a contractor's pension
plan. Cost Accounting Standard 412 sets the sta7e for
improved management in effectively controlling pnsion
plan costs charged to Government contracts. The roposed
standard is needed to clarify the Government's role as
well as to provide guidance when the mix of Government and
commercial work varies from year to year and from ost
center to cost center. The proposed standard is also
designed to assure that pension plan costs are calculated
on a segment (division) basis when appropriate and are
equitably assigned to periods and to cost centers.

     In other chapters we describe how an actuary, by
selecting various actuarial cost methods and by using
liberal or conservative assumptions, can calculate widely
varying annual pension plan costs. Following are examples
of excessive allocations of pension plan costs to Govern-
ment contracts through inequitable funding techniques and
allocation practices.
INEQUITABLE FUNDING TECHNIQUES

Contractor F

     ASPR provides that contributions for unfunded past
service costs shall not exceed, for any year. an amount re-
quired to systematically amortize the unfunded past service
costs over not less than 10 or more than 40 years.




                                 26
     In 1973 contractor F's actuary changed the funding of
the locally hired employee pension plans at the Government-
owned, contractor-operated plant to conform to the ASPR
requirement. However, the entire past service costs of em-
ployees transferring to the Government-owned, contractor-
operated plant from other contractors' divisions continued
to be funded in a single year, contrary to ASPR. In this
case the amount :involved was $156,000.
Contractor and agency comments
     The contractor stated that the unfunded amount has
     always been paid immediately to insure full funding
     upon completion of the contract.
     This situation was brought to the attention of the
     Army and action has been initiated to amortize the
     $156,000 over a 10-year period.
Contractor F
     Contractor F's estimated pension plan costs for 1974
included increased past service liability resulting from
a change in benefits which recognized additional past
service periods for salaried employees. In 1960, however,
the Army agreed to accept only the pension plan costs for
employee service after March 1, 1951. In view of this
agreement, we questioned whether the Army should absorb
the costs of pension plan benefit changes applicable to
pre-1951 service, amounting to $195,000.
     The contractor did not address this issue in response
to the preliminary report. However, the Army notified
us that the contracting officer has determined that the
past service charges of $195,000 have not been reimbursed
by the Government; the matter is now in/litigation.
INEQUITABLE ALLOCATION OF PENSION FUND ASSETS
Contractor B
     Contractor B's subsidiary has been computing annual
pension plan costs by location; however, to do this, the
assets held in common trust must be divided annually by
location. In this case, two plant locations were involved.
     For each year since 1968, the subsidiary has been
allocating trust fund assets in proportion to the actuarial




                                 27
liability for pension plan benefits, a method that does not
recognize net capital contributions by the respective sites
each year. Further, each location does not share equitably
in the capital growth of pension fund investments.
     An equitable and more commonly used method of allocating
assets for each year is the net contribution method. After
the initial allocation of assets, each site or cost center
is assigned a portion of fund assets based on prior contri-
butions. income, benefit payments, and expenses. Use of this
method produces results identical to those attainable when
separate trust funds are maintained for each cost center
but pooled for investment purposes. Each cost center re-
ceives full credit for its cash input to the fund, including
capital growth, and bears only those annual pension expenses
it generates.
     The method this contractor used to allocate assets
between the two plants caused plant 2, which does pre-
dominately Government work, to absorb a disproportionate
share of the annual pension plan costs. If the assets were
reallocated between the two sites on a net contribution
basis, plant 2's portion of the pension fund would have
reached a surplus condition by the 1973 actuarial valuation
date, thereby eliminating the need for additional contri-
butions for plan year 1973 and requiring only minimal
contributions for plan year 1974.
     Our actuary recomputed annual pension contributions
using the net contribution method of allocating assets
between the two plants. The results of the calculation
are summarized in the following table.
                                      Pension    Government
                                       cost        share

  Amount overcontributed by
    plant 2                          $243,000     $218,000
  Amount undercontributed by
    plant 1                           (99,000)     (57,000)

       Overpayment by Government                  $161,000

Contractor and aency comments
     The contractor maintained that it was questionable
     whether the actuarial liability method or the net
     contribution method is either preferable or equitable.
     Both methods are acceptable by the Internal Revenue



                                28
     Service and ASPR. The Army felt that the contractor's
     method was equally equitable and. in compliance with a
     subsequently promulgated cost accounting standard on
     pension plan costs.
GAO comments

     We do not agree that using the actuarial liability
method is equitable since contributions made for plant 2
employees, as well as their earnings, were far greater than
the assets assigned to plant 2 under that method. Furthermore,
the reduction in the actuarial liability due to terminations
at plant 2, being apparently greater than at plant 1, re-
sulted in the assignment of a lesser share of the assets to
plant 2 under the actuarial liability method instead of the
net ontribution method. Although the procedure the con-
tractor used may be acceptable under Internal Revenue
Service Regulations, this does not imply that it meets the
Government procurement regulation pertaining to equitable
cost allocation.

     We understand that"the proposed CASB standard, dated
February 3, 1977,wequires the net contribution method to
be applied on asset allocation whenever feasible. The
actuarial liability method the contractor used would be
allowable only as an alternative, when the preferred method
was not feasible.

     We believe that the ontracting officer should recover
the amount due the Governmenr and. the contractor should be,
required to adopt an equitable method for allocating
pension fund assets between the two plants.

Contractor G

      At contractor G a commercial subsidiary which was
acquired in 1972 is not making pension fund contributions.
Instead, the pension fund surplus (see p. 12) is used to
fu"nd the subsidiary's pension plan costs. Since the pension
fund surplus was accumulated mainly through Government reim-
bursements that exceeded the amcints required, the Govern-
ment's proportional share of the surplus has been diluted
by the annual pension plan costs of this commercial sub-
sidiary.
     This subsidiary became a division in April 1973, and
the contractor's pension benefits were then extended to
cover the division's employees. This division's pension




                              29
plan costs amounted to $42,600 for 1973. The 1974 costs were
not available at the time of our review. Although these
additional employees have earned pension benefits for 1973
and 1974, no contributions were made by the contractor be-
cause its pension plan was overfunded.
     Since the funding surplus was identified, Government
contracts have been receiving credits by the application of
the excess funding to succeeding years' pension plan costs.
However, the use of the surplus to fund the pension benefits
of the commercial division employees was not justified since
there were no prior contributions to the pension fund by
this division.
Contractor and agency comments
     Contractor G fficials informally stated, and Defense
     Contract Administrative Services (DCAS) advised us,
     that the pension plan costs associated with the com-
     mercial division were not likely to be significant.
     DCAS felt that inclusion of a commercial division in
     the allocation of benefits from excess pension plan
     costs previously allocated to Government contracts
     did appear inequitable.
     DCAS also felt that considering the complexities of
     this contractor's pension plans, the elimination of
     annual funding for several years, the size of the
     surplus funds involved, and the percent of flexibly
     priced Governiment contracts, the extent of the in-
     equity to the Government was insignificant.
GAO comments
     We believe that it is inequitable for the contractor's
commercial operations to benefit from excessive pension
plan costs allocated to prior Government contracts.
     We also believe that the 1973 commercial subsidiary's
pension'plan cost of $42,600, while not significant in
relation to total pension costs, is important enough to
be reported. We also believe that the contractor should
be required to pay the Government the amount of contri-
butions to the fund which it shopld have made and should
make in the future for its commeocial operations. This
procedure, which will amortize more rapidly the over-
fhnded condition caused by excessive charges to Government




                                 30
contracts, is suggested since pension fund assets are placed
in an irrevocable trust; that is, the funds cannot be with-
drawn to refund excess contributions.
INEQUITABLE COST CENTER ALLOCATION PRACTICES

     When a single pension plan is used to cover Government
and commercial operations, cost can be calculated in total
and allocated to cost centers, or calculated by individual
cost centers. When pension plan costs are allocated, there
are opportunities to inequitably shift pension plan costs
from one cost center to another. One of the common methods
is to use the same employee termination assumption for all
cost centers even though terminations of employees not
fully vested in pension benefits are generally much more
prevalent in cost centers doing Government work. In effect,
actuarial gains applicable largely or solely to Government
work are spread over all of the contractor's business.
A discussion follows of this and several other methods of
shifting pension plan costs from one cost center to another.
Contractor B

     The parent company used the same employee termination
assumptions for contractor B's plants 1 and 2 in computing
the salaried pension plan contributions even though the
terminations at plant 2 were far greater than those at
plant 1. Plant 2, with a larger percentage of Government
business than that of plant 1, had a decrease in salaried
employees from 216 to 119 between 1971 and 1973, while plant
1 increased from 2,845 to 2,904. By using the same termin-
ation assumption, plant 2 made excessive contributions for
the pension plan costs as computed by profit center (plant).
The excessive contributions resulted in an actuarial gain,
which normally serves to reduce future years' contributions.
However, as explained on page 28, the assets that were
generated by plant 2's contributions were assigned to plant
1 by using a questionable asset allocation technique, further
increasing costs to the Government.

Contractor comments

     The contractor stated that Government business fluctu-
     ates, and although some inequities exist periodically,
     the overall costs to the Government have been equitable.




