Written evidence submitted by Healthcare
Audit Consultants Ltd
1. THE UK PROBLEM
WITH CAPITAL
SPENDING AND
PUBLIC SPENDING
IN GENERAL
Despite all the evidence that the state has performed
an essential and providential role in providing the infrastructure
of public goods and services that provide the basis of our quality
of life and security in the UK their remains a reticence for the
state to accept that role and to manage that role positively.
All political parties have been reluctant to invest in capital
goods for long term benefits (for fear of the short term costs
in terms of taxation or the impact on totems of sound economic
management—value of the pound, PSBR , money supply, inflation
etc).
The advice of civil servants has been tainted by
Treasury orthodoxy which has viewed public expenditure as a necessary
evil and essentially a cash issue—there has been no balance
sheet mentality or a view of public assets being developed and
nurtured.
The controversies over the years led to severe constraints
on capital spending, underinvestment in essential utilities and
publicly owned industries, and, eventually to the privatisation
of large sections of the economy at bargain prices. The subsequent
flourishing of some of these industries (although not all) has
reinforced a common sense that public sector management is bad
and the private sector good.
Controversy remains even in the firmly established
public spheres of health and education which has recently funded
large investment programmes through the PFI route. PFI was chosen
both to introduce private sector expertise in the management of
large capital projects but more importantly as an off balance
sheet solution to the capital funding requirement rather than
the state funding projects directly and acknowledging the investment
on its own balance sheet even though this may have been cheaper
in terms of the cost of capital.
In my view reluctance by the state to accept that
there can be comparative benefits from retaining certain key industries
and services within the public realm and managing them responsibly
is a problem that could weigh on the nation in the future.
Everyone accepts that private monopolies can be a
bad thing and that private control of health services in particular,
as in the USA, can lead to profiteering and a sub-optimal service
at excessive costs. This is why regulation of key industries such
as armaments, telecommunications, utilities, transport and banking
remain controversial as the benefits of light touch regulation
have been offset by the loss of control over location of factories,
payment of taxes , excessive risk taking and sustainability and
security of long term services.
Recommendation 1
The UK should be more even handed and strategic in
managing key industries and services and accept that certain goods
and services can be supplied by the public sector; and, if this
is accepted, that Investment funds should be available at market
costs- without artificial funding barriers erected on essentially
ideological grounds.
2. WHAT
ARE THE
PROBLEMS WITH
PFI PROJECTS?
There are several problems that have been identified:
— It
has created more public debt at a time when public debt is excessive.
— It
is more expensive than Government debt.
— Transaction
costs are very high.
— It
has caused knock on funding crises in local hospitals and education
authorities as the new facilities failed to deliver savings and
are more costly to sustain.
— The
schemes consolidate old ways of working and do not represent good
investments in themselves.
— The
schemes are inflexible with the costs of change prohibitive.
— The
inflation escalation clauses mean that the burden of PFI schemes
will increase over the years.
— There
is uncertainty at the end of the contract period as to what will
happen with the large risk that the NHS will be forced to pay
twice for a public asset.
MY COMMENTS
AND RECOMMENDATIONS
ARE:
2.1 On the Public Debt
The distinction between public debt and private debt
can be arbitrary with hospitals providing similar services being
classified as either public or private in an inconsistent way
from country to country.
There is no right or wrong way. There is no reason
to suppose that the UK has overinvested in hospitals in the last
few years. Indeed all the evidence suggests there is still a backlog
of old out-dated facilities requiring modernisation and improvement.
Up until the recent banking crisis UK public debt
was low by international standards. The current government are
taking stringent measures to reduce public spending to reduce
public debt.
Recommendation 2
Valid international comparisons of debt should classify
the debt associated with hospital funding programmes on a consistent
basis. But we know of no evidence to suppose that investment in
UK PFI hospitals is excessive or represents poor value for money
in comparison to the extent of hospitals in other countries (most
have many more beds and hospitals) or in the method of funding
(most are funded through private routes involving premiums to
sovereign debt rates).
2.2 The Cost of PFI capital in relation to
Sovereign Debt
PFI schemes raise money from banks at a small premium
to the LIBOR rates and UK sovereign debt. This is to compensate
the private provider for taking on the construction risk and the
risk of overspending for the project. There is some debate on
whether this is excessive or not but in any case there is a risk
and the extra cost is not large in relation to the costs and benefits
overall at c2-3%.
Recommendation 3
The excess cost of capital for PFI schemes should
be kept under constant central review to ensure that the risk
premium is proportionate to the actual risks and not to notional
risks.
2.3 Transaction costs are high
Transaction costs were much lower in earlier years
when the NHS managed the process but arguably this led to overspends
and extra costs through underspending on project management and
risk management.
Recommendation 4
The transaction costs of PFI schemes should be kept
under constant review by the DH and steps taken to ensure these
are proportionate to the risks involved. The Treasury should be
alert for PFI industry capture of the advisory process leading
to excessive costs in comparison with other countries procurement
processes.
