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Insuring Public-Private Construction

Insurers value the track record of European-based highway builders and operators, and are welcoming this business.

Residents of the East Coast don't need to look far to see how risky investing time, energy and money in public transportation projects can be.

It was just a year ago that New Jersey's pugilistic Republican Gov. Chris Christie cancelled an $8.7 billion tunnel project that went by the working title of Access to the Region's Core, or ARC.

The project had been planned to ease train congestion from New Jersey into New York City. It was the biggest transportation project in the U.S., and when Christie did what he did, U.S. Transportation Secretary Ray LaHood demanded an explanation.

Christie, who has won praise from fiscal conservatives for his approach in battling an $11 billion state deficit, foresaw projected cost overruns for the project that ranged in the multiples of billions of dollars.

No matter how irritated LaHood was, Christie got his way, by essentially demanding that the federal government pay for overruns that they were only too ready to foist on his state budget.

That cautionary tale aside, insurers are looking with favor on what is an emerging trend; public-private partnerships in the U.S. that often involve foreign capital or construction expertise.

Highway contractors and financiers with roots in Europe, Australia and Japan are increasingly extending themselves to partner with cash-strapped state governments here in the U.S. to build, renovate and operate our highways. States that don't preclude the design-build structure crucial to the arrangement are gearing up to pave the way for these projects.

In May, the Texas Legislature passed a bill allowing the Texas Department of Transportation to sign public-private partnerships to build three major North Texas highway projects with a combined price tag of $8.7 billion. The action in Texas brings to 29 the number of states that currently allow these partnerships.

In Pennsylvania, the state government is assessing whether to establish a Public-Private Transportation Partnership Board, which would be appointed by the governor and state legislators, and which would decide which projects to build and which contractors to hire.

The tight finances of state governments in the U.S. will in all likelihood influence the insurance market for public-private transportation partnerships in another way. In many states, cash-strapped governments have had difficulty keeping up with infrastructure repairs.

In New York alone, it is estimated that 5,521 of that state's 17,400 state and local highway bridges are deficient. That number is expected to increase by 3,000 in the next 10 years, state officials said.

The New York story is one echoed in many states across the country. If motorists are going to stay safe, more capital must be found to fix roads and bridges that local governments have ignored for too long.

Some sniff at what they see as the selling of domestic assets to foreign interests. But granting a company a concession to operate a highway in exchange for a toll-sharing agreement or some other type of payment isn't the same thing as selling the asset, even though such revenue-sharing arrangements could stretch well into the future.

To insurers, European-based contractors, many of whom have extensive experience in public-private partnerships, are attractive business partners. Estimates are that a minimum of $200 billion in construction investment capital is poised to be brought to bear in this sector. And insurance capital will not be far behind, according to professionals.

"If you have a company or team that is going to do a lot, so that you have the opportunity for recurring revenue, and they are a name brand then you are going to attract insurance capital all day long," said Michael Hastings, an Atlanta-based managing director and project risk practice leader for Marsh.

"What I see is that the time is really ripe for these types of arrangements," said Bill Sullivan, a Hartford, Conn.-based vice president of product development, construction segment for the Hartford Financial Services Group.

But as Gov. Christie showed us all, there are risks here.

One of them is that there are varying degrees of sophistication among the state governments that might seek to ease the pain of their purses with public-private partnerships.

"I think every state is at a different level of sophistication in terms of letting contracts and a lot of that is driven from the amount of significant infrastructure that the state may entertain for a new building or maintenance every year," said Scott Rasor, the Schaumburg, Ill.-based head of construction for Zurich North America.

Rasor said Florida, California, Illinois and New York --states that have fairly sophisticated transportation department contract offices -- will likely lead the way for now in the area of P3's or public-private partnerships.

"I really believe that there will be a number of states on the cutting edge of public-private partnerships that will help lead other states to understand it better later," Rasor said.

Another risk is that there is a clear bifurcation between the risks associated with construction and the risks associated with operating a highway. Zurich's Rasor said there is nothing that changes much when it comes to the construction piece, but the operations piece is another matter.

One hang-up is that in the United States, there really isn't much a of a track record that can show underwriters what kinds of losses can develop when highways owned by public entities, which are traditionally shielded by sovereign immunity, are handed over for operating by the private sector.

"We could draw parallels to other businesses but the truth of the matter is when there is no liability there are no cases," Zurich's Rasor said.

"So, for the insurers domestically they are trying to understand that risk," Marsh's Hastings said.

"I think where it gets tricky is the operation of the public asset," Rasor said. "Is there really a differential in the ability to defend yourself or extinguish cases? Some might argue that the maintenance and care of the public asset is maintained to a higher level than the public operator would maintain it."

Rasor said the public sector might upgrade roads only when it has the tax revenue, whereas the private sector might invest in upgrades as a matter of course of protecting a business asset from which they derive revenue.

"There is not a mature market for operating roads in the United States because that is typically done by public entities that often have sovereign immunities," Hastings said.

The Hartford's Sullivan said that there will be those insurers who would rather take on the construction piece and others that will be just as fine insuring construction and operation.

"Some carriers might approach it a bit differently and might turn down an opportunity with more variables, but we do insure both aspects of these types of projects," Sullivan said.

When a public transportation asset is being transferred to private hands, Hastings said, one area that merits particular focus are environmental exposures.

"Storm water runoff due to road construction is a big environmental hazard," Hastings said.

The public entity, with its sovereign immunity protections, might have engineered the highway in a way that led to runoff that damages water supplies or other assets.The private operator taking over the maintenance of the road may have that deficient engineering built into their risk exposure.

Then throw in the heavy rainfall attendant to a Hurricane Irene and a Tropical Storm Lee that soaked the Northeast this summer and the runoff risk is magnified.

Professionals agree that this public-private partnership approach to highway construction and operation isn't a fad. Just how quickly it will take hold will depend on the projects already launched, such as the I-95 corridor expansion in Florida and that state's Miami tunnel project.

"The difficulty is that every public entity that is entering into this is doing it for the first time so there is a great variety of understanding," Marsh's Hastings said.

November 1, 2011

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