Overview of the financial performance of the NHS in Scotland

Prepared for the Auditor General for Scotland
December 2006

Auditor General for Scotland
The Auditor General for Scotland is the Parliament’s watchdog for ensuring propriety and value for money in the spending of public funds.

He is responsible for investigating whether public spending bodies achieve the best possible value for money and adhere to the highest standards of financial management.

He is independent and not subject to the control of any member of the Scottish Executive or the Parliament.

The Auditor General is responsible for securing the audit of the Scottish Executive and most other public sector bodies except local authorities and fire and police boards.

The following bodies fall within the remit of the Auditor General:

•	departments of the Scottish Executive eg, the Health Department
•	executive agencies eg, the Prison Service, Historic Scotland
•	NHS boards
•	further education colleges
•	Scottish Water
•	NDPBs and others eg, Scottish Enterprise.

Summary

Introduction

1. This report provides a financial overview of the NHS in Scotland in 2005/06. The annual accounts for 2005/06 cover a year where the NHS continued to develop single system working and establish new structures in the form of Community Health Partnerships (CHPs).

2. The NHS in Scotland spent almost £9 billion in 2005/06 (this is net of operating income), representing around a third of the total spend in the public sector. It remains Scotland’s largest employer with over 150,000 staff (almost 130,000 whole time equivalent) providing care in community, primary and acute settings throughout the country. 

3. Despite record increases in funding, the NHS continues to face challenges over the coming years which will require robust long-term financial and service planning. These include a range of cost pressures such as the UK-wide pay modernisation agenda, the increasing cost of drugs and rising energy prices. In addition, technical advances in the way in which healthcare can be delivered, changing training requirements for medical staff and a growing older population all contribute to the need to change the way in which health and related services are delivered. 

4. NHS Argyll and Clyde was dissolved on 31 March 2006. Comments on the board’s annual accounts for 2005/06 and the financial implications of its dissolution on the two successor boards (NHS Greater Glasgow and Clyde and NHS Highland) are included in this report.

Summary of key messages

5. Funding for the NHS in Scotland was almost £9 billion in 2005/06 and is planned to reach £10 billion by 2007/08.

6. The financial position of the NHS in Scotland (including the Scottish Executive Health Department and the 24 NHS bodies) has moved from an overall overspend of £32 million in 2004/05 to an overall underspend of £70.6 million against the health budget for 2005/06. Most of this relates to an underspend
on capital. 

7. At the end of 2005/06, NHS Argyll and Clyde received £82.3 million from the Scottish Executive Health Department (SEHD) to write off its £81.7 million cumulative deficit. Excluding NHS Argyll and Clyde, the total cumulative revenue underspend for the remaining 23 NHS bodies increased by £4.9 million to 
£69 million in 2005/06.  

8. Two of the 24 NHS bodies failed to meet one of their financial targets (NHS Lanarkshire and NHS Western Isles), and the annual accounts for NHS Highland were qualified.

9. NHS bodies are expected to contribute to the Efficient Government Initiative by making £523 million savings by 2007/08. Cash-releasing savings are being reported across the NHS; less savings have been reported from time-releasing activities.

10. Most NHS boards are making progress in setting up structures and governance arrangements to support single system working but the transition has been more challenging for some of the larger NHS boards. Governance arrangements for the new CHPs are at an early stage.

Information sources

11. The commentary on financial performance and governance is based largely on the audited accounts and auditors’ reports on the 2005/06 audits of the 15 NHS boards, nine special boards and the SEHD.1 Auditors’ reports are available on Audit Scotland’s website.2 The final financial positions in 2005/06 for the NHS boards and special boards are shown at Appendix. For ease of reference, figures in the main body of the report have been rounded. 

12. NHS financial performance cannot be considered in isolation from overall performance and service delivery, so this report should be considered alongside our overview report on the performance of the NHS published in December 2005.3  Our next performance overview report on the NHS will be published in December 2007.

13. We have tried to minimise the use of technical terms, but in some places this is unavoidable and we have therefore included a glossary at Appendix 2.
 
All NHS bodies met the new deadline for submitting their audited accounts to the Scottish Executive Health Department

14. The SEHD brought forward the deadline for the submission of audited accounts from 31 July to 30 June for the 2005/06 annual accounts. This meant that the timetable for preparing accounts and completing the audits was tight. All NHS accounts were audited and submitted by the revised deadline. The majority of auditors reported that the audit process ran smoothly and that draft accounts and supporting schedules were of a good standard.

Supporting continuous improvement through audit

15. The audit process is essentially risk based and provides an independent and objective examination of the financial affairs of NHS bodies. The audit process is not only about holding audited bodies to account but also aims to support continuous improvement by making recommendations in management reports and final audit reports, and monitoring progress against agreed action plans. Final audit reports to NHS bodies focus on issues of real importance, and challenge and support NHS bodies in managing major risks and improving performance.

16. We highlight a number of issues about financial performance in this report. Auditors will continue to monitor the financial performance of NHS bodies during 2006/07.

