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Budgeting[pic]External Environment to Budgeting[pic]National Health Service
Structural Changes in the National Health Service [pic]Accounting and Budgeting Practice [pic]Financial Framework[pic]Developments in NHS Budgeting[pic]Sources of Further Information
October 2005
External Environment to Budgeting: NHS

This section identifies the external factors and developments which influence budgeting in the national health service, summarising the main developments which have taken place in recent years.

The information in this section refers to the NHS in England. There are substantial organisational differences in the NHS in Scotland and Wales
The NHS is the biggest organisation in Europe in terms of the number of people it employs. At the top level of the structure is the Department of Health (DOH) the government department which makes decisions on the future direction of the NHS and secures funding. Further down the structure are Strategic Health Authorities (SHA’s) which oversee services on regional basis. At local level Primary Care Trusts (PCT’s) are responsible for assessing the needs of people in their area, commissioning the appropriate services and monitoring General Practitioners (GP’s). Actual delivery of services are carried out by Primary Care services (GP’s, Dentists, Opticians, pharmacists , NHS walk in centres) and Secondary Care Services ( Acute Hospitals, mental hospitals and ambulance trusts).

The NHS operates on a purchaser/ provider split. On the purchasing side money from the taxpayer goes to the Department of Health which then allocates the money to the local purchasers who are the PCT’s and GP’s. These purchasers then purchase services on behalf of patients from NHS Trust providers and private sector providers.

The NHS is currently undergoing major changes including

* Practice Based Commissioning. This will increasingly make GP’s the lead commissioners of services rather than PCT’s * Patient Choice for elective care(planned procedures). Patients will no longer be automatically sent to their local NHS Trust. They will have the choice to go to other providers. * Payment by Results. Providers are paid on the basis of actual activity based upon a national tariff * Competition for NHS Trust providers from new independent treatment centres for both elective surgery and diagnostics

These reforms effectively introduce a new internal market in the NHS.

There have been many structural and procedural changes to the NHS over the last 60 years. However certain key features remain largely the same: • Service is free at the point of delivery. Nearly all spending is funded from taxation • The need to manage spending within overall resource limits set by the government • The problem of trying to ration finite resources in the face of nearly infinite demand • Public scrutiny of NHS activities

Structural Changes in the National Health Service

The statutory and corporate framework for the National Health Service was established by the NHS Act of 1946.
Since then there have been many structural changes, however this section will only focus upon the most recent ones.
Structural reforms introduced in 1973, 1977 and 1980 did not radically alter the financial and budgetary regime under which the service operated although the latter did specify the duty of regional health authorities, as they were then constituted, to ensure that resources earmarked to regional and district health authorities were not exceeded.

The 1990s heralded a decade of radical structural and financial reforms which materially altered the basis under which NHS budgetary structures and processes operated. The NHS and Community Care Act 1990 was the first major reform which created the internal market by making a distinction between purchasers (e.g. health authorities and general practice fundholders) and providers (e.g. hospital and community trusts). The NHS (Primary Care) Act 1997 introduced the idea of single practice based budgets for G.P’s

The Health Authorities Act 1995 which abolished regional health authorities, district health authorities (DHAs) and family health services authorities (FHSAs) further refined the principles initialised under the 1990 Act.

In some areas, health commissions were established integrating the management of FHSAs and DHAs which were responsible for commissioning health services on behalf of their populations. These reforms were extended in the NHS (Primary Care) Act 1997 which heralded the introduction of single practice based budgets for GPs and established budgets at health authority level to purchase appropriate services from dentists to meet specific local need.

The election of the Labour government in May 1997 heralded a period of further change, with the proposed replacing of the internal market with 'a new system of integrated care based on partnership and measures to improve efficiency'.

The White Paper The New NHS – Modern Dependable proposed the creation of primary care groups (PCGs) which would take responsibility for commissioning all services in the local community. Health authorities were to be slimmed down and would allocate funds to PCGs on an equitable basis.

The Health Act 1999 implemented many of the white paper proposals including the abolition of GP fundholders and the establishment of new primary care trusts (PCTs). The NHS Plan published in July 2000 set out the government’s intentions over medium term and prescribed a new planning system.

