Select Committee on Health Appendices to the Minutes of Evidence


Supplementary evidence by Professor Allyson Pollock (PS54D)

(15 November 2001, Questions 401-4020)

  I made two claims of fact in the Questions above and in Oral Evidence: first, that PFI involves an open-ended financial commitment (the "open-ended cheque"); and secondly that PFI is an inefficient use of public funds. Here is the evidence. In order not to clutter the text, I have put references footnotes.


  PFI, or for that matter any system for divestiture of public service infrastructure, involves government in an open-ended financial commitment because if a PFI consortium is bankrupted or fails to comply with its contract, the government has to step in to pay the debts it has guaranteed and sustain the essential service. PFI is mainly financed through bank loans that have been secured at relatively low interest rates because of government guarantees. The guarantees require government to repay the banks' loans in the event of bankruptcy or contract termination. But government also retains responsibility for the essential service. Thus, government has a financial commitment in excess of the actual cost of the PFI infrastructure. The commitment is indeterminate and therefore open-ended.1

  Termination liabilities of this type increase when PFI deals are refinanced. The National Audit Office and the Select Committee on Public Accounts have already drawn attention to the way in which refinancing deals have the potential to greatly increase the cost and risks to the public authorities from termination liabilities.2 The refinancing of the Fazakerley PFI prison contract increased the rate of return on the initial investment to shareholders from 16 per cent to 39 per cent throughout the life of the contract. But more critically the restructuring of the debt left the Prison Service exposed to greater financial risk in the event of contract failure, that is, to higher termination liabilities because of extended debt repayments. The committee noted that the Prison Service's refinanced PFI `increased its liabilities by up to £47 million in cash terms'. The NAO concluded: `All PFI deals may therefore be subject to refinancing, the exact details of which will depend on the terms and nature of the project in question.'3 Thus refinancing introduces a further open-ended element to PFI.

  The Public Accounts Committee also noted that refinancing brings new risks to the public sector. It observed that refinancing changes the profile of cash flows so that shareholders returns rise in the short term and `go down sharply in 2012' when operating costs are beginning to rise and the Prison Service's termination liability is at a maximum. The committee notes: `This could give an incentive to FPSL (the private sector) to under-perform so that the Prison Service might have to terminate the contract when it would face the maximum financial risk from doing so and of course have to reprovide the services.'

  Crucially the NAO has shown that only 24 per cent of projects surveyed have taken steps to at least ensure they share from refinancing gains but it is far from clear that projects can protect themselves from the `open ended' and higher costs of termination liabilities due to extending the senior debt.


  PFI costs more than traditional procurement because private sector sources of finance are more expensive than government borrowing and because PFI financing costs not payable under traditional procurement add 25 per cent-35 per cent to construction costs in the hospital sector. The revenue impact of the additional capital costs are substantially above existing NHS capital charges paid by the PFI trust and above the NHS capital charges that would be paid under traditional procurement. We draw your attention to the following reports and articles where the relevant evidence is set out.4 The committee should note that the relatively high cost of PFI is not generally contested.

  Financial advisers have argued that extra costs will add to public sector liabilities unless a PFI deal brings in new third-party payers such as service users.5 Charging has been ruled inappropriate for NHS investment although it is being considered for roads in the form of tolls. Thus the extra costs of PFI investment in the NHS have to be met from within existing public finances.

  There is now a strong body of evidence showing that the higher costs of PFI in the NHS are not justified by risk transfer and that therefore PFI is an inefficient use of public funds. The evidence is as follows:

  Risk transfer calculations are used to justify the higher costs of PFI in value for money (VFM) terms but risk transfer is liable to exaggeration in PFI business cases according to Jon Sussex, associate director of the Office of Health Economics.6 Sussex has argued that exaggeration arises because of trusts' perception that there is no alternative to PFI when public capital is subject to tight cash limits. Trusts are therefore inclined to treat VFM as a hurdle they have to surmount rather than an objective test.

  Termination liabilities (see above) also suggest that risk transfer is unlikely to be as great as often suggested in business cases. Termination liabilities are devices whereby Government guarantees the loans of senior lenders such as banks, thereby securing lower rates of interest and reducing the cost of PFI. But if loans are guaranteed the Government retains the type of contingent liability that is supposed to be transferred to the private sector as risk. We draw your attention to evidence of incorrect identification and valuation of risk transfer in NHS PFI business cases.7

  The higher cost of PFI creates an affordability gap in the NHS that leads to service reductions. This is because, unlike local authorities, NHS trusts do not receive additional revenue to cover higher debt repayment after new investment (although concealed subsidies are sometimes available, for example, in Swindon). The service reductions are greater than those that would occur under traditional procurement because the debts are greater. It is usually maintained by PFI trusts that service reductions are in line with clinical trends in the NHS and are not financially driven. However, this is not borne out by trend data. Service reductions that are against trends in clinical productivity frustrate Government health care objectives. We draw your attention to evidence of financially driven reductions in acute sector capacity as a result of the shift to debt financing and private financing.8

  Thus the system of debt financing operates against NHS objectives of universality based on needs-based planning and is therefore an inefficient instrument for NHS aims. I laid this evidence before you in December 2001.9

May 2002

REFERENCES1 Evidence of open-ended financial commitment can be found in the contract termination provisions of local authority PFI contracts.