                              31
GAO comments
     The general statement that overall costs to the
Government have been equitable was made without factual
support. An analysis of the effect of the termination
assumption will show the amount of excess contributions
and the need for the contracting officer to obtain credit
for any overpayments.

Contractor D

     Contractor D is another example of the Government-
oriented cost-center bearing more than its share of the
costs. Until 1973 the pension plan costs for its one plan
were calculated using corporate-wide assumptions. However,
we noted considerable differences in the rates of employee
terminations among divisions, with higher termination rates
in Government-oriented divisions. Overall the company had
a net decline of 926 employees from 1969 to 1973. The major
Government group (two divisions), however, experienced a
decline of 1,349 employees, which was partially offset by
net increases in other divisions. The cost to the Govern-
ment would have been much less in those years if the dif-
ferences in termination experience had been recognized.

     We requested data regarding the terminations by
divisions for the last 5 years, but the contractor's actuary
cited the difficulty and expense of compiling this data.
Contractor comments

     The contractor stated that while inaccuracies in
     termination assumptions may have resulted in in-
     creased costs, other assumptions have had the
     opposite effect and should be viewed accordingly.

GAO comments
     As noted earlier, the method used by the actuary to
calculate annual pension costs did not identify gains or
losses. Also, the contractor formally advised us that it
was too costly to provide detailed data on termination gains
or losses.

     The existing cost accounting standard requires that all
assumptions should be separately identified. The proposed
standard would provide additional specificity in that the




                              32
assumptions have to be quantified on a segment (division)
basis rather than on a plan or contractor basis.

     This was not done by contractor D. Although the events
in question occurred before the effective date of the
standards noted, we believe that DOD should seek a price
adjustment under the abnormal forfeitures section of ASPR.
     DCAS stated that its records showed a net increase-in
contractor's employment, but agreed in its next visit to
review the points made in this report and make appropriate
recommendations.

Contractor A

     Before October 1970 two wholly owned subsidiaries of
contractor A were members of the contractor's salaried
pension plan but accounted for and assigned their pension
plan costs separately. In addition to funding normal cost,
the two subsidiaries had an unfunded past service cost of
$614,177 as of January 1, 1970.
     In October 1970 the contractor reorganized its cor-
porate structure to include one of these subsidiaries as a
division. In the following year this division's pension
plan costs for salaried employees were included as part of
the contractor's pension plan costs. In 1972 similar
treatment was given to the other subsidiary.

     For 1971 and 1972, past service costs for the former
subsidiaries allocated to other divisions of the contractor
totaled about $104,000, with the Government contracts re-
ceiving about $89,000. Assuming that the ratio of Govern-
ment business to commercial business remains about the
same, an additional $909,000 will be allocated to the
other divisions of the contractor, with the Government
absorbing about $727,000 during the estimated 15-year
amortization period.

     Since these former subsidiaries had little if any
Government work during the time when the past service
costs were accrued, there appears to be no basis for
charging this cost to Government contracts.
Contractor comments

     The contractor stated that it is improper to evaluate
     pension plan costs on a specific issue basis; the




                              33
     merger in question incorporated a number of fringe
     benefit items and the costs should be viewed accord-
     ingly.
GAO comments

     Our position--supported by ASPR--is that cost should be
allocated between overnment contracts and other work in
reasonable proportion to the benefits received. This was
not complied with.

      In answer to our inquiry, DCAS negotiated an agreement
which eliminates the amortization of $1,092,138 for past
service costs of the former subsidiaries from contractor
overhead commencing in 1973 with savings of about $874,000
accruing to the Government. The actual figure negotiated
is greater than the amount stated above due to more,current
data.
CONCLbSIONS

     ASPR cost principles provide that cost is an allowable
charge if the tests of reasonableness and allocability are
met. More specifically, a cost is considered reasonable if
it is one that would be incurred by an ordinarily prudent
person in the conduct of competitive business. Further, a
cost should be allocated between Government contracts and
other work in reasonable proportion to the benefit received.

     It s important that pension plan costs follow these
principles and be equitably assigned to periods and to
cost centers because the mix of Government and commercial
work often varies from year to year and from ost center
to cost center.
     We have noted that Government divisions were being
charged more for pension plan costs

    -- than commercial work because different actuarial
       cost methods were used,
    -- because pension fund assets were not allocated in
       proportion to contributions, and

    -- because pension plan costs were calculated on a
       companywide basis instead of by divisions or cost
       centers.




                             34
     In addition, the Government's share of excess pension
fund credits is being dissipated by pension plan costs
applicable to commercial operations not being reimbursed
to the fund.

     In summary, we believe that in some cases the Govern-
ment is bearing a disproportionate share of pension plan
costs because contractors have taken advantage of the widc
latitude in acceptable actuarial funding techniques, asset
allocation procedures, and cost center groupings.      4

     We believe that when conditions demonstrate a wide
variance in experience--for example, terminations--contrac-
tors should calculate pension plan contributions by cost
centers. We noted that some contractor locations do follow
this procedure.

RECOMMENDATIONS
     We recommend that the Secretary of Defense have the
Armed Services Procurement Regulation revised to

     -- require that pension plan costs charged to the
        Government (1) are equitably distributed between
        Government and commercial work when different
        actuarial cost methods are used, (2) reflect alloca-
        tion of pension fund assets in proportion to contri-
        butions, and (3) are allocated by using assumptions
        based on division or cost center experience instead
        of companywide experience, and

     -- fully disclose any changes in the policies and pro-
        cedures affecting allocation of pension plan costs.

     We also recommend that the Secretary of Defense seek
appropriate credit for those improper allocations of pension
plan costs noted in these cases.




                              35
                          CHAPTER 4
         NEED TO IMPROVE CONTROLS OVER T   SELECTION

            AND REVISION OF ACTUARIAL COST METHODS

     Changes in actuarial cost methods have increased the cost
of Government procurement. Actuarial cost methods are de-
signed to spread costs over the life of the pension plan.
Some methods tend to distribute costs evenly to each year
while others produce uneven distributions.
     Before July 1972 contractors were able to increase the
cost of existing contracts by changing their cost accounting
practices, including pension plan accounting practices. Since
July 1972 Cost Accounting Standards Board regulations pro-
hibit changes in contractors' cost accounting practices from
increasing costs to the Government under existing contracts
subject to cost accounting standards. The only exception
is when the change is required by a cost accounting standard.
     Actuarial cost methods are considered to be cost
accounting practices. Therefore, if they are changed, the.
contractor must bear any increased costs applicable to
contracts which are subject to standards and which are being
performed at the time of the change.
COSTS TO THE GOVERNMENT INCREASED BY
CHANGES IN ACTUARIAL COST METHODS

     We noted three istances in which contractors changed
actuarial cost methods and increased costs to Government
contracts before the 1972 CASB requirement for consistency
in accounting practices became effective. These types of
changes are still permitted, but increased costs from them
are not to be charged to the Government under existing
contracts covered by CASB requirements. However, we are
bringing these cases to the attention of contracting and
auditing activities that review pricing proposals, or future
contract costs, to determine if changes in actuarial cost
methods (1) are justified, (2) are in accordance with prudent
business practices, and (3) will result in reasonable and
equitable costs to the Government on future contracts.
Contractor C

     At contractor C, effective January 1972, the actuarial
cost method for computing the cost of the early retirement
benefit was changed.


                             36
     Under a former method, all costs--including past service
costs--were funded over the average future working lives of
the employees (approximately 17 years). Using the newer
method, the past service cost was being funded over 13 years.
The result is a probable increase in costs to Government
contracts estimated at $1.9 million during the first 13 years
after changing the method. Shortening the amortization
period for past service costs resulted in increasing the
pension plan cost during the early years, although the
present value of future pension plan costs was not affected
by the changes.
Contractor and agency comments
     The contractor stated that the change in the method
     of calculating the pension plan costs was to comply
     with an Internal Revenue Service requirement and that
     our conclusion that the change probably resulted in
     increased Government costs is inappropriate. The
     contractor also maintained that the amortization period
     used was (1) in accordance with its principles of
     funding past service liabilities and (2) within the
     limits allowed under ASPR which allows an amortization
     period of 10 to 40 years.
     The Navy stated that the increase in the pension plan
     costs due to the change in actuarial cost method was
     partially offset by the increase in the investment
     income assumption and the change in asset valuation
     to recognize market value. The Navy also felt that
     since the net cost of all the changes was considered
     reasonable and the change was made before the effective
     date of the CASB regulations (July 1, 1972,), no
     recovery can be made.
GAO comments
     We were subsequently advised by an official of the
contractor that the change in actuarial cost methods was
not made to comply with a requirement of the Internal Revenue
Service Code, but was made to facilitate determining annually
whether the pension fund was overfunded. We believe that
this reason was not a justifiable basis for accelerating
the funding of the pension plan through increased charges
to the Government.
     We also disagree with the Navy evaluation of the
reasonableness of the increased cost of the change in the




                                 37
actuarial cost method since the change in the investment
income assumption and recognition of increased market value
of pension fund assets would have been made regardless of the
change in the actuarial cost method. We do recognize, how-
ever, that this change occurred before the issuance of a
cost accounting standard dealing with changes in actuarial
cost methods, and therefore, we are not suggesting a refund.

