Model vs reality in health care funding

There is a detailed academic debate surrounding health care funding and provision in Australia (as there is globally).

But the debate is clouded by observer bias – by the relatively wealthy senior academics, government officials, and consultants, who provide the analysis in the policy-making environment.  If everyone involved feels burdened by their own choice to send their children to private school, or irrationally choose private health insurance, because of a culture of social class bias, what type of policy recommendations can you expect?

Consider the King-Gans argument, based on a theoretical micro-economic model of health insurance developed in this paper.  The model assumes individuals with perfect knowledge of future health care needs, which leads to a massive adverse selection problem for the private health insurance market.  After a few pages of mathematical labyrinths, the conclusion follows that:

…those in society who are most likely to be ill will ‘opt out’ of public insurance and purchase private insurance. The public health insurance will only be used by those in society who are healthiest (i.e. least likely to become ill). The high-risk individuals are made worse off by the public insurance because they are required to cross-subsidise the public insurance of the low-risk individuals through the tax system (my emphasis).

This conclusion completely contradicts the current reality in Australian health care, whereby the public system typically deals with the most serious cases of trauma and chronic illness.  While the model conclusions are laughable, the policy implications that follow from this model outcome are actually being taken seriously.

As far as the details of the model are concerned, we all know the best measure of a model’s usefulness is how well it predicts outcomes.  The King-Gans model requires the following assumptions to come to the conclusion that a mix of private and public insurance will result in higher cost to the most ill people, because only the most ill will choose private health insurance:

  1. Adverse selection of private health insurance by a set of people who happen to know in advance their future health care needs and probability of illness
  2. People value actuarial fair insurance.  That is to say that they value insurance only as a tool for spreading health costs over their lifetime.
  3. They assume a perfectly competitive private insurance market.  While the market is good, I would be hesitant to got that far, but it is probably okay.
  4. They assume there are not ‘too few’ people with a high risk of being ill who know their risk in advance.
  5. They assume identical income for all individuals at a level that justifies PHI for those individuals who know their risk of illness, and subsequently their expected future health costs, in advance.
  6. The ignore all externalities associated with health care.

For me, apart from the above-list of unrealistic assumptions, the analysis ignores the critical fact that risk averse wealthy people will both choose private health insurance (PHI) AND preventative health care through healthy living choices.  PHI is a complement to better voluntary health choices, so we should expect that private patients are typically the healthier members of society, and the publicly funded public hospitals will be treating the most ill patients.

This paper, by Buchmueller et al., finds empirical evidence that contradicts the result of the King-Gans theoretical model.  They find that there is beneficial selection of PHI in Australia, meaning that the healthiest people tend to be privately insured.  May I suggest this conflict between empirical ‘reality’ and theoretical abstraction is the result of the above ignore concept of complementarity of PHI and healthy lifestyle choices.

The conflicting result is also a product of ignoring the relationship between income, health, and PHI.  Higher income people both typically value health more highly (since the can, even though it may not be as high as a proportion of their income of many not-so-wealthy individuals), and are incentivised to be covered by PHI through tax rebates.

The second major shortcoming of the King-Gans model, and the analysis of health care funding and insurance more generally, is that it ignores the fact that end of life health costs are unavoidable.  Death is usually a costly process.  Thus, there is no way to adversely select health insurance for these ‘death costs’ in advance.

Third, many PHI covers are incomplete covers.  That is, that when a health service is claimed against the insurance cover, the reimbursement is a fraction of the total cost, and there are still out-of-pocket costs for the patient.  Thus, for anyone expecting to require a lot of non-elected medical care, public health provision may be the rational choice, given the risk-adjusted premiums for the most comprehensive PHI cover.

Fourth, PHI is incomplete in terms of scope of medical coverage.  Emergency departments, for example, are typically the domain of public hospitals, treating public and privately insured patients at public cost.

In all, these overlooked considerations render the theoretical outcomes of the King-Gans model inaccurate, and the policy implications that follow from it to be counterproductive.  The reality of beneficial selection of PHI means that wealthy sick individuals are provided a premium health insurance service, because their insurance funds are pooled with a selection of healthy people, to offer an attractive way of making elective health services more affordable.

