Blog Posts

What is the value of off-balance sheet public-private partnerships (PFI)?

15/3/2015

On 5th March 2015, in answer to the following question from Nicholas Soames MP:

To ask Mr Chancellor of the Exchequer, what the value is of off-balance sheet public-private partnerships.

The Chief Secretary to the Treasury, Danny Alexander, provided a written response:

A spreadsheet containing data on all operational PFI projects can be found on the following link. Balance sheet treatments for each project are recorded in columns O, P and Q and the capital value is recorded in column R.

Taking capital value only, and using the spreadsheet cited by the Minister, it is possible to provide monetary answers based on the relevant accounting standards. These are as follows:

The total capital value of all projects is £56.6 billion and data was not provided for projects with a capital value of £12.8 billion. Under UKGAAP, therefore, it is possible that the actual value of off-balance sheet PFI contracts is nearer £45 billion.

The above is calculated (in accordance with the parliamentary answer) on the basis of capital value. Of course, the amount repaid over the terms of these deals includes a basket of services as well as the repayment of capital value and interest.

Total payments for all signed PFI deals amount to £310 billion. In the year 2017-18, alone, the estimated total payments to PFI companies will be £10.6 billion.

Data source: Private Finance Initiative Projects: 2014 summary data (HM Treasury)

Public Accounts Committee - scope to make savings on PFI

3/2/2015

The Public Accounts Committee today published its report on the financial sustainability of the NHS. The report's recommendations included the following regarding PFI:

There is scope to make savings in the amount paid under private finance initiative schemes, which cost the NHS some £1.8 billion a year, as there are some examples where refinancing or buying out existing schemes could provide better value for money in the long run. There are also opportunities to release funds tied up in surplus capital assets that could be used for upfront investment in new models of care. For example, there are some £1.5 billion worth of unused land and premises in London alone.

Further, the Department of Health should:

support evaluation of alternative financing or operating options for costly private finance initiative schemes where there is a clear opportunity for improving value for money

With 26% of all NHS Trusts in deficit, including 80% of Foundation Trusts, this is clearly a pressing matter. Financial pressure is set to increase. As the report concludes:

It is clear that the old ways will no longer work – radical change is required to make the NHS financially sustainable.

The report notes that four of the six trusts with deficits greater than £25million had a PFI scheme, whilst Northumbria, who bought out their PFI scheme with assistance from a Local Authority loan, expect a £21.5m surplus this year.

The DoH reported that whilst buying out PFI contracts was not always appropriate, they were exploring other options such as renegotiating soft services, which make up a large proportion of PFI schemes.

What is still wrong with PF2?

15/1/2015

In 2012 the Treasury issued “A new approach to public private partnerships”, otherwise known as PF2. Whilst an improvement on the original PFI, we believe that PF2 has failed to address some important issues. Here we look at four problem areas that remain in PF2, which continually arise in our work with the Public Sector helping to manage their existing PFI contracts:

1 Use of Advisors
Whilst section 2.2 of the PF2 guidance points to the early appointment of advisors; there is no guidance on the scope of appointments for advisors for the Public Sector. Time and time again we see errors in the operational contracts that are primarily due to the lack of coordination between the legal, technical, financial and insurance advisors’ scope of service. The reality is that a commercial lead should be appointed to oversee the work carried out by these different disciplines to ensure that the awarded contract is fit for purpose.

2 The ability to change the contract
Whilst section 11.2.12 recognises the potential need to change the contract for issues other than Works or Services, unless the standard form explicitly enshrines this right, which it does not, it will remain the subject of continued disputes with the private sector.

3 Persistent Breach
The current guidance (23.2.3) is that minor breaches should be dealt with via performance points, with persistent breach termination rights only being enshrined in the contract if the performance points do not adequately incentivise the private sector to rectify minor breaches. Experience to date has shown that remedies using performance points are treated by the private sector on a purely business case basis. If the performance points are worth a deduction of £1 but the cost of rectification is £10, they will rarely bother to rectify the breaches. As such we believe that it should be mandatory for persistent breach termination rights to be enshrined in the PF2 contract.

