Compacts of Free Association: Trust Funds for Micronesia and the
Marshall Islands May Not Provide Sustainable Income (15-JUN-07,
GAO-07-513).
In 2003, the U.S. government extended its economic assistance to
the Federated States of Micronesia (FSM) and Republic of the
Marshall Islands (RMI) through Amended Compacts of Free
Association. From 2004 to 2023, the United States will provide an
estimated combined total of $3.6 billion, with annually
decreasing grants as well as annually increasing contributions to
trust funds for each country. The trust funds are to be invested
and provide income for the FSM and RMI after the compact grants
end. A trust fund committee for each country is to establish and
oversee the funds. This report examines (1) the committees'
progress in establishing, investing, and reporting on the funds;
(2) the sustainability of income from the trust funds; and (3)
potential options to supplement or enhance the trust funds'
income. GAO reviewed trust fund-related documents and
legislation; interviewed U.S., FSM, RMI, and industry officials
and used a simulation model to project the trust funds' income.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-07-513
ACCNO: A70845
TITLE: Compacts of Free Association: Trust Funds for Micronesia
and the Marshall Islands May Not Provide Sustainable Income
DATE: 06/15/2007
SUBJECT: Federal aid to foreign countries
Financial analysis
Financial management
Financial statements
Foreign economic assistance
Fund audits
Funds management
Grants
International agreements
Investment planning
Reporting requirements
Strategic planning
Trust funds
Compact of Free Association
Federated States of Micronesia
Republic of the Marshall Islands
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GAO-07-513
* [1]COMPACTS OF FREE ASSOCIATION
* [2]Trust Funds for Micronesia and the Marshall Islands May Not
* [3]Contents
* [4]Appendix I Objectives, Scope, and Methodology 36
* [5]Appendix II Technical Notes on the Trust Fund Simulation Mod
* [6]Appendix III Disbursing All Income Compared to Disbursing Pa
* [7]Appendix IV Key Events in the Establishment of the FSM and R
* [8]Appendix V Comments from the Department of the Interior 53
* [9]Appendix VI Comments from the Department of Health and Human
* [10]Appendix VII Comments from the Department of State 62
* [11]Appendix VIII Comments from the Federated States of Micrones
* [12]Appendix IX Comments from the Republic of the Marshall Islan
* [13]Appendix X GAO Contact and Staff Acknowledgments 73
* [14]Tables
* [15]Figures
* [16]Results in Brief
* [17]Background
* [18]Trust Fund Contributions
* [19]Trust Fund Structure
* [20]Trust Fund Governance
* [21]Investment Returns and Volatility
* [22]Establishment of FSM Trust Fund Is Complete, but RMI
Trust F
* [23]Trust Fund Committees Have Taken Steps to Establish
and Inve
* [24]Several Factors Slowed Establishment of the Funds
* [25]Timing of Trust Fund Investment Reduced Potential
Earnings
* [26]Trust Fund Committees Did Not Publish Annual
Reports as Requ
* [27]FSM and RMI Trust Funds May Not Provide Sustainable
Income a
* [28]Market Volatility Could Lead to Wide Range of Trust
Fund Bal
* [29]Trust Funds May Not Provide Sustainable Income
after Compact
* [30]FSM Trust Fund Income
* [31]RMI Trust Fund Income
* [32]Several Options Exist for Supplementing FSM and RMI
Trust Fu
* [33]Greater Tax Revenue through Economic Development
* [34]Growing Emigration and Remittances
* [35]Economic Assistance from Other Donors
* [36]Trust Fund Securitization
* [37]Conclusions
* [38]Recommendations for Executive Action
* [39]Agency Comments and Our Evaluation
* [40]Appendix I: Objectives, Scope, and Methodology
* [41]Appendix II: Technical Notes on the Trust Fund Simulation Mo
* [42]Appendix III: Disbursing All Income Compared to Disbursing P
* [43]Appendix IV: Key Events in the Establishment of the FSM and
* [44]Appendix V: Comments from the Department of the Interior
* [45]GAO Comment
* [46]Appendix VI: Comments from the Department of Health and Huma
* [47]GAO Comment
* [48]Appendix VII: Comments from the Department of State
* [49]GAO Comments
* [50]Appendix VIII: Comments from the Federated States of Microne
* [51]Appendix IX: Comments from the Republic of the Marshall Isla
* [52]GAO Comments
* [53]Appendix X: GAO Contact and Staff Acknowledgments
* [54]GAO Contact
* [55]Staff Acknowledgments
* [56]Order by Mail or Phone
Report to Congressional Committees
United States Government Accountability Office
GAO
June 2007
COMPACTS OF FREE ASSOCIATION
Trust Funds for Micronesia and the Marshall Islands May Not Provide
Sustainable Income
GAO-07-513
Contents
Letter 1
Results in Brief 3
Background 6
Establishment of FSM Trust Fund Is Complete, but RMI Trust Fund Is Not Yet
Fully Established 15
FSM and RMI Trust Funds May Not Provide Sustainable Income after Compact
Grants End 20
Several Options Exist for Supplementing FSM and RMI Trust Fund Income 28
Conclusions 32
Recommendations for Executive Action 32
Agency Comments and Our Evaluation 33
Appendix I Objectives, Scope, and Methodology 36
Appendix II Technical Notes on the Trust Fund Simulation Model 38
Appendix III Disbursing All Income Compared to Disbursing Partial Income
48
Appendix IV Key Events in the Establishment of the FSM and RMI Trust Funds
51
Appendix V Comments from the Department of the Interior 53
GAO Comment 56
Appendix VI Comments from the Department of Health and Human Services 57
GAO Comment 60
Appendix VII Comments from the Department of State 62
GAO Comments 65
Appendix VIII Comments from the Federated States of Micronesia 67
Appendix IX Comments from the Republic of the Marshall Islands 69
GAO Comments 72
Appendix X GAO Contact and Staff Acknowledgments 73
Tables
Table 1: U.S. Assistance to the FSM and the RMI under Amended Compacts,
Fiscal Years 2004-2023 7
Table 2: Annual Compounded Real Returns and Standard Deviations for Large
Company and International Stocks and for U.S. Treasury Bills (in
percentage), 1970-2005 14
Table 3: Possible Outcomes of Three Types of Investment Strategies, with
Associated Real Returns and Standard Deviations 14
Table 4: Projected Trust Fund Balances in 2023 with and without
Securitization, under Aggressive Investment Strategy 31
Table 5: U.S. Scheduled Contributions to FSM and RMI Trust Funds, as
Outlined in Amended Compacts 38
Table 6: Taiwan's Scheduled Contributions to RMI Trust Fund, as Outlined
in Agreement with RMI Government 39
Table 7: Real Returns Distribution Based on Historical Data from 1970 to
2005 42
Table 8: Cross-Correlation and Serial Correlation of Historical Annual
Returns 43
Table 9: Trial Values of the FSM Trust Fund Balances under Moderate
Investment Strategy, Fiscal Years 2006-2023 44
Table 10: Trial Values of the RMI Trust Fund Balance under Moderate
Investment Strategy, Fiscal Years 2006-2023 46
Figures
Figure 1: Structure of FSM and RMI Trust Funds 10
Figure 2: Inflation-Adjusted Annual Returns of International and Large
Company Stocks, 1970-2005 13
Figure 3: Timeline of Key Events in Establishment of FSM Trust Fund 16
Figure 4: Timeline of Key Events in Establishing the RMI Trust Fund 17
Figure 5: Projections of FSM Account Balance with Three Possible
Investment Strategies 21
Figure 6: Projections of RMI Account Balance with Three Possible
Investment Strategies 22
Figure 7: Probability of FSM Trust Fund Income Not Reaching the Maximum
Disbursement Levels Allowed, Fiscal Years 2024 - 2050 24
Figure 8: Probability of No Disbursement from FSM Trust Fund, Fiscal Years
2024 - 2050 25
Figure 9: Probability of RMI Trust Fund Income Not Reaching the Maximum
Disbursement Levels Allowed, Fiscal Years 2024 - 2050 26
Figure 10: Probability of No Disbursement from RMI Trust Fund, Fiscal
Years 2024 - 2050 27
Figure 11: Probabilities That FSM Trust Fund Income Will Not Reach the
Maximum Disbursement Level Allowed When Disbursing All Income vs.
Disbursing Partial Income 49
Figure 12: Probabilities That RMI Trust Fund Income Will Not Reach the
Maximum Disbursement Level Allowed When Disbursing All Income vs.
Disbursing Partial Income 50
Figure 13: Key Events in the Establishment of the FSM Trust Fund 51
Figure 14: Key Events in the Establishment of the RMI Trust Fund 52
Abbreviations
FSM Federated States of Micronesia
HHS Department of Health and Human Services
RMI Republic of Marshall Island
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United States Government Accountability Office
Washington, DC 20548
June 15, 2007
Congressional Committees:
From 1987 to 2003,^1 the United States provided about $2.1 billion in
economic assistance to the Federated States of Micronesia (FSM) and the
Republic of the Marshall Islands (RMI) through a Compact of Free
Association.^2 In 2003, the U.S. government extended its economic
assistance to the FSM and the RMI governments through Amended Compacts of
Free Association.^3 Under the amended compacts' terms, the United States
will provide an estimated combined total of $3.6 billion in economic
assistance to the FSM and the RMI from 2004 to 2023,^4 to assist the FSM
and the RMI governments in their efforts to promote the economic
advancement and budgetary self-reliance of their people. This assistance
consists of annually decreasing grants targeted to certain development
sectors and annually increasing contributions to a trust fund for each
country, to which the FSM and the RMI are also to make initial
contributions. The trust funds are to be invested, and after termination
of annual U.S. grant assistance in 2023, annual disbursements of the
investment earnings^5 are to provide an ongoing source of revenue to
assist the FSM and the RMI in achieving economic advancement and long-term
budgetary self-reliance.
^1In this report, all years cited are fiscal years (Oct. 1 - Sept. 30)
unless otherwise noted.
^2A key goal for this assistance was to advance the countries' economic
development and budgetary self-reliance. In 2000, we reviewed the impact
of compact funding and found that U.S. assistance had resulted in little
economic development for either the FSM or the RMI. See GAO, Foreign
Assistance: U.S. Funds to Two Micronesian Nations Had Little Impact on
Economic Development, [57]GAO/NSIAD-00-216 (Washington, D.C.: Sept. 22,
2000).
^3Whereas the original compact (approved in Pub. L. No. 99-239, Jan. 14,
1986) was one agreement among the U.S., FSM, and RMI governments, the
amended compacts (approved in Pub. L. No. 108-188, Dec. 17, 2003) are
separate agreements between the United States and each of the two
countries.
^4The $3.6 billion in assistance includes (a) compact grants; (b) trust
fund contributions; (c) Kwajalein impact funding provided to the RMI
government, which in turn compensates Kwajalein Atoll landowners, for U.S.
access to the atoll for military-purposes; and (d) estimated values of
compact-authorized federal services such as weather, aviation, and postal
services, at around $200 million over the 20-year period. Services
associated with the Federal Emergency Management Agency have been
excluded.
^5The annual disbursements may not exceed the amounts, adjusted for
inflation, that each country receives as grant assistance in 2023.
The amended compacts and subsidiary trust fund agreements^6 require the
formation of a trust fund committee for each country. Each committee is
responsible for establishing the trust funds by, among other things,
hiring trustees, independent auditors, investment advisers and money
managers. The trust fund committees' responsibilities also include
overseeing the funds' operation, supervision, and management; the funds'
investment; and the conclusion of agreements with any other contributors
to the funds.^7 The trust fund agreements do not specify a time frame for
establishing and investing the funds. Within 6 months after the end of
each fiscal year, the committees are to provide annual reports to the
governments on the trust funds' activities, management, financial
operations, and effectiveness at accomplishing the purposes of the funds.
Each committee comprises representatives from the U.S. government, the
country's government, and any subsequent contributors; a representative
from the Department of the Interior (Interior) serves as the chair of each
committee.
U.S. legislation approving the amended compacts requires that we report
periodically to Congress on the status of compact implementation. In 2006,
we provided two reports responding to this mandate.^8 This report provides
additional information, examining (1) the trust fund committees' progress
in establishing,^9 investing, and reporting on the funds; (2) the
sustainability of income from the trust funds after the compact grants end
in 2023; and (3) other potential sources of revenue to supplement or
enhance trust fund income after 2023.
