living longer, living better: reform report #2 - gt review australia
DESCRIPTION
This is our second report in response to the Government's Living Longer, Living Better package. In this document, we discuss the implications of, and industry reaction to, the initiatives recently announced by the Government as more detail of their response to the Productivity Commission's report emerges.TRANSCRIPT
Review the Government’s Aged Care Reform Package
Living Longer, Living BetterReform Report #2 - The unintended consequences
June 2012
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Our first review of the report revealed that the package had the potential to deliver some positive outcomes for consumers and the aged care industry, although most of the structural reforms proposed by the Productivity Commission had not been adopted. We speculated that the value of the Government’s reforms would be measured on the detailed changes that would be required in implementing the policies outlined.
Over the past two months, more of that detail has been provided. This paper draws on the views of industry experts to provide an analysis of the initiatives revealed by the Government and their likely consequence for the aged care industry.
Cam AnsellNational Head of Aged CareGrant Thornton Australia
In our last publication, we explored the Government’s Living Longer, Living Better package which was released on 20 April 2012. The package provided a response to the Productivity Commission’s Caring for Older Australians report.
Contents
01 Welcome
02 Progress on the reform package
08 The way forward
09 Contacts
Welcome
2 Grant Thornton June 2012
Progress on the reform package
While there has been progress on a number of fronts, the key elements of the Living Longer, Living Better package have been:
1 The Government’s plan to undertake a recalibration of the Aged Care Funding Instrument (ACFI) to reduce the subsidies generated under current arrangements; and
2 The development of a draft Terms of Reference for the Aged Care Financing Authority.
Adjustment to the Aged Care Financial Instrument
Our first Reform Report explained that a substantial portion of the funding for the package was to be sourced from adjustments to the residential aged care funding instrument. This instrument was developed without using comprehensive data on the cost of delivering care. We warned that uninformed changes to the model would undermine investor confidence in the viability of the sector.
Late in May, the Department of Health & Ageing (DOHA) provided some “proposed” adjustments to the subsidy funding instrument to achieve the desired savings outlined in the Government’s reform package. The changes included modification to the personal hygiene and medication components, making it more difficult for providers to claim for residents with support needs in these areas.
Providers quickly carried out their own assessments of the impact of the changes using information on residents currently in care. Analysis of over 25,000 residents across the country revealed likely funding cuts of between 8% and 15% compared to subsidies achieved using the funding instrument in its current form. The cuts appeared most heavily weighted towards high care and dementia specific facilities.
“The industry was alarmed to learn that the Government had planned to cut $500 million from projected funding for 2012/13”
Further consultation with the Department of Health & Ageing and operators in June 2012 revealed that the difference between the Government’s proposed ACFI unit subsidy cuts of $500 million and the Living Longer, Living Better targeted cuts of $50 million related to what the Government referred to as “frailty drift” (increasing levels of functional dependence among the resident population) and claiming growth generally.
The Department had undertaken an analysis of claiming rates over recent years and determined that downward adjustments of $500 million were necessary to curtail increased funding claims for residents that were requiring higher levels of support during their term in residential aged care. The Government had noted that the “frailty drift” was a major cause of subsidy payments in excess of the original forward estimates.
The reduction in care funding raises serious viability concerns in an industry already suffering from declining investment levels. The Government’s own performance benchmarking shows that operators achieve an average earnings before interest, tax, depreciation and amortisation (EBITDA) of only $6,417 per resident 1 on facilities that cost over $225,000 per bed to build.
Across the country, providers have worked with both Grant Thornton and the Department of Health & Ageing to assess the likely impact of the proposed ACFI modifications.
Grant Thornton Australian Cost of Residential Aged Care Research, January 2012
1 Department of Health & Ageing Information Paper – Aged Care Funding Instrument – May 2012
Review the Government’s Aged Care Reform Package 3
It has become clear that the Department has recalibrated the instrument using historic subsidy data from ACFI and the predecessor system, the Resident Classification System (RCS) without consulting those responsible for actually delivering care. This results in several critical problems with the Government’s approach to adjusting the instrument:
a The fundamental assumptions impacting subsidies are heavily influenced by provider claiming trends and escalating resident care needs. The historic failure of both the ACFI and RCS systems to accurately measure these elements makes them inappropriate tools on which to simulate future subsidy patterns.
b The Government’s modelling does not adequately address the increasing levels of functional dependence presented by residents during their time in residential aged care, relative to the limited opportunities available for operators to adjust funding during that time.
c The “admission/discharge gap”, where new residents replace departing residents with higher funding allocations (reflecting higher acuity), has not been appropriately recognised in the modelling and requires more detailed analysis and consultation with operators.
d The more significant factor influencing claiming levels follows naturally from greater familiarity with the ACFI instrument, which was introduced in March 2008. As was the case with RCS, providers have been able to increase their claiming as they become more conversant with the funding instrument. It is not possible to accurately measure the extent to which providers have maximised their claiming potential based on the information available to the Department. Assuming a consistent pattern of growth is not appropriate four years after the instrument was introduced.
