Source: Best’s Review, November 2016
By: Lori Chordas

Insurers are becoming big investors in public-private partnerships designed to fund the revitalization of America’s aging infrastructure.

American infrastructure is in dire  straits. Public spending on aging assets—such as structurally deficient bridges, congested roads and deteriorating schools and waste treatment plants— has fallen to its lowest level since 1947, according to former U.S. Secretary of Transportation Ray LaHood, and trillions of dollars in investment is needed to bring U.S. infrastructure up to snuff.
Cash-strapped governments are challenged to finance infrastructure projects on their own due to  deflating budgets and decreased tax revenue. The American Recovery and Reinvestment Act of 2009 authorized more than $125 billion for infrastructure. Measures like that are “a good start, but the money can be stretched much further if government agencies partner with the private sector for additional  financing,” according to PwC’s Public-Private Partnerships: The U.S. Perspective report.
While public-private partnerships, or P3s, have been frequently put to use in other countries, they have been slow to catch on in the United States. Governments at the federal and state level, however, are now trying to bring P3s out of their nascent stage.
The contractual agreements between private sector entities and government agencies require private parties to assume a major share of a project’s financing and construction risks and ensure effective performance of the infrastructure—from design and planning to long-term maintenance.
Those  partnerships are opening new doors for insurers, who are not only insuring P3s but are also investing in them.

Land of Opportunity

For more than a decade, John Hancock Financial has been funding public-private partnerships in Europe and Canada. More recently it has started moving some of those dollars into the U.S. market, said John Anderson, senior managing director of the bond and corporate finance group for the insurance and financial services company.
“For example, we’ve invested in a toll road in Houston, and we are an investment partner of the Meridiam Infrastructure Fund in the Port of Miami tunnel project,” he said. That project created a  dedicated roadway connector that links the Port of Miami with the MacArthur Causeway and I-395 on the mainland.
With a P3, private entities are responsible for maintaining the facilities, said Patrick Harder, a partner and chair of Nossaman law firm’s infrastructure practice group. Then they hand the facilities back “in good condition” to public agencies at the end of the contract term, he said.
“The Port of Miami tunnel project, for instance, was a five-year construction period with a 35-year contract term,” Harder said. “During the remaining 30 years, the selected concessionaire is responsible for operations and daily maintenance of the tunnel and the capital maintenance necessary to hand back the facility in good condition at the end of the term,” he said.
Today, insurers are among some of the largest investors in public-private partnerships, generally by investing in debt, said Tariq Taherbhai, a senior director with Aon Infrastructure Solutions.
Life insurers are particularly drawn to the model. “Life carriers’ payment profiles—longterm, stable, low-risk, low-volatility payments at fixed rates of return—closely match P3s’ liability profiles, which is to make payments over long periods of time,” Taherbhai said. “P3s guarantee insurers a revenue stream for 30, 40, 50 years or more.”
Public-private partnerships are also grabbing the attention of some property/casualty carriers,  Taherbhai said. “That’s because they pay more than what you’d get by investing in a Treasury bond. Today, everyone is chasing yield, so this is another area where insurers can do that, and it’s an asset class that’s uncorrelated to stocks and bonds.”
Adding to the beauty of P3s is their solid track record of completing construction projects on time or ahead of schedule and without the typical cost overruns that plague many multiyear infrastructure projects, Anderson said. Projects such as the Virginia Pocahontas Parkway highlight that point. Construction of the 8.8-mile toll highway south of Richmond, Virginia, came in $10 million below the original $324 million estimated cost, according to reports.
“Many people view public-private partnerships as being better managed than other construction  projects,” Taherbhai said. “Therefore, we believe the rates of insurance should be less than other types of projects because of lowered risk.”

New Business Opportunities

Along with investment opportunities, P3s are also driving new business into the insurance sector.
“In the past few years, we’ve seen increased opportunity for infrastructure-related projects—many of which have come in the form of P3s,” said Bill Hazelton, executive vice president of construction and
environmental at Chubb North America.
“Some of the coverage areas where there has been an increased interest are general liability-only wrapups, environmental liability, excess casualty and inland marine,” Hazelton said. “Our primary casualty group also has seen a number of large infrastructure opportunities where our primary casualty  capabilities in general liability, workers’ compensation, excess casualty and third-party claims  administration with our [risk management products and services provider] ESIS team have been called  upon to provide solutions to owners and contractors as well as P3 clients.”
In 2014, XL Catlin created a P3 insurance solution—P3 Plus—that manages the design, construction and operational and maintenance phases of P3 risk that accompanies public infrastructure projects and protects contractors from associated risks and potential losses throughout a project’s lifespan. Coverage options include primary casualty, excess casualty, builder’s risk, professional liability, pollution liability and surety protection specific to a project.
P3s also have seen new surety bonds “that are replacing banking products used on P3s,” Taherbhai said. “Historically, banks provided letters of credit used on P3s to secure the performance of construction contractors because developers, concerned about construction contractors suffering a default or delay,
wanted a way to ensure that they had capital available to quickly fix the problem or bring in a new  contractor.”

