Compacts of Free Association: Actions Needed to Prepare for the Transition of Micronesia and the Marshall Islands to Trust Fund Income

In 2003, the United States approved amended compacts of free association with the FSM and RMI, providing a total of $3.6 billion in economic assistance in fiscal years 2004 through 2023 and access to several U.S. programs and services. Compact grant funding, overseen by the Department of the Interior, generally decreases annually. However, the amount of the annual decrease in grants is added to the annual U.S. contributions to the compact trust funds, managed by joint U.S.-FSM and U.S.-RMI trust fund committees. Trust fund earnings are intended to provide a source of income after compact grants end in 2023, but GAO and others have previously found that the trust funds may not provide sustainable income.

GAO was asked to examine preparations for the transition in 2023. This report examines (1) the use and role of U.S. funds and programs in FSM and RMI budgets, (2) projected trust fund disbursements and potential strategies to address risks to those disbursements, and (3) FSM and RMI plans to prepare for grant decreases and the transition to trust fund income. GAO reviewed compact agreements, audit reports, and U.S. law; modeled trust fund performance under existing conditions and using potential strategies; and reviewed FSM and RMI plans. GAO visited each country and interviewed FSM, RMI, and U.S. officials.

The Federated States of Micronesia (FSM) and the Republic of the Marshall Islands (RMI) continue to rely on U.S. grants and programs, including several that are scheduled to end in 2023. U.S. compact sector and supplemental education grants, both scheduled to end in 2023, support a third of the FSM's and a quarter of the RMI's expenditures. Agreements providing U.S. aviation, disaster relief, postal, weather, and other programs and services are scheduled to end in 2024, but some agencies may provide programs and services similar to those in the agreements under other authorities. FSM and RMI eligibility for some other U.S. grants and programs is expected to continue after 2023.

Disbursements from the compact trust funds face risks that the trust fund committees have not addressed. GAO found that the trust funds are increasingly likely to provide no annual disbursements in some years and to not sustain their value. Potential strategies such as reduced trust fund disbursements or additional contributions from the countries or other sources could help address these risks. Changing the trust fund disbursement policies could also address these risks but may require revising the trust fund agreements with each country. However, the trust fund committees have not prepared distribution policies, required by the agreements, which could assist the countries in planning for the 2023 transition to trust fund income. The committees also have not prepared the required fiscal procedures for oversight of the disbursements or addressed differences between the timing of their annual determination of the disbursement amounts and the FSM's and RMI's annual budget cycles.

The FSM and RMI did not implement planned budget reductions to address decreasing compact grants owing to increased revenues from other sources that offset the grant decreases. Current FSM and RMI infrastructure plans address the 2023 transition, while health and education plans focus on strategic goals. Both countries have established new compact planning committees to identify future challenges and develop plans for the 2023 transition to trust fund income.

GAO recommends that Interior work with the compact trust fund committees to develop distribution policies and fiscal procedures for the funds and to address disbursement timing. Interior concurred with the recommendations.

In 2003, the United States approved amended compacts of free  association with the Federated States of Micronesia (FSM) and the  Republic of the Marshall Islands (RMI) that provide for a total of $3.6  billion in compact sector grants, trust fund contributions, and other grants,  as well as access to several U.S. programs and services, in fiscal years  2004 through 2023. This compact assistance is intended to assist the  FSM and RMI governments in their efforts to promote the self-sufficiency  and budgetary self-reliance of their people. Compact sector grants,  managed by the U.S. Department of the Interior (Interior), generally  decrease annually before their scheduled end in 2023. However, the  amount of the annual decrease in compact sector grants (also referred to  as the annual decrement) is added to the annual U.S. contributions to the  compact trust fund established for the benefit of each country. Investment  earnings from the compact trust funds are intended to provide an annual  source of revenue after the compact sector grants are scheduled to end  in 2023. In 2007, we reported that the compact trust funds may not  provide sustainable income after the compact sector grants end. As  2023 approaches, questions remain as to whether the FSM and RMI will  successfully transition to greater self-reliance when the 20 years of U.S.  compact economic assistance end.

You asked us to review issues related to the FSM’s and RMI’s transition  from compact grant assistance to relying on income from the compact  trust funds. This report examines (1) the use and role of U.S. funds and  programs in the FSM and RMI budgets, (2) projected compact trust fund  disbursements and potential strategies to address risks to those  disbursements, and (3) FSM and RMI efforts to prepare for the scheduled  decrements in compact grant funding and the transition to relying on  compact trust fund income.

To examine the use and role of U.S. funds and programs in the FSM and  RMI, we interviewed U.S. officials, and we also interviewed FSM and RMI  officials during our site visits to each country in July and August 2017. In  addition, we reviewed U.S. law; the FSM and RMI compact agreements  and the associated military use and operating rights agreements  (MUORA) and programs and services agreements; the FSM and RMI  government and component unit single audit reports for fiscal years 2012  through 2016; and U.S. Region IX reports for fiscal years 2015 and  2016. To assess the reliability of federal program funding information, we  reviewed the single audit reports and found that the auditors did not  express any qualified or adverse opinions regarding the information the  auditors used to prepare the audits’ Schedule of Expenditures of Federal  Awards listing the amount and use of federal grants. We therefore  concluded that these data were sufficiently reliable for estimating the role  of federal programs in the FSM and RMI budgets. To determine the legal  status of U.S. grants, programs, and services after 2023, we analyzed  U.S. law and requested review of our analysis from officials of U.S.  agencies that provide grants, programs, or services in the FSM and RMI.  Although we took multiple steps to validate our list of programs with the  FSM and RMI and the relevant U.S. agencies, our analysis may not have  captured all U.S. grants and programs provided in the FSM and RMI.

To examine projected compact trust fund disbursements and actions to  address risks, we reviewed previous studies of the compact trust funds,  the U.S.-FSM and U.S.-RMI compact trust fund agreements and other  governance and reporting documents, such as investment policy  statements, presentations before the committees for each compact trust  fund, audits, and annual reports. We also interviewed compact trust fund  committee members and the funds’ administrator, investment advisers,  and money managers.

To project the compact trust funds’ average disbursements, likelihood  of years with zero disbursement, and likelihood of maintaining value  after fiscal year 2023, we built a Monte Carlo simulation model and  performed 10,000 trial runs of projected returns and disbursements.  We used the unaudited fiscal year 2017 year-end balances of the  compact trust funds as the starting point for our projections. To  assess the reliability of the unaudited balances, we reviewed the  previous years’ audits and discussed with the trust funds’  administrator whether these audits had resulted in any significant  change between the preliminary unaudited balances and the final  audited balances. The March 2018 audited fund balances, released  after we completed our analysis, were within $5 of the unaudited fund  balances. We concluded that the unaudited balances were sufficiently  reliable as a basis for our projections of future trust fund performance.  To assess our net rate of return assumptions, we reviewed the trust  fund money managers’ capital market assumptions and projections  and tested varying rates of return and return distributions.

To consider the effects of alternative trust fund strategies, we again  performed the Monte Carlo analysis to determine the likely effects,  relative to the baseline, of five potential strategies that used one of  three approaches: (1) reducing annual compact trust fund  disbursements, (2) making additional contributions, and (3) changing  the disbursement policies, including strategies that would require  changes to the trust fund agreements. To select these potential  strategies, we reviewed previous studies of the compact trust funds  and interviewed agency and trust fund officials.

To examine FSM and RMI preparations to address the compact grant  decrements and the transition to trust fund support, we interviewed FSM and RMI officials and reviewed the FSM and RMI decrement  management plans. We compared these plans to single audit reports,  budgets, and actions to determine whether the plans were implemented.  We also followed up with Interior and the FSM and RMI governments  regarding the status of the plans and plan updates. To identify current  planning documents for the key sectors of health, education, and  infrastructure in the FSM and RMI as well as the status of current  planning efforts, we obtained the plans from department heads in each  key sector from the RMI and FSM national and state governments and  confirmed our identification of the documents with FSM and RMI officials.  We then reviewed these plans to determine whether the plans discussed  budget changes to address the transition to relying on compact trust fund  income after 2023. We also interviewed U.S., FSM, and RMI officials and  reviewed documentation to identify and describe ongoing planning  committees and working groups for the 2023 transition.

For more details of our objectives, scope, and methodology, see app. I.

We conducted this performance audit from March 2017 to May 2018 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

The FSM and the RMI are independent countries located about 3,000  miles southwest of Hawaii (see fig. 1).

The FSM is a federation of four semiautonomous states—Chuuk, Kosrae,  Pohnpei, and Yap—whose population and income vary widely. Chuuk,  the largest state by population, has the lowest per capita gross domestic  product (GDP). Overall, the FSM had a 2016 population of approximately  102,000 and a GDP per capita of about $3,200. The RMI’s 2016  population was approximately 54,000 with a GDP per capita of about  $3,600. The RMI’s most recent census, in 2011, found that approximately  three-quarters of the population lived in Majuro, the nation’s capital, and  on the island of Ebeye in the Kwajalein Atoll. Table 1 shows the FSM’s,  FSM states’, and RMI’s estimated population and annual GDP per capita  in fiscal year 2016.

The FSM states maintain considerable authority, relative to the FSM  national government, to allocate U.S. assistance and implement  budgetary policies. While the United States provides compact sector  grants directly to the FSM national government, a large portion of these  grants is passed through and provided to the four FSM states. The states  also receive other U.S. program grants that have been passed through  from the national government but may also receive grants directly from  U.S. agencies.

Overall, FSM public sector revenue sources include U.S. compact and  program grants; grants from other countries; taxation, including taxation  of foreign corporations domiciled in the FSM; and Parties to the Nauru  Agreement fishing fees charged to vessels operating in its waters. In  addition to maintaining departmental budgets, both the FSM national  government and the FSM states have government-owned enterprises and  component units, such as public utilities and port authorities, whose  operations are supported by public funds. Some of these component units  also receive U.S. compact sector grants or other U.S. grants passed  through the FSM national or state governments or directly from U.S.  agencies. According to Graduate School USA, the FSM’s public sector  accounted for about 53 percent of all employment in the FSM in fiscal  year 2016.

The RMI government is responsible for allocating U.S. assistance in that  country, though the RMI’s 24 local governments exercise local  government authority. RMI public sector revenue sources include U.S.  compact and program grants, grants from other countries, ship and  corporate registry earnings, and Parties to the Nauru Agreement fishing  fees. The RMI government also has state-owned enterprises and  component units whose operations are supported by public funds. Some  of these component units receive U.S. compact sector grants or other  U.S. grants passed through the RMI government or directly from U.S.  agencies. According to Graduate School USA, in fiscal year 2016, RMI’s  public sector accounted for approximately 48 percent of all employment in  the RMI. The U.S. Army Garrison–Kwajalein Atoll, located near Ebeye  island, also provides a significant source of employment for Marshallese.  In September 2017, U.S. Army Garrison-Kwajalein Atoll officials  estimated that approximately 1,100 Marshallese were employed at the  garrison.

U.S. relations with the FSM and the RMI began during World War II,  when the United States ended Japanese occupation of the region.  Beginning in 1947, the United States administered the region under a  United Nations trusteeship. During the 1940s and 1950s, the RMI was  the site of 67 U.S. nuclear weapons tests on or near Bikini and Enewetak  Atolls. The four states of the FSM voted in a 1978 referendum to become  an independent nation, while the RMI established a constitutional  government and declared itself a republic in 1979. Under the trusteeship  agreement, both newly formed nations remained subject to the authority  of the United States until 1986.

In 1986, following a period of negotiations, the United States entered into  a compact of free association with the FSM and the RMI that provided for  economic assistance to the two countries, secured U.S. defense rights,  and allowed FSM and RMI citizens to migrate to the United States. The  compact provided a framework for the United States and the two  countries to work toward achieving the following three main goals: (1)  establish self-government for the FSM and the RMI, (2) ensure certain  national security rights for all of the parties, and (3) assist the FSM and  the RMI in their efforts to advance economic development and self- sufficiency. The compact’s third goal was to be accomplished primarily  through U.S. direct financial assistance to the FSM and the RMI.

Under the original compact, the FSM and the RMI used funds for general  government operations; capital projects, such as building roads and  investing in businesses; debt payments; and targeted sectors, such as  energy and communications. The FSM concentrated much of its spending  on government operations at both national and state levels, while the RMI  emphasized capital spending. While the original compact set out specific  obligations for reporting and consultations regarding the use of compact  funds, the FSM, RMI, and U.S. governments provided little accountability  over compact expenditures and did not ensure that funds were spent  effectively or efficiently.

