The Handling of PFI Leasing Charges in
Government Accounts:
the implications of information on how
PFI schemes actually behave.
Jim Cuthbert
Margaret Cuthbert
www.cuthbert1.pwp.blueyonder.co.uk
What this talk is about
We are going to look at how PFI schemes
are reflected in
a) The departmental accounts of public
sector bodies
b) the National Accounts:
and consider whether this makes sense in
the light of information on how PFI
schemes actually behave.
PFI (also known as PPP)
• What is PFI? A public sector client contracts to
make regular payments over 25 or 30 years for
the provision of a serviced asset, (like a school
or hospital). This regular payment, known as the
unitary charge, covers both the procurement of
the capital asset, and the provision of services
during the life of the contract.
• PFI is large. In the UK as a whole, contracts had
been signed for over 700 projects by January
2009, with a total capital value of more than £60
billion.
Departmental Accounts Produced by individual public
sector bodies to standards laid down in Treasury’s
Financial Reporting Manual, consistent with International
Financial Reporting Standards, (IFRS).
National Accounts Picture of whole economy, produced by
Office for National Statistics, to principles set out in the
System of National Accounts 1993, (SNA93), and the
European System of Accounts 1995, (ESA95).
Note that different accounting standards are applied in
these two contexts: For example, the national accounts
take a more restricted view than IFRS about what
constitutes a liability: in particular, the national accounts do
not recognise provisions for future expenditure or
contingent liabilities.
The Key Question
The accounting treatment of capital assets
in PFI schemes depends on the key
question:Is the capital asset an asset of the public
sector, or not?
What matters is economic ownership, not
legal ownership.
Prior to 2009
The answer to this question, applied in both
departmental and national accounts,
depended on a risk based assessment:
schemes for which the public sector body
was deemed to bear the risks and rewards
of the asset were counted “on the books”
of the public sector.
Under this test, the great majority of PFI
schemes, by number, were “off the books”.
How are “on book” schemes treated.
• In departmental accounts, the accounts score an
asset, valued at the relevant concept of fair
value as used by the department: and a liability,
which will essentially be the written down cost of
the capital good.
• In the national accounts, “on book” PFI schemes
count as an asset in the public sector capital
stock, with an equal and offsetting liability in the
public sector net debt aggregate.
• ONS relied on the judgement of the public
sector’s external auditors to decide whether a
given scheme was “on book”, and for the
valuation of the relevant asset.
What happened in 2009?
• The government adopted IFRS for departmental
accounting. This means almost all PFI schemes
are likely to come “on book” as regards
departmental accounts.
• But this change does not apply to the
compilation of the national accounts, where the
former risk based test still applies. So the
adoption of IFRS does not necessarily mean that
more PFI schemes will be recognised in the
national accounts. And, since ONS relied on
departmental auditors, it poses a real logistical
problem for ONS
Evidence on how PFI schemes actually
behave.
• Such evidence is very hard to come by, because
details of PFI operation are commercial in
confidence.
• We have acquired, through Freedom of
Information, the financial projections for 8 PFI
schemes.
• These are the detailed projections produced by
the operating consortia when the PFI contracts
are signed.
What we did with this evidence: (1)
• We took the projected stream of annual payments made
by the public sector, and stripped out of this payments
for services: what is left is effectively the payments being
made for the provision of the capital asset.
• It is then natural to ask: if the public sector had not gone
down the PFI route, how much could it have borrowed
for the same cost as this stream of capital related
payments?
• The answer is: calculate Net Present Value (NPV) of
these payments, discounted at National Loan Fund
interest rate, (around 5%).
Eight PFI Schemes: Capital Raised, Total Capital
Related Payment, and Ratio of Net Present Value of
Payment to Capital.
