Check-up time for Southern Cross

Many of the things that make Southern Cross special would disappear if it ever became a for-profit organisation the chairman, Graeme Hawkins, has argued. Photo / Thinkstock

New Zealand's biggest health insurer faces some weighty issues as it begins its second half-century, reports Karyn Scherer.

On Tuesday morning, a few hundred people will make their way to the Ellerslie Event Centre in Auckland's leafy eastern suburbs, for the annual get-together of the Southern Cross Health Society.

Like most large AGMs, it's likely to be a fairly sedate affair, attended mostly by superannuitants and those with nothing more important to do at 10am, with less than three weeks until Christmas.

But there is also a distinct possibility that this year's meeting of our largest private health insurer could prove more memorable than most, with crucial issues up for debate which will potentially affect the lives of more than 800,000 New Zealanders.

As it happens, this year is the 50th anniversary of the founding of Southern Cross. And on the face of it, the "friendly society" appears to be facing middle age in pretty good shape.

In the year to June, its members handed over more than $662 million in premiums, and claimed back just $577 million in healthcare costs - allowing the society to declare a surplus of just over $28 million, after absorbing other expenses.

A surplus is necessary to ensure the society maintains sufficiently large reserves to smooth the bad years, and to provide a buffer in case of any unusual circumstances. In 2009 and 2010, those reserves proved their worth.

Higher than expected costs led to a deficit two years in a row, prompting the board to dip into the reserves to help keep premiums down. But some members have begun grumbling that premiums are still too high, particularly for older members, and are questioning whether the board is being as prudent as it claims.

At next week's meeting, high-profile Auckland accountant Bruce Sheppard intends to force the issue, after succeeding in placing several items on the agenda that question fundamental management strategies.

Sheppard believes the board spends too much on marketing, and that there are signs of "gold plating" with its new head office at Britomart. He is also keen for the board to re-examine ways of reducing premiums for long-term members and to rethink its affiliated provider programme, which strikes fixed-price deals with preferred service providers.

Auckland real estate agent Michael Pinkney is also keen for the board to investigate a major restructuring, which some believe could lead to the organisation becoming a takeover target.

And another disgruntled member, Kerikeri businessman Robert Sintes, is determined to kick up a stink about what he claims is the board's blatant disregard for democratic principles in its governance.

As if that is not enough, rising healthcare costs, an ageing population, and a trend for members to downgrade to much cheaper policies mean there are questions over the organisation's long-term future. And hovering in the background is Australia's largest health insurer, Medibank, which has made it all too clear that it wouldn't mind being a part of the answer.

For that to happen, Southern Cross would almost certainly have to demutualise - in other words, transform from a co-operative owned by its members to a registered company.

Many members seem to be under the misapprehension that if that were to happen, they would receive a generous windfall. But in fact, if the society were dissolved tomorrow, its hundreds of millions of dollars worth of reserves would be distributed to various trusts and charities.

"Someone has stumbled across the fact that the reserves don't belong to members and raised the question whether they should," explains chairman Graeme Hawkins.

It is not demutualisation itself that will be discussed at next week's meeting, he insists. However, the ownership of its assets does need to be resolved, so the board is open to investigating the matter, he says.

"It will take a bit of money to do this because it's quite complicated technically and legally ... but if members want to spend their money - and it is their money - then we're happy to look at it."

Fittingly, from his soon-to-be-vacated office in the AMP Centre in Auckland's CBD, Hawkins looks down on Southern Cross' next biggest rival, Tower.

There are more than 10 players in health insurance in New Zealand, but the industry is dominated by Southern Cross, Tower, Sovereign and UniMed.

With around 61 per cent of the market, Southern Cross is the leader by far and remains fiercely proud of its not-for-profit status. That status, argues Hawkins, allows it to be more generous than its fully commercial rivals, and enabled it to fund 70 per cent of all health claims paid out by the industry in the past year.

In fact, Southern Cross has recently increased its market share, after a torrid period in the 80s where its members left in droves, spurred by higher premiums, a government decision to slap fringe benefit tax on employer contributions, and new rivals luring members away.

