not reporting a profit: constructing a non-profit organisation

Financial Accountability & Management, 27(4), November 2011, 0267-4424

NOT REPORTING A PROFIT:CONSTRUCTING A NON-PROFIT ORGANISATION

CAROLYN CORDERY, RACHEL BASKERVILLE AND BRENDA PORTER∗

INTRODUCTION

Since the end of World War II, governments have assumed increased respon-sibility for funding their citizen’s health care as they have sought to promotepopulation health and to meet citizens’ demands for health care assistance(van Kemenade, 1997). Governments have developed a range of alternativedelivery methods, with contracting-out being increasingly adopted as thepreferred method for financing and delivering health care (Robinson, et al.,2005). This accords with the New Public Management (NPM) reforms whichsought to reduce the extent of direct service delivery by the government.As a corollary, reliance on the private sector and market forces increasedin the apparent belief that greater efficiency would be achieved (Johansson,2008; Lapsley and Llewellyn, 1992; Lindkvist, 1996; and Newberry and Barnett,2001). Under economic rationalism, contracting-out and creating competitionare expected to meet citizens’ demands, reduce costs, and deliver services of anacceptable quality (Silverbo, 2004). Hood (1998) notes, however, that ‘humanist’values of public policy are also important and, if necessary, some loss of efficiencymay be suffered in order to secure greater equity among citizens.

While contracting-out of primary health care1 should result in the efficientuse of public funds, it must also meet the three tenets agreed by the WorldHealth Organisation’s (WHO) Alma Ata Declaration (WHO, 1978). Theseare: (i) to increase equity and affordability of access, (ii) to promote goodhealth (health promotion), and (iii) to encourage multisectoral cooperationin meeting citizens’ health needs. In the UK, the introduction of marketstructures and competitive practices to primary health care was initially shown toresult in inequality of access and limited cooperation across providers (Lapsley,1993). Although a later study suggested that no inequities between patients

∗The first and second authors are from the Victoria University of Wellington. The thirdauthor is from the University of Exeter and Chulalongkorn University, Thailand. They wouldlike to thank the research participants and acknowledge the helpful feedback received fromthe participants of the 12th Financial Reporting and Business Communication Conference,Cardiff, 2008; Academy of Management Conference, Chicago, 2009; and the two anonymousreferees.

Address for correspondence: Carolyn Cordery, School of Accounting and CommercialLaw, Victoria University of Wellington, P.O. Box 600, Wellington, New Zealand.e-mail: [email protected]

C© 2011 Blackwell Publishing Ltd, 9600 Garsington Road,Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA, MA 02148, USA. 363

364 CORDERY, BASKERVILLE AND PORTER

existed (Maddox, 1999) it seems that the UK’s Fundholding schemes did notresult in a cost-effective use of public money. Llewellyn and Grant (1996)reported that 60% of the cost savings made from these schemes in the early1990s were spent on premises and office equipment rather than on patientcare.

Cognizant of such findings, the WHO (2000, p.63) concluded: ‘markets workmore poorly for health care’ than in sectors where quality and costs aretransparent. Continued government contracting-out to profit-oriented healthcare organisations, despite its negative effects, is evidence of Hood’s (1998)hypothesis that ideas vary about how public services should be organised. Indeed,he states this is a recurring theme in public management, supporting the beliefthat there is no ‘one best way’ to deliver cost-effective, and socially acceptable,health care (Robinson et al., 2005).

This paper builds on this recurring theme of NPM, as well as the contentionof Lapsley and Llewellyn (1992) that using profit-oriented health providers willreduce the benefits of a public health system. It examines a government strategyof contracting with non-profit organisations to meet the WHO’s three goals.Putnam (1993) argues that the archetypal non-profit organisation builds onstrong social capital to deliver services (such as primary health care) moreefficiently than profit-oriented entities. This paper reports research based onfour case study non-profit primary health care organisations. A key objectiveof the research was to determine whether the non-profit organisational formachieves the government’s goals of efficiency gains as well as the humanistvalues highlighted by Hood (1998) – or whether (as suggested by Hood, 1998;and Lapsley, 2008), unintended consequences result.

This paper is structured in four further sections. In the next section, thesalient attributes of organisational forms used for the provision of publiclyfunded health care services are outlined, followed in the third section byan explanation of the context of the research. In the fourth section, theresearch data are examined in the context of the characteristics of non-profitorganisations. In the final section, conclusions from the research findings arepresented and opportunities for future research are identified.

SALIENT CHARACTERISTICS OF ORGANISATIONAL FORMS FOR HEALTHSERVICES PROVIDERS

A health care system delivered solely by the public sector tends to be hierarchicalin nature, centrally organised and delivers primary health care on the basis of‘one size fits all’. The strength of such systems lie in the co-ordination of healthcare services made possible by a single funder directly employing primary healthcare professionals and administrators. The British National Health Service wasformerly a public sector monopoly and many countries where the citizens arepredominantly low and middle-income earners, such as Lithuania, have alsoadopted this option (WHO, 2000).

C© 2011 Blackwell Publishing Ltd

CONSTRUCTING A NON-PROFIT ORGANISATION 365

Public sector monopolistic systems tend to be inefficient as providers havefew incentives to deliver health care services cost-effectively (Robinson et al.,2005) and over-demand by patients may be encouraged. Further, when providers(or administrators) establish and negotiate health care charges, they may skewinformation in order to obtain more funding than is justified by the servicesprovided (WHO, 2000).

Such homogeneous, monopolistic systems are unlikely to address community-specific primary health care needs as they lack the flexibility to promote andachieve community participation in the planning and control of primary healthcare delivery. They may also impede equity of access to primary health carefor citizens who require services other than those prescribed centrally. Withoutcommunity participation in determining local health care needs, the WHO’shealth promotion goal of having individuals take control of their health andhealth environment is unlikely to be achieved. Lithuania’s health care systemprovides an example of a monopoly that has become ineffective due to a lackof choice for patients (service homogenisation) and central control that stiflesinnovation and provider autonomy (Robinson et al., 2005).

