Private Finance Projects and off-balance sheet debt - Economic Affairs Committee Contents

Examination of Witnesses (Question Numbers 205-219)

Crisp, Ms Rachel Lomax, Sir John Gieve and Sir Kevin Tebbit

3 NOVEMBER 2009Lord

  Q205  Chairman:

Welcome to the Economic Affairs Committee. This is the fourth public hearing of our inquiry into private finance projects. Copies of members' entries in the Register of Interests and interests declared that are relevant to this inquiry are available to the public and witnesses on that table. Ms Lomax, Lord Crisp, Sir Kevin, Sir John, thank you very much for coming to give us evidence this afternoon. It is not often that we see four former permanent secretaries together. We were musing on what the collective noun might be but we will not go any further into that.

Lord Crisp: A mandarate!

  Q206  Chairman: We would be grateful, as always, if you could speak as clearly as possible for the web cast and the shorthand writer. Do any of you wish to make an opening statement or shall we go straight into the questions? As there are four of you and we have quite a lot of questions to ask in a fairly short time, I will be happy to take silence as assent if others agree with the first answer, but feel fee to put your own slant should you wish to do so. Perhaps I can make a start. Before we go into specific questions, and this is the exception, I would like all four of you to say something. Could each of you give as brief an overview of the use of privately financed projects in your former departments as possible? Perhaps you could outline the benefits to us, if any, of the freedom that goes with having PFIs.

  Sir John Gieve: At the Home Office I think the two main bits of PFI I was associated with were firstly knocking down the old Marsham Street building and building a new headquarters, so that was a big construction project, and secondly the building and operation of a number of private prisons. On the first, I think, so far—touch wood—it has worked quite well, we got it built to time and budget, and it has proved to be a good building and not at excessive cost. In terms of the prisons the PFI was much more important because it was not just financing the construction of prisons, it was creating an estate of privately run prisons so, if you like, the finance was a secondary issue, it was about creating competition really for the core public services in the prisons and, therefore, giving an alternative to turning to the public service in prisons for bits of the prison estate which were not working properly. That was very important and goes beyond the PFI because it has been important over the last 10 years in driving better performance throughout the prison estate.

  Ms Lomax: I was actually permanent secretary to three departments which used PFI, first of all in the Welsh Office where the big PFI project we did was what is now called Lloyd George Avenue and Callaghan Square in Cardiff, which was an innovative PFI for building a stretch of road and getting developers to develop the bit between the station and Cardiff Bay. It was a crucial part of putting in place the infrastructure for the Assembly down on the Bay. That was an interesting one. Then at DSS, which subsequently became DWP, I inherited some PFI projects and had a few that came to fruition. They were really in two sorts. One was some large IT projects, some of which went spectacularly wrong, like NIRS2 and the benefit payment card, both of which collapsed before I arrived and we spent quite a lot of time tidying them up. Then a major outsourcing to EDS which really was designed to modernise the DSS's IT estate, starting with the CSA and then going on to things like pensioner credit and eventually the payment modernisation project which was about paying benefits by card. That was hugely ambitious. It had lots of problems but I think it also brought lots of benefits as well in terms of sharpening the Department's ability to handle a major modernisation programme. We did it by PFI because, frankly, that was the only way we would have got permission from the Treasury, but I think it has some other benefits as well which we can talk about later. The big hit during the time when I was at DWP was the PRIME project which was when we sold off the Department's estate, transferring some 700 offices to a consortium which became known as Trillium and eventually was bought by Land Securities. In return they gave us fully serviced and very flexible office accommodation. That has been a big success. It was an innovative deal. It was the first time that had been done. I think the BBC have done something similar, Norwich Union and others. The Department has gone on and extended it. That was a success. Then I spent an interesting year only at the Department for Transport, which is a story all of its own. You know about Metronet and the London Underground PPP, but I think the roads story is actually much better.

