THE ECONOMIC RECORD, VOL. 79, NO.

246, SEPTEMBER, 2003, 279–296

Adverse Selection and the Decline in Private Health

September
3O
78riginal
Blackwell
Oxford,
The
ECOR
2003
0013-0249
Economic
Economic
The Article
UK
Decline 2002
Publishing
Record
Record
in Health Ltd.
Insurance

Insurance Coverage in Australia: 1989–95*

GARRY F. BARRETT AND ROBERT CONLON
School of Economics, University of New South Wales, Sydney, Australia

The decline in private health insurance coverage over the period

1989 –95 is analysed using the ABS National Health Surveys.
Individuals’ health status and health risk behaviours are found to be
significant determinants of their decision to purchase private health
insurance. At a point in time, the pool of the insured is very hetero-
geneous, with a mix of both good and bad health risks. It is found that
the decline in insurance coverage over the period 1989–95 coincided
with an increase in the degree of ‘adverse selection’ within the insured
population.

I Introduction In recent years the role of governments in the

Total expenditure on health services in Australia
was just under $61 billion in 2000–01 or
approximately 9 per cent of GDP. This obviously
represents a substantial resource cost and is a
concern for public policy. The potential growth in
future health care expenditures is a further concern
to both Commonwealth and State governments
which provide an overwhelming proportion of the
funds. If past experience is a guide, the potential
problem is significant. Health expenditure per
person in constant prices rose by nearly 40 per
cent over the period 1990–91 to 2000–01 (AIHW
2002, tables 2, 3.1, 6, 8, 9). With an ageing popu-
lation, and increasing availability of new and
more expensive medical technologies, it is diffi-
cult to see anything other than real expenditures
continuing to rise, and possibly accelerate, in the
future.
* We thank two anonymous referees, Colin Cameron,
Denzil Fiebig, seminar participants at UNSW and
participants at the ‘Regulating Private Health Insurance’
Workshop, ANU, June 2002, for very helpful comments.
Correspondence: Garry F. Barrett, School of
Economics, University of New South Wales, Sydney
2052, NSW, Australia. Email: g.barrett@unsw.edu.au
future funding of health care services has become
an important political and economic issue. While
private health insurance funds have played a sig-
nificant part in funding health care in Australia
for some time,1 many have seen that role being
threatened by declining membership of private
insurance funds and with it, a rising concern that
health care will be an ever increasing drain on
public revenues. As an illustration, in mid-1984
about 50 per cent of the population had private
hospital cover, in 1990 about 44 per cent, and by
mid-2000 this had fallen to just over 31 per cent
(Industry Commission 1997, p. xxx). These fig-
ures and the likelihood, without intervention, of
continued declines provided the impetus for the
health insurance initiatives introduced by the
Commonwealth government in recent years.
In a context in which the Commonwealth govern-
ment is seeking to shift more of the financial burden
of health care to the private sector, we analyse the
1
The private sector funds about 30 per cent of all
health care, though less than 10 per cent is provided
from private health insurance; the remainder comes from
out-of-pocket private expenditures (about 15 per cent)
and other non-government sources (about 5 per cent;
AIHW 2001, p. 10).

