CORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 1204-iii

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

HEALTH COMMITTEE

 

 

NHS DEFICITS

 

 

Thursday 19 October 2006

 

PROFESSOR SHEENA ASTHANA, PROFESSOR MERVYN STONE

and PROFESSOR BARRY McCORMICK

MR ANDY McKEON and MR PHIL TAYLOR

Evidence heard in Public Questions 388 - 529

 

 

USE OF THE TRANSCRIPT

1.	This is a corrected transcript of evidence taken in public and reported to the House. This transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.
2.	The transcript is an approved formal record of these proceedings. It will be printed in due course.

 

Oral Evidence

Taken before the Health Committee

on Thursday 19 October 2006

Members present

Mr Kevin Barron, in the Chair

Mr David Amess

Charlotte Atkins

Mr Ronnie Campbell

Jim Dowd

Sandra Gidley

Anne Milton

Dr Doug Naysmith

Dr Howard Stoate

Dr Richard Taylor

________________

Witnesses: Professor Sheena Asthana, University of Plymouth, Professor Mervyn Stone, University College London, and Professor Barry McCormick, Chief Economic Adviser, Department of Health, gave evidence.

Q388 Chairman: Good morning. Could I welcome you to what is our third evidence session on our inquiry into deficits. I wonder if I could ask you to introduce yourselves please.

Professor McCormick: Good morning. My name is Barry McCormick and I am the Chief Economist in the Department of Health.

Professor Asthana: Good morning. My name is Sheena Asthana and I am a professor of health policy at the University of Plymouth.

Professor Stone: Mervyn Stone. I have been a UCL professor for longer than I care to remember.

Q389 Chairman: Thanks very much indeed for coming along. I wonder if I could ask, starting with Professor Asthana and Professor Stone, in very broad terms what is wrong with the existing funding formula?

Professor Asthana: I think there are three broad areas in which the funding formula, one could suggest, is flawed. The first is that the philosophy or the principles on which it is based, namely reading need off existing use, I think, is of questionable legitimacy. It would be preferable to read need off direct measures of health rather than existing use of health services, so that is the 'principal' issue. Secondly, there are a number of technical problems or problems with the technical design of the formula. I think the main issues are that there are problems around the way in which one controls for supply and there are problems about the conceptualisation and the measurement of unmet need. At the moment the main problem, I think, would be the relative importance that is accorded to age and additional needs factors in the final calculation of PCT allocations. Then the third area for which I think the formula can be criticised relates to its outcomes. For example, this inquiry is about deficits and there is strong evidence of a systematic pattern in deficits - that certain areas with certain population characteristics are far more likely to be in deficit than other areas. There is equally very strong evidence of geographical differences in waiting times which again maps on to the same sort of population characteristics that you can see with regard to NHS deficits. In terms of the outcomes, this suggests that it is not just a problem of local management, but there is something systematically flawed. It is likely that it relates to funding insofar as risk of deficit is strongly associated with level of funding.

Q390 Chairman: Professor Stone, do you agree with that? You seemed to be nodding then.

Professor Stone: Almost everything she said, I would agree with, but I would put it slightly differently and I would introduce a bit of history. I think we should distinguish two aspects of this formula, what it is and what it does. I think the way in which we look at what it is and what it does are completely different things and in both areas there is a vacuum of information and a vacuum of understanding. If we look at what it does frankly, as far as any particular year is concerned, at the moment it produces 303 numbers, the allocations to 303 Primary Care Trusts. That might change, but it does not matter, the formula is the thing which claims it can do anything for any area in the country by amalgamation. Then as to what it does, how do we say whether it is fair when we are just looking at those 303 numbers? There seems to be a kind of paralysis there in which currents of opinion go this way and that way, parties say this and other parties say something different. What we need is something that Sheena just mentioned. We have to have direct measurement of something in order to validate these numbers and say, "Yes, we're happy". Opinions are not enough. It is not enough to say, "Yes, the formula is about right". People who say that or who perhaps say that it is perhaps as good as anything around should be challenged to say what the evidence is on that, "Are you sure that your feeling that some Primary Care Trusts should receive twice as much per capita as others", which may be a warm-hearted feeling, but that is what inequality calls for, "are we sure that it is going to the right Primary Care Trusts?"

Q391 Chairman: Could I ask you, on that basis, are we to assume that you do not have an alternative on the shelf at the moment?

Professor Stone: I think we have an alternative, but I think it is in the future. This should have been recognised at a much earlier stage by the committees that dealt with this situation. If I cross to the "is" from the "does", the "is" is frankly scandalous. I have a grandson who is interested in horrible histories and I would like to see this particular formula, and not just the formula but the machinery that goes with it that would produce a replacement for it, consigned to history and replaced by better machinery, one that brings in independent opinion from universities which are letting this country down by not getting involved.

Q392 Chairman: Well, we may be asking for comments on individual issues on the current formula. Professor Asthana, do you agree that there is nothing on the shelf at the moment that you believe would replace the current formula with something which you believe to be fairer?

Professor Asthana: I think there is something on the shelf actually. In 2001, we presented a paper to the Technical Advisory Group of ACRA, demonstrating the feasibility and impact of developing morbidity-based computations. It is easy now. In fairness to the utilisation-based formula, I think the reason that the original model was produced in 1994 and the York team chose utilisation was because really utilisation data were the only data available at the time. Since that period, there has been an explosion in epidemiological data that can be extrapolated to create bottom-up estimates of need. Now, it is very easy to create morbidity-based estimates at quite a fine level within different disease categories, for example, particularly within coronary heart disease where you can start to go down to levels of angina, et cetera, not just a block of coronary heart disease. It is slightly trickier, I think, then to map on morbidity estimates to actual clinical need for services, but I do not believe it is impossible to do that. I can think of at least two methods and again we have suggested methods to do that very thing, so there is something else on the shelf and it is simply that for some reason the Department of Health has not shown much interest until recently in an alternative.

Q393 Chairman: Could I ask you, Professor McCormick, and clearly Professor Stone does not ringingly endorse the current situation, what do you feel about the issue of this mistrust in some circles about the allocation or people being trusted to allocate resources between different PCTs? How do you answer this type of criticism?

Professor McCormick: I think I would begin by saying that I think the Department takes a very responsible position in that it has an independent body that has sitting on it clinicians, economists, statisticians, a broad variety of people with knowledge of the health world. It commissions externally published work and makes recommendations to the Government based upon that externally published work and it is not just opinions, as Professor Stone has ventured, so I think the context in which we are working here is one in which alternative models are explored, are examined and, at the present state of play, we believe that we are using the best model that was available. It was developed under academic research at the University of Glasgow, not in a sort of opinion-forming climate, and I do not personally believe that it is responsible for driving the deficits, but it seems to be the back on which the present concern which many people have about the formula is being driven. I do not believe that link is actually that well established.

Q394 Mr Amess: You are all professors and I am clearly not one, but I am hoping that we are going to have a lively session and that my question may provoke some sort of academic falling-out. Now, the three of you seem to have a different view on the weighting which is given to age, and at the end I will tell you which side I am on. Now, Professor Asthana and Professor Stone, could you give the Committee your view on this matter?

Professor Asthana: If you look across a whole range of different conditions, I think, with the important exception of mental health, the vast majority of diseases, particularly the diseases that consume the most healthcare resources within this country, such as coronary heart disease, other cardiovascular diseases, cancers, et cetera, the age gradient or age is a more important determinant of disease risk than socio-economic status. So it is not denying that there are health inequalities. Health inequalities are very, very important, but I think sometimes we get so immersed in the whole concept of deprivation and health inequalities that we do forget the role played by age. I think what has been happening is a sort of muddling up really between the kind of concept of health care equity, which is what the NHS formula is supposed to be promoting - which is equal treatment for equal needs, and the concept of health equity which is based on a desire to reduce health inequalities. I am wondering if this might be underpinning the relative balance that has been given to additional needs (which is basically very strongly correlated with deprivation) and the age in the formula. Given the fact that we know that age is a major driver of the vast bulk of disease that will require hospital treatment, you would expect areas with the most ageing populations to get the most resources. But that is not necessarily the case because, in the way in which the formula is put together, the additional needs indices are given more importance. In other words, you could have a fairly young, deprived population receiving more per head than an old, wealthy population. Now, that young, deprived population may have higher relative needs and if you took a standardised mortality ratio, it might have a higher risk of premature illness, but at the same time it might have a lower absolute level of ill-health than your older, wealthier population, if that makes sense.

Q395 Mr Amess: Before Professor Stone comes in, Professor McCormick, why do you disagree with that point of view?

Professor McCormick: Firstly, because I think age is well captured in the formula. Age matters a lot in the formula, but it is just that need also matters too. Can I fill out some intuition perhaps for why I think it is often hard to realise why simple relationships between the age index in an area and the allocation to an area are less well fitted than commonsense might suggest. I have asked the Centre for Health Economics at the University of York to provide me, and I will be able to pass it on to your researchers at the end of this meeting, with some evidence on the dispersion of costliness of running a hospital system in a deprived area versus a less deprived area within age/gender categories, so, holding constant your age/gender group, how much does the cost of running a hospital system vary as you move from a very deprived neighbourhood to a much less deprived neighbourhood, and the difference is up to 140% based on usage. This is actually not using a model, but this is cranking through HES data, the 13 million episodes of HES data that occur within the single year. It is up to 140% more expensive to run the more deprived neighbourhood, so the fact that we see large dispersions in allocations, holding constant your age/gender factor, should not surprise us. It is a lot more expensive to run a hospital system, in particular, in such neighbourhoods.

Q396 Mr Amess: Professor Stone, could I put words into your mouth and ask, do you think Professor McCormick is talking nonsense?

Professor Stone: No, not at all. I think what he is invoking is the idea of direct measurement because what he is doing is he is making an observation on what he can see from doing this, holding the age/gender category constant, and then looking at costs and he is looking at what the relative needs are and how it relates to ethnicity and things like that. He is coming close to making observations that would allow possibly, although I do not believe it would, to be honest, but it is on the right road to make that connection. But I must go back a little bit to what he was saying earlier. He was making a defence, I am sure rightly so in the sense that all the people involved in this have good intentions, but what I am suggesting is that they are victims of a government machinery which goes back through many administrations, it is not just one Party by any means, which does not open issues out at the early stage. There are many serious issues which I have tried to raise in the written evidence to the Committee which the bulk of statisticians would say were disgraceful in the way that that formula was concocted. There was one statistician, as far as I can see, in the group that prepared the bits and pieces that the Finance Division in Leeds decided to use and put together and there was no explanation of why the Leeds Division put them together in that way. The formula has never been tested in academic circles at all. It was presented from pieces prepared by the group to which Professor McCormick referred.

Q397 Mr Amess: But to get back to the point of age, clearly, Professor Asthana, you do not agree with what Professor McCormick is saying?

Professor Asthana: No, I do not agree.

Q398 Mr Amess: And I do not agree either.

Professor Asthana: I think there are two issues here. The first is that you need to make a separation, as the formula itself does, between measuring need and adjusting for the additional costs of providing services. What you have been talking about is adjusting for the additional costs, whereas what we were talking about is how you measure need. Now, in the need aspect of the formula, greater weight is given to deprivation than age and that is just wrong. Coming back to the additional costs issue, again I actually do fundamentally disagree with you. Most deprived areas also happen to be urban areas and if we look at additional costs, I do not fully understand. Okay, there is a difference between private-sector provision, such as supermarkets and hospitals. However, it is patently obvious that supermarkets find it a lot cheaper and can obtain far greater economies of scale in urban areas, whether they are deprived or not, than they do in wealthy, rural areas. So I am really unclear and I do not understand why your costs of provision per unit would be higher in an urban, deprived area. Coming back to your saying that we are reading off utilisation statistics, this is precisely the problem of using utilisation statistics. Your costs may be higher because you have pumped so much more money into those areas, so what you are reading off is simply the higher resourcing that is going in.

