The financial exchange mechanisms that will replace contracting are still unclear. Eugene Milne suggests a solution

The details of how services will be purchased in the new NHS remain uncertain. Commissioning and providing will still be separate, and primary care groups will be the main commissioners, but the processes for financial exchange and for specifying volumes of activity are not yet clear.

The PCG pilot project in Newcastle and North Tyneside, and the creation of the Tyne and Wear health action zone opened up a debate on alternatives to contracting within the framework of The New NHS white paper.

Most health authorities seem to assume that the process formerly known as contracting will still be the basis of service agreements between PCGs and trusts. But the current reforms present a golden opportunity to sweep away the worst aspects of contracting and replace them with much more constructive relationships.

The white paper spells out some basic requirements of the new system which can be seen as criteria for ways of replacing contracting.

In broad terms, there are two extremes of financial and activity exchange between a commissioner of health services and a provider. They can be characterised as allocation - money irrespective of output - and transaction - money dependent on output. The internal market reforms partly succeeded in a move from allocation to transaction. So within the current contracting model both extremes are found, in the form of block and cost-per-case contracts respectively.

Neither of these extreme approaches can fulfil the criteria identified in the white paper. Current cost-per-case exchanges are visibly the stuff of the internal market, while block contracting, even on a three to five- year basis, is held in suspicion because of its centralist, pre-market connotations.

In establishing PCGs, the government needs to capture the drive and enthusiasm of GP fundholding, as its adherents are likely to be the powerhouses of many of the new groups. For these key players, the white paper statement that 'the government wants to keep what has worked about fundholding, but discard what has not', is a central issue. What has worked includes the 'GPs and fund managers (who) have used the fundholding scheme to sharpen the responsiveness of some hospital services and to extend the range of services available in their own surgeries'. The prospect of a return to allocation or long-term block agreements leaves this group cold. 'Where,' they ask, 'are the levers for change if all the money is committed in advance?'

As part of the PCG pilot project in Newcastle and North Tyneside, we explored several options for financial and activity exchange and arrived at a locally preferred model for the new NHS.

Early attempts at developing a framework for PCG commissioning looked at elaborating on fundholding processes (big fundholding), devolution of HA processes (small HAs), and developing specialty-based agreements.

We looked more closely at a system of programme-budgeting by PCGs with detailed allocations taking place through 'programme boards' or development groups. This approach would have made the health improvement programme central to commissioning hospital services, leaving PCGs to focus on locality- specific and community services.

Consultation on the programme-based proposal yielded much interest, particularly in its coherent approach to strategic planning and in the opportunity it presented for client-group allocations.

The latter aspect appealed particularly with respect to inter-agency working. In such a system it would be practicable to have budgets in different agencies synchronised with, for example, elements of a joint children's services plan.

Two central issues emerged:

the need for PCG freedom to vary levels of activity, releasing funding by reductions or increasing activity by allocation of savings; and

the need for financial stability for trusts, together with a strategic approach to staffing and facilities, which should not be vulnerable to rapid variations in funding.

These issues are often thought to be irreconcilable. But there may be a way around this.

The stakeholder model

Will Hutton describes stakeholder economics in his book The State We're In.1 He envisages company shareholders in the form of regional banks which make a long-term commitment to the development of the company, eschewing short-term dividends. The shareholding investors become participants in the strategic direction of the company rather than speculators seeking short-term advantage.

Translating this to the new NHS, for 'regional banks' read 'PCGs', and for 'company' read 'trust'.

In this model, a PCG would receive its allocation of funding for its residents and would administer that funding in four streams:

A multi-purchaser levy - which would support the specialist commissioning arrangements and provide insurance for PCGs against financially volatile services.

Direct managed services - initially being elements of general medical services, but potentially progressing to the direct employment of large parts of community (and some hospital) services.

Trust shares - this is a new concept. A trust share for a PCG would represent the fixed costs of the trust that are maintained in order to provide a service for that PCG. So for a trust serving only one PCG, the trust share would be the total fixed cost of maintaining that trust without any activity. For most trusts, there would be a number of participating PCGs, each holding a share of the total fixed costs of the trust.

Treatment costs - owning a trust share would entitle a PCG to buy up to a specified level of activity from the trust at a fixed treatment cost tariff, which would reflect the marginal cost of that activity. The PCG could buy this activity on a (tariff) cost-per-case basis, or could choose to block the activity back to the trust in exchange for volume-independent quality standards. It would be under no obligation to use all or any of its entitlement. Where additional capacity was available, a shareholding PCG would be entitled to buy extra activity at the same tariff up to the point where step costs become necessary.

