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and the extent to which the Government, or its suppliers, should bear such a risk.

THE ROLE OF INSURANCE

Most suppliers carry some form of general or product liability insurance providing financial protection for claims resulting from loss or damage caused by defective products. However, we have been unable to obtain detailed data on specific types and amounts of coverage. Despite the lack of specific details regarding premium costs and the extent of product liability coverage, a number of basic facts about product liability insurance and insurance practices can be verified.

"Product liability" is commonly understood to mean liability of a contractor for injury to persons or property caused by its defective products, and includes liability to third parties who are not parties to the contract. Such liability to third persons is insurable, and most manufacturers and suppliers carry product liability insurance for third-person liability. However, product liability insurance is not intended to be a guarantee of good workmanship; it does not normally cover loss of or damage to the product itself nor the cost of repair, replacement, or removal of the product.

Military aircraft, missiles, space systems, and other complex products, including spare parts and components, which are destroyed or severely damaged, are not generally included in the premium rate of the manufacturer and its component manufacturer's product liability insurance coverage.

Neither commercial nor Government product liability insurance covers the "business risk" of the failure of a product to perform its intended purpose due to improper design or specification. An example of an uninsurable business risk is the costly recall situation, or "sistership" liability, such as liability caused by the grounding of all aircraft of the same type. It is not uncommon for the product liability insurance carried by industry to cover both its commercial and Government work. This is especially true at the subcontractor and supplier level.

The premium costs for product liability insurance are determined or structured by loss experience, and experience with a particular

company is nearly always the major or controlling factor in setting premium rates. Costs for premiums are reflected in contract pricing through a number of different accounting methods. Often, such premium costs are allocated to an overhead expense pool which is then prorated as part of an indirect expense rate against all contracts. Sometimes costs may be charged as a direct expense to a contract. Some companies segregate amounts for military insurance coverage from commercial coverage.

Because premium costs are determined by loss experience and the exposure to liability for such losses, there is a direct relationship between costs paid by the Government in its contract prices (directly or indirectly) and the amount of damages it recovers as a result of loss or of damage to Government property.

PRICING

Finally, the present uncertainty and vagueness of the extent of contractor and supplier liability for loss of or damage to Government property have made it difficult to price the risks involved adequately or accurately.

Warranties in Government contracts pose a nearly insoluble pricing problem. While Government policy allows the inclusion of a factor in the price to cover the cost of including a warranty, the contractor's difficulty is one of establishing some reasonable basis for predicting warranty costs for a product being produced for the first time. The problem is further complicated because postacceptance Government remedies are provided for in so many different standard clauses and are stated to be "nonexclusive"; that is, are merely remedies in addition to whatever other remedies may exist under the law.

CONCLUSIONS

A lack of a clear and explicit definition of postacceptance rights of the Government and obligations of contractors and suppliers increases the probability of disputes and litigation. It places indefinite risk on contractors and suppliers because of the inability to predict or determine the extent of the exposure to liability. Further, the lack of a clear statement

of postacceptance rights makes it difficult for the Government and its contractors to determine the adequacy or reasonableness of product liability insurance coverage or its costs.

The present structure of product liability insurance premiums reflects a loss experience with the Government acting as a self-insurer for loss of or damage to Government property occurring after final acceptance of supplies delivered to the Government. Any Government action that alters or tends to reverse this selfinsurance policy will increase the premium costs reflected in the contract prices paid by the Government to its suppliers. The extent of such increases would relate directly to the loss experience on Government property, and any substantial increase in loss experience and the amount of recoveries for loss of or damage to Government property would tend to limit the available insurance coverage.

Further, because premium costs for insurance are based on loss experience (that may or may not include projected risk exposure) plus the administrative costs and profit for the insurer, the total actual cost of providing private insurance for Government property would exceed the amounts received by the Government for its loss and damage or the available insurance market would be withdrawn. Such a conclusion derives from the simple fact that capital funds will flow from an unprofitable to a profitable market.

