THE PFI RECKONING · ARTICLE 9 OF 12
Insource or Reprocure After PFI: The VAT Trap, the Pension Deficit, and the Decision Most Authorities Are Not Modelling
When a PFI contract expires, the authority must decide how FM services will be delivered from day one of the post PFI operating environment. Insource and manage directly. Retender to a new contractor. Extend with the incumbent. Or some hybrid of all three. Most authorities have not modelled any of these options with the rigour the decision requires. The VAT implications alone can wipe out the apparent savings of insourcing. The pension liabilities can make the business case unrecognisable. This article examines what the decision actually involves, what most authorities are getting wrong, and what the financial model must include.
The decision most authorities have not made
The insource versus reprocure decision should be made at least three years before PFI expiry. NISTA’s PFI Contract Strategy guidance (March 2026) positions this as a Senior Responsible Owner (SRO) level decision within the seven year expiry programme. It drives everything that follows: workforce planning, TUPE strategy, capital budgeting, procurement timelines, and operational readiness. Without this decision, every other workstream is working in a vacuum.
Most authorities have not made it. Some have not started the analysis. Some have started but lack the data to complete it. Some have deferred the decision because the options are all difficult and the political dynamics are complex. The result is that the decision is made by default in the final 12 to 18 months, under time pressure, with incomplete information, and with insufficient time to implement whatever option is chosen.
An authority that reaches year 24 without a clear post PFI delivery model is not making a strategic decision. It is accepting whatever outcome the timeline imposes.
An authority that reaches year 24 without a clear post PFI delivery model is not making a strategic decision. It is accepting whatever outcome the timeline imposes.
The three options
Insource: bring FM services in house
The authority directly employs the FM workforce, manages maintenance operations, and controls the budget. This gives maximum control over service quality, compliance, and cost management. It also transfers all operational risk, employment liability, and management responsibility to the authority.
Insourcing is often presented as the default because it avoids the cost and complexity of procurement. In practice, it introduces costs and complexities of its own that many authorities have not anticipated.
Reprocure: tender to a new contractor
The authority tenders FM services competitively and awards a new contract. This maintains a managed service model and transfers operational risk to the contractor. It also requires a procurement process that can take 12 to 24 months, requires good quality estate and asset data to define the scope, and requires sufficient market appetite to generate a competitive process.
The quality of the data package provided to bidders directly affects the pricing the authority receives. If the asset register is incomplete and the condition data is unreliable, bidders will price the risk into their offer. Article 6 of this series examines the data problem in detail. Poor data does not just create a handback problem. It creates a reprocurement problem.
The maintenance specification in any reprocured contract should also address the SFG20 dependency question directly. The SFG20 Reckoning series examines why using SFG20 task durations as cost inputs without site-specific adjustment creates structural mispricing from day one of the new contract, and why the asset register on which the SFG20 schedule depends is almost universally wrong at mobilisation. Authorities reprocuring FM at PFI handback should specify the SFG20 dependency question in the procurement, not assume the bidders will resolve it.
Extend: negotiate a continuation with the incumbent
Some authorities negotiate a short term extension with the existing SPV or FM provider to allow time for a permanent solution. This avoids service disruption but typically comes at a premium because the authority’s negotiating position is weakest when the alternative is no service at all. Extensions should be planned, not reactive. An authority that reaches expiry without a permanent solution and negotiates an extension under pressure will pay more than an authority that negotiated the extension as a deliberate bridge two years earlier.
Before deciding: test the market
Before committing to insource, authorities should consider running a soft market test. Invite the private market to indicate what it would price the estate at under a new managed service contract. If the market prices are high, it is a signal that the asset condition is worse than the authority believes. If there is limited market appetite, it tells the authority that insourcing may be the only viable option regardless of preference. Either way, the market response provides commercial intelligence the authority needs before making the decision.
The VAT trap
This is the single most underestimated financial risk in the insource decision. Under a PFI contract, the authority pays a unitary charge. The VAT on this charge is typically recoverable because it relates to a supply of services. When the authority insources FM services, the VAT treatment changes.
