CHAPTER 1

This part of the report covers two topics related to the consequences of accidents occurring in connection with Government procurement programs: (1) how the risk of liability for damage to Government property caused by defective products purchased by the Government should be spread between the Government and its contractors and (2) the need to develop adequate means (a) to compensate the victims of a catastrophic accident occurring in connection with a Government procurement and (b) to protect Government contractors from uninsurable risks in connection with such an accident. These topics, summarized below, are discussed in greater detail in Chapters 2 and 3.

1

SELF-INSURANCE OF GOVERNMENT PROPERTY

When the Government procures goods there is always a risk that they will prove defective and cause damage to Government property. The damage caused may greatly exceed the cost of the product itself; the failure of a single component may cause the destruction of an entire system. For example, the failure of a small resistor could cause the loss of a multimillion dollar missile.

In spreading the risk of loss of or damage to Government property between the contractor and itself, the Government has in the past generally acted as a self-insurer of its own property against damage caused by defects in products supplied by contractors. Accordingly,

1 For purposes of this report, a "catastrophic accident" is defined as an accident causing damage that exceeds the limits of available insurance coverage. See Chapter 3, infra, for a discussion of the term.

the insurance industry has structured its coverage and set its premium rates to contractors on the basis of this past Government practice. However, the Government as a whole has not published any general policy governing the extent to which and under what circumstances the Government will act as a self-insurer. Recent events, notably a case in which the Australian Government sued an American landinggear subcontractor for loss of an entire aircraft sold to Australia by the U.S. Government, have caused uncertainty in the insurance and contractor communities as to future Government practice.

In the absence of a clear statement of the Government's policy, this uncertainty could result in an increased cost of the products sold to the Government through increased insurance rates. Any reversal of the practice of acting as self-insurer will likely result in significant increases in the cost of contractor insurance, and the higher cost will be passed on to the Government.

The Department of Defense (DOD) has adopted a written policy to act, with some exceptions, as self-insurer for loss of or damage to Government property occurring after final acceptance of supplies delivered to the Government and resulting from any defects or deficiencies in such supplies. While it is the best statement yet of agency policy, the DOD policy has itself produced some uncertainty in its application in that it does not expressly cover a number of areas. Though the DOD policy generally is thought applicable to subcontractors, there is no express statement that subcontractors are relieved of liability to the same extent as prime contractors. In addition, where procured items are sold or otherwise furnished by

the Government to a third party, the existence and extent of contractor liability remains unresolved. The net effect of these omissions is to pressure the contractor to procure additional insurance coverage or to maintain a reserve fund for self-insurance. Such a result is inconsistent with the rationale for having a general policy of self-insurance.

We thus recommend that a Government-wide policy of self-insurance, subject to certain exceptions, be established for the risk of loss of or damage to Government property resulting from any defect in items supplied by a contractor and finally accepted by the Government. This general policy should apply equally to prime contractors and their subcontractors and suppliers. In addition, where items delivered by a contractor to the Government are sold or otherwise transferred by the Government to a third party, we recommend that the third party have no greater rights against the prime contractor or its subcontractors or suppliers than the Government would have had, had it retained the items.

LIABILITY FOR CATASTROPHIC ACCIDENTS

The Government increasingly has engaged in procurement of items containing or giving rise to physical and chemical forces of tremendous power. The unintentional explosion of a nuclear device aboard an aircraft, the misfiring of a missile or rocket, and the accidental release of poisonous or otherwise hazardous substances are examples of catastrophes that might arise from Government procurement activities. The safety record of the Government and its contractors has thus far been excellent, with only one recent catastrophic accident, the 1947 Texas City explosion, arising in connection with a Government program. However, human and mechanical error cannot be completely eliminated, and the risk of such a disaster is real and must be faced. Thousands of lives could be lost and millions of dollars in property damage sustained as a result of a single calamitous accident.

We found the existing laws and insurance programs inadequate to cope with two basic

needs that would exist in the event of a catastrophic accident arising from a Government program: (1) the need to provide prompt and complete financial assistance to the victims of a catastrophic accident, and (2) the need to shield contractors and subcontractors from unrealistic and uninsurable risks in connection with such an accident. As in the case of natural disasters, which occur with some regularity and even predictability, providing relief from the damage caused by a catastrophe arising from a Government program has not been the subject of careful advance legislative planning and preparation, except in certain special cases.

At present, there are two primary means of providing relief through the private sector in connection with Government-connected catastrophic accidents: private insurance and civil suit against a negligent Government contractor. Due primarily to the magnitude of the damage that would be involved in a catastrophic accident, we found that neither can provide adequate relief to victims nor protect contractors against the risk of such an accident.

First, private insurance carried by individuals is inadequate because only a small percentage of individuals carry such insurance and, even when it is carried, it only affords protection up to a certain dollar limit. Second, although contractors engaged in hazardous Government programs ordinarily carry insurance, including product liability insurance, the liability for a catastrophic accident would exceed the limits of commercial insurance coverage and, in many cases, the total assets of the contractor. Thus, a successful suit against a contractor as a result of a catastrophic accident would likely result in the liquidation of the contractor without fully compensating the victims. Moreover, the problems of proving liability for a catastrophic accident can be difficult or impossible. The program might be highly technical and highly classified, with only the Government and involved contractors capable of identifying the facts; or the faulty equipment could be destroyed in the accident. It would be difficult to trace the cause of the accident, to identify the responsible contractor, and prove its liability in a lawsuit.

Apart from the contractor, the Government also may be liable. Government liability at present may be based on one or more of several existing statutes and programs providing for

Government relief. We have found these existing laws inadequate because they generally lack mechanisms for providing prompt financial relief to victims, contain no authorizations for agencies to provide interim funds pending final settlement, provide no clear declaration of congressional policy encouraging broad indemnification of Government contractors, and unreasonably limit the amount of recovery by foreign citizens.

We recommend that legislation be enacted to assure in advance prompt and adequate compensation for victims of catastrophic accidents occurring in connection with Government programs. We further recommend that legislation be enacted to provide Government indemnification of contractors for liability above the limit of available insurance.