PFI: Risk and Reward

Another micro-blog, this time on PFI, and a not very hot take on Carillion and Capita.

I was going to avoid talking about the collapse of Carillion.  I get a bit frustrated talking about PFI because lots of people strongly dislike it without knowing much about it, which makes for a less than fun debate.   The same is true of Government outsourcing, which isn’t the same as PFI, but tends to get bundled together with it because lots of PFI schemes involve the outsourcing of some or all facilities management services as part of the PFI deal.

I’m not as hostile towards PFI as some people, partly because I worked on a couple of Hospital PFI schemes.   It’s not a bad capital sourcing route when the Treasury cost of capital is very high, but when the interest rates the Government can borrow at are as low as they are right now there is no point in PFI at all.

I do however have a big problem with off balance sheet accounting, which is a technique associated (but not the same as) PFI where Governments hide the amount of debt they have run up.  The reason why PFI and other off balance sheet wheezes continue to be popular with Labour and Tories is because Politicians don’t want to be honest about the amount of debt they want to incur.

I don’t have a problem with outsourcing either – I just believe that there are some bits of the public sector like basic administrative tasks which work well on an outsourced model, and lots of bits of the public sector which should never be outsourced; including all of Criminal Justice.  I also think that there are lots of parts of the public sector where the costs of administering outsourcing are so high they outweigh any advantages outsourcing might have – the NHS for example.

One of the main factors with PFI and any kind of outsourcing is the extent to which the Government or the NHS transfers risk to the Private Sector.   There a lots of good reasons why the State would outsource work or sign a PFI deal – they need short term but not long term capacity, or they want specialist skills in building or managing a project.  Whatever the reason for the PFI project or the outsourcing decision the contractual arrangements should always show a transference of risk.  The private sector takes on work because it wants profit, and any profit/reward should reflect the degree of risk the contractor takes on.

While I was sad that Carillion collapsed this is essentially the consequence of PFI working properly.  It’s not meant to be risk free.  The problems with Carillion aren’t a sign that PFI has failed. The show that it is working.  Carillion either got greedy, or it failed to appreciate the degree of risk it was taking on over the 400+ Public Sector contracts they took on.

This is a graph showing Carillion’s income from PFI contracts when they went bankrupt:

Screen Shot 2018-03-05 at 14.15.48

This is a graph which shows total PFI payments past and present across the whole industry:

Screen Shot 2018-03-05 at 14.16.10

The 2 graphs aren’t exactly the same shape, but the similarity is striking.  Carillion was pretty typical slice of the PFI market.

All this really tells us is the size of the reward. The question is – did Carillion simply have more risk than other companies?  Was it just badly run?  Or is there more systemic risk in the PFI market than we thought?

I changed my mind about writing about Carillion because I saw the headlines on Capita.   They issued another profit warning this week, disclosing a £513.1m pre-tax loss due to £850.7m of “specific non-underlying items” which dragged on its performance.  This compares with an £89.8m loss in 2016.    Capita have over 1000 public sector contracts and their collapse would be much messier.

I visited some of Capita’s outsourcing sites a few years ago when I was assessing potential outsourcing partners for the DWP Quango I was working for.   They have lots of high profile, mission critical, outsourcing work, including the Congestion Charge, Teachers Pensions, TV Licensing and lots of NHS back office work.  Some of their work in criminal justice is scary stuff – offender tagging, and 999 systems.    Notably they haven’t been awarded any new Government contracts this year, which suggests that there is a growing reluctance to give them work.   Knowing a bit about the rigid thinking of public sector procurement teams there must be something very scary in the financials to put them off.

The shape of the 2 graphs above and the scary state of Capita suggests that Carillion’s problems might actually be systemic across the industry, rather than just the result of poor risk management.

When Carilion went under there was an obvious solution to their problems.  HMG could have borrowed cheaply, bought out the PFI contracts from Carillion.  This would have given the remaining private sector division of Carlillion enough capital to keep it afloat, while cutting the long costs (because the PFI contracts would effectively had been refinanced more cheaply).  A clever person would have taken over all of Carillions PFI division and used it as a state owned infrastructure company which could have taken over other expensive or problematical PFI or outsourcing contracts from other contractors.

But that would have been ideologically impossible to either Political Party.

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