3. Is there significant risk transfer to the private sector or is it more apparent than real?
3.1 There is significant risk transfer. PFI involves payment for performance and this is a fundamental driver of VFM-contracts link payment to quality of services rather than construction of an asset. The recovery of the contractor's capital investment is deferred over many years to ensure that the assets remain fit-for-purpose.14 The private sector having capital as well as future profits at risk is a powerful incentive for pre-signature due diligence and performance against the contract.
3.2 PFI contracts transfer delivery risk to the private sector in a way which is not achieved with the conventional separate procurement of capital investment and service delivery. PFI bundles the initial investment together with asset maintenance and related services in a single contract with a performance-related payment and internal interfaces managed by the private sector. If performance is sufficiently poor that the contract is terminated for contractor default, PFI does not guarantee a compensation payment- shareholder and lender investment in the project remains at risk.15
3.3 A number of contractors and banks have lost money on PFI investments. Detailed information is not easy to obtain because businesses do not see this as a "good news story" but there are a number of well-known examples within the industry where providers of capital have lost money, including a number of transactions involving Jarvis, National Physical Laboratory, several projects with Ballast Wiltshire as contractor, Neath Port Talbot energy-from-waste, and more recently Cornwall schools and Defence Animal Centre.
3.4 The private sector charges a cost for assuming risks and it is the cost: benefit analysis which is the central question here. This analysis involves comparing (a) the risk premium charged by the private sector to (b) an estimate of additional costs associated with those risks were they left with the public sector. The analysis is more than simply two parties performing exactly the same analysis and coming up with different answers (if it were simply that, the private sector risk premium would likely equal or exceed the public sector's cost of risk)-both analyses will reflect the potential costs which might arise under a given allocation of risks and the objective is to determine a risk allocation which incentivises the right people to do the right things.
3.5 It must also be recognised that where public services are involved the public sector will never be in a zero-risk situation. There will always be some risks retained by the public sector. For example if the construction of a school is delayed that will affect the delivery of teaching, which is delivered by the public sector for the local community using the PFI assets and services.16
3.6 One of the issues PFI was designed to address was poor maintenance of facilities and the long-term cost of this. It was considered that parts of the public sector gave insufficient attention to life-cycle maintenance. PFI was designed to break this cycle of new build and decay by making long-term maintenance integral to the project-long-termism as an antidote to the false economies of the past.
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14 Typically this "deferral" is achieved using a combination of bank debt and contractor equity invested in a special purpose vehicle. However, the choice of the best form of financing is part of the competitive procurement.
15 A limited number of transactions have moved away from this-in some circumstances underwriting lender losses to some degree may be value for money given potential savings on finance costs. Similarly, some projects involve public-sector capital contributions of a limited value at the outset, to reduce external financing.
16 In any event there will likely be specific risks it is VFM for the public sector to retain, for example certain risks relating to insurance or the condition of existing facilities-these are examples of the many questions of detail which procuring authorities need to consider for their project.