3.  Advantages and limitations of PFI

Summary

PFI projects can deliver benefits but are complex. 

Potential benefits include:

•  Risk transfer to the private sector from the public sector

•  Provides an opportunity to deliver an asset which may be difficult to finance or procure conventionally.

•  Encourages ongoing maintenance via more transparent whole-life costs 

Limitations of PFIs include:

•  Higher cost of finance

•  Inflexible contracts

•  Ultimate risk lies with public sector

Potential benefits include:

Potential disadvantages include:

The delivery of an asset which might be difficult to finance conventionally

Assumptions that using PFI reduces the need for a robust value for money assessment to be conducted

Potential to do things that would be difficult using conventional routes. For example, encouraging the development of a new private sector industry

Reduced contract flexibility - the bank loans used to finance construction require a long payback period. This results in long service contracts which may be difficult to change

Encouraging the allocation of risks to those most able to manage them, achieving overall cost efficiencies and greater certainty of success

The public sector pays for the risk transfer inherent in private finance contracts but ultimate risk lies with the public sector

Delivery to time and price. The private sector is not paid until the asset has been delivered which encourages timely delivery. PFI construction contracts are fixed price contracts with financial consequences for contractors if delivered late

Private finance is inherently complicated which can add to timescales and reliance on advisers

The banks providing finance conduct checking procedures, known as due diligence, before the contract is signed. This reduces the risk of problems post-contract

High termination costs reflecting long service contracts

Encouraging ongoing maintenance by constructing assets with more efficient and transparent whole-life costs. Many conventionally funded projects fail to consider whole-life costs

Increased commercial risks due to long contract period and the high monetary values of contracts

Encouraging innovation and good design through the use of output specifications in design and construction, and increased productivity and quality in delivery

Increased cost of finance since the credit crisis

Incentivising performance by specifying service levels and applying penalties to contractors if they fail to deliver

Fewer contractual errors through use of standardised contracts

The National Audit Office (NAO) has found that generally, PFI projects are built close to the arranged timeframe, budget and specification, with more than two-thirds of the sample size being delivered on time and almost two-thirds of the sample size being delivered within the agreed price. 8

Other issues may arise with respect to PFI, such as over specification and over complexity. In instances where the procurement process is slow and lengthy, value for money for the taxpayer can be reduced, and this may result in higher costs overall.

It can be difficult to make alterations to projects, and take into account changes in the public sector's service requirements. Contracts that would need to be terminated would generally have to pay compensation. An example of this is Northumbria Healthcare NHS Foundation Trust buying out its PFI deal, for which the Trust had to pay £24 million in costs to terminate the contract and a further £4 million in compensation.9 Despite these costs, the foundation trust was still able to obtain savings of over £67 million from ending the PFI contract early.10

PFIs are generally built on time, within budget and to the requested specification

There have also been criticisms of excessive returns relative to the risks taken on by the PFI projects: Infrastructure UK, a division of HM Treasury, has stated that:

There are concerns that the equity returns achieved in PFI projects have been too high and that some investors have made windfall gains . 11

Expected returns to investors have typically been in the range of 12-15%12, and some earlier PFIs had expected returns as high as 20%. A striking example is an increase in the rate of return of the Norfolk and Norwich PFI Hospital from 16%, before refinancing, to 60% just after refinancing 13, an outcome that contradicts the claims that higher costs of capital are largely a result of the risks taken on.

Some firms have managed to obtain very high returns on PFI projects