The public-private infrastructure insurance market has regained some of its old buoyancy in the wake of the global financial crisis, but a number of challenges remain.
Rasaad Jamie, Global Markets Editor
There is a great deal of uncertainty in the UK about the value for money represented by infrastructure projects funded by public-private partnerships (PPP) or private finance initiatives (PFI), such as the Crossrail and High Speed 2 railway projects.
The flow of PPP/PFI infrastructure projects in the UK (excluding Scotland) has more or less come to a standstill following the global financial crisis and, in particularly, the emergence of the Conservative/Liberal Democrat coalition government in 2010.
Now the re/insurance market is looking overseas for opportunities relating to these projects, particularly in emerging market regions such as Latin America, the Middle East, central and eastern Europe and Asia-Pacific, including China.
Steve Downing, a senior vice-president in broker Lockton’s London-based real estate and construction team, says the amount of PPP/PFI activity in the UK has reduced quite significantly over the past five or six year period in comparison with the 20-year period that preceded it, when there was a huge amount of investment in transport, healthcare and education infrastructure via the PFI-type model.
“There is now very much the feeling in the UK that PFI, on a long-term basis, is a very expensive way of procuring these projects and all that happens is while the considerable upfront cost of a project is deferred, the money spent by the public sector over the next 25 or 30 years is significant,” he says.
The financial crisis, not surprisingly, had a significant impact on PPP/PFI infrastructure project activity globally. Mike Roberts, managing director at loss adjuster Cunningham Lindsey’s major and complex loss – construction and engineering division, says between 1990 and 2009 there were around 1,400 projects in the EU with a capital investment of €260bn ($285.33bn).
Elsewhere, Australia, Canada and a number of countries in Asia and the Russian Federation have all developed PPP programmes, with more than 300 projects in Russia alone before 2013. “The 2008 financial crisis led to a drop of approximately 40% in capital expenditure,” Roberts says.
But things are changing and the global PPP market is starting to regain some of its old buoyancy. “This is despite the fact in many developed economies, the immediate pipeline of PPP activity has dried up somewhat, as wider fiscal policy is focused on debt reduction rather than infrastructure investment. “Even in these economies, projects are still being procured,” Andrew Briggs, a partner at in the construction practice at law firm Hogan Lovells, says.
Roberts agrees. He points to the fact in the UK over the past 15 years there have been close to 600 projects with a capital value of £60bn ($93.31bn). Although much of that funding would have been secured during the first 10 years, he says there are also new opportunities emerging.
He highlights the launch of the PF2 infrastructure programme in 2012 and the suggested £1bn of new projects a year. “The PPP sector is both alive and well and, in addition, it is developing into new areas in the UK. Even the European Bank for Reconstruction and Development hosted a two-day PPP event in London only last month,” he says.
Yet the bulk of the activity in PPP infrastructure has moved to developing and emerging markets, where the PPP procurement approach is gaining wider traction. For example, Briggs says a wide range of government bodies in central Europe, Asia, Africa, the Middle East and Latin America are putting in place PPP legislation and pilot schemes.
“Notably, most global financial institutions – including the World Bank, the UN, the European Investment Bank, the Asian Development Bank and the African Development Bank – are promoting PPPs and providing support and guidance for government bodies to implement and accelerate infrastructure investment. The need is critical and it seems PPP will increasingly play a part in fulfilling that requirement,” Briggs says.
PPP infrastructure activity in the Middle East and north African (Mena) region, which was hit hard by the global financial crisis, has made a strong comeback in recent years as a result of the re-emergence of structured financing to bridge the infrastructure investment deficit created by the crisis.
Most of the previous large PPP project financings in the Mena region that have closed in recent years have tended to be in the utilities sector, normally with a large tranche of exporting credit agency financing from the Japan Bank for International Co-operation (JBIC) or the Export-Import Bank of Korea and with the offtaker’s payment obligations being backstopped by a sovereign payment guarantee.