The polar opposite to a public sector monopoly – a system based on free marketcompetition – may also fail to deliver effective primary health care as informationon the quality of the service provided may be lacking and equity of access may beimpeded (Wallis and Dollery, 1999). Although increased competition has beenshown to result in more cost-effective health care services delivery, there is littlesupport for the proposition that competition improves the standard of care, thatis, the outcomes acheived (Smith et al., 2005).

The failure of both competitive market systems and public sector monopoliesto deliver primary health care that meets the WHO’s (1978) goals indicatesthere is an opportunity for governments to contract differently with for-profit and/or non-profit organisations for the delivery of health care services.Putnam (1993) suggests that non-profit organisations are able to use theirfinancial capital more efficiently than for-profit entities as they can augmentit with social capital. Ben-Ner and Gui (2003) contend that non-profitorganisations are less wasteful than for-profit organisations. They propose thatprofit-oriented entities are less cost-effective as a result of four key factors,namely:

(i) Information asymmetry: by controlling the information they provide, for-profit organisations can ‘hide’ profits made at taxpayers’ expense;

(ii) Non-transparent costing: without full disclosure, for-profit organisationscan increase prices without a corresponding increase in their costs;

(iii) Making private gains from related party transactions, excessive remu-neration and dividend payments; and

(iv) Focusing on the most profitable patients, rather than on the community’shealth needs.



Evaluation of Community-Based Non-Profit Organisations as Health Care ServiceProviders

Figure 1 summarises and compares the salient characteristics of non-profit andfor-profit entities’, and the public sector’s delivery of health care services. Itindicates that the provision of health care services by non-profit entities canenable governments to fund cost-effective health care services that focus oncommunity needs and, at the same time, build social capital. However, asnoted by Lapsley (2008, p.87), policy and practice may differ and ‘examplesof implementation difficulties abound’ in reforms, resulting in unintendedoutcomes from using non-profit entities to provide health care services. Forexample, a non-profit organisation’s aim (not to make a profit) is questioned byLeone and Van Horn (2005), who analysed non-profit hospitals in the UnitedStates. They concluded that these organisations manage earnings around a

Figure 1

Salient Characteristics of Organisational Forms for Health ServicesProviders

Salient Characteristics

Community-BasedNon-Profit Entities

Privately-Owned For- Profit Entities

Public Sector Monopoly

(i) Primary beneficiaries of health care funding

Orientation not to make a profit means that full benefit of financial resources should go into services (Silverbo, 2004)

Orientation to make a profit means quality may be reduced (Smith et al., 2005)

Orientation not to make a profit means that full benefit of financial resources should go into services (Hood, 1998)

(ii) Efficient use of public funds

Member managers2 ensure public funds are used efficiently and effectively (Ben-Ner and Gui, 2003)

Competition provides cost control, hence increases efficiency of use of financial resources from the public purse (Smith et al., 2005)

Bureaucracy may lead to inefficient use of financial resources (WHO, 2003)

(iii) Diversion of public fundsto private gain

Non-distributionconstraint reduces likelihood that public funds will be used for private gain (Weisbrod, 1988)

Excessiveremuneration and dividends allow for diversion of public funds to private gain (Robinson et al., 2005)

Public sector unlikely to lead to diversion of public funds to private gain (Hood, 1998)

(iv) Focus of serviceprovided

Focus on health needs of the community. Aims to grow social capital (Bryce, 2005)

Focus on health needs of customer patients (Johnston, 2005)

Focus on health needs of nation’s citizens as a whole (Robinson et al., 2005)



surplus or deficit close to zero through accruals management and discretionaryspending. Similarly, Ballantine et al. (2008), who studied public sector NHSHospital Trusts in the UK, and Chang and Tuckman (1990) who examined non-profit organisations in the US, found that accruals management facilitates themanipulation of reported earnings to achieve a result of low or no profits.3

A second characteristic of non-profit entities delivering health care servicesshown in Figure 1 is that their member management will use public fundsefficiently and effectively. Privately-owned profit-oriented entities may fail todisclose information about the cost and/or quality of the health care servicesthey provide, notwithstanding that such services are funded from the publicpurse. Failing to disclose information on cost and/or quality of the servicesprovided enables these entities to (artificially) increase costs or reduce qualityfor their own ends. Where non-profit organisations are managed by membersof the community, these dangers are reduced as their focus is on effectivelymeeting local health care needs at minimum cost. Non-profit or community-based organisations are also able to benefit from community members’ wealth ofexperience in determining their strategic direction (Ben-Ner and Gui, 2003; andHansmann, 1987). The concept of mutual benefit suggests that their membermanagers will seek to meet the community’s service quality expectations whilekeeping prices as low as possible. However, although low prices increase equityof access, they are also likely to result in increased demand for service; hencedemand for, and supply of, services needs to be carefully managed.

A further characteristic of non-profit entities to deliver health care servicesis the absence of profit distribution. As a consequence, organisational servicecharges do not contain a ‘profit’ element (Weisbrod, 1988) and this, togetherwith volunteer inputs to non-profit organisations, may result in lower chargesfor similar quality services provided by for-profit organisations.

Figure 1 shows that another characteristic of non-profit community-basedorganisations is their aim to grow social capital. The notion of social capital isdescribed by Putnam (1993) as trust, norms and networks that improve society’sefficiency through coordination. Social capital enhances economic and socialwelfare through lower transaction costs (Bryce, 2005). When local knowledge isused by non-profit organisations to assess local needs, it increases the likelihoodof publicly-funded services being provided appropriately to meet these needs(Weisbrod, 1988).

Although, as indicated above, non-profit organisations can benefit frommember management, non-distribution constraints, and a focus on meetingthe community’s health needs, some may not. Dees and Anderson (2003) notethat non-profit organisations may ‘sector-bend’ into for-profit organisations, asa result of contracting or cooperating with for-profit organisations. When thisoccurs, public resources (including tax privileges) may be diverted to private gainand the community’s health needs may be subordinated to those of particularpatients. Along similar lines, Ben-Ner and Gui (2003) suggest that, despitethe non-distribution constraint, non-profit organisations’ managers are able to



pursue their own objectives at the expense of stakeholders. Dissonant behaviourincludes transacting with related parties at inflated prices and executivesdrawing excessive salaries.

