Public-Private Risk Sharing:
Searching for a WIn-Win

The U.S. is seeing a growing trend in the use of public-private partnerships (P3s) for the delivery of transportation infrastructure through an infusion of infrastructure funds into the revenue- strapped public infrastructure market. The Federal Highway Administration defines a P3 as “a long-term partnership arrangement between a government agency and a private sector party…resulting in the private sector party providing public infrastructure and/or services that are traditionally delivered by the public sector.” P3s, in their most basic form, are a mechanism for a government sponsor/partner to shift project-related risks to the private partner/investor.

While discussions of the P3 delivery model tend to focus on the “bottom line” potential, few understand one of the basic motivators behind a successful P3 project: the appropriate sharing of risk.

Understanding Shared Risks

The use of various P3 delivery models brings to bear the ways in which risks can be shared between public and private entities. A key objective of a P3 is strategic distribution of risk to maximize the benefit to the public—otherwise known as the Value for Money (VFM). Distribution or allocation of specific risks between public and private partners is primarily determined by the rule of control: the risk should be allocated to the party best able to control the risk; if neither party is able to control a risk, then the risk should be shared.

The traditional infrastructure delivery model is usually referred to as a Design-Bid-Build (DBB) process. In the DBB process, the public agency assumes all risks with the exception of actual construction risks. Construction risks are assumed by the private constructor in lieu of a payment for delivering the project. By contrast, in a full Concession delivery approach, the private entity assumes the largest percent of project delivery, financing, revenue, operation, and maintenance risk.

General protocols for determining and assigning risks include:

• Term of the contract: a private investor may be more liberal in accepting a specific risk as influenced by the term of the contract—longer term contracts equate to a higher probability that a risk event will occur.
  
  
• Type of revenue: A private investor may be more liberal in accepting a specific risk as influenced by the type of revenue—a user fee contract has “revenue upside” as compared to an availability payment contract that has no or limited upside.
  
  
• Timing of the risks: A private investor may be more liberal in accepting a specific risk as influenced by that risk’s timing—a risk that could occur during the construction period (three years) has fundamentally a lower probability of occurrence than a risk that could occur during the service period (35 to 50 years). Another key understanding with respect to the timing of risks is that during the term of the P3’s contract, the private risk profile changes; risks drop away as time goes on.

Variations in the risk regime are driven by the following considerations:

• Greenfield or Brownfield project
  
  
• User Fee or Availability Payment project
  
  
• First time or mature public agency sponsor
  
  
• State P3 legislation level of detail
  
  
• Specific objectives of the P3 program
  
  
• Type of project—new asset or rebuild, toll road, or managed lanes

Achieving a Win-Win

The success of any P3 agreement is contingent upon having an alignment of interests and a solid contract for delivery of the project between the public and private entities, regardless of the model to be used. Among the keys to this success are:

• Public entity identification of the project’s value/need and clear communication of the value/need to potential private entities
  
  
• Well-defined services and products to be achieved by the private entity
  
  
• Use of transparent and commercially acceptable regulatory and procurement processes
  
  
• Clearly defined transfer of risks from the public to the private entity along with the ability to undertake steps to manage and address those risks
  
  
• Identification of a real, incremental economic advantage of a P3 as compared to the traditional in-house governmental option, otherwise known as VFM
  
  
• Political will to maintain the course of the procurement and implementation processes
  

The successful P3 does not happen without overcoming challenges, which may typically include:

• Selection of the right project and continued political will and support
  
  
• Need for complex structure and deal documents that clearly define parameters
  
  
• Adequate time to arrange agreements and understandings
  
  
• Willingness by both parties to commit to high up-front costs
  
  
• Demand of significant senior staff time from the public agency

Today’s infrastructure market is complicated and growing in complexity as qualified private entities vie for roles typically assumed by public agencies. The transfer of risk from the public agency to the private entity is a critical consideration in a public agency’s strategy to become involved in public-private partnerships. Understanding these relationships can result in better projects and the long-term alignment of interests for the benefit of the public.

The graphic below depicts the shift in risk areas among various delivery models. Areas of risk are summarized for each major portion of project delivery, from project initiation through construction and operation. Those areas highlighted in a darker color represent those risks assumed by the public agency. Those areas highlighted in the lighter color represent those risks assumed by the private entity. Those areas shaded in both colors depict risks shared by both the public and private entities.

Moving from left to right, the delivery models show a greater assumption of risk by the private entity and additional shared risks between the two entities.