Feature / New perspectives

The delivery of healthcare is undoubtedly a people business. But walk into any hospital or health centre and it becomes apparent that the delivery of modern healthcare also depends on equipment, both high and low tech.

Over the past decade the NHS has turned to leasing for everything from PCs to diagnostic scanners, beds and even mattresses. But some feel the introduction of international financial reporting standards (IFRS) has made this alternative source of finance less viable.

Other changes in the NHS operating environment could also restrict equipment leasing. Most trusts in England have surpluses, so many could decide to buy new equipment. Or, with the squeeze on public finances after 2011, trusts could choose to extend the life of existing equipment, rather than committing to new expenditure via leasing agreements.

Equipment leasing began in the 1990s after the launch of the private finance initiative – the Private Finance Act 1993 gave trusts the power to acquire equipment using alternatives to capital expenditure. It was given a shot in the arm following the introduction of capital spending restraints at the turn of the century. Leasing became instantly attractive because the operating leases trusts agreed were off-balance sheet, so they did not affect external financing limits. Trusts could also show value for money as the lessors took the residual value risk.

Managed equipment services – deals that include maintenance, training and equipment refresh – were initially part of PFI deals but trusts are increasingly signing stand-alone deals lasting 10 to 15 years. The refresh element of these deals, which can be leases, is important given the pace of change in technology. For example, the latest CT scanners can produce more detailed images, in less time and with less radiation exposure.

A little over a year ago, the NHS Purchasing and Supply Agency (PASA) estimated the NHS leasing market was worth £500m a year.

Other areas of leasing

Of course, the NHS has other leases, the biggest being PFI and local improvement finance trust (LIFT) schemes. The financial implications of the move to IFRS for these leases, which has reclassified many as on-balance sheet finance leases, has been well publicised and equipment lease schemes are encountering the same problems, albeit generally on a smaller scale.

Classification of each lease is the crux of the matter. As they are on-balance sheet, finance leases attract capital charges at 3.5% and depreciation. Finance leases are charged against a trust’s capital resource limit and absorb some of the trust’s capital budget for the year. Operating leases are off-balance sheet, but annual lease costs are charged to revenue.

International accounting standard (IAS) 17 applies to leases and is broadly similar to UK GAAP’s SSAP 21 when defining operating and finance leases. But there is one big difference. Under SSAP 21, the decision on whether a lease was a finance or operating lease was based on the 90% net present value test – if the net present value of the lease payments was worth 90% or more of the capital value of the asset, this would tend to classify it as a finance lease. Under IAS 17 this is dropped in favour of a more subjective test, which could lead to more deals being classified as finance leases.

Each lease must be examined on its own merits (including existing leases) and will be considered a finance lease if the net present value of the lease payments amounts to substantially all of the fair value of the asset. No numerical value is given, but the net present value of the payments, the level of residual risk taken by the lessor and the professional judgement of auditors and finance managers will come into play when classifying a lease.

To some in the NHS, this was the final nail in the coffin for leasing. NHS PASA was moved to issue a FAQ document last December, which said that not only was the health service ‘allowed’ to enter into leasing deals, but could also use operating and finance leases, as long as trusts could demonstrate value for money.

NHS Supply Chain, the Department of Health’s joint venture with logistics firm DHL, took over responsibility for equipment leasing and the national framework agreement for operating leases from PASA at the beginning of this month. It insists leasing remains a viable source of finance for the NHS.

 NHS PASA’s operating lease framework agreement expires in March next year and Supply Chain’s procurement director, Roger West, says it is working on its replacement. ‘NHS Supply Chain has already started working to introduce new contracts from April 2010 that will allow NHS trusts to use NHS Supply Chain as a one-stop shop for procuring, financing and maintaining capital equipment.

Dudley Group of Hospitals NHS Foundation Trust leases equipment as part of its £168m private finance initiative deal, which includes buildings, equipment and hard and soft support services. Fixed large-scale medical equipment, such as MRI and CT scanners are included in the lease but not mobile equipment such as mobile ultrasound scanners.

Continuing attraction

Director of finance and information Paul Assinder says leasing avoids large upfront cash payments and is likely to remain attractive. ‘When you have a strong balance sheet, the temptation is to fund assets through direct capital purchasing. But in a challenging period for NHS funding many finance directors are taking the view that they want to maintain that healthy liquidity position. So, trusts probably won’t be rushing into mainstream capital spending and for that reason leasing will remain a fairly attractive option.’