17. This report is organised into three main parts:

•	Part 1 outlines recent organisational change in the NHS in Scotland and provides a commentary on some of the key challenges facing the health service.
•	Part 2 considers financial performance in 2005/06.
•	Part 3 reports on how governance arrangements are keeping pace with organisational change across the NHS in Scotland.
1	For the purposes of this report, NHS National Services Scotland and the Mental Welfare Commission are referred to as NHS special boards. The Mental Health Tribunal for Scotland is an executive agency and is responsible for laying its own accounts in Parliament, and so is excluded from this report.
2	http://www.audit-scotland.gov.uk
3	An overview of the performance of the NHS in Scotland 2004/05, Audit Scotland, December 2005.

Part 1. Setting the scene

The NHS in Scotland has undergone major reorganisation in the last three years

18. The structure of the NHS in Scotland has changed significantly over the last three years, including:

•	The establishment of single system working, dissolving trusts and developing 15 unified NHS boards. The aim of establishing boards as single systems was to remove organisational barriers and to establish shared aims and clear lines of accountability across NHS board areas.
•	The development of CHPs to improve collaborative working between primary and acute healthcare, and between health and local authority partners.
•	More recently the dissolution of NHS Argyll and Clyde and the transfer of the board’s services and responsibilities to NHS Greater Glasgow and Clyde and NHS Highland. This reduced the number of NHS boards from 15 to 14 from April 2006.
Funding for the NHS in Scotland reached almost £9 billion in 2005/06

19. The Scottish Parliament voted £7.5 billion for the NHS in Scotland for 2005/06. In addition, the NHS received income of around £1.5 billion from national insurance contributions. The total funding available for the NHS in Scotland in 2005/06 was almost £9 billion (£8.65 billion revenue and £0.305 billion capital).

20. The NHS consolidated outturn statement shows that NHS bodies received £8.43 billion (revenue) for the year ended 31 March 2006. This left £220 million from the revenue budget to meet the SEHD’s running costs and centrally funded healthcare programmes.   

Planned expenditure on health in Scotland will have grown by almost 40 per cent over the five years to 2007/08
21. The health budget has increased in real terms by 18 per cent over the last three years and is planned to rise by almost 40 per cent over the five years to 2007/08. Much of this growth in funding has been to develop patient services, increase staff numbers, reform staff pay structures and drive down waiting times.4 

Spending on healthcare in Scotland is relatively high compared to other UK countries
22. In 2004/05, Scotland spent more on healthcare per head of population compared with the rest of the UK. Budgeted expenditure on health in Scotland for 2005/06 was over 13 per cent higher than the UK average of £1,481 per head of population.5

The NHS in Scotland faces a number of major challenges

23. Making sure that the large sums of public money allocated to the NHS lead to better patient services and outcomes requires sound planning, good financial management, robust monitoring and effective leadership at a national and local level. Ensuring that the additional investment in the NHS adds value is even more of a challenge given the recent scale and pace of change, and increased public expectations. Some of the major challenges are outlined in the rest of this section.

The NHS is the largest employer in Scotland
24. The NHS is Scotland’s largest single employer with about 154,000 staff or 6.3 per cent of the total workforce in Scotland.6 7 The NHS in Scotland currently spends around half of its budget on staff, excluding independent contractors such as GPs and community pharmacists.

25. There have been a number of major changes which affect staffing and present particular challenges for NHS management and clinical practice. These include:

•	three UK-wide pay modernisation agreements – the consultant contract, the new General Medical Services (GMS) contract and Agenda for Change
•	the European Working Time Directive and ensuring compliance with reductions in the hours that junior doctors can work
•	NHS policies of no compulsory redundancies and a no detriment rule for existing staff whose jobs change. The no detriment rule means that pay and terms and conditions are protected for staff whose jobs change as a result of reorganisation.
26. The pay modernisation agenda is currently one of the largest cost pressures faced by the NHS. The additional costs of implementing the new pay agreements are estimated at £291 million for 2005/06 and at least £207 million for 2006/07. The largest pay stream is Agenda for Change and some boards are still in the process of calculating the full cost of this. The SEHD estimates that there will be no additional costs for GMS out-of-hours in 2006/07 and 2007/08.

The NHS is managing its surplus estate and changing its infrastructure 
27. The NHS in Scotland has fixed assets valued at £4.4 billion, resulting in capital charges of around £335 million each year.8 As the NHS moves away from hospital-based services and develops alternative community services, such as enhanced primary care centres, this will affect the NHS estate.

28. The NHS in Scotland can make use of Private Finance Initiative (PFI) agreements to develop its estate. Data from the Scottish Executive show that there are currently 49 PFI contracts in operation across the NHS in Scotland with a capital value of approximately £553 million. A further 31 PFI contracts are planned with a capital value totalling £982 million.9 The first PFI contracts in the NHS in Scotland became operational in 1992 and typically last for 25 years or more.

29. Rather than owning an asset (such as a hospital building) and paying for its build from their capital budget, PFI agreements mean that NHS bodies pay annual charges out of their revenue budget to their PFI partners. This adds to the need for NHS bodies to plan for the impact of PFI payments on their revenue budgets and to manage these.

The cost of drugs is rising 
year on year
30. Expenditure on prescription drugs and drugs used in hospitals amounted to just over £1 billion 
and £212 million respectively in 2005/06.10

31. The cost of drugs prescribed in the community has risen significantly since 1990.11 In recent years however, the rise has slowed. This is likely to reflect a greater use of cheaper generic medicines, drugs coming off patent and most recently the drugs price regulation scheme. The overall growth reflects increased availability of medicines; guidelines recommending the use of medicines, such as statins, for a wider range of conditions; and people living longer with a range of health conditions that can be managed with medicines.