Contractor
     At contractor F the use of varying actuarial cost
methods resulted in additional costs to the Government.
Certain employees of the Government-owned, contractor-
operated plant are members of a corporatewide pension plan
in contrast to the division plan for hourly workers. Pension
plan costs for all corporatewide employees were computed on
the basis of an actuarial cost method that provided for
relatively low annual pension plan costs. Beginning in
1966, however, without seeking Army approval, the contractor's
actuary made a separate calculation of pension plan costs for
the Government-owned, contractor-operated plant members by
using an actuarial cost method that generated higher annual
pension plan costs. The actuary continued to use the
actuarial cost method producing lower annual contributions
for all members of the corporatewide pension plan, while
claiming reimbursement at the higher rate for the members
of the same plan employed at the Government-owned, contractor-
operated plant.

     The actuary stated that different actuarial cost
methods are used under the portions of the plan to (1)
give relatively low annual pension plan costs to contractor
F commercial divisions on the assumption that enough time
will be available to fund the contractor's portion of the
plan and (2) recognize the Government cost at a faster rate
on the assumption that the contract will have a relatively
short life. As a result, the Government has been allocated
a disproportionate share of the contractor's corporatewide
pension plan costs.

Contractos and agency comments
     The contractor stated that the use of different actuarial
     cost methods is not precluded by ASPR and is consistent
     with the objectives of the CASB-proposed standard on the
     adjustment and allocation of pension plant costs.




                                 38
     The contractor also explained the adoption of a new
     actuarial cost method in 1966 by the fact that the old
     method resulted in a cost increase from 5.0 percent of
     payroll in 1962 to 6.3 percent in 1965 with no change
     in the plan. The contractor maintained that the
     second method change did not materially affect the
     pension plan costs but merely shifted some liability
     from future service cost, where it is funded over the
     average remaining working lifetime of the membership,
     to past service cost, where it is funded over 10 years.
     The contractor also stated that its objective for
     funding pension plans was to provide reasonable
     assurance of full funding at the termination of the
     contract work.
     The Army felt that since a maximum of 40 employees at
     this plant location were under the corporate-wide
     pension plan, it was questionable that inordinate
     costs were absorbed by the Government.
GUAO comments
     While ASPR does not specifically preclude the use of
different actuarial cost methods, the principle of reason-
ablVness of benefits received to costs incurred must be
recognized.
     The proposed CASB standardKited by the contractor,
however, shows that where pension cost is separately
calculated for one or more segments, the actuarial cost
method used for a plan shall be the same for all seg-
ments.
      Further, we do not agree that the change in actuarial
cost methods had no material effect on pension plan costs.
The new method, while producing a level cost pattern,
resulted in much higher annual costs during the first few
years following the change. It is during this early period
that the annual pension plan costs are accelerated and the
Government costs are increased. This practice is in line
with the contractor's stated objective of full funding at
the termination of contract work. This concept of full
funding for accrued liability, when applied to Government
and not to commercial work, is inequitable to the Govern-
ment. If Government work declines or is terminated, the
pension fund applicable to Government work may well be




                              39
overfunded in terms of the liability accruing to the plan
participants that will either be laid off or transferred to
commercial work. The future commercial work would then
benefit from the previously overfunded plan assets by not
having to fund the pension plan until the excess of Govern-
ment pension plan contributions is absorbed.
     Regarding the DD contention that costs may not have
increased, our calculations show that the difference may
total $130,000 each year.
     Since a consistent and equitable actuarial cost method
should be applied to all of the contractor's divisions, we
believe that the Army should determine the amount of excess
contributions and seek recovery.
Contractor A
      In 1970 contractor A changed the actuarial cost methods
for  its  slaried plan. The effect was to accrue more cst
in  the  current  year (1970) than would normally have been
accrued under    the former method. In its 1970 financial
statement, the contractor stated that
     "Certain plans were amended to provide increases in
     retirement benefits * * * as well as revisions in
     certain actuarial assumptions and an actuarial cost
     method. These changes accounted for most of the
     increased pension costs in 1970."
     Since no actuarial report was made for 1970 showing the
effect of the change in the actuarial cost method, we pre-
pared a mathematical model to demonstrate its effect. On
the basis of this model, we estimated that pension plan costs
for 1970 increased by about $2 million solely as a result of
the change in the actuarial cost method. The Government's
share of the increase was estimated to be about $1.6 million.
The costs for several years after 1970 would be similarly
increased.
Contractor and agency comments
     Contractor A stated that our analysis also should have
     considered changes in benefits, investment income
     assumption, and asset valuations. While not questioning
     our conclusion that changing the funding method increased
     costs, the contractor believed that the net cost of
     the new plan installed in 1970, with all of its attendant




                           40
     changes, was less costly to itself and its customers
     by approximately $1.7 to $1.9 million each yar. The
     contractor also considered the change in funding method
     as necessary to meet requirements of the Accounting
     Principles Board Opinion Number 8.
     DCAS felt that changes in the investment income assump-
     tion and asset valuation partially offset the increased
     pension plan costs resulting from changing the actuarial
     cost method. However, the net effect was an overall
     increase in pension plan costs.
GAO comments
     The changes in benefits, investment income assumptions,
and asset valuations were necessitated by changes in the pro-
gram and investment earnings in excess of the assumptions and
would have been necessary even if the contractor did not
change the actuarial method. The change in the actuarial
cost method was made at the contractor's option, and, as
stated previously, increased Government costs by about $1.6
million for 1970. The fact that the net cost of the new
plan with the new actuarial method is not greater than the
old plan under the old method shows how important it is to
have a thorough review of contractor pension plan costs by
people with actuarial expertise who can analyze the effect
of actuarial method changes.
     Accounting Principles Board Opinion Number 8 does not
require a company to change its actuarial cost method, but
simply requires disclosure if the actuarial cost method is
changed.
CONCLUSIONS
     Before the July 1972 CASB regulations, the contractors
were able to increase contract costs by changing their
cost accounting practices. In some cases, contractors
changed to actuarial cost methods which increased the costs
of existing Government contracts. Because of the CASB
regulations, such increased costs on existing contracts
may not be borne by the Government. However, the costs
applicable to any contracts entered into after the change
can be increased.




                            41
RECOMMENATION
     We recommend that the Secretary of Defense require
contracting and auditing activities, when reviewing pricing
proposals or future contract costs, to determine if the
changes in actuarial costs methods (1) are justified, (2)
are in accordance with prudent business practices, and
(3) will result in reasonable and equitable osts to the
Government on future contracts.




                            42
                            CHAPTER 5
             NEED FOR THE DEPARTMENT OF DEFENSE TO

          INCREASE ITS EXPERTISE IN THE AUDIT, REVIEW,
       AND EVALUATION OF CONTRACTORS' PENSION PLAN COSTS

      Although contracting and auditing activities have
large recoveries or reductions in pension                made
                                           plan costs charged
to the Government, we believe much more needs to
                                                  be done.
DOD has provided only limited staffing and expertise
                                                       for re-
view and evaluation of the allowability, reasonableness,
allocability of pension plan costs charged to Government and
contracts. None of the staffs included actuaries.
                                                     Instead,
reliance is placed on Armed Services Procurement
                                                  Regulation,
general knowledge of industry pension plan practices,
tacts with or hiring of actuaries as consultants,       con-
                                                   and
comparisons of pension plan practices among contractors.
Even with limited staffing, effort, and expertise,
                                                    some
important recov_.ies or adjustments to contract
                                                 costs were
realized by DOD personnel during reviews of contractors'
pension plar costs.

     Notwithstanding the success of its limited reviews,
DOD in May 1975 issued a directive suspending  reviews by
the mi tary services and by the Defense Contract
tration Ser.vices of contractors' pension plan costsAdminis-
                                                      charged
to Government contracts when contractors met certain
tion criteria.                                         exemp-

DOD REVIEW OF CONTRACTORS' PENSION PLAN COSTS

Defense Contract Administration Services

      Late in 1968 the Defense Contract Administration
Services (DCAS) established a special activity
                                                to examine
insurance and pension programs of Defense contractors
determine the allowability, reasonableness, and         to
of costs for those programs. The need for such    allocability
analysis arose because cost patterns, especially special cost
                                                   for pension
programs, were increasing substantially. Sporadic
nations before 1968 by isolated audits indicated     determi-
problems, particularly when substantial employee   cost
                                                   layoffs
occurred in connection with Government work. The
                                                    need for
pension specialists was recognized, and DCAS established
activities in' New York, Chicago, and Los Angeles
                                                   to specif-
ically examine Defense contractors' pension plan
                                                   and in-
surance practices and costs.