Q399 Mr Amess: Well, I think, Professor Asthana, you have done a magnificent job and we will not even let Professor McCormick defend himself! The Chairman wants us to move on, so would the three of you quickly tell us, do you agree that the market forces factor is fair?

Professor Stone: Well, I will contract out of that. That is beyond any expertise that I have.

Professor Asthana: I do not believe that the market forces factor is fair for a number of reasons and again I will raise the economies of scale issue. It is clear to me that certain communities, and I suppose I am putting my rural hat on here, but it is clear to me that it is more difficult to obtain economies of scale in rural areas than it is in urban areas. There are a whole other range of factors, such as your travel time. Delivering community nursing in a dispersed area is a complete nightmare compared to in an urban area, so if you are visiting terminally ill people, you might be able to do two a morning compared to ten a morning, et cetera, and that is patently obvious. Another reason is this idea that we adjust for the higher labour costs in metropolitan areas. We have a national wage scale in the NHS. In fact what you will find is that your nursing staff in urban areas tend to be on lower grades because there is a higher turnover of nurses, whereas again in rural areas you tend to have nurses on higher grades who are far more expensive and they need to be because they need to work with a degree of autonomy. For example, if you are working in a community hospital, you actually have to do quite a lot more than a low-level nurse in a busy, large hospital would have to do, so for a whole series of reasons you could argue that rurality creates additional costs. Yet, with the exception of ambulance services, no adjustment is made for rurality at all. By contrast, it is driven by labour costs and I just do not understand that at all. It does not make any sense.

Q400 Mr Amess: Well, I suppose we will, on this occasion, let you defend yourself, Professor McCormick, but I do not think you are going to win!

Professor McCormick: The MF factor is designed to offset unavoidable costs of supplying services. It is not designed to identify additional costs that come on the costs of providing the service; they should be coming out of the mechanisms that we have already discussed. The resource model there is primarily designed because the cost of recruiting staff, which we know is the major element of cost in the NHS, varies considerably across the country. Even when we are using national wage scales, it is often the case that in those areas where we are paying relatively high rates relative to local wages, we have much lower vacancy rates than we have in areas where we are paying national wage rates in a place like London, so we have to buy effectively agency nurses in a place like London to stem the costs of not being able to fill those jobs. The MF factor is there because it is just more expensive to hire the inputs that we need unavoidably in certain parts of the country. Now, that is a technical matter then that goes down to people who provide those kinds of services and measure the costs of those sorts of inputs. They do it for private-sector companies as well as for government companies, it is a relatively 'techie' matter and that is something that is open to the Committee to scrutinise.

Q401 Charlotte Atkins: Some PCTs appear to get twice as much funding per capita as others. Now, would you, and I think maybe I will start with Professor Asthana on this, accept that that funding formula is very much biased towards the urban, deprived, rather than rural, areas?

Professor Asthana: Yes.

Q402 Charlotte Atkins: Is that assumption made because it is assumed that rural areas are in fact affluent rather than having pockets of deprivation?

Professor Asthana: Yes.

Q403 Charlotte Atkins: In my experience of rural areas, there may well be affluent, rural areas, but there are other rural areas where there are significant pockets of deprivation and, what is more, not just in terms of deprivation of income, but deprivation in the sense that they have not got access to the sort of services that many people would come to expect in an urban setting.

Professor Asthana: I very much agree with that.

Q404 Charlotte Atkins: Therefore, would you say, for instance, that in a rural area many people would probably not present themselves to a doctor or to a health centre as often as they would in an urban area and, therefore, possibly when they come back for health treatment, actually they are at the more serious level than perhaps they would be in an urban setting?

Professor Asthana: There is some evidence that rural residents make lower use of health services just simply per capita than urban residents which, given we know that rural residents are older and, therefore, we would expect them to have a higher level of morbidity, would come as some surprise. What worries me, looking at the pattern of deficits, looking at the pattern of waiting times, looking at the way in which allocations vary so much between, as you say, rural, affluent areas and urban, deprived areas, is whether what you get depends on where you live. I am pretty sure, and I think it is highly likely, that there is a real postcode lottery going on out there now and that if you tracked two people with similar conditions in similar circumstances, they may get very, very different access to care. That said, I think some things in rural areas are probably done better. We have done some work, and I think there may be another way of looking at this, which is to look at the relative balance between primary management and hospital care. Some of the earlier work we have done suggested that prescribing levels were actually very good in your affluent areas, and I do believe that in the more deprived areas there is hospitalisation above the level that underlying morbidity would suggest. I do not think that is a good thing. We always seem to indicate that there is an inverse care law where people are using hospitals less, whereas actually that might reflect inappropriate hospitalisation and a failure of primary care and perhaps community management or compliance with drug treatments in the community, et cetera. In other words, rather than flinging more hospital treatments in urban, deprived areas, perhaps what we ought to be doing is actually considering how we could strengthen primary care and community management. At the same time, it is quite feasible that there is a need for more hospital treatment in rural areas because people have got to that age, they have got that level of morbidity and, although there is good primary management going on they still need curative care, particularly when they start to die. Death is associated with need for hospital care.

Q405 Charlotte Atkins: But are we moving increasingly now towards finding solutions in the primary care setting rather than the hospital setting and presumably in rural areas because of the distance that you will be going to a hospital, at least 10/15 miles, and you are more likely to be searching for solutions in the primary care setting and in fact you probably need more money, therefore, for things like lift programmes and health centres and so on which would take on a lot of the jobs which a hospital will perhaps do in an urban setting?

Professor Asthana: I think some of the reforms actually to primary care are also quite damaging in rural areas, some of the recent out-of-hours provision and things like that, so I think there are problems there as well. What we just do not know and what we need further information about at the moment is whether there is relative under-presentation. I suspect that there probably is. If you look at sheer per capita use of health services, I think that there is suppressed use, suppressed demand in rural areas, but that could well reflect supply insofar as they are actually getting less to start with and, as a result, the expectations become slightly lower. As I said, I think there is possibly inappropriate hospitalisation going on in urban areas as well, perhaps people going straight into hospital rather than being dealt with properly within the primary setting, so there is a whole range of different factors going on, but yes, I absolutely agree with your first question which is the fact that rural residents are losing out, I think they are definitely losing out.

Q406 Charlotte Atkins: I am a bit concerned that the assumption tends to be made of urban deprived and rural affluent, but is there any tracking of rural, deprived communities against urban, deprived communities because it is certainly the case that not all rural areas are affluent and there are certainly important pockets of deprivation in rural areas? Has there been any research done on what the outcomes are for those sorts of communities?

Professor Asthana: With regards to poverty?

Q407 Charlotte Atkins: With regards to how the formula works for them.

Professor Asthana: If you go to the more remote rural areas, I think levels of, is it, households under the 60% median income can go up to about 30% and that will be captured by the formula, so in areas where you actually do have pockets of deprivation, that will be reflected. I think, for example, west Cornwall would get a relatively higher allocation because it is possible to capture deprivation there. What is more problematic is, I think, in mixed rural areas where you clearly have deprivation, you have deprived people living amongst affluent people, but they are hidden. It is impossible, using aggregate statistics, to capture that, particularly, I think, amongst the indigenous, elderly, poor people who are living in areas which are poorly resourced with regard to health services. Because they are unfortunate enough not to be located amongst the rich, I think they are really losing out.

Q408 Charlotte Atkins: Does anyone else want to come in on those issues?

Professor McCormick: If I could address your initial concern which was because of the distance from hospital, from general practice or private hospitals that people in rural areas are less likely to use the facilities and that if we base a model of allocations on usage, we are going to under-provide in rural areas, that is absolutely correct, except we do not base the model solely on usage, we base it on need. The extent to which people are inhibited from going to their hospitals and their general practitioners or private hospitals because they are so far, the distance factor, from those institutions is incorporated into the model and we do not just pay back into those areas their usage, but we pay back an additional allowance based upon the amount of depressed usage that has been brought about because they are further from those areas as a way of enabling the authorities in those areas to put in place services which will compensate for that factor, so that is an integral part of the model. I cannot say that I agree with Professor Asthana that we cannot capture deprivation if it is laced, if you like, within middle-class communities. There are statistical methods of doing that and at the same time I think where I would share an agreement with them is that this model, this approach to funding, should not be seen as something set in stone, but it is something that is continually rolling forward, looking for improved and better methods of achieving, so last time round we introduced various morbidities that were not in the previous model of needs. We are presently putting out a tender for relevant educational organisations to come forward with proposals for a more developed model for the resource model, and I say "we", this is the organisation, ACRA, that supervises and monitors that process. I do not think we should see this process as something set in stone and certainly the independent body, ACRA, and government are continually looking to learn from this process and make it a more fair and reasonable institution, although I am not sure that we are vulnerable to the criticisms which have just been levied.

Q409 Charlotte Atkins: Professor Stone?

Professor Stone: Well, if I could comment directly on some phrases that were just raised there, "incorporated into the model", "an integral part of the model", here there is an invocation of a science-based procedure and this is what has to be questioned. The Department of Health ought to realise that there is a great deal of dissension about the fundamental technicality that allows this thing to be produced almost out of a sausage machine; that is where the statisticians will see this who have had experience in dealing with choice of a multivariable nature. I recall working on the first computer we had in Aberystwyth as a naïve statistician and I had a lot of variables from Ireland and one of the variables turned out to indicate that it would pay the Irish farmers to pay other Irish farmers to take their land away from them. That came out as a negative coefficient. It was an absurdity arising from the technique used. A great deal of care has to be used in such things and the sloppiness with this formula relates to even the thing that was attempted to be fitted is extraordinary. There is plenty of room there for other models, none of which, as it were, could be said to be fair because they are not incorporating judgments of fairness, which have been raised indirectly by the last two contributors; fairness depends on value judgment. Health cost is a very variable thing. It is applied to IVF and it is applied to cancer. You cannot aggregate all of this together, but you have got to use value judgment. That is why direct measurement has to address the serious problems and, if I could put another thing into the mill, as it were, slightly different from the questions that Sheena has raised, Jane Galbraith and I have thought about this because we were challenged, "Well, you are very critical about this formula, but what would you do?" Well, I would actually go to a sampling of GP-registered patients in a pilot study of something first. I would use a small fraction of the money that I believe has been wasted by this formula, a very small fraction, to investigate, using trained nurses, sampling patients, some of whom will not have had any costs on the Health Service in the previous year. So fine, that is a zero and then forget about it, but other patients will have had certain calls on the Health Service. A trained nurse would be able to elicit, as near as one could get, the real health need of that patient and then there would be another committee, a committee of committees, as it were, to put pounds on this and say what this really costs, but that would bring up the question of value judgments. The whole thing is a charade at the moment because it pretends to be science-based and it is not.

Q410 Sandra Gidley: Professor McCormick, you have touched on this partly, but can you tell us how the current allocation formula does actually take account of the extra costs of delivering healthcare associated with rural locations? Professor Asthana sort of gave an example of the density and how many patients nurses could see in a morning.

Professor McCormick: I think it is a mistake to suppose that for each different sort of topological structure across the country, whether we are looking at places that have got high blocks of flats or low-density accommodation, you need a different formula. I think you need a different health delivery system in terms of the way doctors and primary care practitioners work, but that is not the same as you need a different financial formula, if you like. What we have got inside the model at present is a set of factors, like the problems of achieving usage in rural areas, the distance factors, appropriate deprivation factors, which capture the differential nature of factors that would apply equally whether in a block of high-rise flats or in a less dense situation. We are looking for arguments and factors that, if you like, span over or umbrella different types of communities rather than picking out a fact and saying, "Ah, if you're rural or in a high density, we should pay you more money per se".

