Response to PACU Discussion Paper

Transcription

1 2/826 Whitehorse Road 979 Burke Road BOX HILL VIC 3128 CAMBERWELL VIC 3124 Telephone: (03) Telephone: (03) January 2013 Mr Shaun Gath Chief Executive Officer Private Health Insurance Administration Council PO Box 4549 KINGSTON 2604 Via Dear Mr. Gath, Response to PACU Discussion Paper We are pleased to provide comments on your discussion paper Competition in the Australian Private Health Insurance Market. The paper was prepared by your Premiums and Competition Unit (PACU) to stimulate comment on competition in PHI. This is a joint submission from AHSA and hirmaa. AHSA facilitates arrangements between health insurers and hospitals, doctors and health service providers. hirmaa is an industry body representing community based restricted and regional health insurers. Together AHSA and hirmaa represent 26 of the 34 registered private health insurers (our member funds are listed at the back of this letter). We have consulted extensively with our member funds to prepare this submission. We provide detailed comments in several attachments to this letter, grouping the questions by theme. A summary of our comments is as follows: Smaller funds are crucial to competition We agree with PHIAC s comments that the presence of a large number of smaller and regional insurers [has] an important impact on competition (refer to P19 of the discussion paper). PHIAC s statistics show smaller insurers increasing market share, which is evidence of dynamic and vigorous competition by our member funds. Smaller insurers are also efficient, and provide excellent service to their members. The average management expense ratio of 9% is similar to the largest funds. hirmaa funds surveyed over 16,000 members this year, finding 98% are satisfied with their fund. 1

2 Customers make informed decisions The survey results explain the high customer retention rates of our member funds. Customers stay with an insurer if they are satisfied, and leave if they are not. To suggest otherwise is to question the intelligence of the customer. We see them make informed decisions. It is expensive to recruit and enrol new members, and these costs necessarily flow through to premiums. High retention rates allow insurers to spend premiums on healthcare rather than on paperwork and to save on the marketing and promotional costs that would otherwise need to be incurred. Competition is strong where regulation permits The short summary (pages 7 and 8 of the discussion paper) covers all the most material issues. We note the comment that the rewards for innovation are shaped by regulation of premiums and risk sharing between insurers. PHI pricing has been repeatedly examined by Australia s leading economists, and the flaws of the current process are well documented. Any serious attempt to increase competition in PHI should allow the market to set prices. Moving the debate beyond net margins Premiums cover claim costs, expenses and a profit loading, with profit being by far the smallest of the three components. Surplus or profit margins provide insurers with capital, which gives members confidence that claims can be paid. Lower surplus/profit margins would not have a noticeable effect on premiums, but would reduce insurers financial strength and the ability to compete for new members. Any meaningful downward pressure on premiums would require lower claims costs, which account for around 85% of premiums. This would involve creating a more level playing field between insurers and providers, such as hospitals and prosthesis manufacturers and would require serious policy input from Government to address multiple cost levers such as MBS, Prosthesis and Informed Financial Consent (to name just a few). What next for PACU? The paper brings together existing research and statistics relevant to competition, and is well presented. The paper should achieve the stated aim of promoting discussion on competition in PHI. But what is the aim of the discussion? It would be useful if any further PACU derived papers outlined PHIAC s intended timelines and anticipated next steps once comments have been received. As an example, we are unsure what PHIAC intends to do with the submissions and comments generated by this paper in the context of subsequent policy, discussion or actions. PHI serves public policy objectives, principally by making private healthcare affordable to all Australians. The public policy objectives place some restrictions on industry competitiveness, for example, by requiring insurers to share claim costs through risk equalisation. It was difficult to determine if PHIAC has determined a position on whether PHI is adequately competitive from this discussion paper. The evidence suggests there is strong competition between funds. 2

3 We are sympathetic with PHIAC s difficulty in assessing competition as it is an interesting and arguably unique situation for a regulator to find itself in this dichotomous position. DoHA has policy responsibility for PHI, ACCC is the competition expert, and the Productivity Commission is the government s independent research body. PHIAC s core role is as a prudential regulator, ensuring health funds have enough assets to pay claims. There is a potential conflict real or perceived between maintaining financial security and pushing down premiums. Conclusion We appreciate the opportunity to respond to the discussion paper, and would be happy to provide further detail on any of the points raised. Yours sincerely, Andrew Sando Chief Executive Officer AHSA Ron Wilson Executive Director hirmaa 3

4 Detailed Response We provide detailed comments in several attachments to this letter, grouping the questions by theme as follows. A Market Composition 5 B Profit and Expense Margins 8 C Product Design 12 D Pricing Oversight and Other Regulations 14 E Community Rating and Risk Equalisation 16 F Barriers to Entry 17 G Economies of Scale 20 H Portability 21 I Intermediaries 25 J Supply Chain 26 List of AHSA and hirmaa Funds 28 4

