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Regulatory regime needs to change before the VHI can be privatised Back  
The possible privatisation of the VHI has surfaced and resurfaced on a number of occasions, writes Professor Ray Kinsella, but unless Ireland’s regulatory regime changes, privatisation will not be the answer to VHI’s woes.
There are three other reasons why the issue of the possible disposal of the VHI by Government is very timely. The first has to do with the Exchequer Returns to date, will help shape budgetary policy. The second relates to the recent publication of the VHI’s Annual Report and Accounts 2003. The third concerns initiation by BUPA Ireland of legal proceedings against the Government in the European Court of Justice.

The Exchequer Returns highlight the fact that any additional funding of the overstretched public acute system is simply not a runner. Against this background, commentators have pointed to the possible proceeds of the sale of VHI as something which would lessen the burden. It wouldn’t. The proceeds from any privatisation would be once off. Depending, inter alia, on the process chosen and market sentiment at that time, privatisation of VHI might generate from E300 - E500 million. This compares with total voted expenditure (current) by the exchequer in 2003 of some E8 billion, and PMI claims paid by VHI and BUPA Ireland amount to about E700 million.

This is not to say that self-funded (included PMI) expenditure is not important. It is - especially for private hospitals as well as for some public hospitals for whom PMI receipts are a key element in their financial planning.

The point is that the public/private ‘mix’ of funding is still very much stressed towards the public system. Too much so, in fact - it’s not sustainable over the short/medium term. There are upward pressures - medical cost inflation -, which only competition can effectively constrain and, even then, PMI premia will rise significantly over the medium-term. Then there is the rise in costs associated with a marked expansion - of over 30,000 - in healthcare since 1997. The Exchequer returns and the ‘cuts’ made to date make absolutely clear that this is not feasible over the medium-term.

At one level, therefore, the total proceeds of any privatisation of VHI will have little impact on the medium - term sustainability of the acute system. Its not the real issue. What VHI want is ‘greater commercial freedom’( in some form of trust that effectively, keeps them within the broader ‘public sector’. What the Department of Finance are interested in are the proceeds, not withstanding their relative size compared with total exchequer spending. What the Department of Enterprise and Trade want is more - real - competition in PHI, which is lacking at present. Both of the Departments do not want any half-way house to privatisation. They want the real thing. And that’s what’s going to happen. A difficult - but straight forward - privatisation. The key questions are how, and when, is this going to happen.

Difficulties in privatisation
It won’t be easy - it will involve, to begin with, the amendment/repealing of the VHI Act, 1957. This is a necessary - but not a sufficient condition. What is also needed is deregulation within the PHI sector - removing barriers to market entry, restriction on innovation, the end of any cross - subsidization and, in general, a more pro-active driven process. Equally, so, a move towards deregulating the public system, which is characterized by widespread restrictions, is needed, as Professor Muris X Fitzgerald, UCD’s Dean of Medicine has argued. The net effect should be a supply - side dynamic, of which VHI privatisation would constitute an important element.
We turn now to the VHI’s Annual Report, which provides the immediate context, and defines the parameters for any possible privatisation.

Key financial outcomes
The key financial outcomes set out in the recent Annual Report and Accounts include:
• An increase in gross premium income of over E90 million
• A net profit of E33.8 million equivalent to 4.9 per cent of turnover reflecting an increase of just under 1 per cent in membership subscription increases as well as (the knock-on effect on profitability (to record levels).
• A transfer of some E20 million to an ‘Unexpired Risk Regime’ (see below)
• An increase in claims costs of E75 million (14.3%) - despite, its worth noting a significant increase in day case surgery
• A small decrease in administrative costs as a percentage of premium income
• Revenue per member well in excess of that of BUPA Ireland and significantly lower unit costs

In effect, the VHI has record gross premium income, record membership but wants risk equalisation transfers equivalent to about 4 per cent of its profit to help keep the lid on increased premia in the face of rising claims. In the notes to the accounts, VHI state that E35 million is in ‘respect of losses anticipated on contracts that the Board will be obliged to incept or renew arising from the commitment of the Board to a certain level of price increases from 1st September 2003 and anticipated increases to in the costs of providing healthcare benefits’ The notes go on to say that ‘provision has not been made for further significant losses it [the Board] considers may arise in subsequent periods in the absence of… [Risk Equalisation] and commercial freedom for VHI’

All of this seems largely uncertain, in view of the actual results themselves, the rationale for and timing of future significant losses and difficult strategies for containing claims costs. Indeed, the report of the Auditors (page 22) specifically draws attention to this whole issue of the unexpired risk account: ‘in view of the significance of the uncertainties with regard to the assumptions underlying the provision and the likelihood of future significant loses, we consider that the matter should be drawn to your attention’. It is important to note that they add, ‘Our opinion is not qualified in this respect’.

Nevertheless, it appears so far as one can see because its not easy to follow that there are uncertainties’ regarding the assumptions underlying ‘Unexpired Risk Reserve’ and that the case for it is predicated on the immediate introduction of Risk Equalisation. The problems here are numerous - why has VHI, in its history since 1957, never sustained an ‘aging’ reserve? Why should not a different ‘ business model’ or strategy be used to address rising claims cost, rather than a dependence upon extracting a ‘rent’ from a much smaller - and only - competitor. VHI are seeking a transfer equivalent to about 4 per cent of its premium income - about E25-30 million - not too far off the ‘Unexpired Risk Reserve’.

