PFI construction cost inflation

Treasury urged to assess PFI construction cost inflation

The House of Commons Public Accounts Committee has observed that there is no central data on PFI construction cost inflation or the impact of government building programmes on public sector building costs.

"In order to manage better the future PFI programme", it says, "the Treasury should provide an annual assessment of the effect of construction cost inflation on public building projects, including the effect on PFI projects and a comparison with private sector performance".

The committee's recommendation on recording comparative building economics appeared following its critical commentary on the refinancing of the £250 million Norfolk and Norwich University Hospital.

Its report deplored the large gains made by the private sector Octagon consortium in refinancing the project after construction of the new hospital had been completed.

The operation was fully analysed by a National Audit Office team, who showed that the internal rate of return enjoyed by the financial backers soared to 60 per cent compared with the 19 per cent expected when the contract was let (CIOB International News, March 2005).

The NHS Trust managing the project on the other hand received only 29 per cent of the gains despite taking on substantial new risks following the refinancing.

As the Public Accounts Committee says, Octagon achieved this outcome by increasing its borrowings by 53 per cent, from £200 million to £306 million.

It then used the increased funds to accelerate the financial benefits which the investors would receive from the project.

After other financing adjustments, the total refinancing gain was £116 million of which £82 million was retained by Octagon.

The accounts committee comments that the benefits the consortium derived simply by borrowing more rose on refinancing to levels which are unacceptable even for an early PFI deal.

"This project", says the committee in its conclusions and recommendations, "again shows an authority too readily agreeing with refinancing proposals when more robust negotiations could have produced a better outcome".

'Poor deal for hospital trust' Edward Leigh, the committee's chairman, described the outcome of the Norfolk and Norwich refinancing as a poor deal for the hospital trust, commenting that it might now have to pay up to £257 million more if it needs to terminate the contract early.

"This is taxpayers'money", he said, "and the risk of this large liability was incurred essentially so that investors could have fatter returns".

The Trust has also taken a step in the dark in agreeing to extend the minimum period of the PFI contract to 2037.

It is surely impossible to predict so far in advance the nature and extent of the services that might be needed.

"Even though this was an early PFI deal, it is hard to escape the conclusion that the staff managing the project were not up to the rough and tumble of negotiating refinancing proposals with the private sector".

"Such staff should be trained to understand refinancing issues which can be highly complex and should appoint experienced advisers to help in robustly negotiated refinancings.

"My committee would not expect to see another accounting officer defending what we believe to be the unacceptable face of capitalism".

"Such a face was shown by this private sector consortium in its dealings with the public sector.".

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