PFI, and other forms of public private partnership (PPP) as practised in England and Scotland, are well known to be very problematic concepts. They involve, on the one hand, extremely high rates of return for investors in many schemes – but on the other hand, an unacceptable rate of failure in other schemes.
What is less clear is why PFI/PPP has behaved so badly. This note explains why the above characteristics are inherent in the way PFI/PPP has been set up, as a consequence of the very long time periods over which the risk premium in PFI/PPP projects is paid to the equity investors.
― The paper explains how paying the risk premium for equity investors in a PFI/PPP scheme over the 30 year life span of the project opens up the potential for equity investors to pocket excess returns immediately after the construction phase of the project – provided construction appears to have been completed satisfactorily.
― This situation is compounded by the extent to which the projected returns to the equity investors are loaded towards the end of the project life: a point whose significance was missed by the public sector when PFI was being set up.
― The paper quotes evidence that the return to equity market investors on secondary market sales of PFI holdings has been a staggering 28% per annum on average.
― But the same mechanism actually also contributes to the high rate of PFI/PPP failure. Paying the risk premium late in the life of the project means that the risk premium is not actually available when it is needed, thus increasing the likelihood of failure if a scheme hits problems.
― There is a further danger, in that the inherent instability in the system risks destabilising the balance sheets of the parent companies which hold PFI/PPP – witness Carillion.