Clinical services are being redesigned
32. Building a Health Service Fit for the Future (the Kerr report) highlighted that more than a quarter of the population in Scotland will be over 65 within 25 years.12 The report recommends that all NHS boards establish a systematic approach to caring for the most vulnerable with long-term conditions (particularly older people).

33. Implementing the changes envisaged in Delivering for Health (the Scottish Executive’s response to the Kerr report) will require NHS boards to change the way in which services will be delivered.13 This will be a considerable challenge for the NHS, and will require strong financial management and effective planning involving patients and clinicians. Reconfiguring services means that surplus assets may be disposed of to free up resources for reinvestment. This means that boards face a temporary increase in cost pressures from accelerated depreciation charges. Service redesign may also involve increased running costs for a transitional period to ensure that there are no disruptions to existing services. The financial impact of redesigning services needs careful planning to ensure clinical services continue to operate effectively. 

The new tariffs are expected to be cost-neutral but may be a future cost pressure for some boards 
34. Delivering for Health included a commitment to introduce national tariffs for hospital procedures. The national tariff will set prices for activity carried out by one NHS board for patients who reside in another board area. This is intended to simplify the process for service level agreements for cross boundary work, improve the accuracy of cost and activity data, and encourage benchmarking among NHS boards.

35. The application of the national tariff to cross-boundary activity will be phased and started with two specialties in 2005/06 – Orthopaedics and Cardiothoracic Surgery. Tariffs will be extended to a further six specialties in 2006/07 (eight in total).

36. The implementation of tariffs is expected to be cost-neutral across the NHS in Scotland. However, several of the smaller boards (including the island boards) have highlighted that tariffs may be a cost pressure in 2006/07 and beyond. We will consider tariffs in more detail as part of our NHS overview report in 2006/07.

NHS boards have identified increasing energy prices as a cost pressure
37. The latest update on quarterly energy prices by the Department of Trade and Industry showed that the overall price paid for fuel and light in real terms had risen by 12 per cent between the first quarters of 2005 and 2006. The price of heating oils increased by 27.4 per cent over the same period.14 Rising energy prices will be a cost pressure for all NHS boards and plans should be in place to address these. 

38. Two boards reported that they had exceeded their budgeted costs for energy in 2005/06 (Dumfries and Galloway and Lanarkshire) and two further boards have identified rising energy prices as a potential cost pressure in 2006/07 (Borders and Lothian). In 2005/06, NHS Lanarkshire exceeded its energy budget by over £1 million and NHS Borders is setting aside an additional £750,000 in 2006/07 to meet increases in energy costs.

4	Our National Health: A plan for action, a plan for change, Scottish Executive, 2001.
5	The Scottish Executive draft budget for 2007/08, Scottish Executive, September 2006.
6	NHS in Scotland Workforce Statistics as at 30 September 2005, Information Services Division (ISD), 2005.
7	Public Sector Employment in Scotland statistics as at June 2005, Scottish Executive, June 2005.
8	NHS Scotland consolidation of NHS annual accounts, 2005/06.
9	Scottish Executive Private Finance and Capital Unit, October 2006.
10	Scottish Health Service Costs (Cost Book), ISD, December 2006.
11	Prescribing costs update, ISD, September 2006.
12	Building a Health Service Fit for the Future. A National Framework for Service Change in the NHS in Scotland, Scottish Executive, May 2005.
13	Delivering for Health, Scottish Executive, November 2005.

14	Energy Trends and Quarterly Energy Prices, Department of Trade and Industry, June 2006.

Part 2. Financial performance

Key messages

•		The financial position of the NHS in Scotland (including the SEHD and the 24 NHS bodies) has moved from an overall overspend of £32 million in 2004/05 to an overall underspend of £70.6 million against the health budget for 2005/06. Most of this relates to an underspend on capital.
•		At the end of 2005/06, NHS Argyll and Clyde received £82.3 million from the SEHD to write off its £81.7 million cumulative deficit. Excluding NHS Argyll and Clyde, the total cumulative underspend for the remaining 23 NHS bodies increased by £4.9 million to £69 million in 2005/06.
•		Two of the 24 NHS bodies failed to meet one of their financial targets (NHS Lanarkshire and NHS Western Isles), and the annual accounts for NHS Highland were qualified.
•		NHS bodies are expected to contribute to the Efficient Government Initiative by making £523 million savings by 2007/08. Cash-releasing savings are being reported across the NHS; less savings have been reported from time-releasing activities.
The NHS in Scotland as a whole has an underspend against its overall budget, most of which relates to capital

39. The NHS in Scotland as a whole (SEHD and NHS bodies) had a small overspend of £176,000 against its overall revenue budget (£8.6 billion) and an underspend of £70.8 million against its overall capital budget (£305 million) in 2005/06. This amounts to a total underspend of £70.6 million against the overall budget (Exhibit 5). This compares to a £32 million overspend in 2004/05.