^6Agreement Between the Government of the United States of America and the
Government of the Federated States of Micronesia Implementing Section 215
and Section 216 of the Compact, as Amended Regarding a Trust Fund;
Agreement Between the Government of the United States of America and the
Government of the Republic of the Marshall Islands Implementing Section
216 and Section 217 of the Compact, as Amended Regarding a Trust Fund.
^7Contributors other than the U.S., FSM, and RMI governments may include
any government, international organization, financial institution, or
other entity or person who contributes grants, not loans, to the trust
funds.
^8GAO, Compacts of Free Association: Development Prospects Remain Limited
for Micronesia and Marshall Islands, [58]GAO-06-590 (Washington, D.C.:
June 2006); Compacts of Free Association: Micronesia and the Marshall
Islands Face Challenges in Planning for Sustainability, Measuring
Progress, and Ensuring Accountability, [59]GAO-07-163 (Washington, D.C.:
Dec. 15, 2006). For an initial review of trust fund implementation, see
GAO, Compacts of Free Association: Implementation of New Funding and
Accountability Requirements Is Well Under Way, but Planning Challenges
Remain, [60]GAO-05-633 (Washington, D.C.: July 11, 2005).
To answer these objectives, we reviewed the amended compacts, the trust
fund agreements and bank statements as well as documents related to
establishing the funds. We also reviewed documents related to the
implementation of the trust fund agreements. We interviewed officials from
U.S. government agencies, including Interior, the Department of State
(State), the Department of Labor (Labor), and the Department of Health and
Human Services (HHS), as well as officials from the FSM and the RMI. We
interviewed the RMI's trustee and selected investment adviser. In
addition, we built a Monte Carlo simulation model--based on the trust fund
agreements, contributions to date, and historical returns of the
market--to project the trust funds' likely income levels, given market
volatility as well as historical returns of various asset classes,
including large company stocks, treasury bills, and international stocks
from 1970 to 2005. (Actual trust fund income will depend on the investment
strategies chosen for the funds, market trends, and investment
performance.) We also analyzed the probability that the trust funds can
maintain the maximum disbursement level allowed under the trust fund
agreements.^10 We conducted our work from July 2006 to March 2007 in
accordance with generally accepted government auditing standards. (For
more details of our objectives, scope, and methodology, see app. I.)
Results in Brief
The FSM trust fund committee has fully established the country's trust
fund, but the RMI trust committee has not; further, investment of the
funds was slow, and both committees missed the deadlines for submitting
the required annual reports. The FSM committee has appointed a trustee, an
independent auditor, an investment adviser, and money managers. As of
March 2007, the RMI committee had not appointed an independent auditor
and--in part because the trustee and the investment adviser disagree over
the assignment of custodial rights to the fund--had not appointed any
money managers. Investment of the FSM and RMI trust funds began 22 months
and 16 months, respectively, after the countries' initial contributions,
with the funds remaining in low-interest savings accounts until their
investment. According to U.S. government officials, unexpected contracting
delays, as well as the trust fund committees' processes for reaching
consensus and obtaining administrative support, contributed to slowing the
funds' establishment. However, the committees have not taken steps to
improve the processes. The committees did not meet the trust fund
agreement requirements to submit and publish annual reports on the trust
funds for 2004 and issued the reports for 2005 several months after the
March 2006 deadline. Moreover, the reports do not assess the trust funds'
likely effectiveness in helping the FSM and the RMI achieve economic
advancement and long-term budgetary self-reliance by providing a source of
revenue to the FSM and RMI governments after 2023.
^9In this report, "establishing the funds" refers to the selection and
hiring of the trustees, independent auditors as well as the selection and
hiring of any investment advisers and money managers.
^10According to U.S. officials, the trust fund income is intended to be
one source of income, and the amended compacts do not guarantee that the
trust funds will provide the maximum disbursements allowed by the trust
fund agreements. However, projections of the trust funds' ability to
disburse the maximum allowed amounts can indicate the likely level and
sustainability of the funds' income.
Owing in part to market volatility, the FSM and the RMI trust funds may
not provide sustainable income to the countries after annual compact
grants end in 2023. Market volatility, in addition to the investment
strategies chosen, may lead to a wide range of trust fund balances in
2023. For example, our analysis shows that the trust fund balance could
range^11 from $697 million to $1.3 billion for the FSM and from $439
million to $862 million for the RMI under a conservative strategy, from
$663 million to $2.2 billion for the FSM and from $438 million to $1.4
billion for the RMI under an aggressive strategy. Moreover, we found
increasing probability that income from the trust funds cannot sustain the
maximum disbursement level allowed--an amount equal to the compact grant
assistance in 2023, adjusted for inflation. Furthermore, the trust funds
face increasing probability of providing no income at all in some years.
For instance, our analysis shows low probabilities that the trust funds
will not reach the maximum allowed disbursement levels immediately after
the compact grants end. However, by 2050, with a conservative investment
strategy, income from the FSM and RMI trust funds, respectively, is more
than 90 percent and 60 percent likely not to reach the maximum allowed
disbursement levels and more than 20 percent and 15 percent likely to
allow for no disbursements.
^11The ranges referred to in this example are between the 10th and 90th
percentile values from the results of our simulation model under different
scenarios. Ten percent of the range of possible trust balances lie below
the 10th percentile; 90 percent of the range of possible balances lie
below the 90th percentile. See appendixes I and II for more information.
The trust funds' income could be supplemented or enhanced through (1)
greater tax revenue through economic development; (2) increasing
remittances from growing numbers of emigrants;^12 (3) economic assistance
from other sources; and (4) securitization of the funds.^13 However, each
of these scenarios has its limitations.
o Greater tax revenue. Economic development could increase the FSM
and the RMI governments' tax revenue. However, as we reported in
2006, the countries' prospects for economic development and higher
tax revenues remain limited.
o Growing emigration and remittances. As compact grant assistance
decreases, emigration from the FSM and RMI may rise, easing the
governments' cost of providing services to remaining residents and
possibly leading to growing remittances from the emigrants.
However, FSM and RMI emigrants have limited earning opportunities
abroad, owing to inadequate education and vocational skills, and
may therefore not remit significant amounts.
o Assistance from other sources. The RMI trust fund received a
commitment from Taiwan to contribute $40 million over 20 years to
the RMI trust fund, which improved the RMI fund's likely capacity
for disbursements after 2023. However, except for Taiwan's
commitment to the RMI, there is no certainty of external trust
fund contributions other than those from the United States.
Further, although donors other than the United States have given
the two countries economic assistance unrelated to the trust
funds, such assistance is not assured for the future.
o Securitization. Although securitizing the trust funds--that is,
issuing bonds against future U.S. contributions--could increase
the funds' earning potential by raising their balances, it could
also lead to lower balances and reduced income. According to
Interior officials, the trust fund committees are reviewing this
option but have not initiated an independent study to objectively
evaluate its potential risks.
^12Remittances are personal funds that emigrants voluntarily send to
residents in their home countries.
^13With securitization, the trust funds would sell bonds to investors and
the cash generated through bond issuance would become the trust fund
principal to be invested. Future contributions to the trust fund would be
used to pay bond holders instead of building the funds. Securitization
could help increase the principal of the trust fund more quickly than
would annual contributions to the fund.
In this report, we recommend that the Secretary of the Interior
direct the Deputy Assistant Secretary for Insular Affairs, as
Chairman of the FSM and the RMI trust fund committees, to develop
strategies for improving the committees' decision-making and
administrative processes; ensure timely reporting of trust fund
activities, including assessment of the funds' likely status as an
ongoing source of revenue and their potential effectiveness in
helping the FSM and the RMI achieve economic advancement and
budgetary self-reliance; and obtain an independent evaluation of
the potential benefits and risks of securitization.
Interior, HHS, State, and the FSM and the RMI governments provided
written comments regarding a draft of this report. Interior, HHS,
and the RMI government agreed with our recommendation on
developing strategies for improving the trust fund committees'
decision-making and administrative processes. Interior generally
agreed with our recommendation on ensuring timely reporting of
trust fund activities. However, HHS and State stated that our
report reflected a fundamental misunderstanding of the outcome of
the negotiation of the amended compacts and a misreading of the
international agreements, which we strongly disagree. Our report
clearly stated that the purpose of the trust funds is to provide
an ongoing source of revenue. To further clarify this point, we
modified our recommendation and added language specifying that
there is no minimum disbursement required or guaranteed by the
trust fund agreements. Interior, HHS, and the RMI government
agreed with our recommendation on obtaining an independent
evaluation of the potential benefits and risks of securitization.
The FSM government generally agreed with all of our
recommendations. State did not provide any comment about our
recommendations.
Background
The U.S. trust fund agreements with the FSM and the RMI state that
the purpose of the trust funds is to contribute to the countries'
economic advancement and long-term budgetary self-reliance by
providing an annual source of revenue after fiscal year 2023.^14
Annual compact grants end in 2023. Although the agreements state
that the annual disbursements may not exceed the amounts that each
country receives as grant assistance in 2023, adjusted for
inflation, they do not establish or guarantee a minimum
disbursement level.
^14The trust fund income is intended to provide assistance in development
sectors currently receiving grants under the amended compacts: education,
health, infrastructure, private sector development, the environment, and
public sector capacity building, with priority given to education and
health. The income may also be used for other sectors mutually agreed to
by the United States and the countries.
Trust Fund Contributions
Under the amended compacts, annual U.S. contributions to each of
the countries' trust funds increase by the same amounts as the
annual grants to the countries decrease; in addition, the
contributions are partially adjusted for inflation. (See table 1.)
However, the scheduled trust fund increments and grant decrements
for the two countries differ: the grant decrement and trust fund
increment for the FSM is $800,000 per year, and the grant
decrement and trust fund increment for the RMI is $500,000 per
year. The timing of the first decrement for each country also
differs: under the amended compacts, the decrement for the FSM
began in 2007, but the decrement for the RMI began in 2005. As a
result of these differences, final grants to the FSM will decline
from the initial grants by a smaller total percentage than will
grants to the RMI (18 percent versus 21 percent).
Table 1: U.S. Assistance to the FSM and the RMI under Amended
Compacts, Fiscal Years 2004-2023
Dollars in millions
Annual grants contribution Trust fund contribution
Fiscal year FSM RMI FSM RMI
2004 $76.2 $35.2 $16.0 $7.0
2005 76.2 34.7 16.0 7.5
2006 76.2 34.2 16.0 8.0
2007 75.4 33.7 16.8 8.5
2008 74.6 33.2 17.6 9.0
2009 73.8 32.7 18.4 9.5
2010 73.0 32.2 19.2 10.0
2011 72.2 31.7 20.0 10.5
2012 71.4 31.2 20.8 11.0
2013 70.6 30.7 21.6 11.5
2014 69.8 32.2 22.4 12.0
2015 69.0 31.7 23.2 12.5
2016 68.2 31.2 24.0 13.0
2017 67.4 30.7 24.8 13.5
2018 66.6 30.2 25.6 14.0
2019 65.8 29.7 26.4 14.5
2020 65.0 29.2 27.2 15.0
2021 64.2 28.7 28.0 15.5
2022 63.4 28.2 28.8 16.0
2023 62.6 27.7 29.6 16.5
Total $1,401.6 $629.0 $442.4 $235.0
Source: Compact of Free Association Amendments Act of 2003 (Pub.
L. No. 108-188).
Note: These dollar amounts will be adjusted each year for
inflation by a percentage that equals two-thirds of the percentage
change in the U.S. gross domestic product implicit price deflator,
or 5 percent, whichever is less in any one year, using the
beginning of 2004 as a base. Both grant funding and trust fund
contributions can be fully adjusted for inflation after 2014 under
certain U.S. inflation conditions.
The U.S. contributions to the trust funds are conditioned on the
FSM and the RMI making their own required contributions. The FSM
was required to contribute at least $30 million before September
30, 2004; the FSM made this contribution on October 1, 2004, and
the United States made its first contribution on October 5, 2004.
The RMI was required to contribute at least $25 million on the day
the amended compact went into effect or on October 1, 2003,
whichever was later; $2.5 million before October 1, 2004; and an
additional $2.5 million before October 1, 2005. The RMI made its
initial contribution on June 1, 2004, and the United States made
its initial contribution on June 3, 2004.
