Examination of Witnesses (Questions 460
THURSDAY 15 NOVEMBER 2001
460. We as a Committee have a right to have
concerns about the kind of company which may seek to get involved,
do you think there is an issue about being fit to carry out this
kind of work?
(Mr Stone) No, I think what is important is that as
the process is created, and there are some pathfinders under way,
the process itself is properly open and robust and that there
is proper credit given for competence of organisations in their
ability to deliver the services which are involved and manage
the risks involved, just as had been the case in the overall approach
to the PFI process. What is most important is to make sure that
we do not just take the first project in London and lock the model
up but we learn from the experience and develop that. One of the
aims clearly has to be one of helping the industry as a whole
grow and increase the security of supply and competition.
461. Turning to Mr Davis, I noticed in your
evidence there were concerns about the limited size of the PFI
market for health schemes and that more needs to be done to stimulate
the size of the market.
(Mr Davis) Yes.
462. Does this mean it has got more than it
can cope with in the acute sector and the primary health sector
is a step too far and something which will remain undeveloped?
(Mr Davis) Talking for our organisation, we are resource-constrained
for the NHS PFI projects and we are concentrating that resource
on helping to provide acute facilities. In the next few years
we would not be looking at LIFT-type arrangements, although I
hope to see this change, but that is a capacity issue.
463. Mr Stone is talking about lessons learned,
does that mean companies are coming in which have not learnt lessons
and we will have to go through the whole painful process again
in primary care?
(Mr Davis) I think that reinforces Mr Stone's point.
The NHS is learning, and there is a lot of internal know-how which
has come from acute sector PFI procurements which will beneficially
move over into LIFT. On your point about the capacity of the market,
there is an issue, not so much about the absolute capacity of
the market but about the timing of the deal flow, to put it crudely.
If they all come at onceand in the next six months we expect
somewhere around 8 to 12 major PFI schemes coming on to the marketthat
is going to cause a problem. So the capacity is there if there
is a smoothing of the deal flow into the market.
464. Can I turn to Professor Pollock and put
some of these issues to her. I know you have written on this issue
quite recently. Primary care facilities have traditionally, on
the whole, been privately owned, often by individuals acting together
in some cases, and there is no change here in terms of the principle
of private sector ownership of it.
(Professor Pollock) Yes, we wrote a series of three
papers in the BMJ on primary care earlier this year pointing
out basically primary care had always had a system of debt finance,
public finance originally and then it was privatised in 1989 and
sold to the Norwich Union. We are talking about a different kind
of ownership. You are absolutely right, it is one of the Achilles
heels of the 1948 NHS that primary care services were not brought
into the public domain and public ownership, and that has always
been a battle and it has always been recognised as one of the
fundamental weaknesses of the NHS that GPs are independent contractors.
I think the last survey showed that 80 per cent of the primary
care premises were owned by GPs and then they are paid a rental
income for their practice premises. That has always been a major
problem, although it has been dealt with by capping the budgets,
so GPs have not been able to exploit it unduly although they have
had a nest egg, it is true, on retirement. We are now looking
at major change, and it is a major shift to privatisation we are
documenting. One of the really regrettable things is how little
data has been collected by the Department of Health, that is evident
in the public expenditure questionnaire, on primary care premises,
the new ownership arrangements, the changing patterns, the scale
of the debt, the scale of the loans and the debt servicing and
the implications for the revenue budget.
465. Everyone would accept that the facilities
are very poor.
(Professor Pollock) Yes, many, not all.
