Feature / Surplus with a purpose?

NON-FOUNDATION TRUSTS are getting to grips with planning for, and achieving, a surplus. In the meantime their emancipated cousins foundation trusts have already forged ahead – generating surpluses by becoming more efficient, increasing their activity and selling assets that are no longer needed. But what is the rationale behind foundation trusts’ surpluses? Is it acceptable to generate a surplus and then appear to ‘sit on it’? Or should a surplus always be generated for a specific purpose?

On the face of it, one of the main reasons for generating a surplus is to ensure a better financial risk rating from the foundation trust regulator Monitor. The regulator uses a number of metrics, including the level of income and expenditure surplus, to calculate a foundation trust’s risk rating. A higher risk rating (meaning a lower risk) has benefits – the higher the risk rating, the greater the freedom to borrow under foundation trusts’ prudential borrowing code. A surplus that contributes to a financial risk rating higher than 2 will ensure the trust is monitored quarterly (at most) by the regulator rather than monthly.

There is some anecdotal evidence that in the early days of foundation trusts there was some reluctance, even embarrassment, among foundations to post a surplus. This was particularly keenly felt when other parts of the local health economy were in deficit.

Foundations quickly stopped dragging their feet, however, and in 2006/07 the 59 foundation trusts reported an aggregate surplus of £153m. The 70 foundations authorised on 31 July this year plan to have a surplus of £198m in 2007/08. At the end of 2006/07, foundations held cash balances of £995m, though it is planned this will fall to £791m by the end of the current financial year.

According to Monitor, the ability to retain surplus income for reinvestment is one of the benefits of foundation trust status, and provides an important incentive for strong financial performance. But strong financial performance is not an end in itself.

‘Surpluses, which should be invested to improve healthcare services, can be used to replace assets, or to fund investment in new services and facilities,’ a spokesperson says. ‘This allows boards of NHS foundation trusts to consider, create and deliver medium-term strategies that are fully funded. This may entail significant investment in assets but also in the delivery of improved services, acquisition or investment in other services or in wider reconfiguration. NHS foundation trust boards should engage and communicate with their patients, governors, members and wider communities about future investment and how services may be improved.’

The money has left foundations well placed to quickly adopt the recommendations of Lord Darzi’s Next Stage Review, which many are predicting will recommend a new network of local units such as polyclinics complementing elective surgery centres and specialist hospitals. ‘We believe NHS foundation trusts’ financial strength means they are best placed to invest in re-shaping healthcare services, working in partnership across local health economies,’ says the Monitor spokesperson.

Though Monitor says surpluses could be used for a number of purposes, capital investment seems to be the chief reason for generating a surplus. Paul Briddock, director of finance and contracting at Chesterfield Royal Hospital NHS Foundation Trust, says his trust is determined to use the financial freedoms of the foundation regime to renew and invest in its equipment and facilities.

Since it became a foundation in 2005, the trust has turned its pre-foundation annual small surplus into a much larger one. It is now using these larger surpluses and the cash from the annual depreciation charge, which as a foundation trust it now does not have to return to the strategic health authority or Department of Health, to drive forward an ambitious capital investment programme.

‘The hospital is approaching 25 years since it was built, so parts of it need refurbishment,’ says Mr Briddock. ‘We have a prudential borrowing limit of £32.4m that we have not used. We are fortunate in that the hospital is just 25 years old so we’ve not had to redevelop the whole site.

In 2005/06, the trust generated a £3.9m surplus, followed by £5.4m last year and plans for £5.5m this year. The cash retained from the annual depreciation over that period amounts to £11.3m.

‘That’s £26.1m of cash that we would not have been able to generate prior to becoming a foundation trust, and we will be pumping this back into our capital expenditure programme,’ says Mr Briddock. ‘In 2005/06, our capital expenditure was £7.6m; in 2006/07, it was £5.2m. This year we plan the trust’s highest-ever capital spending of £10.3m. That’s a total of £23m of capital expenditure, or about £8m a year. To put that in perspective, we used to spend around £3m per year before foundation status.’

The trust is keen to show staff and patients that any surplus is used to improve facilities. ‘We use the term “surplus for a purpose” a lot,’ says Mr Briddock. ‘There is still a cultural issue for some people trying to get their heads around making a surplus and there is some cynicism that it might be taken off us.

‘We want to demonstrate that we are reinvesting back in our organisation. While £5m sounds a lot in terms of a surplus, our overall income is £150m, so it is just over 3%. We say that for every pound we receive, 97p goes on treating patients and 3p is held to make sure they are looked after in a pleasant, up-to-date environment with modern technology and equipment.’

The trust is about to embark on a £5m scheme to build a new children’s facility. This will bring services that are currently provided in a number of ill-repaired properties offsite into a dedicated new building.

