The MOD's 10 year budget

Both the MOD and the NAO are late and have missed their "hoped for" release dates for the Basing Plan, 10-year Equipment plan, NAO evaluation paper of the same document and the NAO Major Projects Report 2012. They were all due in the Autumn, or anyway before Christmas, but they have all slipped, and are now expected to make interesting the months of January and February.

Waiting for their release, i can however provide some more details on the famous 10 year budget, at least in terms of money and concept, thanks to what Jon Thompson, Permanent Under Secretary, Ministry of Defence, and David Williams, Acting Director General Finance, Ministry of Defence, said to the Parliamentary Defence Committee on Wednesday 12 December. The uncorrected evidence is available here.

First of all it must be noted that the 10-year budget relates to equipment: it is the amount of money the MOD will have to acquire, operate, upgrade and support existing and future equipment. It includes the cost of running kit already in service; but it has nothing to share with funding for basing, accommodations and personnel. These are budgets in their own right, and an announcement on the money available for the basing of the forces is expected early into the next year: this is a particularly important area, as the army returns from Germany and adapts to its Army 2020 plan.  

It has emerged that the 10-years budget includes several layers of built-in flexibility, with contingency money available to cover cost-growth and unpredicatable issues and urgent requirements that might always emerge, depending on the military situation.

Then there is, as we know, a Core Committed Budget, which is money already allocated to specific programs: we do not yet know all of the programs on the list, but several have been revealed and are, indeed, very evident to the eyes of anyone: from the Carriers to the 7 Astute submarines, from Typhoon to A400 Atlas, and for the Army the Warrior CSP, Apache CSP, Challenger 2 CSP later in the decade, FRES SV and FRES UV, plus Foxhound and other systems.

Then there is an as yet uncommitted amount of money - some 8 billion pounds - which will be, in time, assigned to a number of other procurement programs.

These "other programs" are included in what the MOD calls Single Integrated Capability Priority List (SICPL), nicknamed "White Board". This list includes requirements from the three services that haven't yet been assigned a budget, and have seen no contracts signed. According to Jon Thompson, the value of the items on the list ranges somewhere between 7 and 12 billion, with the value "continuining to reduce", which suggests that the service chiefs are still engaged in a process to decide what is really necessary, and what can be postponed further.

The MOD's Equipment Plan, to be published in the near future, will provide indications on what exactly is part of the Core committed budget, either already under contract or anyway firmly planned for the next few years, while the White Board remains an internal list that the MOD is not keen to reveal. In the words of Mr. Thompson:

The white board are those things that we would like to do over time in order to fully deliver all the public aspects of Future Force 2020, which were announced in the SDSR. We have 10 years to do that. That, if you like, is the list of the things that we would like to do in that period of time. As the Secretary of State also said on 14 May, we have £8 billion of financial headroom over that 10-year period. Our funding assumption at that time was that we had £161 billion to spend, but the core programme was £153 billion, and therefore you have £8 billion of headroom.

On the other side of that equation, you have the white board of things that you want to do over that period. As we enter the annual budgeting process, we can see how much of the headroom is available and what we would like to pull off the white board and commit ourselves to, so that over the 10-year period, you would spend the £161 billion and deliver all the items on the white board. That is the conceptual framework.

 

The Type 26 frigate is part of the Core Committed Budget, with planning assumption for 13 hulls to be built, Mr. Thompson assures. 
However, i must note that much of the actual building phase of the ships will be outside the current 10-year plan, so that the money currently allocated covers the design phase and the building of the very first ships, assuming that the first hull is built as planned from 2018 and enters service in 2021. 
The current planning assumption appears to be a 12-months interval between one Type 26 and another, which would mean the last would be launched in 2034 or later (compatible with the plan that sees the last Type 23 bow out of service in 2036).

Another program "with a very long tail" is the F35, and Thompson makes another very interesting statement regarding this particular program, confirming that the 10-year plan includes funding for 48 airplanes. According to my interpretation of the MOD's Business Plan 2012-2015, the 48 F35Bs will all be delivered to the MOD by 2023. 

