04 Dec 15. The Committee of Public Accounts 
urges the Ministry of Defence to adopt new measures intended to guard against “significant risks” to the future stability of its budget.
The Committee’s recommendations are outlined in its Eleventh Report of this Session, Strategic financial management in the Ministry of Defence and Military flying training.
The Report follows an inquiry by the Committee, which in turn followed steps taken by the MoD to address a £38 billion funding gap. The Committee also heard evidence on the project to create the UK Military Flying Training System.
Commenting on its findings, PAC Chair Meg Hillier MP said today: “Individual policy challenges should not distract from the fact the Ministry of Defence needs to keep a grip of its finances. It is vital it manages its budget effectively, and in particular projects carried out by contractors.
“This point is well illustrated by the project to introduce a new military flying training system, which proceeded on outdated assumptions and without sufficiently swift action to tackle poor performance. Such weaknesses and related delays can result in additional costs to the public purse.
“More broadly we recognise the MoD has taken steps to operate within its means and restructure significant aspects of its operation. However, we are concerned it has done so in part by deferring some costs to future years and by delegating responsibilities to staff with limited experience of handling large budgets.
“While this is well-intentioned, there is a real risk of taxpayers being left further out of pocket. The Department must equip itself with the skills to ensure projects begin on a sound footing, properly monitor their progress and, should circumstances change, have credible measures in place to respond effectively.”
INTRODUCTION
Prior to the 2010 Strategic Defence and Security Review, a £38 billion gap was identified between the funding the Ministry of Defence (the Department) expected and the forecast cost of Defence over the following ten years. This funding gap was having a destabilising effect on the defence budget. Since 2010, the Department has adopted a two-pronged approach to improving its financial management. It has sought to:
- a) address the funding gap in its equipment programme and reduce costs in all areas of the defence budget to meet the Spending Review 2010 settlement; and
- b) improve its management structure by delegating greater financial responsibilities to the Armed Forces who, since April 2015, have managed over 70% of the £34 billion defence budget.
The Department has sought to reduce costs by reforming its Head Office, its procurement arm (Defence Equipment and Support) and its estate management organisation (Defence Infrastructure Organisation). Reform of the procurement and estate management functions is being sought through contracts with industry to provide additional skills and capabilities the Department does not hold.
The use of industry expertise to reform areas of the Department’s business is not new. In 2008, the Department signed a 25 year contract with Ascent, to develop and manage a new approach to core flying training. Under this approach, Ascent is responsible for providing aircraft and simulators for training, running training courses and training an agreed number of aircrew from all three of the Armed Forces each year.
The Department remains responsible for many aspects of core training. These include providing military instructors, determining the number of students it needs and setting the training input and output standards. However, full implementation of the new core training has been delayed by nearly six years.
Several events affected the Department’s original assumptions about how its 25-year contract with Ascent would work. These include the government’s decision to reduce the size of the front line fleet of aircraft, resulting in a substantial reduction in the number of aircrew entering training each year; a decrease in overall funding from a forecast of £6.8 billion to £3.2 billion; changes to the funding approach (from PFI to conventional funding); and poor contractor performance between 2008 and 2012. These events took the Department time to resolve but contractor performance has since improved.
PAC REPORT SUMMARY
The Department has addressed the £38 billion funding gap that emerged prior to 2010 between the funding it expected and the forecast cost of Defence over the following ten years. It has also cut its costs to live within a reduced budget. However, this has been achieved not just by delivering financial savings, but also by deferring some costs into future years, at the risk that these costs could increase because of the delay.
The stability of the Department’s financial position depends on the accuracy of a large number of assumptions it has to make, many of which have proved over-optimistic in the past, and its ability to: control its costs, achieve the significant savings anticipated in the equipment and infrastructure budgets, and manage the cost of the Department’s portfolio of nuclear-related programmes.
The Department is reliant on contractors to fill gaps in its skills and capacity and to help it achieve savings and operate more efficiently. But the Department’s management of its contractors has often been poor. For example, the introduction of a new military flying training system has been delayed by six years due to poor contractor performance and significant changes to the assumptions underpinning the contract on the number of students, the method of financing and the total forecast cost.