It is also implementing a £5.1m ward upgrade programme that will provide medical gases at every bed, increase the number of single rooms and install new floors. ‘There will be an increase in the number of wash-hand basins, which is linked to reducing hospital-acquired infections and our infection control measures,’ says Mr Briddock. Other capital programmes include a £2m outpatient upgrade, £4.3m on new equipment and £1m on new car-parking facilities. The plan to create extra car-parking spaces is significant.

‘We have about 2,000 parking spaces, but we always get complaints from patients, visitors and staff that there’s not enough. In the past it was unlikely you would get strategic health authority capital funds for car-parking, but we have the autonomy to make that decision along with the staff, the public and the board of governors. The stumbling block for schemes like this used to be money. Now we can generate the money, the issue is [whether or not] we can get planning permission.’

But what if a trust has a new, state-of-the-art hospital that will not require updating or rebuilding for years? Is a surplus still necessary? And even if a surplus is needed, should that trust be able to generate a smaller surplus than those with more dilapidated estate without being penalised by Monitor’s risk ratings?

‘While surpluses would not be needed to renew existing facilities, they could be needed when the trust wanted to invest in new and different types of facility or to expand its business into different areas,’ says Mike Foster, deputy chief executive of University College London Hospitals NHS Foundation Trust, which opened the country’s biggest new hospital in 2005, built using the private finance initiative (PFI).

‘In some cases it is sensible for surpluses to be generated for particular investment purposes. But it is also legitimate for organisations to create some financial headroom, to create some financial resilience. This helps deal with unexpected events, such as changes in the level of commissioning, demand fluctuating through Patient Choice or changes in the level of the tariff.’ 

It is feasible that Monitor may consider setting different surplus targets for organisations facing different circumstances in future – perhaps recognising the condition of different organisations’ capital estate and their need to invest. But for now it remains off-limits, having been dismissed by the regulator in its review of the compliance framework, which came into being in April. The regulator said individual financial efficiency targets ‘would require a degree of analysis on a case-by-case basis for all NHS foundation trusts’ that Monitor was ‘not currently proposing to undertake’.

Mr Foster believes variable targets are unnecessary. It could even be argued, he suggests, that those trusts with good-quality modern estate should be generating a larger return because of the quality, efficiency and modern design of their facilities. ‘I don’t really think that a uniform efficiency/surplus target could drive some organisations to generate surpluses that they don't have a use for – because, surely, all organisations do have a use for surpluses in terms of improving their day-to-day services,’ he says.

Sue Jacques, executive director of finance at County Durham and Darlington NHS Foundation Trust, agrees that surpluses are essential. She adds that by generating surpluses now, her trust is hoping to protect itself from potential income fluctuations in the future and invest in services to ensure that the trust is able to provide first-class healthcare that attracts patients under Patient Choice.

'Last year we had a surplus of £5m and we are planning for £4.5m this year,’ she says. ‘In our case we wanted to have good liquidity because of pressures elsewhere. We are using it in a number of areas, not just for capital investment.

‘Payment by results transitional relief ends this year, so we will lose £4m in 2008/09. Because of this we want to become more efficient to get ahead of the game. We are also looking at a reduction in elective activity as we achieve the 18-week target and in non-elective care because of predictions our primary care trusts are making about delivering more care closer to home.'

The trust is still using some of its surpluses to invest in renewing its assets, she says. It has three PFI developments on its hospital sites. Even in these units, however, money is needed to fund the renewal of equipment and changes to the buildings to support service developments. These developments include the introduction of a new CT scanner that allows procedures that are normally invasive to be undertaken non-invasively.

Counter argument

Some would argue that foundations (or, indeed, any NHS trust) should not make surpluses. They would claim these trusts’ income is too high and the money should be redistributed to other parts of the NHS. There is concern among foundations that these voices could create political pressure to relieve them of their surpluses – possibly by increasing the public dividend capital (PDC) dividend that foundations are expected to pay to the Department of Health (currently 3.5%) or even by demanding repayment of PDC.

‘If the Department of Health tried to create a higher level of PDC dividend, it would be accused of taking away the level playing-field with non-foundations,’ Mr Foster says.

He adds that introducing what would be seen as penalties for high-performing trusts – which operate efficiently and at a reduced cost compared to the tariff – through higher levels of PDC dividend would quickly disincentivise high performance and would be counterproductive.

Whatever surpluses are spent on, Monitor believes that commissioners have a key role to play. It reports that last year capital expenditure was £198m short of plan. It believes this was because of uncertainty over commissioners’ long-term intentions. ‘To provide NHS foundation trust boards with the confidence to invest, there is an increasingly urgent need for clear indication from commissioners about their healthcare purchasing intentions,’ it says.

Surpluses are becoming increasingly important across the NHS but it looks as if foundations will continue to lead the way in generating them and, perhaps, spending them.