  Lord Crisp: Can I have three positives and three negatives in the story that I am about to tell? The background is the 1990s and not a lot happening in capital investment in the NHS and a massive backlog of maintenance being built up. At that period we started to get involved in PFI and that very early period was what I would describe as a thousand flowers blooming. Every hospital was trying to get private finance in through some means or other. What then happened was the Department of Health established some priorities and started to manage this market so that we set priorities about how many hospitals at a time would come to market, recognising our understanding of how much potential market there was for these projects. From then on there was what one could call a journey, I guess, over the next 10 years of a smarter way of learning how to use PFI to do the two things we wanted, which was to get the best deal for patients and best value for money for the taxpayer. The three positives are, firstly, the Government set out in 2000 for 100 major hospital projects to be built as part of the NHS plan and that was achieved in 2008. At today's date I am assured there are 116 major hospital projects. What is interesting is that three-quarters, which is 87, are PFI and 29 are public sector capital, so 3:1. In value terms PFI deals are higher so that seven billion are private sector and one billion is public sector. There are some more to come. That has had an effect on the whole estate of the NHS, including the backlog maintenance. Ten years ago more than 50% of the estate was pre-1948 and now only 20% of the estate is pre-1948. There has been a big, big change and I think it would be difficult not to argue that would not have been achieved—forgive all the double negatives—but for PFI. It was a pretty fast development of capital. Some of that was about improvements in the process, but I have to say the biggest bit was that this was about availability of money and this was what made that possible. That is the first positive. The second positive is that the PFI creates greater local accountability. Under the old system you allocated capital from the centre and then it was subject to patronage and the distortions that you could potentially get by a centre allocating the capital. Every project had to stand up to private sector scrutiny, to business plan scrutiny and every chief executive of every hospital and board had to sign it off and had to take that responsibility. We still had the role overall that I described, but prioritising and only letting a certain number of schemes go to market at any given time and, of course, funding the public sector, so some local accountability. The third one is a change in politics, a change in the political scene. PFI, and I am sure you are looking at this, is only part of a wider set of changes between public and private sector which emerged at the beginning of this century in health when the principle became that as long as we kept a clear focus on the public goals and that these were controlled by public bodies that it was reasonable to use the private sector in whatever way. There is a spectrum of activity: from PFI we then moved into LIFT, which you may or may not look at, which is a shared joint venture as opposed to a straight PFI contract arrangement. Subsequently you will observe at the other end of that spectrum is that in my time certainly we actually bought a number of companies to operate ourselves as the NHS. So to secure a supply of blood products we bought an American blood company which I notice this year is turning in profits of $30 million to $40 million. My point in saying that is to make the point that this is a two-way street and PFI helped the debate. The negatives, and you may want to go into these, I will headline because I am talking too much. The first one is complexity. If you are going to specify things early then you are involved in more complexity than you would have done in the traditional scheme. That changed to some extent during the course of the last 10 years and then from 2003 no PFI schemes were done for less than £20 million. The reason for that was the overhead of the transaction costs and everything else for a lower value scheme made it not worth doing, but LIFT went on at a lower value. Complexity is an issue. The second one is the health sector is about relationships—doctor-nurse, doctor-patient, manager-doctor, GP-specialist—and this added another relationship into the equation and that makes for complex management. I could say something on that and if you check out what is happening you will hear people talking about problems this has brought in some places. I can give you the odd instance if you want. The third one is that because this was in a sense the only show in town there were some rigidities built in in terms of how we spent a lot of time on capital planning and major acute hospital builds whereas arguably maybe were money available by different routes we might have paid more attention to community service development in different ways. There are some positives and negatives. You will gather my view is the positives outweigh the negatives but there are negatives.

  Sir Kevin Tebbit: A broadly similar experience in a different context from the MoD, I think. We have used PFI very extensively across a wide variety of areas. It started before I became PUS in 1998 and has carried on to date. £9 billion of capital investment has come into the Department through PFI during that period and we have applied it across accommodation, training facilities, equipment areas, and also other support things, including, for example, the Skynet satellite which was done by PFI. A very broad and diverse range of activities. The biggest one is more or less happening now. There is Project Allenby/Connaught which has accommodation for 18,000 military and civilian personnel and involves several hundred buildings, new ones as well as demolishing old ones. Some are quite high profile. The main building of the Ministry of Defence is a PFI project, for example. We have equipment quite close to the frontline under PFI. There is a contract for heavy equipment transporter facilities actually manned by sponsored reservists which operates in Iraq and Afghanistan all under a PFI. The future tanker service for the air fleet has just been concluded under a PFI arrangement. It is a very broad and diverse programme and would not have been possible if we had relied on conventional money, we would not have had it, and that was very evident. The benefits: for the MoD projects to time and cost are not perhaps as familiar particularly to the public as they should be. All of these projects have run to cost and time. Eighty-eight per cent of them were within two months of the end target date, which is much better than conventional comparators. I had a study done before I left in 2005 and those figures come from that study. That has more or less been borne out by subsequent examination from the NAO and the Treasury, so I think they are fairly accurate figures. The other benefit is that the quality has been high, particularly in an area I have not mentioned, which is in flight simulator training where the quality of tuition has gone up enormously since we have been using PFI contracts for simulators for helicopters and fast jets. A final plus would be the level to which this has raised the Department in understanding partnering with the private sector, not just within PFI but in a broader context, the need to look through life at whole life costs of projects for 35 years and not just the upfront cost. That has brought better discipline into the Department. The negatives are rather similar to Lord Crisp's. The length of time it has taken to negotiate some of these has been extraordinary, particularly the rather novel ones. With accommodation, once you have got a template going you can more or less measure it. Some of them have been extraordinarily long in the making and I am surprised that everybody has hung around to make it work, frankly. The other negative is more a question. The public comparators are often very difficult to establish. Although we believe we got value for money in every case because we hit the right markers and criteria, getting those criteria in place was very difficult.

