GAO Report B-133149, June 15, 1964 3. Title: "Excessive Prices Negotiated by the Defense Petroleum Supply Center for Storage of Petroleum in a Commercial Facility at St. Ignace, Mich." (OSD case No. 1812). GAO finding: Prices negotiated under contract ASP-15734 for petroleum storage in a new commercial facility at St. Ignace included excessive amounts of $67,000 for interest on a contractor's construction loan and $223,190 for operating costs. GAO estimate of unnecessary costs: $290,190. Time period of GAO report: The contract in question was awarded on March 19, 1957, and gives the Government renewal options through 1967. DOD comments on GAO finding: DOD agrees that insufficient attention was given in the original negotiations to certain elements of the contractor's estimate of cost, including interest, which may possibly have afforded a basis for negotiating additional reductions, although it is to be noted that extensive competition was solicited and the contractor who received the contract was the lower of two bidders by $993,492 for the 10-year period. DOD comments on costs: No independent estimate made by DOD. DOD corrective action: After thorough review by DSA of the facts of the case it was concluded that there are no legal grounds for seeking a price adjustment and since there was no misrepresentation of any sort, there are no grounds for seeking a voluntary adjustment. DSA was partially successful in negotiating lower renewal prices totaling $204,764 over a period of 7 years. DSA has taken the following action to improve petroleum storage procurement: (1) Procedures have been developed to insure consideration of Government ownership as opposed to contractor ownership whenever practicable, (2) effective use is being made of multiyear techniques, (3) further emphasis has been placed on procedures for obtaining, analyzing, and effectively utilizing cost and pricing data. GAO Report B-146922, August 4, 1964 4. Title: "Improper Reimbursements for Personal Property Taxes to Hoffman Electronics Corp., El Monte, Calif., Under Defense Contracts and Subcontracts" (OSD case No. 1908). GAO finding: Hoffman Electronics Corp. improperly claimed and was reimbursed $55,619 by the military departments for personal property taxes paid to Los Angeles County. In addition, Hoffman retained $3,433 of a tax refund from Los Angeles County which should have been returned to the Government. GAO estimate of unnecessary costs: $59,052. Time period of GAO report: 1953 through 1958. DOD comments on GAO finding: DOD agrees with GAO findings. DOD comments on costs: DOD agrees with GAO's estimate of $59,052 and also is questioning an additional $120,759, for which Hoffman was reimbursed under a subcontract. DOD corrective action: Action has been initiated to obtain recovery from Hoffman. Problem ADDITIONAL COMMENTS BY THE DEPARTMENT OF THE AIR FORCE GAO review of personal property taxes included in the prices of defense contracts and subcontracts with Hoffman Electronics Corp., El Monte, Calif., disclosed that the corporation had improperly claimed and was reimbursed $55,619 by the military departments for taxes paid to Los Angeles County. Hoffman claimed reimbursement in certain instances because a new tax had been assessed against Government-owned property, whereas the taxes included in the claim primarily related to contractor-owned property and were of a type for which provision hal already been made in the contract prices. In other instances, payment of the taxes had not been protested by Hoffman, as required, which precluded the obtaining of any refund from the county when the taxes on Government property were subsequently declared invalid by the California courts. In addition to the improper reimbursement of $55,619, Hoffman retained $3,433 of a tax refund from Los Angeles County which should have been returned to the Government. The Government improperly reimbursed Hoffman for the taxes covered by this report because of misrepresentations by the contractor that the taxes were on Government-owned property or otherwise came within the "price adjustment" provision in the tax clause. GAO recommendation That the Department of Defense, in coordination with the Department of Justice, take action to obtain appropriate recovery from Hoffman. Statement The Department of Defense agreed with the GAO proposals and stated that it would take appropriate action to recover these amounts. The case was referred to the Air Force General Counsel. Status: On October 23, 1964, Mr. G. Wesselink SAF-GC, as chairman of the California Tax Refund Group wrote to Hoffman Electronics asking them to repay the sum to the United States. In three interim replies, Hoffman Electronics failed to be specific. On May 4, 1965, Mr. Wesselink again advised Hoffman Electronics that unless they paid the amount within 30 days appropriate action would be taken. GAO Report B-146922, September 1, 1964 5. Title: "Unnecessary Costs to the Government for Insurance on GovernmentOwned Inventories and Special Tooling Held by Contractors Under Negotiated Fixed-Price Contracts" (OSD case No. 1884). GOA finding: The Government incurred unnecessary costs of about $1,237,500 over a 5-year period ended in 1961 because the military services required four defense contractors to bear the