Value for Money Test in Korea

PIMAC Hojun Lee [email protected]

Public and Private Infrastructure Investment Management Center

Value for Money Test

1. Process of PPP Project Implementation 2. VFM : The Theory 3. VFM : The Practice in Korea

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Part-01 Value for Money Test

1. Process of PPP Project Implementation

Project Initiation



Both the government and a private company can initiate a PPP project



Solicited Projects

  A solicited project is that the competent authority identifies a project for private investment and announces a RFP Competent authorities develop a potential project after considering related plans and demands for the facility. They then weight the procurement options in order to determine whether the PPP procurement is more efficient than the conventional procurement  

Unsolicited Projects

For an unsolicited project, a private company (project proponent) submits a project proposal, and then the competent authority examines and evaluates the contents and value for money of the private proposal, and designates it as a PPP project 5

Procurement Steps of a Solicited Project

Competent Authority Competent Authority Review by PIMAC Competent Authority Solicited Project Selection of PPP Project VFM Test Designation as the PPP Project Announcement of RFPs Submission of Project Proposals Evaluation and Selection of Preferred Bidder Negotiation and Contract Award (Designation of Concessionaire) Application for Approval of Detailed Implementation Plan Construction and Operation Competent Authority Private Sector → Competent Authority Competent Authority Competent Authority → Preferred Bidder Concessionaire → Competent Authority Concessionaire 6

Procurement Steps of an Unsolicited Project

Unsolicited Project Submission of Project Proposal VFM Test Notification of Project Implementation Announcement of RFPs Submission of Project Proposals Evaluation and Selection of Preferred Bidder Negotiation and Contract Award (Designation of Concessionaire) Application for Approval of Detailed Implementation Plan Construction and Operation Private Sector → Competent Authority PIMAC Competent Authority → Proponent Competent Authority Private Sector → Competent Authority Competent Authority Competent Authority → Preferred Bidder Concessionaire → Competent Authority Concessionaire 7

2. VFM : The Theory

The VFM Concept



What is Value for Money?

 The best available outcome after taking account of all benefits, costs and risk over the whole life of the project (HM TREASURY)  Not lowest price 

Why it is Used?

 Seek the best use of available resources  Efficient and effective public service delivery  “ The competent authority uses VFM reports as basic material to make a judgment on whether to move forward with the PPP project proposed by the private proponent” according to the Article 7, Paragraph 3 of the Enforcement Decree of the PPP Act 9

Key Elements of VFM



VFM is often a comparative assessment

 Requires a benchmark cost : PSC (Public Sector Comparator) 

PSC is a benchmarking and evaluation tool : a Key tool

 Benchmarks the cost of government service delivery  Evaluates whether VFM is delivered from bids 

A Procurement principle, not only for PPP



Adopted by different countries to meet government

’

s procurement practices

 Not a universal tool 

Applied on a project or program basis



Innovation, asset utilization, risk sharing, competition, service integration ate main key drivers of VFM

 Presence of VFM drivers confirms suitability for PPP 10

The Role of PSC



Promote whole life costing early in the project

’

s development



Assist in assessing the project affordability



Provide a means for demonstrating VFM

 Provide a consistent benchmarking and evaluation tool 

Encourage bidding competition



Based on :

    Reference Project Risk analysis Cash flow over the life of the project (inflation, cost, revenue, discount rate..) Government procurement costs to asses project affordability 11

VFM Assesment



Compare to PSC or between bidders



Presence of VFM confirms suitability for PPP.

PSC NPV of Retained Risk NPV of Transferable Risk NPV of Competitive Neutrality NPV of Raw PSC PFI NPV of Retained Risk QUANTITATIVE VFM NPV of PPP Contract 12

3. VFM : The Practice in Korea

Implementation



PIMAC of KDI is in charge of VfM test as stipulated by the PPP Act



VfM test is carried out in accordance with ‘Guidelines for implementation of VfM Test/Review of Proposal for unsolicited BTO projects’.



Five interim review meetings are held during the VfM test



The duration of each project research should take up to six months



Same methodology and procedure are applied both to VfM Test and Review of Proposal



Objectivity, consistency, independence as well as professional expertise are important elements in conducting VfM tests.

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Organization of a Research Team



A VfM test is carried out by a multi-disciplinary research team



KDI (Project Manager)

 Experts with relevant skills and expertise for the project are selected at the preliminary stage 

External experts (selected from human resource pool)

   Demand forecasting : university professors Cost estimation: engineering companies Accounting: accounting firms 15

Scope of a VFM Test



Phase 1: Feasibility study (Decision to Invest)

 The cost- benefit analysis is conducted to determine feasibility of the project from a national economy perspective.



Phase 2: Value for Money Assessment (Decision on PFI)

 The government payment of PSC (Public Sector Comparator) is compared against that of PFI (Private Finance Initiative) to assess whether the PFI achieves VfM. 

