Annual Unitary Charge and Indexation

A table showing the Base Unitary Charge split between the proportion that is indexed and the proportion that remains constant should be included as a schedule in the Project Agreement per the base financial model (showing the figures in real terms at a set Base Date in the financial model). The Base Date will be fixed and indexation will apply on the anniversary of the fixed Base Date. The Project Agreement allows for part of the Unitary Charge to be increased relative to general movements in prices using a published index called RPIX.  Part of the Annual Unitary Charge is increased annually using this index.

HM Treasury guidance on the Standardisation of PFI Contracts Version 4 suggests that full consideration be given to indices other than RPI.  A range of alternative indices have been reviewed and it is considered that the best practise for Fire and Police PFI projects remains to use RPIX.  Additionally, certain elements of the Unitary Charge should not receive annual indexation because a proportion of the underlying cost will not fluctuate due to general price movements. The most significant such cost is fixed financing charges associated with repaying the debt for capital investment.  As a working assumption for this guidance, the fixed element of the payment is taken to be 70% (and consequently not indexed) and the variable element is 30% (indexed at RPIX).  The actual percentages to apply should be based on the specifics of the deal and the financial advisers or finance team on the project should consider the appropriate proportion of the payment and set the requirement regarding indexation when inviting tenders from bidders.

The various aspects of indexation will be illustrated below using a simplified example. The example is based on a Unitary Charge of £2 million stated in real terms as at 1 April 2006 in the Project Agreement. 70% of this charge remains fixed over the term of the Contract and the other 30% constitutes the variable element that is indexed on the anniversary of the Base Date (1 April 2006).  The following table shows how indexation would be applied to the variable element of the Unitary Charge over the first five years of the contract from the Base Date.

The Annual Unitary Charge that applies to the third year of the Project Agreement (1.4.08-31.3.09) is £2 million stated at the price levels at the Base Date which was 1.4.06.  Initially, the Base Date forms the set date for the purposes of calculating the indexation.  The Annual Unitary Charge to apply for year 3 of the Project Agreement is therefore calculated as follows:

There are two further issues that need to be considered.

The first is that the Annual Unitary Charge agreed at the start of the Project Agreement might legitimately be altered during the term of the Project Agreement.  This could be due to agreed changes to the services (i.e. through the use of the change procedure contained in the Project Agreement) or it could be due to undertaking a benchmarking or other exercise.  At the point at which any in-year prices are agreed, for example as a result of benchmarking, the fixed Base Date should be used to re-base the new figures to 1 April 2006 (the Base Date). This enables the figure to be entered into the financial model to determine the impact on the Unitary Charge going forward. It also facilitates the Contractor's management of its sub-contracts. The following example shows the impact of a new benchmark price for the variable element of the Unitary Charge being applied in the fourth year of the contract.

The Base Date remains the same at 1 April 2006 following the benchmarking exercise. This therefore requires the benchmark figure in year 4 to be re-based back to the Base Date. All subsequent indexed figures then apply using the same methodology but with a revised base figure in the financial model. The Unitary Payment is not adjusted retrospectively and the re-based figures are used to determine the new payments to the Contractor from Year 4 in the example.

The second issue relates to the time delay in publishing RPIX indices.  Typically, the Office of National Statistics (ONS) publishes the latest monthly index one or two months after the end of the month to which it relates.  Assuming in the previous examples that indexation needs to be applied from the Base Date we would need to use the index available on the 1 April 2007 to apply the first year's indexation. To enable this to happen it is appropriate to use the most recently available published RPI(X) figure at the point when applying the indexation. This is likely to be the February 2006 figure or possibly the March 2006 depending on timing. This approach of using the most recently available published index must be applied consistently and variations between the actual April to April indices should be dealt with through an end of year reconciliation as appropriate.