Products – The Centre for Independent Studies

Saving Medicare: The Case for Market-Based Health Reform

Jeremy Sammut
27 August 2013
Saving Medicare: The Case for Market-Based Health Reform

Paper for the Catholic Health Conference Australia. 26-28 August, 2013

Good morning ladies and gentlemen, and I’d like to thank Catholic Health Australia for the invitation to address the conference.

In this presentation I am going to try to convince you why we should ditch a lot of the orthodox thinking about health policy and the best ways to finance the healthcare of the Australian community. The orthodox thinking among most health academics and commentators is that Medicare must be preserved more or less in its current configuration because a universal taxpayer funded health system, which enables health services to be consumed at zero (or near zero) prices, is the only fair and equitable way to organise access to health care.

[Slide 2]

A lot of the ideas that I think need to be at the centre of the health reform process – such as greater personal responsibility for health expenditures and a larger role for private sources of health care financing and insurance – are seen as illegimate. The catch all response to any suggestion that we should move towards the more market-based system I am going to advocate is that this will take Australia down the inequitable US private health care path.

That maybe an effective political response if your objective is to preserve Medicare as is. But it does not address the financial challenges facing the Australian health system, given the impact of population ageing on health expenditure, and the inveitable consequences escalating costs will have on rationing of care. I also think it is wrong in fact, and that well-designed reforms can actually increase the fairness of the health system by correcting the inequities and inefficiencies inherent in the existing Medicare scheme.

Politically speaking, however, the kind of health reform I am going to talk about is difficult to achieve. The health system is the largest entitlement economy in the country, and politicians get nervous at the mere thought of taking entitlements away from any group of voters let alone the millions of consumers and hundreds of thousands of producers of health services.

But that is what structural reform is about – telling people that they are no longer entitled to the share of public resources they are accustomed to recieve, because there are better ways to deploy these resources and to fund and deliver health services for the benefit of the community.

The unwillingness to face the structural reform challenge in health leads to the kind of piecemeal approach to so-called health reform that is the norm: such as spending more on preventive health, or on coordinated primary care. These popular strategies have I believe been over-sold as so-called ‘solutions’ for problems like rising costs and hospital overcrowding, even though the evidence that they will be effective is scant.

This is another point at which I depart from the orthodox thinking. Health is usually treated primarily as a social policy problem that can be solved by creating new entitlement or programs –Super Clinics, Medicare Locals, GP Management Plans, National Preventive Health Agencies. I think the solutions for the major challenges facing the health system – including gaps in chronic disease care and public hospital waiting times – lies in treating health primarily as an economic problem involving how to use   increasingly scarce health dollars to receive more, better, and more effective health care in coming decades.

What I’m going to do is outline the sustainability problems facing Medicare, what the consequences might be, and suggest some reform options that will improve the long-term financial sustainability of the Australian health system.  In a nutshell, I’m going to argue that what needs  implementing are policies that introduce more self-financing and allow for health care to be funded by saving over-time, with a much greater emphasis on using choice and competition to increase the efficiency of the health system.

[Slide 3]

To get a sense of what the future holds for the finances of the health system, you can look to recent history.

In the last decade:

  • Real combined federal, state and territory government spending on health (adjusted for inflation) has increased by 80% – from $53 billion in 2000–01 to more than $90 billion in 2010–11.
  • Public health expenditure rose from 5.6% of GDP to 6.4% over the period.
  • Non-government health expenditure increased by 0.2% of GDP to 2.9%.
  • This was outstripped by the 0.8% of GDP increase in government health , spending which was principally responsible for increasing total national health expenditure to 9.3% of GDP (or $130 billion) in 2010–11.
  • Real average health spending increased 70% faster (5.3% per year) than real average GDP (3.1% per year).

The trends of the last decade – the escalating cost of health to the nation as a whole, and particularly to government budgets – portend the fiscal challenges facing the health system in an ageing Australia.

They also show that the private health reforms of the Howard Government, despite their impact on the proportion of the population with private cover, have not been as successful as might have been hoped in altering the balance between public and private funding for health.

[Slide 4]

Leaping ahead, by 2050, the higher cost of caring for the elderly is projected to be the major contributor to a significant increase in total federal government spending.

According to the 2010 Intergenerational Report, in absence of adjustments to policy, the ageing will result in Commonwealth expenditure exceeding revenue by a ‘fiscal gap’ of 2.75% of GDP.

Ageing-related spending on pensions, health and aged care currently accounts for a quarter of federal government spending, and the increasing costs of these payments and services is projected to consume almost half of federal expenditure by 2050.

