Assessing relative importance

The risk that the Project will be exposed to inflation is probable considering the long term nature of the Project - notwithstanding any wage, or labour services agreements that seek to provide some semblance of certainty regarding wage growth.  Assessing relative importance of inflation risk would require further analysis of cost drivers for the project.  For example, the following observations in relation to this NSW hospital PPP were used in drawing conclusions about the relative importance of inflation risk:

•  Construction costs were deemed to be likely to increase from Financial Close to the end of the Construction Phase, given the market for construction services at the time.  The PSC assumed a fixed price contract that included an allowance for escalation over the estimated three year construction period, but included no allowance for Systematic Risk.

•  The cost of non-core services can include non-wage components.  For example, catering services were found to consist of only 53 per cent labour cost, with the remaining 47 per cent being largely food costs.  Catering costs represented 36 per cent of the operating service costs on an NPC basis.

•  Operating costs account for a significant proportion (approximately 56 per cent) of the Raw Public Sector Comparator on an NPC basis, and represented the more significant inflation risk exposure to both the government and the Project Company.  Labour was found to comprise approximately 67 per cent of the cost of the operating services.

•  Specific side agreements governing the sharing of costs between the government and the private company can also be useful in determining relative importance of the risk.  For example, under the terms of the Labour Services Agreement for this particular hospital PPP, the Project Company agreed to bear the risk of increases in labour unit costs only to the extent that they represent promotions or the need for agency staff/casual labour, while the government agreed to bear the risk of changes to wage rates under the Industrial Instruments.

Overall, compared to the other risks, this risk is considered to be of medium importance.