REVIEW OF THE PUBLIC PRIVATE PARTNERSHIP PRISON CONTRACTS: National Treasury briefing to Portfolio C

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REVIEW OF THE PUBLIC PRIVATE PARTNERSHIP PRISON
CONTRACTSNational Treasury briefing to
Portfolio Committee on Correctional Services18
March 2003
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CONTENTS

• WHAT IS A PPP?
• TREASURY REGULATIONS FOR PPPs
• TASK TEAM FINDINGS
• November 2002
• TREASURY RECOMMENDATIONS

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What is a PPP?

• A contractual arrangement between a public sector
  institution and a private entity where the
  private party performs an institutional function
  OR uses state property in accordance with output
  specifications for a significant period of time,
  in return for a benefit.
• It involves a substantial transfer of all forms
  of project life cycle risk (financial, technical,
  operational) to the private party.
• Public sector role shifts Government is
  purchaser of services and/or enabler of the
  project - monitor and regulator of service
  delivery, no longer its direct administrator.

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What is a PPP?
degree of risk transfer to private party

• Privatise
• Assets purchased
• Liabilities purchased
• Government has regulatory function only

• PPP
• Private party
• Finances (whole or most)
• Designs
• Builds
• Operates
• Government purchases complete service and/or
  enables business
• Fixed assets belong to government

• Outsource
• Capitalisation is for government account
• Government buys specific services but retains
  risk
• Fixed and movable assets belong to government

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What is a PPP?
Government institution
Generic project finance structure for PPPs
PPP Agreement
Private party (special purpose vehicle)
Debt
Equity
Loan agreement/s
shareholding
Sub-contracts
Sub-Contractor eg construction
Sub-Contractor eg operator
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What is a PPP?
Traditional payment mechanism Example Govt-built
and operated prison
Payment (Rands)
Overruns
Delay costs
Construction/ development
Overruns
Operating costs
0
3
10
15
Time (years)
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What is a PPP?
PPP payment mechanism Example PPP Prison
Payment (Rands)
Operational period Pre-set payment by govt
against delivery
Construction Period No initial payment by govt
0
2
10
15
Time (years)
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South Africas regulatory framework for PPPs

• The Constitution
• Public Finance Management Act
• Treasury Regulations
• First issued in terms of PFMA in May 2000.
• Reg 16 deals with PPPs (amended May 2002),
  applies to all
• national departments
• provincial departments
• Schedule 3 public entities and business
  enterprises
• not to local govt - Municipal Finance
  Management Act

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SAs Regulatory framework for PPPs

• Regulation 16 requires all PPP deals to obtain
• National Treasury Approvals for
• Affordability
• Value-for-money
• Appropriate allocation of Risk
• These approvals embedded in Generic PPP Project
  Life-cycle
• TA I Demonstrating Affordability
• TA II A II B Demonstrating Value-for-Money
• TA III Financial Closure

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Clear Government policy and systems now in place
for PPPs Generic PPP project life cycle
Reflecting Treasury Regulation 16 issued in
terms of the Public Finance Management Act, 1999
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Feasibility method to set affordability and
calculate value-for-money Treasury Approval I
Adjustment for private sector efficiency
Preliminary affordability
Nominal affordability
Value for money
Actual affordability and value for money
Rand affordability
NB Value for money is only achieved if all
appropriate risks are transferred to the private
sector
Public Sector Comparator (PSC)
Risk- adjusted PSC
PPP reference
Actual private sector proposal
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REVIEW OF THE PUBLIC PRIVATE PARTNERSHIP PRISON
CONTRACTSFindings of DCS, National Treasury and
DPW Task TeamNovember 2002
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TASK TEAM TERMS OF REFERENCE

• To understand output specifications, costing
  assumptions, project finance and risk allocation.
• To identify capital and operational costs.
• To identify features for re-negotiation to
  address DCS affordability constraints.
• To establish a sound methodological basis for
  comparison with existing and recently constructed
  conventional prisons.
• To report to Ministers of Correctional Services,
  Finance, Public Works and Portfolio Committee.