The concerns identified by Dees and Anderson (2003) and Ben-Ner and Gui(2003) suggests that governments may not achieve the benefits from contractingwith non-profit organisations for the provision of health care services identifiedin Figure 1. Nevertheless, faced by the failure of competitive markets to deliverhealth care services efficiently and in line with the WHO’s (1978) goals,governments around the world continue to search for the optimal organisationalform for the delivery of publicly funded primary health care services.

THE NEW ZEALAND PRIMARY HEALTH CARE REFORMS

In New Zealand, as elsewhere, the government faces public demand for increasedhealth care funding. In response, the New Zealand Government’s expenditureon health care has risen at a rate of 5.1% per annum on a compound basis from1996, with the overall health expenditure increasing from 7.3% of GDP in 1996to 8.5% of GDP in 2004. This spending outstripped the weighted averages fromother OECD countries (Ministry of Health, 2007).

One reason for the increased health sector funding was the New ZealandGovernment’s reforms of primary health care in 2001. However, fundingincreases were restricted to new non-profit organisations called Primary HealthOrganisations (PHOs). Government funding was channelled to the PHOsthrough District Health Boards (DHBs); the latter were prohibited fromcontracting with for-profit organisations (for primary health care) so that publicmonies ‘would not be diverted into dividends’ (Minister of Health, 2001, p.14).By 2007, 80 PHOs had been established. Each acted as an intermediary betweenthe government funder (one of the 21 DHBs) on the one hand, and GeneralPractitioners (GPs) and other primary health care providers on the other.Notwithstanding their non-profit form, PHOs are able to contract with bothfor-profit and non-profit entities to secure primary health care services. PHOfunding is based on the number of members (patients) enrolled with the GPswho are contracted to the PHO. The system’s structure is shown in Figure 2. TheMinistry of Health is responsible for vision and policy and funds the 21 DHBs.These DHBs run hospital services from a provider arm and contract with Non-Governmental Organisations (NGOs) (as well as PHOs) for other health careservices.

Under the Primary Health Care Strategy (Minister of Health, 2001) PHOs arerequired to design and fund the delivery of primary health programmes so as toimprove their communities’ health. Such programmes include health promotion(through, for example, encouraging individuals to increase their exercise andimprove their diet) and improving access to basic services. PHOs are required toinvolve local communities in their governance structure in line with the WHO’s(1978) goals. They are also required to be ‘fully and openly accountable’ for the



Figure 2

Structure of New Zealand’s Primary Health Care System

DHB as providerNon-

GovernmentalOrganisations

Primary HealthOrganisation

District HealthBoards (DHB) and

other funders

Funds

Ministry of Health– Vision and policy

General Practitionersand General

Practices

FundsFunds

Funds

Accountability

Accountability

Accountability

Patients

New Zealand Population

FundsServices

ServicesServices

Services Funds

Accountability

use of public funds and, inter alia, they are required to produce annual reportswhich include audited financial statements.

PHOs embody a fundamental shift in approach from the past. Previously,the DHBs contracted with a range of providers from an individual Practice,to groups of General Practices. Following the market-based reforms of the1990s, 67% of GPs joined Independent Practitioner Associations (IPAs) thatlobbied, negotiated and managed their contractual funding arrangements withthe relevant DHB.4 However, these IPAs were for-profit organisations andthe 2001 reforms required PHOs to be non-profit organisations. Nevertheless,despite the over-riding requirement for PHOs to be non-profit organisations, as aresult of factors such as their historical origins, the rapidity of the establishment



of PHOs during the first 18 months of the Primary Health Care Strategy, subtledifferences in the demands the 21 funding DHBs placed on PHOs in theirdistricts, and variations in the demographics and health needs of the patientsenrolled in PHOs, a range of PHO legal forms emerged and are ‘tolerated’ bythe DHB funders. These range from PHOs that were formerly for-profit IPAsto community-based non-profit organisations (Abel et al., 2005).

INVESTIGATION OF PHOS IN NEW ZEALAND EMPIRICAL RESEARCH SITES

As noted in the Introduction, this paper reports research designed to determinewhether the non-profit organisational form for the delivery of primary healthcare services achieves the government’s goal of efficiency gains as well asthe humanist values highlighted by Hood (1998). In accordance with thisobjective, all 80 PHOs in New Zealand in 2007 were requested to providetheir annual reports for the years 2005 and 2006, however, only 19 did so.5

The organisational structure and annual surpluses or deficits as a percentageof revenue for the years 2005 and 2006 of these 19 PHOs are shownin Figure 3. The size (based on the number of enrolled members) andorganisational structure of the 19 PHOs are presented in Figure 4. As maybe seen from Figure 3, 13 of these 19 PHOs (69%) were constituted ascharitable trusts, five (26%) as limited liability companies and one (5%) as anincorporated society. Figure 4 provides the range of memberships in each of theorganisations.

Figure 3

Annual Surpluses or Deficits as a Percentage of PHO Revenue

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

PHO1

PHO3

PHO5

PHO6

PHO7

PHO8

PHO9

PHO10

PHO11

PHO12

PHO13

PHO14

PHO15

PHO2

PHO4

PHO16

PHO17

PHO18

PHO19

Profit 2005

Profit 2006

Average

Charitable Trusts

Limited Liability Companies

Inc. Soc



Figure 4

Range of Memberships of the 19 PHOs Which Provided Their 2005 and2006 Annual Reports, Based on the Ministry of Health’s Funding

Categories

Number of Enrolled Members in PHOOrganisational Type + 75,000 40,001-75,000 20,0001-40,000 <20,000

Charitable Trust

PHO PHO PHO PHO PHO

PHO 10 PHO 12

PHO PHO 11

PHO PHO PHO PHO 14

Limited Liability Company PHO PHO

PHO PHO 16 PHO 18

Incorporated Society PHO 19

9 158

2

367

13 154

17

From these 19 who provided their annual reports, eight PHOs differing insize, location and enrolled population characteristics were selected. The AnnualGeneral Meetings (AGMs) of these eight PHOs were attended. In Figures 3and 4 these eight PHOs are identified by the labels PHO 1 to PHO 8. Itmay also be seen in Figure 3 that all but two of the eight PHOs (PHO 2and PHO 4) whose AGMs were observed are charitable trusts. These six trustswere community-based organisations with trustees elected from medical andcommunity representatives. All six of these ‘charitable trust PHOs’ held AGMsthat were open to the public. Unlike the other six PHOs, PHO 2 and PHO 4were non-profit limited liability companies. At the start of the research period,they were 100% owned by for-profit IPAs with directors appointed by the IPA.However, during the research period the IPA owner of PHO 4 devolved half ofits shareholding to the community. While PHO 4 had an AGM which was opento the public, PHO 2 did not do so.

