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9.3 A pathway to reforming health care


Health is an issue of great importance to all Australians. While our current health system has many strengths and produces excellent health outcomes for most of us, the nature of health care is highly complex and there are enormous knowledge and information imbalances between users and producers. Illnesses can arrive randomly and often entail significant expense. It is also a reality that sick people often feel vulnerable.

Against this background governments have an essential role to play in the health system.

The combination of demographic trends, income growth and new technologies means that demand for health care in Australia will increase strongly. The reality is that older people tend to use more health care services, which will raise health care costs.

Australia’s approach to health service delivery is underpinned by a universal health care system that includes access under the Medicare Benefits Schedule (MBS) to free or subsidised essential health services, benefits for privately provided medical and pharmaceutical services, access to affordable medicines through the Pharmaceutical Benefits Scheme (PBS), and free public hospital treatment as a public patient.

A private health care system adds to Medicare and allows individuals to make a greater financial contribution towards their health care in return for greater choice about the care they receive.

Health expenditure is a major area of Commonwealth spending, with $65 billion on the health function in 2013-14 accounting for 16 per cent of total Commonwealth expenditure. Expenditure on health programmes is projected to grow by 6.5 per cent per year in nominal terms over the period from 2013-14 to 2023-24 and this growth is expected to continue.

Expenditure on health in Australia has more than doubled as a share of GDP over the last 50 years to just over 9 per cent of GDP in 2010. Such trends are not unique to Australia, with almost all OECD countries seeing health expenditure rise as a share of GDP (OECD, 2013).

Such trends are expected to continue, with the 2010 Intergenerational Report (Australian Government, 2010) projecting Commonwealth expenditure to increase from 4.0 per cent of GDP in 2009-10 to 7.1 per cent by 2050 (Chart 9.3.1). Similarly, recent projections from the Productivity Commission suggest that health expenditure by the Commonwealth Government will rise from around 4.0 per cent of GDP in 2011-12 to 7.0 per cent in 2059-60. Health expenditure by State governments is projected to rise from around 2.5 per cent of GDP to almost 4.0 per cent of GDP over the same period (Productivity Commission, 2013).


Chart 9.3.1: Projected Commonwealth health spending

This chart shows expenditure on private health insurance, the Medicare Benefits Schedule, Hospitals, the Pharmaceutical Benefits Scheme and other health expenditure from 2009-10 to 2022-23. From 2023-24 to 2049-50 it shows total expenditure on health.

Source: Australian Government, 2010.


Public hospitals are the single largest component of the health care system, with about 30 per cent of total health care expenditure directed to Australia’s 753 public hospitals. The cost of public hospital care for the Commonwealth and States exceeds $40 billion a year and is growing well above the inflation rate.

Public health care in Australia is also underpinned by Medicare (refer Attachment 9.3.1) with Commonwealth expenditure on the Medicare Benefits Schedule at around $19 billion in 2013-14. In 2013-14, an estimated 353 million medical and associated services will be funded through Medicare, approximately 15 services per year for each person in Australia (Australian Government, 2013).

While the MBS is responsive to patient needs, it is not efficient at managing health expenditure. One reason for this is the ability for providers to induce demand for services (CEDA, 2013) and another is there is no incentive on the consumer to constrain demand.

Australia’s health care system is also fragmented across several different funding sources. In 2011-12, the Commonwealth Government funded around 43 per cent of expenditure, State governments around 28 per cent and the non-government sector, including individuals and private health insurance (PHI), around 31 per cent. The share of health funding has been relatively stable across these sources since the mid‑1980s (Chart 9.3.2). That said, individual out-of-pocket costs have been growing as a share of non-government funding over this period. In contrast, the proportion funded by individuals through private insurance has tended to fall since the introduction of Medicare (refer Attachment 9.3.2).

Between 2001-02 and 2011-12 funding by individuals grew by an average of 6.1 per cent a year in real terms, compared with an average of 5.4 per cent for total funding of health expenditure (AIHW, 2013c).


Chart 9.3.2: Sources of health funding

This chart shows the sources of funding for health services from 1961-62 to 2011-12. The sources are Australian Government, State and local government and non-government.

Source: Australian Institute of Health and Welfare, 2013c.


Compared with other countries, Australia has an efficient health system that delivers relatively strong health outcomes (OECD, 2010a). According to OECD figures (OECD, 2013), Australia’s average life expectancy of 84 years is better than all but a handful of countries, while our level of health expenditure is below the OECD average in terms of expenditure as a share of GDP. Australians are generally satisfied with the quality of health care they receive, expressing a high level of confidence in the health care system (Menzies Centre for Health Policy, 2012).

That said, Australia’s health expenditure per capita is above the OECD average and, as noted above, expenditure is expected to grow significantly (Chart 9.3.3). Health expenditure also represents one of the Commonwealth’s largest long-run fiscal challenges.


Chart 9.3.3: Projected growth in Commonwealth health spending

This chart shows the projected expenditure for the Medicare Benefits Schedule, the Pharmaceutical Benefits Scheme, and National Health Reform Hospital Funding to 2023-2024.

Source: National Commission of Audit.


Rationale for government intervention

All governments in developed countries intervene in their nations’ health systems, typically through regulation, funding and the provision of services, although these interventions vary substantially in their nature and extent.

The rationale for government involvement in health systems ranges from a desire to address a number of market failures through to securing broader social and political objectives.

Market failures that governments seek to deal with include providing public goods and addressing positive externalities, such as encouraging immunisation and controlling contagious diseases. There are also negative externalities that governments seek to deal with, as well as so-called ‘internalities’ and provision of merit goods, for example, the banning of smoking in public places and promotion of healthy eating habits.

