U.S. arms buyer dismisses Boeing tanker cost fears

* Carter says Boeing decided on below-cost bid

* McCain concerned taxpayers will part of overrun

* Ceiling bid a primary factor in contract award

By David Alexander

WASHINGTON, July 15 (Reuters) - The Pentagon's top weapons buyer dismissed concerns on Friday that Boeing is projecting huge cost overruns in developing a new Air Force refueling tanker, saying it was a fixed-price contract and company losses were "not our problem."

Defense Undersecretary Ashton Carter said Boeing (BA.N) had made a commercial decision to offer a below-cost bid for development of the aircraft in hopes of making up its losses during production of 179 of the aircraft through the 2020s.

The development contract for the KC-46 tanker, based on Boeing's 767 wide-body commercial airliner, had a ceiling price of $4.9 billion, while the overall deal for 179 aircraft is valued at $30 billion, one of the Pentagon's costliest purchases.

Boeing agreed to a $3.9 billion target price for tanker development, including the first four aircraft. Any cost overruns above $3.9 billion would be shared 60-40 between the Pentagon and the company, to the fixed ceiling of $4.9 billion. The company had to cover any costs above that.

Boeing won the tanker contract in February against European aircraft maker EADS (EAD.PA), which produces the Airbus, after years of contract disputes. Boeing notified the Pentagon in April that it expected to exceed the development contract's ceiling price by $300 million.

That means it would miss the target price by some $1.3 billion. The Pentagon would be responsible for 60 percent of overruns up to the ceiling price, or about $600 million.

Senator John McCain wrote a letter to Carter on Thursday expressing concern about the projected cost overruns, saying it was "unacceptable" in the current difficult fiscal climate for the contract to allow the company to pass on $600 million in development costs to the taxpayer.

"That is gravely wrong and creates an incentive, particularly on very large programs, for contractors to low-ball a contract bid knowing that the taxpayer will subsidize at least some of the overruns that will be needed to actually complete the work," McCain wrote.

But Carter, answering questions about defense procurement at the Brookings Institution think tank on Friday, dismissed reports of Boeing's cost overruns, saying, "It's not our problem because it's a fixed-price contract and it was written with ... protections for the taxpayers."

He said the issue was the value of the contract at its ceiling price.

"The fact that Boeing decided that it would lose money in the development phase, presumably in the hopes of making money in the production phase, was a decision that they made, and that's not a problem from the Defense Department's point of view," Carter added.

He noted that the contract work is just getting under way and the figures at this point are estimates.

"What this means is that Boeing will have every incentive .. to control costs so that those estimates don't come true, otherwise they're going to lose money."

Air Force spokeswoman Jennifer Cassidy said the bids from both Boeing and EADS were evaluated based upon their ceiling price, "which is the Air Force's maximum financial liability."

"The Air Force will not pay any more than the contractually binding KC-46 Engineering, Manufacturing and Development ceiling price of $4.9 billion, regardless of what it might cost Boeing to satisfy the terms and conditions of the contract," she said.

Boeing spokesman William Barksdale has said the company will make money on the overall KC-46 program. (Editing by Eric Walsh)