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An analysis on behalf of People vs PFI by Martin Gaskin and Helen Mercer

Two complementary reports were released last week that draw significant and damning conclusions about the Private Finance Initiative (PFI or PPP) funding of public infrastructure capital projects. The reports are all the more significant in that they were produced independently of each other and are directly concerned with the risks and financial rewards related to PFI.

The first is the ‘Report of the Independent Inquiry into the Construction of Edinburgh Schools’ chaired by construction expert, Professor John Cole CBE, which investigated the causes and implications of the collapse of part of an external wall at Oxgangs Primary School Edinburgh and the discovery of similar defects in the construction of the external walls of 16 other schools in Edinburgh, resulting in the enforced closure of all 17 schools.

The second is a report by the respected independent researcher, Dexter Whitfield from the European Services Strategy Unit (ESSU), entitled ‘PFI/PPP Buyouts, Bailouts, Terminations and Major Problem Contracts in UK’. The report identifies the scale and public cost of all PFI/PPP contracts subject to buyout, termination or major problems, and explains the causes and fundamental flaws in the PFI/PPP model.

Overview of the Edinburgh report

The Edinburgh Schools report relates to a specific incident and a single PFI contract but draws far wider conclusions and implications. These relate to:

  • the transfer of risk (which is a key theoretical driver for the implementation of the PFI programme across the UK);
  • the additional risks that PFI contracts carry compared to previous public methods of financing;
  • the scrutiny of build and project quality in those projects;
  • the costs of remedying defects;
  • the responsibilities (and their fulfilment) of public government bodies who are responsible for the services being provided under PFI;
  • and the rights of the ultimate users and funders of the services so provided – the ordinary people who pay their taxes and pay for and use the services.

In addition, the report shows clearly, if not directly, how PFI has actually led to a reduction in competition among public infrastructure providers, despite being politically justified as necessary for the opening up of market competition.

Responsibility for the “failures of the quality assurance process” is laid squarely on “the various contractors and sub-contractors, who built or oversaw the building of the PPP1 schools”. However, the report also suggests that the public sector was under-resourced vis-à-vis the PFI companies and far too dependent on their own self-certification practices:

“it was insufficient for public sector clients [Edinburgh] to so largely rely on the quality assurance processes of contractors… The Council itself…failed to appreciate the demands of the PPP process…and had under-resourced the team that represented the Council”.

However, the report is, understandably, relatively sympathetic to Edinburgh Council’s position. The inference in the report, following that over-used and inadequate mantra, is that there was no alternative to the use of the PFI funding and scheme if Edinburgh were ever to fulfil its responsibilities in relation to the provision of public services:

“Under the terms of the competition for financial support from the Scottish Executive for PFI schools, no funding for the [Public Sector Comparator] was available”.

In other words, a scheme based on a philosophy of cost and risk reduction through opening up competition in fact ensured the opposite – no competition, choice or alternatives.

In relation to risk and cost, the report argues that while the primary cause of the collapse of the wall at Oxgangs school was poor quality construction, “the way in which the PPP methodology was implemented on these projects did increase the risk of poor quality design and construction.” It further states that “the approach adopted on the Edinburgh scheme was quite typical of that adopted generally at the time”.

However, the report pulls short of criticising or blaming the PFI financial model per se for the construction and risk transfer failures it found:

“the method of the method of financing the project, per se, did not negatively influence the quality of construction in the Edinburgh schools. There is no reason why properly managed privately financed public sector buildings should not be capable of delivering buildings constructed to a very high standard, if best practice approaches to ensuring the quality of design and construction are properly incorporated”.

Were the construction problems due to the PFI model itself?

We could find no evidence in the rest of the Edinburgh Schools report to support the assertion above. But we did find several statements which contradict it.

Firstly, the report outlines how the PFI contract was preferred over a so-called ‘public sector comparator’ (PSC) and demonstrates that the PSC only became greater than the PFI costings once a total of £13.424m to cover ‘construction risk’ was added. No figures are given in the report for the cost to the contractors of the remedial work carried out following the discovery of the defects, so we have no sure way of establishing whether the cost of the remedial work paid for by the contractor reflects the level of imputed risk applied at the stage of awarding the contract. However, the annual accounts of Edinburgh Schools Partnership Ltd (ESP) – the company which signed the PFI contract with Edinburgh City Council – show that the repairs paid for up to December 2016 came to at least £2.8m. In addition, ESP received a £5.5m cash injection to cover ‘the immediate costs of the Company and to provide it with sufficient cash to continue to meet all of its liabilities in the foreseeable future’ (1).

