Policy innovation in voluntary hospital private health insurance: Combining risk adjustment and risk sharing in...

Australia's voluntary hospital Private Health Insurance (PHI) uses community-rated premiums to enhance fairness and accessibility. However, community rating results in predictable profits on young, healthy people and predictable losses on the elderly and chronically ill, creating incentives for insurers to engage in risk selection. To address this, a risk equalisation scheme is applied.

This paper evaluates the effectiveness of Australia's current risk equalisation scheme in achieving its goals and explores policy innovations integrating risk adjustment and risk sharing.

We simulate the current risk sharing-only scheme and compare it to alternative models combining risk adjustment and risk sharing. Each model is evaluated using indicators that capture incentives for risk selection, incentives for cost control and overall payment system fit. Additional analyses examine how these alternatives affect claims cost across product tiers.

The current scheme leaves substantial incentives for risk selection and contains weak incentives for insurers to control spending. Simulations of alternative payment systems show that modifications can simultaneously reduce incentives for risk selection and improve incentives for cost control, while maintaining fit. Changes in the payment system increase insurers' net cost for basic, bronze, and silver plans, while decreasing costs for gold plans.

Combining risk adjustment with risk sharing shows promising potential for consumers in mitigating selection and improving incentives for cost control, while maintaining fit. This paper provides a direction for reforming the risk equalisation scheme to reduce selection incentives and enhance cost control.