Safety and Cost Effectiveness of Private Prisons

Tabled: 29 March 2018

5 Negotiating new private prison contracts

The original service contracts for Fulham and Port Phillip were due to expire in 2017. DJR recommended negotiating long-term contract extensions with the incumbent operators, partly because other options would involve significant costs to 'buy out' the site leases held by the operators which extended for many years beyond 2017. DJR maintained alternative options, such as re-tendering the contracts, as a fallback in case the negotiations did not achieve a value‑for‑money outcome.

Government accepted this recommendation in 2014, and new contracts were finalised during 2015. These contracts have performance-based terms of up to 20 years that align with the revised site lease terms. DJR forecast the new contracts to cost the state around $4.5 billion in nominal terms, or $2.4 billion in net present cost terms, if they run for the full term.

In this part of the report, we examine whether DJR:

  • thoroughly analysed the procurement options
  • developed and implemented a comprehensive negotiation strategy to manage the risks arising from the lack of competitive tension and delivered value for money
  • provided robust advice to key decision-makers, including government, on options and outcomes
  • used the new contracts to adequately address key weaknesses in the previous contracts.

5.1 Conclusion

DJR successfully navigated significant challenges to negotiate new contracts with the private operators of Fulham and Port Phillip that addressed key weaknesses in the previous contracts and broadly met the government's approved cost limits. DJR's advice to government on whether to enter into the new contracts was sound, with some minor exceptions that did not invalidate the outcomes achieved.

5.2 Options analysis

The state needed Fulham and Port Phillip to continue operating beyond the expiry of the initial contracts to accommodate rising prisoner numbers.

Options to achieve this included:

  • negotiating short- or long-term extensions with the incumbent operators
  • directly operating the prisons
  • competitively tendering for the operation of the prisons.

DJR tried to negotiate surrender of the leases as part of the end-of-service term reviews for both prison contracts in 2011 and 2012. This would have provided the state with unencumbered access to the prison facilities and discretion to competitively tender future service delivery. However, the complex issues around the leases meant DJR did not pursue surrender of the leases at that time.

Legacy issues with the initial contractual arrangements meant the state could not consider each of these options on a 'level playing field'. The key issue was that the operators held leases over the prison sites that extended many years beyond the service contract terms. The lease granted for Fulham in 1995 extended 18 years beyond the service term to 2035, and the Port Phillip lease, granted in 1996, extended 29 years beyond the service term to 2046.

The misalignment between the contracts' service terms and lease terms created significant uncertainty about the state's ability to secure access to the prison facilities in 2017 if it decided to let the operators' service contracts expire and either engage other operators or directly operate the prisons.

While DJR considered compulsory acquisition in its options analysis in 2013 and 2014, the state's lease acquisition rights were seen as complex and would have involved considerable risk and cost if pursued. Given this, DJR appropriately treated the lease term misalignment as a serious constraint on the state's options.

The government decided to negotiate new contracts with the incumbent operators based partly on advice that pursuing other options would involve significant additional costs.

Timeliness of options analysis

DJR analysed the most viable procurement options sufficiently early to protect the state's negotiating position.

The initial contracts for Fulham and Port Phillip included an option for the state to negotiate extensions beyond the 20-year service terms ending in 2017. The state had to give the operators three years' notice if it wanted to negotiate extensions—meaning by April 2014 for Fulham and September 2014 for Port Phillip.

These time lines meant the state needed to consider all options well before the expiry of the contracts to optimise its leverage in any negotiations with the operators. Positively, DJR and DTF considered an appropriate range of available options as early as 2011, years in advance of contract expiry.

Adequacy of options assessment

DJR's options analysis and advice to government was adequate.

DJR provided the Minister for Corrections with high-level advice in May 2013 on the misalignment of the lease terms and the options available to keep the two prisons operating. The minister approved:

  • more detailed options analysis to inform recommendations to government by mid-2014 on whether to negotiate contract extensions
  • initial contact with the two operators to advise them that the state was willing to discuss possible contract extensions beyond 2017.