risk of loss or damage to certain Governmentowned parts, materials, inventories, work in process, and special tooling in their possession under fixed-price contracts. At a fifth major contractor's plant, the Government assumed the risk of loss or damage to such property in the possession of the contractor and, as a result, avoided costs of about $295,800 during a comparable 5-year period. Accordingly, the GAO recommended that the Government take over the risk of loss or damage to this property and eliminate insurance through private insurers. GAO estimate of unnecessary costs: $1,237,500. Time period of GAO report: 1957 through 1961. DOD comments on GAO finding: The GAO takes the position that the Government should assume the risk of loss to this property in order to avoid the cost of premiums paid by contractors for private insurance. This position logically can be based solely on the premise that private insurance is uneconomical and should be replaced by the Government's acting as its own insurer. In our opinion, the sample used by GAO to support this position is totally inadequate. The partial experience of only five contractors, over a 5-year period, was examined by GAO. Their actual loss experience for the period was $12,500, or a little over 1 percent of premium costs, whereas insurance industry averages indicate that losses approximate 50 percent of premium costs. In the year immediately following this period, one of the contractors experienced a loss of $110,000. In addition, GAO did not consider other significant costs. example, there was little consideration given in the report to the additional costs for such services as inspection, claims adjustment, litigation, etc., which the Government would have to provide if it were to assume the risk of loss to the property in question. In short, the report does not demonstrate that private insurance is uneconomical. For DOD comments on costs: The report presents no evidence on which it can be concluded that there were any unnecessary costs. DOD corrective action: No corrective action is necessary. The question of the reasonableness of insurance rates is one of the subjects being considered in our continuing review of insurance coverage in defense contracts. Problem ADDITIONAL COMMENTS BY THE DEPARTMENT OF THE AIR FORCE In a review of insurance costs incurred by four major contractors during ear periods ended in 1961, the GAO found that the Government incurred necessary costs of about $1,237,500 because the military services required these contractors to bear the risk of loss or damage to certain Governmentowned parts, materials, inventories, work in process, and special tooling in their possession under fixed-price contracts. GAO estimates that prices negotiated with these contractors for fixed-price contracts included costs for insurance and related profit, totaling about $1,250,000, that could have been avoided if the military services had followed the Government's established policy of self-insurance. During the 5-year periods, the amounts received by the contractors for losses on this property totaled only $12,500. At another major contractor's plant, the Government assumed the risk of loss or damage to such property in the possession of the contractor and, as a result, avoided costs of about $295,000 during a comparable 5-year period. GAO recommendations (a) The Secretary of Defense take action to provide for Government assumption of risk of loss or damage to all Government-owned property of this type in the possession of contractors under negotiated fixed-price contracts unless, in individual cases, contracting officials can show that assumption by the contractor of the risk of loss on such property is less costly to the Government. (b) When the Government bears the risk of loss on such property, the contractor should be required to represent that no costs for insurance on the property are included in the prices established for negotiated fixed-price contracts. Statement The findings, conclusions and recommendations of this final report are predicated entirely on an examination of the experiences of five contractors over a 5-year period. It is our opinion that the small sampling of premium-loss data from a limited group of contractors does not provide a positive basis for departure from our policy on progress payments under which title to the property vests in the Government and the contractor bears the risk of loss and responsibility for the unliquidated progress payments. An exception to this policy permits the Government to assume the risk of loss expressly in appropriate cases. Our general policy and current progress payment clause follow the pattern established by 28 Comp. Gen. 468, that with the making of partial (progress) payments the Government must take title to the partially completed equipment in question. The report said further "that the contractor shall be responsible absolutely, and not as a mere bailee, for the trenching machine while it remains in his possession." The fire insurance premium and loss figures of four of the selected contractors: Boeing, McDonnell, North American, and Republic for the 5-year period, as cited in the report, show insurance premium costs of $1,146,000 (excluding your computation of the extra expense of profit