Appeal of government decision denying liability for contractor’s underfunded pension plan is granted. The contractor had a pension plan, and it allocated the overhead costs of that pension plan to several government contracts. When the contractor curtailed the pension plan, it determined that the plan’s liabilities exceeded its assets. The contractor filed a claim with the government to recover the difference between the plan’s assets and liabilities. The government denied the claim, contending that the contractor had miscalculated the plans future liabilities by relying on different mortality tables then it had used when it adopted the plan. The board found that the contractor had not violated the cost accounting standards by using different mortality tables; rather, the contractor had adopted new mortality tables to better reflect the actual life-spans of plan participants. The government also objected to the manner in which the contractor had accounted for taxes on the plan’s income by discounting income by the tax rate instead of separately accounting the taxes. The board found that while the contractor’s method for accounting taxes violated the cost accounting standards, it did not result in material difference in the amount of tax liability.
In 2003, Northrop Grumman adopted a defined benefit pension plan called the Officers Supplemental Executive Retirement Plan. The plan’s assets were held in trust. The costs of the plan were allocated to Northrop Grumman’s several government contracts as overhead costs.
Northrop Grumman curtailed the executive retirement plan in 2014. This meant that the plan was frozen—no further contributions would be made to the plan. Under the Cost Accounting Standards, when a plan is frozen, the contractor must calculate the difference between the plan’s assets and its liabilities. If the assets are greater than the liabilities, then the government has overpaid the contractor’s overhead costs and is entitled to a reimbursement. But if the present value of the plan’s liabilities exceed its assets, then the overhead costs are too low, and the government owes the contractor money.
At the time of curtailment, Northrop Grumman determined that the assets in its plan were worth about $92 million. But the company determined that the value of the plan’s liabilities—i.e., what it would pay out in the future—was $190 million. This meant that the government owed Northrop Grumman money for the underfunded plan. Based on the amount of overhead costs charged to the government under Northrop Grumman’s contracts, the company determined the government owed $74 million.
Northrop Grumman submitted a $74 million claim to the government. The government denied the claim. The government believed that Northrop Grumman had used improper mortality rates in assessing the plan’s liabilities, and that the company had miscalculated taxes owed on the plan’s income. Northrop Grumman appealed to the ASBCA.
As an initial matter, the parties disagreed on how to interpret the relevant cost accounting standard, CAS 413-50(c)(12). That provision provides that “the difference between the market value of the assets and actuarial accrued liability [of a curtailed plan] represents an adjustment of previously determined pension costs.” The government interpreted this language as backward-looking—that is, the adjustment merely ensures that all previous pension funding has been allocated correctly. The provision, according to the government, did not look forward, taking into account the plan’s future expenses. Thus, in accounting or future liabilities, Northrop Grumman had miscalculated the adjustment.
But Northrop Grumman contended the adjustment was forward looking. The adjustment is intended to set the plan up for the remainder of its existence and thus it must take into account the plan’s future liabilities. Therefore, in performing an adjustment, a contractor is supposed to account for future liabilities.
Citing COFC caselaw, the board agreed with Northrop Grumman. The end goal of CAS413-50(c)(12) is to ensure that a pension plan is fully funded to meet promises made to the employee-participants. Indeed, the board reasoned, what other purpose would be served if the balancing of liabilities and assets was not meant to cover the contractor’s employees once it was closed?
The government also objected to the mortality rates Northrop Grumman used in calculating future liabilities. When Northrop Grumman adopted the plan, it used mortality tales created by the Society for Actuaries in 2000 for calculating future payment obligations. In 2014, however, the Society issued new mortality tables. The 2014 rated reflected that people were now living longer. Northrop Grumman used the 2014 table in calculating the plan’s liabilities. Because the 2014 table reflect longer life-spans, the present value of plan’s obligations had increased.
The government argued that under the Prefatory Comments to the 1995 revisions to the CAS, the assumptions used to determine the actuarial liability must be consistent with the assumptions that have been in use. By basing its adjustment calculation on the 2014 mortality tables, the government contended, Northrop Grumman was not basing its liability adjustment on the assumptions—the 2000 mortality tables—that had been in use.
But the board found that the 1995 Prefatory Comments also provide that the rule requiring an adjustment to be consistent with the assumptions in use was not intended to “prevent contractors from using assumptions that have been revised based on a persuasive actuarial study.” Northrop Grumman’s switch to the 2014 mortality tables appeared to be the exact type of “persuasive actuarial experience study” contemplated by the CAS board. Moreover, from the record, it appeared that Northrop Grumman’s switch to the 2014 tables was part of a larger corporate decision to use more accurate tables and not a subterfuge to obtain more money from the government.
Finally, the government was displeased with the way in which Northrop Grumman had accounted for tax liability on the plan’s income. Northrop Grumman paid taxes on the plan’s income. But instead of keeping track of the taxed paid on the income, Northrop Grumman calculated the value of the plans assets by discounting them by 35% marginal tax rate. The government argued this accounting violated the CAS, which provide that taxes on income from a pension plan must be treated as an administrative expense and not as a reduction to earnings.
The board agreed that Northrop Grumman’s approach to taxes seemed to be explicitly forbidden by the CAS. But the board also noted a FAR provision on materiality—FAR 30.602(c)(1)—which provides that the government should make adjustment to a contract when there is no material cost difference due to a CAS violation. Ultimately, the board found that Northrop Grumman’s calculation of the investment return as discounted by taxes provided roughly the same result as paying the taxes as an administrative expense.
Northrop Grumman is represented by James A. Tucker, David A. Churchill, and Daniel E. Chudd of Morrison & Foerster LLP. The government is represented by Arthur M. Taylor and Robert L. Duecaster of the Defense Contract Management AgencyASBCA Northrop Grumman