40. The SEHD was forecasting an underspend of £44 million against the overall NHS revenue budget in May 2006, which was largely due to NHS Argyll and Clyde’s cumulative deficit being cleared during 2005/06. The SEHD used some of its surplus funds held in the Scottish Executive’s Central Unallocated Provision (CUP) to clear this.

41. The SEHD was also forecasting an underspend of £25 million against the capital budget (£305 million), resulting in a total forecast underspend of £69 million against the health budget for 2005/06. The final position for 2005/06 was a £70.6 million underspend.

42. The SEHD faced particular financial pressures in 2005/06 due to the overspend of £32 million for the NHS in Scotland as a whole in the previous year. The auditor has reported that the SEHD completed an internal review of financial management and budgetary control during 2005/06 and is now in the process of restructuring its finance function. The SEHD has asked its auditor to do a joint review with internal audit of the new arrangements during 2006/07.

Most NHS bodies met their three financial targets

43. The SEHD has three financial targets for NHS bodies. The targets are they should stay within their:

•	Revenue resource limit (RRL) – this is the revenue budget allocated for the day to day operation of services. Underspend against the RRL, where approved, may be carried forward to the next year; any overspend has to be carried forward and is then deducted from the RRL allocation in the following year.
•	Capital resource limit (CRL) – the funding that a health body has available for capital programmes. NHS bodies normally return any surplus CRL to the SEHD for re-allocation in the following financial year.
•	Cash requirement – this is the amount of cash drawn down by NHS bodies to fund ongoing operational costs and new capital investment.
44. The total RRL outturn for all NHS bodies was an underspend of £69.6 million in 2005/06. The overall underspend for NHS boards was £45.4 million and £24.2 million for special boards. This compares to an overall underspend of £4.6 million in 2004/05. 

45. While this appears to represent a significant movement in the financial performance of NHS bodies in Scotland, it includes the write-off of NHS Argyll and Clyde’s cumulative deficit of £81.7 million during 2005/06. When NHS Argyll and Clyde is excluded, the total cumulative underspend for the remaining 23 NHS bodies increased by £4.9 million to £69 million from 2004/05 to 2005/06.

Two NHS boards overspent their revenue resource limit
46. Thirteen NHS boards achieved their RRL target (including NHS Argyll and Clyde), with a combined underspend of £56.3 million (11 boards and a £69.7 million underspend in 2004/05). 

47. NHS Lanarkshire and NHS Western Isles overspent against their RRL, with a combined cumulative deficit of £10.9 million. The same two boards also overspent against their RRL in 2004/05 with a combined cumulative deficit of £20.8 million.15

48. NHS Lanarkshire reduced its cumulative deficit from £20 million in 2004/05 to £8.4 million in 2005/06 by achieving an in-year surplus of £11.6 million. It did not achieve the level of recurring savings it had planned and relied on non-recurring funding and capital to revenue transfers totalling over £21 million to support its financial position in 2005/06. NHS Lanarkshire anticipates that it will clear the rest of its cumulative deficit through the sale of surplus land at the former Law Hospital, subject to the approval of planning permission. The board has recognised that it needs to take further action to achieve recurring savings that will help it move towards financial balance.

49. NHS Western Isles began 2005/06 with a cumulative deficit of £738,000. Half way through 2005/06, the board predicted a year-end cumulative deficit of £2.038 million. However, reliable draft budgets were only available from the end of September 2005, when it became apparent that the projected outturn was likely to be worse than initially forecast. The final position at  31 March 2006 was a cumulative deficit totalling £2.484 million. The board’s financial recovery plan does not show NHS Western Isles returning to a surplus position until 2008/09. Further comment on NHS Western Isles is included in Case Study 3.

NHS Grampian reported a cumulative deficit in 2004/05 but achieved financial balance 
in 2005/06
50. NHS Grampian had a cumulative deficit of £10.8 million at the beginning of the year and the 
board’s financial recovery plan anticipated that the deficit would be reduced to £2.7 million at the end of 2005/06. The board actually achieved a £0.4 million surplus against its RRL target for 2005/06 largely due to an earlier than expected sale of property surplus to requirements. This allowed the board to repay all of its cumulative deficit a year ahead of schedule.

51. Although NHS Grampian has achieved financial balance in 2005/06, the board is going into 2006/07 with a recurring funding gap of £21.4 million. NHS Grampian will continue to rely on non-recurring income to support its financial position, although it expects to reduce its reliance on non-recurring funding over the next few years. The auditor has commented on a number of challenges for the board to remain in financial balance, including Agenda for Change.

