Purposeful Risk Equalisation in Private Health Insurance

The intention of this article is to get readers to reflect on the question, what is a broad purpose for risk equalisation as one instrument forming part of a health system?

This is motivated by illustrating actuarial capabilities as ideal for dealing with equity, fairness and balancing stakeholder needs and benefits. This is more than an analytics calculation or a puzzle to be solved.

Australia’s total health expenditure is around 9.9% of total economic activity¹. Of this, Private Health Insurance hospital benefits paid totalled $18,064m in the 2023/24 year, with 48% of these hospital benefits shared or subject to risk equalisation².

In Australia, the rules for how risk equalisation is to work are in the legislation, however the purpose or goals of risk equalisation are not clearly specified.

Regulated health insurance markets typically rely on community-rated premiums to achieve objectives such as access and affordability of health insurance for high-risk people. That is, a form of cross subsidy so high-risk members can still access PHI, which may not occur if premiums were risk rated. In Australia, the same premium is paid by healthy and unhealthy members. 

However, community rating has a drawback. It presents insurers with predictable profits (on the young and healthy) and predictable losses (on the old and chronically ill) on average. This creates incentives for insurers to engage in risk selection, that is, actions to attract profitable and deter unprofitable members. The Private Health Insurance market in Australia has community rating and risk equalisation is a tool to support community rating.

Why clarify the purpose?

The motivation for clarifying the purpose of risk equalisation is that research indicates a lack of goal clarity is a predominate reason why change efforts fail. There are several ‘design elements’ that are required for change in a multi stakeholder system such as – clarity of goals and vision, governance, information and measurement systems.

The focus here is on purpose – mission, vision and goals – noting that the purpose and clear goals are those that are shared among members of a system. Goal clarity – or at a minimum compatibility – is an essential ingredient that promotes system functionality. A lack of goal clarity can be a predominate reason why change efforts fail. Hence, developing a broad vision and clear goal for risk equalisation is important.

Specifying the challenge

Risk equalisation alone is not a goal but part of health care overall.  From a policy makers’ perspective, the broader objectives of health care include:

1. Accessibility (Premiums that are economical, irrespective of risk)
2. Efficiency (Incentives to manage benefit outlays while maintaining access)
3. Equity and fairness (Who subsidises who and by how much?)

‘Risk equalisation’ is just one instrument within the broader policy toolkit. Other common instruments are premium regulation (such as community rating), open enrolment, standardisation of benefits, consumer choice, instruments for insurers to manage care etc.

Together these instruments should form an effective blend to achieve overall ‘system goals’ in relation to policy settings such as for accessibility, efficiency and equity.

Goals for risk equalisation in various countries

International experts have differing opinions on the goals of risk equalisation in regulated competitive health insurance markets.

A paper titled, “The goal of risk equalisation in regulated competitive health insurance markets”³ highlights that while there is consensus on some aspects, the role of efficiency remains debatable. By ‘efficiency’ we mean the optimal use of resources to achieve the best possible outcomes with minimal waste.

One agreed-upon goal is to remove predictable over-and-under-compensations of subgroups of insured individuals, thereby eliminating incentives for risk selection.

The research identifies two key themes:

• Equal insurance risk: Ensuring each applicant whom an insurer must accept forms an equal insurance risk, making each applicant equally financially attractive.
• Efficiency considerations: Balancing equal insurance risk with maintaining incentives for efficiency within the healthcare system. Efficiency or cost management incentives are important objectives, and the risk equalisation system ought to support these as much as possible.

Embedding these goals in legislation is a good practice. For example, in the Netherlands, the legislation states that the goal of risk equalisation is to ensure each applicant whom an insurer must accept forms an equal insurance risk for the insurer.

A proposed purpose

A working draft purpose statement for Australia could be:

The above is not intended to represent the goals at an individual organisation but rather the goals at a system level. Frank Redington, a renowned UK actuary, is well-known for the essay “The Flock and the Sheep” broadly discussing the tension between individual equity and collective security. Redington emphasises the importance, in actuarial work, of considering both individual and collective interests to ensure fairness and sustainability in insurance.

Looking at Australia

Feedback in Australia suggests that the purpose of risk equalisation is unclear. When considering its specific objectives, keep these points in mind:

1. The goal of risk equalisation depends on what is considered ‘fair’ and ‘efficient’. How much cross-subsidisation is fair?
2. The objectives and requirements for risk equalisation depend on the system’s context, including other goals and settings. Is the benefits package standardised? Are there different coverage tiers? Is participation mandatory?
3. Clear goals help the system function better. For risk equalisation, clear goals enable improvements and create a foundation for ongoing enhancement.

In conclusion, while no model can achieve all goals perfectly, having a broad purpose allows for comparing different enhancement possibilities. This enables evaluating tools like risk equalisation against scheme objectives. Clear objectives lead to better measures, informed choices, and improved outcomes, a necessary component for improving over time through innovation and adaptation.

References 

[1] Australian Institute of Health and Welfare. (2023). Health expenditure Australia 2022-23.  https://www.aihw.gov.au/reports/health-welfare-expenditure/health-expenditure-australia-2022-23/contents/overview/total-health-spending

[2] Australian Prudential Regulation Authority. (2024). Annual private health insurance performance statistics.  https://www.apra.gov.au/operations-of-private-health-insurers-annual-report

[3] van de Ven, W., Hamstra, G., van Kleef, R., van Vliet, R., & van Kleef, R. C. (2023). The goal of risk equalization in regulated competitive health insurance markets. European Journal of Health Economics, 24, 111–123. https://doi.org/10.1007/s10198-022-01457-7