From a purely cost-effective standpoint, it is cheaper for the Government to act as a selfinsurer than it is to shift the risk of loss or damage to private contractors. The contractors simply would pass on to the Government the cost of private product liability insurance premiums, including the addition of applicable indirect expenses and profit.

Our recommended general policy of Government self-insurance could include the following elements:

• First, such policy would not cover claims and losses caused by the willful misconduct or lack of good faith on the part of the directors, officers, or principal officials of contractors, subcontractors, and suppliers.

• Second, such policy would not apply to standard commercial items, such as automobiles, generators, etc., where it is the custom

of the trade not to relieve the manufacturers from liability as may arise out of products of defective manufacture.

Third, the Government would retain its rights from contract warranties that provide postacceptance remedies, such as repair or replacement of defective supplies or equitable adjustments in contract prices when defects or deficiencies are discovered prior to the loss or damage.

• Fourth, all such postacceptance remedies would be expressly set forth in one provision or clause in each Government contract. Such remedies should be exclusive (both in contract and tort) to, and not cumulative with, any other express or implied warranty or action for negligence. Contract prices should not include any costs or allowances for warranty contingencies, or product liability or insurance premiums which are not consistent with the postacceptance obligations expressly imposed by contract.

• Fifth, the Government's policy of selfinsurance for defects would not include assumption of responsibility for, or liability for injury to, or wrongful death of, third parties, including military and civilian employees, nor loss of or damage to property of third parties, except as may be provided by indemnification legislation applicable to strophic accidents arising out of Government programs (discussed in Chapter 3).

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These elements include exceptions to the general policy, such as those under Defense Procurement Circular No. 86. We support such appropriate exceptions, but we recognize that fragmentation of a policy of Government selfinsurance by numerous exclusions, limitations, or qualifications is self-defeating because it necessitates some continuation of product liability insurance protection for the risk exposure that the Government has not assumed. Adoption of a policy that holds contractors expressly liable for loss or damage in those circumstances stated in exclusions, limitations, or qualifications will eventually increase costs to the Government. We therefore recommend that a central office, such as the Office of Federal Procurement Policy, be designated to screen and approve requested exceptions to the policy.

SUBCONTRACTORS AND THIRD

PARTIES

Recommendation 2. Apply the Government policy of self-insurance to subcontractors on the same basis as to prime contractors.

Recommendation 3. Ensure that, where items delivered by a contractor to the Government are transferred by the Government to a third party, the third party has no greater rights against the contractor or its subcontractors than the Government would have if it retained the item.

SUBCONTRACTORS AND SUPPLIERS

To a large extent, the warranty problems of subcontractors and suppliers under Government contracts are the same as those of prime contractors. The impact of the assignment of risk for loss of or damage to Government property can be magnified as it moves down the tiers of subcontractors and suppliers. While the extent of pyramiding or accumulation of insurance costs has not been established, such costs will include premiums for product liability insurance protection throughout the complete subcontracting chain. The same risk exposure will be covered to some degree by every subcontractor and supplier who bears the risk of liability.

From industry's viewpoint, DPC No. 86 has not provided acceptable relief from the risk of loss of or damage to Government property for subcontractors. This risk exposure may be unrecognized by the supplier when standard commercial items are incorporated in special high-value Government products or systems without the supplier's knowledge of the purpose for which its product is used. The resolution of this issue is beyond the authority of and cannot be negotiated by prime contractors or higher-tier subcontractors with lower-tier suppliers. It is a matter of governmental policy and decision.

THIRD PARTIES

As seen from the Menasco case, DOD has no policy as to what the risk assumption is to be when a Government-procured item is sold or otherwise furnished to other parties. The typical aircraft products liability insurance policy expressly excludes coverage for liability for damage to military products supplied to U.S. or foreign governments whether sold directly or transferred from one to the other.

As a result of Menasco, some contractors are now hesitant to sell major items to the Government when it is known that the items are to be furnished or sold to a foreign government. The problem is even more inequitable and impossible of reasonable solution if equipment is sold to the Government and later sold or transferred to a foreign government without the knowledge of the contractor. Any equipment sold to the Government is, of course, subject to such disposition without the consent or knowledge of the contractor.