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TASK TEAM MEMBERS
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TASK TEAM FINDINGS

• Part I Existing PPP Transactions
• Overview of existing PPP transactions.
• Options for Re-negotiation of Existing Contracts.
• Conclusions and Recommendations.
• Part II Future Prison Projects
• Illustrative comparisons of Public and PPP
  Prisons
• Future Evaluation Methodology Feasibility
  Protocol.
• Conclusions and Recommendations.
• Part III Recommendations for Next Steps

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PART I EXISTING PPP PRISONS TRANSACTIONS
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1. OVERVIEW OF EXISTING PPP PRISONS TRANSACTIONS
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BLOEMFONTEIN PRISON PPPPARTIES TO THE CONTRACT
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LOUIS TRICHARDT PRISON PPPPARTIES TO THE CONTRACT
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DCS SPECIFICATIONS

• Specifications based on inputs rather than
  outputs or outcomes.
• Specifications imported from UK prison ideal
  and high level.
• No prior feasibility undertaken to ensure
• Affordability limits
• Optimal value-for-money
• Optimal risk transfer

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DCS SPECIFICATIONS DESIGN

• Cell configuration (2-man and 4-man cells).
• Security.
• Special centres (e.g. assessment, visitors,
  special treatment).
• Utilities.
• Service centres (e.g. catering, health,
  religious).
• External works.

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DCS DESIGN SPECIFICATIONS EXAMPLES

• Cell size 5.5m2 single or 8m2 double.
• Cell height 2.7m.
• Minimum 5 layers of security.
• Telephone monitoring system.
• CCTV, cameras, x-rays, etc.
• Minimum requirement according to Health and
  National Building Regulations.

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DCS SPECIFICATIONS OPERATIONS

• Goal 1 Keep inmates in custody
• Central control, number of prisoners per cell,
  supervision, security during visits, escorts,
  special category prisoners, roll checks, etc.
• Goal 2 Order, control and safety
• Regulating remedy deficiencies, grievance
  procedures, use of force, financial transactions,
  repairs, maintenance, drug control measures, etc.
• Goal 3 Decent conditions for inmates
• Admission times, personal hygiene clothing,
  bedding, cell equipment, meals, healthcare, etc.
• Goal 4 Prepare for return to community
• Legal rights representation, official visits,
  unofficial visits, etc.

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DCS SPECIFICATIONS OPERATIONS

• Goal 5 Structured Day Programmes
• Structured Day Programme, times of unlocking,
  activities, time outdoors, social work services,
  religion, work, education training programmes,
  physical education library, psychologists, etc.
• Goal 6 Deliver services with maximum efficiency
• Strategic development plans, personnel policies,
  equal opportunities, drug alcohol free
  work-place, conditions of service, uniforms,
  recruitment selection and training.
• Goal 7 Promote community involvement
• Community participation and vice versa, formal
  informal community development, employment to
  local community, local PR policy.

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OVERVIEW
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FEES PAYABLE BY DCS
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COMPARISON OF FEE STRUCTURE

• Fee comparison complicated by
• Different start dates.
• K-Factor
• Real increases above inflation.
• Bloemfontein from 0.623 to 0.789 six monthly.
• Louis Trichardt six monthly increases
• Years 2-3 6
• Years 4-5 5
• Year 6 4
• Years 7-9 2
• Years 10-13 1
• Years 14-25 3 decrease each 6 months
• Net Present Value of all fees (8 discount rate)
• Bloemfontein R1.3 billion
• Louis Trichardt R1.2 billion

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REAL INDEXED FEE ADJUSTED FOR K-FACTOR
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BREAKDOWN OF OPERATING COSTS (BLOEMFONTEIN)
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BREAKDOWN OF OPERATING COSTS (LOUIS TRICHARDT)
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EXISTING PPP PRISONS FINANCE
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RISK ALLOCATIONTECHNICAL / OPERATIONAL
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RISK ALLOCATION LEGAL / FINANCIAL
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2. OPTIONS FOR RE-NEGOTIATION OF EXISTING
CONTRACTS
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OPTIONS FOR RE-NEGOTIATION

• Construction Expenditure
• None.
• Operating Expenditure
• Changes in levels of service.
• Amendments to fee payment structure.
• Change in prisoner numbers.
• Refinancing
• Possible conversion of debt portfolio to
  inflation-linked funding.