Four of these eight PHOs were asked if they would participate in the researchas case studies; all four agreed. In Figures 3 and 4 these four PHOs are identifiedby the labels PHO 1 to PHO 4. These four case study PHOs varied widely interms of their size, location, the ethnicity and socio-economic status of theirpopulations, and their organisational structure.

During 2006 and 2007, for each of the four case study PHOs, documents(including contracts, accountability documents and organisational communi-cations), were analysed, 14 public meetings were observed and 37 semi-structured interviews were conducted with PHO stakeholders. The intervieweesincluded DHB planning and funding staff, PHO Chairs and Chief Executives,representatives from service providers (GPs, nurses and pharmacists), localauthorities, the media, NGOs and community groups. The key questionsaddressed by the empirical research are indicated as ‘salient characteristics’ inFigure 1. These are used below as sub-headings to report the research findings.



RESEARCH FINDINGS

Primary Beneficiaries of Health Care Funding

In order to examine the non-profit orientation of PHOs in New Zealand, theaudited financial reports of the 19 PHOs that provided annual reports for theyears 2005 and 2006 were analysed. The PHOs’ surpluses (or deficits) werecalculated as a percentage of their revenues so that meaningful comparisonscould be made. (The percentage of revenue calculations eliminated variationsresulting from differences in the size of these PHOs’ enrolled populations.) Theresults are presented in Figure 3 with the PHOs’ classification based on theirlegal form.

From Figure 3 it may be seen that 13 of the 19 PHOs (69%) realised anaverage surplus equal to or less than 1% of revenue; and a further five (26%)recorded average surpluses of less than 3% of revenue. The deficits recordedwere minimal and none of the PHOs recorded a deficit in consecutive years.The concentration of PHOs’ surpluses and deficits in the zone of less than3% of revenue is similar to that reported by prior researchers (for example,Leone and Van Horn, 2005), and suggests the existence of an unwrittenrule or assumed target for these non-profit entities. In order to establish thePHO’s surplus/deficit goal, an attendee at an AGM held by PHO 3 asked thequestion:

Is there, or was there an intention to have a certain amount of surplus, or is it bychance? (AGM at PHO3).

The Chair explained:

Our aim as a Board is to make sure we have enough money to pay all the liabilities wehave and to have enough money there to cover redundancies. We are not looking forprofit to reinvest in the Board or anywhere else but we can actually make a profit onour contracts and our intention in this organisation is to be the best in terms of beingable to put value back into the services that we provide (AGM at PHO 3).

This statement by the Chair implied that the governors of PHO 3 are concernedto use any pecuniary gains to improve the services it provides to the communityrather than distributing them to Board members or General Practices.

Figure 3 shows a correlation between PHOs’ legal form and their reportedsurpluses; a greater proportion of limited liability companies reported a surplusthan did charitable trusts. The suggestion that some companies may have‘managed’ the level of their surplus is acknowledged by the Chair of PHO 2– the only PHO incorporated as a company which did not make a profit. Theyexplained:

. . . A profit for us is embarrassing. We don’t want to make a profit. We aim not to,but we don’t want to be inefficient and sloppy with the money either (IntervieweePHO 2).



The aim not to make a profit may not be restricted to PHO 2. Analysis of the19 PHOs’ audited financial reports for 2005 and 2006 reveals that accruals wereused to ‘manage’ surpluses to be close to zero. For example, at the beginning of afunding period, DHBs provide funds to PHOs for Health Promotion and Servicesto Improve Access (SIA). However, PHO spending of those funds typically doesnot occur until the DHB approves specific projects. It might be expected that theportion of these discretionary funds spent by a PHO in the current financial yearwould be recorded as revenue and related expenses, that committed (but unpaid)expenses would be recorded as ‘accrued expenses’ and the profits or lossesfrom the projects undertaken would be reported in the appropriate financialyear. It might also be expected that the uncommitted funds would be recordedas ‘income in advance’. However, the 19 PHO’s annual reports for 2005 and2006 revealed three broad methods of accounting for unspent (committed anduncommitted) discretionary funding:

(i) all unspent funds accrued as a single item – ‘income in advance’6 or‘expenses accrued’7 – irrespective of whether or not a portion of thefunds has been committed or expenses have been incurred but not yetpaid for. No notes are provided to enlighten the reader.

(ii) unspent funds accrued as in (i), but with note disclosure explaining thecategories in which the funds will be spent in the future8 or, as in PHO 7and PHO 8, with details of under- and over-spending in those categories.In PHO 7 and PHO 8 the profits and losses from contracts are disclosedbut they are not recognised in the Profit and Loss Statement.

(iii) PHO 13 applies a stringent surplus/deficit test for each project and thesurplus or deficit resulting from each project is taken to the Profit andLoss Statement. The resulting retained earnings are separately identifiedas being available for Health Promotion, SIA and other projects.

