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Revenue Risk Sharing for Highway Public-Private Partnership Concessions

December 2016
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The U.S. Government does not endorse products or manufacturers. Trademarks or manufacturers' names appear in this report only because they are considered essential to the objective of the document.

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Technical Report Documentation Page

1. Report No.
2. Government Accession No. 3. Recipient's Catalog No.
4. Title and Subtitle
Revenue Risk Sharing for Highway Public-Private Partnership Concessions: A Discussion Paper
5. Report Date
December 2016
6. Performing Organization Code
Volpe National Transportation Systems Center
7. Author(s)
Sasha Page, Wim Verdouw, Marcel Ham, and John Helwig.
8. Performing Organization Report No.
9. Performing Organization Name And Address
U.S. Department of Transportation
John A. Volpe National Transportation Systems Center
55 Broadway
Cambridge, MA 02142
10. Work Unit No. (TRAIS)
11. Contract or Grant No.
12. Sponsoring Agency Name and Address
Federal Highway Administration
Office of Innovative Program Delivery
1200 New Jersey Avenue, SE
Washington, DC 20590
13. Type of Report and Period Covered
14. Sponsoring Agency Code
15. Supplementary Notes
Contracting Officer's Technical Representative: Patrick DeCorla-Souza, FHWA Office of Innovative Program Delivery
16. Abstract
This discussion paper was developed for transportation professionals who may be involved in a Public-Private Partnership (P3) concession project. P3 concessions are an integrated service delivery approach where a public transportation agency enters a contractual agreement with a private sector entity to deliver a service and/or facility for a specific period. Under the P3 approach, the private sector entity is singly responsible for the design, construction, finance, operations and maintenance of facilities for a specified concession period. During the last decade, several U.S. P3s experienced significant financial stress requiring restructuring. Lately, some private concessionaires have avoided revenue risk P3s, preferring those in which public agencies assume all the revenue risk, typically through availability payments. To ensure robust private participation in U.S. P3s - and explore whether there is a "middle ground" between availability payment and revenue risk toll P3s -this paper seeks to foster a discussion about revenue risk sharing. The discussion paper evaluates revenue risk sharing mechanisms from both the public and private sector perspectives, applying four criteria -- value for money, fiscal impacts, financeability and ease of implementation. The discussion paper was developed based on existing literature, interviews with over 25 P3 market participants, and analysis of cases in the U.S. and internationally.
17. Key Words
Public-private partnerships, highway project delivery, revenue risk, toll concessions, project financing
18. Distribution Statement
This document is available to the public through the National Technical Information Service, Springfield, VA 22161. No restrictions
19. Security Classif. (of this report)
20. Security Classif. (of this page)
21. No. of Pages
22. Price
Form DOT F 1700.7 (8-72) Reproduction of completed page authorized


On July 17, 2014, the Build America Investment Initiative was implemented as a government-wide effort to increase infrastructure investment and economic growth. As part of that effort, the U.S. Department of Transportation (USDOT) established the Build America Transportation Investment Center (BATIC). The BATIC helped public and private project sponsors better understand and utilize public-private partnerships (P3s) and provided assistance to sponsors seeking to navigate the regulatory and credit processes and programs within the Department. In December 2015, the Fixing America's Surface Transportation Act (FAST Act) was enacted, which directed USDOT to establish a National Surface Transportation Infrastructure Finance Bureau, which was renamed the Build America Bureau (the Bureau).

Building upon the work of the BATIC, the Bureau was established in July 2016 as USDOT's go-to organization to help project sponsors who are seeking to use Federal financing tools to develop, finance and deliver transportation infrastructure projects. The Bureau serves as the single point of contact to help navigate the often complex process of project development, identify and secure financing, and obtain technical assistance for project sponsors, including assistance in P3s. The Bureau replaces the BATIC and is now home to DOT's credit programs, including Transportation Infrastructure Finance and Innovation Act (TIFIA), the Railroad Rehabilitation and Improvement Financing (RRIF) and Private Activity Bonds (PAB). The Bureau also houses the newly-established FASTLANE grant program and offers technical expertise in areas such as P3s, transit oriented development and environmental review and permitting. The Bureau is also tasked with streamlining the credit and grant funding processes and providing enhanced technical assistance and encouraging innovative best practices in project planning, financing, P3s, project delivery, and monitoring.

