Private Health Insurance (PHI)

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1 Private Health Insurance (PHI) Proposed means testing not consistent with Community Rating 12 July 2011 On 7 July 2011, the Commonwealth government introduced legislation into Parliament to establish a means test covering PHI premium rebate payments which the government makes to individuals, or to employers in respect of their employees. Changes are also proposed to the Medicare Levy Surcharge taxation arrangements for individuals in respect of PHI. Both changes would be effective from January This update sets out the implications of the proposed changes and suggests an alternative proposal that, unlike the government s current means testing proposal, would be consistent with Community Rating. Our proposal would be expected to result in lower rates of medium term future premium increase than those which are expected to arise from the government s proposed means test. This would produce the same level of cost reduction for the government, without introducing any of the complexity and additional cost which the government acknowledges would result from its proposals. A summary of the Commonwealth government s means test (effective from 1 January 2012) for the premium rebates it provides to private health insurance (PHI) policyholders, along with the its proposed increases to the Medicare Levy Surcharge tax (MLS), is set out in the table overleaf. The legislation is complex, and consists of amendments to each of the Age Discrimination Act 2004, the Private Health Insurance Act 2007, the Medicare Levy Act 1986, the Medicare Levy Surcharge Fringe Benefits Act 1999, and to four Acts that cover taxation. The largely tabular summary of the new laws in the government s Explanatory Memorandum runs to over five pages. Important details relating to the administration of the proposed means test which need to be included in the Private Health Insurance (Incentives) Rules 2007 are not available at the date of this update. If the legislation is passed by Parliament, premium rebates will decrease progressively for about 24 per cent of policyholders (covering about 2.5 million people) whose incomes exceed the government s prescribed thresholds. Consequently, younger and healthier policyholders (who also tend to be on higher incomes), will face a substantial increase in premiums, as set out in Table 01 overpage. The proposed means testing is therefore inconsistent with Community Rating requirements that, for many years have provided affordable PHI for older, less-healthy individuals. To deter policyholders from dropping their PHI hospital insurance as a result of the changes, the government has announced proposed increases (also effective from 1 January 2012) in the MLS. The MLS applies if a taxpayer does not have an eligible PHI hospital product. We note that the MLS does not deter policyholders from downgrading their hospital insurance, or from dropping or downgrading their extras insurance. The proposed means testing (which was first proposed in the government s 2009 Budget but not passed by the Senate) has again been presented by the government as having little or no effect on the PHI industry. Our May 2009 update outlined the adverse consequences of the proposed means testing for all policyholders of private health insurers. These can be summarised as follows: 1. Policyholders with hospital insurance can be expected to downgrade their level of insurance, which will reduce the revenue base of insurers 2. Policyholders with extras (general treatment) insurance will either drop or downgrade it, which is an important source of insurance margin, again reducing the revenue base of insurers 3. The policyholders who drop or downgrade their insurance will likely be those who either do not expect to make significant claims in the near term, or who can bring forward elective procedures and subsequently drop or downgrade their insurance 4. Sales of and communication about PHI policies will be made materially more costly by the significantly increased complexity which means testing will introduce. towerswatson.com

2 These major adverse consequences were quantified by a study commissioned by the Australian Health Insurance Association (AHIA) earlier in 2011, which was undertaken by Deloitte. The AHIA study estimated the numbers of PHI policyholders who are expected to drop or downgrade their cover, and the consequential premium increases which are expected from the first three items above. It appears that the AHIA study made no allowance for increased administration, communication and acquisition expenses when projecting the higher premium increases which are expected to result from the proposed means testing. The government stands by Treasury s estimates that 99.7 per cent of people are expected to remain in private health insurance (or that only 27,000 individuals are estimated to withdraw from PHI). An estimated 2.5 million persons (that is, 24 per cent) would pay higher PHI premiums 1 as a result of the means test from January Table 01 summarises the government s proposals for different levels of PHI rebate which are estimated to reduce the government s rebate payments by $768 million over the 2012/13 fiscal year. Table 01 shows that PHI policies covering about 2.5 million people are expected to experience initial premium increases between 14 per cent and 67 per cent, with people distributed approximately equally between the three means tested income bands. The complex definition of income is also worthy of note. The AHIA report estimates that the proposed means testing will lead to a material increase in PHI premiums for all policyholders (that is, in addition to the significant initial increases in premiums which about 24 per cent of policyholders will pay). By 2016, the AHIA report estimates that the average PHI premium will increase by approximately 10 per cent over and above normal premium growth. In five years time, we will be able to see the difference between the AHIA s estimates and what has actually occurred. However, even if the AHIA s estimates are 1. The Australian Health Insurance Association estimates that the initial increase in PHI premiums for affected policyholders will be between $315 and $935 per year per person covered. Table 01. Current and Proposed Premium Rebates and MLS Thresholds Income 2 - Singles >$80,000 $80,001 - $93,000 - Couples 3 >$160,000 $160,001 - $186,000 Current 1 Proposed 1 Proposed 1 Proposed 1 $93,001 - $124,000 $186,001 - $248,000 >$124,000 >$248,000 Estimated number of policyholders (in each income tier) the government expects 940, , ,000 to be affected 4 MLS (%Taxable Income) 1% 1% 1.25% 1.50% PHI rebate (%premium) - Up to 65 years 30% 20% 10% Nil years 35% 25% 15% Nil - 70 years & over 40% 30% 20% Nil Initial premium increase 5 - Up to 65 years 14% 29% 43% years 15% 31% 54% - 70 years & over 17% 33% 67% 1. For the financial year. 2. We assume that means testing will apply to income that is used for MLS purposes, where: Income for MLS purposes = Taxable income (including any exempt foreign employment income) + Reportable superannuation contributions + Total reportable fringe benefits + Total net investment loss. 3. The threshold amount for couples increases by $1,500 for each dependent child after the first. 4. These figures were released by the government to The Australian as published in their article Wealth test on health cover to hit millions on 24 June These are the initial percentage increases in premiums as a direct result of the reduction in the PHI rebate received by the policyholder. Additional effects such as selective dropping and downgrading of insurance by policyholders and increased management expenses would be expected to result in further premium increases for ALL policyholders, not only those directly affected by the means test. towerswatson.com Means testing not consistent with Community Rating 2

