Feature

Payment by results

Despite the row over foundation trusts, it is New Labour’s plan to change NHS financial flows that will trigger radical change in the NHS, explain Ruth McDonald and Stephen Harrison

For most of its history, the NHS has operated as a unified system – central government has allocated financial resources to hospitals and GPs within specific localities via intermediate tiers of organisation, such as health authorities. From the late 1970s, this allocation was largely based on formulae that took the NHS budget allocation for each of the four UK countries and divided them geographically to take account of variables such as population size, age, sex, service usage and mortality. But this relatively simple system came to be criticised on two grounds.

First, since GPs were free to refer patients to any hospital anywhere in the UK, there was no necessary relationship between the population whose characteristics drove the formula and the actual patients treated in specific localities. This problem of ‘cross-boundary flow’ was to some extent dealt with by adjustments to the formula, but it took some two years after the event for hospitals ‘importing’ patients in this way to be recompensed. Second, hospitals had little incentive to increase the number of patients treated since any such increase would have to be dealt with from an existing, finite budget.

In the face of evidence suggesting that hospitals used increases in budget allocation to diagnose and treat existing numbers of patients more intensively rather than to treat more patients,¹ and that some consultants allowed NHS waiting lists to grow to stimulate demand for their own private practice,² ideas began to develop about systems under which (as it was later expressed) ‘money follows the patient’.

The intellectual origins of this idea, became the Conservatives’ so-called ‘internal market’ of 1991-97, were in the work of Enthoven and Maynard on incentives for hospitals and GPs respectively to be more efficient and to provide higher standards of service.^{3 4}

Operationally, the new arrangements took two, not entirely compatible forms: health authority purchasing and GP fundholding. Both forms centred on the notion that the actual provision of services should be the function of NHS trusts, independent of direct HA control, but in a quasi-contractual relationship with both them and GP fundholders for the supply of patient services.

In the first model, HAs became financially responsible for purchasing health services from trusts on an annual basis for geographically defined resident populations. In the second model, volunteer GPFHs were allocated a budget (deducted from the population-based allocation to the relevant HAs) from which to purchase secondary care services from trusts or perhaps from the private sector.

Such services included elective surgery, directly accessed diagnostic and therapeutic services (such as pathology, radiology and physiotherapy), outpatient services, and some domiciliary nursing. GPFHs also received a prescribing budget.

There is little evidence that this resulted either in competitive behaviour by NHS institutions, or great service improvements.^{5 6} Nor is there much evidence of resulting service deterioration, though it is probable that administrative costs increased.

New Labour in opposition repudiated the internal market.^{7 8} But when it came to office in 1997, it decided that its structure for the NHS would ‘go with the grain’ of some of the Conservatives’ arrangements that were seen to have had value, while abandoning notions of competition and the market.

Fundholding was formally abolished from April 1999 and replaced by primary care groups (later trusts). NHS trusts were left, as before, managerially independent of HAs, but with the former annual contracting process replaced with a system of longer term ‘commissioning’ via ‘service agreements’.

Such agreements were said to be ‘contestable’ rather than competitive – to be abandoned only in the event of extreme dissatisfaction. In 2002, the commissioning process was taken over by PCTs.

The next big idea

The most prominent element of New Labour’s current proposals for further NHS change in England (political devolution to Scotland and Wales having resulted in considerable organisational divergence: see page 12) is the creation of foundation trusts. They will be able to borrow capital (subject to a ‘prudential limit’ set by the Treasury), sell assets, retain surpluses generated in-year and undertake joint ventures with private companies. They will be accountable to a new independent regulator rather than to the health secretary. Their boards will (unlike other trusts) have members elected from local patients, residents and NHS staff.

This proposal has aroused considerable opposition, both inside and outside the Labour Party.^{9 10 11} But despite their political and media prominence – the foundation proposals scraped through the Commons by a majority of just 17 votes in November – they are only a part of New Labour’s proposals for further changes in NHS financial flows, officially described as ‘payment by results’.¹² This represents a radical challenge to the NHS as it presently operates.

First, PCTs will receive stable three-yearly financial allocations but will be expected to commission from a variety of providers other than their local trust hospitals. These will include other NHS trusts and foundation trusts, private sector providers and the 52 planned ‘treatment centres’ some of which will be privately operated and employ staff imported from overseas.

Second, the ‘currency’ of ‘service level agreements’ between PCTs and providers will progressively shift from the present rather general service descriptions to payment for actual provider workload, defined in terms of a case-mix measure, Healthcare Resource Groups (HRGs).¹³

Third, there will be a progressive shift towards the pricing of HRGs at a national standard tariff, leaving low-cost providers to retain surpluses to ‘plough back’, but creating financial difficulties for hospitals operating at above-tariff prices. This tariff, with minor adjustments for regional market price differentials, will eventually be based on ‘optimal practice for desired treatment’, presumably implying reimbursement for adherence to clinical guidelines.

Fourth, PCTs will be responsible for meeting waiting time targets for their own patients, and will contract with secondary care providers for the numbers of HRGs needed to meet their targets. Providers will be immediately penalised for failure to deliver the agreed number of cases by withdrawal of funds on a quarterly basis. The capping of PCT budgets will discourage growth, other than in accordance with formal priorities, and some unspecified risk-sharing arrangements between PCTs and providers. Strategic health authorities will arbitrate in the event of disputes.

