Germany: Risk allocation and incentive systems in the case of a Private Finance Initiative

Last Updated: 16 December 2004
Article by Ulrich Eder

Not every public sector investment project can be realized as part of a public-private-partnership (PPP). For those projects that cannot be realized in this form alternative forms of financing are available. Nevertheless, the penalties suffered by the public sector partner are normally much greater if it consents to a disadvantageous allocation of the project risks and allows the PPP project to be performed uneconomically. Consequently, an advantageous allocation of risks and the creation of an incentive system are two inseparable key elements when structuring the public-private-partnership to the advantage of the public sector.

Projects realized in Germany to date do not allow any uniform risk structure to be discerned. This is partly due to the fact that the projects themselves differ too greatly and the aims of the public sector are too varied. Consequently, there is only a limited degree of comparability. Moreover, the negotiating power of the public sector and the appreciation of the risks on the part of those acting for the public sector may also vary to a very great extent. At the time of planning and realizing the projects, there is a focus on the benefits of mutual success and an unwillingness to discuss the consequences and remedies of failure. Experience shows that specific risk allocation tends to be based on random considerations than on any form of systematic planning. It is necessary to say that there is no such thing as a generally acknowledged market standard in this area. Instead, it is possible to elaborate an individual risk profile tailored to the circumstances of the specific case.

The involvement of private capital and private expertise in public infrastructure projects is not an automatic guarantee of the economic efficiency of the PPP model. The private partner’s pursuit of profit in the transaction in accordance with the commercial principles can only be an incentive for cost-effective project realization if the public partner does not unilaterally bear the risk of the costs. For this reason, these risks must be structured and shared in such a way that private and public partners benefit equally from cost advantages and optimization. If the private partner has no particular incentive to realize the project better, faster and more cost-effectively than the public partner could do alone, the PPP model will gradually lose its attraction. For this reason, the creation of an incentive system is particularly in the public interest. Experience has shown that, in practice, it is impossible to separate risk allocation and the establishment of this incentive system and this must be regarded as a single structuring task.

The risks of PPP and their distribution between the parties

Construction of a public infrastructure project involves a large number of different types of risks. It makes sense to define and classify the specific risks when they can be, and will be, divided between different parties. Accordingly, public-private-partnership is a matter that necessarily requires careful evaluation of any existing risks.

Advisers and consultants are familiar with different risk classifications. On the one hand, origin-based criteria are defined and a distinction is made between commercial risks, political risks and force majeure. Secondly, there is a phase-related classification of risks during planning, construction and operation. Nevertheless, schemes of this kind are only of limited value to the public partner because it depends on implementation in the individual case. What is required is a multi-dimensional risk matrix geared to the individual measure that also takes account of any conceivable "worst case" scenario. If no proper care is taken to identify the nature, probability, time of occurrence and amount of damages of the conceivable risks, the ability to distribute the risks fairly between the parties is also impaired.

Risk matrix for PPP projects

Risk classes

Risk distribution

Risk assessment

  • Origin-based criteria (commercial risks, political risks, force majeure)
  • Phase-related criteria (planning, construction, operation)
  • Multi-dimensional matrix (type of risk, probability and timing, amount of damages)
  • The extent to which the risk can be influenced or controlled
  • Opportunities/risks – mirror principle
  • Ability to bear damages and insurability
  • Requirement of the individual case taking account of risk costs
  • Distinction between key risks and non-key risks
  • Economical efficiency of risk transfer
  • Risk acceptance and economic efficiency
  • Risk structuring as an incentive to minimize and avoid risks

Various principles can be applied to a possible distribution of risks. The degree to which they can be influenced and controlled can be used as a yardstick. Alternatively, risks can be assigned to the party, which benefits from the opportunities necessarily associated with the specific risk. Another aspect is the question of what party is in the financial position to bear the risk in the event of damages being suffered, and what party is able to insure itself against that risk.

The private partner frequently quotes alleged market standards for specific risk distribution and talks of a typical risk profile. This may – or may not be – true in the individual case. Ultimately, what is customary on the market is no decisive criterion for the public sector. If key risks only arise in the course of PPP projects and the public partner cannot hedge against these risks or devolve them onto the private partner, it may be appropriate for the public sector to dispense with the public-private-partnership. This may be relevant in the individual case with regard to certain insolvency risks.