Access to relevant information can be a significant issue, where consumers are either less able to judge the quality or necessity of recommended services (information asymmetry and supplier induced demand) or where adverse selection means that those most likely to use health services sign up for insurance, thereby reducing the degree to which risks are spread and increasing the cost of insurance.

Where a third party, such as the government or an insurer, is paying for a service, moral hazard can lead providers and consumers to use more services than would otherwise be demanded. Moreover, when consumers are not faced with paying the costs associated with these services, they have little incentive to limit the use of these services.

Governments seek to deal with the information problems through interventions such as setting minimum safety standards for therapeutic goods, incentives and subsidies to promote some choices over others (for example, the Pharmaceutical Benefits Scheme subsidises drugs on the basis of cost-effectiveness as well as other factors), and by setting price signals to consumers so that they pay at least a part of the cost of the care that they receive.

Social policy reasons for government intervention include the provision of cost-effective quality health services to those who would otherwise not be able to afford even basic health services, as this is recognised as an effective and socially acceptable way of ameliorating disadvantage.


Health will continue to be one of the fastest growing areas of expenditure for the Commonwealth Government. This is driven by population ageing and by higher costs associated with newer, more complex and more effective treatments, as well as by the increasing use of health care services.

Commonwealth expenditure on health is projected to nominally increase from about $65 billion in 2013-14 to $123 billion by 2023-24, or from around 4.1 per cent of GDP in 2013-14 to around 4.8 per cent by 2023-24.

The largest growth area within health for the Commonwealth relates to public hospitals (see Attachment 9.3.3), which is currently projected to grow by 171 per cent over the decade, partly as a result of the Commonwealth taking on an increasing share of expenditure rather than just underlying cost and service growth. This is double the projected rate of growth for PBS expenditure and almost double the projected rate of growth for Medicare.

By the end of the next decade, transfers to the States for public hospitals will be the largest health programme and will account for just under a third of total Commonwealth health expenditure rather than just over one fifth of expenditure currently.


Underpinning this historical trend has been a range of demand and supply side factors, including societal preferences and expectations, growth in real incomes and lifestyle behaviours, which have increased the prevalence of some types of chronic disease, as well as new knowledge, technological advances and real wages growth.

A fundamental driver of demand is the preference of households to devote more of their disposable income to health care as real incomes rise. This reflects the view that additional resources devoted to health will enhance wellbeing by improving individuals’ quality of life and extending their lifespan.

This preference has also been implicit in government policy decisions, together with the view that a lack of financial means should not be a barrier to accessing acceptable standards of health care, the latter being enshrined in the Medicare principle of universal access to health and emergency services.

New knowledge and technological advances are fundamental drivers of the supply of health care. In addition, since productivity growth can be more difficult to achieve in some service industries such as health, the real cost of wages – and hence the real cost of supplying such services – can grow relatively strongly (Chart 9.3.4). This highlights the need for ongoing reform of the health sector to help to manage growth in the cost of services.


Chart 9.3.4: Selected health price indices, 2001-02 = 100

his chart shows the growth in prices for Medicare medical services, hospitals and nursing homes, professional health workers wage rates and total health price index from 2001-02 to 2011-12.

Source: Australian Institute of Health and Welfare, 2013c.


Another fundamental driver of health care costs in Australia is the ageing of the population – as older people tend to be higher consumers of health services and are more likely to suffer from chronic diseases such as arthritis, dementia and cancer. Between now and 2050, the proportion of Australians aged over 65 years or more is expected to almost quadruple (Australian Government, 2010).


A rise in the share of the nation’s income devoted to health care is not necessarily a matter of policy concern as long as the expenditure is cost effective, used efficiently, and the benefits outweigh its opportunity cost (including the excess burden of the taxes raised to pay for the expenditure).

However, health comprises a significant and growing share of Commonwealth and State government budgets. While this could be consistent with society’s preferences and expectations, the 2010 Intergenerational Report suggested that existing funding arrangements are not financially sustainable into the future without increasing the taxation burden and/or redirecting existing expenditure.

A framework for making the funding arrangements more sustainable could consider: policy interventions aimed at restraining expenditure; policies aimed at improving the efficiency of expenditure; and policies aimed at more fundamentally changing the incentives faced by users, providers and governments.

Policy interventions aimed at restraining growth in government expenditure on health could be implemented quickly and effectively (for example, through budget caps). However, care is needed with such supply side interventions in order to avoid unintended reductions in the quality of or access to care, particularly for lower income groups.

It will also be important for the Commonwealth to work with the States to better manage hospital costs. While the national efficient price arrangements introduced under the Council of Australian Governments National Health Reform Agreement (COAG NHRA, 2011) are the basis for Commonwealth funding assistance in this area, there is room for reform — particularly against the backdrop of other reforms to Commonwealth-State relations being recommended by the Commission.

The Commonwealth’s ability to restrain health expenditure growth is also limited by the fact that over 80 per cent of expenditure is a result of demand-driven programmes — the MBS, the PBS and the PHI rebate.

The Commonwealth’s current commitment under the NHRA to fund 45 per cent of the ‘efficient’ growth in the cost of public hospital services from 2014-15 to 2016-17, and then 50 per cent from 2017‑18, is a major driver of increasing Commonwealth expenditure. Currently the Commonwealth provides just over a third of public hospital funding. Charts 9.3.5 and 9.3.6 show the funding source proportions for public hospitals and private hospitals.

Demand side interventions that shift costs to the private sector through co-contributions can improve incentives for consumers of health goods to be conscious of cost effectiveness when making choices about health care. There are some risks with co-contributions, such as the potential for introducing access barriers for low income groups or for heavy users of the health system, or through increasing costs over the longer term if treatment is delayed. However, such payments also send clear price signals to consumers of medical services and can be underpinned by effective safety net arrangements.


