PART TWO

15

Factors which may affect the comparison of the pricing of PFI hospitals today compared with those procured in 1998

The factors which will affect comparisons of the pricing of PFI deals at different points in time include the following:

The nature of the deals being entered into

Specification: The nature of the facilities which are being procured in 2005 has evolved and changed in the light of developments in health care provision since 1998.

Changes in contract periods: The minimum contract periods which the Department now seeks in its PFI hospital procurements are generally longer than those which were contracted for in early PFI deals. This affects the annual price payable by NHS Trusts.

General economic factors

Building costs: Building cost inflation has been significantly in excess of general inflation since 1998 (Figure 16).

Commercial interest rates: General interest rates have fallen since 1998 (Figure 9).

Source: The National Audit Office

Factors specific to the PFI market

Improved financing rates: Financing terms have improved as a result of the development of the PFI market and the successful delivery of many early PFI deals (Figures 5 to 8).

Increased familiarity by the private sector with estimating and managing the costs of PFI projects: As a result of the experience of completing early PFI buildings, and managing the early years of the operation of these buildings, the private sector should be able to use this knowledge to improve the efficiency of their pricing of future PFI deals, particularly where there is strong competition during the procurement.

NOTE

The Department collects information on various aspects of the pricing of PFI deals in its monitoring of PFI contracts entered into by NHS Trusts.

The Department has not fully analysed all the factors which may have affected the pricing of PFI hospital deals at different points in time.

16

Comparison of Aggregate and Mean Inflation 1998-99 to 2004-05 

BMI
%
increase1

MIPS
%
increase2

RPI
%
increase3

Aggregate 1998-99 to 2004-054

22.8

49.2

18.5

Average yearly compounded change4

3.5

6.9

2.9

Source: The Department

NOTES

1  BMI is the Building Maintenance Index compiled by the Royal Institute of Chartered Surveyors (RICS).

2  MIPS Is the Median Index of Public Sector Building Tender Prices published by NHS Estates based on information compiled by the Department of Trade and Industry.

3  RPI is the all-items Retail Prices Index.

4  This is the compounded year on year effect. Figures included for 2004-05 are forecasts.

5  The factors which have contributed to the high rates of recent construction cost inflation include large purchases of building materials by certain overseas countries and a relatively large supply of government building projects in the United Kingdom market.

In addition to the information shown in the above table the Treasury has conducted separate analysis indicating that the significant inflation in construction prices may have added 10 per cent to the cost of public sector building projects in recent years.

17

Comparative building costs on PFI hospital deals

Norfolk & Norwich hospital (1998)

The Department's expectation of the range of construction costs which will apply to current PFI hospital deals (2005)

Building costs per square metre

£1,589

£2,500-£3,0001

Increase compared with Norfolk & Norwich

57-89%2

Source: The Department

NOTES

1  The Department currently expects, based on information from various market sources, to pay £2,500 - £3,000 per square metre for PFI building work. There may be differences in building cost rates in different parts of the country at any point in time. The Department is aware that the building work for a PFI hospital outside London, comparable to the Norfolk & Norwich hospital, was recently priced at £2,600 per square metre.

2  The increase in PFI building costs between 1998 and 2005 is higher than the general rates of increase in public sector building costs of 49.2 per cent shown in Figure 16. The general rates of increase in public sector building costs in Figure 16 is derived from a mix of projects of varying degrees of complexity. The Department considers that a new hospital on a greenfield site, incorporating advanced technology, is at the relatively complex end of the scale and explains the higher than average increase in building costs which have occurred on PFI hospital projects. In addition, as explained in our previous report on PFI Construction Performance (HC371 2002/03) the private sector, in taking forwards PFI building projects, seeks to consider a whole life solution and so they may make trade-offs between spending more money on initial building costs to produce savings on later maintenance costs.

18

The Department's estimate of the effect of pricing the Norfolk & Norwich hospital deal at current rates of construction costs

Base construction costs of Norfolk & Norwich hospital

£159 million

Department's estimate of the increase in construction costs in real terms that would arise based on the rate of building costs the Department currently expects to pay on PFI hospitals

£52-95 million

Department's estimate of the increase in construction costs in real terms based on the general increase in public sector building costs (as shown by the MIPS index, Figure 16)

£41 million

Source: The Department

NOTES

1 The increase in construction costs is expressed in real terms as the annual price of the PFI contract increases, in any event, for changes in the Retail Prices Index (RPI). 

It is not possible to be certain on how the market would price the Norfolk & Norwich hospital if the same deal was to be funded today. The Department estimates, based on advice from Royal Bank of Canada, that the additional increase in building costs in real terms shown in Figure 17 could increase the annual price of the PFI original deal by up to £5 million whilst the improved financing terms now available could reduce the annual price of the original PFI deal by a similar amount, assuming no increase to the original minimum contract period or the level of debt in Octagon's 1998 financing arrangements. Octagon was also able to generate substantial additional refinancing gains by increasing its borrowings and accelerating its shareholder distributions but Royal Bank of Canada considers there would be less scope for such gains on current deals in situations where the level of debt, in relation to the private sector's expected net income from the project, has been maximised in the original funding arrangements. The Trust has received a benefit of £1.7 million a year from these improved financing terms now available including the increase in Octagon's borrowings, with the balance of the Trust's £3.6 million a year benefit from the refinancing (Figure 24) arising from the contract extension. There may, however, be other factors involved in comparing the pricing of early PFI hospital deals with current deals including any efficiencies which the private sector can now offer as a result of their greater experience of estimating and managing the costs of delivering PFI buildings and related services. The Department has not analysed all the factors which may have contributed to a comparison of the pricing of early PFI deals with current deals (Figure 15).

19

he benefits to the Trust and the local community during 1998 to 2005 from the early delivery of a new hospital

The Trust has identified the following benefits which the Trust and the local community have received from the early delivery of the new hospital:

■  Improved overall environment for patient care

■  Improved efficiencies due to better adjacencies between
clinical activities which have improved patient flow and
patient safety, reduced travelling time within the hospital
and enabled better access and efficiency of working within
diagnostics and treatment

■  Improved ratio of single rooms on wards enabling isolation
of appropriate patients

Source: The Trust