4 Due diligence over subcontracts
Section 27 does make a small number of recommendations over the level of due diligence that an Authority should carry out on the subcontracts. In reality this is where any Authority should ensure that a high level of due diligence is carried out. The Authority needs an in depth understanding of a whole range of issues: the way the subcontractors have priced delivery, levels of margins, loss of profit rights for early termination, responsibilities for latent defects, and risk allocation. The list of issues that can fundamentally affect an Authority over the lifetime of the contract is vast and PF2 guidance does not go nearly far enough.

Sell-off

13/1/2015

Peter Bach's independent film, Sell-off, highlights the pressures the NHS is under. Naturally PFI is heavily featured. You can watch the whole thing, below, or visit the Sell-off website.

P2G charitable donation for 2014

12/1/2015

Each year, P2G donate 10% of profits to charity. This is our second year of operations. In our first year we chose the children's medical research charity, Sparks. This year, despite Bruce having his own bike stolen and Russell managing to walk past ranks of Boris bikes every day without even being tempted, our charitable donations were cycling themed.

Cycling has obvious health and environmental benefits. A team of trust staff and private sector partners at University College Hospital London showed that it can also raise money for a good cause. P2G donated £2,000 in sponsoring their “Mallorca 300” cycling fundraiser, which raised a total of £50,000 for Great Ormond Street Hospital.

UCLH-Partners participating in the "Mallorca 300" for GOSH photo: oliver_neilson

Unfortunately, cycling also has its dangers. Every year in the UK 19,000 cyclists are involved in accidents, 3,000 of which result in death or serious injury. Despite these numbers, the data available is poor and policy decisions are often made on the basis of speculation rather than clear evidence. The Royal London Hospital has seen a 400% rise in the number of cyclists killed or injured in recent years.

Serious cycling casualties requiring full trauma team activities at RLH

In response, Barts Charity ran a unique, multi-disciplinary seminar chaired by Jon Snow, with the subsequent launch of its Safe Cycling Appeal. Their flagship project being to compile a database on cycling injuries to address the poor state of information currently available. This new data will be used to monitor and reduce such incidents in the future. Our £14,792 donation has helped the campaign to reach a significant project milestone but much more can be done. Please take a look at the campaign website and donate if you can.

The Royal London Hospital

We're looking for good causes for next year's donation. If you have any suggestions, please let us know by email.

An action plan for health PFIs?

23/10/2014

The subject of PFI came up in parliamentary questions on Tuesday with Jesse Norman asking what steps are being taking to encourage NHS Trusts to manage their PFI costs effectively. There were some interesting answers from Daniel Poulter, Health Minister:

“PFI schemes have had their contracts reviewed for potential cost savings. A major data collection on the results is currently under way.”
DoH would “do all we can to support hospitals to reduce the costs of PFI that have been inflicted upon them”
And “make sure that that specialist advice is available for the NHS”
Hexham “has seen that the way forward is to buy out the PFI and free up more money for front-line patient care. We will support as many more hospitals in doing that as can be achieved”

We look forward to seeing how this develops.

Why aren’t we seeing more PFI savings?

20/10/2014

We know that many PFIs are overly expensive, by which we mean that the financing and delivery of services, to the same facilities and to the same standards, could be achieved for a substantially lower cost over the existing contract term.

We also know that PFI contracts contain variation mechanisms via which the public sector is able to enact changes to the existing arrangements. In short PFI contracts can be changed.

PFIs are expensive + PFIs can be changed = ?

The case for the public sector to pursue savings seems so obvious yet we hear of so few examples. On the latest available data, 566 PFIs have yet to report savings *. Why is this the case? We suggest that there are 5 main reasons.

