Compacts of Free Association
Trust Funds for Micronesia and the Marshall Islands May Not Provide Sustainable Income Gao ID: GAO-07-513 June 15, 2007In 2003, the U.S. government extended its economic assistance to the Federated States of Micronesia (FSM) and Republic of the Marshall Islands (RMI) through Amended Compacts of Free Association. From 2004 to 2023, the United States will provide an estimated combined total of $3.6 billion, with annually decreasing grants as well as annually increasing contributions to trust funds for each country. The trust funds are to be invested and provide income for the FSM and RMI after the compact grants end. A trust fund committee for each country is to establish and oversee the funds. This report examines (1) the committees' progress in establishing, investing, and reporting on the funds; (2) the sustainability of income from the trust funds; and (3) potential options to supplement or enhance the trust funds' income. GAO reviewed trust fund-related documents and legislation; interviewed U.S., FSM, RMI, and industry officials and used a simulation model to project the trust funds' income.
The FSM trust fund committee has established the fund by appointing a trustee, an auditor, an investment adviser, and money managers. As of the end of March 2007, the RMI committee had not appointed an auditor or a money manager. Investment of the funds began 22 months and 16 months, respectively, after the FSM's and RMI's initial contributions, with the funds remaining in low-interest savings accounts until their investment. Contractual delays contributed to the time taken to establish and invest the funds, as did the committees' processes for reaching consensus and obtaining administrative support; the committees have not yet taken steps to improve these processes. Although the committees are required to report annually on the trust funds, they did not publish reports for 2004 and were late in publishing the reports for 2005 and 2006. Moreover, the published reports do not assess the trust funds' potential effectiveness in helping the FSM and RMI achieve the compact goals of economic advancement and budgetary self-reliance. The FSM and RMI trust funds may not provide sustainable income after the compact grants end. Market volatility, as well as the investment strategies chosen, may lead to a wide range of trust fund balances in 2023. There is increasing probability that in some years the trust funds will not reach the maximum disbursement level allowed--an amount equal to the inflation adjusted compact grants in 2023--or be unable to disburse any income. GAO's analysis shows low probabilities of not reaching the maximum level allowed or disbursing no income in 2024 but higher probabilities of not reaching the maximum level allowed in 2050. For instance, by 2050, with a conservative investment strategy, income from the FSM and RMI trust funds, respectively, is over 90 percent and 60 percent likely to be less than the maximum level allowed and more than 20 percent and 15 percent likely to allow for no disbursements. The trust funds' income could be supplemented or enhanced through (1) greater tax revenue, (2) increasing remittances from growing emigration, (3) economic assistance from other sources, and, possibly, (4) securitization of the funds. However, limited development prospects constrain the countries' ability to raise tax revenues to supplement the trust fund income. In addition, FSM and RMI emigrants' inadequate education and vocational skills may limit their earning opportunities. Further, although the RMI trust fund received contributions from Taiwan, it is unclear whether the FSM trust fund will receive other contributions. Finally, although securitization--the issuing of bonds against future U.S. contributions--could increase the funds' earning potential by raising their balances, it could also lead to lower balances and reduced income. The committees have not yet obtained an independent evaluation of securitization's potential benefits and risks.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-07-513, Compacts of Free Association: Trust Funds for Micronesia and the Marshall Islands May Not Provide Sustainable Income
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Report to Congressional Committees:
United States Government Accountability Office:
GAO:
June 2007:
Compacts Of Free Association:
Trust Funds for Micronesia and the Marshall Islands May Not Provide
Sustainable Income:
GAO-07-513:
GAO Highlights:
Highlights of GAO-07-513, a report to congressional committees
Why GAO Did This Study:
In 2003, the U.S. government extended its economic assistance to the
Federated States of Micronesia (FSM) and Republic of the Marshall
Islands (RMI) through Amended Compacts of Free Association. From 2004
to 2023, the United States will provide an estimated combined total of
$3.6 billion, with annually decreasing grants as well as annually
increasing contributions to trust funds for each country. The trust
funds are to be invested and provide income for the FSM and RMI after
the compact grants end. A trust fund committee for each country is to
establish and oversee the funds. This report examines (1) the
committees‘ progress in establishing, investing, and reporting on the
funds; (2) the sustainability of income from the trust funds; and (3)
potential options to supplement or enhance the trust funds‘ income. GAO
reviewed trust fund–related documents and legislation; interviewed
U.S., FSM, RMI, and industry officials and used a simulation model to
project the trust funds‘ income.
What GAO Found:
The FSM trust fund committee has established the fund by appointing a
trustee, an auditor, an investment adviser, and money managers. As of
the end of March 2007, the RMI committee had not appointed an auditor
or a money manager. Investment of the funds began 22 months and 16
months, respectively, after the FSM‘s and RMI‘s initial contributions,
with the funds remaining in low-interest savings accounts until their
investment. Contractual delays contributed to the time taken to
establish and invest the funds, as did the committees‘ processes for
reaching consensus and obtaining administrative support; the committees
have not yet taken steps to improve these processes. Although the
committees are required to report annually on the trust funds, they did
not publish reports for 2004 and were late in publishing the reports
for 2005 and 2006. Moreover, the published reports do not assess the
trust funds‘ potential effectiveness in helping the FSM and RMI achieve
the compact goals of economic advancement and budgetary self-reliance.
The FSM and RMI trust funds may not provide sustainable income after
the compact grants end. Market volatility, as well as the investment
strategies chosen, may lead to a wide range of trust fund balances in
2023. There is increasing probability that in some years the trust
funds will not reach the maximum disbursement level allowed”an amount
equal to the inflation adjusted compact grants in 2023”or be unable to
disburse any income. GAO‘s analysis shows low probabilities of not
reaching the maximum level allowed or disbursing no income in 2024 but
higher probabilities of not reaching the maximum level allowed in 2050.
For instance, by 2050, with a conservative investment strategy, income
from the FSM and RMI trust funds, respectively, is over 90 percent and
60 percent likely to be less than the maximum level allowed and more
than 20 percent and 15 percent likely to allow for no disbursements.
The trust funds‘ income could be supplemented or enhanced through (1)
greater tax revenue, (2) increasing remittances from growing
emigration, (3) economic assistance from other sources, and, possibly,
(4) securitization of the funds. However, limited development prospects
constrain the countries‘ ability to raise tax revenues to supplement
the trust fund income. In addition, FSM and RMI emigrants‘ inadequate
education and vocational skills may limit their earning opportunities.
Further, although the RMI trust fund received contributions from
Taiwan, it is unclear whether the FSM trust fund will receive other
contributions. Finally, although securitization”the issuing of bonds
against future U.S. contributions”could increase the funds‘ earning
potential by raising their balances, it could also lead to lower
balances and reduced income. The committees have not yet obtained an
independent evaluation of securitization‘s potential benefits and
risks.
What GAO Recommends:
GAO recommends that the trust fund committees improve administrative
and decision-making processes, ensure timely reporting, and obtain a
full and independent evaluation of securitization‘s potential benefits
and risks. Interior, which chairs the committees, agreed with all of
the recommendations.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-513].
To view the full product, including the scope and methodology, click on
the link above. For more information, contact David Gootnick at (202)
512-3149 or gootnickd@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Establishment of FSM Trust Fund Is Complete, but RMI Trust Fund Is Not
Yet Fully Established:
FSM and RMI Trust Funds May Not Provide Sustainable Income after
Compact Grants End:
Several Options Exist for Supplementing FSM and RMI Trust Fund Income:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Technical Notes on the Trust Fund Simulation Model:
Appendix III: Disbursing All Income Compared to Disbursing Partial
Income:
Appendix IV: Key Events in the Establishment of the FSM and RMI Trust
Funds:
Appendix V: Comments from the Department of the Interior:
GAO Comment:
Appendix VI: Comments from the Department of Health and Human
Services57:
GAO Comment:
Appendix VII: Comments from the Department of State62:
GAO Comments:
Appendix VIII: Comments from the Federated States of Micronesia:
Appendix IX: Comments from the Republic of the Marshall Islands69:
GAO Comments:
Appendix X: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: U.S. Assistance to the FSM and the RMI under Amended Compacts,
Fiscal Years 2004-2023:
Table 2: Annual Compounded Real Returns and Standard Deviations for
Large Company and International Stocks and for U.S. Treasury Bills (in
percentage), 1970-2005:
Table 3: Possible Outcomes of Three Types of Investment Strategies,
with Associated Real Returns and Standard Deviations:
Table 4: Projected Trust Fund Balances in 2023 with and without
Securitization, under Aggressive Investment Strategy:
Table 5: U.S. Scheduled Contributions to FSM and RMI Trust Funds, as
Outlined in Amended Compacts:
Table 6: Taiwan's Scheduled Contributions to RMI Trust Fund, as
Outlined in Agreement with RMI Government:
Table 7: Real Returns Distribution Based on Historical Data from 1970
to 2005:
Table 8: Cross-Correlation and Serial Correlation of Historical Annual
Returns:
Table 9: Trial Values of the FSM Trust Fund Balances under Moderate
Investment Strategy, Fiscal Years 2006-2023:
Table 10: Trial Values of the RMI Trust Fund Balance under Moderate
Investment Strategy, Fiscal Years 2006-2023:
Figures:
Figure 1: Structure of FSM and RMI Trust Funds:
Figure 2: Inflation-Adjusted Annual Returns of International and Large
Company Stocks, 1970-2005:
Figure 3: Timeline of Key Events in Establishment of FSM Trust Fund:
Figure 4: Timeline of Key Events in Establishing the RMI Trust Fund:
Figure 5: Projections of FSM Account Balance with Three Possible
Investment Strategies:
Figure 6: Projections of RMI Account Balance with Three Possible
Investment Strategies:
Figure 7: Probability of FSM Trust Fund Income Not Reaching the Maximum
Disbursement Levels Allowed, Fiscal Years 2024 - 2050:
Figure 8: Probability of No Disbursement from FSM Trust Fund, Fiscal
Years 2024 - 2050:
Figure 9: Probability of RMI Trust Fund Income Not Reaching the Maximum
Disbursement Levels Allowed, Fiscal Years 2024 - 2050:
Figure 10: Probability of No Disbursement from RMI Trust Fund, Fiscal
Years 2024 - 2050:
Figure 11: Probabilities That FSM Trust Fund Income Will Not Reach the
Maximum Disbursement Level Allowed When Disbursing All Income vs.
Disbursing Partial Income:
Figure 12: Probabilities That RMI Trust Fund Income Will Not Reach the
Maximum Disbursement Level Allowed When Disbursing All Income vs.
Disbursing Partial Income:
Figure 13: Key Events in the Establishment of the FSM Trust Fund:
Figure 14: Key Events in the Establishment of the RMI Trust Fund:
Abbreviations:
FSM: Federated States of Micronesia:
HHS: Department of Health and Human Services:
RMI: Republic of Marshall Island:
United States Government Accountability Office:
Washington, DC 20548:
June 15, 2007:
Congressional Committees:
From 1987 to 2003[Footnote 1], the United States provided about $2.1
billion in economic assistance to the Federated States of Micronesia
(FSM) and the Republic of the Marshall Islands (RMI) through a Compact
of Free Association.[Footnote 2] In 2003, the U.S. government extended
its economic assistance to the FSM and the RMI governments through
Amended Compacts of Free Association.[Footnote 3] Under the amended
compacts' terms, the United States will provide an estimated combined
total of $3.6 billion in economic assistance to the FSM and the RMI
from 2004 to 2[Footnote 4]023, to assist the FSM and the RMI
governments in their efforts to promote the economic advancement and
budgetary self-reliance of their people. This assistance consists of
annually decreasing grants targeted to certain development sectors and
annually increasing contributions to a trust fund for each country, to
which the FSM and the RMI are also to make initial contributions. The
trust funds are to be invested, and after termination of annual U.S.
grant assistance in 2023, annual disbursements of the investment
earnings[Footnote 5] are to provide an ongoing source of revenue to
assist the FSM and the RMI in achieving economic advancement and long-
term budgetary self-reliance.
The amended compacts and subsidiary trust fund agreements[Footnote 6]
require the formation of a trust fund committee for each country. Each
committee is responsible for establishing the trust funds by, among
other things, hiring trustees, independent auditors, investment
advisers and money managers. The trust fund committees'
responsibilities also include overseeing the funds' operation,
supervision, and management; the funds' investment; and the conclusion
of agreements with any other contributors to the funds.[Footnote 7] The
trust fund agreements do not specify a time frame for establishing and
investing the funds. Within 6 months after the end of each fiscal year,
the committees are to provide annual reports to the governments on the
trust funds' activities, management, financial operations, and
effectiveness at accomplishing the purposes of the funds. Each
committee comprises representatives from the U.S. government, the
country's government, and any subsequent contributors; a representative
from the Department of the Interior (Interior) serves as the chair of
each committee.
U.S. legislation approving the amended compacts requires that we report
periodically to Congress on the status of compact implementation. In
2006, we provided two reports responding to this mandate.[Footnote 8]
This report provides additional information, examining (1) the trust
fund committees' progress in establishing,[Footnote 9] investing, and
reporting on the funds; (2) the sustainability of income from the trust
funds after the compact grants end in 2023; and (3) other potential
sources of revenue to supplement or enhance trust fund income after
2023.
To answer these objectives, we reviewed the amended compacts, the trust
fund agreements and bank statements as well as documents related to
establishing the funds. We also reviewed documents related to the
implementation of the trust fund agreements. We interviewed officials
from U.S. government agencies, including Interior, the Department of
State (State), the Department of Labor (Labor), and the Department of
Health and Human Services (HHS), as well as officials from the FSM and
the RMI. We interviewed the RMI's trustee and selected investment
adviser. In addition, we built a Monte Carlo simulation model--based on
the trust fund agreements, contributions to date, and historical
returns of the market--to project the trust funds' likely income
levels, given market volatility as well as historical returns of
various asset classes, including large company stocks, treasury bills,
and international stocks from 1970 to 2005. (Actual trust fund income
will depend on the investment strategies chosen for the funds, market
trends, and investment performance.) We also analyzed the probability
that the trust funds can maintain the maximum disbursement level
allowed under the trust fund agreements.[Footnote 10]We conducted our
work from July 2006 to March 2007 in accordance with generally accepted
government auditing standards. (For more details of our objectives,
scope, and methodology, see app. I.)
Side bar: Monte Carlo Simulation:
Our methodology for projecting trust fund income is based on a
technique known as the Monte Carlo simulation.This problem-solving
technique approximates the probability of certain outcomes by
performing multiple trial runs, called simulations, using random
variables. The simulations capture the volatility of market returns and
reflect that volatility in the projection of the future earnings of the
trust funds. GAO has used the Monte Carlo simulation in past reports,
and it has also been used by the Congressional Budget Office in Social
Security projections.