Chart 9.3.5: Public hospital funding sources, 2010-11

 the Australian Government (37 per cent); State and Territory governments (52 per cent); individuals (3 per cent); the Department of Veterans' Affairs (2 per cent); health insurance funds (1 per cent); rebates of insurance premiums (1 per cent) and other (4 per cent).

Source: Australian Institute of Health and Welfare, 2013a.


Chart 9.3.6: Private hospital funding sources, 2010-11

 the Australian Government (2 per cent); State and Territory governments (4 per cent); individuals (13 per cent); the Department of Veterans' Affairs (9 per cent); health insurance funds (45 per cent); rebates of insurance premiums (21 per cent) and other (6 per cent).

Source: Australian Institute of Health and Welfare, 2013a.


Improving the efficiency of the health sector could also occur through shifting the provision of care into lower cost settings where clinically appropriate (e.g. from hospitals to primary health care or subacute care). Technical efficiency may be enhanced through activity based funding of health care where appropriate, together with measurement and monitoring. There is also a role for the private insurance sector to help drive efficiency through competition and promotion of the most cost effective services.

The ageing population also brings pressures on the health system. In particular, older people tend to consume more health care than others reflecting the higher incidence of disease amongst this group and the complexities of managing chronic health conditions that often occur later in life. This is a growing concern as more Australians are living longer, often resulting in a longer decline and increasing dependence on health care before the end of life.

Individuals can already provide instructions regarding their future health care preferences. Australians 18 years of age and over can choose to put in place an Advance Care Directive (ACD) — also referred to as a living will. These are documents that specify decisions made by individuals about future preferences for medical, surgical, dental treatments and other health care. ACDs usually only come into effect if a person is unable to make reasonable judgements about their treatment at the time it is required. The use of different types of directives are already an important feature of many aged care services and will be incorporated in all home care packages through the introduction of Consumer Directed Care (CDC) directives from July 2015. The CDCs will allow consumers and their carers to make choices about the types of care and services they access.

Potential areas for reform

Requiring higher-income earners to take out private health insurance for basic health services in place of Medicare

Medicare provides universal access to health care for all Australians. However, the commitment to universal health care comes at a substantial cost as limited resources are diverted from people who most need them to people that do not.

Better targeting of Medicare would protect the truly disadvantaged. At a fundamental level, this means reducing the amount of subsidises that the Commonwealth provides for those who can afford to fund their own health care.

Consistent with the Commission’s Principles of Good Government, those on higher incomes should take greater individual responsibility for the cost of their health care. They are better placed to take out private health insurance and should be required to do so. They should not be relying on government to insure against their risk of poor health.

Expanded private health insurance coverage should be introduced for basic health services currently covered by Medicare. Higher-income earners should be obliged to take out private health insurance for basic health services in place of Medicare.

Expanded private health insurance plans would, at a minimum, cover all services provided by Medicare and public hospitals and would have to pay for all health care expenses of the insured, including the cost of treatment in a public hospital.

PHI could play both a substitutive and a supplementary role. The substitutive role means that all people who take out expanded PHI cover would access health care through their private insurance plans. The supplementary role means that people who retain their Medicare coverage would still be able to purchase additional private hospital and ancillary insurance as is the case now.

This obligation on higher-income earners to take greater responsibility for their health care could be put into effect through increasing the Medicare Levy surcharge in instances where they do not purchase expanded PHI coverage.

Based on the rates for the 2013-14 tax year, the threshold for purchasing expanded cover would be set at $88,000 for singles and $176,000 for families. A means-tested Medicare Levy surcharge ranging from 1 to 1.5 per cent already exists and this should be increased by 2 percentage points to encourage the switch to private health insurance (Table 9.3.1).


Table 9.3.1: Proposed Medicare Levy surcharges


Base Tier

Tier 1

Tier 2

Tier 3


Less than

$88,000 -

$102,000 -

$136,000 +


Less than

$176,000 -

$204,000 -

$272,000 +











Source: Department of Health, 2013; National Commission of Audit.


The majority of Australians would be unaffected by this change and would carry on with Medicare as now.

Private Health Insurance rebate

By encouraging higher rates of PHI coverage, the government aims to shift the burden of delivering hospital services from the public hospital system to the private system, as well as shifting some of the cost of delivering these services from public budgets to health funds and their members.

A number of policies in place are designed to promote the take-up of PHI and improve the risk profile of the insured pool. These include the PHI rebate, the Medicare Levy surcharge and Lifetime Health Cover Loading.

The taxation system encourages middle to high income earners to take out private health insurance. While most taxpayers pay a 1.5 per cent Medicare Levy, an additional Medicare Levy surcharge of between 1 and 1.5 per cent is payable by those taxpayers who earn more than $88,000 and do not have private insurance. The surcharge is income tested (Table 9.3.1).

The Commonwealth also provides a rebate to help people meet the cost of purchasing PHI. The size of the rebate varies with age and is currently means-tested — noting that the Government has undertaken to remove means testing (Table 9.3.2).


Table 9.3.2: Private Health Insurance rebate by age and income threshold (2013-14 tax year)


Base Tier

Tier 1

Tier 2

Tier 3


Less than

$88,000 -

$102,000 -

$136,000 +


Less than

$176,000 -

$204,000 -

$272,000 +

Less than age 65





Between age 65 and 69





Age 70 and over





Source: Department of Health, 2013.


The Lifetime Health Cover Loading is a regulatory ‘stick’ designed to discourage people from delaying purchase of PHI by allowing funds to vary the premiums of individuals above 30 according to the age of entry into the fund.

A person’s loading is determined by the number of years over the age of 30 they are at the time they take out hospital cover. Each year attracts an additional 2 per cent to their hospital cover premium.