Clearly, the modified instrument will not be ready for introduction on 1 July 2012 and the Government is now considering the alternative of reducing the price points within the ACFI domains and cutting future subsidy indexations to achieve their target cuts.
“This leaves the industry in the unenviable position of having to support a broad-based reduction in care prices rather than be exposed to the Government’s rushed ACFI modifications.”
However many of the assumptions around subsidy price cuts will be common to those inherent in the ACFI modification strategy – both represent an unacceptable risk to aged care providers and the residents they care for. The Government should defer any material changes until more robust, consultative modelling can be undertaken in a less politically charged environment.
“Clearly, the modified instrument will not be ready for introduction on 1 July 2012 - the Government should defer these planned changes until more robust, consultative modelling can be undertaken in a less politically charged environment.”
4 Grant Thornton June 2012
These events have also created serious concerns for the banking sector. Richard Gates, Head of ANZ Healthcare, has been working with leading financiers and valuers to the aged care sector:
The main, immediate concern to banks of the proposed changes is the ACFI recalibration, to take effect from 1 July which principally focuses on ADL Domain 3.
Based on broad industry feedback and confirmed independently, we have been advised that this changed scoring will see a reduction in the ACFI subsidy of around 9% or in excess of $4,500 annually per bed. This ignores the grandfathering provisions but on a “steady state” basis, operators will likely be experiencing a substantial ACFI revenue reduction in the 2013/2014 year as new residents are progressively admitted.
It is estimated that the majority of this revenue reduction will fall directly to a reduction in sustainable earnings as resident needs have not reduced and commensurate reductions in operator cost structure will be very difficult.
From a financial covenant perspective, the obvious negative is interest cover - the ratio of pre tax earnings to interest expense. A top quartile operator achieves around $15,000 EBITDA per bed per annum
after head office costs. Assuming, for illustration, a current interest cover ratio of 2.75 times coverage (covenant of two times coverage), the ACFI reduction probably will see this ratio head towards the two times breach point, commencing second half of 2013/14 as the resident mix is substantially refreshed.
Industry EBITDA averages are of course around $6,400 per bed and these operators will likely be even more financially stressed. Fortunately it is rare for such operators to carry core debt. Nevertheless, they will be experiencing substantially reduced cash flows and operating margins.
The other adverse financial covenant outcome is loan to value ratio (LVR).
Initial discussions with valuers indicate that core business value may reduce by 20% if ACFI changes are implemented. So a typical borrower with a 50% LVR (covenant of 65%) may see his LVR push up to 62%, marginally below the covenant breach point.
Clearly, the above analysis is indicative only and will need to be proved by real experience and very specific modelling of actual data.
We also acknowledge Department of Health & Ageing’s view that it does not agree with the above industry impact analysis of the reduced ACFI subsidy per bed as no allowance has been made for frailty drift which the Department estimates will actually see some ACFI subsidy increase. However, our clients and the Department are struggling to reconcile this difference in view – only actual results will show who is right.
Richard Gates Head of ANZ Healthcare
The views of Richard Gates are his personally and are not necessarily reflective of ANZ’s position
A Banker’s Perspective
Review the Government’s Aged Care Reform Package 7
Paul Billingham, Grant Thornton’s Managing Partner of National Financial Advisory echoed Richards concerns:
“Any significant adjustment to a major income and cash source would impact upon individual operators and the industry as a whole.
A shock of this nature and magnitude will require fundamental operational changes. There could be an immediate fallout for those operators who are currently struggling with occupancy and overleveraged facilities. Those that will not be able to adjust quickly enough will also start experiencing pressure on cashflow, earnings and serviceability of debt.
There are a significant number of operators in the aged care sector that are operating at the margins of lending parameters. Threats to earnings and the ongoing serviceability of debt will only make it more difficult for such businesses to remain viable which will prove a challenge for the banks’ lending to these customers.”
Paul Billingham Managing Partner of National Financial Advisory Grant Thornton Australia
6 Grant Thornton June 2012
The Aged Care Financial Authority
Our previous Reform Report described the Government’s plans for the establishment of an Aged Care Financing Authority (ACFA) which will provide advice to Government in relation to care and accommodation pricing in aged care. We raised concerns regarding the suggested approach that the Authority might have in regulating accommodation bond levels.
In an attempt to provide clarity and certainty regarding the Authority’s role, the Government released a draft Interim Operating Framework for the Financing Authority in May 2012. The document sets out, at a very high level, the key responsibilities of the Authority.
However, the document does not provide guidance on the likely process for regulating bonds or prices generally for aged care services– rather these decisions are deferred until the creation of the Authority which is scheduled for late in 2012. It seems unlikely that the sector can expect any indication of how the body might regulate bonds for some time.