Q411 Sandra Gidley: Well, that is as clear as mud to me, I am afraid! It may be that I just have not followed you, but I do not see how that works in practice. Are you able to give a practical example of how that works?

Professor McCormick: I think what I am trying to tell you is that we are looking for reasons why we should pay more money to different areas and if we suppose that deprivation is one, we have got to make sure that we measure deprivation carefully, whether it is in a block of flats or it is in a group of small villages. As long as we measure deprivation carefully in either context and then place it inside the model in an appropriate and fair way, then I think we feel we are capturing how we should allow being rural or being in a block of flats to influence the money that we are sending down.

Q412 Sandra Gidley: I think the deprivation is probably a side issue to this. The point is that it actually costs more to deliver these services in rural areas. How is that taken into account in the formula?

Professor McCormick: Well, the formula should be capturing that on the provision side of the model.

Q413 Sandra Gidley: It should be. Are you convinced that it is?

Professor McCormick: I have come here today to talk about the relationship between the deficits and the formula.

Q414 Sandra Gidley: I was coming to that.

Professor McCormick: I am not the expert in the Department on the working of the model. I am happy to comment and I am happy to send you a note down, but I think it would be wrong of me to offer comments on other colleagues' areas.

Q415 Sandra Gidley: If I tell you that PCTs in deficit are of a far greater number in areas with a lower population density, would that not indicate to you that there is something slightly amiss with the formula?

Professor McCormick: No, it does not actually, Ms Gidley. I have been, within the Department, looking quite carefully not just at PCT deficits, but at health economy deficits, so we have been integrating into the health economy of the local areas, some rural, some urban, the deficits of acute trusts and the other providers to a PCT with the deficits of the PCTs. The problem we have got with just looking at PCT deficits is that in some parts of the country these deficits and local agreements have caused the deficits to lie on the PCT side of the accounts and sometimes they have caused them to lie on the acute trust side of the accounts, so an appropriate way, if we are to get a proper picture of whether an area has problems or not, is to bring together the accounts of the trust in the area with the PCT in the area and see them in a unified fashion. May I continue and tell you what I found when we do that?

Q416 Sandra Gidley: Yes.

Professor McCormick: When we do that, what we find for 2003/04 is no relationship at all between the age/needs index and the deficits of an area, and I will leave documentation for this and I will discuss it with your researchers after the meeting, if I may. When we do it for 2004/05, we do find a relationship in that we find in the less needy areas a slightly greater tendency for deficits to arise. It is not a strong tendency, but there is a slight tendency in the evidence. Now, 2004/05 was the year in which the aggregate deficits also arose on the scene for the first time, so this relationship between being a needy area or not and having a deficit or not, which has motivated some of the literature that Professor Asthana has contributed to and commented on, this relationship, when judged at the health economy level which we regard to be the appropriate way of thinking about it, did not exist in 2003/04, but did exist in 2004/05 in a moderate way. Now, the question is: why did it emerge in 2004/05 and was not driven by the resource model? I do not believe, and we do not believe in our research group, that the resource model has driven it for three reasons. Firstly, the linkage between being a needy area or not and having a deficit does not emerge in 2003/04 which was the year in which the resource model was changed, but it emerges a year later when the aggregate deficits emerge, so there is not a simple time link. Secondly, if you look at the growth of allocations to PCTs between 2003/04 and 2004/05 and match them against the deficits in PCTs in 2004/05, you do not find any correlation. The PCTs that did well ----

Q417 Sandra Gidley: Can you say that last bit again?

Professor McCormick: I would be happy to. The PCTs that did well in terms of the growth of their allocations from 2003/04 when there was no relationship that we have just discussed to 2004/05 when there was, that growth of allocation is not correlated with the deficits in the local area. In other words, the areas that did well in terms of income growth were no more or less likely to have deficits than the areas that did badly in terms of income growth. The third reason I do not believe that these deficits in the less needy areas have been driven by the resource model is that if you look over a longer span since the new model was introduced in 2003/04 through to 2005/06 at the movement of resources into those areas and compare it with the level of age/need in those areas, if you take out nine outliers of the 303 PCTs that had resource allocations over this period in excess of 39% and look at the 294 PCTs that are left, there is very little relationship between those organisations that have high age/needs and whether or not they got large growth in resources over that period of time. Therefore, if you ask me for an explanation as to why we are seeing a relationship between age/needs and deficits, it is because, for a reason that we are still trying to understand, the areas that are less needy have had a bigger blip in their spending, on the expenditure side of their budget in 2004/05, and we are still trying to come to terms with why that happened. That fits with the employment patterns that exist in the country. The employment growth in the NHS has been most rapid in East Anglia, an area which has had the biggest deficits or some of the greatest concentration of deficits have occurred in East Anglia and they have also had the biggest growth in NHS staff over the relevant period. It is very hard, I think, to attribute this relationship which is interesting and which, I will acknowledge as Chief Economist, appears to emerge in 2004/05 between age/needs and deficits to the income side of the budget, but I suspect it is rather more accurately attributed to the expenditure side of the budget.

Q418 Sandra Gidley: I was actually talking about rurality rather than age/needs which is a slightly different thing because other government departments do actually weight that factor much more strongly. They do in Scotland, they do in other countries. Why is the Department of Health different? Why does it not seem to accept that it is more expensive to deliver services in the rural areas?

Professor McCormick: I think the Department of Health believes in taking advice from recognised authorities, and it has set up an independent panel that comprises senior clinicians, economists and statisticians to advise it. It has looked at the rurality matter on many occasions and we are presently in the situation that we are, taking advice from that panel.

Q419 Sandra Gidley: But, as we move to more community-based services, is this not going to become a greater factor? Our Health, Our Care, Our Say is all about delivering in the community.

Professor McCormick: I would hope, if this is going to deliver increased costs of delivering that kind of care in rural areas, that the model would pick that up.

Q420 Sandra Gidley: You would hope?

Professor McCormick: I would hope so, but this is an issue that has been referred many times to that body of independent observers and they have recommended what we have at the present time. This is not something that has been politically imposed, except as a consequence of taking the advice of the independent body.

Q421 Sandra Gidley: Does anybody else want to add anything to that?

Professor Stone: I think I would stress that this word "independent" covers a multitude of varieties of independence and that really what we have not found is a recognition that there has been a continuous, unresolved disagreement now for decades in relation to the allocation of resources to the National Health Service right from the days when Crossman introduced his simple formula for the number of beds and things like that. Every so often the Department of Health changes the team that has to produce the formula. Actually the Advisory Group was changed in 1998 and it is rather interesting, I have it here, the report of the 1998 Committee, if I can find it. This is the Report of the Advisory Committee on Resource Allocation 1998, published in 1999. Appendix 1 is by the Technical Advisory Group, I think. They have this technical group of specialist people and the appendix here is very interesting as it lists six criteria that are essential that a resource allocation formula should satisfy and some that are desirable. Some of these pass the criteria, but the majority do not and, if I were to read them out, I think you would begin to feel a little amused by the language that is used. I recommend that anybody studying those criteria that were laid down in 1998 by the Committee that was looking ahead to what this group, based in Scotland, would achieve and, as far as I can see, it would be nice if we had some further debate on whether or not the current formula has met those criteria, which it has not!

Q422 Sandra Gidley: We had rather guessed that.

Professor Asthana: I would just like to pick up on several of the points just made. The first one is your question about additional costs, and basically looking for deprivation in rural and urban areas does not address the additional costs of providing rural services or associated rurality and they are simply not dealt with in the formula, so let us just be clear about that. The second is that I am really surprised that you are saying, "Let's get away from looking at PCTs because there is a balance between hospitals and PCTs. Let's look at the whole economy", and that there is no relationship, no geographical pattern here with regard to looking at the broader economy. I have the list here of 2005/06 and this is at the regional level: North East, in surplus; North West, in surplus; Yorkshire and Humberside, in surplus, with the exception of key rural areas which are in deficit; East Midlands, in deficit; West Midlands, in deficit; East of England, in deficit; London, in deficit overall; South East, in deficit; South Central and South West, in deficit. Am I alone in seeing a slight north/south pattern here?

Professor McCormick: What year is that?

Professor Asthana: It is 2005/06.

Professor McCormick: Well, did I not acknowledge that in 2004/05 was when this relationship began?

Professor Asthana: Yes, but why did it begin? It began because we saw an end to brokering. I think there are several parts of the country which have had longstanding financial problems. Cornwall is one, East Anglia is another, Cumbria has managed to get in and out of its problems, but the reason that these problems have emerged is not because they are suddenly being profligate users of health services, but because they can no longer broker within mixed areas to cover their financial problems. I think to blame sudden profligacy is misleading. I am also surprised that your research has suggested that there is no relationship between funding increase and risk of deficits. We looked at this and we found that only four of the PCTs with the greatest funding increases between 2003/04 and 2004/05 were in deficit compared to 34 out of 60, so 7% of PCTs with the greatest funding increases were in deficit compared to 57% of PCTs with the smallest funding increases. In other words, there is a relationship between funding increase and risk of deficit and, moreover, this relationship is going to get worse because, with the progressive shift of funding. One of the things I will agree is happening is that things are changing year on year and the reason I think they are changing year on year is because there is a progressive shift of funding away from the very areas that are getting the least and are at risk of deficit towards the areas which are at least risk of deficit and getting the most. In other words, to them that have comes more. The whole thing is completely bizarre. You said there is a balance here, that it is misleading to look at PCTs alone because sometimes hospitals are mopping up or taking up the slack, but let us cut it a different way and let us look at waiting times. There is a significant association between the time that a patient has to wait for an inpatient appointment and deprivation by region (and this range is enormous), deprivation by ward, et cetera. I think in Caradon, a patient in 2004 - I cannot remember which year we used, it could be a later year - had to wait for 145 days compared to 54 in Hackney. We are talking huge, huge differences. Moreover, there is a very, very significant geographical pattern in waiting times, so, regardless of whether hospitals are taking up the slack or whatever, let us look at the key outcome in terms of access to services. Perhaps I should not also point it out, but there is also a significant difference according to political constituency.

Mr Amess: Game, set and match to Professor Asthana!

Chairman: I think the debate we have just had covers about the next four or five questions!

Q423 Mr Campbell: The Department has issued an invitation for work to review the funding formula and the question is why now and why this particular time and what is the real concern of the Department?

Professor McCormick: The reason is very straightforward. I think the Department is continually concerned to make sure that it is bearing in mind or that the independent committee's advice is bearing in mind the best possible research that is available. As Professor Asthana has said, evidence on the availability of information on morbidity at a local level is improving and that makes feasible different estimation models that were not feasible when we did not have the data sets available ten years ago, so I think the Department is merely trying to make sure that it is making the most of the data that is available and the best thinking at the time on how to construct the models. I think the Department is mindful that there is more than one way of constructing models of this sort and it is merely interested in constructing the models which are most appropriate on the basis of fairness and efficiency.

Q424 Mr Campbell: What do you think is the most important thing they should be focusing on, basically the big issue? What is the big issue for the Department? What should they be focusing on?

Professor McCormick: That is almost a political question which I am tempted to pass back. It is almost a political question because I think the maximand for healthcare, what we are trying to achieve in healthcare is something that deserves to be considered deeply by politicians and offered to their civil servants to implement, but in some broad sense we are trying to enhance the health gain that comes from the large sums of money we spend in the health arena and that will be perceived through a different prism in different ways by different parties.

