A Public/Private Partnership: The Royal Ottawa Hospital Experience
One such case involves the redevelopment of the Royal Ottawa Hospital (ROH). In 1997, the ROH was mandated by the Government of Ontario and the Health Services Restructuring Commission to be the Champlain Health District's Tertiary, Academic Mental Health Centre. This has driven a variety of transition plans over the last five years aimed at realizing this mandate.
- renovation of the existing facility would cost more than a new
- the ROH would not be able to fully discharge its new mandate in the existing facility, even after expensive renovations.
The decision was made in December of 2001 to build a new facility adjacent to the existing facility. The redevelopment of the ROH was to be structured as a P3 project roughly modelled on the U.K.'s Private Finance Initiatives (PFIs).
The term P3 is used to describe a broad range of contractual
arrangements between government and private enterprise that share,
in varying amounts, the role traditionally played exclusively by
the public sector. It involves a redistribution of risk between the
public and private sector based on who has the greatest capacity to
manage respective risks. In this model, much of the redevelopment
and operating risk shifts to the private sector provider. This
represents a new operating platform that integrates the developer,
designer, operator and financier into all aspects of the project
from schematics into full operations, usually over the life of a
long-term lease. Examples of P3 arrangements that have been used
for healthcare include transactions where the private
- Finances, builds and leases facilities
- Finances, designs, builds and leases facilities
- Finances, designs, builds leases and operates
- Finances, builds, leases and operates facilities and provides non-clinical services such as food preparation, security and laundry services
In the case of the ROH, the structure of the P3 transaction is consistent with Alternative 4 above.
This story starts well before the December 2001 announcement. It has its genesis in a decision made a decade ago by the ROH to outsource all its facility management and related services to a private sector partner. This experience formed a positive and constructive base to build on in the P3 approach at the ROH, which included a facility management component. Those starting such a project without the benefit of this experience may face a more difficult and politically charged transition, where the focus may be on labour issues in addition to a complex financial structure.
Why the ROH Went This RouteThere are several reasons why the ROH went this route. The key ones include:
- The previously mentioned positive experience with the
outsourcing of its facility management services.
- The realization that traditional funding approaches would not
provide a timely solution. The gap between healthcare
infrastructure need and its supply is well known. Government's
ability to narrow this gap through traditional capital funding
grants was perceived as very limited.
- With the development of Superbuild in Ontario, the timing was
right to consider this approach in the healthcare arena. Superbuild
was established to foster the development of such public projects
by leveraging limited public capital and having the private sector
take on the main financing and development risk.
- The ROH and government's decision to do a complete rebuild of
the antiquated plant made the project of a scope and size that was
attractive to private development and operation. This decision was
based on a carefully articulated business case anchored in the cost
benefits of rebuild versus renovation.
- The positive experiences of other countries, mainly the U.K.,
provided a supportive background for government and the Board of
the ROH (Board).
- The realization that the private sector may be in a better position to manage the risks of building and operating a complex facility.
All these forces converged at the same time, and combined with the Hospital's vision, values and needs, provided a high level of comfort in moving to pioneer the application of this approach in Canadian healthcare.
Ultimately, this project was a highly successful one. While the process was long, each of the steps was well thought out. The bulk of the remainder of this article discusses some of the key critical success factors (also summarized in the chart to the right).
|Key Success Factor
Setting the Stage
The Selection of Private Sector Partner
Setting the StageFollowing the announcement in December, 2001, the ROH had to gear up to move the project forward in the absence of government policy, funding methodologies and proven practices and work plans. What follows are some of the critical starting steps or factors that were put in place to prepare for the next important step of selecting a partner.
The Functional Plan/ProgramUnlike a traditional fixed sum tender with its well-defined specifications and working drawings, the functional program becomes the important first link in the P3 process. The translation of the functional plan into output specifications represents the foundation for the eventual qualifying consortia to build their case and for the hospital to evaluate their proposed solutions. Rather than being completely prescriptive, as we would under a traditional capital program, we were challenged to limit our prescriptive specifications to safety and security issues. The trick is to strike a balance in your output specifications, which allows for maximum creativity in the design response, without compromising safety concerns. Each organization has to decide on the right balance in this respect. Setting these output specifications requires clinical and support teams to think of the desired outcome of the design rather specifying a solution or specific dimensions.
