Risk Management and Governance for PFI Project ... - Title Page - MIT

Chapter 5: Potential Problems and Possible Solution in
Japanese PFI
The previous chapter investigated the method of proper risk management on the basis of the case
studies where the risk had become actualized. This chapter considers potential problems at the
decision-making stage of the PFI projects, apart from the individual risk management problems.
After pointing out the limitations and problems of the VFM indicators used in the decision-making
process of PFI projects and examining the issues pertaining to the application of the PFI method in
the first half of the chapter, the second half discusses an evaluation by a third-party organization as
an approach to the resolution of those problems.
Limitation of VFM Indicator
It is obvious that the VFM indicator can be used for judging the propriety of the PFI method, but
this indicator has various limitations and problems. These problems will be explained below.
Quantification of Risk
VFM guidelines include the following three major ways to quantify the risks: (1) a way to
assume the plural combinations of the probability that a financial burden would occur in the
future and the amount of it at the time, then to calculate the sum of product of those numbers
for each year, and to convert it into the present value 20 , (2) a way to calculate the product
(present value) of the probability of occurrence of financial burdens during the entire project
period and the amount of them, and (3) a way to use an estimate of insurance premiums. The
guidelines, however, just present the above-mentioned concepts and do not present a concrete
methodology, such as eliminating the arbitrariness of the probability calculation.
For example, the Ministry of Land, Infrastructure, Transport and Tourism (MLIT) published
the "simple VFM simulation model" in 2003 and an Excel spreadsheet for the "simplified
calculation tool for VFM" in 2008, but they do not contain any concepts of probability
[distributions] or a modeling method for it. Because the risks and uncertainties are not
considered at all, the calculation of VFM is unreliable. However, if it provided a modeling
20
If you dare to express this in a formula, it would be as follows:
ENPV = � �
1
�1 + r�� � �������� ����� �
�
Where ENPV = Expected Net Present Value of a project; r = risk free rate; i = year; a �= individual risk after i year(s);
� �� = cost resulted from the risk a after i year(s); �= probability density distribution. However, unless the guideline
indicates concrete method about how to model the probability distribution of the cost, this approach is no more than a
mere theory.
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