5 A. Market Composition Your Questions Q1 To what extent has the development of different markets in the various states had an impact on competition? Q5 What effect does the regulatory system have on either consolidating the national market or encouraging the development of state, territory and regional submarkets? Key Points We do not see significant differences in competition between states. Every state shows a high level of competition, with smaller insurers trying to grow market share and large insurers fighting to maintain their position. PHIAC s statistics show smaller insurers are dynamic and vigorous market participants, driving competition in PHI. Larger funds are losing market share. If PHIAC wishes to promote competition in PHI, it should encourage a wide variety of insurers to operate in the market. Detailed Response Every State is Competitive The position in each state is that there are two insurers with a large market share (or three in NSW), and a number of insurers with smaller market shares. Regulations restrict what can be covered under health insurance policies, and cost sharing (through risk equalisation) makes it difficult for one insurer to charge significantly less than another. Insurers therefore have to compete through other factors, such as level of customer service. Role of Smaller Insurers We agree with PHIAC s comments that the presence of a large number of smaller and regional insurers [has] an important impact on competition (refer to P19 of the discussion paper). Small funds targeting a market niche can sometimes compete more effectively than large funds that rely on mass marketing. The large insurers in each state have typically been slowly losing market share to other insurers, as shown in the following chart. The consistent growth of smaller insurers is evidence of competition at work. The relatively slow rate of change is to be expected, given regulations limit the ability to compete on price and product design. It also reflects the prudent financial management of smaller funds, who realise they cannot grow faster than their capital allows. The following figures show how market shares have changed over time for the three largest states. We show the combined market share of the largest two insurers, and of all other insurers combined. Note that all statistics in this report are sourced from PHIAC, unless otherwise stated. 5

6 80.0% Figure 1 NSW Market Share Analysis Market Share 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% Largest Two Other Insurers 0.0% 80.0% Year Ending 30 June Figure 2 VIC Market Share Analysis Market Share 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% Largest Two Other Insurers 0.0% Year Ending 30 June 80.0% Figure 3 QLD Market Share Analysis Market Share 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% Largest Two Other Insurers 0.0% Year Ending 30 June 6

7 There may be differences within states that may be relevant to competition, for example, where insurers have a significant presence in a particular town or region. However, there does not appear to be any material differences in the level of competition between states. Role of Large Insurers Medibank and BUPA have combined market share of over 55%, so the overall level of industry competition will depend on the actions of these insurers. Therefore if PHIAC has concerns about competition, its investigations should start with the market leaders. It is unusual in a competitive industry for the government to own the largest insurer. There is significant potential for conflict (real or perceived), especially when government also oversees industry pricing, and supports the industry through premium rebates and other measures. Changes in Market Share Reflect Customer Preferences We conclude by noting that market shares are not determined by regulation, but by customer decisions. These decisions reflect the product, pricing and customer service offerings of each insurer. In particular, the high member growth and retention rates of smaller funds reflect high levels of member satisfaction. 7

8 B. Profit and Expense Margins Your Questions Q2 Are levels of profitability consistent with existence of effective competition? Q3 Does variability in management expense ratios and net margins reflect competitive tensions in the market? Q4 To what extent does the regulatory system provide incentives to manage and contain margins and to what extent is this driven by competition for members and the need to provide member services? Key Points Insurers costs are uncertain and profit margins reflect this risk. Profit/surplus contributes capital to not for profit insurers, providing members with confidence that claims will be paid. Profits must also mitigate and compensate for sovereign risk, with For profit insurers also looking to ensure they have adequate finance and cash flow to pay dividends. A small number of insurers have entered the market in recent years, demonstrating that there are no material barriers to entry. If profits were excessive then more new insurers would enter the industry. Expenses are modest, do not vary materially between health insurers, and compare favourably to general insurers. Profit/surplus and expenses represent only around 15% of premium. While we do not believe this can reduce significantly, even if it could the effect on premiums would be inconsequential. Any meaningful change in premiums would require lower claims costs, and we consider this further in Section J. Detailed Response Underwriting profits are modest Profit margins in health insurance are poorly understood by many stakeholders. This makes health insurance different from both other insurances and other highly regulated industries, and so we welcome this opportunity to provide information. The discussion document states that profits are low relative to premium income, but high relative to the level of capital invested. While premium revenue and capital are important drivers of profit/surplus, the most important profit driver is risk. Underwriting profits are restrained, and are always under threat. The regulated pricing process allows insurers to change premiums only once per year. Insurers are required to estimate claims and expenses up to 18 months in advance, including the cost of illnesses and injuries that have yet to occur. The estimates need to allow both for current members, potential future members, and members of other insurers (through risk equalisation). 8

