[acca global] the private finance initiative - a briefing

7/31/2019 [ACCA Global] the Private Finance Initiative - A Briefing

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THE PRIVATE FINANCE INITIATIVE

A briefing

September 2002


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Introduction

The Private Finance Initiative (PFI) has been shrouded in controversy since its

inception in 1992. Opinion is at best divided on the value of using PFI tofinance and improve the quality of public services.

In a recent survey of ACCA members working in the UK public sector only one

percent of the respondents strongly agreed that PFI generally provides value for

money whilst well over half of the respondents disagreed with this statement. In

a survey undertaken by the magazine Public Finance last Autumn, only one in

ten senior public sector finance managers agreed that:

"PFI and other forms of Public-Private Partnerships are having abeneficial effect on public services."

James Stuart, Chief Executive of Partnerships UK, admitted last year that the

government faces an uphill task in convincing the public of the need for PFI

deals. A recent pubic opinion survey found that 2 in 3 public feel that in

general public services should not be run for a profit.

Whether using PFI will provide public services efficiently is still largely a

political rather than professional opinion as there is so little evidence of the

outcome of such agreements. In a report1 last year the Audit Commission

stated that it was "too early to say whether PFI contracts generally offer the

public sector long-term value for money". The UK government is, however,

convinced that "the private and voluntary sectors can play a rolewhere use of

them can improve public services, nothing should stand in the way of their

use"2. As a result, in the short-term at least, the Public Finance Initiative (PFI)

is often the "only show in town", in that it is only this approach that will gain

HM Treasury approval for much needed capital investment.

1Building for the Future, PFI Management Paper, Audit Commission June 20012 Tony Blair in a speech to public sector employees, 16 October 2001


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The Commission on Public Private Partnerships3 commented that there should

be "an evidenced based approach to policy. A commitment is necessary to

pilot, monitor, and systematically evaluate a spectrum of partnership

arrangements. Depending on the evidence that emerges PPPs could be rolled

out or rolled back".

ARGUMENTS FOR THE PRIVATE FINANCE INITIATIVE

PFI was developed and was seen as attractive by the Labour Party

administration in 1997 as it appeared to be able to reconcile two apparently

conflicting objectives:

to significantly increase the investment in public services to maintain the national debt at a prudent level compared to the GDP.

The main arguments for PFI are now that it:

provides value for money by bringing private sector expertise in tomanage public services

provides the finance for significant investment in public services whichwould otherwise not be possible

and

allows a significant level of risk to be transferred to the private sector.

3 Institute for Public Policy Research, Building Better Partnerships: The final Report of the

Commission on Public Private Partnerships, July 2001


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THE MERITS OF THESE ARGUMENTS - A DISCUSSION

The question of whether PFI can actually provide value for money in the

procurement and provision of public services is discussed in the first section

below. Before any PFI project is approved it must be subjected to a comparison

with the costs that are assumed would be incurred if the project involved atraditional approach to public sector procurement. This evaluation of the

relative merits of the PFI and the Public Sector Comparator are considered in

the second section below.

UK public finances have fundamentally changed since 1997, the national debt

is now little more than 30% of GDP compared with Gordon Brown's prudent

level of 40%. Thus the government could borrow an additional 300 billion

without breaching this target. This compares with the capital value of 22

billion for the UK PFI schemes that have been completed so far and the 14billion of further schemes where formal contacts had been signed by July

20024. The issue of whether PFI will allow more public sector investment in a

shorter time-scale is considered further in section three below.

The fourth section of this briefing deals with the issue of the transfer of public

sector risks to the private sector. The final section is an article from a recent

edition of Public Finance which discusses the effects of PFI schemes on the

public sector employees directly involved.

4 OGC website July 2002


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SECTION ONE:

Does PFI provide value for money?

The government argues that partnerships with the private sector will ensure that

public services are provided more efficiently and so achieve greater value for

money. However, if we look at the structure of PFI projects it is hard to see

where this value for money can come from. In addition, if PFI is so efficient,

why does the government provide subsidies to public sector organisations that

use the PFI route? Finally why does the government not allow public sector

organisations a free choice on whether to use PFI or to finance their capital

investment directly?

