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What Went Wrong With PFI Funding, and How Can it be Fixed?

March 13, 2018, 12:21 GMT+1
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  • Once heralded as the answer to the country’s infrastructure woes, PFI funding is now seen by many as tainted. What went wrong?
What Went Wrong With PFI Funding, and How Can it be Fixed?

For those in the business of public sector construction and service management, the first weeks of 2018 were gloomy indeed. Carillion had been among a select group of large firms frequently called upon by the government to handle building and outsourcing for a host of different projects across a range of sectors. Before January was over, the company had collapsed in the wake of three profit warnings, mounting debts and nonpayments to sub-contractors.

The pertinent part of the tale for PSM readers is the extent of Carillion’s involvement in schools, which at the time of its liquidation was reported to include daily deliveries of 32,000 school meals, facilities management and cleaning services for numerous schools across the country, sponsorship of an academies trust and Private Finance Initiative (PFI) arrangements.

The latter has repeatedly come up in recent discussions of school underfunding, with many pointing to the exorbitant contract payments being made to PFI firms by schools and LAs. With Carillion’s collapse prompting much soul searching over the future of outsourcing, and school funding likely to remain a hot button issue for the foreseeable future, just how bad is the PFI situation? And is it a funding model with any kind of future?

Addressing the myths

The PFI funding model was introduced by the Major government in the early 90s, and enthusiastically taken up by New Labour towards the decade’s end. What made PFI attractive was the way in which it allowed the upfront costs of expensive public infrastructure – chiefly hospitals, schools and public highways – to be moved off the government’s balance book. Instead, private investors would build, maintain and manage said infrastructure, in return for regular payments by state authorities over an agreed contract period.

The model began to fall out of vogue with the arrival of the coalition government. Prior to 2010, Labour had signed 620 PFI contracts; between 2010 and now, only 80 have been signed.

Jonathan Hart is a partner at international law firm Pinsent Masons. A self-described defender of sorts for the PFI model, he’s worked on various projects since its very inception. “Without it, we’d have seen far fewer new schools being built in the last 15 to 20 years,” he reasons. While he recognises the concerns that have been raised over the expense of PFI contracts, he’s also keen to address a persistent myth.

“They’re seen as significantly more expensive than other types of contract – where government provides the funding and school is built – but you’re not necessarily comparing like with like,” he says. “A typical PFI project won’t just involve building a school; it’s also about maintaining and looking after that school for the next 25 years. That’s everything, from replacing boilers to re-roofing and re-glazing. Even reactive maintenance – if a ball smashes a window, it’s the PFI contractor’s job to send somebody out to fix it.”

Lock in

Julia Harnden is funding specialist at the Association of School and College Leaders (ASCL), “Schools are increasingly having to take a more businesslike approach to their operations,” she says. “What a PFI contract does is take away the financial risk that a school might otherwise have to take on in terms of building and maintenance costs. When it works well, it means schools don’t need to worry about what happens if their boiler breaks.”

As Harnden goes on to explain, however, “There are two clear issues. One is the impact of schools’ annual PFI contributions on squeezed budgets. The second is that they’re unable to effectively hold contracted parties to account. PFI contracts are usually watertight and will be index linked in terms of the annual contributions for the life of the contract.

“For example, there’s a school I know of that was putting aside around 10% of their annual budget to support PFI contributions five years ago. In 2017 they were expecting to have to put aside over 17%.”

This cuts to the nub of the issue many have with PFI – that schools are essentially locked in to contracts that don’t take account of wider changes that affect education funding, be it the rise in demand for specialist support, the apprenticeship levy or any other developments that put pressure on school finances.

Jonathan Hart notes that only around a dozen of all the PFI contracts signed to date have ended early, and that premature termination is only possible in a handful of scenarios. One would be ‘project company default’. “That’s what was breathing down Carillion’s neck up until its liquidation,” he explains. “It’s when there’s been a serious delay in construction, to the point where children might be waiting 12 to 18 months before moving into their shiny new school. Under those circumstances, an LA can terminate the contract.”

Another scenario is where a change in government policy results in PFI arrangements being brought back under government control – as pledged by shadow chancellor John McDonnell at last year’s Labour Party conference.

Next steps

So, where should PFI projects go from here? “Going forward, we’d like to see a bench marking process that allows annual contributions to be renegotiated so that they reflect changes affecting a school’s funding – changes which will often be out of their control,” says Julia Harnden. “There’s the life cycle pot, into which all the money for required improvements and maintenance is collected over the life of the contract. If schools could be more involved in agreements over what should happen and when in terms of spending that money, it would be enormously helpful.”

As far as Jonathan Hart is concerned, “It still costs a lot of money to set up public sector projects in the first instance. If you look at the capital budgets of what the DfE has been wanting to spend on building schools, it’s been really slimmed and slashed back. Unless there’s a rethink, I can’t see them doing much to increase the building of new schools, to be frank – with or without the PFI model.”

PFI step-by-step

1. A PFI contract is agreed between an LA and a special purpose company (SPC) set up specifically for the project. The SPC’s shareholders will usually include representatives of the constructor and service provider, alongside a financier or PFI specialist.

2. Construction commences. During this period (which typically lasts 18 months to two years) the SPC pays itself using money borrowed from a bank or bondholder and builds the school. The LA pays nothing (for now).

3. Once the school is built, the arrangement changes and the LA starts making monthly payments to the SPC. These payments will be used by the SPC to pay off the debt incurred by building the school and cover the costs of maintaining the school – while also enabling the SPC to make a profit.

4. Over the next 25 to 30 years, the LA continues to make monthly payments until the debt is paid off and the contract comes to an end.