Jon Thompson: The Joint Strike Fighter has a very long tail. It is more than 10 years. Our commitment over the first 10 years is for 48, which was part of the announcements on 10 May in relation to the reversion to STOVL. Over time, we would expect the number to rise to beyond three figures, but that would be in the second decade.

Thomas Docherty: So there are 48 in the core equipment programme, and any beyond that would be effectively on the white board.

Jon Thompson: No; because it goes beyond the decade, that is an issue that can be considered in the next SDSR, and then you would think about it in longer terms. We are only talking here about the 10-year period.

The Core budget was determined in a relatively simple way:

David Williams: If it helps in terms of the content of the core equipment programme, the way in which we built the content of that programme up over the 10-year period was to start off with everything that was contractually committed, to add in the deterrent and wider nuclear submarine enterprise costs, and then to add in as the next layer other projects to which there had been a ministerial commitment. The most recent set of those, at the time, was the announcements that Liam Fox had made in July 2011 around carrier, Type 26, aspects of the armoured fighting programme, Chinook and Air Seeker. We then added in a degree of contingency or financial realism on top, took stock of how much headroom we had against the forecast budget over the period and decided how much of that we wanted to allocate out and how much we wanted to retain as unallocated provision or headroom for the future.

In terms of nuclear deterrence, the expenditure goes on well past the end of the current 10-years planning horizon, but it is interesting to note that the current planning is made on the assumption that the Vanguards will be replaced like for like, four new boats to replace the four old ones. A wise way to proceed. 
Naturally, we know what we are contractually committed to, but very often the MOD deals with costs that aren't initially clear, and that are often subject to variations. Cost growth has been a serious issue for Defence, and so the 153 billions of the Core budget include a contingency of 4.9 billion (more than the "4 billion" figure originally announced): 148 billions are already set aside and assigned, with some 4900 million pounds destined to cover cost growth, variations etcetera. This is extremely important, especially because there are important items in the equipment program that do not yet have a clear pricetag: namely, the F35B.

Thomas Docherty: Hang on-I am going to end up down a cul-de-sac if I am not too careful. Let us take one single item, the Joint Strike Fighter. We are buying 48 of them.

Jon Thompson: Yes.

Thomas Docherty: But you do not know how much they are going to cost? Because the US Air Force do not know much they are going to cost, the Chief of Defence Materiel does not know, and the US Congress do not know. It is going to cost you more than you think because the cost keeps going in the wrong direction. So you do not have £8 billion to play with because you are going to have to use some of that £8 billion if you have committed to buying 48.

Jon Thompson: As David said, the way in which we have approached that is that we have used the best information we have about what the programme is currently estimated to cost, and that is in the core assumption, the £153 billion. Then we added in £4.9 billion of risk provision within the core programme on the assumption that, as some of these programmes mature, the cost will rise. Then, rather than having to cancel a project that you have already committed to, you can use some of that risk provision, which is built into the £153 billion.

Thomas Docherty: Is that £4.9 billion out of your £8 billion?

David Williams: No, it is in addition.

Jon Thompson: It is in addition.

Thomas Docherty: So you have got £8 billion, then you have got another £4.9 billion?

Jon Thompson: Yes.

Thomas Docherty: Is that £4.9 billion within your £153 billion?

Jon Thompson: Yes.

  

The use of contingency money specifically set aside to tackle in-year changes to procurement contracts is a conceptually simple but absolutely vital change in the way the MOD works. A change that i've been praying for, for a long time, because the lack of spare money in the pockets in the past has been the cause of an endless series of program cancellations and delaying, which has resulted in lost capability and in monstrous cost escalations. As Thompson explains:

[...] in the past, if you go back two or three years, the way in which the Ministry of Defence approached this was to say, "We have a cost increase on a programme-what shall we do now? Everything is committed, so we will have to cancel something else." Or, as in the most extreme version, the carrier decisions in 2009, "We will stretch out that programme over a longer period of time," which leads to a sub-optimal value for money solution.

