GAB Decision 008
February 7, 1975 State of Connecticut; Docket No. 9 Van Orman, William;
Malone, Thomas DeGeorge Francis
This is an appeal pursuant to 45 CFR Part 16 from the action of Mr.
Henry Kirschenmann, Jr., for the Department of Health, Education, and
Welfare on September 13, 1973 in sustaining the exceptions taken by the
Department of Health, Education, and Welfare Audit Agency in its audit
Report No. 30136-01 dated May 23, 1973, relative to the practice of the
State of Connecticut charging Federal programs for employees retirement
contributions at an actuarial rate greater than the rate charged State
programs. This decision is made on the basis of the documents submitted
to the Board and an informal hearing held in Washington, D. C., on
September 5, 1974. The undersigned members of the Grant Appeals Board
have been designated as a panel of three for the disposition of the
instant case.
Background
The pre-negotiation review of the Consolidated State-wide Cost
Allocation Plan for the State of Connecticut by the Regional Audit
Director identified several unresolved problems for the fiscal year
ending June 30, 1970. The problems were summarized in Mr. Edward A.
Parigian's memorandum dated January 27, 1970. Item 3 of the memorandum
discussed fringe benefits and indicated that the "salary and wage
amounts used in the various costs analyses used for allocation purposes
were increased by 18.06%." The memorandum indicated that only 3.28% of
the 18.06% was substantiated, and that the 13.36% difference represented
an increase in pension costs that results from an actuarial study of
State pension benefits made by an actuarial firm. The actuarial study
was not reviewed at that time by the auditors.
On May 23, 1973, the Regional Audit Director issued Health,
Education, and Welfare Audit No. 30136-01. The audit reviewed
State-wide cost allocation plans, provisionally approved by the Office
of Grants Administration Policy (OGAP) for the four years ending June
30, 1973. The audit concluded (page 5) that the actuarial contributions
to the State Employees Retirement Fund by the State for the fiscal years
1972 and 1973 were 6.69% and 7.805% respectively below the percentage
rates provisionally approved by Health, Education, and Welfare. The
report indicated that "those States using the higher rates (2) are, in
fact, claiming excessive reimbursement under Federally-supported
programs" (page 5).
The State of Connecticut took exception to the findings claiming that
(1) the accounting principal of accrued liabilities was well
established; (2) that OMB Circular A-87 provides for accrual
accounting; (3) that A-87 also provides that the cost of personal
services includes all costs, paid or accrued; (4) that the "22.3%
retirement adder" was developed by a competent actuarial firm; (5) that
the State has an unconditional obligation ultimately to pay the
retirement benefits; and (6) that the relation of the State to its
employees is usually long-range and the accrued liability for pension
benefits is eventually paid.
On September 13, 1973, the Division of Cost Policy and Negotiation,
HEW, by memorandum substained the HEW auditors in the exceptions taken
"to the practice of assessing Federal programs at a rate in excess of
State programs," as well as the depositing of funds received for such
differences in accounts other than the retirement fund. The basis for
the disallowance was: (1) The action was inconsistent with OMB Circular
A-87, particularly Section C.1.d which calls for consistent accounting
treatment between all Federally assisted programs, as well as other
activities so charged. (2) The definition of cost was improperly
interpreted by the State -- more specifically, that it must be necessary
to "liquidate the legal liability of the State arising from the conduct
of the Federal programs." (3) That there was a question as to whether
the State had incurred any legal, enforceable liability to its
employees. (4) That it "was almost a universal practice of States and
other organizations performing under Federal Grants to fund employee
retirement at an actuarially determined rate.
On October 16, 1973, the State of Connecticut by letter pursuant to
45 CFR-16 (38 FR 9906, dated April 20, 1973) appealed the decision of
Mr. Henry G. Kirschenmann, Jr., Director, Division of Cost Policy and
Negotiation, HEW.
On September 5, 1974, after several delays, an informal hearing was
conducted in Washington, D.C. Mr. Wendell Gates, Assistant Attorney
General, represented the State of Connecticut and Mr. Henry G.
Kirschenmann, Jr., represented the Department of Health, Education, and
Welfare. The participants to the hearing were given 30 days from the
receipt of the transcript to submit final briefs on their positions.
The State of Connecticut and the Department of Health, Education, and
Welfare submitted final positions during the time periods indicated.
(3) Discussion
During fiscal years 1972 and 1973 the State of Connecticut claimed
and was paid for by the United States Government, the cost of deferred
retirement benefits in excess of the rates charged itself and paid into
the retirement fund for all State employees. The Federal Government
paid to the State of Connecticut 13.36% and 22.3% respectively of the
salaries of State employees engaged in Federal programs while the State
charged itself 6.69% and 7.8$for the fiscal years 1972 and 1973. In
addition, the State did not deposit the entire amounts so received from
the Federal Government in its retirement fund.
In fiscal year 1972 the State discarded its "pay-as-you-go" funding
system and changed to a system funded on an "actuarial reserve basis."
The State employed an actuary to determine various alternative actuarial
methodologies. From these the State recommended an alternative whereby
the State would contribute annually over a 15 year period increasing
percentages of the sum of the system normal cost plus the amount
necessary for a 40 year amortization of its unfunded liability. In the
15th year and subsequent the State would contribute the system's normal
cost plus the amount needed to amortize the unfunded liability.