While King and Gans acknowledge some of these shortcomings, they stand by the conclusions of their model, which feed into their policy recommendations.  Given their academic reputations in the policy-making community, this is dangerous territory.

Finally, my personal gripe with the paper, and the policy agenda being pushed of a result of this (and similar) analysis, is that it ignores the social agreement that has evolved to the current provision of a pooled national health insurance program.  When PHI coverage was over 70% in the 1970s, reforms were aimed at generating a more equitable and broader system of public health coverage.  The very nature of a mostly private health care system is that the unhealthy poor have both the highest need, and the least ability to pay for health services.

That basic philosophy of public health care is that national insurance, funded in a progressive manner through the tax system rather than through actuarial risk-reflective premiums, is provided by publicly run enterprises to fulfill equity considerations (for example, geographically equitable access to health care) and provide broad external community benefits by having a healthier population.

It is also easier to evolve a publicly run system of hospitals and health services to become a platform for implementing auxiliary health policy goals, such as vaccination programs, education programs, doctor training programs, and research.  The current system provides, on the whole, quite a reasonable combination of the benefits of both a private and public system, even if it does perpetuate notions of social class in Australia.

All things considered, the legislation currently being proposed to remove the income tax rebate for individuals covered by PHI may actually promote a more effective market for PHI to offer simple top-up coverage at reduced cost, and generate a welfare shift from the wealthy insured to the poor uninsured. Back in 2004, Dawkins et al. noted that the implementation of the 30% rebate for PHI in 1999 (following more subtle incentives in 1997 and the implementation of ‘lifetime’ health cover) made those on high incomes better off –

There is strong evidence that not only a larger number of households of higher income and socio-economic standings responded to the policy changes, but also they were more likely to have PHI even without the policy changes. These latter households enjoyed “deadweight benefits,” in the sense they needed no such benefits to purchase PHI to begin with. Given that households who took up PHI ought, by their revealed preference, to be better off, we can reasonably conclude that households with high income and socio-economic standings are the main beneficiaries of the policy changes.

As we have seen above, the idea that the ill rich are paying twice for health care is surely not at all representative of the present situation in the Australian health care system, and furthermore, policy advice derived from a bizarre theoretical model whose results oppose the empirical evidence should be carefully scrutinized with a dose of old-fashioned commonsense.

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  1. Can anyone actually explain to me what private health cover actually pays for ?

    In my experience all the actual treatment seems to be paid by medicare and that the Private insurance pays for “extras” and accomodation.

    • From my experience, yes, pretty much the hospital fees are the biggest component of cover from private health care. I am guessing that hospital fees can be quite exorbitant, however. The biggest advantage is getting into the nicer/better private hospitals.

      I think they also cover some other 25% (I think it’s 75% to 25% Medicare to private ratio?) of the scheduled benefit cost, plus some other ancillaries, like part of the blood work and medication and treatments.

    • About 12-15 years ago my mother developed a medical condition that stemmed from an underlying genetic disease that she didn’t even know she had. She required repeated surgeries and skin grafts and was in hospital for quite a long time.

      She swears by PHI because she always had her own private room (as opposed to the 4/6/8 man dorms in public hospitals), and she had her own private specialist who was one of the best in Australia for her condition. And besides some relatively small surcharges from the initial discovery of the condition (she was initially in a public hospital), she didn’t pay a cent for her quite long hospital stay, rehabilitation, outpatient services, etc.

      She also said the doctors and nurses were a lot better in the private hospital and she hated it when she was in the public hospital.

    • If you need elective surgery you can get it done publicly or privately.

      If you get it done publicly, the disadvantages are:

      1) You need to wait on the waiting list.

      2) The trainees (registrars) may do a greater or lesser part of the operation under greater or lesser supervision from the specialist.

      An elective hip replacement performed privately will cost you around $30,000 without insurance. This is hospital fees, theatre fees, equipment fees ($6000 hip prosthesis), and specialist doctors’ fees.