If we take the example of a PFI hospital project, a PFI project will typically

include the provision of a new building and the services associated with that

building. This can include, for example, cleaning maintenance, heating, public

utilities and ancillary services for example, catering. Under PFI, the

accommodation would be designed by architects in consultation with health

managers and other users and built by a construction firm. Under traditional

procurement methods essentially the same approach would have been adopted.

The PFI project will also usually include all the associated non-clinical services

that will be required in the building over the life of the contract. In many

hospitals these services are already outsourced to a private sector provider.

With PFI, all these contractors are chosen as a job lot as they combine

themselves into a consortium to bid for the project. This may provide less value

for money as the trust may not be able to choose the optimum combination of

private contractors. A company that is very efficient at providing cleaning

services may not be as cost effective at providing building maintenance. In

addition, the financing of PFI schemes is estimated to cost at least one or two

percentage points more than if the money had been borrowed centrally by the

Treasury, as happens in traditional capital schemes.


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Competitive pressure will also be significantly reduced with PFI schemes as

these are usually for 30 or more years rather than three to five years for a

typical service contract. The long-term nature of PFI contracts means that,

however poor the value for money they provide, there is no escape route.

Possibly because of this, the government provides a range of subsidies that

mean that even if an individual PFI project is not cost effective, it will at leastcost less, for the particular organisation, than the traditional direct procurement

option.

In central government and the NHS, if the PFI route is chosen the NHS trust,

for example, will be able to reclaim any VAT they have paid to the PFI

contractor. If a new hospital is contracted for directly, the construction costs

are also liable for VAT, only in this case the VAT is not reclaimable by the trust.

This results in a government subsidy of 17.5% towards the construction costs

of all hospitals built under PFI.

In addition, each year NHS trusts (and central government departments) have

to pay capital charges of 6% of the value of their capital assets. These capital

charges are paid back to HM Treasury funds and so they can be re-cycled to

fund other public services. Capital charges are not due on PFI projects, an

effective subsidy to the trust of 6% of the capital costs of each PFI project.

In English local government, the subsidy is even clearer, if not so generous.

Special Grant Report No. 765 details the objectives of this subsidy as follows:

"to assist local authorities in England to meet that part of their

expenditure under private finance transactions which is attributable

to the capital element of the project costs."

This special grant scheme provides an annual grant to local authorities of

11.5% of the notional credit approval for their PFI schemes (in broad terms the

capital value of these schemes).

5Special Grant Report (No.76), Local Government Finance (England), DETR February 2001


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Despite these subsidies, public sector organisations are still not given the

freedom to choose the option that they consider will provide them with better

value for money. Capital finance or approval to borrow to invest is rarely

available and so PFI is seen as the only game in town. If investment is needed

it is PFI or nothing.

Even the recent IPPR report6, which is convinced of the benefits of public

private partnerships, recommends that:

'Government departments should be set an overall capital spending

budget that encompasses both traditional financed spending and the

capital value of PFI spending.'

and:

'PFI projects should not go ahead because a public authority believes

there is no alternative.'

The report also calls for

'an evidenced-based approach to policy. A commitment is necessary to

pilot, monitor, and systematically evaluate a spectrum of partnership

arrangements. Depending on the evidence that emerges PPPs [including

PFI projects] could be rolled out or rolled back.'

This seems to be a sensible idea. Instead of continuing to push through PFI

schemes, careful consideration should be given to the actual value for money

that existing schemes are providing. It does not appear prudent for the

government to ensure that the vast bulk of its capital investment is undertaken

via PFI without first undertaking a detailed study of the relative success of the

schemes that are currently in operation.


Commission on Public Private Partnerships, July 2001


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SECTION TWO:

PFI and the Public Sector Comparator:

are comparisons objective?

Since 1997, when the current government was first elected, 85% of the funds

for major NHS capital projects have come from PFI schemes. In each case the

costs of the PFI scheme have been compared with an estimate of the costs of

procuring the project by conventional means (the public sector comparator).

For a PFI scheme to obtain the go-ahead, this comparison has had to show

that, over the life of the scheme, the PFI option will be more economic than the

public sector comparator (PSC). In addition, the PFI scheme must also be

shown to be affordable.