Q425 Mr Campbell: Professor Stone?

Professor Stone: We have just heard that there are many ways of constructing models and I think it is a point I made earlier, that within the framework of the fitting that was carried out by the area study group, there are many models and there is a lack of imagination. All that was done was to say, "We'll have a little bit of that, plus a little bit of that, plus a little bit of that" in relation to the thing that was then being fitted. Such models are highly specific. How can you believe that the reality does simply oblige you in that matter? It is all right in a scientific investigation and epidemiological studies where we like to say, "The risk of taking that kind of fat when you take account of these other kinds of fat gives a clue", but no one really believes it because next month there is going to be another epidemiological study that will turn that thing around completely. They provide indications. There is a difference between scientific investigation where we do things like that and then follow up clues, but producing a financial formula that has the serious job of dividing 60 billions at the moment roughly among 303 Primary Care Trusts, I think it is a scandal that the present formula is even as influential as it is, and it is influential because the gap between target and the allocations is narrow. I think it is a national scandal which the Department of Health does not face up to. We have talk of independent advisers, but the chief statistician in the Department of Health is not involved in this. Why not?

Q426 Mr Campbell: Is there an easier way out of this formula problem?

Professor Stone: No, I think it is ----

Q427 Mr Campbell: There is no easier way it can be done?

Professor Stone: I think it is a long-term task. It is a serious task, a serious statistical analysis. The methods used, by the way, they are called 'econometric', but these depend on methods which were invented in my own department or developed in my own department up to 100 years ago. They are classical statistical techniques. There is no wonderful thing associated with economics that validates these things. We have got to go back to basic principles and involve a much wider discourse than we have at the moment. I do not accept these claims that we have sufficient independence, I think that is not the case.

Professor Asthana: Can I just add to that, that I agree, I think it is a serious task. I should declare a conflict of interests here because I have put in an expression of interest to do this piece of work, although I think it is very unlikely that I will get it! However, my concern, I think, about this process is that, first of all, two and a half weeks' notice was given for the expression of interest and then they are envisaging the work being done within six months and really this is a serious, ambitious task. That said, I think that my team is capable of doing a very ambitious piece of work and exploring the potential of a morbidity-based approach. It may be that a reformulation of the current utilisation-based formula would attain greater fairness, but I think one could test that against a morbidity-based approach, so one does not necessarily need to radically change. I think one also needs to be aware of the kind of danger of turbulence within the system and it would be highly turbulent to suddenly and radically shift resources back again. You ask what is the big issue, and the big issue for me is getting away from the constant refrain that we have a fair funding formula based on an independent set of advisers. It is a murky, unfair formula. It can be criticised on so many different levels and I think that if we could just have a little bit of honesty about that, that would be a great start. Actually I am puzzled and a little worried about your phrase "enhancing the health gain" because effectively there are different ways of looking at this. I know that there is interest at the moment, for example, in allocating resources in a way that we try to address health inequalities, even if that means giving less resources for overall morbidity until we close the gap. That is a very, very different principle from the current principle of equal access to equal needs. It means we are shifting from the principle of health care equity to a principle of health equity, and indeed I think that is what has been happening in a way already, but we need to be open and honest about this and about which principle we are actually following and perhaps we can be clear about the principle and recognise that it is feasible to actually introduce a morbidity-based approach. I think you said that the formula already has a morbidity-based approach, but it uses it in its unmet need area in the most bizarre way, sort of standardising, destandardising, standardising again. It makes very little sense to me the way in which that part of the formula is used. It is perfectly feasible to actually replace the current formula with something far more transparent and far more direct. Six months is challenging, but we could do it.

Mr Campbell: You have got the job!

Anne Milton: Chairman, we are presumably completely off script now, are we, as we have sort of covered it all?

Chairman: We normally are, but I think this morning we certainly are, yes!

Q428 Anne Milton: Professor McCormick, I think you should cheer up actually. You look very miserable because you have got two people to your left who could give you lots of independence and add independence to the Department with whom clearly it would be very challenging and stimulating to work. I just wanted to pick up on a couple of things. I appreciate Professor Asthana's comments. Words like "health gain" and "needy" which, Professor McCormick, you used an awful lot, I think, do skew the picture somehow because needy is obviously something that we need to address. You talked about suppressing demand and suppressed demand, that you feel there is a lot of suppressed demand. I would be interested in your comments on the fact that we are to lose around 60 acute trusts around the country over the next few years. My concern is that actually what that will do is actually suppress demand and there is talk of suppressed demand, so rather than seeking out the existing suppressed demand, I would appreciate your comments on whether you would share my concerns that actually there is now an active programme of suppressing demand even further, particularly in the rural areas?

Professor Asthana: I absolutely agree with you. My feeling is that I have so far to be convinced that we have a fair funding formula; I think it is extremely unlikely that we have a fair funding formula. I think the funding formula discriminates against particular types of areas, rural areas, rural affluent areas being particularly the case, and if we are going to base hospital closures, et cetera, on deficits which are actually as the result of an unfair funding formula, then that has to be stopped. It has got to be stopped now. I think we need to address this issue before there are any more closures, particularly in paediatrics, maternity services and A&E services. All of these areas are being cut. What of the vulnerable, the needy, the elderly in areas which are already under resourced? There is a big equity issue out there and we need to wake up and address it.

Q429 Anne Milton: Have you done any work on looking at what would happen on deprived areas if those more rural areas got more funding?

Professor Asthana: No, I have not. Again, I have alluded to this. In the forthcoming review of the Resource Allocation Formula I think anybody who would do that needs to accept the fact that turbulence needs to be reduced, because it is not helpful to suddenly strip areas of resources in a fundamental sort of way, and that would lead to immediate problems in those areas, but I think that we need to move towards a stable solution and away from what we have got at the moment.

Q430 Anne Milton: Your comments, lastly and briefly, on funding public health. Public health is where you will do something about deprivation, and there is an argument to say that actually putting the money through a public health budget that is separated from the budget that supplies services would be a better way of addressing deprivation. I would appreciate all your views on that, briefly, or I shall be cut off by the Chairman?

Professor McCormick: I think that is something I would prefer to have the Chief Executive of the NHS answer, or the CMO. I do not think that is my area of speciality, to be frank.

Professor Asthana: I have just written a book about health inequalities! Basically, it is generally agreed that for curative services, the issue of health and equality is tantamount to shutting the stable door after the horse has bolted. What we ought to be doing is preventative measures, public health measures. Basically, the vast bulk of hospital community services go to curative care. In other words, it is an ineffective solution to pour additional resources at deprived areas. You are absolutely right; we should have a separate public health budget.

Professor Stone: I have no comment. I defer completely to even both of my colleagues.

Q431 Dr Taylor: You have mentioned brokerage as the only thing that has kept the system working over the past few years. Is not the Government's suggestion of a buffer in fact bringing back brokerage?

Professor Asthana: I do not know what the Government's suggestion of a buffer is, I am afraid.

Q432 Dr Taylor: It is a suggestion of a reserve held centrally which can then be fed out to trusts in deficit?

Professor Asthana: I suppose that central brokerage would be better than nothing.

Q433 Dr Taylor: About your redesign of the funding formula, is this paper from you?[1]

Professor Stone: No, I am afraid I am responsible for that. That was to illustrate. People asked me, "What is the formula?", and I could not tell them because it is a very complex piece of algebra, although it is not really complex, but it appears to be very complex. This is a simple graphical way of seeing how these little things that are put into the formula would change the result.

Q434 Dr Taylor: Am I right in interpreting it that the age profile has relatively little effect?

Professor Stone: That is right, yes. It is overwhelmed by it, and this came out in my comment on the Finance Director's claim that, if we went to equality, then the aging populations would suffer.

Q435 Dr Taylor: The things that really drive it are the market forces, the ambulance service and HIV?

Professor Stone: You can see the big jumps there, yes. I think the point to emphasise in connection with that, if I were to talk to it briefly, is that there appear to be variables along the way which appear to be direct health measures. They are not. They are combinations of socio-economic variables that were found to correlate, by some kind of correlation analysis done years ago, based on self-reported health largely, though one aspect of it, mental health, was nurse controlled. So it really is all socio-economic. I would describe all those variables as proxies, and we are not using direct measurement in constructing such a target.

Q436 Dr Stoate: Professor Asthana, you argued that it is the PCTs with lower than average capita funding that are likely to be in deficit; you have also argued that it is the areas with the smallest increases that are facing difficulties at the moment. Could you not look at it as just the case that it is those areas that are having the biggest transition from over-funding to fair funding that is causing the real problem?

Professor Asthana: That is assuming that the funding formula is fair. As I said, if you look at the principles, if you look at the technical design and you look at the outcomes in terms of waiting lists, in terms of all sorts of things, particularly the relative balance given to age and additional links which we have just been talking about, there are a number of grounds to suggest that the funding formula is very unlikely to be fair. So, no, I would not assume that.

Q437 Dr Stoate: You are genuinely satisfied that these areas are simply short of money and that is the simple reason why they are having difficulties?

Professor Asthana: I think that is also too simplistic an explanation. I suspect there is a whole range of different factors. Local management may be a factor; I would not argue it was a systematic factor. I think we have got a complex picture going on, but there is a significant association between level of funding and likelihood of being in deficit for a PCT, and that would suggest to me, in conjunction with the population characteristics and what we know about the way in which age determines disease risk, that, yes, those areas are under-funded.

Q438 Dr Stoate: If you look at the map of PCTs, which we obviously have looked at, the deficits seem fairly random?

Professor Asthana: Is this the map?

Q439 Dr Stoate: Yes.

Professor Asthana: I was intrigued by this map, because this map was produced by the King's Fund, I think, in black and white. One of the problems with the map is that you will notice that the same colour is used for overspend here and surplus here in the middle line, so we reproduced the map in colour. I think there is quite a strong geographical pattern there. For example, if we look between the north and the south, 72% of PCTs north of that line from the Wash to here are in surplus compared to only 47% of PCTs to the south of that line.

Q440 Jim Dowd: What is the proportion of the population covered by those?

Professor Asthana: I think it is roughly equal.

Q441 Jim Dowd: So you do not know?

Professor Asthana: I do not know. What I was effectively saying is that this map is a misleading map. I do not understand that map at all.

Q442 Dr Stoate: Fair enough. How much do you think managers are partly to blame for the difficulties or do you think is it just the funding?

Professor Asthana: I have no idea how much managers are to blame for it, but what I would suggest is if you have as strong a statistical relationship between level of funding, age characteristics, all of these types of things, population characteristics and deficits, it is highly unlikely that local management is to blame because if it was local management you would expect a random pattern, you would not expect such a systematic pattern. The other thing that makes me wonder is that among those interested in the inverse care law with regard to access to primary care, there was always the idea that doctors, as middle-class professionals, liked to settle in leafy, rural areas and urban deprived areas lacked these professionals. It seems to me that financial accountants are extremely altruistic in their choice of location. The most competent ones seem to want to go and work in the most urban deprived areas! It is very, very unlikely.

Q443 Dr Stoate: Professor McCormick, do you share that view or do you think there is an alternative explanation? Do you think it is nothing much to do with management, it is all to do with funding, or do you think there is a significant management element?

Professor McCormick: I think there is an interface of them both. I think in certain parts of the country, in 2004/2005, not earlier, and quite possibly on-going into 2005/2006, managers have been under greater strain to balance their books than in other areas. I think the question is why has that arisen. I am not at all convinced that it is due to the funding side of the budget equation.

