PFI: Challenging overly expensive contracts

Written by: Andrew Chubb | Published:
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As an academy trust CEO, Andrew Chubb successfully challenged aspects of his school’s PFI contract, leading to substantial savings. He looks here at why PFI often proves unfairly expensive for schools – and what can be done about it


PFI, or the Private Finance Initiative, was originally introduced in 1992 as a way of financing the much-needed regeneration of a tired public building estate. The scheme was accelerated from 1997 onwards, and was used to build many schools, hospitals, prisons and other public infrastructure buildings and facilities.

Under the terms of a PFI contract, a group of investors (funders) forms part of a so-called Special Purpose Vehicle (SPV) to fund the building, typically along with a main contractor (builder) and FM (facilities management) contractor.

Generally, at handover, the builder is paid, leaving the FM provider and SPV in place – the former to run the building and the latter to recoup their investment and make a profit through charging the owner an annual fee over an agreed period – typically 25 to 30 years (very much like a mortgage).

The scheme was popular with governments as it enabled them to demonstrate that they were investing heavily in public services, but without the cost. It was equally popular with investors, many of whom have been able to make extraordinary levels of profit out of the annual unitary charges.

PFI has been heavily criticised over the years, including by the National Audit Office (2018), for being an inefficient way of procuring these buildings. There have now been countless press articles detailing how the annual charges are strangling the provision of the very services the new buildings were designed to support.

There are strong economic and moral imperatives for organisations operating within a PFI building to challenge poor performance and the contractual financial imbalance. While PFI operators have a history of giving the impression that challenge is virtually impossible, the reverse is in fact true.


The basics

Like any successful model, over time, variations develop. What is described below is PFI in its most common form. However, many of the principles outlined apply to other privately funded contracts (such as “Design and Build”, or PFI-funded extensions of an existing estate).

A PFI contract is akin to a mortgage. To repay the debt, the local authority uses a combination of its government-issued “credits” and several other charges:

  1. Hard Facilities Management (Hard FM), which pays for all planned and preventative maintenance (PPM).
  2. A “Lifecycle” charge, linked to the above, which factors in the cost of replacement items in the building over the period of the contract.
  3. Soft Facilities Management (Soft FM), which covers typical caretaking, catering, cleaning and grounds maintenance.
  4. Insurance Reconciliation.
  5. A fee to the company that manages all of the above.

The first three of these are incurred by schools through “back-to-back” contracts with the local authority.

However, as described below, schools can often end up paying for charges four and five through the back door.

At first sight, all five charges seem reasonable – buildings need maintaining in order to be safe, warm and dry places in which to work. However, as described below, the underlying assumptions at the outset of the contract often lead to disproportionately high costs being charged to the end-user. To understand this fully, it is important to grasp the roles of all the people involved, and their respective responsibilities and accountabilities.


The players

Essentially, there are four main groups responsible for the building’s operation post-completion:

  1. The SPV – the limited company set up to manage the PFI contract. They source the investors who put up the capital for the project. They are in contract with the builder, FM provider and invariably the local authority. Post-build, the SPV and FM provider aim to maximise profits for shareholders during the operational phase of the contract.
  2. The Management Services Company: This organisation is procured by the SPV to ensure that services are delivered efficiently for the SPV.
  3. The local authority: They typically contract directly with the SPV for the delivery of the project on behalf of its “end-users” – in this case, schools and academies.
  4. Schools and academies, who contract with the local authority “back-to-back” for the delivery of services that run their school estate.


Profit for investors

The cost of PFI schemes are typically 40 per cent more expensive than traditionally procured public building schemes (Syal, 2018). Let’s look at the elements that make up the charges levied on schools and how they can often work in practice.

Hard FM: The SPV has an interest in ensuring that as few deductions as possible are made for poor performance, so when setting the charge for Hard FM, generous levels of maintenance staffing are assumed in the model. This can mean that the cost to the local authority and therefore the end-user – schools – is greater than is needed for this service.

Lifecycle replacement: The assumed costs for lifecycle replacement are “flatlined” across the life of the building and the cost of the contract. For example, if the total lifecycle costs were worked out at £25m over 25 years, then the lifecycle charge would be £1m per year. However, it is obvious that in the early years of the building, little replacement is necessary. This means that the SPV has the local authority’s money in the bank as a lifecycle underspend when there is no justification. It could also be seen that the SPV has an interest in ensuring that as little is spent on lifecycle replacement as possible. This is especially true in the early years of the contract, as this can enable the SPV to “sell on” the lifecycle contract to another provider at a huge profit.

