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PFI under review

21st July 2007

The government is scaling back its programme of PFI hospital developments, and is reviewing the whole process in light of a new EU Directive and lessons learned to date.

UHB New Hospital1

In June the Department of Health was celebrating the fact that it would hit its target of building 100 new hospitals by 2010 in the "largest hospital building programme in history". Whereas £1.1bn capital was invested in new hospital facilities in 1997/98 when the present government was first elected, the figure for 2007/08 will be more like £5.5bn.

Most of this has been achieved using the controversial Private Finance Initiative (PFI) – a model of public private partnership relied upon by this government to fund its ambitious building programme for schools, hospitals, and other public amenities over the last ten years. Of the 88 new hospitals already opened since 1997, 67 were funded via PFI. Nineteen of the remaining 23 schemes under construction and due to complete by 2010 are PFI.

The problem with PFI

The government maintains that using private money to build (and often run) new facilities for the public sector has allowed larger scale developments to open faster than schemes traditionally funded with public capital, and that PFI has a better track record of delivering new facilities on time and to cost. Critics of PFI say that the NHS has been mortgaged to the private sector through the availability payments it must make to PFI developers over lengthy contract periods (in some cases up to 60 years), often signing over its assets, including land and buildings, as security in the deals. They say the overall cost to the NHS will be higher in the long run than having built the same schemes using public money in the first place. The ‘Keep Our NHS Public’ campaign estimates that the private sector will have generated £23bn in profits from the NHS over 30 years of PFI.

A report by the National Audit Office published in March of this year looked at a sample of PFI schemes between 2004 and 2006. It found that:

  • Average length of the tendering process was 34 months, with 12 months being taken to finalise the deal with the preferred bidder once they had been selected. In some cases the tender process took five years. The NAO advised that tendering should only take 18 to 24 months in total.
  • There was a growing lack of competition as bidders were deterred by the time and cost of bidding for PFI schemes. It found that a third of schemes only had two interested bidders – twice as many schemes in such a position compared to previous years. This poses a significant threat to the NHS achieving value for money through PFI competition.
  • There were significant cost shifts through the negotiation process, with some schemes changing their estimated costs by as much as 17%.

In January of this year the £900m Paddington Basin scheme, which was meant to bring together three west London Trusts in one major PFI redevelopment, spectacularly failed after £15m fees had already been spent by the NHS during five years of aborted planned. A review blamed poor cost forecasting, local planners who were out of their depth working in this commercial arena, and insufficient clarity from the Department of Health about how to proceed with the scheme.

Under the Freedom of Information Act, the Department of Health recently disclosed that five early hospital PFI deals had resulted in the NHS leasing its land to the private partner for up to 125 years – far beyond the 60 year term of the PFI contracts in question. This means that land worth an estimated £500m (or much more if redeveloped for housing, for example) would be lost to the NHS if it ever terminated the PFI agreement in that time. This effectively makes the PFI deals fixed once signed off. Unison cited this as another example of the NHS’ "ineptitude at negotiating".

A recent review of PFI in South East London found that the availability payments NHS trusts make to their PFI partner are often greater than the capital charges allowance built into the national Payment by Results tariff. This leaves them with an instant affordability gap which they cannot close. They have no options around sale or lease of their assets to raise additional funds as these have been tied into the PFI deal, and a re-negotiation of the PFI contract is unlikely to yield sufficient savings.

The review also concluded that PFI was incompatible with service redesign as the PFI contracts - with their level of fixed costs and semi-fixed occupancy related costs - could not tolerate changes to bed numbers or the configuration of facilities. Such changes would almost certainly lead to penalty charges being levied against the NHS. Once tied in to such deals, NHS Trusts therefore have little scope to make revenue cash releasing savings through service redesign. In turn this leaves non-PFI’d Trusts under disproportionate pressure to find cost savings for local health economies from their more flexible asset base which is still under NHS control.

It is possible to renegotiate PFI contracts to some degree after they are first signed off. The Public Accounts Committee published a report last month on how the NHS has done out of refinancing such deals. It concluded that local NHS officials were frequently "outwitted" by their commercial counterparts during original negotiations and subsequent re-financing discussions. This left the NHS tied in to long contract periods with high termination liabilities, particularly in the earliest PFI schemes. The refinancing of the Norfolk & Norwich scheme resulted in a windfall for private investors of £80m, with their rate of return rising from around 15% to 60%. The government has subsequently agreed arrangements with the private sector for sharing 50/50 the returns achieved through re-financing. Even so, the PAC has recommended that the Treasury should take responsibility for refinancing PFI debts, and has urged for a scale down of PFI overall amid fears over value for money.

Cutting back on PFI

Whilst the Department of Health has been reviewing the process for PFI procurement over the last 12 months, its latest figures show that the PFI hospital building programme has been cut back by a third in the last 16 months from £12bn to £8bn. A number of major schemes have had the green light, including the £1bn Barts & The London project, the £600m Birmingham redevelopment, and seven other smaller schemes totalling £1.5bn between them. But a number of these have had costs shaved off their original values, and other schemes have not received approval even with modification, including ones in Plymouth, Liverpool, South Devon and Whipps Cross. Other schemes in the pipeline are delayed and undergoing rigorous review.

The Construction Products Association found that healthcare construction output was down 9% in 2006. Whilst it also found that levels of PFI investment were being maintained, this was due to a small number of large schemes (such as Barts & The London).

It is likely that the government is becoming increasingly nervous about the long term service and financial plans literally set in stone in PFI deals at a time of financial uncertainty for the NHS, and when it is trying to encourage extensive service reconfiguration with shifts of care from hospital to community settings using advances in medical technology and workforce utilisation.

Interestingly, a number of schemes are now looking for other ways to achieve their redevelopment plans outside the PFI regime. Two schemes in North and South Devon, plus the unsuccessful Plymouth scheme, have decided to embark on rolling programmes of refurbishment and redevelopment over a number of years using traditional sources of public funding.

Future changes to PFI

Problems identified with PFI, and an EU directive issued in January 2006, have led the Department of Health to review how PFI works in the NHS. The EU procurement directive requires a shift from the competitive negotiation process which has characterised PFI deals to date, to what is being called ‘competitive dialogue’. This requires bidders to be involved in a ‘dialogue’ with the NHS contracting body to develop the final scheme, with all issues of substance, detail and cost being resolved before they submit their final tenders. By the end of the dialogue process, the two remaining bidders will be asked to submit their tenders to deliver the finalised scheme. There will be no scope for variations to the detail of the scheme after this point except for minor points of clarification. In the old process, variations of the scheme would be developed by different bidders, and the preferred bidder would be selected with much of the detail still to be finalised after their appointment.

The process of competitive dialogue risks extending the time and amount of work to be put in by bidders before they are appointed. But two further improvements being proposed will help mitigate this:

  • The Department of Health is looking into a scheme to reimburse the unsuccessful bidder a portion of their costs. This would only apply to the bidder coming second, having been one of the two bidders invited to proceed to ‘competitive dialogue’, but eventually being the one unsuccessful in being appointed.
  • The Department of Health is working with new approved PFI schemes to run what is being described as ‘smart PFI’. This involves the majority of the planning and design work being completed by the NHS contractor prior to the project reaching ‘competitive dialogue’ stage, or even before it is advertised. The North Bristol scheme at Southmead Hospital is a test case. They are looking at completing much of the design work before inviting bidders, because they have recognised that 75% of all accommodation in the new development is generic room space which can be specified before individual bidders get involved. This is an approach being advocated by the Royal Institute of British Architects (RIBA).


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