Amended Compacts of Free Association (2004– Present)

In 2003, following a period of negotiations, the United States approved  separate amended compacts with the FSM and the RMI that went into  effect on June 25, 2004, and May 1, 2004, respectively.

Compact Grants and Trust Fund Contributions

The amended compacts’ implementing legislation authorized and  appropriated direct financial assistance to the FSM and the RMI in fiscal  years 2004 through 2023, with the base amounts decreasing in most  years. The annual decrements in assistance are added to the amounts  deposited in the trust funds established under the amended compacts for  the two nations. Earnings from the compact trust funds are intended to  provide an annual source of revenue after the scheduled end of compact  sector grants at the end of fiscal year 2023. Both the compact sector  grants and trust fund contributions are partially adjusted for inflation each  fiscal year. Appendix II provides additional information on the base and  inflation-adjusted amounts of U.S. compact sector grants and trust fund  contributions in fiscal years 2004 through 2023.

The amended compacts and associated fiscal procedures agreements  require that compact sector grants support the countries in six core  sectors—education, health, infrastructure, environment, private sector  development, and public sector capacity building—with the education and  health sectors having priority. These grants are described in section  211(a) of each compact and are referred to as compact sector grants or  211(a) grants. Section 211(b) of the RMI compact further states that the  RMI must target a specified amount of grants to Ebeye and other  Marshallese communities within Kwajalein Atoll. The RMI MUORA  states that the Kwajalein-related funds provided to the RMI in the  compacts shall be provided through fiscal year 2023 “and thereafter for as  long as this agreement remains in effect.”

Compact Trust Fund Management and Implementation

The amended compacts and their subsidiary trust fund agreements  provided that each trust fund is to be managed by a compact trust fund  committee. Each compact trust fund committee includes representatives  from both the United States and the respective country, but the United  States is required by the terms of the trust fund agreements to hold the  majority of votes on each committee. The Director of Interior’s Office of  Insular Affairs serves as the chair of each committee. Trust fund  committee responsibilities include overseeing fund operation, supervision,  and management; investing and distributing the fund’s resources; and  concluding agreements with any other contributors and other  organizations. As part of this oversight, the committees are to establish  an investment and distribution policy. The committees are also to  determine fiscal procedures to be used in implementing the trust fund  agreements based on the fiscal procedures used for compact grant  administration unless otherwise agreed by the parties to the agreement.

The trust fund agreements between the United States and the FSM and  the RMI allow for the agreements to be amended in writing at any time,  with mutual consent of the governments. However, the U.S. legislation  implementing the amended compacts requires that any amendment,  change, or termination of all or any part of the compact trust fund  agreements shall not enter into force until incorporated into an act of  Congress.

According to the trust fund agreements, each trust fund committee is to  appoint a trustee and an independent auditor. Each committee has  retained an Executive Administrator to manage the daily operations of the  trust fund. In addition, the committee has the authority to appoint 1 or  more investment advisers and may enter into a separate agreement with  1 or more money managers. The investment policy statement for each  fund guides the fund’s investment strategy and portfolio.

The compact trust fund agreements state that no funds, other than  specified trust fund administrative expenses, may be distributed from the  compact trust fund prior to October 1, 2023. From fiscal year 2024  onward, the maximum allowed disbursement from each compact trust  fund is the amount of the fiscal year 2023 annual grant assistance, as  defined by the trust fund agreement, with full adjustment for inflation.

In addition, the trust fund committees may approve additional amounts for  special needs. The RMI compact trust fund agreement excludes from  the calculation of the allowed disbursement the amount of the Kwajalein- related assistance defined in section 211(b) of the RMI compact.  Although the compact trust fund agreements state the maximum  allowable disbursement level, they do not establish or guarantee a  minimum disbursement level.

Each country’s compact trust fund consists of three interrelated accounts:  the “A” account, the “B” account, and the “C” account.

The A account is the trust fund’s corpus and contains the initial, and  any additional, U.S. and FSM or RMI contributions; contributions from  other countries; and investment earnings. No funds, other than  specified trust fund administrative expenses, may be disbursed from  the A account.

The B account is the trust fund’s disbursement account and becomes  active in fiscal year 2023. All income earned in 2023 will be deposited  in the B account for possible disbursement in 2024. Each subsequent  year’s investment income will similarly be deposited into the B  account for possible disbursement the following year. If there is no  investment income, no funds will be deposited in the B account for  possible disbursement the following year.

The C account is the trust fund’s buffer account. Through 2022, any  annual income exceeding 6 percent of the fund balance is deposited  in the C account. From 2023 onward, if annual income from the A  account is less than the previous year’s disbursement, adjusted for  inflation, the C account may be tapped to address the shortfall. After  2023, any funds in the B account in excess of the amount approved  for disbursement the following fiscal year are to be used to replenish  the C account as needed, up to the maximum size of the account. The  size of the C account is capped at three times the amount of the  estimated annual grant assistance in 2023, including estimated  inflation. If there are no funds in the C account, and no prior year  investment income in the B account, no funds will be available for  disbursement to the countries the following year.

Figure 2 shows the compact trust fund account structure and associated  rules.

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 compact trust fund A account between 2004 and  2023. A “D” account may also 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. Only the RMI has a D account, governed in part by an agreement  between Taiwan and the RMI.

Compact Accountability, Management Structures, and Reporting

The amended compacts’ implementing legislation and their subsidiary  fiscal procedures agreements established committees to oversee  compact grants to each country—the Joint Economic Management  Committee (JEMCO) for the FSM and the Joint Economic Management  and Financial Accountability Committee (JEMFAC) for the RMI. Each five- member committee comprises three representatives from the U.S.  government and two representatives from the corresponding country, with  the Director of Interior’s Office of Insular Affairs serving as the chair.

JEMCO’s and JEMFAC’s designated roles and responsibilities include the  following:  reviewing the budget and development plans from each of the  governments; approving grant allocations and performance objectives; attaching terms and conditions to any or all annual grant awards to  improve program performance and fiscal accountability; evaluating progress, management problems, and any shifts in  priorities in each sector; and  reviewing audits called for in the compacts.

JEMCO and JEMFAC can require that terms and conditions be attached  to any and all annual compact sector grant awards to improve program performance and fiscal accountability. Under the fiscal procedures  agreements governing the amended compacts, the Office of Insular  Affairs is responsible for using financial reports to monitor each country’s  budget and fiscal performance and for using performance reports  submitted by the countries to evaluate sector grant performance. The  FSM and the RMI also must adhere to specific fiscal control and  accounting procedures and are required to submit annual audit reports,  within the meaning of the Single Audit Act as amended.

The FSM and RMI compacts require each country to develop multiyear  plans that are strategic in nature and continuously reviewed and updated  through the annual budget process and that address the assistance for  the defined sectors. In 2013, we recommended that Interior, as Chair of  JEMCO and JEMFAC, ensure that the FSM and the RMI complete plans  to address the impact of declining compact sector grants (in this report,  decrement management plans). In November 2013, the FSM finalized  its decrement management plan for fiscal years 2014 through 2023; the  plan indicated that a similar planning process is to be repeated in 3-year  intervals. In September 2014, the RMI finalized its decrement  management plan for fiscal years 2015 through 2023; the plan similarly  stated that a comprehensive planning process to address the ongoing  decrement may proceed on a 3-year update schedule. Each decrement  management plan includes commitments for budget reductions in the  national governments and, in the FSM, the state governments, as well as  plans to undertake actions such as tax reform.

Programs and Services Provided in Compact-Related Agreements

The amended compacts’ implementing legislation incorporates by  reference related agreements extending programs and services to the  FSM and RMI. The programs and services agreement with each country  identifies the following programs and services as being available to each  country: U.S. postal services, weather services, civil aviation, disaster  preparedness and response, and telecommunications. Each programs  and services agreement extends for 20 years from the compact’s entry  into force. Therefore, the agreement with the FSM ends on June 24,  2024, and the agreement with the RMI ends on April 30, 2024.

The amended compacts’ implementing legislation (Pub. L. No. 108-188)  and other U.S. legislation authorize other U.S. grants, programs, and  services for the FSM and RMI. Pub. L. No. 108-188 authorized an annual  supplemental education grant (SEG) for the FSM and RMI in fiscal years  2005 through 2023, to be awarded in place of grants formerly awarded to  the countries under several U.S. education, health, and labor programs.  The FSM and RMI are not eligible for the programs replaced by the SEG  during these years. Unlike the compact sector grants, the amended  compacts’ implementing legislation authorized the SEG but did not  appropriate funds for it. Funding for the SEG is appropriated annually to  the U.S. Department of Education (Education) and transferred to Interior  for disbursement. Other provisions of the amended compacts’  implementing legislation, as well as other U.S. law, make the FSM and  RMI eligible for a number of additional programs. Other federal  departments are responsible for the administration and oversight of their  respective programs in the FSM and RMI.

The FSM and RMI Continue to Rely on U.S. Grants and Programs That End in 2023

Compact sector grants and the SEG, each of which end in 2023, continue  to support a substantial portion of government expenditures in the FSM  and RMI. In the FSM, compact sector grants and the SEG support about  one-third of all government expenditures. The four FSM states rely on  these grants to a greater extent than the FSM national government does.  In the RMI, compact sector grants and the SEG support about one- quarter of all government expenditures. The end of the compacts’  programs and services agreements in 2024 would also require the FSM  and RMI to bear additional costs to provide services currently provided by  the United States as part of the Agreements. Appendix IV provides a  detailed summary of programs and services we identified that have been  provided through the amended compacts, the amended compacts’  implementing legislation, compact-related agreements, and other  provisions of U.S. law, as well as their status in the FSM and RMI after  2023.

U.S. Compact Grants and Other Grants Continue to Provide Substantial Support to the FSM and RMI Budgets

U.S. Grants Scheduled to End in 2023 Support About One- Third of Total FSM Government Expenditures

The FSM national and state governments overall continue to rely on U.S.  support for program expenditures. Compact sector grants, the SEG, and  other U.S. grants supported almost half of FSM national and state  government expenditures in fiscal year 2016. Compact sector and  supplemental education grants that end in 2023 supported approximately  one-third of total FSM national and state government expenditures in  fiscal year 2016, while other U.S. grants supported an additional 15  percent of total FSM government expenditures (see fig. 3).

Compact sector and supplemental education grants that end in 2023  support a larger proportion of FSM state governments’ expenditures than  of the FSM national government’s expenditures. In fiscal year 2016,  compact sector grants and the SEG supported 8 percent of national  government expenditures but supported 50 percent or more of each  state’s government expenditures. Among the FSM states, Chuuk—both  the largest state and the state with the lowest per capita income in the  FSM—has the highest percentage of its expenditures supported by U.S.  grants. (See table 2 for a summary of FSM national and state government  expenditures supported by compact sector grants and the SEG, and by  other U.S. grants.) Compact sector grants and the SEG support an even  higher proportion of FSM states’ health and education expenditures. See  app. III for a summary of the role of compact funds in the FSM health and  education sectors.

The RMI continues to rely on U.S. support for program expenditures.  Compact sector and supplemental education grants that end in 2023  supported approximately 25 percent of the RMI’s $123.5 million in  government expenditures in fiscal year 2016, while other U.S. grants  supported an additional 8 percent. Compact Kwajalein-related grants  that do not end in 2023 supported an additional 3 percent (see fig. 4).  Compact sector grants and the SEG support an even higher proportion of  RMI health and education expenditures. See app. III for a summary of the  role of compact funds in the RMI health and education sectors.

End of the Programs and Services Agreements Would Also Affect FSM and RMI Budgets

FSM and RMI budgets would be affected if the countries were to assume  responsibility for providing some additional programs and services  currently provided by the United States. Current U.S. law enables U.S.  agencies to continue providing some programs and services now  provided under the agreements after they end in 2024. However, under  current law, some programs and services provided in the programs and  services agreements will end and would require the FSM and RMI to bear  additional costs. See appendix IV for a summary of the status of  programs and services provided under the programs and services  agreements after the agreements end.

