Barriers to entry in the Australian
private health insurance market
03
Research Paper 3
June 2015
1
About PHIAC
The Private Health Insurance Administration Council (PHIAC) is an independent statutory
authority that regulates the private health insurance industry. Private health insurance policy
is set down by the Australian Government via the Department of Health (DoH).
PHIAC’s statutory objectives are described in the
Private Health Insurance Act 2007 (PHI Act).
Section 264-5 of the PHI Act instructs PHIAC in
performing its role, to “take all reasonable steps” to
strike an “appropriate balance” between the three
objectives of:
a. fostering an efficient and competitive health
insurance industry;
b. protecting the interests of consumers; and
c. ensuring the prudential safety of individual
private health insurers.
In order to promote these objectives, PHIAC has
undertaken research on competition and other
issues within the Australian private health insurance
industry. The aim of this research is to support an
improved understanding of the Australian private
health insurance industry.
It is important to stress that PHIAC is not a policy
body. As noted above, policy responsibility for
private health insurance is reposed within the DoH
as principal adviser to the Minister for Health and
the Government. Accordingly, PHIAC does not seek
to propose, nor to advance, any particular policy
prescription or solution to the matters it examines.
It does, however, aspire to provide the factual and
contextual basis for a much improved discussion
about the important issues that affect private health
insurance in Australia. It should not be implied
that any view expressed in this research paper is
necessarily that of the Minister for Health or the
Government.
The Government announced in the 2014–15
Budget that PHIAC will be closed with effect from
1 July 2015. PHIAC’s operations will be merged
into, predominantly, the Australian Prudential
Regulation Authority, with the remainder of its
functions reverting to other agencies.
102i
2
Preface
Private health insurance is a vital product for many Australians. In December 2014, around 47
per cent of Australians — or 11.2 million people — held a health insurance policy which covers
them for hospital treatment, while around 55.5 per cent of the population — or 13.1 million
people — were covered for general treatment, which provides cover for dental care, optical
services, and many other health services. In addition, around 11 per cent of the value of all
health services provided in this country is paid for by the private health insurance industry.
The level of competition in a market is integrally
linked to the ability of suppliers to enter the market.
This paper presents for consideration by interested
stakeholders a review of the major issues related to the
entry of a business into the Australian Private Health
Insurance (PHI) market.
Perceptions of the severity of the barriers to entry may
differ based on the perspective of the viewer. For
instance, those already in the market may perceive
that the barriers to entry are minimal. On the other
hand, those seeking to enter the Australian PHI market
or those new to the market and struggling to establish
a market presence may view barriers to entry as far
more numerous and significant.
The paper draws on a variety of sources, many of
which are set out in the bibliography in addition
to quantitative analysis. The paper also references
submissions received by PHIAC in response to its
first discussion paper, Competition in the Australian
Private Health Insurance Market, released by PHIAC in
November 2012 (PHIAC 2012).1
1
See www.phiac.gov.au. Not all submissions received by
PHIAC were approved for public release. PHIAC has preserved
confidentiality where it was sought both in this paper and on its
website.
ii
3
Preface
Use of this Paper
Derivative work
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If you have modified or transformed PHIAC material,
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Based on Private Health Insurance Administration
Council data
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Provided you have not modified or transformed
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Source: Private Health Insurance Administration Council
The terms under which the Coat of Arms can be
used are set out on the It’s an Honour website
(see www.itsanhonour.gov.au)
Disclaimer
The purpose of this paper is to stimulate discussion.
It is not a position paper and the information
canvassed in it does not constitute recommendations
or legal advice. While PHIAC endeavours to ensure
the quality of this paper, it does not accept any
responsibility for the accuracy, completeness or
currency of the material included in this paper, and
will not be liable for any loss arising out of any use of,
or reliance on, this paper. PHIAC encourages private
health insurers to seek independent advice and to
exercise care in relation to any material contained in
this paper.
4
Table of Contents
About PHIAC
1
Preface
2
1. Conceptual overview of barriers to entry
5
1.1
Economics of barriers to entry
2. Structure of the Australian private health insurance industry and market entry
5
7
2.1
Industry structure and concentration
7
2.2
Profitability of the Australian PHI market
9
2.3
Entry and exit in the Australian PHI market
12
2.4
Entering the Australian PHI market
12
3. Barriers in the Australian private health insurance market
14
3.1
Regulatory burden
14
3.2
Sovereign risk barrier — the potential of regulation and policy change to impact on profitability
16
3.3
Market characteristics and contestability barriers
17
Appendix A — Econometric model of sovereign risk in the Australian PHI market
Modelling government policy changes on the number of persons covered in the Australian PHI market
23
23
Abbreviations and acronyms
27
Glossary and definitions
28
References
29
5
1. Conceptual overview of barriers to entry
Although entry into the PHI market is open, subject to a regulatory vetting process, there have
been very few new entrants into the market over the last twenty years.
Barriers to entry in any industry allow incumbents to exercise market power and set prices above
their costs. The consequences can be that with barriers to entry, prices might be higher than they
would otherwise be and so in economic terms there is a loss of welfare to consumers.
1.1 Economics of barriers to entry
What is a barrier to entry into a market? Carlton
and Perloff (2005, p.76) define barriers to entry
as ‘anything that prevents an entrepreneur from
instantaneously creating a new firm in a market’, while
Church and Ware (2000, p.487) define barriers
to entry as ‘structural characteristics of a market that
protects the market power of incumbents by making
entry unprofitable’, adding that they typically depend
on both structural characteristics of the industry as well
as the behaviour of incumbents after entry. Barriers
to entry relate both to costs of entry and how long it
would take to enter the market (Carlton and Perloff
(2005), p.76).
According to McAfee et.al. (2004, p.465), where
eleven different definitions of barriers to entry in the
economic literature are identified; there seems to be
no clear consensus on what constitutes a barrier to
entry. What can be said from the literature is that
a barrier to entry exists if it is not costless to enter
or exit the industry and the costliness — both in
establishing a business and responding to the actions
of competitors — of overcoming the barrier or group of
barriers will determine whether entry can occur.
From the perspective of a new entrant to a market,
barriers to entry can be classified under two broad
categories, legal and natural barriers, and structural
and economic barriers.2
Legal and natural barriers
These barriers generally cannot be overcome in the
short to medium term and include:
• Government issued monopoly;3
• Natural monopoly (water distribution, electricity
transmission etc.) where only one provider is
feasible and market entry leads to wasteful and
costly duplication; and
• Patent barriers, where a firm has a short-term legal
monopoly on the production of a good or service.
Potential entrants to the Australian PHI market do not
appear to face barriers of this kind.
2
These barriers to entry are standard concepts of market structures
described in most economic and industrial organisation textbooks
(See Pass and Lowes 1993 and Church and Ware 2000).
3
For example, in Australia, the market for delivery of small items up to
250 grams is a statutory monopoly held by Australia Post (Australian
Postal Corporation Act 1989 (Division 2)).
01
6
1. Conceptual overview of barriers to entry
BOX 1 — CONSUMER ADVANTAGE OF MARKET ENTRY IN HIGHLY CONCENTRATED MARKETS
Insurers in Australia offer coverage nationally and each geographic market is actively serviced by a number
of insurers. In the USA, where insurers offer coverage at the county level, there is perhaps more opportunity to
assess the value to consumers of the competitive pressure that a new entrant may provide.
The New York Times (2013) has reported that consumers in rural counties which are serviced by a smaller
number of insurers are faced with significantly higher premiums than their urban counterparts. In many of these
rural counties, there are only one or two insurers. Evidence is cited that in those rural counties where a new
competitor has entered the market, premiums are significantly lower compared to neighbouring counties where
there was no new entrant. This suggests a strong link between lower levels of industry concentration and
reduced premiums.
In relation to the barriers faced by insurers and the reasons why these rural markets are concentrated, the
New York Times stated that, “Insurance companies are reluctant to enter challenging new markets, experts say,
because medical costs are higher, dominant insurers are difficult to unseat, and powerful hospital systems resist
the efforts to lower rates.” (New York Times 2013)
Structural and economic barriers
These barriers represent features of the structure of an
industry and market which deter entry, but which can
be overcome at some cost. These include:
Regulatory burden and sovereign risk
•
•
•
•
Prudential capital and solvency requirements;
Price regulation;
Regulation of products;
Sovereign risk.
