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Infrastructure: Risks and Opportunities

One of President Trump’s stated goals is to initiate significant investment in U.S. infrastructure — bridges, roads, airports, seaports, pipelines, fiber optic cables and water projects. As with any major spending measure — and the most common number being tossed around for this one is $1 trillion — there will be political hurdles. However, the U.S. House of Representatives Transportation and Infrastructure Committee just launched its #building21 campaign effort to promote its vision for 21st Century American infrastructure, calling for significant investment.

Infrastructure spending of such magnitude will bring many opportunities for construction and infrastructure companies. Organizations need to be strategically positioned to capitalize on the opportunity, well-prepared to engage in the heightened competition facing the industry and flexible enough to absorb an increasing level of risk.

Infrastructure Plans

In December 2015, Congress passed and President Obama signed the Fixing America’s Surface Transportation Act (the FAST Act), which increased the collection of gasoline taxes to pay for transportation infrastructure projects. The FAST Act authorized $305 billion for highway and motor vehicle safety, public transportation, motor carrier safety, hazardous materials safety, rail and research, technology and statistics programs. Although FAST Act funds are to be allocated to rehabilitate the country’s transportation network, there remains a significant infrastructure deficit in the country.

During his campaign, Trump called for $1 trillion in infrastructure investment in transportation, telecommunications, water, power and energy. Before his inauguration, Trump’s transition team circulated a list of 50 priority emergency and national security projects. Since then, Trump has given every indication that he plans to continue pushing to enhance infrastructure. For example, on Jan. 25, he signed an executive action related to one of the more controversial project proposals, a wall along the U.S.-Mexican border that many experts suggest would cost $15 billion to $25 billion.

See also: Insurtech Investment to Flourish in 2017  

Against the same funding challenges the Obama administration faced, Trump’s plan calls for much of the infrastructure investment to be driven by the private sector through a series of tax credits and private funding as a means to encourage infrastructure investment in a revenue-neutral fashion. Trump’s plan also calls for the relaxation of various regulations to accelerate project delivery times and reduce cost.

Challenges and Headwinds

Most Democrats and Republicans agree on the need to improve this country’s infrastructure. A key difference, however, is how to pay for the upgrades.

On Jan. 24, Senate Minority Leader Charles Schumer introduced a $1 trillion infrastructure plan that relies heavily on direct government funding rather than on tax credits and private investment. Democrats generally argue that, although tax breaks may encourage investment, they will not necessarily bring about those infrastructure projects that are most needed, because the underlying economics may not make such projects profitable.

Despite these political differences, it is likely that some form of Trump’s plan will secure support as infrastructure renewal is a common interest. If an infrastructure spending bill is passed by Congress, organizations in the construction and infrastructure industries will be affected in a number of ways, including:

  • Increased competition: With an economic slowdown in some areas of the world and with increasing volatility, a large inflow of foreign capital will likely occur as international contractors seek opportunities to invest in and build U.S. infrastructure projects. Consolidation of market share in the sector is also likely.
  • Talent and labor shortage: Already facing a shortage of skilled professionals, the construction industry will need to compete with other industries to attract and retain talent.
  • Private investment: Regardless of which infrastructure plan takes hold, public-private partnerships will be a pivotal model to deliver infrastructure in the immediate future. Consider that more than 30 states have enabling legislation in place and are poised to act immediately on already-identified projects.
  • Increased risk: We are witnessing an ever-increasing trend of infrastructure projects being delivered through complex delivery methods, including design-build; design, build, operate and maintain; and integrated delivery. All such contracts result in increased risk being assumed by contractors. With competition expected to heat up, contractors will be expected to have greater risk-bearing capacity. Another consideration is that infrastructure and construction companies are increasingly tied to the “Internet of Things” through operational technology, electronics, software and network connections; this brings significant cyber exposures. And infrastructure itself is increasingly a target of cyber criminals.
  • Risk financing: Insurers and others continue to develop new risk consulting and risk transfer products and services. Not only do insurers absorb performance and hazard risks associated with infrastructure development, they are increasingly becoming infrastructure investors, as well. It remains to be seen how this level of infrastructure exposure will lead to new products and services or new alternative risk structures.

See also: New Wellness Scam: Value on Investment  

The American Society of Civil Engineers (ASCE) estimates that the U.S. will face a $1.6 trillion infrastructure deficit in 2020. Although it is too early to know exactly how the new Congress and the Trump administration will proceed, we believe it’s safe to expect that infrastructure and development will be a hot topic this year and for many to come. If you’re not doing so already, now is the time to discuss with your advisers the risk and insurance considerations at the advent of a likely major U.S. infrastructure investment initiative.

infrastructure

New Approach to Risk and Infrastructure?

Globally, the World Economic Forum estimates that the planet is under-investing in infrastructure by as much as $1 trillion a year. Since 1990, for example, the global road network has expanded by 88%, but demand has increased by 218%.

