PROPOSAL

5. The Government has made 'in-principle' decisions to finance DHBs with a mixture of debt and equity, and not to allow DHBs access to private sector financing except for working capital [CAB (00) M 20/4 refers].

6. Implementing these decisions will require the establishment of a Crown financing agent (CFA) to administer the debt financing for DHBs. This paper:
   • outlines the roles and responsibilities of such an agency;

   • suggests criteria for deciding who should undertake the role;

   • makes a recommendation about the best agency to undertake the role; and

   • describes the further work required to implement this recommendation.

BACKGROUND INFORMATION

Core function

7. There are certain 'core functions' that are fundamental to the CFA role. To qualify as a candidate for the CFA, any potential candidate must be able to perform the following functions efficiently and effectively:
   • approving or declining individual DHB loan applications;

   • setting terms and conditions of loans;

   • ensuring that the total amount on loan at any time fits within the appropriated funding;

   • ensuring compliance with loan conditions;

   • ensuring loan repayment; and

   • managing 'at risk' loans.

Additional Functions

8. In addition to the core functions there are other functions that the CFA could perform that would assist in improving financial management within the sector. These include:
   • determining sector standards for financing levels and credit worthiness;

   • monitoring credit worthiness of DHBs;

   • providing early warning of fiscal risks;

   • giving an independent view of the financial performance of DHBs;

   • providing another incentive for prudent financial management of DHBs;

   • assessing business cases for capital investment from a financing perspective;

   • managing the process of conversion of existing private sector debt into public sector debt; and

   • managing the overall relationship with the private sector for existing Hospital Health Services (HHS) loans which have yet to revert to the Crown.

9. These additional functions provide the criteria for assessing the candidate solutions and choosing between them. The key criteria are ability to provide an independent view of financial performance and ability to provide further incentives for prudent financial management of DHBs.

Optional Functions

10. In addition to the functions described above, debt financing of DHBs will involve managing the actual cash transactions to and from the DHBs as loans are drawn-down and repaid.

11. The CFA or the Debt Management Office of The Treasury (NZDMO) could perform the cash management function. This issue will be the subject of further work by officials.

COMMENT
Options for the CFA

12. Five main options for the agency to carry out the CFA role have been identified. These are:
    • the Ministry of Health;

    • The Treasury;

    • the Residual Health Management Unit (RHMU);

    • a new Crown entity; or

    • a private entity.

13. A three step process was used to determine which of the five options was most appropriate:
    • should the CFA role be outsourced or provided within the Crown?

    • should the CFA be a government department or a Crown entity?

    • should RHMU be used or a new Crown entity formed?

14. The logic of this process is shown in the decision-tree diagram below:

    

    The bold lines indicate the recommended path, with RHMU as the preferred financier.

Outsourcing to the Private Sector

15. It would be possible to find an existing private financial institution that would be willing to act as the CFA in return for a fee. The advantages of such an arrangement would include:
    • providing the Crown with access to private sector financial expertise; and

    • the agency having its reputation at risk, which should motivate it to provide independent monitoring advice if the lender considers there is a risk that the entity would fail.
16. However, the disadvantages of the Crown contracting out such a role include:
    • previous experience that private sector financiers added very little value, in the way of risk transfer or monitoring, to the financing of HHSs. This was due to the perception that HHSs had an implicit Crown guarantee. Given that this proposal would see the financial institution lending Crown funds rather than its own, it is difficult to see that the private financier would have increased incentives to add value;

    • it is likely to be more difficult to set up accountability and incentive arrangements that protect the Crown's interests for a private institution than for a Crown entity; and

    • a private financier is likely to charge the Crown a reasonable margin over costs to provide such services. Unless there are considerable economies of scale, which appears improbable, this is therefore likely to be a more costly option.

17. We would therefore not recommend contracting this service out to a private sector institution.

Department or Crown Entity

18. Within government departments, the CFA role would most appropriately fit with either the Treasury or the Ministry of Health. The following table summarises the relative merits of the role being undertaken by a department versus a Crown entity that is more distant from the Crown.

19. Given the potential benefits of a stand-alone entity, especially in regard to the ability to set up appropriate incentive and accountability arrangements, we do not recommend that the CFA role be located within either the Treasury or the Ministry of Health.

RHMU or a New Crown Entity

20. RHMU has been operating as the Crown's lender to Crown Health Enterprises and HHSs since 1993. The Public New Zealand Health and Disability Bill legislates for the continued existence of RHMU and allows the Minister of Health to add functions to RHMU's mandate.

21. RHMU is currently the 'lender of last resort' and has been winding down its operations as HHSs have been encouraged to seek private sector financing. The move to refinancing HHSs within the Crown through RHMU would therefore require a greater focus on this role and increased resources. The alternative would be to establish a new Crown entity to undertake the financier role.

22. The relative merits of each alternative are summarised in the following table.

23. The main issue with establishing a new entity is that it does not appear to have any advantages over the RHMU option, but would likely be more costly and complex to set up and would require a longer learning period.

24. A new entity may be justified if the role was extended to include the lending to other Crown entities. However, at this stage the only area being actively considered in this way is Housing New Zealand Corporation (HNZC). The HNZC will be a single entity and is expected to require funds in large, relatively infrequent 'lumps'. In contrast the 21 DHBs will have smaller, more frequent transactions. The HNZC is likely to borrow directly from the NZDMO.

25. Therefore, we recommend allowing RHMU to expand its existing role rather than establishing a new Crown entity.

Ministerial Responsibility

26. The Minister of Health holds overall responsibility for RHMU and will continue to hold this responsibility following enactment of the New Zealand Health and Disability Bill. Some current functions of RHMU are delegated to other Ministers, including new HHS debt and surplus HHS property.

