Select Committee on Environment, Transport and Regional Affairs Minutes of Evidence

Supplementary Memorandum from the Department of the Environment, Transport and the Regions (EST 98F)

  Main Estimates 1998-99 and Annual Report 1998

  During the course of the Select Committee's hearing on 1 July 1998, Department of the Environment, Transport and the Regions officials undertook to provide the Committee with further information on a number of points raised by Members.


  The Committee asked for information on the comparative lifetime costs of projects undertaken using private finance and public finance options using examples from both Roads and London Underground, and others where available. (Q356 and 358)

Assessing value for money in PFI

  1. The Committee at their meeting on 1 July asked how the Department assesses whether a service procured under the PFI provides good value for money compared with a publicly funded alternative. There are two main factors involved in determining value for money. The first is ensuring that the PFI tendering process is competitive throughout and that the best deal for the public sector is achieved. The second is comparing the costs of achieving the desired outputs via the PFI with the estimated costs of a "traditional" publicly financed approach.

  2. The Committee was interested to know how the Department approaches the second of these factors. This is usually done by the development and use of what has become known as a "Public Sector Comparator" (PSC). It has become standard practice for the public sector body responsible for a PFI procurement to develop a PSC for most PFI procurements. This is to assist in determining whether the lifetime costs of the project to tbe delivered through the PFI are likely to provide good value for money.

Approach to Public Sector Comparators

  3. PSCs are now modelled for most PFI projects. Their particular value is in helping to appraise those projects involving an on-going cost to the public sector, such as, a periodic charge for a particular service—e.g., delivering and maintaining a stretch of road. For PFI projects classified as financially free-standing—in that they involve no public funds but direct charging to "users"—PSCs have tended not to be used because there is not a valid publicly-financed alternative.

  4. A Policy Statement on PSCs and value for money in PFI projects was published by the Treasury in March 1998. The guidance recommends the use of PSCs for appraising most PFI procurement, particularly those structured as "Design Build Finance Operate" (DBFO) contracts for the procurement of services by the public sector. Other privately financed projects, such as those involving some public subsidy but with revenue coming principally from third parties (the users of the service) might require a different form of comparator to assess alternative ways in which the public resources involved might be used. It does not recommend the use of a public comparator for financially free-standing projects.

  5. The Treasury guidance reflects the current views on best practice in the use of PSCs in PFI and the approach followed by this Department The Department has encouraged local authorities to adopt a similar approach when they are appraising the value for money of PFI projects they wish to pursue.

What is a Public Sector Comparator?

  6. A public sector comparator is a benchmark against which value for money in undertaking projects under the PFI can be assessed. The PSCs used by, for example, London Transport are cost estimates for a notional project that has the same scope, outputs and timing as a PFI project. Costs are compared over the whole life of the contract and therefore include the operational/maintenance costs as well as the construction and financing costs. The PSC differs from the PFI project in that it is assumed to be undertaken under a traditional procurement route, resulting in greater risk being retained by the public sector. The costs of retaining these risks are included in the PSC. PSCs are assumed to be financed by the public sector, resulting in a lower cost of finance.

  7. The public sector uses comparators to assess whether the value for money achieved by procuring services under the PFI route, rather than assets under the PSC route, outweigh the additional cost of private finance. The PSC is used to determine whether the PFI is the most appropriate procurement route. In circumstances where there is limited competition in the procurement process, the PSC can also be used to enhance the competition as the bidders will have to demonstrate better value for money than the PSC.

  8. It has been emphasised by the NAO, and reinforced by the Public Accounts Committee, in their reports on the first four DBFO road contracts that PSCs should be used sensibly by the public sector in its decision-making. They should be used as part of the appraisal of value for money and not be seen as a substitute for vigorous competition between bidders. Departments are expected to carry out value for money appraisals in a way which is sufficiently robust to support the decisions made and which avoid spurious accuracy in the use of the comparator.