As a package, these policies have played an important role in increasing take up of PHI (Chart 9.3.7). Since their introduction over the period 1997 to 2001 take-up rates have increased markedly.

Some studies suggest that the cost of the PHI rebate is greater than the flow-on savings to the public hospital system and that large savings could be achieved by removing the rebate altogether, although these arguments have some limitations (refer Box 9.3.1).


Chart 9.3.7: Private Health Insurance – hospital treatment coverage in Australia

The Chart shows private health insurance (Hospital Treatment coverage only) in Australia over the period 1971-2013.

Source: Private Health Insurance Administration Council, 2013.


A key shortcoming of providing rebates to everyone who purchases PHI is that the spending is poorly targeted, with the rebate disproportionately flowing to individuals and families who would have taken out PHI anyway.

Given the Commission’s proposal to make it mandatory for high income earners to take out private health insurance, it is not necessary for these people to have access to the PHI rebate.

The Commission recognises, however, that making private health insurance mandatory for higher-income groups may have consequences for the operation of the health insurance market including people’s responsiveness to price changes. This may impede the development of a more competitive health insurance market.

Further analysis should be undertaken to examine the interaction between the surcharge, the rebate, lifetime cover and the extent of eligible insurance coverage as part of a more fundamental review of the health care system.

Box 9.3.1: Evidence for and against phasing out the PHI rebate
The paper by Cheng (2013) 'Does Reducing Rebates for Private Health Insurance Generate Cost Savings?', finds that reducing the rebate could lead to large savings, as the reduction in spending on rebates would outweigh the predicted increase in public hospital costs by a factor of 2.5. Using this analysis, the Grattan Institute estimates that by completely removing the rebate the Commonwealth Government could save around $3.5 billion per year (Daly et al, 2013a).

On this argument, if individuals are not very price sensitive when it comes to buying health insurance, subsidising PHI is unlikely to result in overall cost savings.

Empirical calculations, such as the ones mentioned above, are underpinned by estimates of the price elasticity of demand — that is, how responsive an individual's decision to purchase health insurance is to changes in price. In the case of Cheng (2013), the estimate used is that a 10 per cent increase in premiums would result in a reduction in PHI coverage of less than 2 per cent.

However, as noted by Cheng (2013), the price elasticity of demand used to calculate this estimate is lower compared to those used in other studies, which range from a 10 per cent increase in premiums resulting in a reduction PHI coverage of between 3.5 per cent and 5 per cent. If a higher price elasticity of demand was used the overall size of the saving from reducing the rebate would be smaller.

A counter argument has been presented by Robson et al (2011) in 'The Analytics of the Australian Private Health Insurance Rebate and the Medicare Levy surcharge'. They suggest that there may be a feedback loop which could increase the drop-out rate from policies such as reducing the rebate.

This study notes that low-income consumers of PHI are likely to be more price elastic, so that reducing the rebate could cause these consumers to drop their PHI cover. Those who keep their PHI cover would be less price elastic. This would allow PHI providers to increase their mark-ups. Higher premiums could then result in a second round of low-income consumers leaving PHI, and a higher than initially anticipated demand for public resources, exacerbating waiting times and cost pressures in the public system.



The Grattan Institute argues that ‘increases in health expenditures are primarily driven not by an ageing population, but by people of all ages seeing doctors more often, having more tests and operations, and taking more prescription drugs, often employing new – and effective treatments. These changing practices are costing more per person’ (Daley et al, 2013b).

These trends are amplified by Medicare, which provides free, or highly subsidised, access to General Practitioners (GPs) and other out-of-hospital care. From an economic perspective, health care is like any other good or service in that utilisation increases dramatically when the marginal cost approaches zero.

There would be substantial benefit in addressing health costs if the community is more aware of the real costs of using the health care system. An early mechanism to promote this would be through requiring that all consumers make a small contribution towards the cost of their health care by introducing a co-payment for health care services provided through Medicare. Co-payments send a clear price signal that medical services come at a cost. This may help to reduce demand for unnecessary or overused services, as well as encouraging individuals to take greater responsibility for paying for some of the cost commensurate to their health care decisions.

The co-payment could be based on a matrix pricing structure, similar to arrangements currently in place for the PBS. Co-payments would be underpinned by a simple means test based on concession status and complemented by a strengthened safety net arrangement. To protect lower-income earners and the chronically ill from excessive out-of-pocket costs, the safety net would take effect when a patient exceeds 15 visits over the course of a year. Once a patient exceeds the safety net threshold the co-payment would reduce by 50 per cent.

To reflect a balance between these issues the co-payment could be set at the levels outlined in Table 9.3.3 below. These co-payments would be in addition to any existing out of pocket costs. Box 9.3.2 provides a further discussion on options for implementing co-payments.


Table 9.3.3: Co-payment rates for general patients and concession card holders


Below safety net threshold

Above safety net threshold

General patients



Concession card holders



Source: National Commission of Audit.


Box 9.3.2: Options for implementing co-payments
If the Government adopts a co-payment policy, it would need to consider how to best implement charging arrangements. Options include:
• charging a co-payment per MBS service used; or
• charging a co-payment per visit to a GP.

Each method has advantages and disadvantages.

If co-payments were charged on a per item basis, the cost to the consumer would be greater, particularly for patients with chronic conditions and/or co-morbidities, who in a single visit to a health care provider may require multiple MBS services. If a per service co payment is introduced an arrangement similar to 'the cone' currently used to cap pathology rebates (where the pathologist can only seek reimbursement for up to three MBS items in recognition of the low marginal cost of some pathology services) could be considered. Under such an arrangement the patient would pay the co-payment for up to a maximum of three services per visit then any additional service would become free.

