Submission to the Review of the Conditional Adjustment Payment

28 August 2008 Submission to the Review of the Conditional Adjustment Payment "#$%&''&()$*+,,-''.,()(%&,'/0*1&%&0-23(4 Baptist Care Australia Catholic Health Australia Uniting Care Ageing NSW & ACT

5-6&-7(308-9()2&0&():;+2<#'0%-)0/:*%-)0 CONTENTS Executive summary... i 1. Introduction... 1 2. Residential aged care in Australia... 2 2.1 Australian Government funding... 2 2.2 Costs... 4 2.3 Productivity... 6 2.4 Future trends... 7 3. Indexation... 9 3.1 Indexation of Government payments... 9 3.2 Indexation of the CAP...10 References... 13 CHARTS Chart 1: Level of basic subsidy and CAP from 2003-04 to 2007-08 3 Chart 2: Annual growth rates in basic subsidies and CAP 4 Chart 3: LPI growth: health and community services vs all industries 5 Chart 4: Wage and price index growth over recent years 11 TABLES Table 1: Average annual growth rates since 2004-05 5 Table 2: Indexation arrangements for selected Government payments 9 While every effort has been made to ensure the accuracy of this document, the uncertain nature of economic data, forecasting and analysis means that Access Economics Pty Limited is unable to make any warranties in relation to the information contained herein. Access Economics Pty Limited, its employees and agents disclaim liability for any loss or damage which may arise as a consequence of any person relying on the information contained in this document.

5-6&-7(308-9()2&0&():;+2<#'0%-)0/:*%-)0 GLOSSARY OF ACRONYMS AIHW AWOTE CAP COPO CPI DoHA LPI MTAWE RCS SNA WCI Australian Institute of Health and Welfare Average Weekly Ordinary Time Earnings Conditional Adjustment Payment Commonwealth Own Purpose Outlay Consumer Price Index Department of Health and Ageing Labour Price Index Male Total Average Weekly Earnings Resident Classification Scale Safety Net Adjustment Wage Cost Index

5-6&-7(308-9()2&0&():;+2<#'0%-)0/:*%-)0 EXECUTIVE SUMMARY In 2006-07, the Australian Government provided funding of $5.7 billion for residential aged care services, the majority of which was provided through the basic subsidy. Since 2004-05, eligible aged care providers have also received a Conditional Adjustment Payment (CAP) on top of the basic subsidy, which has increased 1.75% each year since it was introduced. It is only with the addition of the CAP that subsidy rates have grown at a slightly faster rate than general prices. In other words, the CAP is the only reason that CPI growth has been covered historically. But even this falls short of actual cost increases. Labour costs particularly the wages of nursing and other care staff make up around 75% of total costs in the sector. Since 2003, nurses wages have risen rapidly and may continue to grow at above average rates in the future. While productivity and efficiency has improved over recent years, such gains have been mitigated by the increased costs arising from changes in Government regulatory and accreditation requirements. The labour intensive nature of service provision in the sector also acts as a limit on its ability to achieve significant ongoing gains. But even where gains are achieved, they tend to flow through to improvements in the quality of care rather than act as an offset to increasing costs. The sector s funding needs will continue to increase over time as a result of cost pressures arising from the growing demands and complexity of aged care provision. As such, it may be preferable to undertake a more comprehensive review of the sector s long-term funding needs and levels that considers the basic subsidy and CAP together. Given strong growth in costs over recent years which appear only to have been exceeded (in CPI terms) on the revenue side when one includes the CAP and its progressive increases, the CAP should continue in the meantime and be subject to annual indexation. This will only address short-term funding needs. If they are considered important, the three conditions currently attached to receipt of the CAP should become uniform mandatory requirements for approved providers, rather than being tied to the payment in perpetuity. The CAP should be indexed in line with a benchmark that better captures cost pressures in the sector than the one currently used for basic subsidy rates. We recommend the adoption of a new benchmark weighted at 75% for wage growth and 25% for non-wage growth, using the Labour Price Index (health and community services) for the wage element and the Consumer Price Index (CPI) for general prices. Based on recent experience, any productivity offset to this rate is likely to be captured more as improving quality of services rather than moderation of costs. A similar mechanism could apply to indexation of the basic subsidy, and further review is recommended into long-term sustainable financing mechanisms for residential aged care. Any such review would include perhaps a greater role for private sector provisioning vehicles. Recommendations: 1 Undertake a comprehensive review of long-term funding needs and levels in the residential aged care sector, including consideration of the indexation method used to adjust basic subsidy payments. 2 In the absence of a review, the CAP should continue, with increases indexed on an annual basis at least in line with the current practice for other Commonwealth Own Purpose Outlay (COPO) payments. i

