Report questions ballooning use of cost-plus contracts

The Bush administration significantly increased the use of a contract structure that is risky to the government, according a new report by the Office of Management and Budget.

Cost-reimbursement contracts and similar deals in which agencies offer contractors incentives or award fees based on their performance are popular with procurement officials for projects that require significant research and development, and for complex programs where costs are difficult to estimate.

But in a report to the Senate Homeland Security and Governmental Affairs Committee, OMB Director Peter R. Orszag suggested that the use of cost-reimbursement contracts increased at a troubling rate during the previous administration.

In fiscal 2000, he said, agencies obligated about $71 billion in cost-reimbursement contracts. By fiscal 2008 that figure had grown more than 90 percent to $135 billion.

"This near-doubling in cost-reimbursement contracts calls into question whether these vehicles are being used excessively or without adequate justification, and whether agencies have the necessary skills and capacity -- within both acquisition and program offices -- to successfully administer these contracts," Orszag said.

The report, required under the 2009 Defense Authorization Act, noted that five agencies -- the Defense, Energy, Health and Human Services, and Homeland Security departments, and NASA -- made 95 percent of the total cost-plus obligations in fiscal 2008.

Despite the rapid increase in dollar obligations, use of cost-reimbursement contracts has decreased as percentage of overall spending.

In fiscal 2000, cost-type contracts accounted for about 35 percent of $208 billion in total contract obligations. That decreased to 25 percent of more than $500 billion total contract obligations in fiscal 2008. The government spent about 60 percent of contract obligations, or $315 billion, on fixed-price contracts that year.

Nonetheless, Orszag expressed concern that cost-type contracts pose a "substantial risk" to the government and might need to be reined in.

"Agencies must apply appropriate surveillance during performance to provide reasonable assurance that efficient methods and effective cost controls are used," he wrote. "This oversight requires more resources and the involvement of a broader range of disciplines than are typically required to administer a fixed-price contract. In addition, the contractor's accounting system must be adequate so the government and contractor may accurately identify costs applicable to the contract."

In a March 4 memorandum to all federal agencies, President Obama said cost-reimbursement contracts should be used only when circumstances prevent agency officials from defining requirements in enough detail to use a fixed-price contract.

Obama asked OMB to review the use of cost-reimbursement and sole-source contracts, which he said can be "wasteful, inefficient, subject to misuse, or otherwise not well-designed to serve the needs of the federal government or the interests of the American taxpayer."

By June 1, OMB must develop guidance that will identify and correct specific wasteful and inefficient contracts, according to the memo. And by Sept. 30, OMB must issue additional guidance on the appropriate use and oversight of sole-source and other types of noncompetitive contracts and on maximizing the use of full and open competition.

Separately, the Civilian Agency Acquisition and Defense Acquisition Regulations councils -- which are responsible for amendments to the Federal Acquisition Regulation -- are developing regulatory changes to the administration's policies associated with cost-reimbursement contracting.