An estimated $57 trillion of infrastructure investment is required between now and 2030 just to keep pace with global GDP growth (McKinsey Global Institute). If you add on current backlogs and inadequate maintenance and renewal programmes, the figure could be substantially higher. So, with infrastructure projects depending more and more on private investment, how is that demand going to be delivered?
There is hope that institutional investors, such as pension funds, will fill the gap left by stretched government budgets. There are, for instance, good investment opportunities in the UK and strong markets in Canada, Australia and northern Europe. However, the shift to private sector involvement will intensify the focus on the sector’s risk management.
Take the rail system in Australia. It was previously a government project, so a lot of the inherent risks never came to the insurance market. Now, as a private sector business, the funding banks and institutions require their lending to be underpinned by insurance.
Insurance may constitute a fraction of one per cent of the project value, but these costs can also make or break a scheme, particularly if there is the possibility of volatility driven by any catastrophe exposure, natural or human driven. Insurance premiums for offshore wind power projects can be as much as 3-4 per cent of costs over the project lifecycle. So the need to carefully manage both construction and operational risks is essential to a scheme’s financial viability. Getting the balance right from the outset is the way to open investment doors.
With public private partnership deals the risk transfer can change dramatically from project to project, particularly between market risk and availability payment projects. The advantage with the UK’s private finance initiative (PFI) and other international PPP arrangements is that the responsibilities are very clear in the initial agreement. All the pain is up front in the contract negotiation. But, while the operational risks are largely well understood, the demand and performance risk has increased over time as more complex sectors such as waste have moved into PFI/PPP.
Significant risks remain too with construction, where margins are still tight and contractors face significant liquidated damages and penalties in the event of over-runs. The recent experiences of Australian contractor Leighton Holdings with the Brisbane Airport Link and the Victorian desalination plant show the potential impact.
Operational risks, on the other hand, must be assessed over 25 -30 years on average. So it’s essential to have a full understanding the operational model and its implications before entering into the agreement. Similarly errors in the performance of a scheme or unanticipated maintenance costs will seriously hit profitability. With PFI there has been a lot of learning on the hoof. Knowledge of how buildings ‘behave’ over the long-term has improved enormously over the last 15 years. But there are still uncertainties. That is the nature of risk and it is the single most important reason why there is no alternative to involving an experienced insurance broker in the scheme right from the outset.
For further information, please contact Paul Knowles, CEO Construction on +44 (0)20 7528 4044