Focus on Insurance

May/June 2009

New Alignments, New Risks

Public-private partnerships challenge insurers to assign risk case by case

By Bruce Buckley

Public-private partnerships remain a hot topic among states desperate to maintain and expand infrastructure, but finding a common ground on the risks of PPP has proven to be difficult.

PPP is a standard delivery option for infrastructure projects globally, especially projects in which the mix of financial-, political- and construction-related risks are well defined. However, in the U.S. market, some players are still trying to get comfortable with the concept.

(Photo courtesy of Faiss Foley Warren PR)

Much of the PPP process is standardized in markets such as the United Kingdom, says Jesse Phillips, vice president of U.S. infrastructure and project finance for RBC Capital Markets, New York City. In the U.S., PPP proposals pass through the hands of a diverse group of state and local authorities, which Phillips says creates a lack of common standards.

“There’s no centralized process, and there have not been many precedents here in the U.S. so far,” he adds. “That opens up different interpretations of how to approach and bid these deals. Once we start to see some well-structured, commercially realistic deals come to market and reach financial close quickly, people will have something from which to work.”

For now, consortiums are taking a broad and sometimes inconsistent view of risk allocation, says Les Snyder, chief operating officer at Barton Malow, Southfield, Mich., a member of multiple AGC chapters, and chair of AGC’s PPP Task Force.

“In Europe, you see a mature model where risks are defined and clarified,” he says. “They have a standardized approach, much like states [departments of transportation] do with the design-bid-build process. At this point in the U.S., deals happen project by project, which makes it all the more difficult.”

Lump-Sum Risk

For contractors accustomed to working with government agencies, PPP represents a significant shift in approaching risk. Often, risks that are typically held by a public entity are transferred to the consortium in a PPP. In many cases, these risks are then passed on to the contractor.

The Northwest Parkway, a six-year-old toll road north of Denver, improved its finances by signing a $603-million concession agreement with Brisa of Portugal and CCR of Brazil. (Photo by Fred J. Fuhrmeister, Time Frame Photography)

“The ultimate goal of concessionaires is to push all risk away from themselves and onto the designer and constructor,” Snyder says. “They want to see a guaranteed lump-sum price that covers all risks.”

Although the infrastructure under a PPP might be for public use, concessionaires approach risk from a purely business-driven view, says Steve Bobrick, operations director for the Northwest Parkway in Colorado. In 2007 the Northwest Parkway Public Highway Authority signed a 99-year, $603-million concession agreement with Brisa of Portugal and CCR of Brazil.

Having worked for both public and private entities, Bobrick says the distinctions are clear. “A toll authority enjoys certain governmental immunity that you don’t have in a private concession,” he says. “Everything a concessionaire does is literally a business decision. You have to think of what’s best for the business. That includes how you analyze risk.”

For contractors, adding new risks can create issues early in a project. The transfer of preconstruction duties such as permitting to a contractor can open up the company to risks associated with meeting schedules. Likewise, delays caused by un­known site conditions—such as utilities, environmental issues or archeological discoveries—can fall on the contractor.

In addition to being responsible for mitigating these issues, contractors could face penalties from the developer if the project falls behind.

“A lot of these PPP deals are setting large liquidated damages for missing the schedule,” Snyder says. “It’s not unusual to see $100,000 or more per day.”

New Liabilities

With so many unknowns, contractors typically add significant contingencies that drive up bids, says Mary Ann Krautheim, client strategy officer with Aon Construction Services Group in Minneapolis, a member of multiple AGC chapters.

“We’ve seen deals where the bids were all over the map,” she says. “In some cases, the public body shifted more risk than should have been allocated to a construction team. Sometimes the construction team wasn’t in a position to identify what those risks might be or what it might take to handle something that’s not in their normal venue. It all just serves to drive up costs.”

Insurance costs also can rise as contractors are forced to take on new risks. Depending on how a deal is structured, a contractor may assume certain professional liabilities that it wouldn’t handle on a purely public job, Snyder says.

Those liabilities could include definition of project goals, constructibility reviews and value engineering. As a result, a contractor could have gaps in insurance coverage that need to be addressed.

“Where equity partners have the most concern is on the construction-risk side,” Krautheim says. “The more you can identify and quantify all risks and then find the best methods to transfer that risk, the better the chance the insurance will satisfy the equity partners so that you will have an uninterrupted construction schedule.”

Phillips says that in projects where significant unknowns exist, a public entity or concessionaire may need to assume certain risks in order to make the deal viable.

“To the extent that anything is seen as a true unknown in these projects, it’s often in the entity’s interest to manage those risks and keep them on their books so they get the most competitive bids possible,” he says. “Otherwise, you can see significant risk premium built into a bid, or it may be difficult to attract bidders at all.”

Early Contractor Buy-in

AGC’s PPP task force is advocating that the designer and builder be brought into discussions from a project’s inception to establish well-defined contracts and memoranda of understanding with team members. The task force proposed the idea in a 2007 white paper.

Tight credit markets and hesitation by political leaders and their constituents to allow private entities greater control over public infrastructure have halted several attempts to close deals in recent months.

For example, efforts to lease the Pennsylvania Turnpike for $12.8 billion were stalled last summer by the state Legislature. As a result, the consortium, led by New York-based Citigroup and Spanish firm Abertis Infraestructuras, allowed its offer to expire on Sept. 30. In December, the proposed $1.7-billlion Port of Miami tunnel project was derailed when the main financial partner, Australia-based Babcock & Brown, faced possible bankruptcy. It is partnered with French construction company Bouygues Travaux Publics. The Florida Dept. of Transportation is still searching for a solution to the funding concerns within the consortium.

“Generally, these are not small deals,” Snyder adds. “Contractors can tie up a lot of resources for something that may not make it to close.”

Although the risks are considerable, Snyder says the industry needs to continue to push for progress. The most recent “Report Card for America’s Infrastructure” released by the American Society of Civil Engineers identified $2.2 trillion in unmet needs, and Snyder says PPP will ultimately need to be developed as a viable option to build new infrastructure or maintain current systems.

“This is the big question for the U.S. market,” he says. “It’s clear that PPP isn’t the solution for all problems, but we can’t expect the states and municipalities to raise taxes for improvements. So where does the money come from? We think PPP is one answer.”