We could also find no evidence for the report’s assertion that since remedial works have been carried out at the cost of ESP, this “demonstrates the application of risk transfer to the Private Sector”. To make such a claim suggests a PFI-friendly reading of what risk is and how it should be estimated. The official estimation of risk when comparing public with private finance in this PFI scheme – and indeed in the general process for tendering PFI contracts – is expressed as a monetary figure: the risk is monetised. Yet public authorities have a statutory duty to their users and one of these, especially when it comes to schoolchildren, must be to ensure absolutely and as far as practically possible both their safety and their ability to access the services provided. Hence the risk to public authorities of failures is not one to which a monetary figure is easily applied.

In the case of Edinburgh schools, it is clear that the PFI scheme did nothing to protect children from the risk of major, traumatic injury from tonnes of falling masonry and in fact the scheme actually increased that risk (through “poor quality design and construction”). It is not even clear in the report that all costs, including consequential losses and costs, of remedying the defects have been met by ESP. 17 schools were closed with over 8,000 pupils relocated. Primary school pupils lost an average of 71 minutes daily teaching time during the disruption. Who is picking up the cost of this? And who will compensate the pupils for the lost education time (given that if it were deemed to be the ‘fault’ of parents for missing school, it could result in criminal prosecution)? The report not only minimises the educational loss, but makes no reference to any additional financial costs the Council incurred to provide some continuity of education.

Far from indicating the efficacy of PFI risk transfer as the Edinburgh Schools report states, ESP paying for the building repairs forms only part of the many risks that have been experienced in this matter – the total costs paid and expected, including the cost to children, parents and the country of lost school time, are explicitly NOT allowed for in Value for Money assessments in the PFI model.

Secondly, the report comments on the fact that the PFI project relied on self-regulation:

‘Edinburgh Council, in common with probably a significant majority of public sector clients undertaking PPP projects, did not appoint Clerks of Works to provide inspection services on the PPP1 schools’ (3.4.9).

This full-scale delegation of responsibility for building inspection included the failure to receive completion certificates before the buildings were occupied, a flagrant breach of Scottish legislation. Self-regulation in fact meant that construction defects were not reported both at the time and after they were discovered:

“it is the view of the Inquiry that the defective fire-stopping could have been identified earlier and that, prior to the recent actions of ESP and Amey, there had been a failure to identify, report and remedy the breaches in fire-stopping from which ever date they were first caused.” (11.1.16)

Yet this failure is intrinsic to the PFI model, as self-monitoring and self-certification by the chain of contractors is the default position. We have seen in PFI contract after PFI contract the same problem – the public authority relies on the word of the PFI contractor that the output specification has been met. Such self-regulation by companies whose sole purpose is to make profit, not only for the building contractors but also for the financiers, means there is little incentive to report defects and hence face potential fines or temporary suspicion of the payments by the public authorities. A whistleblower who used to work for Balfour Beatty on its Birmingham hospital commented:

“One thing that has to be kept in mind is that these are self-monitoring contracts… The private finance initiative has to report its own deficiencies to the NHS on a monthly basis and where things are deficient a deduction in the payments are made. The problem with that is that there is a bit of a disincentive for a PFI company to always be completely transparent. If they tell the whole truth it’s going to cost them a lot of money.”(2)

Thirdly, the report provides evidence of the difficulties of rectifying defects as a result of contractual conditions:

“the timely making available of all relevant information to the Council was less than ideal. This was particularly true in relation to the lack of clarity provided to the Council by ESP as to the detailed proposals that Galliford Try were adopting in their approach to the remedial work” (12.3.5).

ESP’s agents initially focussed more on “legal and financial matters and was less clear as to how to address the practical issues arising from the defective construction”. The report concludes that at the remedial stage “the nature of the PPP contract structures seemed to act to inhibit the Council in its desire to undertake due diligence in seeking appropriate assurance as to the safety of the schools” (12.3.16)

Therefore there is ample evidence provided in the report that the very nature of the PFI contract mode itself meant that the contractors did not accept risk in the way the construction was supervised, affected the way defects were reports at the operational stage and the pace and method of remedying defects.

While focused on the specifics of PPP in schools in Edinburgh and wall building defects, the report referred repeatedly to wider and deeper risks of PFI build contracts. It refers to “widespread knowledge within the PFI industry that defective fire-stopping had been discovered to be a problematic issue in PPP schools and hospitals”. In addition it states that “it would be naïve to assume that the lack of quality control evidenced… is limited either to Edinburgh or to school buildings”.

Wider implications – new findings by the European Services Strategy Unit (ESSU)

Those wider implications – albeit actually related to financial cost and risk – are echoed in the ESSU’s latest report on the failures and costs of PFI/PPP schemes in the UK. The ESSU’s reports show that the problems experienced in Edinburgh – that financial and other risks have not been passed on successfully under PFI (in fact costs have potentially been increased) – are in fact widespread in terms of geography and sector across the UK.

