pfi_a_briefing by stariya



A briefing

September 2002
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                                                                     Page 1


The Private Finance Initiative (PFI) has been shrouded in controversy
since its inception in 1992. Opinion is at best divided on the value of
using PFI to finance and improve the quality of public services.

In a recent survey of ACCA members working in the UK public sector
only one percent of the respondents strongly agreed that PFI generally
provides value for money whilst well over half of the respondents
disagreed with this statement. In a survey undertaken by the magazine
Public Finance last Autumn, only one in ten senior public sector
finance managers agreed that:

     "PFI and other forms of Public-Private Partnerships are having a
     beneficial effect on public services."

James Stuart, Chief Executive of Partnerships UK, admitted last year
that the government faces an uphill task in convincing the public of
the need for PFI deals. A recent pubic opinion survey found that 2 in 3
public feel that in general public services should not be run for a

Whether using PFI will provide public services efficiently is still largely
a political rather than professional opinion as there is so little evidence
Page 2

of the outcome of such agreements. In a report1 last year the Audit
Commission stated that it was "too early to say whether PFI contracts
generally offer the public sector long-term value for money". The UK
government is, however, convinced that "the private and voluntary
sectors can play a role…where use of them can improve public
services, nothing should stand in the way of their use"2. As a result, in
the short-term at least, the Public Finance Initiative (PFI) is often the
"only show in town", in that it is only this approach that will gain HM
Treasury approval for much needed capital investment.

1   Building for the Future, PFI Management Paper, Audit Commission June 2001
2   Tony Blair in a speech to public sector employees, 16 October 2001
                                                                                   Page 3

The Commission on Public Private Partnerships3 commented that there
should be "an evidenced based approach to policy. A commitment is
necessary to pilot, monitor, and systematically evaluate a spectrum of
partnership arrangements. Depending on the evidence that emerges
PPPs could be rolled out or rolled back".


PFI was developed and was seen as attractive by the Labour Party
administration in 1997 as it appeared to be able to reconcile two
apparently conflicting objectives:

         to significantly increase the investment in public services

         to maintain the national debt at a prudent level compared to the

The main arguments for PFI are now that it:

         provides value for money by bringing private sector expertise in
          to manage public services

         provides the finance for significant investment in public services
          which would otherwise not be possible

3   Institute for Public Policy Research, Building Better Partnerships: The final Report of
the Commission on Public Private Partnerships, July 2001
Page 4


     allows a significant level of risk to be transferred to the private
                                                                    Page 5


The question of whether PFI can actually provide value for money in
the procurement and provision of public services is discussed in the
first section below. Before any PFI project is approved it must be
subjected to a comparison with the costs that are assumed would be
incurred if the project involved a traditional approach to public sector
procurement. This evaluation of the relative merits of the PFI and the
Public Sector Comparator are considered in the second section below.

UK public finances have fundamentally changed since 1997, the
national debt is now little more than 30% of GDP compared with
Gordon Brown's prudent level of 40%. Thus the government could
borrow an additional £300 billion without breaching this target. This
compares with the capital value of £22 billion for the UK PFI schemes
that have been completed so far and the £14 billion of further
schemes where formal contacts had been signed by July 20024. The
issue of whether PFI will allow more public sector investment in a
shorter time-scale is considered further in section three below.

The fourth section of this briefing deals with the issue of the transfer
of public sector risks to the private sector. The final section is an
article from a recent edition of Public Finance which discusses the
effects of PFI schemes on the public sector employees directly

4   OGC website July 2002
Page 6
                                                                    Page 7

Does PFI provide value for

The government argues that partnerships with the private sector will
ensure that public services are provided more efficiently and so
achieve greater value for money. However, if we look at the structure
of PFI projects it is hard to see where this value for money can come
from. In addition, if PFI is so efficient, why does the government
provide subsidies to public sector organisations that use the PFI route?
Finally why does the government not allow public sector organisations
a free choice on whether to use PFI or to finance their capital
investment directly?

If we take the example of a PFI hospital project, a PFI project will
typically include the provision of a new building and the services
associated with that building. This can include, for example, cleaning
maintenance, heating, public utilities and ancillary services for
example, catering. Under PFI, the accommodation would be designed
by architects in consultation with health managers and other users and
built by a construction firm. Under traditional procurement methods
essentially the same approach would have been adopted. The PFI
project will also usually include all the associated non-clinical services
Page 8

that will be required in the building over the life of the contract. In
many hospitals these services are already outsourced to a private
sector provider.

