Health

Administered Prices
HEALTH
A report for National Treasury
ALEX VAN DEN HEEVER

Preface
This report was prepared for National Treasury to support its assessment of administered
prices in South Africa. The objective of the study was to assess the processes involved in
setting prices in regulated industries. By evaluating the efficiency, effectiveness and
analytical rigour of the regulatory processes involved in setting prices for the services
involved, an assessment can be made of the likelihood that the resultant tariffs approach
efficient levels. Volume I of the report sets out the main findings and recommendations
with supporting information relating to the individual sectors included within the scope of
the study provided in a summarised form. Volume II contains more detailed sectoral
reports, covering individual review of the water, electricity, telecommunications,
transport, health and education sectors.
The report does not offer a detailed quantitative assessment of the performance of the
regulatory regime, and is largely based on in-depth interviews and documentary analysis.
The authors would like to thank the interviewees for their cooperation and valuable
insights. Although much care was taken to provide a correct reflection of the opinions
expressed, the authors remain entirely responsible for any inaccuracies.
CONTENTS
EXECUTIVE SUMMARY 1
INTRODUCTION 3
1. GENERALISABLE FEATURES OF THE HEALTH SECTOR 4
1.1 Overview 4
1.2 The role of government in the regulation of health markets 5
1.3 Consumer protection 5
1.4 International trade protection 6
1.5 Concluding remarks 6
2. COST INCREASES EXPERIENCED IN THE SA PRIVATE HEALTH SECTOR 7
2.1 Introduction 7
2.2 Cost trends 7
2.3 Reasons for cost increases in the private sector 10
3. DEMAND-SIDE OF THE INDUSTRY 12
3.1 Overview 12
3.2 Medical schemes 12
3.3 Medical scheme members 12
3.3.1 Employers 12
3.3.2 Individuals 14
3.4 Medical scheme administrators (third-party administrators) 14
3.5 Brokers 15
3.6 Managed care and selective contracting 15
3.7 Inelastic demand for health insurance 16
4. SUPPLY SIDE OF THE INDUSTRY 18
4.1 Overview 18
4.2 Hospitals 18
4.3 Primary care providers 18
4.4 Pharmaceuticals 19
4.5 Other suppliers of goods 21
5. REVIEW OF TARIFF SETTING VIA MEDICAL SCHEMES IN SOUTH AFRICA 22
5.1 Overview 22
5.2 Medical schemes and tariff setting 22
5.3 Some history 23
6. SUMMARY OF FINDINGS AND RECOMMENDATIONS 26
Demand-side cost factors 26
Supply-side cost factors 26
Medical schemes 26
REFERENCES 32
LIST OF TABLES
Table 1: Real per capita claims cost changes in medical schemes (constant 2001 prices) 9
Table 2: Summary of cost drivers within the private healthcare market and suggested
solutions 29
LIST OF FIGURES
Figure 1: Real per capita claims cost changes in medical schemes from 1988 to 2001
(constant 2001 prices) ...................................................................................................... 8
Figure 2: Medical scheme cost areas as a percentage of total cost for the years 1991, 1996
and 2001 ........................................................................................................................... 8
Figure 3: Real costs per beneficiary, contributions and benefits: 1988 to 2001 (constant 2001
prices) 10
Figure 4: Overview of issues affecting the determination of healthcare costs in the private
health system in SA ........................................................................................................ 11
Figure 5: Medical scheme beneficiary trends in open and closed (employer-based or
restricted membership) schemes from 1990 to 1999...................................................... 14
Figure 6: Key relationships on the demand side of the private health sector in SA............... 17
EXECUTIVE SUMMARY
This report evaluates the healthcare sector in South Africa, and focuses on an evaluation of
price-setting processes and factors effecting health sector costs, as well as the identification
of those areas leading to inefficient price-setting outcomes within the health sector.
The assessment covers both the demand and supply sides of the health sector, and includes
the influence of the public sector.
The private healthcare market in South Africa has experienced systemic cost increases over
the entire recorded history of the market. Certain services – hospitals, medicines and
specialists – have however increased in cost more than others. However, in recent years
medical schemes have faced dramatically increased intermediary and non-health costs in
excess of the increases in medical costs.
There are key areas affecting price determination on the demand side of the health market:
Employers tend to abdicate their influence on medical schemes and consequently become
price takers in the market. They are excessively influenced by brokers who operate in the
interests of third-party administrators. Similarly, individual purchasers of medical scheme
cover have no market power, and are excessively influenced by brokers.
Government needs to consider positive inducements to achieve greater employer and
employee participation in the decisions made by their medical schemes. The reconfiguration
of the tax subsidy framework could be considered in this regard.
On the supply side, in the author’s opinion an effective cartel exists in terms of hospitals,
which prevents shifts away from fee-for-service billing to selective contracting.
Pharmaceutical costs passing though hospitals are a major cost driver regardless of the ex-
manufacturer price. Hospitals obtain substantial discounts from manufacturers, which are not
passed on to patients.
General practitioners have been shifted into the out-of-pocket market and government
legislation has limited their ability to dispense. Primary care is beginning to respond more
rapidly to the emerging low-cost market. For these reasons, primary care services are not
likely to remain a major driver of cost into the future.
Specialists have an incentive to collude with hospitals to protect the fee-for-service market.
So they remain a significant driver of healthcare decisions within hospitals and are key to the
direction costs take in the future.
Moreover, the pharmaceutical market is rife with kick-backs directed at the key agents
making healthcare decisions – the doctor and specialist. Although new legislation has been
introduced to weaken this link, give the pervasive nature of the practice, it may nevertheless
continue.
Lastly, new technology enters the market without proper assessment of cost-effectiveness.
Given the nature of the market, with demand almost guaranteed, new technology enters the
market at a high price and utilisation is induced by doctors and specialists given specific
financial incentives to do so.
Government should consider supply side interventions to limit the unnecessary expansion in
a range of services. These include hospitals and new technology. Such interventions
typically require the establishment of review committees that approve new services. Such
committees already exist at a provincial level for private hospital beds. However, no such
arrangement exists for expensive equipment and other areas of new technology.
1
The conduct of health professionals should also be regulated more assertively, with a more
adequate resourcing of the Health Professionals Council considered.
In addition, the policy of permitting public hospitals to compete with private ones must be
expanded, although consideration should also be given to the expansion of this initiative into
a broader range of services, including out-of-hospital services such as chronic medication
and treatment.
The inelastic demand for medical scheme cover opens members to the possibility of abuse
by any party profiting from increased medical scheme contributions. In such circumstances
regulatory intervention is needed to prevent the unfair pricing of medical scheme
contributions.
Restricted medical schemes have strong governance, but lack the buying power to influence
medical service providers. They are unable to access selective contracting arrangements
except through intermediaries.
Open schemes, on the other hand, tend to have weak governance but in a number of cases
have the buying power to monopsony price. However, the weak governance structure results
in excessive profit extraction from the scheme, negating any positive influence on bringing
down medical costs. Open scheme administrators are also able to exert influence on the
schemes to such an extent that the interests of members are given a low priority.
The existing process for centrally bargained medical scheme tariffs is flawed, inflationary,
and open to special interest manipulation. It exists within a regulatory vacuum, resulting in
both medical scheme and service providers engaging in a confusing set of interactions which
rarely benefit the public.
Although extensive regulation is in place to guarantee the independence of scheme
management structures from both administrators and brokers, this is an area where
continuous improvement will enhance the functioning of the market.
2
INTRODUCTION
This report forms part of a broader review of regulatory price structures and the influences on
these. The main focus is on price formation processes rather than the absolute prices or
marginal costs. The assessment includes a qualitative assessment of the price formation
process’ ability to lead to efficient pricing in a number of selected sectors, including
electricity, telecoms, water, transport, education and healthcare.
This report contains an evaluation of the healthcare sector in South Africa (SA), and focuses
on:
An evaluation of price-setting processes and factors effecting health sector costs.
The identification of those areas leading to inefficient price-setting outcomes within the
health sector.
This assessment covers both the demand and supply sides of the health sector, and includes
the influence of the public sector.
3
1. GENERALISABLE FEATURES OF THE HEALTH SECTOR
1.1 Overview
To provide some guidance on international trends in healthcare finance and provision it is
important to note that a high degree of consensus exists on understanding the core
problems. Although measures to deal with these problems vary across countries, it is clear
that government intervention is crucial to achieving key social objectives. It is also important
with respect to basic consumer protection.
Internationally, governments intervene heavily in the financing and provision of healthcare.
The reasons for this are well established. Because of asymmetric information between
buyers (patients) and sellers (doctors, hospitals, etc.), buyers are vulnerable to over-
servicing, quackery and over-charging. Monopoly power on the part of service providers
results in higher prices, lower output and lower product quality. Information is costly to
consumers when services are purchased infrequently, and because of the technical nature of
much of medical care, the emotional state of patients, and the urgency required at point of
service.
The lack of information over the form, amount and cost of future healthcare requirements
leads to a derived demand for good health – the demand for insurance. This leads to further
problems affecting healthcare costs, services and quality of care.
The original theory of market failure in health, developed by Arrow (1963), explained the
effect of insurance on incentives. Where the incidence of illness and the cost of treatment are
uncertain and a risk-averse population is a given, health insurance is demanded. However,
insured people – once they exceed any deductible – face zero costs for further healthcare
purchases. Consequently insured people will buy more care than would be the case if they
were paying out-of-pocket.
In addition, doctors acting as agents for their patients recommend and provide more care
when reimbursed on a fee-for-service basis. They are given significant incentives to provide
more services than necessary due to the financial reward involved. The net result is
increased demand for existing services and new technology without any effective discretion
provided by consumers. This results in systemic cost increases over time.
Incentives throughout the market are consequently so skewed that the normal rules of
competition do not work. Prices remain high even when volumes traded are high.
Technology remains expensive even when widely used. Hospitals and doctors remain in
business even when they charge excessive prices for equal quality or fail to provide high-
quality services. Incentives exist only for innovations that raise costs or increase quality
regardless of cost. (Teisberg et al, 1994).
Current estimates indicate that the US bed occupancy is around 50%. (This is similar to the
position of private hospitals in SA, based on personal communication with members of the
hospital industry). This suggests substantial excessive capacity, which is sustained by the
reimbursement system. Competition between health plans has had very little impact on
provider efficiency and appropriate resource allocation decisions.
4
1.2 The role of government in the regulation of health markets
It is a well-recognised phenomenon that private markets for healthcare suffer from inherent
destabilising factors, which result in:
Systematic cost increases;
Adverse selection (in the case of health insurance);
Provider-induced moral hazard (where providers and suppliers of service have a profit
motive to supply more services than the patient actually needs); and
Consumer-related moral hazard (where insured patients face zero cost at point of service
they have an incentive to consume services in excess of their actual needs).
Within the healthcare market, many perverse relationships exist that are geared toward the
provision of services substantially beyond their value to the individual and society. The
resulting cost spiral serves to destabilise the viability of private markets for healthcare. A
further disturbing trend, however, is that the excessive shift of financial resources into the
private environment results in an artificial shift of staff out of the public into the private
environment.
Private markets for healthcare traditionally invert normal market behaviour. Whereas in other
sectors demand leads supply, within the health sector the supply of services creates
demand. For this reason, many governments focus on restricting healthcare supply in
addition to demand-side measures. Controls are typically placed on the creation and
deployment of new services and equipment. However, any attempt to deal with cost
increases within private health markets requires a combination of measures, operating on
both the supply and demand side.
Demand-side interventions include the regulation of the funding side of health systems,
either through tax-funded mechanisms, or through regulated private insurance markets. The
latter tend to involve restrictions on annual increases in contributions or premiums rather
than medical service prices.
Supply-side market interventions regulate the supply of new technology, increases in the
number of beds, the registration and distribution of drugs, increases in the number of new
professionals (for example, doctors, nurses and auxiliaries), price controls and ceilings,
marketing practices, pricing practices, dispensing, and the irregular incentivisation of doctors,
pharmacists and hospitals. Such interventions can be used both for specific situations such
as an epidemic and for controlling perverse practices and the abuse of monopoly power (the
ability to use unfair market power or collusion to drive up prices). Since the health market is
especially prone to supply-side problems, government’s regulatory power is regarded as
essential, especially where large private health sectors are involved.
In conclusion, no single measure or instrument is sufficient on its own to deal with the multi-
dimensional nature of a health system. The regulation of the health system involves
interventions on publicly and privately provided health services on both the demand and
supply side. Partial approaches are also vulnerable to circumvention.
1.3 Consumer protection

