19.8.1 Authorities should consider how far their payment mechanisms are able to accommodate change in Authority requirements, whether in terms of additional capital works or changes to Services. This is partly a matter of payment mechanism design, but Authorities should also consider including in the payment mechanism a process for annual review of weightings, rectification times, etc.24 Such a review may only provide for changes to be made where both parties agree, but the Contract can nevertheless set out a framework for discussions and provide a formal opportunity to consider the workings of the mechanism in the light of emerging guidance and best practice for the sector, and experience of the practical application of the mechanism to the particular project. Such a review might be appropriate at the end of any bedding-in period.
19.8.2 For those payment mechanisms where the payment varies with usage or volume (see Section 19.4 (Usage-based Systems)), the payment mechanism allows (subject to any minimum take-or-pay level or the limitations of design capacity) for the payment to be adjusted in response to changes in throughput (e.g. waste or street-lighting). In accommodation-based schemes (e.g. schools and hospitals), it can be more difficult to design such flexibility into payment mechanisms, partly because the Service is not easily divided into discrete units (i.e. there are large common areas like corridors and halls), and partly because the cost structure is largely fixed relative to usage.25 As a result, it is more common in these sectors to have payment mechanisms which are designed based on a given aggregate capacity and a given schedule of areas required, with each area receiving an "area weighting" according to which its corresponding availability and performance deductions can be computed. This typically means that as changes occur (e.g. new classroom spaces are added), the payment mechanism needs to be re-calibrated. The weighting of the original facilities as a proportion of the total post-variation Unitary Charge will need to be amended in order to preserve the incentive effect of the original calibration. Particularly where the changes are small to medium-value, the transaction costs of re-calibration can be quite high relative to the cost of the changes.
19.8.3 A relatively straightforward way of dealing with this issue is to design the payment mechanism in such a manner that it can automatically be extended to cover changes up to a limit, with only a periodic review (say once a year, perhaps part of the general annual review suggested above or when the value of the changes exceeds a certain threshold. An example of this approach is provided in the Priority Building Schools Programme, where the deduction values are stated in monetary amounts for different areas, with the implication that as new areas are added on the corresponding deduction levels can automatically apply to them. So, for instance, if the deduction value for an unavailable classroom is £x, new classrooms can be added on to the school, each carrying a deduction level of £x without re-calibration. A recalibration is only performed when the cumulative total value of variations since the last recalibration is in excess of 5% of the unitary charge.
19.8.4 Further flexibility can be gained if Authorities agree with the Contractor and its Senior Lenders that below certain volume and value thresholds, change orders will be regarded as normal churn in the Project and will not have to go through detailed due diligence. Instead the Contractor can simply certify, in quarterly/annual reports to the funders, what changes have been put through the Contract with automatic extensions of the payment mechanism. Annual reviews can be carried out as above to check that the calibration is still in balance. This will save technical and legal due diligence fees as well as management time.
19.8.5 In order to allow for greater flexibility around the Services being provided the payment mechanism should allow for other pre-determined charges (e.g. Pass Through Costs and/or Elective Services Costs) to be included within the Unitary Charge if and when Elective Services are switched on or off. By definition Elective Services are pre-priced in the Contract and therefore there is no need to rerun the financial model to calculate the impact when an Elective Service is added to or taken away from the Services.
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24 This approach has been adopted as standard in the health sector; see Part D of the standard Department of Health payment mechanism issued in December 2006.
25 However, housing PF2 schemes are one example of accommodation-based schemes where the service is divided into discrete units (i.e. flats or houses), and because of the ability of tenants to exercise their right to buy their properties, it is increasingly common in housing PF2 payment mechanisms to include a method of adjustments to the Unitary Charge payment as a result of changes to the number of housing units, based on calculations of fixed, variable and semi-variable costs.