Ian McAuley, Jennifer Doggett, John Menadue. Private Health Insurance companies are price takers. Prices are set by doctors and hospitals.

Jan 14, 2016

Repost from 22/10/2015

On Tuesday the Australian Competition and Consumer Commission (ACCC) released its  report on private health insurance.

Private health insurance (PHI) was also in the news a day later with the standing down of the CEO of Medibank Pte, the largest PHI company.

The ACCC report has been a regular report since 1999, when the Howard Government introduced a swag of subsidies for private health insurance. It covers specific “consumer” issues, such as possible false or misleading representation of products, anti-competitive behaviour, and the incidence of unexpected out-of-pocket expenses.

Because government policy is taken as a given condition, its recommendations are confined to administrative matters. In this year’s report they are largely about the need for insurers to use standardised terminology and clearer information on restrictions, exclusions and out-of-pocket costs.

Although not explicitly stated, its concern seems to be to help consumers to make a choice within the range of products (more than 20 000 on offer) from 34 private insurers, rather than helping consumers make a choice whether to hold private insurance or not.

Unsurprisingly, the report finds that consumers are faced with what the cartoonist Scott Adams (creator of the Dilbert character) calls “confusopoly”. The range of products is bewildering, different insurers use different language to describe similar products, and there  are subtle definitions in policy exclusions (who knows the difference between “obstetrics” and “gynaecology”, for instance?).

Its most telling findings are that complaints are on the rise, and that the main concerns of complainants are the unpleasant surprises they get (exclusions, co-payments, restrictions on choice of providers) when they come to claim on a policy. The price of private insurance is only of minor concern, even though its price, in real (inflation-adjusted) terms has risen by 54 per cent since 2000.

We don’t find that at all surprising.  Since the Howard Government introduced generous subsidies for private insurance in 1999, six million more people have taken some form of hospital cover. Many of these have been virtually forced into private insurance by the Medicare Levy Surcharge applying to those with high incomes, and many others were  enticed by the 1999 “Run for cover” scare campaign.

Research in behavioral economics shows that people don’t make careful, rational choices about insurance. People tend to over-insure for small risks, while leaving themselves inadequately covered in other areas. People buy insurance because they believe it is a prudent thing to have, without giving it much consideration.

This is confirmed by the ABS in its survey of reasons why people hold private health insurance. It has found that financial considerations hardly count, but that “security, protection, peace of mind” is the overwhelming reason for people to hold private insurance.

It’s only when people come to make a significant claim, which can be many years down the track, that they realise that they have bought a dud product. Or, perhaps, after outlaying thousands of dollars for private insurance over many years, they have a medical emergency and discover, for the first time, that there is an efficient and responsive public hospital system covering their needs.

What comes through in the ACCC’s report is a level of frustration. This is a body with a strong faith in the benefits of competition. It says “as a starting point, competition should be relied upon to drive efficient outcomes wherever possible”, but finds that even though there are plenty of players in the market the industry is not providing what consumers want.

The problem the ACCC faces is that in private health insurance competition doesn’t work, mainly because the insurers are simply a financial intermediary between consumers and well-organised suppliers, as we have pointed our in our work on private insurance for the Centre for Policy Development. Insurers, are essentially price-takers in a market dominated by powerful suppliers.

That power asymmetry was illustrated earlier this year in the dispute between Medibank Private, Australia’s largest health insurer and Canberra’s Calvary Hospital. The fact that MBF had to back down in this dispute may explain the standing down of the CEO of Medibank Private, George Savvides. He understood the power of providers, but his board didn’t.

As we point out in our research, it takes the power of a single insurer, such as Medicare and similar bodies in other countries, to ensure that costs are controlled and to see that scarce resources are put to their best use. A case study in resource misallocation (the economists’ term for “waste”) driven by the perverse incentives in private insurance was provided by a recent ABC Four Corners program on over-servicing in private hospitals.

While the ACCC is critical of some insurers’ practices, particularly some potentially misleading product descriptions, it does not claim that this industry is engaged in collusion or other systemic anti-consumer behaviour. It seems to be annoyed by consumers who do not do their homework and shop around for the best deal – this is a common grizzle by competition regulators, who seem to believe that we all have unlimited time to devote to comparison shopping.

But even if we were all well-informed and diligent consumers, shopping around for the best products, this would still be a market subject to fundamental market failures that go well beyond the usual scope of competition regulators. Private health insurance is simply a high-cost financial intermediary that takes 14 cents in the dollar for management and profits, without adding any consumer value.

The fundamental problem is that insurance of any form, be it public or private, by its very nature suppresses price signals – the very mechanism that makes markets work. When a service is free at the point of delivery the discipline of markets does not operate. Economists know this problem by the quaint term “moral hazard”.

The ACCC acknowledges the existence of moral hazard in private insurance, but there is no way it can resolve the fundamental conflict: that is seeking to use market mechanisms to regulate an industry whose very raison d’etre is to allow people to buy out of the discipline of markets.

Of course there is still moral hazard in single insurer systems, but a single national insurer can use its power as a strong purchaser to make sure suppliers operate efficiently. There are plenty of successful overseas models of single national insurers, particularly in Canada and the Nordic countries, but, closer to home state governments, particularly in Victoria, and the Commonwealth Department of Veterans’ Affairs, act as single purchasers of hospital services. And moral hazard on the part of consumers can be held in check by the use of judicious co-payments set at such a level to provide some market discipline but not so as to discourage those with limited means from seeking necessary care.

Perhaps, when the ACCC produces its 2014-15 report for release this time next year, it could remember that competition is not the answer to all market failures. Competition is not an end in itself – it is one way, in some markets, whereby efficient and fair outcomes can be achieved. In some markets it doesn’t work.



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