Private finance initiative: A catalyst for better healthcare design?

April 30, 2005
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This article is the third in a series on healthcare design in the United States and the United Kingdom. In the May 2004 issue (“Lessons From Both Sides of the Pond,” p. 23), Derek Parker contrasted healthcare architecture in the two countries, and in the November 2004 issue (“That Vision Thing,” p. 28), Annie Coull explored the role of visioning in the design process in the United States. This article discusses the United Kingdom's Private Finance Initiative (PFI) system for drawing on the private sector to build public healthcare facilities.

The British government introduced PFI in 1992 as an alternative to relying largely on public money to build and maintain capital projects. PFI is a specific type of public/private partnership that follows the design/build/finance/operate model. With PFI, a government entity contracts with a private-sector consortium that is typically led by a large construction firm and a facilities-management (FM) firm to design, build, finance, operate, and manage the project. The public authority then leases the building and pays for the consortium's services. After a specified period of time (typically 25 to 30 years), ownership reverts to the public authority. The result is that significant risk is transferred to the private entity, and the government can move forward with much-needed projects without first having to raise all the capital required. The Channel Tunnel is perhaps the most prominent project to be carried out using a form of PFI.

For the National Health Service (NHS), PFI has allowed the government to begin replacing its aging infrastructure, an effort that had long been neglected. Many healthcare buildings currently in use date back to Victorian times or were built in the wake of World War II. Tight budgets had resulted in a large backlog of maintenance projects, and the governmental procurement process in the United Kingdom had a reputation for significantly exceeding budgets and schedules for capital projects.

So far the NHS has had 64 major PFI schemes approved, 21 of which are operational, with a combined capital value of about $20 billion, according to a May 2004 report by the Chartered Institute of Management Accountants in the United Kingdom.

The private-sector partner benefits from having the opportunity to participate in an ongoing series of major large-scale projects while having a guaranteed income for a long period of time. The advantage of PFI for the government is that it can bring the discipline and efficiency of the private sector into the construction and maintenance of public-sector projects. Because the consortium does not receive payment until the facility opens, it has a strong incentive to avoid delays in the schedule. And because the consortium will be responsible for ongoing facility management, it has a motivation to provide high-quality construction to keep subsequent costs down.

In addition, contracts require the private consortium to maintain the projects according to certain standards that both parties agree upon in advance. These standards are typically higher than those previously established by the public sector for itself. Since the facility manager chosen by the consortium will be contracted to work with the client for 30 years, facility management is a significant factor in the selection. There are two aspects: “hard” facility management—general maintenance and building management—and “soft” facility management—security, food service, portering, parking, and laundry.

The public authority—typically a hospital trust in the United Kingdom—makes a monthly payment, called a unitary payment, to the consortium after the project opens. The unitary payment includes the cost of financing the capital project, as well as the cost of delivering the FM services and the consortium's profit. If the facility is not meeting the standards set by the contract, the consortium pays a penalty, often quite steep. This approach provides strong motivation for compliance, which can ensure a more reliable result. But it can have a downside, making the consortium less willing to take risks in construction methods or to try new materials.

While the major financial risks are on the private side, there is an ongoing debate as to where the ultimate risk lies. For example, what happens if one day a cure for cancer renders a cancer hospital no longer necessary? It is impossible to forecast what changes may occur over a 30-year period. And if the private consortium running a facility were to become insolvent or if the need for a facility were radically altered by medical breakthroughs, the ultimate responsibility still would lie with the government, which still would have to make payments. This is one of the primary reasons PFI has not caught on as a method for building new hospitals in the United States, because the answer to the question of who shoulders the ultimate risk remains unclear. In addition, hospital ownership in the United States is not centralized as it is in the United Kingdom.

Before PFI, the NHS had responsibility for every aspect of building and operating hospitals and used its own in-house design studios. The NHS designers emphasized building research much more than healthcare design firms did in the United States. Much of the research was focused on finding the most efficient and inexpensive way to design hospitals, so the NHS could replicate those methods, often relying on minimum space standards or modular systems. While this approach might have kept costs down, it often led to a monotonous kind of architecture that was out of step with the architecture being developed outside the NHS.

The introduction of PFI opened up U.K. hospital design to a much wider range of architecture firms, including those with healthcare experience in France, the United States, and elsewhere, as well as British firms known for creative approaches in other building types.

The architectural approaches that tend to win PFI bids are those that successfully meet the clinical needs of physicians and healthcare staff and simultaneously apply strong architectural and urban design principles to the design of the site and building overall. In the United Kingdom, several advocates have arisen in recent years to raise awareness of the value of well-designed buildings and good urban design. In 1998, the Prince of Wales established the Prince's Foundation for the Built Environment, an educational charity that sponsors conferences and classes and provides consulting services for public and private architectural and urban design projects.

In 1999, the government established the Commission on Architecture and the Built Environment (CABE) as its “watchdog” to promote better architectural design. While it is not a statutory authority, it can influence the direction of a project significantly through publicity and through its influence on town-planning reviews. And in 2000, the Prime Minister announced the Better Public Building Initiative, involving ministers and departments in improving public building design. The Better Building Awards, cosponsored by CABE and the Office of Government Commerce, recognizes public buildings that meet high standards for design, construction, delivery, operational performance, financial management, procurement procedures, and social and environmental value. The NHS also has a Design Review Panel and recommends that a design champion be appointed within the hospital organization for each project. All of these forces put pressure on those creating healthcare facilities to deliver high-quality design.

