Using PAFI to calculate the impact of inflation

Introduction

This case study reports on Crossrail’s procurement strategy to award a number of delivery contracts where the employer takes on the risk associated with inflation by adopting the NEC3 suite of contracts. These contracts use the BCIS Price Adjustment Formulae Indices (PAFI) to identify the impact of inflation, measured against the contract base date, and to periodically change the contract ‘Total of the Prices’ by way of a price adjustment.

Crossrail’s procurement strategy for contracts of a certain construction duration and commodity mix  was to request the contractors not to price for the risk of inflation, but instead confirm that the employer would be allocated the risk. This strategy resulted in initial tender returns that excluded contractors’ inflation allowances based on broad assumptions over long periods of time, and an agreed contractual and accurate method to measure the impact of inflation during the contract and amend the ‘Total of the Prices’ accordingly. This procurement strategy and risk allocation has arguably provided savings to Crossrail in the initial contract award values.

Background

Crossrail is one of the biggest transportation projects in Europe. It is the new high frequency, convenient and accessible railway for London and the Southeast. Valued at £14.8 billion, Crossrail trains will travel from Maidenhead and Heathrow in the west to Shenfield and Abbey Wood in the east via 21 km of new tunnels under central London. It will link Heathrow Airport, the West End, the City of London and Canary Wharf.

Implementation

Crossrail adopted the NEC3 suite of contracts as the standard form of contract for delivering their requirements. For the contracts selected, the mechanism provided an equitable share of savings and a real incentive to control costs to deliver within the target price.

The strategy considered that the most valuable approach would be supported by a sensible and fair allocation of risks between the parties to the contracts. Requiring contractors to take responsibility for risks which they cannot assess or manage would have likely resulted in high-risk premiums or commercial pressures caused by insufficient provisions.

Crossrail’s procurement strategy provided that the NEC3 contracts with secondary option X1 (Price adjustment for inflation) were let on lump sum options A & B and target option C. The calculation of the Price Adjustment Formula (PAF) varied depending on which form of contract was applied.

The NEC3 contract provided the calculation to be applied using the indices, proportions and base date information as set out in the contract data of each X1 contract. With all data and calculations being clearly defined in the contract data and agreed between the parties, this left limited opportunity for ambiguity in the inflationary measures (price adjustment), and promoted a collaborative commercial arrangement between project manager and contractor.

The X1 option was applied to a number of stations, systems and civil engineering contracts, where the commodity mix and contract duration was deemed to represent the best opportunities for Crossrail to take on the cost risk associated with inflation.

Crossrail have used the PAFI series published by BCIS. Each contract has a different mix and weightings of the indices modelled to the works that are to be delivered. The index series used have been selected from:

• Price Adjustment Formulae Indices Building Series 3
• Price Adjustment Formulae Indices Civil Engineering 1990 Series
• Price Adjustment Formulae Indices Specialist Engineering Series
• Specialist Engineering Series

Each contract was procured with its own unique set of data, used to measure the impact of inflation to ensure an accurate price adjustment is applied, resulting in the contractor recovering the full entitlement of budget to match the cost impact of the inflation incurred. The indices to be used in the measurement, the proportions that those indices would represent, any non-adjustable percentage and the base date were allocated based upon the activities carried out in delivering the scope of works, and the proportion that these activities represent versus delivery of the scope of works as a whole. These were then agreed between the parties as part of the contract negotiation and document execution.

Solution

For each of the 14 contracts procured with X1 to be administered consistently across the programme, Crossrail specified, designed and developed a contract management application providing an online tool where all data and calculations are stored and reports generated.

This limited the individual user to entering data only, and ensured that there was no opportunity for differing interpretations of the contractual requirements. This application was also designed in such a way that it interfaced directly with the existing cost management system, ensuring accurate and consistent reporting of budgets and performance throughout the business.

The indices are downloaded from the BCIS online service as a CSV file and imported into the application directly. The application then applies the necessary calculations, and provides the relevant inflationary measure (PAF) for each contract. This is then applied to the ‘Price of the Work Done to Date’, taken from the periodic assessment of the contractor’s application, to provide the periodic price adjustment.

The periodic price adjustment provides an accurate adjustment to the contractor’s ‘Total of the Prices’ for the impact of inflation. It is therefore paramount that when ‘Implementing a Compensation Event’ (ICE) that it is assessed at base date values. This means that any aspect of the agreed quotation making up the ICE that is not already priced at the contract base date must be deflated back to the contact base date set out in the contract data. If ICEs are not implemented at base date values there is the potential that the contractor will receive an assessment of inflation twice, once with the ICE and again when the periodic price adjustment is applied. Again, the application developed by Crossrail provided this calculation for the user in accordance with the details set out in the NEC3 suite of contracts.

The indices are easy to access and download from the BCIS online platform. Crossrail set up its systems to update the valuations based on the last published indices. BCIS have instigated feeds for the indices which alert users when an index is changed.

On a project the size and complexity of Crossrail, implementing a centrally administered application to control the assessment and process any budgetary requirement has proved invaluable.