With estimated annual revenues of approximately $9.5 billion in 2015, the growing ecological restoration sector is an established industry. Much of this business relies on states and cities to hire restoration contractors through a bid process. Most projects succeed, but not all do, because of environmental variation, extreme weather or failings on the part of the restoration team. When governments issue contracts for such projects, they are responsible for managing their risk; and when such projects involve construction work, risk management standards tend to be high.
But upon closer investigation, there is often a mismatch between the actual project risks and the costly risk reduction approaches required. By requiring expensive risk mitigation approaches—like letters of credit, surety bonds, bid, performance and payment bonds and escrow accounts—governments create higher costs for permittees, higher costs for the public, and limit the number and type of firms that bid on such projects.
One example is the case of wetland mitigation projects, for which the Army Corps of Engineers generally expects permittees to carry expensive financial assurance coverage. While Corps policy technically allows projects to use insurance—a more affordable risk mitigation tool—it is rarely approved. This is likely to limit smaller firms from bidding, which means fewer bids. That drives up project costs for the whole restoration sector.
Some of the commonly used financial assurances for wetland mitigation projects are:
- Letter of Credit: A letter of credit is collateralized with cash, meaning the permittee must set aside extra cash that can’t be used for project costs. It guarantees that cash will be paid to the government in the case the project is not completed.
- Surety Bond/Performance Bond: Similar to the letter of credit. It is a guarantee that the permittee will complete the project. The company issuing the bond will pay the regulating agency in the event the permittee doesn’t finish the project.
- Escrow: The permittee places cash with a third party and that cash is paid to the permit-grantor in the event the project is not completed. This cash is in addition to funds they will use to pay for project completion.
All three of these instruments require cash on hand in excess of the project costs, which means a project contractor will have less money available to bid on or perform additional projects. For example, consider a $1 million restoration project with a $1 million cash in escrow requirement. The restoration business has to have $2 million on hand to pay its workers and subcontractors and to park with the escrow agent. That’s fine for a big firm, but it’s going to push away small businesses. When smaller firms are cut out, the diversity of potential contractors diminishes and minority- and women-owned businesses may be less likely to submit contract bids.
There are opportunities to speed up the pipeline of projects and save taxpayer dollars without affecting taxpayer risk. States and municipalities should consider how they can better match risk mitigation tools to actual project risk with a few changes to procurement policies.
Some solutions include:
- Match risk mitigation products to actual project risk. If the restoration firm is carrying the risk, they should not be required to purchase additional risk mitigation products simply on precedent. For example, in the case of the Klamath River dam removal project the Klamath River Restoration Corporation has proposed an extensive insurance package. Their approach will address all conceivable project risks at a level commensurate with the probability and impact of those risks. A letter of credit approach here would require hundreds of millions in extra cash on hand.
- Develop new procurement policies that allow for innovative delivery of restoration outcomes. One example is a pay-for-performance approach, such as the DC Water stormwater environmental impact bond, which places project risk in the hands of private investors. The regulator only pays for successful project outcomes, thereby reducing their risk.
- Consider creative private financing approaches that rely on funding from private entities that accept project risk and pay for project outcomes, such as in the Forest Resilience Bond for wildfire prevention. Perhaps even mission-aligned charitable foundations could step in as guarantors, partnering to fund surety bonds or other financial assurances during project development and implementation.
- If there is no public risk, don’t make one up. Often restoration work involves no risk to public dollars. Companies own the land on which restoration occurs, have significant experience with zero or low failure rates and public money isn’t spent until progress is documented. Government doesn’t require insurance on automobile construction – they just buy the autos they need. Restoration often works the same way and contract requirements should reflect it – doing so will save everyone a lot of money and time.