EDUCATION & DEBATE
NHS internal market 1991-2: towards a balance sheet
Roland Petchey
The first year of the internal market in the NHS has
been claimed to have resulted in increased efficiency.
These claims, however, are hard to substantiate
because the systems for operating the market are not
fully in place. Examination of data on tax relief for
private health insurance premiums for over 60s,
general practice fundholding, and implementation
and transaction costs suggest that much of the
increased efficiency is not due to the reforms but
to increased funding. Furthermore, some of the
changes seem to be decreasing market forces and
reducing efficiency.
Evaluation of the first year's operation of the internal
market is not straightforward. The first difficulty is the
scale of the reforms, which are generally agreed to be
the most wide ranging and fundamental since the
inception of the NHS in 1948. Secondly, the white
paper' and the working documents2 that supplemented
it give only the barest outline of the market framework
and leave several key issues unresolved. The resultant
local variation in working arrangements has greatly
complicated national assessment. Thirdly, the first
year of implementation presents problems as a basis for
evaluation. The market was established before the
information on which it depends (population health
needs, service costs) was available. As a result most
contracting in the first year was in the form of
unsophisticated block contracts. Furthermore, the
reforms were introduced during the run up to a general
election in which it was widely (but incorrectly)
expected that health would be the key issue. Accord-
ingly, the NHS Management Executive advised
regions and districts against major shifts in service
patterns. This resulted in 75% of contracts being
placed with the traditional provider.3 Because the
pattern of trading in the first year of the market was so
confined by technical and political constraints it would
be unsafe to generalise from it.
In this article I examine claims that the reforms have
improved efficiency by considering three aspects of
health services: tax relief on private health insurance
premiums for the over 60s, general practice fund-
holding, and transaction and implementation costs.
These data suggest that the reforms may not be
responsible for the improved performance observed.
Department ofGeneral
Practice, University of
Nottingham, Nottingham
NG7 2UH
Roland Petchey, non-clinical
lecturer
BMJ 1993;306:699-701
Increased efficiency or increased finding?
The difficulties in assessing the internal market
already identified did not deter the NHS Management
Executive from attempting an evaluation of the first six
months of operation. In what was clearly intended as a
pre-emptive strike against Labour's expected attack,
it claimed the reforms were improving quality and
responsiveness and providing "even better value for
money."4 The claims of increased activity were
disputed5 but were apparently confirmed by the
absence of those traditional indicators of NHS
inactivity-hospital beds temporarily closed as a
year end cost saving exercise. Further apparent
corroboration has come from more recent independent
statistics.6 These show that in 1991-2 inpatient
numbers rose 3.5%, day cases 31%, total outpatient
attendances 3.2%, and new outpatient attendances
2.-/3% compared with 1990-1.
Government claims on waiting lists were also
substantiated, although allowance has to be made for
reductions achieved clerically rather than clinically.
But the momentum of reducing waits of over two years
does not seem to have been sustained beyond the
election and might be partially offset by a rise in waits
of between one and two years.7 This concern was
expressed as early as spring 1991.8 Others were anxious
that patients with long waits had received priority over
those with clinically more urgent conditions.59 10 On
balance, though, the evidence suggests record levels of
NHS activity during the first year of the internal
market.
Before this increased activity is attributed to the
internal market, alternative explanations such as
increased funding need to be eliminated. Analysis of
NHS spending and activity during 1979-92 points
strongly towards this possibility (Colin Thunhurst,
personal communication)." Whereas there had been
virtually zero real growth in NHS funding during the
1980s, in 1990-1 and 1991-2NHS spending rose in real
terms by 2-8% and 4-1% respectively. In other words
almost all the real growth during the decade coincided
precisely with the run up to the implementation of the
internal market (and the general election). It must,
therefore, be included in any explanation of increased
activity. Nor can the elimination of two year waits be
attributed to the internal market. It is the culmination
of a centrally coordinated and continuing "waiting list
initiative" begun in July 1986 and costing £156m. It
thus validates not the internal market but "the power
of a key ministerial priority and targeted additional
funding."6 Similarly, the rise in day case surgery
originates from medical advances and investment
decisions that predate the reforms. It cannot be
claimed as evidence of their effectiveness.
Tax reliefon private health insurance premiums
Evidence for the effect of tax relief on private health
insurance premiums for the over 60s is fairly secure
since the scheme has been operating for two years.
