Presupuesto y Gasto Pblico 45/2006: 65-74

Secretara General de Presupuestos y Gastos

2006, Instituto de Estudios Fiscales

UK Private Finance Initiative (PFI): reflections on recent

developments
EDWARD FARQUHARSON
Projects Director Partnerships UK 1

Recibido: Diciembre 2006

Aceptado: Enero 2007

Summary

The value for money benefits of PFI flow from the long-term focus it brings on whole-life costs, the private sectors
risk management expertise incentivised by having private finance at risk, and the certainty for public services it pro-
vides of specified outputs being delivered at the cost contracted for. PFI will continue to be used only where it can
demonstrate value for money.

Evidence shows that PFI is now meeting public service needs across more than 500 operational projects: users are
satisfied with the services provided, public authorities are reporting good overall performance and high levels of sa
tisfaction against contracted levels of service. Incentivisation within PFI contracts is working.

This article describes the measures the UK Government is taking further to ensure consistent high performance from
the operational phase of projects, bolster public sector PFI procurement professionalism, and ensure authorities un
derstand long-term trade-offs about flexibility and value for money.

Key words: PFI, value for money, procurement, operational performance, HM Treasury, PUK, operational taskforce

Introduction

PFI: Meeting the Investment Challenge, published in July 2003, explained the UK
Governments approach to its PFI programme and its contribution to improving public ser
vices through increased investment and reform. The Government presented evidence of PFIs
overwhelmingly strong record at delivering the construction of vital new facilities on time and
at the cost contracted for. PFI: Meeting the Investment Challenge, set out clear evidence
based criteria for the areas where PFI was likely to deliver value for money and overhauled the
process of assessing the value for money of PFI projects when compared against convention
ally-procured investment. PFI remains one of a number of procurement options and PFI:
Meeting the Investment Challenge set out the Governments systems for ensuring that there is
no bias as to the correct procurement route. The Government also reconfirmed that value for
money in PFI should not be obtained at the expense of employees terms and conditions.
PFIs track record in supporting public service delivery means that the Government re
mains committed to using it as a procurement route, and there is an ongoing pipeline of pro
66 Edward Farquharson

jects in procurement. PFI will continue to play a small but important role in modernised pub
lic services where it demonstrates value for money. Research shows evidence that PFI is
meeting the expectation of users and public sector managers in operation, service levels are
being met, and the incentives are working.
In March last year, HM Treasury set out its up-dated approach to PFI in the document
PFI: Strengthening Long-Term Partnerships. This document, building on the measures in
troduced since 2003, set out further improvements to PFI to support its ongoing important
role in delivering better public services. These recent approaches include
measures based on the Governments research to build on the operational and con
tractual flexibility under PFI, including increased support to public sector managers
during this phase of the contract;
measures that the Government is taking to improve the ability of the public sector to
understand where PFI is likely to offer better value for money than other procure
ment routes. This will be achieved by assisting procuring authorities in understand
ing the value for money of key decisions within a project including strengthening the
test for the inclusion of soft services;
Measures to bolster the professionalism of PFI procurement to reduce procurement
times. While improving, the Government believes that procurement times remain unnec
essarily long and is introducing steps to improve the maturity of projects before they are
tendered into the market, to reduce unnecessary uncertainty later in the procurement; and
How local decision making in PFI may be supported by central skills and capabilities
and how changes to the existing framework will reinforce this so that approvals are
given at the right points in the process.
The remainder of this article summarises the measures introduced over the past 3 years,
research undertaken and the steps that the Government is taking to improve continually the
value for money and procurement of PFI. The policy proposals have direct effect only in
England, as policy on PFI is devolved in Scotland, Wales and Northern Ireland.