The lifecycle replacement fund links closely to the Hard FM charge – the better the maintenance, the less likely the need for replacement – which again supports the levying of a higher Hard FM charge on the contracts and therefore, by definition, the schools.

Soft FM: As for Hard FM, despite the fact that a level of risk of deductions is included in the charge, the SPV has an interest in ensuring that there are no deductions for poor caretaking, cleaning, catering or grounds maintenance services. Again, there is an interest in over-providing for these services, at an increased cost to schools. To make matters worse, after an initial period of “bedding in”, the contractors have a vested interest in reducing the number of staff to deliver the contract, in a bid to maximise profits.


Potential PFI charging abuses

The line between “making a profit” and “profiteering” can perhaps be a fine one. In the previous section, we looked at some of the ways profits are achieved. In this section, we look at how the contract can be manipulated.

Cost of original equipment and its replacement: A common underlying assumption of all PFI schemes is that the SPV, through its FM provider, should have a considerable mark-up on its services. In my experience, this is usually at least 10 per cent. On this basis, the more expensive the equipment, the greater the profit available to the SPV. It is therefore perhaps no surprise that in one PFI scheme we have heard about, it was proposed that the basic cost of a chair deemed “fit-for-purpose” was around £190. In a school of 1,000 pupils, that would equate to a profit of £20,000 on chairs alone.

Charges for upgrading the building: This can include something as simple as replacing a plug-socket or installing a new one. As the charge for this assumes an impact on the lifecycle of the building, use of contractors and of course the 10 per cent mark-up, these too can be astronomical – in one case, a school was charged around £300 for installing a new plug socket.

Charges for keeping the school open after hours: A big design feature of most PFI schools is the ability for it to “serve the community”. However, the charge for this does not just include the cost of a caretaker opening and closing the facility, but also assumptions based on the amount of wear and tear that will be made on the building, and the implications of this for lifecycle replacement. All of this could mean that opening costs are several times more expensive than would be imagined. The situation is exacerbated in that the unitary charge to the authority and the schools includes these costs, whether or not the school is actually open for that particular period of time – meaning that these already excessive charges could be made for a service that is actually never fully used, or indeed not used at all.

Compulsory five-year re-benchmarking of Soft FM costs: PFI schemes often include a mandatory requirement for the FM provider to benchmark their Soft FM costs every five years. However, this exercise is carried out by the management company, who ultimately work in the financial interests of the SPV, not the end-user. As such, it should be no surprise that after these reviews, costs always rise. This cost increase can and should be challenged as in most cases the local authority simply passports the increases down to the schools via the “back-to-back” agreement.

Insurance Reconciliation: Many of the insurances under PFI are arranged by the SPV who pass these costs on via the unitary charge. Because constructing a building is the riskiest part of the operation, these insurance costs are highest at the start of the operation. However, on-going insurance costs are often set at this increased level and fixed for the duration of the contract, indexed at the rate of inflation at the time of the contract start.

As this arrangement was patently unfair, for many PFI contracts the principle of “Insurance Gain Share” was introduced, whereby the SPV takes the insurance to a broker who is asked to obtain competitive quotes for the premiums. The expectation is that these costs would reduce over time, with savings passed on to the end-user. However, the Gain Share mechanism benefits both the SPV and the authority as the savings are shared. This has added up to tens of thousands of pounds not being available to individual PFI schools each year.

The role of the SPV’s management company: As stated above, the role of the management company is to ensure the efficient delivery of services by the SPV to the end-user. The cost of this company also forms part of the “unitary charge” to the end-user – schools. However, the targets of the management company from the employer’s (the SPV) point of view are:

  • To minimise the impact of the contract on the SPV.
  • To minimise deductions against performance.
  • To minimise lifecycle replacement expenditure.
  • To optimise profits.

From this it can be seen that in order to achieve bonuses, the management company actually has to act in the interests of the SPV, rather than the local authorities and the schools.


Between a rock and a hard place

It is important to note that in many cases the local authority finds itself caught between the demands of the SPV, central government and those of the schools. Let me give two examples…

First, local authorities are given the money to fund PFI in the form of central government “credits”.

However, these are often not sufficient to pay for the unitary charge, not least as this often rises throughout the duration of the contract. The authority can thus be obliged to “raid” the total pot of money provided for all schools in its area – including those who have not benefited from PFI. In these cases, non-PFI schools end up having to contribute to the unitary charge, a fact of which they may well be unaware.