Compact Trust Funds Face Continuing Risks That Trust Fund Committees Have Not Yet Addressed

Previous studies of the FSM and RMI compact trust funds, including a  review we conducted in 2007, found that after fiscal year 2023 the funds  are unlikely to provide maximum annual disbursements, may provide no  disbursements at all in some years, and are unlikely to sustain the funds’  fiscal year 2023 value. Our updated projections for the compact trust  funds show similar outlooks. Several potential strategies could improve  the compact trust funds’ outlook; some of these strategies could be  implemented under the current trust fund agreements, while other  strategies may require changing the trust fund agreements. The compact  trust fund committees have not yet prepared distribution policies, required  by the trust fund agreements, that could assist the countries in planning  for the transition to trust fund income. In addition, the committees have  not established fiscal procedures for oversight of compact trust fund  disbursements as required by the trust fund agreements. Further, the  trust fund committees have not yet addressed a potential misalignment  between the timing of their annual calculation of the amounts available to  disburse and the FSM’s and RMI’s budget timelines, potentially  complicating each country’s planning and management.

Previous Studies of Compact Trust Funds Found Increasing Risks to Disbursements and Sustainability under Current Rules

Previous studies of the compact trust funds have found that some yearly  disbursements from the funds after 2023 are likely to fall short of the  inflation-adjusted amount of annual grant assistance in 2023 and that the  funds may provide no disbursement at all in some years. Our 2007  analysis of the compact trust funds projected a wide range of potential  balances and found that the funds’ capacity to provide the maximum  allowable disbursement would likely decrease over time. In addition, our  analysis showed an increasing likelihood that the trust funds would  exhaust the C account and be unable to provide any disbursements in the  latter years of our projection. Other analyses have similarly found risks  of low or zero disbursements and risks to sustainability.

Graduate School USA has prepared an annual series of economic  reports on each country, including analyses of their compact trust  funds.

In 2015, an Asian Development Bank report separately analyzed the  trust funds.

The International Monetary Fund projected the status of the trust  funds as part of its biennial FSM and RMI consultations.

Updated Projections Show Continuing Risks to Compact Trust Fund Disbursements and Sustainability

Our updated projections for the FSM and RMI compact trust funds after  2023 indicate a continued likelihood that, given their balance at the end of  fiscal year 2017 and current compact trust fund rules—the baseline  scenario—the funds will be unable to provide maximum disbursements (equal to the inflation- adjusted amount of annual grant assistance in 2023) in some years; unable to provide any disbursement at all in some years, with the  likelihood of zero disbursement in a given year increasing over time;  and unable to maintain the inflation-adjusted value of the compact trust  fund after fiscal year 2023.

The compact trust funds’ C account—designed as a buffer to protect  disbursements from the B account in years when the funds do not earn  enough to fund the disbursement—could be exhausted by a series of  years with low or negative annual returns. Since current rules do not allow  disbursements from the compact trust fund corpus (the A account),  exhaustion of the C account would result in zero disbursement in years  when fund returns are zero or negative. Thus, there may be no funds  available to disburse even if the funds’ A accounts have a balance. As a  result of low or zero disbursements, the countries could face economic  and fiscal shocks and significant challenges in planning programs and  budgets.

Our model projects that, given the baseline scenario and a 6 percent net  return, the FSM compact trust fund will experience declining  disbursements relative to the maximum allowable disbursements; an  increasing chance of zero disbursements; and a declining likelihood of  maintaining its 2023 balance. See appendix I for a full description of our  methodology and appendix V for the baseline results with alternative net  returns.

Projected disbursements. We project that the FSM compact trust  fund will, on average, be able to provide disbursements equal to 82  percent of the maximum allowable disbursement—the inflation- adjusted amount of 2023 annual grant assistance—in its first decade  of disbursements. The likely average disbursement falls to 49 percent  of the maximum in the next decade and falls further in subsequent  decades. In addition, the amount available for disbursement may  fluctuate substantially from year to year. Depending on the compact  trust fund’s performance in the previous year, disbursements may be  higher or lower than the average amount if the balance in the C  account is not sufficient to provide additional disbursements.

Likelihood of providing zero disbursement. We project a 41  percent likelihood that the FSM compact trust fund will be unable to  disburse any funds in 1 or more years during the first decade of trust  fund disbursements. This likelihood increases over time, rising to 92  percent in fiscal years 2054 through 2063.

Likelihood of maintaining inflation-adjusted 2023 balance. We  project a 13 percent likelihood that the FSM compact trust fund will  maintain or exceed its inflation-adjusted fiscal year 2023 value in  fiscal year 2033. This likelihood decreases in later years.

Figure 5 shows our projections of the FSM compact trust fund’s average  disbursements as a percentage of maximum disbursement, the likelihood  of 1 or more years of zero disbursement, and the likelihood of the fund’s  maintaining its inflation-adjusted fiscal year 2023 balance given the  baseline scenario and a 6 percent net return.

The FSM also maintains its own trust fund separate from the compact  trust fund (see app. VI for additional information). We did not  independently project the FSM Trust Fund’s future balance or potential  disbursements after 2023.

Our model projects that, given the baseline scenario and a 6 percent net  return, the RMI compact trust fund will experience declining  disbursements relative to the maximum allowable disbursements; an  increasing chance of zero disbursements; and a declining likelihood of  sustaining its 2023 balance.

Projected disbursements. We project that the RMI compact trust  fund will, on average, be able to provide disbursements nearly equal  to the inflation-adjusted amount of 2023 annual grant assistance as  defined by the trust fund agreement—the maximum allowable—in its  first decade of disbursements. However, the projected disbursements  as a percentage of the maximum disbursements decline by about 10  percentage points in each subsequent decade. In addition, the  amount available to disburse may fluctuate substantially from year to  year. Depending on the compact trust fund’s performance in the  previous year, disbursements may be higher or lower than the  average amount if the balance in the C account is not sufficient to  provide additional disbursements.

Likelihood of providing zero disbursement. We project a 15  percent likelihood that the RMI compact trust fund will be unable to  disburse any funds in 1 or more years during the first decade of trust  fund disbursements. This likelihood increases over time, rising to 56  percent in fiscal years 2054 through 2063.

Likelihood of maintaining inflation-adjusted 2023 balance. We  project a 41 percent likelihood that the RMI compact trust fund will  maintain or exceed its inflation-adjusted fiscal year 2023 value in  fiscal year 2033. This likelihood decreases in later years.

Figure 6 shows our projections of the RMI compact trust fund’s average  disbursements as a percentage of maximum disbursement, its likelihood  of 1 or more years of zero disbursement, and its likelihood of maintaining  its inflation-adjusted fiscal year 2023 balance given the baseline scenario  and a 6 percent net return.

The RMI also maintains its own D account separate from the compact  trust fund (see app. VI for additional information). We did not  independently project the D account balance or potential disbursements  from the D account after 2023.

Reducing Disbursements, Making Additional Contributions, and Changing Disbursement Policies Would Each Affect the Outlook of the Compact Trust Funds

We conducted a series of simulations to determine the likely effects of  potential strategies for improving the outlook of the FSM and RMI  compact trust funds. Prior studies by Graduate School USA, the Asian  Development Bank, and the International Monetary Fund examined the  effects of three general approaches for improving the trust funds’  outlooks: (1) reducing planned disbursements from the funds, (2) making  additional contributions to the funds, and (3) changing the compact trust  fund disbursement policies. These prior studies included strategies that  would require changing the trust fund agreements to permit  disbursements from the A account. To isolate the impact of individual  changes on compact trust fund balance and disbursements, we  developed and analyzed five potential strategies based on the  approaches examined in the prior studies.  1.  Annual disbursements are reduced below the maximum allowable  disbursement.  2.  Additional annual contributions are made to the trust fund in fiscal  years 2018 through 2023.  3.  The trust fund agreement disbursement policies are modified to limit  the annual disbursement to a fixed percentage of the fund’s moving  average balance over the previous 3 years, up to the maximum  disbursement amount defined by the current trust fund agreement.  4.  The trust fund agreement disbursement policies are modified to  reduce the amount of the annual disbursement if the compact trust  fund’s moving average balance over the previous 5 years is lower  than a primary target amount.  5.  The trust fund agreement disbursement policies are modified to set  the target disbursement as 2.1 percent of the compact trust fund’s  balance in fiscal year 2024. The disbursement amount is further  decreased if the fund’s moving average balance over the previous 5  years is lower than the primary target balance.

Implementing either of the first two potential strategies would not require  any changes to disbursement provisions in the existing trust fund  agreement, but implementing any of the remaining three strategies may  require such changes. In strategies 3, 4, and 5, we analyzed strategies  that would permit disbursement from the A account. Disbursing from the  A account would require changing the compact trust fund agreements.  The agreements can be amended in writing at any time, with mutual  consent of the governments. However, the U.S. legislation implementing  the amended compacts requires that any amendment, change, or  termination of all or any part of the compact trust fund agreements shall  not enter into force until incorporated into an act of Congress.

All of the potential strategies we analyzed would reduce or eliminate the  risk of the compact trust funds experiencing years of zero disbursement.  However, all of the potential strategies would require the countries to  exchange a near-term reduction in resources for more predictable and  sustainable disbursements in the longer term. Appendix VII presents the  detailed results of our analysis.

Compact Trust Fund Committees Have Not Addressed Issues Related to Distribution Policies, Fiscal Procedures, and Disbursement Timing

Trust Fund Committees Have Not Developed Distribution Policies Required by the Compact Trust Fund Agreements

Under the compact trust fund agreements, each trust fund committee  must develop a distribution policy, with the intent that compact trust fund  disbursements will provide an annual source of revenue to the FSM and  RMI after fiscal year 2023. The trust fund committees could use  distribution policies to address risks to each fund’s sustainability. For  example, the committees have the discretion to disburse an amount  below the established maximum. Our analysis of potential strategies for  improving the funds’ outlook shows that reducing the size of  disbursements would improve each compact trust fund’s long-term  sustainability. According to interviews with, and documents provided by,  the trust funds’ administrator, the committees reviewed presentations in  2016, 2017, and early 2018 from the authors of previous studies and fund  managers regarding the likely status of the trust funds after 2023 and  have also reviewed options for addressing risks to the trust funds’  disbursements and sustainability, including changes to disbursement  provisions in the compact trust fund agreements. However, as of January  2018, according to the trust funds’ administrator, neither committee had  developed a distribution policy. Without a distribution policy that provides  information about the size of expected disbursements, the FSM and RMI  are hampered in their current and ongoing efforts to plan for the potential  reduction in U.S. compact assistance after 2023.

Trust Fund Committees Have Not Established Fiscal Procedures Required by Compact Trust Fund Agreements

The compact trust fund committees have not yet established fiscal  procedures for compact trust fund disbursements after fiscal year 2023.  Each trust fund agreement requires the respective committee to  determine the fiscal procedures to be used in implementing the trust fund  agreement. The committees are to base their procedures on the compact  fiscal procedures agreements, which define the membership and duties of  the JEMCO and JEMFAC and single audit report requirements, among  other things, unless the parties to the trust fund agreement agree to adopt  different fiscal procedures. No compact trust fund disbursements are to  be made unless the committee has established such trust fund fiscal  procedures.

U.S., FSM, and RMI officials are aware of the need to determine the fiscal  procedures that will govern oversight of compact trust fund  disbursements. Issues related to future oversight of compact trust fund  disbursements have been raised for discussion with U.S. representatives  on JEMCO and JEMFAC. However, according to an RMI representative  on the compact trust fund committee, that committee has not discussed  fiscal procedures for the compact trust fund disbursements. In addition,  FSM officials noted that they were unsure whether the JEMCO or the  compact trust fund committees would approve specific projects. Without  fiscal procedures in place, the trust fund committees will not be able to  provide disbursements and the United States, the FSM, and the RMI will  lack clear guidance to ensure oversight for trust fund disbursements.

