News analysis Trusts feel impact as PFI and payment by results collide

Imagine buying a house for a family with four children. Over the next few years you know you will need a lot of space to accommodate noisy teenagers. But in 10 years' time your needs are not so clear cut: children may leave, elderly relatives may come to stay or you may be on your own. Your income is also uncertain and not under your control: your boss has just refused a pay rise to reflect your high accommodation costs and says you can have the same as everyone else.

Given that, would you take on a 30-year mortgage which could not be transferred to another property and which has severe penalties if you wanted to redeem it early? And, for good measure, it includes all your maintenance, cleaning and catering.

Probably not. But that is effectively what some of the trusts with earlier private finance initiative deals have done. These were often devised when the NHS's need for extra capacity was acute and hospitals were at the centre of the NHS's model of care. Early PFI hospital plans were frequently criticised for having too few beds and some were revised upwards.

But in the last few years these assumptions are being challenged. The need for extra capacity post-2008 is now being questioned as up to 10 per cent of NHS patients are likely to be treated in the independent sector. The white paper on care outside hospitals envisages a different role for the acute sector.

But for trusts with PFI payments to make, the immediate problem is payment by results, which does not recognise the higher costs they have to face.

In Woolwich, south London, Queen Elizabeth Hospital trust chief executive John Pelly says: 'The funding mechanism for hospitals does not reflect the cost of PFI. We are left with a huge extra cost and no chance of recovering it.'

His trust's PFI scheme adds£8-9m to its costs each year compared with the 'average' hospital. This means its reference cost is above the national tariff rate at which it will be paid, even though there is nothing that the trust can do to reduce this additional bill.

The trust was recently the subject of a public interest report from the Audit Commission because of a looming deficit and the likelihood that it would not break even within a set timescale.

PFI expert and Edinburgh University research fellow Mark Hellowell comments: 'PFI puts a hell of a lot of financial pressure on trusts. PbR will exacerbate that ? new market entrants will make demand volatile and it is based on a tariff that does not cover your true costs.

'We now have a mismatch between the way the NHS is funded and the way PFI is funded.'

The problem is that the national tariff only includes an average payment for capital charges ' hospitals which have invested heavily in new buildings either through PFI or other funding will have higher-than-average costs.

However, non-PFI projects are shown as a capital charge of 3.5 per cent of the value of the asset whereas PFI projects typically cost around 15 per cent of a trust's income (although this may include some services). They are also committed to the payments plus inflation for 25-30 years.

HSJ columnist and independent finance consultant Noel Plumridge says there may be particular issues in south-east London, which has a large number of hospitals with PFI deals, and where choice may bite particularly hard. Many patients will have several hospitals within easy reach, including the central London teaching hospitals. Similar problems may exist in other big cities where there are lot of trusts on the periphery, potentially competing with well-known hospitals in the city centre.

But if the number of trusts in any area looks unsustainable under PbR and choice, the PFI payments may affect reconfiguration. Abandoning a PFI site is likely to incur large penalties ? so changes may have to focus on non-PFI hospitals.

For example, Norfolk and Norwich University Hospital trust's PFI deal could cost up to£257m to terminate early. The Commons public accounts committee recently looked at the refinancing of the project which extended the length of the contract and said 'there can be no certainty that a hospital will be needed in its current form in over 30 years' time'. Committee chair Edward Leigh ? a Conservative MP ? described the refinancing deal as 'the unacceptable face of capitalism'.

High reference costs

At Bromley Hospitals trust, where the£155m Princess Royal University Hospital (Farnborough) was funded by PFI, managers are reasonably confident they can cope with the challenges of the future. However, estates and facilities director Trevor Willis says that how the trust's other older hospitals are used may ultimately change.

But the trust's PFI charges are a major factor in it having high reference costs. 'We are working to reduce that but that will take a long time,' he says.

Mr Hellowell says: 'It would be disproportionately expensive to close down services at PFI trusts. It would not be that surprising to find that it is the non-PFI trusts close to PFI trusts that get services closed down.'

But in the short-term the challenge for some PFI trusts is to break even and this may require radical thinking 'A hotel may invest a lot in its buildings to improve its attractiveness to guests but recoup this through higher prices. That's not available in the NHS,' says Mr Plumridge. 'I can see some real new thinking about the model of care and how we will change this to get out of deficit.'

