Feature / Park life

Alder Hey may be breaking the mould with the design of its new children’s hospital in a park. But it has also brought innovation to the way the partly PFI-financed deal has been structured. Steve Brown reports


The Guardian newspaper last year suggested that the new Alder Hey in the Park, which is scheduled to open in 2015, could be the most iconic publicly owned healthcare building in the UK.

A ‘hospital in a park’ concept  – specifically aiming to look as little like a hospital as possible – has been used for a children’s health centre in Melbourne, but this is the first time it has been seen in Europe. It even incorporates some children’s ideas into the final design.

But the innovation doesn’t stop with the buildings and setting. The finance and payment scheme also breaks new ground. To get a major capital project to financial close in the current economic climate – and using the private finance initiative – is no mean feat.

Following a major review of the PFI, the Treasury announced details in December 2012 of its new PF2 scheme, which will be used for future public-private partnership capital deals. Only a handful of NHS schemes, started before the Treasury review, have continued down the original PFI route. And given the concerns over value for money that sparked the PFI review in the first place, these deals have inevitably been subject to even greater scrutiny.

Alder Hey Children’s NHS Foundation Trust is one of the largest children’s hospitals in Europe. It covers a catchment population of

7.6 million and delivers more than 244,000 episodes of care per year. It provides services in over 20 sub-specialties, organised in seven clinical business units.

Plans for a new model of care – underpinned by a new children’s hospital – began back in 2004. But the project really got serious after the trust gained foundation trust status in 2008 and drew up an outline business case for a new development in 2009.

This was further updated in 2011 and followed by an appointments business case later the same year. After appointing PFI partner – the aptly named Acorn, bringing together John Laing, Laing O’Rourke and Interserve – a confirming business case at the start of 2013 was the final step before financial close was achieved on the project in March the same year. The project has been refined over the years, the biggest change being the inclusion of a new outpatients facility, originally envisaged as a second phase project.

Each step has required the trust to demonstrate affordability to its regulator, Monitor, and value for money to the Department of Health and Treasury. This would be difficult at the best of times. But major financial pressures in the broader economy and in the NHS, and significant structural changes involving commissioning organisations, strategic health authorities and at a national level have added to the challenge.

Affordability challenge

Steering the project through to final close and the start of construction has been a significant undertaking, not least for the finance team, which has had a key part in delivering and demonstrating affordability and supporting the commercial arrangements underpinning it.

‘It has been a big challenge,’ says Melanie Simmonds, associate director of finance and development at the trust. ‘The scrutiny – in particular from Monitor – has been extensive. It has involved additional resources, but I think the key decision was to have the finance department very much integrated with the project team.

‘Some finance managers have led projects and taken on the performance management roles for those work streams. Knowing the business – last year’s HFMA theme – has been crucial. It was important that they understood all the issues and how, when something changes, it changes the costs.’

Affordability was the focus for Monitor’s work and is probably the key issue facing most organisations with PFI deals. There have been high-profile concerns about the affordability of some early PFIs. The five PFI deals managed by the former South London Healthcare NHS Trust, which contributed to the financial problems that led to the trust’ dissolution last year, were costing the trust 18% of its turnover. This was way above the 12.5% rule of thumb (unitary payment as percentage of turnover or more recently estates costs as percentage of turnover) used centrally to gauge affordability.

It is even further above the 10.3% average in trusts where PFI contracts were deemed to be impacting on long term sustainability.

There are some grey areas around what is actually included in these figures, but Alder Hey is comfortably under these cost levels, with a final £13.5m unitary payment that represents around 7.3% of its £185m turnover.

Affordability has two components: income and costs. The trust has provided a thorough challenge to its current and potential future income. Costs are linked to size and bed numbers and the trust has kept bed numbers at similar levels to the current hospital (270), albeit supporting a different casemix.

Alder Hey has experienced activity growth in recent years, as clinical governance issues have pushed more children’s services to be provided in specialist centres – and greater specialisation continues to be the direction of travel. But the trust believes it can accommodate future growth by changes in pathways. More services will be delivered in the community, providing better care and avoiding some hospital admissions. Reduced length of stay also helps keep the bed requirement down.

Affordability has primarily been ensured through the use of trust surplus funds to keep the unitary payment down. Although the new PF2 builds in public sector equity investment as part of the approach from the outset, Ms Simmonds says previous PFI schemes had restrictions on the amount of their own money trusts could put into schemes.

‘You could only put in up to 30% of total project costs as cash,’ she says. ‘But we wanted to put more in.’

In fact, the trust was looking to invest about £82m of its own funds, accrued through surpluses in recent years. This proposed ‘bullet payment’, which grew from an initially proposed £30m as the project proceeded on the back of further accrued surpluses, represented close to 35% of the overall project costs.

