3.9 Under the vast majority of PFI contracts in England, the risk of damage or failure of the assets during service delivery is transferred to the contractor. Since most contractors are limited recourse special purpose vehicles, they take out required insurances in the market. Their estimates of likely insurance premiums are included in the base case Financial Model that determines the unitary charge.
3.10 The insurance market is cyclical and contractors build in contingencies against adverse movements in the market. Over time, cost sharing mechanisms have been developed and implemented whereby authorities and contractors share the risk of premium fluctuations arising from market movements. These provisions were standardised and mandated in 2006. These provisions, and the non-standard ones that preceded them, attempted to minimise the inclusion of risk contingencies within unitary charges, whilst still incentivising contractors to seek the keenest prices.
3.11 As part of the initiative to review the scope for savings under operational contracts, insurance was highlighted as an area for investigation since
• there were reports of contractors enjoying very significantly reduced premium payments whilst authorities were paying out high amounts (as forecast in the model) as part of the unitary charge;
• there was concern expressed that the market might be mispricing PFI insurances and that PFI's low claims record was not being reflected in lower premiums (effective market failure).
3.12 HM Treasury has accordingly undertaken an exercise to review the market and the various insurance mechanisms within existing contracts, and to work with Departments to review whether existing contract insurance provisions are being implemented correctly (including the extent to which there have been financial rebates to authorities when due).
3.13 This work has confirmed that a large number of existing contracts do not have insurance risk sharing provisions. For these contracts, introducing sharing provisions now would expose authorities to additional costs in future insurance costs (as market rates are predicted to rise from a current low point in the cycle) and is not recommended. Government will continue to explore mechanisms for getting better value from insurance arrangements in these contracts.
3.14 Of the contracts that do have insurance risk sharing provisions, where contracts have applied risk sharing provisions correctly, these have often yielded rebates in insurance costs for the relevant authorities. However there is evidence of reviews of insurance costs not having been undertaken, and of risk sharing provisions having been incorrectly applied. Contract managers should ensure that insurance reviews are undertaken that could give access to additional financial rebates due to public sector authorities.
3.15 It is important that PFI contract managers familiarise themselves with how the contract's insurance cost/gain share provisions work. Each authority should ensure that their PFI provider complies with its reporting obligations in relation to insurance, and applies premium risk sharing provisions correctly.
3.16 Questions have been raised about whether additional insurance savings should be due to the public sector resulting from insurances being bought on a group basis across a portfolio of PFI projects owned by the same investor. To the extent that contracts contain insurance premium risk sharing provisions, then these should already apply to any such reductions in insurance premiums that have been achieved by the project company.
3.17 Alternative approaches to insurance are being considered by Government for future procurements (eg self insurance and pooled insurance), to weigh up potential cost benefits and the additional risks that would be brought back to the public sector. These alternative approaches are unlikely to apply in all cases but may be suited to the risk profile of particular sectors, and further work will be taken forward to consider these options.