Market characteristics and contestability
• Cost advantage of incumbency including product
differentiation, brand loyalty and name recognition
coupled with consumer apathy, high switching
costs between suppliers to the market;
• Economies of scale and scope;
• Incumbents’ strategic response to potential new
entrants adversely affecting the new entrants’
profitability.
These barriers to entry may impact on costs and/or
pricing and market access which can combine and
reinforce each other to delay or prevent market entry.
The existence of any of the above barriers to entry
could restrict the supply of goods and services to the
market and result in incumbent firms earning above
normal profits in the longer term.
As pointed out in a 2013 submission to the first PHIAC
paper on competition in the Australian PHI market,
the market displays some competitive signs, as there
are 12.5 million persons with insurance provided by
34 insurers competing to meet the specific needs of
customers by providing thousands of differentiated
health insurance products which can all be compared
(Peter Carroll 2013, p.4). Furthermore, policy holders
can change insurer at little or no cost. While these
factors suggest that the market has a number of
competitive features, they do not necessarily mean that
the market is easily contestable for new entrants even if
the insurer seeking entry can provide a better offering
both in terms of price and coverage (See Box 1 for
example of geographic barriers to entry in PHI).
A new entrant into the Australian PHI market represents
a competitive threat to incumbents with the potential
to recruit members and in so doing to moderate
increase in industry premiums. However, a new market
participant may face competition in market conditions
at some disadvantage compared to incumbents,
who as a consequence of long tenure in the market,
possess significant industry and corporate knowledge
as well as brand recognition. It could be argued that
unless a new entrant has a superior product or service
offering, that is sufficiently price competitive, they may
not be able to achieve the minimum threshold of policy
holders needed to compensate for the sunk and fixed
set-up costs of entry.4
4
KPMG (2013), p.7 concurred with this point.
7
2. Structure of the Australian private health insurance
industry and market entry
The number of health insurers has declined over the last forty years, but only recently has this
been as a result of merger and acquisition activity. Insurers in general have seen increases in
profitability with strong and stable net margins.
2.1 Industry structure and
concentration
The proportion of the population covered by private
health insurance in Australia has declined significantly
since the 1970s. In 1971 more than 77 per cent
(or 10.2 million people) were covered and this had
declined to 47 per cent (or 11.2 million people)
by 2014. Over the same period there has been
considerable consolidation in the industry as Figure
1 shows. In June 1971, there were 110 private health
insurers. At the end of 2013–14, the number of health
insurers had fallen by almost two-thirds to 34. There has
also been significant structural change over the period,
from a total absence of for-profit insurers in 1971 to 9
in 2014, accounting for 68 per cent of the market.
Industry concentration as measured by the Herfindahl–
Hirschman Index (HHI)5 is an indicator of competition
in the market.6 Figure 2 shows the quarterly HHI
market concentration for the Australian PHI industry
from December 1995 to December 2014. Based on
the U.S. Department of Justice and the Federal Trade
Commission definition of market concentration7, the
data shows that prior to June 2010, the Australian PHI
industry was below the 1500 level (defined as unconcentrated). In recent years, a number of acquisitions
and mergers has seen the HHI index increase to the
moderately concentrated market range.
5
The HHI index is based on adding the sum of the squares of market
shares.
6
Concentration measures such as the HHI are set and used by various
competition authorities as a form of evidence of the competition
impacts of mergers (see U.S. Department of Justice and the Federal
Trade Commission (2010); Australian Competition and Consumer
Commission (2008))
7
The ACCC (2008) uses a 2000 HHI threshold and will generally
be less likely to find adverse impacts of horizontal mergers or if over
2000 but with a change in the index of less than 100 units.
02
8
2.Structure of the Australian private health insurance industry and market entry
1. Number of insurers in the Australian PHI market 1971 to 2014
120
110
Restricted for profit
100
Open for profit
90
Restricted not-for-profit
Number of insurers
80
Open Non-Profit
70
60
50
40
30
20
10
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
0
Source: PHIAC data
Note: This chart shows the number of insurers in the Australian PHI market. Prior to national registration began in 1995, insurers could have
separate funds in different state jurisdictions.
2. Herfindahl–Hirschman Index of market concentration for the Australian PHI market (total policies)
December 1995 to December 2014
3000
2800
Highly concentrated market: HHI above 2500
2600
Herfindahl-Hirschman Index
2400
Moderatly concentrated market: HHI between 1500 and 2500
2200
AHM merger by
Medibank Private
2000
MBF merger by Bupa
1800
All industry market concentration
1600
1400
Largest four insurers (in 2014) market concentration
1200
1000
Dec 95
Jun 96
Dec 96
Jun 97
Dec 97
Jun 98
Dec 98
Jun 99
Dec 99
Jun 00
Dec 00
Jun 01
Dec 01
Jun 02
Dec 02
Jun 03
Dec 03
Jun 04
Dec 04
Jun 05
Dec 05
Jun 06
Dec 06
Jun 07
Dec 07
Jun 08
Dec 08
Jun 09
Dec 09
Jun 10
Dec 10
Jun 11
Dec 11
Jun 12
Dec 12
Jun 13
Dec 13
Jun 14
Dec 14
Unconcentrated market: HHI below 1500
Source: PHIAC data
9
2.Structure of the Australian private health insurance industry and market entry
3. Gross and net margins in the Australian PHI industry June 1995 to Dec 2014
30%
Gross Margin (GM)
Net Margin (NM)
25%
Percentage of premium income
20%
15%
10%
5%
0%
–5%
–10%
14
13
Jun
12
Jun
11
Jun
Jun
10
09
Jun
Jun
08
07
Jun
Jun
06
05
Jun
Jun
04
03
Jun
Jun
-0
2
01
Jun
Jun
00
99
Jun
Jun
98
97
Jun
96
Jun
Jun
Jun
95
–15%
Source: PHIAC data
Note: Gross margin is defined as premium income less benefits paid. Net margin is gross margin less managerial expenses. The large jump
and subsequent fall in the gross and net margins around 2000 reflect the implementation of Lifetime Health Cover (LHC).
2.2 Profitability of the Australian
PHI market
Is the level of net margin/profitability in the industry
sufficient to attract new entrants? If so, why have
there been so few entrants in recent years?
By some measures, the Australian PHI industry has in
recent years been a relatively profitable and therefore
apparently attractive industry to enter. Figure 3 shows
it achieved a positive and consistent net margin for
most of the period, averaging 4.5 per cent over
the last ten years, indicating apparent strong levels
of profitability and low volatility across the industry
over an extended period. Further, the industry has
historically experienced a very low risk of operational
loss which reinforces the attractiveness of entry into the
PHI market.
The private health insurance industry has not always
been as profitable (as indicated by strong net margins)
as it has in the last ten years. Figure 3 shows that
prior to 2000, net margins were zero or negative
and experienced significant volatility reflecting both
the steady decline in the number of persons insured
(since the introduction of Medicare in 1984) and
demographic changes in the market.
As the proportion of the population covered by
PHI decreased, the average age of policy holders
increased as the younger and healthier policy holders
were less likely to take-up or retain private health cover
than their older and less healthy counterparts (the result
of adverse selection). The average health status of
persons with PHI declined leading to higher average
claims per person covered which had an adverse
effect on gross and net industry margins and the
overall level of industry profitability.