The planned subsidy claw back and the uncertainty around bonds has resulted in billions of dollars of planned investment being shelved. This means that the fundamental objective of improved choice and quality for consumers cannot be achieved in the foreseeable future.
In the last two months since the Government’s reform announcements, over $3.5 billion in planned aged care development projects have been shelved” 2
The combination of subsidy cuts and uncertainty regarding capital is proving to be a major concern for valuers and financiers. David Nelson, Senior Valuer at Nelson Partners provided the following input:
A Valuer’s PerspectiveThere are clearly two components arising from a valuation perspective. The first is the short term cash flow impact from the recalibration of ACFI that is being proposed and commencing from 1st July 2012. Based on a phasing in period due to a grandfather clause, there will be an ongoing flow effect to cash flows and we consider there will be a negative impact for the earnings (EBITDA) for the sector. The decreased EBITDA will have a direct proportional effect in decreasing the value of the core asset, in our opinion.
The second component is the long term restructuring from July 2014 which has potential benefits in the combining of high and low care classification into a single classification. The difficulty is in respect to the unknowns associated with the new guidelines for accommodation bonds post July 2014 and the role and the guidelines of the new Authority in approving the accommodation bond or equivalent periodic payment component.
The declining earnings and the uncertainty regarding the Authority will make it particularly challenging to undertake valuation work in the sector.
2 LASA Provider Survey 2012
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Richard Gates from ANZ Healthcare adds:
The secondary concern of the Living Longer, Living Better package to banks is the role of the ACFA, particularly setting accommodation bond prices. The issue here is light touch versus excessive regulation. Until the industry sees worked guidance on how bond prices will be set, investment confidence and certainty is on hold.
Bank confidence and support for clients is heavily driven by investor appetite and confidence. Banks generally remain committed to the industry but the proposed ACFI changes and uncertainty around bond pricing under ACFA are real concerns.
It will be imperative for banks to work much more closely with clients and the Government to ensure the necessary transitional provisions and monitoring is in place to deal with adverse unintended consequences.
Grant Thornton maintains that if the broader reform process is successful in stimulating competition and innovation, market forces should ensure that accommodation bonds and charges will remain competitive without the need to introduce another layer of bureaucracy that is unlikely to protect consumers.
The Government should monitor accommodation bond and charge levels with reference to a relevant property based benchmark. By exception, the Financing Authority could identify instances where consumers have been unfairly treated.
The Government should not have to wait on the formation of the Authority to provide certainty on this matter.
8 Grant Thornton June 2012
The way forward
On 20 April, the Prime Minister and Minister for Ageing & Mental Health explained the need to claw back funding because of widespread over-claiming and rorting of public subsidies by aged care operators. It was suggested that the required savings could be achieved by targeting care providers that were claiming inappropriately.
However the changes described above actually hit funding to all providers, particularly those caring for people with higher levels of frailty and those in regional/remote locations. The short notice period and the Government’s original allegations of “rorting” will make it difficult for the industry to object.
From a policy perspective, events over the last few weeks confirm that this “reform” package has become a net liability to the industry. The uncertainty regarding accommodation bonds and the reductions in real subsidies has severely dampened the enthusiasm stimulated by the Productivity Commission’s Caring for Older Australians report.
To address the challenges associated with a rapidly ageing population, the Productivity Commission recommended major reform initiatives that would stimulate the sector through the relaxation of regulation and greater levels consumer centred investment. To date, the Government has responded with plans of increased price regulation and reduced real subsidy levels.
It is imperative that the Government revisit the Productivity Commission’s recommendations and work with the industry to implement them. Major changes to the funding system should be deferred until a more informed approach can be developed to address:
i. Changing patterns in consumer care needs and demand;
ii. The actual cost of delivering residential aged care services;
iii. The affordability and sustainability of public subsidy payments; and
iv. The evolution of a user payment system recommended by the Productivity Commission
This understanding will be paramount if Australia is to be prepared for the greatest demographic change in the country’s history.
Further informationIf you would like to discuss any aspect of this report, or possible coverage in future reports, please contact Cam Ansell or your local Grant Thornton office:
T +61 8 9480 2062 E [email protected]
Contacts
AdelaidePhilip PatersonT +61 8 8372 6601E [email protected]
BrisbaneDan CarrollT +61 7 3222 0304E [email protected]
Graham McManusT +61 7 3222 0224E [email protected]
MelbourneBrad TaylorT +61 3 8663 6137E [email protected]
George LiacosT +61 3 8663 6183E [email protected]
PerthCam AnsellT +61 8 9480 2062E [email protected]
Jeff VibertT +61 8 9480 2190E [email protected]
SydneyAndrew RigeleT +61 2 8297 2595E [email protected]
Trevor PogroskeT +61 2 8297 2601E [email protected]
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