a premium struggle to obtain peace of mind Wollongong mother Phoebe Murphy had her daughter Charlotte, 6, in a private hospital but when it came time to give birth to Archie, now 15 months, she chose the public system. The birth of Charlotte was a joyous occasion, but along with the Murphy family's first child it also delivered $3000 in out-of-pocket charges not covered by their private health insurance policy. In the lead-up to Charlotte's birth, Murphy and her husband Sean, who works in mining on the NSW South Coast, had been paying an extra $50 on their monthly premium with insurer HCF for obstetrics cover. This was lumped in with mental health coverage they also didn't need. Illustration: Simon Bosch. Faced with a stretched household budget, the family decided obstetrics cover was just not worth it. "As the cost of our insurance kept going up it was an easy choice to drop it," she says. Without the added obstetrics cover the family pays $246 a month, after the private health insurance rebate, which Murphy says is "manageable." This covers basic hospital, ambulance and extras such as dental, optical and chiropractic. "But it keeps going up every year," she adds. The Murphy family's experience is emblematic of the conundrum facing the 10.7 million, or 46.9 per cent of Australians covered by private health insurance. Stretched budget: Phoebe Murphy at home with Charlotte and Archie. With premiums soaring well above inflation at an average annual rate of 6.5 per cent since 2002, affordability of private health cover has become a big issue. Macquarie analysts estimate that as a proportion of household disposable income health insurance rose from 4.6 per cent to 6.1 per cent over the past 11 years. And while the cost is not in the realm of mortgage repayments or private school fees, the rise in premiums shows no sign of abating. The threat is that if private health insurance becomes too unaffordable, it could lead to increased pressure on the public healthcare system as well as proving a headache for the business models of both insurers and the private healthcare providers. The previous government's move to means-test the private health insurance rebate, and other cost-saving measures, have boosted the cost of private health insurance. On April 1, premiums are set to rise again by an average of 6.2 per cent across the industry - a "double-edged sword," says Nomura analyst Toby Langley. "While it does help to sustain momentum in premium growth, it does put more pressure on the consumer," he says. Every year insurers must apply to a government council to increase premiums. The insurers apply for the rises on the basis that their costs, charged by healthcare providers, have gone up. Although premiums will rise by an average of 6.2 per cent, the Coalition estimates the health insurance industry's overall cost of paying out benefits to providers such as private hospitals, dentists, optometrists and medical equipment suppliers increased by 8 per cent in the past year. When Health Minister Peter Dutton announced the latest round of increases on December 23 it was an unwelcome Christmas present for policy holders. His move to deliver the news of the highest increase since 2005 two days out from Christmas was dubbed "cynical" by opposition health spokeswoman Catherine King. But Dutton said the increases were justified, blaming the cost increases on Labor for putting undue pressure on the private health sector while it was in government. But the real reasons behind rising healthcare costs, which are borne out in premium increases, has less to do with politics and more to do with demographic trends. For governments, the cost of healthcare must generate the strongest migraine, the dullest back pain and the sharpest chest pinch. Macquarie analysts say that Australia's health system is efficient by international standards. We have a high life expectancy - ranked fifth out of 34 developed countries, at 81.6 years. And 9.3 per cent of GDP spent on health is better than the 9.6 per cent Organisation for Economic Co-operation and Development countries average. But according to research from Melbourne think tank the Grattan Institute, government health spending grew 74 per cent in the past decade, outpacing gross domestic product at 46 per cent growth above inflation. Health expenses account for 19 per cent of state and federal government budgets, up from 17 per cent in 2002-03, the institute found. By steering people towards private healthcare, governments can reduce their spending on health. The government pays only about 27¢ in the dollar for a privately treated patient, but 100¢ if the same patient is treated publicly, according to Macquarie research. But this does nothing to stem the rise in healthcare costs. These just get passed on to insurers and healthcare providers. At its simplest there are three main drivers of increasing healthcare costs. The first is, demographically Australia has a larger and older population than ever. A straight line links a larger population with increased demand for healthcare, and the reason that age is important is that people need more healthcare in their last years of life. Second, an increase in the incidence of chronic conditions such as obesity, heart disease and diabetes compound health bills. These diseases don't kill you immediately, but are expensive to manage and lead to a raft of health complications. Thirdly, improved technology, although it has led to better health outcomes, also adds to cost. "On average, a 50-year-old now is