1. 1 REVIEW OF THE PUBLIC PRIVATE PARTNERSHIP PRISON CONTRACTS 8 November 2002

2. 2 TASK TEAM TERMS OF REFERENCE  To understand output specifications, costing assumptions, project finance and risk allocation.  To identify capital and operational costs.  To identify features for re-negotiation to address DCS affordability constraints.  To establish a sound methodological basis for comparison with existing and recently constructed conventional prisons.  To report to Ministers of Correctional Services, Finance, Public Works and Portfolio Committee.

3. 3 TASK TEAM MEMBERS ChairpersonMr NW TshivhaseCFO DCS SecretaryMr JJ VenterASD Financial Planning DCS Adv M NdzibaMinister’s Special Advisor Mr NS MakhaniDirector Financial Planning Ms J SchreinerCDC Functional Services Ms RST MthabelaDC Offender Control Mr J MaakoDirector APOPS Mr C BassonDeputy Director APOPS Mr CH PaxtonDirector Legal Services National Treasury Mr VH MbetheChief Director Dr K BrownDirector Integrated Justice Cluster Mr W MothibediActing Director DCS Ms S LundSenior Transaction Advisor PPP Unit Mr W KrauseSFAO DCS DPWMr L van HeckeActing Director APOPS Consultants Mr T WilliamsDirector Ignis Mr P ChipinduAssociate Ignis

4. 4 TASK TEAM FINDINGS Part I: Existing PPP Transactions  Overview of existing PPP transactions.  Options for Re-negotiation of Existing Contracts.  Conclusions and Recommendations. Part II: Future Prison Projects  Illustrative comparisons of Public and PPP Prisons  Future Evaluation Methodology: Feasibility Protocol.  Conclusions and Recommendations. Part III: Recommendations for Next Steps

5. 5 PART I EXISTING PPP PRISONS TRANSACTIONS

6. 6 1. OVERVIEW OF EXISTING PPP PRISONS TRANSACTIONS

7. 7 BLOEMFONTEIN PRISON PPP PARTIES TO THE CONTRACT

8. 8 LOUIS TRICHARDT PRISON PPP PARTIES TO THE CONTRACT

9. 9 DCS SPECIFICATIONS  Specifications based on inputs rather than outputs or outcomes.  Specifications imported from UK prison – ‘ideal’ and high level.  No prior feasibility undertaken to ensure: Affordability limits Optimal value for money Optimal risk transfer

10. 10 DCS SPECIFICATIONS: DESIGN  Cell configuration (2-man and 4-man cells).  Security.  Special centres (e.g. assessment, visitors, special treatment).  Utilities.  Service centres (e.g. catering, health, religious).  External works.

11. 11 DCS DESIGN SPECIFICATIONS: EXAMPLES  Cell size*: 5.5m 2 single or 8m 2 double.  Cell height*: 2.7m.  Minimum 5 layers of security.  Telephone monitoring system.  CCTV, cameras, x-rays, etc. * Minimum requirement according to Health and National Building Regulations.

12. 12 DCS SPECIFICATIONS: OPERATIONS Goal 1: Keep inmates in custody  Central control, number of prisoners per cell, supervision, security during visits, escorts, special category prisoners, roll checks, etc. Goal 2: Order, control and safety  Regulating remedy deficiencies, grievance procedures, use of force, financial transactions, repairs, maintenance, drug control measures, etc. Goal 3: Decent conditions for inmates  Admission times, personal hygiene clothing, bedding, cell equipment, meals, healthcare, etc. Goal 4: Prepare for return to community  Legal rights representation, official visits, unofficial visits, etc.

13. 13 DCS SPECIFICATIONS: OPERATIONS Goal 5: Structured Day Programmes  Structured Day Programme, times of unlocking, activities, time outdoors, social work services, religion, work, education training programmes, physical education library, psychologists, etc. Goal 6: Deliver services with maximum efficiency  Strategic development plans, personnel policies, equal opportunities, drug & alcohol free work-place, conditions of service, uniforms, recruitment & selection and training. Goal 7: Promote community involvement  Community participation and vice versa, formal & informal community development, employment to local community, local PR policy.

14. 14OVERVIEW BloemfonteinLouis Trichardt Number of inmates2 9283 024 Total capital expenditure (R’m)435392  Construction (R’m)270303  Pre-operating interest / fees (R’m) 10426*  Start-up costs (R’m)5849  Contract signed24 Mar 0011 Aug 00  Opening date1 Jul 0119 Feb 02  Full capacity dateJan 02Sep 02 * Interest deferred in terms of financial structure.

