Alternative to Government Revenue Guarantees: Dynamic Revenue Insurance Contracts

Abstract

Public private partnerships (PPPs) are arrangements under which the private sector supplies infrastructure assets and services that traditionally have been provided by the public sector. Public authorities may enhance the marketability of PPP projects by offering revenue guarantees. However, government revenue guarantees can pose significant fiscal risks for the issuing government, particularly during economic crises. This paper presents a new type of revenue risk hedging contract, the dynamic (flexible) revenue insurance contract, which can be offered as an alternative to the conventional government guarantees. This new contract gives PPP stakeholders other than the government the opportunity to participate in the revenue risk coverage. Potential revenue risk insurers include international financial institutions, export credit agencies, and private insurance companies. The key feature of these new contracts is that they facilitate the pooling of project revenue insurers by accommodating insurer financial and risk preferences. These contracts are modeled as multiple exercise options and priced by using two different Monte Carlo methods, the multiple exercise boundary method and the multiple least-squares method. Because of its inherent flexibility, the dynamic revenue insurance contract offers risk coverage similar to the conventional revenue guarantee at much lower cost to the government. A numerical example on a build operate transfer toll road project shows the substantial cost reduction sustained by the government.