5-6&-7(308-9()2&0&():;+2<#'0%-)0/:*%-)0 3 A more appropriate benchmark for CAP (and basic subsidy) indexation would be weighted 75% for wage growth and 25% for non-wage growth, using the LPI (health and community services) for the wage element and the CPI for the nonwage element. ii

1. INTRODUCTION Access Economics was commissioned by Catholic Health Australia, Baptist Care Australia, and Uniting Care Ageing NSW & ACT to prepare a submission to the CAP Review. This submission is structured as follows. Chapter 2 discusses the residential aged care sector in Australia, including Australian Government funding, costs and productivity in the sector, and future trends. Chapter 3 outlines the principles underlying the indexation of Government programs and recommends an option for the indexation of the CAP. 1

2. RESIDENTIAL AGED CARE IN AUSTRALIA 2.1 AUSTRALIAN GOVERNMENT FUNDING The Australian Government supports the provision of residential aged care services through a range of payments under the Aged Care Act 1997. In 2006-07, Government expenditure on residential aged care subsidies and supplements was $5.7 billion. The majority of Government funding is provided through the basic subsidy. The rate of subsidy payment is determined on a per bed day basis according to each resident s care needs. Until 20 March 2008, residents were assessed against the Resident Classification Scale (RCS). For permanent residents, RCS categories 1-4 corresponded to high level care and categories 5-8 to low level care. Respite residents were classified either as respite high or respite low. The RCS was replaced by the Aged Care Funding Instrument from 20 March 2008. Basic subsidy rates are adjusted annually in line with movements in the COPO index formula. The particular index used for residential aged care is Wage Cost Index 9 (WCI_9), which is weighted at 75% for wage costs and 25% for other costs. WCI_9 uses the growth in the Safety Net Adjustment (SNA) for indexing wage costs and the growth in the CPI for non-wage costs. Eligible aged care providers also receive the CAP on top of the basic subsidy amount (and in addition to annual indexation). The CAP was introduced in the 2004-05 Budget (at a cost of $877.8 million over four years) in response to the Review of Pricing Arrangements in Residential Aged Care (the Hogan Review). The Hogan Review recommended that an incentive supplement, linked to gains in efficiency, productivity and workforce training, be paid to providers in order to secure reductions in the real costs of aged care. The CAP provides financial assistance to providers while encouraging them to become more efficient through improved management practices. Providers are only eligible to receive the CAP if they: 1 give their staff information and opportunities regarding workforce training; 2 make audited accounts publicly available each year; and 3 take part in a periodic workforce census. The CAP is calculated as a fixed percentage of the basic subsidy normally payable for each resident. The level was set at 1.75% of the basic subsidy in 2004-05, increasing by 1.75% each subsequent year to reach 7.0% in 2007-08. The Government provided an extra $407.6 million in the 2008-09 Budget to increase the level to 8.75% in 2008-09. Chart 1 shows the historical increases in basic subsidy rates and the CAP over the 2003-04 to 2007-08 period. 2

