Australia's health care system is complex and loosely organised, with responsibilities for care split between the Commonwealth Government and State Governments, and services provided in both the public and private sectors.

Chapter 4.6 of the report provides a summary of the current arrangements.

This appendix outlines other approaches that would need further development and provides more background and discussion of several aspects of the changes recommended by the Commission.


Over the last two decades real per capita health expenditure has increased at an annual average rate of 2 per cent (the real increase has been about 3 per cent a year over the last 3 years). Health expenditure has risen from 5.6 per cent of GDP in 1970-71 to its current level of 8.4 per cent of GDP. By way of comparison real per capita health expenditure in the United States has been growing at around 4 per cent a year for the past five decades. EPAC has projected that aggregate national health spending could increase from 8.4 per cent to more than 10.5 per cent of GDP by the year 2030 due mainly to the ageing of the population. Later research by the RIM Task Force, which assumes that the past increase in demand for health services by all age groups will continue into the future, projects growth to 14.5 per cent of GDP by 2030.

Over the period 1995-96 to 1999-2000, Commonwealth outlays on health are estimated to grow from $18.6b to $23.1b, a real annual average growth rate of 2.4 per cent. Within this overall growth, Commonwealth own purpose outlays are estimated to grow at a real annual average rate of 3.3 per cent. Specific purpose payments to the States for health are estimated to grow at a real annual average rate of 0.1 per cent, largely due to the capped Medicare agreements.

Long term projections have to be interpreted carefully, particularly in relation to the impact of technology. It is generally accepted that the impact of technology in the health sector over recent decades has been to raise per capita expenditure. An interesting question for the health sector is when, or if, technological development will act to reduce per capita expenditure. However, there is no sign of this occurring and steps should be taken sooner rather than later to control health expenditure.


Duplication and overlap between Commonwealth and State activities occur at several points in the delivery of health and related services. This essentially arises from two factors. The first factor is the concurrent funding of different parts of the delivery system by different levels of government. The second factor relates to the inability of the current Commonwealth and State administrative framework to deal with the main pressures on the health system.

Concurrent funding by the Commonwealth and States has resulted in the accretion of a number of input-based and provider focused programs. Consequently, there are too many program boundaries, too many separate administrative and accountability requirements (but little information of use to policy makers or clients) and too many incentives to cost shift between programs offering the same or substitutable services.

Removing duplication and overlap between the Commonwealth and the States is a necessary, but not a sufficient, condition for reform. The key issue in refocusing health and related services toward outcomes is to set up a framework for contestability in the purchase and delivery of services.

The current set of Commonwealth/State arrangements does not deal effectively with the major structural issues facing the health sector. These are:

The impact of technology on service delivery has changed and will continue to change the boundary between institutional and community care. A growing number of health services will be delivered in the community or will have an institutional and a community component. The boundaries between hospitals and other health services will become increasingly blurred.

The duplication and overlap between the Commonwealth and the States have arisen in large part because of the inadequacy of the current set of administrative arrangements to cope with these pressures.

The response has been to construct elaborate administrative and reporting structures attached to specific purpose payments to the States (for example the Medicare and Home and Community Care agreements) that seek to constrain or deflect these pressures. This has contributed to duplication and overlap of administrative effort.

A 1995 survey by the Department of Finance estimated the cost to the Commonwealth of administration of specific purpose payments to the States to be around $60m. As health constitutes around 30 per cent of specific purpose payments the administration of the payments in the health sector probably costs around $18m. This administrative overhead would be higher when collateral processes such as the Grants Commission and Premiers Conference processes are taken into account.

The Commonwealth and the States need to construct a new administrative framework to reflect their shared roles and responsibilities in health and related services and to deal with the emerging pressures on the sector.

This will involve:

Box C.1: Focus on outputs and outcomes

'An output or outcome focus should lead to improvement in public sector management and Commonwealth/State relations. First, it would allow government to focus more clearly on what it is trying to achieve and allow different strategies across Australia of ways of achieving those objectives. Secondly, a focus on outputs/outcomes would facilitate recognition that different States and Territories have developed differently and the same approach (process) to meeting a particular need is not going to be relevant in all parts of the country. Flexibility in processes will probably improve efficiency, effectiveness and responsiveness. In turn this improvement...... will hopefully lead to better consumer outcomes.'

Source: Steven Duckett and Hal Swerissen, Specific Purpose Programs in Human Services and Health: Moving from an Input to an Output and Outcome Focus, June 1995.

The main areas of cost shifting from the States to the Commonwealth are:

The availability of the open ended MBS and PBS programs means that managers of the capped health services programs, who are predominantly in the States, will direct their clients to access the same or substitute services from MBS and PBS when their programs are under financial pressure. This occurs irrespective of the cost effectiveness of the alternative service options.

