Why Public Private Partnerships Make Sense

Why Public Private Partnerships Make Sense

Consensus on major policy issues is exceedingly rare right now in U.S. politics. Yet both Republicans and Democrats agree that the nation’s infrastructure is in desperate need of repair and that federal funding alone can’t solve the problem.

It’s a predicament familiar to governments around the world: a dauntingly long list of public service projects that need funding and constrained public budgets that force painful choices.

Take infrastructure, for example. 

The McKinsey Global Institute estimates that around $2.5 trillion is spent on infrastructure projects worldwide each year – but that $3.3 trillion is needed annually to meet current needs.

For decades, private companies have been partnering with government agencies around the world to help bridge this public funding gap, transforming compelling proposals into concrete projects. From power plants to ports, roads to railways, these public-private partnerships (PPPs) have helped finance, build and operate a huge number of public assets.

Perhaps the clearest example of the inherent need for infrastructure is China’s Belt and Road Initiative. The Initiative’s central pillar involves infrastructure-driven economic development with the goal of strengthening trade and investment flows between China and markets in Asia, the Middle East, East Africa and Europe. The sheer size and scale of the initiative makes it an ideal candidate for PPPs.

Insurers are well-suited to invest in infrastructure. The extended duration of their liabilities match the lifespan and long-term cash flows generated by infrastructure assets. Yet, due to the capital treatment assigned to the asset class and certain accounting, solvency and rating regimes that do not appropriately recognize the unique characteristics of infrastructure investments, insurers have traditionally been less attracted to investing in this space as they otherwise could be.

The topic of how to foster more investments in infrastructure by insurers and other institutional investors features prominently on the agenda of the G-20 and of other influential international bodies. I recently participated in a World Bank infrastructure investment panel where I discussed the need to address the issue of regulatory disincentives but also to expand the use of PPPs in order to attract insurers’ investments in this space.

At the most recent International Business Leaders Advisory Council (IBLAC), AIG presented a paper to the mayor of Shanghai outlining how PPPs could help inject private sector experience and innovation into a range of public sector projects, from cultural initiatives to infrastructure. The paper drew upon our extensive global experience with the kinds of unique insurance solutions that can help PPPs be more successful. The paper also highlighted the unique position of the insurance industry to help support growth and resilience by utilizing our data and analytical expertise and sharing our risk management know how. To complement the research and recommendations, AIG’s paper also considered a number of ways private sector resources might be able to meet public needs and improve the daily lives of Shanghai’s 24 million residents.

It’s an approach that is gaining momentum worldwide – the total value of PPP-funded projects due to start in 2018 stands at $2.6 trillion, according to the Timetric Construction Intelligence Center Database. That’s an encouraging number, but more PPPs are needed today, as many of those projects will take five, ten, even twenty years before they materialize.

In developing economies, PPPs can be powerful engines of sustainable and economic development, helping bring clean drinking water or electricity to areas that have never enjoyed them before and building roads or repairing impassable ones. These projects help create local jobs, they don’t stretch limited government resources, and they lay the vital infrastructure upon which further growth can be built.

In advanced economies, the need is less dire in some sense, but no less great. McKinsey estimates that by 2020, the cumulative infrastructure needs in the U.S. will total close to $3.5 trillion. According to The Economist, South Africa, Britain and Germany fell short of their necessary infrastructure spending between 2008 and 2013 (and so did India, Indonesia, Mexico and a host of other countries).

And while infrastructure PPPs can seem like simple questions of money and mortar, they require a host of private sector players. AIG, for example, has been working with New York City’s Port Authority on the renovation of LaGuardia Airport. It’s a hugely important project for the city – the airport handled nearly 30 million passengers in 2016 – and also an immensely complicated one. AIG is providing tailored insurance solutions that cover both the construction and operation of the airport during its renovation. In other words, we’re simplifying and strengthening risk management on the project.

As compelling as they sound on paper, PPPs can be challenging to execute in practice. The idea of connecting private sector capital and expertise with public needs sounds simple enough. But so does “buy low, sell high” to the investing community. The devil is in the details. 