10
2.Structure of the Australian private health insurance industry and market entry
4. Age demographics of insured persons before and after LHC
40%
Lifetime Health Cover 1 July 2000
35%
30%
30–44
25%
45–64
20%
Age groups of insured persons
Percentage of insured persons
0–29
65+
15%
Sep 97
Mar 98
Sep 98
Mar 99
Sep 99
Mar 00
Sep 00
Mar 01
Sep 01
Mar 02
Sep 02
Mar 03
Sep 03
Mar 04
Sep 04
Mar 05
Sep 05
Mar 06
Sep 06
Mar 07
Sep 07
Mar 08
Sep 08
Mar 09
Sep 09
Mar 10
Sep 10
Mar 11
Sep 11
Mar 12
Sep 12
Mar 13
Sep 13
Mar 14
Sep 14
10%
Source: PHIAC data
Figure 4 shows that when LHC was introduced,
younger people responded to that incentive to takeup private health cover (particularly the 30–44 age
group), the average age of policy holders declined
and industry net margins improved (as indicated in
Figure 3). The increase in the size of the market and
changing demographics underpinned stronger industry
profitability in subsequent years.
To put recent average net margins into perspective,
Table 5 shows profitability rates (defined as profit
(after tax) divided by the end of financial year health
benefits fund capital)8. The data shows that for the
industry, net margins and profit rates of return as
measured against health fund capital appear healthy
and may be expected to provide a strong incentive
for market entry. However, we should be mindful
that accounting profits differ from economic profits
and insurers may in fact be earning zero economic
profits, as economic profits must take into account the
opportunity cost of capital (the return on the capital
from an alternative investment) and market related risk.
8
The health benefits fund capital is one option to value the investment
required to establish a health insurer business. The next best option
is to compare the profits/surplus generated with the value of the
business.
11
2.Structure of the Australian private health insurance industry and market entry
5. Returns on health benefit fund capital (HBFC) of market participants
in the Australian PHI market 2012–2014
Return on health fund capital 2012–13
Industry average
Return on health fund capital 2013–14
18.3%
Industry average
17.1%
BUPA Australia Pty Ltd
52.3%
BUPA Australia Pty Ltd
60.5%
National Health Benefits Australia Pty Ltd
33.2%
NIB Health Funds Ltd
31.0%
NIB Health Funds Ltd
27.2%
National Health Benefits Australia Pty Ltd
30.9%
Australian Unity Health Ltd
25.1%
Australian Unity Health Ltd
22.9%
Police Health Ltd
22.6%
Doctors’ Health Fund Ltd, The
20.7%
Grand United Corporate Health Ltd
20.9%
Medibank Private Ltd
20.2%
HBF Health Ltd
18.9%
Police Health Ltd
16.9%
Railway & Transport Health Fund Ltd
16.8%
CUA Health Ltd
13.0%
Medibank Private Ltd
16.3%
Lysaght Peoplecare Ltd
12.6%
Doctors’ Health Fund Ltd, The
14.4%
GMHBA Ltd
12.5%
Health Partners Ltd
14.4%
CBHS Health Fund Ltd
11.5%
Lysaght Peoplecare Ltd
14.2%
Transport Health Pty Ltd
11.5%
Transport Health Pty Ltd
13.9%
HBF Health Ltd
11.3%
Health Insurance Fund of Australia Ltd
12.9%
Health.com.au Pty Ltd
10.1%
GMHBA Ltd
12.8%
Queensland Country Health Fund Ltd
10.0%
CUA Health Ltd
12.7%
Navy Health Ltd
9.7%
Healthguard Health Benefits Fund Ltd
12.4%
Healthguard Health Benefits Fund Ltd
9.6%
Defence Health Ltd
11.6%
Defence Health Ltd
8.5%
Reserve Bank Health Society Ltd
11.5%
Latrobe Health Services Ltd
8.2%
Hospitals Contribution Fund of Australia Ltd, The
11.3%
Teachers Federation Health Ltd
8.0%
CBHS Health Fund Ltd
10.9%
Grand United Corporate Health Ltd
8.0%
Navy Health Ltd
10.2%
Health Partners Ltd
7.7%
St Luke’s Medical & Hospital Benefits Assocn Ltd 10.2%
Health Insurance Fund of Australia Ltd
7.7%
ACA Health Benefits Fund Ltd
Hospitals Contribution Fund of Australia Ltd, The
7.5%
7.1%
10.0%
Westfund Ltd
9.5%
Reserve Bank Health Society Ltd
Queensland Country Health Fund Ltd
9.4%
ACA Health Benefits Fund Ltd
6.7%
Queensland Teachers’ Union Health Fund Ltd
9.3%
Queensland Teachers’ Union Health Fund Ltd
5.9%
Health.com.au Pty Ltd
9.1%
Phoenix Health Fund Ltd
5.3%
Mildura District Hospital Fund Ltd
6.3%
Westfund Ltd
5.0%
Health Care Insurance Ltd
6.2%
Railway & Transport Health Fund Ltd
3.7%
Cessnock District Health Benefits Fund Ltd
5.9%
Mildura District Hospital Fund Ltd
3.3%
Latrobe Health Services Ltd
5.5%
St Luke’s Medical & Hospital Benefits Assocn Ltd
3.2%
Teachers Federation Health Ltd
5.5%
Health Care Insurance Ltd
2.3%
Phoenix Health Fund Ltd
3.7%
Cessnock District Health Benefits Fund Ltd
0.8%
Source: Based on return on fund capital calculation from the operations of private health insurers annual reports 2012–13 and 2013–14
(PHIAC (2013a) and PHIAC (2014))
Note: For-profit insurers highlighted.
2.Structure of the Australian private health insurance industry and market entry
It may be the case that the rates of return presented
in Table 5, in fact represent the required return on
capital adjusted for market risks (Brealey et al 2005).
These risks can take the form of regulatory risks,
sovereign risks (government policy changes) and
risks associated with the characteristics of the market
such as the behaviour of competitors and the type of
product being offered and more fundamentally, market
uncertainty in the longer term which drives up the risk
premium on an investment.9
It may be that a material decline in current profitability
would see insurers vacate the industry and seek
to deploy their capital in activities with higher risk
adjusted returns. Consistent with this view, it is
reasonable to assume that a diminution of these risks
would encourage entry into the market.
2.3 Entry and exit in the
Australian PHI market
The fact that there have been only two new entrants
who have entered the market by establishing a new
insurer since 1996 10, suggests there may be barriers
that are restricting market entry. If entry barriers were
low as suggested by some industry participants11, the
lack of new entrants into the market despite apparent
persistent strong profitability across all sizes of insurers
in the market (see Table 5) requires explanation.12
It is noteworthy that over this period there has been
a significant level of merger and acquisition activity
reducing the number of insurers in the market (See
Figure 1).13 14
9
It may also be that health fund capital is not an accurate
representation of the capital that must be invested in order to achieve
the returns experienced.
10
National Health Benefits Australia Pty Ltd on 8 June 2007 and health.
com.au Pty Ltd on 16 April 2012.
11
Deloitte Access Economics 2012, p.18; AHSA and hirmaa 2013,
p.8–9; KPMG 2013, p.14; HBF 2013, p.7.
12
Submissions to the first PHIAC paper (Deloitte Access Economics
2012, p.35; AHSA and hirmaa 2013, p.18) suggest that the level of
profitability is not sufficient to attract new entrants and that if profits
were excessive then there would be more entry into the market (AHSA
and hirmaa 2013, p.8).
13
Gale and Watson (2007) provided a detailed chronology of the
changing nature of the Australian PHI market and health funds from
1840 to 2007.
14
A Poisson regression model (a type of count model used to identify
the probability of certain events occurring such as market entry) were
constructed using the number of insurers who entered the market over
the period 1971 to 2014 as the dependant variable and the number
of persons covered by the industry and significant policy changes
(binary variables) as the independent variables to test market size
and policy drivers of entry into the Australian PHI market. Because of
the large number of binary variables representing key policy change
were still effective in the industry and the lack of variation in the
dependent variable (number of firms entering the market), the model
12
2.4 Entering the Australian
PHI market
A greenfield entrant —
establishing a new health insurer
The process for registration of a private health insurer
in Australia is contained in Division 126 of the PHI
Act 2007. PHIAC is the body which determines if an
applicant is to be registered as a health insurer.15 The
PHIAC practice note ‘Registration of a private health
insurer’ (PHIAC 2013b) provides an overview of the
registration process and the supporting documentation
required to be submitted with an application.
