Wednesday, 17 October 2012

PFIs for Jersey Hospital Development: A Bad Idea

In the pre-amble talk before the main speaker at the Chamber of Commerce lunch yesterday, David Warr raised the spectre of PFI - Private Funding Initiatives - as part of a favourable suggestion that would be coming from the Chamber to the States; he particularly singled out the building of a new hospital. What is a PFI? And why is it in fact a bad idea?

A PFI is a partnership between State and the private sector, which Tom Clark explains:

The private finance initiative was devised to get schools, hospitals and roads built without swelling the government's overdraft. Critics discerned a conjuring trick. Instead of the state borrowing, private consortiums did, and then the public paid - at a premium rate. It has often been likened to sticking a mortgage on a credit card; but Whitehall always resisted that charge. (1)

I do hope that Jersey does not go down this route without serious thought. Private Eye is littered with examples, in almost any edition, of PFIs that have plunged hospital trusts or schools into long term debt. Basically, PFIs always seemed an idea too good to be true, and they were! In 2011, a committee headed by a Conservative chairman, Andrew Tyrie, and a coalition  majority investigated PFIs in detail to see how the extravagant claims made matched the reality. The results were devastating. Tom Clark notes:

Calmly and forensically, the committee weighs costs and claimed benefits to damning effect - and also confronts ministerial motives.

It finds the temptation to fiddle the figures alive and well. A loophole in European accounting standards keeps PFI liabilities out of the national debt figures the Treasury explicitly targets. Much has been made of the fact that public authorities must now declare PFI debt on their books, but they also have to live within capital budgets set for two to three years. A PFI that pushes costs out as far as 20-30 years is still often the only way to get something built.

Tyrie set his crunchers to work without fear or favour - with breathtaking results. Post-credit crunch, investors can demand higher returns, and so the financing costs of a typical PFI deal now exceed 8.5%, more than double the rate at which the government can borrow. For PFI to stack up, those claimed benefits around risk thus have to be not merely valid but overwhelming.

The committee dutifully details every risk management argument. Tackling cost overruns? PFI may help a little, but smarter conventional contracts would be just as good. Increased financial flexibility? Hardly, long-term contracts leave the taxpayer over a barrel. Encouraging innovative building that lasts for longer? In theory 20- to 30-year PFIs might help; in practice contractors play safe. (1)

The Spectator also looked at PFIs and the report.

'There were instances where PFI may have been used where there was no evidence that it was the best procurement route. Local authorities and health trusts used PFI because there was no realistic alternative, not because it represented best value for money.

The use of PFI and its alternatives should now be robustly evaluated. Looking back at PFI procurements, the government should also do more to find out where and why PFI works best and capture the lessons. Departments should also do more to ensure they get the best out of existing PFI contracts.' (2)

Richard Hellier, writing in the Yorkshire Post in March this year, was even more trenchard in his criticism:

PFI has been rudely described as the "biggest money-laundering scheme in the world." It pretends to transfer the cost of a new public asset from the public to the private sector. Under PFI (the Public Finance Initiative) of borrowing to pay for the asset itself, under PFI (the Private Finance Initiative) local or national government commissions the asset but asks a private company to borrow the money to build it. Government then pays back the company over a long period, usually adding guaranteed payments for maintenance.

Since government can borrow more cheaply than the private sector (UK public borrowing is now about half the cost of private) the Treasury traditionally frowned on PFI. This attitude changed in the economic crisis of 1992 and a resulting major squeeze on capital spending, when Norman Lamont was Chancellor (advised by a young David Cameron). PFI took off under Tony Blair and Gordon Brown, who relaxed the rules early after taking office.

Under New Labour, the Treasury soon displayed a massive bias in favour of  PFI (later re-branded as PPP, Public-Private Partnerships). They produced more and more arcane calculations to claim that it was better value for money than conventional public borrowing. If the calculations did not come out right, they added new numbers to "correct" them. A public-spirited Yorkshireman, Mr J P Heawood, recently exposed one of the worst examples, the York Schools PFI project.