      If you need emergency surgery (think appendicitis), the benefits of private health insurance are less, although because the specialist is able to bill your private health company then he or she will generally be the one performing the surgery rather than the trainee.

  2. I am curious:

    To MB commentators: do you have any private health insurance? If yes, why and if not, why not?

    • I do. My partner has actually a very nice corporate private health scheme, including getting the excess refunded. Seeing as I required an operation in 2011, it actually came in as quite beneficial.

      • Oh, and why?

        I see it as a risk/reward trade off. Having already had 4 operations so far, I see a high downside risk of not having it. The reward of some extra money, pretty much all of which would be eaten by the medicare surcharge anyway, is, quite frankly, not nearly enough reward.

        Particularly for those who intend on having kids.

    • Yes, paying $600/yr to avoid $1200/yr in tax (or something around those figures) (i.e. I come out $600/yr ahead before claiming for optical & dental.)

        • The policies that cost that much are generally the policies that exclude all of the things that you might actually need but think you won’t need, such as cardiac, joint replacement, psychaitric treatment.

          I’ve seen people in their 30s with heart attacks, primary osteoarthritis, and unannounced psychosis (not all the same person, I must add). Most pregnancies are unplanned too.

      • My wife and I have PHI but it’s largely a financial decision (ie: it’s cheaper than the extra tax).

        Eight so years ago my wife had a kidney infection and was treated entirely within the public system with zero complaints (much praise, in fact). She was living in Toowoomba at the time.

    • Jumping jack flash

      I don’t have it as a matter of principal. It is just another wealth transfer device.

      I am young and healthy. I pay my taxes which are precisely for this.

      I even pay the levy and surcharge when required, although I believe these are totally unnecessary considering we now have the GST given to the states.

      If my kids need glasses or fillings I have money set aside for that. Consider that if I did have private health insurance I would be paying a lot of that cost anyway, plus the ongoing monthly premiums that always and forever go up.

      It will be interesting to see what happens when the boomers all want hip and knee replacements. around 60% of boomers I know have had at least one of these procedures performed.

      Will the premiums of the young and healthy increase to cover this? You can bet on it. It is happening already.

        • Jumping jack flash

          2 kids, 2 emergency Cesarians.
          Didn’t need to pay a cent, and I feel no guilt because I pay my dues.
          Now, if I had private cover, I can’t say for sure, but I probably would have been up for something on top of the monthly premiums.
          And I can’t say for sure, but it would have been likely that because we had an emergency Cesar with the first, they wouldn’t have touched the second, or it would have been more expensive, considering the baby was a similar size, and my wife is small with a low pain threshold.

          • It depends on your income level. This is why I think that the modelling done by Doloitte that claims most people would drop their PHI if the 30% is means tested is a load of crap.

            For example, with a medicare surcharge at 1%, that’s, say, $1k on a $100k combined income, or, say, $2k on a $200k combined income.

            In my case, we’ll likely be paying about $2k for the medicare surcharge if we didn’t have private health cover.

            Her private corporate plan (including extras) costs us about $1k per year to cover both of us. It’s an easy decision to make – financially and for peace of mind.

            You can get decent family cover for $2k PA currently (and basic at $1.5k) – so why anyone on over, say, $250k PA would dump their cover if the means test is removed is beyond me.

    • I do ask myself that question sometimes and then I see articles like and I know why I have it. I’m in Queensland but I suspect the same principles apply.

      “The case of a Hobart man who had to wait 15 months for a colonoscopy only to discover he had bowel cancer has highlighted the critical state of hospital waiting lists in Tasmania.”

    • Got it to the tune of 2500 per year. It is a complete waste of money and will get rid of it after I’ve finished having kids.
      We had the last kid in a private hospital. The specialists and assistant surgeons and anthaetists bill you separately and you end up paying a raft of out of pocket costs.
      I think it ran to 3000 out of pocket, before I paid the OB another 5000.
      What am i saving exactly?

