Warranties and guarantees are both mechanisms  to address the correction of shipbuilder-responsible defects, but they  differ in key ways. Table 2 shows key elements of warranties and  guarantees. Table 3 shows the contract and vessel type for each Navy and Coast  Guard ship we reviewed. Navy’s Guaranty Mechanism Generally Has No Effect on Improving Cost and Quality Outcomes, in Contrast to FRC and Commercial Warranties

The Navy and Coast Guard paid shipbuilders to repair shipbuilder- responsible deficiencies after delivery for most of the ships that we  reviewed. In the four case study ships that used a fixed-price incentive  contract with a guaranty, the Navy and Coast Guard paid the shipbuilder  to build the ship as part of the construction process, and then paid the  same shipbuilder a second time to repair the ship when defects were  discovered after delivery. Contract Type and Terms Dictate the Degree to Which the Government Pays for Defects after Delivery

For the six government ships we reviewed, the type of contract and terms  used to purchase the ship determined the degree to which the  government or the shipbuilder paid for shipbuilder-responsible  deficiencies after delivery. For ships with fixed-price incentive contracts,  we found that, included in the costs the government paid to correct  shipbuilder-responsible defects, the shipbuilders earned between 1 and  10 percent profit or fee under the construction contract or under a follow- on arrangement to correct the defects determined to be their  responsibility for both guaranty claims and follow-on work to correct the  defects. Without reassessing its practice of allowing the shipbuilder to earn profit  for correcting shipbuilder-responsible defects, the Navy may be missing  opportunities to improve incentives and lower costs to the taxpayer. Robust Defect Correction

In general, commercial buyers, as well as the Coast Guard for the FRC,  submitted more claims for correcting defects than the Navy did for its  ships with guarantees. While use of a warranty per the FAR is not mandatory, the  Navy has not examined whether or not a warranty is appropriate for the  ships it purchases—a practice recommended in DOD guidance. In contrast, the Coast Guard’s FRC program warranty is based on FAR  principles. The FAR provides that: (1) the agency assesses whether or  not a warranty is worth the cost, (2) the government may direct the  contractor to repair or replace defective items at the contractor’s expense,  and (3) a principal purpose of a warranty in a government contract is to  foster quality performance. According to Standards for Internal Control in the  Federal Government, government programs require objectives and  guidance to ensure that a program is achieving the desired outcomes in a  manner that effectively uses funding. Although the FAR provides  for consideration of certain factors in determining whether a warranty is  appropriate for an acquisition and DOD requires documentation of why a  warranty is or is not appropriate, the Navy has not considered or  documented whether or not a warranty would be appropriate for its ships. Establish and document a clear objective for using a guaranty, and  then create guidance for contracting officers that illustrates how to  implement a guaranty that meets this objective. The Navy plans to coordinate its findings with DOD’s Defense  Procurement and Acquisition Policy and complete the study by  September 30, 2016. We are sending copies of this report to the Secretary of the Department  of Defense, the Secretary of the Department of Homeland Security, the  Secretary of the Navy, the Commandant of the Coast Guard, and  appropriate congressional committees. Appendix I: Objectives, Scope, and Methodology

This report assessed: (1) the extent to which the Navy and Coast Guard’s  guaranty or warranty mechanisms reduce the government’s exposure to  additional costs and improve the quality of basic ship construction, if any,  as compared to commercial shipbuilding; and (2) the extent to which the  Navy and Coast Guard use available acquisition regulation and guidance  in implementing guarantees and warranties in shipbuilding programs. To assess the extent to which the Navy and Coast Guard use available  acquisition regulation and guidance in implementing warranties and  guarantees, we reviewed and analyzed the ship construction contracts for  each of the six case studies.
Why GAO Did This Study

The U.S. government spends about $17 billion per year building ships to support national defense and homeland security. Defects often become evident shortly after a ship is delivered. Warranties and guarantees are both mechanisms to fix defects for which shipbuilders are responsible.
Warranties give the government a contractual right to direct the correction of defects at the contractor's expense.
Guarantees are Navy-specific contractual mechanisms that provide for the correction of defects; but unlike warranties are not covered in the FAR.
The House report accompanying the National Defense Authorization Act for Fiscal Year 2015 included a provision for GAO to review warranties and guarantees in government shipbuilding programs. This report assesses the extent to which (1) warranties and guarantees reduce the government's exposure to additional costs and risks of poor quality and (2) how the Navy and Coast Guard use acquisition regulations and guidance to implement warranties and guarantees. GAO reviewed the Navy's and Coast Guard's guaranty or warranty practices and policies and selected six case studies, comprised of four Navy ships—representing ships built in the last five years—and two vessels the Coast Guard most recently purchased.

What GAO Found

For five of the six Navy and Coast Guard ships GAO reviewed, guarantees did not help improve cost or quality outcomes. While the type and terms of each contract determine financial responsibility for correcting defects, the government, in most of the cases GAO examined, paid shipbuilders to repair defects. For the four ships with fixed-price incentive type contracts and guarantee clauses, the government paid the shipbuilder 89 percent of the cost—including profit—to correct these problems. This means the 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. Navy officials stated that this approach reduces the overall cost of purchasing ships; however, the Navy has no analysis that proves their point. In contrast, the warranty on another Coast Guard ship—the Fast Response Cutter (FRC)—improved cost and quality by requiring the shipbuilder to pay to repair defects. The Coast Guard paid upfront for the warranty, which amounted to 41 percent of the total defect correction costs. The figure below shows the amount, as a portion of the millions of dollars required to address defects, shipbuilders and the government paid to correct defects for the ships GAO reviewed and the difference in defect-correction arrangements.
Although the Federal Acquisition Regulation (FAR) and the Department of Defense guidance instruct programs to, respectively, consider and document the use of a warranty, the use of warranties is not mandatory, and the Navy does not consider using them for ship contracts. In contrast, the Coast Guard's FRC warranty, as well as that planned for another upcoming ship class, fosters quality performance by following the FAR warranty provisions. The Navy may be missing opportunities for savings by not considering use of warranties. Further, the Navy has no stated objective for its guarantees, and guidance for contracting officers is minimal as to when or how to use a guaranty. While the FAR does not apply to guarantees, according to federal internal control standards, government programs require objectives and guidance to ensure that they achieve the desired results. 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.

What GAO Recommends

DOD with the Navy should take steps to structure contracts so shipbuilders cannot earn profit for correcting defects for which they are responsible; determine whether a warranty is appropriate; and establish a guaranty objective and guidance. DOD partially concurred with the recommendations and it plans to complete a study by September 2016.