Consumers are often at a disadvantage in situations where there are significant information
asymmetries that require them to rely on the advice and recommendations of third parties.
Consumers cannot inspect every commodity that becomes available on the market or
personally test every product for safety. Great reliance is therefore placed on government
authorities and paid intermediaries to assist the ordinary consumer in making certain
decisions.
5
However, intermediaries are influenced by financial incentives and may be given specific
incentives to advise consumers to use preferred goods and services. The central concern is
that consumers wrongly assume they are receiving independent, objective advice. The
advice given and the resulting consumption patterns are not only market distorting, but result
in individuals deviating from the preferences they would have expressed if they had full
knowledge of all the options.
This in essence reflects an “agency” problem. Two key groups of agents – doctors and
medical scheme brokers – strongly influence what happens in SA. Unfortunately both groups
have become influenced by entrenched kick-back systems, illustrating the perverse
incentives of the system.
1.4 International trade protection

The international trade environment has undergone significant changes over the last 20
years. Initially through the General Agreement on Tariffs and Trade (GATT) and later through
the World Trade Organisation, attempts have been made to remove international barriers to
trade.
The removal of explicit barriers such as tariffs (for import protection) and industry subsidies
(for export protection) has resulted in the emergence of indirect and hidden industry
supports. These have been replaced by less explicit measures, such as quality controls,
subsidised research and development, and voluntary export restraints.
Pharmaceutical patents are an important form of export protection, particularly where
governments intervene to protect them unfairly. In the case of drugs, industrialised countries
attempt to extend patent periods for as long as possible through bilateral negotiations. Once
the patent has expired, competition is permitted, prices drop and production shifts to other
suppliers. Thus if countries can be pressured to accept longer patent periods (irrespective of
any general trade arrangements) or forced to purchase critically needed supplies at
monopoly prices, the source country benefits from a windfall both in terms of jobs and foreign
exchange. Developing countries are typically vulnerable to this form of arrangement due to
their weak bargaining position in bilateral negotiations with industrialised countries or
industrialised country trading blocs (such as the EU).
Import protection in the case of pharmaceuticals is maintained through imposing very high
registration standards for pharmaceuticals under foreign patent. The delays achieved
through the registration period result in a running down of the patent period, thus protecting
domestic suppliers from competition. Typically this is only an issue among manufacturing
countries that use these methods to neutralise one another.
1.5 Concluding remarks

Although the precarious elements and complex nature of health markets are well known by
now, each country must follow its own path in addressing such issues. Costs rather than
prices are focused on as healthcare service suppliers are in a position to manipulate
utilisation of services – diminishing the importance of price constraints as a cost control
measure.
6
2. COST INCREASES EXPERIENCED IN THE SA PRIVATE HEALTH
SECTOR
2.1 Introduction
The private healthcare market in SA has experienced systemic cost increases over its entire
recorded history. However, certain services – hospitals, medicines and specialists – have
increased in cost more than others. Also, in recent years medical schemes have faced
dramatically increased intermediary and non-health costs – in excess of the increases in
medical costs. These trends are discussed and explained in this section.
2.2 Cost trends