CHART 1: LEVEL OF BASIC SUBSIDY AND CAP FROM 2003-04 TO 2007-08 116% 114% 112% 110% 108% 106% 104% 102% 100% 98% 96% 94% 92% 90% CAP Basic subsidy* 7.00% 5.25% 3.50% 1.75% 2003-04 2004-05 2005-06 2006-07 2007-08 * The increases of the basic subsidy bars each year above 100% reflect COPO indexation. Effectively, the annual increase in the CAP is the additional 1.75% increase in the adjusted basic care subsidy, making the real annual indexation factor a combination of WCI_9 and the CAP increase. In 2008-09, this is 4.05%. Chart 2 shows growth in Access Economics estimates of national average subsidy rates since 1999-00. Subsidy rates (excluding CAP) differed in some States prior to the alignment of rates through the Australian Government s Funding Equalisation and Assistance Package. By adjusting high care basic subsidies in all States toward the national average over the period from 1 January 2000 to 1 July 2006, the package led both to changes in subsidy rates over and above regular indexation in some States, and to the differing growth rates between high and low care subsidies seen in the Chart. 3

CHART 2: ANNUAL GROWTH RATES IN BASIC SUBSIDIES AND CAP 6% 5% Year-to % change Low care (excl. CAP) High care (excl. CAP) CPI (excl. GST impact) Low care (incl. CAP) High care (incl. CAP) 4% 3% 2% 1% 0% 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 Source: DoHA, ABS 6401.0, Access Economics Note: Chart excludes one-off grants of $3,500 in 2003-04 and $1,000 in 2004-05 per place. Over the four years following the introduction of the CAP in 2004-05, national average basic subsidies (excluding CAP) increased by an average of 1.8% per annum for high care rates and 2.0% per annum for low care rates. Most notably, increases in both high care subsidy rates (average of 3.5% per annum) and low care rates (average of 3.7% per annum) only kept pace with CPI growth and, indeed, slightly exceeded it (see Chart 2) when topped up by the CAP. 2.2 COSTS Labour costs particularly the wages of nursing and other care staff are the major costs in the residential aged care sector, reflecting the labour intensive nature of service delivery. Overall, labour costs account for around 75% of total costs (Productivity Commission, 2003). Chart 3 compares the recent growth in the Labour Price Index (LPI) for all industries and the health and community services sector (a proxy for the residential aged care sector). The LPI measures changes over time in the price of labour resulting from market pressures (that is, the pure price growth element in wage rises), and is unaffected by changes in the quality or quantity of work performed. The LPI shows that wage growth in the health and community services sector has generally exceeded economy-wide wage growth since 2003 (the reverse was generally the case from 1999 to 2003). 4

CHART 3: LPI GROWTH: HEALTH AND COMMUNITY SERVICES VS ALL INDUSTRIES 6% Year-to % change 5% 4% 3% 2% 1% LPI - all industries LPI - health and community services 0% Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Source: ABS 6345.0, Access Economics Note: Chart shows year-to % change per quarter. Part of the reason for this strong wage growth in the health and community services sector is that nurses wages, a significant component of total costs in the sector, have risen rapidly in recent years as nursing has become a more skilled occupation and the demand for qualified nurses has increased. The Hogan Review suggested nurses wages may continue to grow at above average rates in the future, in the order of an additional 0.25% a year. Nurses wages are a substantial item in the residential aged care cost structure, making up around one-third of labour costs for high care homes and one-fifth for low care homes. Other costs directly related to the operation of aged care homes include catering, cleaning, laundry, utilities, repairs and maintenance, and rates and taxes. These items are captured in the CPI. Table 1 compares the average annual growth in basic subsidy rates, headline CPI (adjusted for GST effects) and LPI from 2004-05 to 2007-08. TABLE 1: AVERAGE ANNUAL GROWTH RATES SINCE 2004-05 Item Average annual growth rate Low care basic subsidy (excluding CAP) 2.0% Low care basic subsidy (including CAP) 3.7% High care basic subsidy (excluding CAP) 1.8% High care basic subsidy (including CAP) 3.5% CPI 3.2% LPI (all industries) 4.1% LPI (health and community services) 4.4% Source: DoHA, ABS 6345.0 and 6401.0, and Access Economics. 5