Accountants are responsible for undertaking these comparisons and for ensuring

that they are objective. Readers of their reports will depend on the accountant's

professional integrity. However, a range of recent publications has suggested

that the financial appraisals that have been undertaken have been skewed in

favour of the PFI option. This may be in the short-term interests of the

particular NHS trust, but in may not be in the longer term interests of the

taxpayer or the longer-term image of accountants. Will accountants be blamed

if PFI schemes turn out to be more expensive than the alternative methods ofprocurement that they 'proved' did not provide value for money?


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In fact this is already happening. An a briefing paper from the BMA7 stated

that:

"Evidence continues to show that PFI hospital schemes are unnecessarily

expensive, and our concerns about affordability, value for money,

inflexibility, risk transfers and service cuts have not been satisfactorilyaddressed. Neither the advantages originally claimed for PFI nor the

improvements introduced by the government are likely to outweigh these

concerns."

The approach to assessing the value for money of a potential PFI scheme could

be considered to be biased in favour of the PFI alternative. The comparison is

undertaken by calculating the net present cost (NPC) of the two alternatives.

The costs of the PFI alternative are discounted as they occur over the, typically

30-year, lifetime of the project. In contrast, the capital funding of the publicsector comparator is not discounted as all the expenditure is assumed to occur

at the beginning of the project period (although it would almost certainly be

funded by an Exchequer loan).

In addition, a constant discount rate of 6% has been used since 1991 for

option appraisals in the NHS despite the significant fall in general interest rates

over the last few years. The viability of PFI schemes are very sensitive to the

discount rate that is used. None of the first 11 PFI schemes in the NHS would

have been considered to provide value for money if the discount rate used had

been 5% rather than 6%8.

7 Parliamentary Unit briefing papers, British Medical Association Funding - the NHS andpublic-private partnerships; September 20018 Sussex J. The Economics of the Private Finance Initiative; Office of Health Economics (April

2001).


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The government cites risk transfer as one of the main advantages of the PFI

approach to financing capital investment in the public sector. Indeed, without

it the case for PFI would fall in every project appraised. This is because the

cost of the risk transferred to the private sector is added to the cost of the

public sector comparator. The cost of the PFI project includes these risks and

so the PSC should be adjusted to include them as well.

However, there is little official guidance on how to calculate the risk transferred

and the publicly available evidence on the risk analysis and transfer actually

undertaken is very limited9.

Two risks that are often cited as being transferred to the private sector

contractor with a PFI project are:

delays in completing the projectand

cost overruns for the project.There is some evidence that the costs of these risks have been exaggerated, for

example, capital cost overruns on conventionally financed NHS construction

projects averaged 7% in the late 1990s. In contrast a cost overrun of 12.5% or

more is added to the cost of the public sector comparator for most NHS PFI

schemes10. The Treasury guidance (the 'Green Book') is currently being revised

and the private sector argument for an increase in the risk of cost overruns is

expected to be treated sympathetically11.

Other ways in which the figures may have been adjusted to indicate that the

PFI option provide greater value for money include assuming:

9 Allyson Pollock, Jean Shaoul, David Rowland, and Stewart Player Public Services and thePrivate Sector: a response to the IPPR; Catalyst www.catalyst-trust.co.uk November 200110 Sussex J. op cit11 Public Finance October 26 - November 1 2001 page 8


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a building life for the PSC of 45 rather than the usual 60 years, for example,the Royal Infirmary of Edinburgh

the opportunity cost of the land and buildings should be added to the PSC the cost of risks such as not meeting clinical saving targets or medical

litigation are to be born by the private partner, but not subsequently

transferred under the PFI contract

a variety of other unspecified risks are transferred to the private sector andthus added to the cost of the PSC

there will be no efficiency improvements over the life of the conventionallyprocured project

revising the PSC costs in the light of PFI bidsand

using market costs rather than actual current costs for the PSC.The other test that a PFI scheme has to pass is that of affordability. Again

there is evidence of creative accounting to show that the PFI scheme will be

affordable, this has included:

assuming a smaller hospital (with fewer beds)will meet future demand. AllPFI schemes have reduced the planned bed numbers as negotiations have

proceeded from the Outline Business Case (OBC)to financial closure, for

example, in Worcestershire a PFI funded hospital will have one-third fewer

acute beds than indicated in the OBC12

12 Froud J, and Shaoul J.Appraising & Evaluating PFI for NHS Hospitals; Financial

Accountability & Management (August 2001).