2.4 The knock on operational and revenue costs
of PFI has prompted funding crises in their wake impacting on
the quality of services
This is where the major controversy has been generated
but we would question whether these problems can be attributed
to PFI or whether they should be more accurately attributed to
the NHS tariff system. The recent Kings Fund booklet "Reconfiguring
Hospital Services" by Keith Palmer attributes the financial
problems accompanying hospitals with recent PFI schemes to the
NHS tariff system which, as it based on funding average historic
capital costs provides windfalls to some hospitals who may have
modernised before the tariff was introduced and penalises hospitals
with more recent PFI schemes. His calculations accounts for the
bulk of the financial problems of hospitals with PFI schemes.
A minor tweak to the market Forces Factor used to supplement the
tariff would cost nothing and relieve much of the so called revenue
problems of PFI schemes. It is perplexing why this has not been
done already.
The explanations that come to mind are:
— Treasury
orthodoxy is still to deter new capital investment (as I encountered
first hand when sent to discuss funding redevelopment of an old
London Teaching hospital site)or at best to delay schemes(they
can do this for years).
— Extra
pressure to reduce revenue costs is seen as no bad thing.
In any case it has been a struggle to manage the
inevitably higher costs associated with modern hospital facilities
in comparison with older, makeshift, ill-equipped facilities not
suited to modern intensive healthcare. The pressure to reduce
costs results in more contracting out of support services, back
office services and pressure (so far resisted ) to contract out
clinical support services. As these services are highly unionised
there has been a well-orchestrated campaign by the staff unions
to oppose this and which has tarred PFI with the accusation that
it is at the root of the problems in local services caught up
in PFI projects.
In reality all the NHS is under pressure to achieve
year on year cost improvements- particularly over the next four
years where cost savings of 4% per annum are planned. It is likely
therefore that savings from contracting out support services;
back office services and clinical support services will be pursued
aggressively across the board, irrespective of a PFI site in situ.
It is predicted therefore that opposition to PFI will metamorphose
into opposition to contracting out and to government policy generally.
This is not to deny that pressure to make cost savings
has been heightened in recent years in organisations with PFI
schemes but to clarify that this situation arose because of the
double penalty of the tariff system (double in the sense that
costs increased with PFI schemes but income failed to match this
leaving Trusts with increased cost savings targets).
Recommendation 5
Hospitals with PFI schemes should have their tariff
adjusted to reflect their actual cost of capital. This could be
funded by adjusting the tariff of the rest who may enjoy fortuitous
benefits at present.
Recommendation 6
Staff opposition to contracting out can be reduced
by harmonising pay and conditions, including pension rights across
the public and private sectors.
2.5 PFI consolidated outdated working practices
rather than lead to modernised practices
It is not argued that this happened—but that
the opportunity to fund a new hospital development appears in
a narrow time window. Achieving clinical change in the NHS takes
too long to negotiate and so there has been the consolidation
of old working practices.
Recommendation 7
There should be more central identification and driving
of change as part of the PFI approvals process. For example modernisation
of pathology services should be mandated prior to approval.
2.6 PFI schemes are inflexible and the costs
of change prohibitive
There has been considerable adverse publicity to
the charges levied for items of extraordinary maintenance or for
making small changes to premises.
Recommendation 8
The problem of PFI contract inflexibility can be
resolved by the insertion of a standard clause requiring arbitration
to ensure reasonable costs only can be charged as a result to
changes in premises. This should be imposed nationally.
2.7 PFI inflation escalation clauses will
escalate funding problems over the years as the prices of services
will rise with inflation despite most costs having been sunk
The maintenance and support services costs would
rise with inflation but the historic investment will not.
Recommendation 9
The fairness of the PFI price escalation clauses
needs to be reviewed to ensure that they do not guarantee excessive
profits over time. Again a centrally imposed change may be required
to ensure fairness.
2.8 The situation at the end of the PFI period
is unclear in many contracts with the high risk of the asset having
to be paid for twice
In order to preserve the fiction that the asset is
not a public asset the premises at the end of the contract period
will revert to the private sector at the end of the contract.
The issue will be on what terms the contract will be renewed.
There is every chance the NHS will be asked to pay twice for the
right for continuing use.
Recommendation 10
It is recommended that each PFI contract be reviewed
to ensure there is no ambiguity and risk of the public sector
being seriously disadvantaged in any renewal negotiation. A central
team should be designated to achieve a fair settlement.
3. FAILING PFI'S
AND KILLING
THE CUCKOO
If the recommendations above are followed there is
no reason why a lot of the problems associated with PFI's shouldn't
be overcome but there will be instances where past PFI's are too
expensive for the larger NHS community to bear without inappropriate
distortion to the resources available for healthcare and the accessible
delivery of healthcare. This can arise when an oversized development,
inappropriate to modern needs is in situ requiring escalating
funding—effectively cannibalizing adjacent providers—and
which can only be sustained by the recurring pre-emption of an
ever increasing proportion of the commissioners funds.
The system must be able to recognise failure and
write off assets and liabilities that cannot be sustained.