                              43
      DCAS currently nas 12 specialists conducting these
reviews nationwide. Contracting officers request that these
specialists examine pension plan and insurance costs of
Defense contractors when DCAS has cognizance. These reviews
are generally biennial and were performed originally only
when the contractor had $5 million or more of noncompetitive
awards. This threshold was raised to $10 million, imposing
additional limitations on the scope of pension plan reviews.
Reviews covering both pension and insurance practices are
conducted mostly at corporate headquarters' offices. DCAS
personnel spent an average of about 5 working days reviewing
pension and insurance practices and costs at a contractor's
office. Even with the some-hat limited reviews and lack of
actuarial expertise, from lr© to June 30, 1975, the DCAS
staff has brought about $40 , ' on in recoveries or reduc-
tions of pension plan costs -. ged to the Government. This
amount does not include contin ng savings beyond June 30,
1975.
Defense Contract Audit Agency

     The Defense Contract Audit Agency (DCAA) had no special-
ized field staff trained to review a contractor's pension
plan practices. Its reviews of contractor pension plan costs
usually consist of verifying whetner the amount is (1) the
same as that calculated by the actuary and accepted by the
IRS for income tax purposes and (2) properly included in the
overhead for allocation to Defense contracts. If any ques-
tions of a contractor's pension plan practices arose, DCAA
contacted DCAS or the Air Force pension representative for
assistance or followup. For example, DCAA observed a situa-
tion involving pension plan cost overaccrual. This situation
was brought to the attention of the Air Force pension and
overhead cost review representatives who determined the
amount involved. As a result, an agreement was entered into
with the contractor for amortization of the pension cost over-
accrual of $91 million.

Air Force
     The Air Force Contract Management Division had one indi-
vidual making annual reviews of pension plans and insurance
costs of 11 major Air Force contractors, 1 of which was re-
cently transferred to DCAS for contract administration. This
individual retired in December 1975. The Air Force was
working on an agreement for DCAS to review contractors' pen-
sion plan practices at the request of Air Force contracting
representatives. Since 1967 the reviews by the Air Force


                                44
specialist have resulted in refunds, decreases in pension
plan costs, and amortization of pension plan ccst over-
accruals totaling about $67 million. In addition, he has
brought about large reductions in pension plan costs included
in contractors' pricing proposals.
Army
     An Army headquarters representative stated that the Army
relies on DCAA to make pension plan reviews. He stated,
however, that DCAA di' not have sufficient capabilities to
review contractors' pension plan practices in detail. He
also stated that DCAS may be called on to make pension plan
reviews for the Army.


     A Navy representative stated that the Navy has no pen-
sion plan specialists but relies on DCAS or DCAA to look into
pension plan problems at its request. Recently the Navy ar-
ranged for DCAS to perform, on request by its contracting
officers, pension plan reviews of contractors under Navy cog-
nizance for ontract administration.
COMMENTS ON DOD REVIEWS OF CONTRACTORS'

     While DOD has responsibility for assuring that pension
plan costs are reasonable, the cognizant audit and contracting
activities are generally accepting the amounts computed by
the contractor's actuary. We also found that there is insuf-
ficient eview:by DCAA and contracting officials of the allo-
cation of pension plan costs to their proper periods and
cost centers. As a result, millions of dollars of pension
plan costs ere allocated to Government contracts without
question by DOD audit and contracting activities.
     A primary cuse for inadequate surveillance appears to
have been the inability of DOD to obtain the information
needed to make meaningful evaluations. However, the cost
accounting standards (including the proposed standard) on
pension plan Costs contain requirements designed to enhance
the visibility and verifiability of contractors' pension
plan accounting practices and actuarial assumptions. These
requirements should help the Government in making meaningful
reviews of contractors' pension plan practices.




                             45
     Another cause for the inadequate surveillance is that
DOD does not have enough skilled staff--especially in pension
accounting and actuarial computation--to adequately evaluate
whether pension plan costs are being properly computed and
charged to Government contracts. Despite the fact that pen-
sion plan costs are a large percentage of the total contract
cost, it appears that DCAA places a low staffing priority on
indepth analysis. Also, DCAS now reviews the pension plans
of only those contractors who have received noncompetitive
awards in excess of $10 million in a year, and even in that
category certain contractors are exempted from pension re-
views, as discussed in the next section.
     Following are instances in which the propriety of pen-
sion plan costs was not questioned or insufficient action was
taken by contracting and auditing activities to resolve the
issues.
     At contractor D, (discussed on p. 22) neither the DCAA
resident auditor nor the DCAS Region pension specialist
reviewed or questioned the actuarial assumptions. Similarly,
at contractor C, (discussed on page 21) the DCAS Region re-
view did not question the use of the investment income rate
guaranteed by the insurance company, which was lower than
actual income earned. At contractor A, (see pp. 40 and 33)
DCAA did not question the change in the actuarial cost method
or the amortization of two commercial subsidiaries' unfunded
past service costs as a charge to Government contracts.
     At contractor G, (see p. 11) we did note that the Air
Force, DCAA, and DCAS questioned the overfunding of a pen-
sion plan. The administrative contracting officer's
position was that a reduction of future pension plan costs
would insure an appropriate credit to the Government; how-
ever, this method may not be equitable since the contractor's
Government business has declined in recent years.
     At contractor H, both DCAA and DCAS Region identified a
potential credit because of a major reduction of employees.
In this case we believe that a reduction of future pension
plan costs provides an appropriate credit to the Government
as long as the Government/commercial mix of business remains
stable. The administrative contracting officer agreed.
CURTAILMENT OF DOD PENSION PLAN REVIEWS
     Even though limited reviews of contractors' pension
plan costs have resulted in important accomplishments, the

                             46
Acting Assistant Secretary of Defense, Installation and
Logistics in a May 5, 1975, memorandum directed the military
services and the Defense Supply Agency to immediately suspend
the requirement for conducting employee compensation systems
reviews and insurance/pension reviews at contractor locations
that were qualified under the contractor-weighted-average-
share-in-cost risk (CWAS) program.
     This program was set up as a management tool to limit
Government surveillance over its contractors. It is based or.
the assumption that contractors with a large percentage of
competitive, firm fixed-price Government contracts and non-
Government business have sufficient competitive motivation
to minimize costs. The basic assumption has never been
tested by DOD to our knowledge. If the basic tests of allow-
ability and allocability are met, the Government would assume
that certain selected costs are reasonable at the CWAS-
qualified locations. A contractor qualifies under CWAS if it
has met the threshold of 75 percrent of total costs being
commercial and competitive fixed-price costs.
     DOD's reason for the May 5, 197    d!cective was to reduce
contract administrative costs. A CWAS evaluation group eval-
uated the effectiveness of the .eovised CWAS procedure, and its
recommendations are now being consigr:red for incorporation in
a revised directive dealing with the review of activities of
CWAS-qualified contractors.

     We questioned DOD on the practicality of suspending re-
views of contractors' pension plan pr~atices in view of our
findings and the success of pension plan reviews performed
by DCAS and the Air Force. Furthermore, as previously dis-
cussed, these activities spend only a limited time at con-
tractors' plants reviewing both insurance and pension plan
practices. A DOD representative maintained that the Govern-
ment's interest would still be adequately protected since
the contractors' pension plan costs charged to the Government
would still be reviewed for allocability by DCAA.

     We believe that the types of findings discussed in our
report, as well as those developed by DCAS and the Air Force,
probably would not have been questioned during a outine re-
view of pension costs. DCAS and Air Force representatives
also felt that certain of their findings would not have been
observed with only a passing knowledge of pension plan prac-
tices.




                             47
     DCAS advised us that to comply with the above directive
it had to suspend reviews of insurance/pension practices of
16 contractors.
CONCLUSIONS

     Notwithstanding the success of its limited reviews, DOD
exempted in May 1975 certain qualified contractors from mili-
tary services and DCAS reviews of their pension plan practices
and costs.

     At the contractors reviewed, we noted that questionable
actuarial assumptions were being made, actuarial cost methods
were being changed, and inequitable allocations procedures
were being used--all increasing costs to the Government--that
were not adequately evaluated by contracting activities or
by DCAA because of limited staffing and actuarial experience.

     We believe that the cost accounting standards--including
the proposed standard--contain requirements to make the
contractors' pension plan accounting practices and actuarial
determinations visible and verifiable. These requirements
should help the Government in making meaningful reviews of
contractors' pension plan practices.

     We also believe DOD should have personnel with actuarial
skills to evaluate pension plan costs. The value of devel-
oping this capability is even more apparent with the issuance
of CASB pension plan cost standards. Reviews of pension plan
costs should include the impact of actuarial cost methods
and assumptions, funding techniques, and allocation of costs
by cost centers as well as by periods so that the Government
is charged an equitable share of the pension plan costs.

     We also believe that DOD should reinstate the military
services and DCAS reviews of certain contractors' pension
plan practices and costs. The findings discussed in this
report and the findings of DCAS and the Air Force indicate
that the time these groups spent reviewing contractors'
pension plan practices and costs was relatively small
compared to the realized and potential accomplishments.
DOD comments

     DOD's comments on our findings are incorporated in the
body of the report under each contractor, as appropriate. In
addition, DOD offered comments in two principal areas that



                            48
     -- the $110 million in questioned costs should reflect
        that $92 million relates to one contractor dated
        back to 1952 and
     -- many of the findings were already noted by DOD repre-
        sentatives, existing expertise and surveillance in
        pension matters are sufficient, and that outside
        actuaries are occasionally utilized.

GAO comments

       DOD is correct that one finding accounts for most of the
Dollars. However, this report also shows instances where the
 o'..lar impact of questionable contractors' pension plan
)ractices was not determined. With respect to the case re-
ferred to as contractor G, the buildup of actuarial gains
began in 1952 and continued tc as late as 1974. About 93
percent of the gains developed in the last 11 years.    Dating
the finding back to 1952 illustrates the long and continued
need for realistic actuarial assumption for terminations and
interest rather than an outdated or obsolet set of assump-
tions. The present overfunded amount of $26 million was charged
to Government contracts for employees who terminated with
no vested rights, and for an unrealistic intierest assumption
that was used over a number of years. We      'ieve that this
demonstrates the lack of close scrutiny b r u.