According to the U.S. trust fund agreements with the FSM and the
RMI, contributions from other donors are permitted. In May 2005,
Taiwan and the RMI reached an agreement that Taiwan will
contribute a total of $40 million to the RMI's trust fund from
2004 to 2023.
Trust Fund Structure
As specified in the trust fund agreements, each country's trust
fund consists of three interrelated accounts, labeled "A," "B,"
and "C."^15
^15A "D" account may be established to hold any contributions by the FSM
and the RMI governments of revenue or income from unanticipated sources.
According to the trust fund agreements, the D account must be a separate
account, not mixed with the rest of the trust fund; it is not part of the
corpus of the trust fund. As of March 2007, only the RMI had a D account,
governed by the agreement between Taiwan and the RMI. Taiwan will
contribute $10 million to the RMI's D account in 5 years.
o The A account, which was to be created on the amended compacts'
effective date, forms the trust fund "corpus"^16 and contains the
country's initial contributions as well as the annual U.S.
contributions. It also holds any contributions from other donors,
such as Taiwan's to the RMI. The A account additionally consists
of income from the trust fund's investment. Through 2022, any
annual investment income exceeding 6 percent of the fund will be
deposited in the C account, up to a certain limit. After 2023, if
the income in the B account is less than the previous year's
distribution, and if the C account cannot cover the shortfall in
the B account, the corpus shall not be accessed to compensate for
the shortfall.
o The B account, which is to be created at the start of fiscal
year 2023, will be used to disburse income after the compact
grants end. All annual investment income earned in 2023 will be
deposited in the B account for possible disbursement in 2024.
Thereafter, the B account will consist of the prior year's
investment income in the A account. The annual disbursement from
the B account may equal, but not exceed, the inflation-adjusted
grant assistance in 2023 plus any additional amounts for special
needs agreed to by the trust fund committee. Any amount exceeding
the annual disbursement will be transferred back to the A account
or--if the C account contains less than three times the estimated
equivalent of 2023 grant assistance, including estimated
inflation--transferred to the C account to bring it to the maximum
level allowed.
o The C account, which was to be created at the same time as the A
account, is designed as a buffer against low or negative annual
investment returns after 2023. During the period before
disbursements begin, any annual income on the fund exceeding 6
percent will be deposited in the C account; however, the C account
cannot exceed three times the estimated grant assistance in 2023,
including estimated inflation. After 2023, if annual income from
the A account falls below the previous year's distribution,
adjusted for inflation, the C account can be drawn down to address
any shortfall in the B account.
^16According to the trust fund agreements, "corpus" means a collection of
bonds, stocks, or other holdings that form the principal of the trust
fund. It also includes all accumulated income that has been reinvested and
is not available for distribution.
Figure 1: Structure of FSM and RMI Trust Funds
Trust Fund Governance
The trust funds, incorporated in the District of Columbia as nonprofit
corporations, are governed by the FSM and the RMI trust fund committees,
with the United States holding the majority of votes and the Deputy
Assistant Secretary of the Interior, Office of Insular Affairs, serving as
the chair of each committee.^17 The committees' responsibilities^18
include establishing the funds as well as overseeing their operation,
supervision, and management; investing and distributing the fund's
resources; and concluding agreements with any other contributors and other
organizations.
According to the trust fund agreements, each trust fund committee is to
appoint a trustee and an independent auditor. In addition, the committee
has the authority to appoint one or more investment advisers and may enter
into a separate agreement with one or more money managers.
o The trustee19 is to have the entire care and custody of all
assets comprising the trust fund. The trustee's duties and powers
include collecting money due to the fund, disbursing income in
accordance with the trust fund agreement, and maintaining records
of all financial transactions related to the fund.
o The independent auditor is to audit the trust fund from its
establishment through 2023 at appropriate intervals and annually
after 2023.
o The investment adviser is responsible for recommending one or
more money managers who will invest the assets of the fund to
produce a diversified portfolio, take direction from the trust
fund committee regarding investments, and oversee day-to-day
investments by the money manager.
^17Except for where stated otherwise in the agreement, trust fund
committee decisions are made by a majority vote. The FSM trust fund
committee has five voting members: three from the United States (Interior,
State, and HHS) and two from the FSM. The RMI trust fund committee has
seven voting members: four from the United States (Interior, State, HHS,
and Labor); two from the RMI; and one from the other contributor, Taiwan.
^18Each agreement states that either the U.S. government, in consultation
with the FSM or the RMI government, or the trust fund committee, if it is
operational when the amended compact takes effect, is responsible for
establishing the trust fund. (In this case, "establishing the trust fund"
refers to the incorporation of the fund rather than to the selecting and
hiring of the trustee, auditor, investment adviser, and money manager, as
the phrase is otherwise defined in this report.)
^19The trust fund agreements states that the trustee shall (a) be selected
from among trust institutions organized in the United States, (b) have a
net worth in excess of $100 million, (c) have at least 10 years experience
as a custodian of financial assets, and (d) have experience in managing
trust funds of at least $500 million.
o The money manager is to invest the funds in particular
investment vehicles or categories.
The trust fund agreements do not specify a time period for
selecting these entities.
In addition, the committees are responsible for publishing annual
reports on the trust funds and submitting the reports to the
governments of United States and the FSM or the RMI within 6
months after the end of each fiscal year--that is, by the end of
the following March. These reports are to describe the activities
and management of the funds, including the operation of the A, B,
and C accounts, and to contain audited account information and the
audit reports. The reports are also to assess the effectiveness of
the funds in contributing to the economic advancement and
long-term budgetary self-reliance of the FSM and RMI. The reports
may include recommendations to improve the effectiveness of the
funds.^20
Investment Returns and Volatility
Because the level of income that the trust funds will generate
depends on investment returns, it is subject to market volatility.
Historically, the stock market has experienced fluctuations. For
example, from 1970 to 2005, annual inflation-adjusted returns of
U.S. large-company stocks ranged from negative 34 percent to
positive 34 percent, and annual real returns from international
stocks ranged from negative 31 percent to positive 68 percent (see
fig. 2). With positive returns, the trust funds will earn
investment income, and with negative returns, the value of the
trust funds will fall.
^20In addition, Pub. L. No. 108-188 requires the President to report
annually to Congress regarding the FSM and the RMI, including information
on non-U.S. contributions to the trust funds and, if appropriate, making
recommendations to Congress to adjust the inflation rate or to adjust
contributions to the trust funds based on non-U.S. contributions.
Figure 2: Inflation-Adjusted Annual Returns of International and Large
Company Stocks, 1970-2005
Note: The returns were published in Stocks, Bonds, Bills and Inflation
(SBBI) 2006 Yearbook, Ibbotson Associates, Chicago, Illinois. The
inflation-adjusted returns are the geometric difference between the
nominal return and the inflation rate. Our calculation is based on returns
in calendar years (Jan. 1 - Dec. 31).
The annual compounded real returns^21 of large company stocks and
international stocks from 1970 to 2005 were around 6 percent (see table
2), with standard deviations^22 of approximately three times the return
for the large company stocks and more than three times the return for the
international stocks. U.S. treasury bills have the least volatility and
the lowest returns, around 1 percent.
^21To calculate the compounded real returns, we used the annual total
nominal returns published in IBBOTSON Associates 2006 Yearbook and
constructed the inflation adjusted returns, which is a geometric
difference between the nominal return and the inflation rate. We then
constructed the real and nominal return indexes with year end 1969 = $1.00
to calculate the annual compounded returns.
^22Standard deviation is a statistical measure of how widely spread the
distribution is from its mean. It is obtained by calculating the square
root of the average of the squares of deviations around the mean of a set
of data.
Table 2: Annual Compounded Real Returns and Standard Deviations for Large
Company and International Stocks and for U.S. Treasury Bills (in
percentage), 1970-2005
Large company U.S. Treasury
stocks International stocks bills
Compounded real 6.12 6.18 1.27
returns
Standard deviation 17.09 22.05 2.50
Source: GAO analysis of data from IBBOTSON Associates 2006 Year Book.
Note: Percentages shown are based on returns in calendar years (Jan. 1 -
Dec. 31).
Investment strategies vary in their levels of returns and volatility. A
more conservative investment strategy usually carries a lower level of
volatility but also brings lower levels of expected returns over time; a
more aggressive investment strategy seeks higher returns but is likely to
have higher volatility, with returns on the investment varying more widely
year to year. By varying the weight of each investment asset, investors
can vary their return and risk levels. With the approach of 2024, when
disbursements from the trust funds will begin, the portfolio can be
adjusted to take on less risk. To illustrate possible outcomes of the
trust funds' investment returns, table 3 shows potential returns for three
types of investment strategies--conservative, moderate, and
aggressive--based on historical annual compounded returns and volatility
on large company stocks, international stocks, and treasury bills in 1970
to 2005.
Table 3: Possible Outcomes of Three Types of Investment Strategies, with
Associated Real Returns and Standard Deviations
Large
company International Treasury Standard
Strategy stocks stocks bills Return deviation
Conservative (Lower
expected return/lower
volatility) 40% 20% 40% 4.19% 10.48%
Moderate (Medium expected
return/medium volatility) 40 40 20 5.17 14.18
Aggressive (Higher
expected return/higher
volatility) 50 50 0 6.15 17.53
Source: GAO analysis of data from IBBOTSON Associates 2006 Year Book.
Note: Percentages shown are based on returns in calendar years (Jan. 1 -
Dec. 31).
Establishment of FSM Trust Fund Is Complete, but RMI Trust Fund Is Not Yet Fully
Established
The FSM trust fund committee has appointed a trustee, an independent
auditor, an investment adviser, and money managers; investment of the FSM
trust fund began 22 months after the country's contribution. The RMI trust
fund committee has appointed a trustee and an investment adviser, but as
of March 2007, it had not yet appointed an auditor-- in part because of
disagreement between the trustee and investment adviser over the assigning
of custodial rights--nor had it appointed a money manager. Investment of
the RMI's trust fund began 16 months after the country's initial
contribution. Unexpected delays related to contractual problems and trust
fund committee processes contributed to the time that elapsed between the
countries' initial contributions and the investment of the funds.
Moreover, the period of time that the funds remained in low-interest
accounts before their investment may have reduced potential investment
earnings, particularly for the FSM. The committees did not meet the trust
fund agreements' requirements to submit and publish annual reports on the
funds for 2004 and were late in publishing the 2005 and 2006 reports.
Moreover, the reports did not assess the trust funds' potential status as
an ongoing source of revenue or effectiveness in helping the FSM and the
RMI achieve economic advancement and long-term budgetary self-reliance.
Trust Fund Committees Have Taken Steps to Establish and Invest the Funds
The FSM trust fund committee has appointed a trustee, an independent
auditor, an investment adviser, and money managers. The RMI trust fund
committee has not officially appointed an auditor or a money manager.
Investment of the funds began in August 2006 and September 2005,
respectively.
o FSM. The FSM trust fund committee hired a trustee, an auditor,
an investment adviser, and a money manager 24, 33, 16, and 21
months, respectively, after the amended compact went into effect.
Investment of the FSM trust fund, according to its adopted
investment policy, did not begin until August 2006, nearly 2 years
after the FSM's initial contribution to the trust fund. Figure 3
provides a timeline of key events in setting up the FSM trust
fund. (For details about this timeline, see app. IV).
Figure 3: Timeline of Key Events in Establishment of FSM Trust Fund
Note: The years shown are calendar years (Jan. 1 - Dec. 31).
o RMI. The RMI trust fund committee hired its current trustee and
investment adviser in August 2005, 16 months after the amended
compact went into effect. However, as of March 2007, the committee
had not yet hired an independent auditor. In addition, owing to a
disagreement between the trustee and the adviser over the
assigning of custodial rights, the committee had not yet hired
money managers to actively invest the funds according to the
proposed investment strategy.^23 The trust fund agreements state
that the trustee shall have the entire care and custody of all
assets comprising the fund, however, the investment adviser has
requested "subcustody" to allow it to better monitor the money
managers' adherence to the investment strategy. The RMI trustee
has not agreed to this arrangement, stating in a letter to the
trust fund committee chairman that the trust fund agreement does
not allow such an arrangement without legislation to amend the
trust fund agreement. U.S. officials told us that they had been
searching for a resolution of this dispute. Although the RMI made
its first contribution of $25 million in June 2004, a month after
the trust fund agreement went into effect, the country did not
make its second contribution until February 2005--almost 5 months
after the deadline--when it contributed $1.5 million, which was $1
million less than required.^24 The RMI government explained that
it faced various financial challenges in 2005, including the cost
of upgrading infrastructure at the College of the Marshall
Islands.^25 The committee transferred the RMI trust fund from
low-interest bank accounts and began to invest it at the end of
September 2005, 16 months after the initial contribution to the
trust fund. In May 2005, Taiwan contributed $1 million to help
fulfill RMI's second contribution requirement, and in October
2005, the RMI made the final contribution of $2.5 million. Figure
4 provides a timeline of key events in setting up the RMI trust
fund. (For details of the timeline of key events, see app. III.)
