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7.3 A pathway to reforming health care

Health is an issue of great importance to all Australians. Our current health system has many strengths — including highly trained and dedicated doctors and nurses — and produces excellent health outcomes for most of us.

But the nature of health care is highly complex, illnesses arrive randomly and can often entail significant expense. There are enormous knowledge and informational imbalances and it is a reality that sick people often feel vulnerable. Given this, governments have an essential role to play.

The Commission considers that in a civilised, affluent and modern country like ours, universal health coverage is absolutely necessary for everyone.

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

Recent Productivity Commission projections suggest Commonwealth Government spending on health will rise from around 4 per cent of GDP in 2011-12 to 7 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 per cent of GDP over the same period. Other research projects similar trends.

Health care spending represents the Commonwealth’s single largest long-run fiscal challenge, with expenditure on all major health programmes expected to grow strongly to 2023-24 and beyond (Chart 7.6). At a practical level, increased health spending reduces resources for other key areas.

Australia’s health system is not equipped to face these future challenges and a universal health scheme is unlikely to be sustained without reform. We need to make the system we have work better.

Putting health care on a sustainable footing will require reforms to make the system more efficient and competitive. The supply of health services must increase in line with growth in demand and improvements in productivity are a natural way of ensuring this. More deregulated and competitive markets, with appropriate safeguards, have the greatest potential to improve the sector’s competitiveness and productivity.

Also, in a system like ours, the community must become more aware of the real costs of health care.

As with much of the Commission’s report, there are no instant or easy solutions to the challenges of health care. But we should be prepared to take steps now to begin strengthening the health system, otherwise more difficult and painful reforms will be needed later.

Chart 7.6: Projected growth in Commonwealth health spending

This chart shows total health expenditure, disaggregated by expenditure on the Medicare Benefits Schedule; Pharmaceutical Benefits Scheme; National Health Reform Funding; and other, from 2013-14 to 2023-24.

Source: National Commission of Audit.

The Commission has separately examined the Pharmaceutical Benefits Scheme (Section 7.4), the structure of the Health Portfolio (Section 9.1) and mental health (Section 8.6).

In relation to the overall health care system, the approach taken by the Commission is to outline a two-stage process for reform.

The first stage consists of a number of incremental changes that could be introduced relatively quickly to improve the system’s short-term viability. More important, they would provide necessary foundations for larger structural reforms.

The second stage will require detailed consideration of opportunities to restructure the health system for the long-term. The inherent complexities of the sector and its risks and uncertainties must be acknowledged as should the fact that health care is a shared responsibility across the Commonwealth and State governments.

A framework for reforming funding arrangements 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 for users, providers and governments. The Minister for Health should take this forward.

These reforms are not just about reducing costs. They also aim to increase efficiency, provide consumers with more power in selecting who arranges their health services, provide better quality care for those with chronic conditions and build a fairer health system for all Australians.

Short to medium-term reforms

In suggesting a number of reforms to the health system, the Commission is guided by the principles outlined in Chapter One, including the need to protect the truly disadvantaged, respect personal responsibility and choice, reduce complexity, ensure value for money and be open to the use of markets and contestability in the provision of services.

The suggested reforms fall into five categories:

  1. Requiring those on higher incomes to take greater responsibility for their own health care needs.
  2. Requiring everyone to make a small contribution to the costs of their own health care.
  3. Improving the effectiveness of private health insurance arrangements.
  4. Improving the effectiveness of Medicare.
  5. Improving arrangements with the States.

People 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.

Expanded private health insurance coverage should be introduced for basic health services currently covered by Medicare. Higher-income earners should be required to insure 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.

This requirement on higher income earners to take greater responsibility for their health care could be put into effect through a penalty arrangement that would result in an increase in the Medicare Levy surcharge for people on high incomes who do not purchase expanded private health insurance coverage.

The threshold for purchasing expanded cover should be set at $88,000 for singles and $176,000 for families. A Medicare Levy surcharge of 1 to 1.5 per cent already exists and this should be increased to between 3 and 3.5 per cent as part of this reform in order to encourage the switch to private health insurance (see Table 7.2).

Table 7.2: Proposed Medicare Levy Surcharges

Base Tier

Tier 1

Tier 2

Tier 3

Singles Less than

$88,000 -

$102,000 -

$136,000 +
Families Less than

$176,000 -

$204,000 -

$272,000 +
Current 0.00% 1.00% 1.25% 1.50%
Proposed 0.00% 3.00% 3.25% 3.50%

Source: National Commission of Audit.

