Maritime Security Fleet: Factors to Consider Before Deciding to Select
Participants Competitively (Letter Report, 09/24/97, GAO/NSIAD-97-246).

Pursuant to a congressional request, GAO evaluated whether the Maritime
Security Fleet (MSF) program costs could be reduced by changing the
selection process to permit owners to compete, rather than apply for,
available slots, focusing on: (1) the potential impact that a
competitive selection process could have on the number of qualifying
vessels, program costs, and existing agreements; and (2) the views of
Department of Transportation and Department of Defense (DOD) officials
on making such a change to the selection process.

GAO noted that: (1) three factors warrant consideration before
determining whether to incorporate a competitive selection process into
the Maritime Security Fleet program: (a) the number of vessels that
could qualify; (b) the effect of such a process on program costs; and
(c) potential legal risks; (2) opening up the selection process to
competition would not increase the pool of qualified applicants or the
number of eligible vessels without a change in the eligibility and
selection criteria; (3) it is uncertain whether competitive selection
would result in bids lower than the current $2.1 million annual Maritime
Security Fleet payment and thereby lower program costs because: (a)
annual crew costs alone for a commercial ship operating under U.S.
registry exceed those for the foreign registry operation with the next
highest crew cost by about $2.4 million; (b) average annual payments
under the expiring Operating Differential Subsidy program exceeded the
$2.1 million level in every year since 1982; and (c) bids under
competitive selection may take inflation and operating cost increases
into consideration, whereas the current program fixes the maximum annual
per ship payment at $2.1 million through fiscal year 2005; (4) finally,
unilateral changes to the program could lead to legal challenges by
vessel owners with whom the government has contractual agreements; (5)
these challenges could result in substantial costs to the government and
the transfer of vessels to foreign registry; (6) on the basis of their
analysis of the number of fully qualified vessels eligible to
participate in the program and the possibility that competitive
selection would lower program costs, neither Transportation nor DOD
favor changes to the current selection process; (7) officials of both
agencies believe that a competitive selection process would not result
in lower program costs and could actually result in vessel owners
withdrawing from the program to operate their vessels under a less
costly foreign registry; and (8) such actions could result in a loss of
assets needed in a time of national emergency.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-97-246
     TITLE:  Maritime Security Fleet: Factors to Consider Before 
             Deciding to Select Participants Competitively
      DATE:  09/24/97
   SUBJECT:  Ships
             Industrial mobilization
             Competitive procurement
             Defense contingency planning
             Eligibility criteria
             Marine transportation operations
             Contractor selection
             Defense cost control
IDENTIFIER:  DOT Maritime Security Fleet Program
             DOT Operating Differential Subsidy Program
             
******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO report.  Delineations within the text indicating chapter **
** titles, headings, and bullets are preserved.  Major          **
** divisions and subdivisions of the text, such as Chapters,    **
** Sections, and Appendixes, are identified by double and       **
** single lines.  The numbers on the right end of these lines   **
** indicate the position of each of the subsections in the      **
** document outline.  These numbers do NOT correspond with the  **
** page numbers of the printed product.                         **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
** A printed copy of this report may be obtained from the GAO   **
** Document Distribution Center.  For further details, please   **
** send an e-mail message to:                                   **
**                                                              **
**                                            **
**                                                              **
** with the message 'info' in the body.                         **
******************************************************************


Cover
================================================================ COVER


Report to Congressional Requesters

September 1997

MARITIME SECURITY FLEET - FACTORS
TO CONSIDER BEFORE DECIDING TO
SELECT PARTICIPANTS COMPETITIVELY

GAO/NSIAD-97-246

Maritime Security Fleet

(703198)


Abbreviations
=============================================================== ABBREV

  DOD - Department of Defense
  MARAD - Maritime Administration
  MSF - Maritime Security Fleet
  ODS - Operating Differential Subsidy

Letter
=============================================================== LETTER


B-277913

September 24, 1997

The Honorable Trent Lott
Majority Leader
United States Senate

The Honorable John McCain
Chairman, Committee on Commerce,
 Science, and Transportation
United States Senate

In accordance with the Maritime Security Act of 1996 (P.L.  104-239),
the Department of Transportation's Maritime Administration (MARAD)
recently entered into agreements with 10 shipping companies to
participate in a program that would provide the Department of Defense
(DOD) access to U.S.-registered commercial ships, their crews, and
other related transportation assets in a time of national emergency. 
MARAD selected participants from applications submitted in response
to its solicitation.  As you requested, we evaluated whether program
costs could be reduced by changing the selection process to permit
owners to compete, rather than apply for, available slots. 
Specifically, we determined (1) the potential impact that a
competitive selection process could have on the number of qualifying
vessels, program costs, and existing agreements and (2) the views of
Department of Transportation and DOD officials on making such a
change to the selection process.  On June 6, 1997, we briefed your
staffs on the results of our work.  This report summarizes and
updates the information provided at that briefing. 


