Reforming the finances of the NHS

It is a time of transition in NHS finance. The planned recovery from years of deficits and debts that plagued parts of the NHS in recent years has been hit by the enormity of the Covid-19 shock.

Alongside this planned recovery, the NHS has been moving away from its decades-long journey toward competition between individual organisations and using market-like approaches to improve performance, to a design based on collaboration and improving population health. Before the Covid-19 pandemic, the NHS was working to restore financial health and deliver on fundamental reform; now, it must achieve these objectives with the added challenge of recovering from the damage of Covid-19.

In this long read, we look at the history of NHS finances over recent years to draw out learning for this new design. It will be important to apply this learning if the system is to avoid the recurrent ‘resets’ to NHS finance that have been necessary but have only provided temporary solutions, and deliver a new approach that is consistent with the wider objectives of collaboration and integration. 

Many decisions about the design of the financial system are taken at national level. However, as key elements of the future NHS evolve – integrated care systems (ICSs), new provider collaboratives, new forms of contracting – many of these decisions are also being taken at a more local level. This long read hopes to help those making decisions, at all levels, about the new financial system. 

In summary, recent history provides four key lessons.

• Get the balance right: the centre needs to ensure that, broadly, the performance and finance ‘ask’ of the system are affordable. This will enable realistic plans to be developed at local level. Recent years have seen successive planning rounds around both finance and performance. Despite all the effort put into engaging with stakeholders and developing plans, these plans to restore financial and operational performance have often proved very short-lived. Yet in a system that has stepped away from the invisible hand of the market, these plans are the best way to agree priorities, monitor performance and hold systems and institutions to account. It is critical that future plans are clearly achievable and that everyone engaged in delivery is signed up.

• Be coherent and comprehensive: the approach to finance should be part and parcel of the overall direction for the system, both in its fundamentals (a publicly funded service that guarantees equal access) and in its latest priorities (supporting collaboration). This means resisting the temptation to impose yet more market-like incentives and concepts, particularly complex ones. 

• Support well-led institutions: the NHS is not a single entity but an interconnected system of many institutions. The wider system must be built from well-led organisations that are supported to thrive. As the health system moves towards a system-led approach, this shift must not undermine the fundamentals of well-run institutions.

• Resist zombie policies: there are a small number of finance policies that recur again and again, despite their poor track-record. 

  • Unfettered financial freedoms for the NHS: the NHS is a publicly funded system and fundamental attempts to move away from this reality (such as moving foundation trusts ‘off balance sheet’) won’t work. 

  • Moving away from equity-based allocations: financial allocations to clinical commissioning groups (CCGs) (and previously primary care trusts) are determined by a complex formula looking to ensure equal access to services across England. Attempts to move ‘off formula’ – for example, by including incentives, or attempts to ring-fence resources – have had little success. 

In this long read we focus on the revenue side of finance. This is not because we believe that the approach to capital finance is settled. Rather, there are clearly similar arguments and issues around capital finance and these have grown in importance over time, not least given the prominence of new hospital building within the government’s manifesto. However, capital has its own complexities and is worth considering separately.

Get the balance right

The onset of austerity in 2010 clearly posed a challenge to NHS finances yet, at least at the start, there was a plan to meet this challenge: the Quality, Innovation, Productivity and Prevention programme (QIPP). On balance, it is likely that QIPP contributed to the success with which both NHS finances and performance (or at least, waiting times) initially held up despite the slowdown in funding growth, even if many of the financial savings came through cost control including a pay freeze.

In 2013/14, successive years of surpluses in NHS providers came to an end and rapidly turned into substantial year-on-year deficits (see Figure 1). As NHS provider budgets are part of the Department of Health and Social Care budget, these deficits put the Department at increasing risk of its own over-spend even after the occasional in-year top-up from HM Treasury and a series of cuts to the capital budget to support day-to-day revenue spending.

Yet this change in financial fortune after 2013 was not the result of incompetence or loss of discipline in the NHS finance community. Instead, deteriorating NHS finances were largely a consequence of the competing objectives NHS leaders were tasked to deliver, and the constraints that limited efforts to improve financial performance, including:

• maintaining or improving the quality of care, often characterised in the years immediately after 2013 by an attempt to deliver safe staffing levels, particularly for nurses

• continuing to deliver key performance standards, most obviously waiting times in A&E and planned care (18-week referral-to-treatment for planned care, 62-day cancer treatment),

• attempting to boost investment in sectors such as mental health services, while simultaneously maintaining investment in hospital services

• the general refusal to allow services to close, or more accurately, the refusal to allow acute and specialist acute providers to close or cut back services significantly even where there were concerns about quality or financial sustainability. This was not a luxury (or curse, depending on your point of view) allotted to all providers: after 2010, mental health, community and primary care providers all made cuts and, for example, shrank key elements of their workforce as a consequence.