279
© 2003. The Economic Society of Australia. ISSN 0013–0249
280 ECONOMIC RECORD
determinants of private health insurance coverage.
The analysis contributes to the literature by:
• analysing in detail the relationship between a
comprehensive set of health risk factors, for all
family members, and the demand for private
health insurance;
• analysing the incidence of private health insurance
coverage at two points in time, 1989 and 1995,
between which a dramatic decline in private health
insurance coverage was observed;
• evaluating whether the shrinking pool of those pri-
vately insured was increasingly composed of ‘high
risk’ consumers, reflecting what may be termed an
‘adverse selection’ spiral underlying the contrac-
tion in the market for private health insurance.
We find a range of health risk behaviours are
significantly related to the decision to purchase
private health insurance in 1989 and 1995. At any
time, it is apparent that the pool of the insured is
very heterogeneous, comprising a mix of both bad
health risks (indicating adverse selection) and good
health risks (consistent with risk-averse preferences).
However, we find that the decline in insurance
coverage over the period 1989–95 coincided with
an increase in the degree of ‘adverse selection’ in
the pool of the privately insured.
The structure of the paper is as follows. A brief
outline of the Medicare system is provided in the
following section. Section III describes the find-
ings of previous research, and in section IV the
theoretical model and statistical framework of the
present analysis is presented. The data sets used
for the empirical analysis are described in section
V and the results are presented and discussed in
section VI. The final section contains concluding
comments and suggestions for future research.
II Outline of Health Insurance in Australia
Under Medicare, introduced in 1984, compulsory
primary insurance provided basic public hospital
care and core medical services. Consumers could
purchase supplementary (secondary) insurance
from a private health insurance fund that would
provide a potentially higher quality of hospital
care (either in a private hospital or as a private
patient in a public hospital) and/or ancillary services
not covered by Medicare (e.g. dental services). The
substance of these arrangements has now operated
for nearly 20 years. Those who choose not to take
out private cover may be treated in a public
hospital without charge by registered practitioners
nominated by the hospital. Those choosing private
SEPTEMBER
treatment in either a private hospital or as a private
patient in a public hospital (most by far, but not
all of whom are privately insured) have a choice
of doctor. For a particular service Medicare pays
75 per cent of the fee appearing in the Medical
Benefits Schedule (MBS). The remaining 25 per
cent of the MBS fee is coverable by private insur-
ance, but any charge in excess of the Schedule fee
– the ‘gap’ – until recently had to be paid by the
patient. Charges associated with the services of
the hospital such as operating theatre fees and
accommodation are all payable by the patient, but
fully insurable.
The regulatory framework of the health insur-
ance system is provided by The Health Insurance
Act. Insurers must be registered under the Act, and
accept all applicants. Insurers may not discriminate
on bases of sex, race, the use of services and, until
recently, age in setting premiums or paying bene-
fits to those insured.2 Such attributes are related to
health risk (and hence expected costs to an insurer)
and the requirement that insurers must ignore these
risks in setting premiums is known as ‘community
rating.’ There are obvious distortions caused by
community rating and funds having high propor-
tions of high risk members are compensated
through a reinsurance pool.3,4
2
From 1 July 2000 private health funds were able to
charge premiums on the basis of age of entry to private
health insurance (known as ‘lifetime community rating’).
Individuals (and families) pay an extra 2 per cent in
premiums for each year over the age of 30 they are when
they first take out private hospital cover, subject to a
maximum 70 per cent surcharge.
3
The reinsurance arrangements redistribute funds
among insurers favouring those with above average
claims for people in specified categories, such as those
who are 65 years and over, and those who have been
hospitalised for more than 35 days in a year. People in
these two groups incur 48 per cent of claims costs
(Owens 1999, p. 174). The reinsurance arrangements
may influence the marketing strategies of health funds
and thus the demand for insurance; taking account of
such strategic supply-side behaviour is beyond the scope
of the present analysis.
4
An assumption underlying our analysis is that
hospital insurance policies were close to identical over
the study period 1989–95. There was relatively little
variation across health funds in the hospital insurance
products offered during this time due to, at least in part,
the operation of the regulatory environment (Industry
Commission 1997). During this period most funds
offered three tiers of cover (basic, intermediate and
high).
2003 THE DECLINE IN HEALTH INSURANCE
III Previous Research
Under the Medicare arrangements operating in
1989 and 1995, health insurance choice essentially
entailed a simple decision – whether or not to
purchase secondary insurance from a private fund.
Analysis of the determinants of this type of
decision is particularly suited to the use of binary
discrete choice models using either the logit or
probit forms of the probability function. Repre-
sentative of the approach, Cameron and Trivedi
(1991) specified a conditional expected utility
function that is associated with alternative health
care regimes. The consumer chooses the regime
that maximises expected utility. Other studies
using a similar approach include Scotton (1969),
Cameron et al. (1988), Ngui et al. (1990), Cameron
and McCallum (1995), Hopkins and Kidd (1996),
Schofield (1996), Butler (1999) and Savage and
Wright (1999).5
Beginning with Scotton’s (1969) pioneering
work, income has been found to be a dominant
influence on health insurance choice in Australia.
Savage and Wright (1999) found significant posi-
tive effects of income on private insurance choice
for singles, couples and couples with dependents.
Their results are consistent with those of Ngui
et al. (1990), Cameron et al. (1988) and Cameron
and Trivedi (1991). In other countries, Propper
(1989) obtained similar results for families in Eng-
land and Wales as did Hurd and McGarry (1997)
for the elderly in the USA.
Of the other possible determinants of the deci-
sion to purchase insurance, an obvious candidate is
price. However few studies have attempted to esti-
mate price elasticities of demand owing to the lack
of price information in standard data sets used by
researchers in this area and, importantly, the lim-
ited nominal price variation across individuals and
families observed in the highly regulated health
insurance market. An exception is Butler (1999)
who constructed ‘effective prices’ from informa-
tion on insurance fund premium revenue (averaged
over policies sold) and the expected benefits paid
out by age category. Butler’s (1999) point estimate
of the own-price elasticity of demand for hospital
insurance was – 0.50.
The available evidence suggests that socio-
economic variables act on choice in the expected
ways. Those who are employed (whether full- or
part-time), and those in white collar occupations
5
Some of these studies also looked at other aspects of
health care, such as the effect of insurance status on an
individual’s utilisation of hospital services.
281
were more likely to purchase some or all categor-
ies of insurance as were those with tertiary, or at
least some form of post-school education (Butler
1999; Savage & Wright 1999). Married respond-
ents were more likely to take out coverage
(Cameron & McCallum 1995), though family size
apparently has been of little influence on the pur-
chase decision (Cameron & Trivedi 1991). Age has
also been shown to have a significant influence
on insurance choice. Cameron et al. (1988), Ngui
et al. (1990) and Savage and Wright (1999) have
all found age has a positive and significant impact
on the probability of having insurance cover.
Of course age is related to health risk and health
status, but it is perhaps surprising that when spe-
cific measures of these risks have been examined,
the evidence that such factors affect insurance
choice has been equivocal. In a system where pre-
miums are determined by community-rating rather
than risk-rating, Cameron and McCallum (1995)
considered the question of whether long-term
health risk is a major determinant of health insur-
ance choice. They concluded that any relationship
between choice and health status/health risk is
weak. The findings of Cameron and Trivedi (1991)
suggested those choosing insurance were more
likely to be women and older people (who tend to
be relatively heavy health care consumers), and
coverage increased with age at an increasing rate.
Additional indicators of health status were not
found to have a significant effect on the insurance
decision.
Not only is a consumer’s knowledge of being
at risk by being a member of a particular group of
people with high-risk characteristics (e.g. those
who know they have high cholesterol) likely to
influence their insurance decision, his/her attitude
to risk is also of likely importance. Hopkins and
Kidd (1996) and Butler (1999) found that smokers
are less likely to purchase insurance. Smoking
behaviour is viewed in these studies as a proxy for
risk-aversion.
Several recent papers examined the empirical
evidence for adverse selection in health insurance
markets in the United States. In these studies
‘adverse selection’ is defined as the situation
where consumers have differential health risks but
are not charged a premium equal to the expected
marginal cost of their insurance. As a result, ‘high
risk’ consumers find insurance most attractive and
will tend to take out more generous and expensive
policies relative to ‘low risk’ consumers (Cutler &
Zeckhauser 1998). This may set off a spiral,
whereby insurers realise greater than expected
282 ECONOMIC RECORD
costs and respond by increasing premiums, leading
lower risk consumers to quit the market, causing a
further round of premium increases and market
contraction. In the extreme, this may lead to the
collapse of the insurance market.6 Cutler and
Reber (1998) found that an ‘adverse selection
death spiral’ was responsible for the demise of the
Harvard University health insurance plan in the
1990s. Similarly, Thomasson (2002) found that
(voluntary) community rating of health insurance
by the Blue Cross and Blue Shield health funds
in the fledgling health insurance market of the
1950s became untenable owing to the problems
of adverse selection. However, Buchmueller and
DiNardo (2002) evaluated the effect of mandated
community rating in the market for individual
health insurance (as distinct from group, workplace
based, plans) in several states, and found no evi-
dence of an adverse selection spiral in jurisdictions
where community rating was adopted.
IV Model
We consider the decision to purchase private
health insurance (PHI) using the theoretical model
presented by Cameron and Trivedi (1991). The
decision to purchase PHI is treated as a choice
between two discrete alternatives. The first is for
the consumer to rely upon the universal cover
provided by Medicare and not purchase private
insurance.7 The second is to purchase supple-
mentary cover offered by private health funds. The
net expected utility of purchasing PHI is assumed
to be given by the linear index function
EVi = β 'xi + εi (1)
6 allows us to control for the characteristics of every
The original treatment of adverse selection was
presented in Rothschild et al. (1976). Strictly, adverse
selection occurs where consumers have hidden infor-
mation regarding expected health insurance costs that
insurers are unable to use in the setting of actuarially
fair premiums. However, ‘adverse selection’ as used in
the empirical literature, and adopted in this paper, more
generally refers to situations where high risk consumers
differentially prefer insurance (or purchase more
generous insurance). This may occur due to the problems
of hidden information or as a consequence of the
community rating (rather than risk rating) of insurance
premia.
7
In fact, uninsured individuals (and families) may
either rely upon Medicare or they may ‘self-insure’ and
directly purchase private hospital treatment. We are
unable to distinguish between these two situations with
the NHS data.
SEPTEMBER
where xi denotes individual/family characteristics
and other conditioning variables, β (the parameter
vector to be estimated) is the impact of those charac-
teristics on the decision to purchase insurance, εi
is a random error term and i indexes individuals.
We do not observe the net expected utility of
purchasing insurance but rather a binary variable
indicating whether the net expected utility is
positive and the individual was observed to purchase
insurance. The probability that an individual pur-
chases PHI is modelled as
Pr(PHI = 1) = Pr(EVi > 0) = F( β 'xi) (2)
where F(.) denotes the standard normal distri-
bution function. This corresponds to the standard
probit model, which is estimated using maximum
likelihood techniques (see Greene (1997, pp. 662–
75) for further details).
V Data
The data analysed in this study are from the
Australian Bureau of Statistics National Health
Surveys conducted in 1989–90 (NHS89) and 1995
(NHS95).8 We examine the decisions by both
‘singles’ and ‘families’ to purchase private health
(hospital) insurance. The set of records for
individuals indicating their income unit status as
‘single person’ comprised the sample of single
adults. The set of ‘family’ records were those who
indicated their income unit status was ‘married
couple with dependent child(ren)’, ‘married couple
without dependent child(ren)’ and ‘single parent
with dependent child(ren)’. The basic unit of
observation in the NHS is the individual – and an
important feature of these data is that individual
records can be matched into income units. This
member of a family. To construct the estimation
samples we excluded income units where the
‘head’ was less than 20 years of age or was a full-
time student. In addition, for the family samples,
income units were excluded where the reported
insurance status of the ‘head’ and ‘spouse’ were
inconsistent.9
8
A detailed data description is contained in an
appendix available on request from the authors.
9
This lead to the exclusion of 614 and 329 observa-
tions in 1989 and 1995, respectively. When these observa-
tion were included in the analysis, and either the ‘head’s’
or ‘spouse’s’ insurance status is used for the family, the
estimation results were very similar, and the qualitative
inferences were identical, to those reported in the text.
2003 THE DECLINE IN HEALTH INSURANCE
The dependent variable in the analysis is a
binary variable indicating whether or not the
individual or family had private health insurance
which provided cover for the costs of in-hospital
procedures. The explanatory variables may be
broadly classified into two groups. The first
includes the basic demographic and socioeconomic
variables such as sex, age marital status, the
number of dependent children (where relevant),
immigrant status, state of residence, education and
gross annual income of each single or family
member. This set of explanatory variables also
includes controls for main source of income,
labour force status, and an indicator of whether a
person worked full-time or part-time. There is also
a variable indicating whether the person has a
government health card (which entitles them to
subsidised health care).
The second group of explanatory variables pro-
vides information on the prevalence of health con-
ditions among respondents (and their families), and
behaviour that is likely to affect their health. Here
we focus on a narrow set of relatively common
specific conditions by controlling for the presence
of diabetes, high blood pressure and high choles-
terol, as well as the number of recent and chronic
(long-term) conditions, and individuals’ self-
assessed health status (SAHS). We also control for
a wide range of health risk behaviours. The set of
behaviours will reflect individuals’ attitudes to risk
(since the behaviour affects the probability of
different health states occurring), the rate of time
preference (as it is the realisation of future states
that are affected) and the expected future demand
for health care services. Specifically, we control
for adults’ consumption of alcohol, smoking status,
body mass (whether an individual is underweight,
of acceptable weight or overweight), and the level
of regular exercise (low, moderate or vigorous).
Although the NHS are a rich source of informa-
tion for studying the demand for health insurance,
they have important limitations. First, the surveys
do not record the insurance premiums faced by
consumers. However, health insurance funds are
state-based, and given the policy of community
rating, single adults and families within each state
generally have access to the same set of policies.
Within a state, the family rate for health insurance
is equal to twice that of single adults. Although we
do not directly control for the price of insurance
contracts, we divide the sample of consumer units
into single adults and families and include controls
for state of residence. The state dummy variables
will therefore capture variation in the price of
283
insurance within the separate single and family
samples in each year of the surveys. Second, wait-
ing times – a means of rationing public hospital
resources and one indicator of the ‘quality’ of the
services publicly provided under Medicare – may
be important determinants of decisions regarding
the purchase of insurance, but there is no such
information available from the NHS. Here again,
to the extent that waiting times differ by state, the
state dummies will capture this variation.
VI Results
(i) Summary Statistics
For our samples of ‘potentially insurable’ consu-
mers, the decline in the prevalence of private health
insurance (hospital cover) between 1989 and 1995,
shown in Tables 1 and 2, was marked.10 In 1989
approximately 36 per cent of singles had health
insurance and by 1995 this had fallen to 26 per
cent. Although private health insurance was more
prevalent among families, with 52 per cent of
families purchasing insurance in 1989, there was
a similar decline in coverage of 11 per cent – to
41 per cent in 1995.
The sample summary statistics indicate a number
of changes in the Australian population over the
period 1989–95. There was a decline in the (self-
reported) prevalence of the specific conditions of
high blood pressure and high cholesterol for both the
singles and family samples, and a slight increase in
the prevalence of diabetes between the two surveys.
At the same time there was an increase in the
number of recent, and especially chronic, health
conditions. Nevertheless, the proportion of indi-
viduals who assessed their own health status as
good to excellent increased by about 5 per cent to
around 80 per cent among both singles and adults
in families.
In terms of health risk factors, over the study
period there was an increase in the proportion of
the samples who were low-risk drinkers (among
the singles sample). For the sample of families the
converse was observed. Both singles and family
members indicated a decline in the prevalence of
smoking between the two surveys, while the
incidence of being overweight increased. Indeed,
by 1995 more than one third of the singles and
approximately half of the adults in families indi-
cated they were overweight according to National
Health and Medical Research Council criteria.
10
Complete summary statistics and estimation results
are available on request from the authors.
284 ECONOMIC RECORD SEPTEMBER

