Politicians call credit card companies usurers for charging 30% interest rates- yet this very same Labour government is paying 30% annaul costs for building PFI hospitals. Don't take my word for it- it's the ACCA- the Association of Chartered Certified Accountants who have calculated these charges: 
Evaluating the operation of PFI in roads and hospitals
By the ACCA Research Report No. 84
Pam Edwards, Jean Shaoul, Anne Stafford and Lorna Arblaster, 2004
Executive summary
Partnerships are one of the keystones of the Government’s reform of the public services. They have both macro-level and micro-level objectives. At the macro level, the intention is to lever in the private finance that the Government cannot afford. In some sectors such as roads, a parallel macro objective has been to create private sector capability. At the micro level, partnership objectives embrace value for money (VFM), a concept that includes the transfer to the private sector of risk and the associated costs that would otherwise be borne by the public sector and the greater expertise, efficiency and innovation that the private sector is assumed to possess.
The introduction of partnership working, known as the Private Finance Initiative (PFI), was heralded with much enthusiasm by the then Conservative Government in the early 1990s and was later adopted with similar enthusiasm as a cornerstone of the incoming Labour Government’s policy for improving infrastructure and public services. The Labour Government re-branded the policy as public private partnerships (PPP), widened it to include several different forms of which the PFI is but one, and has, confusingly, used the terms PPP and PFI interchangeably. Under the PFI, the public sector procures a capital asset and non-core services from the private sector on a long-term contract, typically at least 30 years, in return for an annual payment.
Subsequently ministers, Government officials and others with financial interests in the PFI policy have claimed much success for projects. However, numerous IT PFI projects have failed. Several PFI/PPP projects have had to be bailed out, some have been scrapped and others have been the subject of widespread criticism. The National Audit Office (NAO), the Public Accounts Committee (PAC), the Audit Commission and Accounts Commission have been circumspect about the levels of success, and identified various lessons to be learned. Despite the welcome investment in public services, the policy remains unpopular with the public at large and the relevant trade unions.
So far, most research has focused on the decision-making processes that led up to the signing of a partnership contract or examined the benefits and costs from an a priori perspective. The NAO’s studies of some of the early roads projects report that the payment mechanism created additional risks for the public sector that raise questions about the value of risk actually transferred to the private sector (National Audit Office 1998, 1999). In the context of hospitals, a considerable body of evidence challenges both the macro and the micro-economic arguments (Pollock et al. 2002), raising questions about service provision and the conflict between policy promotion and regulation (Froud and Shaoul 2001). Several studies have examined the business cases supporting the use of private finance for new hospital builds, and question the ability of the methodology to measure VFM in an unbiased way, the degree to which the business cases demonstrate VFM and the higher cost of PFI over conventional procurement (Gaffney and Pollock 1999; Price et al. 1999; Pollock et al. 2000; Froud and Shaoul 2001; Shaoul 2005). Their evidence shows that the VFM case rests upon risk transfer. The credit ratings agency, Standard and Poor’s, in its report for the capital markets (Standard and Poor’s 2003), states that the PFI companies carry little effective risk. Other work shows that the high costs of PFI projects lead to affordability problems, an issue that the emphasis on VFM downplays, and lead to hospital downsizing in order to bridge the affordability gap (Hodges and Mellett 1999; Gaffney and Pollock 1999; 1999b; Gaffney et al. 1999a; 1999b; 1999c; Pollock et al. 1999).
By way of contrast, this research study focuses on the actual performance in two sectors, roads and hospitals, which have substantial commitments to partnership financing and projects that have been in place for some years. In roads, where PFI projects are known as design, build, finance and operate (DBFO), the eight projects signed in 1996 represented about 35% of all new construction in the roads sector between 1996 and 2001 (DTI 2002). In the Government’s 10-year national plan, 25% of the £21 billion allocated for the strategic highway network will involve private finance (DETR 2000). In the health sector, there has been a continuous expansion of private finance since the first health contract was signed in 1997 and by April 4th 2003 some 117 schemes had been approved by the Department of Health with a value of £3.2 billion (HM Treasury 2003c). These two sectors offer contrasting environments, in terms of the relationship between central government and the procuring entity, and previous experience of contracting with the private sector.
Our report is in three parts. First, we examine the advice from official bodies about how PFI should be evaluated. We examine the literature as it relates to the available evidence about the nature of post-implementation reviews of PFI projects and the methodology and process issues that constrain such evaluative research.
