Section 22 Reports
Agenda item 2 is a briefing from the Auditor General for Scotland on two section 22 reports, "Scottish Executive Consolidated Resource Accounts" for 2004-05 and "The 2004-05 Audit of the NHS Pension Scheme Scotland Accounts". I invite the Auditor General to brief the committee.
Mr Robert Black (Auditor General for Scotland):
I am able to report on the conclusion of the 2004-05 audit of the Scottish Executive consolidated resource accounts earlier this year thanks to the good work undertaken within the Scottish Executive and by the Audit Scotland team. If you do not mind, convener, I simply record my appreciation of that. Much effort has been put in this year to reach this position.
I have submitted two reports under section 22 of the Public Finance and Accountability (Scotland) Act 2000. One relates to the Scottish Executive consolidated resource accounts for 2004-05 and the second is a report on the accounts of the national health service pension scheme for 2004-05. I will take each in turn.
First, the Scottish Executive consolidated resource accounts relate to the activities of the seven core Executive departments, the Crown Office and Procurator Fiscal Service, all 13 executive agencies and all NHS bodies in Scotland. I have qualified the resource accounts of the Scottish Executive for the past financial year on the regularity of expenditure. That is because the resources used by the Scottish Executive Development Department and the Health Department exceeded the limits authorised by the Budget (Scotland) Act 2004 and by amendments to that act. I have also decided to mention in the same report two other matters: a ministerial written authority that was issued during the year to an accountable officer; and the buyout of the Skye bridge private finance initiative contract.
I turn first to the qualified opinion on the regularity of expenditure of the Scottish Executive Development Department. In 2004-05, the Development Department provided funding for the early repayment of Scottish Homes' outstanding loans to the national loans fund. When the autumn budget revision to the Budget (Scotland) Act 2004 was being compiled, the department provided for the interest and early redemption premium, but not for the early repayment of the principal. The principal was £101 million.
At the time, the Scottish Executive considered that provision in the budget for the early repayment of principal was not required. It was of that view because the grant in respect of the principal repayment was to be funded from a balance in the Scottish consolidated fund. The Scottish Executive now accepts that the early repayment of principal also represented a use of resources. As a result, the Development Department's use of resources for 2004-05 exceeded the total provision in the Budget (Scotland) Act 2004 and subsequent amendments by £68 million, and that excess expenditure must be deemed to be irregular.
The second issue is the qualified opinion on the regularity of expenditure of the Health Department. The remaining 18 NHS trusts were dissolved at the end of 2003-04, and on 1 April 2004 their assets and functions were transferred to their local NHS boards. Prior to that, NHS trusts paid their capital charges to the Scottish Executive Health Department, and the funding of the boards included an element to allow trusts to repay capital charges to the department. After the dissolution of the trusts, there was no longer any requirement to pay those charges to the department.
The Health Department recognised that it had to consider the effect of the dissolution of the trusts and of the removal of the circular flow of capital charges income in its 2004-05 budget, and the auditors had also advised the department to make provision in the Budget (Scotland) Bill for 2004-05 for the loss of capital charges income arising from the dissolution of the trusts—that is, income coming back from the trusts to the boards. It appears that the Health Department considered the effect of the dissolution but came to the incorrect conclusion regarding the resource impact of the loss of income relating to the cost of capital and depreciation charges. Consequently, funds were over-allocated to the NHS. As a result, the Health Department's use of resources for 2004-05 exceeded the total provision in the Budget (Scotland) Act 2004 and subsequent amendments by £32 million, and that expenditure must be deemed to be irregular.
In my report, I have also taken the opportunity to mention the Ballycastle to Campbeltown ferry service. In March 2005, the Scottish Executive, together with the Northern Ireland Executive, announced that it would offer a contract to provide a passenger and vehicle ferry service between Ballycastle and Campbeltown. The invitation to tender was issued in September 2005, and it proposed a five-year contract with a maximum annual subsidy of £1 million and the option to add other routes around the subsidised service.
A previous tender exercise in 2002 offered the same subsidy but failed to find any bidders. At that time, back in 2002, the head of the Scottish Executive Development Department, who is the accountable officer, asked for written authority from the minister to proceed with the tendering. Accountable officers, as I am sure the committee will recall, have a duty to ensure that best value is sought from the use of resources, and they must obtain written instructions from the relevant minister if they consider that any action that they require to take is inconsistent with the proper performance of their duties. In this case, the request for written authority was the result of analysis by consultants, indicating that the subsidy on offer exceeded the expected economic benefits and so did not represent value for money.