Q444 Chairman: Professor McCormick, is it due to the ending of brokerage as we knew it? Brokerage has been the least transparent thing in terms of National Health Service funding that I have ever known. I have been in this House for 23 years. This is a new phenomenon. I knew a little about brokerage. I knew on the odd occasions my health authority had problems in the past, but what we are talking about here is a transparency of brokerage that we have never had in the past. Is not that one of the issues, that the actual spending patterns, as opposed to allocations, have put pressure on individual Primary Care Trusts and hospitals?

Professor McCormick: I think the problem with the argument that brokerage is key to all, which Professor Asthana may share with you, is that if we are observing whole regions that are having more of a deficit problem than other regions, since brokerage would have been on a local basis between adjacent authorities, it is hard to explain the emergence of regional patterns with an end to brokerage. I do think that ensuring that we have got appropriate continuation of the brokerage arrangement through some form of transparent banking facility is important, and that is something that the department is very mindful of.

Q445 Chairman: But on paper is it not that which has caused the current issue, the deficit/overspend, whatever you want to call it? Has that not caused the current problems in terms of NHS finance as far as the general public is concerned?

Professor McCormick: I am not convinced that brokerage is as key to the general financial problem as you fear. There may be other accounting issues that have yet to be fully clarified, and I know the Committee has been mindful of the role of the ending of capital revenue transfers which occurred in 2004/2005 and issues surrounding that, but there are a variety of other issues that, I think, lie deep within the working of the system that we are still trying to understand why the pattern of deficits emerged, as it did, in the middle of a spending review period.

Q446 Chairman: It has a relationship to patterns of historical expenditure, does it not, in simple terms?

Professor McCormick: It does to some extent, yes.

Q447 Chairman: Some people would argue that that was probably a better formula than the one that has been made transparent in the last few years, or is that too simplistic?

Professor McCormick: I am reluctant to say too much in anticipation of a report I am producing for the Finance Director, which he does promise to publish at some stage in due course.

Q448 Dr Taylor: We have missed out the other causes of deficits, which seemed to us to have been really very bad management by the Department of Health of estimates of future costs. We know that the consultant contract agenda changed, the GP contract, all have cost far more than was estimated. What is the explanation for that?

Professor McCormick: I think it is a matter of record. The Finance Director has acknowledged that these contracts have cost more than was originally scheduled.

Dr Taylor: Should this not have been forecast and got better?

Q449 Chairman: Maybe you can ask that question in a few minutes time, if we ever get there. Professor Asthana, the map that you have now brought out in colour, would you mind leaving that with the Committee.

Professor Asthana: Yes, of course.

Q450 Chairman: That particular issue I feel is very important. Could I thank all of you for coming along and opening up this morning's session. It has been quite fascinating. We will have to reflect on everything that has been said. Professor McCormick, you say you are drawing a report up in these areas?

Professor McCormick: Yes.

Q451 Chairman: When it that likely to be in front of the, I think you said, Financial Director?

Professor McCormick: I am expecting to complete it in the next six to eight weeks.

Q452 Chairman: That is a bit beyond our timetable. Perhaps we will have to wait and see. Thank you very much indeed for that opening session.

Witnesses: Mr Andy McKeon, Managing Director of Health, Audit Commission, and Mr Phil Taylor, Chair of the Healthcare Financial Management Association, gave evidence.

Q453 Chairman: Good morning. Could I, first of all, apologise for the lateness of the hour. I do not have to explain why because you have been in the room. I hope you have found the last hour and 19 minutes as informative as the Committee has done. Could I ask you to introduce yourselves and the positions that you hold for the record, please?

Mr McKeon: I am Andy McKeon, Managing Director of Health at the Audit Commission.

Mr Taylor: I am Phil Taylor. I am Chairman of the Healthcare Financial Management Association.

Q454 Chairman: Welcome once again. A question to both of you really. Only 3% of trusts received a score of "excellent" by the Healthcare Commission for their use of resources. Is poor financial management the real cause of the debate that we have just had for the last one hour, this issue of deficits, overspends, or however you currently phrase it?

Mr McKeon: Perhaps I can answer that question first. Only a very small number of trusts did, indeed, get a score of "excellent" for use of resources. As far as the scores for NHS trusts were concerned, only two trusts got an "excellent" score and they are now both foundation trusts. Poor financial management has played a part in producing deficits, and the Commission has gone on record in demonstrating that through various reports we have published, for example, a report on Learning from Financial Failure in the NHS. But it is not the exclusive cause, by any means, of the current problems and it is quite possible that you can get somebody with difficult financial circumstances and poor financial management which come together. When we published the scores last week, in some detail, and the auditors' local evaluation summary results, we took some care to try to distinguish between those organisations which, although in deficit, scored a one for financial management, i.e. were weak, and those who did not. There were 37 organisations which scored a one for financial management, financial standing and value for money and, of those, six scored a one across the board in all five domains that they were scored in by their local auditors. In those circumstances, it is possible to say that poor financial management may well have played a part in their circumstances, but there were other trusts whose financial management was scored as "adequate" and who perhaps had other problems that they had to cope with as well.

Mr Taylor: I think the results of the Healthcare Commission and the Audit Commission's report last week on the ALE scores were disappointing to the finance profession. If you look at the individual measures, on financial reporting 85% were adequate or above. Adequate does not sound that good, but it was at least adequate. On internal control 96% were adequate or better. On value for money, 91% were adequate or better. Those are not good results, but I think you have to bear in mind that this is the first year of a new system, a system which I think has been welcomed across the profession. We do like to have very clear measures, and I think the system invented by the Audit Commission does very clearly set out the financial standards within an organisation, but it being the first year of a new system, inevitably it takes time to learn that system and the individual practitioners who are putting their evidence forward need to learn how to put that evidence forward in order to improve their ratings. Undoubtedly, over future years that will improve and it will drive improvements in the standards of financial management across the system.

Q455 Chairman: How big a factor is the funding formula in explaining deficits?

Mr McKeon: We have had a very interesting debate in the previous session, and I am by no means an expert on the funding formula compared with your previous witnesses, and we have not done a great deal of work in the Audit Commission on the funding formula. What little work we have done actually supports the point that Professor Barry McCormick made. We were only able really to look at PCTs and their financial position compared with their formula because it is a very complicated business to try to get the health economy picture overall, but in terms of PCTs, we found that, yes, there was a statistically significant (i.e. a true) relationship between the level of resources available to an organisation and whether it was in deficit, but that accounted for less than 10% - I think it was actually about 7% - in the variation of performance. So, it may well be a factor in a number of cases but it is not the only factor in those cases. I think there needs to be more in-depth analysis than we have been able to do of the kind that Barry McCormick was talking about before you could get to the bottom of the position.

Mr Taylor: I afraid that we in the Healthcare Financial Management Association (HFMA) are not really experts on the funding formula. My colleagues in the field tend to complain about it when they feel it is unfair to their local health community. There are, I think, following from the debate this morning, many different weights that you can put on the various factors involved which will all come out with different answers at the end of the day. I think from the HFMA's point of view we would accept that whatever formula you choose it is going to be beneficial to some people and less than beneficial to others. From that point of view the starting point for us is that, when you look at it organisation by organisation, your income is determined at a certain level and it is that organisation's responsibility to deliver within the resources that are allocated to it.

Q456 Chairman: Did both of you see the Health Service Journal survey of Chief Executives and what they found about the current affairs? I will give you a couple of examples. I will not go through them all, but I assume that you saw them. 84% thought the Government was trying to dodge its own culpability for the financial problems by blaming it on small numbers of poorly performing trusts, 99% said the Agenda for Change and the consultant and GP contracts were not costed effectively by the department and that this had a big impact on the financial state of the NHS. Do you generally agree with what these Chief Executives have said? What assessment do you make of their views, as it were?

Mr Taylor: Yes, I think the members of the HFMA have told us for a long time that those contracts were under-costed, and, as we know, Richard Douglas has been along to this Committee and agreed that they were under-costed. I think he talked about a total figure of round about £560 million. So, yes, they were under-costed. I think there is a behavioural element possibly here in that when new things are costed in the department the costing might be a little bit optimistic because people want those new initiatives to be put into place. When it goes out to the field, the costing might then be a little bit pessimistic because the people in the field have the problem of implementing them. So, perhaps there is always bound to be a little bit of difference between the department's costings and the NHS's costings, but probably not to the extent that we have had on those contracts.

Q457 Dr Stoate: Several of us this morning had a meeting with Ian Kennedy, who looks after the Healthcare Commission, and he was talking about his annual health check figure. Looking at the figure that he presented, over a third of trusts were declared weak on use of resources, a tenth of trusts were said to be weak on quality of services, but half of all trusts had misrepresented their true performance against standards about health checks. Can I ask you as a representative of the finance directors of health services and trusts, how come a third of them were weak on the use of resources and yet you say that financial management is only a part of the problem?

Mr Taylor: The score on use of resources relates mainly to whether the organisation has a deficit or not. That is the main factor in determining that key line of inquiry. If you have got a deficit you are going to score a one on that factor, and 31% of organisations had a deficit.

Q458 Dr Stoate: It is still pretty concerning that a third of them were declared weak. Not adequate, not fair, not good, but weak, a third of all trusts. Does that not give you cause for concern. Are your members not somewhat alarmed that that is the standard of management that we are seeing?

Mr Taylor: I think the results are disappointing, but I think you need to understand the environment in which the NHS operates. We are asked (I think it was Sir Nigel Crisp who said this) to land a jumbo jet on a postage stamp. You do not want the NHS to overspend, you do not want us to underspend either. You could equally be asking me questions here if we had underspent last year, saying, "Why did you not use all the resources that were available to you?" It is a difficult task, managing the finances of the NHS, it is a complex task, and I do not think we should underestimate it. We have in the NHS a highly skilled and well trained finance function who I think overall are highly competent, highly trained and thoroughly dedicated to the job that they are doing and those people do not want their organisations to be in deficit and they do their very best to make sure that they are not. The fact that so many of them are scored as weak, I think, is a reflection of the very difficult environment that we operate in.

Q459 Dr Stoate: I am not suggesting they do it deliberately, I am saying it is an alarming figure.

Mr Taylor: Yes, it is disappointing.

Q460 Dr Taylor: The audited NHS accounts have gone up, I think it was, from 512 to 547 million. Where did those increases come from? Is that the sort of thing you would expect? Would you not expect greater accuracy? Have you any comments on that?

Mr McKeon: We would expect there to be some variation between the unaudited and the audited accounts because there will be differences in judgments. There was in 2004/2005 a very significant variation between the unaudited and the audited accounts, and that was due very clearly to two or three systematic factors, which I think were explained by Richard Douglas when he came to give evidence in July, and with which we concur. Since then there has been a systematic effort by us and the department and the finance professionals to improve the position. What we saw in 2005/2006 was an improvement. Having looked at the figures, where there was a difference of about £35 million, one organisation accounted for a third of that. There was a difference of £12 million between its unaudited and audited accounts, and that was due primarily, as far as we can tell, to some of the actions of an executive director who is now under suspension or investigation. Five organisations, including that one, accounted for two-thirds of the difference, and a further ten organisations accounted for the remainder. I cannot give you the detail of why each of those had a difficulty. Nonetheless, there were some individual performance issues which I know the department and people locally are pursuing, but overall what you had is something like five organisations, which is something less than 1% of the total, accounting for two-thirds of the difference between the unaudited and the audited accounts.

