Select Committee on Health Minutes of Evidence


Annex A: Evaluation of Risks in NHS PFI Contracts

CONSTRUCTION RISKS

Background

  It is up to individual trusts to initially assess the value construction risk in their PFI schemes as they are best placed to understand local circumstances. The NHS PFI Guidance does, however, provide trusts with advice on how to quantify such risks.

  The value for money test compares the full life cost of public provision (the Public Sector Comparator (PSC)), with that of the private alternative, (PFI) and the value of the risk retained by the public sector in both options.

  To account for the fact that costs arise in different years, a technique called discounting is used that applies more weight to costs falling in earlier than later years. Future payment streams are therefore discounted using the Treasury discount rate, currently 6 per cent. The sum of the discounted costs is called the Net Present Cost (NPC).

RETAINED RISK

  If the value of risk retained in the PFI option is less than that for the PSC, risk has been transferred from the public to the private sector. Table 1 below provides an example.

Table 1: VALUE OF RISK (NET PRESENT COST)

PSC Cost of Risk
Retained
PFI Cost of Risk
Retained
Value of Risk
Transfer
£15m
£5m
£10m


  Thus, in the table above, provided the cost of the PFI option (excluding risk) does not exceed the publicly funded alternative by £10 million or more, it will be better for the taxpaper to accept the PFI option.

  To help trusts calculate risk values the PFI Guidance outlines 22 typical construction and development risks. (Attached as Appendix 1). This list is not exhaustive since not all the risks here are relevant to all schemes. Individual schemes may also identify additional one-off construction risks.

  The PFI Guidance also outlines how individual risks could be allocated between the NHS and the private sector.

VALUING RISKS

  To value construction risks, trusts usually hold workshops that bring together a team of experts. This team might consist of:

    Chief Executive;

Director of Finance;

Facilities Management Adviser;

PFI Project Manager;

Estates management Adviser;

Quantity Surveyor;

Financial Advisers.

  For each risk in turn the workshop will:

    Identify and define the risk;

Determine its impact—for example, changes to design may be required if a particular risk arises;

Provide a commentary that outlines the estimated cost of addressing the risk should it arise;

Determine the probability of the risk arising;

Outline the years over which the risk is likely to arise (for construction, such risks should only occur during the scheme's construction period);

Determine how much risk is retained by the trust under the PSC and PFI options;

Provide evidence for the underlying assumptions.

  For each risk the above information is pulled together in a risk description table an example of which is provided as Appendix B.

  Having determined the most likely cost of each risk over the life of the project, the agreed value of the risks are incorporated into the discounted cash flows to calculate the Net Present Cost of Risk under each of the options.

  The biggest construction risk values tend to be allocated to cost and time overruns. Such risks are often quantified together. The value of cost overruns is typically based on a percentage of the schemes capital costs, which itself is based on historic evidence obtained from the NHS Estates database. A cost overrun is where the cost to the NHS is higher than that agreed in the contract. This could arise because the NHS changes the specification of the materials used in the scheme. A time overrun is where delays in completion means that, for example, the construction workforce must remain on site for longer than was priced for. Since the cost of time delays will also feature in historic cost overrun figures, it is reasonable to estimate the cost of time delays based on historic cost overrun figures.

  Some trusts also quantify additional time overruns—for example time overruns may mean expected savings from rationalisation of facilities management or clinical services are delayed.

SCRUTINY

  When scrutinising business cases, DH compares risk values presented in cases with evidence from the NHS Estates Database and the experience from previous PFI schemes in order to check for consistency.



 
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