The disasterous delay imposed to CVF actually dates 2008, and calling it sub-optimal is really an understatement: according to the NAO, the 2-years delay is responsible for the 1.56 billion increase in cost in the long term that allows opponents of the carrier program to call it a "5 billion program".  It is not. It has been turned into one by a blaring example of financial madness.
Unable to spend some 405 million in-year (which weren't even a cost increase, but just the normal expenditure needed to continue with the original pace set for the CVF contract), the MOD ended up condemning itself to spend over 1500 millions over the rest of the program. And this is just one example, of many that could be made. It is absolutely evident that this must not happen again. 

Is there any indication on what sits on the White Board?
Yes, there are some.

Thompson seems to confirm my interpretation of the little information so far available on the MARS Solid Support Ship, for example: the Core Committed budget includes money for the development of the design of the ships, but their procurement for the moment sits on the White Board, and will move into the Core budget only in the next few years.
Always in terms of requirements not currently funded we have the Fast Landing Craft for the Royal Marines, which was confirmed at the time of the SDSR but is currently on hold, on the White Board.
Further investments into ISTAR, including probably new drones for the Navy and the Army, sit on the White Board, along with other programs, many of which relate to Combat Support and Combat Service Support for the Army. I believe, for example, that the modernisation of the Warrior FV514 Artillery Observation vehicle is likely to be found on the White Board, along very possibly with the long-term replacement of the DROPS trucks (the interim solution has been identified in the EPLS already in use as UOR in Afghanistan), Light Equipment Transporter trucks and General Service Tanker truck replacements.

Another interesting aspect regarding the budget is the significant underspend that was reported in-year. The Hearing provides an explanation:

In relation to 2012-13, the current financial year, we are currently in negotiation to transfer £1.5 billion of the defence budget from the current year into the next two financial years. If we are successful in those conversations with the Treasury, that will be appropriately disclosed to Parliament in supplementary estimates in January.

The MOD is not normally allowed to move money from a budget year to the following ones: the Treasury normally claws back every penny that is not spent. Fortunately, the MOD has been improving its management enough since the SDSR that the negotiations with the Treasury were successful, and a special permission has been gained to move the unspent money into the next two financial years. 

The huge 1.5 billion underspend in-year is due to several factors:

There are three areas that give rise to the sum. First, we have established an unallocated provision in every single year. In the current year, that is approximately £500 million. Secondly, although we think that we have improved the overall costing of the equipment programme, and we have a more stable programme, the programme delivery profile moves slightly back in every financial year. We are therefore looking to transfer half a billion pounds from the current year to future years because the programmes have moved back slightly. Then we have made £500 million of provisions in the wake of the SDSR, either for industrial liabilities or for redundancy payments that we do not think we need in the current financial year. So there are three reasons for it. It depends on how you like to define an underspend.

We earlier saw how the Equipment budget has a 4.9 billion contingency reserve of money. The 500 millions of unallocated provision in-year here mentioned is another layer of financial flexibility and protection:

We spoke earlier about, within the equipment plan across the 10-year period, £4.9 billion-worth of contingency and then £8 billion-worth of headroom, as a second layer. As the third layer in balancing the budget last year, we have put across the entire programme, so not specifically for equipment issues, further unallocated provision, which was £500 million this year and it is about £200 million a year, or thereabouts, across the 10-year period.

The equipment is not the only source of unexpected expenses in year, so the MOD has wisely decided to set aside a certain amount of money, not specifically tied to equipment, to cover other possible problems. For 2012, the unallocated provision was 500 millions, an high one because the MOD is still dealing with the many (and expensive) changes mandated in the SDSR. In the next years, the provision will be of around 200 million in each budget cycle.
This is a cross-sector reserve of 2 billions spread over 10 years. The total expenditure of the MOD over 10 years approaches 400 billions, so it is evident that Equipment is only part of the problem. Manpower is by far the heaviest voice of expenditure, and that's why manpower has been steeply reduced in the cuts.