Table 1
Summary Statistics Describing Personal Characteristics by Insurance Status for Single Men and Women

1989 1995

Explanatory Variables All Insured Uninsured All Insured Uninsured

Private (Hospital) Insurance 0.3606 1.0000 0.0000 0.2600 1.00000 0.0000

Female 0.5047 0.5525 0.4777 0.5060 0.6130 0.4684
Single, Never Married 0.5897 0.6109 0.5777 0.5600 0.5287 0.5710
Separated, Divorced, Widowed 0.4103 0.3891 0.4223 0.4400 0.4713 0.4290
Immigrant 0.2277 0.1756 0.2570 0.2300 0.1861 0.2455
Income ($10 000) 2.2851 2.7590 2.0179 2.1488 2.6584 1.9698
Government Health Card Holder 0.3456 0.2223 0.4151 0.4346 0.3168 0.4760
Age 44.195 44.491 44.027 46.017 50.559 44.422
State
NSW† 0.3575 0.3556 0.3586 0.3451 0.3014 0.3605
Vic. 0.2661 0.2972 0.2485 0.2587 0.2862 0.2490
Qld 0.1586 0.1155 0.1829 0.1821 0.1730 0.1853
SA 0.0798 0.0907 0.0737 0.0799 0.1025 0.0719
WA 0.0901 0.0938 0.0880 0.0826 0.0849 0.0817
Tas. 0.0234 0.0217 0.0243 0.0254 0.0296 0.0239
ACT 0.0148 0.0132 0.0158 0.0095 0.0066 0.0106
NT 0.0097 0.0123 0.0083 0.0167 0.0157 0.0170
Education
High School† 0.5855 0.5132 0.6262 0.5895 0.5241 0.6125
Post Secondary Qualification 0.3142 0.3447 0.2970 0.2913 0.3007 0.2880
Degree 0.1003 0.1420 0.0767 0.1130 0.1653 0.0947
Left School by Age 15 0.2380 0.1686 0.2771 0.2273 0.1909 0.2401
Labour Force Status
Employed† 0.6000 0.6724 0.5592 0.5509 0.5677 0.5450
Unemployed 0.0527 0.0175 0.0726 0.0576 0.0113 0.0739
Not in the Labour Force 0.3473 0.3101 0.3682 0.3915 0.4211 0.3811
Hours
Full Time† 0.5205 0.6021 0.4744 0.4613 0.5018 0.4471
Part Time 0.0781 0.0686 0.0835 0.0895 0.0658 0.0979
Specific Health Conditions
Diabetes 0.0255 0.0192 0.0290 0.0378 0.0422 0.0362
High Blood Pressure 0.2085 0.2022 0.2120 0.1787 0.2239 0.1628
High Cholesterol 0.0883 0.0924 0.0861 0.0641 0.0870 0.0560
Number of Recent Conditions 1.9408 2.0232 1.8944 2.0050 2.3352 1.8890
Number of Chronic Conditions 1.8800 1.9468 1.8424 2.6153 2.9696 2.4909
Self-Assessed Health Status
Poor 0.0569 0.0376 0.0677 0.0605 0.0490 0.0646
Fair 0.1836 0.1545 0.2001 0.1436 0.1233 0.1508
Good/Excellent† 0.7595 0.8079 0.7322 0.7958 0.8277 0.7846
Drinking
Low Risk Drinker† 0.8542 0.8715 0.8444 0.8981 0.8977 0.8983
Medium Risk Drinker 0.0818 0.0804 0.0826 0.0596 0.0638 0.0581
High Risk Drinker 0.0640 0.0481 0.0730 0.0423 0.0386 0.0436
Smoking
Never Smoked† 0.5029 0.5798 0.4595 0.4958 0.6117 0.4551
Ex-Smoker 0.1797 0.1849 0.1768 0.2174 0.2234 0.2153
Current Smoker 0.3174 0.2353 0.3637 0.2868 0.1649 0.3296
Weight: Head
Underweight 0.1349 0.1246 0.1407 0.1145 0.1246 0.1110
Acceptable Weight† 0.4935 0.5041 0.4875 0.4949 0.4748 0.5020
Overweight 0.3716 0.3713 0.3718 0.3906 0.4006 0.3870
Exercise
Low Exercise 0.6483 0.6396 0.6531 0.6761 0.6752 0.6765
Moderate Exercise† 0.1632 0.1726 0.1578 0.1595 0.1682 0.1564
Vigorous Exercise 0.1886 0.1878 0.1890 0.1644 0.1566 0.1671
Observations 9 777 3 557 6 220 4 567 1 252 3 315

† Indicates the omitted (reference) category in the estimation.

