ALP’s planned cap on health premiums could force 85pc of funds into negative earnings: Macquarie

An ALP plan to cap health premium hikes could force more than 85pc of funds into negative earnings, says Macquarie.

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Bill Shorten’s plan to cap health insurance premium increases at two per cent could force more than 85 per cent of funds into negative earnings and erode excess capital.

That is the conclusion of investment bank Macquarie’s analysts who have reviewed the impact Labor’s policy would have on the industry. The opposition leader has promised to cap the annual premium increase at two per cent for the first two years of a Labor government.

“The private health insurance industry is facing substantial challenges with the disparity of profitability widening, the largest states becoming more competitive and more than 85 per cent of funds could have insufficient excess capital to weather two consecutive years of a two per cent price cap,” Macquarie’s analysts said in a report to clients.

Analysis by the investment bank’s analysts found that 32 of 37 funds could be loss making in the second year of the proposed two per cent price cap, as measured against the financial regulator’s stress test scenario.

The Australian Prudential Regulation Authority’s stress test scenario requires 98 per cent probability that premiums would cover liabilities in 12 months’ time.

“Under this scenario, Medibank could be one of the few funds to make a profit,” the analysts said.

The report also noted that 19 of 37 funds could be loss making in the second year of the Labor policy at the current level of expenditure growth.

“Under this scenario, Medibank and Bupa would have a clear profitability advantage versus their peers,” the report said.

“With the data available we can conclude the proposed two per cent price cap is not a sustainable proposition for the industry, unless bundled with measures to address claims growth.”

The squeeze on the bulk of funds under the two per cent environment could provide opportunities for market consolidation, according to Macquarie.

The analysts also outlined that the earnings gap between the for-profit and not-for-profit funds almost doubled in fiscal 2018, raising the possibility of regulators imposing different capital rules by fund type.

For-profit funds reported net margins of around 760 bps higher on average than the not-for-profits. Adjusting for investment income and taxes, the outperformance was 3.1 per cent in fiscal 2018, compared to 1.8 per cent in the prior year.

Despite the difference, Macquarie argued that the profitability gap was not as material as perceived.

The report stated that while a simple comparison of the net margins between for-profit funds and not-for-profits suggested the for-profits were over-earning, the simple comparison failed to account for the different capital structures and the tax paying status of the various funds.

“We believe any perceptions that for-profit health funds are over-earning are lessened through more detailed analysis,” the analysts said.

“It is also possible to conclude that reduced health fund profitability is not a viable solution to affordability concerns in the private health insurance market.”