Figure 1 presents the per capita expenditure for medical schemes on health benefits
(medical claims) from 1988 to 2001 in 2001 prices (using the Consumer Price Index, or CPI).
In 1988, the average beneficiary on a medical scheme spent just over R1,703 annually on all
medical benefits in 2001 prices. By 2001 this has increased to around R4,396 per year – a
158% real increase in costs. Over the period, the coverage of benefits has also declined
consistently.
The most important cost increases are seen in hospitals (a 249% real increase),
medicines/pharmaceuticals (a 153.6% real increase), and specialists (a 183.8% real
increase). Although general practitioner costs appear to have been kept at a reasonable
level, this is only because much expenditure has shifted to outside medical schemes.
Although there has been an increase in capitated1 primary-care expenditure, usually seen as
a cost-saving measure, it appears to have had no material impact on medical cost trends.
The share of total medical scheme expenditure attributed to hospitals, medicines and
specialists has increased from 68.7% in 1991 to 74.6% in 2001. Expenditure on public
hospitals has declined substantially, while the opposite trend can be seen in private
hospitals. Although a part of this trend in hospital expenditure is attributable to a movement
of medical scheme patients out of public hospitals, the increased expenditure in private
hospitals shows a more than proportional adjustment, indicating that the increased use of
private hospitals has resulted in a substantial increase in hospital costs for medical schemes.
1
Capitation occurs when a medical scheme prospectively funds a service, whether hospital-based, primary care
or a combination of services, with a fixed regular payment (monthly, quarterly or annual) in respect of a defined
number of potential beneficiaries. In this way a medical service provider shares in the insurance risk of the
scheme, creating an incentive to contain rather than increase health costs.
7
Figure 1: Real per capita claims cost changes in medical schemes from 1988 to 2001
(constant 2001 prices)
5000
4500
R' millions - bar graph
4000
3500
3000
2500
2000
1500
1000
500
0
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
GPs Specialists Dentists Hospitals Medicines

Allied Ex gratia Other Capitated primary
[Source: Council for Medical Schemes’ Annual Financial Statements of medical schemes]
Figure 2: Medical scheme cost areas as a percentage of total cost for the years 1991, 1996
and 2001
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
General Specialists Dentists Hospitals Medicines Allied Ex gratia Other Capitated
Practitioners primary
1991 1996 2001
8
Table 1: Real per capita claims cost changes in medical schemes (constant 2001 prices)
% change % change
Cost area 1991 1996 2001
over period over period
General Practitioners 329 328 -0.6% 395 20.7%
Specialists 408 610 33.1% 870 42.6%
Dentists 234 262 10.6% 257 -2.2%
Hospitals 525 780 32.7% 1,280 64.1%
Government hospitals 118 43 -174.2% 38 -11.3%
Private hospitals 407 737 44.8% 1,242 68.5%
Medicines 681 936 27.3% 1,129 20.6%
Allied 0 0 na 299 na
Ex gratia* 7 0 na 8 na
Other 163 247 34.0% 116 -53.1%
Capitated primary 0 0 - 42 -
Total 2,348 3,163 25.8% 4,396 39.0%
*Ex gratia payments are benefits paid to members which are not covered by the rules of the scheme, particularly
where great hardship may otherwise arise.
Figure 3 shows the real per beneficiary cost changes from 1988 to 2001 in constant 2001
prices. It also indicates particular periods when regulatory changes occurred, which could
have affected cost trends. The first of these was in 1989 when scheme community rating was
removed, permitting medical schemes to underwrite all people entering a scheme or to risk-
rate members of a scheme. The ability to risk-rate was removed from 2000, with additional
measures protecting open enrolment and minimum benefits in schemes.
The costs in figure 3 are differentiated between contributions per member (net cost over
benefits costs are the red shaded area) and claims costs or benefits paid per beneficiary
(blue shaded area). The red shaded area reflects the real cost changes in administration and
other non-medical costs from the middle of the 1990s to 2001, which saw dramatic
increases. By contrast, from 2000, benefit costs per beneficiary appear to have flattened.
The widening gap between expenditure on benefits and non-medical expenditure reflects the
increasing impact of profit taking from open schemes (over-pricing administration and
reinsurance), increased broker commissions (usually required to accumulate market share),
and increased managed care expenditure.
9
Figure 3: Real costs per beneficiary, contributions and benefits: 1988 to 2001 (constant 2001
prices)
5,500 8,000,000
5,000 7,000,000
4,500
6,000,000
Beneficiaries
4,000
5,000,000
Rands
3,500
4,000,000
3,000
3,000,000
2,500 C o m m u n ity R a tin g
2,000,000
2,000
P e rio d o f R is k R a tin g
1,500 1,000,000
1,000 0
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Contribution per beneficiary Benefits per beneficiary Beneficiaries
2.3 Reasons for cost increases in the private sector

The reasons for the cost increases are as follows:
The existence of medical schemes as the third-party payors of healthcare, coupled with
reimbursement on a fee-for-service basis, has caused medical costs to rise substantially
due to supply-induced demand.
The increased number of private hospital beds, coupled with market concentration in the
ownership of private hospitals, has prevented the emergence of selective contracting by
medical schemes for hospital services which could drive down costs. The retention of
itemised billing has also resulted in deliberate over-billing by hospitals, which rely on the
volume and complexity of the billing process to hide “errors”.
Medicines are marketed primarily through incentives for dispensing doctors and
hospitals, which results in over-priced and increased volumes of drugs sold.
A rise in intermediary costs can be attributed to the increase in open medical scheme
beneficiaries (see review in section 3) where governance is weaker (resulting in higher
administration fees charged than are required to run the scheme), and high broker
commissions (payments to brokers are used to increase scheme market share, resulting
in an increased layer of cost not found in restricted membership schemes).
Some cost increases can be attributed to increased ageing within medical schemes.
However, this trend is very slight at present, and may explain roughly 4% of the real cost
increase over the years 2000 and 2001. Open medical schemes’ discrimination against
older and sicker demographic groups virtually eliminated this as a cost factor for the
period 1989 to 1999.
At present, government does not intervene directly to contain healthcare costs but regulates
the sector for access to healthcare and to address poor governance.

Real cost increases within SA’s private health market have been both persistent and
dramatic over the past 20 years. An acceleration in cost occurred during the period of
deregulation from 1989 to 1999 because of the increased membership of open medical
schemes, which had fewer incentives to control medical costs and have substantially higher
10
non-medical costs. The most important areas for cost-containment in future are hospitals,
medicines, specialists and non-medical expenses.
Figure 4: Overview of issues affecting the determination of healthcare costs in the private
health system in SA
R is k o f c ata s tro p hic c o sts C re a tio n o f third -p a rty p a ym e n t

a s s o c ia te d w ith h e alth c a re m e c h a n is m (m e d ic a l s c h e m e )
B ro k e r a n d in te rm e dia ry
m a rk e t w e a k e n s m e d ic al
F e e -fo r-s e rvic e th e n atu ra l fo rm s c h e m e g o v e rn a n c e a n d
o f re im b u rs e m e nt d iv e rts atte n tio n fro m
m e a n in g fu l c o s t
c o n ta in m e n t
In s u re d s e rv ic e s, fre e at p o in t- U n c o n s tra in e d b u d g e t fo r
o f-s e rv ic e c a u s e s in c re a s e in h e a lth c a re s e rvic e s e n c o u ra g e s
s e rv ic e d e m a n d s u p p ly-in d u c e d d e m a n d
N e w te c h n o lo g y in tro d u c e d th a t
N o t re g a rd e d a s is o v e r-p ric e d a n d n o t c o s t-
p rim a ry c o s t d riv e r e ffe c tiv e
O v e r-b illin g o c c u rs th at is
d iffic u lt to c o n tro l
N e w s u p p lie rs o f s e rv ic e e n te r
th e m a rk e t w ith o u t c o n stra int
11
3. DEMAND-SIDE OF THE INDUSTRY
3.1 Overview
Healthcare is almost invariably characterised by the pooling of funds to purchase services on
an individual basis. So some form of risk pooling, whether through taxation or systems of
insurance, is inevitable to lower the point-of-service costs for acute-care services. However,
such pooling results in a generally diminished responsiveness to certain price indicators.
These tendencies are very evident in SA, as noted in section 2. Understanding these cost
trends requires an overview of the operation of the market and the factors that influence
costs and pricing behaviour. This section provides an outline of the key players in the private
healthcare market – focusing on the demand side – which include medical schemes, scheme
members (employers and individuals), third-party administrators, brokers and managed care.
3.2 Medical schemes