      Regarding our conclusion that more technical expertise
and training is needed, DOD stated that it has 3 highly
qualified insurance/pension specialists who have identified
many of the deficiencies in th.: report. DOD also stated
that:

     "The auditors' expertise in pension matters is suffi-
     cient to disclose situations where the assistance
     of actuaries may be necessary, and * * * procurement
     officials, auditors and contract administrators
     are afforded sufficient training * * * to cope with
     these matters."
     The fact that DOD review and audit organizations did not
question certain deficiencies discussed in this report indi-
cates the need for more expertise and training as well as
additional surveillance. An example of the need for more
DOD involvement is indicated in its reply to our finding
that contractor D used urealistic ctuarial assumptions, re-
sulting in increased costs to the Government.  In tis case,
DOD also found that it was unable to evaluate the aesumptions




                            49
on an individual basis, and simply compared the contractor's
 -sumption with those used in industry, concluding that the
  1sults were reasonable. DOD did not evaluate each assump-
.,on independently.

     This report is designed to improve the type of analysis
that DOD performed in this case. The actuarial experience
of an individual contractor does not necessarily follow
those of industry, and to evaluate in this manner is inappro-
priate. For example, a contractor's termination experience is
peculiar to the company. In this example the transition from
nearly full Government work to a majority of commercial work
necessitated periodic evaluation of the termination assump-
tions.

     We believe the DOD position that the assumptions were
reasonable--without c nsidering actual experience--supports
our conclusion that more expertise is needed to fully evalu-
ate pension costs.
     The type of analysis we applied to this contractor's
actuarial assumptions is now required by CASB Standard 412
and in more specific terms by the proposed Standard 413 on
allocations of pension costs.
     Finally, with reference to curtailing pension surveil-
lance in favor of qualifying this type of cost under
contractor-weighted-average-share-in-cost risk (CWAS) program,
DOD stated in its reply to our preliminary report that the
curtailment was a temporary change. An evaluation of the
CWAS program is underway, and our observations will be con-
sidered.

RECOMM"NDATIONS

     We recommend that the Secretary of Defense rei. ate the
military services and DCAS reviews of contractors' pension
plan practices. In addition, we recommend that the Secretary
have DOD obtain additional staff with the needed technical
skills to

     -- assist in determining if pension plan costs are reason-
        able and equitably allocated to Government contracts and
     -- determine compliance with ASPR requirements and CASB
        standards.




                              50
     We also recommend that the Secretary of Defense initiate
                                                  computation
training programs in pension plan accounting and review
to enable contracting and  auditing personnel to        ade-
quately the contractors'  pension plan practices.




                              51
                          CHAPTER 6
                       SCOPE OF REVIEW
     Our review was directed at the allowability, reasonable-
ness, and allocability of pension plan costs reimbursed to
contractors under Government-negotiated contracts. Specific
attention was given to the procedures and practices the con-
tractors and their actuaries used in computing and allocating
pension plan costs. Generally, we did not verify the actuar-
ial calculations or the data base. Our computations of ques-
tionable pension plan costs used in this report were based on
data the contractors and their actuaries supplied.

     We examined pertinent regulations and guidelines issued
by Government agencies and reviewed actuarial reports, trus-
tee agreements, and related data affecting pension plan costs.
This review included contacting actuarial consulting firms
as well as an insurance company.
     The nine DOD prime contractors selected for review were
engaged in work related to electronics; missiles and space
systems; ammunition; and aerospace, including manufacturers
of airframes, airframe components, aircraft engines, and heli-
copters. Some contractors worked with more than one of
these commodity groups. One of the contractors reviewed
operates a Government-owned plant.




                             52
        AAkOI.{ I                                                                                                                                         mPPENDI   I




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                                                                                           53
 APPENDIX II                                                                  %PPENDIX II

                                   LIST OF FINDINGS

                         AND   UESTIONABLE PENSION PLAN COSTS


                                                                 Questionabl pension
                                                                      plan costs
       Findings                  ecific prblem                  Overall       _o'vernmen_

Unrealii3tic actuarial
  assumptions caused
  excessive pension
  plan costs without
  appropriate Govern-
  ment credit:
    Contractor G         Aonormal terminations              $ 42,441,512       S 40,950,063
    Contractor J         Abnormal terminations                   (3)            b/3,500,000
    Contractor B         Abnormal terminations--Plant 2
                           hourly plan                             597,600          592,000
    Contractor    E      Abnormal terminations                     667,000          589,918
    Contractor    D      Abnormal terminations                     (a)              (a)
    Contractor    G      Unrealistic interest rate              53,783,915       51,197,065
    Contractor    C      Guaranteed interest rate of
                           insurance company used for
                           valuation purposes                      (a)              (a)
    Contractor    D      Assumptions not adequately dis-
                           closed                                  ()               (a)
    Contractors C, D     Actuarial assumptions--partially
                           offset by other incorrect as-
                           sumptions                               (a)              (a)
    ContLactors A, B     Unrealistic actuarial assump-
                           tions offset by erroneous
                           assumptions
Reasonaoleness and
  allocability of
  pension plan costs:
    Inequitable fund-
      ing techniques:
        Contractor F     Funding of past service costs
                           for transferees not in com-
                           pliance with ASPR                       156,300          156,300
                         Charge for past service pen-
                           sion plan costs to the Gov-
                           ernment not in accordance
                           with agreement                          195,500          195,500
    Inequitable allo-
      cation of pen-
      sion fund
      assets:
        Contractor B     Under salaried plan method of
                           asset allocation for actu-
                           arial valuation inequitable
                           to Government                           243,364        c/217,824
                                                                   (99,414)        d/56,504)
        Contractor G     Pension cost of commercial
                           cost center met with surplus
                           funds accumulated through
                           charges to Government con-
                           tracts                                 e/42,600         e/42,60n
    Inequitable cost
      center alloca-
      tion practices:
        Contractors B,   Pension plar. cost not calcu-
          D                lated on division or cost
                           center basis                            (a)              (a)

        Contractor A     Supplemental cost of commer-
                           cial subsidiaries spread to
                           all divisions when subsidi-
                           aries added to plan                   1,092,138          874,000




                                             54
APPENDIX II                                                               APPENDIX II


                                                              Questionable penion
                                                                    plan costs
       Findings                Specific problem               Overl         :Ooverniiimen
Need to improve con-
  trols over the selec-
  tion and revision of
  actuarial cost meth-
  odes
    Contractor C        Change from aggregate level
                          cost method without supple-
                          mental liability to individ-
                          ual level cost method with
                          supplemental liability for
                          early retirement provision       f/19,000,000         1,900,000
    Contractor          Change from accrued benefit
                          method to projected methods           (a)                (a)
    Contractor A        Change from accrued benefit
                          cost method to aggregate
                          method, for its salaried
                          plan                                1,956,300         1,625,685


                            Total                          $120 076,815     $101,784,451
a/Not computed.
n/Net gain applicable to abnormal terminations experienced brought forward to 1975
  was computed to be $6 million. Credit for reduced Government contributions brought
  forward with interest was computed to be $2.5 mi'lion leaving a balance of
  $3.5 million.
c/Contractor 8's Plant 2 overcontrioution
d/Contractor B's Plant 1 undercontribution
e/Pension plan cost for 1973 only; 1974 and future years costs not determined.
f/Increase in supplemental cost only.   Change in normal costs not readily indenti-
  fiable.




                                             55
APPENDIX III                                                                                                                                                                                                                                                      APPENDIX III

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                                                                                                                                                         56
APPENDIX IV                                           APPENDIX IV

        GAINS REALIZED WHEN ACTUAL EMPLOYEE TERMINATIONS

            EXCEEDED THE ASSUMED 'RATE OF TERMINATIONS

                             CONTRACTOR G
Pension                                         Salary plan
 year             Hourly plan               Fixed          Variable
 1952             $      58,717         $   18,046
 1953                       765              3,389
 1954                 a/!14,338)             1,404
 1955                 No report              8,796
 1956                    48,775             41,735
 1957                    84,709            116,910
 1958                   118,670             35,407     $      21,408
 1959                   139,995             13,348            72,334
 1960                   177,741             88,722           209,460
 1961                   226,432             33,580           378,130
 1962                   301,432             19,840           271,548
 1963                   278,239             50,778           466,549
 1964                   370,146            348,855         1,730,970
 1965                 1,168,295            749,003         3,706,274
 1966                 2,108,472            685,492         2,385,544
 1967                 1,999,316            318,318         1,941,306
 1968                   701,000            538,000         2,985,00C
 1969                 1,762,000            433,000         2,401,000
 1970                 2,259,000            265,000         1,530,000
 1971                 1,728,000            216,000         1,771,000
 1972                 1,417,000            111,000           932,000
 1973                   972,000            101,000           680,000
 1974                   587,000          a/(42(000)          310,000
    Total        $16,493,366            $4,155,623    $21 792 523
Grand total $42,441,512
a/Actuarial loss when actual employee terminations were less
  than the assumed rate.




