NHS funding boost: the need to manage expectations

Long read: Ahead of Monday’s Budget, Sally Gainsbury takes an in-depth view at this summer’s announcement that the NHS in England is to get an extra £20.5 billion a year by 2023/24. Just how far will it take the health service?

Blog post

Published: 26/10/2018

When the Chancellor stands up next week to deliver his Budget, many could be forgiven for believing the NHS’s fortunes have already been settled. After all, the Prime Minister used the health service’s 70th anniversary celebrations over the summer to announce an apparent bumper birthday present, pledging to increase the NHS’s budget by an extra £20.5 billion real terms above the 2018/19 level by 2023/24.

That would be equivalent to 3.4% real terms extra funding a year – a significant sum after eight years of austerity, which does not compare too unfavourably to a fairly widespread consensus that annual real terms increases in the order of 4% a year are needed to put the NHS on a sustainable footing.

But the NHS would be wise to hang onto the receipt for this particular birthday present. The pledge applies only to NHS England’s budget – representing what the Treasury like to think of as ‘frontline’ spending. There’s another £17 billion or so of spending in the Department of Health and Social Care’s budget outside of the NHS England ringfence that covers apparently less worthy elements of NHS spending, including public health, training for frontline clinicians and capital investment (for frontline infrastructure such as hospitals and scanners).

If those remaining budgets were frozen in real terms, the funding announcement would represent an overall real terms increase to NHS spending as a whole of around 3%. And if they were cut in cash terms – as they were following the 2015 spending review – then the overall real terms growth would be reduced further still.

All eyes then on what Monday’s red book has to say about the DSC’s full departmental expenditure limits for capital and revenue spending from 2019/20 onwards.

But what of that 3.4% extra for ‘frontline’ spending? Even if we pretended for a minute that real terms cuts or freezes to other parts of the health budget do not ultimately translate into additional burdens (and thereby stealth cuts) for the more obviously ‘frontline’ parts of the health service: how far will the extra 3.4% take the NHS?

Under water

It is traditional and correct here to point out that the £20.5 billion of extra funding by 2023/24 is being added to a system that is currently under water. It is a point worth repeating, not just because it is true, but because to some – perhaps those in the Treasury included – it is not immediately apparent.

After all, both the Department of Health and the NHS as a whole are still, just about, managing to balance the books. We hear a lot about huge deficits among NHS providers – in the region of £1 billion reported in their accounts, and an underlying £4.3 billion annual shortfall now formally recognised by their regulator NHS Improvement. But one way or another, those deficits are smoothed out at the year end to create a system balance – most significantly in recent years by NHS commissioners making a surplus large enough to offset the reported deficit in provider accounts, while massaging away a significant part of the additional underlying deficit through one-off bungs.

We will look a little further at those offsetting numbers shortly. However, there is another reason the NHS has maintained an apparent system-wide balance, which is its ability to release financial pressure through certain safety valves. But these aren’t a neat series of pristine, glistening stainless steel valves, reminiscent of a Bazalgette steam engine. They are instead ugly, oozing makeshift valves, contaminating the entire system with their polluting backflow.

They are made up of areas of spend such as elective surgery, where pressure has been released by allowing the waiting time target to be systematically missed for well over two years, so hospitals can focus their insufficient capacity and resources on emergency patients who literally cannot wait. Then there is putting off regular maintenance, allowing buildings and equipment to fall into disrepair to the point where, by the end of 2016/17, the official estimate of the backlog in maintenance and repairs stood at £5.5 billion. Perhaps most significantly in terms of massaging the apparent financial balance has been the diversion over the last three years of the vast bulk of the £7.9 billion in funding – intended for investment in transforming primary and community care into the vision set out in the Five Year Forward View – to instead plug deficits in the chronically underfunded acute sector.

Releasing financial pressure (aka not spending money) through those safety valves has allowed the NHS to report an apparent system-wide financial balance to date. And it is the concomitant dilapidation in physical condition and service quality that NHS staff and patients are thinking of when they describe the status quo system today as ‘under water’.

This means that the NHS into which the extra £20.5 billion is being added – the status quo we have today – is far from where it wanted or was supposed to be. Waiting times significantly below the NHS Constitution standard; providers operating out of neglected buildings and with poorly maintained equipment; and the Forward View ambition of a boosted primary and community care sector severely undermined.

The extra funding will be able to make good on some of this, given time. But before it can do that, the first call on the £6 billion or so more cash the NHS will receive each year will simply be funding the recurrent cost of the status quo level of service we already have, to a growing number of patients amid inevitably rising prices. It is only what is left after that has been rolled forward that will be available for investment in fixing past neglect or developing and then funding, on a recurrent basis, new or transformed services.

