Select Committee on Public Accounts Minutes of Evidence

Examination of Witnesses (Questions 20 - 39)



  20. The Prison Service managed to get a £53 million advantage over a conventional option in the case of Bridgend, which was negotiated at much the same time. Why was it that much more advantageous there, £53 million on a small contract, when Fazakerley was only £1 million?
  (Mr Narey) The prisons are different. It is fair to say that Securicor who developed Bridgend used a rather different design than the build of what is now Altcourse, Fazakerley, which is largely conventional. There are prisons with different purposes; Altcourse holds category A prisoners for example. I accept that at the time there was a very large gulf between the advantage over the public sector but there was still an advantage against the public sector comparator in the Altcourse project.

  21. You do not mind if I say that one looks with a slight suspicion when one finds a contract for £247 million and it so happens that it fine tunes down to the point where you can specify that there is an advantage of just £1 million between going the conventional route and going the PFI route. One is left with a very clear impression that it did not matter what the outcome was. You were going to go this route anyhow. You were going to go PFI. You just did the comparator as a sop to say you had done it.
  (Mr Narey) I do not believe that to be the case, although as you know I was not around.

  22. No-one was, as far as I can gather.
  (Mr Narey) I firmly believe that my predecessor would not have done that. I will offer the view that one of the consequences of the involvement of the private sector in the Prison Service is that it has made the public sector part of the Prison Service considerably more competitive. One of the things I am looking at at the moment is whether or not there is a case for looking more closely at conventional build. Hitherto to the work done by my predecessor and work commissioned by me when I became Director General 20 months ago suggested that we could not compete competitively. That may now be changing, as demonstrated by the fact that on a rather different contract, a contract for the running of Buckley Hall prison, run very successfully by Group 4, in a market test of that prison last year I took that back into the public sector because the public sector bid was both better on quality and more competitive on price.

  23. I suspect many of us here can well understand why you prefer to go the PFI route and I intimated last time that it could give you an escape route from certain national agreements and so on and manpower commitments which we went into in detail at that time. I do not wish to pursue that further because we dealt with it at the time and probably the less said the better on that particular issue. May I come now to the rate of return? It has increased from 16 per cent to 39 per cent, so we are told by NAO. You agreed that. Does that mean, or is it me not understanding these matters, that in that case you have full payback in two and a half years?
  (Mr Herzberg) The 39 per cent is calculated on a nominal amount of capital still in the company. It is £100 or something now. It is not surprising that you get a statistically very high internal rate of return.


  24. One hundred pounds cannot be right.
  (Mr Herzberg) The share capital of the company which is very small, so that is how you get a very high internal rate of return.[1]

Mr Williams

  25. When did it actually come into operation, I have forgotten?
  (Mr Herzberg) In December 1997.

  26. That is virtually it, is it not? That explains it. In two years we have had payback and you now only just have notional capital. So over a period of 25 years you are going to get ten times payback for this contract. Someone is. We are paying ten times payback. Is that not correct?
  (Mr Herzberg) It is correct that the payback is over that period of time.

  27. We could have had ten prisons for this one in that case.
  (Mr Herzberg) That belies the risks which were actually undertaken on the project at the outset. This is private finance. The banks and Group 4 and Carillion put this equity at risk at the outset and it was only at the end of the construction period that we were receiving any monies back at all.

  28. I have been generous to you. I first of all said it was two and a half years to payback and you have already had payback in less than that. That underestimates anyhow because you and Carillion had a premium rate on this. I understand that the 39 per cent does not include your profits on the construction nor does it include the profits which the shareholder businesses stand to make on their trading operations with the prison. Is that correct?
  (Mr Herzberg) That is correct.

  29. This is a bonanza, is it not? You go into business on this one alone and make a profit. This is like coming up with the lottery several times a year just about, is it not? I think we should put you in charge of the lottery.
  (Mr Narey) The reality is that whatever the additional income which Group 4 generated, we have not paid any more money for this. We are paying the price we contracted at the beginning of this contract, less the amount which was returned for refinancing. The cost per prisoner place of this establishment, which I described as being outstanding—

  30. I understand that but are you disagreeing with Mr Herzberg, who has agreed with me, I think, that they have had payback?
  (Mr Narey) No, I am not. It is not for me to disagree. I am just trying to make the point that we have not paid additional monies from the beginning of the contract.

