The Real Cost of P3s To Taxpayers
When you see the numbers for taxpayer overpayment, it will make you so sick that you might wind up in one of the expensive P3 hospitals outlined in the Ottawa Citizen article. With the overcosting, we could solve Windsor's fiscal problems forever:
- "Audit on Royal Ottawa sought
Same group that built centre blasted by auditor over Brampton hospital costs"
Why would Michigan legislators want to pass P3 Legisaltion after reading this BLOG? They should resist strongly what MDOT and their Australian friends want them to do. The Senators need only do some simple math to see what I mean.
With the Ambassador Bridge competition and the traffic volumes collapsing, a DRIC project would never pay its way. No one would ever bid on it.
Accordingly, to make it work the Governments have to pay out cash or guarantee profitability. Of course, doing so raises legal issues and invites a lawsuit!
I did a bit of math based on what Dwight Duncan said before and I want to show you what that decision will cost taxpayers and users of the road.
- "Duncan said last week funding of the border highway is not a concern despite the massive price tag.
"It's a capital project that's financed over 40 years," he said."
The obvious point to make is that the project is being run by Infrastructure Ontario and not the Ministry of Transportation who is normally responsible for road building. And guess who has joined with Infrastructure Ontario as I told you previously: Len Kozachuk, formerly of URS and intimately involved as Deputy Project Manager for the DRIC project. The only reason why Dwight would not be concerned about finances is because the Province would not be putting up the money. Rather, a P3 road operator would be doing that.
The Province has said that the road would NOT be tolled so shadow tolls would be used as an alternative ie pretend tolls. It would have to be based on some formula rather than on a per vehicle charge since the number of users of the road would be a fraction of say, Highway 407. The formula could be based on a nominal toll based on some agreed upon number with a subsidy, in effect, for the balance of the amount to make up the differnce.
Let's say the toll agreed upon is $5. Over 40 years at an increase of 5% per year, the toll would become $33.50. At 7%, it becomes $70.
Now you know why it would have to be subsidized. No one would use it.
If the P3 operator wanted a rate of return of say 14% on the $2b investment [It could go as high as 20%!] on the cost of the DRIC road, tolls for the low volume traffic would be astronomical. It would want to receive $280M per year or over the 40 years, $11.8B Not a bad return that the Governments would pay out.
Had the Province borrowed the money instead at 5% per annum and amortized the payments as if it was a mortgage, over 40 years its interest cost would be about $2.6B
What this tells me is that Taxpayers are paying a premium of over $7B for what? ($11.8-$2-$2.6). What possible advantage is there?
Remember, this $7 Billion premium is for the DRIC road cost only and does not include the billions for the bridge or the US side construction. Of course we know that the real cost will be higher, perhaps almost double if the Manning Road precedent holds.
The scary part is that this excessive profit is for one transaction only! Imagine the waste with dozens of P3s that the governments at all levels are pushing.
Think I am making things up....then read excerpts from this Report prepared by Ontario's Auditor General on his value for money audit. It will make your skin crawl. Is there anyone who can stop this insanity before taxpayers go broke.
The full report is available at http://www.auditor.on.ca/en/reports_en/en08/303en08.pdf:
William Osler Health Centre (WOHC) is one of Ontario’s largest hospital corporations, serving Etobicoke, Brampton, and surrounding areas. In the late 1990s, the Health Services Restructuring Commission recognized the need for a new hospital in this region. In September 2000, an external consulting firm provided a capital-cost estimate to WOHC for a 1.275-million-square-foot, 716-bed hospital of approximately $357 million (excluding the cost of equipment). This was the estimate if WOHC was to be responsible for the hospital’s design and construction.