With PFI, all these contractors are chosen as a job lot as they combine
themselves into a consortium to bid for the project. This may provide
less value for money as the trust may not be able to choose the
optimum combination of private contractors. A company that is very
efficient at providing cleaning services may not be as cost effective at
providing building maintenance. In addition, the financing of PFI
schemes is estimated to cost at least one or two percentage points
more than if the money had been borrowed centrally by the Treasury,
as happens in traditional capital schemes.

Competitive pressure will also be significantly reduced with PFI
schemes as these are usually for 30 or more years rather than three to
five years for a typical service contract. The long-term nature of PFI
contracts means that, however poor the value for money they provide,
there is no escape route. Possibly because of this, the government
provides a range of subsidies that mean that even if an individual PFI
project is not cost effective, it will at least cost less, for the particular
organisation, than the traditional direct procurement option.

In central government and the NHS, if the PFI route is chosen the NHS
trust, for example, will be able to reclaim any VAT they have paid to
the PFI contractor. If a new hospital is contracted for directly, the
construction costs are also liable for VAT, only in this case the VAT is
                                                                            Page 9

not reclaimable by the trust. This results in a government subsidy of
17.5% towards the construction costs of all hospitals built under PFI.

In addition, each year NHS trusts (and central government
departments) have to pay capital charges of 6% of the value of their
capital assets. These capital charges are paid back to HM Treasury
funds and so they can be re-cycled to fund other public services.
Capital charges are not due on PFI projects, an effective subsidy to the
trust of 6% of the capital costs of each PFI project.

In English local government, the subsidy is even clearer, if not so
generous. Special Grant Report No. 765 details the objectives of this
subsidy as follows:

        "to assist local authorities in England to meet that part of their
        expenditure … under private finance transactions which is
        attributable to the capital element of the project costs."

This special grant scheme provides an annual grant to local authorities
of 11.5% of the notional credit approval for their PFI schemes (in broad
terms the capital value of these schemes).

5   Special Grant Report (No.76), Local Government Finance (England), DETR February
Page 10

Despite these subsidies, public sector organisations are still not given
the freedom to choose the option that they consider will provide them
with better value for money. Capital finance or approval to borrow to
invest is rarely available and so PFI is seen as the only game in town. If
investment is needed it is PFI or nothing.

Even the recent IPPR report6, which is convinced of the benefits of
public private partnerships, recommends that:

        'Government departments should be set an overall capital
        spending budget that encompasses both traditional financed
        spending and the capital value of PFI spending.'


        'PFI projects should not go ahead because a public authority
        believes there is no alternative.'

The report also calls for

         'an evidenced-based approach to policy. A commitment is
        necessary to pilot, monitor, and systematically evaluate a
        spectrum of partnership arrangements. Depending on the
        evidence that emerges PPPs [including PFI projects] could be
        rolled out or rolled back.'

6   Institute for Public Policy Research, Building Better Partnerships: The final Report of
the Commission on Public Private Partnerships, July 2001
                                                                 Page 11

This seems to be a sensible idea. Instead of continuing to push
through PFI schemes, careful consideration should be given to the
actual value for money that existing schemes are providing. It does
not appear prudent for the government to ensure that the vast bulk of
its capital investment is undertaken via PFI without first undertaking a
detailed study of the relative success of the schemes that are currently
in operation.
Page 12

PFI and the Public Sector
Comparator: are comparisons

Since 1997, when the current government was first elected, 85% of the
funds for major NHS capital projects have come from PFI schemes. In
each case the costs of the PFI scheme have been compared with an
estimate of the costs of procuring the project by conventional means
(the public sector comparator). For a PFI scheme to obtain the go-
ahead, this comparison has had to show that, over the life of the
scheme, the PFI option will be more economic than the public sector
comparator (PSC). In addition, the PFI scheme must also be shown to
be affordable.

