Q211 Baroness Hamwee: My Lord Chairman, I know we might come back to procurement and management but I wonder if I could just ask one supplementary arising from that. I can well understand the need for new skills to be learnt. Did you bring in the private sector to help you learn the skills?
Ms Lomax: Yes. That is one reason why it was a bit of a field day for management consultants.
Lord Crisp: The answer is yes and no. In the Department of Health the person who leads it is exceptionally able to do this, has learnt it exceptionally well and has come up through the public sector ranks.
Q212 Lord Eatwell: I was very intrigued by Sir John's notion of competition between prisons. I had an image of the lads saying, "Let's go here rather than there" and so on. My question is rather different, it is about innovation. We have had very different views presented to us about the role of PFI in either stimulating or suppressing innovation, or slowing innovation down in the supply of public services. I wonder what is your view as to who really takes the lead in modernising public services and thinking about innovation?
Lord Crisp: I will dissect this out slightly because I think there are different bits of innovation here. If you take the two phases in the NHS, there was PFI and then there was LIFT. PFI was a contractual arrangement and the only room for innovation in that was in terms of the building. There was some innovation but perhaps not as much as there might have been. Indeed, right at the early stages ministers were very clear that the transfer of facilities management did not include any clinical staff. What you have then seen as the LIFT projects get underway, which are joint ventures, is innovation starting to happen in services. A limited amount of innovation in one when you are purely talking of construction and cleaning, if you like, but starting to see a bit more when you get out into the much smaller projects under the local LIFT scheme. In terms of stifling innovation, one of the problems that people do talk about to some extent, and I spoke to a matron this morning to check this out, is once you have established a deal with a PFI partner it is quite difficult to change sometimes and health moves on. This particular matron said to me, "It's like renting a house rather than owning a house. When we owned the house it was easier for us to make changes, but now we are the renting the facility it is harder to change the nature of the room". When asked about it further, he said, "However, compared to where it was there are enormous benefits for patients from this", so he was saying there are pluses and minutes. Clearly there are some ways in which innovation can be stifled.
Ms Lomax: It does depend what you are talking about. The PRIME contract was an innovative contract but it was actually using fairly well established private sector skills so I do not think what they were doing was innovation. They came together in a framework which set a new way for doing things. On a lot of our IT projects it was part of our naivety at the beginning of PFI that we hoped the private sector would somehow solve problems which were really for management to solve. IT projects were really business transformation projects and I think business transformation has always got to be owned by senior management. Once people really understood that, they learnt how to handle those projects a whole lot better. Where you do get scope for innovation is on a much smaller scale-I am thinking of Jobcentre Plus involving the private sector and delivering various sorts of employment-related services. It is a much smaller scale, it is private finance engaging a different range of people in delivering services in different ways and giving them the freedom. Maybe that is slightly off your dial.
Sir John Gieve: The thing that was a bit new in setting the contracts in private finance terms was the trade-offs between more capital expenditure upfront and less running costs to come which is very explicit and you have got an outside body looking at that. In prisons, for example, putting telephones in prisons or showers in cells which enabled you to cut down on staff escorting or supervising the use of collectively available facilities and so on. That has happened. Just going back to your competition point, the broader point is it is a competition in running prisons and, of course, the commissioning of some private prisons has gone alongside with competing in an open tender for the contract for managing the existing public sector prisons. What the private prisons programme has done is to build up the critical mass of contractors who can credibly take on one of the big public sector prisons and run it, and in the process it has established some benchmarks of what better management or reorganisation can achieve in terms of costs and, of course, the public sector prisons have responded to that. There is not a massive gap between the two but I do not believe we would get those levels of efficiencies if the whole thing was still run by a single service.