  Chairman: That is a very helpful starter for 10 and gives us a view of what the scope is both in what PFIs are about and the reasons for doing them.

  Q207  Lord MacGregor of Pulham Market: To what extent is one of the benefits, if that is the right word, getting round traditional constraints? Will that lead to later year difficulties?

  Ms Lomax: Originally I always felt that was what it was all about. Having started life as a Treasury official who, as you will probably remember, was used to policing these rules, I started being very cynical about PFI, just seeing it as a wheeze to get round Treasury rules. That was how it started, but over time it turned into something else; and where it has really worked is where it has enabled a much more grown-up approach not just to working with the private sector but also to managing capital expenditure. As we got into the new millennium where the public expenditure constraints did not bite in quite the same way and we got new accounting rules, then I think it really did turn into something else.

  Q208  Lord Moonie: We have heard from several sources that the presence of private finance has brought accountability to public infrastructure and services that was sorely lacking in traditional procurement. Has this been your experience?

  Lord Crisp: Shall I start off on that having started slightly on that area? It depends what we mean exactly by accountability, but certainly at the local level I think it has because decision-making has been pushed rather more and business plans have been much more scrutinised. If that is what one means by accountability, that it is not just—I exaggerate wildly—decisions made in smoke-filled rooms but a fairer degree of transparency, within the confines of commercial confidence of course, there has been some improvement of objectivity at least in that sense. It has made people accept the ownership whether they liked it or not and learn new skills and so on. There is a fair amount of it in that sense. It has also changed a bit the relationship between the centre and the locality in that, again, if you give more accountability locally you lose a degree of accountability centrally and it is people over there who are making decisions, so you have ended up with that tension. Certainly I would say objectivity and clarity, so in that sense accountability.

  Q209  Chairman: Is that a common view?

  Ms Lomax: I do not recognise this to the same extent because I was always in the area where services were very much a direct central government responsibility—if you are talking about central government services. They were much closer to the department. I agree with everything that has been said about PFI forcing us to learn better project management and better capital expenditure practices, and accountability in that sense is a good part of that.

  Sir Kevin Tebbit: As a centrally managed department it nevertheless did help people understand better how to manage risk and where risk was best placed because most of the on or off-balance sheet treatment depended on who was bearing risk in what area of the programme and that was a particular advantage in terms of accountability of risk. I speak from a department which needed a lot of these disciplines imposed on it and this did help to impose them.

  Q210  Baroness Hamwee: Can I turn to the performance of privately financed services, the services perhaps more than the capital spending to create the project, and prisons has been mentioned. Is your experience that performance is more variable than public alternatives and, if so, why do you think this is? I am picking up a point that has been made and, if that is so, is that related to the complexity of projects?

  Sir John Gieve: Looking at the prisons, I am not convinced there is a greater variance in performance. Some of the private prisons have run into difficulties, particularly in the early stages, and there have been some disasters but very evidently there were some disasters in public prisons as well. The average scores are a bit more volatile in the private estate but that is because there are only 11 of them and, therefore, one going wrong affects the average much more than in the public estate. On the prisons, the ones that have not worked so well are usually the ones where the private sector under-bid and were over-optimistic about what they could deliver, and that is quite a difficulty. In my experience this was also true in the IT projects which went wrong. Very often the root of that were contractors thinking they could do something they could not do at a price they could not meet. In a sense, one of the bits of learning of this whole process has been do not just take the lowest bid, really be convinced that these guys can actually do it because there are people out there who promise to do it and then there will be a very painful experience for them but also for you in trying to get the thing back on the rails.

