Public Private Partnership Prison Contracts: briefing

Meeting report

CORRECTIONAL SERVICES PORTFOLIO COMMITTEE
18 March 2003
PUBLIC PRIVATE PARTNERSHIP PRISON CONTRACTS: BRIEFING

Chairperson:

Presentation on PPP Prison Contracts
Report of the Task Team on PPP Prison Contracts

SUMMARY
The National Treasury briefed the Committee on public private partnership (PPP) prison contracts. A Task Team, comprising National Treasury, Correctional Services and Public Works, had been set up to review public private partnership prison contracts in November 2002. The Task Team sought, among other things, to understand output specifications, costing assumptions, project finance risk allocation, identify capital and operational costs. Louis Trichardt and Bloemfontein prisons were examples of pioneering projects.

MINUTES
Ms S Lund, Senior Transaction Advisor PPP Unit, National Treasury, briefed the Committee. She explained that a PPP was a contractual arrangement between a public sector institution and a private entity in terms of which the private party performs an institutional function or uses state property in accordance with output specifications for a significant periods of time in return for a benefit. This meant that all forms of the project life cycle risk (technical, financial or operational) were transferred to the private party. She stressed that the private entity assumed all the risks. The government becomes the monitor and regulator of service delivery and no longer its direct administrator. The government purchases the services or enables the project. If the private entity breaches its contract or does not fulfill its obligations, naturally there are penalties. Government remains the owner of the service.

Utilising detailed graphics she explained the generic project finance structure for PPPs as follows:
-Government enters into a PPP agreement with a private party.
-This private party finances itself through either one or several: equity, shareholding, loan agreements or debt.
-The private party then subcontracts to various parties. This was a standard project finance structure utilised globally.

With reference to the payment mechanism and utilizing an example of a PPP prison, she explained there was no initial payment by government during the construction period. During the operational period, there was a pre-set payment by government against delivery. This makes for clear budgeting by government.

South Africa's regulatory framework for PPPs
These were the Constitution, Public Finance Management Act and Treasury Regulations issued in terms of the PFMA. Regulation 16, which deals specifically with PPPs, applies to all National Departments, Provincial Departments, Schedule 3 public entities and business enterprises. These do not apply, however, to local government. They are regulated by the Municipal Finance Management Act. However, they do serve as a guide.

The National Treasury approves the partnerships for affordability, value for money and appropriate allocation of risk. These approvals are embedded in the generic PPP project life cycle. She referred Members to the latest edition of the PPP Quarterly for a clearer graphic presentation of the Generic PPP project life cycle.

Using graphs, she explained the Department's feasibility method to set affordability and calculate value for money. Simplistically, the Departments calculate, over a 25-year life cycle plan, how much it would cost them to construct and operate the prison. This is compared to how much this would cost the private sector. It is widely accepted that the private sector is better at managing risk than government.

A Task Team, comprising National Treasury, Correctional Services and Public Works, reviewed public private partnership prison contracts in November 2002. The Task Team sought, among other things, to understand output specifications, costing assumptions, project finance risk allocation, identify capital and operational costs.

Their findings were divided into three parts:
-Existing PPP transactions.
-Future prison projects.
-Recommendations for next steps.

Overview of Existing PPP Prison Transactions
Ms Lund highlighted in detail the existing PPP prisons transactions, namely, Louis Trichardt Prison and the Bloemfontein prison, and the parties to each of the contracts, emphasizing the leverage of black equity.

The Department of Correctional Services (DCS) specifications were based on outputs rather than inputs as this costs the Department. She presented to Members examples of DCS specifications on design and operations. The idea, she stated, was to make the private sector responsible for the outputs.

With respect to fees payable by the DCS, Ms Lund provided a comparison of the Fee Structure of fees payable by Correctional Services, a breakdown of operating costs of both Bloemfontein and Louis Trichardt.

Options for Re-Negotiation of Existing Contracts
These options were:
-Construction expenditure.
-Operating expenditure (eg. Staff costs, rehabilitation and health care, fee payment structure and change in prisoner numbers).

Recommendations: existing PPP contracts
The Task Team made a number of recommendations with respect to existing PPP contracts.
The PPP Prison projects delivered according to DCS' specifications and achieved the following:
-Competitive construction costs.
-Construction on time, on budget.
-Significant black equity and sub-contracting.
-Significantly higher levels of service and higher quality facilities.
-Appropriate risk allocation and so forth.

Despite these achievements Ms Lund, elaborated the problems as well.

Problems with existing contracts included:
-DCS specifications were too high. She stressed that 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 the DCS system, PPP prisons cannot be overpopulated.

Ms Lund discussed the extent future recommendations can change the standards the DCS will approve for existing projects.

Future Prison Projects - Illustrative Comparisons between Public and Private Prisons
There were barriers to direct comparison between PPP and public prisons, and these related to capital costs and operating costs. They include:
-Differing prisons - max, super max, medium and so forth and size.
-They were constructed at different times.
-Differing geographic locations.
-DCS does not have a cost center focus and PPP operators have different cost allocation structures.
-Historical procurement problems created inefficiencies.

