The new health insurance rebate: an inefficient way of assisting public hospitals

• Private health insurance subsidy is now estimated to cost $2.19 billion; government support for private health care includes a further $1.2 billion of Medicare benefits expenditure in hospitals.

• The subsidy cannot be justified on efficiency grounds, as, on the basis of available evidence and taking casemix into account, public hospitals are more efficient than private hospitals.

• The original stated objective of the subsidy was to "take pressure off public hospitals". If the insurance subsidy and the Medicare Benefit Schedule rebate expenditure were applied to purchasing public hospital treatment at full average cost, 58% of current private sector demand could be accommodated. If 10% of the demand were met at marginal cost, this would increase to 65%.

• The objective of "taking pressure off public hospitals" could be more efficiently achieved by direct funding of public hospitals rather than through subsidies for private health insurance.

The current Coalition Government (elected in 1996) has stated a commitment to "preserving Medicare fundamentals", but has also actively promoted private alternatives to the public healthcare system. In addition to the existing 75% subsidy for medical services to private inpatients in public hospitals, since January 1999 the government has provided a 30% rebate to consumers on their private health insurance premiums. The policy was initially estimated to cost $1.3 billion, but this was recently revised to $2.19 billion.² The justification for this initiative was that it would help the private sector, take pressure off public hospitals and restore "much needed balance" to the healthcare system.³

The rebate is effectively a subsidy to the private health insurance industry and is larger than budgetary assistance for the mining, manufacturing and primary agricultural production industries combined.⁴ There is no intrinsic characteristic of private health care which gives it a greater claim for public subsidy than any other industry, except in so far as it can be shown to be more efficient to subsidise the private sector than expand the public sector (the government's second explicit justification for the new policy). We analyse here the available data to assess whether the latter justification is reasonable.

As Box 2 shows, of the $16 billion spent on hospitals in 1995/96, over 73% came from public sources, with private health insurance contributing about 18%.⁶ If the health insurance rebate had been paid in 1995/96, the private health insurance contribution to meeting health costs would have declined from 18% to around 13%, with a commensurate increase in the proportion of Commonwealth expenditure.

These data reveal apparent differences in costs by DRG between public and private hospitals when adjustment is made for the mix of cases. For example, the estimated average cost for DRG 674 (vaginal delivery without comorbidity and/or complications) is $1795 in public hospitals and $2057 in private hospitals. In contrast, DRG 187 (bronchitis and asthma age < 50 years without comorbidity and/or complications) is less expensive in private hospitals (public hospital cost $1025, private hospital cost $754). The cost for each DRG published in the National Cost Weight Study for each sector can be applied to the relative number of admissions in each DRG⁵ to derive the casemix-adjusted average cost. To account for casemix differences between the sectors, we standardise using the casemix of the public hospital system.

In aggregate, the cost differences appear to favour private hospitals, as shown in Box 4. The Table shows public hospitals' casemix held constant using the average case weight treated in public hospitals while applying the different reported national costs for public and private hospitals. Similar results are also obtained by standardising with private hospital casemix. It can be seen that the average cost per weighted separation in public hospitals, calculated using public hospital costs, is about 11% higher than if the same casemix had been treated using private hospital reported costs.

However, the crude figures need to be adjusted for discrepancies in the way costs of care are met in public and private hospitals, reflecting in turn Commonwealth/State divisions in responsibilities for health expenditures. The most notable differences between the two sectors relate to medical, pharmaceutical and depreciation expenses. Medical services (including pathology testing and imaging) in private hospitals are not incorporated in hospital expenditure, and bills are met by patients directly, reimbursed through Medicare and health insurance funds. Pharmaceutical costs are also met by patients, reimbursed through the Pharmaceutical Benefits Scheme.

In contrast, in public hospitals, all the costs are met by the State government through its funding of public hospitals. For the dwindling number of private patients in public hospitals, medical costs are reimbursed through Medicare, but pharmacy costs are still borne by the hospital. As a result of these differences in funding arrangements, and hence cost recording, the medical, pathology, imaging and pharmaceutical costs per patient in public hospitals (as reported in cost-weight studies) are substantially higher than those recorded in private hospitals.

