Sarah Lafond (@SarahLafond13 on Twitter) is senior economics analyst at the Health Foundation. Read the related blog, Understanding the drivers of deficit: the system or the organisation?, by Phillippa Hentsch (@PHentsch on Twitter), policy advisor for funding and resources, NHS Providers. Tweet #NHSfinances.

For the seventh quarter in a row both Monitor and NHS Trust Development Authority (TDA)reported a net deficit among NHS providers, with nearly all (95%) acute hospitals unable to balance their books. Since 2012/13 the financial performance of NHS providers has rapidly declined - it has become a systemic issue with three quarters of all providers in the red to the tune of £2.3bn. These worsening finances are the result of costs rising faster than income, and translate into low levels of crude productivity. Recent analysis  shows that NHS providers’ productivity fell (-0.5%) between 2013/14 and 2014/15, and our latest analysis shows that the problem is worst among hospitals, with productivity falling nearly 1% in 2013/14 and 2014/15.

To try to understand the causes we decided to look at whether certain characteristics could be associated with poor financial performance. In our report A Perfect Storm: An impossible climate for NHS provider’s finances we identify a combination of factors that has led to the deterioration of NHS providers’ finances.

The largest single factor is an increased reliance on agency staff. This is not surprising. Staff costs account for nearly two thirds of NHS providers’ total costs, and agency staff are more expensive. Following Sir Robert Francis QC’s review, providers were encouraged to increase staffing levels on wards. The rapid increase in demand for clinical staff which ensued was largely met by relying on agency staff. Between 2011/12 and 2014/15 spending on non-permanent staff rose by an average of 15.3% a year, while spending on permanent staff remained relatively flat (0.03% a year).

Despite the increased spend on agency staff, there is still a gap between staffing need and supply. The NAO reports that the gap is greatest for nursing, midwifery and health visiting where training places have fallen by 20% over the last decade. Similarly, NHS improvement - which establishes on 1 April 2016 and consists of Monitor and the TDA and overlooks foundation trusts, trusts and independent providers - estimates a shortage of about 15,000 nurses in hospitals and has highlighted that the ratio of nurses to patients has returned to 2011 levels. So the current ratio is not unprecedented, matching the rate before the rapid deterioration of providers’ finances, which suggests better planning could have limited the increased reliance on agency staff. Whether the price cap implemented by Monitor and the TDA is the appropriate response is uncertain; it is likely to generate savings but the impact of the cap on the workforce shortage is still to be determined.

The increased financial pressures are partly explained by increased activity, but our analysis shows this level of increase is also not unprecedented. This seems to have been exacerbated by the fall in tariff prices in recent years. Our model found that trusts with a higher than average proportion of income covered by tariff were more likely to be in deficit. The annual decreases in the tariff price between 2011/12 and 2014/15 were set on the assumption that providers would achieve the required 4% efficiency savings per year. In reality, efficiency gains among providers have been much lower. 

Monitor recently acknowledged the difficulty of the task by cutting the efficiency requirement to 2% in 2016/17, meaning national tariff prices will rise by 1.8%. This is a step in the right direction to ease the financial pressures on providers. But given the increasing number of CCGs in deficit, it remains to be seen whether the new tariff is affordable to commissioners or whether we are just shifting the burden. Much less whether any of this will result in a more fiscally sustainable climate for the NHS as a whole.

More importantly, our model also revealed a worrying association between poor financial performance and quality of care. Providers rated as inadequate by the CQC and with a higher proportion of staff who wouldn’t recommend their workplace to friends and family for health care have poorer financial performance. Do limited financial resources lead to difficulty meeting care quality standards, or could an inability to deliver required standards of care lead to less satisfied staff, resulting in lower productivity levels and poorer financial performance? More analysis is needed to further understand the nature of this relationship, but this link reinforces the importance of tackling the financial problems facing providers sooner rather than later.

What is clear is that this is not a problem created by poor financial performance at organisational level, but rather a systemic issue affecting the vast majority of providers. The events, reforms and policies that have occurred in recent years have created a climate where it is nearly impossible to maintain a balanced budget while maintaining quality of care and meeting rising demand. Many factors have played a role in creating this perfect storm but when staff cost is the largest single area of spending for NHS providers, when there is a gap as big as 7% between nurses needed and supply, when the cost of non-permanent staff paid at premium rates is rising by 15% per year on average, one might paraphrase former US president, Bill Clinton:  “It’s the workforce, stupid!”.

The Health Foundation report is featured exclusively in HSJ