   BACKGROUND
------------------------------------------------------------ Letter :1

The Maritime Security Act established the Maritime Security Fleet
(MSF) program, authorizing MARAD to enter into agreements with
maritime shipping companies to provide DOD access to commercial
vessels operating under U.S.-flag registry and related assets, such
as port facilities, containers, and rail systems in a time of
national emergency.\1 In addition, the program was established to
maintain U.S.  presence in international commercial shipping by
slowing the trend of U.S.  ships seeking foreign registry, provide a
readily available supply of U.S.  mariners to crew government and
commercial ships in a time of national emergency, and encourage
shipping companies to participate with DOD in contingency planning. 

The MSF program replaces the Operating Differential Subsidy (ODS)
program, which reimbursed American shipowners for cost differentials
associated with operating under U.S.  versus foreign registry,
including higher crew, insurance, maintenance, and repair costs.  The
MSF program, in contrast, provides a reduced fixed rate to compensate
U.S.-flag operators principally for the higher cost of employing U.S. 
citizens aboard U.S.-flag ships.  MARAD estimates that ODS payments
will average $4 million per participating vessel in fiscal year 1997
compared with the authorized $2.1 million per vessel under the MSF
program. 

Under the MSF program, participating companies will receive a yearly
retainer for agreeing to maintain 47 selected ships under U.S. 
registry, crewing them with U.S.  mariners, and making the ships
available to DOD for sealift services in a time of national
emergency.  The act authorized the program to operate for 10
years--from fiscal year 1996 to 2005--and a total of $1 billion, or
$100 million annually, to fund the program.  It also authorized MARAD
to enter into agreements to pay participating companies, subject to
the availability of appropriations and other provisions of the act,
$2.3 million per vessel in fiscal year 1996 and $2.1 million per
vessel each year thereafter.  Although the agreements are to be
effective for 1 year, they are renewable, subject to the availability
of appropriations, for each subsequent year of the program.  The
agreements are defined by the act as contractual obligations of the
United States. 

In October 1996, MARAD advertised in the Federal Register for MSF
applicants; a total of 21 responded, offering 97 vessels.  MARAD used
specific eligibility and priority ranking criteria outlined in the
act, to select applicants for available slots.  To be eligible, a
vessel had to be self-propelled, have a certain physical capacity, be
less than a certain age, and be militarily useful and eligible for
U.S.-flag registry. 

In the selection process, MARAD followed criteria established in the
act, giving first-priority consideration to vessels (1) owned and
operated by citizens of the United States under section 2 of the
Shipping Act of 1916 or (2) less than 10 years of age and owned and
operated by a corporation that was either eligible for U.S.  registry
or currently operating, managing, or chartering vessels for the
Secretary of Defense.  The act limited the number of first-priority
vessels per owner to the number that owner operated in U.S.  foreign
commerce as of May 17, 1995, plus the number that the owner chartered
to DOD as of that date.  Also, if the number of vessels that
qualified for first-priority ranking exceeded available funding, the
act required that MARAD prorate the award of MSF slots among vessel
owners based on the number of first-priority vessels each owned. 

MARAD determined that 53 of the 97 vessels offered for the program
met eligibility requirements for first-priority status.  Because of
their military usefulness, 6 additional vessels had the age
requirement waived, bringing the total number of first-priority
vessels to 59.  The $100 million in annual program funding was
sufficient to fund 47 vessels, and by January 1997, MARAD had entered
into agreements with the 10 owners of these vessels.  However, not
all of the 47 vessels will be immediately eligible for MSF payments. 
Some vessels will have to change from foreign to U.S.  registry, and
others will have to wait until their current participation in the ODS
program expires or other government contractual obligations are
completed--some possibly as late as November 2000.  Because the act
did not become law until fiscal year 1997 and not all vessels will be
immediately eligible for payment, MARAD estimates the total program
costs will be $825.4 million, or about 17 percent less than the $1
billion originally authorized in the act.\2


--------------------
\1 Vessels operating under U.S.-flag registry, unlike those under
foreign registry, must be owned by a U.S.  citizen or an entity whose
members are U.S.  citizens and are capable of holding title under
U.S.  laws, crewed by trained U.S.  merchant mariners, meet U.S. 
crewing and safety standards, and comply with U.S.  tax laws. 

