My previous blog commented on both health and education. Some of the comments on that blog had been addressed in my earlier posts on health insurance. See here, here and here. But the basic message still seems to be getting lost. Australia’s health insurance system penalises the ill. It is a form of anti-insurance. That is why needs to be fixed.
To show this let’s try another story.
Suppose, on Monday, that there are two individuals. They are identical in every way. Let’s call them Sam 1 and Sam 2. Both of the Sams are risk averse and both face a risk of illness that will require hospitalisation sometime in the future. So both Sams would like comprehensive health insurance that is fairly priced (i.e. priced at an actuarially fair rate).
The chance of getting ill in the future is a random event. So let’s suppose that on Tuesday, Sam 1 is lucky and Sam 2 is unlucky. Sam 1 finds out that his chance of becoming ill in the future is relatively low. In contrast, Sam 2 finds out that his chance of becoming ill in the future is relatively high.
On Wednesday, Sam 1 and Sam 2 make their decisions on health insurance. What will they do?
Sam 1, who has the low chance of becoming ill, will choose to rely on Medicare. It is not worth his while to buy private health insurance because he is not likely to need it. Even though he is risk averse, his optimal choice in Australia is to choose the taxpayer-funded partial health insurance called Medicare.
In contrast, Sam 2 has a high chance of becoming ill and needing hospital treatment in the future. He cannot take the risk of just relying on Medicare and so chooses private health insurance. But the price that he has to pay for private health insurance is higher than he expected for two reasons.
First, because of the overlap between the public health insurance scheme and the private health insurance scheme, his private health insurance has to cover some services that he would receive without extra payment under Medicare. As he has already paid his taxes for Medicare, he is essentially paying twice for these overlapping services.
Second, because only people like Sam 2, who have a high risk of needing hospital care, take out private health insurance, the price of that insurance has to be high to cover this ‘adverse selection’ problem.
Now before you say this is all just tough luck for Sam 2, let’s note a couple of things:
- Remember that the only difference between Sam 1 and Sam 2 is that Sam 2 has a higher chance of becoming ill. There is no difference in income. Indeed by any sensible welfare measure Sam 2 is worse off than Sam 1 because of his health risk. But it is Sam 2 that will buy the private health insurance – he can’t take the risk not to buy given his health status.
- If we went back in time to Monday, before each individual learnt of their individual health risk, both individuals would agree that the outcome on Wednesday was undesirable. They would both prefer to live in a society where full health insurance was available at a fair price. The problem is that people make their decisions about health insurance when they know their health risk. The healthy rely on Medicare. Those more likely to require hospitalization (often the elderly) buy private health insurance. Put simply, individuals act in their own self-interest and their own information about their health risk.
Australia’s current health insurance scheme systematically penalises those, like Sam 2, with high health risk. The rebate partly rectifies that inequity. In other words, on Monday, before they know their individual health risk, both Sam 1 and Sam 2 would prefer a society where there is a rebate on private health insurance. Of course, on Tuesday, Sam 1 will decide that the rebate is a bad idea and lobby the government to get rid of it. The government has just responded.
Australia’s health insurance system, which systematically penalises those most at risk of illness, is bizarre. We can design a better health insurance system. That may mean a more comprehensive Medicare scheme with the associated taxes to support it. However getting rid of the rebate is not a way to help improve health insurance for Australians.
Some final points.
- Please note that being in favour of the rebate is not the same as being against Medicare. It is being against a stupid distortion in our current system.
- Using the health insurance system as a hidden tax on the rich creates an undesirable distortion – it also makes those most likely to need hospitalisation worse off.
- Note that health insurance is a separate issue to health provision. The above argument says nothing about public or private hospitals. Confusing the two is like confusing car insurance with a car manufacturer.
- Finally, the proofs of all the above are in Gans and King “Anti-insurance: Analysing the health insurance system in Australia”, Economic Record, 79, (2003), 473-486.