At its peak, more than 1.1 million New Zealanders belonged to the scheme, but these days membership has stabilised at around 835,000 - or so the society hopes. After steady increases last decade, numbers have dropped in the past couple of years. And many existing members have downgraded to surgical-only policies. Last year 25,000 members decided to downgrade and this year another 27,000 joined them.

Before he joined the Southern Cross board three years ago, Hawkins spent several decades in the commercial sector, including senior management roles at Fletcher Challenge and Dominion Breweries. He has previously sat on the board of Fonterra, was chairman of Auckland Healthcare (now the Auckland District Health Board), and remains a director of Ports of Auckland and Cavalier Corporation.

"From my point of view, the last couple of years have been the toughest I've ever seen in New Zealand business, quite frankly," he says. "I think it's amazing we've held on to the numbers we have, but a number of people have been downgrading ... Things really are tough out there for a lot of people."

At the same time, health insurers are coming under increasing pressure to fund more and more services. Three years ago, for example, Southern Cross agreed to provide radiation oncology as a private option - a service that was previously only available in the public sector.

"Last year that cost us $8 million from something that didn't exist and wasn't a burden on us two years ago. We have that debate every year about adding benefits."

One way he believes costs could be contained is through far more co-operation with the public system. His chief executive, Dr Ian McPherson, made the same argument in an article for the Herald last year.

In the article, McPherson argued that numerous reports had warned that New Zealand would not be able to maintain its current healthcare standards without rationing services, slashing other benefits, or increasing taxes. One of the answers, McPherson suggested, was following the British example of allowing private treatment centres to offer public services, such as common elective surgery and diagnostic procedures. He also made it clear that Southern Cross was keen to see parts of ACC opened to competition.

New Zealanders have always been wary of blurring the line between private and public healthcare but that has not deterred Southern Cross from experimenting with its own GP network.

The Southern Cross Health Trust, a separate entity to the society, has so far invested in two GP groups, in Silverdale and Queenstown, and is keen to add many more.

Ultimately, Hawkins confirms, the aim is to build up a critical mass of centres able to share common information systems, and to encourage GPs to be more innovative by offering a wider range of services, including minor surgery, much more cheaply than specialists.

"New Zealand is quite unique with its GP network. It's something a lot of other countries are very envious of," he suggests. "But although it's been theoretically talked about [extending GP services], it's never been used to its full extent."

As chief executive of the Health Funds Association of New Zealand, which represents almost all the country's health insurers, Roger Styles is paid to lobby the Government about such issues. And needless to say, he also frets about where the private sector is heading.

Last year private hospitals performed around 150,000 elective surgeries, Styles notes - around 20,000 more than public ones. That's an awful lot of pressure taken off the public system, he argues.

However he fears that pressure may build up again. Over the past three years the number of New Zealanders with health insurance has fallen by around 35,000 to just over 1.3 million people, or 31 per cent of the population. Of those, less than a third have comprehensive cover - well down on nearly two-thirds just a decade ago.

New Zealand still has very high coverage compared to most countries, given that we don't offer incentives or make it compulsory. However the private sector still accounts for just 19 per cent of total health spending in New Zealand - well below the OECD average of 28 per cent and even further behind Australia's 33 per cent.

This matters, because as the population ages, healthcare costs are expected to increase significantly, and the strain on the public purse could become intolerable, he argues. Even in the past few years, medical inflation has helped push up costs by an average of 9 per cent a year. While the Government has ploughed an extra $800 million or so into public healthcare each year for the past decade, it has made it clear it is not prepared to continue at that rate.

"It's actually a bigger issue in terms of public spending than the retirement age debate in terms of its impact on government finances," Styles argues. "The two certainties in the next two decades are that the retirement age will go up, and people will have to pay more for their healthcare."

While he acknowledges it is up to the Government to figure out what it wants to do, the association has naturally made some suggestions. It has been lobbying for a while now for tax rebates on superannuitants' health insurance premiums - a policy backed by United Future MP (and former Revenue Minister) Peter Dunne. It would also like to see fringe benefit tax taken off employer contributions.