A National Audit Office report finds that the Passport Agency incurred extra costs of £12.6 million that were not recoverable from the private contractor following performance failure. National Audit Office. The United Kingdom Passport Agency: the passport delays of summer 1999. HC 812 Session 1998-99 27 October 1999.

See also Public Accounts Committee consideration of the Contributions Agency IT project, NIRS2, and the Government's decision not to seek compensation from Andersen Consulting for delays and errors. Successive bail-outs of Railtrack are good examples of the principle at work.

2 The Select Committee on Public Accounts. Thirteenth report. The refinancing of the Fazakerley PFI prison contract. London: The Stationery Office 2001.

3 National Audit Office. The refinancing of the Fazakerley PFI prison contract. HC 584 Session 1999-2000, 29 June 2000, p.22.

4 David Ulph. Contract theory and the public private partnership proposals for the London Underground railway system. London: The Industrial Society 2000.

The following reports and articles provide evidence of flawed VFM comparison, affordability gaps, and service cuts:

Rowland D, Pollock AM, Price D. The schools governor's essential guide to PFI. London: UNISON, October 2001.

Pollock AM, Shaoul J, Rowland D, Player S. Public services and the private sector: a response to the IPPR Commission. London: Catalyst, November 2001.

Pollock AM, Vickers N. Private pie in the sky. Public Finance, 14 June 2000: 22-4.

Pollock AM. PFI is bad for your health. Public Finance, 6 October 2000: 30-1.

Gaffney D, Pollock AM, Price D, Shaoul J. NHS capital expenditure and the private finance initiative—expansion or contraction? BMJ 1999; 319: 48-51.

Gaffney D, Pollock AM, Price D, Shaoul J. PFI in the NHS—is there an economic case? BMJ 1999; 319: 116-9.

Gaffney D, Pollock AM, Price D, Shaoul J. The politics of the private finance initiative and the new NHS. BMJ 1999; 319: 249-53.

Gaffney D, Shaoul J, Pollock AM, Vickers N. Public services, private finance: affordability, accountability and the two-tier work force. London: UNISON 2001.

Gaffney D, Shaoul J, Pollock AM. Funding London Underground: financial myths and economic realties. London: Listening to London 2000.

Gaffney D, Pollock AM. Downsizing for the 21st century. Second edition. London: UNISON 1999.

Price D, Pollock AM. Debts, deficits and service reductions: Wakefield Health Authority's legacy to primary care trusts. London: UNISON, April 2002.

5 Nigel Middleton. Experience of privatisation in the UK. PwC, 1999.

6 Jon Sussex. The economics of the private finance initiative in the NHS. Office of Health Economics. 2001.

Price D, Gaffney D, Pollock AM. `The only game in town?' A report on the Cumberland Infirmary Carlisle PFI. London: UNISON 1999.

Deloitte & Touche. Transport for London. Public private partnerships. Emerging findings. Report. July 2001.

7 Pollock AM. Evidence to the House of Commons Health Select Committee. Capital investment in the NHS—is it value for money? 14 December 2001.

Price D, Gaffney D, Pollock AM. `The only game in town?' A report on the Cumberland Infirmary Carlisle PFI.

Deloitte & Touche. Transport for London. Public private partnerships. Emerging findings. Report. July 2001.

8 Gaffney D, Pollock AM, Shaoul J. Capital investment and the NHS workforce. House of Commons Health Select Committee. Future staffing requirements, 1999; 3: appendix 52-3.

Pollock AM, Dunnigan MG, Gaffney D, Price D, Shaoul J. Planning the 'new' NHS: downsizing for the 21st century. BMJ 1999; 319: 179-184.

Pollock AM, Price D, Dunnigan MG. Deficits before patients: a report on the Worcester Royal Infirmary PFI and Worcester Hospital reconfiguration. London: HSPRU, 2000.

Pollock AM. Evidence to House of Commons Health Select Committee. Capital investment in the NHS under the 1990 NHS and Community Care Act: the impact of moving from government grant to debt finance in an under-funded system, 10 December 2001.

9 Pollock AM. Evidence to House of Commons Health Select Committee. Capital investment in the NHS under the 1990 NHS and Community Care Act: the impact of moving from government grant to debt finance in an under-funded system, 10 December 2001.

previous page contents

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2002
Prepared 15 May 2002