Q461 Dr Taylor: I want to go on and try and sort out a suspicion that we have all had. These are that the gross deficit was cut from 1.27 to 512 largely by the use of training budgets. I wonder if you have had a chance to look at this. The figure that was taken from SHA surpluses (and these are the unaudited figures) was 524 million. A complicated letter we got from the Department of Health trying to explain this said that just 133 million of that came from education and training, 145 came from underspends on SHA running costs and the last bit (which is 246 million) really needs to be investigated, I think, because it said, "The third source, we understand, is being held by the SHA as some organisations pass their surplus income to the SHA rather than record it in their own accounts." That sounds absolutely unbelievable when they have spare money that could make them look to be in surplus, that they have passed it on. Have you looked at where that figure of 524 million comes from, because we suspect a lot more of it is education than the 133 million?

Mr McKeon: No, we have not looked in detail at that, but I can say, and Phil Taylor might wish to comment on this, that some SHAs have traditionally acted as banker for surpluses from PCTs in particular and also sometimes from trusts, and so it is not surprising that they end up with a large figure from PCTs and trusts, as that letter from the department says. I do not know whether you wish to comment on that.

Mr Taylor: Yes, I can confirm that SHAs do carry forward funding for PCTs when it is earmarked for spending on particular items that they could not spend in one year. So, if the PCT is unable to spend the money in one year, the SHA will carry it forward for them to the next year so that they could spend it on those issues in the next year. That is called deferred income and it is transferring income from one year to the next by the SHA.

Q462 Dr Taylor: This would not just be the sorts of services that SHAs commission themselves?

Mr Taylor: No, it could be for any sort of service that a PCT was purchasing.

Q463 Dr Taylor: Is it not rather odd that they were not allowed to reduce their own deficits by that amount rather than passing it on?

Mr Taylor: It would generally be from organisations that were in surplus, not ones that were in deficit.

Q464 Dr Taylor: But there are not many that are in surplus?

Mr McKeon: That is partly because those in surplus have handed the surplus to the SHA to be kept for them.

Mr Taylor: Two-thirds of the organisations are not in deficit.

Chairman: Is that not part of the mechanism of the old brokerage system. Richard, I think the answer to that is, "Yes".

Q465 Mr Amess: Mr McKeon, just remind me what your previous job was.

Mr McKeon: My previous job, which I left three years ago, was Director of Policy and Planning at the Department of Health.

Q466 Mr Amess: We have got the right man here! In the Health Service Journal you wrote that, "Over time there has been less of a focus on financial management both nationally and in some organisations." Would you like to expand on that? Presumably this is within the last three years.

Mr McKeon: I think it has been clear that, although achieving financial balance has always been an important issue, greater emphasis has been given to actually achieving targets rather than to achieving financial balance. The performance management thrust has been to achieving targets rather than to achieving finance balance. Nobody said that it was not important to achieve financial balance and nobody said that you should not achieve financial balance at the expense of targets, but the focus of performance management has been on the achievement of outputs for the benefit of patients.

Q467 Mr Amess: I do not think you could be clearer in what you have just said. Are the department and the NHS taking the right steps, and what else do you think they should do improve financial management?

Mr McKeon: I think the department is taking the right steps in the way in which they have targeted a number of organisations with turn-around teams, and so on, in order to help rescue their particular financial position. I think they are taking the right step by reinforcing the focus on financial management and financial balance in the last 18 months, perhaps the last year or so now, and I am hopeful they will take the right steps in considering the report that we gave them in late July, the Review of Financial Management and Accounting Regime. I think the recommendations in there would further bolster financial management within the NHS.

Q468 Mr Amess: You were not working for the organisation three years ago, so would you like to give your thoughts on it, Mr Taylor?

Mr Taylor: I thoroughly support what Andy has just said. I think the Audit Commission's recommendations on the changes to the financial regime will make things a lot more transparent and a lot clearer. If the department accepts those recommendations and removes what has been called the RAB double whammy, it will make the accounting system much more transparent and clear to people who are not specialised NHS accountants. The general principle, I think, of making the NHS accounting rules much more like UK generally accepted accounting practice (UK GAAP) will improve the understandability of the system to the public and to all commentators. I think that will be a good move in the future. You have also made a very good point about getting the priorities right. From the finance profession's viewpoint, finance has to be top of the list, financial balance has to be what you achieve first, but, of course, being the NHS, there are lots of other priorities. People who work in the NHS are actually there to improve the treatment of patients, including the accountants and the finance people who work there. They have those same objectives in mind. It is always a very difficult decision when you are talking about spending a little bit of extra money on patient services that might just push you into financial deficit. You have to have sympathy for boards and individuals who have to take those kinds of decisions about spending at the limit of resources when there are clear benefits for the patients. I think also what is happening at the moment to improve the quality of NHS boards is very important. The financial position is ultimately the responsibility of the board of that organisation, and that board has to have the right skills and expertise in order to be able to ensure that everything is in the organisation to make sure that finance is delivered as well as all the other targets. One point I would quite like to make but I am not sure that anybody else has made: we talked this morning about the distribution of funding through the allocation formula. Another question we have to ask is that, despite the huge increases that there have been over the past five years, averaging out at about 10% a year, are we investing enough in health services in this country? We are still lagging behind other countries, in terms of the investment we make in health services, when we aspire to deliver the same standards of healthcare as other countries. Can I quote you some figures. These are OECD figures. They are a little bit out of date. For example, in France in 2004 they were spending 10.5% of GDP on healthcare. In Italy it was 8.4%, in the Netherlands it was 9.2%, in Portugal it was 10%, in Switzerland it was 11.6%, in the United States it was 15.3%. In the UK in 2004 we were spending 8.3% of GDP on healthcare, and, although we have been increasing at a significant rate, those other countries have been increasing, in some instances, more quickly. Over the five years' figures that I have got here the UK investment increased by 1% of GDP, in the US it increased by 2% of GDP, in France it increased by 1.3% of GDP. So, although we are increasing our investment quite significantly in the UK, so is everybody else and the demands of an ageing population, high cost drugs and all the other factors that come into healthcare are pushing the cost of healthcare up across the world, and so we need to consider whether actually we are pumping enough money into healthcare in the first place.

Q469 Jim Dowd: On that very point, because we have been through this plenty of times and healthcare expenditure has gone up sharply, more sharply than ever before over recent years. You double the expenditure and create a crisis. I am not quite sure how that works, other than that it seems to be a general fact of public spending that the more money you spend on a problem the bigger the problem gets, which I think is a structural issue. You mentioned the US. On the occasions we have been recently to the US the one thing we are almost unanimously unfailingly told is the amount of money they waste. They spend 15%, the largest GDP in the world, and yet waste at least a third of it. Why on earth should we aspire to that?

Mr Taylor: I am not suggesting that we aspire to the levels of waste in the US system. I too have visited the US this year as part of my role as HFMA Chairman, we have an annual exchange with the US, and the investment in bureaucracy in the US system is huge. They spend a fortune. The system I went to had 450 people in the finance department. When I ran a similar size hospital in the UK we had 30 people in the finance department, so that gives you a measure of the enormous bureaucracy in the States, but we should aspire to the levels of access that they have in the States whereby you can get immediate, high quality treatment with the latest high-tech equipment.

Jim Dowd: Sixty million people are not even covered in the United States.

Chairman: I am going to end it here. I have to say that doing a comparator between GDPs of the United States and the United Kingdom on the issue of equity alone, you cannot make a comparison. We heard some horrendous stories last time we were in California about what a self-employed plumber would be able to afford in terms of healthcare, and the answer is very little. It does not matter in the UK, thank God. If you keel over in the street when you leave here, Mr Taylor, someone will come and whisk you away no questions asked. It is difficult to measure that against GDP.

Q470 Sandra Gidley: A question to Phil Taylor. The Audit Commission's Learning Lessons from Financial Failure in the NHS was probably quite damning, and that would have a particular impact on members of your organisation. Some of their conclusions were inadequate leadership, particularly in the post of Chief Executive and Finance Director, limited cohesion among Board members and lack of concentration by the Board on breaking even. How have your members responded to that?

Mr Taylor: I would have to say, first of all, that we think it was a good report, the Audit Commission's report on financial failure, and had some good work in it. I think we do have to recognise that very occasionally the finance function does fail in the NHS and some of the particular instances that were in that report indicated where there had been financial failure, those 25 public interest reports that were examined as part of that showed that we are not perfect and sometimes we get it wrong.

Q471 Sandra Gidley: That was a fairly small snapshot as well. You say it happens occasionally. If it is picked up in a fairly small snapshot, it would indicate a bigger picture than you are indicating here today.

Mr Taylor: You must remember that those were the 25 organisations where public interest reports have been issued. In the remaining 575 organisations they have not got into that state. These were the poorly performing organisations. What we have to recognise is that financial failure is operational failure, it is generally a whole systems failure, and it is weak management, it is not having the clinicians on board, it is a whole series of things that all add up, and when you get all those factors in the same place at the same time, then you end up with a failing organisation. We recognise within the HFMA that our members need to be continuously updated and need to have continuous professional development, and we provide all sorts of courses for them to do that and try to help them with those processes. We also try to provide financial management skills to non-financial managers in the NHS, which is one thing that is important. At the HFMA we train a lot of non-executive directors in financial issues and for other people who have to deal with financing the NHS, we have just introduced a new e-learning package whereby they can learn financial skills through the new learning system. We are all the time trying to improve the skills of the members of the association and improve the financial skills throughout the NHS, not just in people who work in the finance function.

Q472 Mr Campbell: Can I ask first a question on foundation hospitals. In the last report on this issue Monitor had said that the foundation trusts were delivering a strong financial performance. Is it your view that these trusts, set up by a Labour Government, have been getting more money pumped into them than other organisations in the Health Service?

Mr Taylor: My answer to that would be, "No", my view is that they are not getting more money pumped into them. What happened was that the Payment by Results regime was introduced for foundation trusts first and was extended to all acute hospitals this year. Perhaps they were able to take advantage of that system earlier than the rest of the NHS, but I do not believe that means more money was being put into them, I believe that they were being reimbursed in a fairer way than the NHS hospitals for that one year.

Q473 Mr Campbell: So it is not an imbalance. That is the main thing.

Mr Taylor: I do not think so; not in my view.

Mr McKeon: I think in 2004/2005, as Phil Taylor has said, the first foundation trusts did make a gain out of the implementation of Payment by Results. I think, from memory, the overall income of foundation trusts went up by something like 14% compared with 11 or 12% for NHS trusts. Of course Payment by Results has now been introduced across the board. We have not done the analysis for 2005/2006.

Q474 Mr Campbell: The other question is: how has your organisation responded to the deficits and, in particular, how have the financial managers responded to the deficits of the Health Service?

Mr Taylor: You will know that in the current year local NHS banks have been introduced at SHA level. Those banks are moving funding around the system, if you like, to try to bring the whole system into balance. I think that puts pressure on the whole system to deliver, because it puts pressure also on those organisations that are in balance to deliver additional funding, but through that mechanism there is a very good chance, I believe, that we will bring the system back into balance, and financial managers around the system are responding to that need to make contributions to the NHS bank at SHA level.

Q475 Dr Naysmith: What is the difference between that system and the old brokerage system that is supposed to have been dispensed with?

Mr Taylor: I think the new system is much more transparent, and the movement of funds will be declared in accounts and the funds that are collected at SHA level will remain with the SHAs rather than being distributed out across the system; so this year we will end up with surpluses in SHAs to offset any deficits that there are in the system. Brokerage is a difficult question, because I think the Committee has said it made the system less transparent because you did not know where money was moving around the system, but I think always with the very best intentions. Brokerage was used to remedy a number of problems, one of them being the effect that we have talked about of the RAB double whammy. If you gave brokerage to an NHS trust it avoided that problem of the double whammy, so that was one reason for giving brokerage out. You might have used brokerage for other things as well. If a trust was opening a new facility, in the first year or two it is much more expensive when you open a new facility and so you need to pass a little extra bit of funding to that organisation in order to get over that hump. There could be other reasons for moving brokerage round the system, but the intention always was not to make the system less transparent but to oil the wheels to make the NHS able to cope with local difficulties.

