Bermuda's new hospital wing is due to be built with no money down. Bermuda Hospital's Board CEO David Hill and KPMG Managing Director Malcolm Butterfield explain the intricacies of public private partnerships (PPPs). By Matthew Taylor

Ask a construction firm to build you a house, to your own specifications and tell them they won't be paid a penny unless it's done exactly to your liking and you will likely be laughed at.

And yet this is what the Bermuda Hospitals Board (BHB) is planning to do with its $260 million new wing due by 2013.

Yet it is confident plenty of world-renowned consortiums will bid for the job.

Incredibly, it seems Bermuda's largest capital project is also its first major venture into the world of public private partnerships (PPPs).

The model has a chequered history elsewhere. In Britain some hospital projects built under PPP soared in cost by more than 100 percent causing other hospitals to be closed as health authorities sought to save haemorrhaging cash.

In some cases the public surrendered ownership and were held to ransom by consortiums inflating maintenance contracts. When one consortium running a Scottish school went bust, sub contractors burst in and seized pupil's books and computers in lieu of payment.

BHB CEO David Hill doesn't need telling about the UK's PPP horrors the Englishman saw at first hand how some early models spiralled out of control. But he is quick to point out that it doesn't have to be that way hard lessons have been learned and there are plenty of advantages to partnering with private enterprise.

And he said the BHB had taken a lot of expert advice before taking the PPP plunge.

Some of the earlier schemes didn't specify what would happen if the consortium refinanced halfway through to make a profit, said Mr. Hill.

"That will now be clearly covered in the agreement we come up with."

And he said the time between a company quoting a price and when the building started would be a lot shorter so the company could be held to their figure to avoid the moving target scenario in years past.

Some PFI's had the consortiums actually taking ownership of the building and leasing it back but the KEMH deal keeps the new wing in the hospital's hands.

"We will own the building throughout and operate all the clinical services."

And he is confident that Bermuda's particular PPP model, known as Design, Build, Finance, Maintain (DBFM) and recommended by business advisors KPMG, offers better value for money than any of the other options.

It will work as follows:

¦ The first payment for the new construction is in about five years, once the buildings are completed to BHB's specifications. Further payments are spread over years, easing the financial burden of such a large project on the taxpayer.

¦ Many of the risks are transferred to the private partner including potential construction delays or cost-overruns

¦ The new buildings are constructed to BHB's specifications

¦ BHB retains ownership of the facilities and keeps direct control over all operations that touch the patient, allowing BHB to improve patient care

¦ The buildings are maintained by the PPP partner at a mutually-agreed standard over a lengthy concessionary period, giving the partner a vested interest in building quality facilities.

Under the traditional model the hospital would get stung if there were rising costs, said Mr. Hill.

"However under this method the construction company and its partners have to contain any cost escalations. They cannot pass that on to us."

He expects to sign a contract within two years.

"They will give us a price, that is fixed in a very clear, legally binding agreement that says 'you will deliver this facility at this price in three year's time'.

"If their costs go up that is their risk, they cannot pass that on. If it is not to the standard we will not make a payment until they improve it to the standard. There is no ability for the consortium to pass on those traditional costs which have beset some public sector projects in the past.

"Whichever way you do it, whoever you partner with, they need to make a fair return. We will tender it to the best international companies to get the best price."

It's a process Mr. Hill is familiar with. "I am old enough to have gone through PFI when it first started in the UK some of which went pear-shaped. All the lessons have now been learned. All the possibilities are now known."

That's why BHB is employing 'big four' accountants KPMG and Canadian law firm Davis who are experts to protect the Government and Bermuda against risk, said Mr. Hill.

"If the firm defaults it will be very clear in the contract what happens one option is not that we pay more. We don't pay a cent until it's finished. If it is half finished and they walk away, we have got a half-finished hospital and they have not received any money."

Critics have complained Government is still underwriting the project but Mr. Hill said that was no different to other jurisdictions. He added: "We know how to run hospitals, some other people are better at running $260 million capital projects.

"It's not about whether PPP is right for every project it is right for this project."

He said BHB would pay around $40 million as a down payment when the job was done while the rest would be paid monthly. With no money paid up front the consortium would have plenty of motivation to build on time to specifications in order to get their hands on the first tranche of cash.

It seems too good be true but Mr. Hill said BHB would still have to pay, one way or another. "We are not avoiding anything other than the risk of paying more than has been justified by the build to date."

He said the risks with PPP were covered by having the right expert advice.

"This is now a fairly well-proven technique. We are not piloting it, we have expert advice looking at Canada and the UK for best practice.

"There is now 20 year's worth of experience and knowledge and I think both the public and sector have a better understanding (of each other)."

And one of the advantages of PPP was the architectural innovation it encouraged, said Mr. Hill.