Pessimistic early predictions'2 seem to be confirmed by
more recent data. Loss of Exchequer revenue has been
considerable and has not been offset by any gain in total
expenditure on health care. The cost to the Treasury of
tax relief was estimated at about £60m for the year
1991-2,"3 while the number of people claiming relief
was put at 330 000.14 Insurers also incurred substantial
losses. British United Provident Association invested
,C3m in an attempt to tap the expected new market but
failed to recover its investment. Western Provident
Association spent over £1m but recruited just 120 new
subscribers." The scheme has done little to create new
BMJ voLuME 306 13MARCH1993 699
demand. It has simply encouraged existing subscribers
to switch from non-qualifying to qualifying policies.'6
The costs of the scheme do not end there, however.
Tax subsidisation of private health care will have
moved the market away from rather than towards
greater efficiency. By lowering the market price from
what existing subscribers had already shown they were
willing to pay the scheme has decreased the efficiency
of this sector of the health care market. As well as
reducing efficiency, it will also have reduced equity.
People with private health insurance are known to
have above average income" and tax relief therefore
redistributes purchasing power from lower to higher
income groups. Since the wealthy are also likely to be
more healthy the scheme also reduces equity of access;
the more healthy are ensured privileged access to
health care at the expense of those whose need is
greater. It is ironic that reforms intended to increase
efficiency by introducing market disciplines should
have undermined them in the one sector in which they
already existed.
General practice fimdholding scheme
The second area ofconcern is the general practitioner
fundholding scheme. Although it is too soon to draw
definitive conclusions, some aspects of the scheme
raise doubts about the consistency of the government's
interpretation of variations in performance. Working
for Patients' was not a closely argued and intensively
documented analysis of the NHS. It is therefore all the
more significant that, among the few statistics it does
contain, data on variations in performance between
providers feature so prominently-50% variation in
acute hospital treatment costs, for example, or 100%
variation in general practitioner prescribing costs. In
the absence of any reliable direct measure variations
were taken as evidence of inefficiency. Eliminating (or
at least reducing) variations was a main goal of the
reforms.
The budget setting process for fundholding implies
a different attitude towards variation. As no formula
for capitation funding had been developed fundholders
were given budgets on a historical basis. These budgets
allowed them to maintain pre-existing activity and
referral patterns and have resulted in massive variations
in per capita allocations between fundholders. A study
of 15 practices in London and the home counties
showed variation of over 400% in drug budgets, over
300% in hospital inpatient treatment budgets, and
150% overall."' Similar variation was identified
nationally.'9 It seems unlikely that variations of this
magnitude will prove to be correlated with need or
deprivation. If it were consistent the government
would have to view these variations too as evidence of
inefficiency.
It has been claimed that fundholding "has revealed
rather than created these variations."'8 I would suggest
that it has done rather more than just reveal them. It
has reinforced them by building them into practice
budgets. Higher spending practices were rewarded for
their inefficiency and the more efficient penalised by
lower budget allocations. The implication that "easy
money" was made available to some fundholders
was reinforced by reports in January 1992 that some
were expecting six figure savings from their hospital
treatment budgets by the end of the financial year.20
These expectations are rumoured to be confirmed by
an Audit Commission report on fundholding due for
publication last September but delayed.2' It is hardly
surprising that health authorities and hospital managers
were calling for the immediate introduction of capita-
tion funding for fundholders as a means of stemming
losses from their budgets.22
The fundholding scheme has entailed costs for other
actors in the internal market. Providers have had to
cope with the uncertainty created by the unpredicta-
bility of fundholders' purchasing decisions or maintain
services on a lower throughput when fundholders
referred elsewhere. They have had to develop more
detailed service costings than were required by their main
customers, the district health authorities, who were
limited to the less information costly block contracts
during the first year of the internal market. The fact
that these costs cannot readily be quantified or fall
outside the fundholding sector does not mean that they
should be overlooked. Whenever the final balance is
drawn up, costs such as these will have to be offset
against whatever gains arise from the scheme.
Transaction and implementation costs
Although critical of the costs of bureaucratic
organisation, proponents of markets have paid less
attention to the costs of transactions in the market
place.23-25 When the product or service being exchanged
is complex (as is the case with health care), it is either
impossible or extremely costly to specify in advance in
a written contract every contingency that might affect
the transaction. An elderly unstable diabetic patient
admitted for surgery, for instance, is obviously going
to require more hospital treatment than a younger
fitter patient. Because it is difficult to incorporate
contingencies of this kind contracts will inevitably be
incomplete specifications of the rights and obligations
of the contracting parties. Incompleteness creates
scope for opportunism. For example, a provider could
seek to increase profits by trimming the quality of
care or a purchaser to reduce costs by manipulating
information or concealing intentions (for instance,
about the number of patients it will be referring under
a block contract or their health status).