Individual trusts will have limited room for manoeuvre because such a large percentage of their costs are fixed. Non-PFI hospitals under pressure may look at reducing non-essential maintenance, or whether savings can be made in soft services such as catering, cleaning and security. Such savings may be ill-advised, but they can help the bottom line in a tough year.

PFI hospitals cannot do this - typically, these services are included in their contract. Inevitably, savings will have to be made elsewhere - and that is likely to focus on staff costs, as these are usually the largest outgoings for a trust.

For trusts with large PFI payments to reduce their costs ? to under the national average, for example ? they will need to be beacons of efficiency and lean running.

Mr Pelly says: ?To survive in a world of PbR, irrespective of whether or not the market causes work to move away from us, we need to get ourselves into a position where we are in the upper quartile of all resource usage.

'On a day-to-day basis in order to achieve break-even it is about driving down all the other costs that we can control.'

Queen Elizabeth Hospital trust is planning to pull£11m out of its costs in 2006-07 ? including the abolition of some posts ? but is still heading for a£6.5m deficit.

Norfolk and Norwich University Hospital trust has also said its costs are higher ? by around£6m a year ?because it is an early-stage PFI. The trust is trying to head off a£15m deficit in 2006-07 and is considering cutting jobs. A spokesman said that its£38m yearly payment for the building and facilities was fixed so savings would have to be concentrated elsewhere. 'You inevitably do start looking at the wage bill,' a spokesperson said.

In Bromley there is more optimism. Mr Willis believes close working with the PFI partner can help and may even introduce some flexibility around some of the charges, such as those for 'soft services'. It is not in the interests of the PFI partner for the hospital to be in severe financial trouble, he argues.

In the past, PFI trusts have had some recognition of their high costs through fixed-term payments from government and strategic health authorities, but it is uncertain whether these will survive. Norfolk and Norwich has also been supported by a£3.6m yearly payment from its SHA in recognition of the additional PFI costs. It has already fought off one attempt to reduce this and there is no guarantee the payment will continue.

Many early PFI deals were signed when the expected direction of travel for NHS services involved expansion rather than contraction or a different 'offering' of services: they may find downsizing or reshaping their provision more difficult. The National Audit Office recently looked at the refinancing of the PFI deal for the Darent Valley Hospital in Dartford. It said: 'It may be less easy for the trust to avoid expenditure on maintaining areas not in use compared with conventional procurement where an NHS trust can make immediate decisions to stop or reduce expenditure on maintaining areas no longer in use.'

Attracting new patients

The plus side for PFI trusts is that they have new hospitals, often with small wards and new equipment, which may prove attractive to patients exercising choice ? although this will depend on the local market. Norfolk and Norwich, for example, is 30 miles from other acute hospitals and its patient base may remain relatively stable. In London, choice may be more of a challenge ? although Mr Pelly says his hospital has done well in attracting new patients over the last few years.

'I don't have a fundamental issue with PFI. Greenwich needed a new hospital. PFI was the only show in town and it enabled it to get its new hospital,' he says.

'It's now been operational for five years. But this was negotiated and put into effect in a world before PbR.'

He would like to see the 'legacy' costs of PFI reflected in what individual hospitals are paid. This would involve stripping some building costs out of the tariff and hospitals would then be given an individual payment depending on their circumstances ? a little like the market forces factor adjustment.

The problems with the early PFI model are being recognised by the Treasury. Earlier this year it put out guidance which backed shorter contract periods (but could lead to higher costs per year). Some services such as catering, cleaning and security being less likely to be included in these contracts, and technical changes to the finding of schemes which would allow trusts greater flexibility to get out of schemes earlier.

Mr Hellowell points out that these changes will not affect new schemes for another year or two. He doubts the extent to which flexibility can be built into the system, as the essence of PFI ? and what attracts the investors ? is that it offers them a more or less guaranteed return for a long period. Flexibility is likely to come at a price for the NHS, he says.

But while new PFI schemes may be better designed financially from an NHS perspective, the costs of such projects have soared in the last few years as construction costs have leapt up.

The Department of Health is examining proposed schemes and has dramatically downsized some of them to make them affordable. In May it ordered University Hospitals of Leicester trust to cut nearly£200m out of its proposed£761m scheme.

Health minister Lord Warner told HSJ that schemes had 'to conform with the direction of travel set out in the healthcare outside hospitals white paper'.

That is clearly good sense, but it is little consolation with trusts left with earlier schemes to fund for the next 30 years.