As this was the era of austerity, there was no return to the high annual increases in government spending seen in the previous decade and squaring the financial circle was not helped by government and NHS national bodies repeatedly making overly optimistic assumptions about savings and efficiency gains that might deliver both financial balance and quality of care at the same time. As noted repeatedly by NHS Providers (among others), this effectively ‘set the system up to fail’ by committing the NHS to targets that were not affordable or committing it to financial performance that could not be achieved without unacceptable cuts in services. Year after year, underpowered financial injections from HM Treasury have proved insufficient to restore financial or system performance and year on year, parts of the NHS remain almost permanently ‘off trajectory’.

The initial drift into deficit in 2013/14 was caused by too many competing goals. Care failings at the Mid Staffordshire NHS Foundation Trust led, ultimately, to the Francis report. This report made many recommendations, but perhaps its most immediate effect was to emphasise the importance of nurse staffing levels. Reinforced by a newly invigorated Care Quality Commission, many NHS trusts (at least in the acute sector) went on a recruitment round for nurses reversing the declines seen after 2010 (see Figure 2). Given these extra staff were difficult to source domestically (as there had been no surge in training places for nurses in the years before), the NHS both looked to import nurses from abroad and also turned to expensive agency staff to fill the gaps in rotas. The numbers of nurses did rise (see Figure 2), but with austerity continuing, this led to a rapid decline in provider finances (see Figure 1). Such widespread deficits were clearly not the result of a sudden loss of competence by NHS leaders. Rather, they reflected the political priorities of the day that ‘quality trumps finance’.

There were expensive attempts to deal with financial challenge on an organisation-by-organisation basis. The 2012 Health and Social Care Act set up the Trust Special Administrator (TSA) regime. Failing organisations were put into the TSA process with the challenge to return them to good health. It was used in two cases: in South London NHS Trust and Mid Staffordshire NHS Foundation Trust and both disappeared as organisations. But patients still needed to be treated and so services were simply re-allocated to other providers. It is striking to note that the two key organisations that inherited most of the work of South London and Mid Staffordshire – King’s College Hospital NHS Foundation Trust and the University Hospital of North Midlands NHS Trust respectively – were soon in trouble themselves. By 31 March 2019, King’s had racked up just under £600 million in ‘interim funding’ (ie, loans outside the normal course of business) alongside changes in both chief executive and chair. North Midlands received just under £190 million.

This pattern of behaviour cannot be overcome by any clever re-writing of the financial rule book (including attempts to ring-fence money within the NHS budget (see ‘Resist zombie policies’)). It can only be overcome if national bodies – whether in or outside Whitehall – do one of two things: either stop over-committing the NHS and make difficult prioritisation decisions at national level, or give local areas the freedoms (and support) to make those decisions instead.

Once this is done it will enable local areas to develop realistic and deliverable plans rather than the succession of abandoned plans and trajectories seen in recent years. For those tempted to think that the NHS cannot plan effectively, it is useful to remember that between 2006 and 2013 the NHS never overspent (see Department of Health Departmental Reports from 2007, 2008 and 2009 and its Annual Report and Accounts 2013-14), and the goal to reduce elective waiting times first set in the 2000 NHS Plan, led, in stages, to the 18-week referral-to-treatment standard in 2008. This illustrates that the NHS is quite capable of long-term planning, if supported by a sustained increase in funding and stability.

These are challenging times and the temptation to be overly optimistic about money and performance will be as strong as ever. But to make truly system-wide progress the NHS and its partners will need to plan in a way that means all partners are signed up, are clear what they need to do and know how to measure progress. These plans should be developed and enacted with deep engagement across local partners, be realistic and, of course, include and be consistent with the financial flows across the system. Though it may sound challenging, it is an approach followed successfully in other countries (see ‘Canterbury, New Zealand’ below, for example) and one that some local areas are already implementing.

