AF Life Cycle Management Center · 2017-06-27 · – Director of Cost Assessment and Program Evaluation shall ensure that the cost estimation and cost analysis processes ... •

AFLCMC… Providing the Warfighter’s Edge

Inflation & Escalation

Shawn ValentineAFLCMC/FZCR – Wright [email protected]

AF Life Cycle Management Center

mailto:[email protected]

mailto:[email protected]


Background

• Reliable cost analysis is critical to defense management

• Rates at which the prices of defense goods are expected to change are often important determinants of system cost

• Well-researched forecasts for price growth help the DoD make sound acquisition tradeoffs and adequately budget for weapon systems

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Weapon Systems Acquisition Reform Acts (WSARA)… It’s The Law

• WSARA Section 2334 – Director of Cost Assessment and Program Evaluation shall

ensure that the cost estimation and cost analysis processes of the Department of Defense provide accurate information and realistic estimates of cost for the acquisition programs of the Department of Defense. In carrying out that responsibility, the Director shall … periodically assess and update the cost indexes used by the Department to ensure that such indexes have a sound basis and meet the Department’s needs for realistic cost estimation.

• Priority given to “realistic” estimates• Some indices are given, i.e., use OMB rates (Mil Pay,

Civ Pay, Fuel, Medical)• Other indices (such as PPI, contractor history, etc.)

may be used to support “realistic” cost estimating for categories other than Mil Pay, Civ Pay, Fuel, Medical)

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Overview

• Definitions and standard terminology• Minimum standards for documenting and labeling

indices used in an analysis• Use of realistic escalation rates to estimate

investment and sustainment costs• Selection of long-term assumptions about fuel

prices and other rates to maximize the realism and stability of the estimate

• Selection of indices for converting then year estimates to base year

• Inflation adjustments for formal acquisition reporting– What rates should I use?

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General Definitions

• Price – Quantity of dollars given in return for goods and

services• A price change includes inflationary impacts and

market forces (e.g. supply, demand, productivity, etc.)

• Price Index – Accounts for changes in price for specific goods and

services • Producer Price Index (PPI)

– Specific escalation indices generally track specific industries, commodities, services (e.g. Aerospace Industry, Medical Equipment)

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Inflation

• Inflation is the increase in the general price level of goods and services over time– Inflation refers to the change in value of the

currency relative to goods and services• If the general price level is rising, then the

same quantity of dollars purchases fewer goods; therefore, the value of the dollar is decreasing

• Generally speaking, dollars in one year are typically not equivalent—in terms of purchasing power—to dollars in another year

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Inflation

• Price changes generally change for two broad categories of reasons– Changes in the value of the currency (e.g. the

dollar)– Changes in the market for a good or service

• “Normalizing” for inflation means applying the inflation index to cost data in order to remove the effect of inflation in order to determine the “real” price change– After “normalization” dollars in one year are equal

to dollars in another year• Inflationary pressure is typically brought on

by increases in the money supply7


Why Worry About Inflation

• Changes in the value of the dollar distort the real price of goods and services, which create difficulties in making informed decisions

• Periods of high inflation create more volatile price behavior, making planning and executing programs more difficult– Any given year’s appropriation will actually be

expended over multiple years in the future– Budget to be sent to Congress plus five

planning/programming years• To properly plan, program, and budget for

programs, analysts should consider the impact of inflation

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Escalation

• Escalation is the change in the nominal price of goods and services (i.e., the total change in price) over a period of time

• It includes both the effects of inflation and market forces and is typically measured by a specific price index

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Why Worry About Escalation

• In addition to inflationary impacts, analysts and decision makers should consider the market impact on prices; escalation addresses both inflationary and market effects on the price of goods and services

• Government must have sufficient budget to purchase the goods or services at the time of acquisition

• Addressing escalation enables analysts to more accurately determine the prices of goods and services, considering both inflation and market conditions

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Standard Terminology

• “Constant Year (CY) dollars” are dollars that have been normalized for inflation, not escalation, using an economy-wide index such as the Gross Domestic Product Implicit Price Deflator (GDP Deflator)– CY dollars measure what goods and services

economy-wide would have cost in a base year by adjusting for the decrease in the value of the dollar

– This term will NOT be used to refer to costs normalized for price escalation

– CY dollars are used for reporting purposes: Select Acquisition Reports (SARs), etc.