An alternative model would be to charge co-payments on a per visit basis. The shortcoming of this method is patients would have strong incentives to maximise the number of MBS items billed per visit, resulting in potentially unnecessary utilisation and higher costs. If co-payments are charged on a per visit basis they should not be limited to GP services, they should also apply to specialists, pathology, diagnostics tests and optometry.

Should the Government introduce co-payments it would need to strike an appropriate balance between ensuring adequate access and cost effectiveness.

There would also be a need to ensure that the co-payment provides a price signal as actually intended. In this light, consumers would not be able to insure against the co-payment. Similarly, medical practitioners who wish to bulk bill should not be able to waive the co‑payment. The Commonwealth will need to ensure the cooperation and compliance of insurers and doctors in the implementation of these arrangements.

By introducing co-payments for services that are currently covered by bulk billing there is a risk of cost shifting, as some patients may seek out free treatment in the emergency room of public hospitals for services that would more appropriately be treated by a GP. To address this issue, State governments should consider introducing equivalent co-payments for emergency room settings.

One possible co-payment structure for emergency rooms could be based on the hospital triage categorisation system. Emergency room patients are currently triaged on the basis of the speed with which they need medical attention. Triage categories one, two and three relate to patients who present with critical, life-threatening or potentially life threatening conditions. Triage categories four and five relate to less urgent conditions that in many cases could be more effectively treated in a GP setting and at a lower cost.

State governments could consider introducing co-payments for triage categories four and five, at levels higher than those proposed for out-of-hospital services. A payment structure along these lines would retain free emergency room care for those in genuine need while providing price signals that direct patients to access the most cost effective treatment setting. Another alternative is having available at or near the hospital 24/7 GP service to deal with triage categories four and five.

Reform safety net arrangements

There are two safety net arrangements in place to protect patients from high out-of-pocket costs:

  • the Medicare Safety Net provides patients with additional financial assistance for out-of-pocket costs for out-of-hospital Medicare funded services. Once out-of-pocket expenses for medical services reach the safety net threshold of $430.90 (as at 1 January 2014), all future Medicare services are paid at 100 per cent of the Medicare Benefits Scheduled fee (not at the 85 per cent Medicare rebate) for the remainder of the calendar year for all Medicare cardholders; and
  • the Extended Medicare Safety Net provides 80 per cent of any further out-of-pocket expenses for out-of-hospital costs in a calendar year, once the relevant thresholds have been met. For concession cardholders and families eligible for Family Tax Benefit A the threshold is $624.10 (as at 1 January 2014). For all other Medicare cardholders the threshold is $1,248.70 (as at 1 January 2014).

There is scope to improve their effectiveness to ensure that they provide assistance to those most in need.

A 2009 review found the Extended Medicare Safety Net to be an inefficient mechanism by which to fund health care services (Centre for Health Economics Research and Evaluation, 2009). The review found that:

  • funding consumers out-of-pocket costs led to significant increases in doctors’ fees. The review estimated that for every dollar spent on the Safety Net, 43 cents went towards provider incomes and 57 cents went towards reducing patient out-of-pocket costs; and
  • most of the benefits were poorly targeted, with 55 per cent of safety net money found to be directed to the 20 per cent of families living in Australia’s wealthiest areas. Only 3.5 per cent of safety net money is directed to the 20 per cent of Australian families living in the poorest areas.

Despite changes made in the 2009-10 Budget to cap the payments for some services, including obstetrics and assisted reproductive technologies, the fundamental drivers of cost increases and inequitable access have not been addressed (Centre for Health Economics Research and Evaluation, 2009).

In line with the Commission’s Principles of Good Government, the safety nets should be targeted to protect the truly disadvantaged and should not be directed towards people who can afford to make an appropriate contribution to the cost of their health care. To that end, the General Extended Medicare Safety Net should be increased to a higher level than what is being proposed from January 2015 (an increase to $2,000), to a new level of $4,000. The Concessional Extended Safety Net threshold should remain unchanged.

Remove/replace ineffective MBS items

There is also scope to introduce a more effective mechanism for examining the MBS to identify and remove inefficient, expensive (where a less expensive option is available) and potentially overused MBS items. Recent research published in the Medical Journal of Australia (Elshaug et al, 2012) suggests that only 3 per cent of the nearly 6,000 items on the MBS in 2012 (excluding pharmaceuticals) had been formally assessed against contemporary evidence of safety, effectiveness and cost effectiveness. More than 150 potentially ineffective and/or unsafe and therefore potentially low-value health care practices could be reviewed.

There is also growing evidence of over-utilisation of some MBS items. In one analysis of Medicare provider data published in the British Medical Journal (Belinski and Boyages, 2013), it was reported that between April 2006 and October 2010 there were more than 4.5 million tests for 25‑hydroxvitamin D in Australia. This test measures how much vitamin D is in the body. Some individuals were subject to multiple tests, having up to 79 tests in that period. The research also found that the rate of 25-hydroxvitamin D testing in Australia increased 94-fold from 2000 to 2010 and the costs to Medicare increased from $1.3 million in 2000-01 to $140.5 million in 2012-13 (Medicare Australia, 2013).

In cases of overutilisation, consideration should be given to reducing the value of the listed MBS price for these items.

Reforming private health insurance

Almost half of all Australians have Private Health Insurance. If provided with the right incentives, this industry could play a constructive role in driving efficiency in the health care sector. Health insurers whose members receive the best and most efficient health care should win more business. Likewise, their operating model is more likely to succeed if they are able to deliver health care that keeps their members out of hospital.

The National Health and Hospital Reform Commission (NHHRC) recognised the potential of PHI to improve the responsiveness and efficiency of Australia’s health system.

However, if health funds are to drive greater efficiency their role will need to be transformed from being passive payers into genuine health care partners that support their members to navigate the health system and assist them to better manage chronic conditions.

