A guide to successful transition
Whether you know it or not, you’ve likely encountered a Private Finance Initiative (PFI) or two. Have you ever wondered how some public projects, such as hospitals, schools, prisons, and even roads, are funded and built?
Chances are it’s through a PFI.
Our latest report addresses how public procurement can get ahead, ensure value for money, and avoid the significant risks of failing to manage PFIs effectively.
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Private Finance Initiatives (PFIs)
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PFis A guide to Successful transition – 5 key takeaways
1. PFI’s are a ticking time bomb: Successful transition of post-expiry requirements takes seven years – if you haven’t started planning for those expiring by 2030, you are already behind.
2. Significant savings opportunity: Focus on the return, not the cost of doing; together, PFI health checks and effective expiry management have the potential to release £millions to reinvest in live challenges across the public sector.
3. Funding the long-term through early improvement: Addressing PFI expiry is complex and costly, so securing funding by improving contract management processes and recouping in-life savings in the first instance is vital.
4. Navigate the knowledge gap: Knowledge across the PFI landscape is patchy, act quickly to access the right expertise in the market to get ahead with progress.
5. Plan for sustained value: Consider how you embed the revised processes for ongoing, proactive management of re-tendered services to sustain the value generated.
What is a PFI?
PFIs are long-term agreements between a private party and a government entity. The private party designs, builds, finances, and operates the government entity’s asset—whether for an NHS Trust, Local Authority, or a central government Ministry/Agency. This agreement style is often compared to a mortgage, where funds are taken from another party to pay back over time in exchange for a building and often a managed service within the building (catering, FM, cleaning, etc.), typically for 25-30 years.
What is the role of a Special Purpose Vehicle (SPV)?
A Special Purpose Vehicle (SPV), a company specifically created to implement the PFI project, has no other business than running the PFI. It creates subcontracts to undertake the project, using finance from lenders and investors, typically through debt and equity. Establishing an SPV as a separate legal entity isolates the parent companies from financial risks related to the PFI project.
Furthermore, the SPV is responsible for overseeing the construction of the asset, maintaining and operating the asset over the contract term, managing the contract, and collecting payment from the public sector client over the contract term.
“There are 669 live PFI contracts in the UK, with a total capital value of over £50bn.”
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The significant saving opportunities PFI's present.
PFIs have played a significant role in British infrastructure development since being introduced under a Conservative government in 1992.
Expanded under Tony Blair’s Labour government from 1997 (and those that followed), today there are 669 live PFI contracts, with a total capital value of over £50bn, delivering significant requirements across the public sector – particularly in Health, Defence, and Education.
Over the years, the public and the press have criticised PFIs. They were positioned as poor value for taxpayers’ money, with infamous accounts of reckless overspending—a £5,500 sink here, a £884 chair there—but the benefits were seldom highlighted.
PFI History and Criticism
PFIs tend to be contracted on an asset being built and used and then handed back to the public sector entity at a stated time and in a certain condition. Maintenance budgets are ‘baked in’, and the asset is maintained throughout its life. Buildings not financed this way tend to have budgets chopped to use funds elsewhere, with maintenance budgets often taking the brunt of reallocating funds.
Often, there is a notable difference that regularly funded upkeep makes. When a PFI asset (e.g., building, etc.) is handed back at the end of the contract, the ownership of the budget and the ability to reallocate funds return to the Authority finance team. This works well if the contract is effectively managed and the organisations behind the SPV remain enthused, focused, and in business.
What is a Unitary Charge?
An annual payment made by the public sector to the private sector in a PFI contract, covering the costs of construction, maintenance, and operational services.
For a PFI-funded hospital for example
The Unitary Charge might include the cost of the building’s construction, maintaining medical equipment, cleaning wards, catering for patients, and groundskeeping. The public sector pays this charge to the PFI’s Special Purpose Vehicle (SPV).
The collapse of Carillion
The collapse of Carillion in 2018 brought to light significant issues with how the contracts were managed. Financial strain in the form of cost overruns and delays that led to the collapse also saw the risk transfer revert to the public sector, questioning the effectiveness of risk transfer in PFI contracts. That same year, the government ended PFI for future infrastructure projects. Under a new government, the public must wait and see if PFIs will be left in the past or reintroduced as part of the solution to public sector budget constraints – whether under the guise we’re familiar with or otherwise.