[End of side bar]
Results in Brief:
The FSM trust fund committee has fully established the country's trust
fund, but the RMI trust committee has not; further, investment of the
funds was slow, and both committees missed the deadlines for submitting
the required annual reports. The FSM committee has appointed a trustee,
an independent auditor, an investment adviser, and money managers. As
of March 2007, the RMI committee had not appointed an independent
auditor and--in part because the trustee and the investment adviser
disagree over the assignment of custodial rights to the fund--had not
appointed any money managers. Investment of the FSM and RMI trust funds
began 22 months and 16 months, respectively, after the countries'
initial contributions, with the funds remaining in low-interest savings
accounts until their investment. According to U.S. government
officials, unexpected contracting delays, as well as the trust fund
committees' processes for reaching consensus and obtaining
administrative support, contributed to slowing the funds'
establishment. However, the committees have not taken steps to improve
the processes. The committees did not meet the trust fund agreement
requirements to submit and publish annual reports on the trust funds
for 2004 and issued the reports for 2005 several months after the March
2006 deadline. Moreover, the reports do not assess the trust funds'
likely effectiveness in helping the FSM and the RMI achieve economic
advancement and long-term budgetary self-reliance by providing a source
of revenue to the FSM and RMI governments after 2023.
Owing in part to market volatility, the FSM and the RMI trust funds may
not provide sustainable income to the countries after annual compact
grants end in 2023. Market volatility, in addition to the investment
strategies chosen, may lead to a wide range of trust fund balances in
2023. For example, our analysis shows that the trust fund balance could
range[Footnote 11] from $697 million to $1.3 billion for the FSM and
from $439 million to $862 million for the RMI under a conservative
strategy, from $663 million to $2.2 billion for the FSM and from $438
million to $1.4 billion for the RMI under an aggressive strategy.
Moreover, we found increasing probability that income from the trust
funds cannot sustain the maximum disbursement level allowed--an amount
equal to the compact grant assistance in 2023, adjusted for inflation.
Furthermore, the trust funds face increasing probability of providing
no income at all in some years. For instance, our analysis shows low
probabilities that the trust funds will not reach the maximum allowed
disbursement levels immediately after the compact grants end. However,
by 2050, with a conservative investment strategy, income from the FSM
and RMI trust funds, respectively, is more than 90 percent and 60
percent likely not to reach the maximum allowed disbursement levels and
more than 20 percent and 15 percent likely to allow for no
disbursements.
The trust funds' income could be supplemented or enhanced through (1)
greater tax revenue through economic development; (2) increasing
remittances from growing numbers of emigrants;[Footnote 12] (3)
economic assistance from other sources; and (4) securitization of the
funds.[Footnote 13] However, each of these scenarios has its
limitations.
* Greater tax revenue. Economic development could increase the FSM and
the RMI governments' tax revenue. However, as we reported in 2006, the
countries' prospects for economic development and higher tax revenues
remain limited.
* Growing emigration and remittances. As compact grant assistance
decreases, emigration from the FSM and RMI may rise, easing the
governments' cost of providing services to remaining residents and
possibly leading to growing remittances from the emigrants. However,
FSM and RMI emigrants have limited earning opportunities abroad, owing
to inadequate education and vocational skills, and may therefore not
remit significant amounts.
* Assistance from other sources. The RMI trust fund received a
commitment from Taiwan to contribute $40 million over 20 years to the
RMI trust fund, which improved the RMI fund's likely capacity for
disbursements after 2023. However, except for Taiwan's commitment to
the RMI, there is no certainty of external trust fund contributions
other than those from the United States. Further, although donors other
than the United States have given the two countries economic assistance
unrelated to the trust funds, such assistance is not assured for the
future.
* Securitization. Although securitizing the trust funds--that is,
issuing bonds against future U.S. contributions--could increase the
funds' earning potential by raising their balances, it could also lead
to lower balances and reduced income. According to Interior officials,
the trust fund committees are reviewing this option but have not
initiated an independent study to objectively evaluate its potential
risks.
In this report, we recommend that the Secretary of the Interior direct
the Deputy Assistant Secretary for Insular Affairs, as Chairman of the
FSM and the RMI trust fund committees, to develop strategies for
improving the committees' decision-making and administrative processes;
ensure timely reporting of trust fund activities, including assessment
of the funds' likely status as an ongoing source of revenue and their
potential effectiveness in helping the FSM and the RMI achieve economic
advancement and budgetary self-reliance; and obtain an independent
evaluation of the potential benefits and risks of securitization.
Interior, HHS, State, and the FSM and the RMI governments provided
written comments regarding a draft of this report. Interior, HHS, and
the RMI government agreed with our recommendation on developing
strategies for improving the trust fund committees' decision-making and
administrative processes. Interior generally agreed with our
recommendation on ensuring timely reporting of trust fund activities.
However, HHS and State stated that our report reflected a fundamental
misunderstanding of the outcome of the negotiation of the amended
compacts and a misreading of the international agreements, which we
strongly disagree. Our report clearly stated that the purpose of the
trust funds is to provide an ongoing source of revenue. To further
clarify this point, we modified our recommendation and added language
specifying that there is no minimum disbursement required or guaranteed
by the trust fund agreements. Interior, HHS, and the RMI government
agreed with our recommendation on obtaining an independent evaluation
of the potential benefits and risks of securitization. The FSM
government generally agreed with all of our recommendations. State did
not provide any comment about our recommendations.
Background:
The U.S. trust fund agreements with the FSM and the RMI state that the
purpose of the trust funds is to contribute to the countries' economic
advancement and long-term budgetary self-reliance by providing an
annual source of revenue after fiscal year 2023.[Footnote 14] Annual
compact grants end in 2023. Although the agreements state that the
annual disbursements may not exceed the amounts that each country
receives as grant assistance in 2023, adjusted for inflation, they do
not establish or guarantee a minimum disbursement level.
Trust Fund Contributions:
Under the amended compacts, annual U.S. contributions to each of the
countries' trust funds increase by the same amounts as the annual
grants to the countries decrease; in addition, the contributions are
partially adjusted for inflation. (See table 1.) However, the scheduled
trust fund increments and grant decrements for the two countries
differ: the grant decrement and trust fund increment for the FSM is
$800,000 per year, and the grant decrement and trust fund increment for
the RMI is $500,000 per year. The timing of the first decrement for
each country also differs: under the amended compacts, the decrement
for the FSM began in 2007, but the decrement for the RMI began in 2005.
As a result of these differences, final grants to the FSM will decline
from the initial grants by a smaller total percentage than will grants
to the RMI (18 percent versus 21 percent).
Table 1: U.S. Assistance to the FSM and the RMI under Amended Compacts,
Fiscal Years 2004-2023:
Dollars in millions.
Fiscal year: 2004;
Annual grants contribution: FSM: $76.2;
Annual grants contribution: RMI: $35.2;
Trust fund contribution: FSM: $16.0;
Trust fund contribution: RMI: $7.0.
Fiscal year: 2005;
Annual grants contribution: FSM: 76.2;
Annual grants contribution: RMI: 34.7;
Trust fund contribution: FSM: 16.0;
Trust fund contribution: RMI: 7.5.
Fiscal year: 2006;
Annual grants contribution: FSM: 76.2;
Annual grants contribution: RMI: 34.2;
Trust fund contribution: FSM: 16.0;
Trust fund contribution: RMI: 8.0.
Fiscal year: 2007;
Annual grants contribution: FSM: 75.4;
Annual grants contribution: RMI: 33.7;
Trust fund contribution: FSM: 16.8;
Trust fund contribution: RMI: 8.5.
Fiscal year: 2008;
Annual grants contribution: FSM: 74.6;
Annual grants contribution: RMI: 33.2;
Trust fund contribution: FSM: 17.6;
Trust fund contribution: RMI: 9.0.
Fiscal year: 2009;
Annual grants contribution: FSM: 73.8;
Annual grants contribution: RMI: 32.7;
Trust fund contribution: FSM: 18.4;
Trust fund contribution: RMI: 9.5.
Fiscal year: 2010;
Annual grants contribution: FSM: 73.0;
Annual grants contribution: RMI: 32.2;
Trust fund contribution: FSM: 19.2;
Trust fund contribution: RMI: 10.0.
Fiscal year: 2011;
Annual grants contribution: FSM: 72.2;
Annual grants contribution: RMI: 31.7;
Trust fund contribution: FSM: 20.0;
Trust fund contribution: RMI: 10.5.
Fiscal year: 2012;
Annual grants contribution: FSM: 71.4;
Annual grants contribution: RMI: 31.2;
Trust fund contribution: FSM: 20.8;
Trust fund contribution: RMI: 11.0.
Fiscal year: 2013;
Annual grants contribution: FSM: 70.6;
Annual grants contribution: RMI: 30.7;
Trust fund contribution: FSM: 21.6;
Trust fund contribution: RMI: 11.5.
Fiscal year: 2014;
Annual grants contribution: FSM: 69.8;
Annual grants contribution: RMI: 32.2;
Trust fund contribution: FSM: 22.4;
Trust fund contribution: RMI: 12.0.
Fiscal year: 2015;
Annual grants contribution: FSM: 69.0;
Annual grants contribution: RMI: 31.7;
Trust fund contribution: FSM: 23.2;
Trust fund contribution: RMI: 12.5.
Fiscal year: 2016;
Annual grants contribution: FSM: 68.2;
Annual grants contribution: RMI: 31.2;
Trust fund contribution: FSM: 24.0;
Trust fund contribution: RMI: 13.0.
Fiscal year: 2017;
Annual grants contribution: FSM: 67.4;
Annual grants contribution: RMI: 30.7;
Trust fund contribution: FSM: 24.8;
Trust fund contribution: RMI: 13.5.
Fiscal year: 2018;
Annual grants contribution: FSM: 66.6;
Annual grants contribution: RMI: 30.2;
Trust fund contribution: FSM: 25.6;
Trust fund contribution: RMI: 14.0.
Fiscal year: 2019;
Annual grants contribution: FSM: 65.8;
Annual grants contribution: RMI: 29.7;
Trust fund contribution: FSM: 26.4;
Trust fund contribution: RMI: 14.5.
Fiscal year: 2020;
Annual grants contribution: FSM: 65.0;
Annual grants contribution: RMI: 29.2;
Trust fund contribution: FSM: 27.2;
Trust fund contribution: RMI: 15.0.
Fiscal year: 2021;
Annual grants contribution: FSM: 64.2;
Annual grants contribution: RMI: 28.7;
Trust fund contribution: FSM: 28.0;
Trust fund contribution: RMI: 15.5.
Fiscal year: 2022;
Annual grants contribution: FSM: 63.4;
Annual grants contribution: RMI: 28.2;
Trust fund contribution: FSM: 28.8;
Trust fund contribution: RMI: 16.0.
Fiscal year: 2023;
Annual grants contribution: FSM: 62.6;
Annual grants contribution: RMI: 27.7;
Trust fund contribution: FSM: 29.6;
Trust fund contribution: RMI: 16.5.
Total;
Annual grants contribution: FSM: $1,401.6;
Annual grants contribution: RMI: $629.0;
Trust fund contribution: FSM: $442.4;
Trust fund contribution: RMI: $235.0.
Source: Compact of Free Association Amendments Act of 2003 (Pub. L. No.
108-188).
Note: These dollar amounts will be adjusted each year for inflation by
a percentage that equals two-thirds of the percentage change in the
U.S. gross domestic product implicit price deflator, or 5 percent,
whichever is less in any one year, using the beginning of 2004 as a
base. Both grant funding and trust fund contributions can be fully
adjusted for inflation after 2014 under certain U.S. inflation
conditions.
[End of table]
The U.S. contributions to the trust funds are conditioned on the FSM
and the RMI making their own required contributions. The FSM was
required to contribute at least $30 million before September 30, 2004;
the FSM made this contribution on October 1, 2004, and the United
States made its first contribution on October 5, 2004. The RMI was
required to contribute at least $25 million on the day the amended
compact went into effect or on October 1, 2003, whichever was later;
$2.5 million before October 1, 2004; and an additional $2.5 million
before October 1, 2005. The RMI made its initial contribution on June
1, 2004, and the United States made its initial contribution on June 3,
2004.
According to the U.S. trust fund agreements with the FSM and the RMI,
contributions from other donors are permitted. In May 2005, Taiwan and
the RMI reached an agreement that Taiwan will contribute a total of $40
million to the RMI's trust fund from 2004 to 2023.
Trust Fund Structure:
As specified in the trust fund agreements, each country's trust fund
consists of three interrelated accounts, labeled "A," "B," and
"C."[Footnote 15]
* The A account, which was to be created on the amended compacts'
effective date, forms the trust fund "corpus"[Footnote 16] and contains
the country's initial contributions as well as the annual U.S.
contributions. It also holds any contributions from other donors, such
as Taiwan's to the RMI. The A account additionally consists of income
from the trust fund's investment. Through 2022, any annual investment
income exceeding 6 percent of the fund will be deposited in the C
account, up to a certain limit. After 2023, if the income in the B
account is less than the previous year's distribution, and if the C
account cannot cover the shortfall in the B account, the corpus shall
not be accessed to compensate for the shortfall.
* The B account, which is to be created at the start of fiscal year
2023, will be used to disburse income after the compact grants end. All
annual investment income earned in 2023 will be deposited in the B
account for possible disbursement in 2024. Thereafter, the B account
will consist of the prior year's investment income in the A account.
The annual disbursement from the B account may equal, but not exceed,
the inflation-adjusted grant assistance in 2023 plus any additional
amounts for special needs agreed to by the trust fund committee. Any
amount exceeding the annual disbursement will be transferred back to
the A account or--if the C account contains less than three times the
estimated equivalent of 2023 grant assistance, including estimated
inflation--transferred to the C account to bring it to the maximum
level allowed.
* The C account, which was to be created at the same time as the A
account, is designed as a buffer against low or negative annual
investment returns after 2023. During the period before disbursements
begin, any annual income on the fund exceeding 6 percent will be
deposited in the C account; however, the C account cannot exceed three
times the estimated grant assistance in 2023, including estimated
inflation. After 2023, if annual income from the A account falls below
the previous year's distribution, adjusted for inflation, the C account
can be drawn down to address any shortfall in the B account.
Figure 1: Structure of FSM and RMI Trust Funds:
[See PDF for image]
Source: GAO.
[End of figure]
Trust Fund Governance:
The trust funds, incorporated in the District of Columbia as nonprofit
corporations, are governed by the FSM and the RMI trust fund
committees, with the United States holding the majority of votes and
the Deputy Assistant Secretary of the Interior, Office of Insular
Affairs, serving as the chair of each committee.[Footnote 17] The
committees' responsibilities[Footnote 18] include establishing the
funds as well as overseeing their operation, supervision, and
management; investing and distributing the fund's resources; and
concluding agreements with any other contributors and other
organizations.
According to the trust fund agreements, each trust fund committee is to
appoint a trustee and an independent auditor. In addition, the
committee has the authority to appoint one or more investment advisers
and may enter into a separate agreement with one or more money
managers.
* The trustee[Footnote 19] is to have the entire care and custody of
all assets comprising the trust fund. The trustee's duties and powers
include collecting money due to the fund, disbursing income in
accordance with the trust fund agreement, and maintaining records of
all financial transactions related to the fund.
* The independent auditor is to audit the trust fund from its
establishment through 2023 at appropriate intervals and annually after
2023.
* The investment adviser is responsible for recommending one or more
money managers who will invest the assets of the fund to produce a
diversified portfolio, take direction from the trust fund committee
regarding investments, and oversee day-to-day investments by the money
manager.
* The money manager is to invest the funds in particular investment
vehicles or categories.
The trust fund agreements do not specify a time period for selecting
these entities.