Finally, from December 2005, all elective surgical patients will be offered a free choice of provider at the point of referral.

The policy objectives are fairly clear. There is the hope that they will more effectively deliver waiting times targets for hospital treatment while keeping the resource management advantages of capped local budgets. And it is intended that reimbursement on a national standard tariff will avoid price competition and its associated transaction costs, substituting (though the term is not used) provider competition based on the quality of care. It is also planned that, while maintaining ‘open and co-operative’ relationships and ‘clinical engagement’ across primary and secondary care, there will be a diversification of organisations providing secondary care to NHS patients.

What might be the result?

Unfortunately, the above objectives are likely to be undermined by three elements of the reforms themselves.

First, the obligation of PCTs to withdraw funding in-year from acute care providers takes no account of trusts’ ability to cope with such withdrawals, and especially the extent of fixed costs contained within local costs, which cannot be reduced in line with short-term withdrawals in funding. Rather than promoting effective long-term commissioning relationships, which are open and co-operative, the reforms threaten to drive a wedge between commissioners and their local providers.

Instead of reducing negotiating disputes, the measures seem to guarantee protracted and acrimonious dissent on the immediate impact of funding withdrawal and its wider destabilising effects on the local health economy. Taking resources from poorly performing trusts is unlikely to improve their performance and may impair their ability to plan and deliver services at all.

Financial penalties, in the context of staff scarcity nationwide, are likely to worsen problems with recruitment and retention of high-calibre personnel, especially when the less stressful working conditions of the new treatment centres are considered.¹⁴ Many PCTs currently face very large budget deficits, a situation that requires close and transparent working with local providers to produce financial recovery plans for the local health economy. But the financial reforms threaten to undermine the spirit of close collaboration built up as part of this process.

According to the Department of Health ‘innovative commissioners will wish to commission…from alternative providers’ and ‘it is vital for PCTs to plan in advance commissioning from alternative providers’ just in case of local underperformance. So it is an unfortunate irony that, having legislated to make co-operation between NHS bodies mandatory (Health Act 1999 ss 27, 28), New Labour is now mandating adversarial relationships.

Second, the proposed changes are likely to provide incentives for hospital managers to focus on financial risk, rather than clinical risk. The reforms mean that any hospital that is not on course to meet its planned activity target will suffer the certain sanction of financial penalties. In other words, the probability of financial loss in the event of underperformance is 100 per cent. If hospital workloads increase to avoid underperformance, then staff fatigue, equipment failure and other factors that contribute to clinical error will increase, but the risk associated with these is much less immediate and quantifiable.

The fact that trusts pay different levels of insurance premium under the clinical negligence scheme, which reflects the varying extent to which they prioritise clinical risk management, suggests some trusts do not give this area the priority it deserves. The reforms provide further incentives to prioritise financial, over clinical, risk management, yet it is tacitly assumed that external clinical governance reviews will negate this incentive.

Third, experience of GP fundholding suggests that, in practice, most patients will choose to attend their local hospital,¹⁵ so the impact of the 2005 changes on hospital activity will be minimal. If so, then the use of these changes to justify financial reforms is questionable. If, however, patients opt in large numbers to travel further afield for faster access, then the task for PCT commissioners and trusts of agreeing activity prospectively (as opposed to the retrospective reimbursement for out-of-area treatments currently in place) and what the DoH calls ‘whole systems planning’ will be made much more difficult.

The situation is exacerbated by the fact that high-cost providers with short waiting lists may see little benefit in treating additional cases that lengthen lists if reimbursement is made according to a standard national tariff that inadequately compensates them for their efforts. While patient choice is to be promoted for elective care, patients admitted on an emergency basis would have no such choice.

Indeed, the large-scale diversion of elective cases to the new treatment centres and to the private sector will leave existing district general hospitals with a pattern of services that is historically unprecedented in the UK, and may prove barely viable.

Beware unintended consequences

A recurring feature of NHS policy making is the apparent failure to appreciate that system reforms have unintended consequences. Policy documents are filled with statements about desirable outcomes, but it would be more useful to consider the likely consequences, however undesirable they might appear.

Transaction costs may increase rather than decrease as PCT commissioners and hospital managers grapple with the need to fund diverse providers, balance the budgets at local providers and meet increasingly demanding waiting list targets. It does not take a huge leap of imagination to predict that relationships between PCTs and NHS trusts will worsen.

Despite initial expectations, the so-called ‘internal market’ of the 1990s did not lead to major changes in patterns of patient or financial flow, but in the case of the present reforms there seem to be mechanisms to ensure that such changes do occur. And the routine pluralisation of NHS provision to include private sector providers and foundation trusts outside government control is a step towards an NHS that is publicly financed but increasingly privately provided.

Such a trend would be difficult to reverse. The proposed foundation trusts have given rise to a good deal of opposition. Yet it is the proposed reforms of financial flows, rather than a few high-profile hospitals, that will radically change the character of the NHS. Karl Marx famously remarked upon the tendency of history to repeat itself, the first time as tragedy, the second time as farce. The reintroduction of market principles to the NHS may be a case of farce followed by tragedy.