Select Committee on Public Accounts Minutes of Evidence

Examination of Witnesses (Questions 20-39)



  20. That would sound more impressive if it were not for the other side of the page. If you look at page 10, second column, again in banner headlines which you have signed up to it says that further understanding is required of the returns contractors earn. If you do not actually understand the returns they earn how do you know whether they are giving you good value for money or not? It just reinforces what I have said about the value for money inadequacies.
  (Mr Gershon) I am sorry, I do not agree. Firstly, this does not say that there is no understanding today of what contractors earn. It says there needs to be further understanding, but the critical test of value for money if you run a competition is—

  21. You are misunderstanding me. We have £100 billion already committed and you do not even have any meaningful information to give this Committee on rates of returns for contractors. Let us give you an example we had a little while ago when we were dealing with the prisons in the last Parliament. The contract—was it for Fazakerley, or was it Parc, Sir John?
  (Sir John Bourn) Fazakerley.

  22. The contractor said that they required a 50 per cent premium on their normal rate of return for a prison PFI contract, 50 per cent on top of what they would normally expect with a conventional building contract. That seems somewhat obscene.
  (Mr Gershon) That was a very early prison in a very novel market where for the private sector there would have been very significant risk. As the market matures that risk declines and you would expect therefore the rate of return that a contractor expects to decline. This was against a background that in the history of public sector procurement in areas like prisons there were significant cost and time overruns on which the contractor was being asked to take the risk as it moved across from the public to the private sector.

  23. They were making so much profit on their existing PFI contracts that they were using the profit to invest in new PFI contracts because they were such a good deal. Let us take it a stage further. We at that time also, and this is dealt with here, discovered that they had made significant bonus profit as a result of re-financing. I tabled a question and Sir John and his colleagues very kindly prepared a memorandum based on the questions I tabled to every department. Out of a relatively small proportion of these 400 contracts they found that in only 15 per cent<fu1> was there any understanding to share in re-financing profits. We well understand how they arise. The risk is early on—borrow short and high interest rates at the beginning. When the income flow comes in as you get to the building phase you have got the income flow and you now go to a lower rate of interest and longer term borrowing. That is predictable. It was in some of the early contracts in relation to railways but it was not in the later ones. Where was the monitoring of that? Where was the value for money there? Why did Treasury in its guidance tell departments and authorities that they were not to seek any share in re-financing windfall profits? It is in the report and it was in their guidance. They, you were told, are now re-writing that guidance. Is it re-written yet and what is the outcome?

<fo1>  C&AG's Report, figure 8, p 13. An earlier memorandum, summarising the answers to Parliamentary Questions in July 2000, showed that 24 per cent of 105 PFI contracts listed by departments included arrangements entitling departments to share in refinancing gains: The Refinancing of the Fazakerley PFI Prison Contract, 13th Report from the Committee of Public Accounts (HC 372, Session 2000-01), Appendix 3, para 5.

  (Mr Gershon) If I can clarify the position on that, in 1999 we alerted departments to the issue of re-financing and said it was an issue that they needed to take into account. Last year we issued further guidance to departments on the subject of re-financing. The revision of the Standardisation of PFI Contracts that is currently out for consultation, and which we expect to publish by next March, explicitly steers clients towards a 50-50 share of re-financing gains and approval of all re-financing.

  24. You have got there after all this time. Oh, no, you have not got there because you still have some consultation. We do not know, as it is only out to consultation, that that is what the guidance will state at the end, do we? It is conceivable if you do not get the results you want in the consultation that it may not happen. You have not exactly been expeditious.
  (Mr Gershon) It is also the case that if the OGC is now consulted by departments on the subject of re-financing and for a new contract they get a very clear steer in advance of the revision of standardisation which is 50-50.

  25. There you are. It shows that some of the shouting that government departments get in this Committee does at least achieve something. Let us move to the contractual side. I am in favour of PFI but I want it to work properly. I want it to be a good deal for everyone. I want contractors to get a reasonable rate of profit but I want the taxpayer to get a reasonable deal. I have no objection in principle, unlike some people, to the PFI notion. I want it to work effectively. On risk transfer how much further ahead have we gone since we ran into the nonsenses we had with the Passport Office and so on when they incurred costs of £12.5 million as a result of the failure of Siemens, and that two weeks before a hearing here, they were only able to get Siemens to pay £2.5 million towards the losses? That did not seem much of a risk transfer. The fault was mainly that of the company and its computer system and yet the costs were borne by the department. Are we advanced on that now?
  (Mr Gershon) I think there is a much better understanding amongst public sector clients that there are certain aspects of the risk that cannot be transferred, particularly the ultimate responsibility for delivering a public service. As risk management techniques develop within the public sector—and the understanding that there is a retained risk—that is sharpening up focus as to what sort of risks you can sensibly seek to transfer to the public sector, and those that you have to be mindful to retain in the public sector and that should influence how you select and manage your private sector contractor. I am very mindful of the report that came out recently from this Committee about its hearing on the NAO report on risk management where what you advocated was that in the selection of partners (not just private sector partners but also other partners) clients need to understand and satisfy themselves about the risk management systems in their partners. That is certainly one of the things that we take on board. We do not necessarily use the same language but if you look at the guidelines around the Gateway review process that is one of the things that is tested by these independent reviews. We are also in the process of developing enhanced guidance for accounting officers about seeking value for money in complex procurements, not just PFI but PFI is a good example of a complex procurement, and we have factored in that aspect about looking at risk management systems in that advice. You would say, "Bloody slow; they ought to be doing it faster", but—

  26. In slightly more delicate language that is exactly what I would have said.
  (Mr Gershon) In our pedestrian way we are slowly but surely trying to get to where you would have liked us to be a long time ago.