Accountants are responsible for undertaking these comparisons and
for ensuring that they are objective. Readers of their reports will
depend on the accountant's professional integrity. However, a range
of recent publications has suggested that the financial appraisals that
have been undertaken have been skewed in favour of the PFI option.
This may be in the short-term interests of the particular NHS trust, but
in may not be in the longer term interests of the taxpayer or the
                                                             Page 13

longer-term image of accountants. Will accountants be blamed if PFI
schemes turn out to be more expensive than the alternative methods
of procurement that they 'proved' did not provide value for money?
Page 14

In fact this is already happening. An a briefing paper from the BMA7
stated that:

        "Evidence continues to show that PFI hospital schemes are
        unnecessarily expensive, and our concerns about affordability,
        value for money, inflexibility, risk transfers and service cuts have
        not been satisfactorily addressed. Neither the advantages
        originally claimed for PFI nor the improvements introduced by
        the government are likely to outweigh these concerns."

The approach to assessing the value for money of a potential PFI
scheme could be considered to be biased in favour of the PFI
alternative. The comparison is undertaken by calculating the net
present cost (NPC) of the two alternatives. The costs of the PFI
alternative are discounted as they occur over the, typically 30-year,
lifetime of the project. In contrast, the capital funding of the public
sector comparator is not discounted as all the expenditure is assumed
to occur at the beginning of the project period (although it would
almost certainly be funded by an Exchequer loan).

In addition, a constant discount rate of 6% has been used since 1991
for option appraisals in the NHS despite the significant fall in general
interest rates over the last few years. The viability of PFI schemes are
very sensitive to the discount rate that is used. None of the first 11 PFI

7   Parliamentary Unit briefing papers, British Medical Association Funding - the NHS
and public-private partnerships; September 2001
                                                                                  Page 15

schemes in the NHS would have been considered to provide value for
money if the discount rate used had been 5% rather than 6%8.

8   Sussex J. The Economics of the Private Finance Initiative; Office of Health
Economics (April 2001).
Page 16

The government cites risk transfer as one of the main advantages of
the PFI approach to financing capital investment in the public sector.
Indeed, without it the case for PFI would fall in every project appraised.
This is because the cost of the risk transferred to the private sector is
added to the cost of the public sector comparator. The cost of the PFI
project includes these risks and so the PSC should be adjusted to
include them as well.

However, there is little official guidance on how to calculate the risk
transferred and the publicly available evidence on the risk analysis and
transfer actually undertaken is very limited9.

Two risks that are often cited as being transferred to the private sector
contractor with a PFI project are:

     delays in completing the project


     cost overruns for the project.

There is some evidence that the costs of these risks have been
exaggerated, for example, capital cost overruns on conventionally
financed NHS construction projects averaged 7% in the late 1990s. In

9   Allyson Pollock, Jean Shaoul, David Rowland, and Stewart Player Public Services and
the Private Sector: a response to the IPPR; Catalyst
November 2001
                                                                      Page 17

contrast a cost overrun of 12.5% or more is added to the cost of the
public sector comparator for most NHS PFI schemes10. The Treasury
guidance (the 'Green Book') is currently being revised and the private
sector argument for an increase in the risk of cost overruns is expected
to be treated sympathetically11.

Other ways in which the figures may have been adjusted to indicate
that the PFI option provide greater value for money include assuming:

     a building life for the PSC of 45 rather than the usual 60 years, for
      example, the Royal Infirmary of Edinburgh

     the opportunity cost of the land and buildings should be added to
      the PSC

     the cost of risks such as not meeting clinical saving targets or
      medical litigation are to be born by the private partner, but not
      subsequently transferred under the PFI contract

     a variety of other unspecified risks are transferred to the private
      sector and thus added to the cost of the PSC

     there will be no efficiency improvements over the life of the
      conventionally procured project

10   Sussex J. op cit
11   Public Finance October 26 - November 1 2001 page 8
Page 18

     revising the PSC costs in the light of PFI bids


     using market costs rather than actual current costs for the PSC.