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OPTIONS FOR RE-NEGOTIATIONOPERATING EXPENDITURE

• Staff costs
• Hours out of cell.
• Service specifications.
• Rehabilitation and Health Care
• Change in specifications.
• Fee payment structure
• Amendments to K-factor adjustments to improve
  cashflows.
• Change in Prisoner Numbers
• Bloemfontein 2 new units.
• Louis Trichardt convert 2-bed cells to 4-bed
  cells and use reception/special
  treatment centre.

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OPTIONS FOR RE-NEGOTIATIONINDICATIVE FEE
CALCULATION
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OPTIONS FOR RE-NEGOTIATIONREFINANCING

• Methodology
• Net Present Value of unexpired portion of debt
  (settlement estimate).
• Convert into new CPI-linked bond debt and
  calculate new repayments and NPVs.
• Compare with existing payments.

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OPTIONS FOR RE-NEGOTIATION RE-FINANCING
ASSUMPTIONS
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OPTIONS FOR RE-NEGOTIATIONRE-FINANCING BENEFITS
(BLOEMFONTEIN)
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OPTIONS FOR RE-NEGOTIATIONRE-FINANCING BENEFITS
(LOUIS TRICHARDT)
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Need to re-shape cash flows through
negotiations. Both contracts Real (excl
inflation) total fees due
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3. CONCLUSIONS RECOMMENDATIONS EXISTING PPP
CONTRACTS
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CONCLUSION EXISTING CONTRACTS

• The PPP Prison Projects delivered according to
  DCS specifications, notably achieving
• Competitive construction costs.
• Construction on time, on budget.
• Fast-track delivery (lt 2years full capacity).
• Comparative operating costs.
• Significant black equity and sub-contracting
• Significantly higher-quality facilities.
• Significantly higher-levels of service.
• Appropriate risk allocation.
• But

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CONCLUSIONS PROBLEMS WITH EXISTING CONTRACTS

• DCS specifications were too high (the PPP prisons
  remain driven by DCS input specifications).
• Relatively high cost of debt.
• Higher than normal return on equity.
• Additional budgeting pressures for DCS.
• Despite overcrowding in DCS system, no ability to
  over-populate PPP prisons.

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RECOMMENDATION EXISTING PROJECTS

• Operating
• Engage contractors in order to improve Value for
  Money by
• Reviewing standards and specifications.
• Amending fee payment structure.
• Consider options for extra prisoners on a
  marginal cost per prisoner basis. Proposed
  Feasibility Protocol will be used by DCS to
  determine optimal value for money
• Finance
• Engage contractors to
• Improve cash flows and NPV and
• Consider converting debt portfolio to
  inflation-linked funding.

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PART II FUTURE PRISON PROJECTS
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1. ILLUSTRATIVE COMPARISONSPUBLIC AND PPP
PRISONS
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BARRIERS TO DIRECT COMPARISON BETWEEN PPP AND
PUBLIC PRISONS

• CAPITAL COSTS
• Dates of construction
• Type of prison
• Inmates per cell
• Location
• Risk transfer
• Split functions DPW/DCS
• Inclusion of staff housing
• Capacities
• Security levels
• Technology and design

• OPERATING COSTS
• Overcrowding
• Standards of facilities
• Standards of activities
• Hours out of cell
• Rehabilitation
• Health facilities
• Risk transfer penalties
• In-house food services
• Availability of information

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ILLUSTRATIVE COMPARISON RISK TRANSFER IN RESPECT
OF CAPITAL COST
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REASONS FOR DIFFICULTIES IN COMPARING PRISON
CONSTRUCTION COSTS

• Prisons differ by
• Type (e.g. super max, max, medium, youth centres,
  etc.)
• Size (inmates varies from lt1000 to gt3000).
• Constructed at different times, different
  operating philosophies.
• Different geographic locations
  construction/logistical problems.
• DCS does not have a cost centre focus PPP
  operators have different cost allocation
  structures.
• Functions and costs split between DCS DPW.
• Historical procurement problems created
  inefficiencies.

