The Challenge of Affordable Private Health Insurance

Over 40% of hospital and medical costs pass through risk equalisation, making it central to the sustainability of PHI. Ongoing growth in the risk equalisation pool reduces the incentive for insurers to control claim costs, and makes PHI less attractive for people in good health.

The article summarises a paper presented at the Actuaries Summit. If you would like more information, you can read the full paper here.

Affordability will always be the key issue in health funding

Health costs increase faster than consumer prices and wages, because health funding needs to cover both increases in the cost of services provided, and the increasing average number of services each person receives. Drivers of utilisation inflation include the development of new technologies and population ageing. The level of health inflation means affordability will always be a key issue in health funding, whether that funding comes from government, individual insurance premiums or directly from consumers’ out of pocket expenses.

While affordability is always an issue in private health insurance (PHI), recent trends in participation rates bring the issue into sharper focus. Participation rates for younger policyholders have reduced slightly, while participation of people aged over 75 continues to increase. Since premium rates reflect average claim costs, this change in age mix puts further pressure on premiums, which reduces the perceived value of PHI to those in good health.

Risk equalisation adds to affordability challenges in PHI

PHI is community rated, meaning that everyone on the same policy pays the same premium irrespective of expected claims costs. Because premiums reflect average claim costs of everyone insured, affordability depends on whether people in better than average health choose to insure or not.

Risk equalisation transfers funds from insurers with lower than average claim costs to those with higher than average claim costs. This supports community rating but does not directly make PHI more affordable overall. If only people in worse than average health were insured, premiums would be unaffordable regardless of how the costs were shared between insurers. 

Over 40% of hospital and medical claims are shared between insurers in this way, so risk equalisation is a material part of the PHI system. The pooled claims are allocated equally to every adult insured in a state, with a basic policy required to make the same contribution as a more comprehensive cover.  This risk equalisation contribution therefore represents a “flagfall” cost of taking out PHI, and at approximately $750 per adult can represent 70% of the total premium on a basic policy. The flagfall premium has increased by 7.5% per year over the last ten years, significantly increasing the level of cross subsidy between different groups of policyholders.

After deducting expenses and a profit margin, only a small amount remains to cover the policyholder’s own expected claim costs. The high flagfall premium means PHI can represent poor value for money to young people. As noted above, falling participation rates for young people increase premium rates for everyone remaining insured.

Risk equalisation 2030 – the trend continues

Building on our previous paper “Risk Equalisation 2020 – Is the Current System Sustainable?”, we have prepared detailed projections of the risk equalisation pool out to 2030. Assuming no change to risk equalisation arrangements or other significant policy settings, the flagfall premium increases from current levels of around 65% of Average Weekly Earnings (AWE), to nearly 100% of AWE in 2030.

This means that, on average, policyholders under 55 would have to work for a full week to pay for the cost of other people’s PHI claims, before paying anything for their own cover. This would put significant pressure on affordability for younger people or those with relatively low wages.

We project the flagfall cost to increase more quickly in the future than over the last ten years. This is driven by the ageing insured population, with the number of insured people over 75 continuing to increase while participation rates for other age groups have remained broadly constant, or recently reduced.

By 2030, we are projecting that over half of all hospital benefits will be shared through the risk equalisation pool. This would further disincentivise individual insurers from pursuing claims management initiatives with a view to reducing their own claims costs.

Time to think differently?

We think it is time to think differently in order to maintain high PHI participation. Changes to the risk equalisation system could improve the affordability of PHI to people in better than average health. There are also a range of other levers available to government to support PHI participation.

PHI reform options often generate significant debate in the industry. While the need to incentivise young people to purchase PHI is well understood, people rightly balance this with the interests of older members who have subsidised previous generations of policyholders.

Looking at reform options which have been proposed over the years, there seems to be more interest in discounts for young people than premium loadings for older people. It is worth remembering that a discount for young people is effectively a penalty for everyone else. 

Along the same theme, any changes to risk equalisation that could lower the premiums for products which young people tend to buy essentially provides an invisible discount. Also, making no changes to risk equalisation is effectively a choice to continue to increase the level of cross subsidy from younger policyholders to people aged over 55.

Our conclusion is that new measures are necessary to ensure continued high participation rates, and there are a great many options. Perhaps it’s more important to just adopt one of the many sensible options, rather than continue to debate the relative merits of each.

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