27. Given the focus of the CFA, involvement of the Minister of Finance is warranted in this function. Ministerial responsibility for the CFA functions of RHMU will be delegated to the Ministers of Health and Finance.

Further Work to Implement Recommendation

28. We have instructed officials to report back to us on the work described below:

A Definition of Terms of Reference

29. Terms of reference for the CFA must be defined. These terms should include agency responsibilities, powers, membership, structure, performance measures, reporting lines and accountability arrangements. The terms of reference should mandate the CFA to:
    • provide a range of financing instruments with sufficient flexibility to meet the reasonable need of DHBs;

    • operate in a transparent manner; and

    • operate efficiently.

B Operating Costs of the CFA

30. The cost of the CFA will be determined once the appropriate Terms of Reference and structure have been designed.

31. A decision on the source of funding for the CFA is required. The two main options for funding are though a separate appropriation or by 'self funding', with the CFA adding an interest margin on loans to cover its own costs. The decision on funding is linked to the performance measures and accountability arrangements that will be used to ensure good performance of the CFA.

C Cash Management

32. Crown debt financing of DHBs will generate two-way cash flows between the NZDMO and the DHBs. These cash flows will be based on the terms of the loan agreements authorised by the CFA.

33. There are two reasonable options for the handling the cash transactions. Either the NZDMO could handle all of the cash management or the CFA could do the cash management in addition to their role managing the financing decisions.

34. Further work, including consultation between NZDMO and the chosen CFA, will be required to determine the best agency to handle the cash transactions and determine the resources needed to fulfil this function.

D Interest Rate Policy

35. The mechanism for setting the interest rates for DHBs needs to be established. Interest rates could be set to match the risk profile of the individual DHB, be based on the risk profile of the sector as a whole, or passed on at cost. These options are fiscally neutral providing the appropriate adjustment is made to Vote: Health. However, the different options create different incentives and may influence investment behaviour in the sector.

E Implementation Plan

36. An implementation plan is required to ascertain the further actions needed to establish the CFA. This plan should include identification of any legislative changes that are needed and assign responsibilities for the work.

Report Backs

37. Officials have been directed to report back to shareholding Ministers on the issues (A)-(E) above by 30 November 2000.

FINANCIAL IMPLICATIONS

39. It is expected that there will be a net fiscal benefit arising from the transition from private to public sector debt. The cost of debt from the NZDMO will be less than the cost of private sector debt and this difference in the expected to exceed the additional costs to fund the CFA. Exact fiscal implications will be determined in the report backs described above.

40. The Minister of Finance has agreed that refinancing the existing private sector debt of hospitals will not impact on the capital provision framework. New debt will impact on the capital provisions and will have to be planned accordingly.

LEGISLATIVE IMPLICATIONS

40. There are no legislative implications at this time. We will report back on any legislative changes identified during implementation planning.

REGULATORY IMPACT STATEMENT

41. This paper does not require a Regulatory Impact Statement, as it does not propose any Bill or statutory regulation.

HUMAN RIGHTS ACT

42. There are no Human Rights Act implications.

PUBLICITY

43. Publicity requirements will be managed through the existing DHB Establishment communication process.

CONSULTATION

44. Consultation has taken place with Treasury, Ministry of Health, RHMU and NZDMO.

CONCLUSIONS

45. Use of an independent, dedicated Crown entity as the Crown financing agency for DHBs provides the best opportunity to improve financial management in the sector. As RHMU already has experience and expertise in this area it is concluded that RHMU is the best agency to take the CFA role.

AT THE MEETING ON 6 NOVEMBER 2000, CABINET CONFIRMED THE FOLLOWING DECISIONS OF THE FINANCE, INFRASTRUCTURE AND ENVIRONMENT COMMITTEE [FIN (00) M 32/1, CAB (00) M 36/1B refer]

FIN (00) M 32/2

ESTABLISHING A CROWN FINANCING AGENCY FOR DISTRICT HEALTH BOARDS

1. noted that the decision to finance District Health Boards (DHBs) through a mixture of debt and equity creates a need to establish an agency to administer and monitor DHB debt financing [CAB (00) M 20/4 and FIN (00) M 32/1 refer];

Minimising Risks

2. noted that there are a number of risks to the Crown from bringing the debt financing role in-house and that to minimise these risks and maximise the net benefits, the agency will need to carry out the following functions competently and efficiently;

   1. monitor the credit-worthiness of DHBs;

   2. approve or decline DHB loan applications;

   3. monitor lending cashflows in accordance with the appropriation limits;

   4. set the terms and conditions of loans; and

   5. ensure DHB loan repayment and compliance with loan conditions;

The Residual Health Management Unit as Crown Financing Agency

3. agreed that the Residual Health Management Unit (RHMU) provides the Crown with the best option for providing these functions;

4. agreed that the role of RHMU should be expanded to enable it to act as the Crown financing agency (CFA) to DHBs;

5. agreed that Ministerial responsibility for the CFA functions of the RHMU be delegated to the Ministers of Health and Finance jointly;

The Debt Management Office

6. noted that the Debt Management Office of Treasury (NZDMO) will be the source of funds to finance DHB debt and that management of individual cash transactions between the Crown and DHBs could be performed by the CFA or by the NZDMO;

Further Work

7. directed officials to report back to the Ministers of Health and Finance by 30 November 2000 with recommendations on:

   1. terms of reference, membership, structure, accountability arrangements and ministerial responsibility for the CFA;

   2. costs of the CFA and how they should be funded;

   3. the interest rate policy for DHBs;

   4. the appropriate agency to handle the cash management functions (either the NZDMO or the CFA); and

   5. implementation plans and timing, including any legislative requirements to establish the CFA.