- Declining profitability is weighing on Australia's private health insurers, particularly those that lack scale or access to capital.
- Shifting demographics will further hurt claims costs and premium affordability.
- COVID-19 has given insurers some breathing space through a temporary drop in claims but the catchup could hit earnings and trigger consolidation.
Australia's private health system is unwell. Insurers are at risk of declining profitability as squeezed margins undermine their ability to pay claims in the long term, and consumers are being turned off by climbing premium costs.
To combat higher claims, Australia's private health insurers have lifted rates yearly over the past decade and premiums are now over 70% higher than in 2010. Average wages, however, have only grown 32% in the same period. This affordability issue, which we expect to continue to worsen over the next five years, has resulted in declines in participation or level of cover sought.
Without structural change, we expect participation rates to continue to fall, likely led by younger members. A decline in younger premium holders will contribute to diminishing cross-subsidy benefits between older and younger members, further hitting the industry's long-term viability. With fewer new and younger policyholders, we expect health insurers to experience further profit and capital pressures, potentially leading to voluntary industry consolidation or funds forced to merge at the brink of failure.
This comes as the Australian health industry is saturated with over 30 players--but with the top five taking in nearly 80% of insurance premiums and about 85% of profits. While the top five insurers dominate the market, many smaller health insurers are member-owned mutual organizations with very limited access to capital.
In recent years, the underwriting profit of mutual health insurers has been declining compared with their corporate counterparts. In the year to June 30, 2020, mutual health insurers recorded an underwriting loss--the first in over seven years (see chart 1). Corporate health insurers, on the other hand, saw a sharper decline in underwriting profit with claims growth 2.6% above premium growth, compared with the prior year. If future premiums and claims growth remain at the average rate of the past two years, we expect underwriting profit to continue to decline over the next three years. The large insurers will threaten to squeeze smaller insurers, particularly the small mutual health insurers, out of the market.
Absent further operational efficiencies and product innovation, the ongoing trends are unsustainable and will weigh significantly on the financial resources of smaller mutual health insurers and weaken their capital positions. We expect that smaller insurers will need to consolidate to survive. Greater economies of scale support negotiating power with hospitals and service providers and provides greater scope to invest in operational efficiencies. This will enable better control over claims experience and operating expenses, with a flow on effect on pricing and affordability.
Premium Rates Are High Relative To Wages And Growing Faster
Heath insurance premiums have been on the rise, leading to potentially unsustainable premium rates and a decline in participation rates. Over the past 10 years, health insurance premiums have increased by 5% a year on average, whereas wages have increased by only 3% (see chart 2). This disparity has exacerbated the affordability of health insurance premiums and accelerated the decline in participation year on year since 2015. The improved participation rate back in early 2000 reflected the introduction of a lifetime health cover penalty tax loading, which penalizes members who did not obtain private health insurance. However, as premium rates continue to increase and the perceived value of the product diminishes for younger members, people are choosing to cut health insurance as a discretionary expense. We expect participation to continue to decline as premium rates remain unaffordable and unattractive to younger members, in particular, and the public health sector provides a viable alternative for many.
Current economic conditions and the ongoing COVID-19 pandemic are also likely to increase policy lapses and deter new members as people manage their discretionary spending, offset to a small degree by the heightened awareness of health-related issues. Although several insurers have deferred the April 2020 premium increases, we do not expect this to be permanent or to improve premium affordability. Some insurers have passed on rate increases in October 2020. We expect wage growth to be minimal over the next three years as companies manage expenses and job seeker numbers remain high. However, we expect health insurance premiums to continue to rise due to rising claims costs. This, in turn, will accelerate the shifting demographics to an older member age, and further pressure product affordability.
Shifting Demographics Undermine Cross-Subsidies
Australia's health insurance industry uses community ratings to determine premiums and has limited underwriting controls as prescribed by the Private Health Insurance Act 2007. This means insurers are unable to apply a risk-based pricing approach or decline new customers based on factors such as age, gender, previous medical history, or family medical history. As a result, health insurance members are charged a standard premium rate regardless of the risk level, limiting an insurer's ability to attract and manage lower-risk customers. Younger policyholders are overpaying relative to their health risk whereas older policyholders are underpaying, reflecting claims history. This is at odds with, say, the New Zealand model with an age-based pricing approach.
The health insurance industry is therefore highly reliant on cross-subsidization between different demographics to reduce the overall cost of premium increases for all its policyholder members. The younger members have a lower propensity to claim hospital benefits and the under 50s group represents about 20% of total hospital benefits, and has been gradually declining (see chart 3).
