Value for Money Test in Korea

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Value for Money Test in Korea
Hojun Lee hojunlee_at_kdi.re.kr Public and Private
Infrastructure Investment Management Center
PIMAC
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• Value for Money Test
• Process of PPP Project Implementation
• VFM The Theory
• VFM The Practice in Korea

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Value for Money Test
Part-01
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• 1. Process of PPP Project Implementation

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Project Initiation

• Both the government and a private company can
  initiate a PPP project
• Solicited Projects
• A solicited project is that the competent
  authority identifies a project for private
  investment and announces a RFP
• Competent authorities develop a potential project
  after considering related plans and demands for
  the facility. They then weight the procurement
  options in order to determine whether the PPP
  procurement is more efficient than the
  conventional procurement
• Unsolicited Projects
• For an unsolicited project, a private company
  (project proponent) submits a project proposal,
  and then the competent authority examines and
  evaluates the contents and value for money of the
  private proposal, and designates it as a PPP
  project

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Procurement Steps of a Solicited Project
Solicited Project
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Procurement Steps of an Unsolicited Project
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• VFM The Theory

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The VFM Concept

• What is Value for Money?
• The best available outcome after taking account
  of all benefits, costs and risk over the whole
  life of the project (HM TREASURY)
• Not lowest price
• Why it is Used?
• Seek the best use of available resources
• Efficient and effective public service delivery
• The competent authority uses VFM reports as
  basic material to make a judgment on whether to
  move forward with the PPP project proposed by the
  private proponent according to the Article 7,
  Paragraph 3 of the Enforcement Decree of the PPP
  Act

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Key Elements of VFM

• VFM is often a comparative assessment
• Requires a benchmark cost PSC (Public Sector
  Comparator)
• PSC is a benchmarking and evaluation tool a Key
  tool
• Benchmarks the cost of government service
  delivery
• Evaluates whether VFM is delivered from bids
• A Procurement principle, not only for PPP
• Adopted by different countries to meet
  governments procurement practices
• Not a universal tool
• Applied on a project or program basis
• Innovation, asset utilization, risk sharing,
  competition, service integration ate main key
  drivers of VFM
• Presence of VFM drivers confirms suitability for
  PPP

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The Role of PSC

• Promote whole life costing early in the projects
  development
• Assist in assessing the project affordability
• Provide a means for demonstrating VFM
• Provide a consistent benchmarking and evaluation
  tool
• Encourage bidding competition
• Based on
• Reference Project
• Risk analysis
• Cash flow over the life of the project
  (inflation, cost, revenue, discount rate..)
• Government procurement costs to asses project
  affordability

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VFM Assesment
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3. VFM The Practice in Korea
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Implementation

• PIMAC of KDI is in charge of VfM test as
  stipulated by the PPP Act
• VfM test is carried out in accordance with
  Guidelines for implementation of VfM Test/Review
  of Proposal for unsolicited BTO projects.
• Five interim review meetings are held during the
  VfM test
• The duration of each project research should take
  up to six months
• Same methodology and procedure are applied both
  to VfM Test and Review of Proposal
• Objectivity, consistency, independence as well as
  professional expertise are important elements in
  conducting VfM tests.

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Organization of a Research Team

• A VfM test is carried out by a multi-disciplinary
  research team
• KDI (Project Manager)
• Experts with relevant skills and expertise for
  the project are selected at the preliminary stage
• External experts (selected from human resource
  pool)
• Demand forecasting university professors
• Cost estimation engineering companies
• Accounting accounting firms

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Scope of a VFM Test

• Phase 1 Feasibility study (Decision to Invest)
• The cost- benefit analysis is conducted to
  determine feasibility of the project from a
  national economy perspective.
• Phase 2 Value for Money Assessment (Decision on
  PFI)
• The government payment of PSC (Public Sector
  Comparator) is compared against that of PFI
  (Private Finance Initiative) to assess whether
  the PFI achieves VfM.
• Phase 3 Formulation of PFI alternatives
• Based on the results of phase 2, an appropriate
  PFI alternatives are formulated
• The level of project cost, user fee, subsidy
  scale, etc. are suggested from the government.
• Phase 4 Award bonus points to the initial
  proponent
• Bonus points (10 max.) awarded to the initial
  proponent are estimated based on the results of
  VfM tests and the quality of the proposal.

