Technical Director, Health Sector Lead – Victoria, AECOM

The use of the PPP to deliver social infrastructure in Australia, including public hospitals, corrections facilities and schools is not new, and the bundling of contracts for design, construction, finance, maintenance, and ancillary services, such as building management, waste management

and disposal and cleaning, has been demonstrated to provide value for money for suitable projects. A full outsourcing model, where the scope of the PPP agreement is extended to include core services, such as clinical services in the case of a public hospital, may achieve further benefits for government and taxpayers, including access to private sector management and organisational efficiencies, further value for money and greater risk transfer and/or sharing with the private sector partner.

The full outsourcing model, also referred to as the operator-led model as it is often led by the private sector operator rather than equity investors, has been used with reasonable success in the justice sector, with several corrections facilities across the country4 operating under this model. However, its application to hospitals has been only moderately successful, such that, until December 2014 when the NSW government signed the contract for the NBH PPP, no Australian government had contracted for an operator-led hospital PPP in almost 15 years.

This article considers whether improvements to the PPP model in recent years mean that it is time again to contemplate the operator-led model for the delivery of public health services. It provides an overview of Australia’s hospital PPP history, including reasons for the failure of several earlier operator-led hospital PPP projects. It then considers NBH PPP, including project arrangements, likely reasons for government pursuing the operator-led model, and the findings of the 2020 government inquiry into the operation and management of the hospital.5 With consideration to past and contemporary hospital PPPs, including brief comparison with several international operator-led PPPs, the key risks, opportunities and challenges faced by the modern operator-led hospital PPP are identified and strategies to overcome or mitigate risks and enhance opportunities for the benefit of the project, government and taxpayers are evaluated. Finally, the article considers if the benefits of the operator-led hospital PPP outweigh the risks and challenges and whether there is indeed a place for the operator-led hospital PPP in Australia.

On initial review, the operator-led PPP appears to be a robust and feasible option for the delivery of public health services in Australia. However, it is the diametrically opposed purposes of the private and public sectors – the former motivated by profit and the latter by the provision of equitable access to health care, and the inability of government to transfer accountability

for the provision of public health services, that presents the greatest challenge to the success of the operator-led model. The outcomes of the recent inquiry into the operation and management of NBH, including the recommendation “that the NSW government not enter into any public-private partnerships for future public hospitals”,6 is further evidence that the operator-led PPP is not appropriate for the delivery of public health services in Australia.

The primary difference between the pre- and post-2000 PPPs is the approach of government policy to risk allocation and the role of the private sector during the operating term, with the focus of the pre-2000 model on maximum risk transfer and the focus of the post-2000 model on value for money, optimum risk allocation and the public interest test.9

A success feature of past and current PPPs is the ability of the private sector to design, construct, and commission the asset on time and on budget.12 However, it was during the operating phase that the pre-2000 projects encountered difficulties, with government assuming ownership and operation of three of the seven13 hospitals procured under this model before the end of the contract term. Of the remaining hospitals, government assumed ownership and operation of one following the expiry of the contract,14 and the remaining three, Noosa Hospital, Joondalup Hospital and Hawkesbury Hospital in NSW, continue to operate under extended agreements.

While the commercial-in-confidence nature of contracts with the private sector means that the precise reason for government takeover of these contracts is not public knowledge, the reasons are individual to each project. For example, in 1998 the Queensland government entered into separate PPP contracts, with different operators but under similar terms, for Robina Hospital and Noosa Hospital.15 While Robina Hospital was brought under government control before the end of the contract term,16 government renewed its contract with the private operator of Noosa Hospital in June 2020 for a further 10 years.17

Several government inquiries and reports18 identify various problems with these early PPP contracts. These problems include a lack of private

sector understanding of government hospital funding models;19 insufficient economic analysis and benchmarking of the cost of public health services delivery;20 a belief that the private sector could deliver health services more efficiently than the public sector;21 optimism bias and an expectation that government would renegotiate financial terms for troubled social infrastructure projects rather than suffer the political and social risk of failure;22 a guaranteed rate of return to private sector investors;23 and a flawed tender evaluation process focused on cost as the measure of value for money.24

