NHS finance - Achieving a stable financial condition

Deficits do not sit comfortably in the NHS. The idea of a public service spending beyond its means makes ministers and health department officials sweat. Especially given the media’s hunger for health service financial scandals.

Eliminating the NHS deficit, or achieving financial balance, has been deemed so important that for 1999/2000 the NHS Executive had originally been calling for the NHS as a whole to break even. Given the income and expenditure deficit stood at £460m in March 1997, this would have been a spectacular achievement. In fact, the target will be missed, with the Treasury giving approval earlier in the year to a planned £93m deficit, a relaxation that takes account of the extreme pressures facing the NHS this year.

But reaching financial balance remains the objective. The first problem with eliminating deficits is you need to be clear what kind of deficit you are dealing with. NHS deficits can be in-year, underlying or cumulative and some deficits aren’t even real in the first place, but merely of a technical nature.

So-called technical deficits have been a headache for trusts, particularly as the media, perhaps understandably, fails to recognise the distinction.

They arise principally as a result of clinical negligence claims: for instance, if an operation goes wrong and a trust estimates it will have to pay out £1m to the claimant at some point in the future. Under old guidance, the trust was required to enter this provision in its books, which would show up as an income and expenditure deficit of £1m.

Obviously in theory the trust could have immediately raised prices to health authorities, eliminating the deficit in the same year as the provision was made. But this would mean taking money out of patient care upfront, which would then lie idle with the trust until settlement. Besides, the final settlement could be significantly less than anticipated, meaning the service would be deprived of much needed funding.

Instead the approach has been to adjust prices in the year settlement is made. The downside is, in the time between the incident taking place and settlement the trust carries the deficit with it. No money has been paid out and so the deficit is only technical.

While eliminating a deficit has got to be a good thing, timing can be critical. Trusts have a statutory duty to break even over three years, with next March marking the end of the first three-year period, and like the media, the duty makes no allowance for technical deficits.

Until changes were made this summer, trusts were left trying to eliminate these technical deficits in the short term to meet their statutory duty, even though price rises to cover the provision would be made several years down the line.

According to Colin Reeves, director of finance and performance at the NHS Executive, this could have extreme consequences. ‘A trust could close a ward to cover its deficit knowing in two or three years’ time it will have the cash to cover the provision,’ he says.

The new guidance (health service circular 1999/146) gets around this.

Provisions will now disappear from trust books and be picked up by health authorities. Although health authorities must live within cash limits, they have no statutory duty to break even and can handle deficits by a system of cash brokerage and by extending their creditor position.

Trusts account for nearly £60m of the planned £93m deficit in 1999/2000, while health authorities net deficit makes up the balance. Within these figures are provisions for some £130m, with about £100m of that currently sitting in trust books. Under the new guidance, this £100m will transfer leaving trusts en masse £41m in surplus and health authorities £134m in deficit.

The arrangements are being backdated to April 1994. While the NHS cumulative deficit (on course for £623m by April 2000) will not change, the split between trusts and health authorities will. Trusts will soar £500m into the black while health authorities show a net cumulative deficit of £1.1bn.

Reeves’ assertion that this is not a smoke-and-mirrors trick is backed by finance directors in the field. According to Bob Dredge, director of finance at the Royal Wolverhampton Hospitals NHS Trust, the change makes the NHS financial position clearer. ‘It recognises best practice and means financial management can be based in reality and not in technical accounting.’

It also means in the future trusts running up deficits will not be able to hide behind the excuse that problems exist only in a technical fantasy land. As Dredge points out: ‘As we get more and more best practice in and more consistency between health bodies, the places to hide will become fewer and fewer.’

Although the new guidance makes the current measure of the trusts’ financial position a more reliable indicator of performance, there are wider concerns that the definition of financial balance is too narrow. The current focus on achieving in-year balance, a simple comparison of income compared with expenditure, is not ideal. It is prone to technical difficulties already mentioned and takes no account of any transitional relief paid to trusts, special assistance to health authorities or virement from capital.

While the in-year position is important, the NHS Executive believes the definition of financial balance needs extending to embrace two additional targets. First, it believes progress needs to be made towards eliminating underlying deficits of health bodies. The underlying position is effectively the in-year position adjusted for non-recurrent sources of income and expenditure such as charges for clinical negligence liabilities and one-off support payments. This effectively shows a health body’s ability to live within its recurrent funding levels. In terms of health authorities, there has been limited progress in recent years. The £115m underlying deficit in March 1998 is expected to fall to £79m this financial year.

The other target the Executive is focusing on is the cumulative deficit.

The figures can seem alarming with a projected cumulative deficit for the NHS of £623m by April next year.

While a large proportion of this is a result of the good financial practice that requires health bodies to recognise future provisions in their books as and when they arise, there are some concerns.

For health authorities at the end of 1997/1998, the cumulative deficit was £717m, made up of £316m long-term liabilities for pension and clinical negligence costs and £404m net current liabilities, effectively money owing to other health bodies and suppliers. Although this latter figure contains some £207m of GP fundholder savings, failure to stem the rising net liability position threatens health bodies’ ability to achieve public-sector payment policy targets, which dictate that 95% of non-NHS invoices have to be paid within 30 days. The Executive wants health bodies to reduce their net liability position to an ‘acceptable’ level.

But to achieve these three financial targets, the Executive believes plans need to be made over the medium term instead of the current short-term annual basis. In many areas the NHS is already starting to take a three-year view. National priorities are set over a three-year period, new health improvement programmes cover three years and the Comprehensive Spending Review set global NHS spending figures for three years. But contracts, or service and financial frameworks (SaFFs), cover one year.

Health authorities and trusts have complained that longer-term SaFFs are impossible without knowing their allocations over the same period.

The CSR helps, but does not tell a health authority what money will be held back in future for centrally-sponsored initiatives. Equally it does not indicate how growth money will be distributed between health authorities under or over target allocations calculated using the NHS capitation formula.

An agreement has been reached in principle, giving health authorities medium-term resource assumptions when the allocations are announced in November. This is likely to mean assumptions will be published for two years to coincide with the end of the CSR.

Although it is not clear how the system will work in detail, health authorities will have a more reliable estimate for future funding than they have ever had – a move that has met with approval. ‘The NHS has always been blighted by annual settlements,’ says Eric Morton, chairman of the Healthcare Financial Management Association. ‘This will allow planning on a more certain basis.’

The move should allow medium-term SaFFs to be produced and within them the Executive will expect to see a timescale for eliminating in-year, underlying and cumulative deficits. But even with longer-term resource assumptions for health authorities in place, the best-laid recovery plans could be blown off course. Health authorities and trusts can only guess at future activity levels, the rate of drug inflation and at future pay rises for their medical staff. All are unknowns and out of the health bodies’ control.

‘It is a major move in the right direction,’ says Morton. ‘But we have to use the degree of certainty to plan in a flexible way so plans can move to reflect changing circumstances.’ So plans could be based on assumptions for inflation and pay, but scenarios would be drawn up to cover variations from assumptions. Nobody pretends producing three-year SaFFs will be easy or that three-year resource assumptions will lead to the elimination of the deficit. But what is undeniable is the longer-term approach is essential if the goal of financial balance is to be achieved.

Steve Brown is a freelance journalist.