Insurance gain-share

2.12  SPVs pay for insurance and pass on the costs to the public sector through the unitary charge. These costs are estimated at the start of the project, which can last up to 30 years. PFI insurance costs have fallen over the last 15 years. This means that public bodies are paying more for insurance than the actual cost, providing a gain to SPV investors. Some PFI contracts include gain-share arrangements, whereby some of the insurance savings, or costs, are passed back to the public body. IPA told us that the introduction of the sharing mechanism was to incentivise PFI contractors to find the best value insurance.45 The level of savings shared with the taxpayer is dependent on a calculation made by an insurance broker.

2.13  A number of public bodies with PFI schools expressed concerns to us about insurance costs and the gain-share agreement (Figure 11 overleaf). In one case, the SPV eventually agreed to return over £100,000 of withheld insurance savings after being unable to provide evidence that part of the saving should be withheld. Although insurance brokers owe a duty of care to the public authority they are appointed and paid by the SPV creating the potential for a conflict of interest. Local Partnerships told us that the problem started with one particular insurance broker - HM Treasury and the IPA has spoken to this firm, but the practice continues. Insurance costs can be significant - in some legacy PFI school deals, insurance costs can be as high as 5% of the unitary charge. The Department for Education told us that in the new PF2 deals, insurance costs are closer to 1.3% of the unitary charge.

The government does not usually take out private insurance for its buildings as it considers that it is not generally good value for money (VfM) to do so. However private insurance is used in PFI projects - the financial structure means that buildings and business interruption insurance is required. The Project Agreement sets out the insurance requirements for the duration of the contract and a 'base cost' (subject to annual inflation indexation) is agreed and incorporated into the unitary charge paid for by the public sector.

The base cost of insurance included in the unitary charge is in some cases significantly higher than the costs paid by the Special Purpose Vehicle (SPV). This is because SPVs cautiously price the cost of insurance prior to financial close (see paragraph 1.23) and also because the cost of PFI insurance has fallen significantly in real terms over the past 10-15 years- providing again for SPV investors.

Most PFI contracts signed since 2000 include an insurance gain share mechanism which allows the public sector to share part of the savings made by the SPV. The calculation is not straightforward and requires input from an insurance broker.

Concerns about PFI insurance were raised with us during our study:

•  In many PFI schools the unitary charge includes an insurance cost which is several times higher than the actual cost of insurance.

•  Some SPVs are unwilling to share any of the insurance savings that are contractually owed to local authorities and health trusts.

•  Some insurance brokers are not complying with the requirements of the Project Agreement, by not providing justification to support deductions made through the sharing mechanism. This means that the SPV is retaining a significantly higher proportion of the sharing mechanism than the calculation within the Project Agreement would allow if properly applied. In many cases this has reduced the amount due to the local authority by six figure values.

•  Incorrect calculations, provided by an insurance broker, which lowered the value of the gain to be shared with the local authority by nearly £20,000.

Note

1  The insurance gain-share mechanism also means that if the actual cost of insurance was significantly higher than the base cost the public sector would pay part of the additional insurance costs; however this has not yet happened as until now the base cost of insurance has been higher than the actual costs.

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45  Insurance gain-share arrangements can be found in PFI deals signed after 2007 under version 4 of the Standardisation of PFI Contracts (SoPC).