Further changes were introduced oOn 1 April 2002 when 302 new primary care trusts (PCTs) were created with the intention of controlling health care locally, with performance and standards monitored by 28 new strategic health authorities (SHAs), . This new structure replaced the NHS Executive, eight regional offices of the Department of Health (DoH), 99 health authorities and 481 PCGs. PCTs would henceforth receive their funding directly from the Department of HealthoH. From July 2006 onwards the number of Strategic Health Authorities was reduced to 10, and the number of PCT’s to 152.

Practice Based Commisioning has been introduced which means that GP’s can take the commissioning and financial responsibility for parts of the PCT Budget

These structural changes have had significant implications for the NHS budgeting regime.

Thus PCT’s and GP’s have taken over responsibility for commissioning health services at local level (note PCT’s also have a provider role in community services).

Providers of Primary Care include :
Primary Care Trusts (PCT’s)
General Practitioners ( PCT,s)
Walk in Centres

Secondary and Tertiary Care is provided by
Acute Hospital Trusts
Foundation Hospitals
Ambulance Trusts
Mental Health Care Trusts

Following the re-organisation of the NHS into strategic health authorities (SHAs), primary care trusts (PCTs) and provider trusts, the NHS now consists of more than 600 trusts. These vary significantly in size and for many of the smaller trusts the cost of doing everything in-house has proved to be impractical which is leading to the development of shared financial services.

It is government policy to expand the number of foundation trust hospitals which are part of the NHS but work under a different financial regime to NHS trusts. Trusts will have the freedom and flexibility within the new NHS pay systems to reward staff appropriately, be able to exercise full control over their assets and retain their income from of land sales. Freedoms to access finance for capital investment under a prudential borrowing regime have also been granted. The aim is to enable trusts to shape services to meet local needs and priorities. They are accountable to an independent regulator known as the Monitor, rather than through the normal DoH hierarchies. They are required to operate as self sufficient 'businesses'.

In addition there have been initiatives to involve other organisations in the provision of healthcare. Thus Independent Treatment Centres (ISTC’s) have been established to give the private sector a role in delivering treatment to NHS patients.

Planning Systems and Resource Allocation From the Department of Health To PCT’s
Funds for the NHS are allocated under the Governments system of Comprehensive spending reviews and budgets. In these spending reviews the Department of Health will negotiate with the Treasury over the level of NHS spending in line with Public Service Agreement Objectives

Since 1997 the Government has been committed to raising the level of NHS spending in real terms, and it is currently over 8% of GDP. The Wanless Report (2002) concluded that given changes in population structure and developments in medical care, this may need to rise up to around 12% in 15 -20 years time.
However given the long term funding problems now faced by the government following the “ Credit crunch” , the extent to which increases in NHS spending can continue in the short to medium term is open to debate.

There has been a move towards longer planning time frames within government planning systems, The comprehensive spending review looks forward on a three year basis. This is mirrored at local level where The Department of Health makes three year allocations to PCT’s to help improve the service planning process. PCT’s receive their allocations from the Department of health under a weighted capitation formula

Funding is split between PCT’s on a the basis of population need. This is determined by a “weighted capitation formula” which takes on board such factors as population numbers and age.

Payments to Providers - Payment by results

From 2004 onwards, internal funding systems in the NHS in England have been gradually changed to implement payment by results (PbR).
Prior to PBR, NHS providers were paid under block contracts based upon historic activity and costs . Prices in these contracts were determined by local negotiation. Within certain parameters it did not matter whether the NHS Trusts over /under achieved in volumes of service in the year in question – they still received the agreed level of funding.

The basic feature of PBR is that providers are paid by the NHS on a case by case basis at national tariff rates. The PCT and provider will still agree a certain amount of activity at the start of each year to aid planning, but if actual activity is not in line with planned activity there will have to be corresponding refunds of cash to the PCT (or extra payments by the PCT if agreed levels are exceeded).

The activity calculation is based on information of spells /episodes of care and Health Resource Group Categories.
A spell of care is the patients journey from admission to discharge. This journey may involve time in several departments and the time spent in one department is an episode of care. An HRG is a group is similar clinical treatments. For each HRG a national tariff is defined to take into account the cost of providing the service. These are then used to determine the cost of a spell of care.