Continuing to Meet the Investment Challenge

One of the UK Governments long-term objectives is to deliver world-class public ser

vices. To achieve this, sustained increases in investment and reforms to deliver efficient and
responsive services, which meet public expectations throughout the country, are needed.
Strong and dependable public services lay the foundations for a flexible, productive econ
omy. They also promote opportunity and security for all, helping to tackle poverty and social
exclusion and improving the quality of life. PFI has continued to deliver new or modernised
infrastructure for public services on time and on budget. PFI has now delivered over 570 op
erational projects, including;
249 health projects, of which 160 are now operational
199 education facility projects, of which 122 are now operational
59 transport projects of which 53 are now operational
UK Private Finance Initiative (PFI): reflections on recent developments 67

Whilst the vast majority of public investment remains conventionally procured, PFI
consistently makes up 10-15 per cent of public sector investment. This proportion has re
mained at roughly this level for a number of years. The balance sheet treatment of PFI is also
not relevant to the decision about whether to pursue PFI as a procurement option, as this is
based purely on the assessment of value for money. Around 50 per cent of PFI projects by
capital value are on the public sectors balance sheet.
PFIs record of delivery means that the Government remains committed to using PFI as
a procurement option where it is value for money to do so. There are currently around 200
projects with a capital value of 26 billion in the procurement pipeline to 2010. This repre
sents one of the largest committed programmes of new investment in public service infra
structure through PPP and PFI projects globally. Chart 1. below shows the breakdown of
projects in procurement by department (Ministry).

Chart 1.1. Deal pipeline by department

9,000

8,000

7,000

6,000

5,000

4,000

3,000

2,000

1,000

0
Health MOD Develolved DFT Education ODPM Detra Other
administrations

Preferred bidder Post-OJEU Pre-OJEU

Source: HM Tresaury.

The Governments Approach to PFI and Value for Money

As mentioned, PFI is only one of a number of procurement options that the Govern
ment can use to invest in public services. The government only uses PFI where it can be
shown to deliver value for money and does not come at the expense of employees terms and
conditions. PFI offers value for money for certain investments through: a long-term focus on
whole life costs; risk management expertise; and greater certainty for the public sector that
68 Edward Farquharson

services will be delivered to the specified standard. Benefits are derived from PFI where the
risks associated with a project are borne by the party that can best manage them.
Experience has shown that there is usually a range of procurement options, including
PFI, that should be considered as procuring authorities decide how to undertake ma
jor investment programmes. Options include: conventional design and build con
tracts, PFI, programme procurement vehicles such as are being used in Building
Schools for the Future and NHS LIFT, and other approaches to partnering. The UK
Government is continuing to develop ways to improve the procurement of new PFI
sectors and is committed to pilot further project delivery organisations.

Box 1.1
Measures introduced since PFI: Meeting the Investment Challenge

As a result of PFI: Meeting the Investment Challenge and the evidence presented of PFIs strength in delivery, the
Government has introduced the following measures to strengthen the role which PFI plays in improving public ser
vices:
The Value for Money Assessment Guidance published in August 2004 enables departments to maximize value
for money from their investment programmes through the rigorous assessment of PFI compared with other pro
curement options. The Government has adopted a similar approach to the investment programmes of local autho
rities through the reform of the PFI credits system;
PFI is used where it is most appropriate and where value for money can be demonstrated based on clear criteria.
To achieve this, the Government no longer uses PFI for new IT projects and small projects because PFI did not re
present value for money;
Enforcement of the standard PFI contract to bring about a unified approach to risk transfer and to reduce procure
ment times and costs;
Enhanced use of strategic partnerships to co-ordinate procurement such as in the Building Schools for the Future
(BSF) programme that is now well established and will modernize the countrys stock of schools. The NHS LIFT
initiative has delivered approaching 1 billion of investment in primary care infrastructure;
Ensured value for money in PFI does not come at the expense of employees terms and conditions. Departments
have continued to retain the right not to transfer soft service employees to a PFI project and, where employees are
transferred they are protected through the Retention of Employment (RoE) in the NHS and the Best Value Code
of Practice; and
Credit Guarantee Finance (CGF) has been successfully piloted on two PFI projects, producing a whole life saving
of 70 million. The Government will further test the benefits of CGF before confirming its wider role.