Early critics of PFI, led by Private Eye, seriously challenged its key assumptions. Risk was not being transferred to the private sector, and PFI companies were not always better at building or maintaining public assets than the maligned public sector. PFI often produced inferior design (such as the Yorkshire schools built with no light switches and non-opening windows) and service reductions.

Critics also denounced the secrecy of PFI deals, poor negotiating skills by government departments, and the expensive fees paid to lawyers, accountants and bankers to draw up deals. (The PPP contracts for the London Underground cost £500 million and were twice the length of War And Peace. They still failed.)

To adapt Winston Churchill, "never in the history of human finance has so much been paid to so few for doing so little." (3)

The main reason for going down the PFI route is because a government wants to spend money on a new initiative such as a hospital or school, but doesn't want to meet that either out of internal reserves and revenue streams or by borrowing. In other words, it is a fudge that gets round the government policy. Invariably, as the cliché has it, there's no such thing as a free lunch, so the money still has to be paid, but the PFI route is a way of legitimising that and bypassing existing government policy. That is why, of course, it is so beset with problems, because the risks and the payments still exist, they just are not often accounted for as part of the main accounting.

It's a bit like the practice, endemic in the 1980s, to cut civil service numbers by employing what were essentially permanent temporary staff, often with very similar conditions of service; the official numbers of staff employed by the States was reduced, but the real numbers often increased. Later, some of the same staff were made permanent at a time when the focus was on the high numbers of temporary staff, and that moved them off the books once more.

Conjuring tricks with figures may mask the underlying reality, but it remains there all the same. If a new hospital will cost £x amount, no deals with a Private Finance Initiative will reduce that sum; at best it will defray the cost over a number of years; at worst, the interest may be greater, and there may be a loss of amenity (and revenue stream) if some is taken for private health care for private profit by the PFI company. In the long term, it is often a lose, lose situation once stripped of rhetoric. PFI companies are not charities, out to benefit the public, they are businesses out to make a good return to shareholders.

The Audit Commission report exposed the reality of the situation in the UK:

How much are the country's 640 private finance initiative schools, hospitals and the like costing taxpayers..and what can be done to cut the bills? Sadly "a lot" and "nothing" are the answers. Non-negotiable payments under PFI contracts are running at more than £8bn on projects with a capital value of £63bn. But even these numbers mask the difficulties of coping with PFI in practice. Hardest hit are education and health. The latter's budget has £1.2bn in PFI costs to shoulder: and the effect in some trusts has been crippling. A new Audit Commission report shows six acute hospital trusts still burdened by huge deficits despite cuts and efforts at "turnaround". Much of this is put down to poor financial management, but five of the six operate from buildings built and financed through PFI, and so are saddled with massive extra costs too. By contrast, only one of 130 non-PFI acute trusts has a deficit. (4)

Writing in June 2011, Clare Sambrook, a journalist who had both the Paul Foot Award and the Bevins Prize for outstanding investigative journalism in 2010, commented on Radio 4's File on Four which exposed how PFIs represented bad value for money:

More excellent journalism on the almighty (and lawful) rip-off that is the UK Private Finance Initiative has come from BBC Radio 4's File on 4. The programme reveals gigantic profits made on the resale of PFI contracts, suggesting a lamentable failure of vigilance by those entrusted with fighting the taxpayer's corner in the original deals.

For two decades the Private Finance Initiative has been a risky way of funding new hospitals, schools, prisons and roads: companies build and maintain public facilities under contracts lasting as long as 35 years. File on 4 (broadcast last week, available here this week and on podcast indefinitely) identifies PFI hospital contracts that within a few years of being struck have been sold on, yielding profits for financiers averaging 66.7 per cent.

