Private Finance Initiative - Treasury Contents

Written evidence submitted by the CBI

1.  The CBI is the UK's leading business organisation, speaking for some 240,000 businesses that together employ around a third of the private sector workforce. With offices across the UK as well as representation in Brussels, Washington, Beijing and Delhi the CBI communicates the British business voice around the world.

2.  The CBI welcomes the opportunity to respond to the Treasury Select Committee's inquiry into the Private Finance Initiative (PFI). Infrastructure UK estimates that £200 billion of investment is required over the next five years[33] and, with public finances under pressure, it is of paramount importance that private finance can be leveraged to fund new projects. Failure to secure this investment will lead to degraded infrastructure and ultimately, reduced growth. Government must ensure that a range of different models are available to contracting authorities to enable this. PFI has allowed hundreds of schools, hospitals and housing projects to be delivered in recent years, attracting billions of pounds of private investment in infrastructure. PFI has adapted to meet different requirements; it is important that elements that have worked well in the past are retained in the model as it continues to evolve.

What are the strengths and weaknesses of different public procurement methods?

3.  The overarching objective for public procurement must be to secure value for money from spending, with quality services delivered at low cost. The success of public projects therefore depends on how effective procurement is.[34] Various procurement routes are available to public bodies, relevant for different purposes—no one model will be appropriate for every project. In some cases, conventionally procured projects directly funded by the public sector are appropriate while for other projects, initial funding is provided by the private sector, which takes on this risk and aims to recoup cost on delivery of contractual terms. Rather than following a set procedure from previous procurements, officials must consider which model will deliver the best outcome. Of the various models used to leverage private finance, PFI has been the most common and has been used successfully to deliver a variety of economic and social infrastructure projects.

4.  PFI has enabled a great number of infrastructure projects to be delivered that otherwise would not have been. Between 2000 and 2010 over 500 PFI projects reached financial close and over 120 hospitals were built.[35] The UK's Victorian hospitals and dilapidated school buildings needed investment, and PFI has succeeded in directing funding to projects in a way that conventional procurement has often failed to do. When procured conventionally, political and economic cycles have tended to restrict the availability of funding, delaying or cancelling investment. PFI has allowed local contracting authorities to take control of their budgets and the delivery of assets and enabled them to deliver the improvements valued by local citizens.

5.  Transferring construction risk from the public to the private sector in PFI projects has improved efficiency, with more projects delivered on time and within budget compared with those that have been conventionally procured. An NAO study found that 76% of PFI projects were ready to use by the contractual deadline,[36] whereas traditionally procured projects were delivered late 70% of the time.[37] Projects that are funded directly by government are often subject to an optimism bias, meaning that costs and duration are underestimated. Another study of 39 traditionally procured infrastructure projects found that they overran by an average of 17% and cost 47% more than anticipated.[38] Using PFI, the public sector can transfer risk management functions that are not within its core capabilities and concentrate on strategic policy-making and performance management of its contractors.

6.  Under PFI, the design and delivery elements of the contract are integrated, with the private sector provider responsible for the construction, maintenance and associated service delivery. This creates a strong incentive for rigorous planning at an early stage and ongoing innovation over the course of the project. From the outset, the infrastructure is designed with users in mind and potential problems are identified and overcome. Collaborative planning and knowledge-sharing between the public authority and the private sector partner provides opportunities to agree on specifications that are technically optimal and deliver the services that are needed in the most cost-effective way. The PFI approach obliges contracting authorities to quantify costs over a project's entire lifetime, prioritising maintenance and equipment replacement, which can be neglected under traditional procurement. At the end of the contract, the asset is handed back to the contracting authority in good condition as set by pre-agreed standards. The longer-term approach adopted in PFI projects has made it easier to marry sustainability objectives with those associated with service delivery.

Pembury Hospital—innovative design to meet patients' needs

A new hospital will open in July this year and become fully operational in 2012, consolidating Pembury Hospital and Kent and Sussex Hospital into an improved modern facility on the Pembury site. The 512-bed hospital will be the first in the UK to be constructed with 100% single bedrooms with en-suite facilities.