9 By their nature, future cost projections will always be uncertain. Insurers need to charge a margin over expected costs in case experience is worse than expected. This margin was only 5.7% in the year ending June 2011, and has frequently been much lower in previous years. The underwriting margin insurers are able to achieve is very small compared to the level of uncertainty in the pricing projections. Health insurance capital requirements increase every year in line with premium increases and growth in member numbers. A large part of the surplus/profit margin is needed to meet increasing capital requirements, so as to maintain the level of payment security for members. The surplus/profit margins and capital provide members with a high level of confidence that claims can be paid, even at times of severe financial stress. For example, even at the height of the global financial crisis, the ability of Australian private health insurers to pay claims was never in doubt. Following the global financial crisis, prudential regulators around the world want insurers to hold more capital. This is because insurance is an inherently risky business, and a strong capital base protects the interests of consumers. We note that most of our member funds operate on a not for profit basis. All surpluses of these funds ultimately benefit customers. If surplus/profits in one year are higher than expected, investment earnings on those profits can benefit members for generations to come. We note that industry barriers to entry are minimal (refer to Section F). The absence of a significant number of new entrants demonstrates that the available profits are at most a fair reward for risk. We note that sovereign risk (in particular changes to government policy) is a material risk area for private health insurers. Expenses compare favourably to other industries Management expenses for health insurers are modest, and compare very favourably to general insurers. 9

10 Figure 4 Comparison of Expense Ratios General and Health Insurance 30.0% 25.0% Expense Ratio 20.0% 15.0% 10.0% 5.0% 0.0% Year Ending 30 June General Insurance Private Health Insurance Source for general insurance figures: Pendulum Finity Consulting/Deutsche Bank analysis of APRA statistics Expense differences between insurers are immaterial The discussion paper notes that differences in expense ratios between insurers may reflect different management approaches. Our view is that this is probably true. Differences in expenses are largely unrelated to competitive tensions. As evidence for this we note that expense ratios do not vary significantly by insurer scale, as shown in the figure below. Management Expense Ratio 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Figure 5 Expense Ratio by Type of Insurer Insurer Size Large Mid Niche 10

11 Smaller funds have been able to achieve low expense ratios through industry groups such as AHSA and HAMBS, to enhance their competitive position. These organisations allow smaller funds to achieve the economies of scale available to larger insurers. One of the main reasons funds join AHSA or HAMBS is to achieve the enviable expense ratios shown in the figure above and to achieve lower costs of benefit payments and claims processing. Funds target low expense ratios because the PHI market is competitive they need to offer competitive premiums and benefits to stay in business. Competition by regulation In respect of regulation and margins, we note PHIACs comments that the rewards for innovation are shaped by regulation of premiums and risk sharing between insurers. For example, if an insurer was able to reduce claim costs by improving the health of its members, this benefit would be shared with competitors through risk equalisation. Any initial improvement to net margin would be passed to customers through the price regulation process. Price regulation is therefore the key driver of net margins, rather than competitive factors. Only top line growth can sustainably increase profit (in dollar terms), and therefore the focus on competing for new members. What about claim costs? Premiums cover claim costs, expenses and a profit loading, with surplus/profit being by far the smallest of the three components. The lowest level of sustainable premiums would include profit margins that cover only increasing capital requirements. This level of premiums would allow an inconsequential, one off price cut of at most 3%, and much less for some insurers. This estimate is based on calculations performed by PHIAC for our member funds. Premiums at this level (covering only increasing capital requirements) would not allow for profit insurers to pay dividends, and limit the strategic options of not for profit insurers. This would therefore reduce competition for new business, limit further innovation, and make new market entrants unlikely. Any meaningful downward pressure on premiums would require lower claims costs. While there are a number of challenges in this area, we suggest that PHIAC move the competition debate beyond net margins and management expenses. We comment further on this in Section J. 11

