This is the latest in a series of posts by Richard Butler and his colleague Holger Westphely from Aylesbury Partnerships on managing risk in payment by results contracts.
The right incentives?
It’s great to be able to engage in the development of the MoJ’s proposed payment mechanism.
However, the first thing that struck me was its complexity.
Clearly a great effort has been made to design a mechanism that creates the right incentives to develop innovative ways to reduce reoffending.
Will it be sufficiently transparent to stimulate the wide range of providers needed to achieve real innovation or does it favour those with the deepest pockets, who can afford to do the detailed analysis necessary to truly understand the risks inherent in such rehabilitation contracts?
Here are a few thoughts triggered by the document.
Spreadsheet modelling
To understand the commercial drivers and risks of any contract I like to model it in a spreadsheet.
This helps to clarify sensible bidding levels, cashflow constraints, sensitivity etc.
The number of input parameters – the key numbers that determine the attractiveness of the contract is unusually high for this payment model.
Here are a few of the variables that need to be taken into account:
- Weighted Annual Volume (WAV) Tolerance – the volume range within which the Fee for Service (FFS) payment does not change
- Price adjustment percentage – the amount by which the FFS payment changes if actual volumes fall outside the WAV Tolerance
- WAV weightings – the “value” attached to different sentences to reflect the difference in cost
- KPIs that determine potential penalties that the MoJ can impose if quality standards are not met
- Learning Curve Discount – the discount applied year on year to the FFS payment
- PbR Termination Trigger – the reoffending level above which the contract will be terminated
- PbR Penalty Level Baseline – the reoffending level above which financial penalties will be imposed on the contractor
- PbR Target Level Baseline – the minimum reduction in reoffending required for any PbR payment to be triggered
- PbR Payment Cap – the highest possible payment that can be achieved by a contractor
Risk and opacity
Such complexity adds risk and opacity to the contract, increasing the barriers to bidding.
The MoJ describes the thinking behind most of the elements of the mechanisms in terms of the incentives it creates. This helps understand the mechanism and justifies the addition of each step.
The notable exception is the Learning Curve Discount. This additional complexity signals what the commissioner would like to achieve but in no way seems to change the incentives for the contractor.
Apparently providers will bid against a single amount, the fixed annual payment. Presumably all other parameters are determined by the commissioner. This makes the bidding relatively simple and transparent.
There is some mention of other PbR parameters being bid as part of the competition process (p.10), but it is unclear to me how this would work.
Broadly I welcome the approach of designing a payment process that aligns the incentives of commissioner and provider while stimulating innovation.
There are a couple of areas where I feel the process is unnecessarily complex and not entirely clear but hope that these can be ironed out as part of this process.
We will be modelling this mechanism in the coming weeks, add detail as it develops and publish the results online.
I would also like to see more support for smaller organisations to engage with this process provided by the commissioner. Excluding all but the largest and most sophisticated bidders is not likely to achieve the innovation targeted by the MoJ.
Aylesbury Partnership and Russell are running an expert seminar on Managing Financial Risk in Payment by Results on 8 July in London
Visit Aylesbury Partnership at www.aylesburypartnerships.com
Follow them on Twitter: @AylesburyRisk
