Payment Mechanisms for PPP Development off PPP and

Payment Mechanisms for PPP Development off PPP and Implementation Possibilities in Latvia Conference, September 2008

Payment Mechanisms for PPP Public Private Partnerships “PPP is a long term relationship where the provision of a public service is handed to the private sector for a defined period, in return for access to an agreed revenue stream”

Payment Mechanisms for PPP Typical Sectors Transport - Roads - Railways - Airports - Ports Health - Hospitals - Clinics Education - Schools Justice - Courts - Prisons Defence - Barracks - Equipment maintenance - Other support services Municipal Services - Refuse collection - Road maintenance - Social housing

Payment Mechanisms for PPP Typical PPP Arrangements - Design Build Finance Operate Ø Design and build infrastructure Ø Operate and maintain it for a set period Ø Finance the whole project - Operate and Maintain Ø Provide service for defined period Ø Provide working capital Ø Some re-investment may be needed

Payment Mechanisms for PPP Design of the Payment Mechanism - Incentivise contractor to provide a good service at the best possible price - Private contractor will aim to provide the quality of service that maximises his profit - Payment mechanism needs to ensure profit is maximised when the public partner’s desired quality of service is achieved - Need to be realistic about the trade-off between cost and quality

Payment Mechanisms for PPP Potential Payment Mechanisms - User charges - Usage payments - Availability payments - Performance payments - Ancillary revenue

Payment Mechanisms for PPP Typical Payment Structures Source of Payment User Charges Sell services to consumers Sell services to public partner only √ Usage Payments (√) Availability Payments (√) √ Performance payments (√) √ √ √ Ancillary Revenue

Payment Mechanisms for PPP Stage Payments - Stage payments sometimes made to contractor during construction phase of high capital cost projects (eg if EU grant available) - Can reduce overall costs because of lower cost of capital to the public sector - However need to ensure that incentives to long term good performance are not undermined

Payment Mechanisms for PPP User Charges - Applicable where consumers expect to pay, for example: - Toll roads - Railways - Public utilities (eg water, gas, electricity) - Potential to operate without subsidy - Need to satisfy customers provides incentive to quality - Revenue guarantees may be needed - Risk of inflexibility due to contractual guarantees - Risk of monopoly abuse

Payment Mechanisms for PPP Controlling Monopoly Abuse - Regulate profits - No incentive for good service - Potential to hide profits eg through cross-charges - Regulate prices - Potential to increase profit through efficiency gains - Design price controls to meet social objectives - Avoid excessive complexity and very rigid controls

Payment Mechanisms for PPP Usage Payments - Useful where private partner’s performance affects usage but where the public partner does not wish to charge - Common in the highways sector - Risk of unexpected changes in payments - Risk of inflexibility due to contractual guarantees

Payment Mechanisms for PPP Availability Payments - Based on the facility being available for use when needed, with penalties if all or part not available - Typical unavailability criteria for a building: - Not accessible - Not weather-proof - Not compliant with safety regulations - Inadequate lighting - Too hot or cold - Lack of required furniture - Toilets not functioning

Payment Mechanisms for PPP Performance Payment - Availability payments alone will not guarantee high quality delivery - Significant element of payment often related to quality of performance delivery - Performance factors vary between projects, but typical factors include: - Equipment reliability - Speed of response to failures - Cleanliness - Responsiveness to user comments

Payment Mechanisms for PPP Benchmark Performance Penalty Bonus Incentive Regime Pa nt e ym Terminate Unacceptable Poor Fair Good Excellent

Payment Mechanisms for PPP Performance Measurement - Self reporting - System monitoring - Inspection and testing - “Mystery shopper” surveys - User surveys - Staff feedback - User complaints

Payment Mechanisms for PPP Ancillary Revenue - Often opportunities for contractor to provide ancillary services at a profit, for example: - Shops and retail kiosks - Cafes - Sell advertising - Charge for ancillary services (eg car parking) - Generally a small contributor to financing - Useful if does not work against main aim of contract

Payment Mechanisms for PPP Case Study: Northern Line Train Service Provision Contract

Payment Mechanisms for PPP Case Study: Northern Line Train Service Provision Contract - Public party: London Underground Ltd. - Private party: ALSTOM - Contract: 20 year contract to take over maintenance of existing train fleet, replace it with new trains and maintain new fleet - Payment: based on number of trains available for service - Reliability of old fleet quickly exceeded benchmark - New trains unreliable when introduced - Contractor and his staff incentivised to improve performance - Now operating reliably

Payment Mechanisms for PPP Case Study: Liverpool Women’s Hospital, Hospital Information Support System - Public party: Liverpool Obstetrics and Gynaecology Services Health Trust - Private party: Data General - Contract: Install and operate new hospital data system - Payment mechanism: - Availability 70% (with penalty for late delivery) - Performance 20% - Usage 10%

Payment Mechanisms for PPP Calibration of Payment Mechanism - Important to model likely impact of proposed payment mechanism using proposed penalties and realistic data on likely faults - Ensure that the mechanism: Ø Provides right balance between cost and reward Ø Provides the appropriate incentives Ø Does not contain loopholes that the contractor can exploit Ø Does not impose excessive risk of performance penalties or termination - Potential role for Monte Carlo simulation

Payment Mechanisms for PPP Indexation - Need to consider how inflation will be covered in the payment mechanism - Some elements of contractor’s costs not subject to inflation (eg fixed price construction contract) - Other elements may inflate at higher or lower rates than general inflation - Desirable to use a range of indices to try to match payment increases to contractor to his actual cost increases

Payment Mechanisms for PPP Development off PPP and Implementation Possibilities in Latvia Conference, September 2008