Q11 Chair: But we're tied in to contracts for 30 years and, in 30 years, it'll come to the housing ones. We're experiencing it now with the health ones. We're spending a lot of taxpayers' money running services. Now, if they're extracting economies of scale, is there one example out of the 78 that you're responsible for where those economies of scale have flowed through into a saving to the PFI in any of these areas, from Bromley to Norfolk and Norwich?
Peter Coates: The only example I can come up with off the top of my head is that, with all of these tenders, every five years, for the support services, we tender the cost of those services. And we've been looking at the rates coming in during 2010 and they've all gone down in 2010; I think the lowest number I saw was an 8% reduction in the cost of support services.
Q12 Chair: Is that because they've re-specified the service and asked for a lower service, or is it that they're eking out better value because of economies?
Peter Coates: I suspect that it's to do with market pressures around where the economy is at present, but there may be elements of economies of scale in there. I can't say.
Q13 Chris Heaton-Harris: I'm obviously a Conservative politician; therefore, I enjoy private companies making profit and paying tax and everything.
Chair: And paying tax.
Chris Heaton-Harris: And paying tax-I did throw that in, just in case. I don't enjoy paying tax though. But some of the profits that are estimated on some of those PFI schemes are actually quite large in the hospital sector, and it's been put to me that, actually, maybe if you did this through traditional government borrowing or whatever, Government would be saving all this money. Examples given to me: the new Royal Infirmary in Edinburgh, a basic £20 million investment. You'll have probably seen the articles in The Herald in Scotland, where they're talking about the profit being 10 times that: £228 million. The County Hospital in Hereford: £9 million investment and £92 million profit over the period of that scheme. Now, one, are those figures about right, and, two, I want to understand the kind of cost-benefit analysis that might be done in departments as to whether PFI against traditional government spending, plus political priorities and maybe taking things off-balance sheet- at the end of the day, where it all comes from.
Peter Coates: I think my reaction is that there's two points: the first is there's an element here of cake-and-eat-it for the public sector. We set out contracts that try to allocate risk and reward to certain parties, and then, when that reward and risk pans out, we kind of say, "Well, that's not right, actually. We didn't mean to give you that kind of profit or that kind of benefit, and now you've earned it we'd like to take some of it back from you". I think that's a valid point.
The second half of the answer is that there are plenty of occasions when the private sector has lost shedloads of money on these contracts, and one that comes to my mind immediately is Dudley, where Robert McAlpine lost the worst part of £100 million on the contract. In anybody's language, that's company-threatening amounts of money. It's difficult for me as a public servant to say to McAlpine-if they made £4 million profit at, say, wherever they've got another contract-"Because you've made £4 million profit there, I want it all back. By the way, the £100 million, you've got to swallow that-that's your problem".
Q14 Chris Heaton-Harris: Yes, but at some point in the calculation that you make, when you're looking at PFI contracts, you must look at what the endgame is for the company as well, if managed on the interest rates that you're looking at and, going through the process, what their profit's going to be. I would suggest that maybe in Dudley something else happened that was a bit of a freak factor in that.
Peter Coates: We don't look at the projected profits the companies make. When we look at the value for money for tenders, we simply look at the price, look at the cash flow that comes in and is paid out by the NHS. We don't then subdivide that between profit and other knowns. We obviously test the margins within the contract to determine they are value for money and on-market, but whether that's profit or whether that's whatever, we don't test that.
Q15 Chair: But in the housing ones, there was, according to the Report, absolutely no attempt to do a comparator exercise.
Sir Bob Kerslake: No, there was a comparator exercise. I think the NAO Report raised two issues about comparators: one was about whether the strength of our database was strong enough on individual project comparisons; and secondly whether we were doing a programme comparison. On the first of those, we have definitely got a very comprehensive database now that enables us to compare the PFI option with the alternative conventional options on a project-by-project basis. We draw our database from information, and since the NAO Report was done, we've strengthened that. The other area that they raised was the programme comparisons, and we're underway with an exercise on that at the moment, which will conclude by December.
If I can just add a couple of points on the profit part, because I think it's a very fair question, I absolutely endorse the point that Peter's made about the risk and reward. These are typically quite risky projects, particularly in housing on things like refurbishment, so you have got a trade-off. The second point I'd make is that we've done this on a phased basis, so if they've got better at it and then seen aggregated benefits, you will see that coming through in the prices that are bid for.
