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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