PFI NOT PRUDENT GORDON!
The Government maintains that PFI schemes are good value for money because costs are
never more than their public sector comparitors or PSCs (Hansard, col 157, 4 July
2000) but has rejected an important recommendation of the Treasury Select Committee (Fourth
Report 1999/2000, rec. f) that would ensure that this would demonstrably be the case
in practice. Experience has shown that there is little validity in the construction of
PSCs. Because of the non-availability of public finance, value for money appraisals are
mainly about securing approval for a PFI project rather than about choosing between
different options. The manipulation of the figures occurs through two main processes:
1. The effect of the discount rate
This is a way of calculating the difference in costs between making capital payments in
the first few years or in spreading them out over 30 years, as is the case with private
finance. The Treasury requires NHS Trusts to adjust future payments to PFI consortia at a
discount rate of 6%. This means that £1000 paid at £100 a year for 10 years has a
"present value" of £736. This can make a PFI project paid for over 30 years
look better value. This rate was set by the Tories to eliminate any advantages of lower
government borrowing rates (Stephen Dorrell quoted in Treasury Select Committee Sixth
Report 1995/6). As the Audit Commission says, a relatively small difference in the
discount rate used can mean the difference between a PSC being either above or below that
of a PFI bid (Taking the Initiative, 1998). In the case of the Cumberland
Infirmary, a lowering of the discount rate to 5.7% was enough to flip in favour of the
PSC. Even Kate Barker of the CBI has said that it would make sense to look at more than
one discount rate.
2. Transfer of risk
Despite the use of a 6% discount rate, net present values in almost all PFIs have been
to the advantage of the public sector option. However, under Government imposed guidance,
a lump sum is added on to the PSC allegedly to take into account the transfer of risks
which the public sector would have had to take under public procurement. The most
significant component of this "adjustment" is usually an amount to reflect
construction cost overruns but in many cases the figures used are overinflated to achieve
the desired outcome. For example, construction cost overruns for hospital projects have
been estimated at 17 to 18% when it is known from NHS Estates that it is currently around
8%. The risk adjusted PSC for the Cumberland Infirmary (which included £5 million to pay
for the risk of clinical savings targets not being met and £2.5 million for the risk of
medical litigation, neither of which are actually to be transferred) turned a £20 million
public sector cost advantage into a £1 million PFI advantage!
In the past, many of us have argued that the disadvantage of PFI arises from the higher
cost of raising private capital. This is no longer the case. Such has been the effect of
these risk transfer adjustments that the markets see little risk in PFI schemes and it has
been possible to raise capital at favourable rates - between 4 and 5% after inflation.
Interestingly, a favoured mechanism is turning out to be bond finance but the advantages
are kept by the private sector. Due to the increasing confidence in the financial markets
generally, in November 1999, Fazarkeley Prison Services Ltd. refinanced the project it had
been awarded in 1995 to build, maintain and operate the prison (now known as HMP
Altcourse). As a result, dividends to shareholders have increased by £10.7 million or 61%
(National Audit Office 29 June 2000). In the Cumberland Infirmary PFI, most finance
was raised by a bond issue at 7.18% interest (including inflation) whereas the
availability fee charged to the Hospital Trust, which excludes the service charge fee, was
equivalent to an interest rate of 9% on capital employed.
Several National Audit Office reports on PFI schemes justify high costs on the
basis that schemes can be delivered more quickly and the private bidders have introduced
innovative designs. Yet these so-called advantages only exist because of artificial
constraints on the availability of public funding and the Treasury's specific requirement
that the PSC must be based on current arrangements rather than any innovation or use of
new technology, a major factor in the decision to privatise National Savings.
Most public concern about the use of private finance has been in the NHS where new
hospitals are expected to open with fewer beds. Government ministers are adamant that
decisions on bed numbers are made by the hospital trusts and health authorities concerned
before deciding whether public capital or private finance offers value for money but they
have not yet responded to a call by the Treasury Select Committee that they ask the NAO to
study and report on this issue. The Government has, however, promised to consider how to
improve the clarity of the treatment of risks and benefits in the construction of the PSC
and the assessment of value for money. This cannot come too soon!
Article for Campaign Group News, September 2000.