^23The adviser has not billed the committee as of March 2007.
Figure 4: Timeline of Key Events in Establishing the RMI Trust Fund
Note: The years shown are calendar years (Jan. 1 - Dec. 31).
Several Factors Slowed Establishment of the Funds
Unexpected contractual delays, as well as the trust fund committees'
decision-making and administrative processes, slowed the committees'
establishment of the funds.
o Contractual delays. Unexpected contractual delays slowed the FSM
and the RMI trust fund committees' establishment of the funds. For
example, according to an Interior official, the trustee chosen by
the FSM trust fund committee provided the wrong template for its
contract with the committee, with the result that finalizing the
contract took extra time. Also, a disagreement over fees between
the RMI trust fund committee and its initially selected trustee
led the committee to select another trustee, delaying the RMI's
contracting with a trustee.
^24The amended compacts required the RMI to contribute at least $25
million on the effective date of the trust fund agreement or in October
2003, whichever was later; $2.5 million prior to October 1, 2004; and $2.5
million prior to October 1, 2005.
^25The College of the Marshall Islands has experienced accreditation
problems since 2003. According to the President of the college, the
accreditation committee requires evidence that the college's physical
infrastructure will be substantially upgraded. The RMI government had to
find funding for the needed improvements and now has a plan for improving
the college's infrastructure.
o Trust fund committee processes. Delays related to certain trust
fund committee processes also contributed to the time required to
establish the funds. The U.S. members make it a practice to
convene to reach consensus before attending full committee
meetings. However, according to an Interior official, difficulty
in convening all U.S. members has often delayed full committee
meetings for months. Also, Interior noted that the trust fund
committees' reliance on U.S. government staff for administrative
support slowed committee processes. U.S. government employees have
undertaken administrative functions for the trust funds in
addition to their other duties. Interior, which has provided
administrative support for the trust funds, has advocated that the
trust funds hire their own support staff;^26 however, State has
argued that after the trust funds are fully established, such
positions would not be needed and would result in unnecessary
costs. Some trust fund committee officials acknowledged that the
committee processes have slowed the funds' establishment. However,
the committees have not developed strategies to improve the
consensus process and have not reached agreement about whether
they should hire outside administrative assistance to improve
committee performance.
Timing of Trust Fund Investment Reduced Potential Earnings
Although the trust fund agreements do not set a time frame for
investing the funds, the months when the funds remained in
low-interest accounts prior to investment may have reduced their
potential investment earnings. However, the reduction in potential
earnings was significant only for the FSM trust fund.
o FSM. For several months before the FSM trust fund was invested,
stock market returns were notably higher than the interest that
the fund earned in the low-interest savings account. From October
2005 through August 2006, the FSM trust fund--with an October 2005
balance of approximately $80 million--earned about 3 percent
interest, compared with potential stock market earnings of about
15 percent. The difference between the fund's actual and potential
monthly rates of return was about nine-tenths of a percentage
point, amounting to approximately $720,000 per month, taking into
account stock market investment fees. After the FSM's Office of
the Public Auditor issued a report evaluating the trust fund
committee's compliance with the administrative requirements of the
trust fund agreement,^27 the FSM government expressed concerns
over the reduced income resulting from the fund's remaining in the
savings account.
^26Interior believes that an administrative support position is allowed
under the trust fund agreements and its cost can be covered by the trust
funds.
^27FSM Office of the Public Auditor, Inspection of the Compact Trust Fund:
Period Covering August 2004 until May 2006 (Pohnpei, FSM, 2006).
o RMI. For the months before the investment of the RMI trust
fund's approximately $49 million in October 2005, the fund earned
a return of approximately 3 percent, compared with a stock market
return of about 4 percent. Given the small difference in returns,
as well as the fees that the fund would have paid if invested in
the stock market, the reduction in the RMI trust fund's potential
income was small. We estimate that the delay in the RMI's final
contribution to the fund reduced its earnings by approximately
$51,000.^28
^28To estimate the RMI's income loss from late contributions, we
calculated (a) the lost interest income on $25 million between May 2004,
the contribution deadline, and June 2004, when the RMI made its first
contribution; (b)the lost interest income on $2.5 million between October
2004, when the RMI was supposed to make its second contribution, and
February 2005, when it made a partial contribution; and (c) the lost
interest income on $1 million between February 2005, when the RMI
contributed $1.5 million for its second contribution, to May 2005, when
the RMI contributed the remaining $1 million. We used the actual interest
rate the RMI trust fund earned during the period.
Trust Fund Committees Did Not Publish Annual Reports as Required
Neither trust fund committee provided an annual report to the U.S.
and FSM or RMI governments as required in the first year after the
compacts took effect, and both committees were late in submitting
the second year's reports.^29 According to the trust fund
agreements, the committees are to prepare a report for each fiscal
year and submit it to both the U.S. and the FSM or RMI governments
by the end of the following March. However, neither committee
submitted a report for fiscal year 2004, instead submitting one
report for both 2004 and 2005. Additionally, the FSM and the RMI
committees submitted these reports several months after the March
2006 deadline, in July 2006 and August 2006, respectively.
Moreover, the reports do not project the likely status of the
trust funds as an ongoing source of revenue or assess the funds'
potential effectiveness in helping the countries achieve economic
advancement and budgetary self-reliance.^30 Because the trust fund
income will be a main source of U.S. assistance to the FSM and the
RMI after the amended compact grants end, its level has
implications for the economic policies of both countries. For
example, if trust fund income is expected to be inadequate to
replace the expiring grants, the countries will have a greater
need to develop other sources of revenue to help fund government
operations.
^29The International Monetary Fund (IMF) has called for disclosing
publicly the objectives and performance of the trust fund in line with the
IMF guidelines for a transparent framework to ensure accountability and
clarity of the trust fund management activities and results. See
International Monetary Fund, RMI: Selected Issues and Statistical
Appendix, IMF Country Report No. 06197 (Washington, D.C.: March 2006).
FSM and RMI Trust Funds May Not Provide Sustainable Income after
Compact Grants End
The FSM and the RMI trust fund income will likely not reach the
maximum allowed disbursement levels after the compact grants end
in 2023, with the probability of not reaching the maximum allowed
level increasing over time.^31 Variable market returns, as well as
the investment strategy chosen, could lead to a wide range of
potential trust fund balances in 2023. Moreover, market volatility
could contribute to not reaching the maximum level allowed,
including the possibility of no disbursements in some years.^32
^30This information could be included in the President's annual reports to
Congress required by Pub. L. No. 108-188. The legislation does not require
that information such as projections of trust fund balances be included in
the reports. However, its inclusion would provide additional insight
regarding the FSM's and RMI's progress in formulating economic policies to
achieve economic advancement and budgetary self-reliance, to which the
trust funds are intended to contribute by providing a source of revenue to
the FSM and the RMI after 2023. The level of the trust fund income is
directly related to its effectiveness in helping the countries achieve
self-reliance: the higher the trust fund income, the more likely the
countries will be self-reliant.
^31The probability that disbursements will not reach the maximum
disbursement level allowed depends on the actual approved disbursement
levels. For example, if the trust fund committees do not disburse all
earned income and instead reinvest part of the income, the probability of
disbursements not reaching the maximum disbursement level allowed will
differ from the probabilities presented below. (For a comparison of the
probabilities of disbursements not reaching the maximum disbursement level
allowed with and without full disbursement, see app. III.)
^32In addition to market volatility, the amount of contributions to the
trust funds plays an important role in determining whether the trust funds
are able to provide sustainable income. Additional contributions to the
funds improve the prospect of sustainability. For information on how
Taiwan's contributions enhanced trust fund sustainability, see section on
Economic Assistance from Other Donors.
Market Volatility Could Lead to Wide Range of Trust Fund Balances
in 2023
Given historical market returns and volatility, the trust funds'
likely balances in 2023 fall into a wide range, with a more
aggressive strategy leading to higher expected balances but also a
wider range of possible balances (see fig. 5 and 6). For example,
under our projected conservative strategy, in 2023, the FSM trust
fund balance could range from $697 million (10th percentile) to
$1.3 billion (90th percentile) with a median of $959 million; the
RMI trust fund could range from $439 million (10th percentile) to
$862 million (90th percentile) with a median of $612 million.
Under our projected aggressive strategy, the FSM trust fund
balance could range from $664 million (10th percentile) to $2.2
billion (90th percentile) with a median of $1.2 billion; the RMI
trust fund balance could range from $438 million (10th percentile)
to $1.4 billion (90th percentile) with a median of $778 million.
Figure 5: Projections of FSM Account Balance with Three Possible
Investment Strategies
Figure 6: Projections of RMI Account Balance with Three Possible
Investment Strategies
Trust Funds May Not Provide Sustainable Income after Compact Grants End
The FSM and the RMI trust funds may be unable to disburse the maximum
level of income allowed in the trust fund agreements^33 or any income at
all in some years.^34 Although each trust fund has a separate account to
absorb some market volatility, our analysis shows there are some
probabilities that income will not reach the maximum disbursement level
allowed or that no income will be disbursed in some years, with the
likelihood increasing with time.
FSM Trust Fund Income
Under the conservative, moderate, and aggressive investment strategies
that we projected, the FSM trust fund's annual income will probably not
reach the maximum disbursement allowed, with the probability increasing
with time. For example, our analysis shows more than 50 percent
probability that the trust fund's income will not reach the maximum
disbursement level allowed after 2031 under the conservative investment
strategy, with the probability over 90 percent by 2050 (see fig. 7).
^33The trust fund agreements specify that in 2024 and thereafter, the FSM
and the RMI trust fund committees may disburse amounts up to the annual
grant assistance in 2023, fully adjusted for inflation, provided that
funds are available in the B account to reach such level. In 2025 and
thereafter, the disbursements may also include any additional approved
amounts for special needs.
^34Our analysis shows that to maintain the maximum disbursement levels
allowed for 10 years without risk, the FSM and the RMI trust funds need to
earn compounded real returns of around 13 percent and 9 percent through
2023, respectively. However, these percentages are considerably higher
than the stock market's compounded real returns from 1970 to 2005 of
around 6 percent for both international stocks and U.S. large company
stocks. If the trust funds are not in risk free treasury bonds and earn
higher returns after 2023, the required returns for the funds before 2023
will be lower; however, the trust funds will be subject to market
volatilities.
Figure 7: Probability of FSM Trust Fund Income Not Reaching the Maximum
Disbursement Levels Allowed, Fiscal Years 2024 - 2050
Moreover, our analysis shows an increasing probability that market
volatility could prevent the FSM trust fund from making any disbursements
in some years, although a separate account--the C account--was set up to
absorb some market volatility. As shows, under the conservative investment
strategy, the probability of no disbursements grows from 0 percent in 2024
to over 20 percent in 2050 (see fig. 8).
Figure 8: Probability of No Disbursement from FSM Trust Fund, Fiscal Years
2024 - 2050
Note: The chart depicts results from 1,000 trial runs. The change from one
year to the next may not always be monotonic, but the general time trend
is clear. As the number of trial runs increase, the time trend becomes
smoother.
Our analysis shows a wide range of probable disbursements from the FSM
trust fund. For example, under the moderate investment strategy, 10 years
after the trust fund starts to disburse income, we find a 57 percent
probability that the trust fund will disburse the maximum level of income
allowed, which is estimated at $97 million for 2034; a 11 percent
probability that the trust fund will disburse no income; and a 33 percent
probability that the trust fund will disburse some income, between $0 and
$97 million.