Risk equalisation
The real problem is that the implementation of an RES is fraught with legal and other difficulties. It would, almost certainly, result in the ‘crowding out’ of BUPA Ireland on commercial grounds which would have a highly regressive effect, especially, on lower income individuals. And it would remove any competitive/innovative downward pressures on claims cost. It’s not easy to explain - to customers or to Company Group Schemes - why innovate customer - focused PHI products (including, for example, dental treatment) are being exported from the IFSC - but are not available on the domestic market. Or for that matter why the Government pays multinational companies to come into Ireland while it is also charging (via the RES) the side entrant into the Irish PHI market, over E25 million to be allowed to stay in Ireland.

In essence, this migraine-inducing RES scheme would ‘if implemented’ work by extracting about 4 per cent of VHI’s income from the customers of BUPA Ireland some E25 to E30 million a year at current membership levels.

Main options
How best could the PHI get the commercial freedom it desires? There are some four options on the table.

The ‘commercial semi-state body’ idea that was referred to in the White Paper -that’s just not going to happen. Secondly, some form of mutualisation. The VHI board have worked very hard on this over the last couple of years, but the indications are that the model is both complex and probably unattractive to the Department of Health and Children and also to the Department of Finance as well as Enterprise, Trade and Employment. There is the possibility of a ‘trade sale’, and this is, in principle, a sound optimal option, other things being equal.

But they are not. The fourth possibility is full privatisation - that is, floating the company. There are considerable technical difficulties relating to, for example, valuation, possible long-term contingent liabilities on the part of the State and various other uncertainties, including the regulatory system.
What difference would privatisation of VHI make to members and the wider health system? Well, greater commercial freedom for VHI would mean that we would no longer have the ridiculous situation where the Minister has to give his approval for a proposed premia increases and the VHI would be free to innovate and develop it’s own strategic direction.

But the bottom line for the public and any potential bidders waiting in the wings is that unless, and until, there is a genuinely competitive market in PHI - and that means the revoking of risk equalisation, - it will do absolutely nothing to contain the upward spiral in PHI premia.

It’s worth recalling that the VHI will raise premia by 8 per cent from September, bringing the yearly increase to 25 per cent. That’s not sustainable, as the elasticity of demand for PHI with regard to price is relatively low. Particularly given the economic environment into which we are now heading. There are few things that could be done to mitigate the seemingly inexorable rise in PHI premia - but the single most important way of achieving this is a competitive PHI market, rather than VHI’s ‘solution’ of risk equalisation.

Radical option
There is another, more radical version of the privatisation option. We would call this the ‘Baby Bell’ Model - that is, divide the VHI’s book into some three or even four parts and sell each of these more or less equal size portions, leaving it to the market to develop over the medium-term. This would have the attraction of creating instant internally generated competition, since externally generated competition simply hasn’t happened. It would also probably optimise the amount raised. The downside is that it would generate loss of economies of scale compared within the existing institution. Then again, there is no reason why 3 or 4 ‘Baby Bells’ should not be capable of generating economies of scale. Importantly, VHI’s unique 50-year information base would be made accessible to all participating companies, which would increase overall market efficiently.
We have seen in so many other facets of Irish economic policy, that competition brings new capital, new business models and helps to contain costs. Basically, unless the regulatory regime changes, privatising the VHI will do little or nothing for members or for the other Healthcare system.

But if we did have more deregulation and more competition - including the abolition of the RES - and the VHI were privatised, would that help the Irish healthcare system?

Yes it would. It would help to shift the burden of risk and of expenditure from a cash strapped public sector onto the private sector. It would let loose a whole range of new business models, both in the delivery of health care and in clinical practise - which would, in turn, make the system far less inequitable and discriminatory than it is at the moment.

But first we need a competitive market. If this doesn’t happen, it will entail a few cents on income tax, unless there are cuts in other sectors. That’s why Charlie McCreevy, who has gained much kudos from criticising the increases in healthcare expenditure, really does have a responsibility now to come off the fence and to work with Michael Martin to devise a way forward.

One last issue: a figure of E300m is being bandied around. Is that realistic and what should we do with it? It really is quite difficult to put a value on VHI, given the different assumptions that need to be made, the technical difficulties involved in valuation and in deciding upon the precise nature of the insurance contracts involved.

It also crucially depends on brand equity and more (much) more especially on the knowledge and experience of any prospective purchaser - and this is something the government would certainly have to take into account in ensuring that what was a state asset continued to deliver value. But let’s suppose for a moment that it did raise E300m - what should we do? Firstly, the White Paper envisaged that those working in VHI would be given a 15 per cent share in the event of privatisation. This is entirely right since it is the staff that has created whatever is the latest value in the company over the years. And the remainder?

It should go as far away as possible from the ‘black hole’ that is now emerging in the vicinity of Merrion Street. And, upgrade the facilities in Temple Street; demolish Our Lady’s Hospital in Crumlin and use the proceeds as equity in a Public/Private partnership to replace it with a world-class facility worthy of all of the children of the State. That’s what we should do with it.

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