Ian McAuley, Jennifer Doggett and John Menadue. The case for government funding of healthcare.

Mar 27, 2014

In our joint submission to the Senate Inquiry into the Abbott Government’s Commission of Audit, we drew attention to the fact that by international comparison, Australia is a low-taxed country. Furthermore, the trend in Commonwealth expenditures has been downwards since the mid-1980s. Our full submission can be found on my website (click above).

In that submission we made the case for government funding of healthcare as a superior option. Extracts from this submission on healthcare follow.

The flaw in the “unaffordable” argument (made by the Abbott Government in respect of health care) is that even if the government withdraws from funding, we still have to pay for health care, and all the evidence from other countries’ experience shows that if the government abandons responsibility for funding health care, we will end up spending a greater amount for the same or a lower quality of care.

In all probability Australians want to share the bulk of our health costs with one another. Across all OECD countries people pay only about 20 percent of health costs from their own pockets – that is through payments at time of service delivery and in amounts not covered by insurance. In Australia, at 19 percent, we are just below that average. In developed countries most health care costs are paid through insurance – either a government insurer or competing private insurers.

Even if, as is likely, we accept a need to pay more from our own pockets, we will continue to seek insurance cover for large outlays. We may be willing to take our chances in many aspects of life, but when it comes to health care we have little to guide us about our future needs.

Policies which shift funding responsibility from government programs, such as Australia’s Medicare, on to private health insurance (PHI) have a short-term attraction to a government concerned with containing fiscal outlays. But even the best designed policies to entice or force people into PHI are costly and inequitable.

For a start PHI involves high administrative costs. In Australia only 84 cents in every dollar paid to PHI is returned in terms of payment for services. The rest goes to administrative costs and corporate profits. By contrast, Medicare has administrative costs of about 5 percent, and another 1 percent in Tax Office collection costs. That means that Medicare returns 94 cents in the dollar as health services – a ten cent difference in comparison with PHI.35 The USA, highly dependent on PHI, provides the standout example of administrative overheads. Only 69 cents in every dollar Americans spend on health care comes back in terms of services.36

Second, and more important, when there are competing private health insurers they have little ability to control the prices demanded by service providers. If one insurer tries to bargain hard with hospitals to keep prices down, the hospitals will simply choose to do business with another insurer. The insurers have about the same power in the market as consumers do when they are dealing with powerful oligopolies such as banks. By contrast a single national insurer, usually a government agency, has the market power to put some discipline into prices and utilization.

Evidence from international experience bears out these points. When countries rely on PHI to fund health care they pay more for it, without necessarily getting any better health outcomes. To quote at length from the OECD:

Private health insurance markets have resulted in increased overall health costs in several OECD countries. First, by bringing more financial resources into the health care system, it raises total health expenditure. Second, cost-control measures – such as global budgets, price regulation and capacity controls – have been applied to the public sector in virtually all OECD countries. Conversely, the private financing sector in virtually all OECD countries, except the Netherlands, has not been subject to such centralised, governmental cost controls. This has resulted in less tight control over activities and prices in the private sector. Third, private insurers in most OECD countries do not have the same bargaining powers over the price and quantity of care provided to insurees as public systems do, although within concentrated PHI markets insurers can exert stronger pressure, as in the case of Ireland. Payment options such as global budgets that have helped public systems to contain costs in several countries are hard for private insurers to negotiate – or may not be options at all. PHI carriers have generally exerted little leverage over costs – as they might if they engaged in more selective contracting.

In the United States, private insurance has been less effective than the public Medicare programme in controlling costs. Growth in per enrolee payments for a comparable set of services in private health insurance outweighed Medicare over the period 1970-2000, reflecting the higher payment rates to providers paid by private insurers. While “managed care” delivered some cost control in the 1990s, PHI premiums have resumed double-digit growth since 2001.

Cost control is also more problematic to achieve in systems with multiple competing payers, including most PHI markets. Not only their purchasing position relative to providers is weaker, but also shifting cost onto other purchasers, whether public systems or other private insurers, is a more attractive strategy for insurers than restraining cost.

PHI also risks increasing public expenditure on health. This is because, while PHI may serve as an independent source of health funding, its effects are rarely entirely disconnected from the publicly funded system.

Subsidies to private health cover, as in Ireland, Australia and the United States, increase public sector expenditure and have an opportunity cost, sometimes increasing overall utilisation levels as well. Even in the absence of direct or indirect subsidies, PHI has given rise to higher public cost in several countries with a significant PHI market because of the way it interacts with the public system.37

This is borne out empirically by data from the OECD….. The message is clear: the more governments rely on PHI to fund health care the more is the total cost of health care….

