One way to save billions

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As the Guardian reported at the beginning of this month:

As much as £2.4bn could be saved if the NHS bought out the private finance contracts signed by the government to build new hospitals, an economic study has claimed.

Labour's enthusiasm for public finance initiatives (PFIs) has wasted national reserves and enriched private investors, the report by a University of East Anglia academic alleges.

Dr Chris Edwards's investigation focuses on one of the earliest PFI contracts agreed, for the 987-bed Norfolk and Norwich University hospital (NNUH).

The refinancing of the NNUH contract has already been the subject of a critical report by the public accounts committee, which commented on "the unacceptable face of capitalism in the consortium's dealings with the public sector".

Edwards calculates a new figure of how much could be saved — £217m, he says — if the Norwich hospital contract were bought out from the private company that originally financed the deal.

I’ve spoken to the report's author and he sent me additional information, as follows. I think it worth sharing in full because this is a shambles where money could be saved despite the depth of the hole we’re already in:

1. What is the report and what is PFI? The report analyses the Private Finance Initiative (PFI) in the hospital sector in the UK, with particular reference to the Norfolk and Norwich University Hospital (NNUH), one of the earliest and biggest PFI hospitals. Hospitals built under PFI contracts are financed by private companies which then rent them back to the National Health Service over long periods (generally more than 30 years).

2. Who is the author? Chris Edwards who is a Senior Fellow at the University of East Anglia. The 108-page report is available today (Monday 1 June 2009) on the website of the University of East Anglia (just google “Chris Edwards UEA”). In addition, A4-size, plastic-comb-bound copies can also be bought at £10 a copy. If you want to send me comments on the report, please email me at The research has been carried out and completely financed by Chris Edwards over the past five years. The research has been difficult because of the lack of transparency of public expenditure and in spite of the Freedom of Information Act.

3. What is the NNUH? The Norfolk and Norwich University Hospital is an acute general hospital with 987 beds, 18% fewer beds than the two hospitals that it replaced. The Outline Business Case for the NNUH was approved in January 1995, the Full Business Case was approved in March 1996, a financial contract was signed with Octagon Healthcare in January 1998 and PFI payments from the NNUH Trust to Octagon started in August 2001. In December 2003 the NNUH project was refinanced through lower interest rate debt by Octagon Healthcare and the break point of the contract then became 2037 instead of 2032.

The refinancing deal was a poor one for the NNUH. In a 2006 report, the Public Accounts Committee stated that; “This refinancing produced a balance of risks and rewards between the public and private sectors which, even for an early PFI deal, is unacceptable” and in its summary, it said; “we would not expect to see another Accounting Officer appearing before this Committee defending what we believe to be the unacceptable face of capitalism in the consortium’s dealings with the public sector”.

4. How important are PFI hospitals? Between May 1997 and November 2008, £6.1 bn was spent on building hospitals in England. Over two-thirds of these are PFI hospitals. Many more PFI hospitals are under construction.

5. Why was the Labour Government so keen on PFI after opposing it before 1997? Because the investment would not appear as public sector debt. On coming to power in 1997, the Labour Government adopted a fiscal rule that public debt-to-GNP should be kept below 40% and financing public sector investment through PFI was seen as a way of achieving this objective — at least in the short run. As of June 2008, payments over the next 30 years on all PFI schemes (not just health) were estimated as £181 billion.

6. Has PFI been a waste on money? Yes, and inevitably so because the private cost of capital (at 10% a year) is more than double that of the public sector (4.3% a year). In the report, I slot these figures into a financial model of a general hospital (prepared by Andersen Consulting for the Treasury in 2000) and this shows that the cost of a privately-financed hospital will be 60% more than that of a publicly-financed one.

7. Why don’t the value for money (VFM) comparisons between the private and public versions show this? Because the figures have been fiddled. As Jeremy Colman (as assistant auditor-general) has pointed out; “if the answer comes out wrong, you don’t get your project. So the answer doesn’t come out wrong very often” (quoted in the Guardian of April 7, 2009). This manipulation has been carried out mainly by adding on cost overruns to the publicly-financed versions which are very much higher than the average overruns (of no more than 13%) actually experienced. Invariably the cost overrun assumed for the publicly-financed version has been just high enough to tip the VFM assessment in favour of the PFI project.

In the late 1990s, Norfolk and Norwich hospital officials were told that they could have a new PFI hospital or nothing. As a result the Full Business Case for the proposed PFI hospital was rigged. Not only was the cost overrun for the publicly-financed hospital much higher than 13% but — at 34.22% - it was also astonishingly precise. As the Chair of the Select Committee on Health stated in 1999 when referring to the NNUH; “ ‚Ķ in other words, the full business case does not tell us the full business case”.

8. What does the before-and-after analysis show? At the NNUH, over the six years before 2001 (the year the first PFI payments were made to Octagon), operating costs rose much more slowly than in the six full years after PFI. In the post-PFI period, annual costs rose by about £170 mn. from £155 mn in 2000/01 to £323 mn in 2007/08.

Has all of this increase been due to PFI? No, clearly not, because in the period since 2001;

¬? prices have risen in general;

¬? in addition, there were sharp rises in staff pay over and above the rate of inflation;

¬? there was additional expenditure associated with the NNUH as a medical school; and,

¬? there was an increase of about 18% in the number of patients being treated.