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additional funds being provided to the Trusts to cover the additional costs ofthe scheme in the early years

equipment for PFI schemes being funded from NHS block grantsand

assuming demanding reductions in the Trust's clinical costs to meet the PFItariff costs.

Accountants have a responsibility to provide financial information, within the

appropriate rules and regulations, that will further the aims and objectives of

their organisation. However, there may be conflicts and tensions with the

practice of creative accounting. There are also limits to how far it should be

taken without accountants coming up against their professional ethicalresponsibilities.

Jeremy Colman, assistant controller and auditor-general was reported recently

as saying that public sector comparators suffer from "spurious precision". He

went on to say the value for money exercises were "pseudo-scientific mumbo-

jumbo where the financial modelling takes over from thinking It becomes so

complicated that no one, not even the experts, really understands what is going

on". Finally he stated that "People have to prove value for money to get a PFI

deal. But because that is wrongly seen to be demonstrated only by the public

sector comparator, it becomes everything. If the answer comes out wrong you

don't get your project. So the answer doesn't come out wrong very often"13.

13Financial Times, 5 June 2002


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There may also be conflicts between the current requirements and the future

obligations of an NHS Trust. It may appear that capital investment is required

and that the PFI route is the only one that will gain approval. However, PFI,

although initially costing less in the early years of the project, may be more

expensive in the longer run when the capital charges of the traditionally

procured alternative would have dropped to much lower levels. Capital chargesin the NHS are based on the declining balance of depreciate costs and so are

front end loaded and reduce over the period that the asset is held.

In addition, each time a proposal is put forward that indicates that a PFI

scheme should provide greater value for money this reinforces the government's

view that PFI is the most efficient procurement route.

If this is in fact not the case this will have an adverse effect on the longer-term

availability of funds for capital investment as well as revenue funding for theNHS. The costs of PFI schemes will be an obligation for decades to come. In

addition, the more the government is provided with, possibly, subjective,

evidence of the value for money of PFI projects the more they will consider that

this is the standard approach that should be adopted. Again this could be at

the cost to future taxpayers who will be required to fund these PFI projects.

Accountants involved in assessing possible PFI schemes should consider

carefully the objectivity of the evidence that they are responsible for producing.

They should also consider their responsibilities to the longer-term public interest

in general rather than the short-term interests of their particular organisation.

Accountants may feel that they are under undue pressure to produce figures

that will 'prove' that the PFI scheme provides value for money and will be

affordable. If they consider that these pressures are such that they are being

pushed into breaking their professional code of conduct they should seek

assistance.


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SECTION THREE:

Does PFI allow more public sector

investment?Gordon Brown sets great store by 'prudence'. In this article I will argue,

however, that current levels of public investment do not provide an example of

prudent management of public finances. Capital investment in UK public

services recently reached a post-war low as a share of GDP14 and they are now

at recklessly low levels.

Gordon Brown claimed recently that 'public investment [is] being enhanced by

an additional amount of private investment, that leads in some cases to moving

forward with projects more quickly'15 John Prescott also defended public-

private partnerships recently asking 'What is the price of not involving private

finance? The real price is leaky overcrowded classrooms delayed operations

delayed journeys and a lack of care services.'16 In contrast, I want to

argue that the private finance initiative (PFI) and other forms of public-private

partnerships do not enable additional, higher, levels of investment in public

infrastructure.

In reality, one aspect of these schemes is that they are just another form of

state borrowing. They are not clever schemes of off-balance sheet financingthat magically combine high levels of public investment and apparently low

levels of public borrowing.