Future Evaluation Methodology: Feasibility Protocol
DCS needs to demonstrate affordability, value for money and acknowledgement and treatment of risk

Several graphs were shown to illustrate the feasibility protocol. Ms Lund emphasized that the overriding consideration was what the Department could afford, and not an aspiration for a perfect, yet unaffordable package.

Recommendation for future projects
-The DCS has to clearly establish output specifications for design and 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. (This was a sore point for DCS.)
-Comprehensive feasibility.

The Task Team's Recommendations for next steps include the following:
- Engage PPP contractors to improve value for money (reviewing standards, amending fee payment structure, accommodating additional inmates, negotiating debt financing and so forth.)
- The adoption of the Feasibility Protocol for all future prison projects.

The Treasury's recommendations included:
-Negotiations on current contracts must begin now.
-A partnership relationship with two private partners must be built.
Feasibility work must be done as per feasibility protocol before four new prisons are commissioned.

Louis Trichardt prison
Mr Korabie (private sector, Louis Trichardt prison), emphasised the benefits to the government and South African society as a whole when the government utilizes the services of the private sector. He also stated why the private sector was glad to deliver an effective service to government and why they were the appropriate choice. He spoke to the empowerment within such deals with the government, emphasizing the value it brings to the development of South Africa. He referred to the example of empowerment through the recruitment of people at the Louis Trichardt and the quality of services. In essence, they were keen for working a partnership.

Bloemfontein prison
Mr Venter (private sector, Bloemfontein prison) saw their role also in terms of social responsibility. They would also like to continue with the government to provide high standards for the Department with an emphasis on value for money).

Discussion
Mr Chivase (DCS) stated that the Department agreed with the contents of the Task Team Report and the recommendations as the way forward.

The Chairperson asked whether the new generation prisons would be built in accordance with these new projects. The Department deferred their response to a later stage.

Mr Ferreira (IFP) expressed his enthusiasm and support for the project except. However, a problem with the PPP prisons is that they cannot be overcrowded. The reality in SA, he added, is the issue of overcrowding. If the PPP prisons cannot be overcrowded, more and more prisons would be have to be built.

Mr T Williams (Treasury) responded that the Department does not have to have one or the other. Perhaps all Departments concerned should change their standards or specifications, instead of two persons per cell, they could have twelve, for example.

Ms Lund commented that the pressure placed on prisons was from awaiting trial prisoners. This problem had to be dealt with by the Department of Justice.

The Chairperson added that steps exist to deal with overcrowding. It was an issue that the Committee has to deal with very quickly.

Mr D Bloem (ANC) asked about the breakdown of operational costs and what happens to the prisons after 25 years.

Ms E Ngaleka (ANC) wanted an explanation of the "K-factor" used by the Treasury in their presentation. What was the DCS saying about the balancing of factors?

Mr Williams, attempting to answer some of the outstanding questions, explained the 'K-factor'
as a common way of explaining equations which reflected real increases above inflation/adjustments in inflation.

Addressing the concerns cumulatively, the DCS and the Treasury responded as follows.

Mr Chivase spoke on the difficulty of discussing the competency of controllers. He said that the DCS did not intend to outsource the activities of the Department. Instead, the DCS wished to have a 50-50 sharing with the private sector. In other words, the private sector would provide the structure of the prisons, but the Department would run the operations. They were not at a stage to outsource all the activities of the Department.

Mr Korabie, adding to Mr Chivase's comments, stated that in terms of contracting services out, it is not privatizing, it is contracting services out. The responsibility, however, remains with government. He emphasised that the government is not outsourcing any of its responsibilities. Ultimately, it is not for DCS to decide, it is for taxpayers. Delivering the best for taxpayers is what counts.

Ms Lund stated that PPPs are not structured to abdicate responsibilities.

Mr G Oosthuizen (ANC) asked what would be the acceptable rate of return on debt equity; would it be linked to inflation and what would be the measurement link?

Ms Lund stated that the range of equity returns was 17-22%. These returns were not unreasonable.

Mr Bloem (ANC) noted that it seemed as if there was a tension between the private sector and the DCS on mistakes that arising from 'pilot projects'.

The Chairperson noted that another meeting would be held to take a decision on issues. He stressed that this meeting with the Treasury was an information session and no decisions would be made just yet.


Ms Lund added that Louis Trichardt and Bloemfontein were pioneering projects. The four new prisons would be subject to feasibility studies before being carried out.

Responding to queries about the cost of prisoners per day, the figures she provided were the operating costs in October 2002, although the cost they considered was the overall cost over 25 years.

After the 25 year period, she added that the prison belonged to the government. It had to be returned to the government in the same condition after 25 years.

The Chairperson added that he would facilitate communication with the three Ministers to talk about the Task Team Report and that he will be inviting stakeholders to a meeting on the White Paper.

The meeting was adjourned.