2003 THE DECLINE IN HEALTH INSURANCE
When families and singles data are subdivided
into two groups: those with insurance and those
without, a number of features emerge. One striking
feature is the low incidence of coverage of lone
parent families compared with families composed
of two adults with children. Another feature is the
strong (and expected) positive association between
private health insurance coverage and income,
especially among families. In 1989 the average
total income of head and partner was about
$57 000 for those with insurance, and $37 000 for
those without; in 1995 the corresponding figures
were $63 000 and $41 000 (all in 1995 $).
Of the health risk behaviours examined here, one
feature stands out: the remarkably high propor-
tions of singles and families who were current
smokers and who were not covered by insurance.
The apparent relationship between smoking and
fund membership runs counter to the adverse
selection hypothesis. Rather, the evidence from
this and other health related activities (drinking
and exercise) reflects an individual’s attitude towards
risk, with those who are more risk-averse also being
most likely to purchase private health insurance.
While these bivariate comparisons are useful, it
is obvious that potentially important influences on
the decision to purchase health insurance such as
income, age and health behaviours are interrelated.
An advantage of the multivariate probit analysis
that follows is the ability to examine the contribu-
tion of a single determinant while controlling for
the influences of the others.
(ii) Probit Analysis
Sample of single adults
Estimation results for the samples of single adults
are presented in Table 3. To aid interpretation, the
estimated marginal effects of the variables on the
probability of purchasing private insurance (and
the asymptotic standard error of the marginal
effects) are presented. The model specification is
based on that used by Cameron and Trivedi (1991)
augmented with a comprehensive set of measures
of individuals’ health status and health risk
behaviours. The results for 1989 show that, other
things equal, individuals who are female, never
married, and Australian born were significantly
more likely to purchase insurance. Not surprisingly,
if an individual has a government health card, he/
she is substantially less likely to purchase private
insurance. Consistent with the results of Cameron
and Trivedi (1991) and other researchers, income
is a very important determinant of the demand for
285
health insurance. For example, the estimates imply
that, relative to an individual with an income of
$23 000 (approximately the sample average), an
otherwise identical individual with $69 000 income
was 18 per cent more likely to purchase insurance.
However, the positive marginal effect of income on
the probability of insurance coverage declines as
income increases.
After controlling for demographic and socio-
economic factors there is significant variation in
insurance coverage across the states and territories,
with the highest incidence in South Australia and the
Northern Territory, and the lowest in Queensland.
This regional variation may, in part, be due to vari-
ation in the price of insurance across the states
and territories,11 as well as stated-based differences
in institutional features such as South Australia’s
history of no ‘gap’ payments for hospital services,
Queensland’s history of free access to public hos-
pital care and state-based differences in the quality
of public hospital care (such as the well-publicised
length of waiting lists for elective procedures). Age
is also clearly a strong determinant of insurance
coverage. There is a progressive increase in the
probability of insurance coverage with age. For
instance, individuals aged 20–24 years are 35 per
cent less likely to purchase health insurance com-
pared to an otherwise identical individual aged
over 70 years.
The likelihood ratio test statistic for the null
hypothesis that the set of health status and health
risk indicators are jointly insignificant is 194.2
leading to the strong rejection of the null.12 Collec-
tively, the health status/health risk activity vari-
ables are significantly related to the decision to
purchase insurance even after controlling for the
demographic and socioeconomic characteristics.
However the three specific health conditions exam-
ined were not individually significant in explaining
the decision to take out private insurance. The
numbers of recent and chronic conditions were
found to be statistically significant. In particular,
having an additional recent condition is associated
with an increase of 1.6 per cent in the likelihood
of having health insurance. Individuals who report
their SAHS to be poor or fair were significantly
11
However, variation in the pattern of coverage across
states is only weakly correlated with variation in the
price of insurance (as presented by Butler 1999) across
states.
12
The test statistic is distributed χ 2 with 15 degrees
of freedom. The critical value at the 1 per cent level of
significance is 30.58.
286 ECONOMIC RECORD SEPTEMBER

Table 2
Summary Statistics Describing Personal Characteristics by Insurance Status for Families

1989 1995

Explanatory Variables All Insured Uninsured All Insured Uninsured

Private (Hospital) Insurance 0.5195 1.0000 0.0000 0.4081 1.0000 0.0000

Single Parent 0.0898 0.0355 0.1484 0.0933 0.0282 0.1382
Number of Children 1.1026 1.0733 1.1343 1.0559 0.9890 1.1020
Child Aged < 5 Years 0.3089 0.2919 0.3272 0.2857 0.2236 0.3285
Family Size 3.0128 3.0378 2.9858 2.9626 2.9608 2.9638
Ave No. Recent Children’s Conditions 0.7031 0.7201 0.6847 0.6137 0.6355 0.5987
Ave No. Chronic Children’s Conditions 0.3272 0.3372 0.3164 0.4116 0.4113 0.4119
Government Health Card Holder 0.2772 0.1415 0.4239 0.3570 0.1925 0.4705
Immigrant – Head 0.3145 0.2657 0.3673 0.3054 0.2333 0.3552
Head Income ($10 000) 3.2819 3.9484 2.5614 3.2949 4.2974 2.6037
Partner Income ($10 000) 1.4627 1.7347 1.1685 1.7287 2.0108 1.5342
Age: Head 45.502 46.154 44.797 46.383 49.298 44.373
Age: Partner 39.593 42.015 36.974 40.732 45.599 37.378
State
NSW† 0.3395 0.3578 0.3197 0.3389 0.3431 0.3360
Vic. 0.2569 0.2745 0.2377 0.2449 0.2431 0.2461
Qld 0.1672 0.1249 0.2129 0.1797 0.1768 0.1818
SA 0.0902 0.0934 0.0866 0.0849 0.0838 0.0856
WA 0.0958 0.0966 0.0950 0.1000 0.1027 0.0981
Tas. 0.0274 0.0290 0.0256 0.0265 0.0270 0.0261
ACT 0.0155 0.0165 0.0143 0.0107 0.0092 0.0118
NT 0.0076 0.0071 0.0082 0.0144 0.0143 0.0145
Education: Head
High School† 0.4536 0.3874 0.5251 0.4566 0.3637 0.5207
Post Secondary Qualification 0.4342 0.4568 0.4098 0.4022 0.4220 0.3885
Degree 0.1122 0.1558 0.0651 0.1363 0.2097 0.0858
Left School by Age 15 Years 0.2316 0.1800 0.2874 0.1931 0.1559 0.2187
Labour Force Status: Head
Employed† 0.7269 0.8200 0.6263 0.6859 0.7721 0.6265
Unemployed 0.0380 0.0131 0.0649 0.0421 0.0110 0.0635
Not in the Labour Force 0.2351 0.1668 0.3088 0.2720 0.2169 0.3100
Specific Health Conditions: Head
Diabetes 0.0267 0.0246 0.0290 0.0309 0.0263 0.0341
High Blood Pressure 0.1885 0.1940 0.1826 0.1479 0.1669 0.1347
High Cholesterol 0.1271 0.1520 0.1001 0.0867 0.1072 0.0725
Number of Recent Conditions 1.5828 1.5486 1.6198 1.6853 1.7679 1.6283
Number of Chronic Conditions 1.7970 1.8170 1.7754 2.5019 2.6835 2.3767
Self-Assessed Health Status: Head
Poor 0.0471 0.0274 0.0684 0.0404 0.0203 0.0543
Fair 0.1581 0.1294 0.1891 0.1235 0.0841 0.1507
Good/Excellent† 0.7948 0.8432 0.7425 0.8360 0.8956 0.7950
Drinking: Head
Low Risk Drinker† 0.9206 0.9227 0.9184 0.9074 0.9074 0.9074
Medium Risk Drinker 0.0439 0.0442 0.0435 0.0532 0.0607 0.0480
High Risk Drinker 0.0355 0.0331 0.0381 0.0394 0.0320 0.0446
Smoking: Head
Never Smoked† 0.3630 0.4183 0.3032 0.3660 0.4337 0.3194
Ex-Smoker 0.3285 0.3474 0.3081 0.3730 0.4114 0.3465
Current Smoker 0.3085 0.2344 0.3887 0.2610 0.1549 0.3342
Weight: Head
Underweight 0.0562 0.0339 0.0803 0.0490 0.0222 0.0675
Acceptable Weight† 0.4505 0.4465 0.4549 0.4075 0.3937 0.4171
Overweight 0.4933 0.5196 0.4648 0.5435 0.5841 0.5155
2003 THE DECLINE IN HEALTH INSURANCE 287