While it cannot be said that all hospital PPPs brought under government control were financially troubled, this was the case for LRH and PMBH. Flawed tender assumptions resulted in extensive financial losses to the operator of LRH, placing the availability and delivery of public health services at risk and leading the Victorian government to terminate the contract.25 In the case of PMBH, the NSW government entered into a contract under which availability and service payments far exceeded the cost of a publicly funded and operated hospital, and under which it guaranteed an annual, risk-free return to the private sector partner.26 Additional costs incurred by government for the termination of these contracts totalled AUS$1 million for LRH and AUS$35 million for PMBH.27

In undertaking research for this article, information was found to be readily available regarding the reasons and cost to government and taxpayers of the failed pre-2000 PPPs; however, little information was found regarding the performance of those pre-2000 PPPs that continue to operate under extended contracts. In the absence of this information, it is reasonable to question whether these PPP contracts continue to provide value for money.

While Joondalup Hospital PPP is held by its supporters to be a success,28 a 1997 WA Auditor-General report challenged the robustness

of capital cost benchmarking for public sector procurement of the facility, bringing into question the substantial capital cost savings predicted under the PPP.29 The report further observed that the contract did not provide for cost savings during the operating term.30 A follow-up report31 completed three years into the operating term concluded that the contract, valued at AUS$50.8 million for the 1999–2000 year, produced operating cost savings of only AUS$400,000. Further, these savings did not consider public sector costs associated with the management of the contract.32

While the problems identified with these early hospital PPP contracts are various, their lack of success ultimately stemmed from government entering into contracts that did not include mechanisms for review and renegotiation,33 private sector inexperience in the provision of public health services, government pursuit of maximum risk transfer,34 and government confidence that it could successfully transfer accountability for the provision of public health services to the private sector.35

While the National PPP Guidelines allow jurisdictions to decide to what extent core services are provided by the private sector,39 until December 2014 all post-2000 hospital PPP contracts excluded the delivery of core services. Absent a private operator, these modern PPPs were led by a variety of investor types who, motivated by the need to provide a financial return to shareholders, were focused on the delivery of the asset on time and on budget and its availability and performance during the operating term.

These positive outcomes can be attributed to the increased sophistication of government agencies and the market in the delivery of PPPs. Benefits of private sector involvement include private sector ability to access capital, delivering public infrastructure earlier than what would be possible via public sector funds; the use of private finance to promote private sector innovations and efficiencies in design and construction and enhance value for money; increased due diligence and scrutiny by equity investors and financiers; improved budgetary certainty; synergies achieved by bundling D&C, finance, and maintenance contracts;40 the use of key performance indicators (KPIs) and abatements to incentivise performance; and the capacity of the private sector to manage risk.

These benefits and recent track record of hospital PPPs in Australia have led some state governments to consider whether further benefits might be yielded by expanding the current model to include the private sector provision of core services.41 In December 2014, 15 years after any Australian government last contracted for an operator-led hospital PPP, the NSW Liberal government signed a contract with private sector operator, Healthscope to design, build, finance, maintain and operate the Northern Beaches Hospital (NBH) in Frenchs Forest.

Several features of this contract differ from previous operator-led and equity investor led hospital PPPs. While these features are evidence of the application of lessons learnt from previous PPPs and the increasing sophistication of government PPP agencies, NBH has not been without controversy, with a NSW government inquiry into its operation and management launched approximately eight months after its opening.

The following sections describe the specifics of the NBH PPP including the PPP structure, contract features, and value for money outcomes; as well as matters raised in the inquiry into the operation and management of the hospital.

Equity investors have greater appetite for risk than debt financiers on the basis that they will receive a commensurate return on their investment; however, this risk appetite is conditional on them having ownership and control of the SPV.44 This lack of interest from equity investors, together with recognition that profit under an operator-led PPP is made during the operating phase rather than by investment in the physical asset, was likely a consideration in government’s commitment to make a capital payment, equal to the SPV’s debt to its financiers, following commencement of operations.45

Under the two-SPV structure, Operator Co provides the finance for the design and construction of the asset and provides all services during the operating term, and Operator B is responsible for the design and construction of the hospital. This arrangement limits the risk exposure of the parent company, Healthscope Operations, arising from its involvement in both D&C and operating phase activities. Project finance is provided on a limited recourse basis and the establishment of the SPV (Operator Co) limits the recourse of the debt financiers to the assets of Operator Co.