An authority that directly employs staff to deliver FM services is not purchasing a supply of services. It is delivering them itself. Many of the costs incurred, including staff costs, materials, and subcontractor payments, become irrecoverable for VAT purposes depending on the authority’s VAT recovery position. For NHS bodies, the position is governed by the contracted out services VAT refund scheme. For local authorities, Section 33 VAT refunds apply. The rules are different, the recovery rates are different, and the impact on the cost model can be substantial.
The practical impact: an authority modelling insourcing at the gross cost of the current FM provision may find the actual cost is 15 to 20% higher once VAT irrecoverability is factored in. On a large estate, this can amount to hundreds of thousands of pounds per year. If the business case for insourcing was built on the assumption that removing the contractor’s margin and overhead would generate savings, the VAT impact may eliminate those savings entirely.
An authority modelling insourcing at the gross cost of the current FM provision may find the actual cost is 15 to 20% higher once VAT irrecoverability is factored in. If the business case assumed removing the contractor margin would save money, the VAT impact may eliminate those savings entirely.
The pension deficit
Article 8 of this series examines the TUPE and pension dimensions in detail. The critical point for the insource versus reprocure decision is that the pension cost of insourcing is often the single largest variable in the financial model and the one most frequently underestimated.
If the transferring workforce includes staff on NHS Pension Scheme terms, the authority absorbs the employer contribution rate of 23.7%. If staff are members of LGPS, the authority may absorb a deficit funding requirement as well as ongoing contributions. If the authority’s existing workforce is on different pension terms, the insourced staff create a two tier pension structure that is legally permissible but operationally and culturally difficult.
The pension cost does not appear in the PFI unitary charge as a separate line item. It is embedded in the FM provider’s pricing. When the authority insources, that cost becomes visible for the first time. Many authorities are surprised by the scale.
The pension cost of insourcing is embedded in the FM provider’s pricing and invisible during the PFI contract. When the authority insources, it becomes visible for the first time. Many authorities are surprised by the scale.
The capital investment requirement
The post PFI operating model must include the capital investment required in the first five years after handback. This is not optional. If the lifecycle fund was depleted (Article 2), if the compliance gap requires remediation (Article 7), and if the condition survey reveals assets approaching end of life (Article 3), the authority needs a capital programme from day one.
This capital requirement affects both the insource and the reprocure option. If insourcing, the authority funds it directly. If reprocuring, the capital requirement either sits with the authority or is priced into the new contract, increasing the annual cost. Either way, it must be modelled. An authority that models the post PFI operating cost without the capital investment requirement is modelling fiction.
For NHS estates, the capital funding available for post handback investment is shaped by the ERIC reporting framework and the capital allocation formula. The ERIC Reckoning series examines how the 85/15 formula, critical infrastructure risk weighting, and the Estates Safety Fund determine how much capital the trust can access and on what basis.
What the financial model must include
An authority making the insource versus reprocure decision needs a financial model that includes all of the following. Not some. All.
Direct operating costs
Staffing costs on current terms. Materials and consumables. Subcontractor costs for specialist services. Management and supervision. CAFM and technology costs. Helpdesk and administration.
Post-PFI operating cost estimates should be benchmarked against current cost data rather than against the PFI financial model assumptions from 2001. The BCIS Intelligence Series examines the structural limitations of BCIS as a benchmarking tool, including how the data is collected, how representative it is for the asset class and location in question, and where the dependency creates pricing risk. Authorities running the financial model for the post-PFI operating environment should use BCIS as one input alongside actual cost data from comparable authority operations, not as a single source of truth.
Pension costs
Employer contribution rates for every pension scheme represented in the transferring workforce. Deficit funding requirements for LGPS. Actuarial strain if staff return to the NHS Pension Scheme. The ongoing annual pension cost, not just the transfer cost.
VAT impact
The change in VAT recovery position for insourced services. Modelled specifically for the authority’s VAT status (NHS, local authority, education, other). Not assumed. Modelled.
Capital investment
The first five years of capital expenditure required to address lifecycle shortfalls, compliance gaps, and asset replacement. Funded from the authority’s own capital programme or from the new contract if reprocuring.
Compliance gap remediation
The cost of bridging the gap between the contractual specification and current statutory requirements. Modelled separately from lifecycle capital because it is a different cost driver with different funding routes. Article 7 of this series examines the compliance gap in detail.