Box C.2: Cost shifting

Medical registrars in public hospitals routinely discharge patients with a minimum supply of pharmaceuticals for post-discharge use, advising them to obtain further supply from retail pharmacies. This is despite the fact that the drugs would in most cases be more cheaply supplied under the hospital purchasing arrangements than through the PBS.

While impossible to gauge accurately, this cost shifting is estimated by the Commonwealth Department of Health and Family Services to have added several hundred million dollars to Commonwealth outlays over recent years, and it is still rising.

In addition, there is a long term technology driven shift out of institutional care, to care in the community. This will provide efficiency gains and better treatment choices for patients. However, as the Commonwealth funds most of the care delivered in a community setting, the trend is placing an increasing call on the Commonwealth budget.

The following table illustrates these changes:

Table C.1: Proportions of total recurrent public health expenditures by area of expenditure

Area of expenditure








Public Hospitals
Commonwealth 20.70 20.60 19.50 18.70 18.80 18.40 18.40 20.20
State 20.50 20.90 21.70 22.20 21.30 20.80 19.90 17.40
Total recognised public hospitals 41.2 41.5 41.2 40.9 40.2 39.2 38.3 37.6
Medical services 21.50 21.0 20.90 21.40 22.20 22.80 23.70 24.70
Pharmaceuticals 6.0 6.70 6.60 6.90 6.30 6.30 7.20 8.20
Total Medical and Pharmaceuticals 27.5 27.7 27.6 28.4 28.6 29.1 30.9 32.9

Source: Australian Institute of Health and Welfare (AIHW) Health Expenditure Bulletin No. 10, December 1994 and No. 11, October 1995 and unpublished AIHW data for 1993-94.

Table C.1 shows:


In April 1995 COAG agreed to a process of major structural reform of health and community services. This process has led to the implementation of a number of trials of coordinated care for people with ongoing and complex care needs. These will test both the funding arrangements and the health outcomes possibilities of a range of new health delivery models.

On 1 May 1996 the Minister for Health and Family Services announced the Commonwealth position for the next round of COAG discussions. The Commonwealth position has the following elements:


In addition to the reforms currently proposed under the COAG agenda, the Commission has identified two other alternatives which it considers are worth serious consideration in the context of an ideal strategy that would place responsibility for decisions at one level, either the consumer or the States. The main features are identified briefly below, but clearly would require considerable further development.

Full devolution to the States

This option would involve placing all health funding into one health grant to the States.

The grant would be capped and subject to specified national entitlements and standards being met. The States would be given control of a Medicare levy to cover the full costs of public health services. Alternatively, the Commonwealth could collect the dedicated tax revenue for the States.

Accountability would be achieved through mandatory annual reports to the State and Federal parliaments reporting on agreed standards and key performance indicators.

The composition of the medical benefits and pharmaceutical Benefits schedules would be determined by a joint Commonwealth and State body operating within specified cost effectiveness criteria and subject to the overall budget cap.

The Health Insurance Commission (HIC) would act as a national payments agency with access to drawing accounts established by the States.

Integrated Medicare and private health insurance

This option would involve delivering the standard Medicare level of insurance through private health funds. The Commonwealth would pay a national health insurance premium in respect of eligible citizens to registered health funds, to cover public hospital and all other Medicare health services.

The level of the premium would be negotiated triennially with the private health funds. The funds would be required by law to cover a percentage (say 85 per cent) of the MBS schedule fee and free standard ward accommodation in hospital. The composition of the Medical Benefits schedule would be determined by the Commonwealth.

The funds would compete for eligible members by offering greater efficiency and add ons to the standard package. Such extra benefits could include additional nursing home and hostel benefits, physiotherapy, dental treatment et cetera. The choice would lie with the individual. The funds could negotiate hospital charges with the States and any private hospitals willing to treat public patients, and negotiate fees with doctors.

The HIC could act as a national payments agency for the health funds on a tender basis.

This approach endeavours to integrate Medicare and private health insurance. It defines the Medicare entitlement as a community service obligation and makes its delivery contestable.

The approach addresses the bifurcation existing in Commonwealth health policy whereby the success of Medicare has undermined the incentive for people to maintain private health insurance. This has consequently raised the pressure on Commonwealth and State budgets and increased calls for the Commonwealth to do something to increase the level of private health insurance coverage.

It also addresses two issues currently facing the Commonwealth: the blurring of the Medicare entitlement boundary and the lack of consumer choice under Medicare.

However, an expanded national coverage by health funds and a more contestable health insurance market would be prerequisites for implementing this approach.