This transformation will require changes to the rules that govern the private health insurance industry, including around risk equalisation and price setting arrangements.

Risk equalisation is a scheme that supports community rating (effectively a cross subsidy arrangement), whereby individual users cannot be made to pay more for private health insurance due to age or illness. To ensure that particular funds do not struggle financially because they may have to insure larger numbers of unhealthy members, claims for older or high-claiming members are pooled and a proportion are redistributed across the industry to equalise the risk (Biggs, 2013). This is in effect a reinsurance scheme.

These payments are based on actual costs paid out by particular funds, meaning that the more a fund disburses in payments to members, the more it receives through the reinsurance scheme from other funds. This arrangement reduces incentives for insurers to invest in cost-effective disease management because the losses from high cost customers are shared across the industry, rather than borne by individual health funds.

Better approaches to risk-equalisation are available. Paolucci (2011) outlines the benefits from moving to a prospective risk-equalisation scheme:

In an environment where there is arguably too little prevention and too much treatment, paying prospectively rather than retrospectively will create superior incentives to avoid and not over-diagnose clinical conditions.

A system of prospective risk adjusted payments therefore warrants further consideration. Under such a system payments between insurers would be based on the risk characteristics of their members, rather than actual expenses.

This would provide stronger financial incentives for insurers to invest in improving the health of their members, as any savings made by investments in preventative care and more cost-effective management of chronic conditions would flow to the insurer rather than being shared across the industry.

The current industry rules also prevent private health insurers from covering primary care settings, including medical items and services provided through the MBS. This limits the health funds’ ability to assist in improving the health outcomes of the elderly and chronically ill at the point of diagnosis, which is usually when the patient initially visits their GP.

In many cases, health funds are not aware of when their members develop medical conditions and find out only after the member has been treated in a hospital and seeks reimbursement from the fund. By allowing health funds to cover primary care settings they would have greater visibility of the health risks of their members and could assist members to manage chronic conditions in out-of-hospital settings. Such a change is also needed to underpin the requirement for higher income Australians to take out PHI.

Experiences with broader health cover changes introduced in the Private Health Insurance Act 2007 suggest that appropriate relaxations of product regulations can lead to more innovation. Since these changes were introduced an increasing range of preventative and chronic disease management services have become available through insurers. Expanding coverage to primary care settings could allow the industry to design products that would lower the total cost of care, which in turn would be expected to make PHI more affordable for all members (Deloitte Access Economics, 2012).

There is potential for expanding insurance coverage to exacerbate the moral hazard problem posed by full insurance coverage. That is, when third parties fund the full cost of accessing the health system, there is a tendency towards overutilization. To address this, health fund members should be required to make co-payments, with insurance products limited to covering the remaining out-of-pocket costs.

Private health insurance can only play a greater role in driving greater efficiency in the health care sector if it remains affordable for the majority of Australians.

Currently, the Minister for Health has discretion whether or not to allow premium increases. Each year the Minister must make an assessment of each fund’s cost structure and will only agree to increased premiums based on a ‘minimum justifiable’ increase in costs (Access Economics, 2005).

If a fund attempted to reduce administrative costs, the resulting savings would be factored into the Minister’s next assessment of the fund’s premium increase, leaving the fund no better off and removing incentives for the fund to be more efficient. The end result is higher premiums for all members.

Consumer preferences and choices are at the heart of any well-functioning market (PHIAC, 2012). The introduction of more competition in health insurance markets would also assist in providing consumers with more choice of cost effective health care. This is illustrated by a cross-country study undertaken by the International Monetary Fund (Tyson et al, 2012) that found that an increase in choice of providers and insurers, competition and private provision reduces excess cost growth. To this end, the current price setting mechanism could be removed and replaced with a price monitoring arrangement.

Under a price monitoring mechanism, health funds would have the ability to change premiums how and when they choose, but prices would be monitored through an independent regulatory body (Deloitte Access Economics, 2012). Margins would not be regulated and the Minister’s power to regulate premiums would be removed.

Changing the price setting approach would allow more efficient insurers to retain some efficiency gains, and greater competition between insurers has the potential to slow the growth in premiums.

This would also mean a reduced role for the Private Health Insurance Administration Council (PHIAC) — which the Commission recommends should be absorbed into a new Health Productivity and Performance Commission (see Chapter Nine of the Phase One Report, Rationalising and Streamlining Government Bodies) that would coordinate, report on and drive performance across Australia’s health care system.

In its 1997 report into private health insurance, the Industry Commission detailed the arguments underpinning price control arrangements and their limitations. These arguments are reproduced in Box 9.3.3.

For some people poor health is a result of lifestyle choices, in particular from smoking. Lifestyle related conditions impose a significant and growing cost on the health system which is mostly borne by third parties, including health funds, taxpayers and other users, rather than the individuals responsible.

Much of the burden of disease in OECD countries is linked to lifestyle factors, such as smoking, excessive alcohol consumption, unhealthy diets and a lack of physical activity (OECD, 2011).

One estimate (OECD, 2011) of the impact of lifestyle related conditions on mortality finds:

People who live a physically active life, do not smoke, drink alcohol in moderate quantities, and eat plenty of fruit and vegetables have a risk of death in a given period that is less than one-fourth of those who have invariably unhealthy habits.

The community rating of health insurance products means that the unhealthy lifestyle choices made by some forces up premiums for everyone. In other segments of the insurance market, risk factors such as smoking are taken into account when calculating premiums. This principle should be applied to health insurance.

A greater use of incentives could be used to reward those who make lifestyle decisions that reduce their risk of poor health. To this end, consideration should be given to relaxing rules relating to ‘improper discrimination’ that prevent health funds from charging different prices based on a person’s individual characteristics. Instead, health funds should be allowed to vary premiums for a limited number of lifestyle factors, including smoking, which materially increase a person’s health risk.

