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The price-takers

29 October 2015

Private health insurers are simply intermediaries between consumers and well-organised suppliers, write Ian McAuley, Jennifer Doggett and John Menadue. They don’t add value to the health system


On the day before Australia’s largest private health insurance company stood down its CEO, the Australian Competition and Consumer Commission released its 2013–14 report on private health insurance. These ACCC reports have been released annually since 1999, when the Howard government introduced a swag of subsidies for private health insurance. They cover false or misleading representation of products, anti-competitive behaviour, the incidence of unexpected out-of-pocket expenses, and other consumer issues.

Because government policy is taken as given, the ACCC’s recommendations are essentially confined to administrative matters. In this year’s report they largely focus on the need for insurers to use standardised terminology and provide clearer information about restrictions, exclusions and out-of-pocket costs. The ACCC’s aim is to help consumers choose among the 20,000-plus options offered by thirty-four private insurers, rather than help consumers make a choice about whether to hold private insurance or not.

Not surprisingly, the report finds that consumers face 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 subtle distinctions feature in the lists of exclusions. (Who knows the difference between “obstetrics” and “gynaecology,” for instance?)

The report’s most telling findings are that complaints are on the rise and that the main gripes are about the unpleasant surprises – exclusions, co-payments, restrictions on choice of providers – consumers receive when they come to claim on a policy. The price of private insurance is only a minor concern, even though, in inflation-adjusted terms, it has risen by 54 per cent since 2000.

That’s not 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 them have been virtually forced into private insurance by the Medicare Levy Surcharge, which applies to those on higher incomes, and many others were enticed by the 1999 “Run for Cover” scare campaign.

Research in behavioural economics shows that people don’t make careful, rational choices about insurance. They tend to overinsure for small risks while leaving themselves inadequately covered in other areas. They often buy insurance because they believe it is a prudent thing to do, without giving it much more consideration than that.

It’s only when people come to make a significant claim, possibly many years down the track, that they realise 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 that an efficient and responsive public hospital system covers their needs.

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

The problem for the ACCC is that competition doesn’t work in private health insurance, mainly because the insurers are simply a financial intermediary between consumers and well-organised suppliers (as we have discussed in more detail in our work on private insurance for the Centre for Policy Development). Private health insurers consume 14 cents in every dollar of national healthcare spending (in management cost and profits) without adding any consumer value. And they are essentially price-takers in a market dominated by powerful suppliers.

That power asymmetry was illustrated in the dispute between Medibank Private, Australia’s largest health insurer, and Canberra’s Calvary Hospital. The fact that the insurer had to back down in this dispute may explain the standing down of Medibank Private’s CEO, George Savvides, earlier this month. 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 – Medicare in Australia and similar bodies in other countries – to control costs and make sure scarce resources are put to their best use. A recent ABC Four Corners report on overservicing in private hospitals provided a vivid case study in the resource misallocation (the economists’ term for “waste”) driven by the perverse incentives created by private insurance.

While the ACCC is critical of some insurers’ practices – and particularly of potentially misleading product descriptions – it doesn’t claim that the industry is engaged in collusion or other systemic anti-consumer behaviour. It seems annoyed by consumers who don’t do their homework and shop around for the best deal – a common grizzle among 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, this would still be an industry subject to fundamental market failures that go well beyond the usual scope of competition regulators. By its very nature, insurance of any kind, public or private, suppresses price signals – the very mechanism that makes markets work. When a service is free at the point of delivery the discipline of markets doesn’t operate. Economists know this problem by the quaint name of “moral hazard.”

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

There is moral hazard in the operation of Medicare, too, of course. But a single national insurer is able to 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; closer to home, state governments (particularly Victoria’s) and the federal Department of Veterans’ Affairs act as single purchasers of hospital services. Moral hazard on the part of consumers can be held in check by judicious use of co-payments, set at a level to provide some market discipline without discouraging those with limited means from seeking necessary care.

Perhaps, when the ACCC releases its 2014–15 report 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 simply doesn’t work. •

This article first appeared in Pearls and Irritations.

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