Traditionally, much of the risk associated with the design and construction of a transportation project is borne by the government. However, public-private partnerships allow for some of the project risk to be borne by the private sector. The goal of project developers should be to allocate risk to the party best able to manage it.
Proper allocation of risk will result in lower overall risk for the project.[94] And lower overall risk will allow the public-private partnership to save costs and accelerate delivery of a project. The key to proper risk allocation is determining which risks are best carried by the public sector and which should be transferred to the private sector.
Risks can be determined and allocated using a myriad of methods. One approach is through the use of performance specifications for warranty and design-build projects. Performance specifications allow the State highway agency to establish desired quality and outcomes and to allocate risk sharing and liability issues between the contractor and the State Highway Agency (SHA).[95] For example, by using a warranty, a State can shift the responsibility and risk for maintaining an acceptable level of pavement quality over a specified period to the contractor.[96] Warranties also lower the owner's risk by providing assurance that the contractor will correct early failures from material or workmanship that may have escaped notice during construction.[97] When private road builders are also responsible for subsequent operations and maintenance, they have incentives to build roadways that are designed to meet the specific demands and characteristics of users.[98] Assigning risk to the appropriate party enhances the ability of the public-private partnership to deliver a project sooner than under the traditional contracting method. Proper allocation of risk allows for acceleration of projects with schedule and budget assurance.[99]
When the public sector builds a project under the traditional design-bid-build approach, the public sector makes all decisions regarding the provision, production, and financing of assets as well as the operation and maintenance of the services.[100] As a result, very little opportunity exists for the private sector to assume project risk. In contrast, a public-private partnership allows the private sector greater control over the design, construction, operation and maintenance of the facility. With this additional control over the facility comes increasing ability to absorb risk. When considering risk and negotiating a risk allocation position, the public sector entity should prefer to contract with a single party which is fully accountable to government for all contracted services.[101] From a government point of view, risk transfer is most effective if there is a 'whole of cycle' contract with a single private party, to give that party the strongest incentive to ensure that the design and construction phases convert into a highly effective operation for delivery of a project.[102]
Regardless of the contracting method a State selects for the construction of a project, there are certain risks that will always remain with the public sector. These include:
∙ Deciding as the collective purchaser of public services, on the level of services that are required, and the public sector resources which are available to pay for them;
∙ Setting and monitoring safety, quality, and performance standards for those services; and
∙ Enforcing those standards and taking action if they are not delivered.[103]
The following matrix (see Figure 3.3) is taken from Professor Mervyn K. Lewis's (University of South Australia , National Australian Bank) paper on "Risk Management in Public-Private Partnerships" and was developed to summarize the allocation of risk for public-sector and private-sector infrastructure investments. It is helpful because it identifies some of the types of risks, sources of the risks, and which party usually bears the risk. It is important to note that the allocation of risk varies from project to project.
Figure 3.3
Risk Matrix for Public-Private Partnerships[104]
Type of Risk | Source of risk | Risk taken by |
Site risks | ||
Site conditions | Ground conditions, supporting structures | Construction contractor |
Site preparation | Site redemption, tenure, pollution/discharge, obtaining permits, community liaison | Operating company / project company |
Pre-existing liability | Government | |
Land use | Native title, cultural heritage | Government |
Technical Risk | Fault in tender specifications | Government |
Contractor design fault | Design contractor | |
Construction Risk | ||
Cost overrun | Inefficient work practices and waste of materials | Construction contractor |
Changes in law, delays in approval, etc. | Project company/investors | |
Delay in completion | Lack of coordination of contractors, failure to obtain standard planning approvals | Construction contractor |
Failure to meet performance criteria | Quality shortfall/defects in construction / commissioning tests failure | Construction contractor/project company |
Operating Risk | ||
Operating cost overrun | Project company request for change in practice | Project company / investors |
Industrial relations, repairs, occupational health and safety, maintenance, other cost | Operator | |
Government change to output Specifications | Government | |
Delays or interruption in operation | Operator fault | Operator |
Government delays in granting or renewing approvals, providing contracted outputs | Government | |
Shortfalls in service quality | Operator fault | Operator |
Project company fault | Project company / investors | |
The proper allocation of risk is sometimes confused with trying to get the other team member (public or private) to assume as much risk as possible. An example of this is third-party tort liability. Some States have tried to get the private sector to assume third party tort liability as part of a public-private partnership road project. Under this scenario, if an accident occurred on a State highway procured under a public-private partnership model, the private sector would be liable if the accident was a result of poor design or workmanship. Yet the State has sovereign immunity and would be shielded from most lawsuits. Transferring the risk of tort liability to the private sector increases the overall risk of the public-private partnership, increasing its cost and providing taxpayers with a less than optimal deal.