The Contract will contain provisions allowing for the adjustment of the Unitary Charge once a year reflecting the movements in one or more specified price index. The index will normally be a measure of the overall rate of inflation in the economy such as the Retail Price Index (RPI). These provisions ensure that the Contractor's main source of income will respond to inflation in the same way as its underlying costs, thereby broadly maintaining the same level of profit in any inflation scenario. In some cases a weighted basket of indices will be used to try and match the indexation of the Unitary Charge to the underlying cost base more precisely.
The WIDP Contract (Clause 45.9) refers to the provisions the WIDP Guidance on payment mechanisms. These set out the general form of typical indexation provisions used to determine how the Unitary Charge should be adjusted once a year on the Indexation Date. In practice the drafting in specific Contracts is likely to be more extensive.
Although relatively straightforward in principle the annual indexation adjustment can be reasonably complex particularly when a weighted basket of indices is specified in the Contract33. Experience suggests this is an area where there is a lot of value in detailed checks, by the Contract Management Team, of the calculations submitted by the Contractor. The Contract Manager should therefore ensure that the Contract Management Manual sets out procedures that ensure sufficient expertise is applied to such checks and that every aspect of the calculations submitted by the Contractor is checked back to the relevant contractual provisions and the relevant indices.
For more information on indexation, please refer to Section 15.2 of SoPC434.
When providing forecasts of the expected Unitary Charge in future years the Contract Manager should always take indexation into account. This should be based on the best estimates of future changes in the relevant indices at the time and not the assumptions made in the base case financial model which may be significantly different.
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This guidance is available online at http://www.defra.gov.uk/environment/waste/local-authorities/widp/widp-procurement-pack/
34 In addition, HM Treasury's guidance on indexation "Interest Rate & Inflation Risks in PFI Contracts" is available online at http://www.hm-treasury.gov.uk/d/pfi_hedging120506.pdf