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PFI is an acronym for Public Finance Infrastructure. PFI cannot be defined without talking about Public Private Partnership (PPP). PPP can be defined as "contractual relationship where a private party takes responsibility for all or part of governments (department) functions. In essence, it is a contractual agreement between a public sector agency and a private sector concern, whereby resources and risk are shared for the purpose of delivering a public, or for the developing public infrastructure" (Akintoye et al, 2003) . Hence the PFI is a PPP special case where all the finance needed for the capital funding and its basic operation is supplied by the private sector in return for a service charge. (Fewings, 2005)
PFI is not all about borrowing money; it's about creating a structure for the improvement of value for money through private sector innovation and management skills delivering significant performance improvement, efficiency gains and potentially huge benefits to the taxpayer. There are currently three main types of PFI transactions, namely:
Services sold to the public sector.
Financially free standing projects.
(Department of trade and industry, 2010)
How PFI Works
In the provision of a built asset, PFI carries the whole burden of capital funding and running cost of the building/facility by the means of a private joint venture (special purpose vehicle (SPV)) for a period (concessionary) of 20-60 years, and it can be renewed. The authority funds the building or facility and its maintenance as a charge over the agreed period and normally don't include the building/facility in their balance sheet. The capital repayment is serviced annually on a fixed/variable interest capital repayment basis, reducing as the capital reduces while the service charge is usually indexed with inflation to cover the cost of maintenance, updating operation as necessary. The asset goes back to the authority after initial capital repayment period. After the asset has been received back, it can be added to the balance sheet or written off. The main principles guiding this operation include:
Put risk where it can be best managed and assesses it properly.
Value For Money (VFM) by harnessing private management efficiency and may also release land and assets for wider use.
Affordability, which means it, should be financially viable over the contract.
The scope of this report covers the Evolution, Drawbacks, and Advantages of the PFI concept.
The Evolution of PFI
Lamont (1992), former chancellor states that " the rise of the private finance initiative (PFI) as a government initiative to enable public sector works to be carried out using input from the private sector has been marked by evolution as well as growth since its inception."
The Advent of PFI
In the early 1990's, the government was faced by lack of sufficient public funds to improve public sector infrastructure adequately. The situation pushed them to create innovative solutions, which would secure needed investments in public infrastructure without further increasing the Public Sector Borrowing Requirement (PSBR). the biggest step for government to achieve these was to stop being reluctant and use the private sector expertise as much as they could, opening the way for a better use of public funding. (Heinecke, 2002)
The PFI is not a new idea. Countries such as Italy, France and Spain have used it for building motorways for many years whereas it has been used for prison, road and hospital buildings by countries such as Australia, New Zealand and the United States.
Private finance initiative (PFI) has been used as an alternative procurement route open to central government for services and facilities for the public sector without undue immediate effect on the public sector borrowing requirement in the UK since November 1992.(construction industry council, 1998).
In autumn 1993, a rudimentary structure was created in other to back the initiative. Bodies such as the Private Finance Panel and Private Finance Panel Executive were formed. Nevertheless, the main output of the PFI between 1992 and 1997 comprises of Private Finance Panel publications and the number of new projects emerging from the public sector was viewed as poor. Reasons for the perceived shortcomings were due to:
The uncertainty of the public and private sector as to how PFI worked.
Protracted negotiations due to legal contractual disputes.
Highly detailed output specifications that restricted the degree of innovation put in place by the tenderer.
Unrealistic government views on risk allocation.
The inappropriate use of PFI in small scale projects alongside an insufficient administrative system which had to facilitate the tendering process, control changes, settle disputes and thereby increased the high costs of bidding.
Reluctance of the public sector to appreciate the value of the contribution that the private sector could make.
Ongoing criticism from the Labour opposition, which was correctly presumed during that period to be a government-in-waiting.