Phase 3: Formulation of PFI alternatives

  Based on the results of phase 2, an appropriate PFI alternatives are formulated The level of project cost, user fee, subsidy scale, etc. are suggested from the government.



Phase 4: Award bonus points to the initial proponent

 Bonus points (10% max.) awarded to the initial proponent are estimated based on the results of VfM tests and the quality of the proposal.

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Setting Comparators for VFM Test

VfM Analysis Implementation Method

Private Finance Initiate Public Sector Comparator

Unsolicited

PFI p (based on proposal) PSC p (estimated by research team)

Unsolicited With Public Plan

PFI p (proposal) PFI G (research team) PSC p (research team) PSC G (research team)

Solicited

PFI G (research team) PSC G (research team)

Flowchart of a VFM Test

(Unsolicited)

Project Proposal(PFI 0 ) Construction of PSC(PSC 0 )

Phase 1

N Feasibility analysis Construction of PSC 1, PFI 1

Phase 2 Phases 3 & 4

Y VFM test of private proposal (VFM1=PSC1 PFI1≥0) N Construction of PFI 2-i, Y VFM test of PFI alternative (VFM 2 =PSC 1 -PFI 2 * ≥0) N PFI Alternative (PFI 2 *) Calculation of bonus points Implementation of PPP Project Rejection 18

Flowchart of a VFM Test

(Unsolicited with Public Plan)

Project Proposal (PFI p ) Construction of PSC (PSC p ) PSC by Public Plan (PSC G )

Phase 1

N Feasibility Test (PSC p PSC G ) Y

Phase 2 Phases 3 & 4

N Construction of PFIp 2 PSC Y p1 , PFI Y s1 VFM test (VFM P1 ) PSC G1 , PFI G1 Y VFM test (VFM G1 ) Y N Construction of PFI P2 Calculation of Bonus Points (VFM p ) VFM test (VFM P2= PSC p2 -PFI p2

≥0

) Y N PFI Alternative (PFI With bigger NPV 2 * ) Y VFM test (VFM g2= PSC g2 -PFI g2

≥0

) N Rejection Implementation of PPP Rejection

Flowchart of a VFM Test

(Solicited Project)

Construction of PSC (PSC G )

Phase 1

N

Phase 2

Feasibility Test (PSC G ) Y Construction of PSC G1 , PFI G1

Phases 3 & 4

VFM test (VFM G1 ) Y Construction of PFI Alternative N Implementation of PPP Rejection

Phase 1: Feasibility Study (1)



Assess project feasibility and necessity in the context of national economy and policy directions



Cost-benefit analysis method is used to assess the economic feasibility of a project

 CBA is conducted in accordance with sectoral guidelines (e.g. roads, railroads, ports, seaports, dams, and environment facilities) for PFS (Preliminary Feasibility Study)  B/C ratios calculated based on Estimation of demand, costs, and benefits  Sensitivity analysis 

Policy analyses, if necessary, are carried out

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Phase 1: Feasibility Study (2)



Setting a PSC (Public Sector Comparator)

 Setting an appropriate PSC option is very important both to feasibility and VfM of a project 

A basic assumption of VfM test (including FS) is that the level of service same will be provided by both PSC and PFI options

 In reality, a PSC option that is compatible with PFI proposal is formulated 

Total, (risk adjusted) whole-of-life cost of the project is estimated if government is to undertake the project.



User fee and project cost of PSC are not necessarily same as those of PFI

 The user fee of PFI is usually larger than that of PSC 22

Phase 1: Feasibility Study (3)



Policy analyses are carried out if necessary

  Evaluation in qualitative/quantitative terms whether the project is justified in relation to relevant policy issues Relevant policy issues: balanced regional development; consistency with higher level plan and policy directions; and environment impact analysis, etc.



The overall feasibility of a project is assessed based on economic and policy analyses



If the FS results demonstrate that the project is feasible, then VfM assessment ensues.

 If not, the VfM test process as a whole is suspended, and PIMAC recommends the Competent Authority to reject the project proposal.

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Phase 2: VFM Assessment (1)



Government spending of the PSC is compared against government payment requested by PFI proposal to assess if PPP procurement improves the value of tax payer’s money



Features of VfM assessment

     It assists government making decision on appropriate procurement options: conventional public procurement vs. PPP procurement.

It provides a quantitative VfM level and a justification for the decision on procurement option.

It provides a reliable benchmark and specifies project scope.

It encourages project appraiser to consider risks early in the project lifecycle, and address risk transfer options in the bidding process.

It reduces negotiation time and increases the efficiency of bidding costs as the scope of private sector bids are more aligned with the public sector needs, and risk transfer profiles.