The overall increase in surpluses against RRL targets rose by almost £7 million for NHS boards
52. Exhibit 8 shows that between 2004/05 and 2005/06:

•	three boards increased their cumulative surplus (NHS Dumfries and Galloway, NHS Greater Glasgow and NHS Shetland)
•	eight boards reduced their cumulative surplus (NHS Ayrshire and Arran, NHS Borders, NHS Fife, NHS Forth Valley, NHS Highland, NHS Lothian, NHS Orkney and NHS Tayside)
•	one board increased its cumulative deficit (NHS Western Isles)
•	one board decreased its cumulative deficit (NHS Lanarkshire)
•	one board moved from a cumulative deficit to a cumulative surplus position (NHS Grampian).
53. The £6.7 million overall increase in surpluses against RRL targets is mainly due to a combination of:

•	an increased cumulative surplus at NHS Dumfries and Galloway
•	NHS Lanarkshire reducing its cumulative deficit
•	NHS Grampian eliminating its cumulative deficit and moving to a cumulative surplus.
54. The auditor for NHS Ayrshire and Arran reported in 2004/05 that the board had a high cumulative surplus because of slippage in planned expenditure against a number of earmarked allocations. At the beginning of 2005/06 the board planned to reduce its cumulative surplus of £22.9 milion to £9.3 million by the end of 2005/06. The outturn for 2005/06 was a surplus of £17.4 million, but the auditor reported that only £4.4 million related to surpluses brought forward from 2004/05. NHS Ayrshire and Arran received a further £13 million in allocations from the SEHD which contributed to the final surplus for 2005/06. The board’s five-year financial plan shows that the surplus in 2005/06 will be reduced to £5 million by 2007/08, but the auditor expressed concerns over the board’s ability to achieve these forecasts.

55. NHS Dumfries and Galloway had also planned to reduce its £9.4 million cumulative surplus from 2004/05 to £4.1 million by the end of 2005/06. The board had a cumulative surplus of £14.2 million at the end of 2005/06. This higher than planned surplus was due to the board receiving a number of additional allocations from the SEHD during the year totalling £9 million. A number of the additional allocations were larger than the board expected and plans were not in place to use the remaining additional funding.

All special boards achieved their revenue resource limit targets
56. The special boards had a surplus against their RRL targets of £24.2 million. Details of performance against financial targets for all NHS boards and special boards are given in Appendix 1.

NHS Argyll and Clyde received an additional £82.3 million to write off its cumulative deficit

57. The Health Minister announced in May 2005 that, following a period of public consultation, NHS Argyll and Clyde would be dissolved on 31 March 2006; its services taken over by NHS Greater Glasgow and NHS Highland; and funds made available to clear its cumulative deficit.16 

58. The SEHD allocated additional funding of £82.3 million to NHS Argyll and Clyde to clear its cumulative deficit at 31 March 2006. The board reported a surplus of £0.6 million for 2005/06 (against a £59.5 million deficit in 2004/05). 

59. Case study 1 provides further information on NHS Argyll and Clyde’s financial performance in 2005/06.

60. NHS Argyll and Clyde operated with an estimated underlying deficit of £28.4 million which was inherited by the two successor boards upon its dissolution. Responsibility for the Clyde area went to NHS Greater Glasgow (subsequently renamed NHS Greater Glasgow and Clyde) while NHS Highland assumed responsibility for the Argyll and Bute area. The split of funding and expenditure between the Clyde and Argyll and Bute elements of NHS Argyll and Clyde was reviewed by the successor boards. The review also included estimates for recharge costs which reflect the agreed split of management responsibilities between the boards and anticipated service level agreements. As the underlying deficit was attributed to the Clyde area on dissolution, NHS Greater Glasgow and Clyde inherited it.

61. NHS Greater Glasgow and Clyde has prepared a financial plan which provides for the Clyde element to be monitored as a discrete element of the overall plan. A cost savings plan, due to be completed by January 2007, is also being developed and aims to address the funding plan. NHS Greater Glasgow and Clyde is working with the SEHD to identify how the necessary additional funding to bridge the underlying deficit will be sourced.

Achieving financial balance

62. Previous overview reports have highlighted how NHS bodies achieved their RRL targets by using non-recurring funding and making non-recurring savings which do not reduce the operating cost base. This continues to be the case and this part of our report discusses:

•	financial gaps occurring in 2005/06 (this is a gap between expected recurring income and expenditure at the beginning of the financial year)
•	how NHS bodies used non-recurring funding to support their financial position in 2005/06
•	using efficiency savings to achieve financial plans and the ability of boards to monitor and report on savings required by the Efficient Government Initiative.
Twelve NHS bodies had spending plans which exceeded available recurring funding 
63. In 2005/06, ten NHS boards had gaps totalling £147.4 million, with five boards accounting for £131 million of this (Exhibit 9, page 16).17 Two special boards had gaps in 2005/06: NHS Education Scotland (£7.2 million) and the Scottish Ambulance Service Board (£2.2 million). None of the special boards had gaps in 2004/05.

NHS bodies used non-recurring funding to reduce financial gaps in 2005/06
64. We have commented in previous overview reports that NHS bodies rely on non-recurring funding to achieve financial targets or support their financial position. Non-recurring funding is a normal part of running the NHS in Scotland but it should not be used to excess or for sustaining day-to-day activities in the long-term.Non-recurring measures can include support from the SEHD (such as an additional RRL allocation), proceeds from the sale of assets and capital to revenue transfers. Twelve NHS bodies with gaps in 2005/06 identified almost £197 million to reduce or eliminate gaps, 80 per cent of which was non-recurring.

65. HM Treasury rules mean that NHS bodies will no longer be able to transfer funding from capital to revenue after 2005/06. Auditors of three boards (NHS Forth Valley, NHS Lanarkshire and NHS Lothian) have identified the withdrawal of capital to revenue transfers as a major risk to the achievement of their financial plans. These boards have set challenging savings targets for 2006/07 to offset the loss of this source of non-recurring funding. Any NHS bodies that have relied on this source of funding to break even will now need to make additional savings.

