Prosthesis pricing is a dead parrot

May 18, 2021

Hidden in the 2021-22 Budget papers was an announcement that the government had squibbed an opportunity to reduce private health insurance premiums by ending a protection racket involving private device manufacturers and importers, and private hospitals.

The Department of Health was up for reform. Last year they issued a discussion paper which suggested prosthesis pricing reform — a move away from regulated special-deal pricing to a more contemporary approach involving standard pricing, similar to that used to pay for public hospitals. The government backed away from efficiency-based reform as soon as the rent-seekers came out of the woodwork.

There is a desk in Canberra where a public servant manages a spreadsheet with more than 10,000 lines on it. This spreadsheet is important because it sets more than 10,000 prices that private health insurers are forced to pay for ‘prostheses’ – not just artificial hips or knees, but glues, staples, and nails too.

It’s big business: private hospital insurers in Australia pay out more than $2 billion each year in benefit payments for prostheses, accounting for more than 12 per cent of all benefit payments. Yet the way prosthesis prices are set is part Soviet-era price control and part Monty Python sketch. The setting arrangement is a dead parrot and ought to be recognised as such despite the squeaking and squawking of those who profit from the current arcane system.

Prosthesis prices are not set by the market, but rather by an opaque bureaucratic committee. The ‘Prosthesis List Advisory Committee’ is a case-book example of regulatory capture – its 21 members include seven who are explicitly ‘representatives’ of device importers/manufacturers, hospitals, and private health insurers, all with inherent conflicts of interest. There is no formal tender process, nor any serious assessment of the quality of the artificial limbs fitted to patients.

Private health insurers, responsible for paying for prostheses, are effectively price-takers; they have no power to ensure the supply chain is efficient. A system which has no incentives for efficiency is bound to be inefficient, and this one is.

If the process stopped price gouging by device importers or manufacturers, all the red tape involved would be worth it. In fact, the reverse is true – private insurers are forced to pay more than twice what public hospitals pay for the same prosthesis.

What is worse, government has created a protection racket. In 2015 an innovator wanted to undercut the cosy cartel, but the federal government went to court to stop them. The judge said it was OK for the Health Minister to take into account that the competitors may get upset if exposed to the chill winds of market forces.

The direction for reform is obvious – competition would be facilitated by abandoning cosy price setting for each of thousands of items and replacing it with standard prices where like products compete with like, based on different types of patients such as patients receiving hip replacements or a lens procedure. Prices actually paid by private hospitals should be disclosed, because this would put further downward pressure on prices. Private hospitals should not be able to pass on to patients any excess prices the hospital pays over the standard reimbursement.

A new policy along these lines would significantly reduce payments for prostheses. It would shift revenue away from device importers/manufacturers and private hospitals. Private health insurers would gain from such a shift, and their outlays would be reduced.

If it had gone ahead, private insurers could have been forced to pass on the benefits to consumers But alas, it is not to be. Instead, we got an increase in staffing and spending in the Department of Health to ‘modernise and improve the administration of the Prostheses List’. The Budget kicked the prosthesis reform can down the road for another few years, forcing consumers to continue to pay higher insurance premiums than necessary. Another wasted opportunity.

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