PPPs in health are distinct from typical infrastructure projects for a few key reasons. Primarily, private revenue contribution is usually low, and as a result, these projects require a large and ongoing payment from the government. In addition, the ongoing expenses of operating a hospital or other medical facility represent the vast majority of project costs, as opposed to a typical infrastructure project in which capital expenditures (capex) are the main cost element. Thus, there must be money available to fund the project post-construction.
Given that most projects face financial limitations, assessing the government’s funding capacity and the resulting affordability level of a project early on is critical. This will allow for a timely commencement of discussions with the government regarding financial viability, key priorities, and project scoping options. When projects are not sized and scoped according to affordability levels, the projects need to be downsized after construction has already begun. Worst-case scenario: construction is completed but there is no funding to operate the hospital, resulting in the many “white-elephant” hospitals, where beautiful new facilities sit and gather dust while waiting for equipment, medical personnel, and patients.
Analysts must be able to identify how much the PPP project will cost and what the level of government support will be. Analysts must also ensure that the government is committed to making the project work given the financial obligations required.
Assessing the affordability of a project can be done using a high-level financial model that is tailored to health PPPs. There are three key drivers that will help determine if the project is financially viable:
- Estimated capital expenditures: number of beds, gross area per bed, construction and equipment costs.
- Revenue drivers: estimated demand, public funding, copayments, and other private revenue opportunities.
- Estimated operating expenses: salary costs, maintenance costs, supplies and utilities.
With a bit of research and analysis around these key assumptions, we can ultimately derive an expected annual PPP payment that can be compared to the current government budget available for the project.
Conducting an early-stage financial analysis helps clients understand the financial obligations and cost breakdown.
Once an availability payment is derived from the financial model, analysts can assess the potential financing gap. The chart below displays the expected annual availability payment required to be paid by the government to the private operator during the life of the contract, along with the current annual budget allocation available for the project. The difference between the two is the financing gap that must be addressed with the client. Will the client be able to bridge this gap? If not, are donors or other sources of funding available, such as co-payment revenues or private patient revenues? Alternatively, can the project be scoped and sized to match the government’s affordability level? Options to consider include assessing the appropriateness of the standards for the hospital or phasing the project in terms of size and/or services.
Conducting this early-stage financial analysis can also be useful in explaining the financial obligations and cost breakdown of the project to the client. The graphic on the next page, extracted from a hospital financial model, highlights the key components of project cost over the life of the PPP. Used together, these tools for affordability analyses can ultimately lead to more successful project closings, fulfilling client expectations and serving the health needs of large numbers of people around the globe.
Hospital PPPs: Key assumptions
This table, from a hospital PPP financial model, displays in more detail some of the major assumptions, along with some notes regarding specific inputs. Note that for other subsectors of the health industry (such as diagnostic imaging, primary health centers, laboratories, and dialysis, among others), assumptions will vary.
|PPP Period (years)A long-term contract reduces the annual PPP payment.||15|
|Number of beds||90|
|Gross area per bed (m2)Standards drive gross area per bed. Rule of thumb:
Emerging Markets: 120m2 Western Europe: 170m2 U.S.: 360 m2
|Constructions costs/m2Construction costs vary by region. Estimate $2,000/m2||$2,000|
|Construction/Equipment Cost Ratio||1.40|
|Ongoing Annual Capex:|
|Building (as % of original cost)||2.5%|
|Equipment (as % of original cost)||15.0%|
|Tax rate (%)||33.3%|
| Operating cost/bed/year($)Operating expenses per bed figures vary depending on standards
and salaries. Estimate between $120,000 to $160,000.
|Capex SubsidyUpfront capex subsidies reduce the annual PPP payment.||$0|
|Base Loan Interest Rate:||12%|
|Loan to be repaid by year 12||12|
|Target Equity IRREstimate 18% to 20%.||18%|