  3. Thanks for this very interesting policy analysis.

    I don’t have private health insurance myself as I’m fairly healthy and I’ve heard nothing but bad things about it from friends who have taken it out. The most prominent complaint is that if you are really sick with a chronic illness (such as diabetes or a heart condition) the private system doesn’t want a bar of you because private hospitals make most of their money from short proceedures such as births or quick operations like stents. As a result you can end up getting shunted into the public system as a private patient regardless of your policy or level of cover (“We can’t treat such a complicated problem here”). Once that happens you are up for all sorts of charges that normal public health patients don’t have to pay so it can actually end up costing you money despite the fact that you might have already paid a fortune in policies etc.

    The other problem that I’ve heard about is private health funds refusing to fund or treat ‘pre-existing’ conditions. A friend of mine about six years ago had a private policy in place for nearly three years when he developed a prostate problem. His doctor concluded that he could have actually had the problem for a few years so his fund refused to treat it on the grounds that they considered it to be a pre-exisiting condition; the problem was that he’d already commenced treatment in the private system and as a result he ended up being about four thousand dollars out of pocket and had to move to the public system anyway to finish his treatment. Needless to say he dropped his policy not long after that experience.

  4. I do, following a rather scary incident where I discovered a lump in my elbow, which turned out to be located in a vein. I did not have private health cover, and was on a 5 month waiting list to see a specialist surgeon at the public hospital. Afte a month, my mother wigged out and funded a visit to a private specialist. I had two visits to him plus an MRI, to work out that I didn’t need surgery. Medicare covered somehting like 80 % of the cost. The only thing that private cover would have helped with would have been the day surgery costs.

    I have cover now, primarily for extras. The only thing that seems to be of real value is the glasses- because there is so much competition between providers. There are almost no costs to the patient when getting new glasses. This is because one generally doesn’t get too attached to an optometrist, so it is easier to change to a cheaper provider. With services such as dentists, I am attached to a provider who meets my needs. I don’t feel inclined to switch to a “fund partner” for the privilege of getting all of my check up costs covered.

    My husband and I are in an income bracket where we would be paying the surcharge if no insurance- so I prefer to get something for the extra money. I suspect that a reduction in the surcharge and a reduction of the subsidy (simultaneously) would create an exodus, but it might also force the funds to start offering what people want, rather than sticking to a formula set by the government.

    • One othe minor benefit- which is no longer available- was the access to the “emergency clinics” provided by my insurer. wW paid a flat fee of $150 to visit when my husband had breathing problems. Were seen within 30 minutes, xrays and ,meds covered. If we had gone to an ER it would have been a wait calculated in hours. The clinic was not cheap for non fund members- but worth it for us.
      If this cover extended to private ERs this might take some pressure off. I once went to a private hospital ER- in a bed almost before the entry form was complete, heated blankets (it is the little things that matter) and dealt with efficiently, but non-refundable (by anyone) initial payment of $300 plus all of the costs of treatment (later claimed back from Medicare.) They had the required x ray equipment, so was directed there by GP- otherwise not an option.
      The public system is better equipped for major, life threatening issues such as heart attacks, but for anything that is less life and death (broken bones, hip replacements) not so great.

  5. Diogenes the CynicMEMBER

    Rumple what is the alternative model? I read a science fiction story that had a model of a certain amount of cover (indexed for inflation) attached to each citizen when they were born. You could use it as you chose over your lifetime but once the cap was reached you had to pay from your own pocket. Interesting idea, it rewarded those who chose to look after themselves by remaining healthy and prevented excessive medical costs in the final year of life as that was when most people exceeded their “caps.” Of course it does lead to poor results for sick children and I could not see it ever being implemented outside of a dictatorial government.

    We have private health insurance for our family of 4. It paid off with the following situations:
    (1) Busted knee playing indoor soccer, the private health enabled me to quickly have scans, see a specialist and have surgery (on the ACL) saved over 2 years worth of premiums. Apparently this is “elective surgery.” Got a little bit back on the rehab as well.
    (2) My wife had a cancer scare but we managed to identify it very early and have remedial surgery. Saved a year’s worth of premiums. Public health could have meant a very long wait list here with morbidity implications.
    (3) The two births of our children…chose a specialist my wife liked and had pleasant hospital experiences saved 4 years of premiums.
    (4) Glasses and dental have helped but hardly enough to factor into calculations.

