Authorities who are embarking on their P3 journey have a number of factors that need to be examined with respect to risk allocation between the Project Co and the Authority. Insurance is one area that needs to be carefully examined to determine where the insurance program best sits.
Types of Insurance Programs
There are two main approaches to insuring a P3 project – insuring through the Authority (an Owner-Controlled Insurance Program or an “OCIP”) or insuring through the Project Co / Contractor (a Contractor-Controlled Insurance Program or a “CCIP”). There is no one blanket best approach for projects, instead, the pros and cons of each approach should be examined on each project to determine where the risk allocation appropriately sits.
Insurance programs controlled by the Authority provide the Authority with absolute price certainty as they are in control of the insurance procurement process. This allows them to leverage their existing market relationships and provides a certain amount of transparency into the insurance budget for the Authority. On the flipside smaller Authorities may have no leverage in the insurance market and are not able to capitalize on significant premium savings. In addition, particularly on US projects, the ability to insure Project Co and Contractor on the Authorities policies may be an impossible task. Finally, the main disadvantage to utilizing an OCIP is that it does not fit into the typical risk allocation of a P3 whereby the project risks and downloaded to Project Co.
Insurance programs controlled by Project Co or the Contractor are far more frequent and are typically the preferred method for Project Co. The main reason for this is that they align well with the risk transfer under a P3 program. Furthermore sophisticated Project Cos have large insurance programs that they want to leverage. In addition many Project Cos insured beyond the scope of the insurance requirements of the Project Agreement. If they are required to rely on the Authority placing the insurance program they may not be able to access all the bells and whistles they are looking for on a project without purchasing additional insurance. Finally on US projects the issue of insuring under master liability programs comes into play (where in Canada project specific policies are always placed) which can save the Project hundreds of thousands of dollars on a Project.
With every upside there is a downside and running a CCIP program is not immune to disadvantages. The main downside to an OCIP program is that it can lack the transparency to the Authority, particularly with respect to the premiums. In addition many Project Cos will drop down the insurance during the construction period to the general contractor who may mark-up their insurance premiums, thus adding cost to the Project. Finally, and perhaps most critically sometimes Project Co is unable to insure certain risks in the commercial insurance market at rates acceptable to all stakeholders.
Clearly there is no one perfect answer and each method of insuring needs to be carefully examined for each project. In my opinion the best option is usually to move forward with a CCIP or a hybrid of the two.
A Hybrid? What?
We have identified that there are two traditional approaches to insuring a P3 project and that the preferred method of the majority of Project Cos and Authorities alike is to move forward with a CCIP program whereby Project Co is required to procure or cause to be procured the insurance program.
This approach works well in most instances but what happens if there is a risk that should not be or cannot be allocated to Project Co? The majority of risks can easily be passed down to Project Co but certain natural catastrophe risks such as earthquake and windstorm or a terrorist event must be closely assessed with respect to insurability.
Take Partnerships BC’s approach in Canada to earthquake insurance. British Columbia is Canada’s most at risk province with respect to earthquake. Is earthquake insurance commercially available in BC? The answer is yes and full replacement cost limits are also available. So what’s the problem? Partnerships BC determined early on that the cost to purchase adequate earthquake coverage was inappropriate risk allocation due to the high costs of the insurance. They have therefore retained the earthquake exposure for losses in excess of $5,000,000 under the Project Agreement. This allows the Projects to run smoothly with no potential issues surrounding uninsurability or the commercial unavailability of earthquake insurance in BC.
Projects with major natural catastrophe risk may better have a hybrid program whereby the Authority takes the natural catastrophe risk themselves and leaves Project Co to insurance the rest of the insurance program.
Another major area of concern with respect to US projects is the issue of terrorism. Under Canadian projects terrorism is not required to be insured and is simply treated as a Force Majeure termination event. Under the majority of US projects terrorism is required to be insured both during the Construction Period and the Operating Period. Terrorism insurance is commercially available in the US up to a $2 billion limit but Authorities need to review carefully if the cost to commercially insure this exposure is a correct allocation of the risk.
Where else does a hybrid make sense? Many Authorities have large operational programs whereby the P3 asset may fit very well into. A perfect example would be a university campus, a social housing authority or a state or provincial healthcare program. In these instances there is not an issue with respect to obtaining sufficient policy limits at commercially viable rates but rather the operating program may best sit under the existing blanket policies with respect to the property insurance (and in Canada also the liability insurance). These types of hybrid programs classically prescribe a CCIP program during the Construction Period and then a hybrid of insurance responsibility during the Operating Period.
Choosing the Path Forward
Unfortunately there is no definitive answer to how to correctly insure a P3 project. Many factors come into play such as the risk tolerance of the Authority, the size, leverage and sophistication of the Authority, the specific projects risks (earthquake or windstorm exposed) as well as the risk appetite of Project Co. In order to determine the right path for the project we recommend a logical analysis be taken (see chart).
This process should be taken by the Authority early on in the P3 process in consultation with their internal risk management departments as well as with outside risk and project advisors who are specialized in P3 projects since P3 projects are unique in their risk allocation. Striking the fine balance between Authority risk and Project Co risk is a no simple task. It is, however extremely important to find the correct risk allocation to allow for a successful P3 partnership throughout construction and for the 30 year operating term that follows.
President B.A. Hons, CRM, MBA
Global Practice Leader – PPP and Project Finance