A Master Site PlanOne of the earliest decisions we faced was whether to build on the existing campus, or to sell it and build on a new site. A new site may have been less expensive (after disposing of the current site) but would have required a longer period of time to find and obtain the necessary zoning. In addition, a new site would have required additional financing until the new facility was complete and the existing site disposed. With the benefit of the scoping provided by the Functional Program, an overall Master Site Plan was developed to guide the general sitting, fit and configuration of the new facility to temporarily coexist with the current facility. A pure "Greenfield" P3 solution, where building sitting is flexible, could reduce the need for such a master plan. In our case, it was required in order to determine the general sitting and fit of a new facility on the existing campus, while allowing existing facilities to operate during the construction phase. This would categorize it as a "Brownfield" site and solution for purposes of the P3. This highlights one of the main differences from the traditional approach. Land has value as an asset to be either sold or leased as part of the range of P3 possibilities.
Planning for Governance and Management of the ProjectThe P3 approach required a major realignment of our governance and management resources, their organization and traditional processes of project planning, review and approval. In the early stages it was most important for the Board of the ROH (Board) to set out Guiding Principles to reflect key values and parameters to guide the project through its various stages. The issues addressed in the Guiding Principles we employed are:
- a publicly administered model
- focus at all times on excellent quality specialized
- optimize cost and quality objectives
- demonstrate "value for money" against traditional
- employ best-practices model for delivery of
- deliver client-centred healthcare
- transparent accountability and effective risk
- co-location only with activities complementary to the
- partner with strong community commitment
- protection of direct healthcare clinical funding
In addition, the P3 approach requires a reassessment of the governance and management resources to ensure knowledge and familiarity with all major elements of the P3 approach. Board expertise in the financial, development and legal components are critical. The same applies to the management team. The early recruitment of an experienced project manager was critical to ensuring appropriate processes were put into place early in the project. Subsequently, we added financial, legal and design expertise to the project team through an RFP process. The use of external experts is key, as it allows the hospital to focus on its core responsibilities, through the long and complicated process.
An organizational schema that clarified the Board/Man-agement/Project team relationship was developed and sanctioned by the Board. This resulted in the creation of a new standing committee of the Board - the Expansion and Redevelopment Committee - a joint management/project team steering committee chaired by the hospital CEO, a project team office on site as well as the necessary rules of engagement that clarified respective authorities and accountabilities throughout the project.
The Value for Money Benchmark (VFMB)A key component in this approach is the VFMB. This is used by governments to make decisions by testing "whether a private investment proposal offers value for money in comparison with the most efficient form of public procurement." (Partnerships Victoria Public Sector Comparator technical note, Dept. of Treasury and Finance, State of Victoria, 2001, Page 1, section 1.1.)
The VFMB not only becomes an important rationale in the justification of alternate financing approaches but also provides a threshold for the evaluation of proposals. This also puts into proper context the cost of borrowing to government versus to the private sector, which is merely a component of the total VFMB cost.
The VFMB is developed based on researching similar hospital construction projects locally and internationally, with significant input from government officials based on their public procurement experiences and financial consultants familiar with this methodology.
It estimates the expected risk adjusted cost of redeveloping and providing facility arrangement services under a traditional procurement scenario against the alternate finance approach. It fully integrates life cycle costs into an equation that produces a net present value for each option.
Determine What Risks to TransferWhen preparing the VFMB it is critical to categorize risk into one of three areas:
- those that the hospital or Ministry is in a better position to
manage (such as change of healthcare regulation or law),
- those that the proponent is in a better position to manage
(such as construction schedule) and
- those that were essentially unmanageable (such as energy prices).
