How to regulate the profits of public service providers
Originally published on the LSE blog here.
In announcing a review of the children’s social care sector, the education secretary Bridget Phillipson committed to ending the “excessive profiteering” which has become common place by some of the companies providing care homes for children.
According to a report commissioned by the Local Government Association, companies providing residential care to children generated £309 million in profit (measured as Earnings Before Depreciation Interest and Amortisation (EBITDA) at an average rate of 19 per cent with some generating margins of 25 per cent. Almost all of the £1.6 billion paid to these companies came from local authorities who pay the fees for children in care.
In response to this, Phillipson committed to introducing “new powers allowing the Government to directly cap the level of profit from children’s social care placements”.
However, once this logic has been applied to one area of public service provision there is no good reason for it not to be extended to other areas as well.
Some companies are extracting equally excessive levels of profits and dividends from the provision of healthcare services to people who have been raped and sexually abused, including children in Sexual Assault Referral Centres.
What should be the profit margins of public service providers?
If the government has chosen to act because it considers it wrong to generate 20 to 30 per cent profits from “the trauma, abuse […] of some of the most vulnerable children in our country” then it ought to also act in other areas of public services where this is happening.
As we demonstrated in our work with the Guardian earlier this year, some companies are extracting equally excessive levels of profits and dividends from the provision of healthcare services to people who have been raped and sexually abused, including children in Sexual Assault Referral Centres (SARCs).
The latest accounts of one of the companies running SARCS published showed that it had generated a 25 per cent post-tax profit margin and in the previous two years had paid out dividends worth £8.7m..
And what happens when the government realises that providers of care homes for children or sexual assault healthcare services are not the only ones generating excess profits from public services, potentially at the expense of service users and the taxpayer?
When asked what a reasonable rate of return might be, the Education Secretary pointed to the average operating profit margin across all for-profit entities calculated by the Office for National Statistics (ONS) which she stated was 8.8 per cent.
But our forthcoming research into the recent outsourcing of NHS eye care services found that the average operating profit margin for the companies providing these services was 28 per cent with some companies achieving a 50 per cent return, way in excess of the ONS benchmark.
For those who argue that such measures would be difficult to enact there are two current instances where government limits the amount of profit that companies can make out of contracts with the tax payer.
Profit-caps already exist
In order to address the fact that large scale defence procurement often happens without a competitive process the Single Source Contract procedure, requires the government to set the rate of profit which can be generated by those companies with UK defence contracts. For 2024/25 this rate is set at 8.24 per cent and is determined using an agreed methodology.
Similarly, when the Department of Health and Social Care negotiates large scale purchasing of drugs from the pharmaceutical industry it sets prices according to assumptions about “reasonable profit” levels for provider companies. In 2024/25 the rate based on “return on sales” is set at 6 per cent and companies must provide detailed financial information to be part of this voluntary procurement scheme.
Our research into the finances of the UK adult care home sector, found that in many instances large private care home companies recorded losses or very small operating profits, but used other measures to extract funds from the weekly fees paid to care for older people.
One of the stumbling blocks likely to be faced by any government seeking to introduce such a measure is the highly complex forms of financial engineering employed by a number of the large companies who have been successful in extracting large sums from public service contracts.
This means that a sole focus on capping profits is likely to be ineffective in clamping down on companies ripping off the public purse.
Profit-caps are not enough
Our research into the finances of the UK adult care home sector, found that in many instances large private care home companies recorded losses or very small operating profits, but used other measures to extract funds from the weekly fees paid to care for older people.
We found that some companies spent a significant part of their annual revenue re-paying high cost loans to a related company which was part of the same corporate entity.
In total, across the care home sector we estimated that around £1.5 billion leaked out each year through various forms of financial extraction.
Sale and leaseback schemes – where a related property company which owned the care homes charged high cost rent to the operating company – were also a common way of taking money out of these businesses.
The Competition and Markets Authority found that private equity backed care home companies paid large sums in management fees to their investors – estimated to be around £200m a year. However, these wouldn’t feature in a company’s profit and loss accounts.
In total, across the care home sector we estimated that around £1.5 billion leaked out each year through various forms of financial extraction.
If the government is to get serious with profiteering from key public services – as it should – then it needs to do a number of things in addition to introducing a profit cap.
Regulation to close down the loopholes
The first is to introduce something akin to the US Nursing Home Financial Transparency Act, which mandates those companies which provide care home services to the US taxpayer to be transparent about where the money goes.
This would enable a properly resourced and appropriately skilled audit body to determine whether a company was generating excess returns, including whether it was siphoning off money in ways other than through dividend payments.
The second is to introduce a form of financial regulation for public service providers which would examine all aspects of their business model to ensure that it was compatible with the public interest.
In addition to concerns about profiteering and financial extraction, the business models used by some of the companies involved in delivering services to vulnerable people are also high risk.
Over the past decade we have seen the high-profile financial difficulties of private equity backed care chains such as Southern Cross and Four Seasons, in part because of their inability to service high cost loans or keep up with rental payments.
Aside from the issues about the availability of services to vulnerable people which such precarity brings, financially fragile care providers also pose a risk to the safety of patients.
In one example, a corporate provider of mental health services which was struggling to service its debts of £100 million, told its lenders that it would not be “in a position to safely provide care for patients” unless new loan terms were agreed.
Whilst this is an extreme case, large parts of the care sector have for a long time operated with high levels of financial risk.
Once the government has acknowledged that excess profiteering in one area of public service provision is unacceptable it cannot – and should not – resist applying this policy approach to all areas of public services delivered by for-profit companies.
In the run up to the pandemic 60 per cent of all beds in care homes for older people were operated by companies at risk of serious financial difficulty if confronted with a relatively small increase in costs.
And this has been revealed more recently by the potentially devastating impact of minimum wage and tax increases on social care providers.
The government has grasped the importance of this issue when it comes to football by creating a new regulator to address the financial risk faced by English football clubs.
Under the plans only those clubs which can demonstrate that they have their finances in order and are financially sustainable will be given a license to operate.
But if it is right to do something to protect the interests of football fans it is even more necessary to introduce strict financial regulations for those companies providing care to vulnerable adults and children.
Once the government has acknowledged that excess profiteering in one area of public service provision is unacceptable it cannot – and should not – resist applying this policy approach to all areas of public services delivered by for-profit companies.
All articles posted on this blog give the views of the author(s), and not the position of LSE British Politics and Policy, nor of the London School of Economics and Political Science.