Sir Kevin Tebbit: In the MoD in the way in which we approached this it was in terms of "What do you really need to own?" For example, we tried to think of ro-ro ferries. We needed them to surge troops across the Channel to reinforce Europe but we would not need them all the time and, therefore, we would only need to acquire them from the private sector for certain surge periods of the year and they could be used for other purposes as ferries when we did not need them. There was that innovative way of trying to work out a more cost-effective use of assets in the process of looking at PFI. I have to say that was not the majority of the sorts of programmes we introduced. We spent an awful lot of time trying to think of innovative ways of using the private sector which possibly took up more time than it should have done. The main benefits were more in importing private sector systems, standards and techniques into the public sector which perhaps were not there before in a way which was more effective and close to our own staff so they could learn from it than would have been the case through out-sourcing.
Chairman: I fear we are going to have to up our run rate if we are going to get through all of the questions that we have.
Q213 Lord Tugendhat: You have all spoken about how you gained experience over time, in other words you learnt as you went along, and I have two questions arising out of that. The first is, has there been a similar improvement or any other sort of improvement in terms of conventional public procurement? The second is, could PFI now be said in general to yield better results than the alternative, thus to be justifiable on those grounds regardless of the state of public finances?
Sir Kevin Tebbit: Can I have a quick one on that first part, because we found this very valuable in applying these principles to availability contracting for the support of our fixed wing air fleet, for example, Tornado aircraft, and indeed for the integrated operational support of all our helicopters. We used PFI experience to put in place contracting for availability. For example, on an airbase today a commander requires so many Tornadoes at so many minutes' notice every day and the private sector delivers that requirement. With helicopters it is a percentage of the total fleet that has to be available for operational use every day and those come from PFI experience so it has been very useful in building wider understanding in the Department and the private sector. Lord Crisp: Two quick comments. On the public sector, as you saw, a quarter of our work is public sector anyway. There have been some very substantial changes which have not necessarily come from PFI, I have to say. Sir John Egan did a review for us which led to something called Procure21 which was then a methodology by which we could procure from the private sector and contracting sector much more quickly and much more standardised across the NHS, so it was a process of reducing cost and improving quality. On your second point about private sector PFI, I would say that in health a mixed economy is the right one. You do not want to be forced into PFI mode. There is the private sector and if you go to Florence Nightingale's hospital across the water, as it were, the new children's hospital there is basically charitably funded. So in our context of health, which I assume is different to others, it is a mixed economy but you should be able to use PFI.
Ms Lomax: I am going to pass on this because it is six years since I was in central government. I thought things were improving across a broad front but I do not know.
Sir John Gieve: Taking prisons as an example, it has improved the public offering. They have got to meet the competition and in Liverpool Prison and Manchester Prison, the public service managers have to put in a bid and it has to win, so it has a very evident impact.
Q214 Lord Best: My question is about changes that occur later in the course of a contract and whether renegotiation is a big hurdle. There are things that might happen early on and there are things that can happen 15 years down the line. One of the criticisms of the whole PFI approach that we have heard is that you are boxed in to continue to maintain that building long after you want it. It might be a school and you might not have schools in the same way, or care homes, you might not still want a care home of that kind in 15 or 20 years from now, so is getting out of what you signed up to on day one a fundamental problem with the PFI system?
Sir John Gieve: I think there is a benefit to this. We are coming into a period of cuts and normally cuts mean cuts in maintenance first of all and of course PFI contracts lock in maintenance, so that is one of the benefits of doing the contracts. I suspect you are right, down the road there will be occasions when you are left with an estate that you do not want any longer. I do not know whether that will be more expensive than what happens if you do own it. There are always costs of changing your mind on what is required.
Ms Lomax: I think it depends on your original contract. The PRIME contract I have spoken about actually allows quite a lot of flexibility. The shape of the Department that it was supposed to be providing for and the way in which services were delivered really changed quite fundamentally after the project was signed. It was basically a pre-1997 contract and I think one of the pluses about it was that it did prove flexible both for the changes in the first few years of this Government's time and also when it was renegotiated to accommodate DSS turning into DWP, and that was done quite successfully with an improvement in the terms. So that particular contract met that test even though the future was very different from the one that was envisaged when it started but I imagine health is a different one again.