Be coherent and comprehensive

We live in a capitalist, market-based economy and as such, it should perhaps be no surprise that there has been a longstanding temptation to draw on market-based approaches to improving performance in health care. A system where independent organisations compete with each other for the business (ie, money) of customers, growing when they succeed and shrinking when they fail, lay at the heart of reform for many years and reached its apogee in the 2012 Act. But in the main, this approach has not worked to sustainably improve performance and is now out of step with a system aspiring to make a fundamental shift toward integration and prevention.

There are many reasons why a market-based approach has largely not succeeded. One important reason is the difficulty in making anyone really ‘lose’ or ‘win’ to any great extent. In the private sector when enterprises ‘lose’, staff can, and do, lose their jobs, services get withdrawn and quality can fall. For the winners there are profits, bonuses and pay rises. But in the NHS, organisations that ‘lose’ can only lose to a limited extent. There are a number for reasons for this.

• The NHS tries to guarantee access to care. It would not be acceptable for a provider to go bankrupt and for patients to lose this access. Complex and rather tortuous attempts to prove otherwise (like the TSA) could never succeed as a routine tool of policy.

• More generally, when NHS organisations suffer their patients suffer even if services do not reach the point of closure. It has, rightly, always proved difficult to either reward or punish NHS organisations to the extent that the quality of care becomes fundamentally inequitable – it is not, after all, patients’ fault if their local provider gets into financial trouble.

• Just as unacceptable is an attempt to ‘punish’ staff in specific struggling providers (as can happen in the private sector), eg, by pay cuts, changing pension schemes, etc. The existence of national schemes for pensions, for pay and increasingly for procurement also reduces the room for manoeuvre for organisations as large elements of their costs are determined by national decisions.

What all this means, is that for many NHS finance directors and chief executives the ultimate threat on finance is the same today as it has always been: through performance management, the centre may make your life a misery and ultimately, remove you from post. Once many organisations are in deficit at the same time, even this ceases to be a credible threat for many. Clearly, many of these fundamentals apply at their clearest to NHS statutory organisations and do not hold so well for primary care, where financial incentives and payment schemes are routine.

This means financial incentives as a key driver of performance for NHS organisations has always remained underpowered: organisations can be rewarded but not so much that this creates a two-tier NHS and organisations cannot suffer to the extent that it has a major impact on either patients or staff (and if it did, CQC would arrive before too long).

In any case, collaboration and integration are the key to the future evolution of the NHS and this needs to apply to finance just as it does to wider system behaviours. The evidence continues to show that the key to the success of these emerging new systems is the quality of relationships: trust, common purpose, transparency and a focus on improving population health. This is true within NHS providers and for partner organisations and services of the NHS: social care and other critical local government services as well as independent providers, whether they be voluntary sector or other. Within such a framework, performance and joint working are not driven by financial incentives but they can be undermined by payment schemes that drive organisations (and their staff) into adversarial conflict over money. This means money must move across the system in line with its stated priorities and be sufficient to cover provider costs, but leaders should be wary of using financial levers beyond this to drive, rather than support, decision-making.

The role for financial levers

The approach to finance remains a critical issue. At its most simplistic, the NHS needs a financial system that enables money from taxpayers (routed through HM Treasury) to end up in the bank accounts of nurses, doctors and other staff working in the NHS and that also pays the bills of pharmaceutical companies and other suppliers. While there are many ways to do this, a recurrent temptation in England has been to use ‘finances’ as a way to incentivise (rather than to enable) better performance.

The recent history of financial incentives in the NHS suggests two things: first, don’t import large-scale market-like mechanisms into a system where they do not work; second (and critically) ensure finance supports the changes the service wants to make, but don’t waste time trying to design incentives that lead or force change. For example, the NHS wants to ensure equity of access across England. To do this it must ensure that financial resources are distributed fairly across different areas. The NHS resource allocation formula was developed to ensure this happens and as such is consistent with, and a necessary part of, an NHS that wants to ensure equity. However, it is not an ‘incentive’ – it does not try to pay more to ‘good’ areas and less to the ‘bad’ and so is not a market mechanism. This may help explain why it has endured (and been updated but not fundamentally altered) – in one form or another – since the 1970s.

The NHS has also used more targeted financial incentives, aiming, for example, to reward very specific changes to clinical practice. Evaluations of these have also been at best mixed and have underlined how technically difficult it is to design effective financial reward schemes . Common problems include difficulties in accurately measuring outcomes and a lack of engagement with the clinicians they are supposed to influence.