The purchase of private-sector medical scheme cover is income related, with only high-
income groups able to access reasonable cover through a medical scheme. These are non-
profit, pay-as-you-go mutual funds regulated in terms of the Medical Schemes Act and falling
within the ambit of the Minister of Health. At present, most medical schemes reimburse
providers on a fee-for-services basis. Members make monthly payments, with employers
typically contributing at least 50%. A tax deduction is available to the employer for up to two-
thirds of the full contribution. Around seven million people are covered by a medical scheme
(in 2001 and 2002), with total expenditure of about R40-billion in 2001.2
Schemes are also divided into open and restricted membership schemes, with the latter
employer based and historically community rated. (Within SA, a scheme is regarded as
community rated if contributions are in no way differentiated on the basis of health status).
Employer schemes cover around 50% of the total medical scheme members. Since 1
January 2000, open schemes must accept all applicants regardless of health status.
Restricted membership schemes can limit applicants to employees. However, they must
accept all applicants within this limitation.
Because of the initial small size of many employer-based medical schemes, in-house
administration is currently outsourced to third-party administrators. The demand for these
services has resulted in administrators turning into substantial organisations with expanding
interests in commercial for-profit opportunities available in the market. Administrators are
primarily responsible for setting up open schemes.
3.3 Medical scheme members

3.3.1 Employers
Membership of a medical scheme is to a large extent arranged via an employer, irrespective
of whether or not an open or restricted membership scheme is used. Employer behaviour is
thus an important factor affecting the way in which medical schemes behave. Many
employers take very little interest in the quality of scheme selected and often take the advise
of brokers who are not independent (see also section 3.5). As a consequence, employers
within the open-scheme market largely give away their market power and become price
takers. Here the price is the contribution paid.
2
Council for Medical Schemes, Annual Report, 2001
12
Employers have traditionally played an important role in obtaining medical scheme cover for
their employees, usually those with a higher income. Employers often set up the medical
scheme and subsidised the contribution, which extended to retirees and their dependants.
This resulted in a large number of small “closed” medical schemes, where membership is
restricted to the employees of the relevant employer. Coverage in all instances involves the
employee and dependants.
During the 1990s, employee benefit advisors (brokers), incentivised by commission windfalls,
started to advise employers to shift to a “total cost to company” (TCC) approach. This
allowed the employer to cap employee remuneration and the employee to choose his/her
employee benefits voluntarily – and introduced a major shift of membership from closed (or
restricted membership) schemes to open schemes.
The net result from these shifts is the following:
Employers provide virtually no oversight of open medical schemes as the governance
structures are dominated by the administrator. Regulations have recently changed to
ensure an arms length is maintained between the scheme and the administrator.
However, for much of the period 1993 to 2002, administrators were permitted undue
access to the decision-making of these schemes – which still continues. Members’ and
employers’ weak influence on scheme governance results in large increases in non-
medical costs – scheme funds spent on goods and services not involving medical
services.
Employers’ weaker influence on schemes has resulted in higher medical claims costs, as
they no longer make any effort to ensure schemes reduce medical claims costs in the
interests of their members. Open medical schemes often negotiate deals to lower
medical costs outside of the medical scheme, and use the discount obtained to increase
their margins on the administration of a medical scheme.
The influence of brokers, remunerated directly or indirectly by administrators, reduces the
impact of competition – the influence members shopping around for schemes should
have in incentivising schemes to keep costs down. Brokers merely advise members to go
to the schemes where they receive the largest commissions, so the choice of scheme is
not influenced by the quality of benefits or the contributions.
13
Figure 5: Medical scheme beneficiary trends in open and closed (employer-based or
restricted membership) schemes from 1990 to 1999
4,500,000
4,000,000
3,500,000
Beneficiaries
3,000,000
2,500,000
2,000,000
1,500,000
1,000,000
500,000
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Open Closed
[Source: Council for Medical Schemes, medical scheme returns for the period 1990 to 1999.]
3.3.2 Individuals
An individual market for medical schemes exists for those income earners whose employers
operate on a TCC basis, or who are self-employed. A very substantial number of individual
medical scheme members are employees of the civil service (around 500,000 principle
members and a total of about 1.5-million beneficiaries), which since around 1993 permitted
medical scheme membership and choice of scheme to be voluntary. These individuals often
access schemes using brokers who advise individuals rather than groups. Individual
members have virtually no market power in relation to schemes or medical service providers.
As a result they access a market which can increase non-medical costs (administration fees,
broker fees, etc.) with virtual impunity in the absence of normal market checks and balances.
3.4 Medical scheme administrators (third-party administrators)

Medical schemes require the performance of certain basic administration functions. These
include managing membership files and claims. Since the economies of scale did not exist in
the large number of small medical schemes in SA to develop the required systems, the need
arose to outsource these basic functions. This resulted in the emergence of third-party for-
profit administrators. A single administrator would consequently contract with many medical
schemes.
Over time certain administrators began to initiate the development of open medical schemes
over which they had a high degree of influence, even though they could not legally own the
scheme. Contracts with administrators typically involve payment of a fixed percentage of
gross contribution. As a consequence, third-party administrators had very little incentive to
contain medical cost inflation. The larger the medical cost increases, the larger the increases
in administration fees.
14
Administrators have grown to such an extent as organisations that they offer a range of
services which can be sold on to medical schemes over and above pure administration.
These include managed care services, bill review systems and insurance products. Given
the undue influence administrators can exercise over the medical schemes, many contracts
entered into are harmful to the interests of the members. Increased regulation and regulatory
oversight have consequently evolved to review or limit contracts with “related parties” of the
administrator.
To drive membership growth within open medical schemes controlled by a given
administrator, large sums of money have been paid to brokers to persuade employers to
move their employees away from restricted membership schemes. These payments have not
only been very costly but often also illegal, resulting in perverse price wars – with the
members going to the administrator able to pay the highest commission. Members who are
charged high administration fees to the scheme, or reinsurance contracts used to extract
reserves away from the scheme ultimately pay these very high prices. Ongoing
commissions, often referred to as co-administration, are used to retain members. Very little
actual service is provided for these ongoing commissions. Payment is made primarily to
prevent the broker from moving the members elsewhere.
3.5 Brokers
Two forms of broker exist, those serving the group or employer market and those targeting
individuals. The group market is primarily serviced by fairly large, established broker groups
which typically advise employers on a range of employee benefits. The individual market is
serviced by smaller, less well-established broker groups. Probably the largest individual
market is that for civil service employees seeking placement within an open scheme.
As shown above, a perverse market for broker services emerged after the deregulation of the
Medical Schemes Act in 1994 (see figure 5). Brokers, incentivised by large illegal
commissions paid by administrators, targeted employers running small in-house schemes
and persuaded them to move to designated open schemes. Around 1.6-million beneficiaries
moved from closed (restricted membership schemes) to open schemes between 1993 and
1999. Between 10% and 15% of gross contribution income was paid per member shifted,
with ongoing commissions of around 6% to 7%. Administrators unable to pay these
commissions were stripped of members.
Changes to the Medical Schemes Act in 2003 have now limited so-called co-administration
payments to R50 per member per month or 3% of gross contributions, whichever is the
lower. It has also restricted such payments to medical schemes, with administrators legally
barred from making any form of payment for broker services. It is likely that a number of
administrators will attempt to circumvent these limitations.
3.6 Managed care and selective contracting

In recent years managed care companies have emerged, often with strong ties to third-party
administrators. Their role has been to provide services specialised to contain medical cost
increases. These include:
Pre-authorisation services;
Medical case management;
Disease management programmes (usually for chronic conditions and HIV/Aids); and
Networked service providers and capitation arrangements (these can involve primary
care, specialist services and hospital-based services, but are almost exclusively limited to
primary care in South Africa).
15
It is difficult for managed care companies to operate except via arrangements with
administrators. Administrators will try very hard to ensure that their companies get preference
in any arrangements set up with medical schemes. They use their influence over the trustees
to arrange this.
Certain managed care operators exist in a grey area outside the medical schemes regulatory
environment, providing direct services to employers (usually for those employing low-income
groups). These services are primarily for HIV/Aids.
Within this market the strong related-party relationship between the administrators and the
managed care companies significantly reduces their potential effectiveness. Many
administrators try to reduce medical service costs to increase the margins achieved on their
own services rather than to reduce medical scheme costs.
3.7 Inelastic demand for health insurance

The demand for medical scheme cover, quite aside from the issue of tax and employer
subsidies, is inelastic for a number of more natural reasons. The risk of catastrophic financial
loss, with the additional concern that essential medical services could be denied due to the
non-availability of funds, both serve to keep the demand for healthcare constant or rising,
even in the face of real contribution cost increases. In addition, a rise in real healthcare cost
(the costs of the services themselves) increases the risk of catastrophic financial loss or
reduced access to private health services. Thus increasing health service costs effectively
serve to increase the need to have health insurance. All evidence suggests that there has
been an upward sloping demand curve for medical scheme cover over the past 20 years
(see figure 6). This tendency has diminished in the past five years only because cover has
become unaffordable for certain income groups.

