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Operations Of The Private Health Insurers Annual Report 2006-07

Part B

Operations Review

Community Rating and Reinsurance

PHIAC is responsible for administering the Risk Equalisation Trust Fund (RETF), which replaces the Health Benefits Reinsurance Trust Fund (HBRTF). The RETF was established under the Private Health Insurance Act 2007 on 1 April 2007 to continue to support the underlying principle of community rating within the Australian private health insurance industry.

The core principle of community rating is that persons should not be discriminated against in obtaining or retaining health insurance for hospital treatment coverage. Under the Act(9), in setting premiums or paying benefits, funds cannot discriminate in relation to a policy holder or their dependants on the basis of health status, age (other than age at entry under Lifetime Health Cover), race, sex, sexuality, use of hospital treatment, medical or general treatment services, or general claiming history. This means that funds cannot risk-rate, or price premiums at actuarially justified prices.

The risk equalisation scheme transfers and shares risk across all funds, so that funds with an older and less healthy demographic membership are not disadvantaged. The Risk Equalisation Levy enables health funds to charge the same premium to everyone, regardless of their individual risk (community rating).

(9) Private Health Insurance Act 2007 part 3–2, division 55–5 and part 3–3, division 66.

Risk equalisation

Risk equalisation was implemented in the Private Health Insurance Act on 1 April 2007 and replaced the reinsurance system. Risk equalisation acts to average out the cost of hospital across the private health insurance industry. Through this method of shared costs, all Australians have equal access to private health insurance, and all organisations are equally able to operate within the industry. Unlike the reinsurance system where funds participated only in states where they had sufficient members (500 single equivalent units rule) funds are required under risk equalisation to participate in the pool in all states where they have persons covered.

The system is supported by the Private Health Insurance (Risk Equalisation Policy) Rules 2007 and the Private Health Insurance (Risk Equalisation Administration) Rules 2007.

Risk equalisation consists of an age based pool and a high cost claimants pool and transfer of money between insurers based on the relative risk of their funds.

Age based pool (ABP)

Pooling is based on summing a proportion of applicable benefits from each five-year age cohort from age 55, based on the ABP table (see glossary). Applicable benefits include benefits paid for hospital and hospital-substitute, and medical benefits associated with those hospital services, as well as eligible benefits paid for chronic disease management programs. The amount to be notionally allocated to the ABP in a quarter is to be calculated in accordance with the formula pC, where:

p is the percentage of the eligible benefit paid having regard to the age cohort, as specified in the ABP table, into which the insured person falls on the day or days on which the insured person receives the treatment to which the eligible benefit relates, and
C is the gross benefit in the current quarter for the age cohort.

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Table 30 shows the benefits paid in the June quarter 2007 that are included in the ABP calculation. The total of these benefits for Australia was $1,135 million of which $661 million was included in the final calculation of transfers after the percentage of eligible benefits was calculated in each age group.

The Private Health Insurance (Risk Equalisation Policy) Rules 2007 and Private Health Insurance (Risk Equalisation Administration) Rules 2007 detail how the calculation is made and provide clarification. For example, where an insured person receives treatment over a number of days such that the age of the insured person on the day or days on which that person receives the treatment falls within more than one age cohort, the amount to be notionally allocated to the ABP must be allocated proportionately in accordance with the number of days during which the insured person was in each age cohort.

High cost claimants pool (HCCP)

The HCCP deals with benefits not equalised by the ABP. The HCCP includes 82% of benefits for each claim that exceeds $50,000 for the current and preceding three quarters.

Details of the HCCP calculation, with examples, are in the Private Health Insurance (Risk Equalisation Policy) Rules 2007.

During the June quarter 2007, there was a total of 239 high cost claimants for whom the benefits paid was in excess of $50,000 after ABP. The total HCCP amount included in the risk equalisation calculation was $2.998 million.

Transfer between insurers

After the ABP and HCCP are calculated for each fund in each state, they are totalled for each fund and divided by the average number of single equivalent units (SEUs) the fund has in the state. This average benefit is compared to the state average benefit per SEU (for the ABP and HCCP benefits). A fund that paid less than the state average will be required to pay an amount equal to the difference between its own benefits per SEU and the state benefits per SEU, for each SEU in the fund. Similarly a fund that paid more than the state average will receive an amount per SEU equal to the difference. PHIAC calculates the net amount for each insurer over all states and transfers money from some insurers to other insurers. The calculation ensures that the amount paid into the pool equals the amount paid out so that the result is a zero sum.

Reinsurance

The reinsurance scheme that operated until the March quarter 2007 transferred money from organisations that had demographically younger and healthier distribution, with lower claims payments, to those with an older and less healthy demographic distribution and which had higher claims payments.

Under reinsurance, 79% of benefits paid for the following categories were redistributed:

persons aged 65 or over
persons aged 64 or under where the policy to which they belong (excluding any persons in the policy aged 65 or over) has had hospitalisations totalling 35 days or more in a rolling 12-month period.

Reinsurance also included any amounts payable in excess of the Medicare rebate up to the Medicare Benefits Schedule Fee (25% of the schedule fee is payable by the health fund) and any amounts payable under Medical Purchaser-Provider Agreements or Gap Cover Schemes in excess of the schedule fee, up to a maximum of 16% for reinsurance categories of benefits.

Organisations were only required to participate in the reinsurance pool in any state where 500 or more SEUs resided in that state.

For any state where an organisation has less than 500 SEUs, the membership statistics and benefits were included in the state in which, for the organisation, the largest numbers of members reside.

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Reinsurance and risk equalisation payments

Over the four quarters ending 30 June 2007, a total of $203 million was transferred between funds.

PHIAC conducts an annual audit of the HBRTF and RETF calculations when all transactions for the four quarters to 30 June 2007 have been completed. The audit certificate is on page 77.

Reinsurance benefits

Benefits for persons aged 65 and over were on average 44.9% of total hospital treatment benefits, while the number of persons 65 and over was 13.3% of all persons. This demonstrates the higher risk a fund would have if it had a larger-than-average proportion of persons in the 65 and over age category.

Adverse selection (the propensity of those most at risk of needing insurance to take-up insurance and the propensity of those regarding themselves as low risk to not take-up insurance or to drop insurance) has contributed to an historically faster growth in reinsurance benefits than ordinary hospital treatment benefits (those benefits not eligible for inclusion in the reinsurance pool). The historical growth in reinsurance and ordinary benefits is shown in figure 16. In the years immediately before the introduction of Lifetime Health Cover, reinsurance benefits exceeded ordinary benefits.

The introduction of Lifetime Health Cover in 2000 lowered the risk profile of the insured population as many younger people took out private health insurance. Ordinary benefits have exceeded reinsurance benefits since 2000–01, but from 2004–05 to 2006–07 there was faster growth in reinsurance benefits than ordinary benefits.

Risk equalisation benefits

The change from reinsurance to risk equalisation has changed the benefits taken into consideration from 65 and over, to 55 and over. Historically the applicable benefits paid for those persons aged 55 and over has been more than 60% of total benefits and is currently 64%, while the percentage of persons aged 55 and over is 27%. The historical growth of benefits for persons aged 55 and over compared to the growth in benefits for those aged 0 to 54 is shown in figure 17. The growth in benefits for persons aged 55 and over has been greater than for those aged 0 to 54.