RMI Trust Fund Income
Under the three potential investment strategies, income from the RMI trust
fund is likely not to reach the maximum allowed disbursement, with the
probability increasing over time. For example, our analysis shows a more
than 20 percent probability that the trust fund's income will not reach
the maximum allowed disbursement after 2031 under the conservative
strategy, with the probability over 60 percent by 2050 (see fig. 9).
Figure 9: Probability of RMI Trust Fund Income Not Reaching the Maximum
Disbursement Levels Allowed, Fiscal Years 2024 - 2050
Note: This analysis includes Taiwan's contribution to the A account.
Additionally, our analysis shows an increasing probability that the RMI's
trust fund could yield no disbursements in some years, despite the
existence of the C account to absorb some market volatility. As figure 10
shows, under the conservative investment strategy, the probability of no
disbursements rises from 0 percent in 2024 to more than 15 percent in 2050
(see fig. 10).
Figure 10: Probability of No Disbursement from RMI Trust Fund, Fiscal
Years 2024 - 2050
Notes: This analysis includes Taiwan's contribution to the A account. The
chart depicts results from 1,000 trial runs. The change from one year to
the next may not always be monotonic, but the general time trend is clear.
As the number of trial runs increase, the time trend becomes smoother.
Our analysis shows a wide range of probable disbursements from the RMI
trust fund. For example, under the moderate investment strategy, 10 years
after the trust fund starts to disburse income, we find an 84 percent
probability that the trust fund will disburse the maximum level of income
allowed, which is estimated at $43 million for 2034; a 4 percent
probability that the trust fund will disburse no income; and a 12 percent
probability that the trust fund will disburse some income, between $0 and
$43 million.
Several Options Exist for Supplementing FSM and RMI Trust Fund Income
The FSM and the RMI trust funds' income could be supplemented or enhanced
by (1) greater tax revenue through economic development in the two
countries, (2) increased remittances from growing numbers of emigrants,
(3) economic assistance from other donors, and (4) securitization of the
funds.^35 However, each possible scenario has limitations. In particular,
although securitization could lead to higher trust fund balances in 2023,
it also has the potential to lower investment income, reducing the
balances.
Greater Tax Revenue through Economic Development
Economic development in the FSM and the RMI could increase the countries'
tax revenue, helping to supplement the income from the trust funds.
However, as we reported in 2006, the countries' development prospects
remain limited--despite U.S. compact assistance since 1987, aimed at
promoting economic advancement and budgetary self-reliance--and as a
result, greater tax revenue may not be feasible.^36 Both countries'
economies depend on public sector expenditure, funded largely by external
assistance; in 2005, public sector expenditures--about two thirds of which
were funded by grants--were about 60 percent of the gross domestic
product. Further, both governments' budgets face growing wage
expenditures, heightening the negative fiscal impacts they will face as
compact grants decline. In both countries, the growth of key industries
faces multiple constraints. Further, as we also reported in 2006, the FSM
and the RMI have not undertaken many reforms needed for economic
development.
Growing Emigration and Remittances
Growing emigration from the FSM and the RMI could help reduce the
countries' reliance on the trust fund income: as the countries'
populations decline, the governments' need for trust fund income to
provide services would also decline. FSM and RMI residents can relocate to
the United States relatively easily owing to rights granted under the
original compact and extended by the amended compacts.^37 Many FSM and
RMI citizens have chosen to exercise these rights: RMI data suggest that
as of 2005, about 15,000 Marshallese had migrated to the United States,
and FSM data suggest that almost twice as many Micronesians live overseas.
In both countries, the likely effects of decreasing levels of per capita
grant assistance may cause emigration to increase.
^35Through securitization, the trust fund sells bonds to investors, and
the cash generated through bond issuance will become the trust fund
principal to be invested. Future contributions to the trust fund will be
used to pay bond holders before being available as income to the trust
fund. Securitization helps build up the principal of the trust fund right
away rather than slowly by annual contributions to the fund.
^36GAO-06-590.
o FSM. If the FSM population maintains its 2004 level,^38 real per
capita grant assistance in 2023, the last year of compact grants,
will be about 73 percent of assistance in 2004, the first year of
compact grants. Furthermore, even with the aggressive investment
strategy we projected, the trust fund income is likely to be lower
than the compact grant, continuing the declining trend in
government resources. As a result, FSM living standards, including
the availability of social services, will likely be reduced,
potentially leading to further emigration.
o RMI. Per capita grant assistance in the last year of compact
grants will be about 70 percent of assistance in the first year if
the RMI population maintains its 2004 level. Given the aggressive
investment strategy, per capita trust fund income in 2024 and
thereafter may equal per capita grant assistance in 2023. However,
if trust fund income is unreliable, as our analysis shows likely,
RMI living standards, including the availability of social
services, will probably be affected, possibly leading to increased
emigration.
If increasing numbers of FSM and RMI residents choose to emigrate
in the coming years as annual compact grants decrease, remittances
from growing numbers of emigrants could supplement residents'
income and, if taxed, could provide revenue to the FSM and the RMI
governments. However, it is not certain that remittances would
grow significantly or lead to increased government revenues.
Although FSM and RMI emigrants could provide increasing monetary
support to their home nations, inadequate education and vocational
skills may limit their earning opportunities. As we reported in
2006, the 2003 U.S. census of FSM and RMI migrants in Hawaii,
Guam, and the Commonwealth of the Northern Mariana Islands shows
that almost half of them live below the poverty line. However,
some economic experts emphasize that with an upgrading of skills,
the FSM's and the RMI's free access and strong historical links to
the U.S. economy create potential for the two nations to expand
remittance income.^39
^37Under the original compacts, citizens from the FSM and the RMI had the
right to live and work in the United States as "nonimmigrants" and to stay
for long periods of time. Although the amended compacts strengthened
immigration provisions, these rights were generally extended for citizens
as defined under the amended compacts.
^38Owing to emigration, growth of the FSM population has slowed from about
2 percent in the early 1990s to virtually zero since 1995.
^39Experts also suggest that in addition to increasing income from
emigrant remittances, returning emigrants may bring back newly acquired
skills and capital that could support growth in the home economy. See
GAO-06-590; also see Francis X. Hezel, Is That the Best You Can Do? A Tale
of Two Micronesian Economies (Honolulu: East-West Center, Pacific Islands
Policy, 2006).
Economic Assistance from Other Donors
Economic assistance, including contributions to the FSM and the
RMI trust funds, from external sources other than the United
States could lessen the countries' reliance on trust fund income.
For example, our analysis shows that Taiwan's contribution of $40
million to the RMI's trust fund reduced by nearly 10 percent the
probability that the trust fund not reaching the maximum
disbursement level allowed in 2050. However, it is not certain
whether the FSM trust fund will receive any such contributions or
whether the RMI trust fund will receive any further contributions.
Further, although both countries have previously received other
economic assistance from donors besides the United States--for
example, from the Asian Development Bank, Australia, and
Japan--assistance in the future is not assured.
Trust Fund Securitization
Securitization of the trust funds--that is, issuing bonds against
future U.S. contributions to the funds--has the potential to
increase the funds' balances. The benefit from securitization
would mainly derive from arbitrage, or potential differences in
returns on investment and returns on the bonds issued to
investors: the greater the differential, the greater the benefit
from securitization.
However, although securitization of the trust funds carries
potential benefits, our analysis shows that its introduction could
subject the funds to greater risk. Because the full trust fund
amounts would be invested after securitization, loss from
securitization in the early years could lead to smaller investment
income and trust fund balances in later years. Our analysis shows
that securitization could result in a wider range of possible
trust fund balances at the amended compacts' expiration (see table
4). For example, under the possible aggressive investment
strategy, securitization could result in an FSM trust fund balance
of $579 million (10th percentile) to approximately $2.7 billion
(90th percentile), with a median of $1.3 billion; without
securitization, the trust fund balance could range from $664
million (10th percentile) to approximately $2.2 billion (90th
percentile), with a median balance of about $1.2 billion.^40
Securitization could result in a similarly wider range of balances
and larger median balance for the RMI trust fund.
Table 4: Projected Trust Fund Balances in 2023 with and without
Securitization, under Aggressive Investment Strategy
Dollars in millions
FSM RMI
Trust fund
balance With
distribution With Without Without
statistics securitization securitization securitization securitization
10th
percentile $579 $664 $390 $438
Median 1,314 1,182 845 778
90th
percentile 2,700 2,179 1,688 1,401
Standard
deviation 912 647 590 422
Source: GAO.
According to officials of the FSM and the RMI trust fund
committees, the committees are considering securitizing the funds
but disagree over whether this option should be pursued. Some
members believe that securitization could bring great financial
benefits, as a company that performs securitization has asserted
in presentations to the committees; other members are concerned
about potential risks. Others raise concerns of whether the trust
funds could pursue securitization under the current amended
compacts and trust fund agreements or whether amendments to these
agreements would be required. The committees have not initiated an
independent analysis to assist in their decisions.
^40Under different investment strategies, the range of possible fund
balances will be different. However, securitization will still lead to a
wider range of possible fund balances. Securitization can lead to a higher
expected balance when the investment returns are higher than the rate the
funds pay to its bond holders.
Conclusions
Since the enactment of the amended compacts with the FSM and the
RMI, the trust fund committees have taken important steps to
establish the funds. However, the committees' decision-making and
administrative processes slowed the funds' establishment and
investment, leading to lower potential investment earnings for the
FSM. Until the committees develop strategies to improve these
processes, their ability to take timely actions regarding the
funds will likely be impeded. In addition, the committees'
tardiness in publishing the required annual reports limited the
public availability of information regarding the trust funds'
establishment and the committees' oversight. Further, the reports
do not assess the potential status of the funds as an ongoing
source of revenue after the compact grants end. Given the likely
effects of market volatility on the funds' investment earnings,
such assessments are needed to help the countries develop other
strategies for achieving the compact goals of economic advancement
and long-term budgetary self reliance. Both countries have several
options to supplement trust fund income after 2023, but these
options have limitations and are not assured of success. Although
the trust fund committees are considering one of these
options--securitization--to increase the funds' balances, they
have not yet initiated an independent analysis of securitization's
potential benefits and risks, including the possibility that
securitization could lead to lower trust fund balances in 2023.
Recommendations for Executive Action
To enhance the FSM and the RMI trust fund committees' oversight of
the trust funds, we recommend that the Secretary of the Interior
direct the Deputy Assistant Secretary for Insular Affairs, as
Chairman of the committees, to work with other U.S. agencies on
the committees to undertake the follow three actions:
o develop strategies to improve the timeliness of the committees'
decision-making and administrative processes;
o ensure the committees' timely reporting of trust fund
activities, including assessing the funds' likely status as a
source of revenue and effectiveness in helping the countries
achieve economic self-sufficiency and long-term budgetary
self-reliance; and
o obtain a full and independent evaluation of the potential
benefits and risks of using securitization to increase the trust
fund balances.
Agency Comments and Our Evaluation
We received written comments from Interior, HHS, and State as well
as from the FSM and RMI governments (see app. V through IX for
detailed presentations of, and our responses to, these comments).
We also received technical comments from State, which we
incorporated in our report as appropriate. We did not receive any
comment from Labor.
Interior, HHS, and the RMI government concurred with our first
recommendation. Interior also generally concurred with our second
recommendation. However, HHS and State stated that our report
reflected a fundamental misunderstanding of the outcome of the
negotiation of the amended compacts and a misreading of the
international agreements, which we strongly disagree. Our report
clearly stated that the purpose of the trust funds is to provide
an ongoing source of revenue. To further clarify this point, we
modified our recommendation and added language specifying that
there is no minimum disbursement required or guaranteed by the
trust fund agreements. We believe that careful analysis of the
trust funds each year will help establish realistic expectations
of the trust funds and provide information to the trust fund
committees as they make investment decisions and to FSM and RMI
government leaders as they set economic policies and undertake
long-term fiscal planning. Interior, HHS, and the RMI government
agreed with our third recommendation. The RMI noted that it would
like the trust fund contributions to be fully adjusted for
inflation. The FSM government in general agreed with all of our
recommendations.