I think the third point is my experience of outsourcing of long-term projects is that the private sector will typically expect to pay more at the beginning and then reap savings downstream, so there's a kind of trade-off here in the way they do their calculations; in other words, they discount for the aggregation benefits in bidding for the projects. The last point is we, in the housing area, have kept an option, particularly on the later phases, of saying, if we're not happy with the cost of the revenue side of it in terms of services, we retain the in-house option.
Q16 Chair: So, you've got a clause in the contract that allows you-
Sir Bob Kerslake: In the later phases, we are keeping the option of in-house if we're not satisfied about the affordability of the PFI option.
Q17 Stephen Barclay: I think, Mr Coates, we all follow that PFI offers the opportunity to transfer risk and then price it more accurately, and that's offset against what the financing costs are and the concern of those going up, and we touched on that in our last hearing on PFI, where the value-for-money savings, I think the NAO calculated, were overestimated by 5% and it came down to what the financing costs were as to whether that would be value for money. I was just a bit confused by your answer, because I follow there's a market issue here, but my understanding is there's been a massive consolidation within the PFI market and, therefore, in the private sector, they are driving economies of scale. The concern is whether those economies are being shared with the public sector and whether the PFI contracts are being managed individually in silos, and we'll get into the detail but I think 12% of PFI contracts in the hospitals aren't even managed at all. They don't even have a contract manager. So, could you just give us some clarity on this issue of the way the consolidation in the private sector is driving economies, and how that is informing the way you're managing them on the public-sector side?
Peter Coates: The consolidation referred to in the papers is that the very small amount of equity in these projects is owned by a fairly small number of companies.
Q18 Chair: A very small amount of the equity in the project?
Peter Coates: Most projects have between 5% and 10% equity; the rest is debt borrowed from banks or bond houses. So, the consolidation is who owns the benefit of the small amount of equity in each of these transactions, and I guess, flowing on from that, how does that drive economies of scale for the public sector? It seems to me that, below that holding company, such as Innisfree, there are special project vehicles that own each hospital or whatever, and they are responsible for driving the value for the trust.
I go back to my point earlier that I can understand the principle of the point made, but I suspect that value from economies of scale is a thing that goes in turn around the NHS, in the sense that, because firms bid for these competitive tenders let by the SPVs, those companies look to put the lowest price they can to that particular trust that has that particular tender at that time. It may mean Trust A and B don't get economies of scale, but Trust C does, because those firms that are tendering want to get the best price they can. But I don't think that Innisfree, per se, are driving economies of scale and that process through the system.
Q19 Mr Bacon: Sure, but you sound like you're talking about the market for foreign exchange. This is an oligopoly with a fairly small number of players; it's not a perfect market. When we had the Royal Institute of British Architects giving us evidence on this, which was some years ago, they said it cost £11 million just to bid for a PFI hospital.
Peter Coates: Yes, that's right.
Q20 Mr Bacon: It's a fairly small number of people, so they keep quite a bit back, and we've seen in PFI over the years that, when they enter into a new negotiation, they will go back to the very early drafts and they know that they will have to go down the road towards later drafts to see how far they have to go, because the Department of Health and the Treasury were relatively slow off the mark in providing advice to trusts or, worse, were prohibiting them from doing things they wanted. For example, the Norfolk and Norwich wanted to include a refinancing clause, but you wouldn't let them-the Department of Health wouldn't let them-and you were there from 1997 to 2008, so you're one of the people who's responsible for the fact that the Department of Health prohibited Norfolk and Norwich from sharing the refinancing gain, which, as you know, took the internal rate of return from 18% to over 60%. So, I'm with Mr Barclay on this: how do you explain all this huge going around and buying up of assets? There's a relatively small amount of investors going around gobbling up huge numbers of PFI companies. Why? Where's the benefit?
Peter Coates: Well, because they add value in that the cash flows from those concessions are worthwhile in terms of investment, but they're buying a 30-year concession; they're not buying the asset itself. After 30 years or whatever, the asset reverts to the public sector. They're valuing the company as a cash flow entity.