The audit engagement partner for one of the PHOs in group (i) above wasconcerned that, although an asset ‘funds received in advance’ was recorded, thisaccount was opaque. When the audit firm assessed the stage of completion of thisPHO’s current projects, it found that the ‘funds received in advance’ includedrealised surpluses and also losses for projects which could not be completedwith the funds received. When the audit firm required the PHO to change itsfinancial reporting to realise the profits and losses on its projects, the PHOrefused. Despite this, the audit firm issued an unqualified audit report on thePHO’s financial report. The PHO has since changed its auditors.9 The auditorwas concerned that PHOs following the methods identified above as (i) and(ii) potentially understate their liabilities and/or conceal profits by managingliabilities or revenue. Such earnings management through manipulation ofaccruals has also been identified in the non-profit and public sectors by Leoneand Van Horn (2005) and Ballentine et al. (2008). In New Zealand, the DHBsemploy qualified staff to analyse all of their PHOs’ financial reports, and the



DHBs’ Funding and Planning managers deal with problems raised by theseanalysts on an exception basis. Despite PHO 1, PHO 2 and PHO 4 adoptingaccounting practices in group (i) above and PHO 3 adopting practices in group(ii), none of their DHBs expressed concern about the quality of the PHOs’financial reporting, or the potential qualification of their audit reports.10

As indicated above, PHO 13 reports surpluses in a manner which is markedlydifferent from the other 18 PHOs. Completed projects are assessed and theresulting profits or losses are recognised in the Profit and Loss Statementbefore being separately identified in equity as reserves. From the informationavailable, it appears that PHO 13 does not ‘manage’ its earnings. In 2007, PHO 3adopted an accounting treatment similar to that of PHO 13 with a correspondingdramatic increase in its reported surplus. Community members present at theAGM of PHO 3 were enthusiastic about their PHO receiving ‘more appropriate’levels of funding. When one of the researchers enquired about its response to thePHO’s surplus, the DHB signalled that it was ‘not concerned’ about the surpluswhich would be applied to improve services in the area for which funding wasallocated.

Notwithstanding this, where PHOs failed to meet the DHBs’ expectations, theDHBs conducted multiple audits of a PHO and withheld funding. This findingreflects DHBs’ concerns about the second salient characteristic investigated bythe research.

Efficient Use of Public Funds

Surpluses may result from PHOs focusing on revenue rather than on ‘balancingthe books’. Abel et al. (2005) suggest that non-profit PHOs may be used as aconduit for profit-orientated organisations to extract excessive service fees. Moregenerally, Mitchell and Shortell (2000) suggest that ‘inappropriate’ dealing withrelated parties may occur. This is supported, for example, by a DHB interviewee(responsible for funding PHO 4) observing that PHOs seek to maximise theirrevenue:

[Of the PHOs I deal with] I did find the Chairs really fiscally motivated and a lot ofthem are ex-accountants and things like that. The pure motivation was getting themoney in and I had a problem with that as they didn’t understand the concept ofwhat the PHO was actually doing and what they should be doing with that money(Interviewee PHO 4).

As noted, PHO 4 is a limited liability company where the IPA devolved half ofits ownership to the community during the case study period. PHO 4 continuedto contract with the IPA for management services. PHO 2 (also a limited liabilitycompany) is wholly-owned by an IPA, and the DHB staff member responsiblefor its contract expressed the following concern:

That’s my point around structures . . . On paper the PHO is non-profit but obviouslyall the money went into [the IPA]. Therein lies our problem (Interviewee PHO 2).



Another interviewee concurred with this view, noting in respect of the PHO’sIPA owner:

There is quite a significant philosophy behind [the IPA] structure which is saying that,‘Yes we are there for profit,’ not for super-profits, but we are there for the benefit ofour shareholders and endeavour to increase the value of what we provide to GeneralPractice (Interviewee PHO 2).

The DHB staff member cited above considered that the PHO’s structurefacilitates the concealing of profits, as the PHO is a conduit for the service feeswhich are channelled to the IPA owner. The manner in which this PHO deliveredmany of its services – using its own, rather than contracting-in expertise – wasalso a concern to the DHB staff member. This interviewee noted:

With [PHO 2], we have lots of discussion around the pricing and ‘why do you think thatservice is going to cost you a million dollars when a similar service in a similar sizedPHO might cost half that much’, and so ‘where’s all that money going to’. And youknow we might get into a bit of a discussion about ‘so who are you actually employinghere’ . . . We believe there are either poor prioritisation processes or a lack of clarity ora lack of transparency around where the money’s going to and how it’s being utilized. . . Is it partly clinical or is it all management? How much is being invested in IT forexample? And what exactly is going on in IT? . . .We believe there’s a bit of empirebuilding going on. And so services are trying to be developed that are inconsistent withpopulation health principles (Interviewee PHO 2).

This interviewee expressed the view that the PHO’s development of high qualityIT and support services is not cost-effective. Further, a PHO staff member fromthe same PHO described the PHO’s reticence to change programmes to meetthe DHB’s priority. This interviewee observed:

We’ve had a lot of discussions over programmes . . . There’s always the temptationto want to retain the ones [PHO contracts] that produce the best management feefor the PHO . . . So I’m always conscious that we have a management organisation[IPA] that, if I was in there, I may look at with a commercial interest as opposed tolooking at what’s best for the population. I mean the management company [IPA] isa for-profit business otherwise they just wouldn’t be here (Interviewee PHO 2).

The desire to retain profitable programmes, rather than bring in programmesthat better suit the needs of its community, may result in the PHO treatingsome of its enrolled members (i.e. patients) preferentially.

These comments by PHO 2 interviewees appear to suggest that the PHOmanipulates programmes and costs to ensure the for-profit shareholder IPAcontinues to be profitable. Decisions made with profit in mind reflect the findingsdescribed by Dees and Anderson (2003) where the non-profit organisation‘bends’ into (or displays) a for-profit form as a consequence of the interminglingof services.

A related matter raised by interviewees is that of ‘excessive remuneration’paid to senior staff, resulting in the inappropriate use of scarce health dollarsand a lack of accountability. An interviewee from PHO 3 noted that it



is important to recognise that a ‘doctor should be making a good living’,however, external interviewees from PHO 2 conveyed that the IPA’s staff andexecutives should not be making an ‘excessive’ living from public funding.In relation to PHO 2’s IPA shareholder, an informed community memberobserved:

They actually don’t make much money but they’ve got to make a profit, they’ve gotto pay executives down there who get paid huge money. They’ve got to suck moneyout of the PHO to pay for it. There’s no other way they get their money (IntervieweePHO 2).

