Public-Private Partnerships (P3) Effective Risk Allocation & Risk Transfer

22nd Annual Willis Towers Watson Construction Risk Management Conference

September 13,2016

Tom McClellan, The Lane Construction Corporation Scott Hull, Willis Towers Watson Chet Mitrani, Willis Towers Watson

What Is A PPP?

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A Public-Private Partnership is a contractual agreement between a public agency (federal, state or local) and a private sector entity. Through this agreement, the skills and assets of each section (public and private) are shared in delivering a service or facility for the use of the general public. In addition to the sharing of resources, each party shares in the risks and rewards potential in the delivery of the service and/or facility.

22nd Annual WTW Construction Risk Management Conference

Why PPP?

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The key objectives in commission a PPP Project are:

§  Maximize value for money (VFM) of providing service over a long timescale of 20-30 years or more having taken into account the risks. §  Whole project list costing §  Risk Transfer from public private sector §  Incentivize on time and on budget projects

§  Enable public sector to procure services in a manner consistent with economic policy, in particular where sources of public funding are lacking/in short supply

§  Supplementing limited public sector capabilities to meet the growing demand for infrastructure development

§  Benefits of PPP: §  Relieve Public Sector cash constraints by allowing them to spread cost over longer term §  Allow Public and Private sectors to concentrate on activities that best suit their respective skills §  Procurement efficiency §  Improved accountability §  Risk Management §  Enhance quality and quantity of infrastructure

22nd Annual WTW Construction Risk Management Conference

Value for Money (VFM)

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Questions to maximize VFM in risk allocation

§  Which party is best able to control or manage the occurrence of the risk? §  Which party is best able to control or manage the impact of the risk? §  For a particular risk, which party has a great incentive to develop risk mitigation strategies either to

control the occurrence of the risk or its impact? §  For risk that are typically allocated to the public party, might there be innovative opportunities to

reduce whole-of-life costs by allocating (even if only partially) the risk to the private party? §  Which risk allocation would result in the lowest whole-of-life costs? §  Which risk allocation incentivizes preventative risk management as opposed to reactive risk

management?

22nd Annual WTW Construction Risk Management Conference

P3 Screening and Structuring

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INPUTS SCREENING OUTPUTS

Project Characteristics

Sponsor Priorities

• P3 or Conventional

•  If P3, Which Type?

P3 Contract Terms

Competition Structure

Technical

Legal

RFP Submittal Requirements

Evaluation Criteria

22nd Annual WTW Construction Risk Management Conference

Supplier Contract

Public Private Partnerships Infrastructure

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Contractual Structure – Risk Allocation

Equity Sponsor

A

Equity Sponsor

B

Equity Sponsor

C

PROJECT COMPANY Special Purpose Vehicle

LENDERS / BONDS Senior & Subordinated PUBLIC ENTITY

CONSTRUCTION CONTRACTOR SUPPLIER O&M

CONTRACTOR

Sub-Contractor Sub-Contractor Sub-Contractor

Loan Agreement Financial Covenants, Remedies, Reserve and Insurance Requirements and Flow of Funds

Concession Agreement Performance requirements, Risk Allocation, Schedule, Force Majeure, Relief Events

Sub-contracts Sub-contracts Sub-contracts

EPC Contract Insurance

Requirements

O&M Contract Insurance

Requirements Sources and forms of Insurance and Guarantees

Sources and forms of Insurance and Guarantees

22nd Annual WTW Construction Risk Management Conference

CDAs & Risk Allocation

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Assign to Owner

Assign to Developer

Shared Risk

Concession Program Differs from Design / Build

CDAs DELEGATE RISK TO THE PARTIES BEST ABLE TO MANAGE IT.

22nd Annual WTW Construction Risk Management Conference

Key Risk Allocations

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A number of key risks that need to be allocated and managed to ensure the successful financing of the project are:

§  Construction and Completion Risk §  Operating Risks §  Demand Risk §  Force Majeure and Change in Law §  Political and Regulatory Risk and Expropriation and Nationalization Risk §  Environmental Risk §  Social Risk §  Tenor and Refinancing Risk §  Currency Exchange Risk §  Interest Rate Risk

22nd Annual WTW Construction Risk Management Conference

Risk Allocation & Contracting Allocating Other Risks

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§  Right of Way

§  Utility Relocations

§  Differing Site Conditions

§  Force Majeure

§  Hazardous Materials

§  Paleo / archaeo / bio

§  Permits

§  Railroads

§  Who can best control the risk?

§  Who can best manage the risk?

§  Are contractors willing to assume the risk?

§  How much will it cost?

22nd Annual WTW Construction Risk Management Conference

… Shared Risk Allocation

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DESIGN / BUILD D/B/FINANCE D/B/F OPERATIONAL / MAINTENANCE

BUILD-OPERATE-TRANSFER /

CONCESSION

Regulatory Regulatory Regulatory Regulatory

Approvals Approvals Approvals Approvals

Environmental Environmental Environmental Environmental

Customer Acceptance Customer Acceptance Customer Acceptance Customer Acceptance

Design Design Design Design

Traffic / Rev. Traffic / Rev. Traffic / Rev. Traffic / Rev.

