Follow the dollar in health insurance

The change in the thresholds for the Medicare Surcharge has generated much discussion over what it will cost and who will pay (see Tim Dunlop’s useful summary and follow-up here). What I think is that all of this highlights why our health insurance and funding system needs and overhaul. To demonstrate this, let’s follow a dollar around the system.

Imagine a certain individual who is currently paying for private health insurance because it is ‘free.’ That is, because if they did not they would pay the same amount in tax Medicare surcharge. Suppose also that when the threshold changes, for that person, private insurance will no longer be free and they will drop their cover.

So previously, for each dollar that that individual spent on private insurance, they would get 30 cents back in the form of a rebate while 70 cents would go to their insurer. So the government was paying 30 cents while there was additional 70 cents in funding for the private system. Following the change, however, the government saves 30 cents, the private system loses 70 cents while the public sector has to foot the bill for the individual’s health costs.

Now, chances are the individual has very few health costs. That means two things. First, the public sector bill wont rise by much. Second, their previous contribution to the private system is a complete loss in surplus for them. As that system will have to fund the same level of health expenses with lower revenue, there will be pressure on premiums to rise. Third, that premium rise means two things: (i) more individuals may drop private cover — although chances are that they will still be on the more healthy end of the spectrum and (ii) the government will have to pay more in rebates for private insurance.

So in terms of what this might cost the government, it looks hard to say. But that is only because we are not targeting fundamentals. If an individual decides to spend $1 less on private health insurance and that individual creates no health care costs, then, so long as the private health sector (insurance and all) is perfectly competitive, then it will have to recover that $1 in costs from its subscribers. So the government saves 30 cents on the rebate from the individual dropping cover and has to spend 30 cents on the rebate for the increased premiums to remaining subscribers. Put simply, by following the dollar we see that there can be no net saving for the government. And the reason is simple: this does not change the real costs associated with health care.

But that is an ideal situation. First, to the extent that it was receiving the surcharge from some in the threshold window, the government will lose that revenue. Why? Because it is a tax cut (amounting to $660m over 5 years). Second, to the extent that individuals and households dropping private health cover drive some health care costs (you know, get hospitalised), then the savings to the government will depend upon the relative cost associated with providing health care in the public and private system. If the public sector is cheaper at the margin, then the government will save money.

Finally, suppose that the private health sector was not perfectly competitive. In this case, things other than health care costs drive pricing. In this situation, the government might end up paying more in rebates because of the super-competitive premiums being charged in the private sector.

So everyone seems to be wrong here: Treasury, Access Economics, Alan Wood, AMA and whomever. At a baseline, this is a tax cut and so there is no welfare loss and, to the extent that there are some efficiencies in the public sector, it is a net gain. At its core, all of this back and forth is a result of not being willing to look at fundamentals. That said, the structure of our system really makes it easy to look away.

7 thoughts on “Follow the dollar in health insurance”

  1. There was an interview last year on Inside Business (ABC, Sunday mornings) with one of the big-wigs from a health fund (HBA, I think), who proudly stated that half of annual profits came from premiums.

    This is VERY different from the old mutual benefits association model (the higher payouts v low premiums, and wages of association staff, were funded by smart investing of the premiums by the association).

    This difference between how the middle-men are paid leads me to ask “were the old mutual benefits associations better investors, or are the new middle-men greedier?”


  2. My understanding of what you are saying is that all the talk of moving thresholds will make little difference to the cost to the government except perhaps reduce the cost of administering the system. I think you are right.

    No government will survive for very long if people in emergencies are turned away from hospitals if they cannot pay. Thus the government is going to have to provide emergency life saving services from the public purse.

    However the bulk of health costs are in health preventative measures and health maintenance measures. It is in this area we should concentrate our efforts. Both health prevention and health maintenance are best achieved through a simple market. That is, we have a lot of buyers and a lot of sellers where buyers can choose from the sellers with as few restrictions as possible.

    What we have is a system with restrictions and where most transactions are prescribed. That is the buyers have limited or no choice.

    Why is this so? It is because the distribution of public monies is from the top down. Money is allocated in governments for health services. The Federal government gives the money to the states, the states give it to the hospitals and to the doctors and to the pharmacists etc who provide the services. The amount these groups get depends to a small extent on the part that is the “free market” namely the bit that the end consumers pay. That is, the system has attempted to create a “subsidised” market where the amount that is paid by the consumer from their own pocket determines the amount that the government provides. While a worthy idea it falls down because the government money has to be accountable and it has to be shown to be “spent wisely”. In practice the subsidy drives the amount the consumer pays and hence the market fails.

    The obvious solution is to give ALL the government money for health prevention and health maintenance to the end consumers and to let them decide where to spend it. Turn the health funds into MediSaving organisations where we put our own money and the government money for us and let us decide where to spend it. This approach can be implemented incrementally and it can be adjusted and trialled and experimented with to get the best result. It can start tomorrow and while the big investigation is carried out we can run some experiments to better inform the planners.


  3. Simon,

    It appears the good doctor and I (and many others) are suggesting the same approach. Have MediSave rather than MediCare.

    Now if we combine it with one of Joshua’s contingent loans for emergency costs and we might end up with an efficient system?


  4. Good work, Josh.

    Kevin, the American system is broken. We already know that. It costs more and the outcomes are worse. There’s no need to try the same experiment here.


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