CURSHAW’s PFI Inherent Risk Rating - Are all PFIs risky or are some more risky than others?
PFIs present risk
In a previous blog post we commented on the Public Accounts Committee’s (PAC) report on PFI expiry which concluded that vital public services such as schools and hospitals face serious disruption should the government fail to prepare for PFI expiry. We agreed with the conclusion but added that the risk is twofold - the seamless operation of these critical assets is at risk AND there is the potential for substantial contract-end financial liabilities, at substantial cost to the taxpayer.
The PFI question that should be concerning government is whether all PFIs are risky or are there underlying reasons why some are more risky than others? The diversity of operational contracts is widely acknowledged, yet the question of risk appears to be wholly and conspicuously unanswered. What characterises the risky PFI projects and are risky projects more prevalent amongst certain sponsor departments? Can patterns be observed and can related risk treatment plans be developed and deployed? Rather than performing health checks on the contracts nearing expiry is there a smarter way of identifying and addressing the risk of sleeping giants that expire in the mid/long term?
Understanding inherent risk
We’ve answered that question based on a basket of measures we have developed to calculate an ‘inherent risk rating’ so that each operational contract can be assigned a specific risk category. We have done this using CURSHAW’s user-friendly version of the government data. Amongst other parameters, we have accounted for remaining contract term (i.e. proximity of expiry), value, criticality and specialisation of the asset.
You can request access to our interactive inherent risk rating dashboards for each operational contract here.
Importantly, the risk categories that we have assigned are no reflection on our judgment of the preparedness for handback of the contracting authority. This determination of handback readiness is currently being undertaken by the Infrastructure Projects Authority (IPA) on a contract-by-contract basis. Nor does our inherent risk rating include assessment or speculation relating to the perceived adequacy of the contract management, the contracting authority’s capacity and capability nor any expected data deficit.
A true handback risk rating should ideally reflect both our CURSHAW inherent risk rating AND the result of the IPA’s specific contract expiry readiness assessment. It is possible for a contract to have a “red” CURSHAW inherent risk rating against the measures we have applied, but for an IPA assessment of handback readiness to be “green”, in which case the pragmatic risk rating should perhaps be reflected as “amber”. Equally, there may be contracts with a “red” CURSHAW inherent risk rating and a “red” IPA handback readiness assessment. Such contracts should be of immediate concern to senior officials within the responsible sponsor departments and the IPA.
Our insights
PFIs that are approaching expiry in the near-term are not the only projects warranting focus or concern.
PFIs with “red” CURSHAW inherent risk rating account for around 40% of the total value of live PFI contracts;
Over the next three decades, 2036 is the only year that does not face the expiry of any PFI that does not have a “red” CURSHAW inherent risk rating;
‘Risk Rating by Value’: From 2040 onwards, we will begin to see contracts with ”red” ratings dominate the contract value expiry profile. Despite these contracts still being several decades away from handback, their significant contract values, alongside the complexity of the underlying assets / projects, means that these should warrant the same attention today as those contracts that are facing a more imminent expiry. As we wrote about in the first of our series of CURSHAW PFI Perspectives, “with forethought and planning, there should be considerable shared and compound learning from each subsequent expiry, with insight and execution model efficiencies that that learning could provide to subsequent expiries.”
It is important that every contract with a “red” inherent risk rating is being robustly contract managed at every stage, regardless of its expiry timeline. Where a ‘mid-course correction’ is required to improve value for money and service levels this should happen as soon as possible, and long before expiry.
The current focus is understandably on the larger and higher-profile PFIs, and those approaching earliest expiry. However, the large-number of smaller, lower-value PFI contracts also pose their own type of risk challenge. Our analysis suggests that some departments, such as the Department for Education are operating only a limited number of PFIs that we would currently assess as - individually - being of high risk.
However, our ‘Risk rating by Volume’ chart then highlights that the DfE operates more live PFI contracts than any other sponsor department (172 contracts in DfE’s case.)
Whilst their lower contract value relative to the general PFI market leads to their being rated as lower risk, the challenges of multiple, fragmented, smaller-scale expiries requiring expiry management in similar time-frames brings in a different element of risk when attempting to deliver efficient handbacks.
The next seven years of PFI Expiry is only the beginning of the challenge.
Our CURSHAW Risk-rated PFI Dashboard clearly shows a rapid increase in both the value and volume of PFI contracts from now until its peak in the late 2030s.
Of concern - unless addressed - is that more than half of the 82 PFIs expiring before 2028 (so those PFIs which are already within the IPA’s recommended seven-year expiry planning timeframe) are classed in the higher “red” risk categories.
These 82 contracts have a combined value of £18.5Bn. Managed well, these first wave of expiries have the potential to deliver considerable value for the taxpayer and, crucially, operationally-critical public assets that will be transferred in good condition and with a well-defined and sustainable ongoing operating model.
Of further likely value is that these first wave of expiries also represent a crucial and substantial learning opportunity, that should create a pool of both knowledge and market-expertise that will support the subsequent 30+ years of many £100Bns of PFI expiries. The sponsor departments with the highest risk rated contracts amongst these 82 that expire before 2028 are the Ministry of Defence, the Ministry of Justice, the Department for Transport and the Home Office.
In summary, our CURSHAW Inherent Risk Rating has been designed as a pragmatic dashboard with which all parties involved in the PFI market can begin to identify the appropriate and equitable decisions required to ensure an optimum eventual outcome for the public purse across this £280Bn PFI marketplace. The early warnings are already very evident for some of these contracts. Any lack of proactivity to now address these issues will likely bring an uncomfortable spotlight on all parties involved.