In addition, the committees are responsible for publishing annual
reports on the trust funds and submitting the reports to the
governments of United States and the FSM or the RMI within 6 months
after the end of each fiscal year--that is, by the end of the following
March. These reports are to describe the activities and management of
the funds, including the operation of the A, B, and C accounts, and to
contain audited account information and the audit reports. The reports
are also to assess the effectiveness of the funds in contributing to
the economic advancement and long-term budgetary self-reliance of the
FSM and RMI. The reports may include recommendations to improve the
effectiveness of the funds.[Footnote 20]
Investment Returns and Volatility:
Because the level of income that the trust funds will generate depends
on investment returns, it is subject to market volatility.
Historically, the stock market has experienced fluctuations. For
example, from 1970 to 2005, annual inflation-adjusted returns of U.S.
large-company stocks ranged from negative 34 percent to positive 34
percent, and annual real returns from international stocks ranged from
negative 31 percent to positive 68 percent (see fig. 2). With positive
returns, the trust funds will earn investment income, and with negative
returns, the value of the trust funds will fall.
Figure 2: Inflation-Adjusted Annual Returns of International and Large
Company Stocks, 1970-2005:
[See PDF for image]
Source: GAO analysis based on IBBOTSON 2006 Yearbook.
Note: The returns were published in Stocks, Bonds, Bills and Inflation
(SBBI) 2006 Yearbook, Ibbotson Associates, Chicago, Illinois. The
inflation-adjusted returns are the geometric difference between the
nominal return and the inflation rate. Our calculation is based on
returns in calendar years (Jan. 1 - Dec. 31).
[End of figure]
The annual compounded real returns[Footnote 21] of large company stocks
and international stocks from 1970 to 2005 were around 6 percent (see
table 2), with standard deviations[Footnote 22] of approximately three
times the return for the large company stocks and more than three times
the return for the international stocks. U.S. treasury bills have the
least volatility and the lowest returns, around 1 percent.
Table 2: Annual Compounded Real Returns and Standard Deviations for
Large Company and International Stocks and for U.S. Treasury Bills (in
percentage), 1970-2005:
Compounded real returns;
Large company stocks: 6.12;
International stocks: 6.18;
U.S. Treasury bills: 1.27.
Standard deviation;
Large company stocks: 17.09;
International stocks: 22.05;
U.S. Treasury bills: 2.50.
Source: GAO analysis of data from IBBOTSON Associates 2006 Year Book.
Note: Percentages shown are based on returns in calendar years (Jan. 1
- Dec. 31).
[End of table]
Investment strategies vary in their levels of returns and volatility. A
more conservative investment strategy usually carries a lower level of
volatility but also brings lower levels of expected returns over time;
a more aggressive investment strategy seeks higher returns but is
likely to have higher volatility, with returns on the investment
varying more widely year to year. By varying the weight of each
investment asset, investors can vary their return and risk levels. With
the approach of 2024, when disbursements from the trust funds will
begin, the portfolio can be adjusted to take on less risk. To
illustrate possible outcomes of the trust funds' investment returns,
table 3 shows potential returns for three types of investment
strategies--conservative, moderate, and aggressive--based on historical
annual compounded returns and volatility on large company stocks,
international stocks, and treasury bills in 1970 to 2005.
Table 3: Possible Outcomes of Three Types of Investment Strategies,
with Associated Real Returns and Standard Deviations:
Strategy: Conservative (Lower expected return/lower volatility);
Large company stocks: 40%;
International stocks: 20%;
Treasury bills: 40%;
Return: 4.19%;
Standard deviation: 10.48%.
Strategy: Moderate (Medium expected return/medium volatility);
Large company stocks: 40;
International stocks: 40;
Treasury bills: 20;
Return: 5.17;
Standard deviation: 14.18.
Strategy: Aggressive (Higher expected return/higher volatility);
Large company stocks: 50;
International stocks: 50;
Treasury bills: 0;
Return: 6.15;
Standard deviation: 17.53.
Source: GAO analysis of data from IBBOTSON Associates 2006 Year Book.
Note: Percentages shown are based on returns in calendar years (Jan. 1
- Dec. 31).
[End of table]
Establishment of FSM Trust Fund Is Complete, but RMI Trust Fund Is Not
Yet Fully Established:
The FSM trust fund committee has appointed a trustee, an independent
auditor, an investment adviser, and money managers; investment of the
FSM trust fund began 22 months after the country's contribution. The
RMI trust fund committee has appointed a trustee and an investment
adviser, but as of March 2007, it had not yet appointed an auditor--in
part because of disagreement between the trustee and investment adviser
over the assigning of custodial rights--nor had it appointed a money
manager. Investment of the RMI's trust fund began 16 months after the
country's initial contribution. Unexpected delays related to
contractual problems and trust fund committee processes contributed to
the time that elapsed between the countries' initial contributions and
the investment of the funds. Moreover, the period of time that the
funds remained in low-interest accounts before their investment may
have reduced potential investment earnings, particularly for the FSM.
The committees did not meet the trust fund agreements' requirements to
submit and publish annual reports on the funds for 2004 and were late
in publishing the 2005 and 2006 reports. Moreover, the reports did not
assess the trust funds' potential status as an ongoing source of
revenue or effectiveness in helping the FSM and the RMI achieve
economic advancement and long-term budgetary self-reliance.
Trust Fund Committees Have Taken Steps to Establish and Invest the
Funds:
The FSM trust fund committee has appointed a trustee, an independent
auditor, an investment adviser, and money managers. The RMI trust fund
committee has not officially appointed an auditor or a money manager.
Investment of the funds began in August 2006 and September 2005,
respectively.
* FSM. The FSM trust fund committee hired a trustee, an auditor, an
investment adviser, and a money manager 24, 33, 16, and 21 months,
respectively, after the amended compact went into effect. Investment of
the FSM trust fund, according to its adopted investment policy, did not
begin until August 2006, nearly 2 years after the FSM's initial
contribution to the trust fund. Figure 3 provides a timeline of key
events in setting up the FSM trust fund. (For details about this
timeline, see app. IV).
Figure 3: Timeline of Key Events in Establishment of FSM Trust Fund:
[See PDF for image]
Source: GAO.
Note: The years shown are calendar years (Jan. 1 - Dec. 31).
[End of figure]
* RMI. The RMI trust fund committee hired its current trustee and
investment adviser in August 2005, 16 months after the amended compact
went into effect. However, as of March 2007, the committee had not yet
hired an independent auditor. In addition, owing to a disagreement
between the trustee and the adviser over the assigning of custodial
rights, the committee had not yet hired money managers to actively
invest the funds according to the proposed investment
strategy.[Footnote 23] The trust fund agreements state that the trustee
shall have the entire care and custody of all assets comprising the
fund, however, the investment adviser has requested "subcustody" to
allow it to better monitor the money managers' adherence to the
investment strategy. The RMI trustee has not agreed to this
arrangement, stating in a letter to the trust fund committee chairman
that the trust fund agreement does not allow such an arrangement
without legislation to amend the trust fund agreement. U.S. officials
told us that they had been searching for a resolution of this dispute.
Although the RMI made its first contribution of $25 million in June
2004, a month after the trust fund agreement went into effect, the
country did not make its second contribution until February 2005--
almost 5 months after the deadline--when it contributed $1.5 million,
which was $1 million less than required.[Footnote 24]The RMI government
explained that it faced various financial challenges in 2005, including
the cost of upgrading infrastructure at the College of the Marshall
Islands.[Footnote 25] The committee transferred the RMI trust fund from
low-interest bank accounts and began to invest it at the end of
September 2005, 16 months after the initial contribution to the trust
fund. In May 2005, Taiwan contributed $1 million to help fulfill RMI's
second contribution requirement, and in October 2005, the RMI made the
final contribution of $2.5 million. Figure 4 provides a timeline of key
events in setting up the RMI trust fund. (For details of the timeline
of key events, see app. III.)
Figure 4: Timeline of Key Events in Establishing the RMI Trust Fund:
[See PDF for image]
Source: GAO.
Note: The years shown are calendar years (Jan. 1 - Dec. 31).
[End of figure]
Several Factors Slowed Establishment of the Funds:
Unexpected contractual delays, as well as the trust fund committees'
decision-making and administrative processes, slowed the committees'
establishment of the funds.
* Contractual delays. Unexpected contractual delays slowed the FSM and
the RMI trust fund committees' establishment of the funds. For example,
according to an Interior official, the trustee chosen by the FSM trust
fund committee provided the wrong template for its contract with the
committee, with the result that finalizing the contract took extra
time. Also, a disagreement over fees between the RMI trust fund
committee and its initially selected trustee led the committee to
select another trustee, delaying the RMI's contracting with a trustee.
* Trust fund committee processes. Delays related to certain trust fund
committee processes also contributed to the time required to establish
the funds. The U.S. members make it a practice to convene to reach
consensus before attending full committee meetings. However, according
to an Interior official, difficulty in convening all U.S. members has
often delayed full committee meetings for months. Also, Interior noted
that the trust fund committees' reliance on U.S. government staff for
administrative support slowed committee processes. U.S. government
employees have undertaken administrative functions for the trust funds
in addition to their other duties. Interior, which has provided
administrative support for the trust funds, has advocated that the
trust funds hire their own support staff;[Footnote 26] however, State
has argued that after the trust funds are fully established, such
positions would not be needed and would result in unnecessary costs.
Some trust fund committee officials acknowledged that the committee
processes have slowed the funds' establishment. However, the committees
have not developed strategies to improve the consensus process and have
not reached agreement about whether they should hire outside
administrative assistance to improve committee performance.
Timing of Trust Fund Investment Reduced Potential Earnings:
Although the trust fund agreements do not set a time frame for
investing the funds, the months when the funds remained in low-interest
accounts prior to investment may have reduced their potential
investment earnings. However, the reduction in potential earnings was
significant only for the FSM trust fund.
* FSM. For several months before the FSM trust fund was invested, stock
market returns were notably higher than the interest that the fund
earned in the low-interest savings account. From October 2005 through
August 2006, the FSM trust fund--with an October 2005 balance of
approximately $80 million--earned about 3 percent interest, compared
with potential stock market earnings of about 15 percent. The
difference between the fund's actual and potential monthly rates of
return was about nine-tenths of a percentage point, amounting to
approximately $720,000 per month, taking into account stock market
investment fees. After the FSM's Office of the Public Auditor issued a
report evaluating the trust fund committee's compliance with the
administrative requirements of the trust fund agreement,[Footnote
27]the FSM government expressed concerns over the reduced income
resulting from the fund's remaining in the savings account.
* RMI. For the months before the investment of the RMI trust fund's
approximately $49 million in October 2005, the fund earned a return of
approximately 3 percent, compared with a stock market return of about 4
percent. Given the small difference in returns, as well as the fees
that the fund would have paid if invested in the stock market, the
reduction in the RMI trust fund's potential income was small. We
estimate that the delay in the RMI's final contribution to the fund
reduced its earnings by approximately $51,000.[Footnote 28]
Trust Fund Committees Did Not Publish Annual Reports as Required:
Neither trust fund committee provided an annual report to the U.S. and
FSM or RMI governments as required in the first year after the compacts
took effect, and both committees were late in submitting the second
year's reports.[Footnote 29] According to the trust fund agreements,
the committees are to prepare a report for each fiscal year and submit
it to both the U.S. and the FSM or RMI governments by the end of the
following March. However, neither committee submitted a report for
fiscal year 2004, instead submitting one report for both 2004 and 2005.
Additionally, the FSM and the RMI committees submitted these reports
several months after the March 2006 deadline, in July 2006 and August
2006, respectively. Moreover, the reports do not project the likely
status of the trust funds as an ongoing source of revenue or assess the
funds' potential effectiveness in helping the countries achieve
economic advancement and budgetary self-reliance.[Footnote 30] Because
the trust fund income will be a main source of U.S. assistance to the
FSM and the RMI after the amended compact grants end, its level has
implications for the economic policies of both countries. For example,
if trust fund income is expected to be inadequate to replace the
expiring grants, the countries will have a greater need to develop
other sources of revenue to help fund government operations.
FSM and RMI Trust Funds May Not Provide Sustainable Income after
Compact Grants End:
The FSM and the RMI trust fund income will likely not reach the maximum
allowed disbursement levels after the compact grants end in 2023, with
the probability of not reaching the maximum allowed level increasing
over time.[Footnote 31] Variable market returns, as well as the
investment strategy chosen, could lead to a wide range of potential
trust fund balances in 2023. Moreover, market volatility could
contribute to not reaching the maximum level allowed, including the
possibility of no disbursements in some years.[Footnote 32]
Market Volatility Could Lead to Wide Range of Trust Fund Balances in
2023:
Given historical market returns and volatility, the trust funds' likely
balances in 2023 fall into a wide range, with a more aggressive
strategy leading to higher expected balances but also a wider range of
possible balances (see fig. 5 and 6). For example, under our projected
conservative strategy, in 2023, the FSM trust fund balance could range
from $697 million (10th percentile) to $1.3 billion (90th percentile)
with a median of $959 million; the RMI trust fund could range from $439
million (10th percentile) to $862 million (90th percentile) with a
median of $612 million. Under our projected aggressive strategy, the
FSM trust fund balance could range from $664 million (10th percentile)
to $2.2 billion (90th percentile) with a median of $1.2 billion; the
RMI trust fund balance could range from $438 million (10th percentile)
to $1.4 billion (90th percentile) with a median of $778 million.
Figure 5: Projections of FSM Account Balance with Three Possible
Investment Strategies:
[See PDF for image]
Source: GAO.
[End of figure]
Figure 6: Projections of RMI Account Balance with Three Possible
Investment Strategies:
[See PDF for image]
Source: GAO.
[End of figure]
Trust Funds May Not Provide Sustainable Income after Compact Grants
End:
The FSM and the RMI trust funds may be unable to disburse the maximum
level of income allowed in the trust fund agreement[Footnote 33]s or
any income at all in some year[Footnote 34]s. Although each trust fund
has a separate account to absorb some market volatility, our analysis
shows there are some probabilities that income will not reach the
maximum disbursement level allowed or that no income will be disbursed
in some years, with the likelihood increasing with time.
FSM Trust Fund Income:
Under the conservative, moderate, and aggressive investment strategies
that we projected, the FSM trust fund's annual income will probably not
reach the maximum disbursement allowed, with the probability increasing
with time. For example, our analysis shows more than 50 percent
probability that the trust fund's income will not reach the maximum
disbursement level allowed after 2031 under the conservative investment
strategy, with the probability over 90 percent by 2050 (see fig. 7).
Figure 7: Probability of FSM Trust Fund Income Not Reaching the Maximum
Disbursement Levels Allowed, Fiscal Years 2024 - 2050:
[See PDF for image]
Source: GAO.
[End of figure]
Moreover, our analysis shows an increasing probability that market
volatility could prevent the FSM trust fund from making any
disbursements in some years, although a separate account--the C
account--was set up to absorb some market volatility. As shows, under
the conservative investment strategy, the probability of no
disbursements grows from 0 percent in 2024 to over 20 percent in 2050
(see fig. 8).
Figure 8: Probability of No Disbursement from FSM Trust Fund, Fiscal
Years 2024 - 2050:
[See PDF for image]
Source: GAO.
Note: The chart depicts results from 1,000 trial runs. The change from
one year to the next may not always be monotonic, but the general time
trend is clear. As the number of trial runs increase, the time trend
becomes smoother.
[End of figure]
Our analysis shows a wide range of probable disbursements from the FSM
trust fund. For example, under the moderate investment strategy, 10
years after the trust fund starts to disburse income, we find a 57
percent probability that the trust fund will disburse the maximum level
of income allowed, which is estimated at $97 million for 2034; a 11
percent probability that the trust fund will disburse no income; and a
33 percent probability that the trust fund will disburse some income,
between $0 and $97 million.
