Irrational Consumer Behaviour: Key to the Sustainability of the South African Private Health Insurance Industry?

Similar to the United States, South Africa also has a large voluntary health insurance market. Unfortunately, the South African private health insurance industry (called medical schemes) is teetering on the edge of an actuarial death spiral due to a worsening age profile and disease burden among beneficiaries. Medical schemes are required to offer complete indemnity for hundreds of conditions due to the prescribed minimum benefit (PMB) regulations. The industry currently lacks protection mechanisms like mandatory membership or risk equalization between medical schemes. Consequently it is unlikely to be sustainable in the long term. These factors drive contribution increases above CPI and salary inflation, and encourage widespread anti-selection.

While the medical schemes industry is slowly dying, this paper argues that it would have been dead already, were it not for irrational fear-driven consumer behaviour.

After describing the institutional environment and the PMB package, we proceed by developing a model to quantify the differences between various medical scheme options in terms of benefit richness and cost. This is used as the base for a ‘value for money’ index.

The results indicate that the large cost differences between the comprehensive and basic (PMB-only) options do not translate into comparable differences in benefit richness. Basic options are found to provide similar benefits and significantly better value for money. This is an interesting result as comprehensive options are generally perceived to offer superior benefits. The reason for the small difference in benefit richness is largely due to the PMB package.

It is argued that, given the above model results, rational consumers would opt for basic options rather than the more costly comprehensive packages (except for a few specific instances which are discussed). Industry data, however, indicate that most medical scheme beneficiaries still opt for comprehensive options. The data indicate that most members who change from benefit option move to the comprehensive options. This is contrary to the widely believed myth of “buy-downs” in the industry. The paper continues to make an important observation: if consumers behaved rationally, the majority of members would buy-down to the most basic options. Basic offerings would more than meet the majority of members’ real medical needs at a significantly reduced cost, but the analysis also indicates that a change of this nature would severely undermine the long term sustainability of medical schemes. Simply put, aggregate contribution income would be (and would have been) much less, with benefits paid not reducing by the same amount; further impacting on the claims ratio, solvency levels, etc. Had consumers in this market behaved rationally, medical schemes would have died a significantly quicker death. The survival of the market in its current state is thus dependant on the fear-driven irrational behaviour of consumers.

This paper contributes to the literature by, for the first time, quantifying the benefit richness value differences and related ‘value for money’ between medical scheme options. It also disproves the theory of rampant “buy-downs” and provides an interesting assessment of the observed irrational consumer behaviour.