66. Auditors for five NHS boards commented on reliance on capital to revenue transfers, totalling
£44.8 million: NHS Fife (£2.4 million); NHS Highland (£4.2 million); NHS Lanarkshire (£17.8 million); 
NHS Lothian (£19.6 million); and NHS Shetland (£0.8 million). Case study 2 on NHS Lothian highlights the measures it has used to achieve its financial balance in 2005/06 as well as its financial outlook for 2006/07.

67. The overall capital budget for the NHS as a whole was reduced by £120 million to take account of capital to revenue transfers across the whole of the NHS in 2005/06 (paragraph 71).

Current savings targets are challenging
68. NHS bodies reported total savings of £116.4 million in 2005/06 (£115 million in 2004/05). We have previously reported that some boards experienced difficulties in achieving their savings plans because they were overambitious.18 Some of the savings plans set by boards for 2006/07 are challenging and represent a significant increase on the level of savings achieved in 2005/06. 

69. NHS Tayside’s financial plan for 2005/06 set a savings target of £17.5 million. This target was revised to £13.2 million through the use of contingency funds, reductions in capital charges arising from estate revaluations and savings through the pharmaceutical price regulation scheme. The board achieved savings of £11.5 million and the auditor commented that the proportion coming from non-recurring sources was higher than planned.

70. NHS Fife had set a savings target of just over £5 million for 2005/06 but the board reported that it had achieved savings of over £7.6 million. The auditor highlighted concerns about the board’s ability to accurately monitor and report savings achieved and that it was unclear as to the scale to which savings targets had been met. The auditor’s view is that much of the savings reported by NHS Fife were due to slippage against expenditure or from changes in costs largely outwith the board’s control.
  
All NHS bodies achieved their 
CRL and cash requirement targets in 2005/06

71. The original overall capital budget of £425 million for the NHS as a whole was reduced by £120 million to take account of capital to revenue transfers authorised by the SEHD during 2005/06. This left a final overall capital budget of £305 million for 2005/06.

72. The total capital expenditure reported for the NHS as a whole in 2005/06 was £234 million, £27 million less than the overall expenditure reported by NHS bodies (£261 million). The SEHD reduced the capital outturn reported to reflect the treatment of £27 million of capital grants as revenue expenditure within the SEHD’s consolidation of NHS accounts. NHS bodies are required to treat these grants as capital expenditure for calculation of their outturn against the CRL because grants are recognised as a charge against Treasury capital budgets. Within the Scottish Executive’s accounts the grants are treated as revenue expenditure. As a result of these adjustments, the NHS as a whole reported a spend of £234 million against the overall CRL in 2005/06 and therefore had an underspend of £71 million against the revised overall capital budget of £305 million.

73. All NHS bodies achieved their CRL target. They used £261 million of their CRL and had an overall surplus of £14.4 million (£5.5 million for 2004/05).

74. The overall underspend of £14.4 million reported by NHS bodies against the CRL for 2005/06 was largely due to three NHS boards – NHS Lanarkshire (£3.5 million), NHS Lothian (£5.7 million) and NHS Argyll and Clyde (£1.4 million).

75. NHS Lanarkshire is also planning to underspend against its capital budget in 2006/07 because:

•	transfers between capital to revenue are no longer permitted 
•	two of the board’s three main hospitals operate under PFI agreements which means that capital improvements are the responsibility of the contractors
•	the board’s surplus against its capital budget of £3.5 million will be carried forward and available for use in 2006/07
•	the board plans to sell surplus properties and the proceeds from these sales may be available for capital expenditure.
76. NHS Lothian’s underspend against its CRL of £5.7 million was a result of the auditor challenging the change in accounting policy for certain consumable items and the accounting treatment of a cash payment relating to the University of Edinburgh Centre for Reproductive Biology (Case study 2). This meant that a total of £5.7 million of expenditure charged by NHS Lothian against its CRL was subsequently recharged to the RRL.

77. NHS Argyll and Clyde’s capital plan for 2005/06 amounted to £24.7 million. However, the board identified early in the year that £8.7 million would not be required due to the timing of specific projects. An agreement was reached with the SEHD to return this surplus capital funding for carry forward into 2006/07. The board actually spent £14.6 million against the revised CRL, resulting in a £1.4 million underspend. The reason for the slippage against the capital plan is that the majority of projects included in the plan were to support the NHS Argyll and Clyde Clinical Strategy, but were delayed pending the board’s dissolution. Decisions about the future provision of services, and related capital projects, are now the responsibility of the successor boards, NHS Greater Glasgow and Clyde and NHS Highland.

78. It is likely that underspends against capital budgets will continue to occur for two main reasons:

•	capital to revenue transfers are no longer allowed so boards may find it difficult to spend their capital allocations
•	capital projects have an impact on the revenue outturn as well because of the cost of capital and depreciation they attract, and the lifecycle and maintenance costs incurred. There is therefore a risk that boards may continue to underspend on their capital budgets to avoid the revenue implications associated with capital projects.
79. NHS bodies will need to consider how to use the current underspend against capital budgets, and support effective use of capital budgets in the future.

