Capital Financing for Residential Aged Care

COTA Australia has a very active interest in the capital financing of aged care, as it does in the broader matters of the Commission’s Funding, Financing and Prudential Regulation (FFPR) proposals, on which we will provide detailed comment by 6 October, as requested. We intended to provide, and had about half completed, a quite detailed response to all or most of your specific questions on capital financing. However other priority commitments on our time, including dealing with responses to the Commission’s special report on COVID-19, have prevented us completing this by today’s deadline. We are therefore instead sending this short letter headlining our major concerns.

COTA Australia is obviously not an economic think tank, we are the leading consumer advocacy body for older Australians in general, and for aged care recipients in prearticular. Capital financing may not be an obvious priority concern to the consumer movement, but we regard it as such because the economic viability of the sector is a core underpinning of a sector that can deliver good outcomes for older Australians who need its services.

This letter primarily addresses financing of residential aged care. The future hopefully will be a significant pivot from residential to home care. The financing of home care at that scale will present some challenges but nowhere near that of residential care, which is obviously much more capital intensive.

There are three questions about the capital requirements of the sector going forward; first, whether there will be sufficient funds to build (and rebuild) enough stock for the demand for services over the next few decades; secondly, whether the composition of that capital is stable and sustainable; and thirdly, whether the capital financing appropriately supports and enables innovation and consumer-driven transformation.

The answers to those questions are interwoven. None of the current answers to those questions are satisfactory.

Our view is that the industry is currently undercapitalised, both in terms of current needs and especially for the challenges and opportunities going forward. This comes about for a variety of reasons including inadequate levels of funding for the sector from both government and consumers, which reduces funds available for reserving for replacement or expansion; a lack of reinvestment in capital development by many providers from available funds, which means a lot of stock is out of date; significant levels of uncertainty about future policy directions, which preceded the Royal Commission but have been exacerbated by it; and the structure of the industry (e.g. hundreds of small scale operators with little backing).

Our view is that current capital financing arrangements are not in a macro sense appropriate now and will become less so over the next few years as consumer preference becomes more diverse and forceful, especially if policy changes are made to allow consumer preference to have more impact on the market. The shift may be accelerated by a combination of the flow on effects of the COVID-19 experience, and the impact of the Royal Commission’s Final Report, depending what it says.

Our view – expressed repeatedly and publicly, and in submissions, over recent years – is that significant parts of the industry are over-reliant on RADs and the industry is  short on adequate levels of both equity investment and debt capital.

There are a number of issues with RADs, which in short form only, include:

  1. RADs are an unstable form of finance in that providers legally don’t know whether a resident will pay by RAD or DAP so cannot guarantee that a RAD exit will be replaced by a RAD; and providers highly dependent on RADs are susceptible to a cluster of RAD losses in a short period (as COVID-19 in Victoria illustrates);
  2. RADs can be a lazy form of capital compared to debt, where the lender plays an active monitoring role and has covenants in place and equity where clearly the investor has a keen stake in performance in terms of both security of the investment and certainty of return. By contrast RADs are a loan from an individual who has almost no way of monitoring and assessing how it is used. The exception is in the case of ASX-listed companies which are under high levels on analyst scrutiny in every aspect of their business (but of course also open to short term performance pressures which may be detrimental to sound longer term decision-making;
  3. RADs being guaranteed by the government (without which most residents would not pay them) means that if there is a default then either the taxpayer pays for the provider’s errors, or the government imposes a levy on all other providers who didn’t collapse to pay for one that did, with no recourse, which is a cost that would inevitably find its way into consumer pricing;
  4. RADs require substantial prudential oversight and we know that there are significant number of providers who use RADs for other than permitted uses. The government has sought to tighten this up in recent years with some success, but it remains a significant issue;
  5. Despite the fact that legally residents are required; to have free choice as to whether they pay by RAD or DAP or a combination, there are many providers that require a RAD or they will not accept the new resident. They may be informed that they have a choice but then then it will be made clear that a place in this facility is only possible if they pay a RAD. This pressure is inevitable when providers are over- dependent on RADs.

For these reasons COTA Australia believes RADs should play a much reduced role in future aged care financing. To replace them now would be impossible as there is way too little debt or equity capacity to replace them. There needs to be a transition strategy to reduce the proportion of capital in the form of RADs. However, to stop any new RADs next year and grandparent the rest is likely to be too drastic. The key question is from where is substitute capital financing going to come?

From discussions with the major banks and some other financial institutions COTA Australia does not believe that there will be a significant quantum increase in the proportion of capital financing coming from debt in the near future. This could change if the quality of the industry improves substantially as a result of the Royal Commission’s Final Report and its implementation. That would mean more providers would be able to meet the lending criteria of the banks, which have limited appetite for risk. There are, however, limits to the quantum of debt financing available in Australia.

COTA Australia, principally through its Chief Executive, has had extensive discussions with representatives of potential equity investors in aged care. These are both domestic and international funds, and both private equity and superannuation funds in both arenas. Most potential investors have experience in health and some also have experience in aged care, although not major roles in Australia (some are actively invested in Europe).There has always been significant interest but this has not yet translated to actual investment, primarily due to uncertainty about the government’s policy settings and financing decisions into the future and more recently about the outcomes of the Royal Commission.

The measures needed to encourage equity investment basically revolve around the need of investors to be reasonably confident that their sound investment decisions, based on commercial market considerations, can be implemented in a timely fashion; and also that services can then operate in a way that will generate competitive mid-range long term returns with some degree of certainty if the service is of high quality and efficient.

Specific policy measures required from government in the current context include:

  1. Removal of the ACAR process for allocation of bed licences so that providers and their investors can make investment decisions in response to positive consumer demand with certainty that they can put services on the ground without waiting on bureaucratic processes that delay that investment;
  2. A policy framework for government subsidies to residents that is sufficient to cover all costs, including a return on equity, and maintains its real value over time. The creation of an Independent Pricing Authority would substantively assist in this regard;
  3. A policy framework for consumer/resident co-contributions that, while providing a strong government funded safety net for people with low means, allows flexibility in the provision of and pricing of services for all other residents so that real input cost increases can be recovered and equity returns maintained with confidence.

With regard to a number of the other questions the Commission’s Capital Financing paper poses COTA Australia’s strong view is that apart from establishing the Pricing Authority, the Prudential Authority, a strengthened ACFA and policy settings that protect consumer rights, matters like the value of RADs should be left to the market, which has actually worked very well since Living Longer Living Better, as it does for all other real estate transactions.

However, government should maintain a capital grants program to ensure that services are provided for homeless people, outer rural and remote services, and others as required.

With regard to the relationship between RADs and DAPs we refer the Commission to the 2013 ACFA report on ‘Methodology for Ensuring Equivalence Between a Daily Accommodation Payment (DAP) and Refundable Accommodation Deposit (RAD)’