  Lord Crisp: My experience is not that there is more variability for the same sorts of reasons Sir John has said. I think the NAO actually looked at this and could not find more variability, if I remember rightly. Can I touch on the complexity? The complexity is about trying to predetermine things in advance. I have to say that over a 10 year period, which is what we are talking about, or slightly longer, people got better at doing that and we started to issue standard contract terms and we took the schemes out under 20 million, as I said. In some of the earlier schemes some of the things that were not quite so effective were things like design and we spent too much time on the financial aspects perhaps and not enough on some of those aspects. There were things that needed to be learnt as one went through. In terms of performance I do not think there was a difference.

  Sir Kevin Tebbit: Our study in 2005 had a very high satisfaction level. Ninety-seven per cent or above of users said they were satisfied and that is very high indeed. Did I believe it was accurate? What would have been the case with a normal procurement? I think the reason it was high was because the discipline does require a continuous engagement between the customer and provider, particularly on accommodation, training programmes and that sort of thing, and that probably focused both sides more clearly than they otherwise would have been under a conventional procurement. It probably is and has been rather better than the conventional routes within the MoD.

  Ms Lomax: It did involve a lot of painful learning for some departments. It was a completely different way of dealing with outside suppliers. We did have a few bumps along the road, but in the PRIME contract, which I mentioned, and which probably scores as a fairly major success, I do remember, in the first year or so, enormous complaints from the field about quality, and then we learnt how to manage that contract in a way which gave us what we wanted. On IT, I agree with a lot of what Sir John says. Some of it was about us also basically sending people on "mission impossible" and we had to learn to grow up in our thinking about what it was sensible to ask people to do. Our IT people had to behave quite differently from the way they had—in fact, we probably needed different IT people. Departments had to change in order to manage these relationships quite differently. It is about partnership, not about controlling a supplier relationship, and that is a very different mindset which some people were not comfortable with.

  Q211  Baroness Hamwee: My Lord Chairman, I know we might come back to procurement and management but I wonder if I could just ask one supplementary arising from that. I can well understand the need for new skills to be learnt. Did you bring in the private sector to help you learn the skills?

  Ms Lomax: Yes. That is one reason why it was a bit of a field day for management consultants.

  Lord Crisp: The answer is yes and no. In the Department of Health the person who leads it is exceptionally able to do this, has learnt it exceptionally well and has come up through the public sector ranks.

  Q212  Lord Eatwell: I was very intrigued by Sir John's notion of competition between prisons. I had an image of the lads saying, "Let's go here rather than there" and so on. My question is rather different, it is about innovation. We have had very different views presented to us about the role of PFI in either stimulating or suppressing innovation, or slowing innovation down in the supply of public services. I wonder what is your view as to who really takes the lead in modernising public services and thinking about innovation?

  Lord Crisp: I will dissect this out slightly because I think there are different bits of innovation here. If you take the two phases in the NHS, there was PFI and then there was LIFT. PFI was a contractual arrangement and the only room for innovation in that was in terms of the building. There was some innovation but perhaps not as much as there might have been. Indeed, right at the early stages ministers were very clear that the transfer of facilities management did not include any clinical staff. What you have then seen as the LIFT projects get underway, which are joint ventures, is innovation starting to happen in services. A limited amount of innovation in one when you are purely talking of construction and cleaning, if you like, but starting to see a bit more when you get out into the much smaller projects under the local LIFT scheme. In terms of stifling innovation, one of the problems that people do talk about to some extent, and I spoke to a matron this morning to check this out, is once you have established a deal with a PFI partner it is quite difficult to change sometimes and health moves on. This particular matron said to me, "It's like renting a house rather than owning a house. When we owned the house it was easier for us to make changes, but now we are the renting the facility it is harder to change the nature of the room". When asked about it further, he said, "However, compared to where it was there are enormous benefits for patients from this", so he was saying there are pluses and minutes. Clearly there are some ways in which innovation can be stifled.