Secondly, we identify the origins, development, nature and scale of PFI in roads and hospitals. Our study focuses on the first eight DBFO projects in England managed by the Highways Agency and the first 13 PFI hospitals (12 in England and one in Scotland). We then analyse the reported financial performance of both the public and the private sector partners using information obtained directly from the Highways Agency and the hospital trusts, and Companies House respectively. Thus we have focused on information that is in the public domain, supplemented by contextual information provided by staff at headquarters level in both sectors. We also examine the costs and affordability of these PFI projects in terms of their impact on the budget of the relevant procurer. Our emphasis is on costs to the public sector, returns to the private sector, the effective cost of private finance and its affordability to the public purse.
Our concern is with the extent to which the financial reporting by all the parties involved in PFI provides accountability to the public. The concept of accountability in the context of public expenditure on essential public services implies first that citizens, or at least their political representatives, the media, trade unions, academics, etc, can see how society’s resources are being used and, secondly, that no members of that society are seen to have an explicitly sanctioned unfair advantage over others in relation to how those resources are used.
Thirdly, as well as a sectoral analysis of roads and hospitals, we examine two projects in greater detail, one each from the road and hospital sectors. We chose projects that had been implemented for at least three years and in which the construction phase was complete so that, unlike previous work, our focus is on the operation and maintenance phase. We used semi-structured interviews with a range of personnel from various parties to the projects. Given that PFI emphasises the nature of the long-term service agreements, we describe and evaluate the systems that were put in place to monitor the operational phase of projects, ensure that risk transfer operates in the way expected by the contract and thereby obtain VFM.
The research findings may be summarised under three interrelated headings: partnership and managing the contract; VFM and risk transfer; and financial reporting and accountability.
Partnership and Managing the Contract
* Partnership is an ideal to be aspired to rather than a description of the actual working relationship between public and private contracting parties and has implications for monitoring and accountability relationships.
* Planning of the performance monitoring systems is poor and leads to an increased workload in the management of the projects.
* Self-monitoring systems require high levels of trust, which is not always present, and public sector partners are conducting more monitoring activities than expected.
* Outcomes that are subjective in nature, eg hospital cleaning, are difficult to write in contractually effective ways and cause monitoring difficulties.
* While contingency plans should be prepared at least in outline for all major PFIs against the possibility of default by the private sector, none are evident.
Value for Money and Risk Transfer
* Soft project objectives may not be evaluated and user opinions about service are not always sought.
* It is impossible to compare the actual costs of PFI and thus VFM (one of the justifications for PFI) against the original public sector comparator (PSC) as the PSC quickly becomes out of date.
* Additional monitoring costs have increased the public sector’s costs and thus reduced VFM compared with the original expectations.
* Where risk is shared between partners its allocation may be unclear and therefore its transfer – so central to PFI – is uncertain.
In relation to roads, we find that:
* Demand risk is held by the private sector but this may create a new source of risk because the private sector cannot manage this demand.
* The Government guarantees the Highways Agency’s payments to the DBFO companies, which reduces the risk to the private sector.
* We calculate that the Highways Agency paid a premium of some 25% of construction cost on the first four DBFO roads to ensure the project was built on time and to budget.
* In just three years the Highways Agency paid £618 m for the first eight projects, more than the initial capital cost of £590 m, which refutes one of the Government’s justifications for DBFO. This means that the remaining payments on the 30-year contracts (worth about £6 billion) are for risk transfer, operation and maintenance.
* Because the full business cases are not in the public domain, there has been little external financial scrutiny of the deals and post implementation it is unclear how the actual cost of DBFO compares with the expected costs. Our evidence suggests that DBFO has turned out to be more expensive than expected. But how this affects the Highways Agency’s ability to fund other maintenance projects is unclear.
* The special purpose vehicles (SPVs) report an operating profit before interest and tax of about two thirds of their receipts from the Highways Agency and this is after subcontracting to sister companies. This operating profit (less tax) is the effective cost of capital.
* About 35% of the SPVs’ income from the Highways Agency is paid to their operations and maintenance subcontractors, typically sister companies, including an unidentifiable profit element for the subcontractor. Given that the contracts are still in their early years, the payments to the subcontractors are likely to represent operations rather than maintenance.
* Subcontracting in this way means that it is difficult to isolate the costs of operations and maintenance in DBFO contracts since the subcontractor may have multiple contracts elsewhere. The absence of such information makes it difficult for the public sector to benchmark costs when it comes to amending the contracts and negotiating new ones.