    We are healthy, exercise regularly, eat and grow many of our own vegetables etc so we probably could skip the private health if we wanted but I doubt my wife would ever agree. Means testing the rebate on this sucker will not affect us directly but I would expect a few people to drop out and premiums to rise.

    If we could insure for private emergency departments then I am sure my wife would be keen to sign up. Waiting 12 hours to see someone in triage with your sick child is a traumatic experience.

  6. Great pic.

    I’ve got private health care. Fortunately I get it for free through the wifes employer. It’s a no brainer really though to avoid the medicare surcharge, so would have it anyway.

    A recent anecdote on private/public health care.

    My daughter was born with hip dysplasia and needed to go in a brace. We went public for this, and after 12 weeks incorporating 4 appointments with the specialist we never once saw him. Instead his clinic was covered by another doctor (different one each time) who weren’t hip specialists and didn’t really know what they were doing. This culminated in us having a row with the last doctor as he recommended keeping her in the harness for 6 more weeks and we thought he was wrong, so he called the specialist up, who agreed with us based on the scans/test results.

    A few weeks after a friend of ours went private, saw the specialist, had near on identical test results (slightly worse than ours) and was done and dusted in 6 weeks (as should we).

    So we went through six weeks of pain due to the public health service not being good enough.

  7. Part of the issue is that the medicare benefit levels (which drive rebates for medicare and private cover) were last reviewed a decade ago. They have little corellation with actual cost.
    Medicare will generally pay 75% of what the medicare benefit schedule says, and private health cover wil pay the remaining 25%. I am about to embark on some very expensive, somewhat elective medical procedures. The upfront cost (which by no means the total) to commence is around $6,700. The medicare benefit for this- $3000. I will get the full $3000 but no more (that’s still a whopping $800 or so more than I would get without PHI). That leaves me covering more than half the cost out of my pocket. I wish i lived somewhere that was a bit marginal- maybe then my local pollie would care, but I live in K Rudds electorate
    I am firmly of the beleif that gov’t should stop supporting the PHIs, eliminate both the medicare surcharge and the subsidy (howard era inducements) and unfetter the PHI- let them pay what they want, let them charge what they want. I would be much more willing to pay if my PHI promised they would pay 75% of the total cost of what I was doing, not this current mess.
    Of course, finding how much the MBS is not always the easiest task.

  8. I admit that I don’t understand the relative efficiency/effectiveness of PHI in funding the health care the community needs.

    But I would like to understand better the major cost drivers of the current health/sickness system, particularly the costs of hospitalization, the cost of specialist technology and the costs of specialist charges.

    The medical profession needs greater transparency and to be subject to greater accoutability.

  9. Thanks everyone for the great comments.

    Let me respond briefly. I see the comments falling into two major categories.

    1. PHI is a waste of money, because there are still out of pocket expenses and the difference in care is not that great, and

    2. PHI is good value because it paid for itself easily from personal experience (ie. some people have had an unexpectedly high need for health services that was covered by their insurance).

    This makes perfects sense, as it would with any insurance. Because remember, insurance is simply a compulsory savings plan for the pooled risks and health needs of the insured group. Thus, there should be some within the group that ‘consume’ health services that are worth far beyond their personal contribution, and there will be the remaining group who consume far less than their contribution, who effectively pay for the sick people within the insured pool.

    My personal view, given the information at hand, is that self-insurance is by far the optimal approach for those who can afford it. This approach takes advantage of the health services best delivered by the public service (emergency, child birth, etc), and enables private health services to be paid for when required.

    As a side note. since a fairly large chunk of all health care spending is into final year of a patient’s life (12-20% by various estimates) a more tolerant view on euthanasia, and focus on hospice care, will be one of the more welfare enhancing changes to the health system in general (especially given the ageing demographic).