Table 2
Continued

1989 1995

Explanatory Variables All Insured Uninsured All Insured Uninsured

Exercise: Head
Low Exercise 0.6919 0.6750 0.7102 0.6868 0.6467 0.7145
Moderate Exercise† 0.1486 0.1547 0.1421 0.1585 0.1858 0.1397
Vigorous Exercise 0.1594 0.1703 0.1477 0.1547 0.1676 0.1459
Education: Partner
High School† 0.5512 0.5299 0.5741 0.5558 0.5196 0.5808
Post Secondary Qualification 0.2864 0.3410 0.2275 0.2458 0.3015 0.2074
Degree 0.0588 0.0809 0.0349 0.1024 0.1472 0.0715
Left School by Age 15 Years 0.1911 0.1571 0.2278 0.1621 0.1332 0.1820
Labour Force Status: Partner
Employed† 0.4610 0.5483 0.3666 0.4820 0.5827 0.4125
Unemployed 0.0348 0.0255 0.0448 0.0206 0.0075 0.0296
Not in the Labour Force 0.4144 0.3906 0.4402 0.4041 0.3816 0.4196
Specific Health Conditions: Partner
Diabetes 0.0204 0.0165 0.0245 0.0263 0.0206 0.0301
High Blood Pressure 0.2018 0.2044 0.1990 0.1331 0.1520 0.1200
High Cholesterol 0.0957 0.1029 0.0878 0.0636 0.0738 0.0566
Number of Recent Conditions 1.8085 1.9529 1.6525 1.9263 2.2078 1.7322
Number of Chronic Conditions 1.7045 1.8426 1.5552 2.4057 2.6946 2.2066
Self-Assessed Health Status: Partner
Poor 0.0333 0.0283 0.0387 0.0307 0.0281 0.0325
Fair 0.1432 0.1259 0.1620 0.1102 0.0824 0.1293
Good/Excellent† 0.7328 0.8103 0.6490 0.7658 0.8613 0.6999
Drinking: Partner
Low Risk Drinker† 0.8285 0.8804 0.7725 0.8592 0.9055 0.8274
Medium Risk Drinker 0.0595 0.0610 0.0579 0.0381 0.0532 0.0277
High Risk Drinker 0.0222 0.0230 0.0212 0.0093 0.0131 0.0067
Smoking: Partner
Never Smoked† 0.5324 0.6075 0.4513 0.5305 0.6239 0.4661
Ex-Smoker 0.1782 0.1962 0.1586 0.2161 0.2440 0.1969
Current Smoker 0.1996 0.1607 0.2417 0.1600 0.1039 0.1987
Weight: Partner
Underweight 0.1372 0.1384 0.1360 0.1045 0.1070 0.1028
Acceptable Weight† 0.4526 0.5045 0.3964 0.4277 0.4822 0.3900
Overweight 0.3204 0.3215 0.3192 0.3745 0.3826 0.3689
Exercise: Partner
Low Exercise 0.6896 0.7247 0.6517 0.6931 0.7198 0.6748
Moderate Exercise† 0.1276 0.1378 0.1166 0.1340 0.1506 0.1226
Vigorous Exercise 0.0930 0.1020 0.0833 0.0795 0.1014 0.0644
Observations 13 274 6 965 6 309 6 565 2 698 3 867

† Indicates the omitted (reference) category in the estimation.

less likely, other things equal, to purchase private
insurance compared to those who assessed their
health to be good or excellent. The estimated impact
of SAHS is counter to that implied by adverse
selection, and may reflect strategic behaviour by
individuals with poorer SAHS to rely upon Medi-
care services or perhaps the variables capture a
non-linearity in the effect of income.
Turning to health risk behaviours, high risk
drinkers were significantly less likely to purchase
insurance. There was a very strong relationship
between smoking status and private insurance
coverage. Current smokers were 12 per cent less
likely, and ex-smokers 4 per cent less likely, to have
private insurance than non-smokers, other things
being equal. The relationship between insurance
288 ECONOMIC RECORD SEPTEMBER

Table 3
Marginal Effects of Covariates on Probability of Private Health Insurance Coverage, Single Men and Women

Coefficient (Standard Error)

1989 1995

Female 0.0798 (0.0125) 0.0812 (0.0155)

Single, Previously Married −0.0800 (0.0158) −0.0784 (0.0191)
Immigrant −0.1055 (0.0117) −0.0663 (0.0145)
Government Health Card Holder −0.2090 (0.0205) −0.1336 (0.0272)
Income ($10 000) 0.0549 (0.0071) 0.0449 (0.0086)
Income† −0.0034 (0.0009) −0.0026 (0.0007)
State
Vic. 0.0500 (0.0132) 0.0760 (0.0184)
Qld −0.0906 (0.0146) 0.0395 (0.0204)
SA 0.0901 (0.0211) 0.1544 (0.0307)
WA 0.0317 (0.0194) 0.0737 (0.0286)
Tas. 0.0112 (0.0349) 0.1085 (0.0502)
ACT −0.0684 (0.0394) 0.0061 (0.0742)
NT 0.1343 (0.0557) −0.0314 (0.0463)
Age
20 –24 Years −0.1203 (0.0247) −0.1637 (0.0238)
25–29 Years −0.1521 (0.0229) −0.1406 (0.0230)
30–34 Years −0.1282 (0.0250) −0.1118 (0.0262)
35–39 Years −0.0753 (0.0293) −0.0714 (0.0308)
45– 49 Years −0.0006 (0.0344) −0.0346 (0.0359)
50–54 Years 0.0978 (0.0379) 0.0285 (0.0454)
55–59 Years 0.1384 (0.0390) 0.0595 (0.0498)
60– 64 Years 0.2124 (0.0397) 0.1756 (0.0577)
65– 69 Years 0.2070 (0.0429) 0.1898 (0.0607)
70+ Years 0.2301 (0.0381) 0.2424 (0.0529)
Specific Health Conditions
Diabetes −0.0454 (0.0325) 0.0097 (0.0345)
High Blood Pressure −0.0247 (0.0144) 0.0147 (0.0197)
High Cholesterol 0.0034 (0.0192) 0.0112 (0.0275)
No. Recent Conditions 0.0165 (0.0041) 0.0185 (0.0049)
No. Chronic Conditions 0.0162 (0.0042) 0.0103 (0.0047)
Self-Assessed Health Status
Poor −0.0646 (0.0239) −0.0435 (0.0277)
Fair −0.0352 (0.0145) −0.0297 (0.0197)
Health Risk Behaviours:
Drinking
Medium Risk Drinker −0.0170 (0.0187) 0.0207 (0.0289)
High Risk Drinker −0.0501 (0.0211) 0.0850 (0.0392)
Smoking
Ex-Smoker −0.0415 (0.0138) −0.0716 (0.0147)
Current Smoker −0.1179 (0.0116) −0.1247 (0.0142)
Weight
Underweight −0.0337 (0.0155) 0.0278 (0.0225)
Overweight 0.0182 (0.0114) 0.0132 (0.0143)
Exercise
Low Exercise 0.0037 (0.0141) 0.0061 (0.0180)
High Exercise −0.0065 (0.0170) −0.0286 (0.0214)
LLF −5 431.5 −2 154.4
Pseudo R2 0.1502 0.1767

† Income is measured in deviations from the sample mean.

