Subsidizing Private Health Insurance in Australia: Why, How & How to proceed?

1. Subsidizing Private Health Insurance in Australia: Why, How & How to proceed? Francesco Paolucci*, James R.G. Butler Wynand P.M.M. van de Ven *Research Fellow (ACERH, ANU) Francesco.Paolucci@anu.edu.au

2. Agenda • Health care financing in Australia; • Subsidizing PHI in Australia: • Why? • How? • How to Proceed?

3. Health care financing in Australia Mix of public-private financing of health services: Public Health Insurance Scheme (Medicare, 1984); Competitive Private Health Insurance Market (PHI).

4. Medicare Universal compulsory coverage; Tax-financed single-insurer; It provides coverage free of charge: for (some of) the costs of private medical services (Medicare Benefits Schedule) and pharmaceuticals (Pharmaceutical Benefits Scheme); for the full cost of being treated as a public patient in a public hospital.

5. Private Health Insurance (PHI) Voluntary coverage; Around 45% of the population covered by PHI; PHI funds around 7% of total health expenditures; Fairly competitive market: 38 funds (33 not-for-profit); 60% market share for the 4 largest insurers; Heavily regulated (e.g. community rating, open enrolment).

6. PHI coverage Supplementary coverage for (parts of) the costs of services uncovered by Medicare (e.g. hospital charges levied by private hospitals; Duplicate coverage for the costs of services (partly) covered by Medicare Increased choice of doctor for hospital treatment (public patients are assigned a hospital doctor); Shorter waiting times; Better (perceived) quality of care.

7. PHI & duplicate coverage • Duplication in insurance coverage arises for those who purchase PHI. • Duplication arises because the mandatory Medicare coverage for public hospital services cannot be used for private hospital services. • Those who purchase private health insurance therefore have to pay a premium that covers the full cost of private hospital services and not just the additional cost of the private hospital services. • A large part of private health insurance coverage is therefore duplicate coverage while only a small part is supplementary coverage.

8. Subsidies/tax treatment PHI 30-40% ad valorem premium subsidy to individuals who purchase PHI A tax penalty of 1% of income (for incomes exceeding $50,000 p.a. for singles and $100,000 p.a. for couples) if individuals do not hold PHI (the Medicare levy surcharge) Government now proposes to increase the income thresholds for the tax penalty

9. Problems with Subsidizing PHI Duplication? Subsidizing duplicate PHI effective in decreasing the pressure on public financing over time? Is there a stable equilibrium with acceptable waitingtimes in the public sector? Adverse selection? Two-tier system? Political & Regulatory instability?

10. 1. Duplication? • Australia has universal, compulsory, tax-financed public health insurance (Medicare); plusvoluntary, subsidised private health insurance which does not affect Medicare entitlements (no opt-out); → Duplication of coverage

11. 2. Effective? Has the pressure on public financing decreased over time? PHI Coverage 30% → 44% beween 1997 and 2007 Private expenditure share 30% → 32.5% Why? Large public expenditures (i.e. subsidies) associated with PHI policies; Those who are purchasing PHI are not using it as much as they could, many are probably continuing to use public system (Lu & Savage, 2006).

12. 3. Waiting times? Stable and acceptable waiting times in the public sector? Perverse incentives for the government: Not to reduce waiting times in the public sector because the lower the waiting times the lower the demand for PHI; To increase waiting times in the public sector because the longer waiting times increase the demand for PHI and potentially the lower pressure on public finances. Perverse incentives for physicians not to reduce the waiting times in the public sector because it implies a reduction of demand for their own services in the private sector.

13. 4. Adverse Selection? Medicare (1984)  % of PHI-enrolees declined from 50% (1983) to 30% (1997) Regulation-induced adverse selection? 1997-2000, subsidies (PHIIS, 30% rebate, LHC etc.) 43% PHI-enrolees; Further changes (2005-2007): Increased rebate for 65+; PHI covers more long-term services; Reduction of LHC age penalty from 35 to 10 years: More incentives for worse risks to join → increased adverse selection Adverse selection: a constant threat to the stability of the PHI market.