The layout has been designed to enable patients to look out on surrounding woodland, which has been proven to aid recovery. The National Patient Safety Agency (NPSA) was involved in the design of wards so that patients' comfort and safety needs were taken into account at an early stage.

The hospital's development director Graham Goddard said, "Every room is designed to provide the best patient experience and to be safe."

7.  PFI is often criticised for being too expensive, with the private sector companies involved gaining substantial returns on their investments. In reality, very few projects generate above average returns and there are a number of examples where companies have lost money on projects, even entering into administration as a consequence. PFI contracts are let after a competitive process during which providers have to offer the best price possible if they are to be chosen as the preferred bidder. This choice is made on the basis of the lowest net present value, which ensures that bidders price the optimal mix of capital and operating costs. Any gains that are achieved through refinancing projects following the construction phase are now shared between both partners.

8.  Many PFI projects have proved to be adaptable to changing requirements, showing that with good contract design the model is flexible. PFI designs often include spaces that can be used for a variety of purposes, which means that service resources can be allocated effectively to meet changing demand. When the change is significant enough to warrant amendment to contracts, PFI projects can support these variations—an NAO report finding that 90% of contract managers were either satisfied or very satisfied with changes in these circumstances.[39] The long-term nature of contracts, while delivering the benefits mentioned above, requires commissioners to be aware of the need for future flexibility and build change mechanisms into contracts.

Waste management in Southwark—Flexible PFI benefiting residents and charities

Southwark Council's waste management contract shows how the model can be applied flexibly, and used to help charities provide services for the community.

Since January 2010, Veolia has offered the British Heart Foundation access to all the unwanted furniture and electrical items in the borough that currently goes to the Recycling and Reuse Centre it runs in partnership with Southwark Council. Under the scheme, the British Heart Foundation cherry picks items in good condition or that can be reconditioned and sold on to residents.

All funds made from sales of the furniture and electrical items go towards helping the British Heart Foundation fund research, patient care and life saving equipment.

9.  Elements of the procurement process could be modified to produce better results from major projects including PFIs. For example, competitive dialogue has been the preferred procurement route when contracting for PFI, but it is not always the most appropriate. For less complex projects, or those that are similar to previous ones, more simplified procedures could be followed. In circumstances where the contracting authority is unable to determine the technical means by which to achieve the desired outcome it should engage with potential suppliers to negotiate a solution. However, this is not a substitute for conducting sufficient pre-procurement research. The European Commission's review of the procurement directives is an opportunity for UK Government and business to push for simplified rules that reduce bid costs. For complex procurements to be successful it is essential that project teams have the appropriate skills and experience and are adequately supported by central bodies with strategic oversight.

10.  PFI will not be suitable in every situation and not all PFI contracts are perfectly designed or produce optimal outcomes. The Government can borrow money more cheaply than the private sector so the cost of financing conventionally procured projects can be lower if the process runs smoothly. However, publicly-funded projects have been poor at quantifying risk and specifying required outcomes at an early stage. Conventional capital spending with a limited tender process and simple "lowest price wins" award criteria can be brought to the contract award point quickly. However, without rigorous planning numerous variations are often made during the build period. This can add cost to the project and delay it significantly.

11.  Many methods other than PFI are used in the UK and internationally to leverage private finance to fund infrastructure authorities. Tax Increment Financing (TIF) has been used in North America for more than 50 years, and when used properly it results in net gains for local authorities without any need for additional taxation. The Regulatory Asset Base (RAB) model has been used widely in the regulated utilities sectors and has successfully funded projects in airports, energy and social housing. User-pays models have been used extensively in countries such as Australia to fund economic infrastructure projects. Local Asset-Backed Vehicles (LABVs) allow local authorities to use their assets to attract long-term investment from the private sector to deliver socio-economic development and regeneration. These models provide alternatives to PFI, offering commissioners greater flexibility and driving down the cost of finance. For taxpayers to obtain maximum value for money from infrastructure projects, contracting authorities need to develop a good understanding of these models; when they are appropriate and how to apply them.