Procurement and transition costs
If reprocuring: the cost of the procurement process, external advisory fees, legal support, and the transition from PFI to the new contract. If insourcing: the cost of building internal management capability, CAFM systems, supply chain contracts, and operational infrastructure. An authority that has never directly managed FM procurement may find that it cannot buy lift parts, medical gas components, or specialist materials as cheaply as a global FM provider with established supply chain relationships. The purchasing power differential is a real operating cost, not a theoretical one.
Risk and contingency
The model should include an explicit risk allowance. Asset condition uncertainty, workforce retention risk, reactive maintenance volatility in the first year, and the possibility that the handback deduction negotiation does not recover what was expected. A model without contingency is a best case projection, not a business case.
Many of the cost inputs to this model depend on data that the authority may not currently hold. The asset register, the maintenance history, the workforce data, the condition survey, and the lifecycle fund accounts are all prerequisites. Article 6 and Article 4 of this series examine the data and capability requirements.
The early termination question
Some authorities are exploring whether to terminate the PFI contract early rather than wait for natural expiry. The motivation is usually to avoid the handback dispute, gain earlier control of the estate, or access capital that would otherwise flow to the SPV in the final years.
Early termination is contractually possible in most PFI agreements but it comes at a price. The termination payment typically includes the outstanding senior debt, any breakage costs on hedging instruments, compensation for lost equity returns, and in some cases a premium above the NPV of future cash flows. The cost can be substantial.
The financial case for early termination depends on whether the cost of termination plus the cost of the post PFI operating model is less than the cost of continuing to expiry plus the cost of managing the handback dispute. This is a complex financial comparison that requires actuarial, legal, and commercial input. It is not a decision that can be made on the back of a political commitment to end PFI early.
For most authorities, natural expiry with early and thorough preparation is likely to produce a better financial outcome than early termination at premium cost. But the calculation is specific to each contract and should be modelled rather than assumed.
Early termination of a PFI contract is contractually possible but comes at a premium. For most authorities, natural expiry with thorough preparation is likely to produce a better outcome than paying to exit early. But the calculation is contract specific and should be modelled, not assumed.
Distressed PFI: when termination is forced, not chosen
Not all early terminations are voluntary. Some are the consequence of project distress: SPV insolvency, FM provider failure, persistent service-failure deductions that destroy the financial model, or contractual breakdown that cannot be resolved through the dispute mechanisms. NISTA’s Navigating the Risks of PFI Project Distress guidance (March 2025) is now the authoritative public-domain reference for distressed-project mechanics. It covers the early signs of distress (financial covenants under stress, escalating performance issues, refinancing difficulties, deteriorating relationships); the four termination types (default termination, voluntary termination, force majeure, termination for convenience); the role of Direct Agreements with senior lenders; lender step-in rights and cure periods; and the practical implications for service continuity during a distressed exit. The Consort Healthcare (Tameside) restructuring plan in 2024, the first PFI restructuring under Part 26A of the Companies Act 2006, is the live precedent for what a distressed-PFI workout looks like in practice when adjudication awards and persistent service-failure deductions threaten Project Co solvency. Authorities approaching expiry should hold the distress framework alongside the natural-expiry framework: most contracts will reach expiry naturally, but the minority that do not still need to be planned for.
What the financial model must include
To make the financial-model argument concrete, consider an anonymised composite drawn from a recurring pattern across police custody PFI engagements. The contract was a regional custody PFI covering a network of custody suites under a 25-year project agreement. The authority’s financial model compared insource against reprocure on a 10-year forward NPV. The simple operational comparison favoured reprocure by approximately £1.4m in raw FM cost. When the model included VAT (the authority recovered VAT on insourced operations under Section 33; on reprocured outsourced FM, VAT was a real cost), pensions (the inherited workforce included staff with protected public-sector pension arrangements that flowed differently under the two routes), capital investment (the insourced model assumed a £6.2m capital programme over years 1-5; the reprocured model assumed the contractor would amortise £4.8m over the contract term), compliance gap remediation against the dual benchmark in Article 7, procurement and transition costs (£1.1m for reprocurement, £0.4m for insource setup), and risk contingency, the comparison reversed. Natural expiry with insource produced a £6m better NPV outcome over 10 years than reprocurement at the available bid pricing. The authority did not insource because it preferred to. It insourced because the financial model said it should. The structural lesson is not that insource is always cheaper. It is that the headline operational comparison rarely reflects the full cost picture, and that authorities making the decision on operational cost alone are deciding from incomplete information.