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

The Commission has considered the arrangements for the private health insurance rebate which, alongside lifetime health cover and the Medicare Levy surcharge, forms part of the range of incentives to stimulate the take-up of private health insurance.

There is currently an income-tested rebate to help people meet the cost of health insurance (currently set at up to 30 per cent for people under the age of 65). The size of the rebate varies with age and is currently means tested. In addition, the lifetime health cover loading allows health funds to vary the premiums paid by individuals above 30 years of age according to their age of entry into the fund.

The Government has undertaken to remove means testing of the rebate.

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 Private Health Insurance 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.

However, 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.

As well as those on higher incomes, the Commission considers it is important that steps are taken to provide a signal to people about the consequences of the use of the health care system.

This should begin with a proposal for all consumers to make a small contribution towards the cost of their health care through a co-payment for all items listed on the Medicare Benefits Schedule.

Co-payments send a clear price signal to all consumers that medical services come at a cost, which may reduce demand for unnecessary or overused services. The co‑payment could be based on a matrix pricing structure, similar to arrangements in place for the Pharmaceutical Benefits Scheme.

Co-payments would be underpinned by a simple means test based on concession status and complemented by a strengthened safety net arrangement. To protect the less well off 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.

The Commission proposes the introduction of co-payment arrangements as illustrated in Table 7.3 below. These co-payments would be in addition to any existing out-of-pocket costs.


Table 7.3: Co-payment rates for general patients and concession card holders

Below safety net threshold

Above safety net threshold

General patients $15.00 $7.50
Concession card holders $5.00 $2.50

Source: National Commission of Audit.

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 general practitioner. To address this issue, State governments should consider introducing equivalent co-payments for certain emergency room settings.

A 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. Co-payment arrangements would not apply in these cases.

Triage categories four and five relate to less urgent conditions that in many cases could be more effectively treated in a General Practitioner setting. 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.

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 Government will need to ensure the co-operation and compliance of insurers and doctors in the implementation of these arrangements.

While the Commission supports the retention of safety net arrangements, there is scope to ensure they assist those in greatest need.

The Medicare Safety Nets provide financial assistance for out of hospital medical services. There are two distinct safety nets in operation:

  • the original Medicare Safety Net which was introduced at the same time as Medicare in 1984; and
  • the Extended Medicare Safety Net which was introduced in 2004 and provides an additional rebate for Australian families and singles who incur out-of-pocket costs for Medicare eligible non-hospital services.

The extended safety net is not meeting its objectives. In 2009 a review showed 20 per cent of Australians living in the wealthiest areas received 55 per cent of extended safety net benefits, while the 20 per cent living in the poorest areas received less than 4 per cent of benefits.

The Commission considers safety nets should be targeted to protect the truly disadvantaged and not directed towards people who can afford to make an appropriate contribution to the cost of their health care. To this end the Extended Medicare Safety Nets should be increased from $2,000 to $4,000. However, the Concessional Extended Medicare Safety Net threshold should be maintained at the existing levels.

The Medicare Benefits Schedule is large and complicated. In its current form it is 892 pages long with items ranging from medical, nursing and allied health services to pathology and imaging services. Of its nearly 6,000 items (excluding pharmaceuticals) as of 2012, only 3 per cent had been formally assessed against contemporary evidence of safety, clinical effectiveness and cost-effectiveness.

There would be merit in a review or ongoing reviews of the schedule to identify and remove ineffective items.

Opportunities exist to improve the operation of Australia’s private health insurance system. Almost half of all Australians have private health insurance and as long as there are appropriate incentives in place the 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.

If the health funds are to drive greater efficiency they will need to change from passive players 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 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 based on age or illness. To ensure particular funds do not struggle financially because they have to insure larger numbers of unhealthy members, claims are redistributed around the industry to equalise the risk. This is, in effect, a reinsurance scheme.

These payments are based on actual costs paid out by particular funds, meaning 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 the individual health fund.

The Commission considers a system of prospective risk adjusted payments warrants consideration. Under this system payments between insurers are 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 savings from preventative care and more cost-effective management of chronic conditions would flow to the insurer rather than being shared across the industry. Further details are contained in Section 9.3 of the Appendix to this report.

The current rules also prevent private health insurers from covering primary care settings, including medical items and services provided through the Medicare Benefits Schedule. 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 they initially visit their local doctor.