In addition to providing copies of this report to your offices, we
will send copies to interested congressional committees. We will
also provide copies of this report to the Secretaries of Health
and Human Services, the Interior, Labor and State as well as the
President of the Federated States of Micronesia and the President
of the Republic of the Marshall Islands. We will make copies
available to others on request. In addition, the report will be
available at no charge on the GAO Web site at
http://www.gao.gov .
If you or your staff have any questions regarding this report,
please contact me at (202) 512-3149 or [email protected] .
Contact points for our offices of Congressional Relations and
Public Affairs may be found on the last page of this report. GAO
staff who made major contributions to this report are listed in
appendix X.
David Gootnick
Director, International Affairs and Trade
List of Congressional Committees
The Honorable Jeff Bingaman
Chairman
The Honorable Pete V. Domenici
Ranking Member
Committee on Energy and Natural Resources
United States Senate
The Honorable Joseph R. Biden, Jr.
Chairman
The Honorable Richard G. Lugar
Ranking Member
Committee on Foreign Relations
United States Senate
The Honorable Nick J. Rahall, II
Chairman
The Honorable Don Young
Ranking Member
Committee on Natural Resources
House of Representatives
The Honorable Tom Lantos
Chairman
The Honorable Ileana Ros-Lehtinen
Ranking Member
Committee on Foreign Affairs
House of Representatives
Appendix I: Objectives, Scope, and Methodology
In this report on the trust funds established under the U.S.
government's amended compacts with the Federated States of
Micronesia (FSM) and the Republic of the Marshall Islands (RMI),
we examine (1) the trust fund committees' progress in
establishing, investing, and reporting on the funds; (2) the
sustainability of income from the trust funds after the compact
grants end in 2023; and (3) other potential sources of revenue to
supplement or enhance trust fund income after 2023.
To review the trust fund committees' progress in establishing,
investing, and reporting on the funds, we reviewed the amended
compacts, trust fund agreements; annual trust fund reports for
2004 and 2005 by the trust fund committee, trust fund bank
statements, and documents related to the request for proposals to
set up the trust funds. We interviewed officials from the
Departments of the Interior, Health and Human Services, Labor, and
State. We also interviewed relevant RMI and FSM officials and
representatives from companies involved in setting up, investing,
and managing the trust funds.
To project the trust fund income level after the U.S. annual
compact grants end, we obtained historical returns of various
asset classes, including large company stocks, international
stocks, and U.S. treasury bills, from 1970 to 2005 and built a
projection model based on the historical returns, contributions to
the trust fund, and rules governing the disbursement from the
trust fund as outlined in the trust fund agreements. We used the
inflation projection by the Congressional Budget Office to adjust
the contribution and grant levels (see app. II for a detailed
discussion on the key inputs to the projection model). We used a
solver function in our projection model to find the minimum level
of return between 2007 and 2023 required, so that the trust fund
income equals the 2023 grant level plus full inflation for at
least the first 10 years after trust fund disbursements begin. For
this calculation, we assumed the trust funds will be put into U.S.
treasury bonds after 2023. To assess the impact of market
volatility on the trust fund income, we used the Monte Carlo
simulation with computer-generated random draws from a predefined
distribution, based on the historical returns and volatilities of
the various asset classes. Each random draw produces a possible
outcome of the variables we are interested in, such as the balance
of the trust fund and the level of disbursement in a particular
year; 1,000 random draws generates 1,000 possible outcomes. We
studied the distribution of the outcomes to determine, for
instance, the probability that the trust funds' annual
disbursements will be below the maximum allowed disbursement
levels. Probabilistic projection of the trust funds' income is an
improvement over the methodology based on constant returns because
investment returns are volatile.
To examine other potential sources of revenue to supplement the
trust fund income, we reviewed studies on the economic conditions
in the FSM and the RMI. We also reviewed studies examining
emigration of the FSM and RMI citizens. To examine the potential
benefit and risks of securitization, we modified the simulation
model and compared the trust funds' balance in 2023 with and
without securitization. We assumed the bond issued by the trust
fund pays an annual return of 5.5 percent.^1
To ensure the soundness of our projection, we obtained and
incorporated technical comments on the simulation assumptions and
methodology from Interior and the investment adviser of the FSM
trust fund.
We conducted our review from July 2006 to March 2007 in accordance
with generally accepted government auditing standards. We
requested written comments on a draft of this report from the
Departments of the Interior, Health and Human Services, and State
as well as the governments of the FSM and the RMI. All of these
entities' comments are discussed in the report and are reprinted
in appendix V through IX. In addition, we considered all technical
comments and made changes to the report, as appropriate.
^1This number is based on our conversation with an industry expert.
Appendix II: Technical Notes on the Trust Fund Simulation Model
The key inputs that we used to simulate the trust fund income
after 2023 include (1) the trust funds' balances at the beginning
of the projection, (2) contributions to the trust funds, (3)
inflation adjustment to the contributions, (4) different accounts
of the trust funds and the rules governing the inter-account
transfers, (5) the simulation equation; (6) distribution of
returns for the Monte Carlo simulation, and (7) Monte Carlo
simulation results.
1. Trust fund balance at the beginning of the
projection
As of September 30, 2006, the FSM trust fund had a balance of
$86.53 million and the RMI trust fund had a balance of $63.14
million.
2. Contributions to the trust fund
Table 5 shows scheduled contributions to the FSM and the RMI trust
funds by the United States, as outlined in the amended compacts.
Table 5 shows scheduled contributions to the RMI trust fund by
Taiwan, as outlined in its agreement with the RMI.
Table 5: U.S. Scheduled Contributions to FSM and RMI Trust Funds,
as Outlined in Amended Compacts
Dollars in millions
U.S. contribution
Fiscal year FSM trust fund RMI trust fund
2004 $16 $7
2005 16 7.5
2006 16 8
2007 16.8 8.5
2008 17.6 9
2009 18.4 9.5
2010 19.2 10
2011 20 10.5
2012 20.8 11
2013 21.6 11.5
2014 22.4 12
2015 23.2 12.5
2016 24 13
2017 24.8 13.5
2018 25.6 14
2019 26.4 14.5
2020 27.2 15
2021 28 15.5
2022 28.8 16
2023 29.6 16.5
Source: Public Law 108-188.
Table 6: Taiwan's Scheduled Contributions to RMI Trust Fund, as
Outlined in Agreement with RMI Government
Dollar in millions
Fiscal year Contribution to A account Contribution to D account
2004 $1.00 $3.00
2005 0.75 1.75
2006 0.75 1.75
2007 0.75 1.75
2008 0.75 1.75
2009 2.40 0.00
2010 2.40 0.00
2011 2.40 0.00
2012 2.40 0.00
2013 2.40 0.00
2014 2.40 0.00
2015 2.40 0.00
2016 2.40 0.00
2017 2.40 0.00
2018 2.40 0.00
2019 2.40 0.00
2020 2.40 0.00
2021 2.40 0.00
2022 2.40 0.00
2023 2.40 0.00
Source: Subsequent Contributor Accession Agreement between The
Trust Fund Committee Established by the Government of the United
States of America, and the Government of the Republic of the
Marshall Islands Implementing Section 216 and Section 217 of the
Compact, as Amended and Taiwan.
Note: Our projection included Taiwan's contribution to the A
account, but not the D account because it is a separate account
from the rest of the trust fund.
3. Inflation adjustment
The compact grants and the U.S. trust fund contributions are
adjusted for inflation by a percentage that equals the lesser, in
any year, of two-thirds of the percentage change in the U.S. gross
domestic product implicit price deflator or 5 percent, using the
beginning of 2004 as a base. Both grant funding and trust fund
contributions can be fully adjusted for inflation after 2014 under
certain U.S. inflation conditions.
4. Trust fund accounts and transfer rules
The trust fund agreements allow for several types of transfers
among the A, B, and C accounts that we used in our projections.
Before 2023:
o From A to C. At the end of each year before disbursement starts
in 2024, income exceeding 6 percent of the corpus shall be
deposited in the C account. The C account cannot exceed three
times the estimated equivalent of the fiscal year 2023 grant
level, adjusted for inflation.
o From C to A. Any amount in the C account exceeding three times
the estimated equivalent of the fiscal year 2023 grant level,
adjusted for inflation, shall return to the A account.
Beginning in 2023:
o From A to B. During 2023 and each subsequent year, all
investment income will be transferred from the A account to the B
account for possible disbursement in the following year.
o From B to A or C. If the B account balance exceeds the annual
grant assistance level in 2023 plus full inflation, the excess
will be transferred to the A account. However, if the C account
falls short of the specified level (three times the estimated
equivalent of the 2023 grant level, inflation adjusted), any
excess in the B account will be transferred to the C account to
make up the shortfall.
o From C to disbursement or A account. If the B account falls
short of the previous year's disbursement, inflation adjusted, the
C account can be drawn on to cover the shortfall. (The trust fund
corpus may not be accessed for this purpose.) Any amount in the C
account exceeding three times the estimated equivalent of the
fiscal year 2023 grant level, adjusted for inflation, shall return
to the A account.
In our projection, we assume that the trust funds will disburse
the maximum allowed amount if it is available. However, the trust
fund committees may disburse less than the maximum amount allowed
and reinvest some income. For a discussion of how partial
disbursement can affect the probability of trust fund income not
reaching the maximum disbursement level allowed (see app. III).
5. Simulation equation
For the Monte Carlo simulation of trust fund balances, we used the
equation W_t+1= (W_t + C_t - AW_t)* (1+r_t)*(1-F_t), where
W_t+1 = value of the fund at the beginning of year t+1
W_t = value of the fund at the beginning of year t
C_t = contribution to the fund at the beginning of year t
r_t = the annual return in year t
AW_t = the annual withdrawal in year t
F_t = the fees as a percentage of account value the trust fund
pays to its trustee, investment adviser, money managers, and
lawyers, etc. (We assume the fees to be 1 percent of the account
value.)
6. Distribution of returns for Monte Carlo simulation
The returns on the trust fund will be randomly drawn from a custom
distribution, which is based on historical real returns of the
various asset classes and the proportion of the asset in the
investment strategy. The distributions for international stocks,
large company stocks, and U.S. treasury bills are illustrated in
table 7.
Table 7: Real Returns Distribution Based on Historical Data from 1970 to
2005
International stocks Large company stocks U.S. treasury bills
Range Probability Range Probability Range Probability
-30.61% -27.61% 2.86% -34.47% -23.91% 2.86% -3.74% -2.59% 2.86%
-27.61 -22.41 2.86 -23.91 -21.56 2.86 -2.59 -1.99 2.86
-22.41 -21.11 2.86 -21.56 -13.23 2.86 -1.99 -1.72 2.86
-21.11 -17.62 2.86 -13.23 -13.07 2.86 -1.72 -1.70 2.86
-17.62 -16.78 2.86 -13.07 -12.71 2.86 -1.70 -1.55 2.86
-16.78 -15.17 2.86 -12.71 -12.09 2.86 -1.55 -1.13 2.86
-15.17 -14.33 2.86 -12.09 -8.75 2.86 -1.13 -1.03 2.86
-14.33 -9.15 2.86 -8.75 -2.27 2.86 -1.03 -0.84 2.86
-9.15 -6.29 2.86 -2.27 -1.40 2.86 -0.84 -0.71 2.86
-6.29 -4.55 2.86 -1.40 -1.32 2.86 -0.71 -0.43 2.86
-4.55 -1.02 2.86 -1.32 0.79 2.86 -0.43 0.15 2.86
-1.02 0.35 2.86 0.79 1.44 2.86 0.15 0.26 2.86
0.35 2.94 2.86 1.44 2.23 2.86 0.26 0.42 2.86
2.94 3.76 2.86 2.23 4.53 2.86 0.42 0.59 2.86
3.76 5.25 2.86 4.53 4.64 2.86 0.59 0.98 2.86
5.25 5.88 2.86 4.64 7.05 2.86 0.98 1.00 2.86
5.88 8.79 2.86 7.05 7.37 2.86 1.00 1.02 2.86
8.79 9.15 2.86 7.37 10.59 2.86 1.02 1.20 2.86
9.15 10.25 2.86 10.59 11.87 2.86 1.20 1.60 2.86
10.25 10.70 2.86 11.87 15.06 2.86 1.60 1.83 2.86
10.70 11.85 2.86 15.06 16.89 2.86 1.83 1.85 2.86
11.85 16.89 2.86 16.89 17.15 2.86 1.85 1.95 2.86
16.89 18.42 2.86 17.15 17.81 2.86 1.95 2.25 2.86
18.42 19.65 2.86 17.81 17.88 2.86 2.25 2.42 2.86
19.65 20.05 2.86 17.88 18.03 2.86 2.42 2.46 2.86
20.05 23.15 2.86 18.03 18.16 2.86 2.46 2.98 2.86
23.15 23.18 2.86 18.16 19.12 2.86 2.98 3.20 2.86
23.18 23.98 2.86 19.12 25.65 2.86 3.20 3.50 2.86
23.98 26.94 2.86 25.65 26.33 2.86 3.50 3.55 2.86
26.94 28.12 2.86 26.33 26.54 2.86 3.55 3.81 2.86
28.12 29.38 2.86 26.54 26.67 2.86 3.81 4.82 2.86
29.38 33.06 2.86 26.67 27.36 2.86 4.82 4.97 2.86
33.06 36.60 2.86 27.36 28.21 2.86 4.97 5.30 2.86
36.60 51.03 2.86 28.21 31.13 2.86 5.30 5.68 2.86
51.03 68.04 2.86 31.13 34.03 2.86 5.68 6.42 2.86
Source: GAO.