on these contracts, in the amount of $104.000) and related losses amounting to $12,500. These figures reflect a ratio of little more than 1 percent of losses to premium charges. This might indicate that the fire insurance rates for the companies in question are grossly excessive. On the other hand, it might indicate that the selective examples cited in the final report are not representative of premium-loss ratio experience in the industry and are, therefore, not sufficiently reliable as a basis for changing current DOD insurance policy in respect to the contracts in question. We understand that industry averages indicate that claims losses approximate 50 percent of premium cost. Whatever the figure may be, it is difficult to believe that for fire and extended insurance coverage, where premium-loss ratios are actuarially determined on nationwide experience, fire insurance rates in the aircraft industry would be so disproportionate as reflected by the figures cited for the selective group. The final report covered a period ending in 1961. It is significant to note that in 1962 McDonnell Aircraft Corp. paid $90.000 in premiums and sustained a loss of $110,000. This loss, almost tenfold that of the four contractors for the 5-year period studied, is cited to illustrate the insufficiency, in this type of analysis, of a limited statistical study. The fifth example cited in the report was the Georgia Division of Lockheed Aircraft Corp., where the Air Force was obliged to provide to the contractor indemnification coverage in lieu of insurance because the hazardous nature of the plant as a fire risk rendered full insurance coverage either unavailable, or, available only at prohibitive cost. Using comparable commercial insurance rates, to the extent obtainable, for some of the contractor's property located in the plant, the report concluded that the Air Force saved $295,800 over a 5-year period, which savings included some element of profit. Although only $7,159 in losses were sustained, it was not reported that at times the plant contained over $100 million in property. No indication was given of the application of premium savings to the number of years required to show an economic benefit to the Government, in the event that plant had been destroyed by fire. The insurance industry does not reap a profit of the entire difference between the amount of premiums paid the losses paid out. Insurers must provide an efficient inspection and safety service, and if loss occurs, must provide investigative, claims adjusting and legal services to evaluate claims and handle litigation. The Government cannot dispense entirely with the need for like services. If it is to assume risk of loss responsibility for hundreds of millions of dollars worth of property annually in diversified plants, it must staff an appropriate organization to establish requisite safety standards and procedures, maintain surveillance over safety practices in plants, and investigate the nature and extent of losses in order to reimburse the contractor or make other essential contract adjustments. Where mixed commercial and Government business is carried on by the contractor and commercial-insurance applies to property other than that covered by negotiated fixed-price contracts subject to progress payments, there will be the added contract administration and legal burden of working out the respective areas of loss coverage. The final report does not cover these administrative considerations and the attendant costs. Other considerations also lend support to the current policy. Commercial insurance coverage generally assures prompt payment for losses and thus the continued efficient performance of the contract where prompt material or tooling replacement is essential. Where the Government becomes a self-insurer, reimbursement of the cost of such losses will depend on the availability of funds. If funds are not readily available or can only be made available through reprograming action, it may require a change in the quantum of goods or services ordered or perhaps a rescheduling of deliveries in anticipation of later appropriations or the resolution of reprogram problems. It is somewhat optimistic to presume that whatever "savings" in premiums are effected by eliminating commercial insurance, will be set aside as an "insurance" reserve for such purposes. It is not the practice of the Government to “sterilize” funds for such contingencies. No funds are administratively set aside to cover losses of many items of Government-owned property may await the legislative process of obtaining appropriations for replacement, the production process does not permit any such delay. Lack of funding, or delayed funding, can jeopardize or have a serious economie impact on a contract operation. These considerations are also important in evaluating the final report's recommendations, even though it would be hoped that the funding problems described would be the exception rather than the rule. Where, in a special case, as a matter of good business judgment, it is economic to assume risk of loss of property still in the possession of a fixed-price contractor because insurance was unavailable or available only at excessive cost, DOD has not hesitated to become a self-insurer. Thus, the "ground