Second, while many authorities realise they had little choice other than to accept the PFI contracts, they are at the same time responsible to central government for ensuring that their PFI estate is managed in accordance with government expectations. Given the fact that the contracts are complex, and that local authorities are often under-resourced to deal with issues of this level of complexity, tackling unjust PFI contracts can, sadly, be perceived as simply too difficult a task to undertake.


A CEO’s headache

As CEO of the Sentamu Academy Learning Trust, we laboured for many years under the excessive costs of the “Hard FM” and “Lifecycle Replacement” contracts for Archbishop Sentamu Academy, a large 11 to 18 academy of 1,500 pupils built in 2011 under the Building Schools for the Future (BSF) programme.

Although we had managed to dodge the bullets of being tied into equally punitive “Soft FM” and catering contracts, we nonetheless were facing serious financial hardship as a trust from the two contracts we had in place. Indeed, at one point, these risked bankrupting us in the medium term.

While we had been delighted with the building itself, as principal of the academy at the time I was never happy with either the quality of the service from the management services company, nor with the inordinately complicated process in managing the Hard FM and Lifecycle contracts, which involved endless “Groundhog Day” meetings with a succession of people who were unable to address our concerns adequately.

At one point, I became so frustrated with the whole process that I simply stopped paying the bills. This achieved nothing however, other than a somewhat humiliating climbdown. Undeterred, I persisted in trying to find a way to renegotiate the contracts. By 2018 our finances were in a critical position, but at that point, our local authority was good enough to put me in touch with CPP.

CPP specialises in challenging unfair contract charges in the PFI sector. After an initial meeting, we drew up a “battle plan” for challenging the terms of our contracts. This involved carrying out detailed condition surveys of our academy, along with a “bottom-up” benchmarking exercise to compare the maintenance costs we were being charged per square metre with those charged to other institutions.

We also carried out a full analysis of lifecycle replacement needs based on funds already “in the pot” to pay for these and other contingencies. This established that the academy was paying considerably more than it needed in order to ensure the building remained in a good state over the life of the contract.
It was painstaking, detailed work, but at the end of it, we were able to terminate and renegotiate our contracts, demonstrating that we could quite legitimately reduce our payments without jeopardising either the maintenance or long-term condition of the building.

Armed with this high-quality piece of analysis, we put both our contracts out for retender, and ended up successfully recontracting with the same provider for a significantly lower sum. The local authority officer responsible for managing this work was happy to authorise the PFI contract variation, and as a consequence, we saved a six-figure sum every year for the life of the contract – in our case, another 17 years.


Project PFI

While the process of renegotiating the contracts had certainly been a challenge, I became very interested in this area. I just could not believe the apparent level of, in my opinion, excessive profits being made by the management services companies at the expense of schools and pupils.

With this in mind, I approached CPP and suggested that we establish a venture to tackle this issue more widely and effectively. We formed ProjectPFI as a vehicle to expose the issues and offer practical solutions delivered through the CPP operational model, the aim being to make more money available to schools for core services. To this end, we have three priorities.

  1. To raise awareness of the injustices of PFI.
  2. To support CEOs, principals and directors of academy trusts in tackling unfair PFI contracts (via renegotiation or cancellation).
  3. To lobby local authorities and government to tackle PFI more effectively.


Typical savings

From our experience, we have found that typical savings can be made by using specific clauses of the PFI contract to:

  • Take out-of-hours use costs out of the unitary charge.
  • Reduce and/or remove Soft FM services (caretaking, cleaning, catering, grounds maintenance, pest control).
  • Challenge the mandatory five-year benchmarking and market testing review of Soft FM charges.
  • Challenge and reduce the cost of equipment replacement, thereby reducing lifecycle costs.
  • Challenge the effectiveness and efficiency of the Hard FM provider.
  • Review energy and insurance reconciliations.
  • Challenge the lifecycle spend profile.
  • Conclude defects and historical issues.


Conclusion

PFI as a system enables the contracting parties to design expensive buildings, which are expensive to maintain and run, with expensive insurance policies in place, with little or no say for schools in reducing these costs. A further injustice is that schools can be given the impression by the SPV and its partners that there is nothing they can do to rectify the issues. This view is often reinforced by local authority officers, who lack the detailed understanding and/or the resources to challenge contracts.

It is quite understandable that leaders end up putting “sorting out PFI contracts” on the “too difficult” pile. But my experience has shown that by working in partnership it is perfectly possible for very large savings to be made.



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