The position has improved, but we are concerned by how slow the Department was to take action to address these issues with its contractor and its ability to determine whether the expected benefits of the new training system are being delivered. This programme demonstrates the need for the Department to identify and address under performance quickly as it becomes increasingly dependent on contractors to improve its skills and capabilities and deliver its programme.
We remain concerned about project and contract management by the Department, particularly in relation to the Armed Forces who are now responsible for managing over 70% of the defence budget. Failure to improve its skills and capabilities in these areas and to put in place strong assurance mechanisms to identify any problems at the earliest opportunity could threaten the Department’s ability to maintain the stability of its financial position.
SUMMARY OF CONCLUSIONS AND RECOMMENDATIONS
Although the Department has addressed the £38 billion black hole in its finances, and lived within its reduced budget, significant risks to the future stability of its budget remain. The Department has lived within a reduction in its budget of nearly £10 billion between 2010 and 2015. However, it has not adequately tracked how it achieved the savings necessary to do this and the extent to which they relate to achieving greater efficiency or to stopping or delaying programmes. The Department addressed an in-year reduction of £0.5 billion to its budget in 2015-16 solely by delaying a number of programmes where contracts had not been signed. There is a risk that just delaying projects could see the costs of these programmes increase overall. While at times a delay may be prudent or necessary to balance the books, we want the Department to be clear about the possible risks to spending and operational capability of such delays. The Department’s future spending plans are underpinned by a large number of assumptions. These include its ability to operate more efficiently; to realise significant savings already removed from equipment and estates budgets; and to manage the cost of its portfolio of nuclear-related programmes, which it is currently forecasting will exceed £5 billion a year if the nuclear deterrent is replaced. Many of the Department’s past assumptions, including those relating to the Aircraft Carrier programme and military flying training, have proved over-optimistic.
Recommendation: The Department should be alert to the risks and pressures on its budget and report regularly and transparently to Parliament about how it is managing them. It should also put in place a clear process for monitoring how it is achieving savings and whether these are through efficiency measures, cutting programmes or moving costs to future years by delaying planned expenditure. Where it achieves savings by moving costs to future years the Department should ensure it does so only following a thorough assessment of the risks to operational capability and the potential for increased costs overall.
The Department has delegated over 70% of its budget to the Armed Forces whose staff have no previous experience of managing such large budgets. To address weaknesses that led to the £38 billion funding gap the Department implemented a new organisational model which gives the Armed Forces responsibility for determining the equipment they need and for managing the related equipment programmes and budgets. The Department anticipates that the delegated model will encourage the Armed Forces to make better use of their resources. However, the Armed Forces have not previously managed their equipment budgets and there are significant gaps in their skills and expertise to take on their enhanced role. In addition, there is a risk that actions the Department may be required to take to balance its overall budget, such as moving budget between the individual Armed Forces, may undermine the model and disincentivise the Armed Forces from operating more efficiently.
Recommendation: The Department should put in place strong assurance mechanisms to identify and address urgently any risks arising from its new delegated model, such as poor project management by the Armed Forces. It should also report regularly to Parliament on how the new model is working in practice and how it is managing any associated risks.
The Department does not have all the skills it needs across the organisation to address the risk of its budget ‘overheating’ again. From April 2015, the Armed Forces have been responsible for managing their equipment programmes and Defence Equipment and Support has been responsible for delivering to their requirements. The Department is seeking to address gaps in the Armed Forces’ skills and expertise through contractor support. It also intends to use contractor support to improve the ability of staff in Defence Equipment and Support to manage contracts. More generally across the Department, there are too few qualified accountants in finance roles and only 42% of finance staff are either qualified or part-qualified accountants. Finance staff also reported gaps in the skills they needed for their roles, including basic accountancy and analytical skills.
Recommendation: The Department must do more to identify and develop the skills it needs across both the military and civilian elements of the organisation to manage contracts and finances. It should set out a clear and coherent plan for how, and by when, it will secure those skills to ensure the success of its new management structure. The development of these skills should be a priority for the Armed Forces.