Box 9.3.3: Arguments for price control and their limitations
The Industry Commission's report in 1997 into Private Health Insurance noted:

Three principal arguments have been advanced for such [price] controls - solvency, avoidance of market power and equity. All have major limitations.

Solvency arguments for price regulation ignore the existence of separate and more effective solvency rules targeted at the level of funds' reserves. These do not require subordinate controls which seek to influence the pricing decisions of the funds because they may have solvency implications. The principle here is one of regulators setting objectives, and then leaving firms with the freedom to achieve those objectives. Arguably, a fund, like any business, should have the autonomy to vary prices so as to trade out of looming difficulties. In fact, where premium increases have been constrained this has sometimes precipitated a solvency crisis.

Arguments for price regulation based on the principle of avoiding anticompetitive behaviour by funds are also unconvincing. While the industry is concentrated, the scope for exercise of market power in pricing is limited. If anything, collusive pricing can be encouraged by centralised price control. In any case, special purpose legislation dealing with potential breaches of competition policy is unnecessary, given the general legislative vehicles for dealing with such breaches.

The Commission also notes that equity arguments for price regulation to protect the existing contributors of a fund are weak, given the portability provisions of health insurance. A fund which inappropriately increases premiums can be expected to lose members to other funds.

Price regulations — even if infrequently applied — can have another, perverse, impact. They could act as a deterrent to entry by new players used to operating in a market in which they don't have to seek government approval for the prices of their services. In this sense, price controls may deter those market oriented firms most likely to introduce innovative products and to be active in pushing for cost minimisation — thus keeping average premiums higher than necessary.

Source: Industry Commission, 1997.


Public hospitals

The Commonwealth contributes to the funding of public hospitals in the States through the Australian Health Care Agreements. Public hospital services, including outpatient clinics, are usually delivered by the States. The private sector’s provision of health care includes private medical practitioners, private hospitals, pathology services and pharmacies.

Hospital funding is growing strongly (Chart 9.3.8). As previously mentioned, it is the fastest growing area of Commonwealth health expenditure, with this growth largely driven by the Commonwealth’s commitment under the National Health Reform Agreement to fund 45 per cent of the efficient growth in the cost of public hospital services from 2014‑15 to 2016-17 and 50 per cent from 2017-18 onwards.


Chart 9.3.8: Projected Commonwealth spending on hospitals

This chart shows projected hospital spending for period 2013-14 through to 2023-24, based on published MYEFO projections 2013-14.

Source: National Commission of Audit.


Under the current National Health Reform Agreement between the Commonwealth and States, both jurisdictions are jointly responsible for funding public hospitals services. Management of the public hospital system itself is the responsibility of the States.

The States are the main providers of public hospital services and the Commonwealth’s growing contribution to State hospital funding is underpinned by a complex set of reporting arrangements and institutional settings for delivering efficient and fair outcomes.

Efficient growth is determined by the work of the Independent Hospital Pricing Authority (IHPA), which sets the National Efficient Price and the National Efficient Cost of public hospital funding. These are major determinants of the level of Commonwealth Government funding for public hospital services.

In broad terms, hospital funding should be considered in the context of addressing vertical fiscal imbalance – including through promoting a closer matching of revenue-raising capacity with expenditure responsibilities. Such reforms would result in greater flexibility for the States to deliver services such as public hospitals. This brings into question the desirability of the Commonwealth funding more than 45 per cent of efficient growth in the cost of public hospital services.

While reporting on key data is essential, under the approach to addressing the vertical fiscal imbalance mentioned above, there would be less involvement and compliance by the Commonwealth, resulting in reduced duplication of effort and reporting costs. Further details are provided in Chapter Six of the Phase One Report, Reforming the Federation. However, while activity based funding is maintained, it would be important to ensure that the Independent Hospital Pricing Authority continues to receive information essential for undertaking its activities.

In recent years, specific initiatives involving the Commonwealth and State governments have been introduced to reform governance and finance arrangements for public hospitals. The Commonwealth effectively remains the largest public ‘funder’ of the health system, predominately operating a reimbursement model – through the MBS and PBS – and further supported by a hospital activity based funding approach (Bennett, 2013).

The States, however, have overall ownership and management responsibility for public hospitals. Although recent redesigns of governance arrangements in Australia have been put in place so that Local Health and Hospital Districts (LHHDs) have greater control of hospitals in specific regions, the LHHDs are managed by State government-appointed boards of directors and retain high levels of State government involvement.

Alternative governance arrangements for public hospitals have been introduced internationally. The Foundation Trust hospital model, for example, was introduced into the National Health Service in England (Phelan and Sammut, 2013). Adapting the Foundation Trust model to the Australian health system has the potential to transform the structure of the hospital system by separating the roles of the funders and regulators (i.e. Commonwealth and State governments) and the providers of hospitals services, establishing an arms-length purchaser-provider split.

While responsibility for funding and regulating the health system is largely shared between the Commonwealth and State governments, their respective roles are not always clear and the arrangements create scope for duplication and waste to occur. Recent industry analysis on health care reforms has indicated that even after several years of reform effort, the main structural characteristics of financing and stewardship remain largely unchanged, with dysfunctional fragmentation between the Commonwealth, State governments and private insurers (CEDA, 2013).

The approach taken to health care in New Zealand has evolved in recent years. The New Zealand Government announced a series of initiatives designed to improve service efficiency, access, and quality while shifting expenditure away from administration and toward patient services (Thomson et al, 2013). Responsibility for planning, purchasing, and providing health and disability support services lies with 20 geographically defined District Health Boards (DHBs).