2.3 PRODUCTIVITY Productivity refers to the level of output produced for a given level of inputs while maintaining constant quality. At the firm or industry level, productivity gains can be achieved through: more capital (a higher volume of equipment which can produce output more efficiently than alternate processes); better use of capital (having better equipment or making better use of existing equipment to again produce output more efficiently); changing the mix of labour and capital (particularly where lower cost labour or capital can be used to deliver components of services without any loss of quality); more efficient work arrangements; and/or improved administration and management practices. Over recent years, residential aged care providers have been able to enhance productivity and efficiency by: improving work processes, including by better allocating tasks between nursing and other care staff; minimising waste on cleaning costs and food services; increasing the use of IT for administrative purposes (Department of Health and Ageing (DoHA), 2007a); and streamlining back office operations. Gains have also been made by adopting better technology (more and better equipment) and by increasing the size of aged care facilities (35% of homes had more than 60 places at 30 June 2007, compared with 21% in 2000 Australian Institute of Health and Welfare (AIHW), 2008). Achieving these improvements has required additional one-off capital investment and often involves a higher overall ongoing operating cost, while achieving economies of scale in average unit costs over the longer term, which derive from the fixed overhead component. However, such productivity gains have been mitigated by the increased costs associated with changes in Government requirements, particularly: increased accreditation requirements; changes in building certification requirements, with the move from multi-bed wards to single bed rooms increasing staffing costs per bed 1 ; and compliance with CAP financial reporting requirements. In addition, the labour intensive nature of residential care provision acts as a limit on the sector s ability to achieve significant ongoing productivity gains. Further, even where gains 1 The Bentleys and James Underwood & Associates 2006-07 National Residential Aged Care Survey states in the key findings: High Care services operated in single-occupancy room buildings achieve much poorer returns than those in multiple-occupancy room buildings. Even before capital costs are included, the average single-room High Care service makes very low returns unless they have additional income from accommodation bonds and higher fees, as in extra services (ES) facilities. The average EBITDA [Earnings Before Interest, Taxation, Depreciation and Amortisation] of non-es single-room High Care Services was $2.02 prpd [per resident per day]. The EBITDA in these non-es, single-room High Care services averaged over $14.63 prpd less than multipleoccupancy room services. This is an average of $5,340 per resident per annum difference in return. 6

are achieved, recent experience shows they tend to flow through to improvements in the quality of resident care rather than act as an offset to increasing costs for providers. 2.4 FUTURE TRENDS The key cost drivers for residential aged care facilities are resident mix and quality of care. In this context, it is important to recognise that: there are growing numbers of people in residential aged care there were 153,426 permanent residents at 30 June 2007, compared with 144,994 in 2004 (that is, average annual growth of 1.9%) (AIHW, 2008); there are more older people in residential aged care 54% of permanent residents in aged care services at 30 June 2007 were aged 85 years and over, compared with 51% in 2004 (AIHW, 2008); dependency levels are increasing 70% of permanent residents were assessed as high care at 30 June 2007, compared with 66% in 2004 and, in addition, 62% of permanent residents admitted during 2006-07 were already classified as high care (AIHW, 2008). Further, the proportion of operational residential aged care places allocated as low care and utilised as high care was 37.4% at 30 June 2007, compared with 25.5% in 2004 (DoHA, 2007b); people are spending more time in residential aged care the average completed length of stay for permanent residents who left residential care during 2006-07 was 145.9 weeks, compared with 143.7 weeks during 2003-04 (AIHW, 2008). Increases in the average length of stay reflect increasing ageing in place and rising dementia levels; and quality of care is increasing 92% of aged care homes were fully compliant with the Accreditation Standards at 30 June 2007, compared with 88% in 2003 (Aged Care Standards and Accreditation Agency). The average number of residents per room has declined from around 1.57 in July 1999 to 1.19 in December 2006, and all homes will be required to meet space and privacy targets by 31 December 2008 (DoHA, 2007b). With the acceleration of demographic ageing of the population, these trends will continue and indeed become more pronounced in the future, placing further pressure on the residential aged care sector. While increasing frailty would be compensated by movements to higher subsidy rates, the growing demands and complexity of aged care needs will increase the costs of providing services. Additionally, more staff, and higher qualified, up-skilled and competency trained staff, will be required to provide quality care for the ever increasing numbers of frail and disabled people in permanent care. Nurses wages have lifted notably in recent years thanks to strong demand, and the above trends suggest that demand will remain strong going forward. As a result, the sector s funding needs will continue to rise over time, as modelled in the second Intergenerational Report in 2007. Therefore, rather than reviewing the CAP in isolation as is currently being done, it may be preferable for the Government to undertake a more comprehensive review of future funding needs and levels in the residential aged care sector, including consideration of the indexation method used to adjust basic subsidy payments. The review should also consider whether periodic reviews of funding levels would be appropriate given ongoing changes in the sector to ensure adequacy and monitor changes every five years or so. In the absence of such a review, and given strong growth in costs in recent years (which appear to have only been offset by the introduction and progressive increases of the CAP), the CAP should continue on an ongoing basis in order to cover costs. As those costs will 7

