Health insurance faces a bitter pill

The Southern Cross claims debacle comes at a bad time for the industry. DANIEL RIORDAN explains why the outlook is grim.

The health insurance industry needed the latest crisis at Southern Cross like a hole in the head.

For the past decade New Zealanders have been opting out of private cover as premiums soared. For some older Southern Cross customers they have trebled since 1991.

Despite a slight recovery in the past two years, only one in three New Zealanders has private health insurance, compared with one in two 10 years ago.

Health insurers maintain they make hardly any money and their costs go up every year as the population ages and demands more expensive operations.

Yet the prospects cannot be all bad. Over the past 18 months, Southern Cross made a record three attempts to overturn a Commerce Commission ruling that blocked its takeover of Aetna Health, formerly the second-biggest health insurer in the country.

Eventually it won full control of Aetna in the Court of Appeal last month, making it by far the largest health insurer in the country.

This has outraged private hospitals and the Consumers' Institute, which fear Southern Cross will dominate the market - despite the court's opinion that it will not.

How many New Zealanders have health insurance and who covers them?

About 1.36 million New Zealanders spent around $525 million on health insurance last year, spread over 14 insurers. The industry paid $560 million in claims, funding just under 10 per cent of the country's total health expenditure.

Half of all policies are provided under group schemes, typically organised by employers, and just over half of all policies are for comprehensive care, as opposed to policies that cover just major medical costs.

The industry peaked in size in 1991, when 51 per cent of the population was covered, fell steadily for much of the next decade, but has picked up in the past couple of years to 35 per cent.

Southern Cross is by far the biggest player, by either measure of industry size: premium income ($420 million) or number of lives insured (810,000 - policies typically cover more than one person).

After its takeover of Aetna Health - begun in mid-2000 and approved last month after a protracted battle with the Commerce Commission - Southern Cross has about 80 per cent of the market by premium income and 71 per cent by number of lives covered.

Tower Health is the only other company with a market share in double figures (13 per cent of lives covered), which it reached 15 months ago when it bought AXA's heath insurance business.

Apart from acquiring Aetna's better computer system and primary health care network, Southern Cross benefits from adding Aetna's 40,000 policyholders to its risk pool, taking advantage of economies of scale and spreading risk across more policyholders, which it hopes will help it take some of the edge off premium increases for higher-risk members.

Why was Southern Cross allowed to take over Aetna?

Although the Commerce Commission cited market dominance concerns when it blocked Southern Cross' initial application to buy Aetna, the High Court (and later the Court of Appeal) agreed with Southern Cross that profit margins were low and that the threat of competition from new entrants was great enough to outweigh such concerns.

The commission acknowledged that the big general insurance companies in the health insurance market were there to ensure they can offer a full range of insurance products rather than because of the attractiveness of the market.

Southern Cross argued such companies could spread risk across several insurance categories, a concept called economies of scope.

This acted as a powerful deterrent to the dominant health insurer, despite the advantage it enjoyed over other health insurers of not paying tax because of its friendly society status.

The court's rulings - which represented a rare setback for the consumer watchdog - were greeted with disbelief by Southern Cross' competitors, insurance brokers and private hospitals competing with Southern Cross' own stable of 11.

Consumers' Institute chief executive David Russell warned that Southern Cross would find it easier to increase its charges.

Why are some doctors and hospitals at loggerheads with Southern Cross?

Traditionally the company, started by medical specialists as a not-for-profit business, has been seen as friendly to doctors. But in the past year the relationship has gone sour as it tries to introduce advanced fixed-price contracts for operations.

Under the new system, private hospitals sign up with the health insurer to perform operations for a fixed sum. Southern Cross argues that the system, so far covering 15 to 20 per cent of providers, benefits health providers as well as consumers by removing uncertainty.

But many doctors and hospital managers claim Southern Cross will be able to use its market dominance to squeeze down prices, pushing small hospitals out of business.

Will premiums keep going up?

Probably. Health insurers note that medical costs are rising faster than in other parts of the economy. Specialists' costs in particular have risen by 30 per cent since 1994.

