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The Pricing of Private Health Insurance

Major General Gerard Fogarty (Ret’d)
17th October, 2014

Have you ever wondered how private health insurance premiums are set? It’s a more regulated and complex process than you might think.

Private health insurance premiums

Price rises – nobody likes them. But with an ever increasing cost of living, price rises are a fact of life.

When it comes to private health insurance premiums, there’s a bit more at play than the Consumer Price Index. Hospital utilisation rates, medical benefits and risk equalisation all come into the equation.

Every single health fund has a team of actuaries who undertake extensive analysis and projections as part of the premium-setting process. The Minister for Health then examines the reports on a fund-by-fund basis prior to April each year. If the numbers stack up, approval is given. If not, the Minister can tell the health fund to sharpen its pencil and submit a revised schedule of premiums.

Components of price

Hospital costs are an obvious component of an insurer’s cost base. The demand and supply of hospital beds and the cost structure of different hospitals differs from state to state. Insurers and the network of private hospitals negotiate financial agreements on the cost of hospital services. The insurers must also make assumptions based on the increasing number of people going to hospital.

Medical costs encompass the fees set by doctors for hospital treatment and procedures. As discussed in previous articles, Medicare determines the fee for all rebated hospital treatment through the Medicare Benefit Schedule. But there is nothing preventing doctors charging more than the MBS fee.

This can result in significant out-of-pocket expenses for the privately insured. In an effort to limit the insured’s exposure to this risk, the health funds also strike agreements with some doctors and diagnostic specialists to participate in medical gap programs aimed at containing their fees. Participating doctors have the incentive of getting paid faster and receiving a slightly higher benefit from the fund.

Health inflation impacts the costs of health care much more than the Consumer Price Index. The Australian Institute of Health and Welfare reports that health expenditure per person has been increasing at 6.7% in the 10 years to 2011/12.

Rising ancillary treatment costs lead to higher benefits paid by insurers. People with extras cover have a reasonable expectation of a meaningful rebate from their insurer when they visit a dentist or other ancillary provider. Assumptions on the drawing rates of ancillary services must also be made.

The government’s risk equalisation system shares the financial risk of insuring the very old and very sick across all insurers. Under the Australian system known as Community Rating, no-one purchasing health insurance can be discriminated against because of their age or health status. So with an ageing population and rise in preventable chronic disease, the pool of funds required to share this risk between health funds is becoming a significant component of all insurers’ cost structure.

Dividends and corporate tax must also be factored in by for-profit health funds. Registered not-for-profit insurers do not have to consider these additional imposts on member contributions.

Government incentives and penalties

The final premium a consumer pays can also be affected by Federal Government initiatives.

Depending on your income, you could receive an Australian Government Rebate (currently 29.04% for people under 65) on your premium. That’s the carrot. The Government’s stick is Lifetime Health Cover legislation which can impose a premium loading on people who get into private health insurance later in life.

Competition

Despite public perception, the private health insurance industry is highly competitive. Consumers are not locked into a contract with any particular insurer. So they are free to shop around and get the best deal that meets their accepted level of risk.

Margins are low and capital reserves are regulated to safeguard the contributions of all members. And ultimately, the Federal Health Minister is the consumer’s biggest advocate.

Major General Gerard Fogarty (Ret’d)
Chief Executive Office
Defence Health

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