This report analyses the Private Finance Initiative (PFI) in the hospital sector in the UK, with particular reference to the Norfolk and Norwich University Hospital (NNUH), one of the earliest and biggest PFI hospitals. Hospitals built under PFI contracts are financed by private companies which then rent them back to the National Health Service over long periods (generally more than 30 years).
PFI projects have been promoted strongly by Labour governments since 1997. This is in spite of the Labour party being opposed to PFI before it came to power. On coming to power in 1997, the Labour Government adopted a fiscal rule that the proportion of public debt to GNP should be kept below 40% and financing public sector investment through PFI was seen as a way of achieving this objective - at least in the short run.
Alongside this macro-economic rule, there has been the micro-economic objective of providing value for money. The PFI project had to be shown to provide value for money (VFM) and be cheaper than a public sector comparator (PSC). However as Jeremy Colman (as assistant auditor-general) pointed out; "if the answer comes out wrong, you don't get your project. So the answer doesn't come out wrong very often" (quoted in the Guardian of April 7, 2009).
Therefore the macro-economic rule led to the promotion of PFI projects by the Labour Government with the micro-economic objective (of providing VFM) being achieved by a manipulation of the comparisons. This manipulation was mainly carried out by adding on percentages for cost overruns which were very much higher than the average overruns (of no more than 13%) experienced on similar publicly-financed projects. Generally the cost overrun assumed for the PSC has been just high enough to tip the VFM assessment in the favour of the PFI project. The overrun assumed for the NNUH provides a good example. Not only was it very much higher than 13% but - at 34.22% - it was also astonishingly precise.
Thus the VFM comparisons invariably favoured the PFI projects in spite of the private cost of capital being more than twice that of the public sector. The financial model of a hospital analysed in this report shows that in order to compensate for this difference in the cost of capital, the private sector's construction cost has to be 40% lower than that of the PSC.
A major part of this report consists of an analysis of the NNUH, a privately-financed hospital, the first phase of which was completed in 2001. This analysis shows that the additional annual cost due to the PFI contract is at least £19 mn.
The company financing the construction of the NNUH is Octagon Healthcare. Nearly all the extra cost of the PFI contract is attributable to the additional rent payable to Octagon Healthcare. Before the PFI contract, the NNUH Trust was already paying a rent sufficient to finance a replacement hospital.
But the additional annual rent payable to Octagon Healthcare is £18 mn a year (at 2007 prices). This is a rent sufficient to pay three times over for the hospital.
Meanwhile the annual rate of profit for the shareholders of Octagon Healthcare has exceeded 100 per cent. This includes a £95 mn windfall profit in 2003 on refinancing which was described by the Chair of the Public Accounts Committee as "the unacceptable face of capitalism". Roughly a quarter of the shares of Octagon Healthcare are held by the Innisfree Group. Between 1998 and 2008, the annual rate of profit for the shareholders of Innisfree Limited was more than 200 per cent (if the directors' remuneration is included in the profits).
The excess rent of £18 mn payable for the NNUH is a definite loss attributable to the PFI project. In addition there might be excess costs arising from the payments for services and maintenance. This additional cost could be as much as £4 mn but the accounts to which I have had access are insufficiently detailed to confirm or deny this.
However there is an additional cost of about £1 mn attributable to the PFI contract. The new hospital is very much smaller (in terms of beds) than the hospitals that it replaced. This was a deliberate move to make the new, PFI hospital appear 'affordable'. As a result, beds have had to be purchased from private hospitals within the region at higher cost because the NNUH has been unable to carry out all the work itself. My estimate of the excess cost of these bed purchases was over £1 mn in 2008/09.
Thus the minimum additional cost attributable to the PFI contract at the NNUH is £18 mn for the additional rent and £1 mn for the purchase of beds in the private sector due to the overcrowding at the NNUH.
Thus the PFI at the NNUH has been an initiative providing a significant public loss alongside considerable private gain. There is every reason to suppose that the NNUH is not unique given that the private sector's cost of capital is double that of the public sector.
Thus the PFI has been an initiative of micro-economic stupidity. It is an initiative justified by a macro-economic objective of keeping the public sector debt-to-GNP below 40%. It is ironic that this is an objective which has now been rendered irrelevant by the macroeconomic crisis with the debt-to-GNP ratio being expected to rise above 50% in 2010-2011 and even higher after 2011. The macroeconomic crisis has been brought about by the same incompetent government that promoted the PFI.
What, if anything, can be done now? As far as the NNUH is concerned, chapter 11 of this report shows that the government - the taxpayer, if you like - would gain financially by buying out the contract. This is in spite of £300 mn having to be paid (under the terms of the contract) to buy out Octagon's liabilities; it is also in spite of the NHS having paid out already a little under £200 mn (at 2007 prices) in rent. Thus even if the contract is bought out now, the NHS would have paid about £500 mn. for a hospital, the basic construction cost of which in the late 1990s was £158 mn.
Nevertheless, in spite of this - that is, in spite of having to pay £300 mn. to cancel the contract, the NHS (and taxpayer) would still save £217 mn by buying out the NNUH's PFI contract. This is because the rent payable (at 2007 prices) between now and the year 2037 would be £800 mn. and even when discounted at the Treasury's 3.5 per cent per annum, this is equal to more than £500 mn.
All of which goes to show what an appalling waste of public money the PFI has been. It is of course highly unlikely that a buy-out of this or any other PFI contract will be undertaken by the present government led by Gordon Brown. Such a u-turn is unlikely. And it is even less likely under a government led by David Cameron. But at the very least, future PFI programmes should be cut back so as to avoid even higher costs n the future.