The Coalition government is considering selling off Medibank Private. Yet the 2004 National Platform and Constitution of the Australian Labor Party says, ‘Labor believes Medibank Private plays an important role as a market leader to hold down premiums and keep the private health insurance market competitive and consumer oriented. Medibank Private will therefore be retained in public ownership’. So what is the right policy?

While Medibank Private currently has the largest national market share of all funds (29 per cent) there is little evidence that it has led the way in keeping the private health insurance (PHI) market competitive. In 2002 Medibank Private made a net loss of $175 million. Its cost structure was high, revenue didn’t cover costs and the company only survived on investment income, the interest of which was also declining due to a downturn in the share market. Subsequently, a new management team steadily improved performance. Nevertheless, the 2004 PHI Ombudsman’s ‘State of the Health Funds Report’ ranked Medibank Private behind a number of other funds on finances and costs, price of top hospital cover and ancillary cover.

Thanks to Sean Leahy.

By 2004/05, Medibank Private had substantially improved its financial position with a revenue of $2.8 billion and an underwriting profit of $63 million; the latter the first for 5 years. In addition, helped by an equity injection of $85 million from their shareholder (the Federal government), investment income rose to $68 million. Medibank Private also reported reduced management expenses (9.2 per cent of premium income) and a reduction in the inexorable increase of provider costs by more competitive contract negotiations. Furthermore, over the last 6 months of 2005, their membership has shown a small increase (particularly amongst younger people) in response to the introduction of new products.

So would Medibank Private now be attractive to potential purchasers? Last Friday, in response to yet another increase in PHI premiums, Health Insurance Association chief executive Dr. Michael Armitage said the sector only had a 2.7 per cent profit margin. ‘These rises are not going to pay out huge profits and luxurious lifestyles’, he said. On the other hand, in 2005 Medibank Private had the biggest market share, it’s book value (equity) is only $653 million and its operating profit of $131 million gave a 25 per cent return on equity; pretty attractive for a business substantially subsidised by government. In addition, out of its total assets of $1300 million, the firm had $900 million in cash. Any private company so highly cashed up would be considered ripe for a takeover.

So it’s not surprising that some in government think Medibank Private should be flogged off as soon as possible, especially before the overall slow decline in PHI membership accelerates as a result of inexorably increasing premiums. If floated on the market, some analysts think Medibank Private could be the biggest listing for years (with the exception of Telstra) with a market capitalisation estimated to be around $2 billion. The alternative approach is a trade sale. While it’s unlikely that a total sale of Medibank Private to another major fund would be approved by the Australian Competition and Consumer Commission, other funds may be interested in stripping off parts of the organisation in order to improve their own national coverage.

However, the top four health funds already control around 80 per cent of the market so allowing three funds to digest portions of Medibank Private seems unlikely to produce improved performance by itself. Administrative costs might be reduced slightly by economies of scale but these savings are insignificant when compared with the cost drivers of increased premiums; increasing price of services purchased (linked to advances in medical technology) and increased utilisation by members.

These drivers will only be moderated by an innovative health fund who takes on the more aggressive role of health broker (with the support of their members) as distinct from being a passive health payer. A fund acting as a health broker would use its market power to purchase cost-effective services for members at the most competitive price taking into account quality and safety considerations. It would encourage members to utilise more cost-effective services, perhaps by reducing the front-end deductible or co-payment for such services. It would actively assist members to maintain a healthy lifestyle, address their health risks and better manage chronic disease knowing that investments in these areas will reduce hospital utilisation and health costs in the longer term.

One reason for the recently improved financial performance of Medibank Private has been more competitive price negotiations with private hospitals. It may be that government ownership (and sensitivity) hampers commercial negotiations, particularly with high cost hospitals in marginal electorates. It is possible that a privatised Medibank Private could negotiate cost-effective services more aggressively if existing members were educated about what needs to be done and participated in the organisation’s transformation, for example by being offered shares and greater involvement in return for past loyalty. After all, it has been the increased premiums borne by members (as well as more efficient administration) that has made Medibank Private viable for sale. Finally, a privatised, freer, more innovative Medibank Private might stimulate a wave of demutualisation, amalgamation and increased efficiency of the remaining 42 health funds, many of whom are far too small to achieve economies of scales.

However, like all funds, a privatised Medibank Private will still be constrained by existing perverse government regulation. For example, urinary incontinence is prevalent in older women and its management has traditionally been surgical with the cost of treatment around $4000. Physiotherapy has been shown to be an equally effective, low-risk, first-line treatment and costs only about $300. Yet surgery is routinely covered by PHI hospital tables (and Medicare item numbers) whereas physiotherapy is only covered if consumers take out ‘extra’ PHI cover. Another example is the successful pilot programs run by Medicare Private to encourage health risk assessment by members and better self-management of diabetes. Currently, any financial benefit that accrues to Medibank Private from a reduction in members’ hospital claims as a consequence of preventative programs is largely nullified by the reinsurance pool to which all funds must contribute. There is little incentive for one fund to spend substantial money on preventative programs for their members if they end up having to contribute to the hospital costs of other funds who have not undertaken such activities. In short, regulatory issues also need to be addressed by government if PHI funds (and private health care) are to become more efficient.

The following policy options appear open to the government with respect to the sale of Medibank Private:

1. A trade sale of parts of the organisation to other funds to improve their national coverage. This would appear to have negligible impact on making PHI more efficient.
2. A float of the existing organisation, ideally with active member participation through share options and other strategies. It is possible that a privatised Medibank Private could become more innovative and customer-orientated if the government was removed from its role as share-holder.
3. Regulatory changes to encourage all funds to become more innovative and cost-effective. These could include linking government rebates to fund performance indicators as suggested in last week’s essay on PHI.
4. A combination of 2 and 3. This would appear the best option.
5. Doing nothing until such time as the inexorable cycle of rising health care costs, rising PHI premiums and falling fund membership produces another unavoidable crisis.

Further debate on these options (and additional policy suggestions) are welcomed.