‘We started exploring with the Department and Treasury if we could improve affordability and flexibility if they allowed us to increase above the 30%,’ she says. ‘They wanted to explore how this fit with the transfer of risk that is key to PFI.’

Pay-as-you-go approach

However, there were also restrictions on when this could be handed over – with existing policy requiring this to happen at scheme completion. The trust worked with the Department’s Private Finance Unit (PFU) and Treasury  to pay over the cash bullet on a pay-as-you-go basis during the construction phase.

There were major financial benefits. While the injection of cash would already bring the unitary payment down from £18m to about £14m, this could be brought down further by releasing the cash earlier and enabling PFI partner Acorn to avoid high bridge loan costs.

 ‘The rolled-up interest on £82m was significant and would cost another £700,000 per year in unitary payment for the next 30 years,’ says Ms Simmonds. ‘The Treasury had a number of concerns about the pay-as-you-go approach. They argued that the PFI consortium could go into liquidation with our money. We had to work with PFU and Treasury to ensure they were satisfied with the risk transfer and would allow the trust to pay the cash bullet on a pay as you go basis.’

However, the trust did secure Treasury support for the approach. It did its own risk assessment of the pay-as-you-go approach

and showed that the additional value outweighed the financial value of the additional risks by six to one. 

In fact, both these ‘freedoms’ – the ability to self-invest more than 30% of the project value and to release the cash during construction – are features of the new PF2 framework, almost certainly informed by the work at Alder Hey.

A complex funding arrangement will see £40m being borrowed from the Foundation Trust Financing Facility (now rebadged as the Independent Trust Financing Facility). These funds will primarily be used for the outpatient facility and equipment – freeing up trust funds to use in its bullet payment. The funds sit alongside a further £12m in charitable donations (see box previous page).

The rest of the £237m will be financed through the PFI, with the European Investment bank providing half of the required funds (about £54m). The funding for the other £54m was sought using a funding competition – again a feature of PF2.

From several responses to the competition, the trust went with M&G (the investment arm of the Prudential pension fund). ‘We were keen on the bond route [rather than bank financing],’ says Ms Simmonds, ‘because it offered lower costs. But most bonds had to be wrapped and go through one of the monolines [bond insurers] and require a credit rating.’

Ms Simmonds says M&G offered the ‘most favourable’ terms, was actively interested in understanding the project and had the additional benefit of not requiring an external rating, so reducing costs and time.

A final innovation in the commercial arrangements is that only part of the unitary payment rises with inflation – a condition agreed with bidders during competitive dialogue. Just 40%, in fact, of the initial £13.5m payment is linked to RPI.

In particular, the part of the unitary payment associated with the initial building costs isn’t subject to inflation. Ms Simmonds says this results in a slightly higher initial payment, but means the unitary payment effectively ‘flatlines’ and gives much greater certainty over future costs.

So, the deal is done and Ms Simmonds insists that the scheme looks affordable over the long term on current assumptions. The scheme will have an impact on the trust’s risk rating. However, the trust has been a solid 5 rating in recent years under the old compliance framework and is forecasting that it will still be in the top band (a 4 rating) under the continuity of service risk rating. 

Financial flexibilities

Ms Simmonds says that Monitor was reassured by the flexibilities built into the deal and by a number of mitigating actions identified up front if the trust encountered financial problems.

For example, if service delivery changes and some facilities in the new build are no longer required, the building is flexible and could be used for alternative services, which are currently being provided from other facilities run by the trust. Corporate and other clinical services provided in other trust buildings, for instance, could move within the PFI building, enabling revenue savings.

Sue Lorimer, now business director (north) for the NHS Trust Development Authority,

was Alder Hey finance director until April last year and saw the project through to financial close. She believes that the project shows there is a role for private finance in supporting capital projects.

‘It was a long process and a lot of people worked very hard and had to think laterally to get across some of the obstacles,’ she says. ‘There was a lot of mistrust about the PFI in the media and in general. But I think we showed that in the right context and with the right plan, PFI can be a really useful vehicle.

However, the trust is conscious that it has crossed the start rather than a finish line. And the finance role continues.

‘We need to make sure the project remains affordable, so we need to ensure we are integrated into the process and aware of any design changes,’ says Ms Simmonds. ‘And we need to keep the long-term finance model up to date, although there are no further business case reviews before project completion.’

She adds that the finance team is starting to look at patient-level cost data to explore more deeply the impact on costs of delivering services in new ways from the new facilities. ‘For our own benefit, we have to continue to demonstrate affordability,’ she says.