1 Priorities
Many Authorities have not seen PFI as a priority. Where PFI costs are a small part of the budget, e.g. schools within Local Authorities, other areas have been turned to first when looking for savings.

2 Lack of knowledge
There has long been the perception that PFI contracts cannot be altered. This is a misunderstanding of the nature of the agreements. And there have been few publicised examples of restructuring to spur others on. Where they exist, Authorities are either reluctant to make deals public or are prevented from doing so by confidentiality clauses. Media efforts have, to date, been poorly directed.

3 Expense
Both the identification and delivery of savings requires resources. The variation and amendment of contracts requires lawyers and, often, other advisers. The Authority has to spend money to save money. Even committing to expenditure does not guarantee success and, therefore, the prudent nature of public sector spending can often mitigate against its own interests.

4 Lack of good advice
Where is an Authority to turn when wishing to make savings? Lawyers and accountancy practices are expensive and not traditionally good at operating commercially outside their traditional area of expertise. Management consultants do not have a track record in the area and tend to bolt on PFI to their traditional areas of expertise. Semi-public bodies, such as Local Partnerships, are expensive and have yet to deliver significant savings. It is for this reason that P2G was formed. We identify savings at no risk, and with no commitment, to the public sector.

5 Concern over ‘relationships’
The public sector have often, curiously, acted as the junior partner in PFI. The premise of PFIs, that the private sector provides the monitoring of performance, the facility and ancillary services, whilst the public sector concentrates on the teaching / nursing, means that the most significant involvement of the public sector is in paying the bills. This can lead an Authority to be reluctant to rock the boat, even where self-monitoring is clearly not happening.

There is also an element of fear. The private sector is seen as a well-funded beast with big-name advisors and lawyers on tap. Changes that may lead to reduced private sector returns are likely to be resisted and disputed. Such an action could be met with retaliation, e.g. against late payment by the Authority, or just making future operation more difficult.

The truth is that these are contracts and should be dealt with professionally by both sides.

What can be done?
We believe that each Authority should, as a minimum, understand what savings are possible on each of their PFI contracts, and the risks of pursuing these savings.

P2G is a Social Enterprise that has, so far, helped deliver £297 million in savings to the public sector. No other adviser has this track record. We offer a no risk, commitment-free, service in identifying PFI savings. We are here to help.

* Savings from operational PFI contracts (National Audit Office) November 2013

PFI Code of Conduct revisited

8/8/2014

Two months ago we took a look at who had signed up to HM Treasury’s PFI Code of Conduct and what this might tell us.

As we showed, although the Code has largely been seen as “modest” and “toothless”, it does at least require signatories to engage in a constructive and timely manner to discuss savings and operational efficiencies.

The public sector is under pressure to reduce expenditure, whilst PFI’s provide the private sector with built-in annual RPI increases. This really matters.

When we last looked at this, there had been 159 signatories. This has now risen to 205. The make-up of those signatories has changed little, however.

New signatories have included no further investors, sponsors, or lenders. With the exception of two advisors (including P2G), new signatories are all Public Sector bodies or SPCs (and over 92% of SPCs have still not signed).

Through our work, we are aware of investors and lenders that have refused to sign up. Perhaps, as we suggested on our last visit to the subject, it’s time to name and shame.

How flexible is a PFI contract?

8/7/2014

HM Treasury’s 2013 Code of Conduct for PFI contracts placed commitments on the signatories that are pertinent to the ability of the public sector to make meaningful savings on their existing contracts. These include:

Engage responsively when considering the type and price of variations, waivers, changes or approvals. Not unreasonably refuse to consent to these or make unreasonable charges for such consents.
Engage constructively and in a timely manner when approached by public sector bodies to make savings on a specific PFI/PPP contract or across their portfolio of PFI/PPP contracts, including but not limited to exploring the potential cost savings measures set out in the July 2011 guidance entitled “Making savings in operational PFI contracts”. This approach should be flowed down from senior management to contract managers to support effective engagement.