14 Institute For Fiscal Studies, Twenty-Five Years of Falling Investment? Briefing Note No. 20,November 2001, page 215The Times, Tuesday 5February 2002, page 616The Guardian Saturday 2 February 2002


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Since becoming the Chancellor of the Exchequer, in May 1997, Gordon Brown

has defined his prudent approach to public finance through two strict fiscal

'rules':

the golden rule: over the economic cycle, the government will borrow only toinvest and not to fund current spending

the sustainable investment rule: over the economic cycle, the ratio of netpublic sector debt to GDP will be set at a stable and prudent level, defined

by the Chancellor as 40 per cent of GDP.

The government has provided no justification for a net debt target of 40 per

cent of GDP it could just as easily have chosen 35 per cent or 45 per cent.

The Maastricht Treaty, for instance, allows UK gross general government debt

of no more than 60 per cent of GDP. This is consistent with net public debtbeing considerably higher than 40 per cent of GDP17. Historically 40% is a

very low level. For most of the century between 1750 and 1850 and for much

of the 20th century the UK national debt was worth more than 100% of its

national income. During the Second World War it peaked at over double the

national income.

Fig 1: Net UK debt as a percentage of GDP18

17 Institute for Fiscal Studies, The Government's Fiscal Rules, Briefing Note No. 16, April

2001, page 218 Office for National Statistics, Public Sector Finances August 2002, 19 September 2002


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When Gordon came into office, net public sector debt stood at nearly 45%

having grown fairly consistently of the last five years of the Conservative

administration. It has since fallen equally consistently and over the last 18

months has stayed at just above 30% (see Figure 1). The government expects

it to stay at this level until at least 200719.

Over the longer-term, the trend is if anything even clearer. Public Investment as

a Percentage of GDP fell fairly consistently from around 1967 to 2000 (see

Figure 2). By April 2002, the UK had the lowest level of public investment of

any major EU country. Much of this fall in public sector investment can be

explained as being a result of transferring functions away from the public sector.

Housing investment, for example, has been transferred from local authorities to

housing associations.

Figure 2: Public Investment including Capital Spending by the PrivateSector under the PFI as a Percentage of GDP, 1963200020

19 HM Treasury, Chapter 2, Budget Statement, April 200220 Institute for Fiscal Studies, Twenty-Five Years of Falling Investment? Briefing Note No. 20,

November 2001, page 6.


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However, capital investment in health and education has also fallen

significantly over the last 25 years. In 2000 capital investment in the NHS as

a percentage of GDP was approximately half its level in 1992 and at a lower

level than at any time since the early sixties21. In education, after allowing for

changes in the funding regime for further and higher education, capital

investment in 2000 as a percentage of GDP was still only one-third of its levelin 197322.

These low levels of capital investment mirror relatively low levels of overall

public spending on health and education in the UK. In 1998, Japan spent

approximately 75% more per year on each of its primary pupils and nearly 30%

more per year on each of its secondary pupils23. The USA spends a higher

proportion of its national income onpublic health services than the UK. In total

USA spending on health is nearly twice the level in the UK24.

The private finance initiative (PFI) has been used by central government over

the last five years to increase the use of the private sector in the delivery of

public services. PFI is used to buy services and public facilities from a

consortium of construction companies, financiers and service providers. The

public authority contracts with the private consortium to design, build and

operate schools, hospitals or other services.

Unlike previous public sector building programmes which were funded by

central government borrowing, under PFI the private consortium raises the

money to build the new hospitals or schools, for example, from bank loans and

through shareholders.

21 Institute for Fiscal Studies, Twenty-Five Years of Falling Investment? Briefing Note No. 20,

November 2001, page 19.22 Ibid., page 24.23 OECD, Education at a Glance, Paris 200124 Derek Wanless, Securing Our Future Health Draft report 2001


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PFI has had only a minimal effect on the overall level of capital spending as

Figure 2 above shows and there is little justification for using private finance in

terms of maintaining a prudent level of public sector borrowing. All PFI capital

works undertaken during 1999-2002 could have been replaced by traditionally

government borrowing without breaking the either the golden rule or sustainable

investment rule25.

The government could borrow an additional 300 billion pounds without

breaching its 40% of GDP rule. In contrast, the government is hoping for PFI to

deliver only 10.8 billion of capital investment in public services over the three

years from 2001-02 to 2003-0426.