While the COAG reforms are intended to result in a more efficient health sector and improved outcomes for consumers, it is not clear that they will deliver effective containment of health expenditure, unless the Commonwealth takes the lead now to adopt measures that ensures this.

Rebalancing health financing

The States have stated in their submission to the Commission that they will only share the financial risk associated with the growth in MBS and PBS schemes if the Commonwealth acts to contain cost blow-outs in these programs. They suggest, alternatively, that they be quarantined from growth in their expenditures.

Commonwealth outlays under the MBS have been rising at an average of 5.2 per cent a year in real terms over the last 10 years, with real growth of around 4 per cent expected in 1995-96 and the forward years. This growth is driven predominantly by an underlying growth in services of 5 per cent a year, of which 1.5 per cent is due to population growth and the remainder due to continued growth in average use per person.

Outlays on PBS have risen by 16 per cent real on average over the last 4 years, and are expected to continue growing at 7 per cent real a year over the forward estimates period. Past growth has been driven by increases in demand for prescription drugs (an average increase of 8 per cent a year in prescriptions over this period) and a shift to more expensive drugs (an average annual impact of 6 per cent).

There is no allowance in the forward estimates for the effects of adding new, expensive drugs to the schedule. The 7 per cent a year growth referred to in the above paragraph is conservative.

The PBS is particularly influenced by the addition of new high-cost drugs to the schedule which adds substantially to outlays each year. Doctors tend to use the latest available treatments for their patients, even if the treatment gain is marginal. There is no incentive for doctors to seek lower cost options, particularly when the costs to the patients are independent of the costs of the drugs. Figures C.1 and C.2 illustrate the current and projected decline in the level of patient contribution relative to the cost of drugs for both general and concessional users.

Figure C.1: Proportion of drug costs

Undisplayed Graphic

Source: Department of Finance.

Figure C.2: Proportion of drug costs

Undisplayed Graphic

Source: Department of Finance.

Note: Figures C.1 and C.2 are based on an assumed 3 per cent a year CPI growth and a 9.8 per cent a year increase in PBS drug costs.

Measures needed to promote more efficient use of the MBS and PBS programs will require a trade-off between the different objectives of public health insurance. The risk spreading and income transfer objectives have to be balanced against efficiency considerations, given the rising use of health services and the lack of pressure for efficiency due to a lack of price signals.

As with all insurance, Medicare suffers from adverse selection, in that it does not provide a specific insurance package for each individual or levy a premium based on each individual's consumption of health services. There is no disaggregation of risk classes under Medicare to reflect high or low use of health services and no differential premiums.

Around 10 per cent of the population consume around half of all health outlays. In this situation an insurance company would normally respond by raising premiums for this group, introducing front end deductibles or a level of

co-insurance. It may also introduce non price measures such as anti-smoking classes or diet advice.

Given that raising taxes, or introducing specific pricing measures for this group would contravene the equity objectives of Medicare, a managed approach to dealing with high risk groups may be appropriate.

For the majority of the population at lower risk and able to self manage most of their health care requirements, there is a much stronger case for the use of prices to ration access to health care where the information asymmetry is not large and the measurement of the outcome of most treatment is possible. This already occurs with services such as physiotherapy, podiatry and non-prescription drugs, but not with general practitioner consultations.

Eschewing the use of price signals to the consumer forces a reliance on administrative measures to control the supply of services, such as administrative restrictions on doctor numbers, new diagnostic technologies, or prescribing of certain pharmaceuticals. Inevitably this leads to distortions in service supply and demand (costs expressed in dollars or waiting times) as providers and consumers adjust to the administrative restrictions, which then requires more administrative action and so on.

An approach to reducing MBS and PBS growth and which rebalances Commonwealth objectives could contain the following elements:

Contestability in service delivery

A separation of funder, purchaser and provider roles across the health sector is required to embed contestability. Currently, the complementary and substitutable nature of health services at the margin is not fully revealed because existing program boundaries frustrate competition between alternative providers and restrict consumer choice.

Existing programs have a provider focus rather than a client focus and protect providers from competition. Reform of existing program structures, in concert with the separation of purchaser and provider roles, would create the opportunity for more responsive service delivery with an outcome focus.

There is effective competition for the supply of GP services in urban areas, albeit at a floor price guaranteed by the Commonwealth. Some degree of contestability has been introduced into the public hospital area by the adoption of the casemix payment system. As a result hospitals can be compared on a significant part (but not all) of their output. However, large parts of the health sector remain protected from competition on service delivery.

Aged care

The lack of contestability in the delivery of services for the aged leads to higher costs and to a focus on providers at the expense of both innovation in service delivery and a client focus.