Following the ministerial approval, DJR commenced the detailed options analysis and identified the following alternative options and constraints:

  • allowing the contracts to lapse and moving prisoners elsewhere—not considered feasible given capacity pressures across the prison system and the lead time required to expand or build additional prison capacity
  • allowing the contracts to lapse and the state resuming the leases and operating the prisons itself—considered feasible subject to potential cost and risk associated with the lease issue, but considered likely to result in higher operating costs given the benchmarked costs of state-run prisons
  • negotiating extended contracts with the incumbents—the sole-source procurement risks were noted along with the potential upside of resolving the lease issues
  • re-tendering for the operation and maintenance of each prison—constrained by the lease issue and the relatively small number of private prison operators.

The analysis also considered hybrid options including separately tendering the provision of correctional services and accommodation maintenance services.

The final advice to government in July 2014 justified the recommendation to renegotiate with the incumbent operators on the basis that:

  • the operators had lower operating costs than publicly run prisons
  • the operators' service delivery performance was adequate
  • the terms for the new contracts could be aligned with the lease terms
  • an open tender process was unlikely to deliver an outcome that bettered existing costs and recovered the transaction costs, which potentially included lease buy-out costs of tens of millions of dollars for each prison.

This advice to government was adequate overall, aside from the following issues:

  • The summary advice to government did not adequately explain that the estimated lease buy-out costs were preliminary notional amounts that were indicative of potential ambit claims from the operators. DJR sourced these estimates from commercial advice obtained in 2013. Subsequent formal valuation advice to DJR indicated that the approach used in this commercial advice was reasonable, but the underlying estimate of the PortPhillip land value was too high. DJR based subsequent advice to government on the potential cost of buying out the Port Phillip lease on more specific information reflecting the likely profits or margin that G4S would forego if it surrendered the lease.
  • The advice did not present detailed information on the operators' service delivery performance—for example, DJR's concerns about G4S's performance at Port Phillip during 2014 were given little coverage in the July 2014 advice to government. Subsequent advice during 2015 included summary information on the operator's service delivery performance and advice that the Commissioner assessed Port Phillip as performing consistently with the state's other maximum-security prisons over the initial contract period.
  • The discount rates used as part of the net present cost calculations were not disclosed in the advice.
  • The advice materially underestimated the actual required costs for asset maintenance and life cycle expenditure for Fulham. The business case estimated these costs at $16.7 million based on the information available to the state at the time, but the cost ended up at $78 million following more detailed asset condition assessment and review.

Despite these issues, the advice to government adequately captured the risks, constraints and opportunities facing the state in relation to these contracts. It supported the conclusion that the government's best option was to try and negotiate with the incumbent operators.

DTF and DPC supported DJR's recommendations and, in July 2014, the government approved negotiations with the operators to extend the contracts subject to the:

  • costs of the new contracts not exceeding approved negotiating limits that were based on the costs of the existing contracts, with some incremental cost increases to cover changes in services and additional investment in facilities maintenance and replacement
  • service terms for any new contracts aligning with the lease terms and sound end-of-term arrangements.
Ongoing assessment of options

Positively, DJR did not treat the results of the initial options analysis as a given after the government approved new contract negotiations with the operators. DJR appropriately treated the contract extension negotiations as 'plan A', but also adequately considered the merits of a re-tender, which was the state's best 'plan B'.

The options analysis was 'live' during the negotiation process. DJR progressively developed the analysis, using negotiation outcomes and updated analysis of the fallback strategy, including an updated assessment of the costs and risks associated with the lease issues.

This was more formal for the negotiations with G4S for the Port Phillip contract because G4S initially proposed significantly higher‑than‑expected operational costs. In contrast, the operational costs proposed by GEO for Fulham were broadly consistent with the approved negotiating limit and payments under the existing contract.

5.3 Management of negotiations

DJR planned and implemented a robust negotiation strategy. DJR's negotiation process and time line placed the state in a strong position because it retained a realistic alternative to providing the incumbent operators with new contracts—the state had time to competitively tender the operation of the prisons if the negotiations with the operators did not produce a reasonable outcome.

Figure 5A shows key events and decisions in the negotiation of the new contracts.

Figure 5A
Key events and decision points

Date

Event

28 March 2014

The Minister for Corrections (with the approval of the Premier and Treasurer) advised GEO of intention to commence negotiations to extend the Fulham contract.

