The Risks of Public-Private Partnerships

The Risks of Public-Private Partnerships

Source: http://www.businessinsurance.com, November 17, 2013
By: Jeff Slivka

Although not yet as popular in the United States as in many parts of Europe, public-private partnerships have gained ground over the past few years as long-term alternatives for funding U.S. construction projects. While the projects represent an opportunity to improve U.S. infrastructure, the risks of the projects must be carefully evaluated, says Jeff Slivka, executive vice president and chief operating officer of New Day Underwriting Managers.

In April, President Barack Obama introduced a $3.77 trillion spending plan designed to strengthen the middle class, create jobs and grow the economy. This included investing $50 billion in the repair and upgrade of highways, bridges and the country’s mass transit system, as well as other high-priority infrastructure projects, such as building high-tech schools and better preparing the power grid for catastrophic events.

Unfortunately, there are few things that can be agreed upon in today’s highly fractured political climate. One is that these are inconsistent times filled with uncertain outcomes. Another is that America’s infrastructure is crumbling and the investment in its upkeep, no matter the reason, has been steadily declining for decades.

According to a recent report from the American Society of Civil Engineers, the nation’s infrastructure investment shortfall is expected to exceed $1 trillion by 2020 and hit nearly $5 trillion by 2040. In the May Global Competitiveness Report issued by the World Economic Forum, the U.S. global infrastructure ranking No. 14, which represents a drop of seven spots since 2008.

If this wasn’t depressing enough, the ASCE also stated in its Failure to Act series of reports that “if investments in surface transportation aren’t made in conjunction with significant policy reforms, families will have a lower standard of living, businesses will be paying more and producing less, and our nation will lose ground in the global economy.” The price tag for bringing the national infrastructure up to date by 2020 is $3.6 trillion, according to the ASCE.

So what’s the answer to this worsening problem when standard federal resources are thin at best? President Obama touched upon one solution in his January State of the Union Address when he noted the importance of leveraging the private sector to fill public needs.

Although not yet as popular in the U.S. as in many parts of Europe, public-private partnerships, known as P3s, have gained ground in this country over the past few years as credible long-term alternatives for funding a broad range of institutional projects at the state and municipal levels. In fact, approximately 30 states now have legislation that encourages these arrangements. For example, the City of Holyoke, Mass., recently

partnered with a large utility to build a new combined sewer overflow

facility. Similar partnerships helped build the nation’s largest seawater desalination facility in Tampa Bay, Fla., and a new water treatment plant in Seattle.

By definition, public-private partnerships are exactly that in the most general of terms. For example, through such transactions, investment teams often consisting of builders, designers, private equity lenders and others will sometimes join to build a new public facility or upgrade an outdated one. In lieu of the short-term enumeration, they would then receive payment in the form of rights of ownership, mutually agreed-upon fees or rent from facility occupants, and possibly even payment for maintenance or related services. Depending on the contract terms, such arrangements can last for years or even decades.

While the partnership can prove extremely lucrative for the private side, the public sector benefits by sharing the risks that can accompany any large-scale building project and gaining access to a steady source of capital when budgetary restraints are high. This is especially true for municipalities and townships that are in dire need of civic improvements but cannot secure the funding through traditional channels.

Now the downside: P3 deals can be incredibly complex. In addition to comprising dozens of stakeholders ranging from federal, state and local government officials to contractors, lawyers, financial investors, owners, architects and designers, the legislation governing such partnerships can vary from state to state.

Furthermore, the goals, objectives, incentives and motivation of all the different players can present a logistical nightmare on the contractual front. Think about it. The public sector wants to save money. Everyone else involved is looking to turn a profit. And the public often doesn’t know enough about the details to have a truly informed opinion.

As a result, many entities are understandably hesitant to enter into such agreements given the complicated nature of these deals, as well as their overall general unfamiliarity with P3 contractual terms. Another concern is the risk sharing that is commonly integral to P3 arrangements and often not even considered during traditional design-build project discussions.

Most P3 projects approach this in three ways. The public sector retains all the risks. The private industry partner or consortium, as it’s commonly called, takes all the risks. Risk is shared by both entities with direct responsibilities mutually agreed upon before construction starts.

And that’s the rub for contractors, owners and related construction professionals: How can anyone definitively know that an arrangement that is good in today’s marketplace will actually prove profitable and worthwhile during the course of a deal that can stretch across decades? Clearly understanding and thoroughly assessing P3 contractual language is therefore essential for making the agreement work for everyone. This includes the responsibility or arrangements for handling design errors or defects, errors in the construction process, or issues with constructability.

That’s why professional liability insurance products should be considered an essential component for all public-private partnerships. In fact, insurers recently have anticipated this new market need by offering enhancements that reach well beyond typical policies by extending professional liability coverage to entire design and construction teams.

For instance, rectification coverage has been structured to pay for expenses related to design defects identified during the construction process. Under such terms, it is commonly added to the typical project professional liability policy and usually covers the design and construction teams, minimizing the likelihood of project delays and potential costly liability claims. Of course, the insurer must determine that the design defect or error is likely to result in a third-party claim if not remedied, otherwise coverage does not apply. Insurers offering such insurance can do so with limits up to $25 million. Higher-limit programs can be obtained with additional insurers offering capacity above the primary insurer’s limit.

However, even with insurance available to finance a loss, it should never be substituted for thorough project risk management.

Nevertheless, while public-private construction partnerships are expected to provide a boon to municipalities and cities looking to upgrade infrastructure during difficult times, they also can provide a complex contractual maze to the professionals that have yet to get involved with these projects.

On many levels, this is a brand new ballgame filled with a wide variety of rule changes. It is imperative for all the parties to proceed with diligence and trusted partners. Roles need to be clearly defined and safety nets inserted should issues surface.

Jeff Slivka is executive vice president and chief operating officer of New Day Underwriting Managers in Bordentown, N.J. He can be reached at 609-298-3516, ext. 102, or jeff.slivka@newdayunderwriting.com.

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