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ecent research from the Institute for Fiscal Studies suggests that the current recession and the drastic steps taken to try and avoid a prolonged depression have added a significant and structural deficit to public sector finances, adding long term debt worth 6.5% of GDP per annum to the national debt, which is forecast to reach 70-80% of GDP by 2016.

This additional debt is expected to remain high for the next generation and will result in two parliaments characterised by material spending cuts, in order to rebalance the books. From a macro perspective, the likely change in government next year does not make a huge amount of difference. Following the release of his Healthcare Sector Review, Brewin Dolphin Investment Banking’s Chris Glasper, assistant director equity research, looks at the key issues currently affecting health and social care and whether the state of public finances, whilst potentially squeezing profit margins, could provide a significant growth opportunity.

The NHS is one of the largest areas of public expenditure with the Department of Health (DoH) accounting for 18% of total spend. Since Labour came into power in 1997, it has been a significant beneficiary, enjoying real growth in expenditure of 7% per year against 3% historically. There are slim prospects of real increases in NHS spend over the next parliament and possibly the one after. As such, absolute savings will inevitably have to be sought, given that input cost pressures in healthcare tend to be above inflation levels in the wider economy, and the demand for services is forecast to continue to increase, driven by long-term trends in ageing, increasing disease burden from improved survival rates and the negative health impacts from the recession.

Getting more for less

For those companies that are able to save the government money and provide innovative service solutions, there may well be an opportunity for future growth. At the moment, less than 10% of NHS expenditure goes to the private sector. Given that outsourcing companies believe that they can save 20-30% of costs, this figure has scope to rise in the next five years, boding well for the private operators which already have a foothold in the primary and secondary care categories. At this stage it is impossible to quantify how much more will be outsourced, which areas will be affected and to what degree.

The move to outsourcing is likely to be driven at a local level rather than centrally, hence individual contracts may be relatively small. The move to outsource residential, domiciliary and specialist social care has effectively been in train for the last 20 years, so a step change in opportunities is less likely than in primary/secondary healthcare. However, further scope is seen for provision moving out of residential/institutional settings and into more community and home-based care, which is less capital intensive and more cost effective.

According to the CBI, private sector businesses are being deterred from bidding for public service contracts by the need to match what it says are costly pensions when staffs transfer to private firms. Firms have to pay between 25 and 50% of salary to fund the pensions of ex-public sector staff, leaving many unable to compete against a public sector employer, which contributes roughly 15%. This is a key issue that needs to be addressed if outsourcing is to accelerate significantly.

A focus on primary care

To date, the presence of the independent sector in the market has been limited to the margins – relatively small scale and providing ancillary services such as out-of-hours coverage and commuter walk-in centres rather than mainstream front line services. The Darzi initiatives over the last year have made some headway in opening up the market to competition, albeit in a relatively small way. Primary Care Trusts (PCTs) are a very important part of the NHS and have responsibility for about 80% of the total NHS budget (over £80bn pa). PCTs decide what health services a local community needs, and they are responsible for providing them, giving funding to GP practices and purchasing services from the acute hospital trusts. Of this budget, £29.5bn is spent on primary care services and £55.8bn on secondary care.

The big prize in the short to medium term appears to be the divestment of the community healthcare services, mental health and community nursing etc, currently provided in-house. As PCTs are increasingly required to focus on their roles as commissioners of services, these provider arms will be divested. Whilst there are a number of ways in which this can be achieved – forming social enterprises, merging with Foundation Trusts etc – at least some of these services will be put out to competitive tender. It is a £10bn per annum market, so even relatively small scale opportunities could be significant.

Given the expected tightening of purse strings after 2011, the longer-term rationale for outsourcing services to providers who can provide a more cost-effective service would appear logical. Real growth will inevitably be less going forward and unlike many other markets, the healthcare sector is not cyclical which makes revenues more predictable, hence investment opportunities are more attractive to potential investors. However, with more than a million people signing the British Medical Associations’ petition in opposition to the new Darzi centres, there is clearly a large section of public opinion that remains at best sceptical of private sector involvement in the NHS. Similarly, the barriers to external providers entering a closed shop NHS are significant and changing attitudes away from a protectionist philosophy will take time and effort.

The fact remains that healthcare, like education, is prone to becoming a political football. If, as seems likely, a change in government occurs in the next 12 months, further policy shifts are eminently possible.