Within the Health Service, Department of Health figures show that PFI projects

agreed in 2000/01 financed capital investment of roughly half a billion

pounds27

. This is approximately equal to the same Departments underspendon its current budget in that year alone28 and compares unfavourably with the

estimate that there is a backlog of maintenance due in the NHS of over 3

billion.29 The Department of Health also suggests that PFI investment will

increase, from 632 million to 832 million per year over the next three

years30. The NHS Plan31 details the government's goal of establishing 7billion-

worth of hospitals funded through PFI by 2010.


Commission on Public Private Partnerships, 2001, page 81-82.26 Institute for Fiscal Studies, Green Budget 2002, 30th January 2002, Table 3.5, page 46

27 Department of Health, Departmental Investment Strategy, p. 10,www.doh.gov.uk/dis/dis2000.pdf.

28 Institute for Fiscal Studies, Green Budget 2002, 30th January 2002, Table 2.1, page 1629 Department of Health, Departmental Investment Strategy, page 28.30 Ibid., page 23.31 NHS Plan Department of Health 2000.


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PFI is a form of borrowing, not funding, that shifts the burden onto future

generations. As the IPPR acknowledges32, the public sector repays the full cost

of the private sector providing the infrastructure and services in annual

payments over periods of 20 to 30 years. It does not access new forms or

higher levels of funding than would otherwise be the case with public funding.

Indeed, the cost of borrowing for PFI projects is estimated to be 1-2% higher

than the cost of government borrowing for direct public investment. As a result,

the government could increase investment, at no extra cost, if this were all to be

financed by direct exchequer borrowing rather than through PFI.

Far from levering in additional finances, PFI will either reduce the level of

investment achieved or increase the costs for future generations (unless private

sector efficiency can more than compensate for the additional financing costs

associated with PFI).

In addition, most PFI schemes do not now even reduce the government's official

level of borrowing, the Public Sector Net Debt. PFI schemes for roads and

prisons are included within this figure. Since Alan Milburn become the

Secretary of State for Health, in June last year, the capital value of PFI deals

within the Health Service has also been included in the official figures of

government debt.

As shown above, public sector capital investment in the UK is at a low level

compared with historic figures over the last 25 years, those for the last five

years of the previous Conservative administration and is also the lowest of any

G7 country. Government borrowing is significantly below both the Chancellor of

the Exchequer's own ceiling and that set by the European Union. For these

reasons, the argument that PFI is necessary to access much needed additional

finance for investment in public services cannot be sustained.


Commission on Public Private Partnerships, 2001.


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SECTION FOUR:

PFI and risk

Risk is at the heart of all PFI and other public private partnerships, but not

perhaps in the manner claimed by their supporters. It is only by adding the

value of risk that is claimed to be transferred to the private sector that any PFI

project can appear to demonstrate value for money. In reality, the main risks in

the provision of any essential public service will remain with the government. It

cannot afford to let these services fail and so, if necessary, the private sector

provider will be bailed out by the tax-payer. Far from the private sector

managing risks more effectively time and again private sector failures have

demonstrated that the key risks remain with the public sector.

The traditional method for any organisation or individual to avoid risk is through

insurance. We pay an insurance company to take over the responsibility for our

risk of having a car accident or our house burning down. However, most people

will only voluntarily insure against significant risks that they would find difficult

to fund in any other way. The costs of administration (and the profits of the

insurance companies) mean that organisations will usually only insure against

hazards and other risks whose consequences, should they actually occur, would

be difficult to finance.

For this reason, the government, being a large wealthy organisation has a policy

of not insuring its property. If any one government building was, for example,

to burn down, if may cost a few millions pounds to re-build. But, given the size

of the government's annual budget this would be easily absorbed.


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Thus, for example, the fire at the Yarl's Wood detention centre last year was

estimated to have caused damage to the tune of 43 million. This sounds a lot

of money, but compared to, for example, the increase in the Home Office's

budget announced for 2002-03 of 2,900 million the fire would not really

make much difference to the finances of this department.

Thus the advice from HM Treasury33 is that

"As a general rule the government does not purchase commercial

insurance for the risks it faces".