The operational duty transfer the authority inherits
The financial model is one half of the decision. The legal duty model is the other. On the day after handback, regardless of whether the authority insources or reprocures, a series of statutory dutyholder roles transfer to the authority that may not have sat with it during the PFI contract. As building owner and (in most cases) occupier, the authority becomes the responsible person under the Regulatory Reform (Fire Safety) Order 2005, with duties to assess and manage fire risk that cannot be delegated by contract. Health and Safety at Work etc. Act 1974 dutyholder responsibilities apply to the authority as employer and as person in control of premises. The Construction (Design and Management) Regulations 2015 client duties apply to any subsequent capital works, with a transfer date that needs to be documented. RIDDOR reporting obligations now sit with the authority for incidents on the estate. The Building Safety Act 2022 dutyholder regime applies to higher-risk buildings, and the Accountable Person duty under that regime cannot be contracted out. Insurance responsibility transfers: property cover, public liability, employers’ liability if staff are insourced, professional indemnity for any in-house design and surveying. Each of these has a transfer date, a documentation trail, and a notification requirement to the relevant regulator or insurer. The authority that has not mapped the operational duty transfer alongside the financial decision is exposed from day one. See Article 11 for the parallel question of latent defects insurance and the second window of disputes after handback, and Article 12 for the Net Zero capital programme implications of the insource versus reprocure choice.
If the authority decides to reprocure, the procurement runs under the Procurement Act 2023, which came into force on 24 February 2025. The Act applies to all reprocurement above the threshold and changes both the timeline and the operational discipline of the procurement. The realistic timeline for a major FM reprocurement under the new regime is 24 months from market engagement to contract award, not the 12 to 18 months some authorities have assumed. New transparency obligations include publication of pipeline notices, KPI publication for relevant contracts during their term, and contract-modification disclosure. Supplier exclusion grounds are broader and require active assessment. Standstill periods are different. The procurement strategy needs to be designed against the new regime, not adapted from a PCR 2015 template. Authorities that have not yet run a major contract under the 2023 Act will be running their PFI replacement procurement as a learning exercise on the new framework, see Article 4 for why this is a capability question to address ahead of the procurement, not during it.
Market appetite and bidder behaviour
The other reprocurement question is whether the market wants the work. The collapse of Carillion in January 2018 and ISG in September 2024 (alongside the long unwind of Interserve and ongoing pressure on other Tier 1 FM providers) reflects a structural reality: the FM market has limited appetite for low-margin, fixed-price, long-duration contracts of the kind PFI bequeathed. Tier 1 FM providers (Sodexo, Mitie, ISS, Compass, Equans, OCS, ABM, Vinci) are commercially selective about which reprocurement opportunities they bid for, and the ones they do bid for are priced against the lessons of the failures. The mid-tier and specialist FM market is fragmented and capacity-constrained for large public-sector estate. The reprocurement model an authority can actually buy in the 2026 market may need to be different from a like-for-like PFI replacement: shorter contract terms, output-based pricing with indexation flexibility, change mechanisms designed for the operating environment rather than the financial model, and risk allocation that reflects what bidders will accept. Authorities that design their reprocurement against a 2005 PFI template may find the market does not respond. Early market engagement, run with capable advisers and starting in the seven-year window, is the way to test what the market will actually price.
The insource versus reprocure decision is not an operational question. It is a strategic financial decision that shapes the authority’s cost base, workforce, and capital programme for the next decade. An authority that makes this decision without a complete financial model including VAT, pensions, capital, compliance, and risk is making a commitment it does not understand.
Some authorities want insourcing for strategic control. The question is whether they can actually operate the estate safely and compliantly. Insourcing without the technical estates leadership, compliance governance, digital systems, and operational resilience to deliver it is not control. It is unmanaged risk.
PFI expiry does not ask whether you want to be an operator. It asks whether you are ready to become one. The authorities that model the decision early make a choice. The authorities that defer it accept a default.