The Visible Hand
Government intervention and regulation long ago put a stake through the heart of free markets, none more so than in private health insurance (PHI) in Australia. While subsidising premiums for lower income consumers to the tune of c. $6.7bn p/annum, the Commonwealth imposes an unparalleled level of regulation upon the market, the following being a non-exhaustive list:
• The model of PHI is imposed – community (not risk) rated with a retrospective risk equalisation system designed to equalise the risk of each age cohort, no denial of cover for preexisting conditions (aside from maximum wait periods), and no preauthorisation of treatment beyond coverage eligibility checks.
• PHI compliant hospital products must be within one of four product tiers with minimum coverage levels mandated within each tier.
• Premium increases must be justified to and approved (or not) by the Minister on an annual basis.
• Consumers are penalised via higher income tax for not purchasing PHI if they earn above a certain income threshold and are also penalised via higher premiums if they purchase PHI for the first time above the age of 30.
• PHIs are compelled to fund members’ treatment at private hospitals via a mandated formula regardless of whether the PHI has a contract with the private hospital or not.
• PHIs are compelled to fund members’ treatment at public hospitals (if the member ‘declares’ their PHI status) at mandated rates, even though the same members fund public hospitals via their income taxes.
• PHIs are compelled to fund treatment by all accredited doctors (in the inpatient setting) and government mandates minimum levels of PHI co-contribution to Medicare funding.
• PHIs are compelled to fund all prostheses listed on the government’s Prosthesis List at a price mandated by government (which in many cases happens to be about double the rate the paid elsewhere in the world and by the Australian public system).
While some of these regulatory instruments have clearly boosted PHI membership and the fortunes of PHIs, the macro effect has been to homogenise product and pricing to the point where there is little to distinguish any of the thirtysomething health funds in the market. Even the brands have become largely indistinguishable (which PHI isn’t there to support the health of you and your family into old age?). Given the artificial homogeneity resulting from regulation, it makes you wonder why government doesn’t force consolidation of the PHI industry, a move that would save hundreds of millions of admin and marketing dollars annually. I suspect that, despite the intensive industry regulation, government still clings to the erroneous notion that competition promotes pricing tension and consumer choice.
The rational response from PHIs to the regulatory straightjacket in which they find themselves, is to invest in healthcare services of their own (hospitals, GPs, dentists, optical stores etc.). While this expansion has angered the provider community (how many times can you invoke the bogeyman of “US managed care”?), it is one of the few mechanisms available for PHIs to create differentiated propositions for customers (e.g. no gap services) that can’t easily or efficiently be achieved via contracting with third party providers.
The big winners from PHI regulation, however, have been healthcare providers, particularly hospitals and doctors, who are subject to far fewer regulatory constraints. The level of PHI coverage in Australia is far higher than other OECD markets where PHI is a supplemental offering to a universal public health system (e.g. most Western European countries) and this has resulted in a private healthcare sector proportionately and in absolute terms far larger and more lucrative than those markets. Clearly, Australian healthcare providers have an onerous compliance and accreditation burden, some of which can be expensive (e.g. mandated upgrades to hospital sterilisation facilities), but there are far fewer restrictions on the service they provide, the price they charge, and the size and composition of their networks.
Healthcare providers, like many other actors in the economy, desire certainty of price for the services they provide, particularly those with a high fixed cost base. Hospitals, for example, enter into contracts with PHIs, which lock in pricing and annual indexation for a forward period (usually 2-3 years). When entering into these PHI contracts, private hospitals must factor in their own input costs, the majority of which is labour, but also consumables, power, rent, borrowing costs etc. Some of these input costs are also subject to multiyear agreements (e.g. enterprise agreements with nurses), while others are not.
Note that PHI contracts with hospitals do not constrain growth in volume, thus a hospital operator not only receives annual price inflation from PHIs, it also grows revenue and margins by increasing patient volumes. Pre-Covid, private hospitals on average derived a greater proportion of their growth from volume than price increments.
Hospitals enter into PHI contracts freely, amongst other things weighing the risks of input cost increases during the life of the PHI contract. Take for example Healthscope, the second largest private hospital operator in Australia, and one with a sophisticated owner and a board and management comprised of senior, well-paid executives. When they filed their 2022 annual report with ASIC in March 2023, the Chair wrote in the report:
“The Directors maintain the view that the adverse financial impact of the COVID-19 pandemic on the Group’s business is short-term and has one-off impact upon operations. It will not be sustained and does not represent a material long-term deterioration of operations.”
Apparently, 18 months is a long time in hospital land, or perhaps the company’s lenders never shared the Directors’ optimism.
The reason that there’s such acrimony currently in private healthcare is that the pandemic had the effect of increasing hospitals’ input costs materially and concurrently depressing the rate of volume growth at a time when private hospitals had undertaken an unparalleled period of capacity expansion. Such expansion was a voluntary commercial decision by hospitals (with no pressure from government or PHIs), undertaken with the intent of increasing their capacity, spectrum of services, and, ultimately, revenue and profits. Like any commercial decision, management of these organisations would have weighed the risks and benefits.
Contrary to the BS from the APHA, PHIs have been increasing the price they pay to private hospitals every year. The issue is that this indexation hasn’t kept pace with input cost growth in the last few years. Some operators have sought to solve this by requesting additional mid-contract price indexation or new contract pricing from PHIs. Where they have been unable to come to agreement with PHIs, they have threatened termination of contact which would allow them to charge whatever gap payment to the patient they desire over and above the payment that PHIs are compelled to make under second tier regulation (85% of the average rate paid to contracted providers in the state for the same procedure). Concurrently, they are also pressuring the Commonwealth to mandate that PHIs pay an incremental fee every time a member attends hospital. In the long-term, both options would be bad for consumers, for PHIs, for private hospitals, for doctors, and for the public system. Increases in hospital payments would be passed on to members in the form of higher premiums, thereby leading to people dropping or downgrading their PHI (as occurred in the years up to 2020) and fewer people going to private hospitals and doctors. Higher gap payments would have the same effect – why have PHI if you’re stung with high out of pockets every time you use it?
The APHA will argue, no doubt, that without additional funding from PHI, private hospitals will close en masse, and there will be a tidal wave of patients flowing into the public system at a time when pressure is already significant. The evidence is that there are currently more private hospitals and beds than ever before, and perhaps this overcapacity is the fundamental issue. I suggest that the APHA checks out any high school economics book to figure out what needs to occur in a state of surplus supply. One answer they probably won’t find is government intervention to inflate market prices.
However, it’s not surprising that in a world where banks are bailed out by government after making abysmal decisions on mortgage lending practices, that other actors in the economy, such as private hospitals, also seek bailouts when market forces have turned against them. However, further government intervention creates moral hazard. If private hospitals are bailed out which private enterprise or industry shouldn’t also ask for the same when their viability is impaired? If all that is required is a noisy public pressure campaign from a buffoonish peak body in an election year, where will it end? This industry, like many others, requires the Invisible Hand, not an interventionist approach to prop-up commercial decisions that were made freely by private enterprise, knowing the risks, with a profit motive in mind.