Public hospital blame game – here's how we got into this funding mess

Discussions between state, territory and Commonwealth leaders at the Council of Australian Governments (COAG) meeting in Canberra today is likely to be heated, to say the least. Hospital funding is on the agenda, and we’ve already heard the states are unhappy with the deal Prime Minister Malcolm Turnbull is expected to present to them.

A leaked document shows the government will propose a continuation of the current interim agreement. This would see the Commonwealth continue to pay 45% of the cost of hospital funding growth, with a 6.5% cap on spending growth, until 2025. The states want more.

Blame game history

Public hospitals in Australia are owned and operated by state (and territory) governments. So why does the Commonwealth government attract blame for lack of hospital funding?

Commonwealth funding to states for public hospitals started in 1945. By then, as the states had conceded the power to tax income to the Commonwealth, the Commonwealth had the greater revenue-raising power. Contributions from the Commonwealth to the states were negotiated through five-yearly agreements from that time.

The introduction of Medicare in 1984 entitled all Australians to free public treatment, thereby increasing hospital costs. States were compensated though higher Commonwealth contributions, still negotiated through five-yearly agreements.

Read more: Explainer: what is Medicare and how does it work?

Even back then, the five-yearly negotiations generated controversy and angst. At each round of negotiations debate ensued about whether the Commonwealth and the states were paying their fair share of hospital funding. Negotiations in 1998 and 2003 were particularly acrimonious.

The state of public hospitals was a major feature of the 2007 federal election, with then-prime ministerial candidate Kevin Rudd promising to “end the blame game”. Although health policy had been a feature in previous federal elections, it had not focused on public hospitals.

The 2011 Health Reform Agreement established a new approach, and took three years to resolve. It sought to provide long-term certainty around hospital funding, replacing the five-yearly negotiated agreements with a clear basis for the level of Commonwealth contribution.

The Commonwealth committed to an agreed share (45% for the first three years, then 50%) of the growth in public hospital costs.

Read more: Lost about health-care reform? Here's where we got to in 2011

Efficiency was to be assured through activity-based funding (also known as case-mix funding) for hospitals. This sets a price per type of hospital episode, and hospitals are paid on the basis of the number of cases, adjusted by case type.

The “nationally efficient price” is currently based on the average cost of a procedure, test or treatment and is set by the Independent Hospital Pricing Authority. But volume growth was left to be addressed by the states as the “system managers”.

Back to the drawing board

Then came the Abbott government’s 2014 budget. The Commonwealth government delivered a nasty fiscal shock to the states by withdrawing from the 2011 agreement and limiting its hospital funding increases to population growth and general inflation.

As part of the 2011 deal with the states, the Commonwealth had guaranteed a minimum level of growth funding until 2019-20, even if this was higher than the “efficient growth” contribution. This meant that these cuts could only take effect from 2017-18.

Read more: Budget takes hospital funding arrangement back to the future

The unilateral action also did serious damage to the confidence and goodwill generated by the 2011 agreement. A partial respite from the foreshadowed cuts was achieved in April 2016 with an agreement for the period 2017-18 to 2019-2020 for additional funding at 45% of the growth, but subject to a cap of 6.5% per year.

The 2016 agreement also commits the Commonwealth and states to develop a longer-term funding agreement before September 2018.

Read more: Another day, another hospital funding dispute – how to make sense of today's COAG talks

Future of hospital funding

So what are the challenges to be addressed in this new agreement and how might they play out in the next seven months?

Volume growth: Under the activity-based funding system, prices per unit of activity have stabilised. But total expenditure equals unit price by volume, so while price is steady, increases in hospital admissions (and case severity) are driving growth in total expenditure.

It is clear both from theory and international experience that activity-based funding addresses the first (admissions) but not the second (volume). Recent data shows the number of admissions to public hospitals increasing by 3.5% a year over the past five years, with the rate increasing more in the most recent years.

Expect to see discussions about what appropriate volume growth is and how it will be managed.

Private hospitals: Private hospital admissions have been increasing at a faster rate than public admissions. There has also been a steady growth in private patients treated in public hospitals. This exposes the Commonwealth to higher outlays through its subsidies for private insurance premiums.

Read more: Private health insurance rebates don't serve their purpose. Let's talk about scrapping them

The recent private health insurance reforms commit the Commonwealth to explore this issue with the aim of reducing the number of privately insured patients who use public hospitals.

Expect debate from the insurance funds, the private hospitals, and public sector advocates.

Integrated funding models: The current approach for activity-based funding and the Independent Hospital Pricing Authority deals with, well, hospitals.

Improving health sector productivity will require a more system-oriented approach with the concept of a nationally efficient price extended to more health services, including those provided in the community. An “episode of care” extends beyond the hospital walls and includes GPs, specialists, pathology, pharmacy and so on.

This is a challenge which may be addressed or ignored.

Responsibility: The 2011 agreement recognised the need for Commonwealth-state partnership around the health system. The 2014 budget explicitly made funding public hospitals a state responsibility. The 2016 agreement is somewhat ambiguous, recognising the shared responsibility for health, without any explicit statement on public hospital funding responsibility.

The 2016 agreement bought some time for the states and Commonwealth to maintain a status quo. This new agreement will at best provide a long-term stable basis for the joint funding of health services. At worst, it marks a return to the pre-2011 agreement conditions of political rhetoric and blame.