A Private Finance Initiative (PFI) is a public private partnership, used to finance the creation and maintenance of major public sector projects in the UK since the 1990s.
In 2018, the government announced that it would no longer be using this model. With over 700 PFI contracts currently in place across the nation, is the public sector ready to start taking over responsibility for each of them as these contracts expire? This was the focus of a National Audit Office (NAO) report published recently, titled ‘Managing PFI assets end services as contracts end’. Its stated purpose is “to draw out the challenges and best practice that can most benefit those managing PFI contracts coming to an end”.
What Exactly is PFI?
When the 1992 John Major government considered the costs of the public sector infrastructure projects that lay in front of them – such as the building of new roads, schools and hospitals – they chose what they considered to be an innovative approach to funding them.
By creating public private partnerships (PPPs) with select private sector organisations and forming a special purpose vehicle (SPV – a new private finance and operating company), the public sector project would be built and paid for by the private sector partner, with the public sector paying them back over time.
The authority would then pay for their partner to operate and maintain the asset for the term of the contract, usually 25 to 30 years, although we have seen PFI contracts lasting for up to 125 years. The mutual benefit here being that the private sector partner would receive a guaranteed long-term income which would compensate them well for the commercial risk of their initial investment, and the public sector authority would be able to spread the cost of construction and management over decades, and keep the liability off the public sector balance sheet.
On the face of it, this can seem pretty innovative. However, it has been a controversial policy since the very start. In 2003 the NAO’s assessment of PFI concluded that it offered “good value for money overall”, but as it involved the private sector (profit-making entities) in public sector projects, there were always going to be those political detractors who would consider this against the public interest or even “a back-door form of privatisation”.
The Opinion of the NAO
The NAO is an independent parliamentary body responsible for conducting financial and value-for-money audits on government departments, agencies and public bodies to assess “the truth and fairness of financial statements; the regularity (or statutory validity) of the expenditure, and; the propriety of the audited body’s conduct in accordance with parliamentary, statutory and public expectations”.
Its opinion carries some weight, which is one of the reasons why, despite mounting dissatisfaction from politicians and the public, PFIs have continued for many years.
In October 2009, a NAO report titled ‘Private Finance Projects’ produced for the House of Lords Economic Affairs Committee, found that “69 per cent of PFI construction projects between 2003 and 2008 were delivered on time and 65 per cent were delivered at the contracted price. Of those delivered late, 42 per cent were delivered within six months of the agreed time, and under half experienced price increases”.
It then went on to say: “Public bodies using private finance are normally satisfied with the services provided by contractors. High levels of satisfaction are normally reflected in our reports, case studies and surveys.”
However – possibly due to political and public pressure, and the significant and deep impact of the collapse of Carillion – in October 2018, the then Chancellor Philip Hammond announced in his budget speech that the government was to abolish the use of PFI and PF2 (the reformed PFI model introduced in 2012).
What Now for Expiring PFI Contracts?
The latest NAO report reveals its findings and recommendations on what should happen next, given that hundreds of PFI contracts remain active and will, over the coming years, start to expire. This will leave public sector partners with significantly greater responsibilities, some of which they may not yet be ready for.
Key NAO findings include:
- The public sector does not take a strategic or consistent approach to managing PFI contracts as they end and risks failing to secure value for money during the expiry negotiations with the private sector. Any one contract can cover many authorities and local bodies. As a result, around 30% of those the NAO surveyed said that they would like more support as these contracts come to an end.
- There is a risk of increased costs and service disruptions if authorities do not adequately prepare in advance for contract expiry. The costs involved and responsibility over who will continue to manage and maintain the schools, hospitals, roads, and so forth when their contracts expire, needs to be determined well in advance or this risks potential disruption to the provision of services.
- Some authorities have insufficient knowledge about the condition of assets, which risks them being returned to the public sector in a worse quality than expected. Some 55% of survey respondents acknowledged that they needed more information on the condition of their assets; around 35% said they had insufficient access rights and 20% said they considered their contractor to be uncooperative when information was requested.
- Many authorities start preparing for contract expiry more than four years in advance, but there is a risk this is not enough time. While the Infrastructure and Projects Authority (IPA) recommends that expiration preparations should start seven years in advance, the NAO report notes that the actual length of time needed to prepare for the end of a PFI contract depends on a multitude of factors, including the complexity of the asset and its condition.
- Authorities recognise that contract expiry will be resource intensive and require unique skills, and expect to fill gaps with consultants. The NAO survey revealed that 30% of respondents believed they do not have enough staff, and approximately 25% believed they do not have the in-house skills needed to deliver the expiry process.
- A misalignment of investor and authority incentives at contract expiry creates a potential for disputes. More than a third of survey respondents expect to become embroiled in a formal dispute due to the condition of their asset when it is returned to them at the end of their PFI contract. In another survey, four out of nine authorities weren’t satisfied with the condition of their asset when they took back ownership of it. This is expected to be due to a misalignment in priorities as an authority will want their asset back in as good a condition as possible, but a private PFI partner is at their lowest incentive to do so in the final years of the contract.
- Early PFI contracts are likely to contain significant ambiguity around the roles and responsibilities of the parties at contract expiry. Contractual ambiguity can easily cause disputes. Around 25% of respondents said that their contracts said nothing about the condition the asset should be in on return and over 30% said their contracts were unclear about the obligations of parties at their expiry. Thankfully, later PFI contracts have been found to be largely clearer in many of these matters, though some ambiguity still remains.
Conclusion
The NAO has identified numerous opportunities for disputes within its report – areas where expectations may not be met by reality, where surveyed respondents suspect a lack of preparedness, and where there is a lack of support and cooperation from their private sector partners.
However, collaboration is needed more than ever when a PFI contract ends and services and assets revert to public sector control. With hundreds of ageing contracts soon to come to an end, it’s more important than ever to have a coordinated plan of action in place alongside the skills, knowledge and funding to affect this often incredibly complex transition.
In our next article, ‘Public sector preparedness for expiring PFI contracts; NAO findings and recommendations – PART 2’, we will delve into the numerous action recommendations from the NAO’s report and we’ll look into a number of steps your organisation can put in place today to improve your chances of a smoother, swifter transition at the end of your PFI contracts.
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