12 C. Product Design Your Questions Q6 What is the impact of increased exclusionary and restricted products on competition? Q7 Is growth in general treatment only products a signal that the market is increasingly competing in areas that are contributing the least to the objectives of private health insurance? Key Points The discussion paper notes that almost every element of the business of a private health insurer is regulated. However, insurers are allowed some flexibility in product design, including the ability to sell exclusionary and general treatment products. Insurers have taken the opportunity to be innovative, and design products which customers want to buy. The objectives of private health insurance are not universally agreed, and our members hold a range of views on exclusionary products. However, if competition and innovation are objectives of private health insurance, further product design regulations would run counter to the objectives. Detailed Response Customers Want To Choose Exclusionary products are considered an important issue by some in the industry, and there would be a range of views held by AHSA and hirmaa member funds. Customers expect to be able to make choices when buying almost any product, including insurance. For example, customers can choose to exclude certain risks when insuring their car or their home, and choose the sum insured when purchasing income protection or life insurance. More generally, product design is one of the few areas where regulation permits a degree of innovation. The fact that insurers have been innovative is evidence of competition in the sector. Customers Are Smart Enough to Choose Insurers want people to make informed decisions when buying insurance. It is in the insurer s interest for people to purchase a policy that meets their needs. Any other choice ultimately results in customer dissatisfaction, policy lapse and damage to the insurer s brand. The discussion paper notes that PHIO received 2,995 complaints in 2011/12, of which 215 (7%) related to hospital exclusions and restrictions. While any complaint to PHIO is a serious matter, we note there are 1.4 million exclusionary policies in force (and so the complaint rate is an enviable 0.02%). The low complaint rate suggests that insurers are clearly communicating exclusions and restrictions through marketing material and standard information statements. The annual hirmaa surveys are further evidence that members understand their health insurance (refer to Section H). 12

13 One size fits all? While the discussion paper includes statistics on many areas, there are a couple of statements in this section that appear to be assertions: Exclusionary products are chosen, but not valued, by price sensitive consumers [Exclusionary policies are] largely considered to be in the interests of insurers, not customers It would be interesting to see whether these can be supported by evidence. Counter examples might be older people choosing to exclude obstetrics related cover, or young people excluding joint replacement. Some members value health insurance but cannot afford the highest levels of cover. Community Rating The report notes that exclusions are viewed by some industry stakeholders as counter productive to community rating, and some of our member funds would share this view. An alternative view is that basic hospital products support community rating through risk equalisation. All products with hospital cover make the same contribution to the risk equalisation pool, regardless of the number of restrictions or exclusions (risk equalisation contribution varies depending only on scale, for example, single or family). Basic products therefore subsidise high cost claimants on comprehensive products. Indeed, this subsidy represents most of the cost of basic products. This subsidy would not be available if healthy customers on basic products dropped their cover. General Treatment Only Products The discussion paper shows statistics on the number of general treatment only policies, how this varies between insurers and how this has changed over time. It may be useful for PACU to separate ambulance only policies, which may explain some of the differences shown. The discussion document says there is a slight increasing trend in take up of general treatment only products, so it would seem unwise to draw too strong a conclusion here. As PHIAC notes elsewhere in the report, the number of people with hospital cover is also growing. 13

14 D. Pricing Oversight and Other Regulations Your Questions Q9 Are the prescribed requirements on product content and pricing oversight a material barrier to competition? Q12 How could the regulatory system be strengthened or improved to promote further competition as the industry faces further challenges associated with population ageing, deteriorating population health, and rising healthcare costs? Key Points We commented on product design in the previous section, and comment here on pricing oversight and other aspects of regulation. The flaws of the current process of pricing oversight are well documented. Any serious attempt to increase competition in PHI would allow the market to set prices. Detailed Response Our member funds are much more than brands This section of the discussion paper states that some of the very small insurers in particular may be more akin to a brand than a separate insurer that competes with others in the market place. Many insurers use the same IT platforms and negotiate hospital contracts together. Funds join purchasing groups such as AHSA to increase efficiency and lower costs (both benefit and operating costs). This efficiency keeps costs down and thereby positively benefits premiums and ultimately the customer. Provider purchasing groups also seek to balance the market power of hospital groups. The demand for common IT platforms and provider contracts reflects the competitive state of the PHI market. Brands are often present in competitive markets. For example, Suncorp s general insurance brands include AAMI, GIO, Vero, Apia and Shannons. In PHI, Medibank uses ahm as a brand, and GMHBA operates Frank and Fit insurance. Brands use the same balance sheet, being supported by a common capital base. They are directed by the same senior management and board. Brands focus on separate channels or niches rather than competing directly. For example, Apia and Shannons target seniors and car enthusiasts respectively. Another example is that only Medibank s ahm branded products are offered on iselect. Small insurers do not share a balance sheet. Many small insurers compete for members nationally, for example, through intermediaries. While some small insurers target niche markets they remain in competition with other insurers. For example, transport workers have a choice of two competing restricted insurers, or any open insurer. 14

