Market Background
The UK residential care market is a two tier system, supported by a cross-subsidy business model whereby those residents who self-pay their fees (41%) are charged a premium rate to compensate for the losses incurred by care home operators for taking in residents funded in whole or in part by local authorities (49%). The remaining 10% are funded by the NHS because of pre-existing primary health needs. Estimates vary, but in broad terms a care home loses some £200 per week for every local authority funded resident they look after. Without the right mix of self-funders and local authority residents, operators cannot generate profits or positive cash flow.
Crucially, residential care (along with other types of social care provision) is entirely independent of the NHS, except for the limited number of residents funded by it.
The market is dominated by a relatively small group of major operators, who fund their businesses through variations on the private equity model. The key features of the private equity players are extremely high levels of debt and opaque corporate structures, which make comprehensive analysis of their finances close to impossible. These operators account for the vast majority of the sector’s £7bn borrowings. There is an ongoing debate on whether the drive to generate financial returns compromises care standards and whether the high debt burden represents an unacceptable financial risk, especially as interest rates have risen.
Below the major players, there are a number of major charity organisations and then a huge number of much smaller, independent operators often running just one or only a small group of homes.
It is common ground among all commentators on the care sector that substantial additional funding running into several billions from the government is required urgently to enable local authorities to pay higher fees to mitigate or even eliminate the losses on the residents they fund. Promises of extra money have been made for many years, but rarely satisfactorily fulfilled. It is hard to avoid the conclusion that social care is the Cinderella of public health policy.
The imposition of the additional 1.25% national insurance levy in 2022 aimed at generating resources to plug funding gaps across the entire health and social care spectrum is a classic example. The design of this scheme meant that only limited amounts were to be allocated to social care and then only in later years. The levy was then abruptly cancelled in November 2022 and the proposed follow-on Health & Social Care levy due to come into force as a separate, ring-fenced tax in April 2023 was withdrawn in the face of the cost of living crisis.
The Pandemic
Few sectors were more seriously disrupted than residential care and with tragic consequences. Over 42,000 residents and almost 1,300 staff died as a result of Covid-19. Occupancy levels (a critical factor for care home operators) dropped by 8% in the first year of the Pandemic, disproportionately self-funders, so that profitability and ongoing viability was threatened for many operators.
The government provided £2.1bn of financial support during the pandemic through a variety of schemes for care homes for the elderly, including £114m of furlough payments for vulnerable staff who were shielding and £174m of free-issue PPE.
Research by the Centre for Health and the Public Interest (CHPI) examined the impact of the pandemic on care homes for the elderly in their report ‘Bailed Out & Burned Out’ in April 2023, which can be found here.
The clear conclusion of this research is that the government put a financial sticking plaster over the wounds caused by the Pandemic, effectively covering operators’ extra costs and losses, but left the care sector every bit as vulnerable as it had been before Coronavirus and with none of its many underlying problems addressed.
The Workforce
Issues concerning escalating job vacancy rates and staff morale have risen now to be the main worry about the sector, which makes the lack of a workforce plan for social care deeply troubling. The government published a detailed and wide-ranging staffing plan for the NHS at the end of June 2023, but has failed so far to grasp the nettle of deteriorating social care staffing.
Residential care has over three quarters of a million workers, but a vacancy rate of 11%, equivalent to some 90,000 unfilled posts. Anecdotal reports speak of some operators having to reduce capacity because they cannot safely care for all the residents they could otherise take in.
Whilst the primary driver for recruitment and retention issues is low pay, there are other contributory factors including a lack of flexibility for part-time working or on shift patterns. Residential care is very much a vocation, rather than just a job, given the emotional and physical demands put on staff. As such, it is hardly surprising that for some the lure of working instead in a nearby supermarket for an extra £3 an hour is irresistible.
Financial Issues
Overall profile
In previous reports on this sector, we have concentrated solely on care home operators. In view of the ongoing fragile state of residential care in particular and social care more widely, we believe that we should look again taking into account the finances of the entire sector, including this time the wide range of service providers who specialise in it.
Accordingly, our research sample captures 15,974 UK-registered entities, whose finances were analysed using the Company Watch database and analytics. The bare bones of their financial profile are:
• Total assets of £28.5bn
• Total debt of £6.9bn
• Total net worth of £13.5bn
• Total working capital of £3.4bn
Risk profile
Company Watch uses the latest published accounts of every company registered at Companies House and a variety of other data to allocate an H-Score® (financial health rating) out of a maximum of 100. The average H-Score for our sample was 49, which is in line with the economy as a whole. This is slightly down from the average of 50 for the same companies one year previously.