May 2014

DJR set up a project team to negotiate possible contract extensions for Fulham and Port Phillip.

28 July 2014

The government approved negotiation limits for new contracts with GEO and G4S.

22 August 2014

The minister (with the approval of the Premier and Treasurer) advised G4S of intention to commence negotiations to extend the Port Phillip contract.

15 September 2014

The government signed a contract with a GEO-led consortium for Ravenhall.

2 March 2015

The government approved a new contract for Fulham and continuation of negotiations for Port Phillip.

2 April 2015

The government signed a new contract with GEO for Fulham.

19 November 2015

The government approved a new contract for Port Phillip.

17 December 2015

The government signed a new contract with G4S for Port Phillip.

June 2016

Partnerships Victoria project summaries published for both prison contracts.

1 July 2016

New Fulham contract commences (around nine months prior to expiry of initial contract).

10 September 2017

New Port Phillip contract commences (the initial contract expired on 9 September 2017).

Source: VAGO based on information from CV.

DJR's comprehensive procurement and negotiation strategy was ultimately successful in achieving the state's objectives. DJR successfully negotiated for:

  • the continued operation of 20-year-old prisons under contractual provisions that were largely consistent with those designed for the new Ravenhall prison facility which had been subject to a competitive tender process
  • new contract term lengths of up to around 20 years depending on performance, which provided a long-term incentive for the operators while allowing:
    • the cost of services to be adjusted through indexation and benchmarking provisions
    • flexibility for the state to terminate the arrangements based on performance or breach of contract
  • resolution of the lease misalignment issues that had constrained the state's ability to re-tender the initial contracts by requiring the incumbents to 'give something up'—particularly in the case of G4S where the Port Phillip lease extended for some 29 years beyond the expiry of the original contract
  • updated contractual terms, and payment and performance mechanisms, aligned with the state's approach for Ravenhall, meaning greater risk for the operators—a higher proportion of the service payments are based on performance—particularly given Fulham's ageing prison infrastructure and Port Phillip's complex prisoner cohorts.

DJR achieved these outcomes at a cost broadly in line with the government's approved negotiating limits and the cost of the original contracts, noting that:

  • for Fulham, debt service payments of around $8 million per year payable under the original contract were reallocated to asset maintenance and renewal (debt service payments for Port Phillip expired in around 2012)
  • for Port Phillip, the state agreed to contribute around $9 million towards required capital upgrades in the lead-up to the new contract commencing.

The Fulham agreement was signed on time and only a short extension was required to finalise negotiations for Port Phillip.

Governance and oversight

DJR appropriately allocated significant resources to the options analysis and negotiation processes. Project management and reporting processes were consistent with DJR's Project Management Excellence Framework, ensuring regular, robust monitoring and reporting on progress, risks and budget.

A steering committee oversaw the options analysis and negotiation processes. The committee included senior representatives from DJR, DPC and DTF, supported by external legal, commercial and probity advisers. The committee met regularly between November 2013 and April 2016, and there is clear evidence of comprehensive reporting to and engagement by the committee.

Negotiation strategy and implementation

DJR developed and implemented a sophisticated negotiation strategy that adequately mitigated the sole-source procurement risks. Positive features included:

  • definition of high-level project objectives and benefits sought in the project business case, benefits plan and submissions to government
  • development of a detailed negotiation strategy by August 2014, which included time lines, strategic context and fallback strategies
  • identification of 'pillar negotiation parameters' that were important to the state
  • ongoing refinement of the fallback strategy so that the state had a realistic alternative to renegotiation with the incumbent operators
  • use of signed documents with the operators, including a 'Heads of Agreement', to formalise their commitment to the process and time lines and to define the framework for further negotiations
  • undertaking 'health checks' at key points of the process that were linked to further work on the state's fallback strategy
  • defining criteria to measure the 'success' and value for money of the negotiation outcomes.

The negotiation team considered the possible impacts of other projects and initiatives such as:

  • the Ravenhall procurement process, where both operators bid and GEO was awarded the contract in September 2014
  • the prisoner transport procurement process, where G4S was awarded the contract
  • a review of Justice Health
  • capacity expansion proposals for Fulham and Port Phillip.