The key issues in PBR are in defining the activity measure and determining the tariff
PBR uses the HRG classification of activity as a basis for making the payments.However these were developed with the acute sector in mind, and there are gaps with other services need to be filled.
HFG’s link services that are clinically similar, and so far over 1000 of these have been identified. For instance an example of an HRG is a primary knee replacement.
The national tariff for the HRG is based upon the average reference cost for the HRG . Reference costs are based upon actual costs reported by NHS for doing these operations, but these then need to be adjusted for a number of factors e.g. inflation, efficiency factors.

The original intention was to have all commissioning under PBR by 2008. However progress , especially with non acute services has been much slower than this, and there is still much work to be done .

The implications for budgeting are likely to vary depending upon whether the issue is looked at from the perspective of purchaser or provider.


The main aim of PBR is to increase efficiency in the NHS. The prices for services will be transparent. Purchasers will be able to shop around for those providers who are able to provide the services at the best level of quality.

However purchasers have a finite amount of money , mostly received from the Department of Health. They will therefore have to ration the services they buy. A PCT will normally produce a business plan setting out healthcare priorities for the next three years. It will then need to break down expenditure between Hospital Services, Mental Health Services, Community Services, GP services and other services. It is likely that the pattern of budgeting at this level will be largely incremental.

The amount of money for spending on care under PBR will therefore be capped. Thus it is likely that every year they will agree contracts with providers for a specified number of services at a specified price. If demand from patients exceeds this number of services this will create problems. There will need to be a cap placed upon the number of activities that will be funded and also regular monitoring of the actual performance of providers.


Providers will now have to draw up budgets for income based upon the estimated number of services they are contracted to supply. It may be that a fixed annual budget is inadequate and that budgets need to be revised over shorter periods to deal with fluctuations in contracted income and activity.

Providers will need to plan their activity in line with their contracts. If they fail to meet their contracted volume of activity then they will lose income and this will lead to financial problems. Hence it may be that more monitoring of performance is required. In particular it is important that the treatments carried out are correctly coded

The Audit Commission (2004) outlined that for the system to work for a Trust , the Trust would need good quality activity data for billing and an accurate knowledge of their costs. This suggests that budgeting at departmental/clinical level will have to become more sophisticated. An understanding of fixed and variable costs in each area is required, so that budgets can be flexed in response to changes in activity.

The move to national tariffs and payments by number of operations is likely to create a situation where those providers who are efficient will gain financially , but those who are not will lose out. This may impose pressure on providers to improve their costing systems , so they are better able to judge which services cover their costs and which do not. Providers may need to break down each national tariff and identify what has gone into the tariff in terms of nursing treatment, consultant time , theatre time etc. The provider organisation will then need to identify its own costs for these procedures.

It may well be that once information on costs are more transparent certain trusts may decided to specialise on those treatments which they can deliver at a surplus and stop carrying out those procedures which are loss making. Eventually managers may find themselves in charge of profit centres , rather than cost centres which is the current NHS norm.

There is a danger that a provider may reduce quality of care in an effort to reduce costs. Also there is a risk that expensive new treatments are not tried because their cost has not been allowed for in the HRG’s

The Impact to Date

Many commentators have argued that although there is potential for greater efficiency, there is a danger of financial instability in the NHS .Because the implementation of PBR has been slower than planned it is difficult to assess whether these fears will be realised . In order to allow organisation to adjust to the new system a number of transitional arrangements have been applied such as allowing providers to move in steps towards the new tariff and gainers supporting losers.

Accounting and Budgeting Practice

Resource accounting and budgeting in the NHS

Resource accounting and budgeting (RAB) was formally introduced into the NHS from April 2001 in line with the changes being introduced for central government. This means that resource limits rather than cash limits ar allocated.

For the NHS this change was not as significant as for central government departments as it had accounted on a full accruals basis (including accounting for capital charges) since 1991.

A detailed explanation of the new system was provided in guidance issued by the DoH in January 2002 (A Guide to Resource Accounting and Budgeting for the NHS).

The key financial imperatives for NHS organisations, however, remained much the same i.e. they were still required to: • achieve financial balance; • comply with their statutory financial duties, i.e. containing expenditure within resource limits and cash limits in the case of health authorities and PCTs with no break-even duty breaches in the case of NHS trusts.
The introduction of RAB put new control mechanisms in place, which had a significant impact on NHS financial planning and budget setting. Statutory annual resource limits (RLs) were introduced for health authorities and PCTs for revenue and capital. Both had a statutory duty to remain within their RL and thus were no longer be able to fund overspending each year by increasing indebtedness or delaying the timing of payments.

