The valuation process for long-lived assets learned from the Panama Canal.
In 2014, the Panama Canal Authority (Autoridad del Canal de Panamá, or ACP) embarked on a project to obtain a valuation for the locks, dams, power plants, and other structures of the Panama Canal for insurance purposes. This is the second time the ACP hired an independent company to provide a comprehensive valuation for the canal; the first was in connection with financing the canal’s current expansion project.
At just over 100 years old, the canal is still considered one of the largest and most difficult engineering projects ever undertaken. It extends approximately 50 miles through the Isthmus of Panama from the twin ports of Cristobal-Colón on the Atlantic Ocean side to the port of Balboa (near Panama City) on the Pacific Ocean side. It is a globally significant landmark that benefits from the exponential increase in world trade.
With the completion of the canal’s current expansion project in sight, which includes a doubling of the cargo-carrying capacity for ships traversing the canal, the ACP faced a need to protect its investment from increased insurable exposures. Consider the following:
- Twelve thousand ships navigate the canal each year.
- The expansion will add 12-14 larger vessels per day, or an additional 4,750 ships per year.
- Many of the new vessels will be large container vessels carrying significant cargo.
- Three percent of the world’s maritime commerce already transits the canal.
In addition to the sheer volume of goods transported through the canal, the significant expansion of traffic could lead to more shipping incidents, impeded traffic, and risks of business interruption. And, unfortunately, increased geopolitical risk makes any landmark subject to new security threats that were not part of prior insurance evaluations.
The ACP was interested in procuring appraisal services related to the buildings and major structures of the canal in order to determine their replacement cost new (RCN) for insurance purposes. RCN is the current cost of replacing an asset with a new unit using current materials, standards, designs, and layout, and having the nearest equivalent utility to the asset being replaced.
The challenge lies in the very long-lived nature of the assets being valued. In the past, book value of the canal was used for insurance purposes. Book value includes all associated asset costs and generally is too high for insurance purposes, not to mention that many of these types of assets outlast expectations. Further, standard insurance valuations include only above-ground assets, whereas many of the canal’s assets, such as footings and foundations, are below ground and critical to the canal’s operation and, therefore, are necessary to insure.
Insurance users often look at the original cost of an asset to estimate insurance coverage. However, as years pass, original cost becomes less reflective of the true value of an asset for insurance purposes. This is particularly true when you look at the age of the canal. For proper insurance coverage, the ACP needed an accurate estimate of current replacement cost. Without a true insurance appraisal, the canal could be underinsured.
Making the valuation even more complex is the sheer size of the canal and the diverse areas surrounding it. Most insurance losses tend to be partial, so the valuation included an inventory of all assets by department and location. This facilitates the ACP’s ability to make a claim in case of a loss. For example, on the Atlantic side, there is a greater terrorism exposure. The area close to Colón typically has more problems related to safety in the community, while the Panama City side is relatively safe. In the end, whatever the risk, an individual valuation of each asset supports claims requirements in case of a loss. Typical perils might include political and terror-related hazards; natural disasters; fire; lightning strikes; and marine, vehicle, or other accidents.
The Valuation Process
At first glance, it seems like a truly daunting task to place a supportable value on the canal’s assets. However, the engagement scope and methodology provided a process for the valuation to be based on objective and verifiable criteria.
First, the process began by identifying the significant number of buildings, major structures (including locks, dams, and power plants), and other structures (tie-up stations, docks, bridges, and tanks) to get a sense of the entire scope of the project.
Next, on-site visits were organized and conducted to inspect the assets, interview the ACP engineers familiar with the equipment and systems, and create an inventory of the assets by location and facility along the canal.
The methodology applied in arriving at insurable value conclusions needed to be consistent with the standards and guidelines set forth by the International Valuation Standards Committee, a non-governmental organization of the United Nations that works to promote agreement and understanding of valuation standards. This methodology included a review of the fixed-asset records and prior appraisals; the inspection of assets; discussions with ACP personnel; and other relevant information. A cost approach was selected as the valuation technique to estimate the worth of the assets. This methodology uses the concept of replacement as a value indicator. Under this approach, the value of an asset is based on the current cost of replacing it with a new unit of equivalent utility.
Valuation of Buildings
The ACP provided a schedule for each of the 108 buildings located on its properties. Each building was individually inspected, and photographs were taken to document the observed condition and the type of improvements. Using the ACP’s database, fixed-asset records, architectural plans, and information received from engineering personnel, an RCN estimate was developed for all buildings using this cost approach.
Major building components were priced individually using published construction pricing guides and were compared to the values obtained from all other sources. In-house appraisals and appraisals performed by independent government agencies also were considered in arriving at final RCN value conclusions.
Valuation of Major Structures
The cost approach also was used to determine RCN for the canal’s locks, power plants, dams/spillways, water filtration plants, tie-up stations, docks, bridges, and tanks. The valuation process started with an inspection of the major structures. RCN was estimated by using material and labor cost data obtained through Marshall Valuation Service (Marshall & Swift/Boeckh) and other sources. Local adjustment factors were applied to cost data to reflect regional and local Panamanian construction costs. Information from utility and engineering consultants applicable to the various types of construction also was considered. RCN determined under this method was then compared to construction costs for recently completed dams in other parts of the world.
In addition to the direct pricing method described above, an indirect cost pricing approach also was used. Under this method, RCN was developed by applying cost indices to the original (historical) costs provided in the fixed-asset record. Indices were developed for the various classes of construction assets and equipment based on information from construction databases, fixed-asset records, and ACP engineering personnel.
Undertaking a valuation that considers the scope, complexity, and history of the buildings and structures of a site like the Panama Canal may seem overwhelming. However, through the use of generally accepted valuation principles and careful consideration of multiple data sources and inputs, a supportable cost approach analysis can be developed for insurance purposes.