And before we can know how much is left, we first need to know how much the status quo already costs and will cost going forward, as the population grows and costs rise in line with inflation.

Baseline spending

A quick look at NHS England’s accounts for 2017/18 show it ended the year with a cash surplus of £970 million against its budget of £109.5 billion. That sounds fairly healthy, until we remember that NHS England represents a system – or health economy – not just an individual organisation. In system or health economy terms, NHS England was absolutely required to produce a surplus that year in order to offset (and effectively fund, at the level of the government’s budget) the £986 million deficit expected and duly reported by their main trading partners, the hospitals and health services collectively known as NHS providers.

At the NHS England health economy level then, the reported NHS provider deficit completely wiped out the reported ‘surplus’ in NHS England’s financial reports.

But things were actually substantially worse than that straight zero balance would suggest. As NHS England’s financial reports make clear, it only managed to offset the provider deficit by pulling off significant non-recurrent savings to its central budgets and running costs – saving in the region of £500 million.

We then have to consider what NHS England’s budget bought in 2017/18, or rather: what it didn’t buy. 2017/18 saw another further deterioration in elective waiting times as deficit-laden hospitals were forced to cancel planned operations to prioritise their insufficient resources on emergency patients.

As hospitals and other providers are generally only paid for the patients they treat, the 200,000 patient increase to the waiting list and almost 3 percentage point further drop in the proportion of patients seen within 18 weeks effectively saved NHS England money. That was £500 million according to NHS Improvement’s analysis of lost, or missed, income to providers – a figure corroborated in analysis by waiting times expert Rob Findlay.

As we want to know how much it would cost to keep existing standards – rather than slipping further backwards – we need to factor the £500 million ‘saving’ to NHS England brought by further waiting time deterioration back into our baseline spend. It’s basically what the NHS would have spent in 2017/18 if waiting times had just stagnated at 2016/17 levels, rather than worsened further.  

Putting each of those factors together suggests that the real recurrent cost of maintaining the ‘frontline’ NHS status quo in 2017/18 was around £110.5 billion – against its budget for the year of £109.5 billion. That £110.5 billion is our baseline spend that now needs to be rolled forward, as we assess what additional recurrent spending pressures might be brought by demographic change and inflation.

NHS demand and inflation

To project likely future demand on the health service, we can take NHS England’s central forecast, which is for overall NHS activity to increase by around 3.1% a year – using around £3.5 billion worth of the extra £6 billion cash a year in one go in 2019/20. That’s the cost of the extra patients that will need treating each year, assuming they access services at the same rate (and waiting times) and quality as currently.

The more complicated task is working out how inflation will add to the cost of treating each of those extra patients.

NHS Improvement periodically sets out its projections for inflation in the NHS based on its assessment of price changes in the specific basket of goods it consumes. While the most recent of those projections, dated March 2016, has proved to understate the actual level of inflation experienced by NHS organisations, we can nevertheless use its 2% a year assumption for this year and next as the starting point for our analysis here.

That 2% figure does need to be adjusted, however, as it predates the government’s offer earlier this year to lift the 1% cap on NHS staff pay increases – a move that will significantly increase salary costs (and therefore cost inflation) for NHS organisations, and other providers who will be expected to match NHS pay rates, such as GP practices and private operators, from this financial year onwards.

For medical staff – making up on average around a sixth of a typical NHS trust’s cost base – cost of living pay rises will now average 2% a year (up from 1% under the cap). For clinical and administrative staff under the Agenda for Change (AfC) contract (making up almost half of the total cost base of a typical NHS trust), a new pay deal involves a combination of both annual cost-of-living increases of up to 3% a year, and a substantial change to how staff progress up their pay scales as they gain more experience.

The changes to the AfC contract are designed in part to redress recruitment and retention difficulties among clinical staff. And, in so doing, offers staff the chance to progress up their pay scales much quicker, or at least in larger steps.

Pay drift uncertainty

This aspect of the deal makes it hard to predict what the overall impact on the pay bill will be. If it is successful, the early years of implementation will see the pay bill increase at a significantly faster pace than the headline cost of living increases, as staff are motivated to stay and move up their increments, rather than leave and be replaced by cheaper staff lower down the pay scale.

This additional pressure on the NHS wage bill, above cost of living increases, is called ‘pay drift’. In the recent past, NHS Improvement has estimated pay drift to add a further 0.6% to the pay bill (around 0.4% to total NHS costs, or around £400 million).