Risky Business

While P3s help governments address infrastructure problems and are “a wonderful discipline and a good portfolio fit for insurers,” they aren’t without some challenges, Anderson said.
The complexity and long-term nature of P3 projects create unique risk challenges, said Jeff Burns, U.S. head of P3 and global head of innovation for construction at Willis Towers Watson. “Those agreements generally range anywhere from 25 years to 99 years. Forecasting the cost of insurance over that entire time is still not a risk insurers are willing to take. Therefore, many projects are benchmarked with some kind of economic escalator or other criteria against base market insurance rates a few years into operations and maintenance so the allocation of risk that occurs between public and private provides both an opportunity for more value in contracting risk shift to the private sector and a problem for U.S. insurers to better solve.”
The long-term nature of P3s also means there is a “lack of sufficient data of the risks associated with operating and maintaining public infrastructure,” Taherbhai said. The good news is that as more assets become privately insured, “insurers will build up that data repository, and that will allow underwriters to more easily price insurance,” he said.
There’s a tug-of-war of sorts between the risks faced by private investors and public entities, Harder said. “Public agencies enjoy certain immunities not readily transferable to the private sector. For  example, if someone involved in an auto accident asserts that the government is responsible because of a roadway design defect, more likely than not public agencies will be immune. However, the private sector, sitting in the same situation, could face litigation because it does not enjoy the protection afforded by government immunity.”

Lessons Learned

For decades, private entities have invested in P3s in Europe and Canada to develop everything from public health care facilities to highways, schools and courthouses.
“Everyone is preparing for some sort of P3 boom in the U.S., but it just hasn’t caught on as much here  yet,” said Scott Rasor, head of construction at Zurich North America.
One advantage Canada has is that provincial governments have dedicated departments—such as  Infrastructure Ontario and its equivalents in British Columbia and Quebec—to evaluate, run the bidding and create program parameters for P3s, according to John Hancock’s Anderson.
“Those departments have enough scale and bandwidth to articulate to construction companies and investors the benefits and best practices of P3s so they can deliver good value to the community.
“In addition to transportation, Canada’s dedicated departments are also responsible for hospitals and health care,” Anderson added.
In the United States, hospitals and health care are handled privately, Anderson said.
“It’s more fragmented in the U.S., and Americans are trying to figure it out for the first time on their own. As a result, they’re not getting the repeated touches that allow P3s to grow in this country,” he said. Today, only 6% of John Hancock’s $2 billion P3 investment portfolio comes from U.S. projects, he said.
But that may be about to change, with new efforts to encourage P3s being developed at the federal and state level. In 2015 the Obama administration proposed a new class of municipal bonds aimed at leveling the playing field for municipalities seeking to undertake P3s. On the state level, 32 states have now passed some form of legislation enabling P3s, and 13 states authorize P3s for all types of infrastructure, according to the National League of Cities.
There’s still a long way to go before P3s catch up to other countries and the U.S. government warms up to private capital to fund capital-intensive infrastructure projects, Rasor said. “We’re seeing a great amount of caution, especially with the failure of some of these projects.”
In 2010, for instance, California’s $658-million South Bay Expressway project—a private toll highway owned by the Australian investment bank Macquarie Capital—went bankrupt. U.S. taxpayers who subsidized the project with federal loans suffered a 42% loss.

Closing the Gap

Failed public-private partnerships are few and far between, Willis Towers Watson’s Burns said. “But that can grab headlines and in most cases could have been easily avoided.” He expects the multitude of properly-structured global success stories will spur increased interest in P3 investments to help close the gap between U.S. infrastructure needs and traditional public spend.
Already a number of projects, such as a recovery project at LaGuardia airport, are grabbing headlines, Burns said. “Partnerships like that will grow and will eventually trickle down to smallersized and municipal projects. [P3s] are a better value to the public than traditional means of contracting if meaningful pre-project collaboration between grantors and sponsors and risk shift actually happens.”
The rebuild and new construction of infrastructure sectors such as municipal water and transportation will also be ripe for future P3 investments, Taherbhai said.
Projects like that will open up new opportunities for insurers, according to KPMG’s Demystifying the Public Private Partnership Paradigm report. And carriers with a culture of innovation will achieve more from those partnerships, the report said. “Driving value from PPP strategies requires insurers to take a more innovative approach to creating new business models, products and services. Those with an existing culture of innovation and experimentation will be better-placed to identify and commercialize those opportunities.”
“One thing to remember, however, is that P3 isn’t a panacea,” Taherbhai said. “It’s just one tool; it won’t build all infrastructure. But in complicated projects with multiple stakeholders it may be the right  solution because it allows people to form a consortium to address risks rather than having multiple parties with interests that aren’t properly aligned.”
If done right, P3s can be very beneficial to both public agencies and private sector investors, such as insurers, Taherbhai said. “The public sector gets a boost to much-needed infrastructure, along with long-term maintenance; private investors can secure a stable, long-term return through a stake in some of the underlying essentials of our economies.”