A simplified version of a stakeholder PCG budget under this system is shown in the box (see page 24).

Trust shares would guarantee trusts' stability around their fixed costs, and negotiation of changes in them (other than inflation, capital charge changes and so on) would run over a two to three-year timescale, becoming the foundation stone of long-term service agreements.

PCGs would maintain a direct link between their referral behaviour and ability to manipulate resources in the short term - an area where fundholders have succeeded. Both parties would become partners in the future of local NHS services. Already local populations see local hospitals as institutions that belong to them - trust shares would give material expression to that sentiment.

The key to establishing such a system would be agreeing the formula for splitting trust costs into trust share and treatment cost portions. For some elements this would be straightforward (buildings and drugs, for example) but for others, usually regarded as 'semi-fixed', a formula would be needed. Crudely, this would be likely to allocate proportions of particular expenditures to each category. Medical staff costs would mainly be regarded as fixed. Nursing staff costs would also be mainly fixed, but with a greater variable/treatment element to allow for bank nursing and higher levels of staff turnover.

Fundamental to formulating a split of costs would be transparency and explicitness, leading to a clear understanding of the infrastructural investment of each PCG in each of the services delivered by its trusts. It is more important for the formula to be fair and approximately accurate than to be precise, but it would need to be clear in its operation and preclude manipulation for partisan gain.

Negotiating change in services

Trust shares would end the current process of reallocation of fixed costs precipitated by the withdrawal of activity from trusts at full cost. Once established, a trust share would vary due to proportional, centrally agreed inflationary changes or specifically agreed infrastructure changes.

Service changes would be negotiated at a variety of levels. A service provided by a trust specifically for one PCG would be negotiable directly between that PCG and the trust.

A service for two or three PCGs might be handled multilaterally in a similar way, but discussion of more broadly based services would be passed to a district or region-wide forum, in which all parties would participate and whose outcome would be binding.

Crucially, continuing with the link between treatment costs and short- term changes in activity keeps up an incentive for PCGs to regulate their use of services, which would probably be lost in long-term block agreements.

The principle of trust share and treatment costs as separate streams of funding from commissioners can be extended to specialist services.

It would make sense for a specialist commissioning group to have a similar relationship with the trust as a PCG would. Specialist services could thus potentially reinvest efficiency savings in their specialist area.

The role of the health improvement programme

Importantly, the role of the health improvement programme as the definer of the 'range, location and investment required in local health services to meet the needs of local people' would be clarified in this system.

The HIP is better seen as a process than a product, and will require that existing and new forums for discussion of health services focus on strategic planning.

A HIP group for women's services would, therefore, become the natural place for debating the strategic direction of obstetric services provided to a range of PCGs.

The HIP would be expected to define some mandatory aspects of commissioned services, but for more local levels of negotiation would set standards rather than specifics of delivery. As the focus for discussion of appropriate consultant staffing levels, the HIP would fulfil a major role in the definition of trust shares, and would be the main user of reference pricing in doing so.

Quality standards would gain a powerful tool in the clear distinction between fixed costs and treatment costs in managing the introduction of new drugs and therapies.

This separation would allow focused debate about the package of treatment that should be within the trust's tariff. This would mean that if it was decided that a new drug was appropriate for management of a disease, the tariff would reflect that additional cost and PCGs would not have the option of excluding the drug to avoid the cost.

Treatment tariffs would reflect 'take it or leave it' packages of care to avoid the problems of treatment by postcode.

The model in practice

Over the past months there has been extensive local discussion of the stakeholder model of PCG commissioning in Newcastle and North Tyneside and the Tyne and Wear HAZ.

The proposed model has been almost unanimously welcomed by local PCGs and trusts, and sets out how a new relationship of trust and collaboration between commissioners and providers might be developed.

There is clearly much work still to be done, particularly on a formula for separating trust shares and treatment costs, but we believe that this approach offers the best opportunity to fulfil the promise of The New NHS white paper.

It is unlikely that the proposed model will conflict with central guidance, although certain freedoms might need to be sought to allow it to operate in the Tyne and Wear HAZ.

We are now actively seeking local and national support to move in this new direction.


1 Hutton W. The State We're In. Jonathan Cape. 1995.

A system of effective commissioning will be crucial to the reorganised NHS.

Any system must combine flexibility for primary care groups with financial stability for trusts.

A four-part funding stream for PCGs could be effective.