EuHPN Health ClusterNET

1
EuHPN Health ClusterNET Capital Investment
Workshop Krakow 27th-29th April 2006 The UK PFI
Experience Charles Abel Smith Head of PPP
Advisory
2
PFI In Healthcare Major Projects in England
Source Department of Health
3
Conventional Procurement
4
PFI Procurement
5
Finance

• Senior Debt (90 of funding)
• Credit risk margin lt1
• 25 yr loans
• Very low risk appetite
• Equity (10 of funding)
• Takes first loss risk
• Seeks 15 IRR to compensate for risk
• Small equity cushion aims to minimise risk
• SPV has minimal ability to assume risks
• Seeks to pass risk to other parties

6
SPV Delivery

• Construction
• Fixed price date certain turnkey construction
  contract
• Contractor requires up front agreement of
  specification
• Pricing higher price in return for taking more
  risk
• Operations
• Pass through of performance deductions to FM
  Provider
• FM Provider will seek to minimise financial
  exposure
• Limited ability to take long term price risk
  (especially labour costs)

7
PFI versus Conventional Procurement Cost
Comparison
8
Potential PFI Value for Money Benefits

• Better Definition of Public Sector requirements
  at financial close
• Clarity on financial commitment
• Focus on whole life cost of investment
• Service based outputs linked to public service
  delivery objectives
• Risk Management by private sector
• Private Sector risk management expertise
• Incentivisation through having private finance at
  risk
• Detailed due diligence process to ensure robust
  projects
• Scope for innovation
• Ability of private sector to provide innovative
  solutions
• Ability of private sector to optimise investment
  within PFI contract with secure long term cash
  flow
• The greater the scope of the contract, the
  greater the ability to innovate

9
How Has PFI Performed So Far?

• Procurement process
• Project completion
• Operating phase

10
Procurement Process

• Complex Procurement Process
• Complex contractual structure to deal with long
  term contract
• Legal, technical and financial advice required by
  public and private sector
• Improving the Process
• Need for public sector to become intelligent
  client
• Increasing contract standardisation
• Partnership vehicles such as LIFT
• Track Record
• UK projects still taking too long to close
• Other countries have achieved faster procurement
  process

11
Project Completion

• Over 500 PFI Projects currently in operation
• 185 new or refurbished health facilities
• Private Sector Experience
• Contractors have absorbed some significant cost
  overruns
• Contractor insolvency private sector has
  resolved problems without extra cash from public
  sector

12
Operational Phase

• Early Days
• New facilities an improvement on what they have
  replaced
• Generally meeting or exceeding public sector
  expectations
• But
• 25 year contracts
• Complex and relatively inflexible contracts
• Rapidly changing UK health economy
• Speed of technological change
• Can PFI Contracts respond to the evolving
  requirements of the NHS?

13
Some Emerging Operating Issues

• Public sector needs high quality contract
  management skills
• Ability to understand complex contracts
• Constructive use of payment and performance
  mechanisms to improve performance
• Need to simplify payment mechanisms
• Variations
• Capital cost variations are cumbersome and
  expensive
• Public Sector and PFI SPV under-resourced to deal
  with variations
• Improving Hospital operating performance
• PFI contract typically represents 10 of an NHS
  Trust turnover
• PFI contract is an integral part of any Trusts
  business
• NHS Trust management teams must engage with PFI
  contractor to optimise business performance

14
The Key Relationships During the Operation Period
Financial Equity
Service Contract
Senior Debt Providers
Approx. 10 ofCost
Approx. 90 ofCost
Trade Equity
Construction Contract
Operation Contract
15
Conclusion