                                   57
 APPENDIX V                                                      APPENDIX V



                        ASSISTANT SCRTARY OF DOOMS
                              WAIWNSMOW", D.C. asUO



                                                      1 OCT W6
VmSALuA'es AMe LO@6nM




Mr. R. W. Gutmann
Director, Procurement and
 Systems Acquisition Division
U. S. General Accounting Office
Washington, D. C. 20548

Dear Mr. Gutmann:

This is in reply to your letter of July 16, 1976 to Secretary Rumsfeld
forwarding for comment a draft report entitled, "Need for Effective
Control Over Pension Plan Costs Charged to Negotiated Contracts."
(OSD Case #4409)

We have reviewed this draft report and detailed comments regarding
the General Accounting Office (GAO) findings and recommendations
are attached. This is a complex subject, and our comments are
intended to be constructive. Many of the matters discussed in the
draft report were previousiy known by Department of Defense (DoD)
activities, and action ha bei. taken on them.

We noted that of the questioned pension plan costs of about $110 mil-
lion relating to Government Contracts, $92 million rel4te to one
contractor. This one case is based on computations made by GAO
for 22 years, 1952 through 1974, a rather extensive period. Defense
Contract Administration Services (DCAS) has contract administration
responsibility for this contractor. They have advised, as reflected
further in the attached comments, that commencing in 1960 contractor
contributions to the pension plans were reduced and after 1968 elimi-
nated. Pension costs are not being charged to Government contracts.
As noted on page 16 of the draft report, a significant portion of these
excess funds was offset by not collecting from the Government its
share of the annual pension plan costs. Therefore, the GAO estimate
of questioned costs may be significantly overstated.



                                         58
APPENDIX V                                                           APPENDIX V




 However, this pension plan still remains in an overfunded condition.
 DCAS i being requested to initiate a review to identify what part of
 the overfunded surplus is due the Government. If the surplus cannot
 be offset against Government business over the next several years, a
 direct refund or credit adjustment will be sought.

 We appreciate this opportunity to comment on the draft report.

                                        Sincerely,


                                        lnt    Seretary of Defense
                                     .(LtaJlllomn and Logistios)




 Enclosure
   a/s




                                59
APPENDIX V                                          APPENDIX V




                Department of Defense

                         Comments

                            on

               General Accounting Office

                     Draft Report




             Need for Effective Control Over
               Pension Plan Costs Charged
                   Negotiated Contracts




                                           OSD Case 4409




                           60
APPENDIX V                                                      APPENDIX V

sNED TO IMPROVE CONTROLS OVER THE SELECTION AND REVISION

ci-'pir 2 Page'O-24          and chapter 4 P0age    36-42 ).


GAO Findings:

     Changes in actuarial cost methods and unrealistic actuarial assump-

tions have increased the cost of Government procurement by millions of

dollars.

     1.    Changes in Actuarial Cost methods 'ncreased Costs to the Govern-

ment.      Contractors A, F and C   (Report, Pages36-42)

     2.    Unrealistic Actuarial Assumptions Increased Cost to the Govern-

ment.      Contractors D, G and C (Report, Pages 20-24)


GAO Recommendations:

     1. We recommend that the Secretary of Defense determine the increased

costs to the government resulting from changes in actuarial cost methods

discussed in this report and negotiate an appropriate refund with the affected

contractors.     We recommend also that the Secretary require that the con-

sistency provisions of the Cost Accounting Standards Board's regulations be

enforced with regard to changes in actuarial cost method.

     2.    We recommend that the Secretary of Defense ensure compliance

with the CASB standard, especially in the area of evaluating actuarial assump-

tions.


Note: Names of contractors have been deleted ( ).




                                        61
APPENDIX V                                                         APPENDIX V



DoD Comments:

    1.    Changes in Actuarial Cost Methods.

    Contractor A is under the Defense Contract Administration Services

(DCAS) for contract administration.    DCAS advises that A changed its

actuarial costs method for funding its salaried pension plan in 1970 prior

to the Cost Accounting Standard (CAS) of !972.      This standard does not

allow increased costs to existing contracts resulting from such a change.

The GAO report does not mention that, concurrent with the change in

actuarial cnst nethnd that incrqeas    penrsion plan costs, the interest

assumption rate was raised from 3 1/2% to 7,        and the asset valuation

was changed to recognize market value.     These latter changes partially

offset the increased pension costs resulting from changing the actuarial

method.     However, the net effect w-s an overall increase in pension plan

costs.    Since changing the actuarial cost method was acceptable in 1970

and the resulting cost of all the changes was considered reasonable, there

is no basis for attempting to negotiate a refund.




                                      62
APPENDIX V                                                         APPENDIX V


      Contractor F is under the Department of Army for contract admin-

 istration.   The Army advises that a maximum of 40 employees at this

 plant location were under the corporate-wide pension plan.       Considering
 that total employment reached 9000 by 1967 duz '.ng the SEA conflict, it

 is questionable that any inordinate cost was absorbed by the Government

for those enployees covered by the corporate-wide pension plan.

     Contractor C is under the Department of Navy for contract admin-

istration.    The Navy advises relative to the finding:

     "There may have been an increase in costs to the Government

     because of a change in actuarial cost methods. This is being

     investigated.   Either way, there may be no basis for recoveling

     any such cost because it was not until Cost Accounting Standards

     (CAS) in July 1972, that regulations came into being which prevent

     such changes from increasing costs on existing contracts.       The
     (C) change was made in Ja..uary 1972."

     Li light of the above comments we believe appropriate action is

being taken on the cases cited.    As to consistency of treatment of

pension plan costs in accordance with Cost Accounting Standards (CAS),

we are adhering to these standards.        However, we do not interpret

CAS 412 on the Composition     nd Measurement of Pension Cost as

inhibiting appropriate charges in actuarial assumptions when required




                                      63
APPENDIX V                                                              APPENDIX V



but   ather that these changes be known, valid and effected in appropriate

accounting periods.

      2.   Unrealistic Actuarial Assunptions.

      Contractor D is under DCAS for contract administration.           DCAS

advises relative to this finding:

      "With respect to (D), the GAO report indicates there was no analysis

      of actuarial gains and losses and that no such records were main-

      tained even in the aggregate.       We also found this to be true in our

      reviews.   Consequently, our analysis of the assumptions used was

      limited to comparisons with those generally used in industry.            On

      the basis of this limitca evaluation, we found the assumptions used to

      be reasonable.       Jur review was made prior to the effective date

      (January 1, 1976) of CAS #412.        This standard requires furnishing

      of separate accounting for actuarial gains and losses and in sub-

      sequent reviews this information should be available to the DCAS

      insurance/pension review team.            The GAG report states: Since

      the overdue changes had the net effect of reducing annual pension

      plan costs, it appears that prior to 1973 the actuarial assumptions

      were unrealistic and resulted in higher pe nion plan costs.         An

      actuarial assumption according to CAS Board Standard #412 . .

      should reflect long-term trends so as to avoid distortions caused

      by short-terr    f     lRat ons.   In view of this concept, it is re'    ently

      difficult to deermine at -- hat particular Aime a change in assumptiors




                                           64
APPENDIX V                                                       APPENDIX V


     becomes overdue.       However, DCAS is currently conducting an

     insurance pension review of this contractor, and will assure

     compliance with applicable standards."

     Contract 0 is under DCAS for contract administration.     DCAS advises
relative to this finding:

    "With respect to (G), the GAO computations (Appendix I. and IV) of

    realized actuarial gains from 1952 through 1974 of $53. 8 million due

    to a low assumed turn over rate, assume annual payments to the funds

    based on these actuarial assumptions.     Several events occurred     o
    significantly reduce the contractor contributions   o the plans which
    are nct apparent in the GOS computations such as: (1) comniencing

    in iL6 0, contributions were reduced by prior year actuarial gains;

    (2) no contractor contributions were made to the salary plan after

    1965; (3) contributions to the hourly plan were reduced by 500% starting

    in 1966; and (4) no contractor contributions were made to the hourly

    plan after 1968.   Therefore, the GAO estimated $58. 3 million and

    the $42.4 million figures appear to be grossly overstated.   Further,
    since no pension fund costs are being charged   o Government contracts

   and have not been for several years, any change in the actuarial

   assumptions would currently not affect Gvernme        :ontract costs.
   "Notwithstanding the above comments, we agree that       efense con-

   tractors should be required to comply with CAS #412 with respect to




                                       f5
APPENDIX V                                                         APPENDIX V


     identifying and justifying actuarial assumptions.   To tnti   end, our
     insurance/pension specialists have been evaluating compliance with

     CAS #412 since it became effective, 1 January 1976. "

     Contractor C is under      I Department of Navy for contract admin-

istration.   While GAO cited this case as an example of unrealistic assump-

tions no questionable costs were computer.     T e Navy advises, "that no
cost recovery action is involved."

    While the discussion above of the findings indicates a significantly

different perspective, w   have and will continue to adhere to the CAS

standards as they are issued.