seeing doctors more often, having more tests and operations, and taking more prescription drugs, than a 50-year-old did 10 years ago," Grattan Institute researchers Stephen Duckett and Cassie McGannon write on The Conversation. The quality of the treatment they are getting has improved in many cases, and there are new treatments that did not exist in 2003. There is debate about whether all the extra spending is always needed. Medibank's executive general manager, private health insurance, Laz Cotsios, argues that many private hospitals can be too quick to go after new technology as a way to attract doctors, even if it might not be the most cost effective or medically suitable treatment. "You have hospitals who invest in these technologies to ensure they attract the best doctors to use theatres," Cotsios says. They need a return on that investment. In Australia as in the US we have a fee for service. As long as you've got a fee for service, the only way these guys will get paid is to perform a procedure. But Michael Roff, the chief executive of the Australian Private Hospitals Association, says he's "not aware of any instances where there's [new technology] that has a massively increased cost that isn't proven to produce a better medical outcome." This simple argument between insurer and hospital could be played out millions of times on different subjects in the quest to cut health costs. Private hospitals get the bulk of their revenue from insurers. Government reforms to encourage take-up of private health insurance have been good for both industries' profitability. Macquarie says that over the past decade private hospitals have increased earnings before interest and tax at a rate of 10 per cent a year to just under $1 billion in 2013. In the same period, insurers' earnings grew at 16 per cent a year to about $1.4 billion last year. It's a symbiotic, but tense relationship. The two parties have regular contract renegotiations to decide how much the cost of hospital stays and procedures should cost. These usually occur behind closed doors, but were famously thrust in the open last August when the giants of their industry, Medibank and Ramsay, could not agree and began using full-page newspaper advertisements as a proxy for negotiating. Medibank said Ramsay was asking for a too-large increase in payments, while Ramsay argued Medibank was putting patient safety at risk by offering too little. Reducing health costs is a complex problem, made more complicated by the fact that care is funded by different levels of government and there are many vested interests within both industries. But while governments and lobby groups wring their hands over what to do, families are faced with a conundrum: the drivers of cost are common to both the public and private system. What this means is that even if health insurance is becoming unaffordable, if people drop their cover they are still faced with the consequences of a healthcare system fighting rising costs. This fear is only compounded by frequent reports of growing waiting lists for procedures in the public system, and debate about how the government may control its healthcare costs, such as charging a co-payment fee for bulk-billed doctor visits. The tax implications of dropping coverage altogether are an effective disincentive to maintain some level of coverage. This was the case for Murphy, who initially took up coverage to avoid the Medicare levy and the lifetime healthcare loading that is charged to people who take up cover after their 31st birthday. So instead of dropping insurance, members are scaling back coverage and shopping around for cheaper providers. Cotsios says about 8 per cent to 9 per cent of the fund's policy holders switch each year. Of those who stay, but scale back, they have two broad options. "As policies or private health insurance costs rise, people make assessments," Cotsios says. Where in the past someone might have had top cover with no excess, they might reduce their cover to medium hospital cover with a $500 excess, which lowers the premium but leads to greater out-of-pocket costs. Alternatively, policy holders may restrict their coverage to exclude specific areas of healthcare, such as optical or mental health in extras, or cardiac surgery in hospital. Cotsios says this trend hurts at the top and bottom line. He says for every $1 paid in private health premiums, Medibank pays about 87¢ to healthcare providers. The fund needs about 10¢ to run the business and has margins of 3¢ to 3.5¢. "You can see that the margins are very slim," he says. Higher value policies typically have a higher margin. Langley says he expects extras cover - which is more profitable - is the segment most at risk for insurers. "[The scaling back of extras] may not be a big bang, but it's going to constrain the companies' ability to upsell in the way they have done in prior periods," he says. This trend of scaling back also has implications for private hospital operators such as Ramsay Health Care and Healthscope. Healthscope chief executive Robert Cooke says when a patient decides that they don't need coverage for cardiac or orthopaedic surgery because it's too expensive, they are turning their back on the private sector for procedures that are the "bread and butter" of his business. This means fewer procedures are performed in private hospitals, but also increases the strain on both the public system and customers' hip pockets. "Health insurance's prime reason for being is to cover you for expensive care that can be