Australia's private health insurance sector will be able to respond to increasing utilisation and costs associated with medical services, amidst broader affordability concerns, and maintain an ROE well above 10% through 2018, says S&P Global Ratings in a report released last week.
However, S&P notes private health insurers face continued margin pressure with no significant countermeasures evident without healthcare and industry reform. This could lead to industry consolidation in the long term.
Strong earnings to continue but margins likely to contract
The industry has consistently achieved strong returns on invested capital over the past decade, supported by various government policies that encourage policyholder participation and insurer cost-saving initiatives, as well as relatively low capital requirements.
According to regulatory data, the industry's average annual ROE for the year ended 30 June 2017, was 18.4% and has consistently remained above 17% for several years.
However, S&P expects insurer net margins to come under intensifying pressure, driven by an increase in the utilisation of medical services as well as the associated costs of these services (such as the adoption of costly new technology for procedures). The ageing of the insured population has been a key factor behind the increased utilisation.
Affordability risks on the rise
To date, the Australian federal government has approved insurers' requests for health insurance rate increases to recover the level of their claims inflation, which has been well above the level of general wage and price inflation. As a consequence, the growth rate in hospital cover policies has continued to decline toward 0.1% growth for the year to 30 June 2017, although growth in general treatment has consistently ranged between 5% and 6.5% for several years. There has also been a significant shift amongst policyholders to more affordable products with more restricted cover and higher policy excesses.
S&P believes these cover changes could exacerbate adverse selection, as customers tend to select policy options they are more likely to use. It sees a limit to the degree to which insurers can continue to increase premiums or reduce cover before policyholders elect to not renew private health insurance and instead rely on the public health system (or absolute minimum cover).
If the current trend continues, for many the benefits of holding private health insurance in terms of tax savings and policy benefits will fail to outweigh the costs. Younger and healthier policyholders are more likely to leave the industry, putting further pressure on an industry that relies on aged-based cross subsidisation to fund government mandated community rating.
Reform is inevitable
Mounting affordability pressure has sparked calls for a range of reforms to the health care sector, such as rationalising the Medical Benefits Scheme and ending cost shifting from public hospitals. Initially, the federal government was receptive to most of these reforms because private health insurance participation reduces the burden on the public health system. For example, earlier this year, the government implemented the first stage of reforms to the Prostheses List. However, it now appears other elements of reform will require additional validation and support before being implemented, which has somewhat reduced the likelihood the government will implement significant changes in the medium term. S&P therefore expects the private health insurance industry will undertake other initiatives to remain profitable.
Insurers may roll out more preventative healthcare and chronic disease management programmes in an effort to reduce hospitalisation rates. There may also be growth in corporate health insurance schemes to lift the participation of healthier policyholders, or an increase in loyalty initiatives to boost retention for targeted customers.
Insurers may try to develop closer relationships with primary healthcare networks, and increase the transparency of agreements between insurers and medical service providers on fees charged for standard services. On the other hand, policyholders may also see an increase in onerous product conditions in relation to medical procedures and benefit limits.
Whether these initiatives are successful or not, S&P sees high potential for consolidation, as larger players are much better placed to manage industry-related challenges and product reform. There are 37 registered private health insurers operating in Australia as of 30 June 2017, some with a modest premium base of below A$15 million (US$12 million) and capital base below A$10 million.