15 Pricing Oversight The flaws of the current process of pricing oversight are well documented. A recent report 1 noted seven separate studies of PHI pricing had concluded the process was sub optimal. The studies have been prepared by Australia s competition experts, being leading firms of economists and the Industry Commission. Health insurers are competing strongly within the current regulations, which include price and product controls (as well as the broad Medicare system). We agree with the economists that you can t have a truly competitive industry if government decides the amount and timing of any price change. Any serious attempt to increase competition in PHI would allow the market to set prices. Other Regulations The discussion paper summarises PHI regulations including premium approval, premium rebates, lifetime health cover and the Medicare levy surcharge. In summary, PHIAC notes that almost every element of the business of a private health insurer is regulated. The paper notes the important issues of population ageing, deteriorating population health, and rising healthcare costs. The paper asks whether the regulatory system be strengthened or improved to promote further competition as the industry meets these challenges. These population challenges are among the most difficult facing the world over the next fifty years. We are not aware that any country has resolved these issues, but make the following observations: The population issues are challenging all economies, regardless of the insurance models adopted. It is not clear whether the level of PHI competition will have a material effect on how well Australia responds to these challenges. PHIAC has not provided any examples of industries it regards as competitive, and which demonstrate how Australian PHI could improve. It may be that Australian PHI is the model for others to follow. However, it is hard to imagine that strengthening regulation is the appropriate response to ageing population challenges. Australian PHI is made affordable for older or less healthy people by encouraging large numbers of young, healthy Australians to insure. The key to affordability is therefore to make sure PHI remains attractive to younger Australians. We note that the government has proposed that the PHI premium rebate should increase only in line with CPI. PHI premiums increase much faster than CPI, reflecting factors such as our ageing population and improved medical technology. This change therefore makes it more difficult for Australia to deal with an ageing population. 1 Medibank: The Future of Private Health Insurance Premium Setting: Seeking Integrated Solutions 15

16 E. Community Rating and Risk Equalisation Your Questions Q8 Does community rating create a barrier to pricing innovation and reduce incentives to keep the sick well? If so, in what way? Q10 Does risk equalisation penalise insurers in ways that adversely affects competition between insurers? If so, then in what way? Q11 Can the current model of risk equalisation be changed to improve efficiency and competition? If so, in what way? Key Points Some form of risk equalisation is essential to support community rating, so we consider these issues together. Our member funds have a range of views on community rating and risk equalisation, so we will not be commenting in detail on possible changes. PHIAC does not give a definition of competition, or any examples of industries it considers to be competitive. However, we would be surprised if any examples featured community rating and risk equalisation (not to mention price controls and regulations on product design). Community rating and risk equalisation were not introduced to promote competition and innovation, but rather to ensure PHI is accessible to all Australians. Any study of the PHI industry clearly needs to consider broader public policy issues, in particular community rating. PHIAC may form a view that community rating, and many of the other restrictions, are more important than competition. 16

17 F. Barriers to Entry Your Questions Q13 Is the number of new entrants into the private health insurance market a signal that market entry barriers are prohibitive? Q14 Is there any market based factor, including the behaviour of incumbent insurers, that acts as a barrier to entry? Q15 What are the main advantages of long tenure in the market? Key Points We cannot identify any significant barriers to entry into the industry. The fact companies have entered the industry in recent years demonstrates this to be the case. Companies consider both risk and return when deciding whether to enter a new industry. While PHIAC states that returns have been high in recent years, PHI is subject to a high degree of sovereign risk. Insurers are unable to determine what they cover, what is paid to providers, or the price charged to customers. Government support to the industry is continually under review. Sovereign risk is the main reason for relatively few new entrants. Detailed Response There are no significant barriers to entry PHIAC notes that the lack of economies of scale is often a key barrier to firms entering an industry, but that the PHI market has solved for this through the development of industry links, such as contract negotiation, claiming technology and IT systems. The reality is that other than those related to customer loyalty, barriers are low to moderate. The industry is not accountable if outsiders or potential entrants see it otherwise. PHIAC concludes that the main barriers to entry are regulatory registration and associated requirements such as the need to put up capital. While we agree these are the main barriers, they do not appear to be significant barriers at all. For example, most international financial organisations would be able to meet the regulatory and capital requirements. PHIAC names three recent entrants, BUPA, NHBA and health.com.au, which demonstrate the absence of barriers to entry. We note that health.com.au was able to join AHSA and other industry groups. Another recent entrant is Avant, which acquired the Doctors Health Fund. One health insurer is listed on the ASX, so is available for sale to anyone wanting to enter the industry. There are many potential entrants Large financial businesses are continually looking for investment opportunities. For example, looking at the three largest Australian general insurers: 17

