2. In order to obtain the benefits of private finance there is an associated risk premium payable compared with publicly funded projects. This risk premium represents the cost of the private sector taking on and managing certain risks within a project that would otherwise be managed by the public sector and borne by taxpayers. In successful PFI contracts, this risk premium is more than offset principally by the long term focus it brings on whole life costs, the private sector's risk management expertise incentivised by having private finance at risk and the certainty it provides of specified outputs being delivered at the cost contracted for.
3. In 2004 HMT released its Value for Money (VfM) Assessment Guidance and this was updated in 2006. This guidance introduced the three stage VfM assessment process that is currently employed to test the suitability and VfM of PFI. The three stage process has been slightly adapted to meet the needs of the MOD and has been agreed as follows:
a. Stage 1 - Programme Level Assessment
The Programme Level Assessment should be carried out as part of the development of an individual project's Initial Gate Business Case (IGBC). HMT requires that the Programme Level Assessment tests the potential value for money of procurement options when overall investment decisions are made, to ensure PFI is used only for projects where it is appropriate and where there is a good value for money case.
b. Stage 2 - Project Level Assessment
The Project Level Assessment should be carried out as part of the project's assessment phase and before there is any formal engagement with industry. Stage 2 tests the Stage 1 programme level assumption that PFI is the most appropriate procurement route in light of further project specific evidence and requires the Stage 1 qualitative and quantitative assumptions and assessments to be revisited.
Both the Stage 1 and 2 assessments comprise two parts - qualitative and quantitative. At both stages the qualitative assessment should be undertaken first. Assessment of factors affecting the viability, desirability and achievability of VfM in PFI underpins the qualitative assessment methodology. If qualitative considerations indicate that PFI has the potential to deliver a VFM outcome then the quantitative assessment should also be used as a support tool for making an overall assessment. If, however, the qualitative assessment indicates that PFI would not deliver VFM at either of the stages, the project team, with the agreement of the MOD PFU, need not complete the quantitative assessment and it is likely that PFI will be ruled out as the procurement strategy.
c. Stage 3 - Procurement Level Assessment
For projects continuing to pursue a PFI approach, this stage follows on directly from the Stage 2 assessment. It is more iterative than either of the previous two stages. The emphasis at this stage is a continuous assessment of whether the key drivers of VfM for the project are maintained through to award of contract. The Stage 1 and 2 underlying assumptions are continuously retested to ensure that no material changes which undermine the VfM case have occurred. Key VFM indicators during this phase are associated with:
• the quality of the competition;
• the success achieved in transferring an appropriate level of risk to the private sector;
• the reasonableness and stability of costs emerging from the competition following an efficient procurement process.
4. If at any point the Stage 3 assessment suggests that the VfM case is being eroded, the project team and the MOD PFU will have to consider whether the PFI procurement should continue or be halted.