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ILLUSTRATIVE COMPARISON FUNDED CONSTRUCTION
COST FORGOVERNMENT
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ILLUSTRATIVE COMPARISON OPERATING COSTS
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REASONS FOR DIFFICULTIES IN COMPARING PRISON
OPERATING COSTS

• Overcrowding of public prisons.
• Prisons differ by
• Type (e.g. super max, max, medium, youth centres,
  etc.)
• Standards of facilities (health, catering,
  recreation, etc.)
• Standards of activities (education, vocational
  training, work).
• Hours out of cell.
• Different operating philosophies, often result of
  different design.
• DCS does not have a cost centre focus to
  accounting.
• PPP operators have different cost allocation
  structures.
• Risk transfer differs.

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2. FUTURE EVALUATION METHODOLOGY FEASIBILITY
PROTOCOL
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PROPOSED FUTURE EVALUATION METHODOLOGY FOR NEW
PRISONS

• Applicable for projects as both PPP and
  conventional procurement.
• Purpose is to assess all options based on clear
  output specifications.
• For all choices, DCS needs to demonstrate
• Affordability
• Value for Money
• Acknowledgement and treatment of risk

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FUTURE EVALUATION METHODOLOGY FEASIBILITY
PROTOCOL
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FUTURE EVALUATION METHODOLOGY FEASIBILITY
PROTOCOL
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FUTURE EVALUATION METHODOLOGY FEASIBILITY
PROTOCOL
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FUTURE EVALUATION METHODOLOGY FEASIBILITY
PROTOCOL
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3. CONCLUSIONS RECOMMENDATIONS FUTURE PRISON
PROJECTS
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RECOMMENDATION FEASIBILITY PROTOCOL FOR FUTURE
PROJECTS

• DCS to clearly establish output specifications
  (for design operations).
• Establish budget constraints.
• Develop comparable accounting standards for both
  PPP and DCS-operated prisons.
• Adopt clear rules for DCS staff movement during
  any future PPP procurements.
• Comprehensive feasibility
• Cost private design, finance, build and operate,
  versus
• Risk-adjusted Public Sector Comparator.
• Results
• If clear distinction Adopt.
• If depends on assumptions Policy decision or
  pilot comparisons.

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PART IIITASK TEAMS RECOMMENDATIONS FOR NEXT
STEPS
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TASK TEAMS RECOMMENDATIONS FORNEXT STEPS
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TASK TEAMS RECOMMENDATIONS FORNEXT STEPS
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MINISTERS OF CORRECTIONAL SERVICES,
FINANCE, PUBLIC WORKS andPARLIAMENTARY
PORTFOLIO COMMITTEE ON CORRECTIONAL
SERVICES November 2002
REVIEW REPORT SUBMITTED TO
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TREASURY RECOMMENDATIONS
1. Negotiations on current contracts must begin
now Fees are not linked to budget inflation
increases. More value can be achieved.
PPPUnit will help. 2. Partnership relationship
with 2 private partners must be built. Value
must be acknowledged and optimised. SA needs
private investment in public infrastructure and
services. 3. Feasibility work must be done as
per Feasibility Protocol before 4 new prisons are
commissioned. Initial R1b capital sum at stake
much more in opex at stake. PPPUnit will help.
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CONTACT

• PPP Unit
• National Treasury
• 240 Vermeulen St, Pretoria
• Tel [phone]
• Sue Lund tel [phone]
• sue.lund_at_treasury.gov.za
• www.treasury.gov.za