Cross-correlation and serial correlation are built into the Monte Carlo
random draws to capture the co-movement of the asset classes and over
time. (See table 8.)
Table 8: Cross-Correlation and Serial Correlation of Historical Annual
Returns
International Large company U.S. treasury bills
International 1
Large company 0.59 1
Treasury bills -0.12 0.05 1
Serial correlation 0.15 0.04 0.81
Source: GAO.
7. Monte Carlo simulation results
Each year's return is randomly selected from the return distribution of
each asset class. The simulation is run 1,000 times, yielding 1,000
possible outcomes and providing a distribution of annual investment
income, account balance, and disbursements. (Table 9 and table 10 show the
first 20 trial values from the simulation of the FSM and RMI trust fund
account balance.)
Table 9: First 20 of the 1,000 Trial Values of the FSM Trust Fund Balances
under Moderate Investment Strategy, Fiscal Years 2006-2023
Dollars in millions
Trial values 2006 2007 2008 2009 2010 2011 2012 2013
1 $86.5 $133.3 $170.7 $192.8 $196.5 $167.5 $198.7 $236.5
2 86.5 107.5 154.0 194.2 251.4 328.3 332.6 323.1
3 86.5 93.51 138.4 176.0 230.4 267.3 290.0 312.7
4 86.5 129.6 181.4 188.3 210.6 202.1 250.6 295.4
5 86.5 121.5 134.4 148.5 182.6 275.5 386.8 474.9
6 86.5 128.8 124.2 124.4 151.0 155.3 216.6 253.4
7 86.5 122.6 140.2 192.4 202.7 225.3 327.1 358.3
8 86.5 109.1 112.7 174.9 250.4 247.4 256.1 346.3
9 86.5 103.5 140.3 174.8 205.3 256.2 269.1 333.7
10 86.5 99.03 136.1 141.6 173.8 223.9 276.3 337.7
11 86.5 109.5 180.9 214.1 248.7 228.9 330.3 368.2
12 86.5 97.02 129.3 167.2 233.5 274.1 365.2 433.8
13 86.5 91.73 112.9 157.1 204.7 253.1 327.4 388.0
14 86.5 92.69 137.1 147.5 208.1 200.7 256.6 296.7
15 86.5 99.15 107.0 114.7 139.2 207.4 265.7 359.9
16 86.5 98.08 134.3 164.1 160.8 192.9 241.0 347.1
17 86.5 108.0 147.3 195.2 246.9 358.8 464.1 461.7
18 86.5 122.4 150.2 187.1 226.1 346.9 413.8 371.4
19 86.5 116.2 138.9 202.0 218.2 268.0 300.9 270.6
20 86.5 147.8 222.5 293.7 304.0 376.2 362.8 399.9
10^th percentile 86.5 94.23 112.2 135.2 157.6 182.2 210.6 236.9
median 86.5 111.6 139.2 171.5 206.3 244.1 288.9 331
90^th percentile 86.5 128.3 169.3 213.8 261.4 323.8 387 455.5
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
$262.6 $291.6 $301.1 $288.9 $299.4 $282.1 $318.14 $349.58 $409.71 $545.09
337.4 331.8 431.0 497.9 497.0 501.3 520.58 597.5 697.86 907.24
426.2 496.6 522.3 517.4 695.7 842.4 724.48 807.41 1,150.4 1,223.6
402.8 552.2 719.4 937.4 1,000.8 1,029.0 1,267.4 1,357.3 1,771.1 1708
598.9 688.9 932.0 980.7 937.1 1,056.0 1,203.1 1,326.2 1,420.6 1,660.3
349.2 412.0 471.1 569.9 606.2 614.3 768.84 926.91 907.27 932.03
402.5 539.4 679.3 722.9 860.3 1,182.9 1,153.4 1,243.7 1,180.5 1212.3
308.2 314.7 419.3 485.5 540.9 553.9 606.9 772.66 728.88 895.66
447.0 513.0 523.3 619.4 614.1 692.9 758.54 811.66 808.01 943.09
495.8 606.1 621.7 858.4 848.1 925.2 1,137.5 1,022.2 1,182.5 1507.2
392.6 543.5 710.9 782 711.2 783.0 860.09 769.16 651.13 782.25
472.3 436.6 484.6 541.4 530.7 655.9 705.5 806.55 1,164.4 1057.9
503.8 432.6 504.2 581 535.0 687.2 772.5 987.18 1,038.2 1353.6
382.2 443.1 471.2 600.2 764.5 819.6 803.22 925.79 865.13 959.52
456.8 523.4 579.3 560.2 616.3 776.9 1003 1,112.8 1,211.2 1177.6
417.3 449.1 424.7 398.9 361.4 484.6 593.15 689.94 817.63 858.45
471.0 546.3 621.2 704 907.6 1,083.6 888.67 1,021.2 1,308.6 1,589.2
489.0 519.9 677.1 752.7 901.5 1,151.8 1,072.1 1,535.1 1,668.8 1,970.0
291.6 333.6 435.3 526.8 567.9 716.84 889.64 1,169.8 1,402.7 1,489.3
569.8 752.8 931.8 1,149.0 1,467.0 1,466.6 1,727.6 2,193.6 2,290.8 2,525.2
269.1 305.4 342.6 389.3 437.95 473.23 530.46 592.95 651.05 709.73
379.3 433.7 501.8 563.4 643.53 717.1 798.43 910.03 1018.1 1107.9
531.5 623.3 717.3 824.9 940.75 1079.6 1205.9 1351.4 1513.2 1723.9
Source: GAO.
Table 10: First 20 of the 1,000 Trial Values of the RMI Trust Fund Balance
under Moderate Investment Strategy, Fiscal Years 2006-2023
Dollars in millions
Trial values 2006 2007 2008 2009 2010 2011 2012 2013
1 $63.1 $83.4 $101.8 $143.4 $153.2 $191.4 $214.8 $280.8
2 63.1 91.8 123.5 134.3 178.3 201.3 253.5 327.6
3 63.1 73.4 93.8 114.0 159.7 190.5 194.0 242.6
4 63.1 78.0 78.5 102.0 114.0 144.3 126.4 125.9
5 63.1 77.9 89.0 106.7 131.3 178.0 211.1 261.9
6 63.1 79.5 96.9 98.0 100.0 120.5 128.1 157.6
7 63.1 77.9 118.9 131.5 125.8 160.8 214.1 243.7
8 63.1 69.5 93.7 119.8 134.1 175.2 205.5 231.0
9 63.1 73.7 96.9 126.2 147.7 179.7 196.2 216.4
10 63.1 63.4 80.0 103.8 113.0 140.9 151.4 193.0
11 63.1 75.7 86.6 136.6 163.2 172.0 204.4 237.7
12 63.1 84.7 106.7 146.8 197.8 251.4 232.1 289.0
13 63.1 80.0 98.7 110.2 111.1 140.1 207.6 220.5
14 63.1 69.0 82.1 78.4 74.6 86.8 102.5 134.0
15 63.1 66.1 87.3 78.4 93.0 99.7 98.3 116.4
16 63.1 73.3 96.7 96.8 132.5 132.5 123.1 116.1
17 63.1 75.7 90.1 114.7 115.6 155.0 204.3 268.1
18 63.1 59.1 63.2 71.1 93.5 111.4 146.6 139.7
19 63.1 90.7 110.1 119.9 160.1 167.6 242.4 301.3
20 63.1 77.8 93.2 120.6 147.2 221.6 287.5 330.3
10^th percentile 63.1 65.5 76.7 89.1 103.7 119.7 137.6 156.3
median 63.1 78.5 95.5 114.9 137.3 161.6 185.5 214.3
90^th percentile 63.1 89.4 114.7 145.7 177.1 212.8 252.6 299.7
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
$335.2 $369.3 $354.1 $401.7 $501.7 $568.5 $651.7 $604.2 $607.6 $579.2
456.9 632.5 688.6 919.0 1,034.5 1,054.9 1,209.7 1,123.2 1,043.1 1102.8
232.4 232.5 282.0 283.3 357.4 420.5 511.7 596.8 585.8 548.2
156.1 145.7 213.3 278.4 283.4 366.5 340.7 314.0 345.2 819.4
295.3 321.9 383.0 434.9 477.3 567.8 625.5 649.9 727.3 565.8
196.6 169.7 175.4 250.3 323.5 401.3 370.2 469.6 508.9 979.4
227.1 286.1 320.2 389.6 389.3 434.6 426.6 499.5 601.1 1,080.5
315.0 375.9 433.4 504.2 564.2 617.8 528.1 683.9 752.1 786.8
282.5 325.2 378.0 403.0 426.9 464.8 469.6 465.6 555.9 647.2
252.5 317.3 278.8 344.6 429.7 469.7 455.9 570.9 732.0 1,436.0
213.0 271.5 275.0 360.5 344.3 479.8 648.8 746.2 814.2 494.1
351.3 314.2 313.6 355.0 386.6 436.3 626.0 659.0 785.0 582.3
252.1 322.8 337.7 386.8 343.2 332.6 373.1 387.2 417.3 662.6
150.9 170.7 216.6 287.2 342.5 380.5 447.7 479.6 489.5 701.3
118.6 158.1 164.0 185.0 175.8 240.3 272.7 343.2 415.4 841.7
170.9 215.8 270.7 354.6 451.1 471.3 471.3 554.4 506.4 602.2
263.9 343.5 418.3 445.8 547.0 685.5 812.2 831.6 843.2 751.8
149.1 204.0 266.5 282.8 242.7 307.0 302.8 410.9 496.1 936.0
274.8 290.9 366.2 365.8 496.8 538.5 588.7 518.9 510.3 437.1
360.1 397.7 335.6 432.7 404.9 398.8 409.4 468.7 532.8 521.0
176.9 197.7 218.9 246.9 272.0 299.8 337.3 367.8 400.4 439.2
247.1 280.5 315.2 357.7 402.3 451.1 495.4 556.3 611.9 676.5
345.3 397.6 456.9 522.4 597.4 654.4 743.1 831.6 919.5 1,103.0
Source: GAO.
Appendix III: Disbursing All Income Compared to Disbursing Partial Income
The U.S. trust fund agreements with the FSM and the RMI state that the
trust fund committees may disburse an amount up to the inflation-adjusted
grant assistance in fiscal year 2023. However, if the trust fund
committees disburse less than the maximum allowed levels and reinvest part
of the trust fund income, this will change the probability that the funds'
income will not reach the maximum allowed disbursement levels.^1
Figures 11 and 12, respectively, compare the probabilities, under our
projected moderate investment strategy, of the FSM and the RMI trust fund
income's not reaching the maximum disbursement level allowed when all
income is disbursed versus when partial income is disbursed^. 2During the
earlier years, the probability that income will not reach the maximum
disbursement level allowed is generally greater when only partial income
is disbursed. However, the probability that income will not reach the
maximum disbursement level allowed is lower in later years, because the
benefit of the reinvested trust fund income helps protect the trust fund
principal against inflation.