Members under 50 constitute a smaller percentage of insured lives than 10 years ago (see chart 4). We expect younger members are opting out of health insurance due to the unaffordability of premiums and are less likely to benefit from health insurance as it is currently structured. On the other hand, members above 50, who are higher risk and more likely to claim, are increasing as a percentage of insured lives due to the aging population. Members above the age of 80 make up about 5% of the members insured but receive about 45% of the hospital benefits paid (see charts 3 and 4). If younger members continue to opt out, shifting the demographic of the insured lives, and claims from older members grow as a percentage of benefits paid, insurers' ability to meet claims will be compromised. Subsequently, this may lead to further upward pressure on premiums as cross-subsidies diminish, further weighing on affordability.
Claims Costs Are At Risk Of Further Pressuring Affordability And Industry Profitability
Claims costs continue to increase more than premium rates for both mutual health insurers and corporate health insurers; see chart 5 for the difference between premium growth and claims growth. Health insurers are controlling claims costs through partnerships and agreements with hospitals and medical care providers with corporate health insurers experiencing a lower increase in claims costs than their mutual counterparts. The shifting demographics, to older members that have a higher propensity to claim, also adds upward pressure to claims costs and premiums. This will be a greater burden on mutual health insurers that have constrained access to capital and limited bargaining power with providers to manage claims expenditure. Hence, without systemic changes or government intervention, there is little opportunity to reduce premium rates as claim costs are expected to continue to increase.
We expect the reduction in claims due to the COVID-19 pandemic to be short lived, and for claims expenses to revert to normal levels once mobility and travel restrictions are lifted. Strict travel lockdowns, as part of the COVID-19 response, led to the deferral of nonurgent elective surgeries and other ancillary treatments. This deferral resulted in a sharp decline in claims costs during the lockdown period. However, we expect these claims to be incurred in the remainder of 2020 and 2021. Several health insurers deferred premium increases to Oct. 1, 2020, to recognize the inability to claim and to assist members during the pandemic, leading to modest industry premium growth for 2020. Return on equity for the industry has been declining over the past few years and we expect this trend to continue post pandemic (see chart 6). In particular, mutual health insurers are under more severe earnings pressure as evidenced by the decline in return on equity in 2020. We believe that claims that would have been incurred during COVID-19 lock-down have only been deferred and will be paid over the next 12 months.
We also anticipate an increase in mental health claims during and post the pandemic. Government responses to COVID-19, in particular statewide lockdowns and travel restrictions, have hit mental health. According to the Australian Institute of Health and Welfare, the use of mental health services such as Lifeline, Beyond Blue, and Kids Helpline climbed between 15% to 40% over a recent four-week period compared with the prior year. Mental health claims, which are included in some policies as ancillary benefits, typically take longer to be incurred and require repeat treatment. Hence, this could have a lasting impact on insurers, placing further upward pressure on future claims costs.
The catchup in claims when restrictions ease is likely to squeeze health insurance profit margins. We estimate that growth in claims will continue to outpace growth in premiums if there are no changes to existing operating conditions; see chart 5, in which we assume that premium, claims, and expenses grow at the average rate of the past two years. Similarly, chart 6 indicates the resultant impact on forecasted return on equity of claims and expenses trends. In addition to higher claims, mutual health insurers' expenses have been growing rapidly, at an average 10.3% over the past five years. As such, we estimate mutual health insurers will continue to experience profitability pressures over the next three years, in particular.
We expect mutual health insurers will likely consolidate within the next 12 to 24 months. According to Australian Prudential Regulation Authority industry data, 11 insurers reported negative operating profit after tax, as of June 30, 2020. Of the 11 insurers, nine are mutual health insurers, including the industry's largest mutual insurer, the Hospitals Contribution Fund of Australia Ltd. (HCF). Currently, Australia has 25 mutual health insurers that make up about 37% of the country's health insurance market by premium. However, mutual health insurers only achieved a combined profit after tax of A$1.2 million, which is less than 1% of the industry's overall profit for the year. In our view, the ongoing depressed economic conditions and the shifting membership demographics are likely to accelerate failures or trigger industry consolidation.
This report does not constitute a rating action.
S&P Global Ratings Australia Pty Ltd holds Australian financial services license number 337565 under the Corporations Act 2001. S&P Global Ratings' credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act).
|Primary Credit Analyst:||Craig A Bennett, Melbourne + 61 3 9631 2197;|
|Secondary Contact:||Angela Zhou, Melbourne + 61.2.9255.9841;|
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: firstname.lastname@example.org.