Key areas that affect price determination on the demand side of the health market are:
Employers are price takers when approaching open medical schemes. This reduces the
incentive for medical schemes to compete on price.
Members paying contributions are price insensitive to medical scheme contribution
increases. This results from high employer subsidies encouraged by a generous
government tax deduction for employer contributions to medical schemes on behalf of
their employees.
Administrators have to compete for members in open schemes by bargaining up broker
commissions. This increases the cost of schemes.
Brokers are remunerated by administrators paying the highest price for members.
Consequently they do not provide accurate information to members choosing a scheme.
This weakens price and benefit competition between schemes, reducing any pressure
they may feel to keep medical costs down.
Managed care services are often sold into schemes via third-party administrators. In
many instances these services merely serve as an additional layer of administration fee,
with questionable benefits for the scheme.
16
Figure 6: Key relationships on the demand side of the private health sector in SA
R estricted M em b ersh ip M edical

O p en M edical S ch em es
S ch em es
A dm in is tra tors d o m ina te s c h e m e m a n a g e m en t
d e c is io n s – pa s s o n c o n trib utio n inc re as es to
e m p lo y e rs – tak e a d va n ta g e o f ine la s tic d e m a n d
for he a lth ins ura nc e
In -h o u se
T h ird-p arty ad m inistrato rs an d M an aged C are arran g em en ts
ad m in istratio n
C o m m issio n p aym en ts an d kick-b acks
E m p lo yer b ro kers In d ivid u al b ro kers
A d vice o n sch em e selectio n
T ax d ed u ctio n s – red u ce p rice sen sitivity to m edical sch em e co st in creases
M ed iu m /sm all L arg e In d ivid u als

L arg e E m p lo yers
E m p lo yers m em b ers
17
4. SUPPLY SIDE OF THE INDUSTRY
4.1 Overview
Weak competition on the demand side has direct implications for behaviour on the supply
side of the private healthcare industry.
4.2 Hospitals
Private hospitals in SA are primarily for-profit and reimbursed on a fee-for-service basis.
There are three main hospital groups that dominate the private market – Netcare, Afrox and
Mediclinic. For the remainder, most hospitals are independently owned (not part of a group)
or belong to very small groups. Of the not-for-profit private hospitals, most serve mines, and
were originally intended as occupational health facilities. A small number of church hospitals
exist, mostly treating indigent and low-income patients with subsidies from provincial health
departments.
The establishment of these three large hospital groups has served to reduce the possibility of
competition within the private healthcare market. It is also not clear that a mere increase in
the number of hospital groups would provide a solution. Given the small size of the market
and the need for a degree of interconnectedness between health services to enable them to
operate efficiently, it is more appropriate to control abuse of market power.
With many more medical schemes to hospitals, however, and in the absence of a clear
strategy from government to control abuse, there is little possibility that hospital behaviour
can be altered significantly – despite the fact that medical schemes centralise the
determination of a large, but not all-inclusive, range of hospital fees via the Board of Health
Funders’ (BHF) recommended schedule of tariffs (this is discussed in more depth in section
5).
A recent initiative by the Department of Health attempts to address an aspect of this abuse
by permitting public hospitals to compete for medical scheme patients. Differentiated
amenities for private patients in public hospitals have been approved and a pilot process is in
place to develop contractual arrangements with medical schemes. The process would
probably take about two years to evolve fully. Once mature, however, it should play an
important role in benchmarking hospital costs in the private market.
4.3 Primary care providers

Primary care providers have typically involved individual or group general practitioner
practices serving the public on a fee-for-service basis. As medical costs began to rise for
medical schemes, primary care benefits were the first to come under pressure – with annual
benefit limits, deductibles and co-payments. Doctors’ consultation fees were also put under
pressure by the BHF tariff, which offered only low increases.
As a defence against this move, many general practitioners shifted into medicine dispensing
to supplement their incomes. Perverse practices emerged, however, as a substantial portion
of the pharmaceutical manufacturing industry began to provide doctors with kick-backs in
one form or another – bonuses, discounts, free holidays – to sell their medicines. In the case
of discounts, general practitioners charge the published market price, but obtain the product
at a substantially reduced cost.
General practitioners have also grouped themselves into independent practitioner
associations (IPAs) to be able to prevent medical schemes from selectively contracting with
particular doctors, and to establish joint negotiating platforms for extracting kick-backs from
pharmaceutical companies. The latter typically involves the establishment of a limited drug
18
list which pharmaceutical manufacturers have to “buy” their way into. The limited list is
ostensibly selected on the basis of cost-effectiveness criteria. This is rarely the case in
practice, however.
In response to the need for low-cost healthcare, primary care networks have been
established, often with salaried staff. These operations differ considerably from that of the
IPAs as they involve a corporate structure and capitation contracts. In other words, medical
schemes pay a fixed flat fee (capitation fee) per beneficiary, which is paid over to the network
on a monthly basis. The network is thus not paid on a fee-for-service basis, and accepts a
degree of risk associated with the contract. It is assumed that the network can manage this
risk through carefully handling input costs and medical protocols.
The most logical model for providing cost-effective healthcare involves having the primary
care service operate as a gatekeeper for hospital services. At present this gatekeeper
function does not exist in the private market for healthcare, except in the case of mine
hospitals. Fee-for-service arrangements encourage relationships between specialists and
hospitals, with increased referrals rewarded in some manner, for example through free
consulting rooms on hospital premises and shares in hospitals. The existing primary care
capitation arrangements incentivise hospital or specialist referrals, as the primary care
provider only shares risk in relation to the cost of its service. To minimise costs, patients are
under-treated or shifted up the referral chain.
The models of care that involve extensive co-operation between primary care and hospital
services have not occurred as yet because administrator-driven schemes have no incentive
to optimise healthcare, while hospitals make use of their market power to prevent such
arrangements – which would place their high-margin business at risk – from being
established.
4.4 Pharmaceuticals
Pharmaceutical companies influence the principle decision-maker in the process of selling
drugs – the doctor – both through general and specific incentives to sell. The former occurs
because of the percentage mark-up, while the latter occurs when bonuses, discounts and
other inducements are used to get doctors to favour particular brand-name products.
Virtually all the incentives in the private market induce doctors to prescribe high-cost drugs
as often as possible. This behaviour permits the pharmaceutical industry to charge higher
prices than they would in a normally functioning market.
The proposed reforms in the Medicines and Related Substances Control Act (Act 90) focus
on addressing various incentives for doctors to over-prescribe or to prescribe the drugs from
which they receive the greatest profit. If they work, generic substitution, transparent pricing
and the outlawing of specific inducements to doctors should increase price sensitivity in the
market.
There are essentially two elements driving up volume in the private market for drugs.
The first relates to a general incentive given to prescribe higher priced drugs often – the
percentage mark-up. Until now the mark-up has been provided to doctors, pharmacists and
hospitals as a dispensing fee, that is, to cover the cost associated with procuring, storing and
dispensing a drug. The mark-up has been reflected as a percentage on a published price
(e.g. the “Blue-book” price). The final purchaser – the patient – pays a price which includes
this mark-up. As the medical scheme reimburses the patient or directly pays for the drug in
the private sector, patients are not very price sensitive. Even if they were concerned about
the price, they are not in a position to question the decision of the doctor. The general mark-
19
up therefore creates a strong incentive to increase the volume of drugs prescribed and to
prefer the higher priced drugs.
The second element involves specific incentives targeted at doctors responsible for both
prescribing and dispensing. These specific incentives are additional to the general incentive
and are used to create preferences for specific companies or brand names. Incentives take
the form of:
Kick-backs: e.g. overseas trips, direct financial payments for of proof volumes prescribed
and dispensed, etc.;
Bonusing: this is essentially a direct financial kick-back in exchange for proof of volumes
prescribed and dispensed – the extent of the bonus is linked to target volumes;
Discounts of the published price (this substantially increases the impact of any
percentage mark-up;
Formularies: doctor groupings such as Independent Practitioner Associations (IPAs)
create limited drug lists. Pharmaceutical companies essentially have to pay a “fee” to get
on the formulary. Limited lists used by the final purchaser are usually quite beneficial for
cost management. However, when developed used by the agent (i.e. the doctor) they are
used to “pressurize” pharmaceutical companies for additional compensation.
When these elements are combined with a price insensitive final purchaser (i.e. the medical
scheme), the market will be faced with general price and volume increases beyond what is
actually needed and high prices (due to the preference created for high price drugs).
As the mechanisms causing the eventual cost increases (price x volume) result from a
combination of perverse elements, market corrections are required through a combination of
instruments. No single measure is sufficient on its own.
The various measures described below are part of the overall policy package introduced by
the Medicines and Related Substances Control Act.
(a) The general mark-up: The appropriate response here is to move to a flat-rate
dispensing fee rather than a percentage mark-up. However, without addressing the
specific incentives given by pharmaceutical companies to agents, very little will be
achieved by this measure on its own.
(b) Specific incentives: These are dealt with through:
i. Outlawing of bonusing and discounting: On its own however, these measures
are not sufficient, as there are too many ways that kick-backs of one form or
another can be given, both directly and indirectly.
ii. Transparent pricing from manufacturer to final purchaser: This measure can
assist in making all market participants aware of the prices and mark-ups
being paid from the manufacturer to the final purchaser. However, although
this measure is useful, it will achieve little when the purchasing decisions are
controlled by agents receiving kick-backs.
iii. Mandatory generic prescribing: This breaks the crucial link between the act of
prescribing and dispensing – greatly disrupting the ability of the
pharmaceutical manufacturer to incentivise a chosen agent. This is one of the
central measures that begin to address the core problem of specific incentives
to agents.
iv. Single exit price: This eliminates specific discount-related incentives being
provided to agents. It therefore removes an important perverse incentive.
20
v. Elimination of the dispensing doctor: This in conjunction with mandatory
generic prescribing by pharmacists breaks a number of critical collusive
arrangements, making it far more difficult to co-ordinate the allocation of
specific incentives as easily as before.
These measures achieve a number of rational objectives in relation to overall health policy:
(a) The general trend in the cost of drugs can be addressed, reducing the cost of medical
scheme cover and preventing a drop out of membership on to state services.
(b) Basic consumer protection is enhanced through removing incentives to prescribe
drugs that are not either not needed or may even be harmful to members of the
public.
Despite the above policy reforms, it is unlikely that medical schemes will feel the effects of
these reforms until such time as they become intelligent purchasers of healthcare.
4.5 Other suppliers of goods