Rising health costs alone are expected to account for two-thirds of the projected increase in federal government spending, with federal health spending set to rise from 4% to 7.1% of GDP. This implies that combined Commonwealth and state health spending will top over 10 per cent of GDP in 2050.

[Slide 5]

The Intergenerational Report forecasts seem intuitively correct, because health spending is demographically sensitive. The older people get, the more health care they consume to maintain their health and prolong their life. This dynamic will put pressure on government budgets, given the public choice in Australia to run the vast majority of health spending through government programs.

The Intergenerational Reports have concentrated on the impact of federal health spending on the Commonwealth budget. But the revenue-poor and responsibility-burdened states and territories face perhaps even bigger challenges. Most notably, health spending already consumes a third of the NSW budget (as in most jurisdictions), and if health spending continues to grow at current rates, health will consume the entire NSW budget in 20 years time.

This conveys the magnitude of the looming financial crisis facing Medicare.

Health systems like Medicare are 20th century social policies created when health care was relatively cheap and basic. Taxpayer-funded pay-as-you-go health systems were more affordable when most people died in their 60s, and relatively few lived into their 80s and beyond, as is increasingly the norm today.

‘Free and universal’ taxpayer-funded health systems have always had to ration care, via some form of queuing, because government budgets are limited. Governments, faced with competing priorities, already don’t have enough money to pay for all the healthcare the community wants to consume each year.

What is impossible now is set to be totally unrealistic in the future.  Ageing, or rather the intersection between ageing and rapid advances in medical science, is highly likely to lead to more extensive rationing. This scenario could include both longer queues and slower take up of new technology, given that medical science continues to discover more and more things to do to for more and more patients at greater cost.

Continuing to spend every tax dollar collected for health each year in the same years, and neither save nor invest to pay for future health costs, is in my view simply unsustainable.

[Slide 6]

Despite the plausibility and seriousness of the sustainability problems outlined in the Intergenerational Report, the policy response both from Canberra and the states has been next to negligible in terms of implementing comprehensive long term strategies.

The billions of dollars question is with what should fill the policy void?

The appropriate response in my opinion is a reform strategy that shifts responsibility for health costs off government budgets. The sustainable way to pre-fund all the sophisticated health care people will want and need in the future is to enable people to save up and pay for it overtime. The focus of a prudent health policy should also be on maximizing efficiency to ensure that our health dollars are used cost-effectively.

This is where understanding the defects with the current arrangements comes into play.Together with the long term financial challenges, the case for comprehensive health reform starts with understanding the impact of the structural inefficiencies and inequities at the heart of Medicare. These problems mean that we end up spending more on health than is necessary to fund less of the care that people actually need.

I examined the ways that Medicare wastes and misallocates health spending in a paper published  a few years ago, entitled ‘How! Not How Much: Medicare Spending and Health Resource Allocation in Australia’.

[Slide 7]

What this paper examined was past government spending on hospital and non-hospital care compared to what we spend on those things today.

The take away from what I found is that today the federal governments spends through Medicare half as much on medical services (that is GP and other non-hospital care) (around $18 Billion) as combined Commonwealth and State government spending on public hospitals (around $36 billion).

Past spending patterns put these numbers into context.

In 1967-8, for every $1 spent by Australian governments subsidising medical services, $4.83 was spent subsidising hospital services. This was total spending on federal hospital benefits and state grants to public hospitals.

In those days, there were no hospital queues.

By comparison, today for every $1 spent on the Medical Benefits Scheme, the total government subsidy for hospital care is around $2.

So in other words, over the last 40 years, Australian governments have gone from spending approximately $5 subsiding hospital services for every $1 spent non-hospital services, to spending $2 on hospitals for each dollar spent on non-hospital care.

[Slide 8]

These figures in part reflect changes to clinical practice, such as tests that no longer need to be performed in hospitals. However, what I believe these figures draw attention to are the faulty principles and design flaws of Medicare, which mean it is not a soundly constructed insurance scheme.

What it in fact is a ‘reverse insurance’ scheme which provides ‘inverse care.’

What I mean by this is that the minority of patients with major health needs are forced to queue for treatment at overcrowded public hospitals which have capped budgets and rationed care.

Meanwhile the majority, many of who have relatively minor needs, receive ‘free’ or highly subsidised GP visits and other medical services on demand under the uncapped MBS program.

In addition, people are often poorly covered for chronic conditions as the MBS primarily covers doctor’s fees rather than full courses of treatment. Thus many chronic disease suffers can face significant out of pocket charges for non-GP services and medications not fully covered by Medicare.