The NHS in Scotland is expected to contribute to the Efficient Government Initiative by making £523 million savings by 2007/08

80. The Scottish Executive launched its Efficient Government Initiative, Building a Better Scotland, in
June 2004. Its latest technical note shows that it expects the NHS in Scotland to deliver £349.9 million cash-releasing savings and a further £173 million time-releasing savings by 2007/08, a total of £523 million.19 

81. Audit Scotland commented on the Scottish Executive’s Efficiency Technical Notes in May 2005 (cash-releasing savings) and August 2005 (time-releasing savings).20  We will publish a progress report on the Efficient Government Initiative in December 2006. This report looks in more detail at the information underpinning reported savings for the NHS. 

82. Examples of efficiency gains reported by the NHS through cash-releasing activities during 2005/06 include:

•	£71 million of efficiency savings against a target of £88 million. The target represents a recurring one per cent efficiency saving which NHS bodies are expected to make each year.
•	£38 million of savings from national arrangements for the pricing of drugs arising from the Pharmaceutical Prices Regulation Scheme. This scheme was negotiated on a UK-wide basis with suppliers of drugs. The target has been derived by applying a seven per cent discount across all branded drugs. The target for the year was £42 million.
•	£21.6 million from improved drug prescribing including the use of generic medicines, a reduction in inappropriate prescribing and a switch away from branded drugs when patents expire. This is against a target of £5 million. A previous Audit Scotland report in 2003 highlighted the potential to make savings in this area.21 
•	£33.3 million savings from procurement against a savings target of £33 million. These savings are based on reduced prices for equipment and services negotiated as part of national contracts. It includes savings in the procurement of medical locums, drugs, food and IT hardware.
83. In addition, some of the savings identified by the Scottish Executive are expected to come from national initiatives, such as the National Shared Support Services (NSSS) project. This project is designed to provide the NHS in Scotland with a single shared service for day-to-day financial transactions and planned to deliver £10 million savings annually from 2007/08. However, the auditor for NHS National Services Scotland has reported that estimates of recurring savings have been downgraded. This is because many boards have already made savings through the move to single system working and the SEHD now expects a reduced level of savings from the NSSS project.22

84. The NHS has reported less success to date in achieving savings from time-releasing activities. It aimed to achieve £22 million in 2005/06, £46.5 million in 2006/07 and £73.9 million in 2007/08 from improved consultant productivity, but reports no savings for 2005/06. Audit Scotland’s report on the consultant contract highlighted the difficulty of achieving this as many consultants are working over their contracted hours.23 This target will remain a challenge for the NHS.

85. The NHS also aimed to achieve £16.3 million savings in reducing sickness absence but has reported a saving of £5.8 million against this target in 2005/06.

Single system working provides opportunities for better financial management

86. The move to single system working has provided NHS boards with an opportunity to harmonise budget setting and control, and integrate financial systems. Auditors report that financial management arrangements are good at NHS Ayrshire and Arran, NHS Borders and NHS Forth Valley. Following its planned transitional period, NHS Greater Glasgow has made progress in financial planning, control and monitoring, and further work is underway around the format of financial reports to the board and 
its divisions.

87. All NHS bodies received an unqualified opinion on the truth and fairness of their annual accounts, except NHS Highland where the auditor disagreed with the accounting treatment adopted by the board for two PFI agreements. The Auditor General prepared a Section 22 report on this issue.24

88. Auditors have highlighted a number of weaknesses in financial management and overall financial control which shows that some boards have still to make further improvements.

The SEHD is monitoring the financial position of NHS bodies
89. The SEHD currently monitors the financial position of NHS boards through monthly returns prepared by each board. We have highlighted how the SEHD has started to restructure its finance function and the department is in the process of establishing revised monitoring arrangements for Departmental expenditure and expenditure incurred by NHS bodies (paragraph 42).

15	The Auditor General prepared reports on the 2005/06 annual accounts of NHS Lanarkshire and NHS Western Isles under Section 22 of the Public Finance and Accountability (Scotland) Act 2000. The Section 22 reports can be downloaded from www.audit-scotland.gov.uk
16	Statement to the Scottish Parliament by the Minister for Health and Community Care, May 2005.
17	NHS Grampian, NHS Highland, NHS Lanarkshire, NHS Lothian and NHS Tayside.
18	Overview of the financial performance of the NHS in Scotland 2003/04, Audit Scotland, December 2004.
19	Scottish Executive Efficiency Technical Notes, Scottish Executive, March 2006. 
20	Audit Scotland, May 2005 and August 2005.
21	Supporting prescribing in general practice, Audit Scotland, 2003.
22	Scottish Executive Progress Report on Audit Committee Recommendations AU/S2/06/13/5, Scottish Parliament Audit Committee, September 2006.
23	Implementing the NHS consultant contract in Scotland, Audit Scotland, 2006.
24	Prepared under Section 22 of the Public Finance and Accountability (Scotland) Act 2000. A copy of the Section 22 report on NHS Highland can be viewed at www.audit-scotland.gov.uk

Part 3. Governance 

Key message

Most boards are making progress in setting up structures and governance arrangements to support single system working but the transition has been more challenging for some of the larger NHS boards. Governance arrangements for the new CHPs are at an early stage.