Creating a financial structure that politicians, policy makers, regulators, tax payers, bankers, contractors and operators can all agree on is difficult. Managing costs can also be a challenge, given that most governments can often borrow at much lower rates than companies can. Savings on PPPs often have to come through more efficient operations and may take years to materialize. And many PPPs, given their size and complexity, are laden with risk. From project delays to natural disasters, cyber incidents and changes in government to public opposition, there is no shortage of events that can jeopardize these huge projects. Finding a way to manage that risk is critical and requires highly specialized policies and approaches.

One approach that we think could work well for PPPs is called the “availability payments” model. Under this model, the public partner issues periodic and pre-determined payments to the private investor provided the infrastructure in question is available for its intended use and meets performance expectations. The public partner also maintains ownership and control of the project and keeps any revenue that flows from it. This arrangement helps attract private partners who may not be comfortable taking on the operational risks typically associated with these projects.

Understanding public opinion on the most common use cases for PPPs can be crucial to their success. Research by AIG found that attitudes toward PPPs vary across major global cities – adding another layer of complexity to these projects. In Shanghai, Osaka and Seoul, for instance, residents believed PPPs should be used to create employment opportunities. In Atlanta and London, residents believed PPPs should be used to build the infrastructure for utilities. Residents were just as vocal about what PPPs shouldn’t be used for. The kinds of projects that are suitable for a PPP can vary by country, and even by city.

Today, cutting-edge PPPs are going even further than building public works; they’re helping provide for the public good, using data and technology to improve public safety and save lives.

For example, residents of Atlanta identify transportation as a significant area of concern. A partnership between the city of Atlanta and Together for Safer Roads (TSR), a private sector coalition utilizing data from tech startup Zendrive, and whose members include AIG, IBM and AT&T, reduced traffic accidents on one of the most dangerous roads in Georgia – a route that had three times more collisions than a normal road in the state. 

TSR helped determine the cause of the accidents – congestion around local events – and then created a dashboard to track key risk indicators in real time. This dashboard not only reduced accidents, it also helped inform analysis of how the road could be made safer. TSR is looking to scale this approach around the country, and to use data and collaboration to help busy roads become far less dangerous. 

In addition to saving lives today, TSR hints at the possibilities of what PPPs can accomplish tomorrow. Governments have big needs and leading companies have the tools to be able to help. Yes, the challenge of creating, implementing and sustaining PPPs is immense – but so is the power of partnership. 

Manuel Perez

Managing Director en National Standard Finance, LLC ( NSF). More than 25K contacts

5y

Very interesting, thank you Thomas

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Osvaldo Torres

CEO - Principal Consultant Ti-Gestion - FacePhi Official Partner

5y

Globally there are more cash than that we need, currently a big porcentage of this is only moving between in a few hands (in relation to total population) in sofisticated financial market, througth options, derivatives and speculative capital not contribuite to increase the wellfare and solve actual issues. For an instant, thinks if will be possible to develop a world infraestructure market, adecuatelly manged, with transparency, open, without corruption and clear rulers. Additionally that this market provide attractive returns to the people that invest in it. This is a big challenge, there are competent people and good ideas, the world need to work in this kind of solutions, if not we will be down and without future. Underdeveloped and developing countries need more ingraestructura, with this infraestructure, the world will got more income, more people that produce and consume goods and a better future for humanity.

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Thomas I was wondering if you have encountered ppp for providing security technology for facial recognition and motor vehicle licensce recognition to the crime protection agencies.

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Here in Virginia, The Department of Transportation has entered into several Public/Private projects. Some have been successful, providing needed infrastructure elements at reasonable cost to the Commonwealth. However, there is one case demonstrates the pitfalls that can be all too common. Some years ago the VDOT contracted with a private company to build a new crossing of the James River. The route selected provided a shorter and less congested connection between Interstate Routes 95 and 64 east of Richmond. The operator was allowed to toll the facility in order to recover their costs. The alternate route is toll-free. The project has never met its expected return and so the private owner keeps raising the toll. Result: less drivers use the route and revenue falls short. It is a never ending cycle.

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