The models also included controls for education, main source of income, labour force status, occupation and full-time/part-time status.
2003 THE DECLINE IN HEALTH INSURANCE
coverage and body mass is more mixed, since
individuals who are underweight are less likely to
purchase insurance while those who are over-
weight are more likely to have private insurance.
Exercise however, as an indicator of health risk, is
not significantly associated with the decision to
purchase private insurance. Overall, it may be con-
cluded that the evidence regarding health risk
factors does not support adverse selection but the
opposite: individuals who have healthier risk
behaviour are the ones most likely to purchase
insurance. These results imply that an important
element in the decision to purchase insurance is
simply risk aversion, with the more risk averse
adopting less risky behaviours and taking out private
insurance.
Model 2 duplicates model 1 for the 1995 sample.
Wald tests reject the hypothesis that the vector
of coefficient estimates are equal in the two sample
years. Comparing estimates across the columns, an
important difference between the estimates for
1995 and 1989 is the reduced importance of having
a government health card (coinciding with an increase
in the incidence of possessing a health card) and
income in determining insurance status. Further
investigation of the decline in the estimated
impact of income on the decision to purchase
insurance reveals a very substantial decline in
insurance coverage among single men and women
in the highest income bracket (income over
$75 000). This suggests that the smaller income
elasticity of demand for health insurance of single
men and women in 1995 is mainly due to those in
the highest income group deciding to self-insure.
Results for the 1995 sample also highlight
important regional differences in the change in pri-
vate insurance coverage over time. By 1995 single
adults in Queensland were as likely as otherwise
identical men and women in New South Wales,
Western Australia and the territories to purchase
private insurance. South Australia and Tasmania
had significantly smaller declines in the probability
of taking out private insurance, and hence a greater
likelihood of having private insurance in 1995. The
decline in the probability of coverage in most
states and territories may represent the natural
evolution of the health insurance markets under
Medicare toward the situation in Queensland where
there has been a long tradition of free public hos-
pital care. The state dummy variables also capture
the impact of variation in the price of insurance
across the regions, and so state-specific trends in
price (or product quality) may also be reflected in
the estimated coefficients for state of residence.
289
There are also significant differences in the esti-
mated relationship between age and the probability
of buying private health insurance. In particular,
there is a positive monotonic relationship between
age and the probability of insurance coverage,
though the gradient of the relationship was lower
in 1995 than in 1989 for those aged more than
49 years. Nevertheless, in both years the pattern is
consistent and pronounced: relative to the omitted
age group (age 40–44 years), it was significantly
less probable for those in younger age groups to
purchase insurance; more strongly, for those in
older age groups, particularly those older than
54 years, the contrary was true. An implication of
these estimates is that the aggregate decline in
cover over time cannot simply be explained by the
reluctance of the most recent birth cohorts to pur-
chase private insurance.
The estimated impact of several health indicators
proved to be robust over the data period. These
factors were the positive effect of the number of
health conditions on the likelihood of purchasing
private insurance, and the negative estimated rela-
tionship between current smoker status and the
likelihood of purchasing private insurance. How-
ever, the negative relationship between two health
risks (drinking and body mass) and insurance
coverage were no longer significant. In all, the
estimates indicate that over the period 1989–95 the
positive association between several health risk
and status variables (age, specific health condi-
tions) and the probability of insurance coverage
was more pronounced, while the negative associ-
ation between other health risk behaviours and
insurance coverage (risk-seeking) was less evident,
which suggests that the degree of adverse selection
in the pool of privately insured single adults
increased over time.
Sample of families
The model estimates for the sample of families
are presented in Table 4. Focusing on the results
for 1989, the estimates show that lone parent
families are substantially less likely to purchase
private insurance than families of two adults (with
or without) dependent children. Rather than the
total number of children per se, it is the presence
of young children (aged less than 5 years), and the
average number of recent health conditions of
children, that is important in explaining the
decision by families to purchase insurance. If an
adult has a health card then the family is much
less likely to have private insurance, other things
equal.
290 ECONOMIC RECORD SEPTEMBER

Table 4
Marginal Effects of Covariates on Probability of Private Health Insurance Coverage, Families

Coefficient (Standard Error)

1989 1995

Married without Children −0.0360 (0.0226) −0.0701 (0.0304)

Single Parent −0.1182 (0.0530) −0.1088 (0.0623)
Number of Children −0.0125 (0.0076) −0.0221 (0.0111)
Child Aged < 5 0.0377 (0.0110) 0.0438 (0.0158)
Ave No. Recent Children’s Conditions 0.0191 (0.0071) 0.0195 (0.0098)
Ave No. Chronic Children’s Conditions 0.0064 (0.0096) 0.0035 (0.0111)
Government Health Card Holder −0.2033 (0.0173) −0.1381 (0.0241)
Immigrant: Head −0.0901 (0.0130) −0.0981 (0.0171)
Immigrant: Partner −0.1090 (0.0136) −0.1131 (0.0175)
Income
Head ($10 000) 0.0591 (0.0047) 0.0409 (0.0065)
Head† −0.0056 (0.0007) −0.0020 (0.0006)
Partner ($10 000) 0.0174 (0.0077) 0.0160 (0.0095)
Partner† −0.0020 (0.0011) −0.0001 (0.0008)
State
Vic. 0.0284 (0.0132) 0.0292 (0.0225)
Qld −0.1664 (0.0156) −0.0083 (0.0261)
SA 0.0523 (0.0179) 0.0535 (0.0249)
WA −0.0025 (0.0178) 0.0362 (0.0282)
Tas. 0.0202 (0.0199) 0.0464 (0.0365)
ACT −0.0941 (0.0371) 0.0504 (0.0328)
NT −0.0211 (0.0632) −0.0778 (0.0287)
Age: Head
20–24 Years −0.2085 (0.0375) −0.1477 (0.0486)
25–29 Years −0.1125 (0.0274) −0.0903 (0.0378)
30–34 Years −0.0551 (0.0235) −0.0532 (0.0315)
35–39 Years −0.0458 (0.0197) −0.0431 (0.0265)
45–49 Years 0.0093 (0.0216) 0.0709 (0.0293)
50–54 Years 0.0398 (0.0268) 0.1666 (0.0374)
55–59 Years 0.0520 (0.0327) 0.1767 (0.0460)
60–64 Years 0.1081 (0.0375) 0.2262 (0.0545)
65–69 Years 0.1018 (0.0450) 0.3003 (0.0629)
70+ Years 0.1076 (0.0481) 0.3190 (0.0662)
Specific Health Conditions: Head
Diabetes 0.0187 (0.0311) −0.0215 (0.0417)
High Blood Pressure 0.0218 (0.0139) 0.0263 (0.0228)
High Cholesterol 0.0615 (0.0154) 0.0282 (0.0262)
Number of Recent Conditions 0.0026 (0.0044) 0.0080 (0.0058)
Number of Chronic Conditions 0.0050 (0.0041) 0.0077 (0.0052)
Self-Assessed Health Status: Head
Poor −0.0740 (0.0267) −0.1274 (0.0367)
Fair −0.0220 (0.0149) −0.0971 (0.0223)
Drinking: Head
Medium Risk Drinker −0.0078 (0.0246) 0.0063 (0.0309)
High Risk Drinker −0.0490 (0.0269) −0.0412 (0.0355)
Smoking: Head
Ex-Smoker −0.0242 (0.0122) −0.0466 (0.0160)
Current Smoker −0.0725 (0.0128) −0.1033 (0.0182)
Weight: Head
Underweight −0.0634 (0.0243) −0.0361 (0.0371)
Overweight 0.0330 (0.0106) 0.0265 (0.0143)
Exercise: Head
Low Exercise −0.0637 (0.0234) −0.0574 (0.0193)
Vigorous Exercise 0.0306 (0.0103) −0.0127 (0.0240)
2003 THE DECLINE IN HEALTH INSURANCE 291

