False promises, the PFI mess

The recent news that some London Health Trusts are in financial difficulty does not come as a surprise to me for two reasons: I read Private Eye and I have seen or been involved with a number of PFI (Private Finance Initiative) deals. With every single PFI I have looked at, I have never thought that any of them delivered genuine value for money for the taxpayer. But as there was no other money available and as the political instructions were very clear that they should be used, I like many other civil servants, simply had no choice but to get on with it. The sad truth is that many spending promises made by Government in the last 12 years were false promises, using money it did not really have and signing up to deals that were simply licences to the private sector and the banks to rob the UK taxpayer. Thus Labour (and no doubt the Coalition will too) put the public finances into debt in order to buy votes and thanks to the financial/banking crisis the chickens are now coming home to roost.

Maybe I should provide a brief explanation of how a typical PFI arrangement works so that people can understand how ludicrous PFI is. Bear with me as I try to simplify a very complicated area of government business.

Let us say that you are in charge of a project such as building a hospital or school or even to supply the Royal Air Force with air to air refuelling tankers. All this has been done under PFI. You need a big chunk of money to do so, for simplicity’s sake, we will use a nice round number of £1 billion. You are told, that your Department does not have the money and Treasury will not give it to you. But to maintain the current service, the operating budget is £50 million a year and this can be increased to £100 million a year (don’t ask how they manage this, it is a mystery!). As a good project manager, you need to think through-life for your project, thus you combine the cost of buying your hospital/school/tankers and the cost of running it. You need to put a time frame on it so you say 20 years. This neatly means you need £2 billion all in for a 20 year project (£1bn to buy and £50m x 20 = £1bn to support). Lo and behold, the £100 million a year operating budget over 20 years the Department is willing to give you also comes to £2 billion. Result! (Warning: most PFI do not work out this simply, I can almost guarantee that in most cases the PFI forecast is more expensive over the 20 years rather than breaking even, explanation of why is below)

So you now have a requirement, a budget and a plan and so you compete for a private company or consortia able to build what you need and keep it running for 20 years. This competition process may cost you £2 million (team of lawyers, commercial officers and experts to assess bids etc) and takes, at a minimum, two years to get to contract. Fast forward to you have selected your bidder/consortia and the discussions now turn to raising the money. Needless to say, most companies don’t have £1-2 billion in cash, so they go to the bank. The bank is willing to support the deal, but of course they are going to charge you interest on any money borrowed. Oops, this means you need another £200 million over the 20 year project because of course the £100 million a year estimate did not include commercial interest rates (remember it is £50m a year to support, another £50m a year from capital costs). This is where it gets farcical, the Government can borrow money from the Bank of England for a far lower interest rate, but you are not allowed to do so. PFI is about using private money to fund public projects. Your Department approves this increase in budget because you really badly need the hospital/school/tankers.

Off you go, things get built or made and the service is up and running. A financial crisis hits and the bank raises interest rates. That is another £100 million added to the cost. Don’t forget you have effectively borrowed £2 billion for 20 years, money costs more over time due to interest. Now your project will cost 2.3 billion over the 20 years. Of course if you had fronted up the £1 billion construction money from the beginning you wouldn’t have to pay the interest, but you did not have the money and so that is that. Your private company/consortia is able to get a better deal on the interest payments through refinancing, but the contract does not mean you get any of it. The private entity can also sell your PFI contract to someone else and again you contractually have little power over this. The contract is all about delivering output and availability, how it is delivered is not meant to be your concern as long as you get the service you asked for.

Let’s go back a bit and remember that previously it was costing the Department £50 million a year to deliver a service that was probably ok, but not brilliant. Your private entity has managed to get the costs down to £45 million a year by being ‘efficient’. One would think this is a good thing and the private entity is earning the extra profit through this ‘efficiency’. Ignore the fact that the cleaners are illegal immigrants barely paid the minimum wage, maybe the hospital/school is not as clean as it used to be and maybe a few shortcuts are being taken here and there to save money. There are two big problems. One is inflexibility. It is all about the contract. Don’t really need 100 beds or a 1000 school places any more? Tough, it is what was asked for in the contract, you still have to pay for it until the contract ends even if you don’t use it. Of course you could ask for a contract amendment, but I can promise you that the bill will sting. Why should the private entity play nice? Remember, they want the profit, what is in the public interest is your problem not theirs. The second problem is that almost without exception it is impossible to transfer sufficient risk to the private entity, not least because the cost is astronomical and/or you remain responsible no matter what. In the case of the RAF’s tankers, they may well be technically owned by the banks, not the RAF. Funny enough banks are very averse to letting their assets fly to dangerous places no matter how desperate the need. The RAF could over-rule them, but will have to pay a contractual penalty for doing so or suffer the consequences such as a plane having to divert to an airfield thus not achieving its mission. What if a patient dies in your hospital because the contractor did not clean it properly? It may be the contractor’s fault, but the NHS/Department of Health is still ultimately liable because it is with them that the patient has the ‘contractual’ relationship. You struggle to pass the cost to the contractor because the contract said it should be cleaned daily and that is what they did even if badly.


The example above is actually very conservative and I have not tried to over-egg the maths. In the real world, the figures are often considerably worse. All too often the private entity would have recovered all the cost by year 12-15, but of course the Government is still paying the flat rate as stated in the contract. Thus that private entity would, using the example above, make £50m of pure profit for the last 5 years of the contract. So much for saving the taxpayer any money...

Of course there is the irony that thanks to the financial crisis the taxpayers now own most of the banks holding the PFI contracts. So effectively the Bank of England is now loaning/giving the money to the banks who put commercial interest rates onto it and lend it to the PFI contracts who add their cut which is paid for by the Government. No wonder the whole thing is so complicated! Maybe life would be so much easier if Government departments borrowed the money directly from the Bank of England to pay a contractor to build the hospital/school/tankers (thus owning these assets), then paid for the support of these assets to other contractors on a rolling basis. They could even do clever things like break the support contract into small chunks and choose a local small firm thus ploughing money into a deprived local economy. Perhaps such a thing is rather old fashioned, but it does mean the taxpayer is not paying a huge interest bill and inviting the private sector to find ingenious and less than moral ways of making more profit (funnelling payments off-shore to avoid tax, employing illegal immigrants etc). Don’t get me wrong, I am not saying there is no role for the private sector and that they should not be invited to bring their own assets to make a public service work better, but PFI has to be the most convoluted and flawed way possible to achieve this. It has effectively saddled the Government with a huge annual mortgage bill that it is very hard to get out of. There are some PFI success stories, but the astronomical cost and mis-management completely outweighs them.

This Government has set the goal of deficit reduction its number 1 priority. How will it achieve this unless it rips up those billions of PFI deals? Aha, there is a better way – let the contracting authorities such as the London Health Authorities go bust and the PFI investors lose their shirts. Possibly a number of people will be made redundant. Sorry NHS, as the doctor might say, “it will sting a bit, but this treatment is necessary.” But who will treat those patients desperately in need of care? Step up Andrew Lansley’s new commissioning bodies and ‘any willing providers’. Probably the same people who shafted the UK taxpayer on the original PFI deals. Mind the dead bodies as you go please…