Applicants seeking to establish a new health insurer
must adhere to a number of regulations including
satisfying the capital and solvency standards.16 Sunk
costs may however represent a more significant barrier
to this form of market entry, with the potential for
significant costs being required to establish a brand
able to successfully compete with incumbent insurers.
Figure 6 shows the number of health insurers in the
Australian market from June 1971 to June 2014 and
the number of new entrants over that period. The data
shows that although there have been a number of new
entrants into the market, the total number of insurers has
been in consistent decline and there were no entrants
in the 11 years prior to the entry of National Health
Benefits Australia Pty Ltd in 2007. This decline has
occasionally been through actual exit from the industry,
but more commonly, through insurer acquisitions and
mergers.17 The most recent entrant has been health.
com.au in April 2012.
cannot be estimated because of severe multicolinearity (the inability
to estimate a unique parameter for the variables). Estimation of a
Poisson regression using maximum likelihood estimation with limited
binary variables (introduction of Medicare and the requirements of
registration and LHC) resulted in a model with a poor fit coupled with
incorrect signs expected for the coefficients suggests misspecification.
15
Private Health Insurance (Prudential Supervision) Bill 2015 was
introduced into Parliament on 27 May 2015. This Bill transfers
the responsibility for supervision of the PHI industry (including the
registration function) to the Australian Prudential Regulation Authority.
16
See Private Health Insurance (Health Benefits Fund Administration)
Rules 2007. Including amendments around the capital adequacy
standard, capital management plans and solvency standards.
17
A large number of insurers also exited the market due to re-registration
requirements associated with policy changes in 1970–71, 1983–84
and 2007 with the PHI Act 2007.
13
2.Structure of the Australian private health insurance industry and market entry
10
9
8
7
6
5
4
3
2
1
0
–1
–2
–3
–4
–5
–6
–7
–8
–9
–10
–11
–12
–13
–14
–15
120
110
Number of private health insurers
100
90
80
70
60
50
40
30
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
20
New entrants/departures in that year
6. Number of PHI health insurers in the Australian PHI market June 1971 to June 2014
Departing insurers from previous year (RHS)
New entrants (RHS)
Number of private health insurers (LHS)
Source: PHIAC annual reports (various issues)
Note: A number of “new” entrants, particularly in the 1980’s were health organisations which had previously left the market.
Entry through acquisition
An alternative to a ‘greenfield’ entry is one achieved
through acquisition of an existing insurer. In the
case of an entrant from outside the Australian PHI
market, many of the significant potential barriers to
entry such as establishing a brand and brand name
recognition, achieving the minimum required market
share, negotiating supplier contracts and developing
operational and systems capability may be overcome
by the purchase of an existing PHI business. This
method of entry allows for a rapid acquisition of
market share (See Figure 8A for the BUPA acquisition
of MBF and MBF Alliance) and reduces the need for
significant expenditure of sunk costs in establishing
brand awareness and insurer infrastructure.18
18
Merger and acquisition of health benefits funds processes
are identified in Private Health Insurance (Health Benefits Fund
Administration) Rules 2007 Part 4 and Schedule 1, and Division 146
of the PHI Act 2007.
The purchase of an insurer is relatively straight
forward, where an offer is made, it can be accepted
or rejected by the insurer. An acquisition (from a
participant outside the market) does not change the
number of insurers in the market, but it may change
the competitive dynamics. One such change is the
movement of the industry from a not-for-profit majority
to a for-profit majority, as the acquisition process has
usually been preceded by a demutualisation and
conversion to for-profit by the insurer being acquired.
Acquisition of an existing health insurer can overcome
market based barriers faced by insurers seeking to
expand operations in other states.
14
3. Barriers in the Australian
private health insurance market
It could be argued that potential entrants to the Australian PHI market face, to some degree,
all of the economic barriers to entry outlined in Chapter 1. Does regulation of the PHI industry
impact on market entry? If so, are there ways in which these regulations can be modified to
make entry of a new insurer less difficult?
When firms consider entry into a market, an analysis
is undertaken of the costs and benefits of entry.
In the PHI market, the economic barriers to entry
described in Chapter 1 may all be present to some
degree. In this chapter, we will describe how these
barriers may impact on a new entrant. Economic
barriers which will be discussed in detail come under
three broad headings:
• Regulatory burden
• Sovereign risk
• Market characteristics and contestability.
3.1 Regulatory burden
Private health insurance has attracted more attention
from policy makers than most other industries. This
may be attributable to the vital nature of the services
it funds, the interplay between these private services
and the public services that governments fund, the
prudential safety requirements that are common to
many financial and insurance products, and in recent
years the financial stake the government has in private
health insurance (through the PHI rebate).
This policy intervention has resulted in regulatory barriers
to entry such as the need to satisfy prudential capital
requirements and the impact of continued regulation
of operations. Premium changes are governed by
legislation as are the requirements of what must or must
not be included in a private health insurance policy,
who can take out such policies and the minimum cover
that must be provided.19 The regulatory framework for
complying health insurance products is underpinned by
19
These issues are detailed in Chapter 3 of the PHI Act 2007,
Complying health insurance products.
the consumer and industry protection issues that these
regulations were designed to address. Not only must
these issues be faced, but a potential entrant must take
into account that they may change.
Prudential capital and
solvency requirements
Entry into the Australian PHI market requires a
significant level of capital investment. For a new
entrant, raising this capital may represent a significant
barrier to entry. Capital in the form of liquid assets is
required to begin operations and to be available to
pay out potential claims. The Capital and Solvency
standard are set out in the Private Health Insurance
(Health Benefits Fund Administration) Rules 2007 in
Schedule 2 and 3 of the rules and Division 140 and
143 of the PHI Act 2007.
This capital requirement may be a significant barrier
to entry as the new entrant would require a minimum
rate of return on the capital they raise in order to make
entry attractive. The requirement to meet capital and
solvency standards applies equally to all insurers.
However, new entrants may find this requirement
more difficult to meet as they will not have had the
opportunity to build up their capital reserves through
the operation of the health insurer and accumulation of
net margins.
03
15
3. B
arriers in the Australian private health insurance market
Price regulation
Product and other regulation
A condition of entry into the Australian PHI market
is that premium changes are subject to Ministerial
oversight. Premium change proposals must be
submitted for Ministerial approval each year as part of
a ‘premium’ round and may be refused if the minister
considers that it would be contrary to the public interest
to allow the increase (PHI Act 2007 section 66-10(3)).
Unsurprisingly, this level of oversight — which means
that unlike general insurers, private health insurers are
not in control of their own pricing — is often regarded
as a features of the regulatory environment which gives
pause for thought to prospective entrants and as such
could be seen as a barrier to entry. In practice, there
are a number of aspects to premium regulation which
affect insurers including:
• the of limit of one price change per year at a
specific time20; and
• limited ability to undertake strategic premium
pricing through discounts.
A new entrant is obliged to satisfy the requirements
set out by the PHI Act including the issuing and pricing
of health insurance policies based on community
rating, the associated risk equalisation arrangements,
product content requirements (the minimum coverage
that must be offered by a private health insurer)
and portability.22
These regulatory elements may be perceived by
potential new entrants as a condition affecting the
competitive operation of a private health insurer and
as imposing constraints on the market. However,
as Figure 3 and Table 5 shows, the operation of
these restrictions did not result in negative industry net
margins or profitability. Both prior to the introduction
of the premium approval process and subsequently,
premiums have increased mostly in line with
hospital and medical inflation, perhaps suggesting
no significant financial disadvantage to insurers or
consumers. Seen in this light, perhaps the greater
risk is the belief that, notwithstanding this experience,
there is a potential for pricing process to go awry in
a PHI business in ways which could not occur in other
comparable businesses.21
It should be noted that price regulation is not unique to
PHI, it applies to a number of industries with important
social and economic objectives, particularly those
characterised as critical infrastructure (health care and
hospitals, utilities, communications etc.).
20
Although this is the de facto process, there is nothing in the PHI Act
which stops an insurer seeking premium changes at different times of
the year or more than once per year.
