PFI update — insurance premium risk sharing and expiry
On 28 February the Infrastructure and Projects Authority (IPA) published new guidance regarding PFI contract expiry.
Insurance premium risk sharing — successful adjudication decision secured by Weightmans
PFI contracts signed after 2004/05 will almost certainly contain the standard mechanism regarding the sharing of insurance premium risk, introduced by the Treasury in late 2005. Over recent years, the mechanism has been manipulated by certain investors and insurance advisers to the significant detriment of authorities. Insurance costs have fallen markedly since the mid-2000s in most markets (particularly for typical accommodation projects such as schools), resulting in substantial savings that should be shared with authorities, but, taking advantage of ambiguities in the drafting and, on occasion, a lack of scrutiny by authorities, some Project Cos have been offering much smaller amounts than should have been the case.
Weightmans recently advised a local authority which activated the Project Agreement dispute resolution process and challenged two Joint Insurance Cost Reports (JICRs) through adjudication. JICRs are the reports produced every two years by Project Co’s insurance broker, in accordance with the Project Agreement requirements. The JICRs analyse actual insurance costs incurred by Project Co, the insurance costs forecast in the original project financial model, and the reasons for any discrepancy. Depending upon the size of the difference between actual and forecast costs, and the reasons for that difference, a proportion of any savings or additional costs are shared with the authority. While the insurance broker theoretically owes a duty of care to both Project Co and the authority, in reality some brokers appear far more focussed upon protected Project Co’s position and minimising any savings that are shared with the authority.
In our case, despite concerted efforts by the Project Co, including employing a city firm and a QC to represent it, the adjudicator found firmly in our client’s favour — even to the extent that he ordered the Project Co to pay 100% of his costs. The result was that the amounts due to the local authority across the two reports increased from the offered amount in the low tens of thousands to a sum of several hundreds of thousands. More importantly, the Project Co will have to take a different approach to future JICRs with unknown benefits for the council.
We’re aware that this issue affects numerous public bodies and PFI contracts across all sectors. We would urge all authorities to scrutinise each JICR they receive carefully, and obtain specialist advice if you have any doubts. In our experience many of these reports are poorly-prepared, and often contain basic errors as well as deliberately interpreting contract provisions in Project Co’s favour. Above all, do not accept a JICR just because it gives the authority a share of insurance premium savings — you need to question whether the share being offered is all that you are due under the terms of the Project Agreement.
This is a technical area, requiring knowledge of the insurance industry — and the approach to insurance of PFI projects in particular – alongside a clear understanding of the principles of contractual interpretation, as they will be applied by a court. If you have any doubts about JICRs you have received, please feel free to contact us for an initial discussion.
Expiry of PFI contracts — new IPA guidance
On 28 February the Infrastructure and Projects Authority (IPA) published new guidance regarding PFI contract expiry. The comprehensive guidance builds upon previous work in this area, including the 2020 reports by the National Audit Office and Local Partnerships on which we commented previously. It forms part of a package of support that IPA has put in place in the form of an Expiry Toolkit.
The scale of the challenge across the public sector is significant. There are over 700 operational PFIs across the UK. While some are expiring already, the bulk will come to an end between 2028 and 2037, when as many as 50 will terminate each year. Projects are spread across 328 different authorities, 182 of which have only one such contract. Building know-how across so many entities will be difficult; by contrast, just ten investors own half the contracts, giving the private sector the whip hand when it comes to PFI expertise.
The guidance explains the importance of managing contract expiry effectively, emphasises the significant amount of planning and resource that will be needed, and provides authorities with practical advice about the process. It highlights the fact that expiry is a complex process which must be understood as a journey over time. Running to 74 pages, the guidance is a comprehensive document, and will undoubtedly prove a valuable aid to authorities starting to contemplate the end of their PFI arrangements.
Many of the issues raised echo the advice we provided in our previous commentary. Our take on the key messages is summarised below:
- Start planning early — IPA reiterates the NAO’s conclusion that authorities should start planning seven years in advance of the contract expiry date. Early activities will include obtaining leadership team buy-in, establishing governance arrangements to aid decision-making, formulating a strategy and allocating a budget.
- Resource properly and access support — managing the expiry process should be treated as a project in itself, and not simply left to the contract management team (who will in any event have to continue their ‘business as usual’ management in the lead up to expiry). In fact, IPA sees the overall expiry project as comprising three separate, but linked, work streams – BAU contract management, expiry management, and planning for future provision. In addition to internal resource planning, the need for external support should be identified - from bodies like IPA and Local Partnerships, as well as external advisers.
- Review current provision and plan for the future — expiry of your PFI provides an opportunity to revisit your needs, which will likely have changed since the PFI contract was entered into, and plan for a better future. By their nature, PFI contracts are difficult to extend, so it will be essential for authorities to have new arrangements ready to commence on the PFI expiry date. This will require considerable planning, and authorities will have some fundamental decisions to make along the way.
- Know the asset — when the PFI contract ends, the authority will likely become responsible for a building or other asset with which it has had limited involvement for decades. You will need to develop an asset management plan, and ensure you have appropriate skills and resource to enable you to fulfil your responsibilities as asset owner. Integral to this is understanding the asset, its condition and its potential, and what is involved in existing asset management arrangements — for example, what subcontracts does the facilities manager have in place, can they be assigned to the authority or will new subcontractors have to be procured?
- Know the contract, and the wider commercial context — it is important to assess the contractual provisions relating to expiry early in the process. Are they adequate? What ambiguities and inconsistencies do they contain? What gaps exist? (Answer: almost certainly some). To do this you’ll need to collate a full suite of relevant contract documents, updated to include all the variations that have been agreed over the course of the PFI to date. As IPA says, “Put simply, knowing your contract is the necessary starting point for PFI contract expiry and transition planning”.
This will require a clause-by-clause review of the Project Agreement. Provisions relevant to expiry will appear throughout the contract, for example in relation to TUPE, pensions, documentation/records, IPR. All need careful consideration. You should also understand your rights to demand information from the Project Co, as information about the asset, financial performance etc. will be vital to your planning.
Authorities should also seek to understand the wider commercial picture, such as the identity of the Project Co’s shareholders, which party holds any lifecycle funds and who stands to gain from savings, and the position of the funder (in particular, when is the debt due to be repaid). The guidance recommends that all this information is encapsulated in a plain English “expiry summary”, which will become a useful reference document throughout the expiry project.
- Engage with the Project Co and stakeholders — the path to expiry will be smoother if the parties are working to a common understanding of the contract provisions and timeline. If there are deficiencies in the contract drafting, it may be of benefit to agree changes well in advance or to put in place an expiry protocol. Early PFIs will present particular challenges in this regard as they do not benefit from the standardised drafting that was gradually introduced by Treasury as PFI was rolled out.
In some cases, third parties may need to be involved. Particular issues arise in relation to schools that have become academies, given that the asset will not revert to the authority but to the academy trust.