466. Not everywhere but there were examples
of very poor quality services in inner cities particularly. We
need a mechanism, I think, to bring those up to standard quickly,
is not the LIFT scheme providing a way of doing that? Would we
want to transfer these facilities so they are under the responsibility
of the NHS which would then have that headache of taking on the
maintenance and up-keep of the primary care facilities across
(Professor Pollock) These are political decisions,
how you decide to fund your capital investment. There was an episode
in the 1960s when local authorities were actually financing and
funding primary care premises with great success for the local
community, for the staff and doctors, and in fact doctors working
there wanted a salaried service. The issue is that primary care
inner city premises on the whole are pretty appalling so how are
we going to fund and finance them. LIFT is a completely opaque
mechanism, the transparency and accountability are not at all
clear, there are almost no data coming out of there, and the guidance
to GPs is almost negligible, and the issue then comes back to
the whole planning process, how are you going to do a needs assessment
and what is the best way of funding it and the most efficient
way of doing that. So it comes back to your principles. I put
it to you that the problems we have seen with PFI in acute hospitals
are going to be exacerbated a thousand fold when you look at very
complex primary care schemes. One of the other things that primary
care schemes are doing is project-bundling, they are wrapping
up other services and other facilities. Some of it includes commercial
enterprises but other bits include local authority services such
as welfare offices or libraries and social services. What happens
if and when that project fails, where does the risk get held,
who is accountable for the flows of funding, does the public sector
have to come in and pick up the risk when the income fails, say,
from a commercial project and we have an economic downturn? All
these questions remain completely unanswered. I think LIFT and
PUK are deeply worrying, they are removed from Government and
we have no proper mechanism for scrutinising what they are doing
and what data they are collecting.
467. I get the impression there are a range
of models which might be possible in this area, and if primary
care trust holders contract with private sector providers to bring
together a range of primary care providers on one side, would
that not help solve the problems about GP recruitment, in that
they would not have to take a property stake, and also would it
not be more convenient for patients if there was a mix of retailers
as well on site, like pharmacies? It strikes me to dismiss it
totally is a bit premature.
(Professor Pollock) You are starting off with the
assumption that the best way of doing this is using private finance.
I think you have to challenge that notion, you have to start with
a needs based approach. What are the needs of the population?
How are they best served? They are functions which have traditionally
sat with health authorities which are now being dismantled and
abolished. One of the concerns is how that is going to be approached.
The other problem is, of course, as you rightly point out, the
major shortage in GPs' supply with a lot of retirements which
will be taking place in the next five to ten years. I put it to
you, if you start with a decision about how you are going to use
private finance, the distortions and dislocations you have seen,
already will be accelerated and perpetuated, fragmenting a dividing
in the NHS.
468. It means they could spend money elsewhere
in the system.
(Professor Pollock) You would have to spend much more
if you use private finance.
469. They do not have to spend money up-front,
so they may have more money to spend elsewhere. Does it have no
merits at all?
(Professor Pollock) Absolutely not. You are missing
the point. The NHS has traditionally funded capital from a capital
budget, PFI payments have to be made from their revenue
470. But capital is always going to be limited,
is it not, in whatever world we are in. If it is always going
to be limited, everybody cannot have their new primary care hospital
(Professor Pollock) No, they cannot.
471. So in that world, why is it fair to have
one town getting it and one town not?
(Professor Pollock) It absolutely is not fair, but
what you are basically saying is that you are going to devolve
these investment decisions to a local level. The real issue is
that these investment decisions then have to be met from the revenue
budgets at local level, that puts a major pressure on the revenue
budget, then you end up squeezing and cutting services, introducing
private health insurance, introducing more private sector care
and also redrawing lines of eligibility. Do not forget, the NHS
has just seen guidance restricting NHS care to six weeks for intermediate
care. So care trusts are going to come under an awful lot of pressure
to do rationing as a result of the major pressures on their revenue
budget, and they do not even understand the income streams they
are inheriting. Primary care trusts are not actually equipped
or set up at the moment with the expertise to understand the financial
implications of what they are inheriting, whether it be PFI in
hospitals or PFI in primary care.
472. I think you said that you recognised that
many GP practices have been in the private sector ever since 1948.
(Professor Pollock) Yes.