Recommendation 11
If PFI assets become surplus to commissioners requirements
that could be better invested in alternative ways commissioners
and providers should be able to nominate PFI assets for disposal.
In the event of no ready market for partly used NHS premises or
in the event of losses on disposal against redemption of loans
outstanding for these assets then the NHS nationally should meet
these costs. The DH would negotiate with the PFI provider and
bankers for an appropriately discounted early redemption charge.
This is in recognition that it is better to recognise losses early,
that there is a case for creative destruction of assets and such
a move will be beyond the resources of a local community and should
be recognised as an extraordinary event requiring national recognition
and funding.
4. SUMMARY OF
CONCLUSIONS AND
RECOMMENDATIONS ON
PFI FUNDING
(a) PFI has been pursued as a response to the
view that the public sector could not be trusted with large scale
capital projects. It was thought that inevitably costs would escalate
and benefits fail to be realised. But in addition by moving capital
projects off balance sheet it took away many short term costs
from decision makers and imposed them on future generations. PFI
therefore achieved two policy objectives seen to be self-evidently
good: It transferred risk and responsibility for large scale projects
to the private sector and it brought forward the replacement of
public assets sooner than under traditional funding methods ie
bidding for tightly controlled centrally allocated funds.
(b) A more even handed and strategic view needs
to be taken of public investment, the creation of public assets,
and the provision of public goods and services. The experience
of the US healthcare industry shows the risks of private ownership
and control of a public service can lead to over treatment and
poor use of investment capital, lack of access to service by the
underprivileged, profiteering and corruption. The recent experience
within the banking industry reemphasises the risks associated
with light touch regulation and the opportunities for public provision
of banking services eg by the creation of an Infrastructure Bank
funded by the public sector. Just as the European Investment Bank
helped finance the new Barts' and the London Hospital so a UK
infrastructure bank could make funding easier for needed capital
expenditure within the public sector without recourse to the dead
hand of the Treasury or to private banks, who inevitably will
exploit opportunities for large profits at the states expense.
(c) Valid international comparisons of debt should
classify the debt associated with hospital funding programmes
on a consistent basis. But we know of no evidence to suppose that
investment in UK PFI hospitals is excessive or represents poor
value for money in comparison to the extent of hospitals in other
countries (most have many more beds and hospitals) or in the method
of funding ( most are funded through private routes involving
premiums to sovereign debt rates).
(d) The excess cost of capital for PFI schemes
should be kept under constant central review to ensure that the
risk premium is proportionate to the actual risks and not to notional
risks.
(e) The transaction costs of PFI schemes should
be kept under constant review by the DH and steps taken to ensure
these are proportionate to the risks involved. The Treasury should
be alert for PFI industry capture of the advisory process leading
to excessive costs in comparison with other countries procurement
processes.
(f) Hospitals with PFI schemes should have their
tariff adjusted to reflect their actual cost of capital. This
could be funded by adjusting the tariff of the rest who may enjoy
fortuitous benefits at present.
(g) Staff opposition to contracting out can be
reduced by harmonising pay and conditions, including pension rights
across the public and private sectors.
(h) The problem of PFI contract inflexibility
can be resolved by the insertion of a standard clause requiring
arbitration to ensure reasonable costs only can be charged as
a result to changes in premises. This should be imposed nationally.
(i) There should be more central identification
and driving of change as part of the PFI approvals process. For
example modernisation of pathology services should be mandated
prior to approval.
(j) The fairness of the PFI price escalation
clauses needs to be reviewed to ensure that they do not guarantee
excessive profits over time. Again a centrally imposed contractual
change may be required to ensure fairness.
(k) It is recommended that each PFI contract
be reviewed to ensure there is no ambiguity and risk of the public
sector being seriously disadvantaged in any renewal negotiation.
A central team should be designated to achieve a fair settlement.
(l) If PFI assets become surplus to commissioners'
requirements commissioners and providers should be able to nominate
PFI assets for disposal. In the event of no ready market for partly
used NHS premises or in the event of losses on disposal against
redemption of loans outstanding for these assets then the NHS
nationally should meet these costs. The DH would negotiate with
the PFI provider and bankers for an appropriately discounted redemption
charge. This is in recognition that it is better to recognise
losses early, that there is a case for creative destruction of
assets and such a move will be beyond the resources of a local
community and should be recognised as an extraordinary event requiring
national recognition and funding.
NOTE TO
COMMITTEE:
My background: I have
academic qualifications in Public Finance and am a member of the
Chartered Institute of public finance and accountancy (CIPFA).
My professional life has been devoted to the NHS as a Director
of Finance and outside the NHS as a consultant—including
working on large PFI projects in Swindon and North East London—including
Barts' and the London PFI, as acting performance manager for the
NE London SHA capital programme of over £2 billion. Healthcare
Audit Consultants have advised Local authorities on some of the
most controversial putative NHS reconfigurations—many with
PFI's at their core eg SW London, Hertfordshire, West Sussex,
Gloucestershire and West London. I have also worked on business
cases for the private sector including private hospital projects.
This background and experience puts me in a good position to comment
on PFI.
April 2011
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