The Department of Health and Social Care could have avoided paying a £42m compensation package to the PFI company responsible for building a hospital in Liverpool if it had a better cost estimate for completing the facility, the National Audit Office has said.
A report on the rescue of failed construction firm Carillion’s PFI hospital contracts said the government’s keenness to avoid further delays with the Royal Liverpool University Hospital led to the department backing the payment to terminate the deal.
The Royal Liverpool was one of two PFI hospitals being built by Carillion when it went bust in January 2018. The other was the Midland Metropolitan Hospital in Smethwick, near Birmingham. Both hospitals were already facing delays but the Royal Liverpool is now running five years late with no opening date fixed. The Midland Met is targeting a July 2022 opening – three years and nine months behind schedule.
Work on both hospitals stopped in January 2018 and it quickly transpired that the PFI companies responsible for running the facilities would not be able to complete the projects without extra funding, the NAO said.
It said DHSC, the Cabinet Office and the Treasury had wanted to hold the private sector to its contractual liabilities and avoid any bailout that could set a precedent by “breaking the principle that PFI investors bear the risk of their projects”. The NAO said the government was also concerned that such a move could see all its PFI debts reclassified as national debt.
The departments – along with NHS England and NHS Improvement – collectively agreed to end the contracts for the two PFI schemes and replace them with public financing after it became clear that there was no private-sector interest in setting up new operators for the facilities.
Work then restarted at Royal Liverpool, with a new main contractor addressing problems with Carillion’s work – including stripping out three floors of the building and starting major work to reinforce the structure with steelwork and more reinforced concrete.
However, the NAO said that a decision was taken to agree a “consensual termination” of the Royal Liverpool scheme with the project lenders before the full cost of completing the hospital was known.
The public spending watchdog said pursuing a contract termination under the alternative route risked a formal dispute or legal action that could have seen existing construction contracts abandoned and the site mothballed.
It said DHSC and the Infrastructure and Projects Authority estimated that a consensual termination was a better deal as long as the settlement was £51m or less, and encouraged Liverpool University Hospitals NHS Foundation Trust to seek a “quick negotiated settlement”.
The NAO report said ministers had been given an estimate that it would cost £117m to complete the Liverpool hospital, including £12m contingency, but “did not test” what would happen if the actual cost turned out to be even higher.
Spiraling completion costs
Work by engineering and design firm Arup to probe structural issues with the project was only in draft form when the termination deal was struck. As of last month the completion cost had almost trebled.
“By January 2019, following further work by Arup and others, the trust estimated the completion cost had risen to £164m,” the NAO said.
“Had this estimate been used, it would have reduced the contractual compensation to zero. By December 2019 the completion cost estimate had risen to £293m.”
The NAO said the expected cost of building and running Royal Liverpool had risen to £1.063bn, an increase of 42% on the original budget, while “significant risks of further cost increases and delays” remained. The expected cost of the Midland Met was now £988m, up 44%, it added.
The NAO noted that in both cases the bulk of the losses were expected to be borne by the private sector, with shareholders, investors, insurers and Carillion losing “at least £603m on the construction of both projects”.
The NAO said Sandwell and West Birmingham NHS Hospitals Trust and Liverpool University Trust were directly managing the contracts with new construction firms.
It said Sandwell had negotiated a “target price” for work by Balfour Beatty, which meant costs should not rise unless the scope of the project was changed or unexpected problems with Carillion’s work emerged.
The NAO said that new Liverpool Royal main contractor Laing O’Rourke had “no contractual incentives to control costs”. It said NHSE and NHSI had worked with the trust to develop additional oversight arrangements, such as using an independent construction consultancy to advise on the appropriateness of costs.
It added that both hospital trusts would pay an estimated net £155m less than planned under the 30-year operational period of the PFIs, although the new arrangements would require them to pay the construction costs sooner.
The watchdog said the experience with Carillion showed that projects could not entirely be de-risked through the use of PFI because the system could not cope with the loss of a main contractor.
“Some risk ultimately remains with the public sector; when things go wrong beyond a certain tipping point, the public sector will bear the consequences,” it said.
A government spokesperson said the NAO report showed the private sector taken the biggest hit from Carillion’s “catastrophic failure” to complete the two projects.
“To support staff and local communities in Sandwell and Liverpool, we’re giving both trusts the funding they need to minimise the delays caused by the collapse of Carillion and get these two new hospitals open,” they said.
The cross-departmental response underscored that replacing Carillion with firms working on fixed-price construction contracts had not been possible because contractors would not accept the risk that further Carillion building defects would be found.
It said the NHS was now using enhanced oversight, better benchmarking of costs and contractual mechanisms to control future risk wherever possible.