Kansas Audit Offers Flawed Comparative Financing Analysis for Prison Replacement

Commentary

Kansas Audit Offers Flawed Comparative Financing Analysis for Prison Replacement

Key questionable assumptions undermine report's findings.

Public-private partnerships, when used (PPPs) to finance and build public infrastructure assets, provide additional financing tools and project delivery mechanisms beyond traditional public financing. This major benefit creates a wider set of options for policymakers to consider. But to do so effectively, they inevitably must carefully analyze a variety of complex options for financing costs, operating costs, long-term capital investment and risk profile—and even the option set overall. Such analysis is often difficult.

Accordingly, many countries and U.S., states experienced in infrastructure PPPs have developed tools like value-for-money analysis to help policymakers assess the comparative costs, risks and operational issues critical to prudent long-term decision making. A recent Kansas Legislative Division of Post Audit (LPA) report evaluating public and private financing options to replace an aging state prison shows why this is so important.

The Kansas Department of Corrections (KDOC) must replace the state’s 150-year old Lansing Correctional Facility, and it is allowing vendors the opportunity to bid for both public (bond) financing and privately financed design, construction and maintenance. Given this procurement, a legislator requested the LPA to assess and report on the potential costs, benefits and risks of the public and private financing options. Ultimately, the LPA report concluded that public financing would be the most cost-effective.

The LPA applied a life-cycle costing methodology to the analysis (rather than simply examine upfront project delivery costs), correctly recognizing the inherent differences that can occur in life-cycle costs between publicly and privately financed infrastructure. However, the report also made questionable assumptions that distort overall costs and risks associated with either option, diminishing its utility for legislators.

First, LPA assumed that in a hypothetical private financing/lease scenario, the state would be required to purchase the new prison facility at the end of the lease term. Because KDOC’s original cost models did not factor in such a purchase, the LPA concluded that KDOC had undervalued the private financing option and that lease scenarios would cost an additional tens of millions of dollars. In the LPA’s analysis, this made the private lease option significantly more expensive than the public financing options examined, leading to the report’s conclusion that public financing would be the most effective option.

But as many other states’ experience demonstrates, there is no inherent requirement that a state must purchase a facility at the end of a private financing agreement. Lease agreements generally allow for purchase at end of a lease term, but the state entity is under no obligation to purchase, making any purchase requirement a policy decision, not an inherent outcome of contracting. Some states choose to do so; some do not. In fact, new-build private prison lease structures can offer—but not mandate that—a state client purchase a facility at the end of a lease term, allowing states flexibility to deal with changing conditions over the coming decades.

Ultimately, purchasing a privately financed prison is a policy decision, and while KDOC may ask vendors to price out that option today, the state need not make that decision today. In fact, given the wave of criminal justice reforms in many states affecting needed prison capacity, prudent state officials should perhaps not lock themselves today into purchasing a prison 20+ years from now.

As well, the report assumed construction costs were equal between the public and private delivery options, stating that “[t]he design and construction costs are assumed to be the same, regardless of the financing mechanism.” While it may seem that, regardless of financing and delivery method, the private sector is going to build the prison one way or another—so construction costs would therefore be roughly equivalent, this is very unlikely. Design and construction costs often differ widely due to many factors. For example, KDOC acting as a construction project manager (which is not a core skill set of most corrections agencies) versus private corrections firms that are constantly delivering new facilities and managing new construction projects are likely to have different costs. And publicly funded new construction is more likely to generate cost overruns due to delays, compared to private entities who must pay financial penalties for such overruns, and therefore manage their schedules more tightly.

Oddly, after noting that it assumed design and construction costs were equivalent between the two financing options, the LPA report contradicted itself in the very same paragraph by noting that, “[i]n reality, the contractors may not submit proposals for all the options in the RFP, and the design and construction costs may vary greatly between the various contractors.”