Trust Fund Committees Have Not Addressed Issues Related to Disbursement Timing

The timing of the trust fund committees’ calculation of the amounts  available for annual disbursement to the FSM and the RMI does not align  with the countries’ budget and planning timelines. The amounts  available for disbursement in a given fiscal year cannot be determined  until each fund’s returns have been determined at the end of the prior  year. Further, if the disbursement amounts are calculated from audited  fund returns as determined by annual audits required by the trust fund  agreements, the amounts may not be determined until as late as March  31, 6 months into the fiscal year for which the disbursement is to be  provided. However, both the FSM and the RMI government budget  cycles are completed before the annual amounts available for  disbursement will be known. As a result, the FSM and RMI would have to  budget without knowing the amount to be disbursed, complicating their  annual budget and planning processes. See figures 7 and 8 for the FSM  and RMI budget timelines for fiscal year 2024, based on their current  budget calendars, relative to the dates when the compact trust fund  disbursement amounts will be determined on the basis of the funds’  unaudited end-of-fiscal-year balances and of their audited balances.  Standards for Internal Control in the Federal Government—which is  applicable to the U.S. government but can be adopted as a best practice  by nongovernmental entities—states that management should use quality  information to achieve the entity’s objectives. For example, as part of  using quality information, the entity obtains relevant data from reliable  internal and external sources in a timely manner based on the identified  information requirements.

Given the FSM’s and RMI’s current budget processes, the FSM and RMI  will not have accurate and timely information on the amounts that will be  available for annual disbursements for each fiscal year. The FSM  Secretary of Finance and Administration, a member of the compact trust  fund committee, indicated that she is aware of the discrepancy between  the timing of the trust fund disbursement calculations and dates in the  FSM’s budget and planning cycle and stated that the FSM would raise the  issue of this discrepancy as part of its planning for the transition to relying  on compact trust fund disbursements. One of the RMI’s representatives  on the compact trust fund committee stated that the timing of the  disbursement calculations was a challenge and would complicate RMI  planning and management. Each trust fund committee received a briefing  in 2016 from the trust funds’ administrator that discussed issues  associated with the timing of the disbursement calculations. However, as  of January 2018, the committees had not determined how they would  address this issue.

FSM and RMI Decrement Plans Were Not Implemented Because of Increased Revenues, but Each Country Has Begun New Planning Efforts

The FSM and RMI did not implement planned budget reductions to  address decreasing compact sector grants because of increasing  revenue from other sources. FSM officials stated that they did not  implement their plan’s planned budgetary reductions due to increasing  revenues for the state and national governments. The RMI also did not  implement budget reductions but used increased revenue, particularly  from fishing fees, to offset the decrement in compact sector grants. FSM  and RMI strategic plans in the key sectors of education and health focus  on strategic goals and priorities rather than addressing the effect of the  2023 transition on health and education budgets. However, FSM and RMI  infrastructure plans discuss funding requirements and potential alternative  funding sources. The FSM, the RMI, and the United States have each  established bodies to plan to address issues related to the 2023 transition  to trust fund income.

Previous Decrement Management Plans Were Not Implemented Because of Growth in Revenues

The FSM has not implemented budget reductions scheduled in its  decrement management plan, the FSM-Wide Long-Term Fiscal  Framework (Long-Term Fiscal Framework). The FSM’s plan included a  firm commitment for a 6 percent reduction in real terms in FSM state  expenditures in fiscal year 2014. Two additional 6 percent expenditure  reductions were planned for fiscal years 2017 and 2020, but these were  contingent reductions that would not be implemented if the FSM states  received offsetting revenue to address the reductions. According to FSM  national government officials, revenue increases, including growth in  revenue from fishing fees, have enabled the FSM to avoid implementing  the 2017 contingent 6 percent expenditure reductions, and the further  reductions in fiscal year 2020 are not likely to be implemented. FSM  officials cited multiple reasons for not implementing the planned  reductions:  Increasing revenue to the state and national governments. The  FSM’s Long-Term Fiscal Framework included a plan to increase the  proportion of compact sector grant funding distributed among the FSM  states and reduce the proportion retained by the national government.  This change in the FSM’s internal compact grant distribution formula  reduced the amount of the decrement in compact sector grants  received by the states that would have otherwise occurred. The FSM  national government’s revenue from fishing fees has increased rapidly  in recent years, allowing it to use this revenue in place of compact  sector grants.

Effect of inflation adjustments on compact sector grants.

According to FSM officials, because of inflation adjustments, the  nominal value of the compact sector grants has not significantly  declined. As a result, the FSM government questions the need for  expenditure reductions.

In addition to scheduling budget reductions, the FSM’s Long-Term Fiscal  Framework included plans to implement unified tax reform measures,  which also have not been implemented. However, plans to reduce the  national government’s share of compact sector grants and to use  surpluses to mitigate the effect of fiscal reforms were implemented. (See  app. VIII for a summary of the FSM’s planned actions and their  implementation.) As of January 2018, the FSM had not updated the Long- Term Fiscal Framework but had included information updates in its  annual budget submittal.

The RMI government has not implemented budget reductions scheduled  in its decrement management plan. The RMI’s decrement management  plan divided proposed budgetary reductions into three periods: fiscal  years 2016 through 2017, fiscal years 2018 through 2020, and fiscal  years 2021 through 2023. Only the reductions in the first period were to  be considered binding, with adjustments in the later periods subject to  review during the next 3-year planning cycle. According to RMI  government officials, significant growth in fishing fee revenue and growth  in ship registry and income tax revenue has minimized the initially  anticipated impact of the compact decrements, thereby reducing the need  to implement expenditure reductions. RMI officials noted that it expected  to continue to use its own revenue in place of compact funds in fiscal  years 2019 through 2023.

In addition to scheduling the budget reductions, the RMI decrement  management plan includes plans to implement new taxes, program  fishing fees into the annual budget, reduce subsidies to state-owned  enterprises, and reduce compensation to Majuro landowners for the use  of their land for utilities. The RMI has programmed a portion of its fishing  fee surplus into the annual budget in each fiscal year from 2015 to 2017  but has not implemented other planned actions. (See app. VIII for a  summary of planned actions and their implementation.) As of January  2018, the RMI government had not updated its plan and did not intend to  do so, according to RMI officials. However, the officials stated that the  government has incorporated elements of the plan, particularly its  expenditure analysis, into the RMI’s medium term budget and investment  framework, a planning and budgeting document submitted to JEMFAC in  August 2017. In comments on a draft of this report, the RMI stated that it  is developing a long-term fiscal framework in addition to the medium term  budget and investment framework. According to the RMI, the long-term  fiscal framework will have a 10-year outlook through 2028 and take into  account compact decrements and anticipated resources from the  compact trust fund and other sources.

FSM and RMI Have Developed Plans for Health, Education, and Infrastructure

FSM national and state infrastructure plans provide specific budgetary  information to address the fiscal year 2023 transition from compact sector  grants to trust fund income, such as funding requirements and sources of  funding for planned infrastructure projects in fiscal years 2016 through  2025. The FSM national and state health and education plans generally  focus on the national and state health and education departments’  strategic goals and priorities rather than discussing budget changes or  new revenue generation strategies to address the possibility of reduced  resources after 2023.

In addition to preparing sector strategic development plans, the FSM  national and state governments issued the 2023 Action Plan in 2014,  designed to address fiscal and economic challenges before and after  compact sector grant funding ends in fiscal year 2023. In contrast to the  FSM Long-Term Fiscal Framework, which committed to specific  expenditure reductions and government actions prior to fiscal year 2023,  the 2023 Action Plan includes an economic growth strategy that seeks to  boost private sector development. The plan addresses economic growth  strategies and improved performance in key economic sectors such as  tourism, agriculture, and fisheries and identifies the need for the FSM  national and state governments to limit expenditure growth in the medium  and long terms.

The RMI’s infrastructure plan addresses the scheduled cessation of  compact sector grant assistance in fiscal year 2023 through a review of  potential future budgets, while the RMI’s education and health plans  outline strategic goals and priorities. Similar to the FSM’s infrastructure  plans, the RMI National Infrastructure Plan reviews budget information to  address the fiscal year 2023 transition, such as planned infrastructure  investments and potential alternative funding sources for fiscal years  2017 through 2026. The RMI’s national education and health plans  primarily focus on goals and objectives to address key challenge areas in  health and education over the next few fiscal years and do not discuss  specific budget changes for the transition in 2023.

FSM, RMI, and U.S. Planning Groups Have Been Formed to Prepare for Transition to Trust Fund Income

Both the FSM and the RMI have formed planning committees and  charged them with planning for the fiscal year 2023 transition from  compact sector grants to compact trust fund income. In addition, the U.S.  Department of State (State) has organized a U.S. interagency planning  group to help coordinate U.S. policy related to the transition.

FSM Joint Compact Review and Planning Committee

In 2016, the FSM national government established a Joint Compact  Review and Planning Committee to coordinate FSM planning for the  transition from compact sector grants to trust fund income in 2023. The  committee is mandated to, among other things, set goals in anticipation of  the end of compact grants, develop strategies and alternatives, identify  financial assistance sources, analyze economic information, and provide  periodic reports to the FSM Congress. The committee first met in May  2017. In September 2017, the committee hired an Executive Director,  who in turn hired an economist and Executive Secretary prior to the  committee’s February 2018 meeting. As of January 2018, according to  FSM officials, the committee had not produced any publicly available  products but had collected information from various FSM government  agencies.

According to the RMI Office of Compact Implementation, the RMI  established the Compact Review Commission in late 2016 to plan for the  fiscal year 2023 transition from compact sector grants to trust fund  income. According to the Office of Compact Implementation, the  commission is mandated to review the compact and make  recommendations to the cabinet regarding priorities to be addressed for  the fiscal year 2023 transition. Specific priorities may include the status of  federal programs that will expire in fiscal year 2023, the adequacy of the  compact trust fund to provide needed revenue, and other issues relevant  to the cessation of compact grant assistance. In January 2018, the RMI  Presidential Cabinet appointed a Compact Review Commission  Coordinating Committee, consisting of the RMI Ambassador to the United  States, the Director of the RMI Office of Compact Implementation, the  Secretary of Finance, a private sector representative, and a legal adviser,  and directed it to coordinate the commission’s meetings, actions, and  reporting.

State began holding regular meetings of the Interagency Working Group  on the Freely Associated States in February 2017 to provide guidance  and oversight for policy concerning the Compacts of Free Association and  to coordinate U.S. policy in light of the fiscal year 2023 transition. The  group met monthly through the rest of 2017, except in November. The  monthly meetings have focused individually on the FSM and RMI, as well  as addressed cross-cutting issues such as donor coordination. For  example, in March and July 2017, the group’s monthly meetings focused  on the FSM and included participation by the U.S. Ambassador and the  FSM Ambassador, respectively. Similarly, in April and June 2017, the  group’s monthly meetings focused on the RMI and included participation  by the U.S. and RMI ambassadors, respectively. According to State  officials, the meetings will continue indefinitely on a monthly basis.

The U.S. compacts of free association with the FSM and the RMI  provided a framework for the United States and the two countries to work  toward, among other things, the goal of assisting the FSM and the RMI in  their efforts to achieve economic development and self-sufficiency. The  end of U.S. compact sector grants in fiscal year 2023 and the beginning  of disbursements from the compact trust funds in fiscal year 2024 will  mark a key transition in these ongoing efforts, and the FSM and RMI are  currently preparing plans for addressing issues associated with the  transition to compact trust fund income. The countries’ transition to relying  on income from the compact trust funds will likely require significant  budgetary choices. However, lacking the trust fund distribution policies  required under the trust fund agreements, the FSM and RMI are  hampered in their efforts to plan for the potential reduction in U.S.  compact assistance after 2023. In addition, without the required fiscal  procedures governing trust fund actions after 2023, the trust fund  committees will be unable to make disbursements and the United States,  the FSM, and the RMI will not have assurance of necessary oversight of  trust fund disbursements. Finally, without alignment between the timing of  the trust fund committees’ annual calculation of the amounts available for  disbursement and the countries’ annual budget cycles, the FSM and RMI  will have to plan their budgets for each fiscal year without knowing the  amount of the disbursements from the compact trust funds.