21
Deloitte Access Economics 2012, p.18; HBF 2013, p.7; KPMG
2013, p.14; AHSA and hirmaa 2013, p.17.
Community rating is one of the most important
regulatory conditions in the Australian PHI market.
Community rating regulations require a health
insurance policy to be offered to any person on
the same terms, regardless of their health risk (and
potential cost to the insurer) or based on a number of
other factors. This differs from general insurance and
may represent a significant financial risk for a new
entrant, as initially they would be without the support
of a significant customer base to smooth out benefit
expenditure volatility or accumulated capital through
operation. This risk is somewhat mitigated by the
risk equalisation transfer arrangements established to
support community rating.
Portability rules mandate that waiting periods
for hospital treatment cover already served by
a transferring consumer from another insurer be
recognised by the insurer to which they are transferring.
With portability requirements, a new entrant may face
significant hospital and medical benefit claims despite
having received minimal premium income from the
transferring member. Of course, a new insurer may
well find it difficult to attract customers from other
insurers if previously served waiting periods were
not recognised. The new insurer appears to face a
dilemma — the need to attract consumers from other
insurers but not being able to impose a waiting period
prior to being confronted with significant benefit
claims. This issue was canvassed in the PHIAC paper,
Portability, switching and competition in the Australian
private health insurance market.
22
Under the PHI Act 2007, community rating regulation is covered
under Part 3-2, risk equalisation under part 6-7, product content under
Part 3-3 (which also covers portability and waiting periods) and
obligations relating to complying health insurance products under
Part 3-4.
16
3. B
arriers in the Australian private health insurance market
7. Hospital treatment coverage by insured persons June 1971 to December 2014
10
Millions covered by PHI
31 October 2008. Increase
in MLS income thresholds,
subject to annual adjustment.
Commonwealth medical benefits at 30%
flat rate restricted to those with at least
basic medical cover from September 1981.
Change in the
rebate indexation
1 July 2013.
Introduction of Medicare from 1 February 1984.
60%
Introduction of 30%
Rebate means testing
from 1 July 2012.
6
4
80%
70%
Introduction of Life Time Health
Cover from 1 July 2000.
8
90%
Medibank began on 1 July 1975. A program
of universal, non contributory, health
insurance it replaced a system of government
subsidised voluntary health insurance.
50%
40%
Proportion with PHI
12
30%
1 July 1997. A Medicare Levy Surcharge (MLS) of 1% of taxable income is
introduced for higher income earners who do not take out private health insurance.
Higher rebates for older
persons from 1 April 2005.
20%
2
Introduction of 30% Rebate from 1 January 1999.
0
10%
Jun
Jun 71
Jun 72
Jun 73
Jun 74
Jun 75
Jun 76
Jun 77
Jun 78
Jun 79
Jun 80
Jun 81
Jun 82
Jun 83
Jun 84
Jun 85
Jun 86
Jun 87
Jun 88
Jun 89
Jun 90
Jun 91
Jun 92
Jun 93
Jun 94
Jun 95
Jun 96
Jun 97
Jun 98
Jun 99
Jun 00
Jun 01
Jun 02
Jun 03
Jun 04
Jun 05
Jun 06
Jun 07
Jun 08
Jun 09
Jun 10
Jun 11
Jun 12
Jun 13
14
0%
Persons covered by PHI (LHS)
Proportion of persons covered by PHI (RHS)
Source: PHIAC
3.2 Sovereign risk barrier —
the potential of regulation
and policy change to impact
on profitability
Is the possibility of changes in industry
regulation a significant barrier to entry?
Can this risk be assessed?
Sovereign risk in the context of the Australian PHI
industry refers to the possibility that the government will
change policies and regulations such that the business
operations and profitability of private health insurers
are affected. Sovereign risk has been put forward
by many stakeholders as the main reason why there
have been so few new entrants in the market.23 The
primary sovereign risks for the industry are changes to
policy settings that would impact on the incentive for
Australians to purchase PHI cover.
23
HBF 2013, p.7; KPMG 2013, p.14; AHSA and hirmaa 2013, p.17;
Deloitte Access Economics 2012, p.18. All of these submissions
identify very few other barriers apart from sovereign risk and
regulatory burden.
Figure 7 shows PHIAC trends data of the number
of persons covered and the proportion of persons
covered by hospital polices from June 1971
to December 2014 and significant changes in
government policy with respect to PHI over that time.
Although it would appear from the figure that particular
government policy changes resulted in fluctuations
in the number of insured persons (both positive and
negative changes to the size of the market), it is difficult
to say merely from a visual inspection the extent to
which the changes in policy were a contributing factor.
A quantitative analysis was conducted in the hope
that it may shed some light on the impact of these
changes. The analysis is detailed in Appendix A,
where the policy effects were estimated for both the
number of people and the proportion of the population
covered by PHI. The analysis showed that for the
population covered by hospital PHI, only two major
policy changes, the commencement of Medicare and
the introduction of LHC initiative had a statistically
significant impact on the size of the market.
The estimated effect of the introduction of Medicare, as
a standalone effect (excluding all other factors) was to
reduce the number of policy holders by 16.3 per cent
3. B
arriers in the Australian private health insurance market
from the mean. The estimated effect of the introduction of
LHC, as a standalone effect was to increase the number
of policy holders by 24.2 per cent from the mean. In
aggregate, the estimated impact of government policy
changes which had a significant effect on the size of
the market over the past four decades appear to have
had a net positive effect on the size of the PHI market
(as illustrated in Figure 7 by the steep upward slope of
the coverage curve from 2000).
Undertaking the same analysis for the proportion
of persons covered, the results show that only the
introduction of Medicare had a statistically significant
and negative effect (also by a 16.3 per cent decline)
on the proportion covered by PHI and explains why
the proportion of policy holders has not increased to
the same extent as persons covered over the period
(see Figure 7).
Of course potential new entrants will need to assess
both the possibility of future changes to regulation
and legislation and their effects on the PHI market.
Uncertainty regarding future policy changes would
most likely be a consideration in any decision to enter
the Australian PHI market.
3.3 Market characteristics and
contestability barriers
Do incumbents through their actions or strategic
decisions impose barriers to entry?
The Australian PHI market is characterised by a
small number of large insurers and a large number of
small insurers. In this section, we will describe some
of the barriers a new entrant might face that derive
from the actions of incumbents and the dynamics of
the PHI market.
Strategic response of incumbents
In the Australian PHI market, characterised as a mature
market (Stephen 2012, p11), incumbents may make
it difficult and costly for a new entrant to attract new
customers. Some of the direct methods said to be
employed include:
• Use of retention teams, where insurers employ
persons to enquire as to why the policy holder
chose to change insurers, challenging their
decision and encouraging them to remain with
their current insurer.24
24
Queensland Teacher’s Union Health 2013, p 5–6 and confidential
submission to PHIAC DP1.
17
• Product differentiation: the creation of different types
and pricing of health insurance policies (including
excesses and exclusionary products) to capture or
target specific (sometimes price sensitive) sectors
of the market and reducing the need or incentive
for those policy holders to switch insurers. A new
entrant may find it difficult to match these products
due to their lack of scale and consequent inability
to absorb the sunk costs need to develop and
advertise these products (Kessides 1986).
• Incumbents may also have the advantage of
established preferred provider contracts (particularly
for dental and optical, in addition to certain
specialists) increasing the attractiveness to consumers
of their policies over those of new entrants (through
potentially lower or no gap payments).
As a consequence of these and potentially other
responses from incumbents, the task facing a new
entrant to compete on price and non-price factors may
be more difficult. In addition, new entrants would need
to establish brands in order to compete in a market
with existing and well-known brands.
Economies of scale and scope
Entering the Australian PHI market is not costless.
Even if entry is via an internet based business with no
physical shopfronts, significant information technology,
management and administrative sunk costs will still be
incurred. This suggests that for a start-up insurer to be
viable, they need to quickly acquire a minimum policy
subscriber base in order to remain viable.
