Congress established the original Cost Accounting Standards Board (CASB) in 1970 to ensure consistency in the cost accounting principles used by defense contractors and subcontractors, as the results of these calculations are used to request reimbursements for their costs from the federal government. These Cost Accounting Standards apply in many areas, including the calculations of the costs of benefits available to a group of participants covered under a qualified defined benefit plan. These standards have been updated over time to reflect changes in the law, most recently because of the implementation of the Pension Protection Act of 2006 (PPA). As a result, plan sponsors should be familiar with the nuances of the changes in the Standards in order to be sure that they are requesting the appropriate levels of reimbursement for their costs.

Cost Accounting Standard No. 412 (CAS 412) describes the procedures used to determine and measure the various components of pension cost. Cost Accounting Standard No. 413 (CAS 413) provides guidance for adjusting pension cost by measuring actuarial gains and losses and assigning such gains and losses to cost accounting periods. CAS 413 also provides the basis on which pension cost shall be allocated to segments of an organization.

Pension costs under CAS 412
For defined benefit pension plans (excluding plans accounted for under the pay-as-you-go cost method), the components of pension cost for a cost accounting period are:

(1) Normal cost.
(2) Amortization of any unfunded actuarial liability. A new amortization base will be established for any plan or assumption changes.
(3) Amortization of actuarial gains and losses.

Amortizations will be adjusted for interest.

PPA harmonization
The calculations described above have historically followed the funding requirements for pension plans under ERISA. The PPA amended the minimum funding requirements and tax-deductibility of contributions to pension plans under ERISA. As a result, the CASB revised CAS 412 and CAS 413 so that the resulting CAS cost would more closely match (i.e., harmonize with) the updated ERISA minimum required contribution.

The main changes to the rules were the modification of the amortization period for actuarial gains and losses (10 years instead of 15), and the addition of minimum liabilities to the calculations.

Before the implementation of the CAS Pension Harmonization Rule, the actuarial accrued liability and normal cost were calculated on a basis similar to what was used for ERISA funding valuations prior to the implementation of PPA. This approach reflects long-term trends to avoid distortions caused by short-term fluctuations and should represent a contractor's best estimates of anticipated experience under the plan.

The CAS harmonization requires the calculation of a minimum actuarial liability and a minimum normal cost, similar to the methodology used for calculating the funding target and normal cost under PPA. These calculations reflect current market conditions, and are to be computed using an interest assumption that reflects the contractor's best estimate of rates at which the pension benefits could effectively be settled.

The harmonized CAS provides that the sum of the actuarial accrued liability and normal cost is compared with the sum of the minimum actuarial liability and minimum normal cost, and, starting in 2017, whichever measure is larger forms the actuarial basis to be used to compute CAS pension costs. Prior to 2017, minimum amounts are phased in at 25% per year over a four-year period.

To calculate the minimum actuarial liability and minimum normal cost, plan sponsors are permitted to use the same assumptions used to determine the minimum required contributions under Internal Revenue Code Section 430, which includes the Highway and Transportation Funding Act of 2014 (HATFA) rates. These assumptions are considered to be safe-harbor assumptions.

Plan sponsors may use alternative assumptions if they feel they are more appropriate for their circumstances. For example, sponsors could use the full yield curve or the 24-month average segment rates for calculating the minimum actuarial liability and minimum normal cost, if they determined that the use of these assumptions more accurately represented the true cost of the plan benefits.

Plan sponsors also have the leeway to select appropriate mortality tables for valuation purposes. The use of a mortality table available under PPA may be appropriate. Plan sponsors may also wish to consider the recent mortality tables released by the Society of Actuaries (RP-2014 with MP-2015 projections), or the plan sponsor's actual experience if there is sufficient exposure.

Cost allocations under CAS 413
CAS 413 provides rules for allocating pension costs to each segment of a pension plan. These costs can be determined directly for each segment, or can be determined by calculating the cost for the entire plan and then allocating it to each segment. For example, if the plan benefit is salary-related, the plan sponsor may allocate the cost proportionally to the salary if there are no material differences in the benefit level, eligibility, or age distribution of each segment. However, the regulations do not define what constitutes a material difference.

CAS projections and forward pricing
Defense contractors and subcontractors will often agree to contracts that last for multiple years. As part of these contracts, the contractors will need to project their pension costs for each year over the lifetime of the contracts. The assumptions used in these projections should reflect the plan sponsor's best estimates of future interest rates. However, there can be an issue when the plan sponsor is not using a single interest rate for this assumption. For example, assume that the plan sponsor uses the current yield curve for the current year valuation. Using this yield curve for the following year's valuation may not be appropriate, because the current yield curve contains implicit assumptions regarding future interest rates.

Projections of future rates of return on corporate bonds used in discounting the pension liabilities should not be biased in either direction. This is best accomplished by forecasting future rates that have an equal probability of being higher or lower than the actual rate of return. Plan sponsors may wish to seek the guidance of their actuaries or investment advisors regarding selection of interest rates for multiyear contracts.

There are many aspects of CAS valuations that are subject to the professional judgment of the plan sponsors and their advisors. The selection of assumptions can have material impacts on the reimbursement of the plan costs. If you would like to have more information regarding CAS harmonization or any related topics, please contact your Milliman consultant.