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A Guaranteed Taxpayer Rip-Off?

You buy a new car. Days later, you receive a notice from the manufacturer recalling the car due to a defect. It would be ridiculous to pay the manufacturer again to fix the defect, wouldn’t it?

That’s basically what the U.S. Navy and Coast Guard are doing on shipbuilding contracts, according to a report released last week by the Government Accountability Office (GAO). According to the report, this is how it works:

[T]he Navy and Coast Guard paid the shipbuilder to build the ship as part of the construction contract, and then paid the same shipbuilder again to repair the ship when defects were discovered after delivery—essentially rewarding the shipbuilder for delivering a ship that needed additional work.

The GAO reviewed six shipbuilding contracts. Five include guarantees under which the Navy and Coast Guard are obligated to pay the contractor to repair defects that are the contractor’s fault. The sixth contract includes a warranty, for which the government pays at the time the contract is awarded but which requires the contractor to correct its mistakes at its own expense.

For example, on the San Antonio Class Amphibious Transport Dock, the ship’s exterior hull paint began to peel shortly after delivery. The Navy determined that the shipbuilder, Huntington Ingalls Industries (HII), did not adequately prepare the surface of the ship prior to applying a second coat of paint. Nevertheless, the guaranty required the Navy to pay HII $315,000 to repaint the vessel. Guaranty provisions in the contracts to build the Arleigh Burke Class Guided Missile Destroyer and the National Security Cutter cost the government $443,000 and $588,000, respectively, to fix defects that were the fault of the contractors.

In contrast, the contract to build the Coast Guard’s Fast Response Cutter includes a warranty, which requires the contractor to correct its mistakes at its own expense. The Coast Guard paid about $630,000 up front for the warranty, but the GAO found it saved the government more than $1.5 million in repair costs. On all six contracts, the GAO determined that taxpayers absorbed 86 percent of the cost associated with fixing contractors’ botched work—a total of $6.4 million.

The report singled out the Navy in particular for its heavy reliance on guarantees that often result in bad deals for the government. Navy officials insist that guarantees reduce the overall cost of purchasing ships, although they were unable to provide data to the GAO backing up this claim.

“Without a clear objective and guidance for using a guaranty and for determining when a warranty is appropriate in shipbuilding, Navy contracting officers do not have the information they need to make informed decisions regarding which mechanism is in the best interest of the taxpayer,” the report concluded.

Unfortunately, such inadequate planning fits into a larger pattern at the Navy. In a September 2014 analysis of the Littoral Combat Ship program, the GAO observed that the Navy was “driven by a focus on near-term cost performance by shipbuilders [and] a desire to introduce the long-delayed ships to the fleet,” causing the Navy to “devote considerably more time and money to resolving deficiencies after delivery.”

According to the GAO, the government spends about $17 billion per year building ships, which puts the $6.4 million repair cost somewhat in perspective. Nonetheless, we are troubled by the report’s implications. In this particular analysis, warranties may seem to have a cost benefit edge over guarantees, but both arrangements amount to the same thing: taxpayers subsidizing poor contractor performance.