The system needs fixing if we're to find the financiers

Posted: 9 January 2012 by James Barlow

6 October, 2011 | By Steve Wright, James Barlow, Colin Gray

The NHS’s flawed payments system must be mended and evolved into something more robust and attractive in order to secure the as-yet-undecided new financiers, warn James Barlow, Colin Gray and Steve Wright.

In the past weeks, two particularly troubling issues have been highlighted regarding the future of the NHS in England.

First, there is the perceived threat to 22 named hospitals, whose private finance initiative obligations are putting their financial stability at risk. Indeed, according to health secretary Andrew Lansley, they are part of an even larger group of 60 hospitals thrown into serious difficulties by PFI payments.

Second is the argument put forward by the “Shelford Group” of hospitals that the tariff inadequately reimburses leading hospitals for their complex case-mix, teaching and research obligations. In fact, these two issues are part of the same problem: an inadequate payment mechanism which damages planning for appropriate NHS capacity.

A close look at the payment system demonstrates it is a mistake to heap all the blame on PFI for these hospitals’ financial troubles. The payment by results tariff, derived from healthcare resource group prices which incorporate average historical costs, does not allow for the expenses of new capital, whether these are charges for PFI or depreciation of public dividend capital.

This hole in the payments system is a common international problem; a survey by HOPE found that European diagnosis-related group systems cover capital costs only rarely and never prospectively. Of course, this oversight would not matter if new hospitals were correspondingly more cost-efficient than their predecessors.

However, the English hospital building programme was not primarily designed to improve cost efficiency. So newly invested hospitals have been left high and dry under the payments system.

The tariff is associated with two wriggle rooms. One is the market forces factor, used to remove location-specific cost differences in the tariff calculation and to adjust for providers’ “unavoidable costs”. The other is the service increment for teaching and research. However, neither has been reconsidered to support the new structure of the health system. Perhaps these ways out should now be re-evaluated.

Bearing the burden

It is worth remembering that a price uplift to keep good capital stock above water would not be much above the average tariff: the whole cost of capital is less than 5 per cent of healthcare costs. So, in the longer term, commissioners should be encouraged to offer more (but not less) than the tariff, where providers are bearing the cost of developing new infrastructure.

One would expect commissioners to be keen to pay a little more, sending a positive signal to would-be investors that they want new, hopefully more productive, healthcare facilities.

However, the immediate issue is what happens right now to hospitals that are bearing the burden of recent investments. Commissioners may feel this is not their responsibility. So whose is it? Perhaps PFI investors could reduce their monthly unitary charges. But it’s hard to see why they would renegotiate.

Alternatively, the DH could require commissioners to offer a tariff uplift that makes allowance for already incurred high capital charges. This uplift could be tapered over, say, five years so that everyone understands that, in due course, they will have to sink or swim.

Robust ways to deal with financial failure are vital for creating a rationalised and responsive system. However, at present, there seems to be no clear plan for a hospital that is in financial trouble because of capital commitments.

One possibility is injections of public dividend capital. A renationalisation option for foundation trusts has also been highlighted. Another suggestion would allow a failing hospital to raise its prices unilaterally. But that does not add up. It would be like a defunct PC maker raising its prices while Apple was forced to hold down its own.

All this is speculation. Indeed, such uncertainty concerning the “failure regime” does no favours to the goal of achieving sound healthcare planning.

There is also the longer term question of how foundation trusts can raise capital in the new English NHS.

It is tempting to suggest that, with PFI out of fashion, we can turn to public capital for the investment. After all, because of anti-recession monetary policies, real interest rates are currently below zero for UK government borrowing, and considerably lower than for private capital. However, there are few signs that such capital will come available, given that most Western states have reached the limits of their borrowing capacities.

All of this strangely brings us full circle. If governments cannot, in the short term at least, turn to the markets for capital, foundation trusts may have to rely on the private capital markets to finance new infrastructure.

This implies some form of public private partnership, perhaps even outright privatisation of facilities with franchised concessions. However, current problems around the payments system are creating uncertainty and risk, which make such possibilities less attractive and more expensive to the private sector.

A more robust system than is available now will be needed to ensure that income is secure to service debt and make investment in NHS infrastructure an attractive option for all concerned.