* Although the amount of tax payable by the SPVs is only 7% of operating profits, even this overstates the actual tax paid since this includes an element of deferred tax. This low tax rate, in the early years at least, challenges an important part of the Treasury’s new appraisal methodology for PFI which assumes that tax payable will be about 22%, which will in turn distort the VFM analysis in favour of PFI.
* The SPVs’ interest rate of 11% in 2001 and 9% in 2002 and the high level of debt, which is greater than the construction costs, means that the DBFO contracts are considerably more expensive than the cost of conventional procurement using Treasury gilts at the current rate of 4.5%.
* The seven SPVs’ post-tax returns on shareholders’ funds are high and higher than elsewhere in the industry.
* The seven SPVs’ total effective cost of capital was about 11% in 2002. While the NAO believes that this additional cost of private finance (six percentage points above Treasury stock) represents the cost of risk transfer (about £56 m), it is difficult to see what risks the companies actually bore since their payments were guaranteed by the Government and based on shadow tolls. In the context of rising traffic, this means that they were insulated from downside risk at the Highways Agency’s expense.
* In practice, the shadow tolls have led to a front loading of the payment flows to cover the future cost of maintenance, and hence the SPVs’ profits. But in the absence of arrangements to ring fence the post-tax profits, should the DBFOs fail for whatever reason later in the contract, the Highways Agency could find that it has to bear the remaining and higher cost of private capital and the maintenance costs that it thought it had already paid for.
In conclusion, the road projects appear to be costing more than expected as reflected in net present costs that are higher than those identified by the Highways Agency (Haynes and Roden 1999), due to rising traffic and contract changes. It is however impossible to know at this point whether or not VFM has been or is indeed likely to be achieved because the expensive element of the service contract relates to maintenance that generally will not be required for many years.
In relation to hospitals, we find that:
* The annual cost of capital for trusts rises with PFI by at least £45 m over and above the cost of a new hospital financed under the Government’s capital charging regime, even though the hospitals are considerably smaller than the ones they replace. This underestimates the additional cost of PFI, since the construction costs of PFI include an amount of up to 30% to cover the cost of private finance, transaction costs, etc.
* Conservatively estimated, the trusts appear to be paying a risk premium of about 30% of the total construction costs, just to get the hospitals built to time and budget, a sum that considerably exceeds the evidence about past cost overruns. Nine of the trusts report off balance sheet schemes, as the Treasury had originally intended, implying that most of the ownership risks have been transferred to their private sector partners. But as none of the corresponding SPVs report their hospitals on balance sheet either, this creates uncertainty as to who has ultimate responsibility.
* Within a few years of financial close, PFI charges are in some cases much higher than anticipated. This raises questions about the reliability and validity of the VFM case that was used to justify the decision to use private finance.
* The high cost of PFI means that about 26% of the increase in income in 2003 since 2000 is going to pay for PFI charges for new hospitals. About half of the income that the SPVs receive from the trusts relates to the cost of capital.
* About half of the income the SPVs receive from the trusts is paid to the SPVs’ subcontractors (typically sister companies) for construction, maintenance and services. Subcontracting in this way makes it difficult to isolate the cost of services in PFI contracts since subcontractors are likely to have multiple sources of income. This puts the public sector at a disadvantage when it tests the market some years into the contract.
* The SPVs were paying an effective cost of capital of 10% in 2002, about five points higher than the public sector’s cost of borrowing. The SPVs’ high effective cost of capital means that PFI contracts are considerably more expensive than the conventional procurement.
* The SPVs made a post-tax return on shareholders’ funds of more than 100% in each of the three years 2000–02, higher than elsewhere in the industry and which, in the case of the Meridian Hospital Company Plc, was more than expected.
* This financial analysis is likely to underestimate the total returns to the parent companies because the SPVs subcontract to their sister companies and some of these subcontractors benefit from additional income via user charges for car parks, canteen charges, etc.
* £123 m or 51% of the private sector’s receipts from the trusts are attributable to the cost of capital. Since this is about five percentage points above the cost of Treasury debt, then the extra cost of private finance constitutes the cost of transferring risk, the risk premium. The risk premium was approximately £62 m in 2002. It is unclear whether this is money well spent.
* Six out of the 13 trusts we analysed are in deficit, and four of the nine trusts with off balance sheet PFI projects had significant net deficits after paying for the cost of capital.