Examples of PSCs in DETR

  9. The Highways Agency evaluates bids for DBFO road projects against a PSC representing the traditional approach to building and maintaining these roads. The PSC includes a financial assessment of the quantifiable risks transferred to the DBFO contractor such as construction time and cost overruns, ground conditions, latent defects in existing roads etc. The Agency estimates the net present value (NPV) of the payments under DBFO arrangements and compares this with the NPV of the estimated cost of the project procured conventionally. These assessments are discounted to present day values and, for the eight DBFO projects awarded in 1996, Treasury advice was that the rate to be used was 8 per cent real.

  10. The results of the comparison between the PSC and the winning DBFO bid for each of the contracts awarded using an 8 per cent discount rate are as follows:

£ million

ProjectPSC (NPV)DBFO (NPV) Difference

M1-A1344232 112
A1(M)204154 50
A419/A417123112 11
A695762 (5)
M40276182 94
A19177136 41
A50/A5647767 10
A30/A35149148 1

  11. The National Audit Office Comptroller and Auditor General's report into the first four DBFO roads contracts concluded that 6 per cent would have been a more appropriate discount rate to use in appraising these projects and the Public Accounts Committee have endorsed this view. Although decisions on whether or not to proceed with the projects as DBFO projects were based on the comparison using the 8 per cent discount rate the Highways Agency did undertake sensitivity tests to assess the impact of different rates. The following table shows the result of a 6 per cent discount rate.
£ million

ProjectPSC (NPV)DBFO (NPV) Difference

M1-A1372288 84
A1(M)222192 30
A419/A417137140 (3)
A696678 (12)
M40329228 101
A19211171 40
A50/A5649183 8
A30/A35161180 (19)

  12. Since these eight contracts were awarded HM Treasury has reviewed its guidance and the recommended discount rate for appraising road projects has changed to 6 per cent. The effect of this revised advice is that in future bids for any further DBFO contracts will be assessed on the basis of that rate.

  13. London Transport also use PSCs to ensure that value for money is achieved when procuring services using the PFI. LT are close to concluding two PFI deals for "Power" (the renewal of London Underground's high voltage power supply) and "Prestige" (ticketing), and do not wish to disclose the value for money those deals demonstrate over their respective PSCs at this stage. However, in both cases LT expect to achieve value for money compared with the PSC. The PFI deal for Northern Line trains demonstrated better value for money than the PSC by nearly 20 per cent. The project involves private sector investment of about £400 million.


  The Committee asked for a breakdown of the road schemes which had been put on hold, as decided by the Government since 1 May 1997. (Q405)

  14. All the schemes in the Roads Programme inherited by this Government, are being considered in the Roads Review. (A list of those schemes is attached at Annex A). Details of the future of these schemes will be announced shortly when the Roads Review Report is published. Copies of the Report will be made available to the Committee Chairman.

  15. In a few cases where urgent decisions were required, decisions on the future of schemes have already been made following the Accelerated review carried out last July:

    —  the Birmingham Northern Relief Road, A13 DBFO, M66 Denton-Middleton Contract 3, A564 Derby Southern Bypass Contract B, and A2/M2 Cobham to Junction 4 Widening would go ahead;

    —  the M62/M606 Link Roads, M25 J12-15 and the individual schemes contained in the various DBFO schemes which were cancelled (Wessex Link, Cumbria-Bradford, South Midlands and Weald and Downland) would be remitted to the main review for further consideration.

  16. Other problems on the trunk roads network identified in regional consultation are also being considered. Section 278 (developer funded) schemes are not being considered within the review; nor are a small number of small safety schemes.

  The Committee asked what proportion of the money allocated to bridge maintenance in 1998-99 was due to the imminent end of the 40 tonne weight derogation. (Q408)

  17. One hundred and fifty-four million pounds has been allocated for bridge maintenance in 1998-99. This includes both essential and preventative maintenance as well as work on assessing and, where necessary, strengthening bridges in anticipation of the end of the 40 tonne weight derogation. Given that contracts involve various amounts of work in both these areas at the same time, it is not possible to provide a breakdown of the amount allocated purely to cover assessment and strengthening.