The team was also astute in anticipating that the Ravenhall contractual model would be less familiar for G4S and allowing extra time and resources to bring this operator 'up to speed'.

Compliance with Partnerships Victoria and other requirements

The contract negotiations for the private prisons were in a unique position regarding applicable requirements and oversight mechanisms:

  • Although Fulham and Port Phillip were clearly PPPs, they were originally procured before Partnerships Victoria came into existence and the initial contracts were not always treated as being subject to Partnerships Victoria requirements.

The Public Sector Comparator is an estimate of the hypothetical, whole-of-life cost of a project if delivered by the public sector. The PSC is based on the required output specification. It provides government with a quantitative reference point to assess the value for money of private sector proposals.

  • The contract extensions involved a continuation of service delivery via existing assets with some upgrades, unlike typical Partnerships Victoria projects where a private consortium finances the construction of new assets.
  • The lack of a significant 'new-build' asset component meant that the High Value High Risk (HVHR) framework did not automatically apply.
  • The renegotiations were provided for in the original contracts and, in part, were driven by the lease misalignment issue built into the original deals.
  • The Act partly drove the approval requirements.

The new contracts for Fulham and Port Phillip were clearly treated as Partnerships Victoria transactions—for example, Partnerships Victoria project summaries were published. The May 2013 Partnerships Victoria Requirements, applicable at the time the transactions were planned and managed, included key requirements such as the development of a formal Public Sector Comparator (PSC) and application of the state's gateway review process.

The processes used by DJR did not fully align with these Partnerships Victoria Requirements. Specifically:

  • DJR did not develop a PSC for the Fulham transaction—instead, it developed a public sector benchmark that served an equivalent purpose
  • DTF did not undertake the required independent review of the PSC developed for the Port Phillip transaction—DJR had access to operating costs for broadly comparable prisons and could do an open-book review of G4S's existing costs
  • no gateway reviews were conducted for the project.

DTF supported this flexible approach to applying the Partnerships Victoria Requirements, as these were not typical Partnerships Victoria transactions. DTF advised that it was aware of and satisfied with DJR's approach given the context for the transactions and the other information available to inform the state's value-for-money assessments.

The level of oversight and review applied to the project was adequate. Government approved all key decisions after they had been considered by the inter‑departmental steering committee. In addition, the Treasurer approved the new contracts under the Act.

DTF advised that gateway reviews were not required because it considered the project medium risk. Our assessment of the project indicates that the project warranted a high-risk rating, given it involved a significant portion of the state's male prison population and material cost to the state. Nevertheless, we recognise that the evolving nature of the negotiations meant that there was no obvious time to conduct the gateway reviews.

Discount rates

The nominal discount rate applied for Fulham was materially higher than that used for Port Phillip—7.62 per cent nominal for Fulham at 30 June 2014 versus 4.13 per cent nominal for Port Phillip at 30 June 2015. The choice of discount rate for Fulham is not a significant concern because:

  • the 5 per cent real discount rate used for Fulham was broadly in line with relevant guidance published in 2013, and DTF was informed of the rate used
  • the use of a relatively higher discount rate did not distort the analysis as:
    • the selected rate was used consistently in advice to government during 2014 and 2015
    • the focus of the value-for-money and affordability analysis was on the nominal annual contract cost, not a discounted value
  • the project summaries published in mid-2016 for Fulham and Port Phillip included the cost of the contracts in both nominal and net present cost terms, and clearly disclosed the discount rates used.

However, the higher discount rate applied to the Fulham transaction makes it look 'cheaper' in comparison to Port Phillip when the net present cost of expected service payments under the contracts is disclosed without details of the discount rate. For example, the May 2017 DTF publication Partnerships Victoria: Excellence in public private partnerships lists the net present cost of a number of projects and shows Fulham at $593 million and Port Phillip at $1 831 million, without disclosing the discount rates or dates. This makes Port Phillip look around three times more costly than Fulham for a similar contract term when, in nominal terms, it is closer to double—$1 451 million for Fulham and $3 113 million for Port Phillip.

Probity issues

Robust management of probity issues—including actual, potential and perceived conflicts of interest—protects the integrity, fairness and impartiality of government procurement processes.