However, insurers new to the market can often
access efficient processing and contract management
capability networks. In terms of the management of
claims processing and policy management, most small
insurers have agreements in place with organisations
which specialise in these tasks (examples include but
not limited to providers such as HAMBS, Paragon21
and CIVICA). In terms of hospital contracting, smaller
insurers belong to one of two organisations (Australian
Health Services Alliance and Australian Regional
Health Group) which negotiate on their behalf. In
addition, a new insurer can purchase these operational
requirements and management expertise directly from
other insurers (examples of insurers who do this include
the Reserve Bank Health Society Ltd and National
Health Benefits Australia Pty Ltd).
18
3. B
arriers in the Australian private health insurance market
8A. Market share in the PHI market (2% to 30% of the market) — June 1995 to December 2014
35%
Insurer market share (as a percentrage of the market)
30%
Medibank
25%
20%
MBF until 2010 and BUPA after
15%
HCF
BUPAAH
10%
NIB
HBF
5%
AUHL
MBF Alliance
AHM
TFH
Jun 95
Dec 95
Jun 96
Dec 96
Jun 97
Dec 97
Jun 98
Dec 98
Jun 99
Dec 99
Jun 00
Dec 00
Jun 01
Dec 01
Jun 02
Dec 02
Jun 03
Dec 03
Jun 04
Dec 04
Jun 05
Dec 05
Jun 06
Dec 06
Jun 07
Dec 07
Jun 08
Dec 08
Jun 09
Dec 09
Jun 10
Dec 10
Jun 11
Dec 11
Jun 12
Dec 12
Jun 13
Dec 13
Jun 14
Dec 14
0%
Source: PHIAC data
Note: Points where market share stop indicate that the insurer is no longer in operation. Market share for an insurer which suddenly jumps up
is indicative of an intra-industry (within industry) merger of an existing insurer. Acquisitions usually occur prior to mergers. This figure excludes
the insurers HBA and AXA which were acquired by BUPAAH and PA Health Benefits merged with AUHL in early 1996.
With the availability of these networks and the ability
to offer health insurance products over the internet,
scale economies may no longer act as a significant
barrier to entry as it was in the past. This means that
scale economies may be less likely to hinder the
viability of entry of a new competitor into the industry
or overly benefit those incumbents with existing and
expensive internal networks.
Scale economies can give larger incumbent insurers
an advantage in attracting new members through
marketing spends, which may be unaffordable to
a new entrant. However, this may be mitigated by
smaller funds and new entrants utilising the services of
intermediaries who directly enrol consumers.
Cost advantage of incumbency
Attracting new policy holders or wresting existing
policy holders from competitors in order to maintain a
minimum scale of operation is unlikely to be easy in
the current PHI market where there is significant rivalry
among firms (Deloitte Access Economics, 2012, p.18).
Further, it may be that the general apathy of many
customers in making a ‘set and forget’ decision on
PHI represents a significant barrier to entry that new
entrants will need to overcome.25
Looking at the market share of policy holders over
time (Figure 8A, 8B and 8C shows the relative size of
industry participants with most of the industry made up
of insurers with less than one per cent of the market),
the data show that the market has been relatively static
with changes in market share occurring very slowly.
The only significant change in the industry has been
when a private health insurer was purchased by their
peers as an intra-industry acquisition (as in
the case of the BUPA, MBF and MBF Alliances
merger in mid-2010, which saw BUPA’s market
share jump significantly).
25
IPSOS (2013) indicates that only 1.6 per cent of policy holder
change insurers in any given year.
19
3. B
arriers in the Australian private health insurance market
8B. Market share in the PHI market (0.5% to 2% of the market) — June 1995 to December 2014
2.0%
GMHBA
Insurer market share (as a percentrage of the market)
Defence
1.5%
CBHS
MU
1.0%
IOR
Westfund
Health Partners
0.5%
Latrobe
HIF
Healthguard
GMF
Jun 95
Dec 95
Jun 96
Dec 96
Jun 97
Dec 97
Jun 98
Dec 98
Jun 99
Dec 99
Jun 00
Dec 00
Jun 01
Dec 01
Jun 02
Dec 02
Jun 03
Dec 03
Jun 04
Dec 04
Jun 05
Dec 05
Jun 06
Dec 06
Jun 07
Dec 07
Jun 08
Dec 08
Jun 09
Dec 09
Jun 10
Dec 10
Jun 11
Dec 11
Jun 12
Dec 12
Jun 13
Dec 13
Jun 14
Dec 14
0%
Source: PHIAC data
Note: see notes for Figure 8A.
Increasing market share to achieve a minimum number
of policy holders for long term viability may require
significant expenditure on advertising or intermediaries,
representing a large upfront cost and a financial
barrier to entry into the Australian PHI market. By
increasing an insurer’s policy membership, the insurer
also increases their financial burden where additional
levels of capital reserves would be required to
meet prudential and capital standards of increased
membership.
Given the stable level of market share over the medium
term as illustrated in Figure 8A, 8B and 8C, achieving
a growth strategy in the PHI market is likely to be a
costly undertaking and would imply a compounding of
the barriers to entry in the PHI market for a new insurer
deciding to enter and achieve a significant presence in
the market.
The difficultly new entrants face in increasing their
market share is reflected in the health insurance
retention index presented in Figure 9. This data shows
that over the last seven years, average retention rates
for health insurance policies held for two years or
longer have been around 88 per cent, with restricted
and not-for-profit funds having higher retention rates.
20
3. B
arriers in the Australian private health insurance market
8C. Market share in the PHI market (0% to 0.5% of the market) — June 1995 to December 2014
Market share range for the balance of insurers
0.7%
0.6%
0.5%
0.4%
HPL
0.3%
Transition
0.2%
NHBA
0.1%
0%
Sep 95
Mar 96
Sep 96
Mar 97
Sep 97
Mar 98
Sep 98
Mar 99
Sep 99
Mar 00
Sep 00
Mar 01
Sep 01
Mar 02
Sep 02
Mar 03
Sep 03
Mar 04
Sep 04
Mar 05
Sep 05
Mar 06
Sep 06
Mar 07
Sep 07
Mar 08
Sep 08
Mar 09
Sep 09
Mar 10
Sep 10
Mar 11
Sep 11
Mar 12
Sep 12
Mar 13
Sep 13
Mar 14
Sep 14
Insurer market share (as a percentage of the market)
0.8%
Source: PHIAC data
Note: see notes for figure 8A. The three most recent entrants into the PHI market are highlighted. The balance of the PHI industry which
includes the insurers ACA, Acorn, CDH, CUA, DHF, Druids, federation, GU, GUC, HCI, HIF, LOOF, Mildura, navy, Phoenix, Police, QCH,
QTUH, Queenstown, RBHS, RT, SMH, St Luke’s and Transport are within the shaded band and have been relatively stable in their market
share over the last 20 years.
Further, a hirmaa survey of 16,000 members from
11 insurers found that 98 per cent of policy holders
were satisfied with their health insurer (AHSA & hirmaa
2013, p.21–22). This evidence suggests a significant
marketing effort (including the use of intermediaries),
various forms of discounting or a combination of both
would be required to attract a significant number
of these members to a new insurer. An alternative
solution in overcoming the market share barrier is the
acquisition of an existing market participant, which a
number of insurers have undertaken over the last few
years (See Box 2 on recent insurer acquisitions).
The experiences of the most recent entrant into the
Australian PHI market, health.com.au reflects many
of the issues of barriers to entry raised in this paper
(See Box 3 for HPL’s experiences in the Australian PHI
market)
21
3. B
arriers in the Australian private health insurance market
9. Retention index for the Australian PHI industry March 2008 to December 2014
Retention rates of insurers
(as a percentage of total policies)
94%
92%
90%
88%
86%
84%
82%
Restricted
Not for profit
Dec 14
Sep 14
Jun 14
Mar 14
Sep 13
Dec 13
Jun 13
Mar 13
Dec 12
Sep 12
Jun 12
Mar 12
Dec 11
Sep 11
Jun 11
Mar 11
Dec 10
Jun 10
Open
Sep 10
Mar 10
Dec 09
Sep 09
Jun 09
Dec 08
Mar 09
Sep 08
Jun 08
Mar 08
80%
Industry
Source: PHIAC data
Note: The retention rates relate to keeping the same policy holder for two years or longer.