continue to rise, the CAP should be subject to indexation in line with the current practice for other COPO payments. Chapter 3 recommends an indexation benchmark for adoption. While compliance with the three conditions currently attached to receipt of the CAP has been voluntary to date indeed, four approved providers have chosen not to participate (DoHA, 2007b) the conditions are in fact a mechanism for improving transparency and accountability in the sector and therefore we believe should be a uniform mandatory requirement if the Government believes they are important. As such, they would be rolled into existing accreditation standards for all providers. This is in line with the basic principle that policy tools should be directed as sharply as possible that is, with minimum standards of quality or accountability mandated and with subsidy and indexation rates targeted at cost growth. Moreover, now that the sector has largely adopted the accountability standards, there is less of a case for continuing to incentivise this in perpetuity. If the Government wishes to impose additional conditions, it would need to take into account the impact the increased regulatory requirements would have on administrative overheads. The provision of the CAP on top of basic subsidy rates has meant that the growth of Government funding for residential aged care has slightly outpaced CPI growth since 2004-05. However, even with the inclusion of the CAP, subsidy increases have been 0.7% to 0.9% less than the increase in the LPI (health and community services) cost growth over this same period. Going forward, the sector s funding needs will continue to rise as a result of cost pressures arising from the growing demands and complexity of aged care needs. Increasing frailty will be compensated by movement towards higher subsidy rates, but the strong demand may result in continued strong growth in wages for nurses and personal care attendants. Without a more comprehensive review of future funding needs and levels being undertaken, the recent strong cost growth suggests the CAP should continue and be indexed on an annual basis. If the Government considers them important, the three conditions currently attached to receipt of the CAP should become uniform mandatory requirements for approved providers. 8