RMI Trust Fund Income:
Under the three potential investment strategies, income from the RMI
trust fund is likely not to reach the maximum allowed disbursement,
with the probability increasing over time. For example, our analysis
shows a more than 20 percent probability that the trust fund's income
will not reach the maximum allowed disbursement after 2031 under the
conservative strategy, with the probability over 60 percent by 2050
(see fig. 9).
Figure 9: Probability of RMI Trust Fund Income Not Reaching the Maximum
Disbursement Levels Allowed, Fiscal Years 2024 - 2050:
[See PDF for image]
Source: GAO.
Note: This analysis includes Taiwan's contribution to the A account.
[End of figure]
Additionally, our analysis shows an increasing probability that the
RMI's trust fund could yield no disbursements in some years, despite
the existence of the C account to absorb some market volatility. As
figure 10 shows, under the conservative investment strategy, the
probability of no disbursements rises from 0 percent in 2024 to more
than 15 percent in 2050 (see fig. 10).
Figure 10: Probability of No Disbursement from RMI Trust Fund, Fiscal
Years 2024 - 2050:
[See PDF for image]
Source: GAO.
Notes: This analysis includes Taiwan's contribution to the A account.
The chart depicts results from 1,000 trial runs. The change from one
year to the next may not always be monotonic, but the general time
trend is clear. As the number of trial runs increase, the time trend
becomes smoother.
[End of figure]
Our analysis shows a wide range of probable disbursements from the RMI
trust fund. For example, under the moderate investment strategy, 10
years after the trust fund starts to disburse income, we find an 84
percent probability that the trust fund will disburse the maximum level
of income allowed, which is estimated at $43 million for 2034; a 4
percent probability that the trust fund will disburse no income; and a
12 percent probability that the trust fund will disburse some income,
between $0 and $43 million.
Several Options Exist for Supplementing FSM and RMI Trust Fund Income:
The FSM and the RMI trust funds' income could be supplemented or
enhanced by (1) greater tax revenue through economic development in the
two countries, (2) increased remittances from growing numbers of
emigrants, (3) economic assistance from other donors, and (4)
securitization of the funds.[Footnote 35] However, each possible
scenario has limitations. In particular, although securitization could
lead to higher trust fund balances in 2023, it also has the potential
to lower investment income, reducing the balances.
Greater Tax Revenue through Economic Development:
Economic development in the FSM and the RMI could increase the
countries' tax revenue, helping to supplement the income from the trust
funds. However, as we reported in 2006, the countries' development
prospects remain limited--despite U.S. compact assistance since 1987,
aimed at promoting economic advancement and budgetary self-reliance--
and as a result, greater tax revenue may not be feasible.[Footnote
36]Both countries' economies depend on public sector expenditure,
funded largely by external assistance; in 2005, public sector
expenditures--about two thirds of which were funded by grants--were
about 60 percent of the gross domestic product. Further, both
governments' budgets face growing wage expenditures, heightening the
negative fiscal impacts they will face as compact grants decline. In
both countries, the growth of key industries faces multiple
constraints. Further, as we also reported in 2006, the FSM and the RMI
have not undertaken many reforms needed for economic development.
Growing Emigration and Remittances:
Growing emigration from the FSM and the RMI could help reduce the
countries' reliance on the trust fund income: as the countries'
populations decline, the governments' need for trust fund income to
provide services would also decline. FSM and RMI residents can relocate
to the United States relatively easily owing to rights granted under
the original compact and extended by the amended compacts.[Footnote
37]Many FSM and RMI citizens have chosen to exercise these rights: RMI
data suggest that as of 2005, about 15,000 Marshallese had migrated to
the United States, and FSM data suggest that almost twice as many
Micronesians live overseas. In both countries, the likely effects of
decreasing levels of per capita grant assistance may cause emigration
to increase.
* FSM. If the FSM population maintains its 2004 level,[Footnote 38]
real per capita grant assistance in 2023, the last year of compact
grants, will be about 73 percent of assistance in 2004, the first year
of compact grants. Furthermore, even with the aggressive investment
strategy we projected, the trust fund income is likely to be lower than
the compact grant, continuing the declining trend in government
resources. As a result, FSM living standards, including the
availability of social services, will likely be reduced, potentially
leading to further emigration.
* RMI. Per capita grant assistance in the last year of compact grants
will be about 70 percent of assistance in the first year if the RMI
population maintains its 2004 level. Given the aggressive investment
strategy, per capita trust fund income in 2024 and thereafter may equal
per capita grant assistance in 2023. However, if trust fund income is
unreliable, as our analysis shows likely, RMI living standards,
including the availability of social services, will probably be
affected, possibly leading to increased emigration.
If increasing numbers of FSM and RMI residents choose to emigrate in
the coming years as annual compact grants decrease, remittances from
growing numbers of emigrants could supplement residents' income and, if
taxed, could provide revenue to the FSM and the RMI governments.
However, it is not certain that remittances would grow significantly or
lead to increased government revenues. Although FSM and RMI emigrants
could provide increasing monetary support to their home nations,
inadequate education and vocational skills may limit their earning
opportunities. As we reported in 2006, the 2003 U.S. census of FSM and
RMI migrants in Hawaii, Guam, and the Commonwealth of the Northern
Mariana Islands shows that almost half of them live below the poverty
line. However, some economic experts emphasize that with an upgrading
of skills, the FSM's and the RMI's free access and strong historical
links to the U.S. economy create potential for the two nations to
expand remittance income.[Footnote 39]
Economic Assistance from Other Donors:
Economic assistance, including contributions to the FSM and the RMI
trust funds, from external sources other than the United States could
lessen the countries' reliance on trust fund income. For example, our
analysis shows that Taiwan's contribution of $40 million to the RMI's
trust fund reduced by nearly 10 percent the probability that the trust
fund not reaching the maximum disbursement level allowed in 2050.
However, it is not certain whether the FSM trust fund will receive any
such contributions or whether the RMI trust fund will receive any
further contributions. Further, although both countries have previously
received other economic assistance from donors besides the United
States--for example, from the Asian Development Bank, Australia, and
Japan--assistance in the future is not assured.
Trust Fund Securitization:
Securitization of the trust funds--that is, issuing bonds against
future U.S. contributions to the funds--has the potential to increase
the funds' balances. The benefit from securitization would mainly
derive from arbitrage, or potential differences in returns on
investment and returns on the bonds issued to investors: the greater
the differential, the greater the benefit from securitization.
However, although securitization of the trust funds carries potential
benefits, our analysis shows that its introduction could subject the
funds to greater risk. Because the full trust fund amounts would be
invested after securitization, loss from securitization in the early
years could lead to smaller investment income and trust fund balances
in later years. Our analysis shows that securitization could result in
a wider range of possible trust fund balances at the amended compacts'
expiration (see table 4). For example, under the possible aggressive
investment strategy, securitization could result in an FSM trust fund
balance of $579 million (10th percentile) to approximately $2.7 billion
(90th percentile), with a median of $1.3 billion; without
securitization, the trust fund balance could range from $664 million
(10th percentile) to approximately $2.2 billion (90th percentile), with
a median balance of about $1.2 billion.[Footnote 40] Securitization
could result in a similarly wider range of balances and larger median
balance for the RMI trust fund.
Table 4: Projected Trust Fund Balances in 2023 with and without
Securitization, under Aggressive Investment Strategy:
Dollars in millions.
Trust fund balance distribution statistics: 10th percentile;
FSM: With securitization: $579;
FSM: Without securitization: $664;
RMI: With: securitization: $390;
RMI: Without securitization: $438.
Trust fund balance distribution statistics: Median;
FSM: With securitization: 1,314;
FSM: Without securitization: 1,182;
RMI: With: securitization: 845;
RMI: Without securitization: 778.
Trust fund balance distribution statistics: 90th percentile;
FSM: With securitization: 2,700;
FSM: Without securitization: 2,179;
RMI: With: securitization: 1,688;
RMI: Without securitization: 1,401.
Trust fund balance distribution statistics: Standard deviation;
FSM: With securitization: 912;
FSM: Without securitization: 647;
RMI: With: securitization: 590;
RMI: Without securitization: 422.
Source: GAO.
[End of table]
According to officials of the FSM and the RMI trust fund committees,
the committees are considering securitizing the funds but disagree over
whether this option should be pursued. Some members believe that
securitization could bring great financial benefits, as a company that
performs securitization has asserted in presentations to the
committees; other members are concerned about potential risks. Others
raise concerns of whether the trust funds could pursue securitization
under the current amended compacts and trust fund agreements or whether
amendments to these agreements would be required. The committees have
not initiated an independent analysis to assist in their decisions.
Conclusions:
Since the enactment of the amended compacts with the FSM and the RMI,
the trust fund committees have taken important steps to establish the
funds. However, the committees' decision-making and administrative
processes slowed the funds' establishment and investment, leading to
lower potential investment earnings for the FSM. Until the committees
develop strategies to improve these processes, their ability to take
timely actions regarding the funds will likely be impeded. In addition,
the committees' tardiness in publishing the required annual reports
limited the public availability of information regarding the trust
funds' establishment and the committees' oversight. Further, the
reports do not assess the potential status of the funds as an ongoing
source of revenue after the compact grants end. Given the likely
effects of market volatility on the funds' investment earnings, such
assessments are needed to help the countries develop other strategies
for achieving the compact goals of economic advancement and long-term
budgetary self reliance. Both countries have several options to
supplement trust fund income after 2023, but these options have
limitations and are not assured of success. Although the trust fund
committees are considering one of these options--securitization--to
increase the funds' balances, they have not yet initiated an
independent analysis of securitization's potential benefits and risks,
including the possibility that securitization could lead to lower trust
fund balances in 2023.
Recommendations for Executive Action:
To enhance the FSM and the RMI trust fund committees' oversight of the
trust funds, we recommend that the Secretary of the Interior direct the
Deputy Assistant Secretary for Insular Affairs, as Chairman of the
committees, to work with other U.S. agencies on the committees to
undertake the follow three actions:
* develop strategies to improve the timeliness of the committees'
decision-making and administrative processes;
* ensure the committees' timely reporting of trust fund activities,
including assessing the funds' likely status as a source of revenue and
effectiveness in helping the countries achieve economic self-
sufficiency and long-term budgetary self-reliance; and:
* obtain a full and independent evaluation of the potential benefits
and risks of using securitization to increase the trust fund balances.
Agency Comments and Our Evaluation:
We received written comments from Interior, HHS, and State as well as
from the FSM and RMI governments (see app. V through IX for detailed
presentations of, and our responses to, these comments). We also
received technical comments from State, which we incorporated in our
report as appropriate. We did not receive any comment from Labor.
Interior, HHS, and the RMI government concurred with our first
recommendation. Interior also generally concurred with our second
recommendation. However, HHS and State stated that our report reflected
a fundamental misunderstanding of the outcome of the negotiation of the
amended compacts and a misreading of the international agreements,
which we strongly disagree. Our report clearly stated that the purpose
of the trust funds is to provide an ongoing source of revenue. To
further clarify this point, we modified our recommendation and added
language specifying that there is no minimum disbursement required or
guaranteed by the trust fund agreements. We believe that careful
analysis of the trust funds each year will help establish realistic
expectations of the trust funds and provide information to the trust
fund committees as they make investment decisions and to FSM and RMI
government leaders as they set economic policies and undertake long-
term fiscal planning. Interior, HHS, and the RMI government agreed with
our third recommendation. The RMI noted that it would like the trust
fund contributions to be fully adjusted for inflation. The FSM
government in general agreed with all of our recommendations.
In addition to providing copies of this report to your offices, we will
send copies to interested congressional committees. We will also
provide copies of this report to the Secretaries of Health and Human
Services, the Interior, Labor and State as well as the President of the
Federated States of Micronesia and the President of the Republic of the
Marshall Islands. We will make copies available to others on request.
In addition, the report will be available at no charge on the GAO Web
site at http://www.gao.gov.
If you or your staff have any questions regarding this report, please
contact me at (202) 512-3149 or gootnickd@gao.gov. Contact points for
our offices of Congressional Relations and Public Affairs may be found
on the last page of this report. GAO staff who made major contributions
to this report are listed in appendix X.
Signed by:
David Gootnick:
Director, International Affairs and Trade:
List of Congressional Committees:
The Honorable Jeff Bingaman:
Chairman:
The Honorable Pete V. Domenici:
Ranking Member:
Committee on Energy and Natural Resources:
United States Senate:
The Honorable Joseph R. Biden, Jr.
Chairman:
The Honorable Richard G. Lugar:
Ranking Member:
Committee on Foreign Relations:
United States Senate:
The Honorable Nick J. Rahall, II:
Chairman:
The Honorable Don Young:
Ranking Member:
Committee on Natural Resources:
House of Representatives:
The Honorable Tom Lantos:
Chairman:
The Honorable Ileana Ros-Lehtinen:
Ranking Member:
Committee on Foreign Affairs:
House of Representatives:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
In this report on the trust funds established under the U.S.
government's amended compacts with the Federated States of Micronesia
(FSM) and the Republic of the Marshall Islands (RMI), we examine (1)
the trust fund committees' progress in establishing, investing, and
reporting on the funds; (2) the sustainability of income from the trust
funds after the compact grants end in 2023; and (3) other potential
sources of revenue to supplement or enhance trust fund income after
2023.
To review the trust fund committees' progress in establishing,
investing, and reporting on the funds, we reviewed the amended
compacts, trust fund agreements; annual trust fund reports for 2004 and
2005 by the trust fund committee, trust fund bank statements, and
documents related to the request for proposals to set up the trust
funds. We interviewed officials from the Departments of the Interior,
Health and Human Services, Labor, and State. We also interviewed
relevant RMI and FSM officials and representatives from companies
involved in setting up, investing, and managing the trust funds.
To project the trust fund income level after the U.S. annual compact
grants end, we obtained historical returns of various asset classes,
including large company stocks, international stocks, and U.S. treasury
bills, from 1970 to 2005 and built a projection model based on the
historical returns, contributions to the trust fund, and rules
governing the disbursement from the trust fund as outlined in the trust
fund agreements. We used the inflation projection by the Congressional
Budget Office to adjust the contribution and grant levels (see app. II
for a detailed discussion on the key inputs to the projection model).
We used a solver function in our projection model to find the minimum
level of return between 2007 and 2023 required, so that the trust fund
income equals the 2023 grant level plus full inflation for at least the
first 10 years after trust fund disbursements begin. For this
calculation, we assumed the trust funds will be put into U.S. treasury
bonds after 2023. To assess the impact of market volatility on the
trust fund income, we used the Monte Carlo simulation with computer-
generated random draws from a predefined distribution, based on the
historical returns and volatilities of the various asset classes. Each
random draw produces a possible outcome of the variables we are
interested in, such as the balance of the trust fund and the level of
disbursement in a particular year; 1,000 random draws generates 1,000
possible outcomes. We studied the distribution of the outcomes to
determine, for instance, the probability that the trust funds' annual
disbursements will be below the maximum allowed disbursement levels.
Probabilistic projection of the trust funds' income is an improvement
over the methodology based on constant returns because investment
returns are volatile.