  The Committee asked were there any additional costs to contracts incurred on schemes delayed due to the Accelerated Roads Review. (Q409-412)

  18. Three of the DBFO schemes which were cancelled following the Accelerated Review were at tender stage. The Highways Agency has received compensation claims from each tenderer. There are a number of issues to be resolved before final settlements can be made but interim payments totalling £3.2 million had been made by the end of 1997-98. Negotiations are still continuing and it is therefore not yet possible to provide the final figures.


  The Committee asked if the "rurality" factor used to assess the distribution of the Rural Bus Grant was new and distinct from the "sparsity" factor used in the calculation of the SSA, and whether it was felt that the SSA sparsity factor was "sufficiently robust" to be used in this calculation. (Q441)

  19. The definition of "rural population" adopted for distribution of the new rural bus subsidy in England was population in each eligible local authority (country councils and unitary authorities) living outside settlements of 3,000 people or more, as shown by the 1991 census. It was felt that this was a reasonably straightforward and objective measure, based on information that was fairly readily available.

  20. The use of the sparsity factor in the Standard Spending Assessments (SSAs) was considered for the rural bus subsidy. However, the sparsity factor on its own measures density of population rather than absolute numbers. Nor is it a measure of "rurality" as such. Thus on a sparsity basis, the City of London and some other urban areas would have qualified for rural bus grant, and there would have been some difficult judgments in deciding which sparsely populated areas counted as "rural" and which did not. On the other hand, on sparsity alone, some counties with large rural areas, such as Gloucestershire and Hampshire, would have fared less well than under the basis adopted.

  21. The Department understands that the definition of "rural" based on population living outside settlements of over 3,000 people has already been used in the "Right to Acquire" scheme for rural housing association tenants, and in the Village Shop Rate Relief Scheme.

  The Committee asked how many people were involved in the calculation of the SSA. (Q442)

  22. Sixteen DETR staff, including support staff, are currently employed to deal primarily with the formulae by which Standard Spending Assessments and Revenue Support Grant are calculated. In addition, the relevant parts of the formulae are among the responsibilities of staff in the Department for Education and Employment, the Department of Health and the Home Office.


  The Committee asked what was the total cost of the National Bus Company Pension Scheme litigation. (Q451)

  23. Mr Brearley (in answer to question 451) undertook to let the Committee know if the Department had a figure for the total costs of the litigation on the National Bus Company pensions issue.

  24. The litigation on this issue has not yet reached the stage of a hearing by the Courts. It is not possible at this stage to put a figure on the total costs which might be involved since this will depend on future legal developments.


  The Committee asked about the £20 million gross operating loss of London Transport Buses in the current year. How was it made up and what investigation had been undertaken by the Department into the increase? (Q515)

  25. We understand that the Committee has also made enquiries direct to London Transport Buses on this issue and a comprehensive reply has been sent by them.

  26. LTB advised the Department that about £8 million of the £20 million deficit for 1998-99 is attributable to rising tender prices. But there are other factors involved. About £8 million has gone into the higher specification of services—quality improvements, and measures to compensate for the effects of traffic congestion (i.e., increasing the number of buses on a route in order to maintain service frequency). The remaining £4 million is for central services such as increased revenue protection.

  27. LTB are budgeting to the three year gross margin target (-£20 million) which was set by the last administration and is being held to ensure some stability for service planning. The Government has been particularly concerned that progress has not been made towards achieving its service quality targets in the past year and expects some improvement this year. LTB have planned their budget with these objectives in mind.

  28. The Department does not scrutinise the detail of London Transport Buses' commercial tendering activity. However we are satisfied, on the basis of regular liaison with them that the budget is appropriate to the objectives for bus services in London. They have been alerting us, since early 1997 to the upturn in prices. Part of this is due to the risk-averse nature of operators in net cost tendering, and in some instances, to a reduction in competition.

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