\2 Although the act authorized the government to enter into operating
agreements beginning in fiscal year 1996, it did not become law until
fiscal year 1997. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

Three factors warrant consideration before determining whether to
incorporate a competitive selection process into the Maritime
Security Fleet program:  the number of vessels that could qualify,
the effect of such a process on program costs, and potential legal
risks.  First, opening up the selection process to competition would
not increase the pool of qualified applicants or the number of
eligible vessels without a change in the eligibility and selection
criteria.  Second, it is uncertain whether competitive selection
would result in bids lower than the current $2.1 million annual
Maritime Security Fleet payment and thereby lower program costs
because (1) annual crew costs alone for a commercial ship operating
under U.S.  registry exceed those for the foreign registry operation
with the next highest crew cost by about $2.4 million; (2) average
annual payments under the expiring Operating Differential Subsidy
program exceeded the $2.1 million level in every year since 1982; and
(3) bids under competitive selection may take inflation and operating
cost increases into consideration, whereas the current program fixes
the maximum annual per ship payment at $2.1 million through fiscal
year 2005.  Finally, unilateral changes to the program could lead to
legal challenges by vessel owners with whom the government has
contractual agreements.  These challenges could result in substantial
costs to the government and the transfer of vessels to foreign
registry. 

On the basis of their analysis of the number of fully qualified
vessels eligible to participate in the program and the possibility
that competitive selection would lower program costs, neither
Transportation nor DOD favor changes to the current selection
process.  Officials of both agencies believe that a competitive
selection process would not result in lower program costs and could
actually result in vessel owners withdrawing from the program to
operate their vessels under a less costly foreign registry.  Such
actions could result in a loss of assets needed in a time of national
emergency. 


   NUMBER OF QUALIFIED VESSELS
   WOULD NOT INCREASE
------------------------------------------------------------ Letter :3

According to MARAD data, every commercial owner with vessels that
were fully qualified under the existing MSF selection criteria,
applied for and obtained at least one slot in the program. 
Therefore, the number of vessels that could be considered for the
program under a competitive selection process would not increase
unless the selection criteria were changed. 

Of the 97 vessels offered for the program, 53 met all of the
first-priority selection criteria.  An additional six vessels, which
DOD determined would be needed to meet contingency requirements to
transport containerized ammunition from selected locations on the
West Coast, were also granted age waivers to qualify as
first-priority vessels.  On the basis of a pro rata requirement set
out in the act, each of the 10 owners of the 59 first-priority
vessels was awarded at least 1 of the 47 slots in the program,
leaving 12 first-priority vessels unselected.  The number of awarded
slots was based on the percentage of the 59 first-priority vessels
each shipping company owned.  Of the 47 vessels selected for the
program, 24 were owned by 2 shipping companies. 

Some of the 97 vessels that were offered for the program were
determined to be ineligible based on their age or their owner's
citizenship.  Other factors, including vessels not being militarily
useful or not operating in a domestic-foreign trade route on May 17,
1995, excluded the remainder.  Given the same qualifying and
selection criteria, these vessels would still not qualify for the MSF
program under a competitive bidding process. 


   EFFECT OF A BIDDING PROCESS ON
   PROGRAM COST IS UNCERTAIN
------------------------------------------------------------ Letter :4

Although we cannot be certain of the effect that a bidding process
would have on the total program cost, a number of factors suggest
that owners may not bid lower than the current $2.1 million per
vessel authorization.  MARAD data, for example, shows that annual
crew costs alone for commercial ships operating under U.S.  registry
exceed those for the foreign registry operation with the next highest
crew cost by about $2.4 million.  At the time of our review, shipping
companies participating in the MSF program were having mixed results
in their efforts to reduce operating costs by negotiating new labor
contracts that would consider the reduced subsidy. 

In addition, payments under the expiring ODS program have
historically been higher than $2.1 million.  For example, since 1982
the average annual outlay per ship under the ODS program ranged from
$2.3 million in fiscal year 1983 to $5 million in fiscal year 1996. 
In fiscal year 1997, the average annual subsidy per vessel under the
ODS program is estimated at $4 million compared with $1.4 million
under the MSF program (see fig.  1). 

