The document summarizes issues around rising costs, competition, risk, and regulation in Australia's private health insurance system. Key points include: - Private health insurance incentives introduced in 1997-2000 aimed to relieve pressure on public hospitals but had negligible impact on reducing public hospital pressures or waiting times. - While private health insurance coverage increased following incentives like Lifetime Health Cover, premiums continued rising and the incentives became part of the problem for public patients. - There is policy paralysis around reforming the large subsidy for private health insurance due to the politics of high population coverage, despite evidence it is an ineffective policy.

1. Costs, competition, risk and regulation
Elizabeth Savage
Professor of Economics
UTS Business School
16th Annual Health Insurance Summit 2017
Swissotel Sydney
July 27th – 28th,2017

2. Private Health Insurance regulatory framework
• Restricted to non-Medicare health expenditures
• Private inpatient treatment (hospital cover)
• Hospital costs
• Medical costs
• Diagnostics
• Some hospital substitute treatment
• Outside hospitals
• Restricted to drugs not listed on PBS
• Ancillary services (general cover)
• Annual premium increases approved by Australian Minister for Health
• Mandated community rating of PHI premiums and risk equalisation across
funds

3. PHI incentives 1997-2000
• Rationale was to relieve pressure on the public hospital system
• Narrative
• PHI death spiral
• Increasing premiums as PHI risk profile worsened driving patients to public
hospital queues
• Increasing waiting times for elective treatment
• PHI incentives
• Medicare Levy Surcharge 1997
• 30% Rebate to PHI premiums 1999
• Lifetime Health Cover 2000

4. Expectations of PHI incentives
• Higher population coverage and lower risk profile causing PHI
premiums to fall
• Decreasing demand for free public hospital treatment
• Relieving pressure from fixed budgets
• Decreasing waiting times in public hospitals

5. Actual impacts following the incentives
• LHC and associated marketing campaign was the most effective
• Resulted in 50% increase in PHI population coverage prior to deadline, from
30% to 45%
• Changed risk profile of insured – younger and healthier
• But no fall in PHI premiums
• Following the incentives, claimed benefits per day in private hospitals
increased (unclear whether from more services or higher fees per service)
• Negligible impact on reducing pressures on public hospitals
• No decrease in public hospital waiting times
• Public hospital fixed budget pressures remained

6. Government responses
• In 2003, removal of subsidies for ancillary lifestyle items such as gym
memberships, running shoes, relaxing CDs, tents and golf clubs
• In 2009-10, removal of rebate from LHC loadings
• From July 1, 2012 rebate was income-tested and increases tied to inflation
• In 2012-13, a review of rebates for natural therapies, starting with
homeopathy. Minister’s response was that removing funding for specific
ancillary items would not be straightforward
• Over time the LHC loading which aimed to increase cover was thought to
be discouraging PHI take-up, so was removed after a 10-year period
• From 1 July 2015, the income thresholds used to calculate the Medicare
levy surcharge and private health insurance rebate fixed for six years at
2014–15 levels

7. Rising expenditure on PHI rebate
• By June 2015, 11.3 million Australians (47% of the population) had some
form of private patient hospital cover and 13.3 million (56%) had some
form of ancillary cover (APRA 2015)
• Budget cost of the rebate approaching $7 billion
• Yet PHI still funds a small share of total health expenditure
• In 2013-14, PHI funded 8.3%
• Australian government 41%
• State governments 27%
• Out-of-pocket 18%
• Increasing scrutiny of annual premium increases
• Reports of consumer dissatisfaction with PHI as value for money

8. Who buys insurance and why
• Choosing to go private or public depends on motivations for PHI
• National Health Survey reveals 4 main motivations (choice, financial, security and
health)
• Changes in insurance coverage are not good indicators of changes in the
use of the public hospital system
• Choice types four times more likely to be admitted as a private patient,
• Financial types almost equal probabilities of being a private or a Medicare patient
• Those attracted by the financial incentives behave more like the uninsured than long
term enrollees
• A recent survey found the top reason for PHI is ancillary cover
• Funds marketing to young healthy clients (higher profits from ancillary)
• Bundling
• Limited product awareness