14. 5. Two-tier system? A two-tier system can be defined as an health care system in which certain groups (e.g. PHI-holders) within the population have preferential access to care, in terms of waiting times, quality or utilization. In Australia duplicate PHI provides faster access and better (perceived) quality of care (including “private” care actually delivered in public hospitals);

15. 5. Two-tier system? (cont.) • If PHI-holders are likely to be high-income or low-risk groups (Doiron, Jones & Savage, 2008), then the fairness of the two-tier system is questionable: • The beneficiaries of the subsidies are more likely to be high-income or low-risk groups; • The better-off PHI-holders have quicker access to “private” care delivered in public hospitals.

16. 6. Political & regulatory instability Political instability: Labor-government could invest the 3 billion AUD currently spent for subsidizing PHI directly in the public sector, to reduce waiting times & improve perceived quality. This results in decreased demand for PHI: No more subsidies for PHI; Shorter waiting times and better perceived quality in the public sector. Frequently changing regulations.

17. Conclusions on current PHI subsidies Subsidising Duplicate PHI: Appears not to be able to achieve its main policy goals: To decrease the financial pressure on the public scheme; Affordability and fairness in the access to services for everyone. Leaves unsolved several problems which create instability and inefficiencies in the market;

18. What to do? • Remove duplication in coverage • Discontinue subsidies to PHI and bring private hospitals within the Medicare public insurance system (PHI role becomes purely supplementary) (“Only Medicare”) • Increase subsidies to PHI by allowing opting out of public system – people either covered by private health insurance or public health insurance but not both (“Medicare/PHI Choice”)

19. How to subsidise PHI? • Four regulatory tools to make PHI affordable in a competitive insurance market: • Risk-adjusted subsidies; • Claims-based subsidies; • Premium-adjusted subsidies; • Premium rate restrictions; • <Combinations>

20. 1. Risk-adjusted subsidies High-risks receive a risk-adjusted subsidy from a Subsidy Fund, filled with mandatory contributions from the low-risks (system of explicit cross-subsidies). Risk-adjusted subsidies are equal to the predicted expenses based on the risk factors that insurers use, such as age and health status.

21. Risk-equalization Risk-equalization refers to a system of ex-ante risk-adjusted subsidies that equalizes the financial differences between insurers that arise from differences in their risk profile.

22. Effects Risk-equalization schemes achieve affordability in competitive PHI markets; No distortion of premium competition: Insurers are free to set risk-rated premiums; Consumers are fully price sensitive at the margin.

23. 2. Claims-based subsidies Claims-based subsidies are based on some or all actual expenses of insurers, e.g. above a certain threshold for each individual. For practical reasons, insurers receive from or contribute to the Subsidy Fund a claims-based compensation (system of explicit cross-subsidies).

24. Claims equalisation Claims-Equalisation refers to a system of ex-post claims-based subsidies that equalizes the financial differences between insurers that arise from differences in claims.

25. Effects Claims-equalization schemes result in a reduction of the insurers’ financial risk that: Reduces the premiums, in particular for the high risks (i.e. it increases affordability); Limits price-competition (i.e. it decreases efficiency);  tradeoff affordability - efficiency

26. 3. Premium-adjusted subsidies Effective in achieving affordability. But, not optimal: They reduce the consumers’ and insurers’ incentives for efficiency: Less effective price-competition and risk of premium inflation; A welfare loss because of the moral hazard due to over-insurance. They create a misallocation of subsidies.  tradeoff affordability - efficiency

27. 4. Premium rate restrictions Premium Rate Restrictions: Community-rating per insurer implies the same premium for everyone in each insurer pool. Adopted in order to avoid premium differentiation; A ban on certain rating factors; Rate band. Open Enrollment: Adopted in order to prevent insurers to refuse to contract with high-risks

28. Effect Goal: implicit cross-subsidies. Effect: predictable profits and losses for subgroups  incentives for risk-selection.  tradeoff affordability - selection

29. Problems A disincentive to be responsive to the preferences of high-risk consumers;  selection may threaten good quality care for the chronically ill; Risk selection is more attractive than improving efficiency;  selection may threaten efficiency; 3. Market segmentation  selection may threaten affordability. Premium Restrictions and open enrollment are undesirable strategies to achieve affordability.