In May 2001, the then Minister of Finance announced that public-private partnerships (P3s) would have to be seriously considered before the government of Ontario would commit any funding to new hospitals. Generally, P3s are contractual agreements between government and the private sector by which private-sector businesses provide assets and deliver services, and the various partners share the responsibilities and business risks. In the case of a hospital agreement, the private-sector partners would typically be responsible for the design costs, the construction costs, and the financing (and possibly the ongoing facility capital maintenance costs as well). The hospital would then repay the partners through a series of payments over the long term. Governments enter into P3s because they provide an opportunity to transfer risks to the private sector, allow both sectors to focus on what they do best, and accelerate investment to help bridge the gap between the need for public infrastructure and the government’s finan-cial capacity.
In November 2001, the government approved the development of two new hospitals in Brampton and Ottawa using the P3 approach. In August 2003, following a request for proposal (RFP) selection process, WOHC reached an agreement with The Healthcare Infrastructure Company of Canada (THICC), a consortium of the two private-sector companies Ellis Don (construction contractor) and Carillion Canada Inc. (non-clinical-service contractor), and the Ontario Municipal Employees Retirement System (OMERS). Under the agreement, THICC would design, build, and finance a new 608-bed Brampton Civic Hospital. It would also provide certain non-clinical services (including laundry; housekeeping; transporting patients within the hospital; food; security; and maintaining and servicing the facility) over a 25-year period. Under the project agreement with the private-sector consortium, WOHC agreed to pay the consortium a monthly payment over the 25-year service period, beginning on the completion date of the hospital.
AUDITOR GENERAL OF ONTARIO VALUE-FOR-MONEY AUDIT SUMMARY
We noted that WOHC had invested much time and effort in planning and delivering the new hospital project. However, WOHC did not have the option of choosing which procurement approach to fol-low. Rather, it was the government of the day that decided to follow the public-private partnership (P3) approach. We noted that, before this decision was made, the costs and benefits of alternative procurement approaches, including traditional procurement, were not adequately assessed. This, along with a number of other issues we had with respect to this first P3 project at WOHC, led us to conclude that the all-in cost could well have been lower had the hospital and the related non-clinical services been procured under the traditional approach, rather than the P3 approach implemented in this case.
However, as with any new process, there are inevitably lessons to be learned. In responding to our recommendations for future P3 projects (see Appendix), Infrastructure Ontario, the Crown agency now responsible for managing most gov-ernment infrastructure projects, and its ministry partners indicated that most of the issues we raised are now being handled differently to better ensure the cost-effectiveness of current P3 projects.
After the Ministry directed WOHC to follow the P3 approach for the Brampton Civic Hospital project, it then directed WOHC to compare the estimated cost if WOHC itself—that is, the public sector—had undertaken the project with the bids it received from the private sector. In other words, WOHC was to compare the estimated costs under traditional versus P3 procurement. We noted, however, that the assessment was not based on a full analysis of all relevant factors and was done too late to allow any significant changes or improvements to be made to the procurement process. Our more specific significant concerns with the process were as follows:
• A consulting firm engaged by WOHC estimated in September 2000 that the cost for the government to design and build a new hospital would be approximately $357 million (updated to $381 million in October 2001). Using a similar approach in January 2003, a second consulting firm estimated that the cost would be $507 million (updated in November 2004 to $525 million). While there had been increases in labour and material costs during the period, those increases and inflation alone would not account for the large difference in the two estimates. WOHC had not investigated the reasons for the significant difference between the two independent estimates.
• WOHC added to the estimates for the government to design and build a new hospital an estimated $67 million in risks transferred to the private sector. This is equivalent to expecting a 13% cost overrun if the traditional construction method was used. As well, there are a limited number of companies in the province that are willing or able to undertake a project of this size, and therefore the same companies would be bidding for and doing the work regardless of which procurement approach was chosen. We questioned why the estimates for the government design-and-build approach assumed that the risk of overruns would be so significantly greater and would need to be handled differently than under the P3 approach. WOHC should have more carefully evaluated the extent to which a properly structured contract under a traditional procurement agreement could have mitigated the risk of any such cost overruns.