Another community stakeholder noted that the actions of PHO 2 and itsIPA are not necessarily aligned with the PHO’s goal to make no profit. Thisinterviewee reflected on the IPA in the following terms:

They are definitely operating in the private [for-profit] health sector I would havesaid . . . I find it interesting that a non-profit organisation can (sigh) pay or act like aprivate [for-profit] organisation. Do you know what I mean? I work very closely with. . . a lot of struggling NGOs in the health sector and they don’t put lunches on fora meeting, they don’t pay in the high end of the salary bracket [like the IPA does].Those sorts of things I guess is something that is not familiar for me in a not-for-profit(Interviewee PHO 2).

Given the requirement for PHOs to be non-profit organisations, it is unclear whya structure such as that adopted by PHO 2 is tolerated by the DHB. However, aDHB interviewee explained:

You’re obliged to be a mentor and be supportive because it’s a health environment. . . because if thousands of people didn’t have health care suddenly, it would be a bigdisaster, and a political disaster (DHB Representative).

While the DHB funder has a measure of control over its PHOs, they areconstrained by the need for citizens to be able to access primary health carein their area.

A further characteristic of PHO 2 is that it is managed by managers employedby the IPA, not by enrolled members of the PHO. This is in contrast toPHO 3, which is managed by enrolled members of the PHO, replicating themodel suggested by Ben-Ner and Gui (2003) to ensure financial resources areused for the benefit of its community. In PHO 3, the Board of Trustees iselected from amongst its enrolled members, Board meetings are open to thepublic, as are monthly members’ meetings where matters of joint interest arediscussed.

Similar openness was evident in respect of PHO 1. This PHO’s Chief Executivenoted:

[The DHB] is not uncomfortable I think, because we report consistently and constantlyout of the reporting cycle. Because of our view about openness, [the DHB] gets copiesof every status report we do on Health Promotion which we do monthly. [The DHB]gets copies of the stuff that I send out around Services to Improve Access . . . so theyare always in the loop (Interviewee PHO 1).



This PHO had a large Board representing many facets of its community, as wellas a regular cycle of community meetings.

Diversion of Public Funds for Private Gain (Through Loans and Taxes Paid)

A further issue related to the ineffective use of public funds is that of loans torelated parties. Analysis of the 19 PHOs’ annual reports revealed that, in both2005 and 2006, four PHOs (PHO 5, PHO 10, PHO 11 and PHO 12) recorded aloan to the IPA that acts as its Management Services Organisation. The notes tothe accounts reported that the loans were ‘approved by the Board’ of these PHOs(which are charitable trusts) but no further details were available contrary to therequirement to make related party disclosures. The surpluses of three of thesePHOs (PHO 5, PHO 11 and PHO 12) are less than 1% of revenue, and thoseof PHO 10 are less than 3% of revenue. While there is no evidence to supportthe notion that these loans are instrumental in these PHOs meeting the goalto make no profit, it seems that public funds are being used to enhance thecash flow of the IPA-based Management Services Organisation. Using revenueto make loans to related parties suggests that private gains may be made at theexpense of improving the health of the PHO’s community.

In addition to actions that bring into question PHOs’ operational commitmentto non-profit goals, public funding may be lost to tax payments when non-profitorganisations are profit-orientated. Tax privileges enjoyed by New Zealand’snon-profit organisations apply when:

• they have charitable donee status (where donations generate tax rebatesfor individuals); and

• they use tax-free profits for charitable purposes.

While no charitable donations were received by the 19 PHOs whose annualreports were examined, two (PHO 2 and PHO 18) paid tax. Both of these PHOswere incorporated as limited liability companies with IPA shareholders. It isunderstood that the Inland Revenue Department investigated their ownershipstructures and deemed that, notwithstanding a non-distribution constraint intheir constitutions, their profit-oriented IPA owners exercise sufficient controlfor the PHOs to be adjudged profit-oriented taxable entities.11 This statusappears to be at odds with the requirement for the PHO to be a non-profitentity.12

While PHO 18 made a taxable profit in 2005 and 2006 and paid income taxthereon, PHO 2 reported a nil profit in both years, and therefore did not payincome tax, However, Resident Withholding Tax (RWT) was deducted at sourcefrom its interest income.13 As a staff member from PHO 2 explained, havingfunds on deposit was unexpected:

I don’t think it was ever envisaged that there would be that amount of interest beingearned which would cause concern of a massive tax bill. But I think it took a while



to get the wheels in motion, to get the expenditure more in line with funding if youlike. As a result of that, the interest earned has been much more than anticipated. . . I don’t think that earning interest and paying tax was a major factor in thestructural discussion at the commencement. And it follows that any change fromthat . . . would involve re-opening constitutional discussions with the District HealthBoard and I don’t think that it was felt it was worth doing that, even with theamount of money being earned and for which tax is being paid. The interest infuture years is forecast to decline significantly with the catch up in expenditure. . .

We are spending the money . . . at a faster level than we were before (IntervieweePHO 2).

Apart from the RWT paid on the interest income, as with the other PHOswhose annual reports were examined, PHO 2 used the net interest to fundprimary health care projects and in this sense, the interest earned helped toimprove the community’s health. However, the RWT on interest received wasunavailable to PHO 2 for spending on health care services. Further, as withthe income tax paid by PHO 18, its RWT could be applied by the IPA ownersof PHO 2 to any distributions it made from the profits it realised from itsother operations. In effect, part of the benefit derived from each of the PHO’srevenue was diverted from the provision of community health services to theirIPAs.