and flight" risk cov erage was applied to contracts involving "aircraft in the open" (ASPR 10–404). It is noteworthy that such coverage applies regardless whether title to the aircraft has in fact vested under a progress payment clause. DOD is likewise a self-insurer in procurements involving unusually hazardous risks such as contracts for missiles, exotic fuels, nuclear items, and the like. In the latter instance. as well, it is not important whether title to the property has passed to the Government. We recognize the possible savings at which the report is directed. However. these potential savings cannot be evaluated without considering the significant services provided by insurers and funded out of premiums. We feel that the facts of the final report alone do not sufficiently support the recommendation for altering existing policy and assuming risk of loss for property to which the Government has title pursuant to a progress payment clause in a negotiated fixedprice contract. Status: Case closed Policy We believe that current DOD policy, which looks to private insurance to cover property of the type in question in this report, should be continued as long as such insurance is obtainable from the private insurance industry at reasonable rates. As far as the cost of insurance is concerned, close public regulation plus competition within the insurance industry provides strong assurance that insurance costs will be kept at reasonable levels. GAO Report B-133149, September 30, 1964 6. Title: "Excessive Prices Negotiated by the Defense Fuel Supply Center for Storage of Petroleum in a Commercial Facility at Grand Forks, N. Dak." (OSD case No. 1880). GAO finding: The prices negotiated for the firm 5-year period of Contract No. ASP-17894 for storage of petroleum in a new commercial facility provided the contractor with $625,000 in excess of targeted construction costs and included $162,000 in payment of a termination settlement that was not a valid cost. The contractor did not disclose to the Government negotiators the known facts regarding the lower anticipated construction costs, nor did Government negotiators exert a reasonable degree of effort to obtain valid cost estimates for the purpose of evaluating the reasonableness of the contractors' proposals. GAO estimate of unnecessary costs: $787,000. Time period of GAO report: April and May 1959. DOD comments on GAO findings: DSA is of the opinion that the contractor withheld significant and relevant information concerning targeted construction costs which properly should have been made known to the Government negotiators. Accordingly, there is a valid basis for seeking a price adjustment for this item. Consideration also will be given to securing an adjustment for the termination charges. It is to be noted that this was a competitive procurement where the Government negotiated with the lowest of nine responsive offerors. DOD comments on costs: DOD agrees. DOD corrective action: Price adjustment action is in process and is being coordinated with the Department of Justice. Problem ADDITIONAL COMMENTS BY THE DEPARTMENT OF THE AIR FORCE GAO alleged that: (a) The prices negotiated by the Defense Fuel Supply Center (DFSC), under contract ASP-17894 for storage of petroleum in a new commercial facility at Grand Forks, N. Dak., contained $787,000 which reasonably should not have been included. Specifically, the prices negotiated for the firm 5-year period of this service contract (effective from Oct. 1, 1959, to Sept. 30, 1964) provided the contractor with $625,000 in excess of target construction costs and included $162,000 in payment of a termination settlement that was not a valid cost. (b) The contractor did not disclose to the Government negotiators the known facts regarding the lower anticipated construction costs, nor did the Government negotiators exert a reasonable degree of effort to obtain valid cost estimates for the purpose of evaluating for reasonableness of the contractor's proposals. Criticism of the Air Force is restricted to a view that about $1,438,000 could have been saved during the firm period of the contract, and about $1,569,000 during the 20 years covered by the contract, if this facility had been constructed by the Government. GAO recommendation That DOD take all available and appropriate action to obtain recovery of the overstated and improper costs from the contractor and that such actions be coordinated with the Department of Justice to assure that any interests or rights of the Government not be jeopardized. Statement By memo to the Assistant Secretary of Defense (I. & L.) signed by Mr. Racusin, Deputy for Procurement Management, we indicated that the Air Force was not a party to the contract negotiations. Therefore, we deferred any comment on the validity of the report's findings, insofar as the negotiations were concerned, to the Defense Fuel Supply Center. We concurred in the report's recommendation that action should be take to recover any provable overstated, improper contract costs. Status: Case closed. Policy (a) The report covered contract negotiations by DFSC in acquiring subject facility for storage of Air Force-owned petroleum products under the provisions of Public Law 968. This law permits the military to acquire petroleum storage |