While it is not uncommon for governments to make capital contributions to reduce financing costs, it is unusual for the State to enable the SPV to repay its liability in full at this early stage. For example, monthly state capital contributions totalling AUS$300 million were made during the construction of the AUS$1 billion Victorian Comprehensive Cancer Centre,46 and an AUS$820 million47 state capital contribution, equivalent to approximately 50 per cent48 of the capital cost was made on SCUH.

The arrangement on NBH is unique to the contemporary operator-led PPP and would not have been acceptable in an equity investor led PPP where the motive of the SPV is to earn a return on investment over the period of its investment.

The Services51 component of the monthly service payment is calculated based on activity volume, which is subject to an annual limit, and clinical casemix. The National Weighted Activity Unit (NWAU), which is reset annually with reference to the actual cost of public health services delivery, is used to fund public hospitals. This is the basis for the operational funding

of NBH52 and is discounted to account for economies of scale and shared workforce across public and private hospital facilities. The monthly fee for Services is then adjusted for such things as additional services requested by the State, indexed lifecycle payments, abatements for failure to meet KPIs, and penalties payable because of the inappropriate transfer of patients to other facilities.53 The end result is the monthly services payment to the private operator.

The advantages and disadvantages of the operator-led PPP, and the implications of the operating phase risk transfer arrangements, considered in the recent inquiry into the operation and management of NBH, are described below.

Table 1 Financial value for money comparison between public sector and private sector project delivery60

Two things bear mentioning. First, previous studies have shown that, at best, the private sector can deliver public health services at the same cost as the public sector. Secondly, since the disbanding of government public works departments, the public sector has partnered with the private sector, using a variety of procurement models, such that cost of construction should be similar regardless of procurement model. While there is no recent operator-led hospital PPP example, it is interesting to compare the financial value for money of NBH with other hospital PPPs of similar size and complexity where the private sector was contracted to design, build, finance, and maintain the asset. RNSH in NSW, and RCH and RWH in Victoria, are three examples. Available information indicates private sector benefit of 1.2 per cent for RNSH,61 and a 6.9 per cent and 0.67 per cent improvement on the PSC for RCH and RWH, respectively.62

While it might be suggested that the exceptional capital and operational benefits of NBH are a result of private sector efficiencies and innovations, it is more likely that these savings are a result of the efficiencies and benefits realised by the integration of public and private facilities.63 These benefits

include optimisation of building area and the sharing of common areas; the sharing of capital and operating costs for infrastructure and support services; a common workforce across public and private facilities; and the inclusion of profit generating commercial facilities64 such as retail, private consulting suites and a general practice clinic.65

It is fundamental that PPPs should be applied only where they suit the needs of the project, deliver value for money and are in the public interest. Based on these metrics alone, NBH appears to be a perfect candidate.

There were several themes throughout the inquiry that are of relevance to this article, including a perceived misalignment of public sector and private sector interests; lack of transparency and loss of community and stakeholder trust; and the important role of the public sector in monitoring the performance of the private operator.

Tellingly, one recommendation of the inquiry was “that the NSW government not enter into any public-private partnerships for future public hospitals”.66

The inquiry also heard that the culture at NBH was distinctly that of a private hospital providing public health services rather than a public hospital

run by a private operator, and this culture was central to every aspect of the procurement process and the management and initial operation of NBH.68

Interestingly, some of the observations made in relation to the culture and profit motive of the private operator may be a result of the structure of the PPP contract itself. While encouraging patients to use their private health insurance is at odds with the express purpose of the partnership to provide the same levels of service to public and private patients,69 it is the Project Deed that also places an obligation on the hospital to “… maximise the number of patients who elect to use their private health insurance …”.70 Further, the decision to provide a different mix of services within NBH to what was previously available to the community, including the cancellation of some public health clinics, was a government decision made during planning rather than a measure taken by the private operator to save cost and divert public patients to private clinics.71

Several recommendations of the inquiry related to improving transparency. These recommendations included prominent signage related to the right to treatment as a public patient at no cost;73 publication of services available to public and private patients, including out-of-pocket costs;74 and increased performance reporting.75 However, these recommendations could not extend to public disclosure of commercially sensitive information including cost structure, payment arrangements, projected activity schedule and certain terms in relation to KPIs,76 and the true cost to the taxpayer remains unknown.

