News / News analysis: The trouble with PFI …

Gaining FT status is tough enough, but what if a trust is weighed down by a hospital sourced through the private finance initiative? Steve Brown reports on an exercise that aims to find out

Governments have a love-hate relationship with the private finance initiative. They love the access it gives them to greater capital funds – enabling them to deliver more and more modern public service facilities. But they hate the flack that goes with an initiative that is arguably controversial and undeniably unpopular with the public. Last month the coalition government had its first serious run-in with the PFI.

Channel 4 News claimed the government was accelerating the use of the funding mechanism despite key members describing it as ‘discredited’ and ‘dodgy accounting’ before last year’s election. The news programme claimed Treasury figures showed that the new government will sign off 40 PFI projects in 2011 – worth almost £3.7bn – compared with 38 in 2009 and 32 in 2008.

It may be unfair to blame or credit the coalition with all these projects given that many will trace their beginnings back several years, but the fact that the PFI is alive and well is clear. For example, in the NHS, the Royal Liverpool and Broadgreen NHS Trust and North Tees and Hartlepool  NHS Foundation Trust are both pursuing PFI replacements.

But the PFI has more problems in the NHS than simply improving its public image. In particular, can NHS trusts with major PFI hospitals prove their financial viability in the current economic climate and make the leap to foundation status – the deadline for which is April 2014?

There would have been a time when the merest hint that PFI caused financial difficulties for NHS bodies would have led to witch hunts and ministerial dressing-downs. But it seems a spirit of openness has broken out. So much so that the Department of Health itself last month issued a tender looking for consultants to review the cases of 22 NHS trusts where PFI is seen as a potential barrier to achieving FT status.

While at first glance this may seem like manna from heaven for the anti-PFI brigade, the Department is quick to qualify there are many existing and viable FTs with PFI schemes – a fact that  ‘indicates that PFI per se is not necessarily a barrier to long-term financial viability and hence becoming an FT’. But it does acknowledge: ‘PFI presents a challenge to FT authorisations given the combination of today’s market conditions and Monitor’s financial tests.’

There are, in effect, two key issues. The annual unitary payments paid by NHS bodies for their PFI hospitals are largely fixed for the 25-40 years of the deals. Today’s economic context means NHS trusts need to be delivering significant cost improvements across their whole budgets. For example, there is a 4% efficiency requirement built into the national tariff and many hospitals face higher productivity targets than this. With the unitary payment fixed – and often up to 15% of turnover – it is effectively off limits for efficiency, meaning trusts have to make a higher rate of savings in other areas.

The second issue is flexibility – or lack of it. The 4% cost improvement in prices is only part of the pressure on secondary care organisations. Trusts and foundation trusts also face reduced activity in some service areas as commissioners look to implement demand management initiatives and move services closer to patients in the community.

While commissioners pay less to the acute provider in such circumstances, it only becomes a saving for the health economy if the trust can take the costs out of the hospital, for example, by closing wards – reducing capital charges and staffing costs.

For PFI hospitals, there is no obvious way to reduce capacity in line with reducing demand; the capital charges remain fixed. These difficulties can throw a would-be FT’s future viability into question.

While becoming an FT is about more than meeting the metrics in Monitor’s financial risk rating, there is an assumption that a new FT should be able to achieve a level 3 financial risk rating ‘unless there are exceptional circumstances’. And PFI can make this harder.

While an FT might experience a better EBITDA margin as a result of PFI – a result of higher operating efficiency – higher interest payments (reported below the EBITDA line) will hit the income and expenditure surplus margin metric. Would-be FTs with PFIs are also expected to map out their financial plans over a longer horizon, showing assumptions for activity, income, expenditure and required efficiency savings and showing financial viability over this period.

 Not all the 22 trusts identified in the tender document are guaranteed to fail in becoming FTs. The Department says they have been included in the list either because they themselves have cited PFI as an obstacle or because their PFI is ‘of a size that could be a significant issue’.  In fact many of the trusts listed spoken to by Healthcare Finance have dates for FT application (included in their recently filled out tripartite formal agreements, which set out the issues that need to be addressed to attain FT status) well in advance of the 2014 deadline.

One trust director told Healthcare Finance his trust could still become an FT without anything changing, although a national solution that recognised the greater challenges in terms of fixed costs would be welcome. He added that whole health economies with local PFI hospitals had to find ways to maximise the use of what are often state-of-the-art facilities.

However, there is a suspicion that the Department is taking a gloomier view on affordability of PFI. Finance directors suggest the Department has previously used a unitary payment to turnover ratio of 15% as a rule of thumb for affordability, although guidance on the Department’s website suggests that ‘risk adjusted PFI payment to normalised trust turnover’ should not exceed 12.5% when preparing an outline business case. Directors now believe the Department sees 10% as the magic number.

The Department wants consultants to categorise trusts into three bands reflecting the scale of their challenges – in short whether they need local actions by the trust or health economy, extra transitional relief or national financial support (see box).

Healthcare Finance understands the Department is already examining options for delivering any support deemed necessary. There have been concerns for a number of years that the national tariff is effectively based on national average costs, including average capital costs – putting organisations with newer, higher cost capital at a disadvantage unless or until they can use their new assets to reduce running costs.

But a differential tariff is an unlikely fix. Instead, the market forces factor is seen as providing a way to adjust for different capital costs faced by different providers. The provider-specific MFF already adjusts for unavoidable costs facing different providers in different geographic areas arising from capital, land and staff costs. With some development, the MFF mechanism could be used to recognise different capital cost bases – not just arising from PFI. The difficulty is having a balance between recognising these costs and incentivising efficient use of estate.

The Department’s commissioned review will, however, also throw the spotlight on Monitor’s assessment process. Some directors said the real issue was not actual viability but passing Monitor’s metrics. One suggested the Department was ‘making noises’ that Monitor was too risk averse on PFI. Another pointed out that in PFI, under the new on-balance sheet treatment,  early years’ payments were dominated by interest (which hit income and expenditure), while later payments were dominated by capital repayments (which don’t). The risk ratings took no account of this tipping point, he said. 

Monitor is comfortable with its assessment process and happy about the scrutiny. A spokeswoman said the regulator had been involved in discussions with the Department about the content of the tender document before it was published and backed its intention to establish whether or not PFI was an issue in gaining FT status.

‘We believe our assessment process is robust and we do not think it unfairly penalises trusts with PFI schemes,’ she said. ‘It is right that trusts that have or are planning a PFI scheme and wanting to be granted foundation status should have to show that they will be financially viable moving forward.’ But the regulator remains open to feedback and has promised to give any issues raised its ‘full consideration’.