The experience with the use of loans (or debt) in the NHS failed on both counts as it tried to borrow market incentives and also was not consistent with the financial decisions the system was trying to make.

Funding deficits: don’t use debt

In an NHS organisation in deficit, staff and suppliers must still be paid. Initially the Department of Health and Social Care managed this by providing public dividend capital (PDC). This is a cash injection and not a loan. In many ways, using PDC kept at least some features of a market mechanism, as even in the private sector owners can decide to prop up loss-making organisations even if they rarely do so for long. Then two major changes were made to this approach.

• The Department switched from PDC to loans. This ‘interim support’ was intended to pay necessary bills until an organisation returned to balance.

• The Department then took the cash behind the large-scale loans of 2015/16 and passed this to NHS England and NHS Improvement, where it formed the basis of the new Provider Sustainability Fund. This was paid out to providers in return for hitting financial and performance targets and, critically, it counted as income, just like payments for services from CCGs. At a stroke this cut the provider deficit as the £1.8 billion former ‘loans’ that were used to cover deficits, suddenly become ‘income’ as provided by the Provider Sustainability Fund.

These changes introduced a new system of intervention. This system combined control totals for each organisation setting out the required level of performance; payments from a central Provider Sustainability Fund for those that met them, and loans for organisations that still were short of cash. This combination reduced the deficit levels but could not remove them (the improvement in 2018/19 was partly the result of a reclassification change on private finance initiative) (see Figure 3 below).

In addition to interim loans, by the end of 2018/19 the Department had also loaned an additional £3 billion to NHS providers in the normal course of business, ie, that when the loan was agreed, the provider was considered capable of repaying it (see Figure 4).

This approach became increasingly Byzantine as the years went by. To manage the overall finances of the Department, policy increasingly focused on the reduction of the net provider deficit. Yet this focus itself contradicted the underlying financial model where each NHS organisation was responsible for itself, not for the provider sector as a whole. It could make no difference to King’s College Hospital NHS Foundation Trust that University College London Hospitals NHS Foundation Trust continued to amass significant surpluses (partly due to payments from the Provider Sustainability Fund) as there is no way of transferring cash from one to the other. Just as it is of little concern to HSBC if Lloyds TSB makes a loss. This left national bodies and the Department using many levers: trying to performance manage overall spending controls (to ensure total surpluses outweighed total deficits); also using loans to mop up those organisations unfortunately on the wrong side of the aggregate deficit line; occasionally dropping large sums into the bank accounts of providers that ran surpluses as a (sometimes unexpected) reward; and using increasing performance management against CCGs to ensure they raised spending on mental health (for parity of esteem) and then performance managing the mental health sector not to spend it to help offset deficits in the acute sector.

Eventually under the cover of Covid-19, the sorry experiment with debt was stopped and the whole lot written off (see below), again underlining the limited applicability of market-style approaches to the NHS. But it also emphasises the need for a longer-term approach to finance: the switch from PDC to debt in the year it happened appeared a relatively marginal change of little harm. The cumulative effect over a number of years along with all the additional complexities that were bolted onto this system, meant it fell into disrepute.

Well-led institutions

One commonly stated goal of greater system working is that ICSs will manage financial balance in their footprint (possibly sharing this role with other potential ICS-wide relationships, particularly emergent provider collaboratives). Indeed, some powers to re-balance financial targets across member organisations have already been granted to ICSs. In theory at least, ICSs have the potential to manage finance across a footprint as they include both commissioners and providers, in contrast to an NHS pre-ICSs, where the commissioner and provider positions were separate.

However, in practice it will be hard for ICSs to balance the finances of the organisations located within their borders. This is simply because across the current 42 ICSs or sustainability and transformation partnerships (STPs) in England there is great variation in the proportion of overall income trusts draw from their host ICS, which is partly explained by the historical location of hospitals, especially ones dealing with specialist or tertiary care that attract patients (and income) from across England.