Only those that the proponent was in a better position to manage should be allocated to the proponent (and included in the VFMB). An example of this is energy cost. Energy cost is made up of two components: amount of energy consumed and the price of energy. We determined that the proponent was able to manage the consumption of energy principally by the design of the building and its operating systems. The proponent was not in a position to manage energy prices any better than the hospital was. We believed that transferring the risk of energy prices to the proponent would be more costly for the hospital since the proponent would add a risk premium, as would the lenders. Accordingly, the hospital retained the risk of energy prices.
Project Work Plan and BudgetConcurrent with the initial activities was the creation of a broad work plan and project budget. Our project was a pilot, and as such we did not have a blueprint to follow through the various stages of the transaction. This was probably the most difficult aspect of the project's early life. As a pilot project, the development of information to guide future projects became a shared agenda with government, with the understanding that flexibility in work plans and budgets would have to prevail as we mapped out the P3 route together. To guide us through these uncertainties, it was critical to have established charge out rates for our consultants, clear and understood processes for changing work plans and budgets with clear reporting and accountability frameworks both internal to the hospital and with the government representatives.
Proactive Communications PlansNew approaches to healthcare delivery in Canada, especially when they involve the private sector, require early communications planning. This applies to communications to your community, the government, media and staff and volunteers. To counteract the negative opinions of those who are opposed to any private sector participation in healthcare, it is necessary to keep before the community the objective of the exercise - a badly needed new hospital facility that may not be built using the traditional approach. We always found that where possible, it was much more effective to be proactive and get out in front of the parade with communications. Transparency was the order of the day and as far as was practically possible, we went out of our way to share information. For example, we created a special project web site that provided the community with timely information on our progress. We also had numerous staff, community and media briefings. This paid off throughout the project by having a knowledgeable community that was in support of the project.
Even with our extensive prior experience with facility management outsourcing, it was important to regularly and frequently assure staff that their interests were being well represented in the project planning. This was especially true for those directly affected in the facility management areas. It became more critical following the selection of our private sector partner because it involved a change in the facility management provider. Our experience is that proactive communication can head off negative rumours that might otherwise escalate unnecessarily.
Manage Government/Hospital RelationsIn this environment of pioneering change, the relationship with government is critical at all levels. In the early stages of our project, it was not clear to us what roles several government departments/agencies were required to play. With experience it settled to a core team of senior Ministry of Health Staff with their consulting team. Although government is not a signatory to the project agreements, they were required to authorize all aspects of the project, including the project legal agreements and funding.
The pace and direction of the project was largely determined by government decision-making. Knowing up front what you do and do not have in place is an important understanding to reach. Since a P3 approach to hospital facilities had never been done before in Ontario, the absence of policy and process created uncertainty as to how to move the project forward.
There are forces beyond the control of a hospital that simply require a renewed focus on what you are trying to achieve and patience in making adjustments to accommodate a changing landscape. In our case, the change in government in the fall of 2003 represented a schedule setback while the new government reviewed the P3 approach. When the cost, schedule and risk transfer advantages became clear to the new government, and after certain clarifications and reinforcements of consistency with the Canada Health Act and public paramountcy were achieved, progress under the new government continued. Our communications policy again paid dividends since the broad community support for the project made it politically advantageous for the project to be supported by the new government.
With all these elements in place, we were now poised to enter the stage of selecting our partner.
The Selection of the Private Sector PartnerThe ROH was now prepared to solicit proposals from qualified private sector suppliers for the facility and services it required to fulfill its new mandate. As a pilot project with an evolving process of project management that was not reflected in existing government policies or practices, the government encouraged the hospital early in the partner selection stage to acquire the services of a Process Auditor. This was aimed at ensuring the integrity of the selection process. This proved to be a value added decision, providing not only the effective monitoring of ongoing events but a source of advice and counsel to both the hospital and government on a proactive, ongoing basis.
Communications During the Partner Selection ProcessAs noted in the getting started phase, communications planning and strategies were equally if not more important in this phase. External forces opposed to this approach stepped up their activity, including a legal challenge on the government's authority to undertake such an approach. In addition, the very serious work of ensuring a consistent and fair competitive selection process added another dimension that called for careful and thoughtful discussion of when and what could be communicated.