The report finds that of over 800 PFI projects signed across all four countries of the UK, 28% by capital value have been subject to buyout (by public/government bodies), termination or major problems. Health, education and housing – areas of greatest concern to ordinary people – represented a huge proportion of those problem areas. The estimated cost of buyout, bailout, termination and these major problems (including a £1.5bn bailout fund to NHS Trusts that appears woefully insufficient), amounts so far to a huge £27.9bn. In order to give an idea of the scale of the cost, that £27.9bn could have funded instead 1,520 secondary schools for nearly 2m pupils: education issues across the UK could have been eliminated. The UK’s cost of failure ratio of buyout and terminated contracts (6.8% of the cost of investment of all contracts) is “higher than the 5.4% average of World Bank projects in developing countries”.

The ESSU report very clearly enumerates the flaws in the PFI/PPP model that lead to these failures and costs. Many of those flaws are clearly reflected in the Cole report:

  • “Risk transfer is costly and exaggerated”
  • “Affordability – high costs squeeze provision of core services”
  • “Lower cost of public investment option ignored”
  • “Construction performance”
  • “Erosion of democratic accountability and transparency”
  • “Contracts are poorly monitored and rarely reviewed”

The report also echoes much of the Edinburgh Schools report in its recommendations albeit across all PFI/PPP contracts. These include:

  • A detailed review of all PFI/PPP contracts by public bodies to ensure that original contracts services are in fact achieving all they were supposed to;
  • the return of PFI/PPP projects and services and their management to public ownership;
  • a strategic and deliberate approach to the buyout or termination of failing contracts together with the return of those services to public ownership and management;
  • and the termination of the whole PFI/PPP programme to be replaced by an increased public investment which would actually reduce the cost of public infrastructure.

We know already that many of the problems identified in the Cole report are present in other PFI buildings especially, and most worryingly, in hospitals. Nearly 120 hospitals have been built, rebuilt or refurbished using the PFI model, and there is increasing evidence of poor construction especially relating to fire safety issues. People vs PFI is aware to date of several instances of such problems at PFI-built hospitals including:

  • Peterborough
  • Cumberland Infirmary
  • Central Manchester University Hospital
  • Hereford Hospital
  • Coventry University Hospital
  • Royal Derby
  • Walsall Manor
  • King’s Mill, Mansfield
  • Queen Elizabeth Hospital, Birmingham

The Oxgangs disaster, the known replication of these problems elsewhere in the PFI build and the wider £27.9bn of wasted cost demands that we (public and Government) take effective action immediately.

People vs PFI says

PFI is unaffordable. The Edinburgh schools PFI (PPP1) cost £104m more than it would have, had Edinburgh Council used public finance.(3)

PFI lines the pockets of investment funds and others. The total payments due on the Edinburgh PPP1 is £531m on a project whose capital value was £129m. A total of £19.1m profit was made between 2001 and 2016 on ordinary activities, of which £6.7m was distributed as dividends to the owners of ESP: (recently £5.5m was effectively reinjected to cover projected future costs arising from the recent events). In addition, those owners receive a regular profit stream as interest payments on a £10m loan they provided their own company at a rate of 13.07% per year. As noted in the press and elsewhere, the ownership of the contract changes and is opaque, with the owning companies registered in tax havens.

We can’t afford to let each local authority or health trust, each school, each hospital executive, all teaching staff, and every pupil and parent group cope with the financial and safety costs of their particular PFI/PPP scheme(s). These schemes are financially crippling local authorities already bearing the brunt of austerity and, as the Edinburgh Schools report states, it is only a matter of luck and timing that the fabric of these buildings didn’t cripple or kill the primary children who are dropped off at the school gates by parents assuming that it is a place of safety.

The problems identified in these two reports are systemic to PPP / PFI. PFI is costing huge amounts of money to live with and to fix. The problem is not going to go away without a UK-wide response.  We support the recommendations in the ESSU report.

We support the call by Unite to ‘scrap’ the private finance model.

Following the damning evidence of systemic failures in the Edinburgh Schools Report there should be a national safety audit carried out on all PPP/PFI buildings, starting with schools and hospitals.

As the Edinburgh Schools Report states: “In seeking to transfer as much risk as possible away from themselves in relation to the design and construction of facilities, public bodies should understand that they cannot delegate to others the duty that they ultimately owe to the public to ensure the provision of a safe environment for the delivery of services.”

 


Notes
  1. The Edinburgh Schools Partnership Ltd, ‘Annual Report and Financial Statements’ 31 March 2016.
  2. BBC The Price of PFI transcript 5th July 2016 transcript of ‘File on Four’ broadcast. http://news.bbc.co.uk/1/shared/bsp/hi/pdfs/05_07_16_fo4_thepriceofpfi.pdf
  3. http://www.edinburghnews.scotsman.com/news/business/flawed-schools-cost-capital-100m-too-much-says-pfi-expert-1-4102451