As we know, however, the MOD has been badly affected by the cuts announced in the Autumn Statement of the Chancellor: the result is that a significant part of the 2 billion reserve is going to vanish in 2013 and 2014.

The reduction in our resource Departmental Expenditure Limit (DEL) of 1% for 2013-14 and 2% for 2014-15 is the methodology that was adopted for all Departments with three exceptions. Everyone else was treated in exactly the same way as we were.

The exceptions are NHS, Education and International Aid.
Defence was not spared and as a consequence will lose £250m in 2013/14 and £490m in 2014/15.
As a consequence, the 2012 underspend is effectively going back to the Treasury anyway: the permission to "move" this money on to the next two financial years is rather "virtual", as the money will effectively go back to the Treasury.
And it won't even be enough, as one billion out of 1.5 is money that IS going to be spent: these 1000 millions had been set aside to cover the costs of industrial liabilities and personnel redundancies caused by the SDSR, and to finance some of the equipment programs. They have not been used up in 2012 because things have developed in a slower way than expected, but they are costs that are not gone away.
The 740 millions in cuts that the MOD has to tackle in the next two years will eat away the 500 million unused provision moved on from 2012, and part of the unallocated provisions built into the next two years (which should be, as we saw, 200 million in each year).

The cut is manageable, and will not impact the Core Committed equipment budget, nor manpower. However, there obviously is an impact, as that money could have been eventually employed to help fund programs currently on the White Board:

Clearly our previous plan was based on not having that adjustment. Would we otherwise spend it? Yes. I am fairly sure that we would have spent it on appropriate things in accordance with what the defence board decided it should spend that budget on.

For now, there is no big shock, and no impact on the Equipment Budget, but something which could have been given funds and go ahead from the White Board will now have to wait. The real battle will go on over the new year, as the Treasury rolls forwards with a new Spending Review connected with the plan for an extended Austerity period lasting up to 2017/18. 
The Spending Review will determine the amount of money the MOD receives from 2015/16 onwards. Currently, the MOD is working to the assumption that its budget will be flat in real terms (no increases but no cuts either), with the famous 1% budget uplift (for the sole equipment program) in the three years from 2015 to 2018.  
Any reduction imposed on the MOD's budget will have a dramatic impact on military capability that will no longer be possible to absorb with contingency funds without putting the whole plan at serious risk.

The MOD is now planning prudently and rather efficiently: there has been a big impact on capability (and we don't even know yet exactly how many programs have been killed in the book-balancing effort) but there now is a conceptually-simple but effective plan to control spending and deliver programs in the decade.
The Treasury, however, is already starting to put the whole thing at risk: first of all, the MOD desperately needs to be able to negotiate its budget with the Treasury. If a program, for whatever reason, does not reach the Investment point in-year as was expected, the MOD must be able to keep the money, to spend it the following year when the moment comes: if the Treasury claws it all back, when it'll be time to pay the MOD will no longer have the money.
As we have seen, there is a special agreement in place to cover the next two years, but the Treasury must allow the MOD to carry forwards unspent money in the following years too, if the plan has to work.

In the past, knowing that every penny not spent was a penny lost, the MOD used to commit, each year 100% of its money. That meant having no reserve at all to meet cost increases, delays, unexpected changes etcetera, causing the infamous policy of cancelling and deferring, which solved the problems in-year but made them ten times worse in the following financial cycles.

Now that the MOD is genuinely trying not to repeat that suicidal approach, it is fundamental that the Treasury does not get in to claw the underspend away, otherwise the MOD, quite understandably indeed, will be more than tempted to return to the old methods.  

As a last important information, the Afghanistan war expenditure is falling. This additional money is provided by the Treasury over and above the rest of the defence budget, and the cost fell from £3.777 billion in 2010-11 to £3.458 billion in 2011-12. This year it should be around 2.5 billion.
The cost of the last two years of the Campaign, 2013 and 2014, is still being determined: importantly, it will include the money needed to fund the return of equipment to the UK.