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Setting Comparators for VFM Test
VfM Analysis Implementation Method
Unsolicited Unsolicited With Public Plan Solicited
Private Finance Initiate PFIp (based on proposal) PFIp (proposal) PFIG (research team)
Private Finance Initiate PFIp (based on proposal) PFIG (research team) PFIG (research team)
Public Sector Comparator PSCp (estimated by research team) PSCp (research team) PSCG (research team)
Public Sector Comparator PSCp (estimated by research team) PSCG (research team) PSCG (research team)
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Flowchart of a VFM Test (Unsolicited)
Project Proposal(PFI0)
Construction of PSC(PSC0)
Phase 1
N
Feasibility analysis
Construction of PSC1, PFI1
VFM test of private proposal (VFM1PSC1-PFI10)
Phase 2
N
Y
Construction of PFI2-i,
Phases 3 4
VFM test of PFI alternative (VFM2PSC1-PFI2 0)
N
Y
PFI Alternative (PFI2)
Calculation of bonus points
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Rejection
Implementation of PPP Project
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Flowchart of a VFM Test (Unsolicited with Public
Plan)
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Flowchart of a VFM Test (Solicited Project)
Phase 1
Phase 2
Phases 3 4
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Phase 1 Feasibility Study (1)

• Assess project feasibility and necessity in the
  context of national economy and policy directions
• Cost-benefit analysis method is used to assess
  the economic feasibility of a project
• CBA is conducted in accordance with sectoral
  guidelines (e.g. roads, railroads, ports,
  seaports, dams, and environment facilities) for
  PFS (Preliminary Feasibility Study)
• B/C ratios calculated based on Estimation of
  demand, costs, and benefits
• Sensitivity analysis
• Policy analyses, if necessary, are carried out

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Phase 1 Feasibility Study (2)

• Setting a PSC (Public Sector Comparator)
• Setting an appropriate PSC option is very
  important both to feasibility and VfM of a
  project
• A basic assumption of VfM test (including FS) is
  that the same level of service will be provided
  by both PSC and PFI options
• In reality, a PSC option that is compatible with
  PFI proposal is formulated
• Total, (risk adjusted) whole-of-life cost of the
  project is estimated if government is to
  undertake the project.
• User fee and project cost of PSC are not
  necessarily same as those of PFI
• The user fee of PFI is usually larger than that
  of PSC

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Phase 1 Feasibility Study (3)

• Policy analyses are carried out if necessary
• Evaluation in qualitative/quantitative terms
  whether the project is justified in relation to
  relevant policy issues
• Relevant policy issues balanced regional
  development consistency with higher level plan
  and policy directions and environment impact
  analysis, etc.
• The overall feasibility of a project is assessed
  based on economic and policy analyses
• If the FS results demonstrate that the project is
  feasible, then VfM assessment ensues.
• If not, the VfM test process as a whole is
  suspended, and PIMAC recommends the Competent
  Authority to reject the project proposal.

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Phase 2 VFM Assessment (1)

• Government spending of the PSC is compared
  against government payment requested by PFI
  proposal to assess if PPP procurement improves
  the value of tax payers money
• Features of VfM assessment
• It assists government making decision on
  appropriate procurement options conventional
  public procurement vs. PPP procurement.
• It provides a quantitative VfM level and a
  justification for the decision on procurement
  option.
• It provides a reliable benchmark and specifies
  project scope.
• It encourages project appraiser to consider risks
  early in the project lifecycle, and address risk
  transfer options in the bidding process.
• It reduces negotiation time and increases the
  efficiency of bidding costs as the scope of
  private sector bids are more aligned with the
  public sector needs, and risk transfer profiles.

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Phase 2 VFM Assessment (2)

• Cost items adjusted for competitive neutrality
  between PSC and PFI options
• Revenue from user fee is deducted from government
  payment of PSC
• Revenue from supplementary project is taken into
  account in consideration of both options
• VAT and other tax payments are adjusted
• Same amount and payment schedule of land
  acquisition is applied to both options
• Administrative costs incurred by governments for
  project management are excluded from both options
• Insurance fee are estimated in different ways,
  reflecting the difference in market valuation of
  project risk by project owners
• Additional government support if requested by
  private company is included in both options based
  on estimated spending