Medicare is wasteful and unfair because it encourages unnecessary consultations and tests. Consumers, regardless of health needs or income, can use their Medicare cards to either ‘bulk bill’ all the cost of medical services to the federal government or to receive a rebate covering a significant proportion of the cost of each service. Given the size of the subsidies provided, it is impossible to tell how many billions of dollars are being wasted on unnecessary services and trivial health needs.

However, the consequences are far from trivial. High, ever-increasing and open-ended spending on the non-hospital sector has contributed to funding and service imbalances at the most acute end of the health sector – in public hospitals which is the point in the Medicare system where operational capacity is restricted and cost control is imposed, via budget caps and rationing by queuing.

To offset high spending on bulk billing and control the total cost of health to the federal budget, the Commonwealth has tightly capped the level of funding made available to the states for public hospital care.

The way Medicare allocates health funding has left State governments heavily exposed to the financial risk of growth in use of public hospitals. The predictable response has been blunt expenditure controls—frontline budget caps and bed cuts—to ration access to services.

Medicare can thus be described as leaving people over-subsidised and over-entitled at the least acute end of the healthcare spectrum, while the cost of the most serious, most expensive illnesses is inadequately covered, leaving them under-insured against the risk of serious illness requiring hospitalisation.

[Slide 9]

I would argue that as a matter of equity the money the Commonwealth spends on bulk billing and the MBS could be better used to meet unmet demand for hospital care. But redirecting money into bureaucratic, inefficient, and already high cost public hospitals is not sustainable.

In the last decade, government spending on public hospitals has increased by over 60% in real terms, and yet waiting times, particularly for emergency admission, have become an increasingly serious problem. This is attributable not simply to health inflation and rising demand from a growing and ageing population, but also to the non-competitive environment in which public hospitals operate.

Public hospitals enjoy a monopoly on government funding, in return for providing hospital care without user charges, an arrangement which blunts incentives to boost productivity and deliver the best quality care at the lowest cost.

Public hospitals are like other public sector monopolies, and additional inputs do not produce a proportional increase in outputs. This is partly why the federal government subsidises private health insurance as a more cost effective way of meeting demand for hospital care, and is also why some state governments are seeking to outsource the delivery of public hospital services to more efficient private and not-for-profit providers. Note, however, that we have run public hospitals using a productivity-killing, highly centralized and bureaucratic governance model in order to enforce budget limits and ration care.

 [Slide 10]

Medicare’s root flaw, however, is that it exemplifies the intrinsic moral hazard and resultant problems that third-party insurance  funding  mechanisms create in both private and public health systems.

As the increasingly unaffordable United States private health system demonstrates, it is impossible to insure people for all health services without over-use causing a cost and premium spiral. In a private system, moral hazard creates un-affordability; in a free public insurance system like Medicare it causes arbitrary and unethical rationing.

Public and private health systems are both plagued by the problem of ‘first dollar insurance’ – the expectation among consumers that private or public insurance should entitle them to receive treatment entirely paid for by a third-party payer no matter how small the cost or condition.

By contrast, a soundly constructed insurance system should not insure people for all services. Instead, individuals should be required to self insure for minor health needs and expenses. Third party insurance should be reserved to enable people to share exceptional risk involving major health problems, and thus should only cover a minimum package of high-cost treatments for complex chronic and catastrophic conditions.  And personal responsibility, consumer sovereignty, and price signals should also feature by using front-end deductibles and copayments to control costs and deter unnecessary use of marginal and discretionary services and trivial claims.

 [Slide 11]

What my analysis of the structural and long-term financial problems with Medicare suggests is that four key principles should guide debate about health reform:

1. Scarce health resources and subsidises should be allocated on a differential or needs basis to ensure timely access to essential care.

2. Most individuals must pay for minor health expenses out of their own pockets to prevent overuse, making use of personalised funding instruments, know as Health Savings Accounts, which would be modeled on the compulsory superannuation system.

[Slide 12]

3. Medicare should be replaced with a soundly constructed competitive insurance system, along the lines of the Medicare Select risk-rated insurance ‘voucher’ system proposed by National Health and Hospital Reform Commission.

4. And insurance deductibles and copayments should apply for non-chronic and discretionary care.

[Slide 13] 

These principles could be applied reconfiguring the way existing health spending is used to buy insurance and pay for services.

One of way of doing this was set out in my report on health reform which the CIS published earlier this year, which was titled ‘Saving Medicare – But Not As We Know It.’

What I suggested was that we should allow  Generations X and Y to pre-fund future health costs by reconfiguring existing Medicare spending into two new streams of ‘New Medicare’ funding.

