Private Finance Initiative - Treasury Contents

Written evidence submitted by Dr Andrew Edkins, Graham Ive and Alex Murray, University of London

Evidence submission representing the views of Dr Andrew Edkins (Senior Lecturer), Graham Ive (Senior Lecturer) and Alex Murray (Research Assistant), all of whom are employed within the Bartlett School of Construction and Project Management, University College London (UCL). Graham and Andrew are experienced academics in the fields of construction economics and project management respectively. They have worked with Alex over the past two years in developing comparative benchmarks of the operational performance of PFI and non-PFI social infrastructure (schools and hospitals).


—  Different procurement methods offer different and inconsistent benefits to the purchaser. The purchaser should consider what aspect they place the greatest importance on achieving.

—  The level to which risk can be transferred from the public to the private sector depends on three main aspects:

1.  extent to which specifications and standards of the asset or service can be defined;

2.  ability to put in place objective measurement systems accurately to determine if contractual performance has been achieved; and

3.  private capital expenditure should be realised before payment to maintain incentives for delivery.

—  To date, based on limited public information, relatively few PFI projects have failed. Without access to commercially confidential information to ascertain project specific performance, this suggests PFI is performing, in terms of delivery, certainly no worse than publicly funded projects.

—  Comparisons with non-PFI operated social infrastructure suggest PFI facilities are performing comparably in terms of cost, with some higher levels of performance and evidence of investment in the long term maintenance of physical infrastructure.

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

1.1  A full answer to this would exceed the word limit. This submission will therefore only consider procurement method involved in the provision of substantial assets, such as buildings, civil engineering works or complex IT systems. A summary of generally accepted strengths and weaknesses for a broad category of procurement methods is presented:
Procurement Strengths Weaknesses
Separate procurement for design, build, operation and maintenance contracts (D+B+O)
Choose separate tailored parties for
each phase
Can take longer to deliver with opportunities for disagreement
Opportunities for difference between bid prices and out-turn costs and delivery times
Partially integrated:
Single contract for design and build, separated from operation (D&B+O)
Reduced contracting so lower transaction costs Reduced input from client in design process
Incentivises for communications between D & B to improve "buildability" "Buildability" may be achieved at cost of operational performance
Professional: outsourced procurement process as a form of cost plus procurement Operational specifications guide design and build Client retains significant final cost risk
Able to deliver novel projects quickly
Fully integrated: Design, build, finance and operation wrapped up together into one contract eg PFI (DBFO) Fully incentivised whole life factors between D, B & O Inherently inflexible beyond contract close
Risk transfer, client does not pay if agreed service/availability is not delivered Risk transfer can be costly
Access to private capital for public infrastructure Private capital is more expensive than public

1.2  Construction clients suffer both hold-up and quality measurement problems. No procurement method is best at mitigating both problems.[73] By making the constructor (and project company which it part owns) bear the consequences of inferior quality (lower service payments, higher maintenance and life cycle costs), PFI can claim to be superior at solving the problem that some construction contracts give the contractor a perverse incentive to "shade" construction quality.

1.3  However PFI also makes the client particularly vulnerable, potentially, to opportunistic pricing of post-contract changes introduced by the client (the form the hold-up problem usually takes in construction projects). It therefore will tend to be a good choice for the public client in cases where there is little risk of requiring changes, and where the quality giving attributes of an asset are capable of objective measurement and can be linked to contract payments.

1.4  PFI will also tend to be a good choice where the constructor has strong reasons not to take advantage of client vulnerability post contract signature, because they are trying to build a reputation and thus be selected (out of many competitors) to bid for future PFI projects. This is particularly relevant where the public client has an active public programme and where the number of competitors is fairly high.

2.  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?

2.1  The authors of this submission are not qualified accountants and do not reside in an accountancy orientated academic department. We therefore consider ourselves not qualified to answer these two questions. However, we are of the view that the fundamental objective of the PFI is to achieve better value for money for the delivery of services.

3.  How far can risk really be transferred from the public to the private sector?

3.1  A fundamental principle of PFI is the allocation of risk to the party best placed to manage it. The types of risks and duration over which risks are considered are generally service orientated, wide-ranging and long term. This has the fundamental effect of reframing the nature of the challenge to one that includes whole life cost considerations and stable provision.