We are making the following six recommendations to Interior:  The Secretary of the Interior should ensure that the Director of the Office  of Insular Affairs, as Chairman of the FSM compact trust fund committee,  works with other members of the committee to develop a distribution  policy for the FSM compact trust fund, as required by the compact trust  fund agreement, that takes into account potential strategies that could  address risks to the fund’s ability to provide a source of income after fiscal  year 2023. (Recommendation 1)

The Secretary of the Interior should ensure that the Director of the Office  of Insular Affairs, as Chairman of the FSM compact trust fund committee  and of the FSM Joint Economic Management Committee, works with  other members of the committees to develop the fiscal procedures  required by the compact trust fund agreement. (Recommendation 2)

The Secretary of the Interior should ensure that the Director of the Office  of Insular Affairs, as Chairman of the FSM compact trust fund committee,  works with other members of the committee to address the timing of the  calculation of compact trust fund disbursements. (Recommendation 3)

The Secretary of the Interior should ensure that the Director of the Office  of Insular Affairs, as Chairman of the RMI compact trust fund committee,  works with other members of the committee to develop a distribution  policy for the RMI compact trust fund, as required by the compact trust  fund agreement, that takes into account potential strategies that could  address risks to the fund’s ability to provide a source of income after fiscal  year 2023. (Recommendation 4)

The Secretary of the Interior should ensure that the Director of the Office  of Insular Affairs, as Chairman of the RMI compact trust fund committee  and of the RMI Joint Economic Management and Financial Accountability  Committee, works with other members of the committees to develop the  fiscal procedures required by the compact trust fund agreement.  (Recommendation 5)

The Secretary of the Interior should ensure that the Director of the Office  of Insular Affairs, as Chairman of the RMI compact trust fund committee,  works with other members of the committee to address the timing of the  calculation of compact trust fund disbursements. (Recommendation 6)

We provided a draft of this report to the Departments of Agriculture,  Commerce, Defense, Education, Energy, Health and Human Services,  the Interior, Labor, State, the Treasury, and Transportation; the Federal  Communications Commission; the Federal Deposit Insurance  Corporation; the Federal Emergency Management Agency; the National  Science Foundation; USAID; and the U.S. Postal Service, as well as to  the FSM and RMI. We also provided copies of the draft to the  administrator of each compact trust fund and to Graduate School USA for  their technical review. The Department of the Interior, the U.S. Postal  Service, and the FSM and RMI provided official comments, which are  reproduced in appendixes IX through XII with, where relevant, our  responses. The Departments of Agriculture, Education, Health and  Human Services, Labor, State, and Transportation; the Federal Deposit  Insurance Corporation; USAID; the RMI; the trust funds’ administrator,  and Graduate School USA provided technical comments, which we  incorporated as appropriate.

The following summarizes the official comments from Interior, the U.S.  Postal Service, the FSM, and the RMI, and our responses.

Interior concurred with our recommendations and stated that  discussions to address them are ongoing within the trust fund  committees. In addition, Interior stated that a working group  comprising staff from Interior’s Office of Insular Affairs and the  Department of State’s Office of Australia, New Zealand and Pacific  Island Affairs will present recommended actions related to our  recommendations to the trust fund committees in 2018.

The U.S. Postal Service stated that, in general, the report includes  helpful information on the compact obligations regarding postal  services provided to the FSM and RMI. However, the U.S. Postal  Service also provided additional information on the reimbursement  shortfall for its services since 2002 in the freely associated states. The  U.S. Postal Service stated that it recommends that, upon expiration of  the programs and services agreements, the FSM and RMI be treated  as international postal origin and destination points.

The FSM concurred with our recommendations to Interior. In addition,  the FSM stated that the programs and services provided by U.S.  agencies were essential to the FSM and should continue to the  greatest extent possible after 2023. The FSM would like to work with  U.S. officials to ensure timely approval of continuing these programs  and services. The FSM also noted that we had reported the potential  for the FSM compact trust fund to not provide disbursements sufficient  to cover the estimated value of expiring federal services in 2002, prior  to the signing of the amended compact. Further, the FSM provided  additional information regarding its Long-Term Fiscal Framework and  summarized ongoing public sector and tax reform efforts and its own  contributions to the FSM Trust Fund.

The RMI concurred with our recommendations to Interior and  provided additional comments regarding the recommendations. The  RMI asserted that, absent accountability issues, the maximum annual  disbursement amount should be disbursed from the compact trust  fund. However, as our report notes, the compact trust fund  agreements state the maximum allowable disbursement level and do  not establish or guarantee a minimum disbursement level. The RMI  also stated that it would prefer that future accountability procedures  be based on a new agreement rather than a reshaping of the current  fiscal procedures agreement. In addition, the RMI raised the issue of  compensation under the tax and trade provision of the original  compact as well as the effect of delays in investing the RMI compact  trust fund on its current value. We discuss the tax and trade  provisions in Appendix VII of our report. The RMI also recommended  that amendments to the trust fund agreement should not require  action by the U.S. Congress. As our report notes, the U.S. legislation  implementing the amended compacts requires that any amendment,  change, or termination of all or any part of the compact trust fund  agreements shall not enter into force until incorporated into an act of  Congress. Finally, the RMI noted that programs and services provided  through the amended compacts' implementing legislation (Pub. L. No.  108-188) and the compact programs and services agreement were  essential and that the RMI could not replace them by using its own  resources.

We are sending copies of this report to the appropriate congressional  committees and to the Departments of Agriculture, Commerce, Defense,  Education, Energy, Health and Human Services, the Interior, Labor,  State, the Treasury, and Transportation; the Federal Communications  Commission; the Federal Deposit Insurance Corporation; the Federal  Emergency Management Agency; the National Science Foundation;  USAID; and the U.S. Postal Service, as well as the President of the FSM  and the President of the RMI. In addition, the report will be available at no  charge on GAO’s website at http://www.gao.gov.

If you or your staff have questions about 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 XIII.

Appendix I: Objectives, Scope, and Methodology

We were asked to review issues related to the Federated States of  Micronesia’s (FSM) and Republic of the Marshall Islands (RMI) transition  from compact grant assistance to relying on income from the compact  trust funds. This report examines (1) the use and role of federal funds and  programs in the FSM and RMI budgets, (2) projected compact trust fund  disbursements and potential strategies to address risks to those  disbursements, and (3) FSM and RMI efforts to prepare for the scheduled  decrements in compact grant funding and the transition to relying on  compact trust fund income.

To identify the use and role of federal funds and programs, we reviewed  relevant documents and interviewed knowledgeable U.S., FSM, and RMI  officials during our site visits to the RMI in July 2017 and in the FSM in  July and August 2017. We reviewed U.S. law; the amended compacts  and associated programs and services agreements and military use and  operating rights agreements with each country; each country’s  government and component unit single audit reports for fiscal years 2012  through 2016; and U.S. Region IX reports for fiscal years 2015 and  2016. We analyzed expenditure and funding data in FSM and RMI single  audit reports, including their Schedule of Expenditures of Federal Awards,  to identify the sources of funds expended by the FSM national and state  governments, the RMI national government, and their component units  and calculated federal funds as a percentage of each entity’s total  resources. We reviewed the single audit reports and found that the  auditors did not express any qualified or adverse opinions regarding the  information they used to prepare the audits’ Schedule of Expenditures of  Federal Awards, which lists the amount and use of federal grants. We  concluded that these data are sufficiently reliable for estimating the role of  federal programs in the FSM and RMI budgets.

To identify the FSM and RMI national government component units and  FSM state government component units, we reviewed the websites of,  and audit reports from, the FSM Office of the National Public Auditor and  the RMI Office of the Auditor-General and confirmed the list of component  units we identified with FSM and RMI officials. We also discussed the  uses of federal funds in the countries with FSM national and state  government officials, RMI government officials, and FSM and RMI  component unit representatives during our site visits to the countries. Our  portrayal of the role of federal funds in the government and component  unit budgets does not capture the value of any noncash goods and  services that do not appear in the single audit reports. In addition, it does  not capture benefits that some programs provide to individuals, such as  U.S. Department of Agriculture rural housing loans and Federal Deposit  Insurance Corporation insurance that benefits depositors at the Bank of  the Federated States of Micronesia.

To determine the legal status of U.S. programs, services, and grants after  fiscal year 2023, we analyzed the amended compacts, the compact- related agreements, and U.S. law governing the programs, services, and  grants that we identified to determine whether, under current law, they  would still be available to the FSM and RMI after the end of that fiscal  year. For the programs and services agreement with each country, we  reviewed the status of programs and services when the agreements end  in fiscal year 2024. Our legal analysis included programs, services, and  grants that we identified from the compacts, the amended compacts’  implementing legislation, the military use and operating rights  agreements, and the programs and services agreements. We also  included in our legal analysis the programs (1) that we identified through  the single audit reports and Region IX reports and (2) that were not  already identified through our review of the compacts, the amended  compacts’ implementing legislation, and the compact-related agreements;  and (3) that the single audit reports showed as having expenditures  above $200,000 in any year in fiscal years 2012 through 2016 or the  Region IX reports identified as providing more than $200,000 in federal  funding in fiscal years 2015 or 2016. We prepared an initial list of federal  programs based on our review. We then provided our list of programs to  the FSM, the RMI, and the U.S. Departments of State and the Interior for  their review and updated the list on the basis of information they provided.

We prepared a preliminary analysis of the post-2023 status of the  programs and funding sources we identified and asked officials of the  relevant U.S. agencies to review and comment on the accuracy of the list.  As part of this analysis, we contacted officials from the Departments of  Agriculture, Commerce, Defense, Education, Energy, Health and Human  Services, the Interior, Labor, State, and Transportation; the Federal  Communications Commission; the Federal Deposit Insurance  Corporation; the Federal Emergency Management Agency; the National  Science Foundation; the U.S. Agency for International Development; and  the U.S. Postal Service. We incorporated into our analysis the comments  that these officials provided, and we again asked for their review of our  analysis before we completed our draft report. Our conclusions are based  on a review of current law. Therefore, any changes in the applicable law  subsequent to our report but before 2023 may affect the FSM’s and RMI’s  eligibility for U.S. programs and funding. In addition, the availability of  programs depends on appropriations made for that purpose. Although we  took multiple steps to validate our list of programs with the FSM and RMI  and the relevant U.S. agencies, our analysis may not have captured all  U.S. grants and programs provided in the FSM and RMI.

To examine projected compact trust fund disbursements and actions to  address risks, we reviewed previous studies of the compact trust funds;  the U.S.-FSM and U.S.-RMI compact trust fund agreements; and other  governance and reporting documents such as investment policy  statements, presentations to the compact trust fund committees, audits,  and annual reports. We also interviewed FSM and RMI officials, compact  trust fund committee members, authors of the previous studies, and the  funds’ administrator, investment advisers and money managers.

To project the compact trust funds’ likely income at their current value and  under current trust fund rules (i.e., the baseline scenario), we built a  Monte Carlo simulation model and performed 10,000 trial runs of  projected returns and disbursements over a four-decade time period,  using random values for key variables.

We used the following key assumptions in our compact trust fund  analysis:

Compact trust fund balance. We used the unaudited FSM and RMI  fiscal year 2017 year-end compact trust fund balances.

C account balance. We estimated the C account balance on the  basis of the unaudited FSM and RMI fiscal year 2017 year-end  balances.

To assess the reliability of the unaudited balances, we reviewed the  previous years’ audits and confirmed with the trust funds’ Administrator  that previous years’ audits had not resulted in any significant differences  between the preliminary balances and the final audited balances. We  concluded that the unaudited balances were sufficiently reliable as a  basis for our projections of future trust fund performance. The March  2018 audited fund balances, released after we completed our analysis,  were within $5 of the unaudited fund balances.

Amount of future compact trust fund contributions. We based the  amounts of future annual U.S. contributions to both trust funds on the  inflation-adjusted amounts estimated in the U.S. Department of the  Interior’s (Interior) Office of Insular Affairs’ Budget Justifications and  Performance Information, Fiscal Year 2018. For the RMI, we assumed  that Taiwan would continue to contribute $2.4 million per year to the  RMI’s A account each year through 2023 in keeping with Taiwan’s  May 2005 agreement with the RMI.

Estimated annual grant assistance for fiscal year 2023. We based  our estimates of fiscal year 2023 assistance on the inflation-adjusted  amounts estimated by the Office of Insular Affairs. The office  estimated that the FSM would receive $82 million in annual grant  assistance in fiscal year 2023 and that the RMI would receive $36  million, including Kwajalein-related assistance. In keeping with the  RMI compact trust fund agreement, we excluded from our analysis  grants provided to the RMI under compact section 211(b) for  Kwajalein-related assistance, resulting in an estimated $27 million in  grant assistance to the RMI under compact section 211 in fiscal year  2023. The actual amount of annual grant assistance in fiscal year  2023 will depend on actual inflation rates in the years preceding 2023.  Different assumptions about the inflation rates will result in different  estimates of the amount of fiscal year 2023 annual grant assistance.