Under this system:

  • The DHBs pursue government objectives, targets, and service requirements while operating government-owned hospitals and health centres, providing community services, and purchasing services from non-government and private providers.
  • The government sets an annual global budget for most publicly funded health services and sets national requirements for those services to be implemented by the 20 DHBs. Rationing and prioritization are applied largely to non-urgent services, and vary by DHB.

Co-payments are also used widely in New Zealand – covering GP services and many nursing services provided in GP settings, after-hours consultations are generally higher. The median fee for an adult’s GP consultation is NZ$30–$35 (A$28-32), but fees vary significantly as GPs set their own fees. There are arrangements for greater public funding for poorer communities, where the maximum adult fee is NZ$17 (A$16) per visit. Co‑payments are also required for community-prescribed drugs (NZ$5 per item for adults and with items free after 20 items per family per year).

Public health spending accounted for 83 per cent of New Zealand health spending in 2011 (OECD, 2013), distributed as follows:

  • 87 per cent to the New Zealand Ministry of Health, which in turn distributed around 80 per cent of that amount to DHBs and the remaining 20 per cent directly to services providers;
  • 10 per cent to the Accident Compensation Corporation, which provides funding for accident and injury care; and
  • 3 per cent to other central, regional, and local government services.

New Zealand expenditure on health is above the OECD average as a percentage of GDP (10.3 per cent compared with 9.3 per cent). High growth in public expenditure on health has moderated in recent years, reflecting the above reforms. At the same time, stays in emergency departments have shortened and patients have improved access to elective surgery – up 34 per cent in five years (New Zealand Ministry of Health 2013; Ryall, 2013).

Scope of professional practices

Reassessing the appropriate skills mix needed for particular treatments could improve the efficiency of Australia’s health system.

Australia’s arrangements for the scope of professional practices and the appropriate skills mix for health professionals are less flexible than in other countries. Many health professionals have reported that lesser qualified staff could safely undertake a significant share of their work.

While Health Workforce Australia has initiated an Expanded Scope of Practice programme aimed at redesigning roles of the health workforce to improve productivity, retention, efficiency and effectiveness of health care services, this reform can be taken further. In many countries there are ongoing discussions about possible extensions in the roles of nurses, for example, as part of the broader efforts to improve health service delivery in the primary sector and home-based settings to reduce hospitalisations (OECD, 2010b).

In particular, the current scope of the role of pharmacists and Nurse Practitioners could be expanded to provide immunisations, monitor blood pressure and diabetes testing, issue medical certificates for certain conditions (such as colds or hay fever), or undertake some prescribing for chronic conditions following the initial diagnosis and prescription by a doctor.

The pathway to longer-term reform

The Terms of Reference ask the Commission to look at whether there is a strong case for continued direct involvement in activities currently undertaken by the Commonwealth. The options outlined above go part of the way to addressing this issue in the area of health.

However, considerable detailed work will be necessary to delve more deeply into restructuring the health system. This recognises both the complexity and the need to progress reform carefully — either through major structural reform or the alternative of incremental reforms.

Whichever approach is pursued, there are two fundamental questions that must be addressed — who pays for health care and who provides health services?

The answer to these questions has substantial flow-on impacts on how the Commonwealth delivers and influences existing health programmes such as the MBS, PBS, private health insurance and hospital funding.

The 2009 report of the National Health and Hospitals Reform Commission highlighted many of the issues around strengthening and improving Australia’s health system and suggested that the case for health reform is compelling.

Important considerations include:

  • the need for simplicity within the health care system;
  • ensuring people with chronic health issues have access to the appropriate support;
  • the need for Australia to move toward a more integrated health services system whereby people and patients’ medical services are managed on a ‘whole of life’ basis rather than on an ‘episode by episode’ basis;
  • identifying a framework that brings together all aspects of the health system (public and private, hospital and community based) to support the organisation and delivery of health care in a way that is tightly focused on the individual;
  • having the right incentives in place so that the delivery of health services aligns with the requirements of individuals, including constructive use of the contribution of private health insurance and private hospitals;
  • addressing the fragmentation of responsibility, ensuring transparency and avoiding cost shifting;
  • ensuring all Australians face some responsibility for balancing health care choices against the cost of those choices;
  • examining the interaction between the PHI rebate, the Medicare Levy surcharge and the Lifetime Health Cover Loading and how effective these policies are in supporting a fair and sustainable health system for all Australians; and
  • pending a decision on the implementation of co-payments, an assessment of the benefits of co-payments on reducing unnecessary utilisation of health services relative to additional ‘downstream’ costs that may result from patients not accessing necessary treatments due to higher costs.

In investigating options to move the system in this direction the Minister for Health would be tasked with the consideration and development of an approach or approaches that will put Australia’s health system on a more sustainable footing – a system that achieves cost containment while preserving and improving the quality of health care and access to it.

One option for the Minister to consider would be the potential to introduce a universal health insurance arrangement. Another option, proposed by the NHHRC, would be to introduce ‘Medicare Select’, a system of universal health insurance provided through competing health funds.

Another system would be mandatory health insurance for all Australians. The Commonwealth Government would pay the health insurance premiums for those on low incomes and for high risk groups. The government would also pay for the health insurance of all children. It would be compulsory for people on higher incomes to take out insurance with a private health insurer.

Medicare would be retained as the default insurer for those on lower incomes with the insurance premiums paid by government directly to Medicare. People on low incomes could choose to be insured with a private health insurer with their premiums still paid for by the government.

One possible advantage of this approach is that over time Commonwealth funding for Medicare, hospitals and the private health insurance rebate could be redirected into a single pool that would be used to subsidise the health insurance needs of lower income Australians and those in high risk groups including those with chronic health needs. In this sense there will be a greater capacity for the funding to follow the patient.

The capacity for such an arrangement to inject greater competition and therefore efficiencies into the Australian health care system over the longer term should not be under estimated.


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