2.6 Risk allocation

At the core of the PFI model is the principle that risks should be allocated between the public sector and the private sector to the party best placed to manage them. The standardised contractual framework for typical, availability based PFI projects transfers construction and availability risk to the private sector, as well as general risks of asset ownership (which are typically managed through insurance provisions). In some transport public private partnership (PPP) projects, demand risk has also been taken by the private sector, although generally this is only successful where there is an established market with a good track record and where appropriate levers are available to the concessionaire to develop the market and manage demand effectively.

For some other areas of risk that have been transferred under the PFI model, the private sector may not have effective means to mitigate or lay off the risk. This can result in a higher risk premium being charged to the public sector or in an inefficient capital structure and/or capital reserves being maintained.

It is recognised that the principles of risk transfer, cost and flexibility in PFI arrangements are linked - for example, changes to the contractual framework to increase flexibility for the public sector may increase risk for the private sector. Equally, however, where Government decides that it is appropriate to reduce risk transferred to the private sector in some areas, it would expect this to be reflected in lower costs charged back to the public sector. In these circumstances, however, it is important that the potential cost of this risk, in the hands of the public sector, is assessed.