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Phase 2 VFM Assessment (3)
Item Item PSC PSC PFI PFI
Capital costs Project costs Construction cost (1) Cost of survey (2) Design cost (3) Construction cost Construction cost (1) Cost of survey (2) Design cost (3) Construction cost
Capital costs Project costs Land acquisition cost (4) Compensation for land and other possessions Land acquisition cost (4) Compensation for land and other possessions
Capital costs Project costs Supplementary cost (5) Cost for feasibility study (6) Cost for transportation impact assessment (7) Cost for environmental impact assessment (8) Cost for supervision (9) Insurance costs Supplementary cost (5) Cost for feasibility study (6) Cost for transportation impact assessment (7) Cost for environmental impact assessment (8) Cost for supervision (9) Insurance costs
Capital costs Project costs (10) Cost for operation equipment (10) Cost for operation equipment (10) Cost for operation equipment (10) Cost for operation equipment
Capital costs Project costs (11) Taxes and fees (11) Taxes and fees (11) Taxes and fees (11) Taxes and fees
Capital costs Project costs (12) Business setup costs (12) Business setup costs (12) Business setup costs (12) Business setup costs
Capital costs Financing costs (13) Financing costs (13) Financing costs (13) Financing costs (13) Financing costs
operating costs operating costs (14) Operation costs (15) Maintenance costs (16) Management and supervision costs (14) Operation costs (15) Maintenance costs (16) Management and supervision costs (14) Operation costs (15) Maintenance costs (16) Management and supervision costs (14) Operation costs (15) Maintenance costs (16) Management and supervision costs
? Base cost born by the government ? Base cost born by the government (Capital costs operating costs) - operating revenue (Capital costs operating costs) - operating revenue Construction subsidy land acquisition cost additional government support Construction subsidy land acquisition cost additional government support
? Risk adjustment costs ? Risk adjustment costs Cost and time overrun Cost and time overrun
Total government payment Total government payment ? ? ? ? ? ? ? ?
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Phase 2 VFM Assessment (4)

• Present value of government payments for PSC and
  PFI options are estimated (discount rate 5.5)
  and VfM() is calculated
• GP(PSC) Capital costs operating costs
  Revenue
• GP(PFI) Construction subsidy Compensation
  costs Additional government support
• GP(PFI) is the government subsidy requested by
  the private party in the project proposal

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Phase 2 VFM Assessment (5)

• Qualitative VfM assessment
• Allocation of risks (construction, operation
  risks, etc.)
• Improvement of service qualities
• And other ripple effects (positive
  externalities) Promote the financial market
  through the adoption of an advanced financial
  technique, etc.
• Quantification of project risk transfer is not
  satisfactory and those qualitative effects are
  not incorporated into overall VfM assessment so
  far

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Phase 3 Formulation of PFI Alternatives

• Financial analysis and sensitivity analysis are
  carried out to assess the profitability
  (bankability) of a project
• Based on the VfM assessment and financial
  analyses, PFI alternatives including the
  following components, are formulated
• Total project costs
• User fee
• IRR (Internal Rate of Return)
• Total government payments
• Other components related to the implementation of
  the project
• The Competent Authority chooses the most
  appropriate PFI option and invites third parties
  to tendering
• If it is impossible to formulate a PFI
  alternative that delivers VfM at a reasonable
  level of IRR, then the PFI option is rejected

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Phase 4 Bonus Points for Initial Proponent (4)

• The VfM test team makes decision on bonus points
  (10 max) to be awarded to the initial proponents
  based on the VfM() and quality of the proposal
• The quality of a proposal is evaluated based on
  the following criteria
• ? Priority of the project in the mid- to
  long-term government investment plan (10 points)
• ? Composition of equity investors (10 points)
• ? Excellency of construction and operation plan
  (30 points)
• ? Accuracy of demand forecast (30 points)
• ? Prior consultation with relevant government
  agencies and plan of addressing of civil
  complaints (10 points)
• ? Adequacy of required documentation (10 points)

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Phase 4 Bonus Points for Initial Proponent (4)

• Bonus Point
• Swiss Challenge the original proponent has right
  to counter-match any superior offer.
• Best and Final Offer the winning bidder must
  compensate the original proponent for project
  development costs.

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Phase 4 Bonus Points for Initial Proponent (4)
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Phase 4 Bonus Points for Initial Proponent (4)
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Use of VFM Test Results

• The VfM test sets the bottom line to meet the
  condition of VfM0 in selecting preferred
  bidder and following phases of a project.
• VfM reports are used as an important reference
  when tender evaluation committee conducts their
  work.
• VfM reports provide useful information to prompt
  negotiation process.
• VfM reports are used as reference when ex-post
  VfM tests are conducted.

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