The other test that a PFI scheme has to pass is that of affordability.
Again there is evidence of creative accounting to show that the PFI
scheme will be affordable, this has included:

     assuming a smaller hospital (with fewer beds)will meet future
      demand. All PFI schemes have reduced the planned bed numbers
      as negotiations have proceeded from the Outline Business Case
      (OBC)to financial closure, for example, in Worcestershire a PFI
      funded hospital will have one-third fewer acute beds than indicated
      in the OBC12

     additional funds being provided to the Trusts to cover the
      additional costs of the scheme in the early years

     equipment for PFI schemes being funded from NHS block grants


12   Froud J, and Shaoul J. Appraising & Evaluating PFI for NHS Hospitals; Financial
Accountability & Management (August 2001).
                                                                 Page 19

     assuming demanding reductions in the Trust's clinical costs to meet
      the PFI tariff costs.

Accountants have a responsibility to provide financial information,
within the appropriate rules and regulations, that will further the aims
and objectives of their organisation. However, there may be conflicts
and tensions with the practice of creative accounting. There are also
limits to how far it should be taken without accountants coming up
against their professional ethical responsibilities.

Jeremy Colman, assistant controller and auditor-general was reported
recently as saying that public sector comparators suffer from "spurious
precision". He went on to say the value for money exercises were
"pseudo-scientific mumbo-jumbo where the financial modelling takes
over from thinking… It becomes so complicated that no one, not even
the experts, really understands what is going on". Finally he stated
that "People have to prove value for money to get a PFI deal. But
because that is wrongly seen to be demonstrated only by the public
sector comparator, it becomes everything. If the answer comes out
wrong you don't get your project. So the answer doesn't come out
wrong very often"13.

13   Financial Times, 5 June 2002
Page 20

There may also be conflicts between the current requirements and the
future obligations of an NHS Trust. It may appear that capital
investment is required and that the PFI route is the only one that will
gain approval. However, PFI, although initially costing less in the early
years of the project, may be more expensive in the longer run when
the capital charges of the traditionally procured alternative would have
dropped to much lower levels. Capital charges in the NHS are based
on the declining balance of depreciate costs and so are front end
loaded and reduce over the period that the asset is held.

In addition, each time a proposal is put forward that indicates that a
PFI scheme should provide greater value for money this reinforces the
government's view that PFI is the most efficient procurement route.

If this is in fact not the case this will have an adverse effect on the
longer-term availability of funds for capital investment as well as
revenue funding for the NHS. The costs of PFI schemes will be an
obligation for decades to come. In addition, the more the government
is provided with, possibly, subjective, evidence of the value for money
of PFI projects the more they will consider that this is the standard
approach that should be adopted. Again this could be at the cost to
future taxpayers who will be required to fund these PFI projects.

Accountants involved in assessing possible PFI schemes should
consider carefully the objectivity of the evidence that they are
responsible for producing. They should also consider their
responsibilities to the longer-term public interest in general rather
                                                                  Page 21

than the short-term interests of their particular organisation.
Accountants may feel that they are under undue pressure to produce
figures that will 'prove' that the PFI scheme provides value for money
and will be affordable. If they consider that these pressures are such
that they are being pushed into breaking their professional code of
conduct they should seek assistance.
Page 22

Does PFI allow more public sector
Gordon Brown sets great store by 'prudence'. In this article I will
argue, however, that current levels of public investment do not
provide an example of prudent management of public finances.
Capital investment in UK public services recently reached a post-war
low as a share of GDP14 and they are now at recklessly low levels.

Gordon Brown claimed recently that 'public investment [is] being
enhanced by an additional amount of private investment, that leads in
some cases to moving forward with projects more quickly'15 John
Prescott also defended public-private partnerships recently asking
'What is the price of not involving private finance? The real price is
leaky overcrowded classrooms … delayed operations … delayed
journeys … and a lack of care services.'16 In contrast, I want to argue
that the private finance initiative (PFI) and other forms of public-
private partnerships do not enable additional, higher, levels of
investment in public infrastructure.

14   Institute For Fiscal Studies, Twenty-Five Years of Falling Investment? Briefing Note
No. 20, November 2001, page 2
15   The Times, Tuesday 5February 2002, page 6
16   The Guardian Saturday 2 February 2002
                                                                 Page 23

In reality, one aspect of these schemes is that they are just another
form of state borrowing. They are not clever schemes of off-balance
sheet financing that magically combine high levels of public
investment and apparently low levels of public borrowing.
Page 24

Since becoming the Chancellor of the Exchequer, in May 1997, Gordon
Brown has defined his prudent approach to public finance through
two strict fiscal 'rules':

     the golden rule: over the economic cycle, the government will
       borrow only to invest and not to fund current spending

     the sustainable investment rule: over the economic cycle, the ratio
      of net public sector debt to GDP will be set at a ‘stable and
      prudent’ level, defined by the Chancellor as 40 per cent of GDP.