Applied to the headline pay settlements for NHS staff over the next three years, that would increase overall annual inflation from the original 2% predicted to just over 3% in 2018/19, and to 2.5% the years after. That would mean overall annual cost increases in cash terms of around £3.5 billion a year, on top of the £3.5 billion driven by forecast increases in activity.

In other words: the NHS will have more than spent the extra £6 billion cash awarded it a year, simply by carrying on providing the services it does today and without doing anything to improve care quality or access. Worse than that, as the impact of an annual funding shortfall was compounded with each passing year, the NHS would be around £4 billion in deficit by 2020/21, despite the extra funding.

There is a chance, however, that the new AfC deal will motivate more staff to stay and move up their pay scales than has been the case in recent years. That could result in pay drift being higher than the 0.6% experienced over the last decade or so.

Local modelling from one of the largest providers in England suggests drift could be as high as an additional 1% of the AfC pay bill. That could increase costs by a further £500 million a year across the NHS as a whole, increasing the deficit to over £5.5 billion by 2020/21.

The graph below sets out what spending would look like under each of these scenarios. It’s enough to make us all want to go home: an annual funding gap of between £7 billion and £10 billion by the end of the funding settlement period in 2023/24.

All is not lost, however, as the graph does not factor in the single most important assumption we must make about the government’s pledge of £6 billion extra cash a year for the NHS. That is that the NHS will continue to absorb at least the first 2% of any inflationary pressure it faces through its own efficiencies. Without that assumption, the basic maths of the funding settlement cannot work: 5% extra cash a year against 6% combined inflation and demand pressure, before you can even think about any investment in improving, updating and modernising the service – it just cannot work.

Two per cent efficiency a year is worth around £2.5 billion a year to the NHS England health economy.

That takes the extra annual costs of maintaining the same level of service amid rising demand down to around £5 billion, resulting in an average nominal annual £1 billion or so worth of headroom out of the £6 billion-a-year cash settlement.

However, it will take a couple of years for that £1 billion to work through, due to the health economy entering this new phase with an underlying baseline spend £1 billion higher than the actual budget, and the impact of the AfC pay deal being at its highest in the earlier years. As the graph below illustrates, in 2019/20 the headroom could boil down to as little as £500 million after inflation and activity increases set out above have been funded.

From there on it will gradually rise (unless new service commitments are made, beyond the current level of service): to around £2 billion in 2020/21 and then £3.5 billion in 2021/22, but only if the NHS continues to make recurrent efficiencies savings in the region of £2.5 billion, year after year – the equivalent of over £15 billion between 2018/19 and 2023/24.

What’s left?

That £3.5 billion headroom in 2021/22 is worthy of note. It is roughly the size of the planned annual Transformation Fund the NHS was due to have at its disposal every year between 2016/17 to 2020/21 to invest in the service improvements and reform set out in the Five Year Forward View. In the event, however, annual cash increases to the rest of NHS England’s budget of just 2.8% meant the vast majority of the fund had to be spent instead on the day-to-day costs of keeping services going – most predominantly bailing out hospital deficits.

There is a lot of expectation riding on that £2 billion of headroom in 2020/21 and £3.5 billion in 2021/22. And, unlike the original transformation fund, the focus now is also on repairing and recovering the recent decline in performance and physical standards, rather than just investing in more modern modes of health care.

Indeed, in her speech unveiling the £20.5 billion, the Prime Minister made clear that one of the first priorities for improving on the status quo would be core performance targets such as elective waiting times.

But with estimates on the cost of clearing the backlog of elective waits varying between £2 billion and £4 billion (depending on the extra cost of the additional capacity hospitals will need to find, in the form of staff overtime and extra beds), the cost of restoring performance on waiting times alone could consume almost the entire available headroom in both 2020/21 and 2021/22.

But it’s not just all about elective waiting times – the competing wish list of improvements and recovery elsewhere is long. A&E capacity and waiting times, cancer treatment and survival rates, understaffing, access to primary care and mental health services – all of which are likely to require both one-off injections of cash to make good past neglect, and then additional recurrent funding increases to provide the services into the future – quickly eating into the apparent headroom shown in the graph above. Simply filling the estimated 7,000 gap in unfilled nursing and medical vacancies, for example, could increase annual expenditure by around £500 million a year.

Now the birthday celebrations are over, the problem for those now tasked with drafting the NHS’s next five or ten year plan is in managing patient, public and the NHS’s own expectations about what can be achieved (and when), with less money than many might think is the case.

Suggested citation

Gainsbury S (2018) “NHS funding boost: the need to manage expectations”, Nuffield Trust comment. https://www.nuffieldtrust.org.uk/news-item/nhs-funding-boost-the-need-to-manage-expectations