Insolvency risk
Companies which are given an H-Score of 25 or less by Company Watch are in a Warning Area. Historically over more than twenty years, there is a one in four risk that a company in the Warning Area will file for insolvency or need a major financial restructuring within three years. 4,479 (28%) of residential care companies are in the Warning Area, well above the expected norm across the whole economy of some 25%.
‘Zombie’ companies
These are companies with higher liabilities than their assets, making them technically insolvent under one of the two generally-accepted solvency tests. We have applied a de minimis limit of £20k to filter out insignificant balance sheet deficits. Here we found that 3,154 (20%) of residential care companies are zombies, with a combined deficit of £1.2bn. Such companies are obviously at greater financial risk, especially if their profits fall or they experience any cash flow pressures.
Negative working capital
Businesses with negative working capital are, by definition, the most vulnerable of all. Their short term liabilities to suppliers, HMRC, overdrafts and landlords exceed their ‘quick’ or more easily realisable assets, such as cash, inventory and outstanding fees owed for residents. Here too we have applied a £20k de minimis filter, but even so there are 3,736 (23%) residential care businesses in this highly risky situation. Their combined working capital shortfall total £1.5bn.
Scotland
We separated out Scottish-registered companies from the main sample to allow us to form a view about the situation there. Inevitably, this excludes the operators of the major care home chains north of the border, because they are registered in England and splitting out the finances of their Scottish homes is not possible. As such, our sample is heavily focused on smaller independent care home businesses.
This is particularly relevant, because of the different financial arrangements for publicly-funded residents in Scotland, where there has been a long-established agreement between the Scottish government and Scottish Care, which represents independent operators. For many years, the rates paid by councils for the residents they fund have been governed by the National Care Home Contract (NCHC), which is intended to guarantee a profit of at least 4% for independents.
Unfortunately, negotiations for the renewal of the NCHC this year initially broke down over the meagre 6% uplift offered, which was manifestly inadequate in the face of rampant cost inflation and the clear need to raise pay rates for care home staff to address growing vacancy rates. Ultimately, Scottish Care has been forced to accept the 6% offer, but commentators are now reporting that care homes in Scotland are now closing at the rate of at least one a week in a sector already short on capacity, a crisis that is expected to worsen significantly.
Our analysis of the finances of 444 Scottish-registered residential care companies shows a healthier position across a wide range of measurements. Their average H-Score is higher than the rest of the UK – 53 out of 100, compared to 49. Just 14% are zombies (vs. 20%) and 25% are in the Company Watch Warning Area (vs. 28%). Only on negative working capital is Scotland in line with the rest of the UK at 23%. These less negative statistics reflect the greater support until now for independent operators who take in publicly-funded residents, but they are bound to deteriorate as this year’s NCHC settlement bites into the profitability of Scottish operators and their specialist suppliers.
The Future of the residential care sector
Warnings about the imminent collapse of the residential care sector have been sounded for many years, but somehow it seems to muddle through despite its deeply flawed business model, riddled with problematical fundamentals like the over-leverage among the major chain operators, the cross-subsidisation of publicly-funded residents and an ever-worsening staffing crisis.
There remains distinctly uncommon ground between operators who are desperate for more public funding and a government determined to suggest that it is doing all that is both necessary and affordable. Reform of social care in general is still much discussed, but effective action is thin on the ground, perhaps because of the difficulties of agreeing how social care and the NHS should or should not interact and integrate.
The sharp rise in interest rates may well be the straw that breaks the camel’s back, but, pending any major collapses, perhaps the most important question should be why the social care analyst, Carterwood, forecast in 2022 that the total elderly care home bed capacity will decline until December 2024, with 37,500 existing beds lost and only 19,700 beds gained from new development.
They predicted the national shortfall in supply levels of market standard beds will increase to between 57,300 and 64,300 beds by December 2024. This is at a time when all demographic studies show that there will be a sharply increasing need for more residential care capacity for the baby boomer generation.
Clearly, the market’s business model does not currently encourage sufficient investment, which in the face of rising demand is a sure indicator of the underlying financial and commercial risk issues.
August 2023
If you would like to discuss any of the points in the report or believe you have been affected by any of these issues, you can speak to one of our Partners who can discuss options with you. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.