20 January 2006
The Treasury will make a fresh attempt to take the controversy out of the Private Finance Initiative next month, when it makes a deeply technical but potentially significant change to the terms of the standard PFI contract.
The shake-up will alter the rules governing the insurance of PFI projects with the intention, at least, of stopping public bodies from picking up the tab.
The cost of insurance began to spiral in the aftermath of the September 11, 2001 attacks in the US. Asbestos claims and a series of natural disasters, such as the devastating floods that wreaked havoc across Europe the following summer, added to the bill.
As premiums have continued to rise, private contractors have passed the costs on to the public sector.
They have been able to do this as insurance is typically dealt with during the final phase of negotiations with the preferred bidder. Public bodies are then in a weak bargaining position – in essence, they either have to agree to the price demanded or risk the contractor walking out on the deal.
Partnerships UK, the Treasury agency that advises public sector bodies on public-private partnerships, was so concerned that it decided to tackle the problem.
Its concerns related to the impact of insurance costs on the value for money of PFI projects – the principal justification, after all, for going down that route – and the delays to signing off deals caused by the resulting wrangling.
Nick Forster, assistant director at PUK, told Public Finance: 'In 2004/05, insurance was the single biggest issue delaying the sign-off of deals. Last March there were 20 deals all trying to close and all had insurance as the principal outstanding commercial issue.'
PUK has found instances where the insurance costs to the public body have been double the market rate. Overall project costs, meanwhile, have been inflated by as much as 7%. Findings such as these prompted PUK to act.
'We were concerned that deals, in insurance terms, were not delivering the value for money we would wish,' Forster explained. 'But I think to a large extent we've nipped this issue in the bud.'
PUK's solution is to rewrite the insurance provisions in the Standardisation of PFI Projects Version 3, the Treasury's standard contract terms that all public sector bodies must adhere to when negotiating deals.
The new guidance will apply to all UK PFI deals that have not reached preferred bidder stage by February 1. It makes insurance the responsibility of the private sector contractors, who will have to include a robust assessment of the cost in their initial bid.
If the actual cost proves higher than the projection, the contractor will have to absorb the first 30% of the excess. Any further excess is split between the public body and the private firm on an 85:15 ratio.
There will also be a 'symmetrical arrangement' using the same proportions, so that if insurance costs fall below the projection by more than 30%, the resulting savings will also be shared.
In addition, the guidance stipulates that insurance costs must be agreed during the tendering process.
'Looking ahead, we want the insurance issue settled before the preferred bidder stage. We want it dealt with when there is still competition,' Forster explains. This will help public bodies to avoid 'finding themselves somewhat over a barrel'.
At the same time, a biennial review of insurance costs will have to be conducted for each project and the data, which will be made publicly available, submitted to the Treasury.
At the moment it is unclear where that information will be held, but since PUK already has a publicly accessible PFI projects database on its website, this seems the obvious contender.
'The collating of information for projects across the PFI market will assist in verifying assumptions in the insurance report submitted to the authority,' Forster said. 'That will create greater transparency.'
That's a development that even critics of the PFI are sure to welcome.
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