* Assuming that the financial performance of trusts is a proxy for affordability, then the fact that hospitals with PFI contracts were more likely to be in deficit than the national average in the period 2002–03 suggests that PFI is not affordable. This has potentially serious implications for service provision and access to healthcare.
* As well as the cost to the trusts, PFI creates additional costs at Treasury level since the capital charges that would normally be recycled within the healthcare economy ‘leak’ out of the system. We estimate conservatively that this is costing about £125 m a year.
Taken together, this financial analysis shows first, that in some cases PFI has turned out to be less economical than expected, and secondly, since these are all long-term projects, it is impossible to know whether they will deliver VFM over the full term of the contract. In so far as they are costing more than expected, this has an impact on the individual trusts and the wider NHS budget that must affect both staff and patients.
Financial Reporting and Accountability
* Despite annual costs in each sector of about £210 m for just these initial projects, there is little information available to the public as taxpayers and users.
* Financial information about PFI is opaque, partly because of Government-imposed confidentiality. In the roads sector in particular, this restricts access to the Highways Agency’s full business cases used to support the case for using private finance. The lack of information in the public domain makes it difficult to estimate the exact extent of the commitments incurred by the Highways Agency and the Department of Transport (DoT) and therefore provides little accountability to the public. In the NHS, disclosure is generally better than in central or local government.
* Private sector organisations use complex structures that involve close company status. Therefore related party transactions are not disclosed. The result is that returns on PFI projects are spread between these various entities and thus are disguised.
* Not only is there a lack of explanation for the treatment of PFI assets/liabilities and income/expenditure in both sectors, neither the treatments nor the amounts match across the public and private sectors. Some PFI projects are accounted for on balance sheet but others are off balance sheet and there has been a change in accounting policy in relation to some projects.
The net result of all this is that while risk transfer is the central element in justifying VFM and thus PFI, our analysis shows that risk does not appear to have been transferred to the party best able to manage it. Indeed, rather than transferring risk to the private sector, in the case of roads DBFO has created additional costs and risks to the public agency, and to the public sector as a whole, through tax concessions that must increase costs to the taxpayer and/or reduce service provision. In the case of hospitals, PFI has generated extra costs to hospital users, both staff and patients, and to the Treasury through the leakage of the capital charge element in the NHS budget. In both roads and hospitals these costs and risks are neither transparent nor quantifiable. This means that it is impossible to demonstrate whether or not VFM has been, or indeed can be, achieved in these or any other projects.
While the Government’s case rests upon value for money, including the cost of transferring risk, our research suggests that PFI may lead to a loss of benefits in kind and a redistribution of income, from the public to the corporate sector. It has boosted the construction industry, many of whose PFI subsidiaries are now the most profitable parts of their enterprises, and led to a significant expansion of the facilities management sector. But the main beneficiaries are likely to be the financial institutions whose loans are effectively underwritten by the taxpayers, as evidenced by the renegotiation of the Royal Armouries PFI (NAO 2001a).
Our study has identified a number of areas for future research including longitudinal case studies that track the long-term relationships between contracting parties; an investigation into the technical accounting issues that surround accounting for the assets involved in PFI; a comparison of the financial performance of trust hospitals with PFIs against those without PFIs; and an examination both of the impact on public expenditure and the financial performance and viability of both public and private sector partners.
In conclusion, as we state earlier, our concept of accountability in the context of public expenditure on essential public services implies first that citizens, or at least their political representatives, the media, trade unions, academics, etc, can see how society’s resources are being used and, secondly, that no members of that society are seen to have an explicitly sanctioned unfair advantage over others in relation to how those resources are used. With respect to the first point, the difficulties experienced by the research team in obtaining and interpreting the financial statements of the relevant parties do not generate much hope that patients, road users, taxpayers and other citizens can see how society’s resources are being used. It is significant that more information is made available both by the companies and the Government to the capital markets than to the public at large. Within the financial statements there is little information about the impact of PFI contracts on the performance of the procurer, and there is a build-up of commitments and implicit guarantees within very long-term contracts about which there is little transparency. With respect to the second point, our analysis suggests that PFI is an expensive way of financing and delivering public services that may, where public expenditure is constrained, lead to cuts in public services and/or tax rises. In contrast, we suggest that the chief beneficiaries are the providers of finance and some, but not necessarily all of the private sector service providers rather than the public sector.
The above article was reproduced from the ACCA's own website at:
http://www.accaglobal.com/research/summaries/2270443
and a PDF version is available for downloading at ACCA PFI - Please note that it is 864K in size.