473. Much of LIFT is designed to help GP practices
reinvest in themselves or relocate. Insofar as the planning considerations
are concerned for GP practices surely the argument does not hold
so much insofar as there is not a change? It might be you have
always liked it in the public sector but at least there is not
a change. Can you produce evidence to show that the part that
GP practices have been funded privately has led to any increase
in private insurance in the way you have just suggested would
(Professor Pollock) The GPs have had proper rental
incomes to pay for their PFI, so they have actually had a separate
income stream to pay for that. There is no doubt that the switch
to fundholding again was unevaluated but I speak to many GPs who
say that the first thing they do is to check whether their patients
have got private insurance and encourage them to use it, because
they realise when they are working under cash limited budgets
that is in their interests, and that especially happened under
474. You are talking about GPs in London, I
(Professor Pollock) And inner city areas. Even in
inner city areas they are encouraging their patients with private
health insurance to use it. But the fact is there was an identifiable
income stream. The problem was when the interest payments rose
and they got into real financial difficulties in the early 1990s,
and nobody knows how they managed that, nobody knows how that
475. But in terms of planning there is no difference
with what we had before?
(Professor Pollock) I think there is a fundamental
difference. You are talking about a major reconfiguration in primary
care rather than an unfortunate inherited status quo. You
are looking at massive change in the provision, in the location
and in the planning of services.
476. Professor Pollock has referred to the change
in the system of financing which came about in the NHS. Some of
us have a background in local government, and in local government
capital borrowing was always paid for, and in that sense the NHS
was different from local government. At some stage we did have
a freedom in local government, until the Thatcher-Heseltine era,
to make revenue contributions to capital and not borrow, but if
money was borrowed it was borrowed and the interest was paid at
the full rate. In the rest of the public sector one assumes that
any borrowing comes through the public sector works loans board
and a charge is made. The problem for the Health Service was that
would have been a charge somewhere within the corporate budget
but it was applicable to the health authority that was actually
doing the borrowing. When the change came about, suddenly health
authorities had to pay interest on their capital, presumably adjustments
were made to their budgets to take account of that change. I appreciate
that around that time interest rates went through the roof but
is there something inherently wrong in a public sector organisation
paying the true cost of its borrowing, whether it is done publicly
through the public works loans board or through a PFI?
(Professor Pollock) Local government is different
because it has a mechanism for income generation through local
taxation but also through other sorts of income generation, through
commercial activities. Local government has also always had that
function. The whole purpose of the NHS was that it was
477. Well, its commercial activity was cut off.
(Professor Pollock) That was the argument, that local
government could raise money because it also had tax-raising powers
and it could also income-generate. The NHS was not meant to income-generate,
it was supposed to be treating patients, so it was not in the
business of business, as it were. Nor could it raise taxation
at local level, indeed if it could have done that, it would have
acted completely against the spirit of a national health service.
So to give trusts local borrowing and local income-generating
powers is simply to take it back to pre-1948 where you had the
huge inequalities in distribution of resources, and where areas
with a lot of money and ability to pay will raise money easily,
and those that do not, will not. So there is a major problem with
saying that local trusts or local health authorities should have
local borrowing powers. There is another issue which is that capital
has always been starved in the NHS and this must be to do with
the fact that the accountability structures have not been sufficient
that voices have been able to be heard. Stripping out CHCs probably
will not help that either.
478. Can I come on to the question of the public
sector comparator. It is recognised across the board I think among
the witnesses we have had that there are inherent difficulties
in calculating the public sector comparator over a 35 or 40 year
period. The Government assesses that the value for money margin
is slim, averaging out at about 1.7 per cent, and I think KPMG
in their evidence have said that the public sector comparator
against the PFI shows good value for PFI, albeit marginally. My
question really is, if at 1.7 it is marginally in favour of PFI,
what would happen if the discounted cash flow was lowered by a
couple of points? It would then seem the PFI route would not appear
such a beneficial option. I am wondering if that were to happen,
what efficiency gains might the PFI contractors make to retain
that marginal competitive edge?
