Although initially met with scepticism, PFI has firmly established itself in the market. For insurers, this means more properties to insure, but what are the downsides? Andy Cook investigates.
The private finance initiative (PFI) was the brainchild of John Major's Conservative government in 1994. The idea was to replace public capital spending with private spending. So instead of the government paying for a hospital to be built, the private sector would build it and then lease it back to the government.
Despite the suspicions of the unions, whose staff have been transferred from government employment to private sector companies, Labour has carried on with the idea. Indeed, the current government is such a fan of the system that PFI now accounts for more than 15% of all public capital spending and is set to rise further.
Results for the new form of procurement have been mixed. New prisons at Fazackerley and Bridgend have been hailed as successes. New hospitals have had a more mixed response, with Dartford and Gravesend hospital recently being voted one of the worst hospitals in Britain.
PFI schools, roads and police stations have also been built with varying degrees of success for the authorities that commissioned them and, in the case of Laing, the companies that built them. The PFI procurement process has been rocky and the insurance industry is still wary of entering a market that regularly seems on the verge of collapse. But for those who dare, the rewards can be great.
The great thing about the PFI market is that it brings a lot of new property and services into the market. Before PFI, hospitals were uninsured - if the building burned down, the loss would be written off. Now, buildings are owned by a consortium - usually comprising a construction contractor, services contractors and banks - and needs insurance.
Heath Lambert is one of four brokers dominating the PFI market. The broker's UK construction division executive director Greg Bond says PFI projects are similar to any other construction project, but with a few major quirks.
One of the biggest issues faced by brokers and insurers in PFI is revenue protection. If a hospital opens late or is so badly operated that it fails to meet targets for bed availability, then the health authority leasing the hospital can withhold part or all of its payments. This risk can be covered by insurance. Bond says on a non-PFI construction project, premiums for this type of cover cost 35% of the contract value - for PFI, the figure is 65%.
The huge difference between the two premium rates is down to the singularity of PFI projects. Bond says if a factory is built for a customer, it will be one of many. So if the factory is late, the company still produces at the other factories. If a PFI hospital is late, there is nowhere else to go.
Non-vitiation is another key issue in PFI contracts, says Bond. Under normal construction contracts, if a contractor changes design without telling the insurers and the design-change causes a cost over-run (say the building collapses), then the insurer can refuse to pay out.
"What banks think will happen is that the insurer will pay out to the bank and leave the insurer to recover losses from the contractor for telling lies."
He says because insurers are not making a great deal now, some of these cases will start appearing in court.
Bond is also concerned that, if a PFI hospital burned down, it might not be rebuilt under a PFI contract. He says insurers would be responsible for paying out business interruption expenses.
"We would want health authorities to make their minds up in 30 days, or 60 at most. That's a quick process for a quasi-governmental organisation, but we would not be happy sitting around for a year while it made up its mind."
The same for all
Although there are complex issues to resolve in PFI, Bond says that there isn't much difference between building a hospital for a health authority. "There is a standard suite of insurances like constructional risks, material damage and liability," he explains. One of the great advantages of PFI, he says, is that from day one consultants on site of the project, so the risks are very well understood.
The emergence of PFI schools may also be a great opportunity. Local authorities are commissioning PFI consortia to refurbish, rebuild and even build new schools. The rebuilding and renovation process gives school operators the chance to improve risk management enough to make schools insurable.
Zurich Municipal underwriting manager Larry Stokes says the proliferation of arson during the summer holidays, break-ins to steal computers and slips, trips and falls claims make schools unattractive risks to insure.
To help PFI consortia reduce risks in schools and thereby ease the claims burden, Zurich Municipal has launched a design guide that outlines key areas for architects and contractors to address.
Stokes says the consortia, which will run the schools for 20 or 25 years, recognises that keeping claims down is important. But, he adds: "They all seem to be keen on CCTV, but that's not the answer."
"We need to get them more interested in palisade fencing, fire alarms and intruder alarms."
One problem for insurers of PFI schools is that consortia recognise their buying power and are demanding policies without or with very small deductibles, says Stokes. This is a dilemma for companies like Zurich, Groupama and Royal & SunAlliance, who are big players in the school sector. They can neither afford to turn away work nor afford to continue footing huge claims.
Whatever the future of school insurance, PFI is here to stay and those who can understand the processes and identify new clients will guarantee a foothold in a new and growing market.