3 Table 02. Expected impacts of means testing according to various sources Treasury (Industry) AHIA (Industry) NIB Medibank 1 Number of persons expected to drop hospital insurance: 27,000 (0.3%) 175,000 (1.7%) 4,700 (0.6%) over 5 years 1,600,000 (14.7%) Negligible impact 15,000 2 (1%) Number of persons expected to downgrade hospital insurance: 583,000 (5.7%) 19,600 (2.5%) over 5 years 4,300,000 (39.6%) Negligible impact 38,000 3 (2.5%) Number of persons expected to drop extras insurance: 554,000 (5.4% 4 ) over 5 years 2,800,000 (22.2%) Not specified Not specified Number of persons expected to downgrade extras insurance: 803,000 (7.8% 4 ) over 5 years 5,700,000 (44.6%) Not specified Not specified 1. Note that Medibank does not provide an expected time frame for their figures. 2. This figure represents the number of policyholders expected to drop Hospital insurance and corresponds to 1% of Medibank s membership. 3. This figure represents the number of policyholders expected to downgrade their PHI insurance in some way, shape or form and corresponds to 2.5% of Medibank s membership. 4. Percentage estimate based on NIB s estimate of 10.3 million persons with Extras insurance as at 30 June only partly reflected in what does occur, the means test will impact all PHI policyholders, not just those who initially are means tested. By contrast, the Health Minister has stated that the vast overwhelming majority of the community more than eight million Australians will have absolutely no effect from (the means test on private health insurance. While the AHIA report estimates many of the secondround impacts that means testing is expected to give rise to, it appears not to include the potential increase in administration, communication and management costs of private health insurers. The government s Explanatory Memorandum for the legislation states that the proposed means testing is expected to result in a medium overall compliance cost impact. These costs will arise because of materially increased complexity which means testing introduces. The January 2012 implementation date for the proposed means testing gives little time for policyholders to understand the complexity of the proposals or for insurers to implement the necessary system changes. It is difficult for insurers to estimate the number of their policyholders who will be affected by the proposed means testing, and subsequently either decide to take no action, or one of the drop or downgrade actions listed above. The publicly available estimates of the impact of means testing on the PHI industry as a whole and on two major insurers are shown in Table 02. The key for insurers to manage the proposed changes will be to focus on how means testing is likely to impact the individual insurer s policyholders. The estimates in Table 02 show that between about 0.5 per cent and 1.5 per cent of people with hospital insurance can be expected to drop hospital insurance, with perhaps 2.5 to 5 per cent of people downgrading it to a lower premium/lower benefit policy in the first year of means testing. The AHIA report estimates that substantially higher percentages of extras policyholders can be expected to either drop or downgrade it to a lower premium/lower benefits policy, as a result of the absence of MLS support for extras insurance. The complexity of the proposed means test on the PHI premium rebate, coupled with the proposed increase in the MLS is expected to mean that many PHI policyholders will take years to both understand and act on the proposed means testing. These later year effects have been estimated in the AHIA report as significant, with the number of both hospital drop-outs and downgrades over the five years being about seven to nine times the number. One of the key determinants of the number of policyholders who either drop or downgrade their insurance is expected to be the default rebate assumption which the insurer is required to apply, in the absence of the policyholder nominating a particular level of rebate. If the insurer is able to assume a continuation of the current rebate level, fewer policyholders would be expected to either drop or downgrade their insurance than if the insurer is required to assume that no rebate will apply. towerswatson.com Means testing not consistent with Community Rating 3