Many of the matters identified during the inquiry as leading to community and stakeholder distrust in the PPP process and the operation of NBH can be distilled to three key issues: a lack of transparency regarding the scope of the agreement; insufficient community engagement regarding the role of the hospital in the community and the parties’ obligations under the Project Deed; and insufficient public sector oversight.

While PPP structure, payment regime, contract term and political and social context vary between contracts and countries, lessons learnt from these PPPs, and those that still operate, are consistent with those of the pre-2000 Australian PPPs and NBH. Themes include insufficient stakeholder engagement during project planning,84 community resistance to the private provision of public health services,85 lack of transparency in relation to financial performance,86 a false belief that the private sector can deliver public health at a lower cost than the public sector,87 inadequate government oversight and contract management,88 and insufficient mechanisms for contractual review and renegotiation.89

Though not directly related to Australian operator-led PPPs, other issues identified in relation to these international PPPs and their particular social and political context, are worth noting. These include disparities between existing public hospitals and the PPP facility, leading to demand exceeding forecast;90 difficulty monitoring and enforcing clinical quality and performance standards;91 and insufficient competition, leading to a monopoly market.92

Risks typically associated with social infrastructure PPPs fall into several categories93 and some are considered more likely to be impacted under an operator-led model. These specific risk categories are D&C risk, operating risk, default and termination risk, and political and social risk. This article considers each of these risk types, how they are impacted by the operator-led model and how they are allocated and managed, including via the service payment calculation, express provisions in the contract, or via contractual mechanisms for regular review and renegotiation.94 Also considered is the extent to which the transfer of any public sector risks to the private sector is illusory.

While D&C risk allocation will remain the same under an operator-led PPP, the involvement of the operator throughout the delivery phase provides opportunity for the private sector partner to mitigate risks to the benefit of both parties. For example, the operator will have a keen interest in the development of a facility design that is not only cost-effective to construct, operate and maintain, but that also supports the efficient delivery of health services. This may result in reduced operating costs, the benefits of which will be shared with government. The involvement of the private operator in the design process may also mitigate fitness for purpose risk.

Like an equity investor led PPP, provisions in the contract will incentivise the private sector partner to achieve timely completion. These provisions include the delay of payment until commencement of service delivery, and liability for general damages for breach,95 and this risk will be passed

through to the D&C contractor via the liquidated damages provisions in the D&C contract.

The completion and handover of hospital PPPs largely on time and on budget96 has demonstrated the private sector’s capacity to manage D&C risk and this is not compromised under an operator-led model.

Notwithstanding matters raised during the inquiry, the NBH is an example of how the operator-led PPP can provide capital and operational savings unlikely to be achieved via traditional models. For NBH, this is achieved by the integration of public and private facilities, shared infrastructure and support services, and a common workforce.

While operating phase risk is transferred to the private sector, the public sector retains accountability for public health services delivery97 and it is in the interests of government that it establishes the foundations for a successful PPP, doing what it can to ensure that its private sector partner is able to manage its operating phase risks and including in the agreement mechanisms for regular review and renegotiation, reducing the risk of a repeat of the circumstances that led to the failure of LRH and PMBH. For example, market engagement is essential to ensure that proponents understand public hospital funding arrangements and can price accordingly; consultation with employees and unions during planning and procurement is necessary to manage workforce and industrial relations issues; and benchmarking of public hospital operating costs, rigorous analysis of private sector financial proposals, and the use of contractual mechanisms for regular review and renegotiation, is necessary to ensure contracts are flexible and financially sustainable for the operating term.

The public sector must also commit the necessary resources and take an active role during the operating phase, including working collaboratively with its private sector partner, proactively using mechanisms within the contract, such as the Annual Notice used on NBH, to ensure government

continues to receive value for money, closely monitoring performance and enforcing the contract.