9. Private patients in public hospitals
• Evidence of preferential treatment for private patients in public
hospitals contrary to agreements between states and commonwealth
• In NSW in 2004-05, waiting times for elective surgery were found to be
considerably shorter for private patients than public patients with similar
clinical needs
• Comparable private patients were also more likely to be assigned to more
urgent admission categories, which corresponds with a shorter maximum
wait for admission into hospital
• To relieve budgetary pressures public hospitals are increasingly
encouraging insured patients admitted through ED to go private
• Inducements: waive hospital excess, drinks vouchers, better food options and
free parking (Catholic Health Australia)

10. The PHI incentives aimed to relieve pressure
on public hospitals
• Large pool with PHI provides public hospitals with a potential revenue
source to supplement fixed budgets from MBS, PBS and private insurers
• “From 2005-06 to 2010-2011 public patients in public hospitals increased by 16%,
…[while] private patients in public hospitals increased by 50% … $864 million in
accommodation fees was paid by private health funds to public hospitals in calendar
year 2012, a 17.6% increase on the prior year. … The estimated $123 million in
prostheses charges to private health funds is highly profitable for the public hospitals
as these are at private or near private hospital rates as mandated by the
Commonwealth but the purchase price is at public rates. ” ACHR, 2013
• Extra insurance claims from public hospital private patients via ED reinforce
upward pressure on PHI premiums
• The PHI incentives have become part of the problem for public patients

11. Policy paralysis
• Despite the large subsidy, consumers continue to question whether PHI
provides value for money
• There is abundant evidence that the subsidy is an ineffective and costly
policy, but the politics (high population coverage) keep reform of the
subsidy in the too-hard basket for governments
• Rebates for ancillary
• Prefer to increase the Medicare Levy, essentially a flat tax with a burden across the
income distribution than reduce the rebate (raising equity concerns)
• Similarly, unwillingness to urgently address regulatory failure on prostheses
for private inpatients
• Hospital insurance premium increases for hospital cover partly driven prostheses
claims (in 2015 almost A$2 billion or 14.4% of hospital benefits)

12. Budget 2017-18 industry proposals
• Maintain rebate
• Reform Prostheses List benefit
• Abolish 85% benefit requirement except for networks with <3% share
• Discourage public hospital “cost-shifting”
• Desynchronise and arms length premium increases
• Extend LHC incentives to those 18+
• Extend PHI for out-of-hospital care (lessons here from EMSN)

13. Drivers
• States blame Commonwealth for lowering public hospital funding
• In 1996-97, the Commonwealth share of public hospital expenditure was
48%. By 2014-15 it had fallen to 42%
• Annual funding growth of Commonwealth contributions are capped at 6.5%
• Commonwealth funding in 2020-21 will depend on a longer-term funding
agreement to be considered by COAG in late 2018
• Commonwealth blames States for not controlling costs
• Funds have limited market power and blame premium increases on
increasing claims, private hospital concentration and government
failure (prostheses)

14. Limited mechanisms for cost control
• Fragmented complex system
• Separate Medicare funding silos, all demand-driven (open-ended
budgets) except public hospitals
• Limited co-ordination of care for patients

15. Level of subsidy depends on the type of care
• All public patients in hospital receive 100% subsidy
• For each item on the Medicare Benefits Schedule, subsidies are essentially
fixed
• For pharmaceuticals, the subsidy depends on the prescribed drug (price
paid to the company less the patient co-payment)
• Health concession cards decrease the co-payment for PBS drugs and can
influence doctor fees, eligibility depends on income and age (about 50% of
the population have cards)
• Subsidy to PHI premiums (about 30%) flow to relatively high-income
healthy individuals