“But these days, in addition to the utilities sector, there is now also a strong pipeline of PPP transactions in other sectors, most notably in the healthcare, education and transportation sectors,” Adrian Creed, an Abu Dhabi-based partner at law firm Clyde & Co, says.
There is also growing interest in PPP/PFI infrastructure project financing in India, China, Japan, Malaysia and South Korea, according to Colin Rose, senior underwriter and the leader of Beazley’s construction and engineering team.
The attractiveness for the insurance market of a particular PPP project, he says, depends on the governments’ attitude to investment in infrastructure for transport, healthcare and education.
Rose says PPP arrangements can differ significantly from country to country, as there are various interpretations of what constitutes a “partnership” between the private sector and government.
“Insurance brokers with PPP/PFI expertise in London are looking to bring that expertise into play for local retailers. The Beazley experience of the way PFI/PPP projects have been run has been positive, especially where we find the private partners have influence on the running of the projects and there is greater influence in the need to provide a project on time and defect free,” Rose says.
For the insurance market, what are the main challenges in terms of providing coverage and other risk management solutions to PPP/PFI infrastructure projects, as opposed to providing the same solutions to other infrastructure projects, such as those that are solely financed by either the private or public sector?
Rose says the majority of coverages are the same. “The biggest difference lies in the need to ensure all parties are covered by the insurances during construction and also into the operational phase, which can last for a period from 25 to 30 years,” he says.
According to David Hayhow, a partner in construction and engineering team at Lockton, the consideration and implications for the insurers are a little more onerous with a PPP project. “The project is often governed by a principal for whom the project is being built – a government body or department. At the same time, debt finance is being raised against the project and as a consequence the debt provider will also have requirements, which will have implications for how the insurance programme is structured because it will have to satisfy both the government party and the debt finance provider, both in the construction and the operational phase of the project,” Hayhow says.
Roberts says it is important the PPP specialist insurer or broker recognises the interests of all stakeholders and individual needs for brand protection, to avoid complications which might otherwise arise from multi-party disputes and to control costs.
“The key is the contractual matrix, which defines the parameters for asset procurement, renewal, maintenance and performance/availability and determines the financial consequences for unavailability. The financial consequences are formulaic, so the full effect of damage and repair times can be managed. The contracts are not a barrier to efficient and cost-effective reinstatement, particularly as defined roles will mean, if managed properly, the time taken to implement a solution can be reduced,” Roberts says.
“From a loss adjusting perspective, stakeholder management is a necessity as loss mitigation and innovative approaches to complex losses will require consents from several parties and often fall within the parameters of lender governance.”
Things are often done a little differently in countries such as Abu Dhabi and Saudi Arabia, according to Creed. Instead of the private sector party carrying the burden of providing all the upfront finance for the project, the host government will typically take an equity stake in the project special-purpose vehicle (SPV), thereby aligning its interests more closely with the private sector developer than tends to be the case elsewhere.
“In other jurisdictions, such as Bahrain and Jordan, it is normally the case the project SPV will be wholly owned by the private sector developer. Consequently, the extent to which a host government has a direct equity interest in a PPP project has tended to influence how the insurance requirements are crafted,” Creed says.
Traditionally in the UK, the general burden to insure is placed with the private sector partner involved in the PPP project but as the market has evolved, particularly over the past 13 years, a few things have changed in this regard. An important development, according to Nick Tidnam, counsel at Hogan Lovells and one of the most experienced lawyers in the PPP/PFI area, has been the shift from PFI to PF2.
“The guidance for PF2 has introduced a discretion for the authority granting the PPP concession to cover certain risks by way of the grant of an indemnity, rather than requiring the contractor to insure them in the market – for example, to cover material damage and business interruption during the service phase for projects with particular risk characteristics where it represents,” Tidnam says.
“In projects with a dispersed asset base such as street lighting projects, the UK authorities take the view damage can only occur to one or two street lighting poles at a time, for instance where they are damaged by a runaway truck, and so rather than insuring the replacement of all the street lights in a project, it is more cost-effective for the relevant authority to cover the cost of replacement, as that cost should not be significant,” he adds.