More than £250 billion of public money has been committed to PFI projects and we remain trapped in these contracts for decades to come. In Portsmouth alone paying for the Queen Alexandra Hospital means finding £44 million-a-year, rising with inflation, until 2040. Already under strain, in two years since opening the hospital has shed 700 jobs, with 90 more to go and the palliative care ward has been shut. (5)

The File on Four programme notes:

For two decades, the Private Finance Initiative has been a controversial way of building new hospitals, schools, roads and prisons. Well over £200bn of taxpayers' money has been committed to the companies managing these projects. The coalition government describes some PFI contracts as 'ghastly' and wants some of this cash back. One cabinet minister says 'the people on the other side must have been laughing all the way to the bank'.  But, while public services are facing cuts, PFI payments are guaranteed under watertight contracts. So experts say the government can win only small amounts in rebates. Much of the money has already gone offshore. Huge profits have been made by selling and reselling many contracts in a secretive 'secondary market' - with none of the proceeds returning to the taxpayer.(6) 

Jersey, of course, has had a PFI style initiative offered before by Mr Richard Brocken, and it will be interesting to see if his name surfaces with respect of any new hospital development. Stuart Syvret, in his usual uncompromising manner and purple prose, laid out the deficiencies of this kind of scheme:

His plan was to re-develop the site as a private hospital - a scheme which his own advisers said would only be viable if "the risk was shared" with the public hospital.

His plan was to be thus relived of having to bother with the inconvenience of building his private hospital with the full and necessary range of facilities and services a stand-alone medical centre would need.

Instead, the decades of investment by Jersey tax-payers in their health service would enable Mr. Brocken's scheme to piggy-back upon the public services of the Jersey General Hospital.

His private hospital would have siphoned-off the profitable private medical treatment provided in the General Hospital - and which generates an income for the public purse. This would have deprived Health & Social Services of an important source of income. (9)

Part of this almost exactly matches that noted by Jon Sussex,

In NHS PFI deals the private consortium takes on no demand risk. Whatever the future demand for the services of the hospital, the consortium's profits will be unaffected. This distinguishes PFI in the health service from transport infrastructure schemes such as roads, bridges and tunnels. (7)
Sussex also notes that the cost advantages of the PFI schemes are a chimera:

In aggregate, the cost advantages claimed in the official business cases for NHS PFI schemes, relative to their public sector comparators are small. Boyle & Harrison (2000b) report that for the first 11 major NHS PFI schemes in England, the average cost saving officially claimed for the PFI option relative to the public sector comparator was just 1.6 percent (range 0%-4.2%). These are the savings after adding to the public sector comparator's cost the estimated value of the risks that are transferred to the private sector in the PFI option, and have been calculated using the government's required 6 percent real annual discount rate. At a discount rate of 5 percent or less these calculated savings would disappear. (7)

The key factor in favour of a PFI is what is called "deliverability". As an article from 2003 notes:

PFI has already found favour with two different political administrations. This relative longevity, and the fact it has straddled the political divide, is perhaps both the reason for, and the result of, changing justifications for its use. So, what was originally seen as a way of extending public provision without extending public borrowing became justified as a way to achieve value for money in the provision of public services. More recently, the rhetoric has shifted again and PFI is now debated as a way to produce "deliverables".

In summary, the argument that PFI is justified by its ability to provide deliverables is the latest in a series of controversial justifications. Although there is evidence that PFI transfers the risk that building projects will go over budget and take longer than expected to the private sector, there is little evidence so far that it will provide ongoing deliverables in longer-term service delivery.(8)
Whatever PFI suggestions are made locally by the Chamber of Commerce, it is important that the kind of problems which have beset the UK are considered very carefully. It may seem like a neat way of bypassing Treasury policies, and raising cash in the short term, but in the longer term, there could well be - as in the UK - a staggering debt to be paid by future generations of taxpayers.

In June 2012 this year, the Telegraph reported on the failure of the PFI dream:

The near financial collapse of South London Healthcare Trust, which has a deficit of £150 million, serves as a stark warning for other NHS trusts, struggling to cope with the pressures of repaying costly PFI contracts. Financial failure leads to clinical failure, as cutbacks are made to try to plug financial gaps.

103 PFI deals were struck by Labour for the NHS with a combined value of £11.4 billion/ By the time that they are paid off, they will have cost more than £65 billion. These are the same schemes that Andy Burnham said in 2007 were "the right schemes and offer value for money." This profligacy with taxpayers' money was condemned as 'staggering' by Labour MP Margaret Hodge, the chairwoman of the Public Accounts Committee, when it was revealed last year as part of a report on Government use of PFI. These PFI contracts constitute a vast drain on the public finances. (10)

That should sound a warning note to local politicians not to be seduced by the possibilities opened to them by PFI style initiatives. Patents for famed water powered perpetual motion machines always required a tap to supply extra water which it is supposed would eventually be able to be turned off once the inventor had ironed out the kinks in the system. They are no longer accepted by the patent office, which realised that some schemes may never get the kinds taken out of the system, however cleverly the inventor presents his case. The PFI is very like that; it promises much, but will always require that public tap to feed into it.