Focus of Services Provided

Apart from the prohibition of ‘profit’ distributions, the government’s require-ment for PHOs to be non-profit organisations accords with Weisbrod’s (1988)contention that such organisations will assess local needs and increase thelikelihood of publicly funded services being appropriately provided to meet thoseneeds. The government’s adoption of the non-profit form similarly accords withthe notion advanced by Putnam (1993) and Bryce (2005) that such organisationswill augment economic capital with social capital. In this respect, an intervieweefrom PHO 4 acknowledged that the PHO could build on strong networks alreadyexisting in its rural communities commenting:

The amount of interaction there is in communities and volunteer groups is actuallyquite astonishing. There are very strong networks, particularly around health andemergency services and community-type issues. These rural communities are reallystrong . . . [People] will be St John Ambulance volunteers, on a trust board or theschool, doing library books, or meals on wheels. Their reliance on volunteers in thosesmall communities is under-rated actually. In some cases it’s astonishing what they do(Interviewee PHO 4).

The Primary Health Care Strategy (Minister of Health, 2001, p.20) encouragesPHOs to ‘take a community development approach to find appropriate solutionsfor disadvantaged groups’. In addition, it requires PHOs to demonstrate thatthey involve communities in decision-making, as outlined in the Alma AtaDeclaration (WHO, 1978, Declaration VII). In relation to the latter point, aPHO Board member noted:



I think that the Alma Ata has probably been the key driver of some of the policy peoplein the Ministry – the concept that people and communities should ultimately designthe health system that serves them (Interviewee PHO 1).

Involving communities may include PHOs actively building on services thatalready exist in the community. As one interviewee observed:

There was already a lot of health promotion happening so we employed a coordinatorto just help coordinate that and share information across all the services and helpcoordinate health promotion between everybody . . . There’s so much resource outthere . . . so it’s actually just someone to help them coordinate (Interviewee PHO 3).

The concept of developing primary health care networks was also discussedat an AGM presentation:

The obvious overall aim is to improve access to primary health services for allour communities so that the overall health and wellbeing of our communitiesimproves. That’s not exactly rocket science but that’s what we’re here for . . . [notworking] in isolation but rather through working in collaboration and partnership withcommunities, service providers, initiators and funders. The idea is to get everyonepulling in the same direction . . . not to take off all by ourselves but to bring thecommunity in to share with our community service, [make it] community rich, thewhole shooting match and to get the community aligned to actually pull in one direction(AGM at PHO 8).

Although PHOs are relatively new organisations, it appears that their staff andBoards are working to build networks on extant community structures throughBoard representation as well as through contracting arrangements. However, asPHO 3 found, PHOs may need to build thir own capacity in order to generatecommunity alignment. An interviewee from PHO 3 explained:

First of all we saw the PHO as a conduit and an organising organisation. It wouldn’tbe involved in delivery but it would be involved in facilitating contracts . . . and thenbasically pass those contracts along [to non-profit providers]. That was the ideal andwe worked that way for quite a while but I think the reality is a little different. Thereare some services that don’t provide an income, some services that aren’t or can’tbe delivered or provided by a single practice and need to be delivered by the PHOitself and thus we’ve employed the pharmacist and the outreach nurses and the socialworkers (Interviewee PHO 3).

By the end of the case study period, the number of staff in this PHO hadgrown significantly as individuals were employed to fill particular roles in theorganisation. This growth required the PHO to define carefully the services forwhich it was responsible and those that were delegated amongst its networks inorder to use scarce resources efficiently.

In each of the 19 PHOs whose annual reports were examined, members ofthe governing Board claimed directors’ fees and/or expenses, but these wererelatively minor compared to the directors’ fees and expenses reported byfor-profit enterprises. The difference suggests that members of the PHOs’boards donated some of their time. As a PHO Board member observed atan AGM:



The government wishes to enrol the community and get volunteer work out of people.And they will get masses more out of it . . . It’s the whole philosophy of the CommunityOrganisations’ Grants scheme14 or the education system, getting people on the Boardsand so on; I think it has actually improved things in [our area]. And in the PHO ithas made the [General Practices] look outward and start talking to people and take amore preventive focus too (Discussion at AGM PHO 6).

PHOs have recognised that volunteer input is useful to achieving the WHO’s(1978) goals of cooperation; it is also necessary for reaching out into thecommunity. While PHOs may introduce health improvement programmes, theyrequire communities to become involved before these programmes can changecommunity habits. This aspect of change was highlighted by a director of PHO1 at its AGM:

Our Board members, I believe, are coping with change and new opportunities. Thereare threats in that but there are also wonderful opportunities to do new and innovativethings within our community. They’re happening every day. In many cases they’reunheralded. There is an awful amount of the volunteer work being done in thecommunity daily that doesn’t get acknowledged appropriately. It doesn’t probablyget recognised by the media. Tonight I want to acknowledge that, but I want toacknowledge that my Board has worked very hard over the last year to work withnew opportunities and to work in some cases with new people, to make excitingopportunities for a number of problems that have bedevilled New Zealand society foryears (AGM at PHO 1).

Although the evidence from the research is limited to four PHOs, it appears thatvolunteers are important in effecting the positive change in their communitiessought by the PHOs.

DISCUSSION AND CONCLUSIONS

This paper has reported research designed to evaluate the efficiency ofcontracting with non-profit organisations for the delivery of primary health careservices. PHOs formed in response to the New Zealand Government’s primaryhealth care reforms were used for this evaluation. As indicated in Figure 1,non-profit PHOs potentially provide the benefits of: public funds benefitingthe community, being efficient, limiting private gains, and focusing on thecommunity’s health needs.

The research data reveals unintended outcomes, as found in the UK study byLapsley (2008). In this New Zealand case the implementation of health reformsrequiring the organisations which are funded to use a non-profit structureappears to have resulted in PHOs focusing on their ‘bottom-line’. Analysis ofthe annual surpluses and deficits of 19 PHOs showed that in 95% of cases theaverage surplus/deficit was less than 3% of revenues. It is likely a significantnumber of PHOs are manipulating their revenues and/or expenses in orderto achieve a ‘bottom line’ close to zero. However, despite the requirement forPHOs to be non-profit organisations, as a consequence of significant profits inthe case of PHO 18 and sizeable interest income in the case of PHO 2, two of



the 19 whose annual reports were examined were classified as taxable entitiesby the Inland Revenue Department. Nevertheless, notwithstanding their clearbreach of the non-profit requirement, other PHOs may have concealed profitsby, for example, paying excessive remuneration to their IPA managers. Theythereby avoided reporting profits which the Inland Revenue Department mayhave deemed to be taxable. It appears that in order to ensure the continuedsupply of primary health care services (and to avoid the political ‘fall out’ whichseems likely to result if those services were curtailed by the DHB refusing tofund these PHOs), the government is prepared to accept a mismatch betweenits primary health care policy and the implementation thereof.