3. INDEXATION 3.1 INDEXATION OF GOVERNMENT PAYMENTS Government payments are indexed from time to time in order to maintain their purchasing power in the hands of the recipient. That is, the basic principle underlying indexation is that payments are adjusted for movements in prices so that the recipient is able to purchase the same basket of goods and/or services or deliver the same unit of output in different periods. It is therefore important to link payments to indexation benchmarks that reasonably capture the costs that are being compensated for by the payment. Table 2 summarises the indexation arrangements currently in place for a selection of Government payments from the Department of Families, Housing, Community Services and Indigenous Affairs, the Department of Veterans Affairs and DoHA. As can be seen, most payments to the public are adjusted once or twice a year in line with increases in the CPI to reflect changes in the cost of living (some payments are adjusted by changes in legislation). At the time of indexation, the maximum single rate of pension is also checked to ensure it does not fall below 25% of the Male Total Average Weekly Earnings (MTAWE) figure. TABLE 2: INDEXATION ARRANGEMENTS FOR SELECTED GOVERNMENT PAYMENTS Government payment Benchmark Frequency Age Pension CPI plus 25% of MTAWE check 20 March and 20 September Service Pension CPI plus 25% of MTAWE check 20 March and 20 September Carer Payment CPI plus 25% of MTAWE check 20 March and 20 September Newstart Allowance CPI 20 March and 20 September Mature Age Allowance CPI 20 March and 20 September Family Tax Benefit (Part A and Part B) CPI 1 July Remote Area Allowance Adjusted by change in legislation N/A Baby Bonus CPI 1 July Child Care Benefit CPI 1 July Pharmaceutical Benefits Scheme subsidy CPI 1 January Medicare Benefit Schedule fees WCI_5 (a)(b) 1 July Residential Aged Care Basic Subsidy WCI_9 1 July Home and Community Care Program WCI_3 (a) 1 July Community Aged Care Packages Program WCI_9 1 July Extended Aged Care at Home Program WCI_9 1 July (a) WCI_3 and WCI_5 comprise 60% wage growth and 40% non-wage growth. (b) Around 60% of Medicare Benefit Schedule fees are indexed to WCI_5. The remainder are subject to other policy arrangements, and most are not indexed. Source: Centrelink (includes FaHCSIA), DoHA and Department of Veterans Affairs websites, and the Department of Finance and Deregulation. COPO payments, on the other hand, including residential aged care and community care programs, are indexed annually in line with movements in the relevant WCI applicable to the program. Notably, the inadequacy of current indexation arrangements for residential care applies equally to community care. There are several indices currently in use with different weightings for wage and non-wage costs depending on the assumed cost structures of program providers. The construction of the indices is intended to ensure the indexation of the payments includes only those wage increases that are not offset (or not expected to be offset) by productivity improvements (that is, the pure price impact of wage increases is intended). 9

Applying a productivity adjustment makes sense at a conceptual level as wage growth in real terms (that is, above the general rate of inflation) should be roughly equal to productivity growth over the long term. There are, however, three complications with using this approach in an indexation context. Productivity growth is difficult to quantify in practice, particularly in non-market sectors such as health and community services. Many measures of productivity growth are also subject to revision over time, which is not a desirable characteristic for an index used to adjust funding levels. Productivity growth differs between sectors, so using an economy-wide average to discount wage growth means that program providers in less productive sectors will not be fully compensated for cost increases. Productivity growth is particularly difficult to achieve and measure when labour is used to provide care services, where time spent with residents is also an aspect of the quality of the service. 3.2 INDEXATION OF THE CAP The CAP can either be indexed using the same method that applies to basic subsidy rates or an alternative benchmark can be adopted. We recommend the latter approach for the reasons discussed below As previously mentioned, residential aged care subsidy rates are currently subject to annual indexation in line with movements in WCI_9 (as calculated by the Department of Finance and Deregulation). WCI_9 is a weighted index comprising: 75% of the dollar growth in the SNA relative to Average Weekly Ordinary Time Earnings (or AWOTE). The Australian Industrial Relations Commission previously determined the SNA each year; that role has now passed to the Fair Pay Commission; and 25% of growth in the CPI. Chart 4 compares the growth in AWOTE, LPI (health and community services), headline CPI (adjusted for GST effects) and WCI_9 over recent years. 10

CHART 4: WAGE AND PRICE INDEX GROWTH OVER RECENT YEARS 6% Year-to % change 5% 4% 3% 2% 1% CPI (excl. GST impact) AWOTE LPI - health and community services WCI_9 0% 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 Source: Department of Finance and Deregulation, ABS 6302.0, 6345.0, 6401.0, Access Economics Chart 4 shows that: WCI_9 has not kept pace with wage pressures, as indicated by the large gap between AWOTE and WCI_9, and LPI (health and community services) and WCI_9. WCI_9 has not even kept pace with general price pressures, as indicated by the gap between the CPI and WCI_9. Growth in WCI_9 was slower than growth in the CPI for every year from 1999-00 to 2006-07. Examining how WCI_9 is constructed helps to explain why its growth is so slow. WCI_9 measures wage growth with the concept SNA/AWOTE. However, in reality, this concept does not fully capture wage pressures in many sectors of the economy. The SNA is determined as a dollar amount, but it is received mostly by individuals who are on or near the minimum wage. Yet AWOTE is significantly above the minimum wage. In percentage terms, SNA/minimum wage would make sense but SNA/AWOTE is not really a valid comparison. The term SNA/AWOTE can be expanded and shown as: SNA/AWOTE = SNA/minimum wage x minimum wage/awote The increasing average skill level of Australian workers means the minimum wage (reflecting more basic skills) in proportion to AWOTE is declining over time, providing a continuing negative drag on SNA/AWOTE. Rather than making explicit allowance for productivity gains, it would appear that WCI_9 has been constructed to primarily be a slow growing index. The consequence is that, over time, WCI_9 indexation does not adequately compensate for cost increases in sectors where wage rates are above the minimum wage and where there is little scope for substantial productivity gains. 11