18 QBE has acquired around 30 businesses in the last 10 years to enter new regions and product markets Insurance Australia Group (IAG) has acquired 10 business in the last 10 years, as well as expanding existing business into new markets Suncorp is the product of numerous mergers and acquisitions, and now participates in general insurance, life insurance and banking. The three large Australian general insurers are clearly looking for new financial markets to invest in, but have chosen not to underwrite Australia private health insurance. And indeed, one of those groups (IAG) acquired a health insurer only to later exit the market. Many overseas organisations would also have considered underwriting in Australia, but have clearly decided not to. The best way to find out why these organisations haven t entered Australian PHI would be to interview them and understand what barriers or risks prohibited their entry into the market. Sovereign risk keeps new entrants away PHIAC states that private health insurers have experienced high returns on capital in recent years. Insurers need to charge a margin over expected costs in case experience is worse than expected. The ability to change premiums no more than annually increases the required margin. A large part of the profit margin is needed to meet increasing capital requirements, rather than being available for payment as a dividend. Many of our member funds are not for profit, so returns on capital benefit future generations of members. Companies consider both risk and return when deciding whether to enter a new industry. The key financial risks in Australian PHI include: Price: Ministerial approval is required for price changes. Government may prevent an insurer charging the necessary premiums. Government has established PACU to place downward pressure on industry costs and premiums. Government Support: The industry relies on industry support through premium rebates, lifetime health cover loadings and the Medicare levy surcharge. The level of support changes almost every year. Costs: Insurers have limited ability to control claim costs, which may be specified by law. Product Design: Insurers have limited ability to change product design. Prudential: Firms that try to grow market share have been subject to extensive regulatory oversight. Given such an uncertain business environment, it is not surprising that only a small number of firms have decided to invest in the industry. 18

19 We also note PHIAC s comment that: the rewards for innovation are shaped by regulation of premiums and risk sharing between insurers. This describes what would happen if a new insurer were able to navigate the risks and restrictions, launch a successful new product and underwrite profitability. Risk sharing through risk equalisation would increase the insurers claim costs. If any profit margin remained, this would be reduced to the minimum necessary through the pricing process. A potential future challenge The government has proposed that the PHI premium rebate should increase only in line with CPI. PHI premiums increase much faster than CPI, reflecting factors such as new medical technologies and an ageing population. The government is, in effect, phasing out the rebate over a number of years, and this is an example of sovereign risk as discussed above. The details of how this will be implemented are still to be determined. Government officials have told our member funds that the rebate will vary from product to product, and between insurers. Products issued by new insurers will receive the industry average rebate. This means that premiums (and competition) may reflect differences in rebate levels between insurers, rather than insurer efficiency. Advantages of Long Tenure Insurers with long tenure have staff, IT systems and other assets necessary to run an insurer. However, as described above, it is possible for new entrants to hire staff and obtain the assets required to operate a health insurer. Insurers with long tenure also have an existing customer base, and goodwill built up through decades of serving the community. Goodwill can provide a cost effective way to recruit new members, and so is a valuable advantage of long tenure. However, retaining members (and the associated goodwill) requires the insurer to provide excellent customer service. 19

20 G. Economies of Scale Your Questions Q16 What does the expansion of insurers outside of their core business, and/or more deeply and more broadly into improving member health, mean for competition? Q17 With most insurers able to effectively access economics of scale, either as a single large fund or through co operative arrangements, do scale economies have a material impact on market structure and competition? If so, in what way? Key Points The expansion of insurers outside of their core business is evidence that, where regulation permits, insurers will innovate to compete for business. The discussion paper gives a good description of how smaller funds are able to access economies of scale. One issue deserving consideration is marketing economies of scale. A mass media advertising campaign represents a small proportion of revenue for a large insurer, but is simply unaffordable for smaller insurers. We note that the initiatives taken by our members 20 years ago to develop AHSA and HAMBS have made a significant contribution to competition in the market. We comment further on this in Section I, Intermediaries. 20

21 H. Portability Your Questions Q18 In what way does the price responsiveness of consumers in the private health insurance market affect competition? Do different insurer types (such as open vs restricted) have differing levels of price responsiveness? Q19 What is the role, importance and extent of use of member retention bonuses? How is this seen to affect consumer satisfaction and affect competition or the ability of customers to switch? Key Points Customers remain with an insurer if they are satisfied with service received, and leave if they are not. To suggest otherwise is to insult the intelligence of the customer. This year hirmaa funds surveyed over 16,000 members, finding 98% are satisfied with their fund. Member satisfaction rates have been 97% or higher for each of the last seven years. High levels of customer satisfaction are the reason people tend to remain with the same insurer. High retention rates are not evidence that members take a set and forget approach to insurance. Most members reported that they understand their cover and review it regularly. And this understanding will only grow as the use of intermediaries, comparison sites and product review sites continues to expand. The expense of recruiting new members must be recovered from premiums. High retention rates allow insurers to spend premiums of healthcare rather than paperwork. Detailed Response Member Satisfaction The discussion paper raises many of the issues relevant to portability. The discussion paper is correct to note that members will stay with the same fund if they are happy with the product and service offered. Member satisfaction is a key objective for our member funds, who carefully monitor their performance in this area. The hirmaa survey interviewed 16,000 members of 11 funds, and found 98% to be satisfied with their fund. This is in line with results from previous years, as shown in the figure below. 21

