catallaxy files

catallaxy in technical exile

Calvary Hospital Update

with 3 comments

On 28 October I posted on the ACT government’s purchase of the Calvary hospital.

The ACT government are buying the Calvary Public Hospital in Canberra. The Calvary Hospital is owned and operated by the Little Company of Mary Health Care Limited who subcontract health services to the ACT government.

The motivation behind all of this is a bit suspect. The ACT government claim that this is all about making a greater investment in public health and about building up the value of their own balance sheet. But it is not clear that governments are in the business of maximising their own balance sheet values – government is about providing services to citizens. So what is really going on here?

What makes this case all the more interesting is the snow-job the ACT government is pulling over the numbers. The ACT Treasury has produced an analysis of the costs of three alternatives. The status quo is that the ACT government continue to subcontract with the Calvary Hospital. The second option is to buy the Calvary Hospital and the third option is to build a new hospital.

Contrary to what they imply the ACT Treasury calculations do not support the purchase of the Calvary Hospital – rather they support the status quo or base case. The argument that the ACT government should maximise the value of assets on its own balance sheet is quite simply nonsense. It is the function of government to provide services to its citizens and to do so in the most cost-effective manner. The ACT Treasury analysis shows that cost-effective manner to be the maintenance of the status quo.

The ACT Treasury have provided four charts in their analysis (at page 3).
Three of these charts are entirely meaningless. It is not clear what ‘Operating Impact’ is, nor is it clear what ‘Balance Sheet Impact’ is measuring. The change in Net Assets is also unclear. Afterall we might expect that the difference between the two options ‘Buy’ and ‘Build’ would be the current purchase price of the buildings under the ‘Buy’ option. Looking at the graph, Chart 3, this appears to be (approximately) the case. The only graph that makes any sense is the Chart 4. That graph shows something called a ‘DCF’ and ‘Cashflow’ without explaining the difference between the two. However, it is clear that the Base Case (the current situation) has the better spending outcome for the ACT government. In other words, for a given level of health outcomes, the cost to the ACT government is lower with the Base Case than with either of the alternatives. Of course, it could be argued that the Base Case might not offer the same ‘given level’ of health outcomes – but if that is the case, then the entire analysis is fatally flawed because it does not compare like with like.

In their classic finance text Richard Brealey and Stewart Myers indicate that only cashflow is relevant for discounted cashflow analysis. Furthermore they indicate that cashflows must be included on an incremental basis. This, in turn, breaks out into six rules that guide the inclusion of items into a cashflow analysis.

• Do not confuse average with incremental cashflow
• Include all incidental effects
• Do not forget working capital requirements
• Forget sunk costs
• Include opportunity costs
• Beware of allocated overhead costs.
It is my opinion that the ACT Treasury have not followed these criteria when undertaking the analysis that supports the purchase of the Calvary Hospital. This is almost certainly true for the analysis that looks at ‘Operating Impact’. The ACT Treasury say

The favourable operating impacts associated with the Territory owning the assets under “Buy” and “Build” are primarily due to capital investment expenses being recognised over a longer period through the depreciation of the assets.

But depreciation is not a cashflow item and should not be included in the cashflow analysis. It should only be included to the extent that it contributes to the creation of a tax-shield. The ACT government, however, is not a taxpayer and so should not include depreciation in any cashflow analysis.

Looking at Table 1, the ACT Treasury analysis indicates that the base case remains the better option. The overall cost is lowest in that instance.
The ACT Treasury would like us to read across the columns, the correct interpretation is to read up and down the column ‘Cash Impact’. The best outcome is the smallest negative number ($374.8m) – the Base Case.

I reckon the Calvary purchase has nothing to do with the desire to accumulate assets, but rather the ACT government’s dissatisfaction with the contract with the Little Company of Mary Health Care Limited. (People familar with Oliver Williamson’s work will recognise this issue.) The ACT Government Information Paper sets out the problem as follows

It is most unusual for both private and public co‐located hospitals to be owned and managed by the same organisation. The cumbersome cross‐charging arrangements are a direct result of there being no formal commercial separation of the public and private arms of the Calvary operation. Accurate cross‐charging arrangements are critical for the proper allocation of costs between the public and private hospitals, to ensure that public funds are not subsidising the private hospital.
The ongoing difficulties associated with the commercial separation of the public and private hospital operations at Bruce have led to a string of reviews, investigations and audits since 2002, and resulted in ACT Health and CHC entering in to arbitration to determine the most appropriate cost allocation methodology for calculating staff time between the public and private hospitals. This again highlights the problematic nature of the existing arrangements. Given the substantial public monies involved, the ACT Government has a duty to review the arrangements and seek improvements. Under the current arrangements, however, these issues would be very difficult to resolve.

It seems that the ACT government are concerned that the public hospital may be cross-subsidising the private hospital. Yet it is not clear why they have this concern or why they would care if that did in fact occur. The ACT government does not own the Calvary Hospital and contracts on a fee for service basis. At best, the ACT Government has a view that they are paying too much for the service that they receive. But if they wish to reduce ACT health expenditure they should state that desire clearly. The ACT government needs to demonstrate that they are not getting value for money from the current arrangements at the Calvary Hospital and as best I can see they have not made that argument nor have they produced any evidence to support that view. Indeed anecdotal evidence suggests that ACT residents prefer the Calvary to the Canberra Hospital.

Today the ACT government put out a press release saying, in part, “But no one has been able to dispute the Treasury analysis or provide any alternative, any solution, to the dilemma facing the Government.” Of course, that is simply not true. The Treasury analysis is not just in dispute, it is disreputable.

Written by Sinclair Davidson

December 17, 2009 at 12:49 am

Posted in Uncategorized

3 Responses

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  1. Why do governments do this sort of financial work so badly?
    And why do qualified people who must know better go along with it?

    Ken Nielsen

    December 17, 2009 at 1:44 am

  2. Thanks for keeping on this Sinclair. The ACT is only small, but this analysis is so bad somebody needs to expose it.

    Matt C

    December 18, 2009 at 7:28 am

  3. The “ACT Treasury” paper is of such poor quality as to raise the question whether it is the real author. Surely no Treasury in any Australian jurisdiction could produce a document of such lamentable quality and political orientation!

    A B

    December 21, 2009 at 1:15 pm

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