   Figure 1:  Expiring ODS and MSF
   Average Annual Payments

   (See figure in printed
   edition.)

Source:  MARAD. 

Current legislation does not consider future inflation or increases
in operating costs; therefore, the $2.1-million cost per ship per
year will remain constant through fiscal year 2005.  Representatives
of five shipping companies participating in the MSF program told us
that if a competitive selection process were introduced, they would
probably construct their bids to account for inflation.  Our analysis
indicates that bids would have to rise to about $2.3 million in
fiscal year 2000 and $2.6 million in fiscal year 2005 to cover the
current inflation projections (see fig.  2).\3

   Figure 2:  Impact of Inflation
   on the MSF Annual Subsidy of
   $2.1 Million per Vessel

   (See figure in printed
   edition.)

The small number of vessel owners, all of whom are already
participating in the MSF program, also limits the potential cost
savings of competition, as does the fact that over one-half of the 59
first-priority vessels are owned by two companies.  By owning a
majority of the first-priority vessels, these two companies could
possibly exert enough market power to affect both the amount of their
bids and the number of ships they would make available.  In addition,
since DOD has requirements for specific vessel types and associated
transportation systems, the competition may need to be categorized by
vessel type, which would further reduce the number of potential
bidders in each category.  For example, medium-sized container ships,
which were needed to meet DOD's unique containerized ammunition
requirements on the West Coast, were operated by only one MSF program
applicant. 


--------------------
\3 We averaged the annual inflation forecast of two major economic
forecasting firms--WEFA and DRI/McGraw-Hill. 


   LEGAL RISKS COULD BE INVOLVED
   IN CHANGING THE SELECTION
   PROCESS
------------------------------------------------------------ Letter :5

Implementation of a competitive selection process into the MSF
program presents certain legal risks to the government and could
undermine the intent of the program.  As noted by MARAD officials,
current MSF participants may view implementation of a new selection
process as a breach of the government's contractual obligations. 
Under the MSF program, the government entered into 47 operating
agreements with vessel owners.  These agreements, defined by the act
as contractual obligations of the United States, obligate the
government to pay the amount provided for in the agreement to the
extent of actual appropriations.  Provided there is sufficient
funding, the government is obligated to pay $2.1 million a year per
ship to the vessel owners.  The Supreme Court recently held that the
government may be liable for damages if Congress enacts legislation
that breaches an existing contract to which the government is a
party.\4

Changes to the selection process that do not interfere with existing
agreements would minimize potential liability.  According to the act,
if funds are not appropriated, the current agreements would
automatically terminate.  Therefore, one option would be to allow
current agreements to terminate and then enact new legislation to
require competitive selection.  However, vessel owners may have
incurred expenses based on the assumption that the program would last
through fiscal year 2005 and that the government would make a good
faith effort to provide funds.  This situation may provide some
leverage for participating owners to pursue legal remedies.  Also, if
funds are not appropriated and the agreements automatically
terminate, vessel owners could transfer participating vessels to
foreign registry, undermining the intent of the MSF program.  Another
option for changing the selection procedure would be to retain
current MSF agreements and amend the act to allow a bidding process
for the selection of any additional or replacement vessels.\5
Although this option presents the least risk to the government,
current vessel owners could take the position that the language in
the current agreements, specifying that contracts are renewable
annually, would allow them to terminate their involvement in the
program and bid again for their vacated slots at a rate higher than
the current $2.1 million. 


--------------------
\4 See United States v.  Winstar Corp.  116 S.  Ct.  2432 (1996). 

\5 Vessels that originally qualify for the program may have to be
replaced because of bankruptcy or changes in ownership from U.S.  to
foreign, for example. 


   NEITHER TRANSPORTATION NOR DOD
   SUPPORT CHANGING THE SELECTION
   PROCESS
------------------------------------------------------------ Letter :6

Transportation and DOD officials do not support a change in the MSF
selection process to incorporate bidding.  Transportation officials
believe that the existing 47-vessel fleet is the best mix of ships
and associated transportation systems at the best price possible. 
They also believe that the lower level of financial support provided
by the MSF program, as opposed to the expiring ODS program, is
challenging U.S.  vessel owners to lower their costs.  In addition,
these officials note that the MSF program has broad consensus and
support within government and industry.  They believe that a change
would offer little possibility of cost savings and introduce the risk
of DOD not having access to the ships and associated transportation
systems when needed.  In particular, the officials are concerned that
a bidding process could be more costly, result in the government
being held liable for breach of contract, or result in the reflagging
of vessels currently under U.S.  registry.  In June 1997,
Transportation formally recommended that the current program not be
reopened for competitive bidding.\6