“Making savings in operational PFI contracts” included a number of recommendations that would necessitate the amendment of the original scope of the project through the variation mechanism contained within the PFI Project Agreement. These include for example, removal of Hard FM and lifecycle risk (para 3.48), removal of Soft FM Services from the scope (para 3.49) and removal of change in law risk (para 3.68).

Every signatory to the Code of Conduct, therefore, must accept that the public sector should be entitled to vary or omit work from a PFI/ PPP contract in order to make savings.

However, even since the introduction of the Code of Conduct, we are seeing a tendency on the part of the private sector (including signatories to the Code of Conduct) to defend the original scope of the Project Agreement in contradiction to this principle.

Variations are an important facet of PFI contracts. The terms of these agreements are typically from 25 to 50 years in length and, given the rate of change in how public services are delivered, flexibility in respect of how and what services are required has always been a key component. To that end, PFI Agreements have detailed drafting contained within them to allow variations to occur.

The first defence that we see the private sector deploying is the principle that variation clauses do not cover a situation where the employer wishes to omit work and give it to others. Put another way, absent clear words in a contract, the right to omit works from the contract does not include the ability to omit work and have it done by someone else. This is not a contract provision of PFI Agreements but a principle of law.

This is the swings-and-roundabouts principle. The legal premise is that a contractor, when pricing the contract, has struck an overall bargain and in doing so recognises that it will gain on some elements and lose on others. Allowing an employer to cherry-pick individual elements to vary and in particular omit from the contract would therefore, in the absence of clear agreement, be unjust as it would deprive the contractor of his bargain.

Where the courts have previously adjudged work to be wrongfully omitted, most often in relation to construction contracts, then they have had to assess the contractor’s loss. Generally, this is the loss of profit on the omitted work.

However, unlike traditional construction contracts in which this principle has been applied, PFI variation provisions keep the contracting counterparty to the public sector, the Special Purpose Company (SPC), whole, i.e. in a no better / no worse position. In such a case there will be no loss on the part of the SPC as a result of the variation.

The contract terms in a PFI arrangement look back to the position that the parties agreed on at the point the contract was signed. Within the Financial Model, there is expressed an Internal Rate of Return (IRR) for the SPC, on which the private sector will bid, and which is measured against the funds they invested. It is this that is protected by the ‘no better/no worse’ provision.

This is fair and reasonable for two reasons. Firstly, all bidding parties were required to openly declare the IRR they expected to receive on the project. Secondly, there was never an expectation, by the public or private sector, that SPCs would make a profit on the underlying provision of services. The profit element on service provision was contained either within the Construction Agreement or the Facilities Management Agreement. This position was also driven by project lenders who did not want SPCs (which, by their very nature, are thinly capitalised companies) taking risk on PFI projects, given that this could lead to loan default.

The private sector agreed to the principle that, when valuing variations, as long as the SPC was left in a no better / no worse position when measured against the Project IRR, they were content and the variation had to be implemented.

Time has moved on. The original shareholders in SPCs have often sold out, at high levels of return, and the new shareholders from the secondary market are attempting to squeeze out as much profit as they can, often in order to justify large fund management fees. In doing so, they have sought to make a return on the underlying service delivery, rather than just on the capital they invested. They are therefore incentivised to fight against the removal of elements of the underlying service delivery, even when the mechanics of the contract leave them in a no better/ no worse position, and where the public sector can perform these services at a lower cost.

The second common defence is to argue that the contract limits variations to the statement of requirement for the services in question and do not extend to, for instance, changes to the price and the payment mechanism. Mechanically, this is because many PFI projects define Variations as a change to the Works or Services and Works and Services are defined in turn by reference to a specific Schedule to the PFI Agreement.

The argument runs that, unless the proposed variation is limited to matters contained within the Schedule that defines the Works or Services, then the changes the public sector are seeking fall outside the scope of the variation procedure.