To examine other potential sources of revenue to supplement the trust
fund income, we reviewed studies on the economic conditions in the FSM
and the RMI. We also reviewed studies examining emigration of the FSM
and RMI citizens. To examine the potential benefit and risks of
securitization, we modified the simulation model and compared the trust
funds' balance in 2023 with and without securitization. We assumed the
bond issued by the trust fund pays an annual return of 5.5
percent.[Footnote 41]
To ensure the soundness of our projection, we obtained and incorporated
technical comments on the simulation assumptions and methodology from
Interior and the investment adviser of the FSM trust fund.
We conducted our review from July 2006 to March 2007 in accordance with
generally accepted government auditing standards. We requested written
comments on a draft of this report from the Departments of the
Interior, Health and Human Services, and State as well as the
governments of the FSM and the RMI. All of these entities' comments are
discussed in the report and are reprinted in appendix V through IX. In
addition, we considered all technical comments and made changes to the
report, as appropriate.
[End of section]
Appendix II: Technical Notes on the Trust Fund Simulation Model:
The key inputs that we used to simulate the trust fund income after
2023 include (1) the trust funds' balances at the beginning of the
projection, (2) contributions to the trust funds, (3) inflation
adjustment to the contributions, (4) different accounts of the trust
funds and the rules governing the inter-account transfers, (5) the
simulation equation; (6) distribution of returns for the Monte Carlo
simulation, and (7) Monte Carlo simulation results.
1. Trust fund balance at the beginning of the projection:
As of September 30, 2006, the FSM trust fund had a balance of $86.53
million and the RMI trust fund had a balance of $63.14 million.
2. Contributions to the trust fund:
Table 5 shows scheduled contributions to the FSM and the RMI trust
funds by the United States, as outlined in the amended compacts. Table
5 shows scheduled contributions to the RMI trust fund by Taiwan, as
outlined in its agreement with the RMI.
Table 5: U.S. Scheduled Contributions to FSM and RMI Trust Funds, as
Outlined in Amended Compacts:
Dollars in millions.
Fiscal year.
2004;
U.S. contribution: FSM trust fund: $16;
U.S. contribution: RMI trust fund: $7.
2005;
U.S. contribution: FSM trust fund: 16;
U.S. contribution: RMI trust fund: 7.5.
2006;
U.S. contribution: FSM trust fund: 16;
U.S. contribution: RMI trust fund: 8.
2007;
U.S. contribution: FSM trust fund: 16.8;
U.S. contribution: RMI trust fund: 8.5.
2008;
U.S. contribution: FSM trust fund: 17.6;
U.S. contribution: RMI trust fund: 9.
2009;
U.S. contribution: FSM trust fund: 18.4;
U.S. contribution: RMI trust fund: 9.5.
2010;
U.S. contribution: FSM trust fund: 19.2;
U.S. contribution: RMI trust fund: 10.
2011;
U.S. contribution: FSM trust fund: 20;
U.S. contribution: RMI trust fund: 10.5.
2012;
U.S. contribution: FSM trust fund: 20.8;
U.S. contribution: RMI trust fund: 11.
2013;
U.S. contribution: FSM trust fund: 21.6;
U.S. contribution: RMI trust fund: 11.5.
2014;
U.S. contribution: FSM trust fund: 22.4;
U.S. contribution: RMI trust fund: 12.
2015;
U.S. contribution: FSM trust fund: 23.2;
U.S. contribution: RMI trust fund: 12.5.
2016;
U.S. contribution: FSM trust fund: 24;
U.S. contribution: RMI trust fund: 13.
2017;
U.S. contribution: FSM trust fund: 24.8;
U.S. contribution: RMI trust fund: 13.5.
2018;
U.S. contribution: FSM trust fund: 25.6;
U.S. contribution: RMI trust fund: 14.
2019;
U.S. contribution: FSM trust fund: 26.4;
U.S. contribution: RMI trust fund: 14.5.
2020;
U.S. contribution: FSM trust fund: 27.2;
U.S. contribution: RMI trust fund: 15.
2021;
U.S. contribution: FSM trust fund: 28;
U.S. contribution: RMI trust fund: 15.5.
2022;
U.S. contribution: FSM trust fund: 28.8;
U.S. contribution: RMI trust fund: 16.
2023;
U.S. contribution: FSM trust fund: 29.6;
U.S. contribution: RMI trust fund: 16.5.
Source: Public Law 108-188.
[End of table]
Table 6: Taiwan's Scheduled Contributions to RMI Trust Fund, as
Outlined in Agreement with RMI Government:
Dollar in millions.
2004;
Contribution to A account: $1.00;
Contribution to D account: $3.00.
2005;
Contribution to A account: 0.75;
Contribution to D account: 1.75.
2006;
Contribution to A account: 0.75;
Contribution to D account: 1.75.
2007;
Contribution to A account: 0.75;
Contribution to D account: 1.75.
2008;
Contribution to A account: 0.75;
Contribution to D account: 1.75.
2009;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2010;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2011;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2012;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2013;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2014;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2015;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2016;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2017;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2018;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2019;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2020;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2021;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2022;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
2023;
Contribution to A account: 2.40;
Contribution to D account: 0.00.
Source: Subsequent Contributor Accession Agreement between The Trust
Fund Committee Established by the Government of the United States of
America, and the Government of the Republic of the Marshall Islands
Implementing Section 216 and Section 217 of the Compact, as Amended and
Taiwan.
Note: Our projection included Taiwan's contribution to the A account,
but not the D account because it is a separate account from the rest of
the trust fund.
[End of table]
Inflation adjustment:
3. The compact grants and the U.S. trust fund contributions are
adjusted for inflation by a percentage that equals the lesser, in any
year, of two-thirds of the percentage change in the U.S. gross domestic
product implicit price deflator or 5 percent, using the beginning of
2004 as a base. Both grant funding and trust fund contributions can be
fully adjusted for inflation after 2014 under certain U.S. inflation
conditions.
Trust fund accounts and transfer rules:
4. The trust fund agreements allow for several types of transfers among
the A, B, and C accounts that we used in our projections.
Before 2023:
* From A to C. At the end of each year before disbursement starts in
2024, income exceeding 6 percent of the corpus shall be deposited in
the C account. The C account cannot exceed three times the estimated
equivalent of the fiscal year 2023 grant level, adjusted for inflation.
* From C to A. Any amount in the C account exceeding three times the
estimated equivalent of the fiscal year 2023 grant level, adjusted for
inflation, shall return to the A account.
Beginning in 2023:
* From A to B. During 2023 and each subsequent year, all investment
income will be transferred from the A account to the B account for
possible disbursement in the following year.
* From B to A or C. If the B account balance exceeds the annual grant
assistance level in 2023 plus full inflation, the excess will be
transferred to the A account. However, if the C account falls short of
the specified level (three times the estimated equivalent of the 2023
grant level, inflation adjusted), any excess in the B account will be
transferred to the C account to make up the shortfall.
* From C to disbursement or A account. If the B account falls short of
the previous year's disbursement, inflation adjusted, the C account can
be drawn on to cover the shortfall. (The trust fund corpus may not be
accessed for this purpose.) Any amount in the C account exceeding three
times the estimated equivalent of the fiscal year 2023 grant level,
adjusted for inflation, shall return to the A account.
In our projection, we assume that the trust funds will disburse the
maximum allowed amount if it is available. However, the trust fund
committees may disburse less than the maximum amount allowed and
reinvest some income. For a discussion of how partial disbursement can
affect the probability of trust fund income not reaching the maximum
disbursement level allowed (see app. III).
5. Simulation equation:
For the Monte Carlo simulation of trust fund balances, we used the
equation
[See PDF for equation]
6. Distribution of returns for Monte Carlo simulation:
The returns on the trust fund will be randomly drawn from a custom
distribution, which is based on historical real returns of the various
asset classes and the proportion of the asset in the investment
strategy. The distributions for international stocks, large company
stocks, and U.S. treasury bills are illustrated in table 7.
Table 7: Real Returns Distribution Based on Historical Data from 1970
to 2005:
International stocks: Range: -30.61%;
International stocks: Range: - 27.61%;
International stocks: Probability: 2.86%;
Large company stocks: Range: -34.47%;
Large company stocks: Range: -23.91%;
Large company stocks: Probability: 2.86%;
U.S. treasury bills: Range: -3.74%;
U.S. treasury bills: Range: -2.59%;
U.S. treasury bills: Probability: 2.86%.
International stocks: Range: -27.61;
International stocks: Range: - 22.41;
International stocks: Probability: 2.86;
Large company stocks: Range: -23.91;
Large company stocks: Range: -21.56;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: -2.59;
U.S. treasury bills: Range: -1.99;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: -22.41;
International stocks: Range: - 21.11;
International stocks: Probability: 2.86;
Large company stocks: Range: -21.56;
Large company stocks: Range: -13.23;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: -1.99;
U.S. treasury bills: Range: -1.72;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: -21.11;
International stocks: Range: - 17.62;
International stocks: Probability: 2.86;
Large company stocks: Range: -13.23;
Large company stocks: Range: -13.07;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: -1.72;
U.S. treasury bills: Range: -1.70;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: -17.62;
International stocks: Range: - 16.78;
International stocks: Probability: 2.86;
Large company stocks: Range: -13.07;
Large company stocks: Range: -12.71;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: -1.70;
U.S. treasury bills: Range: -1.55;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: -16.78;
International stocks: Range: - 15.17;
International stocks: Probability: 2.86;
Large company stocks: Range: -12.71;
Large company stocks: Range: -12.09;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: -1.55;
U.S. treasury bills: Range: -1.13;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: -15.17;
International stocks: Range: - 14.33;
International stocks: Probability: 2.86;
Large company stocks: Range: -12.09;
Large company stocks: Range: -8.75;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: -1.13;
U.S. treasury bills: Range: -1.03;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: -14.33;
International stocks: Range: - 9.15;
International stocks: Probability: 2.86;
Large company stocks: Range: -8.75;
Large company stocks: Range: -2.27;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: -1.03;
U.S. treasury bills: Range: -0.84;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: -9.15;
International stocks: Range: -6.29;
International stocks: Probability: 2.86;
Large company stocks: Range: -2.27;
Large company stocks: Range: -1.40;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: -0.84;
U.S. treasury bills: Range: -0.71;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: -6.29;
International stocks: Range: -4.55;
International stocks: Probability: 2.86;
Large company stocks: Range: -1.40;
Large company stocks: Range: -1.32;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: -0.71;
U.S. treasury bills: Range: -0.43;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: -4.55;
International stocks: Range: -1.02;
International stocks: Probability: 2.86;
Large company stocks: Range: -1.32;
Large company stocks: Range: 0.79;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: -0.43;
U.S. treasury bills: Range: 0.15;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: -1.02;
International stocks: Range: 0.35;
International stocks: Probability: 2.86;
Large company stocks: Range: 0.79;
Large company stocks: Range: 1.44;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 0.15;
U.S. treasury bills: Range: 0.26;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 0.35;
International stocks: Range: 2.94;
International stocks: Probability: 2.86;
Large company stocks: Range: 1.44;
Large company stocks: Range: 2.23;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 0.26;
U.S. treasury bills: Range: 0.42;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 2.94;
International stocks: Range: 3.76;
International stocks: Probability: 2.86;
Large company stocks: Range: 2.23;
Large company stocks: Range: 4.53;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 0.42;
U.S. treasury bills: Range: 0.59;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 3.76;
International stocks: Range: 5.25;
International stocks: Probability: 2.86;
Large company stocks: Range: 4.53;
Large company stocks: Range: 4.64;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 0.59;
U.S. treasury bills: Range: 0.98;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 5.25;
International stocks: Range: 5.88;
International stocks: Probability: 2.86;
Large company stocks: Range: 4.64;
Large company stocks: Range: 7.05;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 0.98;
U.S. treasury bills: Range: 1.00;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 5.88;
International stocks: Range: 8.79;
International stocks: Probability: 2.86;
Large company stocks: Range: 7.05;
Large company stocks: Range: 7.37;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 1.00;
U.S. treasury bills: Range: 1.02;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 8.79;
International stocks: Range: 9.15;
International stocks: Probability: 2.86;
Large company stocks: Range: 7.37;
Large company stocks: Range: 10.59;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 1.02;
U.S. treasury bills: Range: 1.20;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 9.15;
International stocks: Range: 10.25;
International stocks: Probability: 2.86;
Large company stocks: Range: 10.59;
Large company stocks: Range: 11.87;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 1.20;
U.S. treasury bills: Range: 1.60;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 10.25;
International stocks: Range: 10.70;
International stocks: Probability: 2.86;
Large company stocks: Range: 11.87;
Large company stocks: Range: 15.06;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 1.60;
U.S. treasury bills: Range: 1.83;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 10.70;
International stocks: Range: 11.85;
International stocks: Probability: 2.86;
Large company stocks: Range: 15.06;
Large company stocks: Range: 16.89;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 1.83;
U.S. treasury bills: Range: 1.85;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 11.85;
International stocks: Range: 16.89;
International stocks: Probability: 2.86;
Large company stocks: Range: 16.89;
Large company stocks: Range: 17.15;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 1.85;
U.S. treasury bills: Range: 1.95;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 16.89;
International stocks: Range: 18.42;
International stocks: Probability: 2.86;
Large company stocks: Range: 17.15;
Large company stocks: Range: 17.81;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 1.95;
U.S. treasury bills: Range: 2.25;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 18.42;
International stocks: Range: 19.65;
International stocks: Probability: 2.86;
Large company stocks: Range: 17.81;
Large company stocks: Range: 17.88;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 2.25;
U.S. treasury bills: Range: 2.42;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 19.65;
International stocks: Range: 20.05;
International stocks: Probability: 2.86;
Large company stocks: Range: 17.88;
Large company stocks: Range: 18.03;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 2.42;
U.S. treasury bills: Range: 2.46;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 20.05;
International stocks: Range: 23.15;
International stocks: Probability: 2.86;
Large company stocks: Range: 18.03;
Large company stocks: Range: 18.16;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 2.46;
U.S. treasury bills: Range: 2.98;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 23.15;
International stocks: Range: 23.18;
International stocks: Probability: 2.86;
Large company stocks: Range: 18.16;
Large company stocks: Range: 19.12;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 2.98;
U.S. treasury bills: Range: 3.20;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 23.18;
International stocks: Range: 23.98;
International stocks: Probability: 2.86;
Large company stocks: Range: 19.12;
Large company stocks: Range: 25.65;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 3.20;
U.S. treasury bills: Range: 3.50;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 23.98;
International stocks: Range: 26.94;
International stocks: Probability: 2.86;
Large company stocks: Range: 25.65;
Large company stocks: Range: 26.33;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 3.50;
U.S. treasury bills: Range: 3.55;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 26.94;
International stocks: Range: 28.12;
International stocks: Probability: 2.86;
Large company stocks: Range: 26.33;
Large company stocks: Range: 26.54;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 3.55;
U.S. treasury bills: Range: 3.81;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 28.12;
International stocks: Range: 29.38;
International stocks: Probability: 2.86;
Large company stocks: Range: 26.54;
Large company stocks: Range: 26.67;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 3.81;
U.S. treasury bills: Range: 4.82;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 29.38;
International stocks: Range: 33.06;
International stocks: Probability: 2.86;
Large company stocks: Range: 26.67;
Large company stocks: Range: 27.36;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 4.82;
U.S. treasury bills: Range: 4.97;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 33.06;
International stocks: Range: 36.60;
International stocks: Probability: 2.86;
Large company stocks: Range: 27.36;
Large company stocks: Range: 28.21;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 4.97;
U.S. treasury bills: Range: 5.30;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 36.60;
International stocks: Range: 51.03;
International stocks: Probability: 2.86;
Large company stocks: Range: 28.21;
Large company stocks: Range: 31.13;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 5.30;
U.S. treasury bills: Range: 5.68;
U.S. treasury bills: Probability: 2.86.