30. The preferred strategy Risk-adjusted subsidies or risk-equalisation is the preferred strategy because: In the case of perfect risk equalisation there is no need for any other strategy and no tradeoff exists. Each of the other strategies inevitably confronts policymakers with a tradeoff.

31. Effects of current mixof subsidies in Aust Effects of 2. claims-equalization & 3. premium-related subsidies: reduction of incentives for efficiency; Effects of 4. community rating per product per insurer: risk selection and premium differentiation via product differentiation.

32. “Medicare/PHI Choice” - new subsidies? The preferred strategy (i.e. risk-adjusted subsidies) to achieve affordable health insurance is absent in Australia PHI. Allow insurers to risk rate & replace community rating by a premium rate band; Replace the 30-40% subsidies by risk-adjusted subsidies.

33. Main features No duplication of coverage; Consumers may choose to either be enrolled in Medicare (zero-premium) or PHI (positive-premium): Medicare/PHI are fully substitutable (i.e. “opting-out”); PHI has to pay all health care expenses of their insured.

34. Main features (cont.) Premium Rebate replaced by ex-ante risk-adjusted subsidy: PHI receives a risk-adjusted “opt-out” subsidy; Long run: both PHI and Medicare receive the same risk-adjusted subsidy. Community-rating replaced by rate-banding (i.e. insurers allowed to risk-rate within a politically determined band); The better the risk-equalization the less restrictive the band; The ex-post claims-equalisation redesigned to function as an excess-loss-compensation scheme complementary to risk-equalisation.

35. Effects of new mixof subsidies Reduced incentives for adverse and risk selection; It increases efficiency and affordability for high-risks (e.g. PHI becomes attractive for low-risks); If the allowable premium variation under the best available risk-equalisation is not satisfactory for society, good complements are: claims equalisation & premium subsidies; not community rating plus open enrolment.

36. Pragmatic solution • Policy goals achieved: • By allowing consumers to make a choice among different schemes based eg. on price and quality; • This consumer choice does not affect the (desired) extent of cross-subsidisation across risksas long as the premium differences across insurance products reflect the differences in predicted expenses among these products. • PHI: more tools and incentives for efficiency; • Substantial reduction of problems.

37. “Only Medicare” An alternative to Subsidizing Duplicate PHI in Australia could also be to have a universal mandatory coverage scheme for a uniform set of benefits (Butler, 2008). More efficient and equitable to invest the $3 billion currently used to subsidize PHI on improving Medicare’s responsiveness to consumers preferences and needs.

38. “Only Medicare” • Universality and uniformity of coveragedoes not account for heterogeneity across individuals (especially across income groups) and across treatments: • It does not reflect differences in preferences; • By forcing a level of coverage above the one some groups would have chosen autonomously, it induces moral hazard above the social optimal.

39. “Only Medicare” • Universal mandatory coverage for a uniform set of services is not per se a necessary and/or proportionate measure to achieve the goal of affordable access to (the coverage of) health care services.

40. “Medicare/PHI Choice” - issues • Minimum benefits package is a feature of this scheme also → consumer choice is constrained (as with “All Medicare” • But preferences for additional coverage be reflected in PHI demand (as they can with “All Medicare” buy purchasing PHI supplementary cover) • Risk-adjustment is far from perfect → scope remains for cream skimming behaviour by private insurers • Rate bands constrain risk discrimination in premiums → further incentive for cream skimming • Regulatory apparatus would be more complex than present