Net rate of return. In the baseline scenario, we present our results  based on a 6 percent rate of return after fees are deducted. To select  and assess the reasonability of this projected net rate of return, we  reviewed the capital market assumptions and projections used by the  money managers for the compact trust funds as well as historical  market rates of return. However, because projecting the funds’ long- term performance using the current portfolio and economic  assumptions has limitations, we also conducted our analyses using  different nominal values for the net returns—5 percent, 7 percent, and  8 percent—in each case using a standard deviation of 13 percent.  These results are presented in appendix V. We assumed a normal  distribution, but we tested the same baseline analyses with a t- distribution and found that a t-distribution did not substantially affect  the results.

Inflation rate after fiscal year 2023. We applied the 2 percent long- term inflation rate projected by the Congressional Budget Office.

To further analyze actions that could address risks to the compact trust  funds, we modeled alternative strategies for managing the funds that  were analyzed by previous studies of the compact trust funds. We  identified previous studies through a literature search and by interviewing  cognizant agency and trust fund officials. On the basis of this review, we  developed five potential strategies that are representative of the  approaches identified in previous studies. These five strategies are  examples of many possible strategies, including varying amounts of  disbursement reductions, additional contributions, and methods of  calculating annual disbursements. We are not recommending any specific  strategy. To provide additional information about potential outcomes, we  also analyzed another four strategies that assumed a lower amount of  additional trust fund contributions, lower disbursement reductions, or a  lower percentage of the compact trust fund balance that could be  withdrawn (see app. VII). To help ensure that we had appropriately  reproduced the methods used in previous studies, we shared our  preliminary results for strategy 4, which modeled the Moving Adjustment  Rule, and strategy 5, which modeled the Sustainability Adjustment for  Enhanced Reliability (SAFER), with the Graduate School USA  representatives who had initially prepared these potential strategies. We  analyzed each strategy separately to isolate the impact of individual  changes in the strategy on compact trust fund balance and  disbursements. However, in practice, these individual changes could  occur in combination with each other. We again performed the Monte  Carlo analysis, using the same key assumptions as in the baseline  scenario, to determine the likely effects, relative to the baseline, of five  potential strategies representing three approaches: (1) reducing annual  compact trust fund disbursements; (2) making additional contributions; (3)  and changing the disbursement policies, including strategies that would  require changing the trust fund agreements to permit disbursements from  the A account. We present the results of this analysis with a 6 percent net  return, a standard deviation of 13 percent, and a normal distribution and  tested the results with 5 percent, 7 percent, and 8 percent net returns  (see app. VII for further details).

To summarize and compare our simulation results for the baseline and  alternate scenarios, we analyzed the average disbursements in nominal  dollars, the average disbursements in comparison with maximum  disbursements, the likelihood of 1 or more years with zero disbursement,  and the likelihood that the trust funds will maintain their inflation-adjusted  value after fiscal year 2023.

We calculated the average disbursement in the given time periods by  averaging simulated disbursements over 10-year periods (averaging  first over 10 years and then over 10,000 simulated cases).

We calculated the average disbursement as a percentage of the  maximum allowable disbursement by averaging the ratio of each  simulated disbursement to the maximum inflation-adjusted allowable  disbursement in the given period (averaging first over 10 years and  then over 10,000 simulated cases).

We calculated the likelihood of zero disbursement by counting cases  with 1 or more years of zero disbursement among the 10,000  simulated cases in each 10-year period.

We calculated the likelihood that the fund balance will maintain its  inflation-adjusted fiscal year 2023 value by counting simulation cases  where the simulated balance exceeds or equals its projected inflation- adjusted 2023 balance in the given year.

We report the disbursement results averaged by decade for the first 40  years of compact trust fund disbursements—fiscal years 2024 through  2033, fiscal years 2034 through 2043, fiscal years 2044 through 2053,  and fiscal years 2054 through 2063—to summarize the overall trend in  disbursements. However, depending on market volatility, disbursements  during these decades are likely to fluctuate from year to year. While the  projected per-decade averages can show long-term trends in the funds’  disbursements and sustainability and provide a comparison of the likely  effects of the potential strategies we analyzed, the projected averages do  not provide information about the volatility of changes in annual  disbursement. We compare the compact trust funds’ projected value with  the projected inflation-adjusted fiscal year 2023 value through 2063 in 10- year increments beginning in fiscal years 2033.

To document the status of the FSM Trust Fund and the RMI’s D account  and their potential use to supplement FSM and RMI resources after 2023,  we reviewed information about the FSM laws establishing the FSM Trust  Fund, FSM economic reports, and the RMI-Taiwan agreement regarding  the D account. We also interviewed FSM and RMI officials. We did not  independently verify the FSM’s projections of the future size of, and  disbursements from, its trust fund. The information on foreign law or on  foreign government operations in this report is not the product of our  original analysis, but is derived from interviews and secondary sources.

To examine FSM and RMI efforts to prepare for the scheduled compact  grant decrements, we reviewed each country’s decrement management  plans to determine the FSM’s and RMI’s planned budget reductions and  other actions. We then reviewed the FSM’s and RMI’s single audit reports  and budget documents and interviewed FSM and RMI officials to  determine whether the planned reductions had been implemented. We  compared the planned actions to current legislation, single audit reports,  or recent reports that discussed the status of FSM and RMI economic and  financial reforms. In addition, we interviewed Interior, FSM, and RMI  officials to determine whether FSM and RMI decrement management  plans had been revisited or updated, why the plans were or were not  adhered to, and whether the countries planned any future updates to the  plans. We also conducted interviews with U.S. officials from the  Department of State, a representative of Graduate School USA, and  representatives of the World Bank and the International Monetary Fund  regarding each country’s previous and current planning efforts.

To assess whether the FSM and RMI strategic plans for the key sectors  of health, education, and infrastructure addressed the 2023 transition  from compact grants and other U.S. assistance to compact trust fund  income, we first obtained the relevant plans from department heads in  each key sector of the FSM and RMI national governments and FSM  state governments and confirmed our identification of the documents with  FSM and RMI officials. We reviewed the plans to determine whether they  included any discussion of budget projections, economic or financial  reforms, alternative funding sources or other revenue generation  strategies, and expenditure cuts or saving strategies for periods before  and after fiscal year 2023. We also reviewed the FSM’s 2023 Action Plan  and the RMI’s updated Medium Term Budget and Investment Framework  to determine whether these documents discussed budget changes to  address the 2023 transition.

Through our interviews with U.S., FSM, and RMI officials, we also learned  about other ongoing planning efforts to address the 2023 transition: the  U.S. Interagency Working Group on the Freely Associated States, the  FSM Joint Compact Review and Planning Committee, and the RMI  Compact Review Commission. Following our interviews, we reviewed and  summarized documentation related to the working group’s purpose,  meetings, and membership. We also contacted FSM and RMI committee  members and officials to obtain additional information on the mandate,  membership, and status of the FSM and RMI committees. The  information contained in this report on foreign law or on foreign  government operations is not the product of our original analysis, but is  derived from interviews and secondary sources.

We conducted this performance audit from March 2017 to May 2018 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

Appendix II: U.S. Compact Sector Grants and Trust Fund Contributions, 2004 through 2023

The amended compacts’ implementing legislation authorized and  appropriated direct financial assistance to the FSM and the RMI in fiscal  years 2004 through 2023, and provided for partial inflation adjustment of  the base amount of compact sector grants and trust fund contributions  each year. The base amount is partially inflation-adjusted by the  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 1 year, using the beginning of 2004 as a base. As the base  amount of compact sector grants decreases, the trust fund contributions  generally increase by an equivalent amount. Figure 9 shows the amount  of compact sector grants and trust fund contributions each fiscal year  from 2004 through 2023.

The cumulative inflation adjustment largely offsets the amount of the  decrement, resulting in a relatively steady nominal amount of compact  sector grants after inflation adjustments (see fig. 10). However, because  the inflation adjustment is not equal to full inflation, the value of compact  sector grants continues to decline in real terms.

Appendix III: Compact Grants Supporting Health and Education in the FSM and RMI

U.S. grants that end in 2023 play a significant role in the budgets of the  FSM states and the RMI in the health and education sectors. The  colleges of both countries have also relied on compact sector grants but  rely even more on Pell grants to support their operation.

FSM states rely on U.S. grants scheduled to end in 2023 for the majority  of their health and education expenditures. In fiscal year 2016, compact  sector grants and the SEG supported 60 percent or more of health  expenditures and 82 percent or more of state education expenditures.  Table 3 shows the states’ health and education expenditures of compact  sector grants and the supplemental education grant (SEG) in fiscal year  2016. In fiscal years 2012 through 2016, compact sector grants and the  SEG supported 56 to 99 percent of FSM states’ health expenditures and  82 to 100 percent of FSM states’ education expenditures.

U.S. compact sector, supplemental education, and other grants also  supported approximately 76 percent of the average $21 million in annual  expenditures of the College of Micronesia–FSM, an FSM government  component unit, in fiscal years 2012 through 2016. Compact sector  grants and the SEG, each of which end in 2023, supported approximately  15 percent of the college’s annual expenditures. Pell grants, which  provide support for education expenses for qualifying students, supported  more than half of the college’s annual expenditures. College officials told  us that the college would be unable to operate without Pell grants.  According to officials from the U.S. Department of Education, the college  will remain eligible after 2023 to receive Pell grants that benefit its  students as long as such grants are available to institutions and students  in the United States (see app. IV).

The RMI relies on U.S. grants scheduled to end in 2023 for health and  education expenditures. In fiscal year 2016, compact sector and  supplemental education grants scheduled to end in 2023 supported  approximately 25 percent of RMI health expenditures and approximately  59 percent of RMI education expenditures (see table 4). Kwajalein-related  grants increased these percentages to 32 percent for health and 66  percent for education. In total, in fiscal years 2012 through 2016, compact  sector grants and the SEG supported approximately 58 percent of RMI  education expenditures and 29 percent of health expenditures. During  this period, the percentage of education expenditures supported by  compact sector and supplemental education grants scheduled to end in  2023 remained relatively steady and the percentage of health  expenditures decreased slightly.

U.S. compact sector, supplemental education, and other grants also  supported approximately half of the average $11.9 million in annual  expenditures of the College of the Marshall Islands, an RMI government  component unit, in fiscal years 2012 through 2016. Compact sector  grants and the SEG, each of which end in 2023, supported approximately  8 percent of the college’s annual expenditures. Pell grants supported  about 39 percent of the college’s expenditures. According to officials from  the U.S. Department of Education, the college will remain eligible after  2023 to receive Pell grants that benefit its students, as long as such  grants are available to institutions and students in the United States (see  app. IV). Also in fiscal years 2012 through 2016, compact sector and  supplemental education grants scheduled to end in 2023 supported about  half of the expenditures of the RMI government component unit, the  Marshall Islands Scholarship, Grant, and Loan Board, which provides  financial assistance for educational and training opportunities. Kwajalein- related compact grants that do not end in 2023 supported an additional  13 percent of the board’s expenditures.

Appendix IV: Status of U.S. Grants and Programs in the FSM and RMI After 2023

The amended compacts, compact-related agreements, the amended  compacts’ implementing legislation, and other U.S. laws provide grants or  eligibility for U.S. programs and services for the FSM and RMI. The  amended compacts provided compact sector, Kwajalein-related, and  audit grants. Under current law, compact sector and audit grants are each  scheduled to end in 2023, but the RMI military use and operating rights  agreement (MUORA) extended the time frame of Kwajalein-related  compact grants for as long as the agreement is in effect. The amended  compacts’ implementing legislation provided additional grants, including  authorizing a supplemental education grant (SEG), and identified several  specific U.S. programs as available to the FSM and RMI. Under current  law, the additional grants end in 2023 but the statutory authorizations for  some programs identified in Pub. L. No. 108-188 provide for the  continued eligibility of the FSM and RMI to receive benefits under the  programs. However, after fiscal year 2023, the FSM and RMI will no  longer be eligible under current U.S. law for some programs that the SEG  replaced. The compact-related programs and services agreements with  each country identify additional programs and services that the United  States makes available to the FSM and RMI. While these agreements will  end in 2024, under current law, some U.S. agencies may continue to  provide programs and services similar to those provided in the agreement  under other authorities. Based on the status of current law, the FSM’s and  RMI’s eligibility for other programs we identified that have been provided  under other current U.S. laws will not change after fiscal year 2023.