3.2  Three aspects are relevant in considering limits to the kind of risks that can be transferred. The first is the extent to which specifications of required services or standards can be clearly defined in testable, measurable ways. It is this problem that bedevilled the early and most complex IT projects (NIRS2) and Ministry Of Defence equipment projects (FSTA). The second is the ability to put in place objective performance measurement systems. These are often associated with human assessment where there is no objective test. Soft FM services (such as reception services) present such a challenge in determining standards. It is to be noted that this is a tractable problem as the highly successful prison PFI projects have proved, where performance standards are largely driven by measurements and metrics relating to human performance. It is therefore an exercise of development and refinement of appropriate metrics and measurement systems that frame the questions of how far risks can be transferred. The third aspect is that PFI projects realise capital expenditure before public payments begin, so lenders are at risk (with no government guarantees of debt, except in instances such as the London Underground PPPs). In effect, the public sector relies on the lenders to ensure that project sponsors perform.

3.3  The extent to which risk has and is being transferred in present projects can be deduced from two streams of evidence. The first is where either too much or the wrong type of risk has been transferred, and the consequences are such that the project fundamentally fails. The extreme would require the public sector to take back the risks and responsibility for the project. Examples include the Croydon Tramlink and the two major London underground PPPs. We are not aware of a definitive national list of these failed projects being currently available. Compiling such an official list would be a valuable exercise so that further analysis of any common factors can be undertaken.

3.4  The second stream of evidence to inform the limits of risk transfer is the inverse of the first. Here the evidence base is the population of projects that are operational. The definitive source for this is the HM Treasury PFI signed projects list.[74] This only includes active projects (operational or in-construction). Considering just the operational projects, 569 projects are recorded as being in receipt of unitary charge payments (UCPs) in 2008-09 with a total value of £6.49 billion.[75] The respective figure for 2009-10 is 619 projects being in receipt of UCPs with a total value of £7.37 billion. The net gain in the number of projects and increase in UCPs value has factored in the removal of instances of projects that have been taken back to public sector responsibility, such as Croydon tramlink and the two London Underground upgrade projects. The logical deduction from this is that for the 619 projects in receipt of UCPs, risk of the type and size considered "normal" (construction, maintenance and life cycle cost risks) has been transferred and is being managed by the private sector. The number of projects and sum of UCPs, is therefore evidence of real risk being transferred.

3.5  The presumption for these operational PFI projects is that UCPs are only being made after due assessment that the service provided meets contractual obligations for delivery of acceptable standards of service. Where such service standards or availability are not, as specified, being provided, it has to be assumed that penalty points are being incurred and payment deductions made. Sufficient data to provide more detailed commentary on the performance of individual projects is not publicly available for commercial confidentiality reasons. We believe such data would be extremely useful in providing a true evidence base for the consideration of the extent to which risk has been transferred in such projects. The presence of very few instances of project failure (not all of which were due to issues of risk), coupled with the requirement in such projects for transfer of design, construction and operational risk, reinforces the evidence that significant risk has been transferred.

4.  Are there particular kinds of risk which are particularly appropriate for transfer through PFI deals, or particular projects which are suited for PFI?

4.1  Others such as the National Audit Office have examined and reported on the issue of design and construction risk performance in PFI.[76], [77] The body of evidence is that PFI has tended to handle this risk relatively well. There is less objective evidence of the risks that lie within the operational services provided by such PFI contracts. For the majority of asset-based projects, these can be broadly considered as the risks associated with soft (people centric) and hard (asset centric) facility management.

4.2  The authors, as research active staff within the Bartlett School of Construction and Project Management at UCL, have developed an ability to benchmark the operational cost and performance of aspects of soft and hard services within core social infrastructures, specifically hospitals and schools. This research has been driven by our curiosity to look at the impact of the procurement method on the operational performance of facilities and wider infrastructure.

4.3  We have developed comparisons derived from independently collected data sources in a bid to provide objective evidence to what has largely been a debate driven by perception. This is an area that is poorly developed and served. This is a view held by others, including Infrastructure UK which notes that data on the cost and performance of infrastructure is "uncoordinated".[78] We believe that our endeavours have demonstrated that it is possible to generate objective assessment of the cost and performance of operational services and the assets that underpin them. It is our recommendation that to help solve this issue of poor data on public infrastructure, a national asset register be established to record at the individual asset level, the key information on the asset's creation, expected lifespan, and its operational performance and associated costs. Such an undertaking is recognised as significant. The Canadian Statistical Office collate such data setting a precedent for what can be achieved.[79]

4.4  Taking the example of what our research revealed in the important area of hospital cleaning, the findings from our analyses comparing new hospitals conclude that PFI facilities witness higher levels of cleanliness and quality of patient environment, with no associated statistically significant higher cost of cleaning services.[80] In fact, the dispersion of cleaning costs seen within PFI facilities is significantly lower than in non-PFI new hospitals. We consider this provides procuring authorities with greater certainty on the on going cost of operation. These findings are based on publicly assessed and available data.