As with administrative costs, the stand-out case is the USA, where health care costs are now almost 18 percent of GDP. (Even when the USA is excluded there is a positive relationship, and it is too big to be considered a statistical aberration.) As a consequence of America’s longstanding dependence on PHI – a dependence which could intensify with Obamacare – its government programs, Medicare and Medicaid, now cost around 8.5 percent of GDP. This is more than the governments of Sweden, Norway and Iceland pay for their comprehensive public insurance programs, and more than the governments of UK and Canada pay for their near-universal public programs.

In an attempt to avoid universal public funding, the USA has developed a system which now incurs higher fiscal costs than they would have incurred had they pursued a single insurer option. That is because the government Medicare and Medicaid programs have become passive price-takers in a market where prices are set by powerful service providers. Even here in Australia, because of the generous way we subsidize PHI, those subsidies are costing more than they are saving government outlays. Reducing subsidies for PHI would result in some reduction in membership and therefore more government expenditure on health care, but there would be significant net public savings.38 The Grattan Institute, for example, estimates that even with offsetting compensation to public hospitals removing the PHI rebate could save public budgets $3.5 billion a year.39

Simply ending subsidies for PHI is only part of necessary funding reform. The whole way health care is funded needs to be reviewed – a task well beyond a body such as the Commission of Audit. As a case in point, there needs to be rationalization of co-payments, so that they can serve to bring the benefits of market discipline into health care, rather than encouraging patients to seek “free” services to avoid co-payments. Our present division between “free” services, covered by Medicare or PHI, and paid service, is haphazard.40 Examples abound: public hospitals are “free” while pharmaceuticals incur co-payments; it can be cheaper for a consumer to leave tooth decay until it needs treatment in hospital than to seek paid preventative dental care early on; PHI and Medicare often cap the number of paid services in areas such as physiotherapy, leaving the patient with open-ended risk. Besides savings from scrapping the PHI rebate, the Grattan Institute estimates there are additional savings of around $6 billion a year to be found without comprising the quality of care.41

The national insurer, of course, needs to use its purchasing power to contain costs. In this regard the Commonwealth, once highly effective in negotiating low pharmaceutical prices, as a result of a series of concessions to pharmaceutical firms is now paying more than many other countries for pharmaceuticals. Government purchasing and price negotiation are areas with potential savings.

Replacing PHI with a strong, single national insurer removes incentives for over-servicing and over-pricing, but there are savings in private and public costs if there is less need for health care in the first place, through investing in preventive services.42 Preventive health measures, such as anti-smoking initiatives, deliver high returns, in terms of long-term health outcomes. However, Australia currently allocates less than two percent of the total health budget to preventive health.43 Investing in early childhood health and education is also a proven and cost-effective strategy to prevent the development of a range of lifelong social and health problems, but Australia also falls short in this area:  almost one-quarter of children are developmentally vulnerable at school entry with Aboriginal and Torres Strait Islander children and children in socioeconomic disadvantaged areas most likely to fare worse across a broad range of health and social indicators.44 Failure to fund preventive, public health and early childhood programs adequately represents a wasted opportunity to direct resources to achieve maximum benefit. These are functions which, if abandoned by government, will not be performed by the private sector.

(Our basic case is that by shifting health expenditures from the public to the private sector will cost more. It will increase total costs)


35.          Figures taken from John Menadue and Ian McAuley Private Health Insurance: High in cost and low in equity. Centre for Policy Development 2012.

36.          Henry Minzberg “Managing the myths of health care” World Hospitals and Health Services Vol 48 # 3, 2012.

37.          Francesca Colombo and Nicole Tapay “Private health insurance in OECD countries: the benefits and costs for Individuals and health systems” OECD Health Working Papers No. 15, 2006.

38.          Terence Cheng Does reducing rebates for private health insurance generate cost savings  Institute of Applied Economic and Social Research, The University of Melbourne, July 2013.

39.          John Daley Balancing Budgets: Tough choices we need Grattan Institute 2013.

40.          See, for example Jennifer Doggett “Out of Pocket: rethinking health copayments” Centre for Policy Development Occasional Paper 2009.

41.          John Daley, Grattan Institute op. cit.

42.          World Health Organisation. Key components of a well-functioning health system. May 2010.

43.          Australian Institute of Health and Welfare Health Expenditure Australia 2011-2012.

44.          Australian Institute of Health and Welfare A picture of Australia’s Children 2012.

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