Section 22 Reports
Item 3 is a briefing from the Auditor General and his team on section 22 reports on a number of NHS boards.
Barbara Hurst (Audit Scotland):
There are section 22 reports on the 2004-05 accounts of five NHS boards. The reasons for undertaking section 22 reports vary between the boards.
Both Argyll and Clyde NHS Board and Lanarkshire NHS Board were the subjects of section 22 reports last year. I am sure that committee members remember taking evidence from NHS Argyll and Clyde. The board acknowledged then that it would not achieve in-year balance until 2007-08 and that clearing the cumulative deficit would be a significant challenge for it. The Minister for Health and Community Care then announced the planned dissolution of the board and said that the cumulative deficit would be cleared when the services were taken over by NHS Greater Glasgow and NHS Highland. The latest section 22 report updates NHS Argyll and Clyde's position and shows that although it is still in deficit by just under £59.5 million, its position at the end of 2004-05 was slightly better than that forecast in its financial recovery plan.
Lanarkshire NHS Board also has a large brought-forward deficit from previous years of just under £20.5 million. During 2004-5, the board managed to make a small in-year saving by making savings and taking other measures totalling around £48.4 million, although £38.3 million of those savings and measures were non-recurring. The board forecasts the elimination of its underlying recurrent deficit by 2007-08, but that depends on the sale of a surplus hospital.
Grampian NHS Board's deficit rose over the past two financial years from £4.8 million in 2003-04 to just under £11 million in 2004-05. The board's financial recovery plan does not show recurring in-year balance until the end of 2006-07, with the elimination of the cumulative deficit largely dependent on the sale of assets totalling some £28 million.
Western Isles NHS Board has a section 22 report for two reasons. First, it has a deficit this year of just under £750,000. Although that sounds relatively small, for that board it is as significant a percentage of revenue resource limit as NHS Grampian's deficit is for it. Like NHS Lanarkshire, the Western Isles NHS Board does not forecast elimination of the deficit until 2007-08. The other reason why the Western Isles NHS Board has a section 22 report is that its accounts were qualified in 2004-05 because the board did not comply with European Community procurement regulations.
The section 22 report for the Highland NHS Board is to do with a different issue. It is very similar to an issue that the committee discussed in relation to Kilmarnock prison in 2002. It concerns the accounting treatment of an asset under a private finance initiative, in this instance a primary care resource centre. At present, the asset does not sit on the balance sheet of the board or of the contractor. The auditor's view is that the asset should be on the board's balance sheet, because the risks are substantially with the board. The auditor qualified the accounts for that reason. The board and the auditor are in discussion on how to deal with the matter in future.
We will be publishing an annual overview report on the health service in December. All those issues will be picked up in the wider context of the financial performance of the health service as a whole. In the meantime, we are happy to answer any questions that you may have on the section 22 reports.
What is Audit Scotland's thinking on boards such as Grampian, and Argyll and Clyde, which made savings in non-recurring areas that do not address the issues that will continue to affect them after they are back into financial balance? If those boards use assets to get themselves back into the black without addressing recurring issues, are we just letting them earn another section 22 report later?
We share your concerns about the use of non-recurring savings if costs are not looked at properly so that savings are made on a recurring basis. We will be going into that in more detail in the overview report.
The issue of the PFI in NHS Highland seems odd to me for two reasons: first, there is no standard practice; secondly, the recommendation is that the risk should lie with the board. I thought that the point of the PFI was that that would not happen.
I will kick off on this, although I am not an expert on the technicalities of the PFI. Each of our appointed auditors, when faced with a PFI issue, looks very closely at the assumptions that are made about where the risk lies. Judgment is made case by case. Because the auditor is able to comment only on treatment by the board, not on treatment by the contractor, we might get some variations in interpretation.
Caroline Gardner (Audit Scotland):
I should add that we are not recommending that the risk should sit with the board. That is the auditor's interpretation of the contract; the auditor thinks that, in practice, the risk lies more with the board than it does with the contractor and that, therefore, the asset should be on the board's accounts. That is the reason for the qualification.
Like Eleanor Scott, I was surprised by this part of the report. I try to have a naive view of the PFI, because if I had anything else, I would be completely lost. Indeed, from what you have said, it appears that experienced auditors are also lost, with different people reaching different opinions on this important issue.
Could we not suggest some common practice or best advice to boards before they sign such contracts and enter into such situations? That might allow us to level the playing field a little bit and to find out where the risk will lie. After all, the PFI is being sold to the public on the basis that risk will be transferred from public bodies to the private sector and that that is why we might sometimes have to pay over the odds for those services. If that risk is not transferred, what is the benefit of such an approach?
Of course, we should avoid mentioning any policy issues.
Okay. In that case, I ask the Auditor General whether we could progress this matter by coming up with helpful guidance for boards on common practice or on ways in which they can take this matter forward.
I will take a first stab at that question.