At the extreme, for example, in 2018/19, a substantial portion of [income for the Royal Marsden NHS Foundation Trust](https://shared-d7-royalmarsden-publicne-live.s3-eu-west-1.amazonaws.com/files_trust/s3fs-public/Annual Report 2018-19.pdf) came from research and development funding or private patient work, and the income that did come from CCGs or NHS England was drawn from multiple ICS or STP regions outside its ‘host’ ICS in south-west London. This may be an extreme example, but not a unique one. Many providers within an ICS will draw substantial income from other ICSs (and therefore depend on the decisions within those ICSs and, indeed, other funders). Provider collaboratives may take on some role around mutual aid for their organisations but again, the footprints of providers vary greatly and these collaboratives will be drawing income from many separate decision-makers. What neither ICS nor provider collaborative can do – at least across all of England – is ensure financial balance through their own decisions on financial flows unless the NHS returns to the rates of funding growth it used to see, thereby reducing deficits across the board.

In one sense, ICSs (or possibly a provider collaborative) could be responsible for the financial balance of their footprint. This is if they have powers to performance manage any organisation within that footprint, irrespective of the nature of the state of financial flows in and around the ICS. This would make them operate much as strategic health authorities or Monitor once did. This however takes the NHS back to a more traditional vertical hierarchy of performance management.

Alternatively, the responsibility for balancing the complex mix of relationships could sit with the provider institutions themselves, working with their host ICS, with other funders and with wider provider networks. Indeed, doing so recognises that the financial health of the footprint will need to build on solid foundations of well-led organisations whether these are providers, commissioners or ICSs. While it is true that the widespread deficits in NHS providers after 2013 did not arise through some collective failure of competence, it is also true that organisations can lose control of their own finances and performance. In these cases, where individual organisations get into difficulties, the answer to financial and performance malaise does lie within the organisation and its leadership. This was recognised by the approach to intervention adopted by Monitor and then NHS Improvement that looked to assess how far the leadership team could turn around performance and where it needed support to do so. It is also consistent with earlier assessments of deficits in the NHS.

There is a risk that as there is a move to making more decisions at system level, the importance of well-led, well-run organisations is weakened. This could happen if financial support from stronger to weaker organisations gets baked into the financial plans for a footprint (similar to the ‘planned support’ that some strategic health authorities provided to providers before 2012). It may equally occur in areas of performance if underlying causes of variation are not confronted.

Yet even the best system working can not compensate for poor organisational-level working and the focus on GIRFT (Getting it Right First Time), service-line reporting and the understanding of costs can support improvements in technical efficiency (including clarity around creating best practice tariffs). Indeed, greater use of technical efficiency programmes across providers may enable ‘levelling up’ to occur within systems, where weaker organisations are supported to improve (rather than just subsidised). Either way, local leaders and well-run organisations must be supported and strengthened if system working is to succeed.

Resist zombie policies

Financial freedoms for the NHS

NHS commissioners and NHS providers are part of the public sector. Their deficits and surpluses count towards the Department of Health and Social Care’s overall financial position. While this approach to managing organisational finances has advantages for the NHS it also comes with a set of limitations, and the design of any financial system must recognise these limitations or conflict is inevitable.

The Department of Health and Social Care and its national NHS arm’s length bodies (most notably NHS England and NHS Improvement) are given resources by HM Treasury to spend on the NHS and health. The overall amount – called TDEL  (total departmental expenditure limit) – comes ready split into a small number of sub-budgets between which the Department cannot move resources except under specific circumstances (which often involve getting permission from HM Treasury). These sub-budgets are:

• RDEL, the resource (or revenue) departmental expenditure limit, itself sub-divided into administration, ring-fenced and non-ring-fenced budgets

• CDEL, the capital departmental expenditure limit.

All these budgets are annual, and in-year underspends at Departmental level are simply returned to HM Treasury. Departments have to pay back overspends, but there have been no overspends in the Department of Health and Social Care in any recent year, partly because overspending these controls brings its own set of sanctions.

However, foundation trusts have a degree of financial freedom set out in legislation and this means (broadly) that the Department cannot simply ‘direct’ them to run a particular surplus (or deficit) even if the control total system eroded these freedoms in practice. Equally, though they have less independence, commissioners (primary care trusts and then CCGs) carry surpluses across years that can be drawn down and are also made to pay back overspends from previous years.

For many years this did not seem to matter and it was easy to overlook the tension between NHS rules and HM Treasury rules. This was because, first, Monitor wanted to . Monitor created a system of regulation that pushed foundation trusts to hold large cash balances . This ensured that they would not need to turn to the Department for support and the provider sector as a whole ran persistent surpluses and built up a lot of cash. Second, while overspends on day-to-day (revenue) spending were effectively discouraged through this (very) prudent approach to regulation, foundation trusts had wide freedoms to spend on capital. This posed a theoretical risk that foundation trust spending would lead to a breach of CDEL. However, relative generosity from HM Treasury in setting high permitted capital spending made this unlikely, adding yet more underspends to the Department. These continued for a while even after austerity began and as late as 2012/13 the Department was still underspending its budget by £2.24 billion in a single year.

