Private health insurance: the sad history of a system in crisis

A disappointing aspect of recent concerns with private health insurance has been the Government's willingness to prop up a faltering system at significant cost to every Australian, without initiating a review of its workings.

Private health insurance in Australia has a very long history, starting in the early 1800s with the importation of friendly societies from Britain. We may think of the Free Gardeners, Foresters, Odd Fellows and Druids as no more than quaint remnants, but until the end of WWII they played a major role in providing medical insurance through a capitation system payable to the "Lodge doctor".

In the late 1930s commercial bodies started offering cover over hospital costs. In South Australia, the Mutual Hospital Association Ltd was established in 1937 with 100 persons each subscribing a nominal sum to the company's initial capital. Similar organisations started in other states under the broad banner of 'Blue Cross Funds', reflecting the major funds that were developing in the USA

From the outset, these were companies limited by their share capital, notwithstanding some special requirements which permitted such organisations to operate as non-profit health funds. At the same time, these shareholders had no right to any control over the organisation. The fundamental distinction between a 'for profit' and a 'non-profit' fund is that a 'for-profit' fund may pay dividends to shareholders while a 'non-profit' fund may not. There are also differences in their taxation status.

In 1952, Earle Page, Minister for Health in Menzies' coalition government, introduced the National Health Act, which, through many amendments, has governed the private health insurance industry over the past 50 years. Health insurance funds, principally the Blue Cross Funds in each state, the remaining friendly societies, and other organisations registered under the Act were then able to offer cover over medical costs, some ancillary treatments (although dental cover was not introduced until the 1970s), and hospital costs.

Health insurance differs in many respects from general insurance. A non-profit health fund is not allowed by law to make a profit, but the reality is that the term 'surplus' is substituted for 'profit'. Importantly, private health insurance funds are not, in fact, insurers in the generally accepted sense of the term. They are closer to co-operatives, all members' contributions being pooled and substantially paid out as benefits.

Private health insurance is quite a complex product, made more so by the funds themselves. One of the biggest criticisms of health funds has been that they do not make clear what particular levels of cover provide. (I should emphasise that my comments are primarily aimed at private hospital cover. This is the benchmark used by the industry, governments and commentators. Ancillary cover, for dental, optical, physiotherapy and the like, is not seen as having the crucial funding context applicable to hospital cover.)

There is a useful document published by the Private Health Insurance Administration Council (PHIAC), called Insure? Not Insure?: Your Quick Guide to Private Health Insurance', (pdf, 310Kb). PHIAC is the government body that oversees private health insurance funds in accordance with the National Health Act.

A central concept in the provision of private health insurance has been that of community rating. This is the principle that all contributors to a particular table offered by a health insurance fund shall pay the same contribution irrespective of their state of health or claims experience save that a family shall pay at twice the rate of a single person. There are no 'No Claims Bonuses', no reductions for different classes of contributors, just one rate for all members.

It can be argued that this principle is unfair to people with a low level of claims and unreasonably subsidises those with a high level, particularly the aged and chronically ill. Nevertheless, this principle, embedded in the National Health Act, is accepted by both major political parties and has been since 1952. This is why health insurance funds are legally unable to offer concessions to individuals. Over recent years, attempts have been made to make this rather less rigid.

Most funds now offer "Front End Deductible" tables for hospital insurance, where the member pays the first part of a hospital charge (commonly $100, $200 or $500) in return for a lower contribution rate. Medibank Private in particular has been active in promoting tables that exclude certain conditions, eg cardiac surgery, mental health hospitalisation etc, again in return for lower contributions.

With community rating, contribution costs reflect the whole spread of members' claiming patterns. People who make no claims, or whose benefits are lower than they might expect, are effectively subsidising members whose claims experience is higher. Where members see that this is the case, they are more likely to drop health insurance cover.

The Contribution Cost Spiral

Health funds such as the old 'Blue Cross' funds, which have been in existence for many years, have a relatively higher level of older, long time members, and the fact is that benefit payments to members tend to increase with age.

So there is a downward spiral in which:

• low cost members leave the fund.
• a greater proportion of higher cost members remains to share the contribution burden.
• contributions are therefore forced up.
• this increase causes 'marginal' members to re-evaluate the cost/benefits of health insurance.
• low cost members leave the fund.

In 1989-90, in round terms, 92.9 cents of every dollar paid in contributions was paid back in benefits and 13.1 cents was paid in administration costs. The shortfall of 6.0 cents was made up from investment income of 5.8 cents, and a reduction in reserves of 0.2cents. By 2001-2002, the equivalent figures were 90.3 cents for benefit payments, 11.1 cents for administration costs, but investment income of only 0.9 cents. The Annual Report of Registered Health Benefit Funds for 2001-2002 is instructive on this:

"Although industry management expenses were 11.1 per cent, the ratio is dominated by the few large funds in the industry and individual organisations' management expense ratios continue to vary markedly from the industry average.

Pricing and margins

There is currently the expectation that funds will alter their premiums only once each year, and that the timing of all premium changes is consistent for all funds. This expectation leads to increased risk in the funds' ability to set their premiums at appropriate levels, particularly in the environment of claims and membership volatility, experienced in the post-Lifetime Health Cover period.

