Surety Bonds and P3s

Surety Bonds and P3s

Public-Private Partnerships (P3s) involve a challenging combination of new relationships and risk transfers for the private sector. While it has significant benefits for its stakeholders, this alternative construction project delivery model is not without risks. A surety company can provide very useful insights to a general contractor in this endeavor.

The American Society of Civil Engineers wrote in a 2016 report on U.S. infrastructure that it will cost more than $10 trillion to repair or replace the country's aging infrastructure by the year 2040. Much of this will be dedicated to expensive, high-profile construction projects. As a result, the use of alternative contractual arrangements—such as P3s—for large and complex infrastructure projects has increased over the last 20+ years.

P3 is a project delivery method that involves an agreement between a private sector partner (often referred to as the developer or concessionaire) and a public owner for the design, funding, construction and frequently the long-term maintenance and operation of an infrastructure project by the private sector partner. Under the P3 delivery method, the public owner transfers to the concessionaire/developer risks that are normally retained by the public owner under a conventional delivery method such as design-build or design-bid-build.

The objective of the P3 is to maximize schedule and cost certainty during the construction phase, while distributing funding of delivery costs over the life of the finished project. A Public-Private Partnership project can be delivered in one of several ways, including design-build-finance and design-build-finance-maintain. Each version offers varying degrees of cooperation between the private and public partners.

Yet, despite the potential cost and schedule benefits that P3s present, the structure and function of these projects present more risk for the private contractor versus traditional projects.

A 2021 study of 224 large infrastructure projects conducted by Travelers Surety found that Public-Private Partnerships performed the worst of the delivery methods studied, with many contractors failing to cover costs let alone earning a reasonable profit. Contributing factors that can lead to poor project performance include underestimating quantities, design liability and lack of necessary experience with the delivery method.

As a result, the P3 should receive the same type of surety guarantees that benefit traditional publicly funded projects. Performance bonds help to ensure that the project is finished. They also protect taxpayer and/or investor monies in case the contractor defaults. Payment bonds protect subcontractors and vendors from payment risk.

Experienced surety underwriters understand the degrees of project risks, and function as advocates for both the contractor and the project. A contractor that has a strong, long-standing relationship with its surety partner(s) benefits from the surety understanding the total scope of the project and financial risks the contractor faces across its existing backlog. With this insight, the contractor can understand the risk level that will need to be handled on a new P3 project.

The earlier, the better for the surety team to get involved on a P3 project, ideally during the RFP phase. At the onset, they can assist a contractor in evaluating the suitable levels of risk to assume. A knowledgeable surety partner can help contractors minimize risks by sharing best practices from past projects from around the country with different procurement agencies.

The surety's prequalification process can help give the owner, project concessionaire, and lenders a high degree of confidence that the contractor has the management structure and financial capital to successfully complete a large and complicated P3 job.

With P3 experience, Sureties can also assist their contractor clients with contract reviews, etc., complementing the contractor’s own legal team to assure that risks are identified, and that the surety bonds are aligned with the requirements of the project.

Many surety companies can also give guidance and insight around contract language that has been accepted by stakeholders on past projects. The surety industry continues to create bond language for P3’s that can further enhance the protection of payment and performance bonds by including provisions such as liquidity components, setting surety response timelines and establishing an expedited claims process.

There is enormous, untapped opportunity for Public-Private Partnerships in the United States, where projects that are suited for P3 delivery, if properly performed, can help to deliver important infrastructure projects in a cost-effective and timely manner. Surety bonds remain a proven, time-tested method of project security for construction projects, especially on P3s with their unique risk transfers for general contractors.

Have more questions about how surety bonds can help a P3 project? Contact TSIB today and speak to one of our Risk Advisors. If you have any other insurance questions regarding your commercial property or corporate policy renewal, reach out to TSIB for a free risk review.

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