Q476 Dr Naysmith: My experience of that system was that it was sometimes used to cover up deficits and then, at an appropriate time, the money was moved back again to where it had come from without any real effort being put into sorting out why the deficit arose in the other organisation first. You are saying it is now transparent enough for people to make sure that that does not happen in the future.

Mr Taylor: In the new system it is much more transparent, yes.

Q477 Dr Stoate: Certainly, in my experience, transparency has not been the strong point of the NHS. One of the things I would like to see is that financial directors, generally speaking, know where the bodies are buried, if you will pardon the pun. Are there any bodies that are still buried that the financial directors have not yet owned up to?

Mr Taylor: I cannot answer that question, clearly, but what I can say is that we do run a very tight system here. We are under pressure to spend every penny; it is a very tight system. If you are running a system like that where you are aiming for absolute financial balance every year---

Q478 Dr Stoate: I am not concerned about that. What I am concerned about is are there any underlying financial nasties to come out of the woodwork, or do we now know the full transparent picture?

Mr Taylor: I am afraid I cannot answer that question.

Q479 Dr Stoate: That is even more worrying, because if you cannot answer it, what is going on? You mentioned several times during your evidence that you want to improve financial transparency. I am asking you: is it transparent, is it in the open, or are there still things waiting to come out? If you say you do not know, it does not do much for my confidence in the transparency of the system.

Mr Taylor: I am here as a representative of the HFMA. I do not receive the information that the Department of Health receives every month on the financial position in individual organisations.

Q480 Dr Stoate: Can I ask the Audit Commission if they are concerned about more facts and figures that are yet to hit the headlines, or do we have the full picture of the deficits?

Mr McKeon: I think a lot has been done over the past year and now this year to flush out the financial position of individual organisations. All the trusts have now gone through the trust's diagnostic programme to see what their financial position is, to see how quickly they can get to foundation trust status. All the PCTs are going through a fitness for purpose assessment which is looking at their financial future as well. Existing PCTs which did not change on 1 October have now been done. The ones that changed on 1 October, the new ones, are being done over the next six months. At the end of that period I think we will have a very good idea of all the financial problems in the NHS. Could I guarantee it is 100% transparent? No, I could not guarantee it is 100% transparent.

Q481 Anne Milton: I wonder if I could ask you both what you feel the NHS needs to do to get back into financial balance?

Mr Taylor: We have mentioned a number of things. First of all, we need a clear, transparent financial system so everybody can see what is happening and so it is clear to all involved where financial problems arise. I think we need to do some work on strengthening the boards in NHS organisations. I think we need in organisations to make it very clear what the priorities are. The Department of Health needs to make it very clear what the priorities for the NHS are. We need to have early guidance on what we are going to do for any particular year, and I think we need to recognise that it is a difficult system. As I have said on a couple of occasions, it is not easy to work in that complex system and produce the exact zero answer every time.

Mr McKeon: I agree with that. I think there are two issues: one is to recover financial balance and the other is to have a financially sound position for the future, not just recovering financial balance. I think the department is doing the right things, as I said earlier, in terms of getting into financial balance in individual organisations, in providing the support and help that is going on and providing the right focus on this issue and also the way in which they have curtailed some of their priorities to make sure that financial balance is achieved. I think for the longer term, we need to do the things, as Phil has said, in terms of strengthening boards. I think the department needs to make sure that it issues guidance at the right time, earlier, so that people have enough notice of what is going to happen. I think they need to be more transparent and open in their costings. I am not saying that their costings are poor. I think they need to be more open to challenge about those, also to identify the inherent risks in those costings so that people can be aware of those and work to mitigate them. I think they need to do something on resource accounting and budgeting. All I am saying has been set out in our review. I think these are the sorts of things that we need to do for the longer term. Equally, the finance profession needs to up its skill levels in some particular areas, as the results of our auditors' local evaluation has shown, and to use that as a framework to improve.

Q482 Anne Milton: Somebody said to me recently, and I will ask you whether you think it is valid, that if they were asked to put the cost down for, say, an x-ray department they could make it 300 or 3,000 depending how they accounted for it. Would you dispute those comments? Undue hesitation, Mr Taylor and a smile!

Mr McKeon: I would dispute that they could do it quite that way. In terms of costings, there is a costing manual that is set out by the department which sets out how the cost should be derived for individual units and individual procedures. So there is a rule book which should be followed. Some of this, I have to say, is a matter of judgment and not necessarily an absolute rule that you have to follow. There is variation and there are things to do with how you allocate overheads, for example how the cost of the finance function should be attributed to the pathology department or the x-ray department. The costing manual sets out how that should be done, but in the end there is still a matter of judgment about that.

Q483 Anne Milton: So it is not an absolutely rigid structure; there are opportunities. I do not mean this in a prejudicial way. There are opportunities to be imaginative in your accounting. What you charge up to what department and what you end up with will define the figure then, presumably?

Mr McKeon: There are opportunities to take different judgments about where costs should fall, but one of the points about Payment by Results is it matters, in a sense, not what your costs are, because you are paid the average cost, if you like. What matters is the income that you get. Where there are services which are not funded by Payment by Results, then clearly PCTs tend to look very closely at what the costs attributions are and what they are actually paying for in those circumstances.

Q484 Anne Milton: Mr Taylor?

Mr Taylor: As always costing is not an absolute science. There is always a degree of art about it and there is always, at the margin, a possibility of taking different views on how you allocate costs. There will always be some variation between two different accountants costing the same thing, but what we aim to do, through the costing manual, through procedures, is to reduce that degree of variation and try to get everybody doing it the same way.

Q485 Anne Milton: Do you think the first priority of the NHS is to achieve financial balance?

Mr Taylor: No.

Q486 Anne Milton: Mr McKeon?

Mr McKeon: I think the first priority of the NHS is to treat the people within the resources available. Provide the best service within the resources available.

Q487 Anne Milton: So the answer is, "Yes", then?

Mr McKeon: No, the answer is what I said.

Q488 Dr Taylor: I want to go back to brokerage and buffers and things like that to make sure I have understood it, because it strikes me that we are returning to brokerage with different titles and with more transparency. Mr Taylor mentioned the local banks at SHA level, so that is one reserve being held. We also gather that there is going to be a central buffer held by the department and the Treasury amounting to something like (I have read somewhere) 350 million. Is this not just a return to brokerage and is not this going to let trusts off the hook?

Mr McKeon: Perhaps I can start by talking about the buffer, which is a recommendation in our review which we presented to the Secretary of State in July. The department has not decided on that recommendation and, as far I know, no figures have been attached to what the buffer will be. People may have made guesses, but there is no final figure. As I say, it is still up to the department whether they accept that recommendation. As we set out in the report, the buffer is not a reserve that is meant to be handed out to trusts in trouble. It is not there to be spent on individual trusts in deficit. The need for the buffer arises because one of the problems the department has had through resource accounting and budgeting is that, if the NHS overspends, the Treasury take back the equivalent of that overspend for the next year's allocation. That is then passed down. Effectively, the consequences of that are then passed down to the individual trusts who have overspent, and that has resulted in what Phil Taylor referred to as the RAB double whammy. The point about the buffer was, in a sense, to isolate the NHS from the effects of that so that, if there was an overspend by the NHS in aggregate, the department could meet its responsibilities to the Treasury but not have to pass the consequences of that down to trusts in the way that they have. The trusts would still be in deficit, they would still have to recover, but they would not have the double whammy.

Q489 Dr Taylor: Is it there particularly to protect foundation trusts if they get into trouble?

Mr McKeon: There is a point about foundation trusts, because the department is also responsible to the Treasury for the aggregate overspends or, indeed, underspends of foundation trusts. So, if foundation trusts overspend in aggregate, that is taken into account by the Treasury as to whether the department has overspent its allocation or not. If the foundation trusts underspend, that is also taken into account and the department gets the benefits of that. The department has no way, as it has with NHS trusts, of passing on the consequences of those overspends directly back to foundation trusts, as they have done with NHS trusts. The buffer is a way of ensuring, as I say, that the department can meet any potential overspend and meet its obligations to the Treasury without having to pass down the consequences of that in the way they have to NHS trusts and foundation trusts. The individual organisations will still be left with their financial problems, but they will not have been said to have been compounded with the operation of the system.

Q490 Dr Taylor: Would you go so far as to agree with Professor Asthana? You may not have heard her, but in her written evidence she says, "Brokerage offers the only means of moderating the pernicious effects of the funding formula"?

Mr Mckeon: A way, in her view, of ameliorating or affecting the funding formula is to pass money from one organisation to another. That must be true, but I do not necessarily agree that is the right approach to do it. As you, I think, agreed, the way in which that is done would not be the right way. If there were to be a problem with the funding formula, surely the way is to address the funding formula, not to move money between organisations.

Q491 Dr Taylor: Is it fair to ask if the Audit Commission has a view on the funding formula?

Mr McKeon: No, I think I have said all I can say on the funding formula as far as we are concerned.

Dr Taylor: Thank you.

Q492 Chairman: Mr McKeon, could I ask you about your review. Do you have a timescale when the Government are going to respond to this review?

Mr McKeon: They have not given us a definite timescale but I understand that the Director of Finance is hopeful they will be able to respond next month.

Q493 Chairman: That might be helpful to this Committee in terms of that response. In your review, you conclude that RAB (resource accounting and budgeting) needs to be radically relaxed in the NHS and that accumulated deficits should be written off.

Mr McKeon: No.

Q494 Chairman: Is that a misinterpretation?

Mr McKeon: That is definitely not what we said.

Q495 Chairman: You do not compliment RAB anyway. Let me put it this way: by implication - and I am looking at table 1, which you will be familiar with - if a trust overspends by £10 million, the following financial year it loses that £10 million and also has to pay it back at the same time. That is the double-whammy which Mr Taylor described.

Mr McKeon: Yes.

Q496 Chairman: Who is responsible for that? You suggested in answer to Richard that it may not have been the National Health Service accounting but the Treasury that is responsible for that? In your view, who do you think is responsible for it?

Mr McKeon: The Treasury have laid a requirement on all departments in resource accounting and budgeting. The way in which the Department of Health has met its responsibilities, in the sense of the Treasury's, is to pass that responsibility down directly through the NHS, on the grounds that the individual organisations are overspending or underspending, but if they are overspending they should bear responsibility for that action.

Q497 Chairman: That is then decided by the NHS to pass it down to the individual trust.

Mr McKeon: Yes. This has not always been applied by individual SHAs to all trusts. There has been a variation in the way that has happened.

Q498 Chairman: Mr Taylor, do you agree with that?

Mr Taylor: Yes, I do. We have a conflict between two different forms of accounting. Resource accounting and budgeting is entirely appropriate for government accounting, and as applied to government departments is a very suitable system. When you move down to NHS trusts, we have a system which is much more like normal, commercial UK generally accepted accounting. Those two systems work differently and that is why we have this problem with the clash between RAB and normal accounting. When you apply RAB to an organisation that is doing ordinary accounting as well, you end up with this doubling of the effect. I think the recommendations that the Audit Commission has made, that you protect NHS trusts from the effects of RAB by having a central contingency, provision, whatever you want to call it, is a very good suggestion.

Q499 Chairman: Did the auditors predict a likelihood of what would happen with the introduction of RAB?

Mr McKeon: No, I do not think we did predict this is what would happen with the introduction of RAB.

Q500 Chairman: But we knew the Treasury would not allow any Department to overspend.

Mr McKeon: Yes.