(Mr Stone) If we deal with the discount rate itself
first of all, the discount rate is a measure of saying, "What
is the opportunity cost of capital" to choose between different
schemes. This should apply just as much to the public sector as
well, so the public sector has two alternative schemes. There
is a mechanism which says, "What are the long-run costs of
the process", and let's contrast that with what PFI has done
to include in that process as much of an estimate of risk as we
can. To answer your question directly, if the discount rate is
arbitrarily reduced, then the value for money balance shifts in
favour of the up-front capital expenditure. However, if you went
round the bankers you will discover a deep concern that reducing
the discount rate is actually kidding ourselves. All the deals
which have been financially closed to date, where there has been
any formal analysis of the credit quality of the deal, have suggested
they are somewhere about the BBB area, which in broad terms is
investment grade. If we for a minute suspend disbelief and work
on the assumption that the PFI schemes overall manage risk betterwhich
is the basic premise behind them of coursethen it would
be fairly reasonable to argue that if you were to do an honest
analysis of the equivalent scheme in the public sector, including
its inherent credit quality, that would also be at least BBB if
not worse, and the discount rate you would apply in any other
context to compare and contrast different schemes with these credit
qualities would not be 6 per cent or lower, it would be a bit
higher. So there are two sides to the question. Yes, the discount
rate comes down, the balance shifts more in favour of the public
sector comparator, but at 6 per cent on its own it is probably
not necessarily the right number. Secondly, the other thing which
is important, as I said earlier, is that one of the big components
of the VFM comparison is the true costs of the public sector comparator.
Whilst I cannot give you actuarially certified numbers, everything
we have seen in almost everything we have been involved with leads
us to believe that the estimates on these are pessimistic, they
are-under-cooked. So if there were to be a more vigorous and thorough
and more supportive analysis of the numbers, coupled with a reasonable
approach to the discount rate which takes account of the fact
that what happens traditionally is that the Government hides risks
through its ability to raise money either through gilts or taxes
and there is no accountability for the long-run costs as there
would be if they were visiblefor example with Chelsea and
Westministerthe expectation is that a fairer analysis would
produce a more positive result in favour of the PFI. I should
underline at this point, as I said earlier, the issue that we
are most focused on is not a particular form of solution, it is
an honest analysis. We do not care what the answer is as long
as it is an honest and straightforward and contestable analysis
which it is not at the moment.
479. This is a question for Professor Pollock,
and we have probably already had the answer in the seminar we
had earlier and the various questions which have been asked since,
but because a Treasury official gave this evidence officially
I would like to get Professor Pollock's answer to it on the record.
The Treasury official said that any change in the public sector
discount rate, currently at 6 per cent and it has been there for
quite a long time, would be unlikely to be a crucial factor in
determining the value for money of a project. Is that something
you would agree with?
(Professor Pollock) There are two elements to the
value for money analysis. There is the application of the discount
rate and then there is the risk transfer. One of the elements
which favours the PFI is the staging of the payments, the point
Julia Drown has just been making, although of course there is
no reason why the public sector should not have exactly the same
staging of the payments if the Government were to do the borrowing.
So that is a really important point to make, the PSC adds not
now need to make its payments. To come back, on the 6 per cent,
we found in Carlisle, for example, by simply reducing by half
a per cent it came out in favour of the public sector. But when
we look at the public expenditure memorandum on the selection
of hospitals, all of them show that even with the 6 per cent rate,
which is too high, as has been pointed out by Social Welfare economists,
it still comes out in favour of the public sector. The real element,
when you look at the public expenditure questionnaire, is the
assumptions about risk transfer. In order to get it VFM to stack
is favour of PFI, you are having to make major assumptions about
the scale and the value of risk transfer. Risk is probability
but we are taking about uncertainty. Even when you put in vast
amounts of so-called risk transfer to the public sector, and you
are loading the public sector now against the private sector,
you are finding there is very little difference in the end in
the value of the schemes. The point which it is very important
to make is that these risks are ex ante, they have not been proven
and tested, and yet we have seen already in high profile cases
like the passports office and, Seimens, NIRS 2, even Railtrack,
that when things go very badly wrong, the real risks revert to
the public sector, and in fact there is a real problem in the
penalty clauses, because if they are too high the private sector,
the SPV (Special Purpose Vehicle), can simply walk away but you
are still left having to pay the banks; you still have to pay
the banks and then contract for new services.