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• “Real price change” is price change measured in Constant Year dollars– Positive real price change indicates that an

item has become more expensive relative to other goods and services in the economy, while negative real price changes indicates an item has become less expensive relative to other goods and services

– Real price change enables program decision makers to determine whether or not their program is becoming more expense/inexpensive over time relative to the economy’s general price level

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• “Constant Price” (CP) may be used to refer to costs normalized with an escalation index– Constant Price indicates what a narrowly

defined basket of goods would have cost in a base year

– Examples of Constant Price include contractor labor rates divided by an labor rate index, aircraft unit costs divided by an aircraft index, etc.

– CP addresses market forces (supply and demand) with respect to goods and services

– CP is the normalization used for estimating purposes

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14Then Year Dollars (TY$) are still the official unit for budgeting and are also required in POEs

and OSD reporting.

Constant Price Dollars (CP$)

- Use PPI3364, PPI336411,

OSD Fuel, OSD Civ Pay, or

OSD Mil Pay Price Indices

Performing Cost

Estimates

Constant Year Dollars (CY$)

- 3600, 3010, 3400 Inflation

Indices

Formal Briefings

and Reports

For Estimating Purposes (Data Normalization)

For OSD Reporting Purposes

Base Year Dollars (BY$)- CP$ and CY$ are both

considered BY$

*PPI is appropriation specific


Documentation and Labeling

• Cost estimates must document the inflation and escalation rates used to estimate each component of the program

• References to analyst-developed indices must include a descriptive title, base year, source data, and date– Provide some form of documentation

explaining index derivation

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Documentation and Labeling

• Ambiguous labels, such as “fiscal year dollars” and “base year dollars,” should be annotated to indicate the index used

• Options of labeling both constant year dollars and constant prices– Constant Year dollars can be expressed as

CY$Year or CYYear (CY$12 if the base year is 2012)

– Constant Price can be expressed as CP$Yearor CPYear (CP$12 if the base year is 2012)

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Use of Realistic Escalation Rates

• Cost estimates will incorporate the escalation rates that best forecast funding requirements for the system being estimated, taking specific markets into account

• Analysis should not rely exclusively on DoD-published indices to measure escalation– AFLCMC publishes PPI3364/PPI336411– Cost analysts develop burdened labor rate

indices17


Selection of Long-Term Rate Assumptions

• Estimates of programs with large sustainment costs, normally incurred over many decades, can be particularly unstable

• “Long-term assumptions about inflation and escalation of fuel prices, military pay raises, civilian pay raises, and other prices will be chosen to maximize the realism and stability of the cost estimate”

• OSD (CAPE) will oversee an advisory group charged with recommending post-FYDP price escalation rates to use in cost analysis

• Advisory group will only recommend a change in the rates previously used if the analysis indicates a significant shift in long-term forecasts

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Converting Then Year Estimates to Base Year

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• Constant dollar and constant price figures convey distinct information– Constant dollars eliminate the distortion

caused by the reduced value of the dollar over time but preserve real price change

– Constant prices help measure changes in quantity or capability underlying a then year dollar cost

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AFLCMC/FZC Inflation Adjustments For Formal Acquisition Reporting

• Once you have established an accurate TY$ estimate you will want to calculate a “reported base year” figure– This is the base year dollar amount that will be used to either

establish or measure against the existing APB cost parameters (PAUC, APUC, and appropriation totals)

• The reported CY$ is the TY$ total deflated using the appropriate OSD INFLATION INDEX (not PPI!)