Other suppliers of medical goods and services include equipment suppliers and laboratory
services. Both these markets operate similarly to that for pharmaceuticals. Doctors
sometimes own shares in medical equipment suppliers, while direct kickbacks are made to
doctors who overuse laboratory tests. In neither case are the final prices negotiated
influenced by medical schemes.

The pricing of goods and services on the supply-side of the private health market are heavily
influenced by incentives provided to the key agents in the market, doctors. Once doctors
have been influenced via financial rewards of one form or another, prices are pushed up, and
volumes sold increased.
Government has intervened at this stage through the introduction of Act 90. This will impact
on certain peripheral aspects of the perverse market for drugs. It is however not clear that a
regulatory structure up to the task of achieving compliance and further development of the
regulatory environment will be put in place. The regulation without a regulator will achieve
little, and will potentially be circumvented with ease.
As things stand no process has been put in place to filter the importation and use of new
technology that is not cost effective. Regulatory intervention is typically required in such
instances, where review committees assess the need for new equipment against established
criteria. This serves to limit the introduction of new technology at excessive prices, the costs
of which are passed on to the third-party payor (the medical scheme).
Measures to deal with perverse behaviour amongst medical professionals are always a
difficult matter. The most appropriate measures involve a combination of strong conduct
oriented legislation, coupled with rapid and firm enforcement. Given the individual nature of
medical treatment, direct interference with doctor discretion may not always work well.
Overall cost containment is best achieved however through market-related interventions that
permit the group purchasing of health care services.
21
5. REVIEW OF TARIFF SETTING VIA MEDICAL SCHEMES IN SOUTH
AFRICA
5.1 Overview
Two key areas of fee setting affect the final price of purchase for many health goods and
services. The first involves the fees paid for professional services such as doctors, surgeons,
dentists, specialists, etc. The second relates to tariffs paid for hospital services. Outside of
this are a not insignificant range of goods and services which are not influenced in any way
by the final purchaser – pharmaceuticals, laboratory tests, gases, etc.
5.2 Medical schemes and tariff setting

Medical schemes are insurance vehicles and therefore “reimburse” members for actual costs
incurred. This reimbursement need not involve payment of the full price paid or cost incurred.
Medical schemes have therefore traditionally operated not as purchasers of health care but
the insurers of purchasers of health care. As a consequence the “tariff” set centrally by the
Representative Association of Medical Schemes (RAMS – now Board of Health Funders
(BHF)) were not prices.
However, as many medical scheme members would not be able to pay health care service
providers unless reimbursed by a medical scheme, the tariff set by RAMS (now BHF) has the
effect of being a price. Where doctors were “contracted in” (see below) the tariff operated
unambiguously as a price, as the reimbursement rate matched the final amount paid.
However, doctors contracted in on out on a voluntary basis, reflecting the true nature of the
tariff as reimbursement.
The almost continuous and seemingly irresolvable conflict in price determination between
service suppliers and medical schemes stems largely from the unavoidable requirement
placed on the market to set fees centrally. Given the vast number of procedures, equipment
and consumables, a degree of uniformity in pricing is required to ensure that medical
schemes and service providers can cope with huge volumes of invoices. If a different price
schedule existed for every medical scheme, service suppliers would be given a near
impossible administrative task. However, to negotiate a single schedule in a manner
acceptable to all parties is virtually impossible.
Until 1993 RAMS had the statutory authority to publish the official price list for all medical
schemes. This status was removed from them in 1993, after which they could only publish a
recommended schedule of benefits. Schemes did not have to adhere to the prices. RAMS
was permitted to perform this function, in terms of competition legislation, only as long as
they did not enforce the price list on schemes. Individual schemes could negotiate separate
tariffs with service providers if they wished. However, this was nearly impossible to do, and
consequently the RAMS schedule of fees effectively became uniform throughout the market.
In response to this hospital groups and medical professionals set their fees in accordance
with their own processes. These tariffs are normally higher than the RAMS fees and medical
scheme members are “balance billed” the difference. Threats to significantly increase the
levels of balance billing are often used by service suppliers to extract concessions from
RAMS, now BHF, to increase their schedule of fees. In return, medical schemes penalise
service providers that balance bill by making the member pay the bill first before any
reimbursement occurs. This practice, especially if it becomes widespread, has severe
impacts on hospital cash flow.
Medical professionals are permitted to establish a scale of benefits in terms of existing
competition legislation via the South African Medical Association. This is because it is a
22
professional association. By contrast, hospitals, are not permitted to set tariffs via the
Hospital Association of South Africa (HASA), although for a number of years they were given
an exemption to do so. With the passing of the new competition legislation the exemption fell
away and has not been made available again. The rationale for the original exemption was in
any case highly questionable. It is however not clear what rationale exists for permitting
horizontal collusion in the setting of conditions of service and fees by doctors and not
hospitals.
The BHF scale of benefits however excludes a large number of items, termed “non-
chargeables”, which are priced outside of the control of medical schemes. Although non-
chargeables emerged via agreement between hospitals and RAMS/BHF they have resulted
in an area of healthcare cost where the final prices are not in any way influenced or
controlled. Thus when BHF squeezes the tariffs on the scale of benefits, hospitals increase
the volumes and prices of non-chargeables paid for by schemes. The net result being a net
overall real cost increase.
In recent years, with the aid of regulation, medical schemes have begun to contract directly
for healthcare goods and services, on behalf of medical scheme members. In this
relationship prices and not reimbursement rates are set by medical schemes.
During 2002 and 2003 matters have worsened to such an extent that BHF and service
suppliers have approached government to provide an alternative bargaining framework. A
ministerial committee has been appointed which will make its deliberations known in due
course. The Competition Commission is also independently pursuing the matter.
Presently Government plays no part in price setting within the private sector. Government
also does not control the contribution increases charged by medical schemes.
5.3 Some history