^1According to 2005 study by the Asian Development Bank, a trust fund
established with similar objectives for another Pacific island country,
Tuvalu, reinvests trust fund income to maintain the fund's real value. The
Tuvalu trust fund was established through a multilateral international
agreement among Tuvalu, New Zealand, the United Kingdom, and Australia.
See Benjamin Graham, Trust Funds in the Pacific, Their Roles and Future
Manila, Philippines: Asian Development, 2005.
^2There are many different ways to disburse investment income partially.
For example, the trust fund can disburse only income above inflation; the
trust fund can reinvest to keep the corpus at a certain level before it
starts to disburse any income. In this analysis, partial disbursement
means disbursing income above inflation.
Figure 11: Probabilities That FSM Trust Fund Income Will Not Reach the
Maximum Disbursement Level Allowed When Disbursing All Income vs.
Disbursing Partial Income
Figure 12: Probabilities That RMI Trust Fund Income Will Not Reach the
Maximum Disbursement Level Allowed When Disbursing All Income vs.
Disbursing Partial Income
Appendix IV: Key Events in the Establishment of the FSM and RMI Trust
Funds
Figure 13: Key Events in the Establishment of the FSM Trust Fund
Figure 14: Key Events in the Establishment of the RMI Trust Fund
Note: The years shown are calendar years (Jan. 1 - Dec. 31).
Appendix V: Comments from the Department of the Interior
Note: GAO comment supplementing those in the report text appears at the
end of this appendix.
See comment 1.
Following is GAO's comment on the Department of the Interior's letter,
dated May 11, 2007.
GAO Comment
1. We added clarification that no minimum disbursement from the
trust funds is required or guaranteed. However, the trust fund
agreements establish the 2023 level of compact grants, fully
adjusted for inflation, as the maximum amount of annual income
available for disbursement. Therefore, we believe it is
appropriate to undertake a projection of the likely disbursements
against that benchmark. We modified our second recommendation to
emphasize that the reports should assess the status of trust fund
performance and likely disbursements. We believe that careful
analysis of the trust funds each year will help establish
realistic expectations. Such analysis will also inform the trust
fund committees as they make investment decisions and FSM and RMI
leaders as they set economic policies and undertake long-term
fiscal planning.
Appendix VI: Comments from the Department of Health and Human Services
Note: GAO comment supplementing those in the report text appears at the
end of this appendix.
Following is GAO's comment on the Department of Health and Human Services'
letter, dated May 16, 2007.
GAO Comment
1. We strongly disagree with HHS' assertion that our report
reflects a fundamental misunderstanding of the outcome of the
negotiation of the amended compacts. We clearly stated the purpose
of the trust funds is to provide an ongoing source of revenue for
the FSM and the RMI. Furthermore, we added clarification that no
minimum disbursement from the trust funds is required or
guaranteed. However, the trust fund agreements establish the 2023
level of compact grants, fully adjusted for inflation, as the
maximum amount of annual income available for disbursement.
Therefore, we believe it is appropriate to undertake a projection
of the likely disbursements against that benchmark. We modified
our second recommendation to emphasize that the reports should
assess the status of trust fund performance and likely
disbursements rather than the adequacy of the funds to ensure we
do not imply any required level of minimum income. We believe that
careful analysis of the trust funds each year will help establish
realistic expectations. Such analysis will also provide
information to the trust fund committees as they make investment
decisions and to FSM and RMI leaders as they set economic policies
and undertake long-term fiscal planning.
HHS noted that "so long as the trust funds are a source of annual
revenue at all, they have met their agreed and stated purpose."
For the trust fund committees to be assured of achieving such a
purpose, the trust funds would have to be invested in low-risk,
low-yield government bonds after 2023. This would ensure that the
trust funds will provide some level of disbursement to the FSM and
the RMI. The income from the funds will not reach the maximum
level of disbursement allowed and will diminish in real value over
time. Our analysis shows that right after the grants expire, the
funds will be able to disburse about 50 percent and 68 percent of
the 2023 grant levels for the FSM and the RMI respectively with
the ratios getting smaller over time.^1
^1We used the estimated median account balance in 2023 under the most
aggressive strategy as a starting point for investment in government
bonds.
Appendix VII: Comments from the Department of State
Note: GAO comments supplementing those in the report text appear at the
end of this appendix.
See comment 2.
See comment 1.
See comment 4.
See comment 3.
Following are GAO's comments on the Department of State's letter, dated
May 15, 2007.
GAO Comments
1. We strongly disagree with State's assertion that our reading of
the trust fund agreements is not justified by the terms of the
agreements and is not consistent with the negations that lead to
the agreements. We clearly stated the purpose of the trust funds
is to provide an ongoing source of revenue for the FSM and the
RMI. Furthermore, we added clarification that no minimum
disbursement from the trust funds is required or guaranteed.
However, the trust fund agreements establish the 2023 level of
compact grants, fully adjusted for inflation, as the maximum
amount of annual income available for disbursement. Therefore, we
believe it is appropriate to undertake a projection of the likely
disbursements against that benchmark. We modified our second
recommendation to emphasize that the reports should assess the
status of trust fund performance and likely disbursements rather
than the adequacy of the funds to ensure we do not imply any
required level of minimum income. We believe that careful analysis
of the trust funds each year will help establish realistic
expectations. Such analysis will also provide information to the
trust fund committees as they make investment decisions and to FSM
and RMI leaders as they set economic policies and undertake
long-term fiscal planning.
2. State commented that "so long as the trust funds are a source
of annual revenue at all, they have met their agreed and stated
purpose." For the trust fund committees to be assured of achieving
such a purpose, the trust funds would have to be invested in
low-risk, low-yield government bonds after 2023. This would ensure
that the trust funds will provide some level of disbursement to
the FSM and the RMI. The income from the funds will not reach the
maximum level of disbursement allowed and will diminish in real
value over time. Our analysis shows that right after the grants
expire, the funds will be able to disburse about 50 percent and 68
percent of the 2023 grant levels for the FSM and the RMI
respectively with the ratios getting smaller over time.^1
3. We disagree with State's characterizing our assessment of the
trust funds' likely capacity to provide revenue to the governments
of the FSM and the RMI as "likely to build up unwarranted
expectations." On the contrary, we believe that careful analysis
of the funds' probable income will help build realistic
expectations and provide invaluable inputs for policymakers in
formulating economic policies and long-term plans. It is to this
end that we recommend that the trust fund committees assess the
funds' status as an ongoing source of revenue and effectiveness in
helping the countries achieve economic self-sufficiency and
long-term budgetary self-reliance.
4. State suggested a fifth strategy for enhancing the trust funds'
income would e for the countries to allow the fund to grow further
by refraining from requesting the withdrawal of the full allowable
amount each year. We analyzed the option of not disbursing the
maximum allowed income (see app. III). We compared the likelihood
of not reaching the maximum level allowed when all income is
disbursed versus when some income is reinvested. Our analysis
shows while the benefit of the reinvested trust fund income helps
improve the prospect of the trust funds in later years, the
disbursement in earlier years will be lower.
^1We used the estimated median account balance in 2023 under the most
aggressive strategy as a starting point for investment in government
bonds.
Appendix VIII: Comments from the Federated States of Micronesia
Appendix IX: Comments from the Republic of the Marshall Islands Appendix
IX: Comments from the Republic of the Marshall Islands
Note: GAO comments supplementing those in the report text appear at the
end of this appendix.
See comment 2.
See comment 1.
Following are GAO's comments on the Republic of the Marshall Islands'
letter, dated May 18, 2007.
GAO Comments
1. Our analysis was based on the current contribution structure.
Under certain U.S. inflation conditions, contributions to the
trust fund can be fully adjusted for inflation after 2014.
2. Although the trust fund will have little or no impact on the
RMI's economy until disbursements from the fund begin, we believe
that careful analysis of the fund's likely income will help build
realistic expectations and provide invaluable information for
policymakers in formulating economic policies and long-term plans.
It is to this end that we recommend that the RMI trust fund
committee assess the fund's status as an ongoing source of revenue
and effectiveness in helping the country achieve economic
self-sufficiency and long-term budgetary self-reliance.
Appendix X: GAO Contact and Staff Acknowledgments
GAO Contact
David Gootnick, (202) 512-3149 or [email protected]
Staff Acknowledgments
In addition to the individual above, Emil Friberg (Assistant Director) and
Ming Chen made key contributions to this report. Muriel Brown, Lawrance
Evans, Etana Finkler, Reid Lowe, Thomas McCool, Mary Moutsos, and Wilda
Wong provided technical assistance.
(320439)
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Highlights of GAO-07-513, a report to congressional committees
June 2007
COMPACTS OF FREE ASSOCIATION
Trust Funds for Micronesia and the Marshall Islands May Not Provide
Sustainable Income
In 2003, the U.S. government extended its economic assistance to the
Federated States of Micronesia (FSM) and Republic of the Marshall Islands
(RMI) through Amended Compacts of Free Association. From 2004 to 2023, the
United States will provide an estimated combined total of $3.6 billion,
with annually decreasing grants as well as annually increasing
contributions to trust funds for each country. The trust funds are to be
invested and provide income for the FSM and RMI after the compact grants
end. A trust fund committee for each country is to establish and oversee
the funds. This report examines (1) the committees' progress in
establishing, investing, and reporting on the funds; (2) the
sustainability of income from the trust funds; and (3) potential options
to supplement or enhance the trust funds' income. GAO reviewed trust
fund-related documents and legislation; interviewed U.S., FSM, RMI, and
industry officials and used a simulation model to project the trust funds'
income.
[69]What GAO Recommends
GAO recommends that the trust fund committees improve administrative and
decision-making processes, ensure timely reporting, and obtain a full and
independent evaluation of securitization's potential benefits and risks.
Interior, which chairs the committees, agreed with all of the
recommendations.
The FSM trust fund committee has established the fund by appointing a
trustee, an auditor, an investment adviser, and money managers. As of the
end of March 2007, the RMI committee had not appointed an auditor or a
money manager. Investment of the funds began 22 months and 16 months,
respectively, after the FSM's and RMI's initial contributions, with the
funds remaining in low-interest savings accounts until their investment.
Contractual delays contributed to the time taken to establish and invest
the funds, as did the committees' processes for reaching consensus and
obtaining administrative support; the committees have not yet taken steps
to improve these processes. Although the committees are required to report
annually on the trust funds, they did not publish reports for 2004 and
were late in publishing the reports for 2005 and 2006. Moreover, the
published reports do not assess the trust funds' potential effectiveness
in helping the FSM and RMI achieve the compact goals of economic
advancement and budgetary self-reliance.
The FSM and RMI trust funds may not provide sustainable income after the
compact grants end. Market volatility, as well as the investment
strategies chosen, may lead to a wide range of trust fund balances in
2023. There is increasing probability that in some years the trust funds
will not reach the maximum disbursement level allowed--an amount equal to
the inflation adjusted compact grants in 2023--or be unable to disburse
any income. GAO's analysis shows low probabilities of not reaching the
maximum level allowed or disbursing no income in 2024 but higher
probabilities of not reaching the maximum level allowed in 2050. For
instance, by 2050, with a conservative investment strategy, income from
the FSM and RMI trust funds, respectively, is over 90 percent and 60
percent likely to be less than the maximum level allowed and more than 20
percent and 15 percent likely to allow for no disbursements.
The trust funds' income could be supplemented or enhanced through (1)
greater tax revenue, (2) increasing remittances from growing emigration,
(3) economic assistance from other sources, and, possibly, (4)
securitization of the funds. However, limited development prospects
constrain the countries' ability to raise tax revenues to supplement the
trust fund income. In addition, FSM and RMI emigrants' inadequate
education and vocational skills may limit their earning opportunities.
Further, although the RMI trust fund received contributions from Taiwan,
it is unclear whether the FSM trust fund will receive other contributions.
Finally, although securitization--the issuing of bonds against future U.S.
contributions--could increase the funds' earning potential by raising
their balances, it could also lead to lower balances and reduced income.
The committees have not yet obtained an independent evaluation of
securitization's potential benefits and risks.
References
Visible links
57. http://www.gao.gov/cgi-bin/getrpt?GAO/NSIAD-00-216
58. http://www.gao.gov/cgi-bin/getrpt?GAO-06-590
59. http://www.gao.gov/cgi-bin/getrpt?GAO-07-163EUR
60. http://www.gao.gov/cgi-bin/getrpt?GAO-05-633EUR
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