EXECUTIVE SUMMARY

2. This paper addresses three areas of further work identified in the paper on DHB investment and balance sheet management:
   1. The appropriate roles of private sector finance in its various forms and Crown funding for DHBs;

   2. What should constitute 'significant DHB investments' and 'major DHB transactions' requiring Ministers' approval; and

   3. Whether DHBs should retain the same taxation status as currently for Hospital and Health services (HHSs).

3. On private sector finance, the paper considers two main options:
   1. DHBs to have continued access to private sector finance on the same basis as HHSs (complementing Crown 'equity' investment in DHBs) and existing private sector debts held by HHSs to transfer to DHBs; or

   2. DHBs to be required to obtain all finance (debt and equity) from the Crown and existing private sector debts held by HHSs to be refinanced by the Crown.

4. Officials have different views on the preferred debt financing option and the alternative recommendations in the paper reflect this. The Ministry of Health, CCMAU and HFA consider on balance that the benefits of continued access to private sector finance justify the additional costs of such finance¹. The Treasury considers that these benefits are likely to diminish under the DHB environment and do not justify the costs.

5. The paper provides recommendations on what should constitute 'significant DHB investments' and 'major DHB transactions' requiring Ministers' approval. There will be residual ongoing financial risks for the Crown from DHB decisions on investment in assets (such as new hospitals) and the financing of them. The recommendations set 'materiality' threshholds for DHBs to obtain Ministers' support for these decisions allowing the risks to be appropriately managed by the Crown.

6. The paper evaluates the option of making DHBs exempt from income tax and concludes that there are risks of tax avoidance and distortions could arise if DHBs were tax exempt. The Treasury and Department of Inland Revenue consider there are advantages in DHBs being taxable but the desirability of maintaining them as taxpayers reduces the more they operate in manner similar to government departments. In particular if their activities are restricted there are less concerns in relation to tax avoidance issues. On balance the Ministry of Health and CCMAU are of the view that DHBs should be non-taxable, consistent with the Government's overall objectives for the sector. However, the Ministry and CCMAU is also of the view that DHBs could be made taxable provided there are rules to ensure that DHBs are not taxed on their uncommitted funding.

THE APPROPRIATE ROLE OF PRIVATE SECTOR FINANCE

7. When establishing DHB capital structures the Government has a choice of either continuing with existing HHS private sector borrowing policies or taking the step to increase use of Crown finance (through various debt and equity instruments) and restrict access to private debt.

Background

8. The paper advising on the capital structures and capital investment requirements for DHBs submitted to the Cabinet Committee on Social Policy and Health has recommended that:
   1. DHB capital structures should include both Crown 'equity' in the form of "taxpayers' investments" (net assets) and various forms of financing.

   2. DHBs be given rights and responsibilities to make capital investments in fixed assets (such as hospital buildings and equipment) and manage capital investment resources that are explicitly linked to:
      1. their objectives for achieving effective health and disability services; and

      2. the requirements of good practice, particularly the requirements of the Public Finance Act and other legislation governing the use of public finance.

Crown 'equity' in DHBs

9. I have separately recommended that the DHB capital structures should include both Crown equity in the form of "taxpayers investments" in DHB net assets and various other forms of financing including debt.

Important of debt finance

10. Debt financing for DHB capital investment proposals is important because:
    1. there are large expected future capital needs for the hospital sector. HHSs currently plan over $1 billion dollars of capital investment over the next three years². We could anticipate the same level and trend of investment to continue in the DHB environment. These investment decisions will have a material impact on the value of the Crown's investment in public hospitals; and
    2. short, medium and long term debt finance is variously appropriate to the financing of assets of short or long term life. Debt is therefore required by DHBs to complement Crown equity support for such investments.

11. The size and diversity of investments in new hospitals (up to $1 billion over the next three years) also means that both debt finance in appropriate forms and Crown equity support will need to continue to be provided. Debt and Crown equity will have important complementary roles in supporting capital investment in new public hospital and health service buildings and equipment.

Debt financing options

12. In considering DHB requirements for short and longer term debt financing two main options have been assessed for financing of DHBs are either to:
    1. Allow DHBs to have continuing access to private sector finance for day-to-day cash flow needs and for financing investment in assets (such as health service equipment, vehicles and hospital buildings), complementing Crown 'equity' support (similar to the current situation with HHSs). This includes access to bank overdrafts and short-term credit as well as medium and long-term finance arranged with banks and other financial institutions; or

    2. Remove access to private sector finance. This would require a full Crown debt financing function, in addition to Crown 'equity' support. Under this option DHBs would not be permitted to enter into private sector financing arrangements for any purpose, all capital financing for DHBs will be provided directly by the Crown and the existing $600 million private debt would need to be repaid by the Crown.

13. Some limited Crown debt finance is currently provided to a few HHSs by the Residual Health Management Unit (RHMU). This has essentially become a lender-of-last-resort facility for HHSs. I have recommended that the RHMU continue to have this capacity to assist DHBs.

14. The key factors and issues in considering which option should be pursued are:

Key factors	Key issues
Behaviour: Banks generally seek to encourage good financial disciplines by their customers. This is achieved through their lending conditions, their influence on director and manager reputations (and behaviour) and from the monitoring that they provide. In the NZ public health sector, banks have for many years provided finance and potentially an independent source of monitoring.	The benefits from the incentives that banks provide in the NZ public health sector are reduced by the extent to which there is an implicit Crown guarantee. This arises from the direct Crown funding and ownership of the entities. Moving to DHBs as statutory corporations brings them closer to the Crown and reinforces the implicit guarantee.
Costs: The additional interest cost to the Crown of private sector finance is currently about $8 to $12 million pa on current HHS debt of $600 million3 without fully equivalent risk transfer. There are also legal and administrative costs for arranging private sector finance.	Higher interest costs to the Crown are avoided with Crown debt, but the Crown would incur (as yet unquantified) costs for the Government in establishing an appropriate Crown debt facility (e.g. through RHMU). It is unclear if there would initially be a net saving from refinancing with Crown debt as there will be costs incurred from exiting the existing HHS private sector debt. Note that the Crown would on-lend to DHBs at a risk-adjusted interest rate, not the sovereign rate, and the saving may not be returned to Vote: Health.
Flexible access: Continued access to private sector finance enables DHBs to largely obtain finance when needed and in an appropriate form.	If DHBs were required to rely on Crown debt they might have less flexible access due to the requirements to work with a single Crown agent (e.g. through RHMU). This could give rise to potential difficulties in releasing appropriate levels of finance in a timely manner.

Footnote(s):

1

These costs are relatively small in relation to the amount of finance provided although not all of the costs or the cost savings resulting from any change to 100% Crown debt financing have been quantified.

2

However, based on past experience HHSs have only undertaken approximately 70 percent of this capital investment.

3

This excludes short-term credit, such as bank overdraft currently totalling $19 million.