On May 1st 1997, the government introduced another political environment as well as a chance to review Public finance initiative (PFI) as a procurement route. Before any conclusion was drawn, the government conducted a thorough review of its past experience of using PFI since its advent in 1992 under the chairmanship of Malcolm Bates. The result of this work is known as Bates Review. The result approves PFI and to improve substantially the process and simplify the market (Construction industry council, 1998).
The Private Finance Panel and the Private Finance Panel Executive were replaced by a Treasury Task Force. Some civil servants were trained by Waterhouse Coopers to become PFI specialists. In other to limit bid costs, it was compulsorily recommended that not more than four bidders should be shortlisted. In the event of cancellation of a project at a late stage by the purchasing department, compensation may now be paid to bidders provided that the decision not to proceed was not related to the viability of the tenders received.
The Treasury Taskforce has been replaced by the newly formed Partnerships UK due to a second Bates review of the PFI that was completed in March 1999. (Heinecke, 2002)
In 2005, the prime minister of United Kingdom, Gordon Brown acknowledges the PFI idea and supports it in one of his speeches. Brown (2005) states that "under the private finance initiative (PFI) the public sector contracts to purchase services on a long-term basis so as to take advantage of private sector management skills incentivised by having finance at risk the private sector has always been involved in the building and maintenance of public infrastructure, but PFI ensure that the contractors are bound into long-term maintenance contracts and shoulder responsibility for the quality of work they do. With PFI the public sector defines what is required to meet public needs and ensures delivery of the output through the contract. Consequently, the private sector can be harnessed to deliver investment in better quality public services whilst frontline services are retained within the public sector. The government only uses PFI where it is appropriate and where it expects it to deliver value for money. This is based on the assessment of lifetime cost costs of both providing and maintaining the underlying assets, And of the running cost of delivering the required level of service. In assessing where PFI is appropriate, the government approach is based on its commitment to efficiency, equity and accountability, and on the prime minister's principles of public service reform. PFI is only used where it can meet this requirement, and where the value of money it offers is not at the expense of the terms and conditions of staff. The government is committed to securing the best value for its investment programme by ensuring that there is no inherent bias in favour of one procurement option over another"
(Gordon brown 2005 speech)
The future of the PFI
Local Improvement Finance Trusts are going to redevelop the UK's primary care infrastructure. The innovation is that, as well as being the buyer, the public sector owns a stake in the PFI consortium. That helps bidders who are short of funds and means that the public sector can cash in if the consortium makes a profit. There could even be a 'Bank of PFI' to channel investment.
Other innovations also have a role to play. Recognition that small PFI projects, where bidding costs are a high percentage of the total, do not work is becoming widespread. Standardising PFI contracts saves time and money. The new Treasury guidelines should shorten procurement times and save money all rounds.
So while political controversy over PFI is likely to die down, three major challenges remain. We have got to show that effective long-term contract management is possible without major disadvantage to either party; government has got to be willing to actively manage PFI markets, and innovation in the design of contracts and consortia must continue. If all parties can embrace these developments, PFI will have a healthy future.
Some key facts about PFI
Around 50% of PFI projects by capital value are reported on departmental balance sheets. The accounting treatment of a PFI project follows rule set and audited by a series of independent national and international organisation (PPP/PFI fact sheet, 2006).
Over 630 PFI projects delivering infrastructure investment of over 63 billion pounds have been signed since 1992.(ppp forum, 2006)
Over 540 PFI projects now fully operational.(ppp forum, 2006)
Advantages of PFI
There are two major arguments traditionally put forward for the advantages of PFI. The advantages include
Greater Efficiency Savings
The above mentioned advantages are driven by the following driver's.
Risk transfer from public sector to private sector including construction and operation costs, technological change, and the long-term fit between a facility and its public purpose.
The long-term nature of contracts enables the private investment to be recovered over a reasonably long period and leads to lower costs to government for public services.