BOX 2 — ACQUISITIONS AND MERGERS AS A MARKET ENTRY ALTERNATIVE
The barriers facing an entrant into the Australian PHI market or an insurer seeking to establish a significant
presence in a different state may be high. Acquisition of an existing insurer may overcome many of the barriers
to entry. However, two further considerations must be satisfied — an insurer must be willing to be acquired and
the purchase price needs to be determined.
The table below shows the six most recent insurer acquisitions, the cost of the acquisition and the number of
policy holders the acquired insurer represented.
Number of
Premium over
policy holders in HBFC per acquired
acquired insurer
policy holder
Insurer
acquired
Acquiring
agent
Date of
acquisition
Cost of
acquisition
MBF and
MBF Alli.
BUPA
June 2008
$2.4 billion
922,371 A
$1,260 A
Druids (VIC) GMHBA
October 2008
$4.7 million
6,217 A
$7 A
MU
HCF
December 2008
$256 million
79,132 A
$2,159 A
AHM
MPL
January 2009
$367 million
155,364 A
$979 A
DHF
Avant
August 2011
$28.5 million
7,492 B
$1,149 B
Transport
Health
Primary Health
Care Ltd
November 2014
$18 million
4,816 C
$1,317 C
Note: Cost of acquisition data is based on publicly cited acquisition costs.
A Based on insurers data from PHIAC Operations of Private Health Insurers report 2007–08
B Based on insurers data from PHIAC Operations of Private Health Insurers report 2010–11
C Based on insurers data from PHIAC Operations of the Private Health Insurers report 2013–14
This data shows that in most cases, a significant premium was paid for the acquisition. From the insurer’s
perspective, the acceptable selling price could reflect factors such as the timing of the purchase, the desire of the
insurer to leave the market and the insurer’s current financial performance. On the acquirer’s side, issues such as
the inability to expand through organic growth, the difficulty in entering the desired markets, the number of policy
holders of the target insurer and the return available through scale economies may influence the price paid.
3. B
arriers in the Australian private health insurance market
22
BOX 3 — AN ENTRANT'S VIEW
Health.com.au Pty Ltd — HPL
HPL applied for registration as a health fund in November 2011 and began operations on 16 April 2012.
It can be argued that HPL is the one recent PHI example of an entrant with features (open, for profit and
growth orientated) that a market should be able to accommodate in order to demonstrate and enhance its
competitiveness. In this context the perspective of the senior management of HPL on the barriers it faced as a
new entrant into the industry are worth considering.
In a June 2015 interview the CEO and GM Product of HPL described the main obstacles to the establishment
of a new health fund as:
• Capital costs of customer acquisition. Whether
customer acquisition is achieved by the
fund’s direct marketing or through the use of
intermediaries, the cost of each new customer
takes a significant amount of time to recover and
substantial capital is required over the medium
term. A new insurer cannot spread the cost of the
acquisitions across a broader customer base to
sustain growth.
• “Leakage”, the loss of customers who have been
recently acquired is a major expense given the
capital costs of acquisition.
• Forecasting benefit payments is difficult for a new
fund due to the lack of claims experience. This
can make product design difficult. The claims
volatility that a new entrant experiences has to be
underpinned by a judicious approach to reserving
whilst maintaining an efficient use of capital.
• The risk that government policy settings in regards
to the incentives to take out PHI will change is a
significant deterrent to investors to risk capital in
the industry.
• The regulation of products and the need to
conform to business processes such as Hi-Caps
or the various business support services result in
there being very little room for innovation in policy
design. Very difficult to stand out from the crowd.
• Cost control is very difficult in this industry —
funds tend to be passive acceptors of hospital
cost increases and are forced to acquiesce to
the introduction of new expensive services. This
is accepted, begrudgingly perhaps, by existing
players but is a significant deterrent to new
entrants, which have broad demands on
their capital.
• Risk equalisation payments in respect of customers
new to the industry is a severe impost on funds
given the capital outlays required to acquire them.
Consideration could be given to an amnesty
on RE payments for their initial two years of a
customer’s participation in the industry.
23
Appendix A — Econometric model of sovereign risk
in the Australian PHI market
Sovereign risk was raised as a key barrier to entry in a number of submissions to the PHIAC
consultation on competition in the Australian PHI market and also through informal discussions
with insurers. One way to assess the impact on the PHI market of future changes to government
policy is to review the impact of past changes in government policy on the size of the market, a
key driver of profitability and stability in the industry.26
Modelling government policy
changes on the number
of persons covered in the
Australian PHI market
A new entrant would almost certainly view the size of
the market as a significant factor when considering the
profitability of entry. A stable or growing market would
be viewed as more attractive and favourable for
financial performance than one which was declining.
The impact of sovereign risk on profitability is the way
government policy change adversely or supportively
affects the size of the health insurance market, that is,
the number of policy holders in the market.
The simple econometric model below is used to
estimate the factors which are associated with
changes in the number of persons insured in the
PHI market, the direction of the association and the
statistical significance of the association. The question
that this model seeks to answer is, what changes in
lnPolt = c +
n
∑ + ß lnPol
i=1
1
t–i
government policy had an impact on the size of the
Australian PHI market over time? Econometric analysis
will be used to test how significant each of the major
government policy changes (identified in Figure 7)
have been in shaping the size of the PHI market.27
This model identifies that the change in the number of
persons covered in the market is a function of:
1. All factors other than government policy
changes, which is represented as the sum of the
lag(s) of the dependent variable (the number of
persons covered in the PHI market).
2. Specific and important government policy
changes which have occurred over the last forty
years.
Where:
Polt : Represent the number of persons covered by all
hospital policies.
n
∑ lnPolt–i : Represents the dynamics in the estimated
i=1
model of variables not accounted for by
systemic policy risk.
+ ß2 MBt + ß3 MBenefitst + ß4 Medicaret + ß5 MLSt + ß6 Rebatet + ß 7LHCt
+ ß8 HRebatet + ß9 PHIACTt + ß10 HMLSt + εt
26
As pointed out in section 2.3 and footnote 14, there are not enough
variation in insurer entry data to determine the barriers to entry based
on policy changes directly.
27
The “market” in this analysis is data on persons with hospital
cover only.
Appendix A — Econometric model of sovereign risk in the Australian PHI market
24
A1. Testing sovereign risk in the PHI market for persons covered — June 1972 to June 2014
Policy change
Effect as a percentage change in hospital
treatment coverage of insured persons
Factors other than policy changes
+45.4%***
Introduction of Medicare
–16.3%***
Introduction of Lifetime Health cover
+24.2%***
Net Sovereign risk effect
+7.9%
*** Significance at 1%, ** Significance at 5%, * Significance at 10%
Note: Factors other than sovereign risk include things such as choice in the location, timing and provider of medical treatment, the economic
environment and age as drivers of the take-up of private health insurance policies. Estimate of policy changes which were statistically
insignificant were not reported here.
Specific government policies affecting
the Australian PHI market
MBt : Medibank introduced in 1 July 1975 and ended
in 1978.28
MBenefitst : 30% medical benefits set for those with
at least basic cover introduced in September 1981
and ended in July 1984 with the introduction of
Medicare.
Medicaret : Introduction of Medicare (including
Medicare levy) on 1 February 1984.29
MLSt : Medicare Levy Surcharge (MLS) of 1 per cent
of taxable income for certain people who do not take
out PHI introduced on 1 July 1997.
Rebatet : 30% PHI rebate for policy holders on 1
January 1999.
LHCt : Lifetime Health Cover introduced on 1 July
2000.
HRebatet : Higher rebate for older persons introduced
on 1 April 2005.
PHIACTt : Introduction of the Private Health Insurance
Act 2007 on 1 July 2012.30
HMLSt : Increase in MLS threshold subject to annual
adjustment introduced on 31 October 2008.
28
Program of universal, non-contributory health insurance replacing
government subsidised voluntary health insurance.
