United States General Accounting Office

GAO Report to Congressional Requesters

September 1997 MARITIME SECURITY

FLEET

Factors to Consider

Before Deciding to

Select Participants

Competitively

GAO/NSIAD-97-246

GAO United States

General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

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 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

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.

Page 1 GAO/NSIAD-97-246 Maritime Security Fleet
B-277913 

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

Page 2 GAO/NSIAD-97-246 Maritime Security Fleet
B-277913 

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

Results in Brief 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

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.

Page 3 GAO/NSIAD-97-246 Maritime Security Fleet
B-277913 

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

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.

Page 4 GAO/NSIAD-97-246 Maritime Security Fleet
B-277913 

Effect of a Bidding

Process on Program

Cost Is Uncertain

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).

Page 5 GAO/NSIAD-97-246 Maritime Security Fleet
B-277913 

Figure 1: Expiring ODS and MSF Average Annual Payments

1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

0

1

2

3

4

5

6

Dollars in millions

Average

ODS outlay 

Average

MSP outlays

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

3

We averaged the annual inflation forecast of two major economic forecasting firms—WEFA and

DRI/McGraw-Hill.

Page 6 GAO/NSIAD-97-246 Maritime Security Fleet
B-277913 

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

2

2.1

2.2

2.3

2.4

2.5

2.6

2.7

Fiscal year

Adjusted subsidy

1997 1998 1999 2000 2001 2002 2003 2004 2005

2.100 2.149 2.201 2.257 2.316 2.377 2.444 2.515 2.590

Dollars in millions

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.

Page 7 GAO/NSIAD-97-246 Maritime Security Fleet
B-277913 

Legal Risks Could Be

Involved in Changing

the Selection Process

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.

Page 8 GAO/NSIAD-97-246 Maritime Security Fleet
B-277913 

Neither

Transportation Nor

DOD Support

Changing the

Selection Process

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.

Agency Comments 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.

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.

Page 9 GAO/NSIAD-97-246 Maritime Security Fleet
B-277913 

Scope and

Methodology

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.

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.

Page 10 GAO/NSIAD-97-246 Maritime Security Fleet
B-277913 

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

Page 11 GAO/NSIAD-97-246 Maritime Security Fleet
Appendix I 

Major Contributors to This Report

National Security and

International Affairs

Division, Washington,

D.C.

Elliott C. Smith

Bennett Quade

Charles W. Perdue

Karen Blum

Norfolk Field Office Hugh E. Brady, Jr.

Harry E. Taylor, Jr.

Office of the General

Counsel, Washington,

D.C.

Mark C. Speight

(703198) Page 12 GAO/NSIAD-97-246 Maritime Security Fleet
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