  Ms Lomax: It does depend what you are talking about. The PRIME contract was an innovative contract but it was actually using fairly well established private sector skills so I do not think what they were doing was innovation. They came together in a framework which set a new way for doing things. On a lot of our IT projects it was part of our naivety at the beginning of PFI that we hoped the private sector would somehow solve problems which were really for management to solve. IT projects were really business transformation projects and I think business transformation has always got to be owned by senior management. Once people really understood that, they learnt how to handle those projects a whole lot better. Where you do get scope for innovation is on a much smaller scale—I am thinking of Jobcentre Plus involving the private sector and delivering various sorts of employment-related services. It is a much smaller scale, it is private finance engaging a different range of people in delivering services in different ways and giving them the freedom. Maybe that is slightly off your dial.

  Sir John Gieve: The thing that was a bit new in setting the contracts in private finance terms was the trade-offs between more capital expenditure upfront and less running costs to come which is very explicit and you have got an outside body looking at that. In prisons, for example, putting telephones in prisons or showers in cells which enabled you to cut down on staff escorting or supervising the use of collectively available facilities and so on. That has happened. Just going back to your competition point, the broader point is it is a competition in running prisons and, of course, the commissioning of some private prisons has gone alongside with competing in an open tender for the contract for managing the existing public sector prisons. What the private prisons programme has done is to build up the critical mass of contractors who can credibly take on one of the big public sector prisons and run it, and in the process it has established some benchmarks of what better management or reorganisation can achieve in terms of costs and, of course, the public sector prisons have responded to that. There is not a massive gap between the two but I do not believe we would get those levels of efficiencies if the whole thing was still run by a single service.

  Sir Kevin Tebbit: In the MoD in the way in which we approached this it was in terms of "What do you really need to own?" For example, we tried to think of ro-ro ferries. We needed them to surge troops across the Channel to reinforce Europe but we would not need them all the time and, therefore, we would only need to acquire them from the private sector for certain surge periods of the year and they could be used for other purposes as ferries when we did not need them. There was that innovative way of trying to work out a more cost-effective use of assets in the process of looking at PFI. I have to say that was not the majority of the sorts of programmes we introduced. We spent an awful lot of time trying to think of innovative ways of using the private sector which possibly took up more time than it should have done. The main benefits were more in importing private sector systems, standards and techniques into the public sector which perhaps were not there before in a way which was more effective and close to our own staff so they could learn from it than would have been the case through out-sourcing.

  Chairman: I fear we are going to have to up our run rate if we are going to get through all of the questions that we have.

  Q213  Lord Tugendhat: You have all spoken about how you gained experience over time, in other words you learnt as you went along, and I have two questions arising out of that. The first is, has there been a similar improvement or any other sort of improvement in terms of conventional public procurement? The second is, could PFI now be said in general to yield better results than the alternative, thus to be justifiable on those grounds regardless of the state of public finances?

  Sir Kevin Tebbit: Can I have a quick one on that first part, because we found this very valuable in applying these principles to availability contracting for the support of our fixed wing air fleet, for example, Tornado aircraft, and indeed for the integrated operational support of all our helicopters. We used PFI experience to put in place contracting for availability. For example, on an airbase today a commander requires so many Tornadoes at so many minutes' notice every day and the private sector delivers that requirement. With helicopters it is a percentage of the total fleet that has to be available for operational use every day and those come from PFI experience so it has been very useful in building wider understanding in the Department and the private sector.

  Lord Crisp: Two quick comments. On the public sector, as you saw, a quarter of our work is public sector anyway. There have been some very substantial changes which have not necessarily come from PFI, I have to say. Sir John Egan did a review for us which led to something called Procure21 which was then a methodology by which we could procure from the private sector and contracting sector much more quickly and much more standardised across the NHS, so it was a process of reducing cost and improving quality. On your second point about private sector PFI, I would say that in health a mixed economy is the right one. You do not want to be forced into PFI mode. There is the private sector and if you go to Florence Nightingale's hospital across the water, as it were, the new children's hospital there is basically charitably funded. So in our context of health, which I assume is different to others, it is a mixed economy but you should be able to use PFI.

  Ms Lomax: I am going to pass on this because it is six years since I was in central government. I thought things were improving across a broad front but I do not know.

  Sir John Gieve: Taking prisons as an example, it has improved the public offering. They have got to meet the competition and in Liverpool Prison and Manchester Prison, the public service managers have to put in a bid and it has to win, so it has a very evident impact.