CONCLUSIONS

In summary, the Government policy of acting as a self-insurer for loss of or damage to its property occurring after final acceptance and arising out of any defective supplies and services after expiration of the warranty period, if any, should apply to all tiers of subcontractors and suppliers. The Government's policy of self-insurance for defects or deficiencies of supplies should be included as a constraint in the sale or transfer of products to others including foreign governments, subject to possible reservations and conditions that the Departments of Defense and of State might have to consider for reasons of foreign policy and national defense. No transferee or purchaser should acquire greater rights than those granted to the Government under the terms of the original procurement. The document of transfer, contract, grant, loan, etc., should expressly limit the rights and obligations arising out of any defect or deficiency to those included in the contract under which an item originally was procured.

CHAPTER 3

Catastrophic Accidents

Dramatic scientific and technological advances have occurred in the past few decades. Frequently they have been initiated and paid for by the Federal Government, particularly in national defense, space, and nuclear programs. The probability of a catastrophic accident occurring in connection with one of these programs cannot be accurately estimated, nor can the extent of the damage that might result. Yet, there is a remote chance that thousands of lives could be lost and billions of dollars in property damages might result from a single calamitous incident.1 This chapter, in contrast to the preceding chapter, which was concerned solely with liability for damage to Government property, is concerned with the means available to compensate the victims of a catastrophic accident and to protect Government contractors from uninsurable risks arising from such accidents.

Illustrations of potential disastrous occurrences have been extensively postulated in the news media. The unintentional explosion of a nuclear device being carried by an airplane, the misfiring of a military or civilian missile or rocket, and the accidental release of poisonous or other hazardous substances are examples of catastrophic events which might arise from Government activities. Catastrophic accidents could occur during research and development, production, or operational use.

One disaster reaching catastrophic proportions and involving a Government program did occur on April 16 and 17, 1947.2 At the close of

1 Report of the Committee on Federal Legislation of the Association of the Bar of the City of New York, Protection Against Catastrophic Accidents in Connection With Government Activities, in Hearings on H.R. 474 Before a Subcommittee of the House Committee on Government Operations, 91st Cong., 1st sess., part 8, appendix 19, at 2332 (1969).

F. J. Hand, "The Texas City Disaster," in Hearings on H.R. 474, supra note 1, appendix 20, at 2337.

World War II the Government decided to market ammonium nitrate as a fertilizer. It was highly explosive, and two ships carrying fertilizer-grade ammonium nitrate under a Government contract exploded at the docks in Texas City, Texas. The explosions destroyed virtually the entire dock area of Texas City, killing some 570 persons and injuring 3,500. Approximately 1,000 homes, industrial plants, and other buildings either suffered major damage or were totally destroyed. The total claims were originally estimated at $200 million. After a decision by the United States Supreme Court denying relief to the plaintiffs, Congress enacted the Texas City Disaster Relief Act in 1955, eight years after the disaster. Under a 1959 amendment, it was estimated that an additional $4 million would be needed for payment although appraisals of the actual damages ranged from $300 million to billions of dollars. The Army paid $17.1 million in settlement of claims under the limited settlement authority of the Relief Act, with the last payment being made in September 1962 15 years after the disaster.

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This has been the only catastrophic accident in connection with any Government program. Indeed, extraordinary precautions undertaken to safeguard against such accidents have resulted in an impressive safety record. However, since human and mechanical error cannot be completely eliminated, the risk of a devastating disaster is real and must be faced.

If a catastrophic accident occurs, there is no assurance at present that any of the victims

3 Dalehite v. United States, 346 U.S. 15 (1953).

4 Act of Aug. 12, 1955, Pub. L. No. 84-378, 69 Stat. 707.

5 Act of Sept. 25, 1959, Pub. L. No. 86-381, 73 Stat. 706. Hand, "The Texas City Disaster," in Hearings on H.R. 474. supra note 2, at 2340.

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