4 Premium costs for employer-financed group insurance are likely to increase materially by the proposed means test. If premiums are required to be paid by the employer gross of the rebate (and the premium rebate returned to lower income taxpayers through the policyholder s tax return after the end of the tax year), premium payments will increase by at least 43 per cent (and by up to 67 per cent for older employees) from January This increase will also apply to Fringe Benefits Tax which is incurred by employers who currently pay PHI premiums on behalf of their employees, representing a further cost increase for such employers Intergenerational Report (IGR10) IGR10 has projected the increase in the Commonwealth government s PHI rebate payments per person of 7.5 to 8.0 per cent per annum overall after The IGR s rate of projected increase is higher than the industry average rates of PHI tabular premium increase over recent years. The government s stated justification for the introduction of a means test stems from IGR10, which states the (PHI) rebate is the fastest growing area of (Commonwealth government) health expenditure. However, IGR10 has projected the long term growth rate for the cost of the PHI rebate using data that did not reflect stable PHI rebate policy 2. Despite this limitation, IGR10 s conclusion is unsurprising given that the PHI rebate, a substantially uncapped program, is compared in IGR10 only to projected growth in the Medicare Benefits Schedule, the Pharmaceutical Benefits Scheme and payments made by the Commonwealth to state governments in respect of public hospitals. All of these programs have, at least to some extent, capped Commonwealth expenditure. By contrast with these Commonwealth payments, the major financers of hospital costs (state governments and private health insurers) make payments which are substantially uncapped. IGR10 estimates the net saving over the first five years from the proposed means test as approximately $2 billion (which equates to approximately 0.8 per cent of the Commonwealth government budget for healthcare over this period). This net saving seems small relative to the potential cost-related risks that means testing poses for PHI, and for Australia s public and private hospital systems. The Future Means testing represents a further subsidy of older people s PHI costs by the working age population. Policyholders who are over age 60 will often be at least partly retired, funded in some way by superannuation and/or the Age Pension, and are therefore unlikely to be affected by the means test which will predominantly affect working age policyholders. The proposed PHI changes highlight the need to establish a long-term sustainable funding system for PHI costs, in the face of the movement of the baby-boomer generation into the ages where health care costs increase rapidly. The current Community Rating rules for premiums already impose premium costs on younger policyholders which are generally well above their expected average actual claims costs. The Commonwealth government s proposed means testing will only add to the existing problem, further jeopardising the long term sustainability of Community Rating. If the government needs to generate the same amount of cost reduction as is expected under the current means testing proposal, but in a way consistent with Community Rating and with lower risk of flow-on effects, re-introduction of a uniform rate of premium rebate (as applied up to 2005) would be a much superior proposal. Under this structure, premium rebates for policyholders aged 65 and over would be reduced to 30 per cent so that the same rate of premium rebate would apply to all policyholders. Should this cost reduction fall short of the government s target, a further small reduction of the premium rebate to a uniform rate lower than 30 per cent for all PHI policyholders could be applied. The advantages of this proposal compared to the proposed means testing are: Simplification of the current rebates, without introducing the proposed complex means testing The MLS remains as currently Administration costs of PHI remain as currently Only older age policyholders will face material levels of premium increase (and these policyholders already have substantially subsidised PHI premiums under Community Rating) Pressure for on-going increases in PHI premiums will be reduced (not increased as under the proposed means testing) Community Rating will be sustained for a longer period than can be expected if the proposed means testing is introduced The direct age discrimination (against younger people) which is part of the current premium rebate arrangements will be removed. If the proposed means testing is to be allowed for, private health insurers will shortly face substantial additional complexity when they commence projecting their FY13 to FY15 financial results as is required under the Commonwealth government s process for approving premium increases from April The Health Minister, who approves premium increases, has made her position clear: Nicola Roxon believes that insurers putting up their prices (would not) be an appropriate response to (the introduction of means testing) The data used to project long term growth for the cost of the PHI rebate includes: the introduction of higher rebate rates for older policyholders in 2005; the period of strong growth in PHI coverage prior to due to the non-indexation of the MLS Threshold; and the capping of Commonwealth Government payments to States for public hospital costs. 3. Nicola Roxon Transcript of press conference Canberra, 21 June 2011 towerswatson.com Means testing not consistent with Community Rating 4

5 About Towers Watson Towers Watson is a leading global professional services company that helps organisations improve performance through effective people, financial and risk management. With 14,000 associates around the world, we offer solutions in the areas of employee benefits, talent management, rewards, and risk and capital management. Contact For further information please contact: Rob Paton (02) The information in this publication is general information only and does not take into account your particular objectives, financial circumstances or needs. It is not personal advice. You should consider obtaining professional advice about your particular circumstances before making any financial or investment decisions based on the information contained in this document. Towers Watson is represented in Australia by Towers Watson Australia Pty Ltd (ABN , AFSL ), Towers Watson International Survey Research Pty Ltd (ABN ), Classic Solutions Australia Pty Limited (ABN ) and Towers Watson Pennsylvania, Inc (ABN ). Copyright 2011 Towers Watson. All rights reserved. towerswatson.com

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