22 Figure 6 Members Satisfied with Health Fund (%) 100% 98% 98% 98% 98% 97% 98% 97% Members Satisfied (%) 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Survey Year It would be surprising to see high rates of transfers between funds given these member satisfaction rates. Regulation Limits Competition Regulations restrict what can be covered under health insurance policies, and cost sharing (through risk equalisation) makes it difficult for one insurer to charge significantly less than another. Insurers have to compete through factors other than price and coverage, for example, the level of customer service. The survey results show most insurers are competing for members by providing excellent customer service. Product Complexity Health insurance can be complex. We note that much of the complexity relates to government incentives or regulations on product design, and so is beyond the control of insurers. Insurers want customers to understand their policies, and work hard to explain their products. The hirmaa survey provides evidence that customers do understand their cover, with just 5% not having a good level of understanding. 22

23 Figure 7 Q: I have a good understanding of my cover and how it works (Responses: 15,946) 0% 10% 20% 30% 40% 50% 60% Strongly agree Somewhat agree Neither agree nor disagree Somewhat disagree Strongly disagree Measures of Stickiness The discussion paper uses high insurer retention rates to suggest that customers are taking a set and forget approach and not reviewing their cover. Retention statistics do not show whether or not a member has reviewed their cover. Customers remain with an insurer if they are satisfied with the service received, and happy with the value of the product. However, they will change their cover as their needs or budgets change. Customers regularly contact our member funds to review coverage, change their excess, or add or remove people from the policy. The current trend is to downgrade cover, which may reflect changes to rebates or premium increases (which in turn reflect increases in the utilisation and cost of health care). Customers often ask questions about their coverage, which may or may not result in a change in policy. None of these activities are captured in retention statistics. The level of customer shopping is therefore much higher than your figures suggest. Members are sent Standard Information Statements (SIS) each year, which provide a concise summary of their benefits. SIS mailings prompt members to review their cover; we know this because many call our member funds after receiving the statements. PHIAC notes that products are heavily advertised in all forms of media (P7 of discussion paper). The industry is regularly in the news, with annual price changes receiving extensive media coverage. Every policyholder must know there are a range of health insurers competing for their business. 23

24 High Retention Rates Benefit All Members Insurers incur expenses in recruiting new members and processing new applications for cover. One consequence of higher churn between funds would be an increase in industry management expenses, which would necessarily flow through to higher premiums. High retention rates allow insurers to spend premiums on healthcare rather than paperwork. High retention rates therefore benefit members. Retention Bonuses Member retention bonuses or loyalty schemes operate in a number of industries, such as airlines, hotels and supermarkets. Member retention bonuses are evidence that, to the extent permitted by regulation, insurers innovate to improve member benefits and retain customers. If member inertia was as significant as PHIAC suggests, there would be no need to offer member retention bonuses. As noted above, management expenses are lower for renewing members than for new members. There is therefore an element of fairness in offering higher benefits to members of longstanding, recognising the lower management expenses. Open and Restricted Insurers Portability regulations are common to different insurer types (open vs restricted), and there do not appear to be significant differences in price responsiveness between different insurers. The underlying factors are the same across the industry customers leave if they are unhappy with the service provided. Playing by the rules Large insurers are losing market share to smaller funds (refer to charts in Section A). Some of our members report that, when a customer wants to transfer to their fund, the large funds make this more difficult that it needs to be. Customers have a legal right to change, and this process should be as straight forward as possible. Tactics such as aggressive customer retention teams and slow release of clearance certificates may be within the letter of the law, but are clearly contrary to the spirit of portability. The Code of Conduct covers portability and, while good in principle, appears to be flaunted by some larger funds. 24