International stocks: Range: 51.03;
International stocks: Range: 68.04;
International stocks: Probability: 2.86;
Large company stocks: Range: 31.13;
Large company stocks: Range: 34.03;
Large company stocks: Probability: 2.86;
U.S. treasury bills: Range: 5.68;
U.S. treasury bills: Range: 6.42;
U.S. treasury bills: Probability: 2.86.
Source: GAO.
[End of table]
Cross-correlation and serial correlation are built into the Monte Carlo
random draws to capture the co-movement of the asset classes and over
time. (See table 8.)
Table 8: Cross-Correlation and Serial Correlation of Historical Annual
Returns:
International;
International: 1;
Large company: [Empty];
U.S. treasury bills: [Empty].
Large company;
International: 0.59;
Large company: 1;
U.S. treasury bills: [Empty].
Treasury bills;
International: -0.12;
Large company: 0.05;
U.S. treasury bills: 1.
Serial correlation;
International: 0.15;
Large company: 0.04;
U.S. treasury bills: 0.81.
Source: GAO.
[End of table]
7. Monte Carlo simulation results:
Each year's return is randomly selected from the return distribution of
each asset class. The simulation is run 1,000 times, yielding 1,000
possible outcomes and providing a distribution of annual investment
income, account balance, and disbursements. (Table 9 and table 10 show
the first 20 trial values from the simulation of the FSM and RMI trust
fund account balance.)
Table 9: Table 9: First 20 of the 1,000 Trial Values of the FSM Trust
Fund Balances under Moderate Investment Strategy, Fiscal Years 2006-
2023:
Dollars in millions.
1;
2006: $86.5;
2007: $133.3;
2008: $170.7;
2009: $192.8;
2010: $196.5;
2011: $167.5;
2012: $198.7;
2013: $236.5.
2;
2006: 86.5;
2007: 107.5;
2008: 154.0;
2009: 194.2;
2010: 251.4;
2011: 328.3;
2012: 332.6;
2013: 323.1.
3;
2006: 86.5;
2007: 93.51;
2008: 138.4;
2009: 176.0;
2010: 230.4;
2011: 267.3;
2012: 290.0;
2013: 312.7.
4;
2006: 86.5;
2007: 129.6;
2008: 181.4;
2009: 188.3;
2010: 210.6;
2011: 202.1;
2012: 250.6;
2013: 295.4.
5;
2006: 86.5;
2007: 121.5;
2008: 134.4;
2009: 148.5;
2010: 182.6;
2011: 275.5;
2012: 386.8;
2013: 474.9.
6;
2006: 86.5;
2007: 128.8;
2008: 124.2;
2009: 124.4;
2010: 151.0;
2011: 155.3;
2012: 216.6;
2013: 253.4.
7;
2006: 86.5;
2007: 122.6;
2008: 140.2;
2009: 192.4;
2010: 202.7;
2011: 225.3;
2012: 327.1;
2013: 358.3.
8;
2006: 86.5;
2007: 109.1;
2008: 112.7;
2009: 174.9;
2010: 250.4;
2011: 247.4;
2012: 256.1;
2013: 346.3.
9;
2006: 86.5;
2007: 103.5;
2008: 140.3;
2009: 174.8;
2010: 205.3;
2011: 256.2;
2012: 269.1;
2013: 333.7.
10;
2006: 86.5;
2007: 99.03;
2008: 136.1;
2009: 141.6;
2010: 173.8;
2011: 223.9;
2012: 276.3;
2013: 337.7.
11;
2006: 86.5;
2007: 109.5;
2008: 180.9;
2009: 214.1;
2010: 248.7;
2011: 228.9;
2012: 330.3;
2013: 368.2.
12;
2006: 86.5;
2007: 97.02;
2008: 129.3;
2009: 167.2;
2010: 233.5;
2011: 274.1;
2012: 365.2;
2013: 433.8.
13;
2006: 86.5;
2007: 91.73;
2008: 112.9;
2009: 157.1;
2010: 204.7;
2011: 253.1;
2012: 327.4;
2013: 388.0.
14;
2006: 86.5;
2007: 92.69;
2008: 137.1;
2009: 147.5;
2010: 208.1;
2011: 200.7;
2012: 256.6;
2013: 296.7.
15;
2006: 86.5;
2007: 99.15;
2008: 107.0;
2009: 114.7;
2010: 139.2;
2011: 207.4;
2012: 265.7;
2013: 359.9.
16;
2006: 86.5;
2007: 98.08;
2008: 134.3;
2009: 164.1;
2010: 160.8;
2011: 192.9;
2012: 241.0;
2013: 347.1.
17;
2006: 86.5;
2007: 108.0;
2008: 147.3;
2009: 195.2;
2010: 246.9;
2011: 358.8;
2012: 464.1;
2013: 461.7.
18;
2006: 86.5;
2007: 122.4;
2008: 150.2;
2009: 187.1;
2010: 226.1;
2011: 346.9;
2012: 413.8;
2013: 371.4.
19;
2006: 86.5;
2007: 116.2;
2008: 138.9;
2009: 202.0;
2010: 218.2;
2011: 268.0;
2012: 300.9;
2013: 270.6.
20;
2006: 86.5;
2007: 147.8;
2008: 222.5;
2009: 293.7;
2010: 304.0;
2011: 376.2;
2012: 362.8;
2013: 399.9.
10th percentile;
2006: 86.5;
2007: 94.23;
2008: 112.2;
2009: 135.2;
2010: 157.6;
2011: 182.2;
2012: 210.6;
2013: 236.9.
median;
2006: 86.5;
2007: 111.6;
2008: 139.2;
2009: 171.5;
2010: 206.3;
2011: 244.1;
2012: 288.9;
2013: 331.
90th percentile;
2006: 86.5;
2007: 128.3;
2008: 169.3;
2009: 213.8;
2010: 261.4;
2011: 323.8;
2012: 387;
2013: 455.5.
Source: GAO.
[End of table]
Table 10: First 20 of the 1,000 Trial Values of the RMI Trust Fund
Balance under Moderate Investment Strategy, Fiscal Years 2006-2023:
[Table did not compute- see PDF for table]
Source: GAO.
[End of table]
[End of section]
Appendix III: Disbursing All Income Compared to Disbursing Partial
Income:
The U.S. trust fund agreements with the FSM and the RMI state that the
trust fund committees may disburse an amount up to the inflation-
adjusted grant assistance in fiscal year 2023. However, if the trust
fund committees disburse less than the maximum allowed levels and
reinvest part of the trust fund income, this will change the
probability that the funds' income will not reach the maximum allowed
disbursement levels.[Footnote 42]
Figures 11 and 12, respectively, compare the probabilities, under our
projected moderate investment strategy, of the FSM and the RMI trust
fund income's not reaching the maximum disbursement level allowed when
all income is disbursed versus when partial income is
disbursed.[Footnote 43]During the earlier years, the probability that
income will not reach the maximum disbursement level allowed is
generally greater when only partial income is disbursed. However, the
probability that income will not reach the maximum disbursement level
allowed is lower in later years, because the benefit of the reinvested
trust fund income helps protect the trust fund principal against
inflation.
Figure 11: Probabilities That FSM Trust Fund Income Will Not Reach the
Maximum Disbursement Level Allowed When Disbursing All Income vs.
Disbursing Partial Income:
[See PDF for image]
Source: GAO.
[End of figure]
Figure 12: Probabilities That RMI Trust Fund Income Will Not Reach the
Maximum Disbursement Level Allowed When Disbursing All Income vs.
Disbursing Partial Income:
[See PDF for image]
Source: GAO.
[End of figure]
[End of section]
Appendix IV: Key Events in the Establishment of the FSM and RMI Trust
Funds:
Figure 13: Key Events in the Establishment of the FSM Trust Fund:
[See PDF for image]
Source: GAO.
[End of figure]
Figure 14: Key Events in the Establishment of the RMI Trust Fund:
[See PDF for image]
Source: GAO.
Note: The years shown are calendar years (Jan. 1 - Dec. 31).
[End of figure]
[End of section]
Appendix V: Comments from the Department of the Interior:
Note: GAO comment supplementing those in the report text appears at the
end of this appendix.
The Associate Deputy Secretary Of The Interior:
Washington, DC 20240:
May 1 1 2007:
Mr. David Gootnik:
Director:
International Affairs and Trade:
United States Government Accountability Office:
Washington, D.C. 20548:
Dear Mr. Gootnik:
Thank you for the opportunity to review and comment on the Government
Accountability Office Draft Report no. GAO-07-513, entitled Compacts of
Free Association: Trust Funds for Micronesia and the Marshall Islands
May Not Provide Sustainable Income. The Department of the Interior
finds the Draft Report to be a thoughtful and useful analysis and
generally agrees with the recommendations made by GAO.
The enclosure describes the specific actions that will be taken by the
Chairman of the Trust Fund Committees to address the three
recommendations of the Draft Report. If you have any questions, please
communicate with David B. Cohen, Deputy Assistant Secretary of the
Interior for Insular Affairs, or Nikolao Pula, Director of the Office
of Insular Affairs, at (202) 208-4736.
Sincerely.
Signed by:
James E. Cason:
Enclosure:
U.S. Government Accountability Office Draft Report Compacts Of Free
Association: Trust Funds for Micronesia and the Marshall Islands May
Not Provide Sustainable Income GAO-07-513:
The Draft Report's recommendations for executive action and responses
to them are as follows:
"To enhance the FSM and RMI trust fund committees' oversight of the
trust funds, we recommend that the Secretary of the Interior direct the
Deputy Assistant Secretary for Insular Affairs, as Chairman of the
committees, to work with other U.S. agencies on the committees to
undertake the following actions:"
1. "Develop strategies to improve the timeliness of the committees'
decision-making and administrative processes."
Response: Agree. We believe that the current decisionmaking and
administrative processes should be evaluated; discussions will begin at
the next committee meetings in May 2007. The development and
implementation of strategies will be an ongoing activity and part of
the overall management of the trust fund.
The current arrangement under the Compacts requires the trust fund
committees to act on all issues relating to the management of the trust
funds, no matter how mundane. Current practice is also to have the U.S.
delegation address these issues separately and reach consensus before
they are addressed by the trust fund committees. This approach is
difficult to reconcile in practice with the objective of allowing
decisions to be made expeditiously for the purpose of effectively
managing the trust funds. We note that the trust funds created in
connection with the Palau Compact and Marshall Islands nuclear-affected
atolls are managed without management committees in accordance with
certain prudent requirements and do not face similar management issues.
Title of Responsible OIA Official: Deputy Assistant Secretary for
Insular Affairs:
Target Date: May 31, 2007:
2. "Ensure the committees' timely reporting of trust fund activities,
including assessing the funds' potential adequacy as an ongoing source
of revenue and effectiveness in helping the countries achieve economic
self-sufficiency and long-term budgetary self-reliance."
Response: Generally agree. The trust fund committees should consider
ways to ensure timely reporting. The identification of viable solutions
will be discussed at the next committee meetings in May 2007. Note
however that, although we consider the countries' abilities to achieve
economic self-sufficiency and budgetary self-reliance of paramount
importance, the purpose of the trust funds is to provide an ongoing
source of revenue to contribute to these objectives, but not to meet
any specific payout goal or substitute for other efforts and
initiatives under the Compacts.
Title of Responsible OIA Official: Deputy Assistant Secretary for
Insular Affairs:
Target Date: May 31, 2007:
3. "Obtain a full and independent evaluation of the potential benefits
and risks of using securitization to increase the trust fund balances."
Response: We agree. Options, including contracting for a study, will be
discussed at the next committee meetings in May 2007 and at subsequent
meetings.
Title of Responsible OIA Official: Deputy Assistant Secretary for
Insular Affairs:
Target Date: May 31, 2007:
Following is GAO's comment on the Department of the Interior's letter,
dated May 11, 2007.
GAO Comment:
1. We added clarification that no minimum disbursement from the trust
funds is required or guaranteed. However, the trust fund agreements
establish the 2023 level of compact grants, fully adjusted for
inflation, as the maximum amount of annual income available for
disbursement. Therefore, we believe it is appropriate to undertake a
projection of the likely disbursements against that benchmark.
We modified our second recommendation to emphasize that the reports
should assess the status of trust fund performance and likely
disbursements. We believe that careful analysis of the trust funds each
year will help establish realistic expectations. Such analysis will
also inform the trust fund committees as they make investment decisions
and FSM and RMI leaders as they set economic policies and undertake
long-term fiscal planning.
[End of section]
Appendix VI: Comments from the Department of Health and Human Services:
Note: GAO comment supplementing those in the report text appears at the
end of this appendix.
Office of the Assistant Secretary for Legislation:
Department Of Health & Human Services:
Washington, D.C. 20201:
May 16 2007:
David Gootnick:
Director, International Affairs and Trade:
U.S. Government Accountability Office:
Washington, DC 20548:
Dear Mr. Gootnick:
Enclosed are the Department's comments on the U.S. Government
Accountability Office's (GAO) draft report entitled, "Compacts of Free
Association: Trust Funds for Micronesia and the Marshall Islands May
Not Provide Sustainable Income" (GAO-07-513).
The Department appreciates the opportunity to comment on this draft
report before its publication.
Sincerely,
Sincerely,
Vincent J. Ventimiglia:
Assistant Secretary for Legislation:
General Comments Of The U.S. Department Of Health And Human Services
(HHS) On The U.S. Government Accountability Office's (GAO) Draft
Report: Compacts Of Free Association: Trust Funds For Micronesia And
The Marshall Islands May Not Provide Sustainable Income (GAO-07-513):
General Comments:
The U.S. Department of Health and Human Services (HHS) is grateful for
the opportunity to comment on the draft report from the Government
Accountability Office (GAO) entitled Compacts of Free Association:
Trust Funds for Micronesia and the Marshall Islands May Not Provide
Sustainable Income.
HHS believes the report accurately identifies the areas in which
Committees for the Trust Funds for the people of the Federated States
of Micronesia (FSM) and the Republic of the Marshall Islands (RMI) need
to make improvements to work more efficiently. We agree with the
findings of the Report regarding flaws in the management of the two
Trust Funds:
* Contractual hurdles did delay the establishment of the Trust Funds
and the full investment of their capital;
* Committee processes have taken more time than warranted;
* Progress Reports were lacking for 2004, and the Committees delivered
them late in 2005; and:
* The Progress Reports make no mention of the adequacy and
effectiveness of the Trust Funds.
Addressing these problems in a creative manner will help to make more
robust management of the Funds a reality, which could, in turn, help to
maximize the returns earned by the Trust Funds. HHS concurs with GAO's
findings on these points, and believes the hiring of a dedicated
administrator for the two Trust Funds and the creation of a stronger
coordination process among the members of the Trust Funds Committees,
which should include more frequent meetings, should eliminate the time
lags that have affected the ability of the Committees to make
decisions, produce high-quality and timely reports and finalize
contracts.