Compact Sector and Audit Grants End in 2023, but Kwajalein-Related Grants for the RMI Will Continue

Under current law, compact sector grants provided to the FSM and the  RMI under their compact sections 211(a) are scheduled to end in 2023.  However, the RMI is scheduled to continue to receive $7.2 million,  partially inflation adjusted, related to the U.S. military base in Kwajalein  Atoll and provided under section 211(b) of its compact. Under the terms  of the RMI MUORA, the United States agreed to provide these Kwajalein- related grants for as long as the MUORA is in effect. The MUORA  continues until 2066 and may be extended at the discretion of the United  States until 2086. The amended RMI compact provides for $18 million,  partially inflation adjusted, in annual payments to the RMI government to  compensate for impacts from the U.S. Army Garrison–Kwajalein Atoll.  These payments will continue for as long as the MUORA is in effect.

Annual compact grants of up to $500,000 (not inflation adjusted) to each  country to pay for required annual audits of compact grants are scheduled  to end in 2023. See table 5 for a summary of compact sector, Kwajalein- related, and audit grants.

FSM and RMI are No Longer Eligible for Many Programs Replaced by the Supplemental Education Grant

The supplemental education grant (SEG) authorized by the amended  compacts’ implementing legislation is scheduled to end in fiscal year 2023  and, under current law, FSM and RMI eligibility for most programs that  the SEG replaced will not resume after fiscal year 2023. Absent changes  to current law, the FSM and RMI will not be eligible after fiscal year 2023  for the following programs that the SEG replaced during fiscal years 2005  through 2023: U.S. elementary and secondary education grant programs,  adult education and literacy programs, career and technical education  programs, job training programs, and Head Start early education  programs. However, under other provisions of current law, qualifying  individuals in the FSM and RMI will be eligible after fiscal year 2023 for  undergraduate education grants and work-study programs that the SEG  replaced. See table 6.

Some Programs and Services in the Programs and Services Agreement Will End, while Others May Continue under Other Authorities

Although the programs and services agreements with the FSM and RMI  will end in fiscal year 2024, current U.S. law enables U.S. agencies to  continue providing some programs and services now provided under the  agreements. No current provisions of U.S. law will enable the Federal  Emergency Management Agency (FEMA) to provide disaster response  funding or enable the Federal Deposit Insurance Corporation to provide  deposit insurance or the U.S. Postal Service to provide services to the  FSM and RMI after the agreements end. However, the National Weather  Service, the U.S. Department of Transportation’s (DOT) Federal Aviation  Administration (FAA), and the U.S. Agency for International Development  (USAID) could, under other legal authorities, provide services similar to  those they now provide under the programs and services agreements.

National Weather Service. The programs and services agreements  authorize the National Weather Service to fund the operations of  weather stations in the FSM and RMI, which it can continue to fund  after the end of the Agreements under other authorities, according to  Department of Commerce officials.

Federal Aviation Administration. The programs and services  agreements authorize DOT’s FAA to provide technical assistance in  the FSM and RMI, which it can continue to provide after the end of the  Agreements under other provisions of current U.S. law. However,  DOT officials stated that FAA would require new bilateral agreements  with the FSM and the RMI in order for the countries to continue to  receive the civil aviation safety services that FAA currently provides  under the programs and services agreements. The FAA would also  seek reimbursement for any technical assistance it provides to the  FSM and RMI. With regard to the civil aviation economic services of  the programs and services agreements, DOT officials stated that,  while the FSM and RMI could voluntarily decide to allow U.S. air  carriers to continue operations in the FSM and RMI, new bilateral  agreements would be needed to assure that result.

U.S. Agency for International Development. Following a U.S.  presidential disaster declaration, FEMA provides the funding for  disaster relief and reconstruction, which is programmed through  USAID. Under current law, FEMA funds will no longer be available  for this purpose once the agreements end; however, USAID will be  able to provide foreign disaster assistance funding to the FSM and  RMI under the same terms as it provides this assistance to other  countries. After the programs and services agreements end, FEMA  will be able to support disaster relief efforts only if USAID or the  countries request it to do so on a reimbursable basis.

In addition, according to State and Interior officials, telecommunications- related services that the two agencies provide to the FSM and RMI under  the programs and services agreements will continue as long as the FSM  and RMI provide appropriate authorization for such services. Table 7  shows the status after fiscal year 2024 of programs and services currently  provided to the FSM and the RMI under the agreements.

Programs Identified in the Amended Compacts’ Implementing Legislation Generally Continue after Fiscal Year 2023

Additional grants provided to the FSM and the RMI under the amended  compacts’ implementing legislation will end in fiscal year 2023, but the  countries’ eligibility for programs now provided under that legislation will  generally continue under current U.S. law. Grants provided under the  amended compacts’ implementing legislation for (1) judicial training in the  FSM and the RMI, and (2) agricultural and planting programs on the  RMI’s nuclear-affected Enewetak Atoll are scheduled to end. However,  under current U.S. law, legal authorities permitting the operation of other  programs would remain available to the FSM and RMI after fiscal year  2023. Eligibility under these legal authorities continues either because the  amended compacts’ implementing legislation does not specify an ending  date or because other provisions in current U.S. law make the FSM and  RMI eligible for the program.

Programs provided in the amended compacts’ implementing legislation  include U.S. Department of Agriculture Rural Utilities Service grant and  loan programs; U.S. Department of Education Pell grants for higher  education and grants under Part B of the Individuals with Disabilities  Education Act for children with disabilities; programs for nuclear-affected  areas in the RMI; and additional programs provided by the Departments  of Commerce and Labor as well as law enforcement assistance provided  by the U.S. Postal Service. See table 8 for a summary of the programs  identified in the amended compacts’ implementing legislation and their  status as of the end of fiscal year 2023.

Programs Identified in Other Legislation Generally Continue after Fiscal Year 2023

In addition to being eligible for the programs provided through the  compact, its associated agreements, and the amended compacts’  implementing legislation, the FSM and RMI are also eligible for a number  of programs under other provisions of current U.S. law. The FSM and  RMI have each received funds from the U.S. Department of Agriculture  for forestry and rural housing programs, multiple Health and Human  Services public health program grants, Interior technical assistance and  historic preservation programs, and the DOT FAA airport improvement  program, among others. Under current U.S. law, the legal authorities  permitting the provision of these programs in the FSM and RMI would not  necessarily change after 2023. Table 9 shows the FSM’s and RMI’s  eligibility for these additional grants and programs under current law after  fiscal year 2023.

Appendix V: Compact Trust Fund Baseline Outcomes Calculated with Varying Return Assumptions

In order to the test the sensitivity of our compact trust fund projections to  assumptions about the future rate of return, we also performed our Monte  Carlo analysis using alternate rates of return. We projected the compact  trust fund disbursements and balance under current compact trust fund  rules on the basis of a 6 percent net return and also estimated the trust  fund on the basis of 5 percent, 7 percent, and 8 percent net returns.  Higher rates of return would improve the outlook for each compact trust  fund. However, even with higher rates of return, our analysis shows a  high likelihood that available compact trust fund disbursements will not  reach an amount equivalent to maximum disbursements permitted by the  compact trust fund agreement (i.e., the inflation-adjusted amount of fiscal  year 2023 annual grant assistance, as defined by the trust fund  agreements), a continuing risk of zero disbursements, and a decreasing  likelihood that the fund will maintain or exceed its inflation-adjusted  balance in fiscal year 2023. See tables 10 and 11 for our projections of  FSM and RMI compact trust fund disbursements, likelihood of 1 or more  years with zero disbursement, and likelihood of maintaining or exceeding  its inflation-adjusted fiscal year 2023 value.

Appendix VI: FSM and RMI Country Trust Funds

The FSM and RMI each maintain their own country trust funds separate  from the compact trust funds. These country trust funds are also available  to provide a source of revenue after compact grants end at the end of  fiscal year 2023. We did not independently project the future balance or  potential disbursements from the FSM Trust Fund after 2023.

The FSM maintains its own trust fund, separate from the compact trust  fund, which can provide additional resources after fiscal year 2023 to  offset a reduction in resources relative to those made available as of  fiscal year 2023. The FSM Trust Fund, established in 1999, has grown  rapidly in recent years. In fiscal years 2012 through 2017, the FSM  appropriated a total of $73.3 million for contributions to its trust fund. In  addition, in 2015, the FSM changed its tax law to allocate 20 percent of  revenue collected by the states to state subaccounts within the FSM Trust  Fund. Along with investment gains, these appropriations and  contributions of tax revenue have increased the FSM Trust Fund’s  balance from $8 million at the end of fiscal year 2011 to $115 million as of  the end of fiscal year 2017. As of 2017, the FSM proposed to continue  adding $10 million annually from national government surpluses into its  trust fund, with the aim of achieving a balance of $250 million by fiscal  year 2023 and $10 million in annual disbursements. However, as of early  2018, according to FSM officials, the FSM planned to add $15 million per  year to the FSM Trust Fund and projected that the fund would have a  balance of $275 million by the end of fiscal year 2023. However, like the  compact trust fund, the full balance of the FSM Trust Fund is not available  for disbursement. Under current FSM law, funds in the FSM Trust Fund  may not be withdrawn until fiscal year 2024. In addition, according to FSM  officials, the FSM can withdraw only the fund’s earnings and cannot  withdraw the inflation-adjusted value of the FSM Trust Fund corpus.

The RMI also maintains its own trust fund—the compact trust fund’s D  account. Although managed alongside the compact trust fund, the D  account is not subject to the same disbursement provisions as the  compact trust fund’s A, B, and C accounts. Instead, disbursements from  the D account are subject to the provisions of the agreement between  Taiwan and the RMI under which Taiwan contributed the $10 million that  the RMI used to establish the D account. According to the terms of this  agreement, the RMI may withdraw income after consultation with Taiwan  but may not withdraw funds from the D account’s $10 million corpus. At  the end of fiscal year 2017, the D account had a balance of $15.1 million,  with $5.1 million potentially available for use by the RMI.

Appendix VII: Potential Trust Fund Strategies and Model Results

We conducted a series of simulations to determine the likely effects of  potential strategies for improving the outlook of the FSM and RMI  compact trust funds. Prior studies by Graduate School USA, the Asian  Development Bank, and the International Monetary Fund examined the  effects of three general approaches for improving the trust funds’  outlooks: (1) reducing planned disbursements from the funds, (2) making  additional contributions to the funds, and (3) changing the compact trust  fund disbursement policies. To isolate the impact of individual changes  on the compact trust fund balance and disbursements, we developed and  analyzed five potential strategies based on those examined in the  previous studies. Reduced disbursements and additional contributions  could occur without changes to the trust fund agreement, but changes to  the disbursement policies may require changing the agreements. In  strategies 3, 4, and, 5, we analyzed strategies that would permit  disbursement from the A account. Disbursing from the A account would  require changing the compact trust fund agreements. Table 12 shows the  5 potential strategies we analyzed.

We analyzed two potential strategies that could be implemented without  changes to the trust fund agreements: reductions in the amount of  disbursements and additional contributions to the trust funds.

Strategy 1: Annual disbursements are reduced below the maximum  allowable disbursement. We analyzed the likely effects of reducing  disbursements to an amount 30 percent below the maximum  disbursement, relative to the baseline scenario, for both the FSM and the  RMI compact trust funds.

For the FSM, the average size of the disbursements would be lower in  the first 10 years of our projection, fiscal years 2024 through 2033, but  greater in later years. For the RMI, the average disbursement size  would remain lower than the disbursement amounts we projected  using the baseline scenario. Disbursement amounts would remain  volatile from year to year if the balance in the C account is not  sufficient to provide additional disbursements.

For both countries, the risk of zero disbursements would be reduced,  but not eliminated, in each decade.

For both countries, the likelihood that the funds would maintain or  exceed their inflation-adjusted fiscal year 2023 value after fiscal year  2023 would be higher in each decade.

Reductions in annual disbursements could be effected by the compact  trust fund committees at their discretion, without changes to the compact  trust fund agreements. However, reductions in annual disbursements  below the maximum amount would require each country to permanently  adjust to having fewer resources for their budgets and economies than  the compact grants provided.

Strategy 2: Additional annual contributions are made to the trust  fund in fiscal years 2018 through 2023. We analyzed the likely effects  of additional contributions equivalent to 5 percent of each country’s fiscal  year 2016 GDP, relative to the baseline scenarios, for both the FSM and  the RMI compact trust funds.