This model of NHS funding provision re-ignited a debate that first occurred in the early days of the foundation trust model: were foundation trusts truly public sector organisations or should they move ‘off balance sheet’? The implications of the latter would be that their deficits and surpluses would not score to the Department of Health or to HM Government, just as the finances of for-profit and third sector providers of health care do not. This has sometimes been wrongly described as a political decision, ie, that it is the government that can simply decide an organisation is ‘off balance sheet’. This is incorrect. It is the Office for National Statistics (ONS) that makes this decision according to a set of rules: for example, it matters who is ultimately in control of the organisation. It could be argued that the independence of Monitor and the independence of the price-setting function (aka tariff or Payment By Results) meant foundation trusts were free of direct intervention by government. It could also be argued that the explicit failure regime enshrined in the 2012 Act limited the extent to which government could or would prop up an organisation in deficit. Ultimately no NHS provider (let alone the sector as a whole) went off balance sheet and time proved that this was the correct decision as before long the Department was intervening again and again to prop up provider finances. If it was unlikely in 2012 that ONS would accept a foundation trust was off-balance sheet, how much less likely it is from the perspective of 2020?

Since 2012 tensions in the financial model have become increasingly apparent. In theory, all that matters to an individual CCG or trust is its own financial position. A rich foundation trust surrounded by penniless commissioners or in-deficit providers is still a rich foundation trust. Yet the Department needs to balance the books overall. This has led to the concept of sectoral surpluses and the NHS overall financial position. In this approach:

• in-deficit NHS providers are performance managed to reduce their deficits

• in-surplus NHS providers are performance managed (or incentivised) to increase their surpluses as these, at Departmental level, net off from others’ overspends

• CCGs are managed to raise their surpluses as again, these net off from deficits (though the CCG position deteriorated overtime)

• NHS England holds back money and underspends its own budget.

Instead of independent organisations making their own decisions, the need for system balance means every organisation has financial targets. Ironically, a system need for control has led to extreme performance management of individual organisations. For the future this means there is little point in trying to find ways ‘round the system’ whether this is by borrowing from the private sector (which as the debt belongs to a trust, is just the same as government borrowing and so provides no benefit) or, more generally, designing rules that ignore the public sector nature of NHS commissioners and most providers.

This has underlined that the payment system, including the handling of overspends, is largely a policy decision within the NHS. If an organisation is in deficit, this actually makes little difference if that deficit is financed by some means. This raises the question as to whether every organisation must achieve financial balance (the current objective), if there is way to ensure that the system as a whole is in balance.

Allocations, national to local

Although primary care trusts controlled a higher percentage of the NHS budget than CCGs, it is still the case that the bulk of NHS spending is routed through local commissioners. This means the centre needs to have a way of deciding which area gets what, and this is determined by the weighted capitation formula. This looks to ensure that, wherever patients are treated in the English NHS, there is equal access for equal need. It weights simple capitation by indicators of ‘need’ for health care services, such as age, deprivation and health status. There is important work to be done to future-proof allocations policy, whether it is developing the approach to specialised commissioning or ensuring the measures of need are updated as the health system moves to a world where community-based services come increasingly to the fore. But the established process by which NHS England and NHS Improvement (and the Department before it) updates allocations in a transparent and largely independent process is one of the enduring strengths of the NHS in England at least when compared to other public services. In its comparison of such formulas, the National Audit Office concluded, ‘…the advisory bodies for the health formula have the clearest terms of reference, the most independence from departmental control within a defined technical remit, and the greatest influence over funding allocations. As a result, they are more able to provide effective advice and independent scrutiny over the formula’s development.’

However, financial malaise in NHS providers has led to the creation of large central budgets aimed to incentivise organisations to hit (mainly) financial targets and also to provide them with cash to pay their bills. These central funds and their allocation are much less transparent. Since their introduction in 2016/17, these have grown rapidly, remain substantial and risk undermining the equity basis of existing allocations as large sums move across the NHS. Alongside these central budgets, there have also been attempts to determine spending at local level within the overall allocation. Perhaps the most obvious example is the attempt to determine mental health spending at local level, consistent with the goal to achieve parity of esteem. These attempts at sub-budgets within allocations often struggle to deliver, for clear reasons.