Working through the Bureau, USDOT has made significant progress in its work to assist project sponsors in evaluating the feasibility of P3s, and helping simplify their implementation. In response to requirements under the Moving Ahead for Progress in the 21st Century Act (MAP-21) and the FAST Act to develop best practices and tools for P3s, the Bureau, jointly with FHWA, is publishing this report on U.S. highway P3 concessions.

Executive Summary

I. Introduction

During the past decade, many U.S. highway public-private partnerships (P3s) have experienced financial distress due to lower-than-expected traffic and revenue. The main source of cash flow for tolled highway P3 projects is user fees. Toll revenue is usually the key determinant of whether a P3 project has sufficient liquidity to allow the private concessionaire (Developer) to earn its required return and the debt providers (Lenders) to be repaid. P3 projects that experienced this difficulty and were restructured include the Dulles Greenway (VA), South Bay Expressway (CA), I-495 Capital Beltway (VA), Pocahontas Parkway (VA), and Indiana Toll Road (IN). Most recently, the SH-130 in Texas was reported to be in financial distress and is expected to be restructured.

Due to the uncertainty of traffic and revenue forecasts, the allocation of revenue risk is one of the key decisions in the structuring of a P3 contract. Studies have shown that traffic and revenue forecasts tend to suffer from "optimism bias." Traffic levels are often overestimated due to difficulties associated with predicting economic conditions, demographic trends, or changes in technology. In addition, Developers may have incentives to inflate traffic and revenue forecasts to win a contract award. One of the key decisions in structuring a P3 is which party should bear the traffic and revenue risk - the public agency (Agency) or the Developer.

Although some Developers may be willing to assume traffic and revenue risk, their inability to manage the underlying risk drivers may come at a high cost to Agencies. As confirmed at a roundtable organized by FHWA on the topic of revenue risk sharing, some Developers have become reluctant to bid for P3 projects in which they are expected to assume the traffic and revenue risk. Other Developers, however, continue to bid for such projects, as illustrated by the ongoing development of revenue risk highway P3s across the U.S. Allowing the Developers to bear the traffic and revenue risk, however, may not always deliver the most value for the Agency and society. As part of its bid, a Developer must price the project's risks. As Developers cannot manage many of the underlying drivers of traffic and the revenue stream they generate (such as demographic trends, economic conditions, etc.) they will likely charge a premium for assuming the risk (known as inefficient risk pricing). This, in turn, can result in a higher price or a lower concession fee for the Agency and potentially reduce value for society.

Although some Developers may be willing to assume traffic and revenue risk, often the Agencies absorb this risk with the attendant budgetary liabilities. In availability payment (AP) P3s, Developers receive fixed payments from the Agency as long as the highway meets the contractual conditions. In these P3 contracts, the Agency bears all of the traffic and revenue risk for the project. Many Agencies are unwilling to take on such budgetary liabilities. As a result, many have sought a middle ground between APs and complete revenue risk toll P3s through revenue risk sharing mechanisms.

II. Analytical Framework

The purpose of this Discussion Paper to discuss and evaluate revenue risk sharing mechanisms in P3s. The Federal Highway Administration's (FHWA) Office of Innovative Program Delivery (OIPD) commissioned this Discussion paper (the Discussion Paper) to foster a discussion about revenue risk sharing mechanisms. The Discussion Paper categorizes and evaluates revenue risk sharing mechanisms used internationally and in the U.S. and provides guidance to Agencies in the selection of mechanisms. The Discussion Paper identifies a number of revenue risk sharing mechanisms that could be applied in the U.S. infrastructure market.

The Discussion Paper uses four criteria to evaluate revenue risk sharing mechanisms: 1) value for money (VfM), 2) fiscal impact, 3) financeability, and 4) ease of implementation. VfM assesses the extent to which a revenue risk sharing mechanism allows the Agency to receive (or pay) a fair price for the P3 contract. Ensuring a fair price implies avoiding any risk allocation that requires the Developer to inefficiently (and excessively) price the risk. Fiscal impact refers to the direct and indirect budgetary impacts of a mechanism for the Agency. Financeability evaluates the extent to which a revenue risk sharing mechanism may make it easier to obtain financing for the project. Finally, ease of implementation evaluates the practical challenges associated with implementing a revenue risk sharing mechanism.