With the global population continuing to grow – and urban populations, in particular – the pressure on existing infrastructure is only set to worsen. And in the developed world, that infrastructure is creaking: In the U.K., 11 coal-fired power stations are nearing 50 years old, the end of their operational lives, and replacements have yet to be built; in the U.S., the average age of the country’s 84,000 dams is 52 years old; in Germany, a third of all rail bridges are more than 100 years old; parts of London’s Underground rail system, still in daily use by hundreds of thousands of commuters, run through tunnels that are more than 150 years old.

According to the Report Card on America’s Infrastructure by the American Society of Civil Engineers (ASCE), the U.S. alone will need $3.6 trillion of infrastructure investment by 2020.  The report assigned near-failing grades to inland waterways and levees, and poor marks for the state of drinking water, dams, schools, road and hazardous waste infrastructure.

Europe’s infrastructure is in worse shape. The Royal Institute of International Affairs has suggested that the continent needs $16 trillion of infrastructure investment by 2030, more than any other region in a world.

Taxing Issues, Tragic Consequences

While taxes once covered the cost of building and maintaining public infrastructure, entitlement programs such as Social Security and healthcare have started to claim a larger share of these funds as a percentage of government tax revenue, particularly as the number of people in retirement has expanded.

In addition, as the cost of social programs grew, governments came under pressure to cut taxes, leaving even less money available to maintain existing infrastructure, let alone invest in the requirements of growing populations. “Too often infrastructure is seen only through the lens of cost, expenditure and not as core to society’s prosperity”, says Geoffrey Heekin, executive vice president and managing director, global construction and infrastructure, Aon Risk Solutions.

“Since the 1950s, investment in infrastructure in developed countries has been declining,” he says. “In the U.S., for example, investment as a percentage of GDP has fallen from around 5% to 6% in the 1950s to around 2% today.”

Tragically, train derailments, road closures, water main breaks and even bridge collapses have become commonplace. “Until situations like the water crisis in Flint or a bridge collapse happens, infrastructure does not hold proper weighting in the psyche of leaders in government,” Heekin says.

This lack of attention to infrastructure is costing developed economies billions of dollars in lost productivity, jobs and competitiveness. Without addressing the infrastructure investment gap, the U.S. economy alone could lose $3.1 trillion in GDP by 2020, according to the ASCE, while one estimate attributes 14,000 U.S. highway deaths a year to poorly maintained road infrastructure.

A Private Sector Solution to Public Sector Under-Investment?

To begin reversing the infrastructure gap, it is likely that governments will need to find ways to encourage private sector investment toward replacing, renewing and upgrading physical infrastructure.

Governments of all political stripes are increasingly supportive of private investment in infrastructure. One model that is now gaining attention is the Public Private Partnership (P3) model.

P3s in one form or another have been used successfully in developed countries for several decades. They are being used to procure everything from public healthcare facilities, schools and courthouses to highways, port facilities and energy infrastructure. While the volume and type of P3 deal can vary widely by country, there continues to be an upward trend for the model’s use by the public sector.

In 2015, for example, Canada procured 36% of its infrastructure with the P3 model. Aon Infrastructure Solutions anticipates that 21 P3 projects will close in Canada in 2016, with a total capital value of US$12.8 billion – the highest value of P3 projects in Canadian history. In the U.S., where adoption of the P3 model is less widespread, 11 projects are expected to close in 2016, with a capital value of US$8.7 billion.

Like traditional design-bid-build procurement, P3 projects involve public authorities’ putting public projects or programs up for competitive tender and selecting a preferred bidder from multiple consortia.

The key difference is that the contractual structure in P3 allows the public authority to transfer a different set of risks to the private party – including (but not always) the financing for the project. The arrangement can allow the private partner that designs, builds and finances construction of the asset to operate and maintain it in return for either a share of the revenue generated by the use of the asset, or a stream of constant payments from the public authority (also called availability payments).

Keeping Focused on the Big Picture

“The public sector benefits from P3 delivery when the model is applied to a project that meets a community need and is procured through a transparent, accountable process,” says Gordon Paul – senior vice president, Aon Risk Solutions and member of Aon Canada’s Construction Services Group executive committee and Aon’s  global PPP Centre of Excellence.

“Public authorities seek ‘value for money’ in a P3 project by looking to the long-term value,” Paul says. This means identifying whether the private sector party is able to design, build, finance, operate and maintain an infrastructure project for a price lower than if the public authority did it on its own over the same period. It’s about the full lifecycle of the project – not just the building costs.

Taking a big picture view is equally important for the private sector party, says Alister Burley, head of construction for Aon Risk Services Australia. He points to the importance of taking a holistic view to P3 projects and investments to enable efficiencies to be built that will carry forward.

If done right, P3 arrangements can be a significant benefit to both the public and private sectors. Public bodies gain a much-needed boost to their infrastructure, often with long-term maintenance included in the deal, reducing the potential negative economic and health consequences of infrastructure failure. And private investors can secure a stable, long-term return through a stake in some of the underlying essentials of our economies.

Whatever route governments take to secure the integrity of our underlying infrastructure, one thing is clear – without a significant increase in infrastructure investment over the coming years, the world’s economy and health could well be put at further risk.