• We found that the cost estimates for the government to do the project were overstated by a net amount of $634 million ($289 million in 2003 dollars). Specifically, certain design and construction costs were overstated, and there were costs for non-clinical services that should not have been included in the estimates when comparing to the costs under the P3 arrange-ment. For example, a depreciation charge was inappropriately included as a non-clinical service cost in the government estimate. As well, the costs for utilities and property insurance that WOHC would be responsible for regardless of who provides non-clinical services was counted as a cost only under the estimate for government provision of non-clinical services, but not in the bid for the P3 arrangement. WOHC had also estimated that it could transfer the risks of price fluctuations to the private sector. However, the project agreement contained provisions allowing for re-pricing of these services after the first four years of the agreement.
• The province’s 5.45% cost of borrowing at the time the agreement was executed was cheaper than the weighted average cost of capital charged by the private-sector consortium. Had the province financed the design and construction costs at its lower rate, the savings would be approximately $200 million over the term of the project’s P3 arrangement ($107 million in 2004 dollars). However, WOHC had not considered the impact of these savings in its comparison of the traditional procurement approach with the P3 project.
• WOHC and the Ministry engaged approximately 60 legal, technical, financial, and other consultants at a total cost of approximately $34 million. About $28 million of these costs related to the work associated with the new P3 approach, yet they were not included in the P3 cost. While acknowledging that additional professional services will be required given the newness of the P3 process, we still believe a significant portion of the professional costs relating to the P3 arrangement should have been included in the cost comparison.
On the other hand, it was evident to us that WOHC staff and management carried out extensive research and invested significant time and effort throughout the development of the Brampton Civic Hospital Project. As well, with respect to the selection of the private-sector partner, WOHC followed a competitive selection process and took appropriate steps to ensure that the process was designed and conducted in a manner that was fair to all potential, successful, and unsuccessful respondents. However, a competitive selection process was not followed consistently in the engagement of advisers. Over 40% of the advisers in our sample were single sourced. In addition, many consulting assignments were open-ended, without pre-established budgets or a ceiling price. We acknowledge that this was in part due to the arrangement being a pilot and to the uncertainty regarding the exact requirements of the various aspects of the project.
Over the approximately three-year construction period, the total cost came to $614 million, comprising $467 million in design and construction costs for the hospital, which was built on a reduced scale; $63 million primarily for modifications to the facilities to accommodate installation of equipment; and $84 million in financing charges. We noted that a portion of the $63 million cost to modify the facilities for installation of equipment could have been avoided with better planning.
We have prepared a table of recommendations (see Appendix) for consideration in future infra-structure procurement projects. We shared these recommendations with management of WOHC, Infrastructure Ontario, the Ministry of Energy and Infrastructure, and the Ministry of Health and Long-Term Care. As the responses in the Appendix indicate, management of these organizations believe that their current P3 processes address most of the issues we raised with respect to this first P3 project at WOHC.
With a contract of this size, best practices call for a business case to assess the costs and benefits of a range of alternative procurement models, to allow the option that offers the best value for money to be chosen. One approach is a value-for-money assessment that captures the total estimated cost of the traditional public-sector delivery of an infrastructure project through a design-build approach and compares that to the estimated delivery cost of the same project using a P3 model. This assessment should be carried out early in the process, as recommended, for example, in a 2004 value-for-money P3 assessment guide published by the UK Treasury. The guide says that “it is important that value-for-money assessments take place at the earliest practical stage of any decision-making process and that departments retain the flexibility to pursue alternative procurement routes if at any stage P3 does not offer the best value for money.”
In the case of the Brampton Civic Hospital Project, we noted that the Ministry did direct WOHC to commission a value-for-money assessment of the P3 arrangement, but only after the decision to follow the P3 approach had been made.
enough to support a P3 arrangement for the project. Our review of available information suggested that only a limited number of construction contractors in the province are able or willing to undertake a project of this size. The same construction companies would be involved in the bidding and work regardless of whether WOHC followed the traditional procurement or P3 approach.