Assuming that transparent market relations prevail, risks are assumed in return for a fee. For this reason, the public partner "sells" not only the project responsibilities but also the project risks to the private party and pays a certain price for the same. This object of achieving economic efficiency through the agreement is defeated only if the price for acceptance of the risk is too high. For this reason, it will normally be uneconomic to transfer risks that lie within the area of influence and control of the public sector. It will be advantageous, on the other hand, to devolve groups of risks to a private contractor where the occurrence of such risks depends on his own proficiency, his degree of care and his performance capability. This will give him an incentive to prevent the risk occurring. The premium for the risk is an inseparable part of his remuneration. For this reason, there is a direct link between the acceptance of risks and an incentive-based system of remuneration.

The incentive towards economic efficiency

Statistical surveys in industry indicate efficiency advantages of approx. 10 to 25%. Since reports of this kind are normally interest-driven, and it is almost impossible to make a direct comparison with performance of a purely public contract, this does not in itself constitute evidence of the economic efficiency of the involvement of private expertise and capital. The public partner must consider the fact at each phase of the project that it is perfectly entitled, in accordance with established commercial principles, to exploit any scope for negotiation in its own financial interest and not from a public welfare point of view.

If the public partner receives financial advice only from the private investor (a not infrequent occurrence), the incentive system will normally consist of the private company’s "share in the profits" from a fast or cheap performance. More appropriate is a comprehensive form of performance control that rewards a fast, improved and more favorable performance of the contract and also effectively sanctions delays, quality sacrifices and rising costs. The ultimate result must be reconciliation of interests between the private partner’s pursuit of profit and the public partner’s need for economic efficiency, if the PPP project is to be taken to its successful conclusion.

Incentive-based remuneration systems

Description of service

Assessment of performance

Remuneration agreement

  • Standard of performance in terms of type, scope and quality
  • Availability requirements and time frame
  • Balance between functional (output) and substantial specifications (input)
  • Objective measuring system
  • Technical and time-schedule monitoring of performance
  • Duty of verification and transparency
  • Tailored to overall life cycle
  • Profit-sharing if over-achieved (bonus system)
  • Loss-sharing if under-achieved (premium system)
  • Specification of costs as a lump sum
  • Incentive to minimize risks, improve performance, solve problems and innovation

In spite of the peculiarities of each individual case, it is possible to distinguish three elements in proven incentive systems:

  • Starting point is a comprehensive and clear performance description. It defines the standard of performance in terms of type, scope and quality and describes the availability requirements of the contracting authority. The private partner will typically ask for a performance description based, as far as possible, on output, e.g. a functional performance description. The public partner must additionally consider the fact that although even a simple construction will fulfill its primary purpose, urban planning considerations make higher demands on the actual substance of the infrastructure facility, and therefore, also on its acceptance.
  • The equally important second element is an agreement on performance evaluation. This requires an objective measuring procedure that allows technical and time-schedule monitoring of performance. Assessment and measurement mean that the quality and quantity of performance must be clearly verifiable. Transparency is harmful only to the party that does not have it. Performance evaluation agreements frequently suffer in practice from the fact that they are not geared to the entire life cycle and, in particular, do not take adequate account of energy costs.
  • The third element of the incentive system is the agreement on remuneration. It includes a profit share in the event that specifications and expectations are exceeded (bonus system) and a share in losses in the event of failure to meet specifications and expectations (premium system) and the stipulation of costs in the form of a lump sum to simplify matters and reduce bureaucracy. The remuneration agreement is frequently not so flexibly structured as to be a genuine incentive towards innovative problem solving. If there is no financial incentive for the private partner to depart from established procedures, that partner will not normally be willing to accept the associated cost risk. This unnecessarily restricts and channels creative potential.

    To ensure that the private partner continues to be given incentives throughout the course of the project, a system of remuneration must not be too rigid at the start of a project and then be executed without any criticism. Instead there is a need for examination and adjustment throughout the entire course of the project that continually reflects and reconciles the conflicting interests of the contractual parties. If the state bows to the persistent pressure exerted by the commercial party, it fails to appreciate that the need for economic efficiency is a dynamic challenge and not a static milestone.

    Risk allocation and incentive system as the key to a successful PPP

    Efficiency advantages, i.e. quality improvements and efficiency gains (quantitative benefits) justify the involvement of private capital and private expertise in the performance and realization of public projects. For this reason, it is in the interests of both parties in the long term for companies to be measured against their own self-made claims and for the competition of ideas and opportunities to be preserved.

    Therefore, independent financial advice obtained by the public partner to achieve an advantageous risk structure and create an incentive-based remuneration system is no barrier to the negotiation of project contracts. Instead it is a necessary corrective to the negotiating restraints and information deficits that have emerged as a consequence of the underlying conditions of public procurement and its traditional financing structure.

    The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Mondaq Advice Centre (MACs)
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.