Cut to the chase

A new strategy for preventing fraud could help local authorities to ameliorate the impact of budget cuts, suggests Jim Gee

As the Con-Lib coalition government forges pathways for ‘new politics’, reducing the national deficit continues to dominate policy.  The unveiling of the Office for Budget Responsibility (OBR), with its aim of monitoring government spending, shows that this new government has its work cut out for it.  At the time of going to press George Osborne, the new Chancellor of the Exchequer, has just announced plans to find £6.2 billion in savings to help reduce the deficit through imminent, aggressive public spending cuts.

Last month, MacIntyre Hudson, and the Centre for Counter Fraud Studies at University of Portsmouth, published the Financial Cost of UK Public Sector Fraud Report, the most far-reaching report into this area to date.  The report showed that losses to fraud and error in the public sector are more than twice as high as previously thought, at £38 billion. £22 billion of this figure is shown to be lost involving public expenditure, with a further £16 billion lost in uncollected taxation at national and local levels.

A significant perception gap between official estimates of losses to fraud and the actual likely losses based on data from public sector losses around the world was also identified.  For example, official estimates for losses to fraud in local government were £684 million. The report reveals this figure to be closer to £5.562 billion, eight times greater than the estimate.  If you can’t measure a cost, how can you possibly plan to reduce it or, indeed, prove any subsequent reduction?  

These figures are staggering in themselves, but what’s more surprising, is the lack of a cohesive strategy in recent years to combat this issue hands-on; there is a missed opportunity to achieve major savings from reducing losses to fraud. What’s more, developing work over the last decade has shown these savings are real, rather than just rhetorical.

Fraud losses occur in expenditure on payroll, procurement, benefits, public housing, healthcare and education, and result in lost income across local and national taxation. Fraudsters include staff and managers, contractors and citizens. A dishonest minority affects all public sector organisations of any size and the greatest financial costs are incurred from high volume, low value fraud, rather than vice versa.
In local government, significant sums are lost in the largest procurement and payroll areas of expenditure in particular, as well as in specific services and programmes.

However, the last decade has seen the development of accurate (+or- 1%) and statistically valid (95% statistical confidence) methodologies for treating fraud losses like any other business cost. In this way 132 fraud loss analysis exercises have been undertaken in the last ten years across 44 organisations in nine countries. These have reviewed 32 types of expenditure with a total value of over £800 billion – nearly a third as much again as total UK public expenditure.

The picture shown by the current data is unequivocal. Two thirds of the exercises show losses of between 3% and 9%, with an average percentage loss of 4.57%.

In the late 1990s I led the team tasked with ‘cleaning up’ what had just been described as ‘the most corrupt local authority in Britain – the London Borough of Lambeth. Working closely with Lambeth’s then Chief Executive Heather Rabbatts, we achieved major reductions in fraud losses and helped to set Lambeth on a path to where it is now, after much more hard work - one of the most rapidly improving local authorities in the country.

Our findings have shown that the most cost-effective types of counter fraud activity are those that are pre-emptive - programmes that relate to culture and deterrence as well as the redesign of policy, processes and systems.  With this in mind, the Financial Cost of UK Public Sector Fraud Report outlines a series of clear recommendations to help reduce losses through public sector, to ensure that we, as tax payers, are not being denied the public services we deserve.

The first of these is the need for a proactive Government approach, ideally through the creation of a Public Sector Counter Fraud Agency (PSCFA) with the defined remit, authority and resources to work specifically to reduce losses.  This agency could work alongside the aforementioned OBR with the responsibility for both operational counter fraud work as well as policy work to minimise opportunities for fraud.

Secondly, a programme of accurate measurement of the nature and scale of public sector fraud losses needs to be implemented across each major area of public expenditure.  As I’ve already mentioned, if one doesn’t know what the problem is, how can the right solution be reached?

We also strongly believe that the introduction of an equivalent of the US-style Improper Payments Information Act (IPIA)  would go a long way in terms of promoting accountability and transparency, and help us to stop being in denial about the problem! In the US, the IPIA requires public authorities to estimate the annual amount of payments made where fraud and error are present, and identify plans to reduce them. The openness of this approach means that the extent of public accountability for losses is far clearer and therefore, the resulting public pressure creates a powerful force to drive reduction.

What has been discovered is that the most effective way of reducing losses is in fact to change the culture – mobilising the honest majority of people, incentivising them with clear financial benefits that flow from good practice, and creating strong peer group pressure against fraud. By combining that pressure to do ‘the right thing’ with information targeted at the dishonest minority about the real risks of detection, investigation and sanctions, it is possible to deter – and significantly reduce the size of – the dishonest minority. Institutional change alone is not enough.

This new approach may come as a shock to those brought up on a diet of cops and robbers TV shows such as ‘The Sweeney’, or more recently, ‘Ashes to Ashes’, but we now have the means to make fraud savings real, tangible and provable.

Furthermore, the news from around the world is that the scale of existing losses makes work to reduce them highly beneficial. Referencing examples from both the UK and internationally, the Report demonstrates that by changing the way public sector fraud is managed, these losses could be reduced by up to 30% by 2013-14. This represents a cumulative saving of £22 billion over the next three years and an annual saving of £11 billion by 2013-14. In the current climate where efficiency and cost-savings are king, a reduction of this level would be a real step forwards in closing the UK’s existing budget deficit and safeguarding our public services painlessly and effectively.

Jim Gee is Director of Counter Fraud Services for MacIntyre Hudson LLP, Chair of the Centre for Counter Fraud Studies at University of Portsmouth and an author of ‘The Financial Cost of Fraud Report’ (2010).  To find out more about MacIntyre Hudson’s Counter Fraud services, please visit www.macintyrehudson.co.uk/services/counter-fraud