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Phase 2: VFM Assessment (2)



Cost items adjusted for competitive neutrality between PSC and PFI options

 Revenue from user fee is deducted from government payment of PSC  Revenue from supplementary project is taken into account in consideration of both options  VAT and other tax payments are adjusted   Same amount and payment schedule of land acquisition is applied to both options Administrative costs incurred by governments for project management are excluded from both options  Insurance fee are estimated in different ways, reflecting the difference in market valuation of project risk by project owners  Additional government support if requested by private company is included in both options based on estimated spending 25

Phase 2: VFM Assessment (3)

Capital costs ① ②

Item

Project costs Financing costs operating costs

Base cost born by the government Risk adjustment costs Total government payment

Construction cost

PSC

(1) Cost of survey (2) Design cost (3) Construction cost Land acquisition cost (4) Compensation for land and other possessions

Supplementary

cost (5) Cost for feasibility study (6) Cost for transportation impact assessment (7) Cost for environmental impact assessment (8) Cost for supervision (9) Insurance costs (10) Cost for operation equipment

(11) Taxes and fees

(12) Business setup costs (13) Financing costs (14) Operation costs (15) Maintenance costs (16) Management and supervision costs

(Capital costs + operating costs) - operating revenue Cost and time overrun

①

+

Construction cost

PFI

(1) Cost of survey (2) Design cost (3) Construction cost Land acquisition cost (4) Compensation for land and other possessions

Supplementary

cost (5) Cost for feasibility study (6) Cost for transportation impact assessment (7) Cost for environmental impact assessment (8) Cost for supervision (9) Insurance costs (10) Cost for operation equipment

(11) Taxes and fees

(12) Business setup costs (13) Financing costs (14) Operation costs (15) Maintenance costs (16) Management and supervision costs

Construction subsidy + land acquisition cost +additional government support

② 26

Phase 2: VFM Assessment (4)



Present value of government payments for PSC and PFI options are estimated (discount rate = 5.5%) and VfM(%) is calculated

VfM

(%) 

GP

(

PSC

) 

GP

(

PFI

)

GP

(

PSC

) 

GP(PSC) = Capital costs + operating costs – Revenue



GP(PFI) = Construction subsidy + Compensation costs + Additional government support

 GP(PFI) is the government subsidy requested by the private party in the project proposal 27

Phase 2: VFM Assessment (5)



Qualitative VfM assessment

 Allocation of risks (construction, operation risks, etc.)  Improvement of service qualities  And other ripple effects (positive externalities): Promote the financial market through the adoption of an advanced financial technique, etc.

 Quantification of project risk transfer is not satisfactory and those qualitative effects are not incorporated into overall VfM assessment so far 28

Phase 3: Formulation of PFI Alternatives



Financial analysis and sensitivity analysis are carried out to assess the profitability (bankability) of a project



Based on the VfM assessment and financial analyses, PFI alternatives including the following components, are formulated:

     Total project costs User fee IRR (Internal Rate of Return) Total government payments Other components related to the implementation of the project 

The Competent Authority chooses the most appropriate PFI option and invites third parties to tendering

 If it is impossible to formulate a PFI alternative that delivers VfM at a reasonable level of IRR, then the PFI option is rejected 29

Phase 4: Bonus Points for Initial Proponent (4)



The VfM test team makes decision on bonus points (10% max) to be awarded to the initial proponents based on the VfM(%) and quality of the proposal



The quality of a proposal is evaluated based on the following criteria:

①

Priority of the project in the mid- to long-term government investment plan (10 points)

②

Composition of equity investors (10 points)

③

Excellency of construction and operation plan (30 points)

④

Accuracy of demand forecast (30 points)

⑤

Prior consultation with relevant government agencies and plan of addressing of civil complaints (10 points)

⑥

Adequacy of required documentation (10 points)

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Phase 4: Bonus Points for Initial Proponent (4)



Bonus Point



Swiss Challenge offer.

: the original proponent has right to counter-match any superior



Best and Final Offer : the winning bidder must compensate the original proponent for project development costs.

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Phase 4: Bonus Points for Initial Proponent (4)

2,4 2,2 2 1,8 1,6 1,4 1,2 1 BTO 민간제안 사업 평균 경쟁률 BTO 국가고시 사업 평균 경쟁률 BTO 사업 평균 경쟁률 우대가점 해당 사업 평균 경쟁률 우대가점 발생 사업 평균 경쟁률 32

Phase 4: Bonus Points for Initial Proponent (4)

참여자 수 3 2 1 0 -0,50% 0,00% 0,50% 1,00% 1,50% 2,00% 2,50% 우대가점 33

Use of VFM Test Results



The VfM test sets the bottom line to meet the condition of ‘VfM≥0’ in selecting preferred bidder and following phases of a project.



VfM reports are used as an important reference when tender evaluation committee conducts their work.



VfM reports provide useful information to prompt negotiation process.



VfM reports are used as reference when ex-post VfM tests are conducted.

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