Another questionable assumption is the use of overly reductionist ranges of the variables used in the report’s life-cycle cost analysis. When evaluating the public and private financing scenarios, the LPA report uses the same variable value ranges for its rates of inflation, bond interest, and repair cost growth, yet significant variations between the actual figures relative to the different types of delivery and financing methods are likely. It’s not that one approach to financing has inherent advantages over another, but that these variables are unlikely to be the exact same across the board.

The questionable assumption about having to buy the facility enters into the variable estimates, too. It adds $500,000 in repair costs and a 5% annual growth in rehab and repair costs based on the state paying them after it takes ownership. If the state did not purchase the facility at the end of a lease term, then obviously these costs would not be a factor. The questionable prison purchase assumption accompanies improbable maintenance cost estimates that are not likely to reflect reality. LPA assumes that if maintenance of the facility remains “in-house” (i.e. by government employees), that 40% of KDOC’s maintenance positions at the current prison would be eliminated over the 7-year period under study as the new prison comes online. While one expects less work would be needed to maintain the newer facility, eliminating such a significant portion of an agency work division seems unrealistic.

Finally, the LPA report states that “relying on contracted maintenance increases the risk that necessary maintenance will be deferred.” This is contentious for several reasons:

  • One main reasons—if not the main reason—more public agencies are turning to PPPs in transportation and social infrastructure is that traditional budgetary and procurement procedures have curtailed funding for maintenance, spawning many agencies’ current deferred maintenance problems. Reason Foundation has hardly been silent on this issue, and other states have successfully used corrections PPPs to eliminate—not create or exacerbate—deferred maintenance costs.
  • Infrastructure PPP agreements typically contain dozens of pages listing guidelines, standards, and specifications for determining proper levels of all aspects of facility maintenance, with the intention of avoiding problems of deferred maintenance. Unlike with publicly maintained facilities, these agreements often financially penalize contracted firms who fail to adhere to standards, including that of maintenance. As Cornell University professor Richard D. Geddes notes in his 2011 book, Road to Renewal: Private Investment in the U.S. Transportation Infrastructure, “[d]eferred maintenance is typically precluded by the terms of a PPP contract.” Just as with roads, PPP agreement terms can be structured to preclude deferred maintenance in PPPs involving physical buildings.
  • Some states are using innovative “performance-based asset maintenance” (or “total asset maintenance”) contracting to better address chronic deferred maintenance problems. This decreases the risk that necessary maintenance will be deferred.

Despite the aforementioned flaws in assumptions, the LPA stops short of recommending against the private financing option. Instead, it frames public financing as the more cost-effective choice but suggests that KDOC take life-cycle costing, consistent assumptions, and risk into account in its decision-making once all of the bids are in. Those are generally reasonable points to consider. But such subtleties tend to get lost when policymakers and media focus on the highest-level talking points from a report like this, and in this case, those talking points clearly suggest a preference for public over private financing. Unfortunately, some policymakers ideologically opposed to private infrastructure financing are likely to champion this report as a reason to reject that option outright.

But this would be a mistake. Given the flawed assumptions discussed above, policymakers would be well advised to stay the course on the current KDOC procurement and let the market discovery process work. In its response to the report, KDOC notes that it will “conduct the cost comparisons based on factual information” received from the bids “rather than assumptions.” If the bids come back and validate the LPA’s analysis, then it would make perfect sense for the agency to proceed accordingly.

Either way, with bids in hand, the state will have the critical information needed to make an informed analysis over different financing options and maintenance arrangements. Thus, policymakers should let the final results of the procurement drive their decisions, rather than make firm judgments about the efficacy of either public or private financing options at this stage.

Austill Stuart is a policy analyst at Reason Foundation. Leonard Gilroy is director of government reform at Reason Foundation.

Austill Stuart is a policy analyst at Reason Foundation, a non-profit think tank advancing free minds and free markets.

Leonard Gilroy is Senior Managing Director of the Pension Integrity Project at Reason Foundation, a nonprofit think tank advancing free minds and free markets. The Pension Integrity Project assists policymakers and other stakeholders in designing, analyzing and implementing public sector pension reforms.