The Treasury and organisations such as Partnerships UK have already produced a fair amount of guidance to all public bodies on the construction of PFI deals. I should note two points in that respect. First, decisions on where the risk lies are very often not all that clear cut. As a result, each contract might contain clauses that set out how payment goes from—in this case—the health board to the contractor that provides the hospital and when that income will not be paid. Such clauses depend on a number of factors including availability of the service and breakdown of facilities that, together, lead to a judgment on whether the risk lies primarily with the contractor or with the health board.
Secondly, when this specific deal was closed in 2003, the contractor accepted, after discussions with the trust at the time, its advisers and the auditor, that the asset would sit on its balance sheet. The auditor accepted that position in order to avoid the asset being on both balance sheets. However, since the original agreement was reached two years ago, the situation has changed; the resource centre has opened and the contractor has not placed the asset on its balance sheet. That has brought the matter to our attention this time round.
Bob Black might want to say a little more on whether there is a role for more guidance, but I must stress that the problem lies not with the availability of guidance but with the difficulty of interpreting where the asset sits in each PFI deal. After all, each deal tends to be different, sometimes for good reasons and sometimes as a reflection of negotiations that have taken place.
Could—indeed, should—the contract not include a clause that stipulates the balance sheet on which the asset should sit?
Although agreement was reached on the matter at the time, it did not form part of the contract. Indeed, it might be worth taking a closer look at that to see whether such agreements can be made more binding. That said, accounting treatment has to reflect the realities of the situation as they come into being in fact rather than as they were agreed in principle in the first place.
If we go back to first principles, the purpose of a PFI contract is not to transfer an asset off the public sector balance sheet but to provide a vehicle that gives best value for money to the public sector in delivering a service. The accounting treatment is a consequence, not a criterion, of determining a PFI. We expect the appointed auditors to monitor the deals, as they have been planning to do quite carefully, and to provide an independent assurance that the planning procedures are being competently undertaken and that, before a contract is signed up to, proper arrangements have been put in place so that the purchasing body is satisfied that it is getting value for money. The accounting treatment of the asset follows as a consequence of that, and it is quite a separate issue.
The fact that a particular PFI project is on or off the public sector balance sheet is not strictly relevant to the question of value for money. As Caroline Gardner has said, a lot of guidance is available from the Treasury and elsewhere about the considerations that the management of a public body must take into account when it is determining the accounting treatment.
As Caroline Gardner has outlined, in this case the auditor had doubts on the basis of the limited evidence that was available as to whether a sufficient degree of risk had been transferred for the asset to appear on the balance sheet of the provider body. It has subsequently emerged that the provider is taking a clear view that the risk resides mainly with the health board. It is as a consequence of that that we find ourselves in the current position.
The question that I had intended to ask was on the change of liability. You have answered on most aspects of that, but I would also like to know whether it is unusual for it to be suggested to begin with that the liability rests with one party, but for that to change and for the liability to rest with another party later. That would cause us some concern when it comes to the development of contracts. There is an uncertainty there.
It is fair to say that we are talking about a minority of cases, but it is not unknown for that to happen. There are two points that must be borne in mind. First, many of the issues that are arising now—albeit not the present one—about the balance-sheet treatment of assets that were procured or created under a PFI relate to contracts that were entered into quite a number of years ago. There has since been a steady process of learning and development, and people are getting better at it.
Secondly, and particularly in relation to some of the larger, more complex projects, as experience develops in providing the service that the asset supports, the view of where the risk lies might change. One significant manifestation of that relates to some of the refinancing deals for major PFI contracts that are now coming through. Originally, when the asset was being constructed, the cost of money was very high, because of the high risk premium. Under refinancing, as the market becomes generally more confident about how the services are being delivered, the risk premium is reduced, so the situation stabilises somewhat. In a sense, the assessment of the level of risk and where it lies changes somewhat. It is therefore possible to refinance and obtain cheaper money. One of the current issues is to ensure that a new deal is entered into. If there is refinancing, the public sector payer sees some of the benefit. There has been a significant development and refinement of thinking in that area over the past few years.
You have already said that you think that there is quite a lot of guidance on PFI contracts, structures and so on. Is there sufficient guidance on that changing process?
There has certainly been a great deal of guidance. I think that the industry understands the issue very well now.
I would like to ask a question on the same issue. Is it possible that accountancy treatment of contracts could change in future, because the Treasury may decide that the treatment by which it works should be updated or is not accurate enough? Might that result in some contracts being brought on to the balance sheet that were previously off the balance sheet?
I am struggling to think of any situations where that could be the case, because the accounting standards that the profession applies are based, as Bob Black said, on reflecting the substance of the deal that is in place, so that the person who holds the risk holds the asset on their balance sheet. You will be aware that, in the early days of the PFI, much of the controversy was about how that decision was being made, but the principle itself still holds and it would require a change in global accounting standards to bring that change about, which looks unlikely.
Thank you. That is helpful. There are no other questions on the section 22 reports, so I thank Barbara Hurst for her briefing and I thank the Auditor General and Caroline Gardner for answering our questions.