Conceptually, the CAP should be indexed in line with a benchmark that closely reflects cost pressures in the residential aged care sector. Weights of 75% for wages and 25% for general prices are broadly appropriate given the cost structure of the sector, and growth in the CPI for general prices is broadly appropriate to index non-wage costs. However, we would recommend growth in the LPI for indexing wage costs. The stronger growth in the LPI (health and community services) relative to LPI (all industries) since 2003 largely reflects a stronger wage outcome in 2003. This relative wage growth may continue over coming years as the demand for skilled nurses continues to rise in response to an ageing (and ailing) population. That would suggest LPI (health and community services) may provide the more appropriate benchmark for the wage element of the index than general LPI (all industries). The proposed benchmark does not allow for productivity growth. As previously discussed, productivity gains are difficult to achieve in a labour intensive service delivery occupation and evidence suggests such gains in the residential aged care sector are being captured more as improving quality of care rather than moderation of costs. While appropriate at a conceptual level, any productivity adjustment to the benchmark is likely to be fairly modest in reality and therefore not proposed. In order to maintain their purchasing power, Government payments need to be indexed in line with benchmarks that reasonably capture the costs that are being compensated for by the payment. Current indexation arrangements tend to use either CPI growth or a combination of CPI and wage growth as benchmarks. In the case of CAP indexation, a weighted index comprising 75% wage growth and 25% non-wage growth appears broadly appropriate given the cost structure of the sector. We recommend using the LPI (health and community services) for the wage element and the CPI for general prices. 12

REFERENCES Access Economics, Review of Community Nursing Pricing and Funding Arrangements, Report for the Department of Veterans Affairs, August 2004 Access Economics, EBA outcomes and public hospital funding is the system working effectively in Victoria?, Scoping study for the Victorian Healthcare Association, June 2008 Aged Care Standards and Accreditation Agency, Annual Report 2006-07 ANZ, Residential Aged Care Homes in Australia, Industry Brief, January 2005 Australian Bureau of Statistics, Consumer Price Index, Cat. 6401.0 Australian Bureau of Statistics, Labour Price Index, Cat. 6345.0 Australian Bureau of Statistics, Labour Price Index: Concepts, Sources and Methods, 2004, Cat. 6351.0.55.001 Australian Institute of Health and Welfare, Australia s Welfare 2007, Cat. No. AUS 93, 2007 Australian Institute of Health and Welfare, Residential aged care in Australia 2006-07: A statistical overview, Aged Care Statistics Series No. 26, 2008 Bentleys and James Underwood & Associates, 2006-07 National Residential Aged Care Survey, 2008 Commonwealth of Australia, Intergenerational Report 2007, April 2007 Department of Health and Ageing (a), IT Readiness Survey of the Aged Care Sector 2006: Summary of Findings, prepared on behalf of the Department of Health and Ageing by CHIK Services Pty Ltd, 2007 Department of Health and Ageing (b), Report on the Operation of the Aged Care Act 1997: 1 July 2006 to 30 June 2007, 2007 Hogan, W.P., Review of Pricing Arrangements in Residential Aged Care: Final Report, 2004 Productivity Commission, Submission to the Review of Pricing Arrangements in Residential Aged Care, June 2003 13