The private health insurance sector is ripe for reform, but the Federal Government should look further than populist policies that seem to offer more choice but at a cost to overall equity and efficiency, writes Peter Sivey.

The Federal Government has confirmed that it is considering reforms to private health insurance regulation that would allow new policyholders with healthier lifestyles (including non-smokers and people with low BMI) to pay lower premiums.

This policy change would represent a relaxation of Australia's long-held "community rating" system which enforces a rule that everyone pays the same price for the same policy.

The proposed reform sounds like classic small "l" liberal reform: reducing regulation and improving choice for consumers. But it's bad for fairness and it's bad economics.

Smokers nowadays are a relatively small but highly disadvantaged group in Australian society. Latest estimates suggest only 18 per cent of Australians are smokers. But disadvantaged groups such as Aboriginal and Torres Strait Islander people, remote and rural Australians, those currently unable to work, and single parents have much higher smoking rates, up to twice as high.

We know that smoking is highly addictive and it is hard to argue that the differences in smoking prevalence across socio-economic status represent the rational choices of individuals. On this basis, price discrimination against smokers is unfair and inequitable.

Allowing such price discrimination would surely lead to some smokers dropping their private coverage as their premiums rise to reflect their higher health costs. These smokers would now seek their expensive treatments from the public hospital sector. So the net effect of the policy would be to move more of smokers' health costs (as well as the costs of others with unhealthy lifestyles) onto taxpayers. Previously their costs would have been subsidised by their own health insurance premiums, and the premiums paid by other policyholders in the same fund.

The Government is also considering allowing private health insurance to cover out-of-pocket fees for GP services (for example, when GPs don't bulk bill and charge a fee higher than the Medicare rebate).

Again, this reform seems appealing on the face of it. Why shouldn't we be able to use our costly private health insurance to cover bills from the GP surgery?

A primary reason is that the existing policy of forbidding insurance coverage of GP fees has put the responsibility on GPs themselves and the Government of the day to keep fees low and bulk billing rates high. For example, the Howard government introduced a series of increased payments to doctors which successfully reversed the decline of the bulk-billing rate in the early 2000s. Under private health insurance coverage, GPs would have an incentive to increase fees and the government would have the temptation to deflect any problem with accessibility onto private health insurance. There goes the principle of universal access to primary care.

The private health insurance sector is certainly ripe for reform, but the Government should look further than populist policies that seem to offer more choice to consumers but at a cost to overall equity and efficiency. The ability of health funds to design restrictive policies which exclude certain treatments mainly needed by older people (hip replacements are a common example) would be a good starting point for better regulation.

You only have to look at health insurance TV adverts to see where the system is going wrong. Excessive marketing to young people, and focus on 'extras' cover (dental, optical, etc), shows where the fat profit margins lie. Restricting extras cover and enforcing more adequate minimum levels of hospital cover could improve price competition and improve coverage for essential medical procedures.

Peter Sivey is a senior lecturer in the Department of Economics and Finance at La Trobe University.