4.5  A forthcoming paper of ours,[81] looking into the operational services expenditure between schools renewed via PFI and non-PFI, reveals PFI costs to be higher in six of the nine years into operation. However, these differences are not statistically significant and PFI schools cost less overall in three of the nine years examined. What can also be observed also is PFI facilities are allocating funds to invest in building maintenance with considerable increases in hard FM expenditure following the fifth year of operation. The corresponding expenditure in public funded renewed schools remains roughly flat throughout. The issue of responsible stewardship of infrastructure is as relevant today as it was when PFI was developed in the early nineties. Emerging pressures to cut these budgets in PFI facilities is a case of falling back into old habits. This is an area at the heart of the recent James Review.[82]

4.6  The main risk that cannot be transferred is the reputational risk that is inherent with any public service. The general public will not, and indeed should not, seek to hold accountable any party other than the public sector for any major failing in a public service that is then made the subject of a PFI/PPP contract. However, the alternative is also true, with the public sector enjoying the reputational benefits from improved services from such deals.

4.7  Those projects where clearly understood fixed assets are at the centre of the service delivery are well suited for the transfer of risk for the successful completion of the design, build, financing and operation of the asset. Examples of these include schools, hospitals, residential and office accommodation buildings that make up much of the present PFI/PPP market. Additionally, there are civil engineering dominated projects that form parts of the road, rail, water, and energy sectors.

5.  What state guarantees are explicit or implicit in PFI deals?

5.1  We are not aware of any general area where explicit guarantees are made in PFI projects, but would defer to those legal practitioners in the area of PFI contract law for more detailed comment.

5.2  As we understand the question, the foremost implicit guarantee is of persistence of presence. Without such surety, the private sector would place higher prices on the risks of both "walk-away" and or "hold-up". It is the implicit trust in the State, its government and its agencies that they will endure and be obligated by their pre-existing contractual obligations that provides the comfort needed by the private sector and its financiers. The prevalence of availability payments means that the private sector is guaranteed the equivalent of off-take agreements. Whether the service made available is actually needed (so for example a school building that is open, but for which there are no pupils to require teaching) is a concern for the wider society and tax-payer.

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

6.1  There must always be a strong service element in any PFI as otherwise it is just a form of lease or affermage. The circumstances where the service is best suited for PFI are those where there is a combination of clarity of the output to be specified and established and agreed protocols and metrics for assessing the performance of the service. This set of criteria is most easily accomplished in projects dominated by the technical performance of a relatively stable asset—such as road or simple building. These represent clearly understood entities where not only is the "what is required" clearly defined, but so is the "way it will be measured". This leads to a set of limits where if there is too much novelty, complexity or opportunity for principled disagreement, PFI is not suitable.

6.2  Where straight forward objectively measurable service outputs can be specified, risk of delivery can be priced and wrapped into an integrated contract. Where complex subjective service outcomes are present, risk of delivery will be impossible to price accurately, so will likely include margins of safety which render them not value for money. The recent decision to incentivise the Doncaster prison service provider for the reduction of reoffending rates can be considered as objectively measurable, except it is not a service output (directly within control of the provider), rather an outcome (a result of interaction between service outputs and service users, such as prisoners). In this case, the service provider is not taking the risk of deductions from increased re-offending rates.

April 2011

73   Ive, G and Chang, C-Y (2007) The principle of inconsistent trinity in the selection of procurement systems. Construction Management and Economics, Vol 25, pp 677-690. Back

74   Updated in March 2011 and available at: Back

75   Un-indexed values used. Back

76   Performance of PFI Construction, National Audit Office, 2009. Back

77   PFI: Construction Performance, NAO, 2003. Back

78   Point 3.36, National Infrastructure Plan, Infrastructure UK. Back

79   Age of Public Infrastructure: A Provincial Perspective, by Mychèle Gagnon, Valérie Gaudreault and Donald Overton, Investment and Capital Stock Division, Statistics Canada, 2009. Back

80   G Ive, A Murray, A Edkins and K Rintala, Cost and performance comparison of PFI and non-PFI Healthcare Infrastructure in England, presented at the 3rd Annual Conference of the Health and Care Infrastructure Research and Innovation Centre, Edinburgh, September, 2010. Back

81   Finding of initial analyses to be presented at the 2011 RICS COBRA conference. Paper to be submitted early June. Back

82   Review of Education Capital, Sebastian James, April 2011. Back

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© Parliamentary copyright 2011
Prepared 10 August 2011