25 I. Intermediaries Your Questions Q20 What role (sic) have intermediaries had on the level of competition between insurers for both new members and switching members? Q21 What role do intermediaries have in increasing the contestability of the market for new entrants? Q22 How well are intermediaries able to overcome the underlying stickiness and complexity of private health insurance to promote efficient customer switching? Key Points Intermediaries provide an additional sales channel, allowing smaller funds to compete in markets that would otherwise be inaccessible. Intermediaries therefore increase competition in PHI. Detailed Response Part of the Competitive Landscape The discussion paper raises the key issues relevant to intermediaries. In particular, PHIAC is correct that intermediaries are now part of the competitive landscape discussing the pros and cons is perhaps just an academic exercise. We note that intermediaries are just one of many possible distribution channels for health insurance. The board of each fund decides which channels to use, reflecting the objectives of the fund. Stickiness and Complexity We refer you to our previous comments on these issues (Section H). In summary, the evidence is that: Health insurance can be complex, with regulations driving much of the complexity o However, insurers work hard to explain the cover, and most members understand their products (as evidenced by the hirmaa survey) Members review and change their cover when their needs change o Members are not sticky, but satisfied. Given 98% of members are satisfied with their insurer (based on the hirmaa survey), why is there a drive to encourage switching between insurers? 25

26 J. Supply Chain Your Questions Q23 To what extent does market size matter to pricing outcomes achieved along the supply chain? Q24 Is market power spread efficiently across the supply chain in private health insurance? Key Points PACU has been formed to put downward pressure on industry costs and premiums 2. Since claim costs account for around 85% of premiums, it is surprising supply chain issues did not feature more prominently in the discussion paper. Many supply costs are determined by regulation. These costs are therefore outside the control of insurers, regardless of market size. Providers are subject to much less regulation than insurers, with regards to pricing and transparency. For example, while PHIAC publishes detailed financial information on insurers, much less information is available on providers. While there is not enough public information to comment definitively on the spread of market power, the available statistics such as hospital profit margins suggest providers have the upper hand. We suggest that removing second tier rates for hospitals would be a simple and effective way to promote competition in PHI, by removing the artificial price floor. We note that the existence of AHSA is an important counterbalance to the power of providers. Detailed Response No one monitors provider competition The discussion paper shows detailed statistics on market share, management expenses and surplus/profit for every insurer. While expenses and profit only account for around 15% of premium, insurers are happy to subject their finances to scrutiny, and be accountable to their members. The other 85% of premium is paid to service providers. Do these businesses operate efficiently, and are the profit margins reasonable? Do customers have sufficient information to choose the best doctor, dentist or hospital? How could competition amongst prosthesis manufacturers be improved? The amount of premium paid to providers means these are important questions. There are no statistics on provider competition in the discussion paper. However, PHIAC notes that According to some views, the process of winning and retaining work for private health insurers is intensely contested and very price competitive (P7 of discussion paper). 2 Source: Government announcement of PACU s formation in Portfolio Budget Statements , Department of Health and Ageing 26

27 Given that 85% of premium goes to providers, we suggest PHIAC would be hasty to give providers the tick of approval based on anecdotal evidence. PHIAC should collect and analyse the relevant statistics before commenting on provider markets. Available statistics suggest providers have the upper hand While there is not enough public information to comment definitively on the spread of market power, the available statistics such as hospital profit margins suggest providers have the upper hand. The following statistics are taken from the most recent reports published by Ramsay and Healthscope. The profit margins of 15% are around three times the level of health insurers. Table 1 Hospital Profitability Hospital Group Ramsay Healthscope Revenue ($m) 3,179 1,065 EBITDA ($m) Profit Margin (%) 15% 15% Source: Company annual reports Ramsay figures are for year ending 30/6/12, and refer to the Asia Pacific region Healthscope figures are for the year ending 30/6/11, and refer to the Australia region We note that the Ramsay reported figures are for the entire Asia Pacific region. We don t know how Ramsay s profit margins on Australian private health insurance compare to profits for other Australian funders (such as Department of Veterans Affairs), or profits in other countries. While health insurers are able to negotiate contracts, bargaining power is constrained by the consequences of going out of contract. Going out of contract with a large hospital chain results in increased costs for both the insurer and member, noting alternative hospitals may not be available. Smaller hospitals without a contract have the security of second tier rates. We suggest that removing second tier rates would be a simple but effective way to promote competition in PHI. Abolishing second tier rates would also save administration costs for DoHA and insurers, allowing more money to be spent on patient care. Regulation limits our ability to negotiate There are many cost areas insurers are unable to control, regardless of scale. Examples include: Any amount specified on the Medicare Benefits Schedule (MBS) Prosthesis listed by the government, even if prices are higher than those charged to public hospitals or hospitals overseas, or research suggests an alternative prosthesis may represent better value for money Specifying prices for prosthesis without a mechanism for review relating to exchange rate means that the benefit of the stronger Australian dollar has largely gone to prosthesis manufacturers rather than customers in Australia Rates for private patients in public hospitals. Regulations prevent insurers achieving the most cost effective outcome for our members. 27