We examine interventions by the Australian Government in the market for residential aged care and consider the impacts on the incentives of market participants. We find that providers are likely to have an incentive to discriminate against high-care residents, in favour of low-care residents. As a result, since high-care residents, unlike low-care residents, face few viable alternatives, many are forced into public hospital beds, which has placed pressure on the broader health system. Providers are “squeezed” between an inability to charge high-care residents a bond of any value and an inability to derive bonds of sufficient value from low-care residents, given the availability of substitutes. We stress the importance in policy design of fostering proper incentives and suggest a path for a program of microeconomic reform in health care.