The history of PFIs also provides some key learnings and considerations for the future:
The next big issue facing PFIs is the expiry process. The number of PFIs starting to expire is increasing year on year, peaking in 2036 and reducing thereafter. Are authorities ready to take services in-house or re-tender for the multitude of service contracts they may face from Day One post-expiry?
“The government recommends a seven-year expiry planning process—for some, this may be too little, and for others, too late.“
Challenges and barriers, or a cost opportunity?
Contract Management in relation to PFIs has been generally inconsistent (as found by a National Audit Office report).
Many thought of PFIs as a ‘fire and forget’ solution that would self-manage, but in reality, they are active complex contracts, albeit over a longer period than usual. The need to contract to manage these agreements is more important than ever, as ‘scope creep’, ‘over-enhanced service delivery’, and lack of challenge means that SPVs may have been significantly overpaid for decades.
Given the length of these agreements, effect management is made harder through staff changes likely to occur throughout the lifecycle. Without a structured and controlled contract management approach, knowledge will move with people, opportunities will be lost, and costs will likely increase.
Much of the planned maintenance agreed upon at the outset of these contracts was, in some cases, a “best guess.” It is highly likely that, alongside technological developments, industry innovations, and the pandemic, those schedules no longer reflect true requirements. Effective in-life contract management should enable alignment with contract commitments and thus not leak value. Without that, an intervention or periodic reviews should offer the chance to recoup value.
Examples of these PFI contract management ‘health checks’ are provided below.
Maximising Machine Lifespan
The planned replacement of an MRI Scanner, which was costed into the Hospital PFI, was due, but the existing machine was fully effective and did not need renewal. Maintaining the existing scanner and removing the additional cost of the new scanner delivered ongoing financial efficiencies.
Feeding Reality, Not Projections
PFI companies on two estates were catering for a theoretical maximum number of staff on each site. The PFI charged the total amount (mainly for cleaning and catering)—in one case, for 1,200 meals per day when only c.200 were taken. Challenging this resulted in the lower ‘actual’ rates being charged, with a sliding scale introduced to allow for any surge in numbers. This reduced the ongoing costs and allowed an opportunity to recover from the historical overpayments.
Maintenance Mirage
Approaching expiry, contract management provision on an accommodation PFI demonstrated that maintenance charges continued to be paid, yet actual maintenance of properties had effectively stopped two years before expiry. This would have resulted in significant spending after the contract ended to return assets to an acceptable and safe condition.
Government guidance suggests starting a contract expiry process seven years before the expiry date.
This should allow sufficient time for planning the follow-on services, from requirements and budget setting to in-house training for managing such services and retendering of what could potentially be numerous contracts as the services from the PFI separate and become authority-owned.
The resource burden to manage this well and cost-effectively is significant across the public sector. Mistakes, delays, or underestimating efforts could cost £millions due to possible extension agreements and missed opportunities to engage with the industry effectively.
“Health checks often reveal opportunities to recover historical overpayments.”
Further, with c.30% of live PFIs set to expire by 2030, there is a risk that the sector will face a skills shortage in the market to address these, and the resources needed are unlikely to all be available in-house. Yet, the perceived high cost to manage may be far outweighed by the substantial cost of failure.
An added complexity is the local and/or devolved nature of the majority of PFIs. When agreed centrally, there is extra weight behind finding the means to address PFIs, yet according to government data, only 5% of PFIs are centrally held. This means that decision-making is fragmented across the wider public sector. Although the government can provide advice from the centre, decisions tend to be local.
What’s the value?
World Commerce & Contracting (WCC) reports that the latest average pre-contract value leakage is 8.6%—the worst performers see this rise to as much as 20%.
Moreover, without adequate management, research suggests contracts can lose up to 40% of their value over the in-life period.
Now consider the complexity and length of a PFI contract and the effect mismanagement could have on the value realised.
Conversely, it is also widely recognised that effective contract management and subsequent effective PFI expiry management can generate greater value. For example, re-tendering a PFI instead of extending it allows the opportunity to test the market, reset delivery requirements, and typically achieve savings of over 10%.
Additionally, whereas a PFI operates within the confines of its own contract, there is an opportunity during the expiry process to leverage economies of scale through partnerships with other public sector bodies.
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