Improving the Value for Money and Operation of PFI Projects:

Evidence on operational PFI projects

Research, recently commissioned by the Treasury from Partnerships UK on operational

PFI projects 2 shows that 80 per cent of all users of PFI projects are always or almost always
satisfied with the service being provided. The evidence from this research is also consistent
with other studies conducted by government departments and other bodies. For example, the
KPMG and Business Services Association (BSA) study 3 found that users were satisfied al
ways or most of the time in 81 per cent of cases.
UK Private Finance Initiative (PFI): reflections on recent developments 69

Chart 1.2. Did the last user satisfaction assessment find that services were being deliverd to
an acceptable standard

70

60

50
% of Respons

40

30

20

10

0
Always Almost About half of Almost never Never
always the time

Source: Partnerships UK.

Research also confirms that PFI contracts are delivering the services required under the
PFI contract. Across all the PFI projects surveyed, 66 per cent of public sector managers be
lieved that the service being provided was very good or good and 30 per cent believed the
services to be satisfactory. Performance under PFI contracts has also been consistently high
over time with around 90 per cent of PFI projects performing satisfactorily or better in every
year since 1998.
An effective partnership between the public and private sector is central to a PFI pro
jects ability to deliver the services required and meet the expectations of the public sector.
Public sector managers believe that:
They have developed an effective partnership with the private sector to deliver servi
ces. Over 70 per cent believe that their relationship with their private sector partners
is very good or good; and
The incentivisation within PFI contracts is working with around 80 per cent of public
sector managers agreeing that the payment mechanism supports the effective con
tract management of the project. In just under 70 per cent of projects, levying pay
ment deductions on the PFI contractor to reflect poor performance has led to im
provements in the service being provided.
70 Edward Farquharson

Improving the Operational Performance of PFI projects

While the research in general presents a positive picture of PFI in operation, the evi
dence points to a number of areas where PFI projects in operation could be improved further.
These lessons can be grouped into two categories where:
Operational performance and flexibility within PFI contracts can be improved to en
sure that the public sectors requirements continue to be met in the future; and
PFI could be refined to improve long-term value for money. Just as PFI: Meeting
the Investment Challenge set out areas, based on experience, where PFI was less li
kely to offer value for money, the research into operational projects and recent expe
rience has highlighted areas where the value for money of individual PFI projects
could be improved further.
The steps the Government is taking to improve the operational performance of PFI pro
jects are split between measures to avoid issues arising in the future and improving the per
formance of older contracts that are now operational.
PFI contracts are designed to allow the public sector to make changes in its service re
quirements that become necessary after procurement, through the variation clause in con
tracts. Whether the asset is procured conventionally or through PFI, the costs of such change
need to be borne by the public sector. One of the key benefits of PFI is the requirement for
the public sector to define accurately its requirement through an output-based specification
and to consider and provide for mechanisms to change its requirements over time. This is a
discipline that does not generally exist within conventional procurement.
While generally the contract accurately specifies the services required, public sector
managers believe that the levels of flexibility built into (generally older) contracts to under
take minor variations, could be improved. Evidence suggests public sector managers appre
ciate the long-term certainty over maintenance and service provision created by PFI, but
want greater flexibility to make minor variations and greater alignment of incentives to agree
and complete variations.
To ensure that variations can be undertaken more flexibly in future PFI projects, the
UK Government is ensuring that the flexibility required is adequately assessed both when
scoping the projects requirements and throughout the procurement process, in particular in
the levels of flexibility offered by different bidders. This is being achieved through revisions
to the Value for Money Assessment Guidance. The Government is also improving the lev
els of support to contract managers and has created a PFI Operational Taskforce (described
in Box 1.2) to support contract managers in undertaking variations and improving the flexi
bility of existing PFI contracts.
In response to PFI contract managers believing that they would perform better if they
had increased involvement during the pre-operation phase, best practice suggests:
The earlier involvement of contract managers during the procurement process to de
velop stronger relationships with the private sector;
UK Private Finance Initiative (PFI): reflections on recent developments 71

A more structured handover from procurement to operation, including a user guide to

the PFI contract; and
Authorities to consider using a period of shadow-running to test key aspects of the
contract in an operational environment.

