Francesco Paolucci, James R'G' Butler

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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_at_anu.edu.au

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Agenda

• Health care financing in Australia
• Subsidizing PHI in Australia
• Why?
• How?
• How to Proceed?

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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).

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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.

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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).

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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.

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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.

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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

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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
  waiting times in the public sector?
• Adverse selection?
• Two-tier system?
• Political Regulatory instability?

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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

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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).

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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.

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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.

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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)

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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.

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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.

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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

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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)

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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
• ltCombinationsgt

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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.

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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.

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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.

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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).

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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.

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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

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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

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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

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Effect

• Goal implicit cross-subsidies.
• Effect predictable profits and losses for
  subgroups ? incentives for risk-selection.
• ? tradeoff affordability - selection

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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
  risks as 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.

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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 Medicares responsiveness to consumers
  preferences and needs.

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Only Medicare

• Universality and uniformity of coverage does 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.

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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.

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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