Benefit costs often flow into the rates a contractor charges the government, so a benefit change touches the books.

The cost rule

Under the federal cost principles, fringe benefit costs are allowable when they are reasonable and are required by law, by an employer-employee agreement, or by an established policy of the contractor. An ICHRA that is adopted through a written plan document and communicated to employees fits the established-policy test, and the written record is what supports it. The cost principle names employee insurance among fringe benefits.

Source: FAR 31.205-6(m)(1).

An illustration of the rate effect

Assume 40 employees and an annual labor base of $3,200,000 in the fringe pool. Health cost per employee and the take-up rate move the fringe rate directly.

All figures are illustrative. The allowance is only paid to employees who are enrolled in individual coverage and submit proof, so the cost follows enrollment. The same effect applies in reverse if the allowance is set above the group plan cost.

How a change reaches the billing rate

Billing rates are set by the contracting officer or the responsible auditor and should approximate the final indirect cost rates expected for the contractor’s fiscal year. The rates can be revised prospectively or retroactively by mutual agreement to avoid a substantial overpayment or underpayment. The contractor must submit its final indirect cost rate proposal within six months after the end of each fiscal year. The practical effect is that a mid-year switch to an ICHRA should be put in front of the contracting officer when it is adopted, with the cost model, not for the first time in the year-end proposal.

Sources: FAR 42.704 and FAR 52.216-7(d) and (e).

Questions for accounting and contracts staff

• Which pool holds health costs today, and what is the base used to allocate it?
• Do the contracts include fixed-price work that will absorb a rate change, and which are cost-reimbursement?
• Does the unit follow cost accounting standards, and does the switch change how the cost is accumulated or allocated?
• Are forward pricing rates in front of the government that assume the old plan cost?
• Where will the plan document, the board or management approval and the cost model be kept for audit?

Cost accounting and rate-submission questions belong with the contractor’s accountants and contracts counsel.