Capital Raised
(£m)
189.2
73.4
74.9
6.5
20.7
20.3
16.3
85.5
Total Payment
(£m, nominal)
760.2
330.2
257.4
23.6
73.8
55.2
55.1
228.3
Ratio of NPV to Capital,
discounted at 5%
2.04
1.97
1.68
1.97
1.82
1.49
1.60
1.28
What does this mean?
• The NPV of the payment stream is effectively the liability
which the public sector has taken on to acquire the use
of the capital asset: while it is the capital raised which
will appear as the public sector’s liability, both in
departmental accounts, and, (for “on book” schemes) in
Public Sector Net Debt. The right hand column in the
table shows the ratio of the NPV of the payment stream
to the capital raised. The fact that the ratios are so much
greater than 1 indicates that the true liabilities are
understated in the accounts.
• Implication The way PFI liabilities are expressed in
departmental accounts should be changed, to better
reflect the true scale of the liability taken on.
• Similarly, the PSND aggregate in the national accounts
needs to better reflect the true scale of PFI liabilities:
(according to ONS, however, there are technical issues
here, which may complicate the solution.)
What we did with the evidence: (2)
• As we have seen, ONS are still relying on a risk based
assessment to decide which schemes should come “onbook”.
• But clearly, the level of profit is relevant to deciding
whether risk has been meaningfully transferred to the
private sector. If profits are very high, it is more a case of
“having a flutter with public money” than real risk
transfer.
• So we used the PFI projections to look at the projected
internal rate of return (IRR) on broad sense equity, and
at projected dividend payments relative to the amount of
pure equity invested.
Eight PFI Schemes: IRR on Broad Sense Equity,
Equity Capital Injected, and Total Projected Dividends.
Scheme IRR on Broad Sense Equity
%
A
17.7
B
23.2
C
20.8
D
18.1
E
18.6
F
16.9
G
16.3
H
15.0
Pure Equity Capital
(£m)
0.5
0.0001
0.001
0.08
0.136
0.000197
0.002
0.37
Total Projected Dividend
(£m, nominal)
167.9
89.1
55.7
7.1
24.4
5.9
9.1
10.2
What does this mean?
• Clearly, projected profitability is very high in several of
these schemes. (And in fact, the figures in the table
understate projected profitability on broad sense equity,
since these IRRs are projected to be earned on average
amounts of outstanding debt which are much higher than
the original investment: i.e., significant amounts of
interest are being rolled up.)
• Implication. Application of ONS’s risk based test should
be broadened to include assessment of projected level
of profit, (and amount of equity actually at stake). If this
was done, many more PFI schemes likely to come “on
book” in the national accounts.
Further issues which mean public sector
liabilities likely to be understated
• Timing effects. PFI schemes don’t come “on
book” until construction phase completed,
because up to that point they are regarded as
contingent liabilities. But the public sector has
already entered into contractual obligations: so
the eventual liabilities are “hard contingent”
rather than “soft contingent”.
• Implications of Treasury underwriting PFI finance
given difficulties in credit market.
Does all this matter?
• We argue yes.
• ONS calculated the asset value of “on balance sheet”
PFI schemes included in the PSND for 2009 as £5
billion. This compares with the total capital value of £60
billion at that time for signed PFI deals.
• On the other hand, on the basis of the kind of factors
identified above, the public sector liability associated with
these schemes should probably be more realistically
assessed as being significantly greater than the £60
billion figure, rather than the £5 billion. What should have
been a significant warning light as we headed into
current financial crisis was effectively stuck on “green”.
References on Departmental and National
Accounting.
• H.M.Treasury, (2009): “Financial Reporting Manual
2009-10”.
• Kellaway, M. (2008): “Private Finance Initiative and
Public Debt”, Economic and Labour Market Review,
Office for National Statistics, Vol 2, No. 5, May 2008.
• Maitland-Smith, F (2009): “Government Financial
Liabilities Beyond Public Sector Net Debt”, Economic
and Labour Market Review, Office for National Statistics,
Vol 3, No. 7, July 2009.