The reverse is true for depreciation. Typically, capital costs in public hospitals have been funded separately from operating costs and thus depreciation costs have not been well attributed in the public sector. By contrast, stockholders in private hospitals require a full accounting of capital costs, and thus recorded depreciation costs are higher in the private sector than the public sector.

The second row of the Table (Box 4) shows the adjusted cost per separation, taking into account the different way these cost elements are financed and reported. Removing the discrepant cost elements reverses the apparent greater technical efficiency of private hospitals over public hospitals.

The comparison basis we have adopted of removing the discrepant elements (rather than adding equivalent elements back in) is a conservative approach. It reduces the difference between the cost bases, as private hospitals tend to have a more modern capital stock (increasing depreciation costs relative to public hospitals) and have relatively unconstrained medical and pharmaceutical use (which probably increases their casemix-adjusted costs relative to the public sector). On the other hand, the analysis makes no adjustment for differential tax regimes faced by public hospitals and the for-profit component of the private sector (eg, different payroll tax obligations) which would reduce the difference between the sectors. The net effect of the differential tax regimes is, however, not likely to change the relativities we have reported.

The basis for the argument that private hospitals are more "efficient" than public hospitals is further weakened when the "safety net" or residual role of public hospitals is recognised. For example, to the extent that within-DRG variation exists, public hospitals are likely to have the more seriously ill cases because of referral patterns to tertiary teaching hospitals, provision of emergency services, and the like.

The fact that private hospitals cost more should not be surprising given the different products of the two sectors, which are not taken into account by casemix standardisation. In particular, private hospitals provide greater amenity (better food, more single rooms), which underpins marketing of private hospitals and private insurance. This probably explains some of the cost differences. In terms of meeting health needs, however, the fact remains that public hospitals are less costly than private hospitals per standardised unit of output, and there does not appear to be a strong argument for public sector subsidy to the private sector based on its greater technical efficiency.

• The emerging Australian evidence on variability in medical practice suggests that treatment in the private sector is associated with a higher rate of intervention,⁹ with no demonstrable impact on outcome or quality.

• The relatively higher payment rates for private sector fee-for-service medical practice (vs hospital salaried or sessional payments) create problems for recruitment of medical specialists in the public sector and probably inflate public sector medical remuneration.

• To the extent that the private sector provides consumers with an opportunity to bypass waiting lists and other public sector constraints (and this is another of the marketing claims for private insurance), then it is anomalous that there should be any public sector subsidy at all. To the extent that public sector resource constraints are based on sound clinical judgement or other rational grounds, bypassing those constraints is evidence of unmeasured allocative inefficiency.

In summary, on available evidence hospital care in the public sector is provided at higher levels of technical, allocative and dynamic efficiency than in the private sector. This finding undermines the efficiency justification for a policy of subsidies to the private sector through a health insurance rebate.

A $3.4 billion injection into the public sector at Victoria's projected 2002/03 full casemix payment rate for teaching hospitals ($2463 per weighted case multiplied by the 0.94 average weight in the private sector) would allow an additional 1.5 million cases to be treated in Australian public hospitals. This is 58% of the estimated 2.5 million separations from private hospitals in 2002/03 (assuming a 6.8% increase per year in private hospital admissions, the rate from 1991/92 to 1997/98). Given the substantial change that has taken place in hospital practice in recent years through the increased proportion of day procedures obviating overnight stays, there is spare physical capacity in public hospitals which could absorb a considerable proportion of such a potential transfer with no requirement for new capital stock.

These calculations allow payments to public hospitals at full cost. If it is assumed that some of the patients transferring to the public sector could be treated at marginal cost, then an even higher proportion of the private sector separations could be treated. For example, if the public sector were able to expand its current capacity by 10% at marginal cost, then the $3.4 billion Commonwealth subsidy would enable treatment of 1.6 million additional cases, representing 65% of the projected private hospital activity (using Victorian prices for "margin A" and "variable" payments).¹⁰

Even if the federal subsidy for ancillary insurance were retained, over half of private hospital separations could be treated in public hospitals using the funding for the private hospital insurance rebate (Box 5).