Table 4
Continued

Coefficient (Standard Error)

1989 1995

Age: Partner
20–24 Years −0.1084 (0.0356) −0.1352 (0.0448)
25–29 Years −0.0601 (0.0282) −0.1193 (0.0354)
30–34 Years −0.0267 (0.0247) −0.0463 (0.0328)
35–39 Years −0.0334 (0.0217) 0.0017 (0.0290)
45– 49 Years 0.0264 (0.0239) 0.0201 (0.0307)
50–54 Years 0.0477 (0.0308) −0.0046 (0.0389)
55–59 Years 0.0597 (0.0372) 0.1757 (0.0509)
60–64 Years 0.1214 (0.0401) 0.1435 (0.0602)
65–69 Years 0.0928 (0.0459) 0.1424 (0.0675)
70+ Years 0.0653 (0.0504) 0.0949 (0.0728)
Specific Health Conditions: Partner
Diabetes −0.0986 (0.0353) −0.0430 (0.0436)
High Blood Pressure −0.0160 (0.0134) 0.0055 (0.0239)
High Cholesterol 0.0126 (0.0177) 0.0134 (0.0302)
Number of Recent Conditions 0.0140 (0.0042) 0.0167 (0.0056)
Number of Chronic Conditions 0.0073 (0.0041) 0.0014 (0.0052)
Self-Assessed Health Status: Partner
Poor 0.0196 (0.0290) 0.0108 (0.0445)
Fair −0.0233 (0.0153) −0.0821 (0.0234)
Drinking: Partner
Medium Risk Drinker −0.0688 (0.0208) 0.0167 (0.0363)
High Risk Drinker −0.0180 (0.0338) 0.0913 (0.0737)
Smoking: Partner
Ex-Smoker −0.0243 (0.0134) −0.0199 (0.0170)
Current Smoker −0.1154 (0.0133) −0.1137 (0.0194)
Weight: Partner
Underweight −0.0188 (0.0151) 0.0083 (0.0240)
Overweight 0.0027 (0.0116) −0.0004 (0.0155)
Exercise: Partner
Low Exercise 0.0252 (0.0149) 0.0180 (0.0199)
Vigorous Exercise 0.0045 (0.0210) 0.0364 (0.0300)
LLF −7 106.28 −3 283.83
Pseudo R2 0.2263 0.2614

† ‘Head’ and ‘partner’ incomes are measured in deviations from their respective sample means.
The models also included separate controls for education, main source of income, labour force status, occupation and full-time/part-time
status of both the family ‘head’ and ‘partner’.

Income is a statistically and economically signi-
ficant determinant of coverage, and interestingly
head’s income is much more strongly associated
with the decision to purchase private insurance
than partner’s income. Consequently, it is not
simply total family income, but also whether the
income is received by the head or partner, that is
important to the insurance decision. Further, the
marginal effect of head’s income (and hence head
and partner income combined) on the probability
of purchasing private health insurance is stronger
than that found for single adults.
The pattern of coefficient estimates for the state
dummy variables mirrors that found for singles,
but the size of the marginal effects is larger for the
family samples. The positive, monotonic relation-
ship between the age of the family head on the
probability of coverage is similar to, though
stronger than that found for single adults in 1989.
The relationship between age of partner and the
292 ECONOMIC RECORD
probability of coverage is substantially weaker
than that found for head, though this may be
explained by the high correlation in head and
partner’s age and the importance of head’s age is
capturing part of the importance of partner’s age.
Overall, the pattern of coefficients for the other
socioeconomic characteristics is similar to that dis-
cussed above in relation to single adults.
Of the specific health conditions, the family
head having ‘high cholesterol’ and partner having
‘diabetes’ was significantly related to the pur-
chase of private insurance. The number of partner’s
recent conditions was positively related to the
demand for insurance. The point estimates suggest
that families headed by an individual who assesses
their own health status as ‘poor’ were less likely to
purchase insurance. Families headed by high risk
drinkers or where the partner is a ‘medium risk’
drinker were less likely to have private insurance.
More important quantitatively, is the smoking sta-
tus of the family head and partner. Families where
the head or partner are ex-smokers and especially
where they were current smokers, were substan-
tially less likely to have private insurance coverage.
Families headed by adults who are underweight
(overweight) were less (more) likely to have private
health cover, while exercise was found not to be
significantly correlated with the decision to purchase
private insurance, other things equal.
As found for single adults in 1989, there is
substantial heterogeneity in the pool of families
insured. The model estimates reveal that factors
associated with both bad health risks (reflecting
adverse selection) and good risks (reflecting risk
aversion) were important in determining the private
health insurance coverage of families. However,
comparing the estimates for the 1989 sample with
those for 1995 may reveal the degree to which
these separate factors became more or less pro-
nounced in determining the trend in insurance
coverage among families.
In comparing the models’ estimates across time,
a number of important differences are apparent.
First, the estimates show that families without chil-
dren were disproportionately likely to drop private
cover over the time period from 1989. The pres-
ence of a young child, and the average number of
recent conditions of dependent children continued
to be significantly associated with the decision by
families to purchase private insurance. Similarly,
an adult in the family having a government health
card was associated with a substantially lower
probability of having private health insurance,
other things equal. However, the magnitude of the
SEPTEMBER
marginal effect of holding a government health
card in 1995 was less than that found with the
1989 sample.
The responsiveness of the demand for health
insurance to income was clearly very important in
1995, but again, the magnitude of the marginal
effect of head and especially partner’s income (the
latter being insignificant in 1995) was less than
that found for 1989.
By 1995 most of the coefficients for the state of
residence variables were individually insignificant.
Thus, by 1995 most of the other states and territo-
ries of Australia converged toward the situation
observed in Queensland. Consistent with the find-
ings for single adults, the trend of declining private
hospital cover across most of Australia is again
generally consistent with a natural evolution of the
market for secondary hospital insurance under the
institutional arrangements of Medicare toward an
‘equilibrium’ represented by Queensland with its
unique institutional history of ‘free’ hospital care.
There are important differences in the pattern of
estimates for age of head and partner by sample
year. The age-probability-of-cover gradient was
steeper for both head of family and partner in
1995, and the former exceeds that found for single
adults. This steeper gradient implies an even
greater concentration of elderly people in the pool
of the privately insured and thus is indicative of a
greater degree of adverse selection in the insurance
market in 1995 compared to 1989.
Other significant differences in estimates across
the samples relate to the health factors. The three
specific health conditions were insignificant in
1995 in explaining the decision to purchase private
insurance. The number of recent conditions experi-
enced by the partner of the family head were
significantly and quantitatively more important in
1995. Coupled with the increase in the average
number of recent and chronic conditions reported
over the study period, this suggests a further dimen-
sion in which the degree of adverse selection in
the pool of the insured may have increased over
time as coverage has declined.
Moreover, the estimates for 1995 indicate that in
families where the head of family’s (or partner’s)
SAHS is fair or poor the likelihood of private
insurance coverage was lower . The smoking beha-
viour of the adults in the family was also signifi-
cantly related to the probability of purchasing
private insurance. Families where the head (part-
ner) currently smoked were 10 (11) percentage
points less likely to purchase health insurance than
an otherwise identical family where the head (or
2003 THE DECLINE IN HEALTH INSURANCE
partner) had never smoked. Again, smoking status
appears to be a robust indicator of an individual’s
attitude toward risk.
Overall, the changes in the demand for private
insurance among families between 1989 and 95
suggest a greater degree of adverse selection in the
pool of insured families. Given the decline in the
proportion of those covered by insurance, the like-
lihood of a family being covered in 1995 was more
strongly (and positively) correlated with the age of
head and partner, and number of partner’s recent
conditions. However, there were some countervail-
ing effects, with significant relationships between a
lack of private cover and the family head or part-
ner being a smoker, or assessing their own health
as relatively poor or fair. In the next section we
assess whether the net effect of these changes
was to increase or decrease the concentration of
‘high health risks’ within the pool of the privately
insured.
(iii) Testing for an Adverse Selection Spiral
The analysis has so far considered multiple
dimensions of individual (and family) health risks
and hence of the ‘insurance risk’ they pose to private
health funds. Along several important dimensions,
there is a stronger positive association between the
health risk and the likelihood of holding insurance,
while on other dimensions, that association is
either weaker or in fact negative. In this section we
attempt to assess whether, on balance across these
various dimensions, the net ‘insurance risk’ posed
by the insured has increased or decreased over
time. In this way, we seek to test whether there is
evidence of an adverse selection spiral underlying
the falling demand for private health insurance
over the period 1989–95.
To test for an ‘adverse selection’ spiral, the
probit model estimates were used to predict the
probability of private health insurance coverage.
We focus on the 1995 sample and calculate the pre-
dicted probability of coverage using the coeffi-
cients estimated with the 1989 sample and 1995
sample, respectively.13 By using the 1989 coeffi-
cients, we construct a counterfactual pool of the
insured which would have resulted if consumers
in 1995 had behaved in the same manner as the
consumers did in 1989. This counterfactual is then
compared to the predicted probability of coverage
13
By concentrating on the 1995 sample we do not
have to consider the effect of changing population
demographics, allowing us to isolate the effect of
changing behaviour on the pattern of insurance coverage.
293
in 1995 based on the 1995 coefficients, which
reflects the observed behaviour in 1995. The 95
per cent confidence interval for the mean pre-
dicted level of insurance coverage in 1995,14 using
the 1989 and 1995 coefficients, is plotted against
age in Figures 1 and 2 for the Single and Family
samples, respectively. Age (or age of family ‘head’)
is shown on the horizontal axis since age is readily
observable and strongly correlated with health
status and expected medical costs.15 The decline in
insurance coverage over time implies that the mean
predicted probability of coverage based on the
1989 coefficients will in general be higher than
that based on the 1995 coefficients. If the decline
in coverage was uncorrelated with insurance risk
then the decline will be uniform across all age groups,
and the two profiles should be approximately
parallel. Alternatively, if the lower insurance risks
were disproportionately likely to drop cover, then
the decline in the mean predicted probability of
cover would be greatest among the younger age
groups and least among the elderly.16
Figures 1 and 2 clearly show that the decline
in coverage was most concentrated among the
younger age groups. The tightness of the confi-
dence intervals indicates that the differences in the
mean predicted levels of insurance coverage are
statistically significant for almost every age group.
For singles, if the demand for private health insur-
ance had remained stable over the period 1989–95,
a much larger fraction of the young and middle
age groups (ages 20–49) is predicted to take out
private cover than actually did, while coverage
among the oldest (ages 70+) is predicted to be
slightly less than the coverage observed in 1995.
Figure 2, for families, shows an even more pro-
nounced decline in cover among the low cost
(younger) insurance risks. Comparing the predicted
probabilities of cover by age group shows the
increasing probability of cover with age until the
mid-50 s, then a decline in the probability of cover
with age which eventually plateaus around age 65
(the age of eligibility, for males, for the Age Pen-
sion in Australia, which includes access to a health
concession card). From Figure 2, it is apparent that
the counterfactual predicted probability of cover
14
To construct the confidence interval, the standard
error of the mean predicted level of coverage was
calculated using the delta method (Greene 1997, p. 124).
15
Note, though, that the predicted probabilities do
take account of all the available characteristics of the
individual income units.
16
We thank Colin Cameron for suggesting this test.
294 ECONOMIC RECORD SEPTEMBER

