Health Analysis

Possibilities of optimising private health insurance examined

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Private healthcare policies and incentives have been examined in order to find methods for improvement, writes Professor Francesco Paolucci, Josefa Henriquez, Rhod McKensey and Andrew Matthews.

PRIVATE HEALTH INSURANCE (PHI) is an important part of Australia’s overall healthcare system. The Federal Government provides support for the private health industry through three key policy levers. The effectiveness of these levers against their policy objectives has recently been independently examined.

Key findings from the independent studies included:

  1. the incentives are in aggregate effective, whilst inefficient, in achieving the objectives set out by regulation (such as reducing pressure on public spending);
  2. options to modernise the incentives have been designed for implementation in the short term to improve their effectiveness and their efficiency; and
  3. PHI is relatively inelastic in that small price changes have little effect.

Industry consultation on these reports commenced on 6 June and will run for 11 weeks through to 15 August.

The studies

Independent studies were commissioned by the Department in the 2020-21 and 2021-22 Budgets to evaluate the effectiveness of the regulatory settings for the Medicare Levy Surcharge (MLS), private health insurance rebate (Rebate) and Lifetime Health Cover (LHC) (collectively referred to as the PHI Incentives).

These reviews have been undertaken by Finity Consulting (Finity) and independent academics led by Professor Francesco Paolucci and including Professors Thomas McGuire, Richard Van Kleef, Emmanouil Mentzakis, Jacob Glazer, and Ms Josefa Henriquez.

The aim of these studies was to identify opportunities to improve the affordability and quality of PHI cover for consumers to access private health services and to optimise the contribution private health makes to the health system. 

It is important to note that the objectives of the studies do not address issues related to the public health system. This includes timely access to care, the way in which the public and private systems interact, such as two-tier system-related inefficiencies, or to the way independent healthcare providers deliver quality care and services, or the way in which they are paid.

The role of PHI in Australia

PHI forms a central part of funding in the Australian health system, with over 45% of the population currently holding PHI coverage according to Australian Prudential Regulation Authority (APRA) numbers, whilst it represents only 8% of total healthcare spending. The Australian Government is committed to incentivising PHI uptake as means of contributing to the funding and sustainability of Australia’s health system.

In the late ’90s, given the sharp fall of enrolments from 50% to 30% due to the introduction of Medicare, this commitment led to the introduction of various policies, known as PHI incentives, which included the MLS, LHC and the Rebate.

The objective of PHI incentives is to encourage those who can afford it to contribute more to their healthcare through purchasing PHI, while also supporting access to private healthcare for others. Each policy has its own particular objectives, for example, the MLS seeks to ensure high participation (or contributions) among high earners, reducing average premiums for PHI and private healthcare.

On the other hand, the Rebate attempts to make premiums more affordable for older people, or those on lower incomes, while the LHC incentivises obtaining hospital cover earlier in life and maintaining it. The combination of incentives is meant for Community Rating.

Over the years, these policies have largely remained the same, except for marginal changes with the introduction of means testing and modernisation of the income thresholds, calling for an evaluation of these policies.

Is PHI a good financial deal for the government?

The first study, referred to as the “offset”, focused on understanding the cost to the Government of the Rebate and forgone MLS, both in terms of the impact on the public health system and potential cost savings.

The offsets for the Australian Government were estimated as health care costs saved by the Government because an individual is enrolled in PHI by age, income and family/individual coverage. The reports show large offsets for the Government, on average of $1,434 per person. That is, the Federal Government is $1,434 better off for each person that holds private health insurance, after considering the cost of the rebate, the foregone MLS and the reduction in burden on the public health system.

Offsets for all age, income and coverage group range from $221 to $5,268. Older individuals use more resources than younger groups and offsets are higher for older enrollees.  

The net cost to the Government was estimated by subtracting offsets from government subsidies to purchase of PHI in the form of premium rebates and MLS tax obligation forgiveness. It was found that the current PHI subsidy policy is a good financial deal for the Government. When only considering the premium rebates, net cost to the Government is negative; there are net savings. 

Net savings for the Government average $916 per person. Net savings increase with age. When incorporating the MLS tax forgiveness, savings are roughly cut in half to $554 per person. Savings remain high for the older groups.