These estimates may overestimate the activity increase which might be achieved by using the insurance subsidy to purchase additional public hospital separations directly. Firstly, Victorian payments are lower than most other casemix-funding States.¹¹ Secondly, the full costs of the Medicare inhospital rebate have been applied to purchasing additional public hospital activity. This does not provide compensation to States which currently gain revenue for treatment of private patients in public hospitals, nor leave any room for Medicare medical funding for remaining private hospital patients. Further, the estimates are based on an assumption that there is spare capacity in hospitals and that no additional capital is required.

On the other hand, it is unlikely that the public hospital system would need to accommodate all private hospital activity in the foreseeable future. Although the proportion of the population covered by private health insurance has been declining since the 1970s (except for a policy-related aberration in the early 1980s and the marginal increase effected by the rebate), there is likely to be a significant minority in the population who retain private insurance, even in the absence of subsidies, and who continue to use private hospitals. Further, not all admissions to private hospitals would meet admission criteria for public hospitals (the most obvious example being cosmetic surgery). These factors would reduce the estimated demand to be transferred to public hospitals. Finally, these estimates have been based on the assumption that private hospital weighted separations will grow by 6.8% per year, which is the upper band of any reasonable assumption about private hospital growth.

If the recently introduced subsidy to the private sector were applied directly to enhancing the capacity of public hospitals to meet additional demand, the greater part of current private sector hospital care could be accommodated within the public sector. Such an approach would not only realise technical efficiency objectives, but also arguably enhance the allocative and dynamic efficiency of the Australian healthcare system. Withdrawal of the subsidy would not mean elimination of choice in hospital care. Treatment would continue to be available in private hospitals, but the full cost of insurance would be borne by those who make this choice. The key economic justification for the rebate -- reducing demand on public hospitals -- is not a sound basis for the policy, as the costs of the rebate could have been applied more efficiently to supporting public hospitals directly.

1. Altman S, Jackson T. Health care in Australia: lessons from down under. Health Affairs 1991; 10: 129-144.
2. Senate. Community Affairs Legislation Committee. Hansard, Canberra, 7 February 2000: CA77.
3. Second Reading Speech by Minister for Health and Aged Care, Dr Michael Wooldridge MP introducing the Private Health Insurance Incentives Bill 1998. House of Representatives Hansard, 12 November 1998: 263.
4. Duckett SJ. Policy challenges for the Australian health care system. Aust Health Rev 1999; 22: 130-147.
5. Australian Institute of Health and Welfare. Australian hospital statistics 1996/97. Canberra: AIHW, 1998. (AIHW Cat No. HSE 5, Health Services Series No. 11.)
6. Australian Institute of Health and Welfare. Health expenditure bulletin No. 14. Canberra, AIHW, 1998.
7. Bryce, M. APHA shores up fragmenting industry for joint campaign to push private health care. Healthcover 2000; 10(1): 46-51.
8. Commonwealth Department of Health and Family Services. Report on the national hospital cost data collection 1996/97. Canberra: AGPS, 1998.
9. Robertson I, Richardson J, et al. The impact of new technology on the treatment and cost of acute myocardial infarction in Australia (Technical Report 10). Melbourne, Centre for Health Program Evaluation, 1998.
10. Victorian Department of Human Services. Victoria -- public hospitals: policy and funding guidelines, 1998/99. Melbourne, VDHS Acute Health Services, 1997.
11. Duckett SJ. Casemix funding for acute hospital inpatient services in Australia. Med J Aust 1998; 169 Suppl: S17-S21.

Hospital Services Research Group, Monash University Health Economics Unit, Melbourne, VIC.
Terri J Jackson, MA, PhD, Senior Research Fellow/Manager.

Reprints: Professor S J Duckett, Faculty of Health Sciences, La Trobe University, Bundoora, VIC 3083.
s.duckettATlatrobe.edu.au

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Source: Australian Institute of Health and Welfare.5

Source: Australian Institute of Health and Welfare.6
Federal, health insurance and out-of-pocket figures
have been adjusted to include expenditure on the
Medicare rebate for inhospital services, as the source
data normally count this separately as medical expenditure.