DOD officials believe that the current program provides the
capability needed to ensure sealift support and access to critical
transportation assets in a time of national emergency.  They do not
believe that significant cost savings can be achieved by introducing
a competitive selection process.  According to DOD, over 50 percent
of the contingency sealift capacity needed in wartime would be
provided by MSF recipients, and any disruption to the current program
could affect DOD's ability to effectively plan for these
contingencies.  DOD officials noted that MSF agreements provide
long-term stability for contingency planning and were concerned that
changes could reduce participation by major U.S.-flag carriers, who
provide the bulk of the transportation infrastructure, and leave only
carriers with significantly reduced capabilities.  In a July 1997
letter to the Chairman, Senate Committee on Commerce, Science, and
Transportation, the Secretary of Defense recommended continuation of
the current MSF selection process. 


--------------------
\6 Report to the Chairman, Senate Committee on Commerce, Science, and
Transportation on the Issue of Introducing Competitive Bidding to the
Maritime Security Program (P.L.  104-239), Department of
Transportation, Maritime Administration, June 1, 1997. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :7

The Department of Transportation and DOD reviewed a draft of this
report and concurred with our findings.  Transportation provided
technical comments verbally, which we incorporated where appropriate. 
DOD advised us that it had no comments or suggested changes to the
language of the report. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :8

To address the potential impact of a bidding process on the number of
vessels qualifying for the MSF program, we met with representatives
from MARAD and the Transportation Command.  We analyzed MARAD data
regarding the pool of qualified bidders, the application process, and
selection results.  We also reviewed MARAD-generated data on the
inventory of commercial ships to identify the universe of ships
participating in foreign trade.  We analyzed this inventory to
determine whether ships that met the MSF selection criteria were not
submitted for consideration. 

To address the potential impact of a bidding process on MSF program
costs, we interviewed officials from MARAD; representatives of five
shipping companies that own 33 of the 47 MSF vessels; and the
American Maritime Congress, which represents the interests of the
U.S.  shipping industry and lobbies on its behalf to impact proposed
legislation and other purposes.  We used MARAD cost data to compare
the projected cost of the MSF program with the ODS program and noted
the cost differences of operating U.S.- and foreign-registered
vessels.  We also computed the potential impact of expected inflation
on the $2.1-million MSF payments.  We did not test the validity or
reliability of MARAD cost data. 

To address the legal issues related to introducing a competitive
selection process into the MSF program, we reviewed the Maritime
Security Act and relevant case law, and discussed possible legal
implications with MARAD officials.  We also discussed potential legal
implications with representatives of shipping companies that have
signed MSF agreements. 

To determine Transportation's and DOD's views on the desirability of
instituting a bidding process for MSF slots, we interviewed agency
officials and reviewed related agency reports. 

We conducted our review between April and September 1997 in
accordance with generally accepted government auditing standards. 


---------------------------------------------------------- Letter :8.1

As requested, we plan no further distribution of this report until 15
days after its issue date.  At that time, we will send copies to the
Chairmen of the House and Senate Committees on Armed Services and the
Senate Committee on Appropriations, the Director of the Office of
Management and the Budget, and the Secretaries of Defense and
Transportation.  Copies will also be made available to other
interested parties on request. 

Please contact me at (202) 512-5140 if you or your staff have any
questions concerning this report.  Major contributors to this report
are listed in appendix I. 

Mark E.  Gebicke
Director, Military Operations
 and Capabilities Issues


MAJOR CONTRIBUTORS TO THIS REPORT
=========================================================== Appendix I


   NATIONAL SECURITY AND
   INTERNATIONAL AFFAIRS DIVISION,
   WASHINGTON, D.C. 
--------------------------------------------------------- Appendix I:1

Elliott C.  Smith
Bennett Quade
Charles W.  Perdue
Karen Blum


   NORFOLK FIELD OFFICE
--------------------------------------------------------- Appendix I:2

Hugh E.  Brady, Jr.
Harry E.  Taylor, Jr. 


   OFFICE OF THE GENERAL COUNSEL,
   WASHINGTON, D.C. 
--------------------------------------------------------- Appendix I:3

Mark C.  Speight

*** End of document. ***