There have been a number of major changes affecting the structure of the NHS in Scotland

90. The structure of the NHS has changed significantly over the last three years including:

•	the dissolution of NHS trusts and the formation of 15 unified boards (now 14 with the dissolution of NHS Argyll and Clyde)
•	the establishment of CHPs.
91. Change looks set to continue as the NHS in Scotland moves toward a system which puts more emphasis on improving health and targeting resources on those at greatest risk in line with the aims of Delivering for Health. Good governance arrangements are essential at a time of structural change to ensure that internal controls operate as intended, risks are identified and managed, and key staff members are retained.

The move to single system working has been a challenge for some of the larger boards
92. We reported last year that some boards were operating interim corporate governance arrangements for part of 2004/05. Auditors reported that further progress has been made in 2005/06 although the transition to single system working is taking longer for some of the larger 
NHS boards.

93. NHS Lanarkshire continued to embed single system working during 2005/06 but recognises that further work is required on budget setting and risk management arrangements.

94. NHS Greater Glasgow, given the size and complexity of the board, decided to adopt a two-year approach to implementing single system working. This has involved the dissolution of individual divisions, the creation of one Greater Glasgow-wide board and establishing a complex network of Community Health and Care Partnerships (CHCPs) and CHPs. Further work has been undertaken in 2005/06 including the establishment of single system committees. However, the transfer of services from the former NHS Argyll and Clyde will mean further work is required in the new NHS Greater Glasgow and Clyde, particularly on the board’s risk management strategy and protocols.

95. NHS Lothian implemented the second phase of its restructuring in April 2005, creating the operating division responsible for delivering acute services and a primary care organisation (including four CHPs and one CHCP). The board’s Statement of Internal Control for 2005/06 shows that further action is required before NHS Lothian is operating as a single system. Work planned for 2006/07 includes implementing:

•	a single financial system, completion of outstanding financial operating procedures and harmonisation of risk assessment procedures
•	systems to provide reliable access to patient case notes
•	a board-wide human resource system, including processes to monitor compliance with the EU working time directive
•	comprehensive emergency plans.
96. The island boards have always operated as single systems but we have highlighted concerns for the last two years about corporate governance in NHS Western Isles. The auditor reported that some progress has been made in this area in 2005/06 but that the board still continues to have problems in establishing robust corporate governance arrangements. The auditor will continue to monitor the board’s governance arrangements during 2006/07.

Most CHPs are now established and developing their governance arrangements

97. CHPs in most boards were operational by April 2006 and are anticipated to play a critical role in reshaping health services in Scotland. However, the establishment of CHPs in some boards has been delayed.

98. NHS Argyll and Clyde did not implement its CHPs as planned. Ministers did not approve the five proposed schemes of establishment prior to the decision to dissolve the board and only limited progress was made during 2005/06. Responsibility for developing CHPs in the former NHS Argyll and Clyde area has now transferred to NHS Greater Glasgow and Clyde and NHS Highland.

99. NHS Orkney and NHS Western Isles had not implemented CHPs by April 2006. The scheme of establishment for Orkney CHP was approved in November 2006. 

Governance arrangements in CHPs are still developing
100. NHS boards are devolving key areas of responsibility to their CHPs. Critical to this is the need for sound governance arrangements to support CHPs in doing the job expected of them, and to ensure that they use resources properly and to good effect.

101. Auditors have reported that, where CHPs have been established, governance arrangements are in place but these are at an early stage. Further work needs to be done in a number of governance areas including schemes of delegation (NHS Greater Glasgow); shared objectives and reporting arrangements (NHS Lanarkshire); and accountability arrangements (NHS Grampian).
 
Boards are making good progress in developing clinical governance and risk management arrangements

102. We drew attention last year to NHS Quality Improvement Scotland’s (NHS QIS) interim review of boards’ clinical governance and risk management arrangements.26 NHS QIS reported that boards were making good progress in developing structures and implementing processes to ensure that clinical governance and clinical risk management are embedded in single system working.

103. NHS QIS has now issued standards on clinical governance and risk management. One of the first boards reviewed by NHS QIS in 2006 was NHS Borders.27 The review identified a number of examples of good practice including NHS Borders’ interaction with the public, carers and its joint working arrangements with Scottish Borders Council. The review also highlighted a number of issues for the board to address including business continuity arrangements, reporting arrangements and processes for approving and finalising strategies prior to implementation.

104. Auditors for most other boards have provided high level commentary on clinical governance and risk management arrangements in their final audit reports because NHS QIS is currently reviewing the rest of the boards. Where auditors have commented, it appears that boards are continuing to make progress in this area.28

105. Auditors are working with NHS QIS to share intelligence on boards’ governance and risk management arrangements. NHS QIS intends to publish a national report on clinical governance and risk management in November 2007. We will comment on this in the NHS overview report for 2006/07.

26	Safe and Effective Care: Interim Review of Clinical Governance and Risk Management Arrangements in NHSScotland, NHS QIS, June 2005. 
27	Auditor’s report on the 2005/06 audit of NHS Borders.
28	NHS Ayrshire & Arran, NHS Dumfries & Galloway, NHS Forth Valley, NHS Grampian, NHS Greater Glasgow, NHS Orkney, NHS Tayside, NHS Western Isles.

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