Value for Money Test in Korea

Value for Money Test in Korea

PIMAC

Jungwook [email protected], PPP DivisionPublic and Private Infrastructure Investment Management Center

1. Process of PPP Project Implementa-

tion

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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 re-

lated plans and demands for the facility. They then weight the pro-curement 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) sub-

mits a project proposal, and then the competent authority examines and evaluates the contents and value for money of the private pro-posal, and designates it as a PPP project

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Competent AuthorityReview by PIMAC

Competent Authority

Competent Authority

Selection of PPP Project

Designation as the PPP Project

Announcement of RFPs

Submission of Project Proposals

Evaluation and Selection ofPreferred Bidder

VFM Test

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

Solicited Project

Procurement Steps of a Solicited Project

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Submission of Project Proposal

VFM Test

Notification of ProjectImplementation

PIMAC

Private Sector →Competent Authority

Competent Authority →Proponent

Announcement of RFPs

Submission of Project Proposals

Evaluation and Selection ofPreferred 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

Unsolicited Project

Procurement Steps of an Unsolicited Project

2. VFM : The Theory

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 En-forcement Decree of the PPP Act

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The VFM Concept

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 pro-

curement practices Not a universal tool

Applied on a project or program basis

Innovation, asset utilization, risk sharing, competition, ser-vice integration ate main key drivers of VFM

Presence of VFM drivers confirms suitability for PPP8

Key Elements of VFM

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

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The Role of PSC

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Compare to PSC or between bidders Presence of VFM confirms suitability for PPP.

NPV of Transferable

Risk

PSC PFI

NPV of PPP Contract

QUANTITATIVE VFMNPV of

Retained Risk

NPV of CompetitiveNeutrality

NPV of Raw PSC

NPV of Retained Risk

VFM Assesment

3. VFM : The Practice in Korea

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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 im-plementation 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 profes-

sional expertise are important elements in conducting VfM tests.

Implementation

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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

Organization of a Research Team

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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 com-

pared 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 for-

mulated 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.

Scope of a VFM Test

Unsolicited Unsolicited With Public Plan Solicited

Private Finance InitiatePFIp

(based on proposal)

PFIp (proposal) PFIG

(research team)PFIG (research team)

Public Sector Compara-tor

PSCp

(estimated by research team)

PSCp (research team) PSCG

(research team)PSCG (research team)

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VfM Analysis Implementation Method

Setting Comparators for VFM Test

16Implementation of PPP Project Rejection

Calculation of bonus points

Project Proposal(PFI0)

Construction of PSC(PSC0)

Construction of PSC1, PFI1

Construction of PFI2-i,

PFI Alternative (PFI2*)

VFM test of private proposal(VFM1=PSC1-PFI1≥0)

VFM test of PFI alternative(VFM2=PSC1-PFI2 * ≥0)

Feasibility analysis

N

N

N

Y

Y

Phase 1

Phases3 & 4

Phase 2

Flowchart of a VFM Test (Unsolicited)

Flowchart of a VFM Test (Unsolicited with Public Plan)

Construction of PSC (PSCp )

VFM test (VFMP1) VFM test (VFMG1)

Construction of PFIp2

Calculation of Bonus Points(VFMp )

PFI Alternative (PFI2* )

With bigger NPV

Rejection RejectionImplementation of PPP

VFM test(VFMP2=PSCp2-PFIp2≥0)

VFM test(VFMg2=PSCg2-PFIg2≥0)

PSCp1, PFIP1 PSCG1, PFIG1

N

Y

Y YN N

Y Y

YYN N

PSC by Public Plan (PSCG)

Phase 1

Phase 2

Phases3 & 4

Construction of PFIP2

Feasibility Test (PSCp PSCG)

Project Proposal (PFIp)

Construction of PSC (PSCG)

Feasibility Test (PSCG)

VFM test (VFMG1)

Construction of PFI Alternative

RejectionImplementation of PPP

N

Y

N

Y

Construction of PSCG1, PFIG1

Phase 1

Phase 2

Phases3 & 4

Flowchart of a VFM Test (Solicited Project)

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Assess project feasibility and necessity in the context of na-tional 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 bene-fits

Sensitivity analysis

Policy analyses, if necessary, are carried out

Phase 1: Feasibility Study (1)

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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 same level of service 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 esti-mated 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


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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 eco-nomic 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 recom-mends the Competent Authority to reject the project proposal.


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Government spending of the PSC is compared against gov-ernment 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 op-

tions: 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.

Phase 2: VFM Assessment (1)

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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 consider-ation 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 in-cluded in both options based on estimated spending


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Item PSC PFI

Capital costs

Project costs

Construction cost

(1) Cost of survey(2) Design cost(3) Construction cost

Construction cost

(1) Cost of survey(2) Design cost(3) Construction cost

Land acquisi-tion cost

(4) Compensation for land and other possessions

Land acquisi-tion 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

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 (10) Cost for operation equipment(11) Taxes and fees (11) Taxes and fees(12) Business setup costs (12) Business setup costs

Financing costs (13) Financing costs (13) Financing costs

operating costs(14) Operation costs(15) Maintenance costs(16) Management and supervision costs

(14) Operation costs(15) Maintenance costs(16) Management and supervision costs

① Base cost born by the government

(Capital costs + operating costs)- operating revenue

Construction subsidy + land acquisition cost +additional government support

② Risk adjustment costs Cost and time overrun

Total government payment ① + ②


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Present value of government payments for PSC and PFI op-tions are estimated (discount rate = 5.5%) and VfM(%) is calcu-lated

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

GP(PFI) = Construction subsidy + Compensation costs + Addi-tional government support

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

)()()((%)

PSCGPPFIGPPSCGPVfM


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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


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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 al-ternatives including the following components, are formu-lated:

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

Phase 3: Formulation of PFI Alternatives

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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 ad-

dressing of civil complaints (10 points)

⑥ Adequacy of required documentation (10 points)

Phase 4: Bonus Points for Initial Proponent (4)

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Bonus Point

Swiss Challenge: the original proponent has right to counter-match any superior of-fer.

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


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0.00% 0.50% 1.00% 1.50% 2.00% 2.50%0

1

2

3

Bonus Point

Number of Bidders

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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.

Use of VFM Test Results

Documents

Value for Money Test in Korea