In addition, HHS agrees with the conclusion of the Report (echoed in
earlier GAO documents) that the FSM and the RMI must prepare now for
the end of the current revenue stream under the Compacts of Free
Association after 2023 by introducing important, structural changes and
reforming their fiscal policies. The GAO Report suggests several
options that would supplement the Trust Funds, the most important of
which would be to implement changes in the islands' tax systems and to
reduce the size of government. HHS strongly supports the promotion of
economic development in the two nations, particularly through policies
that encourage entrepreneurship, foreign investment and the growth of
the private sector, as well as the training of a local workforce with
the professional and technical skill sets critical to a dynamic economy
(doctors, lawyers, administrators, and tradesmen, for example).
On the issue of securitizing the Trust Funds, HHS welcomes the
recommendation of the Report to "obtain a full and independent
evaluation of the potential benefits and risks of using securitization
to increase trust fund balances" and would fully endorse the launch of
such a study. While we understand securitization could require explicit
authority from the U.S. Congress, we believe it is a fiduciary
responsibility of the two Trust Fund Committees to pursue every legally
permissible avenue to maximize the Trust Funds' income and long-term
sustainability.
The only point in the GAO Report on which we would disagree is its
assertion that the Trust Funds will be insufficient if the income they
generate "fall(s) short of the maximum allowed disbursement levels
after the compact grants end in 2023." On this point, the Report
reflects a fundamental misunderstanding of the outcome of the
negotiation of the Amended Compacts of Free Association between the
United States, the FSM, and the RMI, which, as spelled out in Article 3
of the two trust fund agreements, "is to contribute to the economic
advancement and long term budgetary self-reliance," not to guarantee a
certain level of income. So long as the trust funds are a source of
annual revenue at all, they have met their agreed and stated purpose.
We hope that this information is useful to you. Please do not hesitate
to contact us if we can be of further assistance.
Following is GAO's comment on the Department of Health and Human
Services' letter, dated May 16, 2007.
GAO Comment:
1. We strongly disagree with HHS' assertion that our report reflects a
fundamental misunderstanding of the outcome of the negotiation of the
amended compacts. We clearly stated the purpose of the trust funds is
to provide an ongoing source of revenue for the FSM and the RMI.
Furthermore, we added clarification that no minimum disbursement from
the trust funds is required or guaranteed. However, the trust fund
agreements establish the 2023 level of compact grants, fully adjusted
for inflation, as the maximum amount of annual income available for
disbursement. Therefore, we believe it is appropriate to undertake a
projection of the likely disbursements against that benchmark.
We modified our second recommendation to emphasize that the reports
should assess the status of trust fund performance and likely
disbursements rather than the adequacy of the funds to ensure we do not
imply any required level of minimum income. We believe that careful
analysis of the trust funds each year will help establish realistic
expectations. Such analysis will also provide information to the trust
fund committees as they make investment decisions and to FSM and RMI
leaders as they set economic policies and undertake long-term fiscal
planning.
HHS noted that "so long as the trust funds are a source of annual
revenue at all, they have met their agreed and stated purpose." For the
trust fund committees to be assured of achieving such a purpose, the
trust funds would have to be invested in low-risk, low-yield government
bonds after 2023. This would ensure that the trust funds will provide
some level of disbursement to the FSM and the RMI. The income from the
funds will not reach the maximum level of disbursement allowed and will
diminish in real value over time. Our analysis shows that right after
the grants expire, the funds will be able to disburse about 50 percent
and 68 percent of the 2023 grant levels for the FSM and the RMI
respectively with the ratios getting smaller over time.[Footnote 44]
[End of section]
Appendix VII: Comments from the Department of State:
Note: GAO comments supplementing those in the report text appear at the
end of this appendix.
United States Department of State:
Assistant Secretary for Resource Management and Chief Financial
Officer:
Washington, D.C. 20520:
Ms. Jacquelyn Williams-Bridgers:
Managing Director:
International Affairs and Trade:
Government Accountability Office:
441 G Street, N. W.
Washington, D.C. 20548-0001:
May 15 2007:
Dear Ms. Williams-Bridgers:
We appreciate the opportunity to review your draft report, "Compacts Of
Free Association: Trust Funds for Micronesia and Marshall Islands May
Not Provide Sustainable Income," GAO Job Code 320439.
The enclosed Department of State comments are provided for
incorporation with this letter as an appendix to the final report.
If you have any questions concerning this response, please contact Mary
Comfort, Attorney Adviser, Office of the Legal Adviser, at (202) 647-
1121.
Sincerely,
Signed by:
Bradford R. Higgins:
cc: GAO - Emil Frieberg:
EAP - Christopher Hill:
State/OIG - Mark Duda:
U.S. Department of State's Comments on GAO Draft Report Compacts of
Free Association: Trust Funds for Micronesia and the Marshall Islands
May Not Provide Sustainable Income (GAO-07-513):
Thank you for the opportunity to comment on the draft report Compacts
of Free Association: Trust Funds for Micronesia and the Marshall
Islands May Not Provide Sustainable Income.
The Department of State has an important role in the implementation of
the Amended Compacts of Free Association between the United States and
the Federated States of Micronesia (FSM) and the Republic of the
Marshall Islands (RMI), including the implementation of the trust fund
agreements. We strongly disagree with the implication that runs through
the report that the trust funds will not have met their stated and
agreed purpose unless they generate a level of income from and after
2024 that equals the level of 2023 grant assistance plus inflation.
Such a reading of the trust fund agreements is not justified by the
terms of the agreements and is not consistent with the negotiations
that led to the agreements.
The assistance format agreed to between the United States and the two
Freely Associated States after several years of negotiation, and
reflected in the final binding international agreements, was a decrease
in annual grant assistance over 20 years, with the decrement to be
placed in trust funds for the benefit of the FSM and RMI respectively.
Although the FSM and RMI would have liked the final agreements to
contain some level of assurance or expectation that the trust funds
would generate annual revenue comparable to the annual grant assistance
received from 2004 t62023, the United States refused to include any
such assurances, or countenance any such expectations. Thus, the agreed
purpose of the trust funds, as spelled out in Article 3 of the two
trust fund agreements, "is to contribute to the economic advancement
and long-term budgetary self-reliance" of the two FAS "by providing an
annual source of revenue, after Fiscal Year 2023, for assistance" in
specified sectors, with priorities in education and health care
(emphasis added). So long as the trust funds are a source of annual
revenue, they have met their agreed and stated purpose.
The GAO report, however, from its title to its conclusion, judges the
trust funds by whether, starting in 2024, .they will generate annual
revenue at the 2023 annual grant level plus inflation. The report
repeatedly questions the "adequacy" of the funds to replace expiring
grants and the ability of the funds to sustain the maximum disbursement
levels allowed, and judges the trust funds against these standards that
do not reflect the agreements reached between the United States and the
two FAS. This is a dangerous misreading of the international agreements
and is likely to build up unwarranted expectations that are not
supported by the agreements reached. This is acceptable to the extent
that the goal of the analysis is to encourage the two FAS not to count
on an unrealistically large income stream coming from the trust funds,
but the overwhelming impression left by the report is that the trust
funds will have failed in their purpose if they do not generate annual
revenue sufficient to replace the expiring grants plus inflation. This
viewpoint is contrary to the actual agreement reached between the
United States and the FSM and the RMI when they designed the trust
funds.
Along these lines, in the "What GAO Found" section of the cover sheet,
and on pages 5 and 28, the report lists four possible ways to enhance
the trust funds' income. A fifth should be added. Although after 2023
the Trust Fund Committee may disburse to the FSM and RMI annual
payments of up to the 2023 annual grant amount plus inflation, there is
no requirement that they request that amount. Thus, a fifth strategy
for enhancing the trust funds' income would be for the two FAS to allow
the fund to grow further by refraining from requesting the withdrawal
of the full allowable amount each year.
Following are GAO's comments on the Department of State's letter, dated
May 15, 2007.
GAO Comments:
1. We strongly disagree with State's assertion that our reading of the
trust fund agreements is not justified by the terms of the agreements
and is not consistent with the negations that lead to the agreements.
We clearly stated the purpose of the trust funds is to provide an
ongoing source of revenue for the FSM and the RMI. Furthermore, we
added clarification that no minimum disbursement from the trust funds
is required or guaranteed. However, the trust fund agreements establish
the 2023 level of compact grants, fully adjusted for inflation, as the
maximum amount of annual income available for disbursement. Therefore,
we believe it is appropriate to undertake a projection of the likely
disbursements against that benchmark.
We modified our second recommendation to emphasize that the reports
should assess the status of trust fund performance and likely
disbursements rather than the adequacy of the funds to ensure we do not
imply any required level of minimum income. We believe that careful
analysis of the trust funds each year will help establish realistic
expectations. Such analysis will also provide information to the trust
fund committees as they make investment decisions and to FSM and RMI
leaders as they set economic policies and undertake long-term fiscal
planning.
2. State commented that "so long as the trust funds are a source of
annual revenue at all, they have met their agreed and stated purpose."
For the trust fund committees to be assured of achieving such a
purpose, the trust funds would have to be invested in low-risk, low-
yield government bonds after 2023. This would ensure that the trust
funds will provide some level of disbursement to the FSM and the RMI.
The income from the funds will not reach the maximum level of
disbursement allowed and will diminish in real value over time. Our
analysis shows that right after the grants expire, the funds will be
able to disburse about 50 percent and 68 percent of the 2023 grant
levels for the FSM and the RMI respectively with the ratios getting
smaller over time.[Footnote 45]
3. We disagree with State's characterizing our assessment of the trust
funds' likely capacity to provide revenue to the governments of the FSM
and the RMI as "likely to build up unwarranted expectations." On the
contrary, we believe that careful analysis of the funds' probable
income will help build realistic expectations and provide invaluable
inputs for policymakers in formulating economic policies and long-term
plans. It is to this end that we recommend that the trust fund
committees assess the funds' status as an ongoing source of revenue and
effectiveness in helping the countries achieve economic self-
sufficiency and long-term budgetary self-reliance.
4. State suggested a fifth strategy for enhancing the trust funds'
income would e for the countries to allow the fund to grow further by
refraining from requesting the withdrawal of the full allowable amount
each year. We analyzed the option of not disbursing the maximum allowed
income (see app. III). We compared the likelihood of not reaching the
maximum level allowed when all income is disbursed versus when some
income is reinvested. Our analysis shows while the benefit of the
reinvested trust fund income helps improve the prospect of the trust
funds in later years, the disbursement in earlier years will be lower.
[End of section]
Appendix VIII: Comments from the Federated States of Micronesia:
Embassy Of The Federated States Of Micronesia:
1725 N Street, N.W.
Washington, D.C. 20036:
Telephone (202) 223-4383:
Telefax (202) 223-4391:
www.fsmembassydc.org:
June 01, 2007:
Mr. David Gootnick:
Director, International Affairs and Trade:
United States Governmental Accountability Office:
Washington, D.C. 20548:
Dear Mr. Gootnick:
Thank you for the opportunity to review and comment on the GAO's draft
report no. GAO-07-513, "Compacts of Free Association: Trust Funds for
Micronesia and the Marshall Islands May Not Provide Sustainable
Income." The Government of the Federated States of Micronesia ("FSM")
is in general agreement with the recommendations of GAO as stated in
the draft Report.
As you know, while the Government of the Federated States of Micronesia
("FSM") occupies only two of the five seats on the Trust Fund Committee
("TFC"), this Trust Fund was negotiated from our side of the table to
provide a smooth transition, in the year 2023, from the annual US
grants into a regime of annual Trust Fund income that would equal or
better the level of US grants at the time of the transition. We are
aware that certain parties on the US side would now prefer to state
that there was never such an undertaking by the US, and that the Trust
Fund represents nothing more than a handshake by the US in 2023 to the
FSM, with best wishes for the future. The Government of the Federated
States of Micronesia strongly disagrees with this concept of the
purpose of the Trust Fund.
Several of the things that are clear by now, having by now experienced
so many unanticipated difficulties of coordination in making the
fundamental organizational arrangements for the Fund, are that:
A. The task of launching the Fund with all the complexities and time-
consuming procedural steps involved was more than the negotiators
anticipated; and:
B. The Fund, as a consequence, has lost substantial income at the
critical beginning, with very negative consequences for the income-
producing ability in 2023; and:
C. Any of the alternatives proposed so far to try and catch up on the
long-term effect of the early losses incurred, such as the proposed
"securitization" carry risks of their own that need to be evaluated
from an objective perspective.
None of these points are made to direct blame toward our partners
within the US Government who have also worked hard to explore, along
with us, this previously unexplored territory.
In the case of this draft Report, as with earlier Reports, the FSM
welcomes the important contributions of the GAO.
Sincerely,
Signed by:
James A. Naich:
Charge d'Affaires, ad interim:
cc: FSM Foreign Affairs - Home Office:
FSM OCM:
[End of section]
Appendix IX: Comments from the Republic of the Marshall Islands:
Note: GAO comments supplementing those in the report text appear at the
end of this appendix.
Embassy Of The Republic Of The Marshall Islands:
2433 Massachusetts Avenue. N.W.,
Washington, D.C. 2008:
Tel. # (202) 234-5414:
Fax # (202) 232-3236:
E-mail: info@rmiembassyus.org:
May 18, 2007:
Mr. David Gootnick:
Director:
International Affairs and Trade:
United States Government Accountability Office:
Washington, D.C. 20548:
Dear Mr. Gootnick:
Thank you for providing the Draft GAO Report (GAO-07-513) "Compacts of
Free Association: Trust Funds for Micronesia and the Marshall Islands
May Not Provide Sustainable Income" to the Government of the Republic
of the Marshall Islands for review and to make comments (please see
attached).
The RMI Government welcomes GAO's input and looks forward to continuing
to work with the GAO in identifying and address issues particularly
related to the Trust Fund for the people of the Republic of the
Marshall Islands.
Sincerely,
Signed by:
Banny deBrum:
Ambassador:
Government of the Republic of the Marshall Islands Comments on the GAO
Report (GAO-07-513) "Compacts of Free Association: Trust Funds for
Micronesia and the Marshall Islands May Not Provide Sustainable Income"
The following comments are based on a review of the draft document. The
Republic of the Marshall Islands (RMI) would hope that the changes
stated and observations made are clarified and reflected in the final
report.
General Comments:
The RMI would like to commend the GAO on an excellent report outlining
many of the issues surrounding the implementation of the Compact Trust
Fund and its likely sustainability.
The RMI would like the report to consider the impact of full inflation
adjustment of the contributions to the Compact Trust Fund (CTF). Full
inflation adjustment has been a long-standing position of the RMI,
since the Government believes that it would have a substantial impact
on the sustainability of the CTF, if incorporated into the agreement.
Page 12: Trust Fund Governance (Annual Reports):
"The (annual) reports are to assess the effectiveness of the funds in
contributing to the economic advancement and long-term budgetary self-
reliance of the FSM and RMI"
This requirement seems to only apply to the situation post-FY 2023,
once the fund is scheduled to start disbursing funds. In the interim,
the Compact Trust Fund (CTF) will have little or no impact on economic
advancement and long-term budgetary self-reliance.
Page 18: Trust fund committee processes:
The problems cited relating to the CTF administrative processes need to
be resolved through the designation of responsibilities. If this
requires external assistance then the Committee should seek this
assistance. Article VIII of the Trust Fund Agreement allows the
Committee to "obtain technical advisory services as needed and
appropriate". This lack of designation of responsibilities is directly
related to the fact that the RMI Trust Fund Committee "did not publish
annual reports as required" (Page 20).