The Department has not yet balanced the cost of the defence estate with the funding available. The estate is larger than needed, under-used, too expensive to maintain and does not meet the future needs of the Armed Forces. In 2010, the previous Committee called on the Department to improve the way it manages the defence estate. Although the Department believes it has made some progress, including consolidating its information on the estate into one system, there remain significant weaknesses. For example, there is an £8.5 billion hole in the estate maintenance budget and it can only afford to fund half of the investments in the estate that the Armed Forces say they need to deliver the Department’s overall plans for the military in the 2020s. In 2014-15 the defence estate was valued at £31 billion and the Department spent nearly £5 billion on estate and infrastructure costs. The Department intends to reduce the size of the estate by 30% over the next ten years and it is important that the Department is transparent in its decision-making regarding its land disposal programme.
Recommendation: the Department should, as a matter of urgency, produce a coherent plan setting out how it will transform the estate to address the forecast gap in funding, reduce maintenance costs and provide an estate that is fit for purpose. The plan should include a comprehensive set of assessment criteria for determining which estate sites to dispose of to maximise value to the taxpayer and local communities in the long term.
The Department’s ability to manage the risks it faces is dependent on improving its management of contractors. The Department has put its faith in contractors to improve both its approach to procuring and supporting equipment and its management of the defence estate. This risks undermining progress in stabilising the defence budget if these contractors cannot deliver the performance improvements required to secure in practice the £11 billion of savings already removed from budgets. The Department must act quickly to address any issues with contractor performance but past experience indicates that it has often been slow to do so. In the case of military flying training the Department took 4 years to address poor performance by its contractor Ascent. Both Ascent and the Department accepted that during this period there had been a blurring of responsibilities under the contract and Ascent acknowleged that it had not had the right people with the right skills to deliver the programme. This led to the entire senior management of Ascent being replaced, but there was not similar accountability within the Ministry of Defence.The result has been a flying training system that is almost 6 years late, has so far cost the taxpayer £143 million and has only produced 151 trained aircrew in total compared with the 320 expected each year.
Recommendation: When entering into a contract, the Department should:
- set clear indicators or milestones that will alert it to poor performance and monitor them to enable it to intervene quickly if contractor performance falls below the required level; and
- consider adding clauses to its contracts placing a duty on contractors to give early warnings of problems with contracts – even if this could be financially disadvantageous to the contractor. Ultimately, it is the taxpayer who picks up the bill for failure. It is not acceptable for contractors being paid by the government to see failure and not act to safeguard the interests of the taxpayer.
Flaws in the Department’s approach to managing contractors are evident from the military flying training programme:
- Key elements of the contract with Ascent to deliver improvements in military flying training no longer meet the Department’s needs. The decision to contract out military flying training was based on assumptions that have fundamentally changed. As a result, the original contract no longer meets the Department’s or the contractor’s needs. For example, the 2010 defence review changed the annual aircrew requirement from 480 to 320 with the result that Ascent can never achieve some of the contract incentives that were based around pre-SDSR training levels. The majority of payments to Ascent have also been related to it running courses, rather than improving training.
Recommendation: The Department should ensure that:
- incentive payments are aligned to match the aims of the contract and incentivise the contractor to seek continuous improvement in time, cost and quality; and
- when its performance requirements change during the life of a contract, reward mechanisms for contractors are realigned as soon as possible to incentivise achievement of the contract’s intended outcomes.
- The Department lacks basic data on military flying training to help it understand training performance and hold its contractor to account. The Department has limited management information on flying training. This undermines the credibility of the original decision to contract out military flying training and limits the Department’s ability to hold the contractor to account for training performance. The lack of sufficient management information is a matter that we and the previous Committee have encountered repeatedly. The Department is undertaking work designed to get a better understanding of flying training from a 2010 baseline onwards. However, it could not tell us when this would be complete.
Recommendation: The Department must ensure that sufficient management information is available for it to make informed decisions about whether use of contractors represents good value for money and to monitor achievement of the anticipated benefits as programmes progress.