One solution to the problem of incomplete contracts
is to try to incorporate as many contingencies as
possible. This, however, requires much more informa-
tion. An alternative is intensified monitoring of
performance in an attempt to ensure compliance with
contracts. Neither solution is straightforward, given
the inherent difficulties of specifying and monitoring
compliance with care plans that are essentially
"customised" to each patient. Both add significantly to
the transaction costs of operating the internal market.
If operating the market entails transaction costs, it is
even clearer that est-ablishing it entails implementation
costs, although the difficulty of identifying and
quantifying them means that estimates vary widely.
One estimate puts the eventual start up cost of the
internal market at £2bn and recurring costs at LO0 5bn
annually.26 Officially, however, only the following
implementation costs have been conceded: £79m in
1989-90, £306m in 1990-1, and an estimated£383m, in
BMJ VOLuME 306 13 MARCH 1993
I...f .: 5 I
runanosrsng nas given prtW6es8
control oftheir budget
but has not reduced variations
in spending
700
1991-2.27 To this, though, we would need to add the
start up costs of the fundholding scheme (14 4m in
1990-1 and £8m in first six months of 1991-228) and the
£11m estimated cost of creating the asset registers
needed for calculating capital charges.29 We should also
add some part of the cost of the increased numbers of
general and senior managers, which rose from 510 in
1986 to 13 200 in 1991,30 31 Between 1987 and 1991 the
salary bill for general managers rose from £25-7m to
£251 5m.32 These increases must be seen in context.
Part ofthe increased numbers may be nominal (because
of changes in title) rather than real.33 Salaries of general
managers still represent only 2-2% of total wages and
salaries in the NHS. Even ifwe add in the £1 *2bn spent
on other administrative and clerical staff as a crude
proxy measure of the managerial and administrative
"overhead" it amounts still to just under 6% of
total NHS expenditure.32 Others have estimated
administrative expenditure in the NHS at around 5%.34
The NHS has always been considered a "good buy"
internationally in terms of administrative costs, and
although precise comparisons are not possible, clearly
remains so, certainly when compared with the 24-1%
calculated for the United States.3" Nevertheless, the
rate of increase in expenditure on senior management
since 1987 is remarkable and the costs are now
equivalent to those of running four medium sized
health authorities.
We are unlikely ever to be able to quantify transaction
and implementation costs with any certainty. None the
less, it is clear both that they are substantial and that
they have to be offset against any putative gains in
efficiency brought about by the internal market. This
conclusion is confirmed by recent experience in the
United States, where rising costs of administration and
regulation are an important factor in the continuing
escalation of health care spending.36-38 The cost of
health service administration in the United States rose
by 37% between 1983 and 1987.35 Much of the high
administrative overhead in the United States is
attributable to the multiplicity of payers and the
necessity of assigning treatment costs to individual
patients and purchasers. In Britain for the foreseeable
future the ultimate purchaser of 80% or more of health
care will continue to be the Treasury. This being so,
the question has to be asked: Will the expected benefits
of the internal market be sufficient to offset the costs of
establishing and operating it?
There is evidence that the government may have
substantially underestimated these costs. The financial
memorandum published in the NHS and Community
Care Bill in 199039 set out its official estimate of the
financial and personnel effects of the legislation. For
items where costs have been disclosed, these estimates
have been greatly exceeded. The £14m annual budget
allowed for establishing fundholding seemed to be
heading for overspend just midway through 1991-2.
Creating asset registers cost double the £5 5m esti-
mated. The acknowleged annual implementation costs
referred to earlier were running at almost double the
£220m estimated for setting up the internal market.
The memorandum expressed the government's
confidence that the extra costs would be more than
covered by the savings they made possible. This
confidence seems unjustified, at least as far as capital
asset charging is concerned. The whole of the first year
was written off as a "shambles."X40
Conclusion
The NHS is changing but the nature of the change
is still unclear. Considerable uncertainty remains
about the balance to be struck between the market and
hierarchy, between economic forces and political
considerations in the determination of health policy.
Politics has predominated hitherto, but its future role
is unknown (and probably undecided). Even if this had
been determined there would still be formidable
technical obstacles to be overcome in realising the
managed market in health care, given that the project
is unprecedented and unpiloted. Under these circum-
stances, attempting even an interim assessment of just
a few facets of change may appear premature (not to
mention hubristic). I would argue that the uncertainties
that make evaluation difficult also make it imperative.
Given the scale and complexity of the reforms final
analysis may never be possible. However, on the basis
of the limited data available, and in the areas that have
been considered it seems probable that substantial and
largely unrecognised costs have been incurred. What is
less certain is whether they have been, or will be, offset
by corresponding gains.
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