Insurance companies are complex organisations, but their core business model is straightforward.
It's built on probabilities. So long as just a few people make claims each year, the insurance company can spread the costs of those who make claims across everyone who buys insurance.
It's a great system, and it underpins consumer, business and household confidence. But it has an Achilles heel.
If risks become systemic and too many people make a claim at the same time, the business model gets into trouble.
Hail is a systemic risk for car insurance given its ability to impact a lot of people's cars all at once.
Bushfires are a system risk for home insurance given they can hit whole suburbs, towns and states at the same time.
The big systemic risk for health insurance? An ageing population.
Australia's private health insurance system works well when lots of people take out insurance but only a minority make a claim. An ageing population reverses this by increasing the number of claims being made in any given year.
Worse still, it can trigger a vicious spiral.
As more people make claims because of an ageing population, insurance premiums go up. If they go up enough, the people who rarely make claims (primarily young people) drop out altogether, pushing premiums up even further, triggering the cycle again.
The end result is more people relying on the public system with more strain on government budgets.
It's the opposite of what sensible economics would recommend. If those who use a system can afford to pay for it, they should. This frees up resources that can be spent on better healthcare for those in need.
Sadly, this vicious cycle is already playing out in Australia.
The demand for surgeries involving medical devices has been growing at 5 per cent every year for the past decade.
As costs have gone up, so have premiums. Premiums have more than doubled in real terms since 2002.
As premiums have gone up, young people have dropped out. Back in 2000, those aged over 70 represented just 35 per cent of people with private health insurance. Today, they represent more than 53 per cent.
This is a big problem. Because more than 14 million Australians have private health insurance, even a small decrease in that number means a big increase in the number of people relying on the public system.
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The community rating system - which means people can't be discriminated based on their health status - makes private health insurance even more unique.
How can we get Australia's system of private health insurance back in the right direction?
There are things we can do to incentivise people to take out private insurance - such as changes to the Medicare Levy Surcharge, the Medicare Rebate and Lifetime Health Cover - but there are also practical things we can do to get costs down.
Australia has a nasty habit of putting the fox in charge of guarding the hen house, and medical devices is a classic example.
The prices of medical devices in Australia aren't set by markets. The fixed price list is set by the federal government and governed by a unilateral memorandum of understanding between the foreign manufacturers of these devices and the previous health minister.
The results from a system controlled by vested interests are unsurprising.
The costs of common medical devices in Australia are 2.4 to 4.7 times higher compared to our peers overseas.
Germany and Sweden pay a quarter of the price for common devices compared to Australia.
Arguments that this is because Australia is a small country that's far away simply don't stack up. In 2022, prices were 67 per cent higher in Australia than those in New Zealand for 25 commonly-used devices.
Nor do higher prices reflect limited supply. In fact, there is ample supply and multiple suppliers for most devices.
The problem is simple: Australia's pricing model is designed for foreign manufacturers, not Australian consumers.
Compared to peer countries, Australia sets non-bundled and non-competitive prices for medical devices. Other international markets ensure efficient prices and overall costs for medical devices through bundling and competitive tendering or negotiation.
Bundling of payments by episode of care encourages efficient allocation of spending and encourages suppliers to lower prices to compete. This helps healthcare markets overseas use market forces to reduce medical device costs compared to Australia.
Introducing greater market-based competition will help reduce prices and improve patient outcomes.
The current system does the opposite: it incentivises the use of the most expensive device, which is not necessarily the best device. It also incentivises the biggest companies to dominate the supply chain in Australia and exclude smaller providers.
Reform can help strengthen incentives to deliver better patient outcomes, such as setting financial incentives for high-performing devices that don't require multiple replacement surgeries in the future, and support Australian industry.
Reforming the way in which we price medical devices might sound niche, but it's a key way we can make Australia's healthcare system more sustainable, with more resources to direct to those who need it.
It's an opportunity to reduce cost of living pressures, boost competition, support Australian industry and help the most disadvantaged in the community.
After all, a healthy population is the best insurance we can get.
Adam Triggs is a partner at the economics advisory firm, Mandala, a visiting fellow at the ANU Crawford School and a non-resident fellow at the Brookings Institution.
Adam Triggs is a partner at the economics advisory firm, Mandala, a visiting fellow at the ANU Crawford School and a non-resident fellow at the Brookings Institution.
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