Can we design a market for competitive health insurance? CHERE Discussion Paper No 53



CAN WE DESIGN A MARKET FOR COMPETITIVE HEALTH INSURANCE?

DESIGN OF THE COMPETITIVE STRUCTURE FOR PRIVATE HEALTH
INSURANCE

The required market structure depends on consumers, insurers, health care providers and
government playing their allotted roles. Another crucial aspect of market structure is that there
are sufficient numbers of insurers and providers to compete. For the provision of primary care, the
relevant market is quite a small geographic area. Although hospitals have larger catchment areas,
the large capital costs and time required to construct new facilities imposes major entry costs which
limit the extent to which new contracts will be contested. Market size is of particular relevance in
Australia where population is concentrated in a small number of urban areas.

Governments have to fulfil two functions, one being to establish the overall regulatory environment
and monitor market performance, while the other is to ensure some levels of equity through
providing public finance and, in the Scotton model, to ensure that there are public budget holders.
The equity role is important as without any cross-subsidy across risk classes there will be large
variations in premium levels; for example, according to van de Ven and Ellis, unregulated premiums
could be as low as 10% of the average premium level in the lowest risk category, ranging to a
premium that exceeds the average by a factor of 10 or more, for the highest risk category (van de
Ven, Ellis 2000). In Australia, total health care expenditure averages just over $3,000 per person per
annum (Australian Institute of Health and Welfare 2000a), suggesting that high risk premiums could
be well over $30,000 per annum.

Government in its equity role will distribute public finance (ignoring the collection side), by providing
risk adjusted capitation payments to the budget holders, both public and private. As this is, in
essence, a voucher system, this means that there must be an appropriate and accurate basis for
risk adjustment, that is an estimate of the expected health expenditures of individual consumers over
a fixed interval of time (van de Ven, Ellis 2000). Without this, private insurers are going to compete
for the profitable enrollees, ie the low risks, and thus the outcome is cream skimming behaviour
rather than greater efficiency. The issue of whether US HMOs/managed care plans achieved lower
costs through risk selection has spawned a large literature (reviewed by (Glied 2000) the results are
mixed but overall these insurers have been able to enjoy a selection advantage. Further, through
careful design of insurance packages, insurers can get consumers to reveal information about
their expected use of health care. Should cream-skimming occur under the Scotton scenario, the
unprofitable risks would be left to the public budget holders, as the insurers of last resort. But this
is unlikely to be a stable situation as the public budget holders will incur higher costs and benefit
payouts than the private budget holders; the public budget holders will be criticised for inefficiency
and arguments will be mounted that it is unfair to pay public budget holders higher capitation rates
than private budget holders, thus encouraging upward pressures on costs.

The insurers as budget holders are responsible for the funds that cover the range of health care
services, with greater efficiencies achieved and duplication of services avoided through the co-
ordination of care. As the insurance package is intended to offer comprehensive cover, regulations
are required to ensure insurers do not exploit uninformed consumers. A common response to this
is to specify the minimum benefits package but this reduces the dimensions on which insurers
compete. At the extreme, it eliminates a strong role for consumer preferences by making all funds
compete on essentially the same package.

Consumers play a crucial role in driving the greater efficiency of the system. They must be able
to choose rationally across insurers and to do that, they must be well informed about the costs,
comprehensiveness and quality of the insurance plans offered. They must also know their own
risk status, and their own preferences, including their willingness to pay for insurance coverage
over what is obtainable with their voucher. In knowing their willingness to pay, they must consider
additional insurance premiums and co-payments at the point of service use. It is worth noting that
many consumers will be poorly informed about the health care market, and have not had substantial
experience in obtaining health care until they face a complex acute illness or some ongoing
condition. Another aspect of consumer choice is whether insurance, at least for some minimum
benefits package is compulsory, or whether consumers can choose to remain uninsured.



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