  Q214  Lord Best: My question is about changes that occur later in the course of a contract and whether renegotiation is a big hurdle. There are things that might happen early on and there are things that can happen 15 years down the line. One of the criticisms of the whole PFI approach that we have heard is that you are boxed in to continue to maintain that building long after you want it. It might be a school and you might not have schools in the same way, or care homes, you might not still want a care home of that kind in 15 or 20 years from now, so is getting out of what you signed up to on day one a fundamental problem with the PFI system?

  Sir John Gieve: I think there is a benefit to this. We are coming into a period of cuts and normally cuts mean cuts in maintenance first of all and of course PFI contracts lock in maintenance, so that is one of the benefits of doing the contracts. I suspect you are right, down the road there will be occasions when you are left with an estate that you do not want any longer. I do not know whether that will be more expensive than what happens if you do own it. There are always costs of changing your mind on what is required.

  Ms Lomax: I think it depends on your original contract. The PRIME contract I have spoken about actually allows quite a lot of flexibility. The shape of the Department that it was supposed to be providing for and the way in which services were delivered really changed quite fundamentally after the project was signed. It was basically a pre-1997 contract and I think one of the pluses about it was that it did prove flexible both for the changes in the first few years of this Government's time and also when it was renegotiated to accommodate DSS turning into DWP, and that was done quite successfully with an improvement in the terms. So that particular contract met that test even though the future was very different from the one that was envisaged when it started but I imagine health is a different one again.

  Lord Crisp: I agree with what was said there. May I reinforce Sir John's point which is that it is not about measuring PFI against a no cost option and a lot of the criticism of PFI is that PFI gets blamed for stuff which you are going to have anyway. If you are going to change a hospital later on there is a cost. Whether it is the same cost or not is another question, but you are going to keep on paying for your capital in some way or another. The other key point I would like to bring in is relationships and all the anecdotal evidence—and I do not know if anyone has looked at it more than that—is that the PFI contracts that work best are the ones where people have really worked at the relationship and the contractor feels part of the process and the NHS feels that the contractor is part of the process and that they are working through changes as they need to do so. That does not always happen. The little anecdote I gave about the matron this morning who clearly felt that it was difficult to make even relatively minor changes but nevertheless on the big picture it was an improvement. It is an issue but my guess is that in 116 hospitals you get 116 different pictures.

  Sir Kevin Tebbit: Back to our 2005 study, 85% of the managers of the contracts felt they had the flexibility sufficient to cope with whatever they could foresee. Of course it does work the other way round as well. With a tight contract, if the supplier gets into trouble, then of course we have the right to terminate, and on that basis you can find yourself inheriting an asset which you do not have to pay the full cost for, so it does work in both directions.

  Q215  Lord MacGregor of Pulham Market: Just following that up, the question of renegotiation does not only relate to changing requirements. If the contract has run into difficulty because the provider perhaps cannot otherwise deliver the renegotiated contract—your point—I do not know if any of you have any experience of one of those happening and, if so, what occurred?

  Sir Kevin Tebbit: My Department tells me we do have one. I am not sure if I ought to talk about it, but we do have one where we are in the process of terminating and the penalties that the contractor will have to pay are very severe.

  Ms Lomax: I can think of two examples. One was while I was Permanent Secretary—a project that I have not talked about, a small PFI which the DSS had for medical services. Originally it was with SEMA, then SEMA got taken over by Schlumberger, so we had Schlumberger/SEMA on the other side and we were very unhappy with what they were doing. It was an unusual operation. We had to renegotiate that and it took up an enormous amount of senior time to do so. It was a combination of them having changed and us learning how to manage the contract. I think that has worked out reasonably well. The other one, which I cannot speak about with any authority, is the London Underground PPP and Metronet, where obviously renegotiation was a big deal.

  Q216  Lord MacGregor of Pulham Market: The question I was going to ask you is how far can private finance be extended to deliver public services, for example pilot training, the supply of nurses, et cetera? Are any limitations doctrinal or economic?

  Ms Lomax: I always thought there were some limitations; because we used to think about this in relation to DSS and DWP, where we really felt we had to outsource almost everything that was not core, so we had to think a bit about what was core for us. We did medical services but we never did benefit administration because we felt that was what the Department was all about. There is just no way you can transfer the risk of something which is fundamental to the Department's purpose and statute. I do not know whether the department still sticks with this but I certainly had a fairly clear line in my mind as to where in the supply chain the private sector stopped and we started.