DJR and the steering committee understood the need for probity during the negotiations and engaged an experienced probity practitioner to provide advice and assurance, partly because there was the possibility of a tender if it needed the fallback strategy. Probity issues identified during the negotiations for the new contracts were largely well managed. However, a commercial adviser working for DJR and one of the operators did not adequately disclose potential conflicts of interest and these were not adequately assessed or acknowledged in advice to government.

The definition of conflict of interest in the project and probity plans was consistent with the National PPP Policy and Guidelines. Any affiliation or interest that prejudiced, or might be seen to prejudice, a project participant's impartiality would be considered a conflict of interest.

Much of the national guidance material focuses on actual and potential conflicts involving external advisers to government agencies, because it is not uncommon for actual or potential conflicts of interest to arise for these advisers. Such conflicts do not necessarily compromise process integrity, as long as they are transparently disclosed, assessed and properly managed.

A conflict of interest exists if an advisor to the state on a PPP project is also advising one or more of the private-sector bidders on the same or a related transaction. This is because the adviser:

  • may have access to confidential state information that could advantage the private client
  • is performing a role with a high capacity to influence the state's procurement decisions.

The National PPP Policy and Guidelines state that an advisor cannot act on both sides of a PPP project where there is a conflict of interest, with only rare exceptions.

The conflict of interest declaration signed by state employees and external advisers listed the incumbent operators and their related entities, including overseas-based parent companies. The declaration required disclosure of individual and firm financial interests in these entities and any actual, potential or perceived conflicts.

The conflict of interest declaration register established for the project recorded more than 60 declarations completed by staff of external advisory firms, including lawyers and commercial and other advisers. None of these declarations disclosed any actual, potential or perceived conflicts. However, seven of the 10 probity issues reported to the steering committee over the course of the project related to actual and potential conflicts of interest for external advisers working for both DJR and the operators.

DJR became aware of these conflicts using information from parties other than the advisers. The pattern of external advisers not proactively disclosing conflicts to the state was disappointing given that the probity advisor clearly and repeatedly communicated the importance for external advisers to meet their disclosure obligations.

The most significant issue related to the state's primary commercial adviser on the project. This adviser played a key role in assessing and advising on the state's options for securing ongoing services at the two privately operated prisons and was responsible for preparing the value-for-money assessments of the incumbent operators' bids for new contracts. Given this, the adviser was in a position to materially influence government decision-making on whether to grant new contracts.

Staff of the adviser's firm completed more than 20 conflict of interest declarations between October 2013 and August 2015, and none disclosed any actual, potential or perceived conflicts. However, in September 2014, the operator of Fulham advised DJR that it was using this firm for tax advice on the Ravenhall transaction and for financial advice on the Fulham contract negotiations. Both situations posed a conflict of interest for the adviser and clearly warranted disclosure to the state. This was particularly the case for the second conflict, where DJR had information indicating that the adviser was acting for both the state and the operator of Fulham on the same transaction.

When DJR became aware of the conflicts in September 2014, it sought information from the commercial adviser and GEO, and advice from the probity advisor:

  • The commercial adviser provided a summary of how it managed such conflicts, including processes for separating advisory teams and maintaining the confidentiality of state information, but did not provide any information about the extent of its role in advising GEO on the Fulham transaction.
  • GEO confirmed that it used the state's key commercial adviser extensively inboth Australia and overseas for tax advice and asserted its intention to continue to use this adviser.
  • The probity advisor did not make any detailed inquiries or document a formal probity conflict risk assessment for either conflict, and advised DJR that there were no probity issues within hours of being made aware ofthem.

DJR relied on the probity advisor's advice and did not seek any further information or commitments from the commercial adviser on how it would manage the conflicts. DJR also advised that it did not seek any further information from the commercial adviser or GEO on the extent of financial advice from the adviser to GEO on the Fulham contract negotiations, as it did not consider this necessary.

The potential risks to the state's interests arising from this situation warranted more detailed probity conflict risk assessments than the cursory advice provided by the probity advisor. DJR should have also required the commercial adviser to supplement its high-level advice on conflict management with specific written assurances on the controls in place to manage the two conflict situations that arose.