In many cases health funds are not made 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. Allowing health funds to cover primary care settings would make it possible for them to be more aware of members’ health risks. Funds could assist members to manage chronic conditions in out-of-hospital settings. This change is also needed to underpin the requirement for higher-income Australians to take out private health insurance.

The Commission acknowledges private health insurance can only play a greater role in driving greater efficiency if it remains affordable for the majority of Australians.

The Minister for Health now decides whether or not to allow annual premium increases based on each fund’s cost structure.

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

Accordingly, the Commission considers the current price setting mechanism should be replaced with a price monitoring arrangement. As outlined in Section 9.1, the Commission proposes that the Private Health Insurance Administration Council be merged with certain other health agencies into a proposed new Health Productivity and Performance Commission.

For some people, particularly smokers, poor health is a result of lifestyle choices. Lifestyle related conditions impose a significant and growing cost on the health system which are mostly borne by third parties, including health funds, tax payers and other users, rather than the individuals responsible.

The community rating of health insurance products means unhealthy lifestyle choices made by some forces up premiums for all. 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.

The Commission considers more incentives should 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.

While responsibility for funding and regulating the health system is largely shared between the Commonwealth and States, their respective roles are not always clear leaving room for duplication and waste.

Hospital funding is a strongly growing area of Commonwealth health expenditure (Chart 7.7), largely driven by the 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.

Efficient growth is determined by the work of the Independent Hospital Pricing Authority, 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. (The Commission recommends that this Authority be subsumed into a proposed Health Productivity and Performance Commission, as outlined in Section 9.1 below.)

Chart 7.7: Projected Commonwealth spending on hospitals

This chart shows hospital expenses growing from around $14 billion in 2013-14 to around $38 billion in 2023-24.

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 hospital services. Management of the systems is the responsibility of the States.

The Commission considers that the provision of public hospital services should remain the responsibility of the States for now. Given this, hospital funding should be considered in the context of addressing vertical fiscal imbalance.

The broader reforms recommended by the Commission to address the degree of vertical fiscal imbalance through a closer matching of revenue-raising capacity with expenditure responsibilities could result in greater flexibility to the States to deliver services such as public hospitals.

In these circumstances, an opportunity would exist to renegotiate current health funding commitments with the States.

In the meantime, the Commission considers the Commonwealth could limit its funding contribution to public hospital services to 45 per cent of the efficient growth in this cost.

A number of submissions to the Commission noted that the National Health Reform process is currently seen as unnecessarily complex and inefficient. This includes overly burdensome reporting requirements that consist of an overarching objective, seven long-term objectives, 11 outcomes, 26 progress measures, 15 outputs and 70 performance indicators. There are also seven performance benchmarks.

As highlighted in Chapter Six of this report, there is a need for a better balance between appropriate levels of reporting between the Commonwealth and States while ensuring the necessary accountabilities.

Although reporting on key data is essential, less Commonwealth involvement would reduce duplication and reporting costs.

However, as long as the activity based funding arrangements for public hospitals remain in operation, it will be necessary for the Independent Hospital Pricing Authority to continue to receive data needed for establishing national efficient price and the national efficient cost estimates. The Commission’s proposals for including the Independent Hospital Pricing Authority in a new Health Productivity and Performance Commission may help address this issue and are further outlined in Chapter Nine.

In seeking to boost the supply of health care services to meet an expected rise in demand it will be important to increase the number of health professionals and examine the scope of practice of some of them. This includes reassessing the appropriate skills mix needed for particular treatments.

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 report less qualified staff could safely undertake a significant share of their work.

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 go further.

In particular, pharmacists and nurse practitioners could, in an expanded range of settings, provide immunisations, monitor blood pressure and diabetes tests, issue medical certificates for certain conditions (such as colds or hay fever) and undertake some prescribing for chronic conditions following an initial diagnosis and prescription by a doctor.

As noted above, older people tend to consume more health care than others, reflecting their higher incidence of disease and the complexities of managing chronic health conditions that often occur later in life. These trends compound among the very old.

About one in four patients at the end-of-life are unable to make their own health care decisions. This is a growing concern as more Australians live longer but with increasing dependence on health care before the end-of-life.

There are opportunities for more individuals to provide instructions regarding their future health care preferences. Australians 18 years of age and over can put in place an Advance Care Directive - also referred to as a living will. These documents specify preferences for future medical, surgical, dental and other health care if a person is unable to make reasonable judgements about required treatment.