The PFI process is long and complex. The government's policy is to use PFI only when it will provide greater efficiency, equity, accountability, and value for money. The PFI process begins with the public authority, or hospital trust (which may manage one or several hospitals), developing a strategic outline case (SOC) for the project. The SOC includes a study of demographics and proposed models of care, and it establishes a brief for the building, FM services, and an expected level of costs.

If the SOC is approved, the hospital trust moves to the next stage, which is to develop an outline business case (OBC). This stage includes a public-sector comparator to calculate the cost of delivering the project using the traditional public-sector process. The purpose of this is to develop more realistic cost estimates and fine-tune the economic model. If the OBC is approved, the project can be formally launched as a PFI project for bidder competition. Up until this point, the hospital trust might have hired outside consultants (including architects) to help them with the process.

The hospital trust issues a contract notice in the OJEC (Official Journal of the European Community), inviting consortia to submit qualifications materials. In addition to the contracting firm and facilities-management firm, the consortium includes a financial institution that serves as an investment banker and a full-service architecture and engineering team. After looking over qualifications materials from each consortium, the trust prepares a shortlist and issues a preliminary invitation to negotiate (PITN). The result of the PITN phase will be a design that is comparable to the conceptual-design phase in the United States. At that point the hospital trust evaluates the proposals and eliminates some of the competitors. The final invitation to negotiate (FITN) phase will carry the design through schematic and design development. At each stage there are equivalent presentations for the FM provider and the financier, in addition to the contractor and design team.

In the early days of PFI, the shortlist would include as many as six consortia throughout the whole process. Over time it became clear that involving so many bidders wasted resources. The government now tends to limit the early bidding to three or four competitors. Given the current booming market for the development of healthcare facilities in the United Kingdom, often no more than two bidders will apply for consideration. This is because the contractors have so much work that they can't take on more, and they don't want to risk time and money without the assurance of winning the contract.

For a large project, the process often takes a year before a contract is awarded. Two teams might spend a great deal of money and time in the negotiation process. By the time a preferred partner is chosen, around 1.5 to 2% of the project's total capital costs might have already been spent—this in addition to the substantial costs incurred directly by the hospital trust. Typically, each consortium pays its design team enough fees to cover its costs during the competition and negotiation phase. Profits are only paid if the team wins.

Following FITN, a preferred bidder is selected, but that is not quite the end of the competition process. Further work is done to refine the bid, but now the hospital trust and the consortium is engaged in more of a partnering relationship than they were during the competition phases. The final milestone of this part of the process is called the financial close. At this point, everybody signs on and the bank releases the funds for the project. Sometimes as much as another year will pass between the selection of the consortium and the financial close, during which time the consortium proceeds at risk with its own funds.

On the day of the close, construction begins while other construction drawings are completed. (During the negotiation phase, drawing continues so that some aspects of the construction documents are already complete.) These are all fast-track projects. At this point, the consortium is spending huge amounts of money on material and financing, and so it is motivated to get some part of the hospital functioning so that the NHS will begin paying rent. With hundreds of millions of pounds on the line, there can be a lot of pressure to get the job done.

While the United Kingdom has pioneered PFI, Spain, Italy, France, Portugal, and Sweden are all exploring versions of it, and examples of similarly structured public/private partnerships for healthcare projects are beginning to appear in the United States and Canada, as well. In Durham, North Carolina, the Department of Veterans Affairs has partnered with a subsidiary of the national development company LCOR to expand the Durham Veterans Affairs Medical Center and create a new mixed-use campus on VA property. LCOR has responsibility for planning, developing, managing, and maintaining the new campus. Financing will come from bonds and private debt and equity. The two parties have signed a 75-year ground lease; LCOR will own the facilities themselves until the lease expires, after which the facilities will become the VA's property. The VA benefits from the opportunity to expand its facilities without the constraints of federal procurement regulations. The federal government's Enhanced-Use Leasing program permits commercial and other activities on federal property, as long as they are consistent with the authority's mission.

Although the healthcare systems in the United Kingdom and the United States differ in a variety of ways, the design/build/finance/operate model could prove a useful tool in the United States, given today's healthcare crisis. For any institution that needs a facility and does not have money up front, or does not want to manage a building project, these kinds of partnerships can help develop, fund, and operate essential capital projects. However, the government has to be willing to take on some kind of role as the ultimate guarantor. The United States already has this role in the banking and housing finance industries. A process similar to PFI might help build much-needed healthcare buildings in the United States—perhaps for less money. HD

Sidebar

In the United Kingdom, several advocates have arisen in recent years to raise awareness of the value of well-designed buildings and good urban design.

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Comments

P3 is not the way out

I have worked on P3's before. I've been on both the client and design side. I have never met a person in design or construction industry who thinks P3 is a good value. I've never meet a client who likes it. I've never met an architect who likes it. Those who are fond of P3 over conventional delivery just haven't done it yet or have no other work. The entire P3 design-build process is a huge waste of money. The politicians, financiers and lawyers love it... what does that tell you?