The Selection ProcessWe decided to use a two stage process, an RFQ followed by and RFP, for the following reasons:
- to test the market to determine if there was sufficient
interest and ability to have a competitive procurement
- to limit our detailed review and scoring at the RFP stage to
only qualified parties
- to obtain feedback from prospective proponents
The RFQThe RFQ was intended to solicit expressions of interest from the private sector and to ensure that they had met minimum qualification standards in criteria considered most important to the project, including:
- property development
- facility design
- property management and leasing
- financial capacity
There are several factors that were critical and/or that we would have done differently, to ensure success. The key ones are described below.
Ensure There Is a Competitive MarketWe set out to design a proposed transaction that the market would find attractive and respond to. We believed that without a minimum of three qualified proponents we could not depend on a competitive market to keep costs down. We received responses to the RFQ from three consortia, all of which had excellent qualifications to build the facility and provide the services. If we had not received responses from three proponents, we would have considered interviewing parties that had decided not to respond to find out why and what if anything could be changed to increase their interest.
Publish the VFMB in the RFQWe did not publish the VFMB with our RFQ, so potential proponents did not know the budget range to which they were expected to work. Although this did not prove to be an issue in our process, we did run the risk of having three proposals that exceeded the VFMB. This could have caused a costly delay. With hindsight we would recommend publishing a summary of the VFMB that identifies the risks transferred and the price range that the bids were expected to meet.
One frequent concern with publishing the VFMB is that it will minimize the likelihood of proponents developing more cost-effective solutions. So long as there are real competitive threats between the proponents, this should not be the case.
Invite Preliminary Design in the RFQOne of our proponents was eliminated at the RFP stage because their design did not meet the output specifications. This issue might have been averted if proponents were afforded the opportunity to submit a preliminary design at the RFQ stage and to receive preliminary feedback before submitting the formal proposal.
The RFP: Balancing Cost vs. BenefitThe RFP was intended to
- outline what the hospital was intending to buy,
- prescribe the format and required content of responses,
- set out how responses would be compared and evaluated.
The ROH, through this process, was able to contract for its new facility and services at a very attractive price, driven partially by the financing rates the selected proponent was able to secure. There are a number of factors that were under the hospital's control, or partial control, that we believe had a significant impact on keeping costs and risks, including financial risks, to a minimum that directly benefitted the hospital through project cost.
The ScoringWe spent considerable effort on deciding which criteria should be mandatory and which should be point scored. In the end we determined there was really only one determining factor; if a criteria was indeed a "deal breaker," then it was mandatory. If it was possible to have a quality proposal from (an already qualified) proponent, then it should be point rated. This eliminated many criteria from the "mandatory" category and provided for more diversity in responses.
Our scoring mechanism can be summarized as follows:
- All mandatory criteria must be met
- Point scored criteria were divided into four categories
- design and construction - 20%
- services - 30%
- management and governance - 15%
- master plan for the site - 15%
- financial management - 20%
- design and construction - 20%
Proponents must have achieved a minimum of 60% of the points available in each category. A Quality Adjusted Net Present Value was calculated by discounting the net present value of all costs by the rated score. RFP proponents' net present value was to be discounted by one quarter of a percent for every percentage point above 60% on the rating scheme, up to a maximum discount of 10%. The adjustment down was limited to 10% of the bid price; this being the maximum, we believed the hospital could afford to pay for a premium proposal.
Based on this process, a preferred proponent was selected, together with the second ranked proponent as a backup in case a transaction could not be concluded with the preferred proponent.
One change we would make to our scoring and evaluation criteria is in the area of Management and Governance. We do not believe we gave this category sufficient weight when considering that we were asking the proponents to not only build a facility but to manage it and nonclinical services for a 20+ year term. We believe our RFP could have been improved in this area by assigning a greater value to the scoring of this area. We would have reduced the scoring allocated to services, based on the rationale that if the management and governance principles are solid, any shortfall in services that does occur during the contract can be better dealt with.