If PFI debt had been on-balance sheet rather than off-balance sheet would PFI projects have been used as much? How should PFI deals be accounted for?

12.  The CBI supports measures to improve transparency and accountability in public sector contracts which will allow contracting authorities to make better-informed judgements on the value for money of services. Bringing all PFI projects on-balance sheet was a positive measure that will help to support the long-term viability PPPs. PFIs should be on-balance sheet and the value delivered by a scheme in terms of certainty and risk reduction should not be skewed by its accounting treatment. For simplicity, one set of accounting standards should be applied to PFI projects to standardize reporting requirements and improve business confidence.

13.  Choosing the right procurement route is dependent on having access to reliable data on the relative costs of each option. Contracting authorities should have access to comprehensive databases that allows the PFI model to be compared with conventional approaches on a project-by-project basis. Final decisions must be made on a value-for-money basis, taking into account the public policy goals that are to be achieved.

How far can risk really be transferred from the public to private sector? What kinds of risk are appropriate for transfer?

14.  As noted above, transferring financial risk to the private sector partner has contributed to improved performance during the construction phase, with a larger proportion of projects being delivered on time and within budget. Risk transfer is real. Numerous examples of private sector losses illustrate this. Where such losses were sustained it is clear that without that risk transfer these would have been incurred by the public sector.[40] Risk transfer is equally valuable on successful projects. When it is transferred appropriately risk will be allocated to the party best able to manage it with incentives to ensure that it is less likely to materialise. Transferring risk when it is more appropriate for it to be retained can lead to higher costs and reduced value for money. For example, transferring those that involve a high level of uncertainty or that are low probability but high-impact can reduce value for money.

15.  It is right for contracting authorities to seek optimal value from contracts and that commercial officials explore opportunities to make operational savings. The CBI therefore supports the Treasury's review of operational PFI projects to identify how savings could be achieved through reallocating certain elements of risk. For example, there could be benefit in the public sector taking on insurance risk in some instances. It may be possible to obtain economies of scale by increasing the range of services that are bundled into PFI contracts. In many recent accommodation projects, "soft" facilities management services have been retained in-house which can limit the efficiency of services by creating additional interfaces. It is important that the drive to find efficiencies in operational contracts is approached in a way that does not damage business confidence and future investment in infrastructure.

Are there particular projects which are suited for PFI?

16.  PFI works well when the risks of a project can be identified, quantified and transferred appropriately. Build and service contracts that have been used to provide schools, simple healthcare facilities and housing have been successful. So too have economic infrastructure projects, which have seen roads, railways and airports built and maintained over the long-term. Schemes which introduce complex technology risk, or in which future outcomes cannot be readily forecast may be less appropriate as they will carry a higher risk premium, which will have an impact on overall value-for-money. Schemes with extended construction periods do incur significant costs around the pricing of contingent events and should be considered in detail as to their suitability.

17.  PFI is suitable for large projects, which justify the comprehensive commissioning process that is typical of this model. It is less likely to be appropriate for projects with a capital value under £30 million. However, if a number of similar projects are being commissioned at the same time it may be possible to take a "batching" approach, to ensure there is sufficient scale to warrant the transaction costs of PFI. This will require leadership from central departments, who can identify the opportunities for implementing this approach and coordinate commissioning.

What state guarantees are explicit or implicit in PFI deals?

18.  As PFI projects are principally financed through debt, they must be an attractive investment opportunity to potential lenders. For this to be achieved, it is important that, whatever the position of the agency involved in the transaction, the Treasury will pay the revenue streams required to service the debt. This gives financers confidence in the covenant of contracting authorities, which is crucial when entering into long-term projects.