• Why not show a true CP$ amount that normalizes for all price escalation?– Answer: The acquisition reporting systems such as DAMIR

automatically calculate the BY$ requirement in this way– If you are showing breach calculations using a BY$ derived

from another index, then you could be under or overstating the breach % that will be calculated automatically in DAMIR

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AFLCMC/FZC Inflation Adjustments For Formal Acquisition Reporting

• Observe the following inflation error in this hypothetical program’s PAUC calculation

• In this example, had you briefed a 10% PAUC growth to senior leadership based on use of a PPI deflator, you were in for quite a surprise (and a lot of explaining) when the information was input into DAMIR 23

X-97 Patriot Program $B

TY$ Requirement $25.000

BY$ Requirement (PPI deflator) $18.116

BY$ Requirement (OSD deflator) $20.661

Qty 36

PAUC (PPI deflator) $0.503

PAUC (OSD deflator - DAMIR) $0.574

APB PAUC $0.459

PAUC Growth (PPI deflator) 10%

PAUC Growth (OSD deflator - DAMIR) 25%


What Rates Should I Use?

• The indices above are 3600 Weighted PPI3364 for Base Year 2017

• AFLCMC analysts use these rates to normalize Then Year development dollars into Constant Price dollars (or vice versa)

• Correspondingly, there are 3010 and 3400 Weighted PPI3364 tables for use with those specific appropriations

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3600 Weighted - PPI 3364

Program Base

Year 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

2017 0.4428 0.4538 0.4666 0.4958 0.5135 0.5350 0.5531 0.5686 0.5820 0.5959 0.6073 0.6146 0.6183 0.6286 0.6474 0.6665 0.6827 0.7024 0.7318 0.7605 0.7901 0.8181 0.8459 0.8674



• Below are the OSD Specific Price Indices for Operating and Support (O&S), as well as the OSD Raw rates for various USAF appropriations for Base Year 2017

• Analysts use the OSD Price Indices to normalize Then Year O&S dollars into Constant Price dollars (or vice versa)

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General Research, Aircraft,Services Develop., Space & Ammo &

Pay Other & Wage Operations Testing, Military Missile OtherFiscal Base Expenses Total Retirement Board Pay Fuel & Maint. Evaluation Construct. Procurement ProcurementYear (3500) (3500) (3500) (3500) (3400) (3400) (3600) (3300) (3010/20/21) (3011/3080)

1949 0.046 0.086 0.050 0.089 0.047 0.059 0.111 0.113 0.110 0.103 0.1121950 0.053 0.090 0.056 0.085 0.049 0.057 0.109 0.111 0.109 0.102 0.1111951 0.055 0.097 0.057 0.137 0.048 0.062 0.116 0.118 0.116 0.109 0.1181952 0.055 0.098 0.059 0.134 0.051 0.060 0.120 0.122 0.120 0.112 0.1211953 0.058 0.098 0.062 0.136 0.053 0.061 0.122 0.124 0.122 0.114 0.1231954 0.058 0.096 0.062 0.127 0.056 0.060 0.123 0.125 0.123 0.115 0.1251955 0.060 0.099 0.064 0.135 0.059 0.064 0.125 0.127 0.125 0.117 0.1271956 0.063 0.103 0.067 0.144 0.064 0.067 0.128 0.131 0.128 0.120 0.1301957 0.061 0.107 0.066 0.150 0.066 0.072 0.133 0.136 0.133 0.124 0.1351958 0.065 0.118 0.071 0.151 0.075 0.072 0.136 0.139 0.136 0.127 0.1381959 0.069 0.120 0.075 0.162 0.080 0.074 0.139 0.141 0.139 0.130 0.1411960 0.070 0.120 0.075 0.161 0.082 0.074 0.142 0.144 0.142 0.132 0.1441961 0.071 0.122 0.077 0.160 0.088 0.075 0.143 0.146 0.143 0.134 0.145

