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"System Blocks Better Health Care," Australian

Financial Review, 22nd March 2004.

It's time to rethink the design of Australia's health insurance system, argue

economists, Professors Joshua Gans and Stephen King of Melbourne BusinessSchool, University of Melbourne.

Imagine a perfect world of complete comprehensive, universal health

insurance. No one would face any financial burden when they fell sick. Everyone

would be able to utilise care of the highest quality both during treatment and

recuperation. And all this without any waiting. This is a world where individuals

health risks have been completely removed.

While nice to imagine, the simple fact is that the economics of health care

does not (yet) permit this world. Governments may aim for perfect universal

coverage, but reality falls short. Indeed, neither the government nor the market comes

even close. As we will argue here, the way we have set up the health system actively

works against improving the level of health insurance. This is because health

insurance is governed by the forces ofself selection.

Lets start with the private market. Self selection drives away those with low

health risk and makes insurance expensive for those more at risk. To see this, suppose

that private insurers set a premium based on the average population health risk. Then

those individuals and families who have a lower than average health risk would find

the price of health insurance too high. But if some low risk families fail to buy private

health insurance then the average risk faced by insurance companies increases and to

remain profitable, premiums must rise. This in turn leads more low risk families to

drop out. In a purely private market for health insurance either high risk families will

pay more for insurance than low risk families or only those who face a high risk of

medical care and hospitalisation will find it worthwhile to buy insurance.

Many societies, however, find such outcomes unacceptable. It seems unfair

that people who face the highest health risk -- the elderly, couples just starting a

family or people with a history of poor health -- should be forced to pay more for

health insurance. It is considered unconscionable to deny medical services to someone

who needs them simply because they lack health insurance and cannot afford to pay

for the treatment. Governments become involved in the provision of health insurance

because a private market outcome would not be either efficient or fair.

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Governments do not, however, provide fully comprehensive universal health

insurance. Providing this insurance for all Australians would be extremely expensive

and would create strong incentives for wasteful over-servicing. As a result, a mixed

system of public (Medicare) and private health insurance has evolved in Australia.

But it too is plagued by self selection.

Even with Medicare, some households self select into the private health

system. The private option allows households to avoid queues that have become a

hallmark of the public system for non-critical procedures. They also receive a higher

level of hospital service including a private room and have a right to their choice of

doctor. If individuals purchase ancillary health insurance then they are covered for a

range of medical expenses, such as dental and optical expenses, that are generally not

freely available in the public system.

But who chooses to go private? For starters, those who can afford it. Because

private health insurance overlaps with Medicare, those utilising the private system

bear one way or another the full costs of procedures. However, because it provides

a higher quality of care, private health insurance better insures against health risk. For

that reason, like any insurance market, private health insurance also attracts those with

greatest risk of falling ill.

Private insurance attracts the well to do and the less healthy because it

provides extra benefits compared with the public system. But every person that goes

private helps the public system. The quality of the public system depends on

congestion, and those who opt to go private reduce this congestion. They also save

public money. People insured by Medicare utilise public hospitals with limited

budgets. Using private health services with private insurance reduces these budget

pressures. This tension between the private and public systems drives health debates.

What are the consequences of these forces of self selection? First, they distortgovernment choices regarding the resources devoted to the public system. Until

recently, the private system was losing. There was a steady decline in the proportion

of Australians taking out private insurance. These people drifted back into the public

system. This drift included many younger Australians who were able to afford private

insurance but did not find it worthwhile. This had both the effect of increasing

congestion in the public system but also degrading the risk profile of those taking

private insurance. Market forces took over, premiums rose and the tide continued.

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health insurance system which makes the ill cross subsidise the well. Of course, good

health insurance is meant to protect the ill in Australia we do the opposite. We have

anti-insurance.

Supporters of the current system counter that wealthier individuals are also

more likely to buy private health insurance than the poor, and as a result the rich cross

subsidise the poor. This is true, but is no defence for the current system. Income

redistribution should not be carried out under the guise of health insurance. If we

believe that the government should tax the rich more and provide more benefits to the

poor then this should be done in a clear, transparent fashion. Further, the health

insurance system transfers money from the sick rich to everyone else. The poor rely

on public health insurance but so too do the well rich. At best, the equity of taxing the

sick rich to pay both the well rich and the poor is debateable.

Some recent changes, in particular the government rebate on private health

insurance, have helped to reverse the distortions in Australias health insurance

system. Essentially the rebate means that families who buy private insurance get a

refund on their public insurance premium. This reduces the pay twice effect. Other

changes, such as taxation penalties for high income earners who do not buy private

health insurance, however, are based on the wrong-headed notion that health

insurance should be used for income redistribution. Further, even the rebate is a

poorly designed band aid. By effectively subsidising the marginal price of private

health insurance, the rebate encourages families to over insure and take out coverage

that they value at less than the cost.

A better answer is to rethink the design of Australias health insurance system.

Ownership of hospitals needs to be clearly separated from ownership of insurance.

The quality of the public health insurance scheme should be maintained and, in our

opinion, expanded. Health insurance should not be used for back-door income

redistribution. The best way to ensure this is to make private health insurancesupplemental to the public system. Private health insurance would only cover services

and procedures not covered by Medicare, and it would not duplicate any part of public

insurance. Such reforms will increase government expenditure on health care but will

also improve the efficiency of health care delivery and raise the level of health

insurance protection for all Australians. It might not result in a perfect world, but it

would be a lot better than the current one!

For more by Joshua Gans and Stephen King on health

insurance: www.economics.com.au.

http://www.economics.com.au/http://www.economics.com.au/

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