It may be that PHOs face an inherent obstacle to becoming ‘true’ non-profitentities. While they contract with their government’s DHB agent for the bulkof their funding (which is derived from the public purse) they also contract withprofit-oriented GPs and other health professionals for the delivery of health careservices. Given their hybrid non-profit/ profit-oriented contractual world, it isperhaps not surprising that at least some PHOs (especially those incorporated aslimited liability companies) tend towards, or even engage in, the ‘sector-bending’identified by Dees and Anderson (2003) whereby they display characteristics ofprofit-oriented entities.

As noted earlier in this paper, one of the key goals of the New ZealandGovernment in requiring PHOs to be non-profit entities was to secure efficiencygains such that a given level of health care funding produced increased healthpromotion and improved health in communities. To this end, the Primary HealthCare Strategy (Minister of Health, 2001) envisaged the PHOs would engage, andwork collaboratively, with their local communities. By this means, the PHOscould ascertain local health needs and match the health care services providedto meet those needs. Additionally, by working closely with their communities, ithas been possible for PHOs to develop – and use – social capital to supplementfinancial capital. A key finding of the research was the universal recognitionby interviewees from the four case study PHOs of the extent and value ofvoluntary (labour) contributions by members of the local community. Indeed, it issuggested that the findings of this study extend the conclusion by Putnam (1993):that non-profit organisations deliver social services (or, more particularly,primary health care services) more efficiently than for-profit entities largelybecause of community members’ voluntary contributions.

The research has shown that the New Zealand government’s experimentin requiring the entities charged with improving their communities’ health tobe non-profit organisations has had mixed success. Where PHOs have strongcommunity involvement (as is the case with PHO 1 and PHO 3, each ofwhich have been established as community trusts), it seems that both the‘no-profit’ and the ‘efficiency gains’ goals of the Government have been met,at least to some extent. This was also related to the structures they usedprior to the Primary Health Care Strategy’s implementation. However, where PHOshave little community involvement and are underpinned by the predecessor



profit-oriented IPAs (as is the case with PHO 2 and PHO 4 –until the latterdevolved its shareholding), surpluses were earned and/or revenue and expenseswere manipulated. These PHOs had less community involvement than theirPHO 1 and PHO 3 counterparts and, as a consequence, had less-developedsocial capital. Further, with less community involvement, it seems likely thatthese PHOs were less able than PHO 1 and PHO 3 to identify the health needsof their local community and were less able to target their health care servicesto meet those needs. It is conjectured that, together, under-developed socialcapital and less well-targeted health care services have resulted in PHO 2 andPHO 4 achieving fewer efficiency gains than PHO 1 and PHO 3.

This data is temporally and contextually bound. Each PHO that participatedin the research has continued to change and adapt to its environment; ongoingmutability cannot be captured in this research which spanned a two-yearreporting period. Should other PHOs have been chosen and consented to bepart of this research, different clustering variations may have been observed.For example, as the PHOs that agreed to be participants in this research werein separate parts of the country, each had different DHB funders. The findingsmay have been different if all the PHOs had one DHB funder or if a longerperiod was used.

Further research could be undertaken extending the core findings of thisresearch: that social capital factors increase cooperation and communityinvolvement. As well, the historical development of health care systems andproviders should be considered before policy-makers implement idealisticsolutions. Further, it would be useful to extend in different contexts thefindings that different organisational structures are appropriate in differentcircumstances. The implication is that it may be more efficient to managestructural diversity than to mandate homogenisation.

NOTES

1 Primary health care is generally defined as a patient’s first point of contact with medicalprofessionals.

2 These are members of organisations who are elected by founders and other members to controlthese non-profit organisation programmes.

3 Chang and Tuckman (1990) analysed surplus/deficits against total income, while Leone andVan Horn (2005) and Ballantine et al. (2007) assessed residual income as a percentage of TotalAssets. Total income is a more appropriate denominator for service-based primary health careorganisations that are not asset-rich.

4 These IPAs were similar in concept to Fundholders in the United Kingdom.5 Although PHOs are required under contract to provide audited financial reports, some PHOs

responded to our request with an advice that these reports were not public documents.6 This practice was followed by PHO 1, PHO 2, PHO 12 and PHO 16. (Varying terms are used,

including ‘funds received in advance’ and ‘deferred income’.)7 This practice was followed by PHO 4, PHO 9, PHO 14, PHO 17, PHO 18 and PHO 19.8 This practice was followed by PHO 3 (for 2005 and 2006), PHO 5, PHO 6, PHO 10, PHO 11,

PHO 12 and PHO 15.9 Despite being almost totally government funded, each PHO selects and remunerates its own

external auditor.



10 However, no PHO had its financial audit qualified due to a lack of compliance with GenerallyAccepted Accounting Practice.

11 This was confirmed in a discussion with the audit engagement partner from PHO 18.12 In respect of PHO 18, the first PHO established in its geographical area failed (as a result of

ongoing conflict between the PHO and its contracted GPs) and this may have contributed to itsDHB being willing to contract with PHO 18 despite its status as a taxable (for-profit) entity.

13 As noted, PHOs often experience a time lag between receiving and spending their funding.Accordingly, significant funds may be held on short-term deposit, giving rise to interest.

14 The Community Organisation Grants Scheme is a community-driven government-fundedscheme. Thirty-seven volunteer Local Distribution Committees consider and make decisions ongrant applications to provide essential support to groups in their local communities. Informationdownloaded from the internet 24 May, 2008, from http://www.dia.govt.nz/diawebsite.nsf/wpg_URL/Services-Community-Funding-What-is-COGS?Open Document

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