Also, people naturally want to make use of new medical technology as it becomes available. While the new technology tends to result in better outcomes, it is typically more expensive than existing technology.

Where once x-rays costing $100 were the only imaging procedure available, today a patient might receive a CAT scan (computerised axial tomography) costing $500, a MRI (magnetic resonance imaging) costing $1000 or a PET (positron emission tomography) costing $2500, for which the nearest provider is in Melbourne.

The number of MRIs performed in the past two years has almost tripled.

At the same time more medical conditions are becoming treatable each year. Southern Cross may have about 25 per cent fewer members than 10 years ago, but each member is twice as likely to have surgery - orthopaedic and gynaecological procedures being the most common.

More elective surgery is being performed in the private sector as surgery waiting lists for public hospitals grow.

Southern Cross has been particularly hard hit by the ageing of the population. A year ago it increased premiums by up to 30 per cent for policyholders aged over 45 and has signalled more premium increases for this year. Other insurers have also raised premiums.

All are grappling with a problem they call adverse selection. This means insurers are losing younger policyholders with few existing medical conditions who have more flexibility in choosing health insurers, and being left older policyholders who cost insurers more.

The picture is worse overseas. Industry umbrella group the Health Funds Association last year calculated that the average New Zealand premium was $360 compared with Australia's $A1000 ($1220) and Britain's £1007 ($3425).

Australian policyholders, however, can claim a 30 per cent rebate on their health insurance costs. New Zealand insurers are arguing for similar rebates here but so far the Government has shown no signs that it is listening.

How do insurers decide on premiums?

Policies are priced in two ways: by individual risk rating or by community rating. Sometimes combinations of the two are used.

In community-rated schemes, premiums are the same regardless of the policyholder's age or medical condition. These premiums are set at the average cost of the broader age group, meaning younger policyholders are effectively subsidising older policyholders, whose medical costs are usually higher.

Individually rated schemes charge premiums based on age, and sometimes on gender and other characteristics.

Five-year age bands are commonly used to group people of similar age so they pay the same premiums. Individuals within these bands might still be charged extra if they have existing conditions.

Alternatively, some insurers may charge ordinary premiums but exclude specific medical conditions from coverage. Premiums increase steadily as policyholders move through the age bands.

Under the Human Rights Act, insurers cannot discriminate on the basis of age, but people can be charged more or less if their premiums are based on statistical data and are reasonably applied.

Older people on average claim more and cost more, and as a consequence their premiums are higher. Unfortunately for them, this comes at a time in their life when their incomes are usually fixed.

Although often described as having a policy of community rating, Southern Cross has rebalanced its premiums to align more closely with risk.

Last year, it introduced a 46-64 age band and raised premiums for about 300,000 members by up to 30 per cent.

That, and the signalling of further increases this year, have upset long-term members whose premium contributions when they were younger typically exceeded their claims and effectively cross-subsidised older members. Those cross-subsidies are being pegged back just as they move into the older age brackets.

Group schemes generally provide for employees with existing medical conditions to be covered on the same terms as other employees.

The ability of anyone with such conditions covered by a group scheme to move to individual schemes tends to be limited.

THE AETNA SAGA

July 2000: Southern Cross agrees to buy Aetna Health, then seeks Commerce Commission approval for the deal.

August 2000: The commission blocks the deal, citing market dominance concerns.

August 2000: Southern Cross reapplies to the commission, undertaking to divest some of Aetna's policies.

September 2000: The commission turns down the second application.

September 2000: Southern Cross applies for a record third time, promising to offload all of Aetna's policies, retaining only Aetna's computer system and its primary care network.

October 2000: The commission approves the third application.

March 2001: The High Court upholds Southern Cross' appeal against the commission's first decision, ruling that the commission erred in its original decision and that Southern Cross can have all of Aetna.

December 2001: The Court of Appeal turns down the commission's appeal against the High Court's decision. The commission says it won't take the matter any further.

Full coverage:
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