Military Compensation

USAF Raw Inflation IndicesBased on OSD Raw Inflation Rates

Base Year (FY) 2017

SPECIFIC PRICE INDICES INFLATION INDEX



• Below are the OSD Weighted Indices for all USAF appropriations for Base Year 2017

• Analysts use OSD Weighted Inflation Indices to normalize Then Year dollars into Constant Year dollars (or vice versa)– For formal briefings and OSD reporting, analysts should use

Constant Year dollars

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Research,Develop., Military Military Military Aircraft Aircraft Missile Missile Space Space Other Other Ammo

Operations Testing, Construct. Construct. Construct. Procurement Procurement Procurement Procurement Procurement Procurement Procurement Procurement ProcurementFiscal & Maint. Evaluation AF Guard Reserve Special Other Special Other Special Other Special OtherYear (3400) (3600) (3300) (3830) (3730) (3010) (3010) (3020) (3020) (3021) (3021) (3080) (3080) (3011)

1949 0.110 0.112 0.112 0.112 0.112 0.106 0.105 0.103 0.105 0.103 0.105 0.112 0.113 0.1131950 0.110 0.114 0.115 0.115 0.115 0.110 0.109 0.107 0.109 0.107 0.109 0.112 0.117 0.1171951 0.117 0.120 0.119 0.119 0.119 0.113 0.112 0.111 0.112 0.111 0.112 0.118 0.121 0.1211952 0.120 0.123 0.122 0.122 0.122 0.114 0.114 0.113 0.114 0.113 0.114 0.122 0.124 0.1241953 0.122 0.125 0.124 0.124 0.124 0.116 0.116 0.115 0.116 0.115 0.116 0.124 0.125 0.1251954 0.123 0.126 0.126 0.126 0.126 0.119 0.118 0.117 0.118 0.117 0.118 0.125 0.128 0.1281955 0.125 0.129 0.129 0.129 0.129 0.122 0.122 0.120 0.121 0.120 0.121 0.128 0.131 0.1311956 0.129 0.133 0.133 0.133 0.133 0.126 0.125 0.124 0.125 0.124 0.125 0.131 0.135 0.1351957 0.133 0.137 0.136 0.136 0.136 0.129 0.128 0.127 0.128 0.127 0.128 0.136 0.138 0.1381958 0.137 0.140 0.139 0.139 0.139 0.131 0.131 0.129 0.130 0.129 0.130 0.139 0.141 0.1411959 0.139 0.142 0.141 0.141 0.141 0.133 0.133 0.132 0.133 0.132 0.133 0.141 0.144 0.1441960 0.142 0.145 0.144 0.144 0.144 0.135 0.135 0.134 0.135 0.134 0.135 0.144 0.146 0.1461961 0.144 0.147 0.146 0.146 0.146 0.137 0.137 0.136 0.136 0.136 0.136 0.146 0.148 0.148

USAF Weighted Inflation IndicesBased on OSD Raw Inflation Rates

Base Year (FY) 2017



• What rates would you use to normalize the following Then Year costs?– Development dollars for cost estimating

purposes…• 3600 PPI3364 Weighted

– Procurement dollars for OSD reporting purposes…

• 3010 OSD Weighted– Civ Pay dollars for estimating purposes…

• OSD Specific Price Indices for Civ Pay (3400)– Civ Pay dollars for OSD reporting purposes…

• 3400 OSD Weighted• Discussion as it relates to DAMIR

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BACK UP


Background and Guidance

• OMB Circular A-11 requires inflation and escalation to be considered in resource planning activities such as budget preparation, life-cycle cost estimates, etc.