The use of an output-based service specification; PFI is based on delivery of a certain level of service--the output desired--rather than on the inputs used to provide the service, e.g., the building or other assets involved in producing the output.
Competition in the bidding process lowers cost of capital and services over the long term.
Performance measurement and incentives are developed and used as the basis for holding the PFI provider accountable for results and can be used to create financial incentives for superior performance.
Private sector management skills increase operating efficiencies including economies of scale and the delivery of the services requiring skills that are non-core to government.
(Forrer, J. 2002)
Case study of a successful PFI project:
The project is on the completion of the extension of the A55 trunk road across Anglesey by constructing of a 7.5 mile length of dual carriageway. The road is a major route for cars and heavy goods vehicles travelling to and from the Holyhead to Ireland ferry crossing. The road has been constructed and it's in operation. It was designed to reduce accident rates and enhance traffic flow. The old road passed through six villages and had a large impact on their communities. The area surrounding the road has many rich ecological habitats and sites of special scientific interest.
THE DESIGN AND BRIEFING PROCESS
Consultations about the project began in 1990, followed by a public enquiry for one part of the scheme in 1995 and the other part in 1997 for the remainder of the route. The public enquiry addressed environmental issues and interested groups, such as Friends of the Earth, were consulted. It was discussed and planed with the Environment Agency and Countryside Council for Wales amongst others.
The scheme was not originally planed to be a PFI project and procured through the PFI route, it was only considered after planning permission had been obtained. The Secretary of State decided that the scheme would be PFI funded at the time of the second public enquiry in 1997. There were four new PFI schemes identified in the National Audit Office Report at that time and the A55 became a trial PFI scheme.
By this stage the improved route had been agreed and an Environmental Impact Assessment and Statement had been produced.
The Euro-Route E22 in Wales used to follow the A55 trunk road along the North Wales coast to Bangor and then the A5 trunk road across Anglesey to the port of Holyhead. In recognition of the economic and social importance of this route, the Government decided in 1994 to extend the A55 dual carriageway across Anglesey.
The Functionality Drivers
The main Functionality Drivers for the Welsh Office were to:
reduce journey times and operational costs for private and commercial road users including public transport
assist economic regeneration
enhance road safety and reduce road casualties
provide relief from traffic related problems in communities along the A5
take account of the environmental implications of the road scheme and include appropriate mitigation measures
Procure the scheme under the Private Finance Initiative to better enable delivery of whole life value for the public money being invested.
The Construction Solution
The decision was made to build a new dual carriageway road across Anglesey. Feature of the road was to address the functionality drivers, which include levelling and straightening the road to improve visibility and safety.
It now by-passed altogether the villages of Caergeiliog and Valley, improving quality of life for residents by reducing traffic flow to local access levels, improving air quality from reduced vehicle emissions and reducing noise pollution. Care was taken to mitigate the effects of building a new road in an area of special scientific interest. One listed footbridge was demolished. It was recorded beforehand by archaeologists, and replaced by a new one to maintain pedestrian access across both the new road and an adjacent railway line.
THE CONSTRUCTION PROCESS
The road was built within a period of two years and completed in March 2001 despite problems with weather and the restrictions caused by foot and mouth disease. Expensive engineering solutions were used in the construction phase including three major tunnels.
A standard DBFO contract was used with penalty points for violations of the contract. Penalty points for environmental issues were set at a higher level than for other issues. Should a contractor receive penalty points then they would be required to rectify the situation or more points would be awarded. If too many penalty points were accumulated then the contractor would be forced to stop and reassess, or potentially lose the contract.
Ray Hooper, the manager for the Transport Directorate of the Welsh Assembly gathered all the data's via an interview.
STAGE WHEN SUSTAINABILITY INCORPORATED
The Welsh Assembly drove sustainability issues within the project and an environmental advisor was used from the start of the project. Legislation also ensured that some of the preparation procedures include sustainability. The contractor was required to meet the Environmental Statement obligations set out. One of the core requirements was that the effects of the built road had to be no worse than those identified in the existing Environmental Statement. Feedback is being given to the Highways Authority to input into other projects. Much of the success of the project was based on trust in other parties involved.