                                      66
APPENDTX V                                                        APPENDIX V


 ABNORMAL MPLOYEE TERMINATION CAUSED EXCESSIVE PENSION
 PLAN COSTS WIfdOUT APPFRPRIATE GOVENlE'£ CREDIT
                                               T
     TReport Chapter 2 Pages 9-20)


GAO Findings:

     At five contractors (G, J, B, E and D) reviewed, the Covernment

had not received appropriate credits for at least $45.6 million of actuarial

gain, resulting from termination in excess of those predicted by the actu-

arial assumptions in the valuations.


GAO Recommendations:

     We recommend that the DoD seek appropriate credits for those pension

plan contributions reirrbursed under Government contracts which, due

abnormal forfeitures, are now excessive.        Cortracting authorities should

enter into negotiations for recovery of these amounts.      The ASPR provision

dtaling with abnormal forfeitures should be clarified and streng hened so

that the contracting authority have a clear direction for recovery of

excessive costs charged to the governrn.o'it.


DoD Comments:

     Contractor G is under DCAS for cont-act administration.       DCAS

advises relative to this finding:

    "With respect to (G), there has been considerable action by the ACO

    and his team regarding the overfunding of the pension plans.      To




                                       67
APPENDIX V                                                       APPENDIX V



 illustrate, in October 1972, ()   and (the Corporate Headquarters)

 were considering merging and consolidating the pension plans.

 This was unacceptable to the ACO and (G) was so notified, as the

 (G) pension plans were overfunded and the (Corporate Headquarters)

 plans were not.   In May of 1973, an advance agreement     as proposed

 to (G) to protect the Government's interest in the pension plan surplus.

 In July 3973, the contractor submitted a draft of an agreement of the

 ACO which was unacceptable.       In November 1973, the ACO requested

 a refurd of $16. 4 million from the contractor as the Government's

 share of the surplus.   In January 1974, the ACO submitted a follow-

 up to his November 1973 demand letter.     In September 1974, the coun-

 tractor infor=mally advised the ACO they could not provide a ash

 refund.   In December 1974, (G) orally    dvised the ACO that the merger

 wvith (Corporated Headquarters) had been dropped and except for (a

 subsidiary) which was participating in the fund, no commercial divisions

would be added.    In regard to the GAO comment concerning a December

1974 DCAA report, 'No action 'as taken by the ACO to resolve the

issues raised in this report, ' the ACO on 12 December 1974 orally

 requested clarification of several points in the DCAA report.    In

February 1975, the contractor formally notified the ACO that the

merger with (Cr rporate Headquarters) had been droped.        The ACO's

May 1975 acknowledgement of the contractor's February letter




                                      68
APPENDIX V                                                      APPENDIX V


      reaffirmed the ACO's concern that the Government's share of

      the surplus not be diluted.   Since this letter did imply acceptance of

      the existing procedure for recapture of the Government's share of

      the surplus, no further action was taken to determine the amount of

      the credit still due the Government.   Benefits from the surplus

      continue to accure to the Government in that no contributions are

      being made o the pension funds by the contractor."

      Contractor J is under the Department of Air Force for contract

 administration.    The Air Force advises relative to this finding that

 GAO's recommended recovery is currently under review.

      Contractor B refers to a subsidiary of this company.     The plants

 of the subsidiary are under the Department of Army for contract admin-

 istration.   The Army advises relative to this finding:

      "GAO concludes that the Government's share of excess pension

     plan cost resulting from significant reduction in employment levels

      amounted to $592, 000.   This amount is based on GAO's estimated

     funding from ]970 through 1972.     GAO further states Armni   officials

     never considered applying the provisions of ASPR 15-205. 6(f)

     regarding reversionary pension credits to an ongoing operation

     but only in situations where the plant was closing.


     "While we agree with he GAO report that a credit is due, the




                                    69
 APPENDIX V                                                          APPENDIX V


     possibility of receiving a lump sunm credit appears remote from a

     contracting point of view because the only types of contracts

     awarded this cost center during this period were Firm Fixed-

     Price and Time and Materials with firm fixed-price rates.          Pro-
     visions of ASPR do not allow for redetermination of overhead costs in

     these types of contracts.      It appears theorore that the only basis

     that exists for recovery of these excess pension costs is through

     credits offsettirg subsequent years funding requirement,.


     "This, in fact, is being done.     The GAO report does not reflect
     the fact that approximately $135, 000 of these costs have been

     recoup.d through the disallowance of all pension costs in the

     negotiations of the forward pricing rates for calendar years

    1973 and 1974.    This process will continue in subsequent years. "

    Contractor E is under DCAS for contract administration.          DCAS
advises relative to this finding:

    "In regard to (E), the Govermurent hs participated in abnormal

    forfeiture gains from commercial plants comparable to those frorn

    Government plants.      Therefore, the credits allocated to the        cvern-
    ment are considered equitable.       The total gafo fo   the period 1960
    to 1971 was $66, 574.    During this 11 year period sales t the Govern-

    ment under flexibly-priced contracts amounted to 12. 3 percent of

    total sales.   Since the Goverln    ent has a legal right to recover




                                         70
APPENDIX V                                                       APPENDIX V


     abnormal forfeitures under flexibly-priced contracts only, the

     total recoverable amount is $81, 989 (12.3% x $66, 574).    A

     of December 31, 1975, the Government has recovered $82, 041,

     therefore, DCAS considers this case closed.     DCAS is currently

     performing a follow-on insurance/pension review of this contractor

     and allowability of pension costs will again be reviewed including

     the area of abnormal forfeiture gains."

     Contractor D is under DCAS for contract administration.         DCAS

advises relative to this finding:

     "With respect to (),   we did not find evidence of 'abnormal for-

    feitures' occurring in (D) during ihe period 1969 to 1973.   Our

    records indicate the com'any had a net increase in employment of

    about 200 during this period instead of a decline of 926 indicated

    by CAO.    In our   ext review of (D), we will review the points made

    in the GAO report and make appropriate recommendations. "

    We believe the above discussion clearly illustrates that DoD

activities were aware of the problems in most instances and have or

are taking appropriate corrective action.   Whilp   e believe the provision

in the Armed Services Procurement Regulation (ASPR) on abnormal

forfeitures is reasonably clear, we will consider carefully the comments

in your report on this matter.




                                     71
APPENDIX V                                                    APPENDIX V


  REASONABLENESS AND ALLOCABILITY OF PENSION PLAN COSTS
        Trport    ihEa r 3, Pag i 26-35



  GAO Findings:

      Excessive allocation of pension plan costs to Government contracts

  results from:

      i.   Inequitable Funding Techniques.

             Contractors        F (Report pages 26-27)

      2.   Inequitable Allocatio. of Pension Fund Asnets.

             Contractors B and G (Report pages 27-31)

      3.   Inequitable Cost Center Allocation Practices.

             Contractors B, D and A (Report pages31-34)


                       [See GAO note on p. 81 .



 GAO Recommendations:

      We recommend that the Secretary of Defense have the Armed

 Services Procurement Regulation provision concerning the determin-

 ation of contractor overhead rates revised to require contractors to:

      -- ensure that pension plan costs charged to the Government are

 equitable, and

      -- require full disclosure on any changes in the policies and/or

 procedures affecting allocation of pension pan costs.




                                     72
APPENDIX V                                                    APPENDIX V


     We also econunend that the Secretary of Defense seek appropriate

credit for those improper allocations of pension plan costs noted in

these cases.


DoD Comments:

     1.   Inequitable Funding Techniques.




                          [See GAO note on p. 81 .1




     Contractor F is under the Department of Army for contract admin-

istration.   The Army advises relative to this finding:




                                      73
A.PENDIX V                                                       APEPINDMX, V


     "GAO states contractor funded past service pension costs for

     employees transferring into the GOCO in A single year in violation

     of ASPR XV.     As indicated in the report (page 27), action has been

     initiated to amortize the $156, 000 in question over a 10-year period.


     "The $195, 000 of past service pension costs for empoyee erlvi co

     earned prior to 1951 has not been reimbursed by the Army.      This

     matter is now presently before the Armed Services Board of Contract

     Appeals. "


     2.   Inequitable Allocation of Pension Fund Assets.

     ContrLa:ctr    in tiis case involves a subsidiary which is inder the

Department of Army for contract administration.      The Army advises

relative to this finding:

     "GAO maintains that (B's) method of allocating pension fund assets

     in accordance with the actuarial liability for pension plan benefits

     is inequitable and they would recommend a 'net contribution method.

     The Army does not concur.     As we understand it, the contractor's

     method is equally as equitable and is in compliance with the subsequently

     promullated Cost Accounting Standard on pension cost.       Conversely,

     the GAO recommended method would cotravene this Standard."

     Contractor G is under DCAS for contract adiritnistration.    D;AS advises

relative to this finding:




                                     74
APPENDIX V                                                       APPENDIX V


       "With respect to (G), the inclusion of a commercial division

       in the allocation of benefits from excess pension plan costs pre-

       viously allocated to Government contracts does appear inequitable.

       However, considering the complexities of this contractor's pension

       plans, the elimination of annual funding for several years, the size

       of the surplus funds involved, and the percent of flexibly-priced

      Government contracts, the extent of the inequity to the Government

      can be considered insignificant. "


      3.   Inequitable Cost Center Allocation Practices.

      Contractor B in this case involves a subsidiary which is under the

 Department of Army for contract administration.      Our comments as to
 this contractor under 2. above are also applicable here.