The following are extracts on a history of price setting between medical schemes and service
suppliers from around 1969 to the present by van den Heever (2003). This review shows the
complex nature of the centralised bargaining process for healthcare services. Over the years
a continuous conflict over prices occurred, resulting in ongoing instability in the market.
“The setting of medical fees between medical schemes and the medical profession was
always a problem and a source of conflict. The Medical Association often objected to the
fees that were set and the arbitration mechanism. This resulted in many doctors choosing to
opt out of the tariff of fees system. If a medical practitioner was contracted in, then the law
guaranteed payment of the account. This provided an incentive for doctors to remain
contracted in. In order to resolve this conflict, a Remuneration Committee was set up in
terms of the Medical Schemes Amendment Act 95 of 1969, to investigate the tariff of fees at
least every two years. The objective of this amendment was to improve the arbitration
mechanism such that disputes would not result in further doctors choosing to opt out of the
tariff of fees system, which was regarded as damaging to doctor/patient relationships.” (van
den Heever, in publication).
“However, the medical profession eventually regarded the Remuneration Committee in a
negative light. Allegations were made that the Act was being used to control the medical
profession and that the inflexible provisions relating to the Remuneration Committee were
financially prejudicial to medical practitioners and dentists. By 1978 the Dental Society and
the Medical Association indicated that they were no longer prepared to participate in the
activities of the Remuneration Committee. Consideration had been given to regulating
against the free choice of doctors to contract out. However, publication of draft legislation to
this effect resulted in a further 1,600 medical practitioners deciding to contract out. By this
23
time 3,941 out of a total of around 14,000 medical practitioners had already contracted out.”
(van den Heever, in publication).
“As a consequence of these conflicts, the Medical Schemes Amendment Act 51 of 1978,
abolished the Remuneration Committee and the Commission that made recommendations to
the Council on fees. Provision was made for the Medical and Dental Council to determine
fees. This was allowed on condition that it prevent further contracting out. If not successful
the Minister would step in to regulate the ability of the medical profession to contract out.
The Medical Schemes Amendment Act 42 of 1980, made provision for contracted in doctors
to send accounts directly to medical schemes. This issue had been a constant source of
conflict between medical practitioners and government. The previous dispensation only
allowed accounts to be sent to patients who had to pass them on to the medical scheme.
Medical practitioners argued that this caused extensive delays and reduced the benefit for
contracted-in doctors of guaranteed payment. However, the Browne Commission (in 1986)
recommended very strongly in its interim report that the provision allowing direct payment be
scrapped and that the doctor send the first and second account to the patient and only the
third directly to the medical scheme. Upon receipt of the account, the scheme was required
by law to pay within six weeks.” (van den Heever, in publication).
“The Amendment Act 59 of 1984, eliminated the principle of contracting-in and contracting-
out. Any profession or service supplier was permitted to determine their tariffs through their
respective statutory control bodies. The Representative Association of Medical Schemes
(RAMS) was, however, allowed to determine a scale of fees after consultation with
representatives of suppliers of services. If a service supplier were to charge fees equal to or
less than the fees indicated on the scale of benefits, the medical scheme was required to pay
the supplier of the service directly, provided the scheme offered that benefit.” (van den
Heever, in publication).

