Select Committee on Health Appendices to the Minutes of Evidence

Appendix 1


  Much of the controversy over the Private Finance Initiative (PFI), particularly in the NHS, has arisen because of the high costs, which then translate into major service reductions and distortions in planning and accountability. The government's standard response to these public concerns is that the increased costs of the PFI are offset by two things: private sector efficiencies which generate better value for money than the public sector alternative; and the transfer of risk from the public to the private sector. But does this really bear out in practice?

  To date, these claims have rested on assertion rather than evidence. With the recent PFI project failures in new IT systems for the Passport Office and Benefits Agency and growing concerns about affordability and value for money in PFI projects for health and education, the Treasury case looks increasingly tenuous.

  In making the case for PFI, the government has been relying heavily recently on a report commissioned from Arthur Andersen and Enterprise LSE, Value for Money Drivers in the Private Finance Initiative. Described as "the first broadly based survey of operational PFI projects", it has been widely cited by ministers and others.

  Most of the attention that the report has received relate to two key "findings": first, that PFI is 17 per cent cheaper than conventionally financed public projects; and, second, that 60 per cent of these "savings" derive from risk transfer. These finds have been presented as drawing a line under the debate on PFI and value for money. Given the political use that is being made of the report in the context of the public-private partnership proposals for the London Underground and the mayoral election for London, the analysis deserves closer scrutiny.

  Both claims were made on the basis of an analysis of 29 PFI Full Business Cases (FBCs). Unfortunately, it is impossible to evaluate this analysis satisfactorily since no information is given on the relevant spending departments (eg, the Department of the Environment, Transport and the Regions), the sectors involved (eg local authority or NHS), or even on the project types involved (eg, building, IT). We made two formal requests to the Treasury Taskforce for information about the sampling methods used, the sectors from which the projects came and the identity of the FBCs. These were refused on the grounds that "the report is intended to stand on its own". We will now examine whether it does.

  Turning first to the claim that PFI is 17 per cent cheaper than conventionally financed public projects. It is important to note that Arthur Andersen is not saying that PFI reduces the cost of services by 17 per cent; it is recording the fact that on average PFI was judged to be 17 per cent cheaper than a notional public sector equivalent scheme, the Public Sector Comparator (PSC).

  The economic appraisal methodology used in these comparisons contains at least two disputable components: discounting and the costing of risk transfer. For appraisal purposes, the net present cost of the PFI and the PSC are discounted at a fixed rate (usually 6 per cent real) over a period of up to 60 years. The NPC of publicly financed projects tends to be high because, by accounting convention, capital expenditure is scored in the years in which it takes place, which tend to be the early years.

  PFI payments, on the other hand, spread capital costs over a longer period, so that the application of a discount rate lowers its NPC by a greater amount. The higher the discount rate—and even the Treasury says that the 6 per cent rate is "the top of the range"—the greater the potential advantage to PFI schemes. So PFI projects with considerably higher cash costs can still have lower NPCs than their Public Sector Comparators.

  Furthermore, the 17 per cent figure is questionable as it is an average calculated from all the business cases—the percentage differences between the net present cost of the PFI and the PSC were added up and the average worked out. When the individual projects are analysed, we find that more than half the total savings come from just one project—Project N (the Prime Project to transfer the estate of the Department of Social Security t the private sector). It and two other projects (S and Y) together account for 80 per cent of the putative cost "savings".

  When these projects are taken out, the average difference between PFI and PSC reduces to the considerably less impressive figure of 6 per cent. This margin is small enough to suggest that, for most projects in the report, value for money simply results from the frontloading of the PSC and the level of the discount rate.

  The Public Accounts Committee, in reviewing the first Design-Build-Finance-Operate road schemes in 1997, recommended that a range of discount rates be used in future economic appraisals. It would be helpful if the government were to publish a comparison of NPCs using such a range. This would help establish the extent to which the value-for-money conclusions drawn in this study are dependent on the discount rate used.

  The second main finding of the report—that risk transfer valuations accounted for 60 per cent of forecast cost savings—is equally tendentious. As the report's authors point out, only 17 of the 29 projects examined included data on risk transfer: the 60 per cent figure refers only to these cases. In the remaining cases, which collectively accounted for more than two-thirds of the NPC of all the projects examined, it was impossible to say what part, if any, of the savings were attributable for risk. As with the 17 per cent "savings", the amount of risk transferred was highly sensitive to a small number of projects. One project, project Y, on its own accounted for 80 per cent of the savings ascribed to risk transfer. It is striking that this was the NIRS2 system for handling National Insurance accounts, supplied by Andersen Consulting.

  The project is currently running three years late, and the extra cost to the taxpayer has been put at £53 million, according to the National Audit Office, including £37 million in compensation for wrong payments. Risk transfer is estimated in the report at £8.7 million. Andersen Consulting has paid £4.1 million in compensation—for late delivery—but no further payment will be sought. This project has been the subject of criticism in two reports by the Public Accounts Committee. The moral of this tale is that value-for-money analysis is ex ante: savings identified may not be realised in practice.

  It is impossible to say whether the Passport Agency's IT system, procured under PFI from Siemens Business Services (SBS), was also included in the study (all projects are anonymous but many can be identified from government reports). The cost of that debacle was £12.6 million. But SBS has agreed to pay just £2.45 million of the costs. The real bearers of the risk in this case have been the public: the cost of overhauling the Passport Agency following last summer's chaos has resulted in the price of an adult passport being increased by £7. (The Immigration and Nationality Directorate IT scheme, provided by the same company, is currently running two years behind schedule.)

  The reported "savings" for all 29 projects was £1,062.5 million—but only £214.5 million (20 per cent) of this could safely be attributed to risk transfer, and even that amount was heavily dependent on a small number of projects. The only individual risk identified was construction cost overrun: it accounted for less than 1 per cent of the total savings. In other words, the source for 80 per cent of cost savings could not be identified. These figures are useful indications of how little is actually known about the putative cost savings in the projects under review. They certainly do not support the opinion of project managers surveyed for the report that the main savings were in the risk transferred.

  If we step back from the report's spin, a number of basic facts stand out. First, the study does not substantiate the central claim that PFI shows 17 per cent savings on conventionally financed projects. Secondly, FBCs seem to be a poor source of information about value-for-money drivers. Finally, in view of the absence of key data about the sample, the findings are not generalisable to other PFI projects.

  It is remarkable that, after eight years of PFI procurement, the Arthur Andersen report appears to be the most the government can offer in response to widespread concerns about the initiative. In the real world beyond business cases, it is far from clear that PFI has passed the value-for-money test. It is time the evidence base for the policy was subjected to thorough independent evaluation.

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