16. Implications
• Total subsidy that ultimately flows to a patient is unrelated to their
individual health risk, measured by their expected health expenditure
• Separate funding sources for hospital treatment, out-of-hospital
medical care and drugs means that there is very limited incentive for
co-ordinated care
• No mechanism to guide the appropriate mix of treatments, likely to
have adverse impacts on overall efficiency and cost-effectiveness
• Lack of co-ordination is more serious problem for patients with a mix
of chronic conditions

17. Step back
• The fundamental market failure in health insurance is asymmetric
information of individual risk class
• Standard model predicts those with higher cover to be an adverse selection
• But asymmetric information in other dimensions can generate favourable
selection
• in Australia there is favourable selection - income and risk preferences (as
well as individual risk class) are hidden information
• Compared with the uninsured, those with PHI cover have better self-assessed health,
lower health expenditures, higher incomes and healthier lifestyles
• Individual health risk has little to do with how subsidies are allocated in the
Australian health system

18. Neglected insights
• Various experts and expert bodies in Australia have proposed taking greater
account of individual health risk in the allocation of health subsidies and using
market incentives to improve efficiency within the Australian context of universal
access to basic care
• Amalgamation into a single national program, integrating funding and service
provision and using a risk-adjusted funding system for program delivery
• Scotton’s proposals of 1995 and 1999
• Senate Inquiry into Public Hospital Funding 2000
• Productivity Commission Report on Government Services chapter 5, 2002
• Special Commission of Inquiry Report into Acute Care Services in NSW, 2008
• National Health and Hospital Reform Commission Final Reports, 2009

19. e.g. NHHC’s Medicare Select
• Single funder (Commonwealth) sets capitated subsidies on a risk-adjusted basis
for all basic Medicare entitlements (Universal Service Obligation)
• Budget holders receive subsidies of enrollees (open enrolment) and purchase
care (set up contracts with competing providers) on behalf of enrollees –
coordination across health care services
• Providers come across the private/public spectrum
• At-risk budget holders retain unspent subsidies – promotes competition between
providers to reduce costs
• Enrollees can move between budget holders – in response to incentives (in
response to cost/quality)

20. Capitated risk-based subsidies are crucial
• Aligning payments with patient need ensures that funding is sufficient to provide
an appropriate level of care
• The efficiency of the health care system requires that subsidies are set to remove
the incentive for risk selection
• This means higher subsidies for those costly to treat to remove incentives for
cream-skimming/shedding high cost enrollees
• Requires detailed analysis of patient-level data to predict consumer expenditure
risk as accurately as possible to set capitated risk-adjusted subsidies that reflect
patient need

21. In summary
• Market incentives are used to promote efficiency and quality within the context
of universal access to basic care
• Separation of funding, purchasing and provision
• Competitive at-risk budget holders purchase services from public or private
providers, with regulated outcome and quality controls, funded by risk-adjusted
enrollee capitation payments
• Budget holders compete for enrollees, with movement of enrollees between
budget holders promoting cost control and quality

22. Looking to the future
• A well-designed and implemented reform has the potential improve
both efficiency and equity
BUT
• Efficient, patient-centred, co-ordinated care is difficult to achieve
• No instant reform: major research task with considerable institutional
change, evidence and careful planning
• Requires pro-active budget holders and responsive consumers to
move between budget holders for better quality and price

23. Issues and challenges
• Estimating the factors and weights for risk-adjusted subsidies
• gender, age, chronic conditions, past expenditures, location, etc
• Defining the Universal Service Obligation
• Setting the regulatory framework eg community rating
• Setting premiums and identifying the role of co-payments
• Payment system for optional health care above the USO
• Identifying and expanding the skill sets of budget holders (insurers, state or
regional government bodies)
• Designing reporting requirements and transparency of information to encourage
enrolees to respond to better quality/cost offerings

24. Worth thinking about
• Currently limited competition means that health care providers have
market power and this impacts patients
• As budget holders, funds could play an active role in promoting
efficiency
• Act as active agents for consumers, promoting competition between
health care providers

25. elizabeth.savage@uts.edu.au