However, the legislature passed Public Act 666 which left the decision
of post-FY 1986 funding to the discretion of the State's retirement
commission. While the State legislature selected the least costly
alternative of financing, the State Commissioner of Finance and Control
selected a more costly approach to charge the Federal Government. In so
doing the State argues that the higher figure represents the true
"costs" of its retirement system.
The State alleges that the extent to which the State elects to fund
this "cost" though actual contributions (cash payments by the State)
to
the retirement fund is irrelevant and "has no effect on the figures
which express the cost of the retirement plan" (appeal document-page
10). The State also alleges that it is not required to place the entire
Federal retirement payment in its retirement fund. In fact it states
that the non-use of funds paid to the State for retirement "costs"
by
the retirement fund is "not an important consideration" (appeal
document-page 20). Finally, the State contends OMB Circular A-87
permits Federal recognition and payment of "accrued costs."
(4) The Government's position is that, with respect to retirement
benefits provided under a plan which is funded on an actuarial reserve
basis, allowable "retirement cost" for purposes of Federal grants
and
contracts is determined by a State's actual contribution to its
retirement fund, so long as that contribution is reasonable. The
reasonableness of a State's contribution depends in part upon the
actuarial cost method and the actuarial tables and assumptions used by
the actuary in developing the plan's funding scheme, and the treatment
of the plan's unfunded liability. It is the Government's view,
therefore, that, if the 6.69% and 7.8% contribution rates applicable to
the State of Connecticut during FY 1972 and FY 1973 were reasonable,
they should have been applied as well to the Federal Government. To the
extent Federal "retirement" payments in those years exceeded the sums
which would have been paid had those rates been applied to the
Government, the payments represented unallowable costs.
The State relies strongly on the princples outlined in OMB Circular
A-87, primarily the concept of "accrued liabilities," arguing that
nothing in A-87 precludes the claims which they have made.
In summary, OMB Circular A-87 provides:
(1) The cost must be approved or authorized by documentary evidence,
or consent prior to incurring specific costs.
(2) The cost must be acceptable to the Federal Government as a
discharge of the grantee accountability.
(3) The cost must be consistent with policies, regulations and
procedures that apply both to Federally assisted and other activities.
(4) The cost must be accorded consistent treatment.
(5) The cost must be distributed equitably to grant programs and to
other activities.
A step-by-step review of the process indicates that the State of
Connecticut has not met the provisions of OMB Circular A-87 in that:
The Federal Government did not finally approve "by documentary
evidence or consent" the State's Consolidated State-wide Cost Allocation
Plan as alleged by the State. The Department's letters of August 2,
1971, and (5) September 28, 1972, under Section III, General -- Part A
Limitations (1) indicate "that no costs other than those incurred by the
State were incurred on its State-wide cost allocation plan proposal and
that such costs are legal obligations of the State, and (2) that similar
types of costs have been accorded consistent treatment. None of the
provisions listed above have been compiled with by the State of
Connecticut.
(1) The State has not incurred the expenses represented by the totals
charged the Federal Government for FY 1972 and FY 1973. The State only
incurred as to legal obligations that rate of cash payments made to the
retirement fund for other State employees. It is difficult to
understand how the State has incurred a cost in excess of the rate that
it has charged itself -- namely 6.69% for FY 1972 and 7.8% for FY 1973.
(2) The State has not incurred a legal obligation for the excess
rates. The State contends that the retirement costs which it fails to
fund, and elects to accrue, represent a "legal liability of the State"
(appeal document, page 27). An entitlement to retirement benefits which
an employee may accrue over the yeas does not represent a legal
liability of the State. The State is free to reduce or terminate such
benefits as it sees fit. To the extent that the State could be liable
for such future benefits, its liability is, at best, a contingent one.
(3) The State has not accorded consistent treatment of similar costs.
While the Federal Government in FY 1972 paid 13.36% of employee salaries
as its share of retirement benefits, the State contributed to the
Retirement Fund only 6.6% of employee salaries. In other words, the
State did not contribute in excess of the 6.6% rate for its own
non-Federally funded State employees, but it has claimed and received
payment from the Federal Government (but not paid the cash into the
retirement fund) at the rate of 13.36%.
The State's argument and its use of the concept of "accrued costs"
should also be fully recognized. Under Connecticut's theory a State has
complete discretion in devising alternative funding schemes, in
selecting the approach under which the "costs" will be measured, and
in
selecting another approach under which (6) it will actually fund the
plan. One approach can then be used for reimbursement to the State
under Federal grants even though the State selects quite another, less
costly, approach under which its financial disbursements are determined.
This theory permits a State to define the "cost" of its retirement
plan
over a short period and to charge the Federal Government on the basis of
this approach. However, the State can at the same time choose an
entirely different and, at least initially, less costly approach under
which it will contribute to its retirement fund. The "difference"
is
treated as "accrued costs." The Board finds that this methodology
discriminates against the Federal Government and does not find that OMB
Circular A-87 or any other Government regulation, instruction, or
interpretation, supports such an approach.
Decision
The appeal is disallowed in full.
OCTOBER 22, 1983