In March this year, the head of department sought similar written authority to proceed with the tendering exercise for the same reasons. The Scottish ministers issued that authority on 31 March 2005. I emphasise to the committee that no expenditure has been incurred to date. The Scottish Executive is obliged to advise me when written authority has been sought and granted. I feel that it is appropriate to alert the committee to that, because the issue is potentially significant. I bring the matter to the attention of the Parliament because written authority has been issued. I will, of course, monitor progress in awarding the service.
The final item that I mention in my report is the buyout of the Skye bridge PFI contract. In December 2004, Scottish ministers and Skye Bridge Ltd reached an agreement to end the collection of tolls on the Skye bridge in return for a lump sum termination payment to Skye Bridge Ltd. That met a policy commitment given in 2003. The Scottish Executive was required by Treasury guidance to negotiate a termination payment that left Skye Bridge Ltd in a similar financial position to the position in which it would have found itself had the contract run its full course. In other words, there had to be no detriment to the company.
The Scottish Executive obtained financial advice on the cost of the options for terminating the concession agreement. The option chosen was to negotiate a voluntary compensation package with Skye Bridge Ltd. The eventual agreed compensation of £26.7 million was at the upper end of the £21 million to £27 million range that the Scottish Executive's advisers had deemed to be reasonable.
The cost of that option was less than the estimated cost to users of allowing tolls to continue, which would have been £38 million. The important point is that after allowing for the taxes that Skye Bridge Ltd would have paid to the United Kingdom Exchequer had it continued to operate, the net cost to public funds and users was neutral whether the tolls had continued or the buyout went ahead. It was the first buyout of a PFI contract in the United Kingdom. I will, of course, continue to monitor significant PFI contracts.
That concludes my comments on the first report. Do you wish me to continue with the second one or pause at this point?
Carry on.
My second report relates to the NHS pension scheme Scotland accounts 2004-05. The auditor's report on the regularity of expenditure is qualified because the use of resources by the scheme exceeds the limits authorised by the Budget (Scotland) Act 2004. The issue comes about because of a problem that arose in the actuarial valuation of the scheme.
Both NHS staff and their employers contribute to the NHS superannuation scheme, which is a defined benefit scheme linked to final salary. Its future liabilities are not funded through investments. In other words, it is a pay-as-you-go scheme, which relies on regular contributions and Government grant to meet pension liabilities as they fall due.
The scheme is administered by the Scottish Public Pensions Agency. The auditor qualified the accounts of the scheme for 2003-04—a prior financial year—because the scheme actuary, which is the Government Actuary's Department, had not completed a statutory actuarial revaluation as at 31 March 1999, when it was due to occur, because of incomplete data. The actuary produced a resource accounting valuation in July 2005, which assessed the scheme liability at 31 March 2005 at £12.7 billion. That is an increase of £4.6 billion on the liability that appears in the 2003-04 accounts.
The increase arises from a misstatement in the estimation of past service liability provided by the GAD in its valuation of the liability at 31 March 1999, when the revaluation was due. That valuation, which was carried out in August 2000, was based on the earlier full statutory funding valuation in 1994. That was updated from 1994 to 1999 to reflect known changes that occurred in that period. Since some data continued to be unavailable, the liability in the 2003-04 accounts was based on the 1999 estimate—the 1999 estimate was flawed and it was rolled forward. The 2003-04 accounts wrongly state the scheme liability at £8.1 billion when it should have been £11.6 billion.
The 2004-05 accounts, on which I am currently reporting, reflect the amended valuation. The level of liability recorded in the prior year 2003-04 has been restated in the 2004-05 accounts and a prior year adjustment is also disclosed in those accounts to reflect the increase in the resources required to meet notional interest charges applied to the liability.
The Budget (Scotland) Act 2004 set a resource budget for 2004-05 for the scheme of £561 million. However, the impact of applying the restated valuation figure to the accounts for 2003-04 and 2004-05 is to increase notional interest charges. That results in an outturn for 2004-05 of £1,404 million, which is £843 million in excess of the 2004 act provision. Therefore, the auditor has qualified the opinion on the regularity of expenditure because, without parliamentary approval, the overspend must be deemed to be irregular.
I emphasise that the increased liability reflected in the 2004-05 accounts, which I have just mentioned, will have no immediate effect on the level of funding available to deliver health services. Health boards contribute to the scheme through the contributions that they make as employers. Contribution levels were increased in 2003-04 to reflect a new calculation methodology and to take account of the increased lifespan of scheme members. Future contribution levels will be assessed regularly by the Government Actuary's Department.
Thank you.
Do members have any questions? I would prefer it if we could take questions in the order of the briefings. Are there questions on the expenditure by the Development Department or the Health Department?
I will ask a question on both, for the benefit of the record. Is there any requirement for retrospective parliamentary approval for the expenditure that had not been given prior parliamentary approval?
No. That is not required, neither is there any direct implication for service delivery. These are purely and simply accounting adjustments.