Figure 1
Predicted Pr(PHI = 1) Singles, 1995

(which assumes the demand for insurance is stable
over time) is much higher for the youngest age
groups (20 – 44 years of age), moderately higher for
middle age groups and marginally lower for the
oldest groups (aged 65+ years). Overall, there is
unequivocal evidence that over the 1989–95 period
those individuals and families who represented
better insurance risks (from the point of view of
insurers), based on observable and unobservable
attributes, were most likely to quit the pool of the
insured. On this basis, at least part of the decline
in insurance coverage between 1989 and 95 repre-
sents an ‘adverse selection spiral’. Nevertheless,
the population of the insured in 1995 remained
heterogeneous, and included both good and bad
risks, therefore it is unlikely that the declining
‘quality’ of the pool of the insured alone can
account for the decline in health fund membership.
VII Conclusion
At any time the composition of health fund
membership comprises a mix of low and high cost
health risks. The former is consistent with risk-
averse preferences; the latter, the presence of
adverse selection. The empirical results of this
paper reflect this mix.
For singles the significance of age and the
number of health conditions that characterised
fund membership in 1989 is indicative of adverse
selection. But there were contrary indications as
well. The health status and health risk indicators
generated estimates contrary to the hypothesis of
adverse selection in the decision to take out private
insurance. Those with worse (self-assessed) health,
risky drinking behaviour and who smoked were all
less likely to purchase health insurance than other-
wise identical individuals who did not have these
attributes. Thus, contrary to the adverse selection
hypothesis, these results suggest, all else equal,
that the pool of the insured represent better health
risks than the population at large. They imply that
a significant element in the decision to purchase
insurance is simply risk aversion, with the more
risk-averse adopting lower risk behaviours, of
2003 THE DECLINE IN HEALTH INSURANCE 295

Figure 2
Predicted Pr(PHI = 1) Families, 1995

which one is purchasing private health insurance.
Analysis of NHS95 indicated that over the period
1989–95 the positive association between several
health risk and status variables (age, and specific
health conditions) and the probability of insurance
coverage was more pronounced, while the negative
association between other health risk behaviours
and insurance coverage was less evident. On bal-
ance, it was found that the degree of adverse selec-
tion in the pool of privately insured single adults
increased over time.
Changes in the demand for private insurance
among families between 1989 and 95 also suggest
an increasing degree of adverse selection in the
pool of the insured. Given the decline in the pro-
portion of those covered by insurance over the
period, the likelihood of a family being covered in
1995 was more strongly (and positively) correlated
with the age, and number of recent health condi-
tions of the partner. Counteracting these effects
were significant relationships between a lack of
private cover and the adult members of the family
being a high-risk drinker and/or smoker, and/or
assessing his/her own health as relatively fair or
poor. Again, on balance it is found that the degree
of adverse selection increased over time.
This study has looked at the determinants of the
decision to take out private health insurance and
how their importance changed over time. There are
many questions still to be answered. What is the
prevalence of ‘hit and run’ and ‘hit and stay’ member-
ship? The former is temporary membership by
those anticipating/planning a medical procedure;
the latter, membership by those reaching (older)
age groups where there is an increasing likelihood
of the need for medical care. Both of these are
manifestations of moral hazard. Related to this,
what determines the duration of fund membership,
and what is the prevalence of the ‘churning’ in the
market? How common is switching between funds
and what are the determinants of such behaviour?
What are the implications for private health insurers
of the decline in fund membership due to the
exit of long-term members and the increasing
296 ECONOMIC RECORD
importance of demographic groups that have rarely
had private cover (e.g. younger age groups, immigrants).
With access to appropriate data, policy evalua-
tions may also be conducted to determine respon-
siveness of demand for insurance to a broad range
of factors (including tax and price incentives). Given
the coalition government’s commitment to private
health insurance shown by the magnitude of subsidies
it currently provides for private cover ($2–3 billion
each year), it would be useful to know just how
effective the subsidies have been and the respon-
siveness of consumers and potential consumers of
insurance to changes in the policy regime.
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