15. 15 FEES PAYABLE BY DCS Bloemfontein R/inmate/day Louis Trichardt R/inmate/day Fixed Fee for Construction Debt  Base Date (1 Jan 98)65.9166.25  Opening83.5073.91 Operating Fee  Base Date (1 Jan 98)88.5073.06  Opening103.9781.51  October 2002132.2086.45 Total Fee  Base date (1 Jan 98)154.41139.31  Opening187.47155.42  October 2002215.70160.36

16. 16 COMPARISON OF FEE STRUCTURE  Fee comparison complicated by: Different start dates. “K-Factor”:  Real increases above inflation.  Bloemfontein: from 0.623% to 0.789% six monthly.  Louis Trichardt: six monthly increases:  Years 2-36%  Years 4-55%  Year 64%  Years 7-92%  Years 10-131%  Years 14-253% decrease each 6 months  Net Present Value of all fees (8% discount rate):  BloemfonteinR1.3 billion  Louis TrichardtR1.2 billion

17. 17 REAL INDEXED FEE ADJUSTED FOR “K-FACTOR”

18. 18 BREAKDOWN OF OPERATING COSTS (BLOEMFONTEIN)

19. 19 BREAKDOWN OF OPERATING COSTS (LOUIS TRICHARDT)

20. 20 EXISTING PPP PRISONS: FINANCE BloemfonteinLouis Trichardt R’m% % Equity 54.0 11 53 13 Debt437.0 89353 87 Total491.0100406100 Base Interest Rate14.58% (deferred start swap rate) 15% (ytm of R157) Cost of Debt2.25% margin2.50% margin Return on Equity (including inflation) ± 29.9% *± 25.1% nominal * Return on Equity (excluding inflation) ± 20.3%± 15.57% Weighted average cost 18.27%18.50% * Based on 8% inflation.

21. 21 RISK ALLOCATION: TECHNICAL / OPERATIONAL RISK ALLOCATION: TECHNICAL / OPERATIONAL Risk TypeContractorDCS Construction – Design  Construction – Cost  Construction – Delays  Change in technology  Operating Costs  Damage to prison  Force Majeure Prison security  Residual Cell availability  Cell usage 

22. 22 RISK ALLOCATION: LEGAL / FINANCIAL Risk TypeContractorDCS Capital outlay  Interest rates  Inflation  Available cash flow  Residual market value  Financial viability  Residual Change in tax legislation  Change in prison legislation / MAGA  Land  Environmental 

23. 23 2. OPTIONS FOR RE-NEGOTIATION OF EXISTING CONTRACTS

24. 24 OPTIONS FOR RE-NEGOTIATION Construction Expenditure  None. Operating Expenditure  Changes in levels of service.  Amendments to fee payment structure.  Change in prisoner numbers. Refinancing  Possible conversion of debt portfolio to inflation-linked funding.

25. 25 OPTIONS FOR RE-NEGOTIATION: OPERATING EXPENDITURE Staff costs  Hours out of cell.  Service specifications. Rehabilitation and Health Care  Change in specifications. Fee payment structure  Amendments to “K-factor” adjustments to improve cashflows. Change in Prisoner Numbers  Bloemfontein: 2 new units.  Louis Trichardt: convert 2-bed cells to 4-bed cells and use reception/special treatment centre.

26. 26 OPTIONS FOR RE-NEGOTIATION: INDICATIVE FEE CALCULATION BloemfonteinLouis Trichardt Current inmates2 9283 024 Potential additional976696 Potential total inmates3 9043 720 Capital expenditure required YesLimited Current rate per day (R)132.2086.45 Average rate / day after expansion 112.3773.48 Rate / day for additional inmates 52.8817.13

27. 27 OPTIONS FOR RE-NEGOTIATION: REFINANCING Methodology  Net Present Value of unexpired portion of debt (settlement estimate).  Convert into new CPI-linked bond debt and calculate new repayments and NPVs.  Compare with existing payments.