• OMB Circular A-94 provides specific guidance on inflation assumptions

• AFI 65-502 sets guidelines for inflation and escalation adjustments in the Air Force Planning, Programming, Budgeting and Execution System (PPBES) and other Air Force analysis/reporting

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Background and Guidance

• Three Executive Branch offices work together to develop economic forecasts for the current presidential administration to include a forecast of the Gross Domestic Product (GDP) price index:– Department of the Treasury– Chairman of the Council of Economic Advisors (CEA)– Office of Management and Budget (OMB)

• OMB is Executive Branch office charged with assisting the President overseeing preparation of the federal budget

• Relies heavily on Bureau of Labor Statistics (BLS) and Bureau of Economic Analysis (BEA)

• After gathering historical data, OMB works with U.S. Treasury and President’s Council of Economic Advisors (CEA) to compile a six-year economic forecast which includes inflation

• OMB provides direct and specific guidance for inflation assumptions

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Responsibilities

• SAF/FMC is the Air Force Office of Primary Responsibility (OPR) for inflation matters

• SAF/ FMC:– Prepares inflation and specific price indices based on

guidelines provided by OMB via OUSD(C), who then passes them on to SAF/FMC

– Makes appropriation-specific inflation and specific price indices available for all Secretariat and Air Staff offices (e.g. Deputy Assistant Secretary of the Air Force for Budget (SAF/FMB)), major commands (MAJCOM), Field Operating Agencies (FOA), and Direct Reporting Units (DRU)

– Loads the inflation and specific price indices onto the Air Force Portal

• SAF/FMC recommends using the Air Force Inflation Calculator, an Excel© add-in, for inflation conversions

• SAF/FMC updates this program annually • The program is located on SAF/FMC’s site on the Air Force

Portal 31


Chain of Policy

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Inflation Adjustment Requirements

• Analysts must use “weighted” inflation indices developed by SAF/FMC unless an exemption has been approved

• When performing cost estimates, analysts should forecast costs as accurately as possible by including all price changes, not just inflation

– Therefore, analysts should use a specific price index (or whatever methodology provides the best forecast) to estimate future costs

– Price indices include both real and inflation-based price changes, resulting in a more realistic estimate of potential future price changes

– AFLCMC often utilizes the Producer Price Index (PPI) 3364—determined by the BLS—which pertains to price changes related to the Aerospace Industry

– Historical program/contract escalation data can also be used• When estimating remember to deflate (de-escalate) TY$ to BY$

using an appropriate weighted index (e.g. PPI)– For example when normalizing learning curve data, the analyst should

normalize all lot costs into a single BY$ by using an appropriate weighted index (e.g. PPI) so that all lot costs in all years are of comparable dollars

• To obtain the correct TY$, escalate using an appropriate weighted index (e.g. PPI) 33


Inflation Tables

• New Inflation Indices are typically published in January/February timeframe each year—for use in President’s Budget

• Rates/indices, however, can be adjusted at other times during the year

• Verify you are using the most current inflation rates

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Where to find Air Force Inflation Tables

• Inflation Calculator – Via Air Force Portal1. Scroll over BASES-ORGS-FUNCTIONAL AREAS, etc. tab,

then click “Functional Areas A-Z Listing”2. Select “Financial Management”, then click on “AFI 65-503,

Cost Factors”3. Click on “Inflation Indexes” located under “Inflation Factors”4. Click on “FY15** Inflation Calculator”

• You can use to do the math for you or• You can use this calculator to generate raw and weighted

inflation tables for any base year between 1949 and 2060• AFLCMC/FZCR produces weighted PPI3364 indices

– Includes BY87 to BY16– Provide other PPI indices upon request– Rates are available at FZCR Sharepoint Website:

https://org4.eis.afmc.af.mil/sites/1536/AFLCMC.FZC/default.aspx

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https://org4.eis.afmc.af.mil/sites/1536/AFLCMC.FZC/default.aspx

Documents

AF Life Cycle Management Center · 2017-06-27 · – Director of Cost Assessment and Program Evaluation shall ensure that the cost estimation and cost analysis processes ... •