The average size of the disbursements would be greater.

Disbursement amounts would remain volatile from year to year if the  balance in the C account is not sufficient to provide additional  disbursements.

The risk of zero disbursements would be reduced but not eliminated.

The likelihood that the funds would maintain or exceed their inflation- adjusted fiscal year 2023 value after fiscal year 2023 would be higher.

Additional contributions to the FSM or RMI trust funds could be accepted  at the discretion of compact trust fund committees, without changes to the  compact trust agreements. However, unless the compact trust fund  committees could identify other donors for these contributions, the  countries would have to choose to reprogram existing revenues from  other uses into compact trust fund contributions. The addition of funds  from other donors would have no negative impact on the trust funds’  outlook if other conditions remained unchanged.

Potential Strategies That Would Permit Disbursement from the A Account

We analyzed three additional potential strategies that would involve  calculating annual disbursements as a percentage of the FSM and RMI  compact trust funds’ balance and which would permit disbursement from  the A account. Disbursing from the A account would require changing the  compact trust fund agreements, necessitating negotiation and agreement  between the United States and each country and statutory enactment by  the U.S. Congress. In strategy 3, disbursements are calculated as a fixed  percentage of the funds’ moving average balance over the previous 3  years. In strategies 4 and 5, disbursements are calculated on the basis of  the funds’ moving average balance over the previous 5 years as well as  the committees’ determination of the target size for the funds’ balance or  disbursements. All three potential strategies would require the FSM and  the RMI to exchange a reduction in resources for more predictable  disbursements in the longer term.

Strategy 3: The annual disbursement is set as a fixed percentage of  the fund’s moving average balance over the previous 3 years, up to  the maximum disbursement amount defined by the current trust  fund agreement. We analyzed the likely effects of limiting annual  disbursements to 5 percent of the moving average balance over the  previous 3 years, relative to the baseline scenario for the FSM and the  RMI compact trust funds.

In earlier years, average disbursements from the compact trust funds  would be smaller than those in the baseline scenario; in later years,  average disbursements would exceed those in the baseline scenario.  For the FSM, the average disbursement would start to exceed that in  the baseline scenario in the second decade after disbursements begin  (fiscal years 2034-2043). For the RMI, the average disbursement  would start to exceed that in the baseline scenario in the fourth  decade after disbursements begin (fiscal years 2054-2063).  Disbursement amounts would be less volatile from year to year than  the volatility that could be experienced in the baseline scenario when  the balance in the C account is not sufficient to provide additional  disbursements.

The risk of zero disbursements would be eliminated.

The likelihood that the funds would maintain or exceed their inflation- adjusted fiscal year 2023 value after that year would be higher than in  the baseline scenario.

Strategy 4: The amount of the annual disbursement is reduced if the  compact trust fund’s moving average balance over the previous 5  years is lower than a primary target amount. We analyzed the likely  effects of implementing this strategy, relative to the baseline scenario for  the FSM and the RMI compact trust funds.

In the FSM, the average disbursement would be lower than that in the  baseline scenario in earlier years but higher than that in the baseline  scenario in the fourth decade after disbursements begin (i.e., fiscal  years 2054-2063). In the RMI, the average disbursement would be  lower than that in the baseline scenario in earlier years but would  equal that in the baseline scenario in the fourth decade after  disbursements begin (i.e., fiscal years 2054-2063). Disbursement  amounts would be less volatile from year to year than the volatility that  could be experienced in the baseline scenario when the balance in  the C account is not sufficient to provide additional disbursements.

The risk of zero disbursements would be greatly reduced but not  eliminated. In the FSM, the risk would be 55 percentage points lower  than in the baseline scenario in the fourth decade after disbursements  begin (i.e., fiscal years 2054-2063). In the RMI, the risk would be less  than 5 percent in each decade.

Strategy 5: The target disbursement is set as 2.1 percent of the  compact trust fund’s balance in fiscal year 2024. The disbursement  amount is further decreased if the fund’s moving average balance  over the previous 5 years is lower than the primary target balance.  Our analysis projected the following effects of implementing this strategy  relative to the baseline scenario for the FSM and the RMI compact trust  funds:

For both countries, the average disbursement would be smaller than  that in the baseline scenario in the first 3 decades after disbursements  begin (i.e., fiscal years 2024-2053) but would exceed that in the  baseline scenario in the fourth decade. Disbursement amounts would  be less volatile from year to year than the volatility that could be  experienced in the baseline scenario between 2024 and 2063 when  the balance in the C account is not sufficient to provide additional  disbursements.

The risk of zero disbursements would be almost eliminated.

The likelihood that the funds would maintain or exceed their inflation- adjusted fiscal year 2023 value would be much higher.

Figures 11 through 16 compare projected compact trust fund  disbursements and fund balances in the baseline scenario with projected  disbursements and fund balances for the five selected potential strategies  for improving the trust funds’ outlook.

The amounts of disbursement reductions and additional contributions  varied among the strategies examined in prior studies. To provide  additional information about potential trust fund outcomes, we analyzed  another four examples of the selected strategies that assumed a lower  amount of additional trust fund contributions, lower disbursement  reductions, or a lower percentage of the compact trust fund balance that  could be withdrawn. Tables 13 and 14 show the results for all 9 analyses.

Appendix VIII: Status of Other Planned Actions in the FSM and RMI Decrement Management Plans

In addition to planning budget reductions in the FSM Long-Term Fiscal  Framework (its decrement management plan) and the RMI Decrement  Management Plan, the FSM and RMI planned other actions such as tax  reforms and subsidy reductions to address the scheduled decrement in  compact sector grants. The FSM implemented two of three planned  actions and the RMI implemented one of four planned actions. The FSM  did not implement unified tax reform measures but implemented a change  in the formula for sharing compact sector grants with the FSM states and  using planned surpluses to mitigate the effects of fiscal reforms. The RMI  did not implement planned new taxes, reductions in subsidies to state- owned enterprises, or reductions in payments to Majuro landowners for  the use of their land for utilities. The RMI did program a portion of its  fishing fee surplus into the annual budget.

As of January 2018, the FSM national government had implemented two  of three actions that the FSM Long-Term Fiscal Framework indicated the  FSM would take in addition to budget reductions.  1.  Implementing unified tax reform measures

Not implemented. The FSM Long-Term Fiscal Framework states  that substantial effort and progress has been made towards  comprehensive tax and revenue reform and that the FSM national  and state governments anticipated that the Long-Term Fiscal  Framework process would provide further impetus towards tax  reform. However, according to FSM officials, two FSM states  (Pohnpei and Yap) did not approve the Unified Revenue Act.  According to FSM officials, the FSM is currently considering other  models for tax reform and plans to revisit the issue in the future.  2.  Reducing the national government’s share of compact grants and  reallocating it to the FSM states  Implemented. According to the Long-Term Fiscal Framework,  FSM Public Law 18-12 reduced the national government’s share  of fiscal year 2014 compact grants from 10 percent to 5 percent,  with the amount of the reduction passed along to the FSM states.  In May 2014, FSM Public Law 18-57 further reduced the national  government’s share of compact grants to 0 percent and increased  the amount of compact grants allocated to the state governments,  according to the FSM.  3.  Using planned surpluses for actions such as possible contributions to  activities that mitigate the effects of fiscal reforms, the FSM’s compact  trust fund, retiring debt, or reform costs.

Implemented. The FSM national government has made additional  trust fund contributions but, according to FSM officials, has made  a policy decision to make these contributions to the FSM Trust  Fund instead of the compact trust fund.

As of January 2018, the RMI national government had implemented one  of four other actions that its decrement management plan indicated it  would take.  1.  Implementing a value-added tax and net profits tax in 2017

Not implemented. Officials from the RMI Economic Policy,  Planning, and Statistics Office and Ministry of Foreign Affairs  confirmed that tax reform has not been implemented due to  political challenges. However, a tax task force has been  established to revisit tax revenue reforms.  2.  Programming 80 percent of unallocated Marshall Islands Marine  Resources Authority fishing fee surplus into the annual budget in  fiscal year 2015 and using the remaining 20 percent to develop the  fishing industry.

Implemented. The RMI programmed a portion of its fishing fees  into the annual budget in fiscal years 2015 through 2017—$15.8  million in fiscal year 2015, $26.3 million in fiscal year 2016, and  $40 million in fiscal year 2017. Although fishing fees were  programmed into the budget, according to RMI’s Office of  Compact Implementation, the formula allocating 80 percent of  fishing fee revenue into the annual budget and the remaining 20  percent to develop the fishing industry is part of proposed RMI  legislation but has not become law.  3.  Reducing state-owned enterprise subsidies by 10 percent in fiscal  years 2016 and 2018.

Not implemented. The RMI national government did not reduce  the total amount of state-owned enterprise subsidies by 10  percent in fiscal years 2016 as committed in the 2014 decrement  management plan. Audit reports for state-owned enterprises in  fiscal years 2015 and 2016 indicate that, while the RMI reduced  subsidy amounts for some state-owned enterprises, other subsidy  amounts increased and overall subsidies were higher in both fiscal  years 2015 and 2016 than in fiscal year 2014. See table 15.  for the government’s use of their land for utilities by 20 percent in  fiscal years 2016, 2018, and 2021.

Not implemented. The RMI national government has not reduced  government transfers to Majuro landowners to compensate for the  government’s use of their land for utilities due to political  challenges, according to RMI officials. RMI Ministry of Finance  officials stated that, as of January 2018, there had been no  reductions in government transfers to Majuro landowners.  According to RMI government officials, the total rent payment bill  has in fact increased as utilities in Majuro have expanded.

Appendix IX: Comments from the Department of the Interior

Appendix X: Comments from the U.S. Postal Service

Appendix XI: Comments from the Federated States of Micronesia

1.  The FSM refers to our testimony in 2002 regarding the potential for  the FSM compact trust fund to not provide funds sufficient to cover the  estimated value of expiring federal services as early as 2002.  2.  The FSM includes a graphic showing the effect of the partial inflation  adjustments and the decrement in the compact sector grants. We  include a similar portrayal of this analysis in figure 10 in this report.  3.  The FSM states that the amount of the decrement in compact sector  grants that is used for annual contributions to the FSM compact trust  fund should be recorded as an FSM contribution to the fund.  However, Section 215 of the FSM compact refers to the annually  decreasing amounts provided to the compact trust fund as set forth in  Section 216 of the FSM compact as United States contributions to the  compact trust fund.

Appendix XII: Comments from the Republic of the Marshall Islands

1.  The RMI states that, absent accountability issues, the maximum  annual disbursement amount should be disbursed from the compact  trust fund. However, as our report notes, although the compact trust  fund agreements state the maximum allowable disbursement level,  they do not establish or guarantee a minimum disbursement level.  2.  The RMI states that the 2-year delay in investing the compact trust  fund will result in a compounded total loss of $33.6 million by the end  of fiscal year 2023. Our 2007 analysis of the trust funds included  information about the delays in establishing the trust funds. We did  not update our 2007 analysis of the loss in income due to the delay in  investing the compact trust fund for this report.  3.  The RMI notes that the amended compacts' implementing legislation  extended several important federal programs. Appendix IV of this  report presents our conclusions, based on our analysis of current law,  that the RMI will remain eligible as of the end of fiscal year 2023 for  special education programs and for some programs replaced by the  supplemental education grant.

Appendix XIII: GAO Contact and Staff Acknowledgments

In addition to the contact named above, Emil Friberg (Assistant Director),  Ming Chen, Neil Doherty, Mark Dowling, Reid Lowe, Moon Parks,  Shaundra Patterson, and Michael Simon made key contributions to this  report. Justin Fisher, Jeff Isaacs, Julie Hirshen, Risto Laboski, Courtney  LaFountain, and Jeffery Malcolm provided technical assistance.

The U.S. is providing $3.6 billion in economic assistance to the nations of Micronesia and the Marshall Islands from 2004 through 2023. This assistance has increasingly been provided in the form of contributions to trust funds for each nation, and is intended to boost their self-sufficiency. After the assistance ends, the trust funds should generate revenue from investments.

But we found the trust funds may not provide disbursements in some years or sustain their value after 2023.

We made 6 recommendations, including that the U.S. Interior Department take steps to address the risks to the funds' ability to provide income after 2023.