  31. In terms of value for money, looked at from where I am sitting—I am not saying it did not achieve what you intended to achieve, what I am saying is what you achieved has turned out to be a very bad deal as far as the public is concerned and an unbelievably good deal as far as the shareholders are concerned.
  (Mr Narey) How I am trying to respond is that in terms of value for money for prisons in the public sector with which I can compare it, this still provides value for money. I accept entirely that we needed to get the price down and in future DCMF prisons, including one being opened by Group 4 next year, we have a significantly lower contract price.

  32. How significantly? Bear in mind that we are talking about ten times payback here. Is it one tenth?
  (Mr Narey) In terms of cost per prisoner place about 30 per cent.

  Mr Williams: That is not necessarily the appropriate criterion, is it? Perhaps you would let us have a note on that.[2]


  33. Forgive me for asking this question but it is just for clarification because of my poor memory on it. The numbers we are talking about, the internal rates of return, are they pre or post inflation? Are they real?
  (Mr Herzberg) After tax real.

Mr Steinberg

  34. I should like to ask you some questions on risk taking but after the questions Mr Williams has just asked it seems to me that there was very little risk at all, so I am not going to bother asking them. You could not really lose, could you?
  (Mr Herzberg) May I continue the line of the previous discussion? This was the first prison project actually to be built under a private finance initiative, but it was also one of the first PFI projects absolutely. We were uncertain as to whether we could actually complete the construction during the programme we set out. There had never previously been a privately financed prison. We also had all the problems of—

  35. How do you mean you could not guarantee the construction? Whether it is the private sector or the public sector it is the same fellows doing it.
  (Mr Herzberg) There was still a very demanding programme, two and a half years. Prisons, hospitals, five ten years ago were taking double that length of time. We have halved the period of time under the private finance initiative as a result of the adverse incentives which are actually on us, the liquidated damages etcetera which are imposed upon us by the banks if we fail to complete on time. Just dealing with this risk point, it was extremely difficult at the outset to finance both prisons and hospitals because a number of banks talked about the reputational risk, the political risk, they would not do it. Indeed on this particular project we were actually turned down by the Chief Credit Officer of one of the clearing banks after we had been speaking to them for some time. We could not actually persuade the other clearing banks to get involved in the first place.

  36. I hear what you are saying but basically what you are telling me is irrelevant. The fact of the matter is that you were quite confident that a PFI scheme was very profitable, you went out of your way to raise the finances. Okay, you had difficulty in raising it but you raised it. The fact of the matter was that the rewards are quite significant and at the end of the day, if you failed, the public sector would have picked it up anyway. So you could not lose, could you?
  (Mr Narey) Risk was certainly there during the construction phase. Risk is still there. Last weekend at Feltham I lost 65 places when there was a mini riot on a wing. I shall lose them for four months. If Altcourse were to lose 65 places for four months, and that could happen, that does happen not infrequently in prisons, it would cost them £1 million in payments which we would not give them, in addition to the rectification costs to put that right.

  37. What happens if they go bust?
  (Mr Narey) If they go bust we get a prison back with a life of about 56 years.

  38. Maybe it would be a good idea if they went bust then.
  (Mr Narey) I do not think so. I am trying to say that the risk is still there now. At the time this prison opened, we had only previously used the private sector in prisons we built ourselves; the history was that those prisons opened with great difficulty. You might remember some of the controversy about both Doncaster and the Wolds. They opened with immense difficulty. There was a significantly reduced confidence relative to today in the private sector being successful in opening prisons and running them calmly.

  39. You have just verified that it is true to say that if they are successful they reap huge rewards, as Mr Williams has actually got out of Mr Herzberg. If they fail, the penalties are minimal and at the end of the day you pick it up anyway or the taxpayer does.
  (Mr Narey) No, we would not pick it up. The penalties are very, very significant. Even for the loss of places on a temporary basis the loss of income for Group 4 is very significant at about £120 per prisoner place per night. There are very significant penalties for Group 4 in potential loss of income if they do not on every single day continue to provide us with the places for which they contracted.

1   Note by Witness: In fact, the cash flow shows full repayment of the subordinated debt, leaving only the share capital of the company, which is very small. Back

2   Note by Witness: See Appendix 1, page 17 (PAC/293). Back

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