Public concern regarding the financial viability of the private provision of public health services is not without basis. First, the assumption that the private sector can deliver public health services more efficiently than the public sector has been found to be incorrect: when adjusted to reflect casemix and cost reporting discrepancies, it has been found that, at best, the private sector can deliver health services for the same cost as the public sector. This brings into question the feasibility of the operating cost savings predicted for NBH. Secondly, the private sector must understand the limitations of public funding arrangements, and previous PPPs have shown this to not always be the case. For example, it was well-known by public providers that Victorian casemix funding at the time of the LRH PPP was not sufficient to cover operating costs, and that top-up funding was available to public hospitals. This top-up funding was not available to the private operator of LRH and the gap between operating cost and payment ultimately led to the failure of LRH PPP.98 Finally, it is not uncommon for private providers, motivated by their obligation to provide a dividend to shareholders, to reduce access to services that are unprofitable. In an operator-led PPP, this is a risk if the cost of health service delivery consistently exceeds payment for services. Funding arrangements for the operating phase must be realistic and clearly understood so mistakes of the pre-2000 operator-led hospital PPPs are not repeated.

Notwithstanding the failure of several early operator-led hospital PPPs, public hospital funding arrangements have been successfully used to purchase clinical services from private providers in public hospitals.99 Further, public hospital funding, including the NWAU, is the basis of operational funding for NBH. This allows the cost of the public health services provided under the PPP to be benchmarked against publicly operated peer facilities. It acknowledges the equivalence in cost of health

services delivered by public and private sectors and provides a balance between incentivising performance and ensuring quality, availability and access to public health services.

The Annual Notice and the use of a discounted NWAU as the basis of the monthly services payment calculation for NBH addresses many of the issues encountered on previous operator-led PPPs, including LRH and PMBH, where the parties had entered unsustainable contracts with limited mechanisms for review.100

The Annual Notice is a key feature of Joondalup Hospital PPP and is likely a key reason for its success.101 While operational funding is not strictly based on public hospital funding arrangements, it is reviewed and adjusted annually based on benchmarking against actual costs, and with consideration to average costs at publicly operated peer facilities. In addition to price determination, the Annual Notice is used to set activity profile and casemix, volume discounts and to adjust KPIs and reporting targets.102

Contractual mechanisms, like the Annual Notice that provide for regular review of service payments, and gain-sharing provisions that ensure that gains achieved by re-tendering service elements are shared between the parties, provide a means by which the private sector can manage much of its operating risk and government can ensure that it continues to receive value for money.

While the private sector operator is responsible for workforce and industrial relations matters during the contract term, the role of government during the planning stages is vital to the success of the PPP. Government must consult with affected groups and develop strategies to manage impacts or address concerns, including via ongoing engagement and contractual provisions and protections.105 The recent application by the Health Services Union of Australia to the Fair Work Commission in relation to the Frankston Hospital PPP106 is an example of the sensitivities around the privatisation of public hospital services and the importance of early engagement with affected parties. Without engagement, misalignment between the expectations of staff, unions and the private operator may lead to industrial action, threatening the availability of public health services.

The risk to government of D&C contractor default or insolvency is unchanged in an operator-led hospital PPP. However, it is during the operating phase that government risk is increased. If losses cause the private operator to default or become insolvent or compromise the availability and quality of public health services, as was the case with LRH, government must step in. The extent to which government is exposed to such risk is determined by the organisational structure of the PPP and may be impacted by financing arrangements.

In a PPP it is not unusual for government to make a capital contribution; however, if the capital contribution repays the full liability, as was the case for NBH, the debt financiers no longer have a financial interest in the asset, limiting the extent to which Project Co can protect government from the operator’s default or insolvency. Further, the structure of an operator-led PPP, where the SPV is established and wholly owned by the operator, puts Project Co in conflict of interest if it is required to remove the operator for default. This leaves government in the position where, if the default is not remedied by Project Co, or if the operator becomes insolvent, its only option is termination of the contract. In this respect, the PPP provides no protections over an arrangement where government contracts directly with the private hospital operator. This is the structure of the agreement for NBH.107

It is in the interests of all parties that the contract remains on foot and that termination is considered in only the most extreme circumstances, such as persistent breach, unremedied default or insolvency of the private operator, force majeure, or uninsurable risk. Contractual provisions, including abatements, and set-off of debts or claims for damages reasonably made by government, and mechanisms, like the Annual Notice, should be used to incentivise performance, ensure the PPP meets the changing needs of government and the public, is financially sustainable and continues to provide value for money. Used to their full extent, these provisions should limit the circumstances under which government might consider the financially and politically costly exercise of termination for convenience.