  Lord Crisp: I take a very similar view. My examples would be that we set up a joint venture for back office services, NHS Shared Services, with the private sector, which works very well. We did at one point look at what would it be like if you decided to do something similar with the teaching hospitals. Teaching hospitals are about the most complex organisation you can get because of the university/hospital relationship and so on and it was far too risky to think about. That would be my example equivalent to Ms Lomax's one.

  Sir Kevin Tebbit: The same thing.

  Q217  Lord Tugendhat: Could I ask a supplementary. This is a very self-interested question and I declare an interest as Chairman of Imperial College Healthcare NHS Trust. It is this: when the Government takes an unexpected initiative, and I have particularly in mind its decision earlier this year that single sex accommodation should become universal by the end of the year, it has always been a priority but it moved up the scale of priorities—if you have infrastructure of the sort that we have at St Mary's and Hammersmith that costs a lot of money and it really does create great structural and financial difficulties. If you are in a PFI hospital and the Government takes an initiative of that sort which has to be done, and I was interested because Sir John talked about maintenance being built in. I realise that they probably have such nice buildings they do not have the same problems over single sex, you see the problem I am getting at? Who bears the burden of that?

  Lord Crisp: I suppose if I were to put on a chief executive hat rather than a permanent secretary hat I would say quite clearly I would have thought your predecessors might have seen it coming. This has been a policy for a very long time. St Mary's has been an issue in this for a very long time. Do you see what I mean?

  Q218  Lord Tugendhat: I see all that and I am living with the consequences but if somebody else was in a PFI situation when they are faced with a policy of this sort which is going to cost money, who bears the burden?

  Lord Crisp: My gentler reply then would be that of course you bear the cost but you are in a position to negotiate that with your purchasers of services and say, "Look, central government is imposing this burden on us and therefore it is reasonable that we should be able to put up the prices that they pay you for looking after patients." That would be the way round it and the dialogue I guess I would try and get into.

  Sir John Gieve: It also depends how much of this is a one-off and how much you are doing a series of deals with the same contractors. If it is the latter there is value in the relationship for the contractor as well as for you. Quite often you can renegotiate these things on a perfectly reasonable basis. If it is a one-off obviously you are more at risk of someone saying, "It is not in the contract and I want to be paid full price."

  Q219  Chairman: So far we have been concentrating on the contractual and operational side of PFIs. Perhaps we could turn to look at the source of funds and the private bit of the finance side. There is a widespread view or at least a view that has been put to us that one of the main benefits of having private finance is that for the most part it off balance sheet. Is there any truth in that?

  Ms Lomax: As I said earlier, I think there was. It was quite an important driver of the initial interest in private finance. It was not the only reason but during the times when public expenditure was very tight during the 1990s, really in my departments until about 2002, it made a big difference whether something was off balance sheet or not. That was always slightly uncomfortable. I think things did change for the better. It really is a very bad criterion for deciding whether to do something, that it is off balance sheet, as we have seen in other contexts recently.

  Sir John Gieve: I think it was a major factor and the Treasury, in a sense, looked at it the other way, that this was the spur to get departments to do things they did not want to do,

  Ms Lomax: I was in the Treasury at the time!

  Sir John Gieve: So for the enthusiasts this was a necessary carrot to get the whole thing started in the 1990s. From the departments' point of view through the years of public sector restraint, which was really all of the 1990s up to about 2000, absolutely you could not do a lot of these things unless you did it off balance sheet. Subsequently of course the NAO have sharpened up their treatment and a lot of these things have come on balance sheet. All the private prisons for example are on balance sheet at the moment. At the same time of course we have had years of plenty in terms of public finance so that has become less important.

  Sir Kevin Tebbit: The Ministry of Defence never had much funding, we never had enough, and my sense was that in the bad old days up to about 2000 the Treasury almost withdrew money from the baseline in terms of capital funding and forced departments to go for PFI on the basis of off balance sheet, which was bad discipline all round but that is what happened. I agree, as time went by value for money became the criterion and one ended up with a mixture, so I think in the MoD it is about three-quarters perhaps that is still off balance sheet and about a quarter on balance sheet and value for money is the criterion one applies, but certainly in the early days there was no alternative.

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