This development also means the state authority and the private sector contractor share the risk of rises in insurance premiums, which until not so long ago was entirely borne by the private sector partners.
“The current guidance relating to PF2 provides that the private sector contractor takes the risk of premium increases up to an agreed threshold above the initial premium and above the threshold the premium increases are shared between the private sector and the authority on the basis of 15:85. The authority has in principle at least discretion to designate the threshold at a level between 105% and 130% of the base premium. From our experience a similar general approach is used in US PPPs, although the thresholds may be set at a different level,” Tidnam says.
But while there is the perception the insurance market in relation to UK PPPs has become deeper and has developed more capacity over the past few years, the market, according to Charles Ford, a counsel at Hogan Lovells, there is still has some way to go. “For example, the PPP insurance market does not yet cover weather risk in relation to the operation of the electricity cable projects linking offshore wind farms to the shore (called OFTOs and this is something which hopefully might be addressed over the next few years as insurers become more familiar with this risk,” he says.
For Paul Knowles, chief executive of construction and real estate at JLT Specialty, it is important both the broker and the insurer involved in the PPP project realise the funders are taking a real risk on these projects and therefore have a big say in the structure of the placements. “They will typically be risk-averse and therefore want wide cover and relatively low attachment points. They will also be more interested in the credit rating of the insurers and will have minimum requirements, which insurers and brokers need to be aware of.”
According to Roberts, in terms of the insurance of a PPP project, the contractual matrix will always dominate the structure and everyone involved will be aware of the risk-transfer mechanisms. “Allied to risk allocation is the requirement for the appropriate insurances. A suite of project specific policies will be used recognising the interests of all stakeholders such as the investor, design and build contractors, subcontractors, plus facilities managers and their contractors for the operational phase.”
These policies, Roberts says, typically provide protection against the cost of reinstating material damage to assets; any reduction an insured event may cause in the revenue the asset generates and/or reductions in unitary charges; and any third-party liabilities throughout the entire project life cycle.
While it is no secret today’s soft market conditions are particularly prolonged, and while the PPP infrastructure market follows the same market cycle as the broader construction market, there are certain characteristics that make PPP projects particularly sensitive to the cyclical nature of the market, according to Knowles. “The long-term nature of the projects – 30 years plus – means customers must have an in-depth understanding of the market cycle and historical pricing to factor in the right amount of contingency, while remaining competitive. Furthermore, companies set up to deliver these projects have a very low capital base and therefore low deductibles, and the widest form of coverage is normally a strict requirement, all of which can be challenging in a hard market.”
Although the international insurance and reinsurance market has always played a major role in large, complex infrastructure projects, particularly when project finance is involved, it needs to work with local insurance requirements and regulations. “Some of the regional hubs are becoming significant players in their own right, so it tends to be a mixture of local and international markets on these big infrastructure deals,” Knowles says.
Although each jurisdiction throughout the Mena region has its own policies with regard to the extent to which international insurers can participate in domestic infrastructure transactions, for the larger, more technical and risky projects (such as petrochemicals and power generation) it is normally the case that lenders will insist on something like 90% to 95% of the main insurance risk being placed with investment-grade international insurers, Creed says. “Any such offshore insurer may be required to enter into reinsurance assignment deeds or reinsurance cut-through deeds, as the case may be,” he says.
Customers increasingly prefer to purchase insurance in their local markets, Knowles says. “But this is a global trend not only applicable to PPP or infrastructure projects; this is particularly true in emerging markets. Furthermore, there is evidence that confirms London’s share of premium is declining. However, overall premium numbers remain high, reflecting the increasing demand for infrastructure.”
But Knowles adds London is still the best-placed market for underwriting the largest and most complex risks. “PPP projects, especially those relating to infrastructure, are just that. Furthermore, London is still the market for excess and surplus capacity from around the world. Therefore, even where large PPP projects are insured locally, they often find themselves reinsured into London via Lloyd’s, for example.”
Source – Insurance Day