The failure of several earlier operator-led hospital PPPs increased public sensitivity around private sector provision of public services, and the recent inquiry into the operation and maintenance of NBH is evidence of the public’s ongoing distrust and resistance to the operator-led PPP model. National PPP Guidelines require that the suitability of the PPP procurement model for a project be tested against key principles,108 and while each of these principles is important, it is the public interest evaluation that is considered most critical.

The purpose of the public interest evaluation is to ensure that the PPP procurement model is not contrary to the public interest, and while each

jurisdiction has implemented its own process for evaluating public interest issues, the themes are common.109 Of the attributes evaluated as part of the public interest test, there are several that have heightened importance in the context of an operator-led PPP. If not addressed via contract, or not appropriately monitored, these issues may expose government to increased risk. These attributes include community consultation, particularly in relation to consumers, employees, and unions; equity and consumer rights in relation to equitable, free access to public health services, a core value of Australian society; and the uninterrupted supply of public health services, even in the event of private sector default or failure to perform.

The contract summary for NBH noted that the public interest test completed at tender evaluation did not preclude PPP procurement, and the inquiry made no mention of the public interest evaluation. However, several of the issues raised during the inquiry point to possible misalignment of aspects of the NBH PPP with the NSW government’s public interest evaluation,110 including community consultation, consumer rights, accountability and transparency, and public access.

The public interest evaluation highlights two issues. First, regardless of the formal risk allocation, government must maintain an active role at all stages as a means of meeting its accountability obligations. Social infrastructure PPPs are particularly sensitive in this regard. Secondly, if public interest issues cannot be managed or mitigated to an acceptable level, alternative procurement models must be pursued.

The NBH inquiry is evidence of the public interest in the role of the private sector in the provision of public services, and the expectation that government actively hold the private sector accountable to its obligations under the contract. The demands of this role for NBH were likely underestimated at business case, when budgets were set, and were likely not appreciated until the early stages of operation. Moving forward, the operation and management of NBH will be subject to intense scrutiny and it is in the interests of government and the private operator that it does not fail. Only time, and rigorous monitoring and accounting, will tell if the contract delivers the substantial savings predicted by the financial value for money assessment.

Notwithstanding examples of successful private sector delivery of public health services in public hospitals, and that several pre-2000 hospital PPPs continue to operate under extended contracts, the benefits of this model and its moderate success both in Australia and overseas do not outweigh the risks to government. There are several reasons why government should not enter into future PPP contracts for the provision of public health services. First, while the primary obligation of the private operator is the provision of health services, if profit is threatened, this obligation may become subordinate to its obligation to provide a dividend to shareholders. Secondly, the commercial-in-confidence nature of the PPP agreement is not consistent with the expectations of the public in relation to transparency. Thirdly, the operator-led PPP structure, where the SPV is wholly owned by the operator, provides no real protections to government over an arrangement where it contracts directly with the operator. Finally, it is the public sector that is ultimately accountable for health service delivery, and to protect its interests, it must invest significant resources into the management and enforcement of the contract.

It is important to distance the largely successful equity investor led PPP, where the private sector is contracted to design build, finance and maintain the asset, from the operator-led PPP. The former has been demonstrated over the last 20 years as a successful model for the cost-effective and on-time delivery and operating phase maintenance of public health assets across Australia and should continue to be considered for suitable projects.

This article considered whether improvements to the PPP model are sufficient to warrant consideration of a contemporary operator-led model for the delivery of public health services. It provided an overview

of Australia’s hospital PPP history and reviewed the NBH PPP, including the findings of the 2020 inquiry into is operation and management. With consideration to past and contemporary hospital PPPs, both in Australia and internationally, key risks, opportunities and challenges of the modern operator-led hospital PPP were identified and evaluated. Finally, the article considered whether the benefits of the operator-led hospital PPP outweigh the risks and challenges of the model.

While the operator-led PPP appears to be a robust model for the delivery of public health services, the opposed purposes of the private and public sectors, and the inability of government to transfer accountability for the provision of public health services, present the greatest challenges to its success. The outcomes of the inquiry into the operation and management of NBH, including the recommendation “that the NSW government not enter into any public-private partnerships for future public hospitals”111 is further evidence that the operator-led PPP is not suitable for the delivery of public health services in Australia.