These factors ‘explain’ about £125 mn of the £170 million increase.

Some of the remaining £45 mn is due to the PFI contract but exactly how much requires access to more detailed accounts than I have seen.

The cost increase that I can definitely identify as due to the PFI contract is the rise in rent. In 1995 after the Outline Business Case was approved, the newly-created Trust (the Norfolk and Norwich Health Care Trust) decided not to take ownership of the old hospitals, but instead rented them back from the Government. The rent paid in 1995/96 was £11.4 mn (at 2007 prices) - more than sufficient (over 35 years) to pay for a new hospital. So the Trust was paying a full, economic rent before the PFI contract. In the six years after 2001, the average rent paid to Octagon was £29.4 mn a year (again in 2007 prices). Therefore the increase in rent as a result of the PFI contract has been £18 mn a year. Note that the average rent of £29.4 mn a year is for a hospital the construction cost of which (in 1998) was £159 mn.

9. Is this (the £18 mn increase in rent) the total extra cost attributable to the PFI contract? No. In addition there could well be additional costs since 2001 arising from the payments for services and maintenance. This additional cost could be as much as £4 mn a year but the accounts to which I have had access are insufficiently detailed to confirm or deny this.

10. Are there any more costs due to the PFI contract? Yes. The proposed hospital was very much smaller (in terms of beds) than the hospitals that it was due to replace. This was a deliberate move to make the new, PFI hospital appear ‘affordable’. Once approved, the size was increased. Nevertheless the NNUH has suffered acute pressures on beds and NHS Norfolk has had to purchase beds from private hospitals (most notably Spire) at higher cost because the NNUH has been unable to meet the demand. My estimate of the excess cost of these bed purchases for 2008/09 is over £1 mn.

11. Thus the minimum additional cost attributable to the PFI contract at the NNUH is £19 mn a year (£18 mn for the additional rent and £1 mn for the purchase of beds in the private sector due to the lack of capacity at the NNUH). Of course, in so far as these higher costs due to the PFI contract are met by NHS Norfolk (rather than central government), then the effect will be felt in cost-cutting within the region - for example on community hospitals.

12. Meanwhile, who has gained? The shareholders of Octagon. The amount invested by Octagon’s shareholders at the end of 1997 was just over £1 mn. (£1,325,000 to be precise). In 2003, the windfall profit accruing to Octagon from the refinancing was £95 mn. To this we can add profits in 2001 and 2002 of £9.8 mn. And so by 2003, Octagon shareholders had reaped more than £100 mn in profits on an investment of just over £1 mn. In 2003, £11 mn was paid out in dividends to Octagon’s shareholders.

Roughly a quarter of the shares of Octagon Healthcare are held by the Innisfree Group. Between 1998 and 2008, the annual rate of profit for the shareholders of Innisfree Limited was more than 200 per cent (if the directors’ remuneration is included in the profits).

13. Thus the PFI at the NNUH has generated a significant public loss alongside considerable private gain.

14. What to do now? The government should buy out the contract. As far as the NNUH is concerned, the report shows that the government — the taxpayer, if you like - would gain financially by doing this. This is in spite of £300 mn having to be paid (under the terms of the contract) to buy out Octagon’s liabilities. It is also in spite of the NHS having paid out already a little under £200 mn (at 2007 prices) in rent since 2001. Thus even if the contract is bought out now, the NHS would have paid about £500 mn. for a hospital, the construction cost of which in the late 1990s was £159 mn.

Nevertheless, in spite of this — that is, in spite of having to pay £300 mn. to cancel the contract, the NHS (and taxpayer) would still save £217 mn by buying out the NNUH’s PFI contract. This is because the rent payable (at 2007 prices) between now (2009) and the year 2037 (the first break point in the contract) would be more than £800 mn. and even when discounted at the Treasury’s 3.5 per cent per annum, it is equal to £517 mn. — that is £217 mn more than the amount payable to Octagon under the terms of the contract

This all goes to show what an appalling waste of money the PFI contract at the NNUH has been.

15. Should PFI contracts at other hospitals be bought out? Almost certainly. If it is worthwhile buying out the NNUH contract, there are two reasons why it is likely to be even more worthwhile to buy out other PFI hospital contracts. First because the NNUH was one of the earliest and therefore the others will have longer to run — and therefore more years of rent to save. Second because the other contracts probably carry lower costs of cancellation than the £300 mn at the NNUH. Obviously each hospital needs to be looked at in detail. However looking at 53 PFI hospitals listed in Hellowell and Pollock 2007, and assuming the same saving as the NNUH, the total savings from buying them out would amount to about £2.4 bn.

In 2000, the government announced that the NNUH would be a university teaching hospital with the first intake of students in September 2002

Called an ‘availability charge’ in PFI jargon

The NNHCT was formed in 1994; it became the NNUH Trust in 2001

Norfolk Primary Care Trust was set up on 1 October 2006, bringing together the previous five PCTs covering Norfolk (excluding the Great Yarmouth area). The Norfolk Primary Care Trust is now referred to as NHS Norfolk

The refinancing agreement of 2003 increased the amount payable to Octagon on a cancellation of the contract. For example now (in 2009), the amount payable is £300 mn. Before the refinancing this would have been about half of this — that is, £150 million.

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