In brief - A warning to private health insurers - fundamental change to the regulatory landscape is coming
Private health insurers are facing increasing public and regulatory scrutiny.
Recent public statements by the Australian Prudential Regulation Authority (APRA) indicate that:
- restricted and not for profit private health insurers should expect intensified supervision by APRA in the short term and in the future
- there is a strong prospect of an independent review of Australia's private health insurance system on the horizon
On Thursday 30 January APRA released an Information Paper on its policy and supervision priorities for the next 12 to 18 months across all APRA-regulated institutions.
Among APRA's policy priorities is its focus on continuing to work on strengthening the capital framework for private health insurers.
In this regard, APRA intends to roll out a new prudential risk rating system to replace its long-standing PAIRS and SOARS models mid-year.
Sustainability and consolidation
In the context of private health insurers (PHIs), these priorities are set against a background of increasing concern by the regulator about the resilience and sustainability of smaller PHIs in the longer term.
In January 2018, APRA expressed its growing concern about the risks posed to both the industry and its policyholders by the challenges of declining affordability and adverse selection.
At that time, APRA confirmed that it had no prudential concerns about the state of the private health insurance industry.
That position has radically changed. On 4 February APRA publicly expressed its fears about the factors threatening the sustainability of PHIs which have become more acute - see Speech to the Members Health Directors Professional Development Program by APRA Member Geoff Summerhayes Tuesday 4 February 2020.
APRA has issued a strong and direct warning that there is a downward spiral in some segments and based on current trends it predicts that private health insurers will forced to "merge or fold" within the next few years, with particular emphasis on the smaller and vulnerable insurers.
A number of factors are contributing to the decline in private health cover
APRA attributes the downward spiral to a range of factors including:
- an exodus of younger, healthier policyholders
- ongoing rise in policyholders in the 70-84 age group
- a primary driver of rising premiums
APRA's view is that the current conundrum is a reflection of:
- the increase in premiums which has been lower than the escalation of underlying costs; and
- the underlying claims cost which has risen at an average of about 5 per cent a year, which is putting further upward pressure on premiums.
APRA has expressed dissatisfaction with the response by private health insurers regarding some of the measures employed to reduce claims costs such as increasing exclusions, increasing excesses and closing products. That is, these efforts to suppress premium growth have not stemmed declining levels of coverage and appear to have reduced policyholder value.
PHI action plan
As a first step, ARRA's primary focus is on lifting PHI resilience and the regulator is insisting that PHIs have in place a robust, proactive recovery plan placing particular emphasis on the three phases of APRA's 'PHI Roadmap' - risk management, governance and capital.
APRA has indicated that it will intensify its supervision according to the comprehensiveness and credibility of each PHI recovery plan by applying prudential risk benchmarks.
We anticipate that in the foreseeable future, APRA will be questioning the Boards of PHIs about their business model and strategies they have in place to address cost factors which the respective PHI can better control, particularly in the areas of:
- governance - appropriate organisational expertise and capability
- business planning - a sustainable business model, strategy to achieve a competitive edge and proactive recovery plan
- risk management - necessary capabilities to address the operating environment
Capital standards review of private health insurers
In November 2018 APRA commenced a review of the capital standards for private health insurers to ensure they remain sufficient to protect policyholders, stating.:
"Private health insurers have been under duress for several years as declining affordability pushes younger, healthier policyholders out of the system, putting further upward pressure on premiums. In times of stress, holding healthy levels of capital enables insurers to continue honouring their commitments to policyholders. This review will determine whether the existing framework still adequately supports that objective."
As a consequence of its current public positioning, we expect APRA will expedite the enforcement of the prudential framework for private health insurance – including the current review of capital standards.
Mergers may be the only way forward for 'at risk' health insurers
To address cost pressures, APRA has acknowledged that larger PHIs have introduced successful strategies such as enhancing value for younger and healthier members outside of typical hospital settings, lowering claims costs through alternative models of care and preventative health, and the use of partnerships and technologies to manage operational costs.
However, APRA's overall prognosis is that realistically, smaller funds have less ability to absorb the cost pressures or invest in the types of innovative service and technological solutions to keep up with initiatives being introduced by larger competitors.
We anticipate that these statements are directed at the restricted and not for profit segment.
Rightly or wrongly, APRA has made it abundantly clear that 'at risk' insurers should consider potential merger partners, and start discussions early, to put them in a stronger position to act quickly if their position becomes unviable. In this regard it has suggested that 'at risk' insurers consider the implementation of a Plan B strategy of consolidation or merger.
Independent review of the private health insurance system
In response to its current assessment of the weaknesses and vulnerability of segments of the private health insurance market, APRA has concluded that a whole-of-industry response will be necessary to reverse the decline in private health cover.
In this regard, APRA has flagged support for an independent review of Australia's private health insurance system led by appropriate qualified experts and involving all key stakeholders encompassing all key policy and regulatory settings such as:
- the ongoing viability of the community rating model
- the risk equalisation pool
- premium pricing methodology
- prices settings between PHIs and medical providers
It is clear that in the immediate short term there will be increased regulatory scrutiny in the PHI sector and the regulator will expect the boards of all private health insurers to take proactive steps to address these market risks, including considering the prospect of a merger where the circumstances indicate a longer term viability risk.