A new capital expenditure resource limit (CRL) was also applied to health authorities and PCTs.

The effect of RAB on NHS trusts was less direct than that for health authorities and PCTs. The control of cash continued to be important and the external finance limit (EFL) mechanism remains as a control on cash consumption. Trusts would continue to have a prime statutory duty to breakeven taking one year with another but received the following flexibilities to enable them to achieve this. • Trusts earning revenue surpluses were able to apply them in following years. • Special arrangements were available to neutralise the effects on breakeven positions of certain changes to the value of assets (e.g. impairments). • Trusts were able, in principle, to give up part of their capital resource limit and have the revenue resource limit of their main commissioner increased although in practice this was only permitted in exceptional cases.
The introduction of RAB therefore had major implications for financial and service management. RAB increases the importance of accurate budgeting and forecasting of non cash items, capital charges and accounting adjustments.

Programme budgeting

In 2002 the DoH initiated the national programme budget project. The aim of the project is to develop understanding on where money is being spent on a specific health objectives or medical conditions.

Since From 20043/054 onwards each primary care trust and strategic health authority has been required to will report within their annual accounts the totality of their expenditure on a programme basis. This historic information may lead to better inform decisions on new investment and on redeployment of existing resources at PCT and Department of Health level..

For further information see Programme Budgeting in TIS Health.

Capital Financing

From 2007-2008 onwards NHS trusts can finance capital investment from cash flow and borrowing. The amount of borrowing is subject to a Prudential Borrowing limit ( PBL). The is the cumulative total amount that the trust may have. . Capital Investment plans need to be approved by the Strategic Health Authority. This regime applies to Trusts only.

Financial Framework

Statutory Duties The Affect The Budget

Section 10(1) of the NHS and Community Care Act 1990 requires Trusts to break even. In practice this is normally interpreted as breaking even over a three year period. The requirement to break even also apples to PCT’s and SHA’s
For these organisations the medium term budget and capital programme will need to demonstrate that this objective can be achieve

However the break even requirement does not apply to NHS Foundation Trusts where the main requirement is to remain solvent.

NHS plan's impact on budgeting – service and financial frameworks

The NHS planning process prescribed in the 2000 NHS plan required the completion of service and financial frameworks (SaFFs). SaFFs were intended to capture the agreed action, investment and activity to be delivered by the local health community and at what cost. This information was then incorporated into local action plans that provide more detail on how the SaFF were to be delivered.

Service and financial frameworks: • set out the planned local NHS activity and resources to support both the modernisation programme and the contribution to the key national and local targets and priorities, and; • demonstrate progress towards delivering the other infrastructure and workforce investment set out in the NHS plan.
In agreeing the SaFFs, regional NHS offices were required to ensure that each subsidiary organisation was planning to make the necessary progress to the targets set out in the NHS plan. They also needed to ensure that collectively the NHS along with the social care community was delivering on that region's share of national targets and ensuring that its share of the national hypothecated investment was incurred.

NHS organisations were also required to develop local action plans which outlined how the system would operate in each area to deliver the agreed milestones and targets and investment set out in the SaFF. These formed the basis of the performance agreement between regional offices and their NHS trusts and health authorities.

Allocation of resources to NHS bodies

In common with the rest of the public sector the level of funding which the NHS bodies in different areas receive is unavoidably a political decision. A number of formulae have been used since 1948 on which to base the allocation of funds between geographical areas or health authorities.

The present system is a modified version of a formula developed by York University, i.e. the HCHS revenue resource allocation weighted capitation formula. The main factors which influence the distribution of funds within this formula are: • capitation (i.e. crude population numbers adjusted for cross boundary flows where patients are registered with GPs in a different PCT from their place of residence); • age profile (i.e. additional weightings for the elderly and children); • morbidity (e.g. higher weighting to reflect differential life expectancy rates); • a market forces factor (to reflect the higher pay and property related costs associated with operating in areas such as London and the south east).
The NHS plan, published in 2000, included a commitment to a single resource allocation formula covering all NHS expenditure including general medical services non-cash limited (GMSNCL). Unified allocations for 2002/03 took account of the distribution of GMSNCL expenditure.