The government has provided no justification for a net debt target of
40 per cent of GDP – it could just as easily have chosen 35 per cent or
45 per cent. The Maastricht Treaty, for instance, allows UK gross
general government debt of no more than 60 per cent of GDP. This is
consistent with net public debt being considerably higher than 40 per
cent of GDP17. Historically 40% is a very low level. For most of the
century between 1750 and 1850 and for much of the 20 th century the
UK national debt was worth more than 100% of its national income.
During the Second World War it peaked at over double the national

Fig 1: Net UK debt as a percentage of GDP18

17   Institute for Fiscal Studies, The Government's Fiscal Rules, Briefing Note No. 16,
April 2001, page 2
18   Office for National Statistics, Public Sector Finances August 2002, 19 September
Page 25
Page 26

When Gordon came into office, net public sector debt stood at nearly
45% having grown fairly consistently of the last five years of the
Conservative administration. It has since fallen equally consistently
and over the last 18 months has stayed at just above 30% (see Figure
1). The government expects it to stay at this level until at least 200719.

Over the longer-term, the trend is if anything even clearer. Public
Investment as a Percentage of GDP fell fairly consistently from around
1967 to 2000 (see Figure 2). By April 2002, the UK had the lowest level
of public investment of any major EU country. Much of this fall in
public sector investment can be explained as being a result of
transferring functions away from the public sector. Housing
investment, for example, has been transferred from local authorities to
housing associations.

Figure 2: Public Investment including Capital Spending by the

19   HM Treasury, Chapter 2, Budget Statement, April 2002
                                                                                Page 27

Sector under the PFI as a Percentage of GDP, 1963–200020
However, capital investment in health and education has also fallen
significantly over the last 25 years. In 2000 capital investment in the
NHS as a percentage of GDP was approximately half its level in 1992
and at a lower level than at any time since the early sixties21. In
education, after allowing for changes in the funding regime for further
and higher education, capital investment in 2000 as a percentage of
GDP was still only one-third of its level in 197322.

20   Institute for Fiscal Studies, Twenty-Five Years of Falling Investment? Briefing Note
No. 20, November 2001, page 6.
21   Institute for Fiscal Studies, Twenty-Five Years of Falling Investment? Briefing Note
No. 20, November 2001, page 19.
22   Ibid., page 24.
Page 28

These low levels of capital investment mirror relatively low levels of
overall public spending on health and education in the UK. In 1998,
Japan spent approximately 75% more per year on each of its primary
pupils and nearly 30% more per year on each of its secondary pupils23.
The USA spends a higher proportion of its national income on public
health services than the UK. In total USA spending on health is nearly
twice the level in the UK24.

The private finance initiative (PFI) has been used by central
government over the last five years to increase the use of the private
sector in the delivery of public services. PFI is used to buy services and
public facilities from a consortium of construction companies,
financiers and service providers. The public authority contracts with
the private consortium to design, build and operate schools, hospitals
or other services.

Unlike previous public sector building programmes which were funded
by central government borrowing, under PFI the private consortium
raises the money to build the new hospitals or schools, for example,
from bank loans and through shareholders.

23   OECD, Education at a Glance, Paris 2001
24   Derek Wanless, Securing Our Future Health Draft report 2001
                                                                                 Page 29

PFI has had only a minimal effect on the overall level of capital
spending as Figure 2 above shows and there is little justification for
using private finance in terms of maintaining a prudent level of public
sector borrowing. All PFI capital works undertaken during 1999-2002
could have been replaced by traditionally government borrowing
without breaking the either the golden rule or sustainable investment

The government could borrow an additional £300 billion pounds
without breaching its 40% of GDP rule. In contrast, the government is
hoping for PFI to deliver only £10.8 billion of capital investment in
public services over the three years from 2001-02 to 2003-0426.

