Contractors shoulder PFI insurance risks

by James Atkinson and Carol Millett

PFI contractors will have to bear a three-fold increase in insurance premiums before the public sector intervenes, according to the latest government guidance on drafting PFI contracts

The document has disappointed some in the private sector with controversy still raging over the vexed issues of project risk insurance and refinancing.

Bill Tallis of the Major Contractors Group said: "Overall the revised guidance significantly moves the balance in the public sector's favour. There is a risk that this time they have gone too far and are about to kill the golden goose."

Partnerships UK (PUK), which has drawn up the guidance on behalf of the Office of Government Commerce (OGC), conceded that not everyone is happy with all aspects of the document, but insisted that all had accepted it as workable.

The biggest issue has been risk insurance on which there is still no final agreement. PUK is working hard to produce an interim guidance as soon as possible. The current position is that the private sector must pay for any hikes in premiums up to 200% above the original insurance premium, according to one source close to the negotiations.

Beyond that, the government would pay for any further increase, perhaps up to 85%. The government would then refund those premiums at five-yearly intervals, but it would also take a share in any savings resulting from a drop in premiums.

Over the longer term, the government is looking to introduce a national index of insurance premiums, but the source said this takes no account of specific project risks and is therefore unlikely to be of much use.

Stan Gniadkowski, partner at PFI lawyers Denton Wilde Sapte, said he was disappointed that the OGC had not adopted the private sector's recommendations to benchmark insurance costs.

"This is a major issue post September 11th and a lot of firms are finding it very difficult to get insurance. Benchmarking would give greater value for money because, as insurance costs come down, that saving is passed onto the public sector," he said.

Tallis added: "It does not represent value for money because significantly more costs will be incurred and therefore the public sector will pick up that problem."

CJ understands the lack of guidance on insurance has caused consternation among public sector clients negotiating PFI deals, as they have been advised to consult PUK first. A source said that the more confident departments are likely to press ahead with their own deals, rather than risk further delay. Others may see their projects held up.

The new guidance confirmed that the gains made from refinancing any future PFI deal will be split 50:50 with the client.

What has caused concern is the wording of the guidance. Gniadkowski said: "The wording is so widely drawn that it is open to interpretation, so that, for example, selling an equity stake in a PFI project could be interpreted as refinancing."

However, the government has agreed that extra profits generated by the private sector partner through efficiency gains are excluded from any refinancing deal.

And if the private sector is earning below its projected revenue level, the public sector client will not take any share of a refinancing gain until those earnings reach the target figure.

More controversially the public sector client has to give its permission before any refinancing deal can be done. By retaining the right of consent over any deal, the government believes it will retain sufficient flexibility to ensure the right spirit is observed.

OGC has stressed that the wording in the guidance emphasises that the government is in favour of refinancing and that it should be encouraged.