  Mr Williams: I think you have successfully talked me through my 15 minutes so I give in at this stage.


  27. I am very sorry—I should also have welcomed Mr Peter Ryan; I am sorry, the Head of the Private Finance Policy Unit. As you have not had a chance of saying yet I would like to give you the opportunity now. Do you have any comments?
  (Mr Ryan) Amplifying Mr Gershon's response, there is clear evidence that in certain contracts we are seeing effective risk transfer and there are contracts where a private sector partner, having failed to perform adequately, is suffering significant financial penalty. We are learning. We are not perfect but we are doing better.

Mr Rendel

  28. I want to start on figure 1, page 2, and also figure 36, page 35, which are obviously connected. Mr Gershon, you said earlier that figure 36 on page 35 shows that there is no cause for complacency. Clearly there are a number of areas in a lot of contracts where the evaluation of how good the contract is in terms of value for money has suffered quite a lot even within the first year. That worries me. My first question therefore is, in those cases where the evaluation has fallen were the authorities concerned simply fooled by the contractor into thinking that they had got a better deal than they had?
  (Mr Gershon) No, I do not think they were fooled. I think in some areas common understanding about what was really required by the contract and what each party had to deliver only became apparent after the award of the contract. That could have been a contributing factor.

  29. So the authorities got it wrong, did not set up the contracts properly and as a result suffered?
  (Mr Gershon) Partnering is a bit like marriage. You enter into it with the view of having a long term relationship and sometimes, regretfully, you discover after the marriage ceremony that the person you thought you had married does not quite turn out to be as you had expected. They have bad habits that only come to light after the wedding ceremony.

  Chairman: Or vice versa.

Geraint Davies

  30. Where is Mrs Gershon?
  (Mr Gershon) Do not draw any conclusions whatsoever about the state of my own marriage. It was excellent on the day of contract award and remains excellent.

Mr Rendel

  31. You say they were not fooled but something went wrong clearly. You think that what happened was that the authorities made a mistake, they misunderstood what they were letting themselves in for?
  (Mr Gershon) Or there was lack of mutual understanding about what was really required.

  32. It does not seem to me that it matters much whether the contractors understood or not. The point is that the authorities thought they were getting a good deal; now they do not. It may still be satisfactory but it is certainly a worse deal than they thought they were getting.
  (Mr Gershon) Yes.

  33. Either they were being deliberately fooled or they made a mistake and misunderstood what they were doing.
  (Mr Gershon) Or potentially they selected the wrong partner.

  34. In that case they made a mistake. Selecting the wrong partner seems to me to be a clear case of making a mistake.
  (Mr Gershon) Yes. What do you do then to try to make the relationship work? In one instance in which I had some personal involvement helping the parties come to a revised arrangement to put the relationship on a stronger footing was the PFI contract for the Armed Forces Personnel Administration Agency where, after the contract was awarded, the relationship went through a bad period and it was necessary to reconstruct it to get to a point where the client now believes that it has the potential to start to deliver value for money. If you look at the NAO report it also illustrates RAF Mail which went from excellent to marginal but also records somewhere else in the report that the relationship has been redefined and the early signs following that reconstruction are encouraging.

  35. Let me pass on from that if I may and say that if we again compare figure 1 to figure 36 the apparently successful outcome of PFI in the NAO view seems to depend very heavily on figure 1. In other words, as Mr Williams was saying earlier, you seem content with what is happening because most people seem to think it has gone well but this is after all a fairly subjective view of what was happening.
  (Mr Gershon) I was careful not to express contentment in the answer I gave to the Chairman's questions, Mr Rendel.

  36. You indeed said there was no cause for complacency. Nevertheless it seems that your general view is that on the whole most people feel that these arrangements have been at least satisfactory and yet within one year of their start in 23 per cent of cases the perception of how good the value for money is has deteriorated within the first year.
  (Mr Gershon) I am slightly confused by this reference to the one year. I recognise the 23 per cent but I do not recognise the one year.

  37. I think somewhere in here we were told that most of the ones that are being looked at had been in operation for about a year.
  (Mr Finlay) The contracts had been let for at least a year, so some contracts had been operating for a year, some two years, some three years.
  (Mr Gershon) For example, one of the projects here, which happens to be in my direct area of responsibility, was let in 1996. It was four years.

  38. The point I am making is not whether it was one year, two years or three years but they are still on the whole, because PFI is a fairly new business, at the early end of their existence. Some of them may be halfway through by now. They have been three years of a six-year contract but a lot of them will be a lot longer than that. Some of them, as we know, go right up to 30 years and are right at the beginning of their term. That being the case, and given that apparently the estimation of value for money is falling away, are you confident that at the end of these contracts we will still have more than 50 per cent in the satisfactory or better area?
  (Mr Gershon) As I said, we are taking a number of measures to strengthen client capability. If you take these 100 projects what could be done to improve value for money would be in the areas of looking at the skills involved with people in managing the contract, the partnering, the strength—

  39. Excuse me, Mr Gershon, I do not think you are answering my question. What I want to know is, if you look at figure 1 and you take figure 1, not just at the contract letting which is the light blue and concurrent which is the dark blue, but if you were to take all these at the end of the contract time, would you get a graph which still showed more than 50 per cent in the first three blocks?
  (Mr Gershon) My belief is yes.

previous page contents next page

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

© Parliamentary copyright 2002
Prepared 11 July 2002