The methodology for the Discussion Paper combines a literature review, interviews with P3 practitioners, case studies, and financial analysis. Evaluations of the revenue risk sharing mechanisms are based on an extensive literature review, interviews with over 25 P3 market participants, and an analysis of revenue risk sharing applications in the U.S. and internationally. In addition, a simplified financial model was developed to demonstrate differences between revenue risk sharing mechanisms.

III. Revenue Risk Sharing Mechanisms

The Discussion Paper considers seven different revenue risk sharing mechanisms, each of which have varying impacts in terms of value for money, fiscal impact, financeability, and ease of implementation. These revenue risk sharing mechanisms are summarized in Table 1 and described on the following pages.

Table 1: Summary of Key Benefits of Revenue Risk Sharing Mechanisms for Agency*
Criterion Present Value of Revenues Minimum Revenue Guarantee Contingent Finance Support Availability Payment & Revenue Sharing Shadow Tolls Regulated Returns Innovative Finance Programs
Value for Money ●●● ●●● ●● ●●● ●●
Fiscal Impact ●●● ●● ●● ●●
Financeability ●● ●●● ●●●● ●● ●● ●●● ●●●
Ease of Implementation ●●● ●●●● ●●● ●● ●●● ●●●

Key: Most value or benefits = ●●●● Least value or benefits =
* Benefits are in terms of maximizing value for money, reducing fiscal impact, enhancing financeability, and increasing ease of implementation. Enhancing financeability benefits the Developer, who usually is responsible for the financing, yet it also benefits the Agency, whose interest is also in a successful financing.

a. Present Value of Revenues

The Present Value of Revenues (PVR) mechanism - in which the contract term can be extended to compensate for lower-than-expected revenues - transfers limited revenue risk to the Developer. Under a PVR mechanism, Developers bid a minimum gross revenue discounted at a common discount rate. The P3 contract ends when the net present value (NPV) of the gross revenue is reached. Because the contract term can be extended if revenues fall below expected levels, risk transfer to the Developer is limited - although not zero, as there is typically a maximum contract duration. By allowing the contract term to be extended, and therefore delaying receipt of toll revenues, the Agency retains most of the revenue risk.

The PVR mechanism may be an attractive mechanism for Agencies, as it is relatively easy to implement, has few immediate fiscal impacts, and is likely to deliver VfM. Although the PVR mechanism transfers most of the revenue risk to the Agency, fiscal impacts are limited to the years of contract extension. Because the PVR mechanism provides downside revenue risk protection for Developers - and therefore minimizes excessive risk pricing by the Developer - this mechanism is also likely to provide more VfM than full revenue risk transfer to the Developer. The PVR mechanism is relatively easy to implement, although the uncertain contract term may present challenges for debt financing terms.

b. Minimum Revenue Guarantee

Under a Minimum Revenue Guarantee (MRG), the Agency guarantees revenues below a certain threshold, partially retaining revenue risk. Under a MRG, the Agency sets a base case revenue line and guarantees revenues below this line. Internationally, Agencies have guaranteed 60% to 85% of projected revenues, covering debt service either partially or fully. The extent to which revenue risk is transferred to the Developer depends on the level of revenue guaranteed by the Agency.

Although a MRG is relatively easy to implement and enhances financeability and VfM, it creates uncertain contingent liabilities for the Agency. A MRG is a transparent mechanism that is relatively easy to implement. Because a MRG reduces revenue risk for the Developer, it may enhance financeability and VfM. However, a MRG creates contingent liabilities for the Agency which are difficult to estimate.

c. Contingent Finance Support

Under a Contingent Finance Support (CFS) mechanism, the Agency provides a guarantee on the repayment of financing, rather than on revenue. By guaranteeing that the project will be able to repay debt, even under extreme downside cases, the CFS mechanism is similar to a MRG. Under a CFS mechanism, the Agency retains significant risk, protecting Developers from lower-than-expected revenues or higher-than-expected operational costs which could erode the project's ability to meet its obligations.

