Feature / Finance explained

Assets inherited by NHS providers at their creation as NHS trusts – and carried forward by those subsequently gaining foundation trust status – were never free goods, writes Steve Brown. They were subject to capital charges, intended to drive the efficient usage of assets. As part of these capital charges, trusts were (and still are) required to pay an annual dividend on the value of these assets. The assets are known as public dividend capital and the annual payment, somewhat awkwardly, as the public dividend capital dividend – or, more easily, PDC dividend (set at 3.5%). Unlike depreciation (the other component of capital charges), the PDC dividend represents a real cash payment made to the Department of Health.

In fact, the calculation of the PDC on which the dividend is paid is more complicated than this. It takes account not of the original value of the assets but the current value, along with any additions over the years. In practice, the calculation has been based on average net assets (asset value at start of year plus value at end, divided by two). While these assets would include cash deposits in commercial bank accounts, net cash balances on deposit with the Government Banking Service (GBS) have always been excluded.

Foundation trusts have greater freedom to invest surplus cash than NHS trusts and many have chosen to access the better rates available in commercial banks, rather than use the GBS. However, the PDC calculation creates an incentive for FTs to transfer funds into the GBS around the year- end, so reducing their PDC and the resulting dividend.

This creates fluctuations in FTs' GBS deposits around year-end – amounting to about £1.8bn at the end of 2011/12 – and these fluctuations can create difficulties for the Treasury in managing wider government debt requirements.

While the PDC calculation will continue to deduct average GBS deposits from average net assets, the Department has been considering a new approach to calculating the average GBS balances. Instead of a simplistic average of opening and closing balances, it is looking at using average daily cleared balances in the GBS. This will remove the incentive for FTs to play musical chairs with their cash deposits at year-end, as a short-term boost to GBS balances will have minimal impact on the overall average. From the Treasury’s point of view, job done, you might think.

But some foundation trusts are not impressed. Generating income from broader investment powers is a key financial freedom for FTs and the interest earned provides a significant return in income, which will have a knock-on impact on the money available to deliver patient care and invest in new services.

It is a point made by the HFMA's FT Technical Issues Group in a paper delivered to the Department in March. 'The rates of interest currently attracted by FT balances held in commercial accounts are significantly higher than the 0.25% yields available through the GBS, even at the low levels currently available given the current economic climate,' it says. 'Although we recognise the importance of the plan to reduce fluctuations in GBS balances, particularly at year-end, in our view a move to average daily balances has the potential to limit the investing activity of FTs.'

Two FTs in the HFMA FT Finance Faculty are anticipating 'losses' of £0.5m and £1.2m respectively if the new approach is adopted. The TIG paper also says the effect of the change will be to concentrate FT funds in a single provider (GBS), contrary to Monitor advice to spread investment risk. And there are concerns about the lack of notice and opportunity to review treasury management policies to mitigate potential losses. Finally, the paper points out that some FTs secure reduced rates from commercial banks for working capital facilities on the basis that they maintain a certain level of cash balance. A change in investment policy might lead to higher working capital facility costs, with the changes taking time to implement.

The TIG suggests that if it is the fluctuations in GBS that are the problem, then an alternative proposal could require FTs to give advance notice of how much would be transferred into the GBS at a particular point, so facilitating overall sector management while maintaining the existing approach to calculation.

Not all FTs are affected in the same way. Some already make greater use of the GBS (and National Loans Fund) than others – in part a reaction to the broader economic uncertainty. And average daily balances will be boosted by contract payments held in accounts before wage bills are paid. Some FTs believe they may actually benefit financially from the new approach. The Department has been in discussion with the NHS Trust Development Authority about the possible change in methodology. But as Healthcare Finance went to press, no final decisions had been announced.