The complexity of medical scheme claims processing makes the establishment of a central
bargaining mechanism for a range of prices inevitable. However, this process comes with in-
built instability, as it is not possible to please everyone, particularly with medical costs rising
significantly in real terms. This results in irreconcilable differences which can only be
resolved through government intervention. The development of direct contracting between
certain medical schemes and service providers in the future will reduce some of this
complexity. However, this cannot be a market-wide solution as direct contracting only works
in the case of very large schemes.
The following issues are therefore important:
A central bargaining process is required for the setting of fee-for-service rates in the
private sector.
This bargaining process should be regulated: the following is an illustration of
Governments potential interventions:
o A formal bargaining process between service providers and medical schemes be
constituted in terms of a clear legal framework;
o All fees charged should be subjected to this negotiation (including pharmaceuticals,
hospital fees, hospital gases, existing non-chargeables, etc.);
o The tariffs set should become the single price for a health service, i.e. there should be
no balance billing (i.e. service suppliers cannot have a different price from medical
scheme reimbursement rates);
24
o Negotiated price changes should only become official, and Gazetted, with the approval
of Government; and
o Non-fee-for-service charges (selective contracting) should be negotiated outside of this
framework between individual medical schemes and service providers – with the
proviso that the resulting charges cannot exceed the Gazetted prices.
25
6. SUMMARY OF FINDINGS AND RECOMMENDATIONS
The private health care market in South Africa has experienced systemic cost increases over
the entire recorded history of the market. Certain services have however increased in cost
more than others. These are hospitals, medicines and specialists. However, in recent years
medical schemes have faced dramatically increased intermediary and non-health costs – in
excess of the increases in medical costs. The influences on costs in the medical sector are
discussed below, a distinction is made between demand side cost factors, supply side cost
factors and medical scheme cost factors
Demand-side cost factors
Employers tend to abdicate their influence on medical schemes and consequently become
price takers in the market. They are excessively influenced by brokers who operate in the
interests of third-party administrators. Similarly, individual purchasers of medical scheme
cover have no market power, and are excessively influenced by brokers.
Brokers targeting employer groups rely on large payments from administrators for their
remuneration. As the employers do not directly pay for broker services, brokers serve the
administrator interests. As a consequence, employers are not advised correctly on options in
the market. Brokers are also in a position to bargain up commissions to attract membership.
Likewise, brokers targeting individual members are remunerated by administrators and not
the members they are placing. As a consequence their advice is not independent, and
administrators are forced to bargain up commissions to attract membership.
Supply-side cost factors
On the hospital side an effective cartel exists in the author’s opinion which prevents shifts
away from fee-for-service billing to selective contracting. Pharmaceutical costs passing
though hospitals are a major cost-driver regardless of the ex-manufacturer price. Hospitals
obtain substantial discounts from manufacturers, which are not passed on to patients.
General practitioners have been shifted into the out-of-pocket market and government
legislation has limited their ability to dispense. Primary care is beginning to respond more
rapidly to the emerging low-cost market. For all these reasons, primary care services are not
likely to remain a major driver of cost into the future.
Specialists have an incentive to collude with hospitals to protect the fee-for-service market.
They remain a significant driver of healthcare decisions within hospitals and are key to the
Moreover, the pharmaceutical market is rife with kickbacks directed at the key agents making
healthcare decisions, the doctor and specialist. Although new legislation has been introduced
to weaken this link, give the pervasive nature of the practice, it may continue nevertheless.
Lastly, new technology enters the market without proper assessment of cost-effectiveness.
Given the nature of the market, with demand almost guaranteed, new technology enters the
market at a high price and utilisation is induced by doctors and specialists given specific
financial incentives to do so.
Medical schemes
Restricted schemes have strong governance, but lack the buying power to influence medical
service providers. They are unable to access selective contracting arrangements except
through intermediaries.
Open schemes on the other hand tend to have weak governance, but in a number of cases
have the buying power to monopsony price. However, the weak governance structure results
26
in excessive profit extraction from the scheme, negating any positive influence on bringing
down medical costs.
The existing process for centrally bargained medical scheme tariffs is both flawed,
inflationary, and open to special interest manipulation. It exists within a regulatory vacuum,
resulting in both medical scheme and service providers engaging in a confusing set of
interactions which rarely benefit the public.
Third-party administrators in restricted schemes are currently quite closely monitored, with
the possibility that they could lose their contract in cases of poor service. In open schemes
on the other hand, administrators are able to exert influence on the schemes to such an
extent that the interests of members are given a low priority.
Table 6.1 provides a summary of factors affecting the pricing and cost of private healthcare
in South Africa. It also provides a suggested ‘optimal response’. Importantly, these
responses do not envisage the significant use of price controls. Instead the focus is on
unblocking potential constraints on the optimal functioning of the demand and supply sides of
the market. It should also be noted that these proposals are provisional and provide a
starting point for discussion rather than final solutions.
Where employers play a direct oversight role in the governance of medical schemes, the
interests of members are often well served. However, the development of a large open
scheme environment where access to medical schemes occurs through the broker
market, employer influence is indirect at best.
Where brokers provide employers with accurate and independent advice on scheme
choice, schemes will be encouraged to operate in the best interests of their members –
effecting both the cost and quality of coverage. The achievement of this independence
can only occur through regulatory intervention, equivalent to the measures introduced in
respect of Act 90 governing incentives provided by pharmaceutical companies to doctors.
The remuneration of brokers needs to occur in respect of a service contract with
employers and not with the medical scheme.
Although extensive regulation is in place to guarantee the independence of scheme
management structures from both administrators and brokers, this is an area where
continuous improvement will enhance the functioning of the market.
Government needs to consider positive inducements to achieve greater employer and
employee participation in the decisions made by their medical schemes. The
reconfiguration of the tax subsidy framework could be considered in this regard.
Supply-side interventions need to be considered by Government to limit the unnecessary
expansion in a range of services. These include hospitals and new technology. Such
interventions typically require the establishment of review committees that approve new
services. Such committees already exist at a provincial level for private hospital beds.
However, no such arrangement exists for expensive equipment and other areas of new
technology.
Government needs to continue and expand the policy of permitting public hospitals to
compete with private hospitals. However, consideration needs to be given to the
expansion of this initiative into a broader range of services, including out-of-hospital
services such as chronic medication and treatment.
Government needs to regulate the conduct of health professionals more assertively.
Consideration needs to be given to more adequately resourcing the Health Professionals
Council (HPC) to achieve this end.
27
Act 90 currently lacks a regulatory authority to back up the legislation. Consideration
needs to be given to the rapid implementation of the Medicines Control Council (MCC) as
a regulatory authority outside of the civil service. In addition, the Pricing Committee,
recommended in the Act, needs to be implemented and properly supported.
The inelastic demand for medical scheme cover opens members to the possibility of
abuse by any party profiting from increased medical scheme contributions. In such
circumstances regulatory intervention is needed to prevent the unfair pricing of medical
scheme contributions. Countries such as Germany have successfully curtailed private
health expenditure increases through regulating health fund contribution increases.
These are not permitted to exceed the general inflation rate. All other healthcare prices
and service supply adjust to the spending control measures.
28
Table 2: Summary of cost drivers within the private healthcare market and suggested solutions
Comment Optimal response
Medical scheme
Schemes have strong governance, but lack the buying Provide mechanisms for employer schemes to group
power to influence medical service providers. They are together to purchase healthcare. This combines strong
Restricted schemes
unable to access selective contracting arrangements governance with improved buying power.
except through intermediaries.
Schemes have weak governance, but in a number of The governance framework operating in open schemes
cases have the buying power to monopsony price. needs to be strengthened to remove the influence of
Open schemes However, the weak governance structure results in administrators and related parties.
excessive profit extraction from the scheme, negating any
positive influence on bringing down medical costs.
The existing process for centrally determining medical Government needs to consider the creation of a regulated
scheme tariffs is flawed, inflationary, and open to special central bargaining process, which permits schemes and
interest manipulation. It exists within a regulatory vacuum, service providers to agree on annual fee-for-service
Central bargaining of resulting in both medical scheme and service providers charges. Government should participate in this process
tariffs engaging in a confusing set of interactions which rarely and approve the final (official) prices. Provision should be
benefit the public. made for medical schemes to bargain individually, outside
of this framework, where the resulting prices are lower
than the official prices.
Third-party
administrators
Administrators are currently quite closely monitored, with
Restricted schemes the possibility that they could lose their contract in cases
of poor service.
Administrators are able to exert influence on the schemes Problems with administrator influence can best be
Open schemes to such an extent that the interests of members are given addressed through a continued strengthening of the
a low priority. governance framework of medical schemes.
Employers tend to abdicate their influence on medical Incentives need to be provided in the market for medical
schemes and consequently become price takers in the scheme cover to ensure direct employer participation in
Group members
market. They are excessively influenced by brokers who medical scheme governance.
operate in the interests of third-party administrators.
29
Individual purchasers of medical scheme cover have no See recommendations on brokers.
Individual members market power, and are excessively influenced by brokers.
Brokers targeting employer groups rely on large The linkage between administrators and brokers needs to
payments from administrators for their remuneration. As be severed. To ensure the most effective market,
the employers do not directly pay for broker services, remuneration needs to derive entirely from contracts with
Group brokers brokers serve the administrator interests. As a employers. Kickbacks to brokers should be outlawed.
consequence, employers are not advised correctly on
options in the market. Brokers are also in a position to
bargain up commissions to attract membership.
Brokers targeting individual members are Members need to have the ability to access a medical
remunerated by administrators and not the members scheme without using a broker. Members not using a
Individual brokers they are placing. As a consequence their advice is broker should receive a discount on contributions for the
not independent, and administrators are forced to commissions not paid. A contract should exist between
the member and the broker.
bargain up commissions to attract membership.
Supply
An effective cartel exists which colludes to prevent shifts The cartel needs to be broken through the application of
away from fee-for-service billing to selective contracting. competition legislation and direct government support for
Pharmaceutical costs passing though hospitals are a competing low-cost hospitals. Restrictions on the
Hospitals
major cost-driver which has little to do with the ex- expansion of private hospital beds should remain in
manufacturer price. Hospitals obtain substantial discounts operation. A certificate of need process should be
from manufacturers, which are not passed on to patients. introduced for applications for new hospitals.
General practitioners have been shifted into the out-of-
pocket market. Government legislation has also limited
their ability to dispense. Primary care is beginning to
General practitioners
respond more rapidly to the emerging low-cost market.
For all these reasons, primary care services are not likely
to remain a major driver of cost into the future.
Specialists collude with hospitals to protect the fee-for- The conduct of specialists needs to be placed under
service market. They remain a significant driver of greater scrutiny. Horizontal collusion amongst specialists,
Specialists
healthcare decisions within hospitals and are key to the and vertical collusion with hospitals should be outlawed.
30
The pharmaceutical market is rife with kickbacks directed Interventions in the pharmaceutical market are complex.
at the key agents making healthcare decisions, the doctor Act 90 provides some possibility for intervention, but lacks
and specialist. Although new legislation has been the regulations for a compulsory license. Parallel
introduced to weaken this link, give the pervasive nature importation of drugs within the private sector should be
of the practice, it may continue nevertheless. permitted, as well as greater scrutiny given to abuses of
patent rights. However, the greatest impact on prices may
Pharmaceuticals
emerge through demand-side interventions - in particular
permitting the public sector to on-sell tender purchased
drugs into the private sector. This will permit medical
schemes to benefit from the government's ability to
monopsony price as a the largest single purchaser of
drugs in the country.
New technology enters the market without any review for A technology review process for both the public and
cost-effectiveness. Given the nature of the market, with private sector is required. This should scrutinize all
demand almost guaranteed, new technology enters the proposed imports or purchases of equipment. If the
Equipment
market at a high price and utilisation is induced by equipment is found to be over priced, or not cost-
doctors and specialists given specific financial incentives effective, it should not receive a license to operate in
to do so. South Africa.
31
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32

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Administered Prices

A report for National Treasury

ALEX VAN DEN HEEVER

1.3 Consumer protection

1.4 International trade protection

1.5 Concluding remarks

2.2 Cost trends

GPs Specialists Dentists Hospitals Medicines

1991 1996 2001

Contribution per beneficiary Benefits per beneficiary Beneficiaries

2.3 Reasons for cost increases in the private sector

2.4 Concluding remarks

R is k o f c ata s tro p hic c o sts C re a tio n o f third -p a rty p a ym e n t

3.2 Medical schemes

3.3 Medical scheme members

3.4 Medical scheme administrators (third-party administrators)

3.6 Managed care and selective contracting

3.7 Inelastic demand for health insurance

3.8 Concluding remarks

R estricted M em b ersh ip M edical

C o m m issio n p aym en ts an d kick-b acks

E m p lo yer b ro kers In d ivid u al b ro kers

A d vice o n sch em e selectio n

T ax d ed u ctio n s – red u ce p rice sen sitivity to m edical sch em e co st in creases

M ed iu m /sm all L arg e In d ivid u als

4.3 Primary care providers

4.5 Other suppliers of goods

4.6 Concluding remarks

5.2 Medical schemes and tariff setting

5.3 Some history

5.4 Concluding remarks

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