      Contractor D is under DCAS for contract adminstration.         DCAS
 advises relative to this finding:

      "With respect to (D), during the period 1969 to 1973, our records

      indicate the company had a net increase in employment of about 200

      instead of a decline of 926 indicated by GAO.   In our next review of
      (D) , we will review the points made in the GAO report and make

      appropriate recommendations."

     Contractor A is under DCAS for contract admin:        ration.   DCAS
 advises relative to this finding:




                                      75
APPENDIX V                                                    APPENDIX V


   "With respect to (A), as stated in the draft report, this issue has

   been settled by an agreement between the Government and (A) which

   eliminates the amortization of $1, 092, 138 contractor overhead

   commencing in 1973.    The actual figure negotiated is greater than

   stated in the GAO report due to more current data.    The $89, 000 for

   years 1971 and 1972 was included in the corporate overhead which

   has been negotiated by the CACO.    DCAS does not agree that action

   should be taken to recover these funds."




                 [See GAO note on p. 81.J




                                      76
APPENDIX V                                                       APPENDIX V


       We believe the above     omments reflect that DoD activities have

  or are taking action on the cases cited in the draft report.   The pur-

  pose of the recommendation concerning revisions to the ASPR pro-

  vision relatin- to "ti, determination of contractor overhead rates",

  is not totally clear to us.   However, we believe that Section XV of

  ASPR lays out the basis for allowability of this cost.   Further, CAS

  412 concerning Composition and Measurement of Pension Cost sets

  the stage for improved management in this area.     Your ,:-2ft report

  notes that the Cost Accounting Standards Board is currently dveloping

  a standard dealing with adjustment and allocation of pension costs.

  When this standard is issued, further improvement in the management

  oi this area will result.




                                        77
APPENDIX V                                                        APPENDTX V


      NEED FOR THE DEPARTMLNT OF OLFENSE O INCHEASL
                                                     ITS
      EXPERTISE IN THE inti, REVIEW ii    EUA'
      CONiRACTUR'                                   IN
                   PENSION PWACI F     (orit   haP     5,
      Pages 43-51)


      GAO Findings:

          At the contractors reviewed, we noted that questionable
                                                                  actuarial
      assumptions were being made, actuarial cost methods
                                                          were being
  changed, and inequitable allocations procedures
                                                  were being used--all
  increasing costs to the Government--that were not
                                                    adequately evaluated
  by contracting activities or by DCAA because of
                                                  limited staffing and
  actuarial experience.

         We also believe that DoD should reinstate the reviews
                                                               of certain
 contractors' pensi.n plan practices and costs by
                                                  the Military Services

 and DCAS.       The findings discussed in this report together with
                                                                     the
 findings by DCAS and the Air Force indicate that
                                                  the time       pent by
 these groups in reviewing contractors' pension
                                                plan practices and costs

 is    relatively insignificant when compared to the realized
                                                              and potential
 accomplishments.


 GAO Recommendations:

        We recommend that the Secretary of Defense reinstate
                                                             the reviews
 of contractors' pension plan practices by the Military
                                                        Services and DCAS.
In addition, we recommend that Dol~ obtain additional
                                                      staff with the




                                       78
APPENDIX V                                                      APPENDIX V


   need technical skills:

        -- to assist in determrining if pension plan costs are reasonable

          and equitably allocated to Government contracts, and

        -- to determine compliance with ASPR requirements and CASB

          standards.

       We also recommend that the Secretary of Defense initiate training

   programs in pension plan accounting and computation to enable con-

   tracting and audit personnel to review adequately the contractors'

  pension plan practices.


  DoD Comments:

       As your draft report notes pension reviews were curtailed with

   regard to contractors that met the threshold of competitive and non-

  Government business to qualify under the Contractor Weighted Average

  Share in Cost    isk (CWAS) program.      This curtailment was a temp-

  orary change intended 'o exempt CWAS qualified contractors from

  certain recurring reviews.      An evaluation of CWAS changes is under-

  way and the GAO observations will be considered.

       As to the recommendation concerning additonal staff, pension

  plan cost is only one of many elements involved in the costing and

  pricing of contracts.     While the individual Military Departments and

  Defense Agencies are responsible for their contracting, substantial,'




                                       79
APPENDIX V                                                       APPENDIX V


 reliance is placed on the Defense Contract Audit Agency (DCAA)

 and DCAS to pericrm reviews of the reasonableness of pension plan

 costs.     DCAS has 13 highly qualified insurance/pension specialists

 in its field activities.   These specialists, through the DCAS contractor

 insurance/pension review program, have identified many of the de-

 ficiencies included in the GAO report and have obtained substantial

credits from contractors as the result of identifying these deficiencies.

DCAS as well as the Army are both endeavoring to recruit an actuary.

DCAA with regard to these matters states:

          ' Sufficient expertise   s available within DCAA to carry out

       audit responsibilities ifr determining allowability, reasonable-

       ness, and allocability of pension costs; these are baic audit

       tasks not peculiar to the audit of pension plans. "


       "The auditors' expertise in pension matters is sufficient o

       disclose situations where the assistance of actuaries nray be

       necessary.      We have availed ourselves of assistance in DoD

       and occasionally used outside actuaries.      The fact that DCAA

       does not have actuaries on its own staff doe. ,,at mean that such

       specialized expertise is not available or wl     not be obtained when

      necessary."

      DCAA further states:




                                        80
APPENDIX V                                                    APPENDIX V



      "In chapter 5 (page 45), GAO concludes there is insufficient

      review by DCAA of the allocation of pension plan costs to their

      proper periods anL .ost centers.     It should be noted that our

      auditors, in fact, observed, questioned,    and recommended action

      to resolve many of the items mentioned in the GAO draft report.

      GAO's statement on page 46 (also page 33) that DCAA did not

      question (A's) amortization of unfunded past service costs of two

      commercial subsidiaries as a charge t      Government contracts

      needs clarification.   For 1971 the contractor had group insurance

      and other fringe benefit costs that we considered as an offset to

      the questionable pst   service costs.   Excess pension contributions

     were cited in audit reports for 1972 and 1973."

     We plan no further efforts with regard to staffing at this time.

     With regard to the recormmendation concerning training, we are

 strong advocates of education and training.     However, we believe our

 procurement officials, auditors and contract administrators are

 afforded sufficient training to enhance their analytical business skills

 to cope with these matters.   To the extent that very specialized skills

 are needed such as acturial capability we would rely c, the Military

 Departments, and Defense Agencies to obtain the necessary skills

 as well as the appropriate training and education.


GAO nte:      References to matters not included in this report
              have been deleted from the DOD reply. Also, re-
              port references have been revised.



                                      81
APPENDIX VI                                          APPENDIX VI

     PRINCIPAL OFFICIALS RESPONSIBLE FOR ADMINISTERING
              ACTIVITIES DISCUSSED IN THIS REPORT

                                            Tenure of office
                                            From          To
                   DEPARTMENT OF DEFENSE
SECRETARY OF DEFENSE:
    Harold Brown                     Jan.    1977    Present
    Donald H. Rumsfeld               Nov.    1975    Jan. 1977
    James R. Schlesinger             July    1973    Nov. 1975
    William P. Clements, Jr.
      (acting)                       May '1973       June      1973
    Eiliot L. Richardson             Jan. 1973       Apr.      1973
    Melvin R. Laird                  Jan. 1969       Jan.      1973
    Clark M. Clifford                Mar. 1968       Jan.      1969
SECRETARY OF THE ARI'*
    Clifford M. Alexander, Jr.       Feb.    1977    Present
    Martin R. Hoffman                Aug.    1975    Feb. 1977
    Howard H. Callaway               Aay     1973    Aug. 1975
    Robert F. Froehlke               July    1971    Apr. 1973
    Stanley R. Resor                 July    1965    June 1971
SECRETARY OF THE NAVY:
    Graham Claytor, J3.              Feb.    1977    Present
     J. William Middendorf           June    1974    Feb. 1977
     J. William Middendorf
       (acting)                      Apr.    1974    June   1974
     John W. Warner                  May     1972    Apr.   1974
     John H. Chafee                  Jan.    1969    May    1972
     Paul R. Ignatius                Sept.   1967    Jan.   1969
SECRETARY OF THE AIR FORCE:
    John C. Stetson                  Apr.    1977    Present
    Thomas Reed                      Jan.    1976    Apr. 1977
    John L. McLucas                  May     1973    Jan. 1976
    Robert C. Seamans, Jr.           Jan.    1969    Apr. 1973
    Harold Brown                     Oct.    1965    Jan. 1969
DIRECTOR, DEFENSE LOGISTICS AGENCY:
    Lieutenant General W. W.
      Vaughan                       Jan.     1976    Present
    Lieutenant General Wallace H.
      Robinson, Jr.                 Aug.     1971    Dec.   1975
    Lieutenant General Early C.
      Hedlund                       July     1967    July   1971


                               82
APPENDIX VI                                         APPENDIX VI

                                          Tenure of office
                                          Prom     .    To
               COST ACCOUNTING STANDARDS BOARD

EXECUTIVE SECRETARY:
    Arthur Schoenhaut              Mar.    1971     Present




                            83