Net savings increase with age, as the average hospital claims funded exceed the average Rebate. For instance, individuals over 75 years of age receive an average PHI Rebate of $965 per person, while the average claims funded are over $7,000 per person. That is, there is a return on investment for Rebate spend.

Can changes to the incentives increase participation?

What changes are effective given studies of consumer behaviour?

A survey was conducted of over 1,500 consumers to assess their preferences and the consequences of different scenarios related to PHI policy settings. This allowed for the identification of changes that would have significant impact on expected consumer behaviour.

The findings would indicate the Rebate is effective. Though, given low elasticity there is little persuasive empirical evidence to increase the amount spent on rebates.

On the other hand, the research indicates that reducing the Rebate further may increase government spending in relation to public hospital costs.

The reports explored consumer behaviour and tested changes to LHC start date, loadings and other rules. It was determined that none of the proposed adjustments represented a significant improvement on the current system. Findings revealed that increasing starting age (from 30 to 35 or 40) would benefit people who take out PHI later in life, but do not result in a materially better outcome overall. Increase in LHC rate by 1 pp (2% → 3%) decreases the overall probability of PHI by 1.7 pp.

Comparatively, the MLS policy has a more pronounced impact on the individuals it targets compared to other PHI incentive policies. Increasing MLS rate by 1% is expected to increase PHI uptake by 11.5 pp. This includes increasing the existing 0% rate for the base tier to 1% so that all taxpayers without PHI would be liable for MLS.  

Other important study findings included:

  • removal of MLS entirely drops PHI participation by 2.2 pp;
  • MLS removal impacts more those with income > $90K;
  • MLS rate has a very strong effect on over 45s;
  • removal of Rebate entirely drops PHI participation by 4.2 pp;
  • rebate removal impacts families and those < $90K more on fam with income; and
  • a 5% increase in rebate leads to a 1% point increase in participation for over 65s.

A key decision revolved around determining when it is fair to apply such a strong incentive to individuals. Even when the MLS appropriately targets specific individuals, it may not be incentivising the most desirable actions because only the purchase of basic tier hospital policy is necessary to avoid the MLS.  

Avenues for change

What are the options for stakeholders to consider and proceed?

In the short run, the policies can be further optimised and simplified within current settings and financial constraints.

Regarding the MLS, its application is to be maintained for individuals with the highest capacity to pay for PHI, while excluding those earning less than $90K. The challenges with the value proposition of PHI for the latter group are evident from their lower participation rate. To optimise the MLS, annual indexing of thresholds based on earnings changes is recommended.

For individuals in the highest income brackets (tiers two and three), the requirement for adequate products should be to purchase silver-tier or higher hospital cover. Increasing the MLS for these high earners to 2% of their income would simplify the system, providing a strong incentive for insurance uptake. The settings can be such that an increased contribution to the health system is achieved from those with a higher capacity to pay.

The Rebate can be increased for those with high utilisation of services (high-risk individuals) and optimised by making it sensitive to risk profiles (risk-adjusted). This is the segment where the Rebate provides greatest value for money for the Government, that is, the public hospital cost savings are highest. Additionally, removing the Rebate for tier two earners, who are strongly motivated by the MLS, would be beneficial as it offers the least value for money to the Government.

This recommended action assumes rebate spend is fixed and the policy objective is to get a greater offset.

Regular review and adaptation of these policies bring a system design that is more agile than a system that lingers for an extended period of time until change is a necessity. Regular analysis and evolution of PHI policies is an ongoing process. This opens up the system to better and more rapid innovation in serving the needs of consumers while moving toward optimising and simplifying to achieve health system objectives.


The study into PHI incentives is published along with a consultation paper on the website of the Department of Health and Ageing. Feedback on the finding and recommendations of the studies is open until 3 PM Tuesday 15 August 2023. The consultation link is here.

Professor Francesco Paolucci is Professor of Health Economics & Policy at the Faculty of Business & Law, University of Newcastle and the School of Economics & Management, University of Bologna. You can follow Professor Paolucci on Twitter @dr_paolucci.

Josefa Henriquez is a PhD student at the University of Newcastle. Her research focuses on health economics topics.

Rhod McKensey is CEO of Honeysuckle Health.

Andrew Matthews is a partner at Finity Australia.

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