Peter Mullin, managing director of Leaseguard Group, which manages all aspects of leasing at 50 trusts, agrees. ‘In the past, when trusts had cash, they bought; when they didn’t, they leased. There will be a requirement to cut costs and inevitably trusts will turn to leasing as it is a way of deferring cash expenditure.’

Mr Assinder says it is difficult for FTs to access large sums of capital on the markets now, even though the NHS has traditionally been seen as a safe area in which to lend. This may add to the attractiveness of leasing for the NHS, as the leasing arms of medical equipment makers with strong balance sheets may be able to access finance more easily.

He adds the NHS will increasingly look to equipment suppliers to accept operating risk. ‘We will see more productivity-based leasing deals, with payments based on meeting manufacturer efficiency claims rather than treating them as an act of faith as previously.’

He feels NHS providers will increasingly work together to improve system efficiency – by sharing diagnostic equipment and reducing the time the equipment is idle, for example.

‘Acute providers have got to collaborate more in terms of sweating their assets. We are increasingly looking at options for operating at a consistent level of provision 24 hours a day, seven days a week and are trying to get staff contracts amended to reflect that,’ he says.

Unsurprisingly, lessors insist the NHS equipment leasing market is not dead. David Martin, general manager, public sector and Siemens businesses at Siemens Financial Services, says IFRS has not had a material impact. ‘From the trusts we have spoken to, we have seen a small number of operating leases reclassified as finance leases. One of the reasons is the lack of understanding of how to apply IFRS and what it means to them,’ he says.

Mr Martin says this confusion is being caused by the replacement of the 90% net present value test by more subjective guidelines on the remaining useful working life of the asset at the end of the lease period.

One trust found only three of its leases should be reclassified as finance leases, but a further 31 could be finance leases depending on how the new rules were interpreted. ‘As it is subjective, it is open to interpretation,’ Mr Martin says. ‘I think trusts would prefer to have something that had a yes or no answer. It is difficult to define the useful working life of an asset; different auditors have different views.’

Mr Mullin says there has been some misunderstanding. ‘There is a view that’s become widespread that auditors have taken as a default position that virtually everything will have to go back on-balance sheet. That’s not what we have seen – we manage 3,500 leases and 90% to  95% of those remained off-balance sheet,’ he adds.

Mr Assinder says auditors‘ attitudes to the classification of leases under IFRS vary.  ‘IFRS is new to them too. Our auditor, when examining PFI leases under IAS 17, asked: “Who’s got the residual interest in the building and who has the operational authority on a day-to-day basis?” If you “fail” either of these tests the asset goes on the balance sheet despite its treatment under the old SSAP 21.’

Jeremy Knight, GE Healthcare financial services country manager for the UK and Ireland, insists that as long as deals are value for money it does not matter they are classified as finance leases, adding: ‘People we have been talking to in foundation trusts have found finance leases with technology risk transfer can be more attractive than an operating lease.’

This is because the charge for operating leases goes above the EBITDA line in accounts, while that for a finance lease goes below.

But leasing can have its downsides. Monitor uses other metrics of financial performance as well as EBITDA. Tying trusts to a lease can reduce their flexibility in tougher times, when the NHS often looks to roll back replacement and maintenance schedules.

Yet the suppliers believe leasing is critical to the NHS efficiency and productivity drive. They argue the pace of change in technology can give opportunities for greater productivity if NHS organisations get their asset finance and utilisation right.

Mr Knight says the NHS has generally viewed the life cycle of such equipment as 10 to 12 years, and he acknowledges that when times are tight there is a temptation to increase this. He believes this will change as the health service seeks to increase efficiency.

‘The time for an MRI full body scan has fallen from 45 minutes to 20 minutes in the last five years. In effect, you could see twice as many patients in the same amount of time for the same cost. If you have two old units, potentially you only need one of the newer ones, which can lead to savings in overheads, staff and consumables,’ he says.

‘That’s where leasing leads you into total life cycle cost management. We are beginning to see a lot more discussion of whether the NHS is working its assets hard enough. Utilising new technologies doesn’t have to cost more.’

The debate over leasing will rage, but the message from the Department and suppliers is clear – leasing can provide the NHS with a viable alternative source of finance.

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