The use of directives is also a feature of many age care packages and will cover, for example, all home care packages through the introduction of Consumer Directed Care directives from July 2015. An opportunity exists to allow and encourage individuals to plan for their future medical treatment as well as their aged care preferences through a broader integrated care directive.

Recommendation 17: Short to medium-term health care reforms

Australia's health system is not well equipped to face future challenges such as an ageing population and rising health services costs. The Commission recommends the Commonwealth Government pursue reforms to improve the health system as soon as practicable including:

  1. requiring higher-income earners to take out private health insurance for basic health services in place of Medicare; and precluding them from accessing the private health insurance rebate;
  2. the introduction of co-payments for all Medicare funded services, underpinned by a new safety net arrangement that would operate once a patient has exceeded 15 visits or services in a year. General patients would pay $15.00 per service up to the safety net threshold and $7.50 per service once the safety net threshold has been exceeded. Concession card holders would pay $5.00 per service up to the safety net threshold and $2.50 per service once the safety net threshold has been exceeded;
  3. implement arrangements to ensure that consumers are not able to insure against the co-payment and that medical practitioners who wish to bulk bill are not able to waive the co-payment;
  4. encouraging the States to introduce a co-payment structure for public hospital emergency departments for less urgent conditions that could be appropriately treated in a general practice setting;
  5. increasing the threshold for the General Extended Medicare Safety Net to $4,000, while maintaining the Concessional Extended Medicare Safety Net threshold at existing levels. Safety net arrangements for Medicare and the Pharmaceutical Benefits Scheme should be retained to ensure support for people facing significant hardship, albeit with some adjustments;
  6. reviewing the Medicare Benefits Schedule to identify and remove ineffective items, replace expensive items with less expensive alternatives where available and investigate options for cost recovery for applications to list items on the Schedule;
  7. reforming the private health insurance market to provide greater incentives for efficient and cost effective health management through deregulating price setting arrangements, allowing health funds to expand their coverage to primary care settings, relaxing community-rating to allow health funds to vary premiums to account for a limited number of lifestyle factors, including smoking; and reforming the arrangements by which insurers equalise risks through the sector;
  8. limiting the Commonwealth's contribution to efficient growth in the cost of public hospital services to 45 per cent applying from 2014-15 and — with the exception of activity based funding — reducing the health reporting requirements significantly that the Commonwealth places on the States; and
  9. extending the current scope of health professional practices (for example, pharmacists and nurse practitioners) to address the future needs of Australia's health care system.

The pathway to longer-term reform of the health system

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 government. The options outlined above go part of the way to addressing this issue in the area of health.

However, the Commission considers detailed work is 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 incremental change.

Whichever approach is pursued there are two fundamental questions, who pays for health care and who provides health services?

The answers have substantial flow-on impacts on how the Commonwealth delivers and influences existing health programmes, such as the Medicare Benefits Schedule, private health insurance and hospital funding.

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

In considering health care reform the Commission is conscious of the fact that people with chronic health issues need the best support. They should not be bounced from doctor to doctor. Australia should move toward a more integrated health services system where people are looked after on a ‘whole of life’ not ‘episode by episode’ basis.

To move the system in this direction the Minister for Health should develop an approach to put Australia’s health system on a more sustainable footing – one that contains costs while preserving and improving access to quality health care.

This is a complex and detailed undertaking but it cannot be avoided.

In undertaking it the Minister should identify 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 tightly focuses on individuals.

The framework should aim for simplicity. The right incentives need to be in place to align health services with the requirements of individual Australians. It must make constructive use of the contribution of private health insurance and private hospitals.

One option (although it is only an option) is a universal health insurance arrangement.

This would make health insurance mandatory for all Australians. The Commonwealth would pay premiums for low income and 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 private health insurance.

Medicare would remain as the default insurer for those on lower incomes, with their premiums paid by government direct to Medicare. People on low incomes could alternatively choose a private health insurer, with their premiums still paid 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 subsidised the health insurance needs of lower income Australians and those in high risk groups, including people with chronic health needs. In this sense funding would 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.

Whether this approach is preferred over alternatives would be a matter for government but the Commission considers it should be considered as one of the possibilities for reforming Australia’s health care system.

Recommendation 18: A pathway to reforming health care

Detailed work is required to examine opportunities to improve the efficiency and effectiveness of Australia's health care system over the medium to longer term. The Commission recommends the Minister for Health be tasked with developing options to reform Australia's system of health care.

The Minister should report to the Prime Minister in 12 months' time on progress and a preferred way forward.