The Extent the Hospital Could Provide Security of Cash Flow to ProponentProponents needed to determine the risk of not being paid after investing $150 million. The ultimate security would have been a contract directly with the provincial government or a provincial government guarantee. Neither of those alternatives was available for our project and the covenant of the hospital was not likely to provide much comfort to the lenders. In the end, we satisfied the lenders that the provincial government had authorized the transaction and that it had signed a Funding Agreement with the hospital. The terms of the funding agreement were required to be confidential between the Ministry of Health and the hospital. We did confirm that there was a Funding Agreement between the hospital and the Ministry for funding for the project.
Performance StandardsWhen setting output specifications you must guard against the temptation of setting a higher standard for the private sector partner than what the hospital itself could reasonably achieve on its own. The temptation exists perhaps out of the hospital's goal of delivering that level of service, but can't afford to, or to set standards for the private sector partner where no standards currently exist. Whatever the reason, if you require higher standards it will cost more and the comparison against the VFMB will not be valid and may result in the project being cancelled, as it may appear that the private sector costs more than the public sector.
Set Appropriate Performance PenaltiesExcessively punitive penalties, especially when combined with higher performance standards, will add cost to the project because the proponent will add in an element of cost to the hospital to offset the penalty. For our project we decided to keep penalties relative to the cost of the service for which the penalty was being imposed. We also allowed for time for the proponent to fix the problem after it is identified, before the penalty is imposed. However if the problem persists, the penalties become increasingly expensive and can result in the service provider being replaced.
Provide Opportunity for Lenders to Step in to Fix ProblemsOne of the advantages of using private capital to finance infrastructure and deliver services is the expectation of the lenders for disciplined debt service payments. Since the proponent is likely to be a special purpose vehicle whose only purpose is to meet the obligations of the consortium to the hospital, the cash flow through the SPV is limited to the hospital's payments. If penalties are imposed, debt service may be jeopardized. The hospital can use the private sector lenders to their advantage; by informing the lenders of problems once they reach a certain level of seriousness, the hospital can rely on the lenders to exert pressure to have the issue resolved before it affects consortium cash flow.
Contract Termination ProvisionsOur contract is expected to last for approximately 23 years and it will take that long for the lenders and equity investors to receive the full return of their capital and expected returns. Because of the long term of the contract, it is prudent to decide in advance what will happen if the contract is terminated. The contract may be terminated in one of three scenarios:
- termination where the proponent is at fault
- termination where the hospital is at fault
- termination for "force majeure"
Although the return to the equity participants in the consortium was different in each of the above circumstances, we decided that exposing the lenders to the consortia to losses of capital when default was due to the hospital or for force majeure would be reflected in higher interest costs for the project and chose not to transfer this risk.
Change OrdersTo instill a high level of discipline in the management of design changes, the hospital, together with the Ministry, required that all design changes not authorized by the Ministry be financed by the hospital's funds. Since the hospital was already required to raise a significant amount for the "local share" of the capital cost, the approval by the Board or senior management of the hospital was required for any hospital initiated design modifications. This measure effectively added a high level of discipline to the design signoff phase.
Contract with One PartyOne of the tremendous advantages of setting output specifications for the facility that must be met for 23 years, and having contracted with one group for services for the same term, is that all of the parties in the consortium are tied together. It forces them to seek the most cost-effective solutions and partners. This lifecycle cost approach can provide significant savings over the long term, by forcing the consortium to choose the design, lifecycle management and service package that is most efficient.
This approach also allowed us to obtain financial guarantees for
the consortium's obligation to deliver to the output specifications
for the entire term. We did this by
- signing contracts with one party - the special purpose
corporation set up by the consortium - for all of the facility and
services to be provided over the 20-year term of the contract, and
- requiring the construction partner and the services partner to cross-guarantee the work of the other partner for the operating term of the contract.
