1. Treasury guidance says that the evaluation of projects should take into account the relevant costs and benefits to government and society of all options.3 In practice, however, departments often place great emphasis on a cost comparison between the PFI contract price and an estimate of the cost of a supposedly equivalent conventionally procured project (the PSC). Being based on very long term forecasts, this comparison is subject to large inherent uncertainties. It does not take into account the various other factors, such as certainty of service delivery or the possibly constraining consequences of a long term contract, which need to be taken into account in deciding whether to proceed with a PFI deal.
2. In this project, the Trust's initial PSC cost estimate was lower than the price of the PFI deal. The Trust had concerns about the accuracy of this initial financial comparison and whether a cost estimate showing the PSC cheaper than the PFI deal would prevent it from obtaining Departmental approval. The Trust and its financial advisers KPMG reappraised the cost comparison believing that there were underestimates in the PSC allowance for risk. Adjustments were made to the PSC before seeking Departmental approval. The final calculations estimated a risk adjusted saving from using the PFI of £5.5 million over 35 years (Figure 1).4
Figure 1: Estimated payments and savings from the PFI deal
| £m | ||
| Estimated PFI payments in cash over 35 years | 470.91 | |
| Estimated net present value of PFI payments | 123.8 | |
| Estimated PSC (without risk transfer) | 116.2 | |
| Estimated PFI excess cost before risk transfer | 7.6 | |
| Risk transfer | 13.1 | |
| Estimated PFI savings after risk transfer | 5.52 | |
Source : The Trust and the Department5
1 Based upon an opening annual payment of £9.77 million which is then subject to inflation uplifts (Qq 59-73, 77-79, 101-102, 146-147,183; Ev 19-22
2 Based upon a discount rate of 6% in real terms which was the rate set out in Treasury guidance at the time this deal was signed.
3. The Department aims to carry out a rounded assessment of PFI deals but sees the PSC as an important part of that assessment. It considers the PSC is a good way of helping NHS Trusts in their negotiations to focus on risks and the PSC could also be used to drive prices down. Whilst these may possibly be benefits from preparing a PSC, Figure 1 shows that the PSC, and the resulting savings attributed to the PFI deal, are significantly affected by the level of risk assumed in the PSC. The risk assumptions in the PSC were based on advice from KPMG and information from the Department about the standard band for risk on these deals. The final overall allowance for risk in the PSC was around 15% of the construction costs. The Department told us some projects had previously experienced 20 or 30% overruns.6
4. The Department acknowledged that there could be no certainty about the savings projected in the cost comparison which was based on assumptions of costs in the long run. Although there was always scope for improvement, there was a rigorous process for estimating PSCs. In calculating the PSC for this deal the Department considered it had made the best possible assumptions based on the evidence it had. It saw the cost comparison as reflecting the fact that construction costs had been driven down very significantly as a result of the PFI process compared to the extensive cost overruns in building projects it had previously experienced. The Department considered this to be the biggest benefit from using the PFI.7
5. The Department stressed that if the West Middlesex hospital deal had not given value for money on PFI terms, the project would have been publicly funded. It had rejected the PFI as the method of procurement for a number of major schemes. Public funding was still being used for certain projects. For example, £84 million of public funds was being used to expand and improve hospital services at the Royal Berkshire Hospital and £50 million of public funds was being used to rationalise various services at Guy's and St Thomas's hospitals.8
6. Although considerable emphasis had been placed on the cost comparison, other factors had been taken into account in the Department's decision that this PFI deal represented value for money:
• Certainty on price and timing of delivery. The Trust pointed to certainty over the price and the timing of the delivery of the new facilities. The Department did not consider the project could have been done more quickly using public finance, where there had been a long history of time overruns.9
• Maintenance. The Trust placed importance on the fact that it would also get a well-maintained hospital whereas the NHS had not had a good history of maintaining facilities. Knowing that the contractor was responsible for dealing with any faults in the PFI building would assist the Trust in managing its annual costs. The Department was now focussing on setting better standards for maintenance in publicly funded hospitals to ensure that all hospitals would be in a good condition.10
• Design and innovation. The Trust thought that better design and innovation had been secured through the PFI bidding process compared with the conventional approach of putting a pre-determined design out to tender.11
• Staffing. Most staff responsible for facilities management had already been working for contractors. Those who would now transfer to Bywest would have their pay and conditions of service protected. The terms and conditions for new staff would be set by Bywest but if these affected Bywest's ability to recruit staff the Trust could raise this issue with Bywest.12
7. The deal also had benchmarking arrangements and controls over the pricing of variations which were intended to ensure the contract continued to deliver value for money in the future. Bywest would not be allowed to make a higher margin on variations than the margin on which the original contract had been based. If the Trust was not satisfied with Bywest's proposals for a variation then the Trust had the right to use another contractor or public funds for the variation.13
8. The financial assessment of a PFI deal may well vary depending on the length of the contract period. In this deal the Trust decided to extend the contract period from 30 to 35 years, partly to reduce the annual payments it would have to make.14 The Department maintained that although this had made the scheme more affordable for the Trust, it had not been done to justify the use of the PFI. The contract extension had not improved the position of the PFI deal relative to the PSC. After 35 years the hospital would revert to the NHS, although there was the option for the Trust to extend the contract to 60 years. If Bywest went into liquidation the banks would have the right to find an alternative provider. If another provider could not be found the Trust would have the right to step in and provide the services.15
9. Interest rates have fallen in recent years and this has been reflected in new Treasury guidance on appraising projects.16 This project was evaluated by the Trust using a discount rate of 6% in real terms in line with Treasury guidance at the time the contract was let in 2001. The new Treasury guidance published in January 2003 expects departments to use a discount rate of 3.5% in real terms. The Department acknowledged that, other things being equal, it would not have gone ahead with this PFI project based on an evaluation using a discount rate of 3.5% in real terms. But the Department and the Treasury told us that the new guidance required other factors to be taken into account in evaluating project costs. The new guidance encourages departments to include provisions for the tendency of project appraisers to be overly optimistic. The guidance also expects departments to take account of taxation differences between alternative options.17
10. The Department acknowledged that it was still developing a strategic plan for London, but in deciding to take forward the West Middlesex project it had taken into account the need to deliver health services to the local population of 300,000. The hospital design and the contract terms had flexibility to adapt to changing needs. The project needed short- term financial support, but underspending in one part of the country could be used to provide short term support in other areas. The Trust stressed that the £1.6 million a year cost savings it had been asked to make to pay for the PFI contract would not result in a reduction of service. The savings would come from using the redeveloped site more efficiently. Clinical staff utilisation would be better, less ambulances and porters would be needed and heating would be less costly. In addition, there would be the opportunity for possible future land sales from the West Middlesex site which the local strategic health authority and the Department would take account of in future planning.18
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3 HM Treasury, Appraisal and Evaluation in Central Government (2003), para 5.8 (updated from previous guidance published in 1991 and 1997)
4 C&AG's Report, paras 3.12-3.13
5 ibid, Figure 11, p21; Ev 22-25
6 Qq 8-10, 16-19, 39-40, 74-76, 104,178, 182, 212
9 Qq 46-52, 172-173, 176-177,183
10 Qq 34-38, 172-173,178, 181, 183, 200-206
14 C&AG's Report, Figure 8 note 3, p17
15 Qq 12-15, 148-149, 181-182, 193-197
16 HM Treasury, Appraisal and Evaluation in Central Government (The Green Book) (2003)
17 Qq 152-160, 168-170, 196; Ev 19-22
18 Qq 1-2,11, 97-100, 127-138, 147, 160-168,181-182, 184-192, 198-199