6. PFI contracts generally contain a mechanism for assessing the VFM of the services on a periodic basis. If the project is for services which can easily be contracted out to a ready market, such as cleaning and catering of accommodation, provisions for using benchmarking or market testing3 to test VFM can be applied. However, for many MOD PFI projects there may be no ready market for all or a significant proportion of the services provided as they can be very specialised and only provided by one or two contractors. As a result a separate process to assess VFM known as the VFM Review Process has been developed.
7. In many cases, the VFM Review clause will include the measurement of the Internal Rate of Return (IRR) that the equity investors are receiving and compare this to the IRR forecast in the original financial model. Where this is included in the contract a review of the calculation will form part of the review.
8. Typically the VFM Review clause will state that if the IRR is in excess of a pre-defined threshold then funds will be set aside in an account, set-up by the Service Provider, to bring the IRR back down to the threshold rate. If at the next review the IRR is below the threshold, some of the funds can be released to the Service Provider but any sums held in the account at the end of the contract will be shared between the Authority and the Service Provider. Details of how to calculate a project IRR should be specified within the contract but a definition and a basic worked example can be seen at Annex A.
9. The VFM Review clause in MOD PFI contracts explicitly refer to the calculation of Actual Equity IRR and excess IRR but they also state that the purpose of the review is to satisfy the Authority that it is receiving good value for money for the provision of services. MOD PFU recommends that VFM Reviews are used to conduct a wide holistic audit of the service. A useful tool in assisting this analysis is the NAO Framework for Evaluating Implementation of PFI projects that identifies key criteria that research has shown are good indicators of whether a project is achieving value for money. The indicators are based around 6 themes. The themes are:
• The project fits with the business requirement of the Authority (including commercial review)
• PFI is the appropriate delivery mechanism
• Stakeholders support the project's progress
• There is good quality project management (including project governance)
• There is an optimal balance between cost, quality and flexibility.
• Effective risk allocation is taking place.
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3 Guidance for conducting Benchmarking and Market Testing can be found at the following link: http://www.hm-treasury.gov.uk/media/0/B/operational_taskforce_note_1.pdf