One stream would fund ‘super-style’ Health Savings Accounts, which people would use to pay for lower-cost medical care.

A second stream would fund private health insurances vouchers, which would cover higher-cost treatment for chronic and catastrophic illness.

This would allow the existing Medicare scheme to be transformed into an age-limited programme for the current generation of retirees or near-retirees (who have had no opportunity to acquire health savings), which can be abolished when the self-funded system matures.

A transitional arrangement of this kind could potentially neutralize the electorally very significant ‘grey’ vote, which is one the major impediments to health reform.

As HSA savings grew and insurers built up reserves overtime, a higher proportion of health costs will be funded by saving through HSA contributions and premiums, and not by taxes.

[Slide 14]

I think using existing spending to fund HSAs and sound insurance would combine greater financial sustainability and enhanced efficiency (both allocative and technical), with improved equity.

It would not just save money on wasteful expenditures, but also improve the quality of healthcare.

Universal coverage would be maintained through appropriate government funding of HSAs and insurance vouchers and rebates for low income earners.

The Medicare Select model, with its mix of taxpayer-funded vouchers plus additional private premiums, would indirectly expose people to the cost of using health care. Cost control would be further enhanced as HSAs would allow for selective use of prices at point of access to directly expose people to the cost of deciding to use some service.

HSAs are also a more efficient way to fund medical care such as GP visits  because they give people a financial incentive to be cost-conscious consumers of health services.

Choice of insurer – the portability of vouchers – would encourage price competition and innovation among health funds.

If health funds were responsible for purchasing chronic care and hospital services for their members, competing providers would have to deliver the highest quality care at the best prices to win service contracts.  Creating a genuine, purchaser-provider split  would spur meaningful reform of public hospitals which, in order to compete against other hospitals on price and quality, would have to address barriers to productivity.

The ‘New Medicare’ system would also improve one of the largest gaps in the old Medicare – the treatment of chronic illness. Because health funds would hold the financial risk for patients with chronic conditions, they would have an incentive to ensure members received all necessary primary care in order to prevent complications leading to high cost hospital admissions.

[Slide 15]

I realise that much of what I have said is an anathema to true believer in Medicare.

True believers maintain that public health services should be quarantined from financial or economic considerations because they are so important a social good.

The corresponding assumption is that pouring too much taxpayer’s money into the public system is therefore never enough, because health is one of those motherhood issues, similar to education – you can never be smart enough or healthy enough.

Higher government health spending is always expected, and perceived to be an unadulterated good, and the realities of a free system – rationing by queuing – are overlooked as this is always seen as caused by ‘lack of funding’.

[Slide 16]

On this view, the only way to save Medicare is for even more of the same. However, this ‘magic pudding’ mentality is outdated given the ageing-driven challenges facing Medicare, and needs to be replaced with an approach that is more focused on economic fundamentals.

Yet this does not mean disregarding equity.  For any reform program to be politically feasible, it will have to be seen as equitable and as allowing all citizens to access health services regardless of capacity to pay.

A prosperous country like Australia can certainly afford to maintain publicly subsidised access to essential health services, so the poor are not denied care due to cost barriers.  The issue is that governments will not be able to afford the much larger bill for Medicare.

Health spending also needs to be efficient because wasteful health spending entails opportunity costs – the forgoing other goods and services, including health care.  Moreover, financial constraints on the public system impact the most on those who cannot afford to avoid public hospital queues by paying for private health insurance or by self-funding their care.

My view is that what really matters now is finding better ways to deliver public subsidies for healthcare than an unrealistic, unfulfilled, and unsustainable promise of ‘free and universal’ access.

The average amount of money spent on health from all sources per year, per Australian is currently just under $5,500. The government-funded share is $3835. This money is not being used in an optimal manner to finance current and future health care requirements. Moreover, these sums may prove to not be enough to finance both current and future requirements. How much we spend or don’t on health is a choice, and ultimately is a matter of deciding to forgo current consumption to accumulate the resources needed to fund lifetime health costs. We already do this to fund pension costs through the superannuation system, and there is no reason for not applying the same approach in health.

The savings-based approach to health care financing I propose would retain the universal principles of Medicare, but would restructure the delivery of public subsidies in ways that I think would improve the sustainability, efficiency, and also the equity of the health system.

Creating a New Medicare fit for purpose in the 21st century would not destroy the idea of the fair go said to be at the centre of the old Medicare.

But it would fundamentally change how health care is financed and how health services are produced. Adopting market-based reforms would  save Medicare – but not as we currently know it.


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