DJR has recently received advice from both the commercial adviser and GEO indicating that the adviser did not, in fact, provide financial advice to GEO on the Fulham transaction. DJR should have obtained definitive confirmation on this issue in 2014.

We reviewed publicly available information and found that, in addition to providing services to the operator of Fulham, the state's commercial adviser's affiliated firm in the United Kingdom also provided advisory services to the global parent company for the operator of Port Phillip between 2013 and 2015.

This company was listed on the conflict of interest declaration form as a relevant entity, and the probity advisor reminded the commercial adviser in November 2013 that it needed to consider services provided to the operators and their related entities by its overseas affiliates when completing the declaration. Despite this, none of the adviser's staff disclosed any potential conflicts. DJR and the probity advisor indicated that they were not aware of this situation until we raised it.

The probity advisor's final reports on each transaction were unqualified and included no discussion of the conflict of interest issues that arose during the project and how they were managed. This was inconsistent with the probity plan for the project and the probity advisor's contract. While the project steering committee was aware of the conflict of interest issues, the probity advisor's reports also formed part of the assurance material provided to the Minister for Corrections and government. Given this, the reports should have explained how the potential conflicts of interest for DJR's key advisers were assessed and managed.

5.4 Demonstrating value for money

Recommending new long-term contracts after exclusive negotiations with incumbent operators required DJR to demonstrate to government that the recommended outcomes represented value for money. This is because the government could not compare the offers from the incumbents against bids from other potential operators in an open competitive process.

DJR communicated the merits of the negotiated contract outcomes in terms of cost, service delivery and performance requirements, risk transfer, and improvements over the original contracts. DJR provided advice to government recommending that it sign new contracts with GEO for Fulham and G4S for Port Phillip in March and November 2015 respectively.

Cost was the main criteria assessed and highlighted in this advice to government, and DJR took reasonable steps to gain assurance on the value for money of the operators' proposals.

DJR only briefly described the incumbent operators' service performance in the advice to government and did not support this advice with any detailed assessments of whether the operators were capable and high performing. DJR gave little coverage of its concerns regarding G4S's performance in operating Port Phillip during 2014.

The negotiated contract prices appear to provide sustainable value for money to the government and a reasonable return to the providers, if they meet performance standards.

Assurance of value for money

DJR primarily assessed the value for money of the operators' proposals against the negotiation limits for the contract extensions approved by government in July 2014, which it based on the costs of the existing contracts with some variations in the scope of services.

The government's approved negotiation limits allowed a cost increase of 4 to 5 per cent over the operating costs of the initial contracts. DJR and DTF appropriately highlighted differences between the negotiating limit and the final outcomes in their advice to government.

To assess the value for money of the operators' proposals, DJR examined their actual and proposed operating costs and benchmarked them against costs in publicly operated prisons. The results of this work indicated that the final offers from the operators represented value for money.

DJR based its advice to government about the value for money of the negotiated outcomes on analysis and sign-offs from external commercial, technical and legal advisers including:

  • value-for-money assessment reports from the state's commercial adviser
  • advice on benchmarking Fulham and Port Phillip's operating costs
  • technical advice about the reasonableness of the asset and life cycle costs proposed by the operators
  • legal sign-off letters on the contracts summarising departures from standard Partnerships Victoria commercial principles, explaining that these were linked to the unique nature of the projects and were not significant, and summarising differences in risk allocation between Fulham and Ravenhall, and between Port Phillip and Fulham.

Review of operator cost proposals

The state knew what it was paying the operators to deliver accommodation and correctional services under the old contracts but only had limited insight into the actual costs incurred by the operators in providing these services. The original contracts included five‑yearly pricing reviews, but these were informed by benchmarking exercises rather than regular detailed examination of the operator's actual costs.

DJR required the operators to complete a financial bid template as part of the negotiations for the new contracts. The financial bid templates required detailed cost information in the following areas:

  • labour costs—including information on salaries per full-time-equivalent staff and staffing numbers across each prison on a unit-by-unit basis, showing daily shifts and weekly hours for each staff 'post' in each accommodation unit
  • outsourced services—including costs for external education providers, allied health services, chaplaincy services and catering services for Port Phillip
  • maintenance services and costs—these services are contracted out by the operators (financial bid template information indicates G4S is paid a margin on these costs whereas GEO is not)
  • supplies—including for cleaning, prison industries and other consumables
  • utilities—comprising water, electricity and gas charges
  • other costs—including for IT systems and equipment leases.