Finance Finance Finance Finance

Technology Technology Technology Technology

R-O-W R-O-W R-O-W R-O-W

Construction Construction Construction Construction

O&M O&M O&M O&M

PUBLIC PRIVATE RISK TRANSFER BY MODEL

22nd Annual WTW Construction Risk Management Conference

Key PPP Project Insurances - Insurance Requirements

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Construction Period §  Construction “All Risks” §  Construction “All Risks” Terrorism §  Soft Costs/Delay in Opening §  Third Party Public Liability §  Statutory Insurances (Workers Compensation/EL) §  Professional Liability (Design and Build) §  Pollution Legal Liability §  Auto Liability §  Railroad Protective Liability

22nd Annual WTW Construction Risk Management Conference

Why Are These Insurances Required?

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§  They protect the Public Agency, SPV, Lenders and other parties with an insurable interest in respect of §  physical loss or damage to Project property/assets §  earnings and additional costs of the SPV in respect of the above §  incurred Third Party Legal Liabilities (bodily injury and property damage)

§  Without insurance the SPV could not accept the financial consequences of such risk events occurring

22nd Annual WTW Construction Risk Management Conference

Why is the insurance regime under PPP different to standard procurement?

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§  The Public Agency, Lenders and others with an insurable interest sit inside the insurance mechanism as a co-insured taking direct benefit for their separate insurable interest

§  Insurances to be procured on a project specific basis and not derived from parent company program. §  Public Agency guidelines and Lender requirements seek to ensure specific conditions are in place

defining the duties of the parties to the Project in terms of the operation of the ‘required insurances’

22nd Annual WTW Construction Risk Management Conference

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What are the options for Contractors

Surety Solutions for PPP

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What Makes PPPs Different? Traditional vs PPP Typical Contractual Structure

Design Project Funding/Debt

Procuring Authority

Contractor

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Typical PPP Contractual Structure

A typical PPP structure involves the creation of a single stand-alone entity financed by the private sector (Project Co or Concessionaire). Its purpose is to create an asset and deliver the service to the public sector in return for payment.

Procuring Authority Lenders / Bonds Equity Investors

Project Co (Concessionaire)

Contractor O&M Contractor

22nd Annual WTW Construction Risk Management Conference 16

Performance Security

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What is changing and why?

§  Projects are getting larger & security is getting more complicated §  Contractors are being asked to provide security solutions that are not just “performance” based but

provide “liquidity” and include “completion” guarantees §  Rating Agencies – Cash is King! §  Contractor’s security directly impacts the project rating – stronger security package will improve ability

to achieve target rating for the project §  New forms of surety solutions

§  Delayed “Funding or Liquidity” Bond §  Alternative Project Delivery Bond §  “Either” “Or” Bond §  Pay On Demand Bond §  Back to Back Bond §  Commercial Warranty or Liquidated Damages Bond

22nd Annual WTW Construction Risk Management Conference

Performance Bonds vs Liquidity Bonds

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PERFORMANCE BOND

•  Typically 100% of contract amount •  Claim requires validation by surety •  Surety may become restricted by legal

proceedings – delay risk to obligee •  Probable Maximum Loss is in the 25-30% of

contract amount •  Increased surety capacity given the favorable

analysis of lower Probable Maximum Loss amount, runoff and liquidity

•  Premium is based on the contract amount – lower effective rate

PAY ON DEMAND BOND •  Typically 5-25% of contract amount •  Claim requires limited validation by surety

(payment can be as quickly as 10 days) •  Delay in resolution of dispute might result

increased risk to the contractor and obligee •  Probable Maximum Loss is estimated at 100%

of bond amount •  Capacity is limited based upon 100% Probable

Maximum Loss, lack of runoff and liquid nature of the obligation

•  Premium is based on the bond amount – higher effective rate to match risk exposure

A Contractors Perspective

22nd Annual WTW Construction Risk Management Conference

Types of Liquidity Bonds

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One size does not fit all…

§  Alternative Project Delivery Bond: Traditional performance bond with a liquid component. The liquid amount is typically 5-20% of the total construction costs. The remaining 95-80% is available as a traditional performance bond.

§  Delayed Funding or Liquidity Bond: Performance bond with a contractually binding investigation period. The bond responds like a traditional performance bond, but limits the time allowed for the surety to investigate.

§  “Either” “Or” Bond: The obligee has a bond with a 15-20% liquidity option or a 100% standard performance bond option. Either option can be selected by the obligee, but the surety has no obligation to the other feature once selected.

§  Pay-on-Demand Bond: A stand alone “liquid” bond that may or may not be written in conjunction with a traditional performance bond. Values range from 5-25% of the construction value. Provides the obligee with the ability to claim the bond in a similar manner as a Letter of Credit. This form of security is more common outside the US and North America (e.g. Australia, Europe, etc.).

22nd Annual WTW Construction Risk Management Conference

PPP Insurances / Bonds –Considerations & Solutions

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§  Relief Events , Compensation Events and Force Majeure §  Premium increases– who bears the risk? §  Insurance market capacity and market participants §  Uninsurability §  Excesses/Deductibles – who pays? §  Meeting bid/tender requirements - what level of information is required – insurance proposals must

remain “fluid” and negotiable until final design and construction timetable is known §  Cost of insurance – provision for cost of insurance in the Financial Model; prevailing market cost +

contingency amounts §  Phased completion timetable §  Overlap of ALOP/BI §  Pre-existing property §  Latent Defects §  Environmental/Contamination issues §  Contractor’s plant and equipment §  Terrorism risk §  Marine/Transit §  Surety 22nd Annual WTW Construction Risk Management Conference