Category Sustainability Benchmark Index Score Percentage
Design 45 64%
Construction 46 67%
Environment 37 55%
Social 41 40%
Economic 103 64%
Overall 45 66%
The existing road went through six villages and the new plans include taking traffic away from all the village centres. The existing road had a very bad fatal accident record. There was a large public consultation exercise. The public's comments did influence the final route of the road. An Environmental Impact Assessment was produced for the scheme prior to it becoming a PFI project and Statutory Land Orders were confirmed.
The winning company after the tender process took over the project on a Design, Build, Finance, and Operate contract. The design for the road required them to confirm that environmental impacts would be no worse than those identified in the existing Environmental Statement. UK Highways A55 won the contract and they suggested altering the levels of the road to give an alternative vertical alignment. The road was both lowered and raised in places from the original design. This improved visibility and enhanced road safety. This required the consortium to carry out extra assessments of the environmental impacts of the changes and provide a report.
WASTE AND MATERIALS
The road was lowered and raised in places from the original design. The consortium had to carry out extra assessments of the environmental impacts of the changes and provide a report. They proposed to reduce the height of embankments and decrease cuttings and give an equal earthworks balance to reduce waste going to landfill. Planning consent was granted for spoil tips. The old road was kept as a heritage site.
It has to be noted that traffic count has increased since the improvement of the road therefore increasing emissions to the atmosphere from car use in this area. Ferry companies working from Holyhead are also predicting increases in passengers. To meet this demand Irish Ferries now employ the largest car ferry in the world on this route and P & O Stena are set to follow. This will further increase traffic volume but with much improved flow.
The contractor used a majority of local labour in the construction phase and trained labour to carry out new bank/hedge construction techniques.
LESSONS LEARNT AND OPPORTUNITIES
This project was an original PFI trial scheme and it is commendable that environmental considerations were a major factor in the design of the project. (There is a legal requirement to carry out an Environmental Impact Assessment). Within this context it must be noted that the improvement of a major arterial route with probable increases in traffic flows and pollution levels would have a major environmental impact on the region.
Considering the above, the brief for the road improvement included the need to reduce accident rates, improve traffic flows and lessen the impact that this arterial route had on the six villages that the original road passed through.
The imposition of a penalty points scheme that encouraged contractors to seek solutions that minimised environmental impacts with the possibility that the contract could be lost if a certain 'points threshold' was breached is cited as a good example of an environmental motivator.
Consideration of ecological issues within the project specification and the detail to which the contractor was prepared to work to ensure that ecological impact was minimised can be cited as a positive outcome. And hence the project is a good value for money.
(Welsh office, 1996)
Drawbacks of PFI
The disadvantages/drawbacks of PFI can be defined as follows:
PFI is Expensive
The National Audit Office says claims that PFI is value for money are based on 'errors, irrelevant or unrealistic analysis and pseudo-scientific mumbo-jumbo.' High rates of interest to banks and profits for the private company mean less to spend on repairs and improvements. Further to this, councils setting up a PFI scheme will have to commit themselves to meeting the high cost of running the scheme for the next thirty years often a problem in terms of "affordability". They may try to tell you that the government covers the cost of the PFI scheme but this is not true, the "PFI credits" only cover part of the cost.
PFI is Risky
The PFI scheme will last for thirty years or more. If it goes wrong then tenants will pay the price. Ministers argue that PFI schemes remove an element of financial risk from public bodies. This is no true in cases where the finances have not stacked up, the PFI consortiums demand more government subsidy - and the government has agreed! Certainly the major PFI players don't see the 'risk' being transferred to them. Mowlem (eight PFI contracts with total value £826 million) says PFI offers them 'longer-term revenues than traditional procurement methods and carries significantly lower risks'.