DJR planned to test the price bids from the operators during the negotiations using 'open book' analysis, cost benchmarking against similar prisons and PSCs. Both operators signed probity and process deeds agreeing to provide the state with full open-book access to all necessary documentation for the negotiations.

DJR undertook reasonable steps to gain assurance about the value for money of the proposals put forward by the operators including targeted examination of their actual and proposed operating costs and benchmarking against costs in publicly operated prisons. DJR was also directly involved in negotiating with both operators and their sub-contractors for the scope and pricing of asset life cycle management and maintenance activities to limit the state's exposure to significant cost increases.

The extent of value-for-money analysis was appropriate given the unique circumstances of the Fulham and Port Phillip negotiations and DJR's advice to government on value for money was sound.

Fulham

The future operational costs initially proposed by GEO for Fulham were consistent with the approved negotiating limit and the payments made under the existing contract. They compared favourably to the costs of similar state-run prisons. DJR identified and assessed the value for money of incremental cost increases proposed by GEO and recommended granting the operator a contract extension without undertaking open-book analysis or a formal PSC as Partnerships Victoria requires. Instead, it compared the operational costs against a public sector benchmark. This benchmarking analysis:

  • was prepared with a clear understanding of operating model requirements at Fulham and how the state would operate the facility
  • confirmed that state delivery would be significantly more expensive.

DJR advised that the outcome of this benchmarking removed the need for a formal PSC. The value-for-money analysis also considered the costs and risks associated with the best alternative option—a tender for the contract—and concluded that a competitive process was unlikely to deliver a better outcome.

DJR did not highlight the lack of an open-book analysis and formal PSC in its summary advice to government in March 2015, in which it recommended signing the new contract. The summary advice referred to an 'appropriate level of due diligence over GEO's existing cost base'. The detailed supporting information included with this advice noted that GEO provided a detailed financial template that enabled DJR to compare cost assumptions against other data.

Port Phillip

When G4S initially proposed significantly higher-than-expected operational costs under the proposed new contract, DJR took additional steps to assess value for money. These included:

  • preparing a formal PSC
  • developing a 'tipping point' analysis informed by an updated estimate of the cost to buy out the lease
  • undertaking open-book analysis of G4S's main operating costs.

The PSC and other benchmarking analysis included in the value-for-money report confirmed that G4S could operate the prison more cheaply than the state. The tipping-point analysis compared the expected costs of a new contract with G4S against the value that an open tender for the contract might achieve.

The sample open-book process undertaken for Port Phillip focused on key assumptions underpinning G4S's employee costs, which represented around 60 per cent of its operating costs. While the scope of this work was limited and the report documenting the work was not formalised beyond a draft, it served a useful purpose in DJR's final negotiations with G4S on costs under the proposed new contract.

DJR's advice to government in November 2015 recommending a new contract with G4S included a robust summary of the value-for-money analysis. The advice accurately described the open-book analysis as a sample-based process focused on G4S's historical costs and pricing assumptions.

5.5 Negotiation outcomes and new contracts

The government signed new contracts for Fulham and Port Phillip in April and December 2015 respectively. The contracts included some important improvements for the state. Figure 5B sets out key information on the new contracts.

Figure 5B
Scope of the new contracts for Fulham and Port Phillip

Measure

Fulham

Port Phillip

Bed capacity

893

1 087

Commencement

1 July 2016

10 September 2017

Initial contract term

11 years

10 years

Further extension term

8.25 years

10 years

Contract expiry (if full term)

October 2035

September 2037

Estimated total payments – full term (nominal)

$1.4 billion

$3.1 billion

Performance bond

$8 million

$12 million

Source: VAGO based on CV information.

Contractual improvements

It is clear that the new contracts negotiated with the operators address substantial weaknesses in the previous contracts. They will place the state in a much stronger position at the end of their service terms to consider and pursue all available options—including competitively tendering the contracts—unencumbered by legacy issues or costs.