Although a CFS mechanism improves financeability, it is sub-optimal from a VfM perspective and creates contingent liabilities for the Agency. A CFS not only protects against revenue shortfalls, but also against operating cost overruns. As a result, it is likely to improve financeability by providing significant protection to Lenders. However, a CFS mechanism is sub-optimal from a VfM perspective, as the Developer is no longer incentivized to minimize lifecycle costs. Like a MRG, a CFS mechanism creates uncertain contingent liabilities for the Agency.

d. Availability Payment and Revenue Sharing

Combining Availability Payments and Revenue Sharing protects the Developer from downside revenue risk while allowing the Agency to earn a share of the revenues. By combining Availability Payments and Revenue Sharing, some of the Developer's toll revenues are exchanged for an AP received from the Agency. By providing an AP regardless of traffic and revenue conditions, the Agency retains a share of the revenue risk. However, by engaging in revenue sharing above a certain threshold, the Agency will also earn a share of toll revenues.

Combining Availability Payments and Revenue Sharing may be attractive from a financeability and VfM perspective, although it may be relatively difficult to implement. Combining an AP with revenue sharing is likely to enhance financeability compared to a full revenue risk transfer, as the Developer is partially protected from downside revenue risk. A mixed AP toll revenue structure could be confusing for Lenders (banks, bondholders, and credit rating agencies), however, since the Developer is compensated through two different payment approaches (AP and toll revenues). This could lead to sub-optimal debt pricing. Although this mechanism is likely to generate VfM, it creates fiscal liabilities for the Agency. In addition, it is relatively challenging to implement.

e. Shadow Toll

In a Shadow Toll mechanism, traffic risk is transferred to the Developer, while toll collection risk is retained by the Agency. In a Shadow Toll approach, the Agency collects the actual toll revenues (if any) and pays a Developer on a per vehicle basis. Because the payments to the Developer depend on traffic levels, the Developer continues to assume traffic risk as under full revenue risk transfer.

A Shadow Toll mechanism is likely to decrease financeability and VfM but could create positive economic externalities. Transferring the full traffic risk to the Developer may result in higher financing costs and lower VfM compared to other mechanisms. However, depending on the exact nature of the road and concession agreement, Shadow Toll mechanisms can be enhanced to increase public welfare by incentivizing the Developer to optimize the number of vehicles on managed toll lanes. Such considerations could provide an economic rationale for using this mechanism. Although a Shadow Toll mechanism requires reliable traffic counting and electronic tolling technology, implementation difficulties are expected to be relatively limited in the U.S. context.

f. Regulated Return

Under a Regulated Return Mechanism (RRM), the Agency guarantees that the Developer will meet its target internal rate of return (IRR), thereby reducing the Developer's exposure to revenue risk. Several adjustment mechanisms can be used to meet the target IRR, including extending the length of the contract, raising toll rates, or providing government subsidies. As a result, the risk retained by the Developer under this mechanism will depend on the rebalancing mechanism that is chosen.

A RRM may be relatively challenging to implement and the VfM and fiscal impacts will depend on the adjustment mechanism used to achieve the target IRR. If a contract extension is used to achieve the required IRR, the RRM will have the same impacts as the PVR mechanism. If a government subsidy is used to achieve the required IRR, the RRM will have direct fiscal impacts. The disadvantage of a RRM is that it may be complex to implement, particularly if the adjustment mechanism is based on net revenues, which will require re-optimizing the Developer's financial model to maintain the target equity IRR. If the Developer is compensated for higher-than-expected O&M costs, a RRM may have high monitoring costs, low VfM, and poor public perception.

g. Innovative Financing

Although Innovative Financing mechanisms may not directly address revenue risk, they may help improve financeability. Innovative Financing mechanisms such as the USDOT's Transportation Infrastructure Finance and Innovation Act (TIFIA) program or state infrastructure banks help ease short-term liquidity by providing low interest rates, long tenors, flexible backloaded repayment terms, and interest capitalization, thereby improving financeability. Although innovative financing mechanisms do not typically pose implementation challenges, they may contradict the P3 philosophy of efficient risk transfer and VfM if they provide protection for overall project risks as opposed to revenue risk specifically.

IV. Conclusions

The PVR and MRG appear to be the most promising revenue risk sharing mechanisms for the U.S. context, due to their relatively positive impacts on VfM, fiscal impact, financeability, and ease of implementation. The MRG, however, is less attractive from a fiscal impact perspective than the PVR, as it creates significant contingent liabilities. For Agencies that are not able to accept such contingent liabilities, a combination of a PVR and a lower MRG could represent a viable alternative. The variables in both of these mechanisms - including the sizing of the MRG and minimum and maximum contract term - allow for considerable tailoring to Agency requirements and the needs of individual projects.

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