Lord Crisp: I agree with what was said there. May I reinforce Sir John's point which is that it is not about measuring PFI against a no cost option and a lot of the criticism of PFI is that PFI gets blamed for stuff which you are going to have anyway. If you are going to change a hospital later on there is a cost. Whether it is the same cost or not is another question, but you are going to keep on paying for your capital in some way or another. The other key point I would like to bring in is relationships and all the anecdotal evidence-and I do not know if anyone has looked at it more than that-is that the PFI contracts that work best are the ones where people have really worked at the relationship and the contractor feels part of the process and the NHS feels that the contractor is part of the process and that they are working through changes as they need to do so. That does not always happen. The little anecdote I gave about the matron this morning who clearly felt that it was difficult to make even relatively minor changes but nevertheless on the big picture it was an improvement. It is an issue but my guess is that in 116 hospitals you get 116 different pictures.
Sir Kevin Tebbit: Back to our 2005 study, 85% of the managers of the contracts felt they had the flexibility sufficient to cope with whatever they could foresee. Of course it does work the other way round as well. With a tight contract, if the supplier gets into trouble, then of course we have the right to terminate, and on that basis you can find yourself inheriting an asset which you do not have to pay the full cost for, so it does work in both directions.
Q215 Lord MacGregor of Pulham Market: Just following that up, the question of renegotiation does not only relate to changing requirements. If the contract has run into difficulty because the provider perhaps cannot otherwise deliver the renegotiated contract-your point-I do not know if any of you have any experience of one of those happening and, if so, what occurred?
Sir Kevin Tebbit: My Department tells me we do have one. I am not sure if I ought to talk about it, but we do have one where we are in the process of terminating and the penalties that the contractor will have to pay are very severe.
Ms Lomax: I can think of two examples. One was while I was Permanent Secretary-a project that I have not talked about, a small PFI which the DSS had for medical services. Originally it was with SEMA, then SEMA got taken over by Schlumberger, so we had Schlumberger/SEMA on the other side and we were very unhappy with what they were doing. It was an unusual operation. We had to renegotiate that and it took up an enormous amount of senior time to do so. It was a combination of them having changed and us learning how to manage the contract. I think that has worked out reasonably well. The other one, which I cannot speak about with any authority, is the London Underground PPP and Metronet, where obviously renegotiation was a big deal.
Q216 Lord MacGregor of Pulham Market: The question I was going to ask you is how far can private finance be extended to deliver public services, for example pilot training, the supply of nurses, et cetera? Are any limitations doctrinal or economic?
Ms Lomax: I always thought there were some limitations; because we used to think about this in relation to DSS and DWP, where we really felt we had to outsource almost everything that was not core, so we had to think a bit about what was core for us. We did medical services but we never did benefit administration because we felt that was what the Department was all about. There is just no way you can transfer the risk of something which is fundamental to the Department's purpose and statute. I do not know whether the department still sticks with this but I certainly had a fairly clear line in my mind as to where in the supply chain the private sector stopped and we started. Lord Crisp: I take a very similar view. My examples would be that we set up a joint venture for back office services, NHS Shared Services, with the private sector, which works very well. We did at one point look at what would it be like if you decided to do something similar with the teaching hospitals. Teaching hospitals are about the most complex organisation you can get because of the university/ hospital relationship and so on and it was far too risky to think about. That would be my example equivalent to Ms Lomax's one.
Sir Kevin Tebbit: The same thing.
Q217 Lord Tugendhat: Could I ask a supplementary. This is a very self-interested question and I declare an interest as Chairman of Imperial College Healthcare NHS Trust. It is this: when the Government takes an unexpected initiative, and I have particularly in mind its decision earlier this year that single sex accommodation should become universal by the end of the year, it has always been a priority but it moved up the scale of priorities- if you have infrastructure of the sort that we have at St Mary's and Hammersmith that costs a lot of money and it really does create great structural and financial difficulties. If you are in a PFI hospital and the Government takes an initiative of that sort which has to be done, and I was interested because Sir John talked about maintenance being built in. I realise that they probably have such nice buildings they do not have the same problems over single sex, you see the problem I am getting at? Who bears the burden of that?