Box 1.2
PFI Operational Taskforce

To provide the public sector with greater support during the operational phase of PFI projects and to bring consis
tency to the public and private sectors approach to the key operational issues, the Government has created a PFI
Operational Taskforce. The Treasury has used Partnerships UK to establish a Taskforce that is working with depart
ment Private Finance Units (PFUs), 4ps and the private sector to provide proactive support to project managers on
key operational issues while also providing greater consistency across older PFI projects. Key priorities for the PFI
Operational Taskforce include:
Improving the levels of guidance and support available to project managers who are approaching their first ben
chmarking or market testing periods;
Proactively assisting the public sector on all operational issues faces;
Considering a limited number of changes to the standard PFI contract that flow from an improved understanding
of operational issues;
Implementing the Refinancing Code of Conduct; and
Collaborating with the Office of Government Commerce (OGC), the UK Governments procurement agency on
a pilot scheme reviewing operational performance, to provide advice to project teams to improve ongoing perfor
mance management.

It is important that the public sector has the ability to reconfigure its asset base, more
structurally than can be achieved within a PFI contract variation mechanism, to meet chang
ing priorities. There will always be constraints on the public sector if its long-term require
ments fundamentally change, whether the assets are procured conventionally or through PFI.
The capital cost of constructing an asset to a particular specification will always have to be
borne, even if the public sectors requirements fundamentally change. The PFI procurement
process ensures that the cost, quality and outcomes of this flexibility are transparently under
stood and assessed. To ensure the PFI as a procurement option does not unduly constrain the
public sectors choice of asset base required to deliver services, the Government will be:
Setting sector specific concession length caps to ensure that the length of the contract
is appropriate to the nature of the services and assets being provided. For example,
where a PFI project has a large service element, the value for money of a longer-term
contract is diminished; and
Reducing the costs of terminating PFI contracts by changing its approach to certain
aspects of the financial structure and the calculation of the payment made if the pub
lic sector wishes to terminate the contract.
The evidence of operational PFI contracts shows a high level of satisfaction with the
operational performance of PFI projects overall. Analysis of performance under the different
elements of the contract emphasises the benefits that PFI brings in terms of the general avail
72 Edward Farquharson

ability of the underlying asset, and its maintenance. The evidence shows that soft services
are performing satisfactorily. All of the PFI hospitals, in cleanliness data examined by Pa
tient Environment Action Teams in 2004, are rated at least acceptable. Research backed up
by interview evidence from the survey of operational projects, illustrates that while 100 per
cent or just less of projects in that sample rated their projects adequate or better on both
availability and soft services, 91 per cent of those projects rated availability as good or very
good, while 58 per cent placed soft services in the same categories. The evidence shows
therefore that soft services are seen as performing less well on average than the very high
scores given to other elements of the PFI framework.
The UK Governments view is that the evidence on satisfaction with soft services does
not demonstrate value for money as consistently as other elements of the framework, and
that the analysis of service outcomes suggests that while standards are no worse than in
non-PFI structures, PFI has not led to a step change in soft service delivery. Therefore the
Government is strengthening its value for money test so that the public authorities must rig
orously prove the case for including soft services in PFI projects.
Research showed that there was significant variation in the nature, and public sector un
derstanding, of the soft service benchmarking reviews required in some PFI contracts. In fu
ture, where the public sector decides to include soft services, the Government will amend the
standard PFI contract so that the soft services elements have greater flexibility. This will be
achieved by requiring the provision of soft services to be actively competed and market tested
at appropriate points during the PFI contract. This will ensure transparency and competition at
the point service requirements are reassessed and re-priced. Improving the guidance and sup
port to public sector managers will be a key priority of the PFI Operational Taskforce.