• They must build from the presumption that, left to their own devices, local commissioners will not spend money as national policy-makers want. This needs careful thought as the whole premise of local commissioners and providers is that they do understand local need better than central planners. There is a risk of misdiagnosis with these ring-fences: for example, it is not that local commissioners do not value mental health but that the total of priorities set by the centre is unaffordable (see ‘Get the balance right’ ). In this case commissioners and providers are forced to look for ways to balance the books by reducing some of their financial commitments, to which the centre responds by increasing audits and controls to enforce the unenforceable.

• Setting controls over how much is spent is a weak way to prioritise, as the system may just spend the money badly. Rather than ring-fence money, it is better to be clear about outcomes and standards and allow local services to determine the best way to deliver these, which may also be the cheapest. So even where these ring-fences may be necessary in the short term, there needs to be a longer-term plan to move to outcomes and standards.

In addition, as well as setting up these other budgets, there is sometimes a temptation to alter the evidence-based approach to area allocations, either by adding an incentive element (you get more if you deliver, this was an element of the related Public Health Allocation system) or by making further value judgements about who should get what. Given the relative strengths of the NHS allocation formula and its long history, all these attempts to fiddle at the margins are best avoided.

As the NHS moves towards allocations at ICS level it will be important to ensure that the formula still works at CCG or potentially, local government level. This is because ICSs are large and within them, it will be easier to lose sight of areas with high inequalities (broadly because well-off areas will average out the poorer areas). Enabling ICSs to understand overall health need within their footprints will help tackle inequalities.

Where next?

Before the Covid-19 pandemic, the NHS had just begun a national review of its financial architecture. A few points appeared to be fixed at the beginning of this review – including national targets to increase mental health funding, and a requirement for every individual NHS provider and commissioner to balance its books by 2023/24. 

But even at an early stage in the review, national bodies signaled some gentle turns away from the recent past. Central funding pots that sit outside the national allocations policy will reduce in size over the course of this parliament. The use of overwrought financial incentives – such as marginal rates and contract sanctions – will be considerably scaled back. And historical debts of commissioners and providers will be written-off, recognising as we have argued, that they served no purpose. 

Taken together, these early changes signaled a gradual return to a financial system that is more coherent and comprehensive than that of recent years. Many of the market-like mechanisms and organisation-focused incentives that supported competition are being replaced with system control totals and risk-sharing aligned incentive contracts that supported the collaborative thrust of the NHS Long Term Plan. Covid-19 may have changed these plans, but the temporary financial arrangements during the pandemic seems to have improved, rather than hindered, the desired-for system working. 

However, some tensions remain. 

Is the balance right and are plans affordable? The new NHS five-year funding deal and ongoing clinically-led review of access standards may lead to a more realistic match between the performance and finance asks. But even before Covid-19 most finance professionals we speak to believe the NHS was still largely over-committed and that financial improvement trajectories would be missed. 

And the balance between systems and organisations is perhaps the most important element of the financial strategy that is yet to be resolved. There are elements of the financial architecture that speak primarily to thriving well-led organisations, including the introduction of more detailed patient-level costing and technical efficiency programmes including Getting it Right First Time. And there are elements of the financial strategy more clearly aimed at system working, including the increasing share of sustainability funding that will be determined by the collective financial performance of a system. 

There is now an opportunity to create real connective tissue between the organisation-focused and system-focused financial strategy that links the decades of culture and history weighted towards an organisation-first approach (which can support well-led organisations) and the new need for system working. This is not first and foremost a financial challenge. Instead, good system working requires the development of a common purpose built around improving population health and reducing inequalities that all organisations involved sign up to. This requires the development of firm relationships and trust and a common understanding of the health challenges facing the population. The financial design challenge is then to support this emerging plan by ensuring money reaches the right place and to avoid creating any potentially toxic conflicts through overuse of incentives or excessive complexity. 

Stepping back, perhaps the most relevant lesson from the past is that the NHS is not a single entity but a network of many interconnected institutions, and that any national financial strategy will be heavily mediated by the quality of local relationships. For this reason, the benefits of a new NHS financial architecture will not come from highly detailed prescription, but from the underlying design features of balance and coherence that history has highlighted.