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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 Business School, 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 of self 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.

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 distort government 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.

To break these forces of self selection, the Federal government has adopted a variety of measures to encourage people back into the private health system. Rebates, a Medicare surcharge levy, and lifetime cover opportunities. These have appear to have worked but they leave the system balanced on tender hooks. Governments face pressure to improve the public system. Ordinarily, this would be a matter of putting in more resources as you might do for defence, scientific research and the environment. However, under our health system, any improvement to the public system creates a real risk that households will move away from the private system. This will cost the government, either to accommodate them or to bribe them to stay away. So improvements to the public system are doubly costly on the public purse. This dilemma restricts the resources available for public care and distorts the way that care is provided. A good example of this is the somewhat arbitrary restriction on receiving public care in public hospitals. Why should the ownership of hospitals be linked to the ownership of insurance? There is no reason why privatelyowned hospitals could not serve patients with either public or private insurance. A Medicare patient could be treated in a privately-owned hospital on the same basis as they would be treated in a publicly-owned hospital. Separating patients between hospitals on the basis of ownership reduces flexibility in health care and exacerbates waiting lists. Consider the prohibition on the choice of doctor in the public system. Is it really the case that the costs of allowing some choice after all, it is not that free under the private system is prohibitive? The main consequences may be that a patient has to wait for their preferred doctor. To date no political party has been willing to advocate allowing choice of doctor in the public system for fear of collapsing the demand for private health cover with undesirable fiscal consequences. One suspects a similar concern arises for dental care (much of which has equal health merit to procedures in Medicare) but here at least Mark Latham has promised to make amends. Alongside the distortion of public health choices, the current system also works against providing the insurance that is desired by all. This is because those people who take out private health insurance effectively pay twice through compulsory contributions to Medicare and their own premium payments. If you couple this with our earlier argument that those going private are also those most at risk of falling ill, the goal of social pooling of health risks is completely undermined. In effect, those who are most at risk of requiring medical care buy private insurance and cross subsidise those who rely on public health insurance. Thus, Australia has a

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 insurance supplemental 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 insurance: Gans and Stephen King on health