Drummond switches cuts for capital infusions in Medibank treatment

Medibank’s base is eroding at a faster clip than its peers and investors need to keep a close watch on its vital signs.

Medibank chief executive Craig Drummond at the company’s AGM earlier this month. (Aaron Francis/The Australian)

Medibank chief executive Craig Drummond outlined the stark challenges confronting his business in an investor briefing today. In a slowing industry, experiencing severe and structural threats, his own business is losing ground to its peers.

That’s not a near term experience but a longer-term trend. The core Medibank brand has been losing market share for years, a trend only slightly blunted by the growth in its lower-cost, lower-margin AHM brand.

Last year Medibank brand’s customer base shrunk by about four per cent, with the performance of AHM reducing the overall contraction in the group’s membership to 2.5 per cent.

The industry is losing customers against the backdrop of premiums that rise inexorably at mid-single digit or more rates, while wages growth is flatlining but Medibank is seeing its franchise eroded at a faster rate than its peers.

That’s not sustainable in the longer term. The exploding costs of healthcare, reflected in insurance premiums that are seeing customers opting out of the private system, are a larger issue for governments and the broader sector. Affordability, for private health insurance customers and the community, is an issue that desperately needs to be addressed.

Medibank’s problems, however, are partly of its own making.

The group’s financial performance in recent years has been very strong. Five years ago it earned $126.6 million. In 2013-14, ahead of its privatisation and listing, it earned $285.3m. Last financial year its profit was $417.6m.

That, however, appears to be part of the problem Drummond now confronts.

Medibank has been too profitable, or at least its profits have been driven by factors that have damaged its franchise.

Five years ago the management expense ratio in its insurance business was 10.7 per cent. Last year it was 8.4 per cent. With revenue growth in the low single digits, earnings have been driven by cost cutting. The decline in customer numbers within the core brand signals that there was too much cost cutting and not enough investment in products and services.

Drummond has made it clear that he is going to trade some near-term earnings growth for an investment in customer service and in an improved product offering to arrest and reverse the destabilising trends within the group’s customer base which has seen Medibank attracting a disproportionate share of the sector’s customer complaints.

With call waiting times in its customer service centre approaching 10 minutes and an antiquated online platform, that’s not surprising.

Drummond’s response is to add 60 new staff to his contact centre, invest more in product benefits, refurbish Medibank’s retail network and bed down new core customer relationship and policy management and internal management platforms.

The new digital platform (there were some well-publicised teething problems at tax time) ought to significantly improve customers’ online experience and take pressure off the contact centre. The new systems also ought to generate significant efficiencies and enable far quicker rollouts of new products or enhancements.

At a more fundamental level, the decisions Drummond has taken and the direction his new management team are heading towards is to reorient the group from a focus on driving near-term earnings growth (which the former management was incentivised to do) towards customer-centric strategies.

There will be a cost to the shift in emphasis — the free dental check-up Medibank has added to its policies will cost $40m over three years, the extra contact centre staff about $18m over the same period and incremental investment in an expanded offering about $8m — but the alternative is, in the long run, unpalatable.

Within three years Drummond hopes to have stabilised Medibank’s market share, lowered complaints and dramatically improved customer satisfaction levels, as measured by the net promoter score methodology — which is now a key feature of executives’ incentive schemes.

He has also set out financial objectives for 2020: a net margin above Medibank’s major peers; a return on equity above its cost of capital and its peers and a doubling of the group’s “complementary services” or non-insurance earnings.

While reform of the sector requires government-led initiatives, Medibank can improve its own performance and the wellbeing of its customers through its negotiations with hospitals and other health care providers but also by using its own data to improve its ability to intervene pre-emptively to alert customers to developing conditions and by developing in-home alternatives to expensive hospital admissions.

In the near term, with revenue for the first four months of this financial year “slightly” below the group’s expectations, with premium revenue growth of only 1.3 per cent, the growth rate for Medibank’s earnings is likely to be quite flat. It says health insurance earnings are expected to be broadly in line with last financial year’s, excluding the $20m claims release.

Drummond has the benefit of being a new CEO. He can, during this initial period, reset expectations and take decisions that have near term costs in order to drive longer term gains.

The extent to which costs had been pulled out of the group and the lack of investment in its products at a time when the affordability of private health insurance has become an increasing issue for the sector may have boosted earnings in recent years but were creating destructive trends within the business that have to be slowed and ultimately reversed.

Over the next couple of years, as closely-watched as Medibank’s earnings numbers might still be, new and critical performance metrics for the group will be its customer and market share numbers and its net promoter scores. If they can’t be turned around the disturbing trends within the business today could become quite destabilising.