There was no formal analysis of the likelihood and potential value of the risks—such as cost overruns—that traditional procurement might have incurred. When such risks are known to be significant, transferring them to the private sector is a key benefit of the P3 approach. A proper business-case analysis would have required much clearer evidence that significant cost overruns were likely if WOHC managed a traditional design-and-build approach. Only then would a P3 arrangement to help mitigate such risks have been thoroughly justified.
Nevertheless, a significant component of cost under either arrangement is the cost to finance the construction of the hospital. In this regard, government could have secured a lower financing rate owing to its credit rating. However, we noted that the Ministry had not conducted a formal assessment of the cost differential between public and private financing, and whether the additional costs associated with private financing would be more than offset by the risks that could be transferred to the private sector.
Another significant cost component that tends to be high for a P3 or AFP arrangement in comparison to traditional procurement is transaction costs, such as fees for technical, legal, and financial advisers. We noted that the potential impact of such costs had not been assessed.
At first glance, when comparing the November 2004 estimate to the amount agreed to under the P3 arrangement, the P3 approach clearly appeared much less costly.
However, as discussed below, we felt a number of adjustments were needed to the November 2004 cost estimate. We also questioned whether WOHC had adequately considered all significant costs of the Project’s P3 arrangement...
On the basis of this concern and the issues we identified (which are presented in detail in the following subsections), we question whether this first P3 pilot project actually did result in the Brampton hospital costing less than it would have under the traditional approach.
As can be seen in Figure 2, the November 2004 design and construction estimate of $525 million (exclusive of transferred risk) exceeds the initial September 2000 estimate of $357 million by $168 million. While there had been increases in labour and material costs (such as steel prices) over the period, those costs and inflation alone could not account for the large difference in the two estimates.
Another concern we had was the $67 million in transferred risks that was added to the November 2004 government design-and-build estimate. This amount was arrived at on the basis of the judgment and experience of management and consultants. Owing to the subjective nature of these estimates, it is virtually impossible to substantiate the validity and accuracy of the quantified amounts. We were concerned that the transferred risks for this project amounted to almost 13% of the November 2004 government design-and-build estimate of $525 million. In comparison, actual cost overruns (a major component of risk transfer) in the design and construction of the Peterborough Regional Health Centre—a hospital built under the traditional procurement approach during the same period—were about 5% of the total contract value.Under the Project’s P3 arrangement, the private-sector consortium is responsible for providing non-clinical services including laundry, housekeeping, portering (transporting patients within the hospital), patient and non-patient food, materials management, security, and plant operations and maintenance. As with the design-and-construction cost comparison, the cost to provide these non-clinical services also seemed to be much lower under P3 than under the traditional procurement approach, as shown in Figure 3. However, our review indicated that the estimate for the hospital to provide these services instead of outsourcing them as part of a P3 contract was overstated by $582 million ($245 million in 2003 dollars). We reviewed our work with an expert in business valuation, who agreed with our assessment.
Governments do have the capacity and the option of financing and typically obtain a lower debt interest rate than private-sector borrowers do. The province’s 5.45% cost of borrowing at the time the agreement was executed was cheaper than the weighted average cost of capital charged by the private-sector consortium. Had the province financed the design and construction costs under the same terms as the private-sector partner but used its lower rate, we estimate that the savings in financing costs would be approximately $200 million ($107 million in 2004 dollars) over the term of the agreement.
As indicated above, 23 companies or consortia made the initial submission in response to the RFEI, but only four consortia were able to submit a proposal. WOHC explained that the P3 process was new to Ontario at the time and that the lack of market readiness limited the number of companies that were able to submit a bid. In this regard, we believe that the bundling of design and construction along with non-clinical services in the P3 arrangement might have further limited the number of companies that were able to bid on the entire P3 contract.
Between 2000 and 2007, WOHC and the Ministry engaged nearly 60 legal, technical, financial, and other advisers at a cost of nearly $34 million to assist with the Brampton Civic Hospital Project.
The value-for-money assessment could be perceived as biased, as the only way WOHC could receive funding for a new hospital was to follow the P3 approach.