In 2003/04 the allocation formula was radically reformed with the most significant development being the introduction of three year rather than annual allocations.

The new needs element of the formula uses alternative measures of deprivation and also takes some account of 'unmet need', where certain groups within the general population (for example ethnic minorities and socio-economically deprived groups) are not receiving healthcare services to the same level to that of others with similar health characteristics. The new formula also benefits higher cost areas by extending the staff market forces factor.

This approach shares much in common with the reform of the local government finance distribution system which is discussed later in this section.

Developments in NHS Budgeting

In April 2002 the Department of Health (DoH) published 'Delivering the NHS Plan - next steps on investment; next steps on reform' which proposed a number of radical changes to the NHS budgetary framework and introduced a new streamlined three year planning framework.

From 2003/04 the DoH has issued funding allocations covering a three-year period which will aid medium term financial planning. This will, in theory, allow organisations to look in-depth at their services, plan change with confidence and implement improvements year on year.

The 1999 and 2006 Health Acts re encourage partnerships between public sector and private sector partners, especially between the NHS and Local Authoritiesforms also a represent a crucial development for closer collaboration between health and social services. In particular, the new budgetary framework requires health and social services to establish a joint lead in mental health and older people services to ensure new standards are met.

The Department of Health has stated that both NHS and local authority social services departments must address a six-stage process in allocating money to improve services: 1. identifying the national and local priorities and the key targets for delivery over the next three years; 2. agreeing the capacity needed to deliver them; 3. determining the specific responsibilities of each health and social care organisation; 4. creating robust plans that show systematically how improvements will be made and which are based on the involvement of staff and the public; 5. establishing sound local arrangements for monitoring progress and NHS performance management, which link into national arrangements; 6. improving communications and accountability to the public locally so as to demonstrate progress and the value added year on year.
Following the re-organisation of the NHS into strategic health authorities (SHAs), primary care trusts (PCTs) and provider trusts, the NHS now consists of more than 600 authorities and trusts. These vary significantly in size and for many of the smaller trusts the cost of doing everything in-house has proved to be impractical which is leading to the development of shared financial services.

It is government policy to expand the number of foundation trust hospitals which are part of the NHS but work under a different financial regime to NHS trusts. The government has stated that by 2008 all NHS trusts should have reached a standard which would enable them to apply for NHS foundation trust status.

Trusts will have the freedom and flexibility within the new NHS pay systems to reward staff appropriately, be able to exercise full control over their assets and retain their income from of land sales.

Freedoms to access finance for capital investment under a prudential borrowing regime have also been granted. The aim is to enable trusts to shape services to meet local needs and priorities. They are accountable to an independent regulator known as the Monitor, rather than through the normal DoH hierarchies. They are required to operate as self sufficient 'businesses'.

Private sector provision

Recent years have seen the development of the treatment centre model where the general hospital is bypassed by a treatment centre offering a fast–access production line approach to routine surgery. While these can be in NHS ownership there have also been examples of this type of work being contracted-out to the private sector.

In January 2004 the Health Secretary stated an aim of 15% of surgery going to the private sector.

Payment by results

From 2004 onwards, internal funding systems in the NHS will be gradually changed to implement payment by results (PbR). This will replace annual negotiations between primary care trusts and hospital trusts with a fee for treatment based upon a national tariff.

While the impact of this has not yet been fully realised it is likely that it will mean that budgets will have to be flexible, adjusting to changes in volumes of activity in different Healthcare Review Groups (HRGs). Budgeting for the trust as a whole may become a more volatile process. It may also lead to trusts building up their budgets from their tariff income in each speciality, rather than using the incremental approach.

For further information see Payment by Results in TIS Health.

Future developments

It appears that the NHS is moving towards a mixed economy of provision with the introduction of market forces. While this market system will still operate within a tax funded, cash limited total budget, there is likely to be volatility in income streams at hospital trust level which will impact upon budgeting at this level.

Sources of Further Information • A Guide to Resource Accounting and Budgeting in the NHS(Short Version) • Shared Financial Services • TIS Health • TIS Health: Payment by Results • TIS Health: Programme Budgeting • Introductory Guide to NHS Finance in the UK, HFMA , 2008 Edition…...

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