The delivery of residential aged care is highly regulated, with little effective competition between service providers. Residential care planning is tied to movements in the growth in the aged population. HACC growth is determined by an ad hoc formula. At the local level, neither of the two planning processes are formally coordinated, nor are they explicitly required to take into account other services provided elsewhere in the health continuum.

In the nursing home sector, consumers have little effective choice and providers receive no additional revenues for providing a higher quality service. Without effective competition high levels of regulation are required to maintain quality and to prevent costs escalating. This leads to rigidities in service delivery which translate into a lower level of services or higher costs.

The effectiveness of the large amount of resources dedicated to regulation in both nursing homes and hostels is questionable. (In 1995-96, $26m in running costs is dedicated to Department of Health and Family Services Sub-program 4.4, Quality Assurance and Accountability.)

Both nursing home and hostel per-unit costs are escalating rapidly, beyond what might be reasonably expected in terms of the increasing frailty of residents. There is little incentive to introduce labour saving technology. The funding system for nursing homes actively encourages the use of labour instead of technology. Care Aggregated Module (CAM) funding (55 per cent of nursing home funding) requires that care expenditures are on nurses wages.

The quality of nursing home accommodation is in question because of the lack of appropriate incentives in the capital funding arrangements and no real consumer choice.

No similar crisis applies for hostels. The funding arrangements and the choices available to clients are quite different. Also, the incentives for hostel proprietors to provide good quality accommodation are very different to those facing nursing home proprietors.

The two principal aims of the 1987 aged care reform strategy, which have been largely achieved, were:

However, further improving the efficiency and effectiveness of the aged care industry and expanding consumer choice is essential if future demands on the health budget are to be manageable. In the absence of change, outlays are expected to rise exponentially after 2010 (see figure C.3).

Figure C.3: Aged care recurrent outlays

Undisplayed Graphic

Source: Department of Finance.

To deal with these pressures, there is scope for the extension of user charging through means testing and entry contributions throughout the aged residential care programs and for the introduction of purchaser/provider arrangements to introduce competition among aged care providers in such a way that it does not threaten access.

This could involve:

Retail pharmacy

In 1992-93 the total remuneration from the PBS for community pharmacy through mark-ups (10 per cent of wholesale costs) and dispensing fees was around $0.5b. Increased contestability in this area of retailing would be likely to produce significant savings.

The Commonwealth has, since 1991, funded a pharmacy restructuring plan. This has provided financial incentives for the closure and amalgamation of retail pharmacies. However, while improving the viability of retail pharmacy, the plan has not significantly improved contestability in the industry.

Current State ownership laws require pharmacies to be owned by pharmacists. The States, by conferring a provider monopoly, are imposing higher costs on the Commonwealth's Pharmaceutical Benefits Scheme.

Allowing non-pharmacists including large retailers such as supermarkets or other chains to own pharmacies dispensing PBS drugs, and allowing pharmacists to own an unlimited number of pharmacies would introduce more competition into the industry. (Doctors and dentists may need to be excluded from pharmacy ownership as this might influence prescribing behaviour.)

This would lead to greater price competition (for example, discounting of drugs below the general co-payment of $16.80), lower Commonwealth costs through lower dispensing fees and, importantly, increased customer convenience.

The inclusion of the PBS in pooling arrangements with the States would permit the dispensing of drugs to the general community from hospital pharmacies.

Diagnostic services

The Commonwealth currently spends around $1.6b on diagnostic services (radiology and pathology) under the MBS. Diagnostic services have been the fastest growing component of the MBS, with benefits paid growing at an average of around 10 per cent a year in recent years.

The diagnostic services industry is a highly specialised, highly automated industry. The bulk of its services are purchased on a fee for service basis, with the Commonwealth providing a subsidy of 85 per cent of the MBS fee for out of hospital services and 75 per cent for private inpatients.

The fee for service payment arrangements mean that government does not necessarily share any of the efficiency gains arising from technological developments or economies of scale. For instance, developments in IT mean that pathology tests can be analysed at a central laboratory, with the results transmitted back to the doctor placing the order via IT systems. Similarly, radiology scans can be transmitted from a central clinic to GPs, specialists and hospitals.

A move to competitive tendering for diagnostic services would:

The design of the tender would have to balance the objectives of reasonable access for referring GPs and price and volume reductions with the risk of the evolution of monopoly providers.

Distribution and use of blood products

Currently, blood products manufactured by CSL (a private company since 1994), are distributed free of charge to hospitals and medical specialists. Synthetic blood products imported by CSL and paid for by Commonwealth and State Governments are also distributed free of charge.

The lack of price signals gives hospitals and medical specialists no incentive to avoid waste or uneconomic use of these products. The introduction of a pricing regime would largely avoid this.

Commonwealth of Australia