19.  Properly transferring risk to the private sector requires that there is no implicit or explicit guarantee that it will be "bailed out" if the project encounters difficulties. This allows the contracting authority to shield itself from the majority of costs incurred when projects are delayed. Examples of businesses shouldering this burden are plentiful and companies have even failed as a result of entering into poor PFI deals. Conversely, there are relatively few examples of PFI companies being bailed out by the Treasury and when it has happened it has been because of contractual guarantees, which have limited the extent to which risk has been transferred.

In what circumstances are PFI deals suitable for the delivery of services?

20.  PFI contracts are suitable when efficient and effective services are conditional on good design and maintenance of the asset. For example incorporating highways maintenance and management services with road building contracts has increased innovation in design, reducing costs throughout the operational period. As the Treasury has noted, PFI refreshes services by "breaking the grip of historic or standard public sector design approaches".[41] If the private sector partner is responsible for service delivery, they are incentivised to ensure that the final design will lead to more efficient services over the long term. For example in PFI hospitals, design changes which reduced the distance between wards raised staff productivity. PFI prisons have adopted the use of long, wide corridors, which has enabled CCTV to be used more effectively, improving safety levels for prison staff and inmates.

Birmingham Highways—successful maintenance and management to support the local economy

In 2010, Birmingham City Council (BCC) signed a PFI deal with integrated public service provider Amey to provide maintenance and management services across the city's road network over a 25-year period. This has enabled BCC to move from a routine and reactive maintenance model to a fully mapped programme of planned asset management.

The deal includes significant improvements to the structural and surface condition of around 45% of the 2,500km road network, strengthening 29 bridges and replacing over 40,000 street light columns with state of the art LED technology.

Amey is working with BCC's Highways Service to reduce congestion, minimise disruption and improve safety by feeding into their traffic management strategy whilst liaising with residents to highlight maintenance priorities in their communities.

21.  PFI has helped to open up public services to a more diverse range of providers including those from the private and voluntary sectors. Competition for service delivery places downward pressure on costs and helps to ensure that resources are distributed most efficiently to improve quality. For prison services it has been estimated that competitions for new-build prisons based on design, construction, management and operation have delivered total savings of 38%.[42]

22.  There is also good evidence to show that services delivered during the operational phase of PFI projects are high standard. In the Treasury's 2006 review of over 500 operational PFI projects, 79% of projects reported that service standards are delivered always or almost always, 89% reported that services were being provided in line with the contract or better, 83% reported that their contracts always or almost always accurately specified the services required, and 72% report good or very good service.[43] A recent study found that PFI hospitals had better patient environment ratings and higher cleanliness scores than conventionally procured hospitals of comparable age in which the facilities management services are provided in-house or by a third party.[44]

April 2011

33   National Infrastructure Plan 2010, HM Treasury, 25 October 2010. Back

34   Procurement in the Construction Industry, The Chartered Institute of Building, December 2010. Back

35   PPP Data and Statistics, HM Treasury, February 2010. Back

36   PFI: Construction Performance, NAO, February 2003. Back

37   Modernising Construction, NAO, January 2001. Back

38   Review of large public procurement in the UK, Mott MacDonald, commissioned by HM Treasury, July 2002. Back

39   Making changes in operational PFI contracts, NAO, January 2010. Back

40   Examples of private sector losses include the National Physical Laboratory, which was terminated in 2004 for non-performance, costing the private sector in excess of £100 million; Dudley Hospital cost sponsors over £100 million; Croydon Tramlink, whose private sector operators made financial losses between 2000 and 2003 of £18.3 million. Back

41   Technote 7: How to achieve design quality in PFI projects, HM Treasury, 2000. Back

42   Market Testing, Ethos Journal, published by Serco, Autumn 2010. Back

43   PFI: Strengthening long-term partnerships, HM Treasury, June 2006. Back

44   Operating healthcare infrastructure: analysing the evidence, UCL & KPMG, May 2010. Back

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© Parliamentary copyright 2011
Prepared 10 August 2011