The modern general approach to the risks faced by all organisations is to adopt

an explicit approach and to positively managing these risks. But in Central

Government, at least, this is a relatively new development. So, for example, the

first formal HM Treasury guidance on risk management was issued inSeptember 2000 as the Orange Book34. This followed the NAO report,

Supporting Innovation: managing risk in government departments35 which

concluded that:

"The Modernising Government programme seeks to encourage

departments to adopt well managed risk taking where it is likely to lead

to sustainable improvements in service delivery. In pursuit of this the

Cabinet Office and the Treasury are acting with departments to promote

better risk management across government, including the requirement

for all departments to produce by September 2000 frameworks setting

out their approach to risk management in their areas of responsibility."

Thus it would appear that the issue of risk transfer should be seen as a method

for justifying a PFI project rather than as a reason for developing such an

approach. It is only in the circumstances of a PFI project that risk transfer is

assumed to be an advantage.

33Government Accounting, HM Treasury 2002

34Management of Risk - a strategic overview (The Orange Book), HM Treasury, September200035Supporting Innovation: managing risk in government departments, National Audit Office,

July 2000


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The value for money test only comes out in favour of PFI after a price has been

placed on the value of risk that is assumed will be transferred to the private

sector contractor. A study in the British Medical Journal36 showed that for

eleven hospitals the PFI was only better value for money than the public sector

comparator after risk was transferred. Even then the difference was very small,

only 0.05% at Swindon & Marlborough, for example. More suspiciously, thestudy demonstrates that "the value of the risk transferred is remarkably close to

the amount needed to close the gap between the public sector comparator and

the PFI".

The value of the risk that may have been transferred often appears to have been

exaggerated. Research, also published in the British Medical Journal37, showed

that NHS PFI schemes "have in most cases assumed that the public sector

projects overrun by 12.5% or more" whereas "the average increase in cost over

approved tender sums for NHS capital projects has been between 6.3% and8.4% in the 1990's". Work undertaken by consultants for the current review of

HM Treasury's Green Book admits that their estimates of cost and time overruns

for large public sector capital schemes are higher than other recent surveys.

This is because there have been improvements in recent years and because

other surveys omitted projects with unusually large overruns.

In reality many risks are not actually transferred to the private sector as a result

of the contract for PFI or other public private partnerships. For example:

Passport Office computer problems in 1999 led to queues and costsestimated at 13 million and the cost of passports being increased by a

third. The contractors contributed only 2.5 million.

Railtrack was effectively re-nationalised last year after it became insolventlast year when the government refused to provide any further funding

36Private Finance and "value for money" in NHS hospitals: A policy in search of rationale?Allyson Pollock, Jean Shaoul, Neil Vickers, BMJ Volume 324, 18 May 2002.37PFI in the NHS: is there an economic case? D Gaffney, A Pollock, D Price, J Shaoul, BMJ

Volume 319, 1999


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a recent report found that 18 of the first 31 NHS PFI schemes were in factdelayed and that, of those delayed, the average delay was 12 months

Channel Tunnel rail link PFI scheme contract let in 1996 for 1.7 billion,1998 the government provided a further 4 billion of funding

National Air Traffic Control System - privatised in July 2001 and providedwith an additional 30 million in January 2002 from the Government

PPP for tube - NAO briefing found that the major risks would not betransferred to the contractors

Yarl's Wood - the contractors are claiming that the Government should beliable for the costs of re-building the centre.

PFI is a form of privatisation. Public service provision is transferred to the

private sector. This can only be justified, from a VFM point of view, if the value

of risks claimed to be transferred to the private sector partner are taken into

account. These risks are regularly exaggerated, other measures to reduce them

are only now being introduced and, in many cases, it turns out that the most

significant risks remain with the public sector.

In reality, the key risk with PFI is of public services being provided at a greater

cost by the private sector. If these projects are successful, the private sector

makes a substantial profit. If they fail, it is the public that suffers disruption to

services and the costs of private sector mismanagement.


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TECH_DOC_001 THE PRIVATE FINANCE INITIATIVE A BRIEFING.DOC

The Association of Chartered Certified Accountants

[acca global] the private finance initiative - a briefing

Documents