28. 28 OPTIONS FOR RE-NEGOTIATION: RE-FINANCING ASSUMPTIONS AssumptionsBloemfonteinLouis Trichardt Original value (R’m)437353 Current annual repayment (R’m) 83.368.9 Settlement estimate (R’m)530.9556.6 Benchmark refinance date30 Sept 0231 July 02 Benchmark Ref. Base Rate (R153 as at 24 Sept 02) 11.80% Benchmark Ref. Real Rate (assume Full Gov. borrowing) 4.50% Margin for refinancing (full)2.252.50 Margin for refinancing (reduced) 1.75

29. 29 OPTIONS FOR RE-NEGOTIATION: RE-FINANCING BENEFITS (BLOEMFONTEIN) Inflation % Excluding Margin Reduced Margin Historical Full Margin Payment 02/03 R’m NPV R’m Payment 02/03 R’m NPV R’m Payment 02/03 R’m NPV R’m 3.0050.9379.357.2426.459.1440.3 4.5051.6413.558.0467.859.9480.0 6.0052.4451.558.9507.560.8524.0 7.5053.1493.759.7554.961.7573.0

30. 30 OPTIONS FOR RE-NEGOTIATION: RE-FINANCING BENEFITS (LOUIS TRICHARDT) Inflation % Excluding Margin Reduced Margin Historical Full Margin Payment 02/03 R’m NPV R’m Payment 02/03 R’m NPV R’m Payment 02/03 R’m NPV R’m 3.0053.4397.760.0447.063.3471.6 4.5054.2433.660.9487.364.4514.2 6.0055.0473.461.8532.065.2561.4 7.5055.7517.662.6581.766.1613.8

31. 31 3. CONCLUSIONS & RECOMMENDATIONS: EXISTING PPP CONTRACTS

32. 32 CONCLUSION: EXISTING CONTRACTS The PPP Prison Projects delivered according to DCS’ specifications, notably achieving:  Competitive construction costs.  Construction on time, on budget.  Fast-track delivery (< 2years full capacity).  Comparative operating costs.  Significant black equity and sub-contracting  Significantly higher-quality facilities.  Significantly higher-levels of service.  Appropriate risk allocation. But …

33. 33 CONCLUSIONS: PROBLEMS WITH EXISTING CONTRACTS  DCS specifications were too high (the PPP prisons remain driven by DCS’ input specifications).  Relatively high cost of debt.  Higher than normal return on equity.  Additional budgeting pressures for DCS.  Despite overcrowding in DCS system, no ability to over-populate PPP prisons.

34. 34 RECOMMENDATION: EXISTING PROJECTS Operating  Engage contractors in order to improve Value for Money by: Reviewing standards and specifications. Amending fee payment structure. Consider options for extra prisoners on a marginal cost per prisoner basis. [Proposed Feasibility Protocol will be used by DCS to determine optimal value for money] Finance  Engage contractors to: Improve cash flows and NPV and Consider converting debt portfolio to inflation-linked funding.

35. 35 PART II FUTURE PRISON PROJECTS

36. 36 1. ILLUSTRATIVE COMPARISONS: PUBLIC AND PPP PRISONS

37. 37 BARRIERS TO DIRECT COMPARISON BETWEEN PPP AND PUBLIC PRISONS CAPITAL COSTS  Dates of construction  Type of prison  Inmates per cell  Location  Risk transfer  Split functions: DPW/DCS  Inclusion of staff housing  Capacities  Security levels  Technology and design OPERATING COSTS  Overcrowding  Standards of facilities  Standards of activities  Hours out of cell  Rehabilitation  Health facilities  Risk transfer – penalties  In-house food & services  Availability of information

38. 38 ILLUSTRATIVE COMPARISON: RISK TRANSFER IN RESPECT OF CAPITAL COST Prison Constr Date Inmate Capacity Original Budget (R’m) Final Cost (R’m) % Budget Reasons Bloemfontein03/002 928270 100% Fixed price contracts. Louis Trichardt 08/003 024303 100% Fixed price contracts. Kokstad Max11/001 440232360155% Increase due to civil works. Empangeni06/001 392195200103% Increase due to escalation (Haylet Formula). Emthonjeni05/98640122124102% Increase due to escalation (Haylet Formula) civil works. Malmesbury11/971 217134190142% Increase due to civil ground works & escalation.

39. 39 REASONS FOR DIFFICULTIES IN COMPARING PRISON CONSTRUCTION COSTS REASONS FOR DIFFICULTIES IN COMPARING PRISON CONSTRUCTION COSTS  Prisons differ by: Type (e.g. super max, max, medium, youth centres, etc.) Size (inmates varies from 3000).  Constructed at different times, different operating philosophies.  Different geographic locations = construction/logistical problems.  DCS does not have a cost centre focus & PPP operators have different cost allocation structures.  Functions and costs split between DCS & DPW.  Historical procurement problems created inefficiencies.