29
Reintroduction of universal, non-contributory health insurance. Also
involved a re-registration of insurers with the requirement for the
merger of hospital and medical funds. Mergers between funds
facilitated. Premium regulation was relaxed and reinsurance trust
fund was changed to operate on a state by state basis to redress
differences in medical and hospital costs across states.
30
Re-registration process for all insurers and a new risk equalisation
regime replacing the previous reinsurance.
The policy variables are represented as categorical
variables (or dummy variables) with a value of 1 in a
year in which the policy change was effective and
0 otherwise. The sum of the lags of the dependent
variables represents the dynamics in the model,
but also all the factors other than those nine policy
changes that are associated with the change in
the number of persons covered by private health
insurers, but which are difficult to measure or observe
but clearly influence the choice to take up PHI (ie.
consumer choice, economic conditions etc.).
The choice of the lag length for the dynamics of the
model is based on minimising the Akaike criterion (not
shown here) which identifies an optimal lag length of
n = 1.
Testing market size and the profitability
outcomes due to sovereign risk
To quantitatively assess the positive or adverse impact
of the risk of government policy change on the PHI
market, an estimation of the impacts of individual
policy changes on the overall size of the PHI market
(based on the number of persons covered) has been
undertaken utilising econometric techniques. Examining
annual data from 1971 to 2014, each of the nine
major PHI policy changes in Figure 7 were modelled
and analysed.
The resulting estimates are presented in Table A1.
With a coefficient of determination (how well the
independent variables predict the dependent variable)
of 88.4, the model as Figure A2 shows a good fit for
the historic data of the number of persons covered by
private hospital insurance. An analysis of the estimated
parameters (Table A1) shows that there were only two
25
Appendix A — Econometric model of sovereign risk in the Australian PHI market
A2. Hospital treatment coverage by insured persons 1971 to 2014, actual and model estimates
12
Commonwealth medical benefits at 30% flat
rate restricted to those with at least basic
medical cover from September 1981.
Millions of persons covered by hospital PHI
10
Introduction of Life
Time Health Cover
from 1 July 2000.
31 October 2008. Increase in
MLS income thresholds, subject
to annual adjustment.
Introduction of Medicare
from 1 February 1984.
8
Introduction of 30%
Rebate means testing
from 1 July 2012.
6
Higher rebates for older
persons from 1 April 2005.
4
2
Medibank began on 1 July 1975. A program of
universal, non contributory, health insurance it
replaced a system of government subsidised
voluntary health insurance.
1 July 1997. A Medicare Levy Surcharge
(MLS) of 1% of taxable income is introduced
for higher income earners who do not take
out private health insurance.
Introduction of 30% Rebate from 1 January 1999.
Jun
Jun 71
Jun 72
Jun 73
Jun 74
Jun 75
Jun 76
Jun 77
Jun 78
Jun 79
Jun80
Jun 81
Jun 82
Jun 83
Jun 84
Jun 85
Jun 86
Jun 87
Jun 88
Jun 89
Jun90
Jun 91
Jun 92
Jun 93
Jun 94
Jun 95
Jun 96
Jun 97
Jun 98
Jun 99
Jun00
Jun 01
Jun 02
Jun 03
Jun 04
Jun 05
Jun 06
Jun 07
Jun 08
Jun 09
Jun10
Jun 11
Jun 12
13
0
Persons covered by PHI
Model estimate
Source: PHIAC data and PHIAC estimates
Note: Actual data is in blue and model estimates are in red.
policy changes that were significantly associated with
changes in the size of the PHI market. These policy
changes were the introduction of Medicare in 1984
and LHC introduced in 2000.
The introduction of Medicare with its “free” medical
and hospital services which did not required a
premium payment or payments by the user of medical
and hospital services, would have the likely effect of
reducing the incentive (financial or otherwise) to hold
any form of hospital private health insurance policy.
Estimate of the model for this policy change showed
it was associated with a 16.3 per cent decline from
the mean in policy holder numbers.31 As expected, the
introduction of Medicare encouraged a fast decline
31
As an explanation, the estimated results presented in Table A1
represent the percentage change in the number of persons covered
due to a number of government policy related factors and one
variable representing all other factors which were not included
or not observable. These factors have both positive and negative
associations with the number of persons covered in the Australian PHI
market. In the case of the introduction of Medicare, the estimated
results show that each year that Medicare was in place (from 1984
onwards), this policy by itself was associated with a 16.3 per cent
in take-up of PHI (See Figure 7). The estimation of
the model showed that the implementation of LHC
was associated with an increase in policy holder
coverage by 24.2 per cent per year above the
mean. In Figure A2, the estimated parameters in
Table A1 are superimposed on the actual number of
persons covered in the market. The estimated 16.3
per cent decline in policy holders due to Medicare
is represented by the fall in the estimated model from
1984, only arrested by the effect of a 24.2 per
cent increase in persons covered due to LHC. The
estimated model (and its representation in Figure
A2) shows the interaction of all the policy variable
estimates and the non-policy variable.
decline in the number of persons covered in the PHI market. The
various factors in the model other than Medicare had both positive
and negative effects on the size of the PHI market, reducing the
full impact of the 16.3 per cent per year decline on average by
this policy. What the estimated parameter for the Medicare policy
change means is that if all the other factors (both positive and
negative) were excluded, the introduction of Medicare would be
associated with a 16.3 per cent decline in persons covered in
subsequent years.
Appendix A — Econometric model of sovereign risk in the Australian PHI market
26
A3. Testing sovereign risk in the PHI market for proportion covered — June 1972 to June 2014
Policy change
Factors other than policy changes
Effect as a percentage change in hospital
treatment coverage of insured persons
+68.3%***
Introduction of Medicare
–16.3%**
Net Sovereign risk effect
–16.3%
*** Significance at 1%, ** Significance at 5%, * Significance at 10%
Note: Factors other than sovereign risk include things such as choice in the location, timing and provider of medical treatment, the economic
environment and age as drivers of the take-up of private health insurance policies. Estimate of policy changes which were statistically
insignificant were not reported here.
The net effect of changes to government policies
which were statistically significant is a positive increase
in the number of persons covered by hospital policies
by 7.9 per cent per year above the mean. These
results suggest that changes in government policy
related to PHI historically may have been a net
positive for the industry.
In terms of the proportion of persons covered, the
results are the opposite (see Table A3), where the only
significant policy effect in changing the trajectory of
the proportion of persons with hospital PHI was the
introduction of Medicare in 1984, which was a net
negative for the industry in terms of maintaining the
proportion of persons covered by PHI.
The foregoing analysis demonstrates the material
effect on profitability — based on the size of the PHI
market — that changes to private health insurance
legislation and regulation might have. Of course for
potential new entrants, it is the possibility of future
changes to regulation and legislation (sovereign
risk) that has to be assessed in addition to the costs
associated with current regulation and legislation.
27
Abbreviations and acronyms
HBFC
Health Benefit Fund Capital
HHI
Herfindahl–Hirschman Index
LHC
Lifetime Health Cover
MLS
Medicare Levy Surcharge
PHI
Private Health Insurance
PHIAC
The Private Health Insurance Administration Council
28
Glossary and definitions
Above normal profit
Also called supernormal profits or excess profit is when a firm earns more than normal
profits which represents the firm’s costs, returns on capital and risk in addition to economic
rents usually created by the exercise of market power by the firm.
Adverse selection
In the context of PHI, those who are more likely to purchase health insurance are those
who are more likely to make a claim.
Market power
The ability of an incumbent to raise prices above competitive levels (marginal cost) or
reduce quality without an immediate competitive response or faces competitive constraints
in doing so.
Normal profit
Also known as normal economic profit is when a firm earns a profit which is just sufficient
for the firm to continue to supply the market. The firm covers both its fixed and variable
costs (including labour and entrepreneur skills) including a return on capital (adjusted for
risk). Economic profit differs from accounting profit.
Sovereign risk
Risks which a firm is subject too but has no control over. Examples of which include
unilateral changes to government policy or regulations.
Sunk cost
Fixed expenditures which is required to begin an operation in the market and which cannot
be used for alternative purposes or easily sold should the firm seek to exit the market.
29
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