Q501 Chairman: They got inside a mechanism that if you do overspend we will punish you the following year. That was known.

Mr McKeon: That was certainly known and I think it has been the effect of the way this has worked out, as is set out in table 1, in terms of the NHS trust accounting system and the way in which the resource accounting and budgeting process has affected that. As we said in the report, however, not all trusts have this applied to them by any means.

Q502 Chairman: Even if they have overspent?

Mr McKeon: Even if they overspent, they did not necessarily have the RAB adjustment applied to them.

Q503 Chairman: Who took that decision then?

Mr McKeon: That decision would have been taken locally.

Q504 Chairman: Taken locally?

Mr McKeon: Yes by the SHA or sometimes by the PCT. Because the way in which this system works is that it is actually the PCT's allocation that is deducted and they technically pass that deduction on to the trust if - if - they decide to do that. Some people decided not to do that. Some trusts were given financial support in order to ameliorate the effects of RAB, as we set out in our report Learning the lesson from financial failure. You cannot lay all the problems of deficits at the door of RAB by any means.

Q505 Chairman: I accept that, but we are looking at a piece of accounting that changed a few years ago now and its effect on a trust, given that the buffer zone, or whatever we want to call it, that has been put in place now was not there at that time. If my trust had spent £10 million more than it should have spent, it not only has to rein back on that £10 million but it also loses £10 million the following year. What are the implications for any organisation of that happening?

Mr Taylor: It is a very punitive regime. The organisations are being punished, if you like, twice for their deficit.

Q506 Chairman: It is not quite capital punishment, but not far off! What are the implications for "the business"?

Mr Taylor: One of the things we do know is that the best indication of whether an organisation is going to have a deficit in the future is whether it had a deficit in the past. We have learned - and you have quoted in your studies - that once an NHS organisation gets into deficit, it is very difficult for it to get out of deficit.

Q507 Chairman: Without ...?

Mr Taylor: Without help.

Q508 Chairman: Without help or cutting back on its business.

Mr Taylor: Yes. Without help and a suitable cover period.

Q509 Chairman: Stopping the over-expenditure. Do you agree with that Mr McKeon?

Mr McKeon: If it has a deficit, then it will have to claw back on its expenditure the following year. That is very clear. There are two points I would make. Where the RAB effect has been applied, it is variable. Where it has been applied, there is no doubt trusts have found it harder to get out of their financial deficit, but clearly that does not apply where it has not been applied. It is also clear, as I think has been said before, that some organisations have had underlying problems for some time which were there possibly before the introduction of RAB and have now come to the fore.

Q510 Chairman: Presumably the implications of the introduction of RAB were not taken into account by (a) the local overspenders or (b) the National Health Service itself. Is that a fair comment to make? The implications of this change of accounting for some trusts who are currently overspending - and some of it may be historical overspending in terms of judgment against the formula - was not looked into in a proper way, the likely effect of this introduction.

Mr McKeon: For some organisations, the effect of it did come as a surprise, yes.

Q511 Chairman: We will pursue this with other people we will have in front of us on this particular inquiry. It seems to me that this was an area that was walked into without looking at the implications of it. How do we get out of it?

Mr Taylor: The double effect when you are going in does actually become a double effect when you are coming out. If the organisation can get over this overspending problem and restore financial balance, when they are coming out they get a double benefit at the other side.

Q512 Chairman: What about the issue of top slicing. Mr Taylor, you are dealing with people on the sharp end of all this. What are the implications for that?

Mr Taylor: Are you referring specifically to the top slices that are being applied this year in order to restore the system to balance?

Q513 Chairman: Yes.

Mr Taylor: I think HFMA members are very keen that the whole system is brought back into balance. It is a very difficult time being in the finance function in the NHS at the moment with the deficit problems. Universally, we want to get out of that situation, so, although top slicing might not be thought to be an ideal way forward, if this year's top slice can sort out the problem, such that we can return to financial balance, then on the whole I think we see it positively.

Q514 Chairman: Returning to financial balance over the short term or the long term? My local trust has been top-sliced. It is not overspent, in deficit, but it has lost about one-third of its growth money this year. That is not devastating for health care in my area, but we could have improved it if we had had all the growth money and not lost one-third of it. For these trusts which are grossly overspent - certainly in the wider region that we have now in Yorkshire and the Humber - that is not going to go away in the next six months, is it? What are the implications, do you think, for your members and budgets for the next financial year after this? Will we see an end to top-slicing?

Mr Taylor: I cannot predict whether we will see an end to top-slicing or not. That is a decision for the Department of Health. I think many of my members are concerned that they have a reasonable period in which to recover. If you do have an organisation which is in deficit, you need to produce a financial recovery plan, and that will set out how you will recover the financial position over a period of time so that you can continue to deliver the services to patients in the period whilst you are in financial recovery.

Q515 Chairman: We have been told that the top-slicing money will go back, with interest. The real question is when? Do your members have any understanding of when that is likely to happen?

Mr Taylor: I think the Department of Health's position is that it will be repaid over three years.

Q516 Chairman: The other thing, of course, is that the top-slicing on this year's budgets equates with the overspend - or we are led to believe that it equates with the overspend, but now we have the real figures I am not too sure about that. If that is the case, would you expect - and I know you have said you do not know - there to be any top-slicing on next year's budget on the basis that this money equates with the overspend this year? Is that a bit complicated?

Mr Taylor: I cannot really comment because it is a Department of Health decision as to whether there is a top-slice next year.

Q517 Chairman: We were told that they will not pay the money off, that people who have overspent will have to get themselves back into financial position, but if they do not pay the money off then there is still overspend next year and the year after, at least, I would have thought, and some of these trusts could go on for ever. Your members have no feeling about when this type of reaction - and I am not saying it is not justified, do not get me wrong - of top-slicing will end while we have overspend. We have no concept of that at this stage.

Mr Taylor: The view of the HFMA would be that this is a short, sharp year of correction and that hopefully we will be back in financial balance in the future. That is certainly what all my members are working towards.

Q518 Chairman: What has happened to this year's budgets, in areas, not necessarily of surplus but, let us say, of underspend, you would not expect that they will be hit again next year.

Mr Taylor: Again, I cannot answer that question.

Chairman: I know it is dangerous ground. I will try it with one or two other witnesses we will have in front of us in the next few weeks.

Q519 Dr Taylor: The Chairman just asked about cumulative deficits, but you rather skated over those. Is it the Audit Commission's view that cumulative deficits should be written off?

Mr McKeon: No. It is not proposed that cumulative deficits should be written off.

Q520 Dr Taylor: I think they amount to £1.3 billion.

Mr McKeon: That is correct.

Q521 Dr Taylor: However are we going to recover those? Or is it, sort of, joke money - does it not really exist? Or where is it?

Mr McKeon: Or where is it? Just to be clear, the proposal we made in our review was that those trusts who had had RAB adjustments made to their budgets should effectively have the money returned to them. That is not the same as writing off their cumulative deficits.

Q522 Dr Taylor: What percentage of the cumulative deficit is due to RAB?

Mr McKeon: I cannot tell you that because I have not been able to look at all individual trusts' accounts and financial performance to see in what way they have had financial support. Because you have to dabble around in quite a lot of the detail, with the SHAs as well, to find which trusts have had financial support in order to remove or ameliorate the effects of RAB, and which have not. It is a very complicated exercise that you need to go through to do that. As far as cumulative deficits are concerned, we said that the first thing was to deal with the consequences of those deficits, and certainly not to write them off but to make sure that the trust was in a proper position going forward. One of the consequences of having a significant cumulative deficit is that you may have a cash problem and therefore you have to have a way of funding the cash and making sure the trust is in a sensible position in order to do that. You then have to look at the ongoing position of the trust and how that is going to perform in the longer term. There was an example in 2004/5 where a trust's cumulative deficit was written off locally ----

Q523 Dr Taylor: Locally?

Mr McKeon: No, by the SHA -- to the tune of some £15 million. The next year, it had a deficit of £15 million. It did not seem a very sensible exercise to spend £15 million to write off the cumulative deficit only to find that the trust in the next year had a further in-year deficit. One needed to look at the structural position of the trust and its spending. Our recommendation is essentially to say: deal with the consequences of cumulative deficits where there are those in cash problems, and, secondly, have a serious look at the trust's ongoing financial position and make some decisions in the light of that.

Dr Taylor: Thank you.

Q524 Dr Naysmith: Mr Taylor, in your written evidence you said, "It would be reasonable to expect 70% of the required savings to come from the staff budget." Does that mean widespread staff cuts inevitably?

Mr Taylor: The point we were trying to get across there is that between 60-70% of NHS spend is on staffing; it is therefore a fairly logical step to take one step back from that and say that if we are going to cut expenditure then probably 60-70% of that cut is going to be on staffing. Of course there are various ways of doing that: you can cut back on bank and agency spend; you can get rid of people who are on temporary contracts; you can not invest in the new staff that you would have invested in. Only at the end of the day would you come to having to make people redundant. Hopefully in very few cases, only where there are severe financial deficits. I think you have to have control of your staff expenditure if you are going to have control of your budget in an NHS organisation.

Q525 Dr Naysmith: What you have said sounds very sensible but some of the things that have been said have been really ridiculous. We have had people emerging from meetings saying, "We are in deficit so-and-so and that means 10,000 people are going to be sacked or lose their jobs." There has been quite a lot of that from some of your members - not necessarily from the ones you represent, but organisations.

Mr Taylor: I think we have all read the press coverage of various organisations around the country saying that they are going to have to lose large numbers of people in some instances, and I am sure that is true. It is just a matter of how much you lose through natural wastage and the other mechanisms that I have mentioned. It has to be put in the context of the huge increase in numbers of staff that have been recruited by the NHS. I read some NHS employers' figures that were out last week that said the NHS had recruited an additional 268,000 staff over the last six years. Perhaps some organisations recruited too many too quickly.

Q526 Dr Naysmith: If it does come down to some people losing their jobs, what sort of categories of staff do you think it will be? Or is it impossible to say? You mentioned agency jobs. Obviously that would be part of it in some places.

Mr Taylor: Yes. I would imagine that staff reductions would come across all categories of staff.

Dr Naysmith: Thank you.

Q527 Jim Dowd: I have one brief question for Mr Taylor in particular. The Chairman mentioned in his opening the questions the survey in the Health Service Journal. One item adduced here is that "39% [of chief executives] believe that the calibre of finance directors was a major contributory factor to deficits." Does it concern you that two out of five chief executives do not trust their finance director?

Mr Taylor: I would not put it quite that way.

Q528 Jim Dowd: I do not have the figures for the reverse, of course!

Mr Taylor: No. I do not recognise that figure, to be quite honest. I saw it in the article you are referring to and I find it difficult to believe that is the case, two out of five. The relationship between the chief executive and the finance director has to be very close. I would be extremely concerned and disappointed if that was the true feeling of all chief executives.

Dr Naysmith: I think you are misinterpreting that. Really it is other finance directors talking about finance directors in other trusts. I myself have heard chief executives being critical - especially if they are being top-sliced because of something that has happened somewhere else.

Jim Dowd: No, I think, Mr Taylor, you got it exactly right.

Q529 Chairman: If you have nothing further to add, could I thank both of you for coming along this morning and helping us with this inquiry. We may at some stage be seeing the wood, though I do not know exactly at what stage. Mr McKeon, if there is a response, is it normally published publicly?

Mr McKeon: I understand their intention is to publish the response, yes.

Chairman: We may be in touch with you or dealing with it ourselves in trying to find out when that is likely to happen. Thank you very much indeed.

---

[1] See supplementary evidence from Professor Asthana (Ev XX)