Were this truly to be the case then no variation would have ever been allowed under PFI Agreements and as such it is, in our view, an extremely narrow interpretation of the contract. PFI Agreements are a complex suite of documents where, for instance, the price and payment mechanism are often contained within a different Schedule of the Agreement to the definition of Works or Services. By their nature, almost all variations will require changes to more than just the statement of requirement, not least because of the financial element of any change.

For instance it is logical that almost every variation to a PFI Agreement will affect the amount the SPC is paid and the basis of that payment. As such it is difficult to envisage any change that could comply with this wholly unrealistic construction. The private sector is basically arguing that, unless they agree, no changes can occur.

The intention of the Variation procedure for PFI contracts was never to restrict Trusts from adding or removing services or obligations from the scope of the Agreement, so long as the public sector did so in a manner that left the SPC in a no better / no worse position with regard to both profitability and risk. Indeed, where Trusts have added scope into PFI contracts, the private sector have never raised such arguments.

To spell it out clearly, the variation mechanism in a PFI contract allows for change and protects the equity return on which the contract was bid. In order to make savings the public sector now needs to enact changes, Rather than fight each change, the private sector, as outlined in the Code of Conduct, should assist knowing that the agreed equity returns are assured.

PFI, the baby, and the bathwater. Why it’s important to take stock of where we are.

10/6/2014

Hexham Hospital is about to go through a voluntary termination. Reportedly, this involves Northumbria NHS Trust paying compensation to the private sector Special Purpose Company (SPC) of £114m. As a result, the Trust will regain ownership and management of the facility in all aspects and save £3.5m per year (£67m over the original life of the PFI contract).

What does this mean?

It means that, for this particular deal, the Trust was able to borrow sufficient funds (in this case from the Local Authority). It means that the cost to the Trust in re-procuring the services to run the hospital for the remaining years of the PFI, together with paying off the private sector for their contractual loss of profit, was £67m less than the cost of continuing to pay the PFI unitary charge.

To put all this in context, according to HM Treasury, the capital cost of the hospital was originally £54.1m.

The Trust Chief Executive called the hospital a “fantastic facility” that could never have been built without PFI. Nevertheless, the PFI was not seen as offering value for money in the current climate. Northumbria NHS Trust are to be congratulated for assessing their options and to have negotiated their way into a significant saving. It has taken them two years to do so.

Is this a model that other NHS Trusts and Local Authorities can follow? Unfortunately not all PFI contracts allow for voluntary termination. In addition, the compensation provisions vary, making termination more or less attractive.

And, crucially, not all PFI contracts are a bad deal for the public sector.

It is true that many PFI contracts have proved expensive, particularly the earlier deals. However, over time, the Treasury refined the standard form of PFI contracts. Mistakes were rectified, the imbalance between amount paid and the risks transferred was addressed.

The later PFI deals were a vast improvement on the earlier incarnations. If we look at later deals, in particular those done in Scotland, PFI was cut down to design, build and maintain. The provision of soft services (cleaning, equipment, catering, portering etc.) was generally outside the PFI. In our desire to rectify the wrongs of early deals we should not be blind to the fact that later deals provided a competitive procurement avenue. We should not throw out the baby with the bathwater.

What should a Trust (or Local Authority) do?

An Authority should be aware of the the difference between the costs of the PFI to the contract term, and the costs of running the facility under self-procurement. An Authority should also assess whether the contract can be terminated, and the amount of compensation payable. If the procurement saving is greater than the compensation payable, then the Authority should seriously consider its options.

Importantly, however, PFI contracts contain variation provisions. This means that the Authority has rights to change the contract. In many cases, significant savings can be made in this way. In assessing value for money, therefore, Authorities need to conduct a full review of their PFI contracts.

PFI contracts are complex and, to date, much of the experience and expertise has sat on the other side of the table. It’s different now. We would urge Authorities to seek expert advice and develop a plan for their PFIs. If value is already being achieved, that’s great. If not, then there is work to be done.