The state's objectives in negotiating the new contracts included:

  • updating the contractual provisions to be more consistent with current Partnerships Victoria PPP contracts
  • addressing key deficiencies in the original contracts, including unclear service specifications and a low proportion of service payments based on performance.

DJR and DTF advice to government in March 2015 and November 2015 included reasonable claims that the new contracts addressed the major weaknesses in the original contracts and that material improvements had been achieved. The new contracts:

  • define the required services more clearly, to assist contract management and enforcement, noting that it remains an 'output specification' that relies on commercial incentives to drive performance
  • improve provisions for asset condition and life cycle maintenance and replacement, including better definition of the operators' obligations and specifying agreed planned works to be funded from a dedicated life cycle payment account, with any underspend at the end of term to be shared with the state
  • include a payment and performance regime that more clearly allocates prison operation risks to the operators—payments are effectively built up from a zero base according to the number of available prisoner places and the quality of services delivered, rather than being deducted from a standard fee
  • include a capacity 'tranching' regime which allows the state to decrease or increase the required bed capacity in the prisons in increments of 50 and adjust the service payment accordingly
  • improve contractual security for the state, through a parent guarantee and increased performance bonds—the performance bond for Fulham increased from $3 million to $8 million, and for Port Phillip from $8 million to $12 million
  • resolve the lease-term misalignment issue, providing the state with improved end-of-term provisions that will allow it to re-tender all or part of the services at the end of term (around 10 or 20 years in each case, depending on whether the operators secure a further extension term).

Appendix D lists the contractual improvements or 'negotiation benefits' described in CV's contract administration manuals for the new contracts and comments on the validity of the claimed improvements and benefits.

Changes to performance-linked payments under the new contracts

The initial contracts for the private prisons provided for an annual performance‑linked payment to each operator based on their achievement of the SDO performance thresholds.

The maximum performance payment payable to each operator was capped, and the fees were not indexed. As a result, they declined proportionally over time and did not provide a sufficient incentive for operators to improve their performance:

  • For Port Phillip, the maximum performance payment was fixed at around 3.5 per cent of the total payments from the state in the first year of the contract. It dropped to around 1 per cent of total payments in 2015–16.
  • For Fulham, the maximum performance payment was fixed at around 7.4 per cent of the total payments from the state in the first year of the contract, dropping to around 3 per cent by 2015–16.

The Commissioner determined the amount of the performance payment paid to each operator at the end of each year, based on advice from CV about actual performance. Under the contract, the performance payment would only be reduced if the operator failed a category of SDO performance thresholds—for example, SDOs related to safety and security—by more than 20 per cent.

While the new contracts retain the SDOs and include additional KPIs, they also significantly increase the proportion of operators' total contract payments that rely on performance. The new contracts also introduced contractual penalties for specific performance failures, known as charge events. These events include prisoner deaths, escapes, serious professional misconduct by prison staff and significant breakdowns in discipline, such as riots.

Along with better processes for addressing performance issues, the new contracts also introduced additional incentives for operators to address poor performance quickly. CV can reduce the service-linked fee, which includes performance payments, if the operators fail to meet SDO thresholds in successive quarters. Under the initial contracts, this was an annual assessment and, once an operator had failed for the year, there was little incentive for it to improve its performance on failed SDOs. The introduction of a KPI that penalises successive quarterly failures has significantly increased pressure on the operators to perform.

Risk allocation

The key commercial features of the new contracts, including the risk allocation, are explained in the project summary documents for each contract publicly available from DTF's Partnerships Victoria website.

We examined this information on the risk allocation, the contracts and the sign‑off opinion letters prepared by the state's legal adviser supporting DJR's recommendations to government. The risk allocations were accurately described in advice to government and the public.

We note that there are some differences in the detailed commercial regimes included in the two contracts. This reflects the project-specific outcomes from the negotiations and differences in the operational and commercial risks carried by the operators. For example, there are differences in the contractual provisions which determine whether each operator will secure a further extension term after the initial 10- or 11-year term, including differences in the allowable number of adverse events and payment reductions.

Despite these differences, it is clear that the new contracts achieve an overall risk allocation for Port Phillip that is broadly the same as that for Fulham and Ravenhall, representing an improvement over the original contracts.

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