Lord Crisp: I suppose if I were to put on a chief executive hat rather than a permanent secretary hat I would say quite clearly I would have thought your predecessors might have seen it coming. This has been a policy for a very long time. St Mary's has been an issue in this for a very long time. Do you see what I mean?
Q218 Lord Tugendhat: I see all that and I am living with the consequences but if somebody else was in a PFI situation when they are faced with a policy of this sort which is going to cost money, who bears the burden?
Lord Crisp: My gentler reply then would be that of course you bear the cost but you are in a position to negotiate that with your purchasers of services and say, "Look, central government is imposing this burden on us and therefore it is reasonable that we should be able to put up the prices that they pay you for looking after patients." That would be the way round it and the dialogue I guess I would try and get into.
Sir John Gieve: It also depends how much of this is a one-off and how much you are doing a series of deals with the same contractors. If it is the latter there is value in the relationship for the contractor as well as for you. Quite often you can renegotiate these things on a perfectly reasonable basis. If it is a one-off obviously you are more at risk of someone saying, "It is not in the contract and I want to be paid full price."
Q219 Chairman: So far we have been concentrating on the contractual and operational side of PFIs. Perhaps we could turn to look at the source of funds and the private bit of the finance side. There is a widespread view or at least a view that has been put to us that one of the main benefits of having private finance is that for the most part it off balance sheet. Is there any truth in that?
Ms Lomax: As I said earlier, I think there was. It was quite an important driver of the initial interest in private finance. It was not the only reason but during the times when public expenditure was very tight during the 1990s, really in my departments until about 2002, it made a big difference whether something was off balance sheet or not. That was always slightly uncomfortable. I think things did change for the better. It really is a very bad criterion for deciding whether to do something, that it is off balance sheet, as we have seen in other contexts recently.
Sir John Gieve: I think it was a major factor and the Treasury, in a sense, looked at it the other way, that this was the spur to get departments to do things they did not want to do, Ms Lomax: I was in the Treasury at the time!
Sir John Gieve: So for the enthusiasts this was a necessary carrot to get the whole thing started in the 1990s. From the departments' point of view through the years of public sector restraint, which was really all of the 1990s up to about 2000, absolutely you could not do a lot of these things unless you did it off balance sheet. Subsequently of course the NAO have sharpened up their treatment and a lot of these things have come on balance sheet. All the private prisons for example are on balance sheet at the moment. At the same time of course we have had years of plenty in terms of public finance so that has become less important.
Sir Kevin Tebbit: The Ministry of Defence never had much funding, we never had enough, and my sense was that in the bad old days up to about 2000 the Treasury almost withdrew money from the baseline in terms of capital funding and forced departments to go for PFI on the basis of off balance sheet, which was bad discipline all round but that is what happened. I agree, as time went by value for money became the criterion and one ended up with a mixture, so I think in the MoD it is about three-quarters perhaps that is still off balance sheet and about a quarter on balance sheet and value for money is the criterion one applies, but certainly in the early days there was no alternative.
Q220 Chairman: Can I ask a slightly different question about the sources of funds. We know that the cost of capital from the private sector is significantly higher than if the government were a borrower. I wonder if we could tease that out a little. We have heard for example that in the United States there are public infrastructure banks which are able to get sources of funds at the public sector rates. If there were something similar here in the UK, a bit like the European Investment Board but operating internationally perhaps with rather wider scope, would you get nearly all the benefits potentially of a PFI in terms of the contractual relationships and the operational look at both the capital investment, the infrastructure and service throughout the whole life of the project or not?
Ms Lomax: There was always a cost/benefit calculation. There was this additional cost from the finance but then you had to try and quantify the benefits that you would get from PFI. I do not think there is a necessary relationship between the risk premium, if you like, that the private sector person had to pay and the benefits that you get from PFI, at least in the PFIs that I was involved with. They were bringing in skills, experience and structures that were there in the private sector and which, after a long period of capital rationing in the public sector, were just not in the public sector. I do not think there is a necessary relationship but obviously the hurdle is less high if the private sector, for whatever reason, can borrow at the risk-free rate.