This meant if poor building design resulted in higher energy consumption costs as the building matures, we will still be dealing with the same consortium and will have the building partner's as well as the services partner's financial guarantee to draw upon over the entire term.
Closing the TransactionAfter selecting the preferred proponent final contract, negotiations were commenced. In our case they were interrupted by a provincial election, change of governing party and subsequent review by the new government of the proposed transaction. We were required to make certain amendments to the project's legal agreements to meet the needs of the new government. Negotiations concluded in July 2004, when the project agreements were signed with the selected proponent. This represented "Commercial Close" of the transaction. The selected proponent then had a period of time to secure the financing for the transaction based on the signed project agreements. This was completed in December 2004. This was a long and challenging process and ensuring that the Board and the project management team were fully committed was critical to achieving close.
The New Operating ParadigmAlternate financing means alternate approaches to how government funds such developments. The principal change is the blending of what have typically been traditionally isolated functions-capital planning and funding and operation funding.
All this collapses into a new operating equation that blends capital and operating components into an ongoing part of your operating plan. This manifested itself in a special Funding Agreement to reflect these new arrangements between the government and hospital.
The hospital's share responsibility still existed as it would under a traditional approach. It allowed for new and innovative ways of managing share, including the cash value of land leases and annual incentives to acquire full share up front as opposed to over the life of the lease. Normal processes for Post Construction Operating Planning (PCOP) are still utilized by government but springboard from the Funding Agreement to focus predominantly on direct clinical costs and volumes.
Areas like Furnishings and Equipment and Information Technology require careful consideration regarding their positioning in these approaches. The hospital favoured building these into the Alternate Finance approach using the lifecycle costing principle and establishing appropriate allowances up front in the project agreements. Based on feedback from past experiences, such as those in the UK, this was perceived to be a sound approach. After extensive deliberation with government on this, there was a preference expressed to deal with the Furnishings and Equipment on a traditional basis. The Information Technology was planned on a similar model to the overall project but in parallel with it. The planning of Furnishings and Equipment became a question of figuring out what could be transferred from current operations, what was eligible for government funding and what the hospital was responsible for. This is an area that needs further discussion and consideration for future approaches like this.
ConclusionsAs we look back over this unique experience in Canadian healthcare, there are many conclusions that can be made, but the main ones, in our opinion, are the following:
- This approach represents a new and viable option for
procurement of healthcare infrastructure and its operation. In a
world of limited government and philanthropic funds and continued
restraint on operating dollars, such arrangements can help manage
- Such approaches do not compromise or put at risk the
organization's ability or responsibility as a publicly administered
body. The values of Medicare as defined under the Canada Health Act
and the governance and management requirements as detailed under
public hospital legislation are fully respected.
- It distributes risk to where it is best managed, leading to
increased probability of better risk management than traditional
capital funding approaches.
- With the effective bundling of the design, build, operate and
finance components over the life of the lease, it better integrates
the creative intelligence of all these elements into new and better
solutions that employ the best that each sector brings to the
table. Through the 'joint and several' nature of the consortium,
fed by partner equity in the project, there is guaranteed interest,
rigour and incentives to make the longer term relationship work for
the benefit of the healthcare organization.
- Most importantly, such an approach is now delivering a badly needed new facility and related service systems to our community on time, within budget and more efficiently and effectively than a traditional approach would have allowed. Having more options to narrow this public health gap without compromising our national values is an important development in the sustainability of Medicare as we know it.
About the Author(s)
David Laird is a Director of PricewaterhouseCoopers LLP in Ottawa. David advised the Royal Ottawa Health Care Group on the financial aspects of the P3 transaction which included the RFP and selection of preferred proponent and negotiation and closing of the transaction. Email: firstname.lastname@example.org
George Langill is Executive in Residence at the School of Management at the University of Ottawa and operates a private consulting practice following his retirement as CEO of the Royal Ottawa Health Care Group in Dec.2004. Email: email@example.com
Dept. of Treasury and Finance, State of Victoria. 2001. Partnerships Victoria Public Sector Comparator Technical Note.
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