Looking at private healthcare profitability from the perspective of the consumer.

From where the user sits

Looking at private healthcare profitability from the perspective of the consumer.

Felicity Duncan
10 Sep 2007 07:24

http://www.moneyweb.co.za/mw/view/mw/en/page149519?oid=159683&sn=Detail&ccs_clear_cache=1#CMT_ANCHOR

Private, or for profit healthcare is controversial around the world. No one likes to imagine a company that profits by the sickness of others. Thus, most healthcare systems, like South Africa’s, are an uneasy hybrid of for-profit and state-funded entities (see Public vs Private).

There are advantages to privately funded healthcare services. Robustly funded, resource-rich hospitals are necessary in any healthcare system, and private healthcare tends to encourage the funding of such hospitals. The prospect of high salaries and prestige attracts many smart, ambitious young people to the study of medicine. Generous margins make it possible for drug companies to fund high-risk research and development (R&D) projects to find the next cure for heart disease or cancer. For healthcare to advance, and to achieve high levels of quality, there has to be money available.

But it is not all roses and sunshine, of course. There are problems with for-profit healthcare. The prospect of higher pay under a fee-for-service model can encourage over-servicing, doctors prescribing unnecessary drugs, or administering unneeded tests. Drug companies, protected by sternly enforced patents, can charge fantastical sums for life-saving drugs, driving up medical inflation and helping healthcare costs to become unmanageable. The diseases of the wealthy, such as cancer and diabetes, attract more attention than the diseases of the poor, such as malaria and TB, because of the profits they promise.

All these problems and benefits manifest themselves in the South African private healthcare context, along with some unique problems of our own. Let’s consider three of the companies and groups that are considered to be drivers of medical costs.

Discovery Health
Discovery Health, part of the Discovery Group (JSE:DSY), is a medical scheme administrator. It manages the Discovery Health Medical Scheme, an independent, not-for-profit entity run by a board of trustees. The scheme covers over 2m people, making it by far the biggest in South Africa, with almost a third of the 7m-strong medical scheme population.

Discovery Health has often been criticised for its admin fees. In South Africa, government guidelines suggest that admin fees should not exceed 10% of scheme contributions. For 2005, according to the Board of Healthcare Funders’ Key Performance Indicators report, it was around 12%, at present, it is just over 11%.

But that percentage has been steadily declining through the years (see chart), and Discovery CEO Adrian Gore says his company plans to have it at 10% within the next year or two. It also compares favorably to the 15%-20% average in the US.

Clearly, despite the criticism voiced by the media and the minister of health, admin fees are not the key drivers of medical inflation.

Netcare
In the last few months, Netcare (JSE:NTC) has faced some stiff criticism for its practice of securing rebates on surgical consumables (see A sickening industry). Discovery and other parties have called on Netcare to adopt a transparent pricing model, which it has agreed to do. Instead of making money on surgical consumables, Netcare will henceforth charge higher ward and theatre fees (see transcripts of a conference call on the subject of Netcare’s pricing).

Netcare has maintained robust margins for many years (see table, or Netcare’s seven-year review). In addition, according to statistics compiled by Discovery, hospital costs per member, per month have been rising at an annualised rate of 12% a year for the last five years (see chart below).

Unfortunately, it is not easy to say whether or not these high prices reflect good quality. Netcare is in the process of implementing a quality management system, which should provide more insight into whether or not customers are receiving value for money at these private hospitals.

It is true that the company has invested heavily in capacity, building new hospitals and training large numbers of nurses and specialists. Nevertheless, it is clear that hospital costs are a key driver of medical inflation.

Perhaps the implementation of new, more transparent pricing models and quality monitoring mechanisms at Netcare will make it easier for medical schemes and their members to monitor and manage their hospital costs.

	2000	2001	2002	2003	2004	2005	2006
	Rm	Rm	Rm	Rm	Rm	Rm	Rm
Revenue	2848.8	3687.7	4812.3	6012.6	6852.5	7533.7	11615.9
Cost of sales	1649.5	889.6	2538.2	2753.3	3490.0	3650.6	6375.9
Gross profit	1199.3	2798.1	2274.1	3259.3	3362.5	3883.1	5240.0
Gross margin	42.1%	75.9%	47.3%	54.2%	49.1%	51.5%	45.1%
Operating profit	413.2	506.3	731.3	922.2	947.0	1209.6	1568.0
Operating margin	14.5%	13.7%	15.2%	15.3%	13.8%	16.1%	13.5%

Specialists and doctors
Finally, medical workers are a source of medical inflation, as they demand pay increases and high salaries for their highly skilled work. In South Africa, these workers are still underpaid relative to their international peers. In addition, they are in undersupply as the table below shows.

Given the low numbers of specialists, particularly, that SA is home to (0,73 per 1 000 patients, in the private sector, compared to 1,86 per 100 in the US private sector), it should not be surprising that these highly skilled practitioners demand higher salaries. The only way to combat this type of medical inflation would be to increase the number of specialists in the country, a daunting task that government and the private sector are already attempting.

	Physicians (density per 1 000 population)	Nurses (density per 1 000 population)	Dentists (density per 1 000 population)	Pharmacists (density per 1 000 population)	Hospital beds (per 10 000 population)
Country	Value	Value	Value	Value	Value
Brazil	1.15	3.84	1.11	0.3	26
China	1.06	1.05	0.11	0.28	22
France	3.37	7.24	0.68	1.06	75
Nigeria	0.28	1.03	0.02	0.05	12
South Africa	0.77	4.08	0.13	0.28	-
Sweden	3.28	10.24	0.82	0.66	52
United Kingdom	2.3	12.12	1.01	0.51	39
United States of America	2.56	9.37	1.63	0.88	33

This brief look at three areas of private healthcare expenditure has shown that, while companies can take action to reduce costs in some areas, the drivers of costs in others are systemic and cannot be easily combated.

Hopefully, as better, more transparent pricing models come on stream, and the private healthcare industry tackles cost and quality monitoring issues, the South African private healthcare system will achieve a position that enables it to grow and serve patients without exposing them to unnecessarily high costs.



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