Within the Health Service, Department of Health figures show that PFI
projects agreed in 2000/01 financed capital investment of roughly half
a billion pounds27. This is approximately equal to the same
Department’s underspend on its current budget in that year alone28
and compares unfavourably with the estimate that there is a backlog
of maintenance due in the NHS of over £3 billion.29 The Department

25   Institute for Public Policy Research, Building Better Partnerships: The final Report
of the Commission on Public Private Partnerships, 2001, page 81-82.
26   Institute for Fiscal Studies, Green Budget 2002, 30th January 2002, Table 3.5, page
 Department of Health, Departmental Investment Strategy, p. 10,
28   Institute for Fiscal Studies, Green Budget 2002, 30th January 2002, Table 2.1, page
29   Department of Health, Departmental Investment Strategy, page 28.
Page 30

of Health also suggests that PFI investment will increase, from £632
million to £832 million per year over the next three years30. The NHS
Plan31 details the government's goal of establishing £7billion-worth of
hospitals funded through PFI by 2010.

30   Ibid., page 23.
31   NHS Plan Department of Health 2000.
                                                                                 Page 31

PFI is a form of borrowing, not funding, that shifts the burden onto
future generations. As the IPPR acknowledges32, the public sector
repays the full cost of the private sector providing the infrastructure
and services in annual payments over periods of 20 to 30 years. It does
not access new forms or higher levels of funding than would otherwise
be the case with public funding.

Indeed, the cost of borrowing for PFI projects is estimated to be 1-2%
higher than the cost of government borrowing for direct public
investment. As a result, the government could increase investment, at
no extra cost, if this were all to be financed by direct exchequer
borrowing rather than through PFI.

Far from levering in additional finances, PFI will either reduce the level
of investment achieved or increase the costs for future generations
(unless private sector efficiency can more than compensate for the
additional financing costs associated with PFI).

In addition, most PFI schemes do not now even reduce the
government's official level of borrowing, the Public Sector Net Debt.
PFI schemes for roads and prisons are included within this figure.
Since Alan Milburn become the Secretary of State for Health, in June
last year, the capital value of PFI deals within the Health Service has
also been included in the official figures of government debt.

32   Institute for Public Policy Research, Building Better Partnerships: The final Report
of the Commission on Public Private Partnerships, 2001.
Page 32

As shown above, public sector capital investment in the UK is at a low
level compared with historic figures over the last 25 years, those for
the last five years of the previous Conservative administration and is
also the lowest of any G7 country. Government borrowing is
significantly below both the Chancellor of the Exchequer's own ceiling
and that set by the European Union. For these reasons, the argument
that PFI is necessary to access much needed additional finance for
investment in public services cannot be sustained.
                                                                    Page 33

PFI and risk

Risk is at the heart of all PFI and other public private partnerships, but
not perhaps in the manner claimed by their supporters. It is only by
adding the value of risk that is claimed to be transferred to the private
sector that any PFI project can appear to demonstrate value for
money. In reality, the main risks in the provision of any essential
public service will remain with the government. It cannot afford to let
these services fail and so, if necessary, the private sector provider will
be bailed out by the tax-payer. Far from the private sector managing
risks more effectively time and again private sector failures have
demonstrated that the key risks remain with the public sector.

The traditional method for any organisation or individual to avoid risk
is through insurance. We pay an insurance company to take over the
responsibility for our risk of having a car accident or our house
burning down. However, most people will only voluntarily insure
against significant risks that they would find difficult to fund in any
other way. The costs of administration (and the profits of the
insurance companies) mean that organisations will usually only insure
against hazards and other risks whose consequences, should they
actually occur, would be difficult to finance.
Page 34

For this reason, the government, being a large wealthy organisation
has a policy of not insuring its property. If any one government
building was, for example, to burn down, if may cost a few millions
pounds to re-build. But, given the size of the government's annual
budget this would be easily absorbed.
                                                                           Page 35

Thus, for example, the fire at the Yarl's Wood detention centre last
year was estimated to have caused damage to the tune of £43 million.
This sounds a lot of money, but compared to, for example, the
increase in the Home Office's budget announced for 2002-03 of
£2,900 million the fire would not really make much difference to the
finances of this department.

Thus the advice from HM Treasury33 is that

        "As a general rule the government does not purchase commercial
        insurance for the risks it faces".

