The Australian private health insurance boom: was it subsidies or liberalised regulation?

Economic Papers (Economic Society of Australia), March, 2003 by H.E. III Frech, Sandra Hopkins, Garry MacDonald

1 Introduction

Over a three-year period from July 1997 to July 2000, the Australian government introduced two waves of price subsidies, then liberalised regulation to increase private health insurance coverage. The combined effect of the policies was an increase in the population coverage from a low point of 30.1 percent to 45.7 percent (1). A motivation for the policy changes was to induce more Australians to use the private sector for their hospital care and in so doing reduce the pressure on the public sector.

Most of the increase in coverage occurred after the introduction of the last policy change of liberalised regulation, prompting many commentators (Butler, 2001, Willcox, 2001) to attribute almost all the increase to the introduction of this policy. We explore the relative impact of the different policy changes using trend analysis and careful attention to timing. While much of the increase in coverage may be attributed to liberalised regulation, the price subsidy did increase coverage. The increase was commensurate with existing estimates of the price elasticity of demand for health insurance.

2 The policy changes

The three new policies designed to promote private health insurance were introduced over a three-year period. The changes included tax surcharges on high-income earners, subsidies on the price of insurance, risk rating of policies and the introduction of a broader range of insurance policies (Hopkins and Frech, 2001).

The first policy change, in July 1997, had two parts. The first part introduced a tax surcharge to induce high-income earners to purchase private health insurance. Couples with annual incomes above $100,000 and singles with incomes over $50,000 are charged an income tax surcharge of 1 percent of their income if they fail to purchase private health insurance. The second part of the policy instituted a means-tested partial refund on health insurance premiums to encourage those with lower incomes to also purchase private health insurance.

The response to this policy was underwhelming. The percentage of the population with private health insurance actually declined from 31.9 at the 30 June 1997 to 30.1 the end of December 1998 (refer to Table 1).

The second policy change, effective from January 1999, provided for a 30 percent rebate (subsidy) on all health insurance. The rebate was not means-tested. Policyholders receive the subsidy through a 30 percent reduction in the insurance premium, as a payment from the Health Insurance Commission or as a tax offset at the end of the year. Over 70 percent of people opt for a reduction in the premium which means that the impact of the subsidy is effective immediately (Butler, 2001).

On the face of it, the response to the substantial rebate was surprisingly slow and small. The percentage of the population with private health insurance increased from 30.1 percent at the end of 1998 to 31.3 percent at the end of 1999 (refer to Table 1.).

The third policy change liberalised the regulations on policy benefits and community rating. The centrepiece of the policy, known as "Lifetime Health Cover", introduced a limited amount of age-rating known as lifetime community rating, into private health insurance. The regulatory change enables people insured before the age of 30 to take advantage of a base premium. The base premium also applies to people over the age of 30 who purchased a policy before the deadline of the 30t June 2000. People who join up after the deadline are penalised by an increase in the base premium of 2 percent for each year the individual is over 30 at the time of first joining, with a ceiling of 70 percent over the base premium. The new prices took effect in July 2000.

The effect of the introduction of lifetime community rating was impressive. The percentage of persons with private health insurance jumped from 31.3 at the end of 1999 to 43 at the end of June 2000 (refer to Table 1).

3 Trend analysis

We use quarterly data on the percentage of the Australian population with private health insurance from the March quarter 1987 to the March quarter 1997 to fit a deterministic trend. This is a period of stable policies. The trend is fitted by regressing the percentage of the population with health insurance on a constant and a time variable. The first quarter 1997 corresponds to the first policy change of a means tested subsidy and tax surcharge for high-income earners. The estimated model is used to forecast forward from the first quarter 1997.

Fitting a deterministic trend to the data is very simplistic. But, the model fits remarkably well during the stable policy regime. The estimation of an alternative more sophisticated forecast of a random walk model with negative drift and using stationary data yields similar results to the simple deterministic model (2). Since the deterministic trend and the negative drift terms give us broadly the same picture, we chose to stick with the simpler method of analysis.

Our approach suffers from the limitation of implicitly assuming that the same determinants have driven the decline in coverage in each period, in spite of the changes in policy. An alternative, albeit problematic, method of mapping the decline in coverage would be to develop a model of the demand for private health insurance with structural breaks for the changes in policy. There would be insufficient data points to use this method.