F24 Demand risk is the risk that demand for the property will be greater or less than predicted or expected. Where demand risk is significant, it will normally give the clearest evidence of who should record an asset of the property. Demand risk is imposed by the economic conditions of the market in which the PFI contract is written. Its existence and significance cannot be altered by the terms of the contract; the contract can only allocate demand risk between the parties to the contract, for example by allowing renegotiation of the contract at certain demand levels.
F25 The first step is to identify whether demand is a significant risk. There may be instances where there is little genuine uncertainty about the level of future demand for the services provided by the property. For example, in a short-term IT contract there may be very little likelihood of demand varying greatly from the levels predicted under the contract. In such a case, demand risk is not significant and little weight should be given to this test. In other cases there may be much genuine uncertainty over the extent to which a property will. be used-for example, a new road to be built in a newly developed area. In these cases demand risk will be significant and who bears it will be highly relevant to determining the appropriate accounting treatment.
F26 The length of the contract may influence the significance of demand risk. In general, demand risk will be greater the longer the term of the contract, since it is usually more difficult to forecast for later periods.
F27 It is also important to distinguish where demand risk is insignificant from where the terms of the contract are such that it is passed to one or other party For example, there may be much uncertainty over the demand for a certain type of property in the long term. However, the terms of a long-term PFI contract for such a property may be such that the purchaser would fill the PFI property in preference to properties not subject to PFI, with the effect that it is very unlikely that the PFI property will not be full. In such a case, the purchaser has retained demand risk.
F28 Where it is established that demand risk is significant, it is necessary to determine who will bear it, ie who will bear the effects of reasonably likely changes in demand. This will depend on the answers to two interrelated questions:
(a) Will the payments between the operator and the purchaser reflect the usage of the property or does the purchaser have to pay the operator regardless of the level of usage (paragraphs F29 and F30)?
(b) Who will gain if demand is greater than expected (paragraph F31)?
F29 Where the PFI payments do not vary substantially with demand or usage of the property (although they may vary with other factors), the purchaser will be obliged to pay for the output or capacity of the property (eg prison places, hospital beds) whether or not it is needed ie whether or not there are sufficient prisoners or patients). This is evidence that the property is the purchaser's asset and the purchaser has a liability to pay for it. In particular, if the purchaser, in substance, is obliged to pay a minimum amount (ie there is no genuine commercial possibility of non-payment) whether or not it will need the property, and the minimum amount more than covers the cost of the property, this is evidence that the property is an asset of the purchaser. In making this assessment of demand risk, any penalties or reductions in payments for non-availability of the property should be ignored: these relate to whether the property is in a state fit for use and do not affect the incidence of demand risk.
F30 Conversely, where the PFI payments will vary proportionately over all reasonably likely levels of demand, the purchaser will not be obliged to pay for the property to the extent it is not needed, which is evidence that the property is the operator's asset.
F31 In addition, the party that bears demand risk will gain if demand is greater than expected. If the purchaser bears demand risk, it will benefit from additional usage of the property at little or no extra property cost (for example, if payment for a hospital outpatients facility is largely independent of its usage, the purchaser will benefit from additional patients being treated when usage is high at little or no extra cost). This is evidence that the property is an asset of the purchaser. Conversely, if the operator bears demand risk, it will benefit from the increased payments that result from any additional usage of the property (for example, if payment for a hospital outpatients facility is based on throughput, the operator will benefit from additional usage payments when usage is high, although it may bear little or no extra cost). This is evidence that the property is an asset of the operator.