The modern general approach to the risks faced by all organisations is
to adopt an explicit approach and to positively managing these risks.
But in Central Government, at least, this is a relatively new
development. So, for example, the first formal HM Treasury guidance
on risk management was issued in September 2000 as the Orange
Book34. This followed the NAO report, Supporting Innovation:
managing risk in government departments35 which concluded that:

        "The Modernising Government programme seeks to encourage
        departments to adopt well managed risk taking where it is likely

33   Government Accounting, HM Treasury 2002
34   Management of Risk - a strategic overview (The Orange Book), HM Treasury,
September 2000
35   Supporting Innovation: managing risk in government departments, National Audit
Office, July 2000
Page 36

        to lead to sustainable improvements in service delivery. In
        pursuit of this the Cabinet Office and the Treasury are acting with
        departments to promote better risk management across
        government, including the requirement for all departments to
        produce by September 2000 frameworks setting out their
        approach to risk management in their areas of responsibility."

Thus it would appear that the issue of risk transfer should be seen as a
method for justifying a PFI project rather than as a reason for
developing such an approach. It is only in the circumstances of a PFI
project that risk transfer is assumed to be an advantage.
The value for money test only comes out in favour of PFI after a price
has been placed on the value of risk that is assumed will be transferred
to the private sector contractor. A study in the British Medical
Journal36 showed that for eleven hospitals the PFI was only better
value for money than the public sector comparator after risk was
transferred. Even then the difference was very small, only 0.05% at
Swindon & Marlborough, for example. More suspiciously, the study
demonstrates that "the value of the risk transferred is remarkably close
to the amount needed to close the gap between the public sector
comparator and the PFI".

The value of the risk that may have been transferred often appears to
have been exaggerated. Research, also published in the British

36   Private Finance and "value for money" in NHS hospitals: A policy in search of
rationale? Allyson Pollock, Jean Shaoul, Neil Vickers, BMJ Volume 324, 18 May 2002.
                                                                               Page 37

Medical Journal37, showed that NHS PFI schemes "have in most cases
assumed that the public sector projects overrun by 12.5% or more"
whereas "the average increase in cost over approved tender sums for
NHS capital projects has been between 6.3% and 8.4% in the 1990's".
Work undertaken by consultants for the current review of HM
Treasury's Green Book admits that their estimates of cost and time
overruns for large public sector capital schemes are higher than other
recent surveys. This is because there have been improvements in
recent years and because other surveys omitted projects with
unusually large overruns.

In reality many risks are not actually transferred to the private sector as
a result of the contract for PFI or other public private partnerships. For

     Passport Office computer problems in 1999 led to queues and costs
      estimated at £13 million and the cost of passports being increased
      by a third. The contractors contributed only £2.5 million.

     Railtrack was effectively re-nationalised last year after it became
      insolvent last year when the government refused to provide any
      further funding

     a recent report found that 18 of the first 31 NHS PFI schemes were
      in fact delayed and that, of those delayed, the average delay was 12

37   PFI in the NHS: is there an economic case? D Gaffney, A Pollock, D Price, J Shaoul,
BMJ Volume 319, 1999
Page 38


   Channel Tunnel rail link PFI scheme contract let in 1996 for £1.7
    billion, 1998 the government provided a further £4 billion of

   National Air Traffic Control System - privatised in July 2001 and
    provided with an additional £30 million in January 2002 from the

   PPP for tube - NAO briefing found that the major risks would not
    be transferred to the contractors

   Yarl's Wood - the contractors are claiming that the Government
    should be liable for the costs of re-building the centre.

PFI is a form of privatisation. Public service provision is transferred to
the private sector. This can only be justified, from a VFM point of view,
if the value of risks claimed to be transferred to the private sector
partner are taken into account. These risks are regularly exaggerated,
other measures to reduce them are only now being introduced and, in
many cases, it turns out that the most significant risks remain with the
public sector.

In reality, the key risk with PFI is of public services being provided at a
greater cost by the private sector. If these projects are successful, the
private sector makes a substantial profit. If they fail, it is the public
                                                                 Page 39

that suffers disruption to services and the costs of private sector
Page 40

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tel: +44 (0)20 7396 7000 fax: +44 (0)20 7396 7070

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