Rather than get an architect to design a building and put it to tender, under PPP rival consortiums would be given a list of necessary components to put into an allotted space and would be given the freedom to suggest clever ways of delivering all the necessary components.

"There's value engineering," added Mr. Hill. "They have to deliver what's in the contract at the lowest possible cost. Rather than have one architect and one scheme, five or six companies will come back with their ideas.

"Until it all comes back we don't know what it's going to look like it's their imagination and their innovation. But I know I will get 90 ensuite inpatient rooms to the standard specified."

These savings needed to be borne in mind when people were worrying about whether the private sector was borrowing at a slightly higher rate than Government, said Mr. Hill.

Once built the consortium has responsibility for maintaining the building. "The contract will be very specific on how that is costed and charged. Which in some of the early ones is wasn't."

Asked on how a company can pitch a realistic price for maintenance for a 30-year contract without needing change down the line, Mr. Hill said: "Before we close with the successful bidder we will make sure their figures are audited so to make sure they have taken into account everything we require.

"We don't want a bid that's underpriced that causes continuing conflict. What we want is a fair price. It's not about holding your cards very close to your chest, they will put in a very detailed submission to us. But the best guarantee we have is we are dealing with companies who are very experienced in this, we are going out to the international market. Already interest has been expressed."

Critics of PPP have argued Governments can borrow money at cheaper rates than the private sector something which could be an even bigger concern in a credit crunch.

But Malcolm Butterfield, of advisors KPMG, said this has been looked at but there were still investors specialising in infrastructure projects who were keen to put in money.

"When you look at the ebbs and flows of the market you have to look at the fact that the infrastructure market is quite different from what we hear about on a day to day worldwide basis," said Mr. Butterfield. "That market is quite positive and quite buoyant."

He said a consortium of financiers rather than one investor would be needed for a $260 million project. And Mr. Butterfield said KPMG's international PPP experts had helped along with legal, technical and clinical advisors.

"All that puts the Bermuda Government in a position to know they are going into an agreement that's well crafted, tight and able to avoid the potential for risk going forward."

He said newer PPP's in Ontario and British Columbia in Canada had successfully stopped any project price hikes and now the UK was moving to the Canadian model. "It will be a flagship transaction, historically I think the largest Bermuda has ever venture."

And Mr. Hill added: "We see ourselves as a flagship which puts responsibility on us to get it right for Bermuda."

PPP Facts

Experts said Bermuda needed 50 percent more space for its acute care services. BHB has approval to construct a new patient tower, an ambulatory care centre and central utility plant over the next five years. At the same time BHB will renovate the existing KEMH in a $55 million project run along traditional lines.

In the BHB's particular form of PPP, the hospital will have an agreement with a private consortium and, like a mortgage, pay back the partner over a period of 25 to 35 years so the BHB does not have to pay the entire construction cost (with risks of over-runs and cost escalation) up front.

The first lump sum is paid in about five year's time, when the new buildings are completed to BHB's satisfaction. The remaining payments are spread over 25-35 years.

While there have been concerns raised that a PPP means you pay back more over time, this ignores the transfer of risk that would not be possible with a traditional style loan or loan through Government, said the BHB.

However there are upfront costs associated with a PPP. A team of experienced international and local advisors are needed to ensure that the correct specifications are put in place for the private partner and to ensure BHB is able to select the private partner offering the best overall value.

Why include maintenance in the PPP?

In a DBFM model, the private partner must perform hard facilities maintenance (e.g. painting, roof repair, structural maintenance) as well as undertake major refurbishments in the new facilities for the entire concessionary period.

This gives the private partner incentive to construct the new buildings to a high standard and have them completed on time, because they only start receiving payments when the buildings are complete and meet the contract's specifications.

Typically, the contract includes provisions so that the payments made to the private partner are reduced in the event that the private partner does not meet its performance obligations.

All healthcare services will continue to be under BHB's control and the building itself will be owned by BHB.

Time frame

Following a competitive procurement process, BHB expects an agreement with a private partner late next year, followed closely by groundbreaking. It is expected that the first patients will walk through the doors of the new facilities in less than five years time.

Cost to Bermuda

In order to continue renovations and build the plant, hospital fees increased by one percent over the annual inflation figure this year.

Of the 6.95 percent fee increase for the fiscal year 2009/10, one percent is related directly to the KEMH Redevelopment Project (and 5.95 percent is related to other cost increases, mainly inflation).

The understanding is that BHB will receive a similar one percent raise for four years after this.

This means the total fee increase directly associated with the KEMH Redevelopment Project will be five percent over five years.

Hospital fees make up about half of healthcare costs in Bermuda so it is likely that this will affect insurance premiums by less than three percent over five years, said the BHB.