40. 40 ILLUSTRATIVE COMPARISON: FUNDED CONSTRUCTION COST FORGOVERNMENT Construction amount (R’m)300 % overrun15% Base interest rate (benchmark government rate in 2000)15% Inter-government margin1% Debt period15 years Construction period24 months Vat Rate14% Number of prisoners3 000 Results Capital expenditure (R’m)393 Pre-operating interest (R’m)63 Total Debt (R’m)456 Annual payment (R’m)82 Cost per constructed inmate place per day (Rands)R74.70

41. 41 ILLUSTRATIVE COMPARISON: OPERATING COSTS Cost Description Public (R/prisoner/day) Private (R/prisoner/day) Budget 2002/03 Bloemfontein October 02 Louis Trichardt October 02 Staff costs-51.54- Administration35.54-23.18 Security / Operations41.22-32.40 Health 4.2414.14 7.76 Programmes 5.6210.7110.08 Facilities Management 1.80 5.72 5.45 Utilities 0.16 5.48- Catering 5.0911.96 7.26 Supplies / Procurement- 8.80 0.32 Insurance- 3.67- Co. costs / Redemption-20.18- Total 93.67 *132.2086.45 Total inmates 172 048 (incl. 70% overcrowding) 2 928 (not overcrowded) 3 024 (not overcrowded) * See comments on the effects of overcrowding (Page 44 of Report).

42. 42 REASONS FOR DIFFICULTIES IN COMPARING PRISON OPERATING COSTS REASONS FOR DIFFICULTIES IN COMPARING PRISON OPERATING COSTS  Overcrowding of public prisons.  Prisons differ by: Type (e.g. super max, max, medium, youth centres, etc.) Standards of facilities (health, catering, recreation, etc.) Standards of activities (education, vocational training, work). Hours out of cell.  Different operating philosophies, often result of different design.  DCS does not have a cost centre focus to accounting.  PPP operators have different cost allocation structures.  Risk transfer differs.

43. 43 2. FUTURE EVALUATION METHODOLOGY: FEASIBILITY PROTOCOL

44. 44 PROPOSED FUTURE EVALUATION METHODOLOGY FOR NEW PRISONS  Applicable for projects as both PPP and conventional procurement.  Purpose is to assess all options based on clear output specifications.  For all choices, DCS needs to demonstrate: Affordability Value for Money Acknowledgement and treatment of risk

45. 45 FUTURE EVALUATION METHODOLOGY: FEASIBILITY PROTOCOL

46. 46 FUTURE EVALUATION METHODOLOGY: FEASIBILITY PROTOCOL

47. 47 FUTURE EVALUATION METHODOLOGY: FEASIBILITY PROTOCOL

48. 48 FUTURE EVALUATION METHODOLOGY: FEASIBILITY PROTOCOL

49. 49 3. CONCLUSIONS & RECOMMENDATIONS: FUTURE PRISON PROJECTS

50. 50 RECOMMENDATION: FEASIBILITY PROTOCOL FOR FUTURE PROJECTS  DCS to clearly establish output specifications (for design & operations).  Establish budget constraints.  Develop comparable accounting standards for both PPP and DCS-operated prisons.  Adopt clear rules for DCS staff movement during any future PPP procurements.  Comprehensive feasibility: Cost private design, finance, build and operate, versus Risk-adjusted Public Sector Comparator.  Results: If clear distinction – Adopt. If depends on assumptions – Policy decision or pilot comparisons.

51. 51 PART III TASK TEAM’S RECOMMENDATIONS FOR NEXT STEPS

52. 52 TASK TEAM’S RECOMMENDATIONS FOR NEXT STEPS Next StepsResponsibility Target Start Date Engage PPP contractors to improve value for money by:  Reviewing standards & specifications;  Amending fee payment structure;  Accommodating additional inmates;  Negotiating debt funding. DCS supported by National Treasury and Financial & Legal Advisors 1 Dec 02 Adoption of the Feasibility Protocol for all future prison projects. DCS1 Dec 02

53. 53 TASK TEAM’S RECOMMENDATIONS FOR NEXT STEPS Next StepsResponsibility Target Start Date Setting of clear DCS policy, processes and decision-making structures for procurement of future prisons. DCS supported by National Treasury 1 Dec 02 Setting and public announcement of DCS policy on unsolicited bids. DCS supported by National Treasury 1 Dec 02 Training of key DCS personnel in:  DCS’s Prison Feasibility Protocol and  DCS’s Procurement policy, methods and standards. DCS supported by National Treasury March 03

54. 54 MINISTERS OF: CORRECTIONAL SERVICES, FINANCE, PUBLIC WORKS and PARLIAMENTARY PORTFOLIO COMMITTEE ON CORRECTIONAL SERVICES REVIEW REPORT SUBMITTED TO: