House of Commons - Public Accounts

Select Committee on Public Accounts Thirty-Fifth Report

3 THE PFI HOSPITAL MARKET

14. The Department pointed out that recent PFI deals had been affected by high rates of construction cost inflation. Heavy global demand for building materials combined with a relatively large supply of government building projects in the United Kingdom market have contributed to recent construction cost inflation in both the public and private sectors. Since 1998, when the Trust entered into its PFI deal, building cost inflation has been 60%, with inflation on private sector building projects higher than that experienced in the public sector. The Department estimates that, if the Norfolk and Norwich PFI hospital deal were entered into today, construction cost inflation would have increased the construction costs by 64% (Figure 5).[18]

Figure 5: Construction cost inflation

Indicator	Inflation 1998-2005	Source
PFI Hospital building cost inflation
The Department's estimate of the effect that construction cost inflation would have had on the Norfolk & Norwich hospital building costs	64%	The Department (note)
Building cost inflation (public and private sector combined)
Public and private sector building inflation on tenders including PFI	60%	The Royal Institute of Chartered Surveyors (RICS)
Private sector building inflation
Private sector building cost inflation on tenders	65%	RICS
Public Sector Building Inflation
Public sector building cost inflation on tenders including PFI	56%	RICS
Public sector building inflation on tenders excluding PFI	50%
49%	The Department of Trade and Industry NHS Estates
Other Inflation
General building cost inflation relating to contract variations (public and private sectors)	41%	RICS
Maintenance cost inflation	23%	RICS
Retail price inflation	19%	The Retail Prices Index

Note: The Norfolk & Norwich hospital PFI contract in 1998 was based upon building costs per square meter of £1,589. In summer 2005 the Department's information was that the building work for a PFI hospital outside London, comparable to the Norfolk & Norwich hospital, had been priced recently at £2,600 per square metre. That is equivalent to construction cost inflation of 64%.

15. The Department had not fully analysed the pricing of deals in the PFI hospitals market or identified all the lessons from the Trust's handling of this deal. Based on current pricing information from market sources, the Department estimates that construction cost inflation on its PFI deals has been in the range of 57% to 89% between 1998 and 2005. This wide range reflects the different types of PFI hospital buildings procured by the Department. The Department's PFI construction inflation has been higher than the average public sector building inflation during this period of 56%. The Department believes that its costs have been influenced by improvements to patient environment and relatively expensive refurbishments of existing hospitals. It is unclear whether the Department's experience of PFI construction cost inflation has been different from other areas of government as neither the Treasury nor individual departments maintain detailed data on PFI construction cost inflation.[19]

16. The Department collects a range of data to assist its monitoring of its PFI projects. The data includes construction and service price trends from the NHS, financial models relating to its PFI projects and other pricing data from the Treasury. Despite this information, the Department has not fully analysed all the factors which will have affected the pricing of current PFI hospital deals. So it is not possible to judge, for example, whether increased familiarity by the private sector in estimating and managing the costs of PFI projects is leading to lower prices.[20]

17. Additional capacity has been added to a number of PFI hospital projects because of the commitment to reduce waiting list times. Buying more capacity after a contract has been let may enable NHS Trusts to treat more patients but, as the Trust acknowledged, also carries the risk that the contract variations will be expensive. The Trust's PFI contract payments had increased by a fifth (£7.1 million a year) to secure 252 additional beds and other variations. The Trust's bed numbers have increased from 701 to around 950 and it is also providing an expanded range of services. The Trust had taken steps to check that the cost of the variations was in line with the pricing of the original contract.[21]

18. After sharing in refinancing benefits, NHS Trusts with early PFI deals continue to pay a premium on the financing costs compared to current deals. This is because the financing costs on early PFI deals reflected the risks of an immature market and the public sector will only get, at best, 30% of subsequent refinancing gains. By closing this early PFI deal in 1998, the Trust is, therefore, paying a financing premium which helped to establish the PFI hospital market. The benefits of establishing the PFI hospital market have been widely shared among many PFI hospital projects. Around 40 large PFI hospital contracts have now been let and PFI contracts for a further 40 smaller new facilities have also been awarded. The additional financing costs of early PFI deals which helped to establish this PFI market were, however, borne by a relatively small number of NHS Trusts, Norfolk and Norwich being one of nine initial deals which were closed in 1997 and 1998. The Trust has, however, been able to deliver clinical benefits by having early use of the new hospital. The Department also believes that the additional construction costs the Trust would have paid if it had built its new hospital today would balance the lower financing costs that would now be available; but this is a different issue which could not have been anticipated when the Trust entered its PFI contract in 1998.[22]