Many funds have had, and continue to project, very narrow gross and net margins for their core operations. These funds tend to rely heavily on other income particularly investment income, to achieve positive returns from their health insurance operations. These decisions are likely the result of the 'mutual' ethos of the industry. This may be unsustainable in the longer term.

In 2001-02 benefit payments increased significantly (15.8 per cent) and were unmatched by contribution income (increase of 1.9 per cent). Should this trend continue, income from investments and other sources is likely to prove inadequate to cover the shortfall. In 2001-02 investment and other income was equivalent to 0.9 per cent of contribution income and 1.0 per cent of total benefits. If a shortfall were to occur funds would be forced to fund this mis-match either from their reserves or seek other capital sources. For many funds their primary and possibly only source of additional capital is derived from contribution income."

The setting of contribution rates is a carefully balanced exercise based on claims experience, anticipated costs and a range of other variables. It is not an exercise that can be linked to movements in the CPI.

Medicare

The introduction of Medicare by the Hawke Labor Government from 1 February 1984 was the most substantial challenge to private health insurance since 1952, (including the introduction of Medibank Mark 1 by the Whitlam Labor Government in 1975).

At one stroke, this removed roughly half of the business of private health insurance funds, the insurance of medical costs. The industry was strongly opposed to Medicare, although it has somewhat grudgingly come to accept its existence. But even before Medicare, Liberal, free market philosophy had been the natural focus of private health care funds, and there have been links between the industry and the party, with funds and fund executives providing input into Liberal health policy.

Following the introduction of Medicare, private health insurance membership dropped steadily and consistently. At 30 June 1984, 50 per cent of all Australians were covered for private hospital insurance. By 30 June 1998, this figure had fallen to 30.6 per cent and stayed at that level in 1999.

By 30 June 2000, the government had introduced its private health insurance 'carrot and stick' reforms, providing a 30 per cent rebate for contributions, but specifying a two per cent per year of age contribution increase for people over age 30 who deferred taking out private health cover. As was expected, the percentage of Australians covered for private hospital insurance jumped to 43 per cent in 2000, and as high as 44.9 per cent in 2001.

By June 2002 the decline had restarted, and coverage is down to 44.1 per cent as the downward spiral kicks in again, health funds apply for further contribution increases and the government is stuck with a 30 per cent rebate for an increasing contribution cost.

Health insurance is expensive. A 'middle of the road' cover will cost a couple without children around $2,500 per annum after deduction of the 30 per cent government rebate. In other words, around $3,500 per annum without the government subsidy. But for the maximum cover, a couple could expect to pay about $4,170 per annum after the subsidy, or nearly $6,000 without the it. This is a high-cost item in most people's household budget, and can be expected to be subjected to a rigorous value-for-money test. This is particularly so where increases regularly exceed CPI, no matter what the reason.

A System In Crisis

It is hardly surprising, then, that an increase about seven per cent, which will cost a further $175 per annum for a couple, should cause much financial re-evaluation and the probability of further decline in private health coverage. Anyone who regularly claims more than the cost of their contributions is likely to stay with private health insurance. People who pay more than they claim will continue to re-evaluate their membership. If the cost is regularly more than the return, and if there is a perception that the system does not provide adequate cover and the product is confusing, people will opt out. To date, there appear to be no proposals for negating the seemingly inexorable spiral of mounting private health insurance contribution costs.

Miles Kemp, in an article titled "A Greedy System" in the Adelaide Advertiser,14 January 2003, said:

"The spiralling cost of insurance premiums is a measure, critics say, of the recent Federal Government policies designed to revive the industry… What the government didn't bank on was that insurers couldn't translate the additional members into profits. The insurers are blaming increased costs. Critics blame bad management and the competition for market share and the miscalculations of fund managers."

We appear to be heading back into a position where, even with a government subsidy of around $2.5 billion, some health insurance funds (including, ironically, the government-owned Medibank Private) continue to make losses.

The PHIAC Commissioner's Annual Report for 2001-2002 contains the ominous comment:

"Benefit payments increased significantly by 15.8 per cent following the expiry of qualifying periods for new memberships resulting from Lifetime Health Cover and, if this trend continues, it will put upward pressure on contribution rates. Factors such as the medical indemnity crisis, increased wages for nurses and other health professionals, increased use and cost of prosthetics, technology costs and consumer expectations all have effects on benefits paid by health funds. These financial pressures are likely to continue over the next twelve months."

No comment is made about fund management standards. The same pressures that have contributed to a general downturn in investment income in a post-September 11 environment will have affected private health insurance fund investment income. However, it is also hard to see how any government can justify continued subsidies to organisations that continue to lose money. The $2.5 billion that goes to subsidise health funds at the expense of the public system can now hardly be withdrawn from the private system, unless the government is prepared to accept the almost certain collapse of private health insurance as we know it.

Paradoxically, there is no evidence to suggest that the public hospital system is benefiting in any substantial way from the money paid into the private health insurance system. The government had expected that the public system would benefit either by removing services from the public to the private system, or by privately insured patients claiming the cost of public treatments from the funds. This latter expectation conveniently ignores the fact that any privately insured Australian is firstly a Medicare contributor, entitled to the benefits of the 'free' public system.

The time is ripe for a full-scale re-evaluation of the whole system of health funding and all the assumptions and myths that underlie it. Not the least the sanctity of private health insurance in general and community rating in particular.