In setting up its Compact Implementation Office, the Ministry of
Foreign Affairs intends to designate an officer with responsibility for
Compact Trust Fund matters. Nevertheless, the RMI believes that the
Committee should consider funding a Trust Fund Secretariat to be
responsible for coordinating all reporting requirements of the Trust
Fund Committee. This would include coordinating Annual Reports, Audit
Reports and providing secretariat services for the Trust Fund
Committee. The Committee should arrange for the approval of an annual
administrative budget each year. The funding should come from the A
Account of the CTF with an annual budget approved by the Trust Fund
Committee.
Pages 21-23: Market Volatility Could Lead to Wide Range of Trust Fund
Balances in 2023.
The presentation of the results from the various scenarios of
investment strategies seems to suggest that the RMI has little downside
risk from adopting an aggressive investment strategy. The comparison of
the 10TH percentile in each strategy (conservative, moderate and
aggressive) indicates largely equal outcomes come 2023. However, the
upside from adopting an aggressive strategy is substantial. The
difference in the CTF balances in 2023 between a conservative and
aggressive strategy, for the median results is $166 million, while the
difference for the 90TH percentile result is $538 million. This would
seem to indicate a huge potential return on the upside by adopting an
aggressive investment strategy (with little downside risk).
Pages 27-32: Several Options Exist for supplementing FSM and RMI Trust
Fund Income:
As mentioned above, the RMI believes that the CTF contributions should
be fully adjusted for inflation. The report should possibly consider
this as an option for supplementing the CTF income, since it has been
the long-term stance of the RMI that contributions should be fully
inflation adjusted.
Page 30: Trust Fund Securitization:
The Government strongly supports investigating this option further and
agrees with the recommendation that an "independent evaluation of the
potential benefits and risks" of this option is needed. The Government
believes, however, that to maximize the potential returns from
securitization this investigation needs to take place at the earliest
possible time.
Following are GAO's comments on the Republic of the Marshall Islands'
letter, dated May 18, 2007.
GAO Comments:
1. Our analysis was based on the current contribution structure. Under
certain U.S. inflation conditions, contributions to the trust fund can
be fully adjusted for inflation after 2014.
2. Although the trust fund will have little or no impact on the RMI's
economy until disbursements from the fund begin, we believe that
careful analysis of the fund's likely income will help build realistic
expectations and provide invaluable information for policymakers in
formulating economic policies and long-term plans. It is to this end
that we recommend that the RMI trust fund committee assess the fund's
status as an ongoing source of revenue and effectiveness in helping the
country achieve economic self-sufficiency and long-term budgetary self-
reliance.
[End of section]
Appendix X: GAO Contact and Staff Acknowledgments:
GAO Contact:
David Gootnick, (202) 512-3149 or gootnickd@gao.gov:
Staff Acknowledgments:
In addition to the individual above, Emil Friberg (Assistant Director)
and Ming Chen made key contributions to this report. Muriel Brown,
Lawrance Evans, Etana Finkler, Reid Lowe, Thomas McCool, Mary Moutsos,
and Wilda Wong provided technical assistance.
FOOTNOTES
[1] In this report, all years cited are fiscal years (Oct. 1 - Sept.
30) unless otherwise noted.
[2] A key goal for this assistance was to advance the countries'
economic development and budgetary self-reliance. In 2000, we reviewed
the impact of compact funding and found that U.S. assistance had
resulted in little economic development for either the FSM or the RMI.
See GAO, Foreign Assistance: U.S. Funds to Two Micronesian Nations Had
Little Impact on Economic Development, GAO/NSIAD-00-216 (Washington,
D.C.: Sept. 22, 2000).
[3] Whereas the original compact (approved in Pub. L. No. 99-239, Jan.
14, 1986) was one agreement among the U.S., FSM, and RMI governments,
the amended compacts (approved in Pub. L. No. 108-188, Dec. 17, 2003)
are separate agreements between the United States and each of the two
countries.
[4] The $3.6 billion in assistance includes (a) compact grants; (b)
trust fund contributions; (c) Kwajalein impact funding provided to the
RMI government, which in turn compensates Kwajalein Atoll landowners,
for U.S. access to the atoll for military-purposes; and (d) estimated
values of compact-authorized federal services such as weather,
aviation, and postal services, at around $200 million over the 20-year
period. Services associated with the Federal Emergency Management
Agency have been excluded.
[5] The annual disbursements may not exceed the amounts, adjusted for
inflation, that each country receives as grant assistance in 2023.
[6] Agreement Between the Government of the United States of America
and the Government of the Federated States of Micronesia Implementing
Section 215 and Section 216 of the Compact, as Amended Regarding a
Trust Fund; Agreement Between the Government of the United States of
America and the Government of the Republic of the Marshall Islands
Implementing Section 216 and Section 217 of the Compact, as Amended
Regarding a Trust Fund.
[7] Contributors other than the U.S., FSM, and RMI governments may
include any government, international organization, financial
institution, or other entity or person who contributes grants, not
loans, to the trust funds.
[8] GAO, Compacts of Free Association: Development Prospects Remain
Limited for Micronesia and Marshall Islands, GAO-06-590 (Washington,
D.C.: June 2006); Compacts of Free Association: Micronesia and the
Marshall Islands Face Challenges in Planning for Sustainability,
Measuring Progress, and Ensuring Accountability, GAO-07-163
(Washington, D.C.: Dec. 15, 2006). For an initial review of trust fund
implementation, see GAO, Compacts of Free Association: Implementation
of New Funding and Accountability Requirements Is Well Under Way, but
Planning Challenges Remain, GAO-05-633 (Washington, D.C.: July 11,
2005).
[9] In this report, "establishing the funds" refers to the selection
and hiring of the trustees, independent auditors as well as the
selection and hiring of any investment advisers and money managers.
[10] According to U.S. officials, the trust fund income is intended to
be one source of income, and the amended compacts do not guarantee that
the trust funds will provide the maximum disbursements allowed by the
trust fund agreements. However, projections of the trust funds' ability
to disburse the maximum allowed amounts can indicate the likely level
and sustainability of the funds' income.
[11] The ranges referred to in this example are between the 10th and
90th percentile values from the results of our simulation model under
different scenarios. Ten percent of the range of possible trust
balances lie below the 10th percentile; 90 percent of the range of
possible balances lie below the 90th percentile. See appendixes I and
II for more information.
[12] Remittances are personal funds that emigrants voluntarily send to
residents in their home countries.
[13] With securitization, the trust funds would sell bonds to investors
and the cash generated through bond issuance would become the trust
fund principal to be invested. Future contributions to the trust fund
would be used to pay bond holders instead of building the funds.
Securitization could help increase the principal of the trust fund more
quickly than would annual contributions to the fund.
[14] The trust fund income is intended to provide assistance in
development sectors currently receiving grants under the amended
compacts: education, health, infrastructure, private sector
development, the environment, and public sector capacity building, with
priority given to education and health. The income may also be used for
other sectors mutually agreed to by the United States and the
countries.
[15] A "D" account may be established to hold any contributions by the
FSM and the RMI governments of revenue or income from unanticipated
sources. According to the trust fund agreements, the D account must be
a separate account, not mixed with the rest of the trust fund; it is
not part of the corpus of the trust fund. As of March 2007, only the
RMI had a D account, governed by the agreement between Taiwan and the
RMI. Taiwan will contribute $10 million to the RMI's D account in 5
years.
[16] According to the trust fund agreements, "corpus" means a
collection of bonds, stocks, or other holdings that form the principal
of the trust fund. It also includes all accumulated income that has
been reinvested and is not available for distribution.
[17] Except for where stated otherwise in the agreement, trust fund
committee decisions are made by a majority vote. The FSM trust fund
committee has five voting members: three from the United States
(Interior, State, and HHS) and two from the FSM. The RMI trust fund
committee has seven voting members: four from the United States
(Interior, State, HHS, and Labor); two from the RMI; and one from the
other contributor, Taiwan.
[18] Each agreement states that either the U.S. government, in
consultation with the FSM or the RMI government, or the trust fund
committee, if it is operational when the amended compact takes effect,
is responsible for establishing the trust fund. (In this case,
"establishing the trust fund" refers to the incorporation of the fund
rather than to the selecting and hiring of the trustee, auditor,
investment adviser, and money manager, as the phrase is otherwise
defined in this report.)
[19] The trust fund agreements states that the trustee shall (a) be
selected from among trust institutions organized in the United States,
(b) have a net worth in excess of $100 million, (c) have at least 10
years experience as a custodian of financial assets, and (d) have
experience in managing trust funds of at least $500 million.
[20] In addition, Pub. L. No. 108-188 requires the President to report
annually to Congress regarding the FSM and the RMI, including
information on non-U.S. contributions to the trust funds and, if
appropriate, making recommendations to Congress to adjust the inflation
rate or to adjust contributions to the trust funds based on non-U.S.
contributions.
[21] To calculate the compounded real returns, we used the annual total
nominal returns published in IBBOTSON Associates 2006 Yearbook and
constructed the inflation adjusted returns, which is a geometric
difference between the nominal return and the inflation rate. We then
constructed the real and nominal return indexes with year end 1969 =
$1.00 to calculate the annual compounded returns.
[22] Standard deviation is a statistical measure of how widely spread
the distribution is from its mean. It is obtained by calculating the
square root of the average of the squares of deviations around the mean
of a set of data.
[23] The adviser has not billed the committee as of March 2007.
[24] The amended compacts required the RMI to contribute at least $25
million on the effective date of the trust fund agreement or in October
2003, whichever was later; $2.5 million prior to October 1, 2004; and
$2.5 million prior to October 1, 2005.
[25] The College of the Marshall Islands has experienced accreditation
problems since 2003. According to the President of the college, the
accreditation committee requires evidence that the college's physical
infrastructure will be substantially upgraded. The RMI government had
to find funding for the needed improvements and now has a plan for
improving the college's infrastructure.
[26] Interior believes that an administrative support position is
allowed under the trust fund agreements and its cost can be covered by
the trust funds.
[27] FSM Office of the Public Auditor, Inspection of the Compact Trust
Fund: Period Covering August 2004 until May 2006 (Pohnpei, FSM, 2006).
[28] To estimate the RMI's income loss from late contributions, we
calculated (a) the lost interest income on $25 million between May
2004, the contribution deadline, and June 2004, when the RMI made its
first contribution; (b)the lost interest income on $2.5 million between
October 2004, when the RMI was supposed to make its second
contribution, and February 2005, when it made a partial contribution;
and (c) the lost interest income on $1 million between February 2005,
when the RMI contributed $1.5 million for its second contribution, to
May 2005, when the RMI contributed the remaining $1 million. We used
the actual interest rate the RMI trust fund earned during the period.
[29] The International Monetary Fund (IMF) has called for disclosing
publicly the objectives and performance of the trust fund in line with
the IMF guidelines for a transparent framework to ensure accountability
and clarity of the trust fund management activities and results. See
International Monetary Fund, RMI: Selected Issues and Statistical
Appendix, IMF Country Report No. 06197 (Washington, D.C.: March 2006).
[30] This information could be included in the President's annual
reports to Congress required by Pub. L. No. 108-188. The legislation
does not require that information such as projections of trust fund
balances be included in the reports. However, its inclusion would
provide additional insight regarding the FSM's and RMI's progress in
formulating economic policies to achieve economic advancement and
budgetary self-reliance, to which the trust funds are intended to
contribute by providing a source of revenue to the FSM and the RMI
after 2023. The level of the trust fund income is directly related to
its effectiveness in helping the countries achieve self-reliance: the
higher the trust fund income, the more likely the countries will be
self-reliant.
[31] The probability that disbursements will not reach the maximum
disbursement level allowed depends on the actual approved disbursement
levels. For example, if the trust fund committees do not disburse all
earned income and instead reinvest part of the income, the probability
of disbursements not reaching the maximum disbursement level allowed
will differ from the probabilities presented below. (For a comparison
of the probabilities of disbursements not reaching the maximum
disbursement level allowed with and without full disbursement, see app.
III.)
[32] In addition to market volatility, the amount of contributions to
the trust funds plays an important role in determining whether the
trust funds are able to provide sustainable income. Additional
contributions to the funds improve the prospect of sustainability. For
information on how Taiwan's contributions enhanced trust fund
sustainability, see section on Economic Assistance from Other Donors.
[33] The trust fund agreements specify that in 2024 and thereafter, the
FSM and the RMI trust fund committees may disburse amounts up to the
annual grant assistance in 2023, fully adjusted for inflation, provided
that funds are available in the B account to reach such level. In 2025
and thereafter, the disbursements may also include any additional
approved amounts for special needs.
[34] Our analysis shows that to maintain the maximum disbursement
levels allowed for 10 years without risk, the FSM and the RMI trust
funds need to earn compounded real returns of around 13 percent and 9
percent through 2023, respectively. However, these percentages are
considerably higher than the stock market's compounded real returns
from 1970 to 2005 of around 6 percent for both international stocks and
U.S. large company stocks. If the trust funds are not in risk free
treasury bonds and earn higher returns after 2023, the required returns
for the funds before 2023 will be lower; however, the trust funds will
be subject to market volatilities.
[35] Through securitization, the trust fund sells bonds to investors,
and the cash generated through bond issuance will become the trust fund
principal to be invested. Future contributions to the trust fund will
be used to pay bond holders before being available as income to the
trust fund. Securitization helps build up the principal of the trust
fund right away rather than slowly by annual contributions to the fund.
[36] GAO-06-590.
[37] Under the original compacts, citizens from the FSM and the RMI had
the right to live and work in the United States as "nonimmigrants" and
to stay for long periods of time. Although the amended compacts
strengthened immigration provisions, these rights were generally
extended for citizens as defined under the amended compacts.
[38] Owing to emigration, growth of the FSM population has slowed from
about 2 percent in the early 1990s to virtually zero since 1995.
[39] Experts also suggest that in addition to increasing income from
emigrant remittances, returning emigrants may bring back newly acquired
skills and capital that could support growth in the home economy. See
GAO-06-590; also see Francis X. Hezel, Is That the Best You Can Do? A
Tale of Two Micronesian Economies (Honolulu: East-West Center, Pacific
Islands Policy, 2006).
[40] Under different investment strategies, the range of possible fund
balances will be different. However, securitization will still lead to
a wider range of possible fund balances. Securitization can lead to a
higher expected balance when the investment returns are higher than the
rate the funds pay to its bond holders.
[41] This number is based on our conversation with an industry expert.
[42] According to 2005 study by the Asian Development Bank, a trust
fund established with similar objectives for another Pacific island
country, Tuvalu, reinvests trust fund income to maintain the fund's
real value. The Tuvalu trust fund was established through a
multilateral international agreement among Tuvalu, New Zealand, the
United Kingdom, and Australia. See Benjamin Graham, Trust Funds in the
Pacific, Their Roles and Future Manila, Philippines: Asian Development,
2005.
[43] There are many different ways to disburse investment income
partially. For example, the trust fund can disburse only income above
inflation;
the trust fund can reinvest to keep the corpus at a certain level
before it starts to disburse any income. In this analysis, partial
disbursement means disbursing income above inflation.
[44] We used the estimated median account balance in 2023 under the
most aggressive strategy as a starting point for investment in
government bonds.
[45] We used the estimated median account balance in 2023 under the
most aggressive strategy as a starting point for investment in
government bonds.
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