PFI Takes Years to Set Up
They are long-winded, complicated and often delayed until the companies get the deal they want. The Chalcots PFI, one of the first "pathfinder" schemes, is still on-hold after five years, with more delays as the private consortium keeps asking for more money. There is also a major issue with cost escalation before contracts are finally signed. One of the first 'Pathfinder' housing PFI schemes - on the Chalcots estate - soared to more than double the original £21 million estimate during the bidding process. Now there is only one contractor left in the running, and surprise, surprise, they want even more money. Setting up the Chalcots PFI began in 1999 and they are still bogged down in contract negotiations. Five years and several millions of pounds later, and no improvements have been carried out at all.
Public Housing not Private Housing
Private finance is an expensive form of borrowing - costing much more than direct government borrowing. PFI developers expect a 15% profit on their investment. PFI means a private company "generating income" from your estate. PFI deals often involve 'gifts' of public land as an incentive, with council homes on the sites demolished. In Leeds, the Little London Scheme involves the loss of 200 homes, to be refurbished and offered at yuppie rents.
PFI - escalating Costs
Massive amounts will be spent on lawyers, consultants, monitoring the contract and higher senior managers pay. Costs escalate between the bid and the final contract: reportedly by over 60 per cent in Sandwell.
(Rossider, A. 2005)
Case Study Showing the Drawback of PFI
The Cumberland infirmary is the first 'flagship' PFI hospital built from scratch under PFI procurement; it has been the subject of bad publicity from the commencement of its operational phase (UNISON, 1999; BBC News, 2001). The contract for building the Cumberland Infirmary in Carlisle was signed in 1997 and worth £87 million. The hospital was designed as an impressive modern construction and, being completed ahead of the time phrase (schedule), was commissioned by the Prime Minister in 2000.
However, subsequently, the project came under criticism on account of a number of flaws.
The old hospital accommodates more (90) beds than the new one (Anon, 2001), which implies that, at times; accommodation capacity will not be enough. Further to this, the wards are smaller and have required the trust to buy new smaller resuscitation trolleys at the cost of £180,000. The waiting time for radiologists was increased due to the shortage of storage space, patient's record and X-ray images have to be gathered in the old premise.
There have been other instances of poor design and execution. Examples include the construction of glass roof which led to very high temperatures during the hot season and noise during rainfalls. Further to this, there have been cases of broken pipes and floods in the operating theatre, falling ceilings, sewage system problems, and damage to some expensive equipment.
In 1999 UNISON sponsored a report on the Cumberland Infirmary Carlisle (UNISON, 1999) which questioned the level of financial diligence and accountability of the respective NHS trust. Specifically this report stated:
Secondly we conclude that the deal does not give the taxpayer value for money. We have shown that the interest rate assumption at the heart of the economic appraisal has been deliberately set to favour the private sector and that after only a minor adjustment the alleged advantages of the PFI option disappear. However, in Carlisle's case, political manipulation alone was insufficient to make the economic case. Only major errors in the Trust's economic calculations could do that. If these were rectified, the PFI option would be seen to be a bad economic option, more costly than the public alternative by £11 million. On a proper economic appraisal, Carlisle's PFI should never left the drawing board. (UNISON, 1999)
The participation of the private sector in financing, building and managing assets is no doubt becoming one of the major construction procurement systems, with the capital value of PFI projects in the UK being 18.65% of the construction industry outcome for 2003; (Ahadzi M. and Bowles G., 2004) showing how important the PFI market share is. PFI delivers new or modernised infrastructure for public services on time and on budget in contrast to conventional procurement route as shown in the table below
Private finance initiative
Projects over budgets
Project over time
(National Audit Office, 2003)
Private finance initiative should be encouraged but attention should be paid to sensitive issues like sustainability, for it can be used as competitive advantages for bidders. It can provide savings in construction, if principles are incorporated in the initial stages.
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