Continuing to Improve the Procurement of PFI

A number of measures have previously been introduced to improve the Governments

ability to procure PFI projects successfully, recognising that procurement skills were at a
particular premium in PFI procurement. Evidence on PFI projects suggests that procurement
times are still long, taking on average over two years from advertising in the Official Journal
of the European Union (OJEU) to financial close. Although it is too early to analyse defini
tively the effect of earlier reforms on procurement times, there is initial evidence that the re
forms have had some impact in increasing the number of projects that close in less than two
years. Initial evidence also suggests that approaches such as NHS LIFT can have a signifi
cant impact in shortening procurement times.
The Government needs to ensure that the public sector has people with the appropriate
skills and experience to develop and manage all procurement projects including PFI projects.
These include:
Developing a secondment model within the public sector so that public servants with
experience of complex procurements can be retained and deployed on projects across
the public sector;
UK Private Finance Initiative (PFI): reflections on recent developments 73

Requiring procuring authorities to publish affordability limits that they have con
firmed are sufficient to meet their requirement. This should assist in shortening the
time taken from the OJEU advertisement to financial close;
Taking steps to ensure that Private Finance Units (i.e. the Ministry based PFI units)
are appropriately resourced to manage their PFI programmes; and
Developing individual and team procurement skills through formal qualification
training.
The Government will also improve the way it monitors projects, building on the lessons
learnt from the inter-ministerial Project Review Group, including changing the points at
which approval is required so that they better match the key stages of a procurement. This
change will help the Government ensure that both central and local government projects are
commercially deliverable before engaging the market.
The Government is also considering whether certain measures introduced into PFI pro
curement can be applied across other forms of conventional procurement. These measures
include:
Extending the use of standardised contracts that articulate a defined risk transfer bet
ween the public and private sector;
Greater use of programme procurement vehicles where there is a sustained
programme of investment required; and
Improving the support structures available to public sector procurers.

Private Finance

Since PFI: Meeting the Investment Challenge, the market for private finance has
continued to develop and debt financing terms have improved. The involvement of private
finance is vital to ensuring that assets are delivered on time and on budget and that the pro
curing authoritys requirement is met through the life the contract.
To support measures to improve the value for money of PFI, the Government will make
a number of minor changes to the role that private finance plays in PFI. These steps include:
Measures to improve the flexibility on termination of bond-funded PFI projects and
amendments to its approach to Authority Voluntary Termination; and
HM Treasury guidance for procuring authorities highlighting the different character
istics of the bank and bond markets and how these characteristics may affect them.
To ensure that private finance supports the lessons and measures introduced on the op
erational flexibility of PFI projects, further guidance on assessing the impact of the financial
structure of PFI projects has been provided in a version of the Value for Money Assessment
Guidance.
To improve further the transparency of private finance within PFI projects, the Trea
sury will require debt funding competitions (post the selection of preferred bidder) across all
74 Edward Farquharson

PFI procurements, except where the procuring authority believes that such an approach will
unduly increase procurement costs and lengthen procurement times.
The Government wishes to ensure that funding markets continue to deliver optimum
value for money, recognising the trade-off between price and risk transfer. Such measures
can include monitoring the use of equity funding competitions and Credit Guarantee Finance
and considering alternative ways of optimising the risk and return of senior debt within PFI
projects.
The development of a PFI programme involves continuing evolution and improvement
as experience is gained, markets develop and new areas for public sector service delivery are
explored. PFI has been successful in delivering high quality facilities for public services,
with the benefit of on time and on budget delivery in key sectors of public investment. PFI
will therefore continue to be used where it is expected to deliver value for money. HM Trea
surys recent publication Transforming government performance, published recently, fur
ther reasserts this drive continually to improve procurement and sets out the Governments
wider vision on procurement overall.

Notes
1. This article has been extensively based on PFI: Strengthening Long Term Partnerships, HM Treasury.
2. Report on Operational PPP/PFI projects Partnerships UK. Available on the Partnerships UK website
(www.partnershipsuk.org.uk).
3. KPMG/BSA (2005): Effectiveness of Operational Contracts in PFI.