(7) Public-Private Partnerships in Hospital Development: Lessons from the UK's `Private Finance Initiative'., Jon Sussex, Research in Healthcare Financial Management, 2003
(8) PFI in the Sky: The Private Finance Initiative Has Caused Controversy in the NHS Ever since It Was First Introduced. Jane Broadbent, Jas Gill and Richard Laughlin Report the Findings of Their Research into the Changing Justifications for PFI and Ask Whether We Have Evidence Showing Its Success or Failure. (PFI in the NHS). Financial Management (UK), 2003


Anonymous said...

Two points you passed over:

1. Part of the reason that PFI is such a problem is that the contracts have been written as "design, build, finance and operate". Not only do the companies get paid for providing the infrastucture - they get control of how it is used (and consequently have incentive to use this to screw more money out of their tenants).

The general example quoted of how this goes is that central government sets a policy that says schools should remove vending machines that sell junk food - but if the school is a PFI facility, this is an amendment to the operating contract, and a penalty clause kicks in. This is fairly trivial: there are other cases I know of where the impact has been much greater.

2.The major scandal with the QAH in Portsmouth is that a significant percentage of the finance is now run through an offshore company (based in Guernsey, I think) - thus ensuring that the PFI consortium wins twice, once by making profit on the contract and second by paying the UK government no tax on the profit. This is becoming more and more common. Letting a contract directly prevents this from happening.

The QAH is not the worst example either: it says something that HM Revenue and Customs transferred its portfolio of buildings into the hands of an offshore company!!

There is, of course, one thing the UK government could very easily do to solve the problem. The first two rounds of Quantitative Easing created money which mostly ended up being trousered by the banksters. QE3 could easily be used to buy out a substantial tranche of PFI. All it requires is the political will to do so. And if G4S, Serco, Capita etc complain about losing lucrative contracts the general public, being aware of the PFI rip-off, will afford them scant sympathy.

Anonymous said...

Tony, I am willing to bet the new hospital will be a PFI deal. Wasn't Morier house built this way?

Recently the States of Jersey Treasury advertised a tender for professional advice on borrowing. Today for the umpteenth time the Treasury Minister said words to the effect "we are great we have no debt".

Yet recently he advertised for borrowing advice and when questioned said it was wise to do so as credit was so cheap right now.

If you have a good look at the MTFP it's clear to see the new hospital cannot be funded without borrowing.

You or I would do without it as we can't afford it. You or I would take great heed of the all the evidence you have produced in another well researched post.

Our government will do neither, they will borrow to build what we cannot afford.

Tom Gruchy said...

Interesting that Morier House is now seen as a very inadequete building by its users and not at all economic value by the States. It is part of a huge (in Jersey terms) portfolio of "public use" property that is not really fit for purpose.
Ozouf did have a grand plan to sell it all off and remove to a new centralised States rented building on the Waterfront as part of a Public Private partnerhsip deal that would be milking the Jersey taxpaying public for generations to come.
Integral to current thinking is the son of WEB aka the Jersey Development Company which will have enormous powers to develope land and properties all over the Island with very little public accountability.
The proprties tied up in the Propery Services section of the States will be augmented as one big potential honey pot for the private devlopers to dip into and since that Department was more or less gutted following the Lime Grove fiasco - along with any chance of an effective audit oversight - well its not too difficult to see who will be making a fortune out of the huge Health Department proposals...

Anonymous said...

One further issue with the DBFO aspect of PFI projects is the transfer of staff. In the UK, transfers from civil service to private sector are protected under TUPE regulations: not least because the Civil Service pension scheme - while nowhere near "gold-plated" - is backed by the taxpayer and cannot therefore go bankrupt.

Jersey, of course, has no TUPE regulations. Expect a considerable amount of unrest and disruption unless this is addressed.