Are there questions on the Ballycastle to Campbeltown ferry service or on the buyout of the Skye bridge PFI?
I have a general point that picks up on the Auditor General's final comment about this being the first buyout of a PFI contract in the UK. It took quite a long time to get to this negotiated position, which the Auditor General said was at "the upper end" of the range of what was seen as being reasonable. Can lessons be learned from the negotiations?
One principal lesson that may be worth mentioning is covered in paragraph 12 of my report, on the original contract. It states:
"The 1991 contract between the Secretary of State and Skye Bridge Ltd did not enable the Scottish Executive to terminate the Concession Agreement as of right. A right of termination subject to defined compensation is now standard for PFI contracts."
Therefore, a significant lesson has been learned as a result of the early experience, and it would be reasonable to suggest that if there was a desire to buy out PFI contracts in future, it would be less complicated and the public interest would be better safeguarded because a right of termination will have been properly incorporated in the individual accounts. That is a significant development since that early PFI deal—it was one of the first PFI deals in Britain—was concluded.
Do we know how many and what other contracts were signed before the change was made, in which that right was not included as standard?
I do not think that we have that information.
From our previous meetings and reports, you will be aware of our interest in West Lothian College and its on-going negotiations with the Scottish Further and Higher Education Funding Council about the possibility of buying out its PFI contract. Might any aspects of this case have a bearing on those negotiations?
Audit Scotland is monitoring the situation. I wonder whether Arwel Roberts can help.
Arwel Roberts (Audit Scotland):
The consultants have not yet reported back, so the funding council has not reached a decision on how to deal with the situation.
We now move to questions on the section 22 report on the NHS pension scheme accounts.
Have there been discussions with the Government Actuary's Department to ensure that it complies with its statutory obligation to produce its actuarial report on time?
We have not had any such discussions. I wonder whether the Audit Scotland team can comment further on the matter.
The department was unable to comply with what was expected of it at the time because of the shortage of available information. It has told us that it usually complies with its statutory obligation, and I see no reason to disagree with that.
Will the significant increases in the salary levels of consultants and general practitioners impact on the scheme's future liability? How will any such liability be met?
Salary levels always have an impact on pension liabilities.
But these are significant increases.
The information on pensions was revised according to individual length of service. The revision was not necessarily linked to salary levels, although they will have a knock-on effect. [Interruption.]
There appears to be an electronic mouse in the room.
Auditor General, you said that there would be no immediate effect on health service funding. However, that suggests that there might be an impact later on. Will you comment further on that?
Any such impact—and there will be one—will come through the periodic reassessment of contributions that have to be made. It is impossible for me to indicate how those will move in future.
An excess £843 million was required to cover the underestimated valuation. However, you said that contribution levels had been increased. Will the increase cover that excess, or does a gap have to be filled elsewhere?
Caroline Gardner (Audit Scotland):
The increase in contribution levels was the result of a separate exercise and reflected the fact that, like all of us, members of the scheme are living longer. It appears that, from the re-evaluation of the scheme's liabilities, which is built into the process and takes place regularly, contribution levels are likely to be increased. Indeed, any such re-evaluation could affect employees and employers who are registered in the scheme, but a future catch-up exercise would cover the scheme's liabilities.
You are saying that, as it is a pay-as-you-go scheme, the costs will have to be met at some point. However, they can be met by increased contributions from staff and employers.
That is the usual way of dealing with such situations. In any case, the reassessment of the contribution levels that are needed to match the current estimate of liabilities takes place periodically.
In a project that we have initiated under the banner heading of "How Government Works", we are examining all the public sector pension arrangements in Scotland. In the course of 2006, we will submit to the committee a report on that project, which might help to fill in the context.
That will be very interesting.
I was about to ask a question on comparisons with other public sector workers. We have visitors with us from Wales. Does the situation affect only health workers in Scotland or does it also affect health workers elsewhere in the UK?
This particular liability was increased because of a misstatement in the information available to the actuary in Scotland. For that reason, the adjustment relates only to the Scottish situation.
The final sentence of the section 22 report says:
"Future contribution levels will be assessed on a regular basis".
What is meant by "regular basis"?
Normally, re-evaluations take place every five years, so we expect the next one to happen in five years' time.
Given ever-changing circumstances in the health service and other public sector services, is five years between re-evaluations sufficient?
I am not qualified to comment on that question, because actuarial matters are highly specialised. However, in general, movements in longevity and so on happen over fairly long periods, which means that their short-term impact is quite minor. I am sure that, for that reason, much thought has gone into the five-year review period. Generally speaking, such a period is accepted as being appropriate.
As members have no further questions, I thank the Auditor General for speaking to those section 22 reports. The committee will discuss its approach to them under agenda item 6.