financially catastrophic to your wallet," Cooke says. Still, the reality is that many customers "set and forget" when it comes to health insurance. Bupa's chief customer officer, Angus Norris, says that, in a given year, no more than 15 per cent of the fund's 3 million customers look to revise their policies. Of those about 60 per cent might choose to downgrade, he says. But another outcome of rising unaffordability is people looking for a better deal. Comparison sites such as iSelect and Compare the Market have spurred this on. "Switching may well benefit those that offer lower value policies, but ultimately it leads to the industry on aggregate making less money," Langley says. It could be a bit of a race to the bottom. Over the past decade the total amount spent on advertising has risen 81 per cent, in line with equivalent growth in the switcher market, Cotsios says. Insurers must work harder to gain and retain customers. Increased marketing costs means the increased amount insurers outlay to get a new customer - "cost per acquisition" in the industry jargon - squeezes profit margins. The fear is that insurers may then need to increase premiums to maintain profitability. Bupa's health and benefits director Angus Norris says the potential privatisation of Medibank could put downward pressure on premiums. The Coalition has commissioned a scoping study to determine whether it will sell or float the $4 billion insurer. "This is a competitive market," Norris says. I certainly don't think there's a role for government to be an owner of a private health insurance company. Langley agrees that competition will be enhanced, saying that Medibank will come under pressure from shareholders to be more cost conscious. Looking at their cost base they appear to have quite a long way to catch up with NIB. NIB chief Mark Fitzgibbon says the insurer has a profit margin of 6¢ compared to Medibank's 3¢ to 3.5¢. On a measure of management expenses per member, the two largest insurers, Bupa and Medibank, have "quite a lot of potential fat to trim" to catch up to industry leader HCF, Langley says. Just as governments are looking for ways to rein in health costs - such as the Coalition's mooted $6 out-of-pocket charge for bulk-billed doctor visits - insurers have a similar motivation. Clamping down on cost inflation charged by providers is not their only option. Langley says the increasing profile of insurers in preventative health campaigns shows they may have a long-term view in their quest to reduce health costs. Some policies include gym memberships and free consultations on strategies for healthy living. "Hypothetically this should reduce the incidence of claims from people that are not looking after themselves properly," he says. Medibank has a partnership with Coles supermarkets that gives its customers extra points on their loyalty program when they buy fresh fruit and vegetables. Television viewers of the Australian Open may have noticed Medibank's new marketing campaign, Generation Better. Advertisements starring tennis great Rod Laver encourage people to live a more active life ("and it doesn't even have to be tennis," Laver says). Cotsios concedes that this kind of activity will have a "slow burn" effect as opposed to immediately pushing down the need for healthcare by Medibank's customer base. "But I think increasingly as a society we're waking up to the fact that chronic diseases such as obesity and diabetes are linked to our lifestyle," he says. In a similar vein insurer Bupa offers its members access to consultants via telephone to give advice on health and wellbeing. More than 3000 members have taken up the COACH program that links dietitians with members who have had a heart attack or stroke for six to nine months of advice. But NIB's Fitzgibbon says insurers might be at a disadvantage when it comes to intervening in health. "People don't trust a finance company to help them improve their health," he says. We need to have a deeper relationship with primary care and GPs. They're the gatekeepers. Bupa has also formalised a relationship with Healthscope where payment for healthcare is linked to quality indicators. If a preventable error occurs in the treatment of a Bupa member at one of Healthscope's 44 hospitals, Bupa will not have to pay. Norris denies this is a cost-saving exercise, saying it is an initiative to ensure the best care for members. The strength of Medicare and the relatively good public system means that many Australians don't like the idea of paying private health insurance. But the proportion of the population that is covered is still growing, albeit slowly at the moment. "I still think people value having the safety blanket and there are obvious tax consequences of dropping your hospital cover," Langley says. Both reasons appeal to Canberra construction business owner Nathan Ramunno. In the lead-up to the birth of his first son, Ramunno with partner Abby signed up to basic ambulance, hospital and extras cover with NIB. When their son Hayden arrived a few weeks early, his first ambulance ride had to be by helicopter, as the couple were on Daydream Island. The $5000 fare was covered by their ambulance cover. Ramunno says this saving has made cover worthwhile for the next few years. But he says the insurance doesn't always deliver great value, especially when you're healthy, but he values the safety net it provides. "You know your children are going to get rotten teeth and broken bones as the years go by," Ramunno says. For me it's peace of mind.