The Ministry of Health is expected to complete a feasibility study into the former option within the next few months. The most optimistic outcome, Styles concedes, is that the Government will conclude that only those who are really struggling should qualify for rebates. And even that might be a tough ask in such straitened times.

Nevertheless, he believes politicians will eventually conclude they have no option but to persuade more people to take out insurance.

"We can either plan it ourselves or wait 10 years and have Standard & Poor's tell us what to do."

And once again, it seems, Australia is being held up as an example to follow.

"Australia is probably about 10 years ahead of where we could be," says Styles. "In the late 90s insurance there funded about $2 billion a year, and it was dropping in terms of the number of people covered. It got down to below where ours presently is - about 30 per cent or below. It looked like it was going to track down to 25 per cent coverage. When they introduced the universal rebate it just changed it dramatically. Now you've got over 50 per cent of Australia's population covered with health insurance, funding over $50 billion a year in health spending."

One aspect of the Australian system that no one in the industry here seems to mention, however, is the fact that it is heavily regulated, and required to operate on a "community rating" basis. This means all consumers pay the same premiums for the same policy, regardless of their age or health.

Southern Cross operated on the same basis until the turn of the century, but its rivals were not required to do the same and they began poaching its younger members by offering them cheaper premiums. So many were lured away that the society feared for its future, and decided to move to a "risk rating" model instead.

This means many premiums are now based on bands of people of a similar age and has meant a huge hike in premiums for its older, and often most loyal, members. This has caused much angst, as many can no longer afford to continue their insurance at the time they most need it - and some would say, deserve it.

While this undoubtedly helps keep premiums down for younger members, some question whether it is good or fair for society as a whole. After all, superannuation itself is based on exactly the same principle as community rating. Contrary to popular belief, NZ Super is not an opportunity to recoup all the taxes you have paid in your working life, as those taxes have already been spent. It is actually a tax on the young, paid to the old.

Southern Cross does offer corporate members a front-loaded plan called Activa, intended to help overcome this problem, but it hasn't proven wildly successful. Hawkins blames Kiwis' relaxed attitude to planning for the future.

"It's New Zealanders' attitude to saving," he harrumphs. "Why don't we save as a nation? Why do we have to have compulsory KiwiSaver?"

He dismisses the community rating issue, however, as a matter for the Government.

"I don't care which way they decide, but if I was a politician the thought of having younger people cross-subsidising older people, there are a number of issues I would have thought with that."

One of those issues, of course, is that demographic trends are not looking good for either NZ Super or health insurance. The same problem will also affect the latest proposal for a "loyalty discount" for Southern Cross members: in essence it is simply another name for cross-subsidisation of the old by the young, Hawkins argues.

Southern Cross, he notes, has already been there, done that. It will simply lead to more younger members leaving, he warns, which he does not believe is a sustainable trend.

Which may or may not bring us back to Medibank. Established in 1976, Medibank is owned by the Australian Government and has around 3.7 million members under two brands.

In 2006 the Liberal Government announced it would privatise Medibank if re-elected. It wasn't, and Labor policy was to keep it State-owned.

However the Rudd Government did change it from a not-for-profit organisation into a for-profit business.

This year Medibank began talking to Southern Cross about a potential takeover, which grew out of discussions over health management programmes. It was reported that the Southern Cross board rejected its offer, and refused to put the proposal to members because it did not believe it was in their interest.

Hawkins confirms the talks were "reasonably serious", but denies Medibank made a formal offer.

"It never quite got to an offer. We're good friends with Medibank, as we are with most other insurers around the world ... They wanted to talk about the possibility and we had those discussions, but it never progressed to the stage where we had an offer to put in front of members. It just sort of withered on the vine."

Others in the industry believe it is convenient that the issue of demutualisation has come up for discussion - albeit in a roundabout sort of way - given that demutualisation would probably need to be a precursor for any such deal to go ahead.

Hawkins insists that if the board received an offer "of a shape or form that looked as if it might fly" it would be happy to put it to members: "I think it depends how good the offer is."

But he also makes it clear some hard decisions would have to be made. For an offer to go ahead, members would almost certainly have to give up Southern Cross' not-for-profit status, he says, "with someone paying some money in some shape or form to either reduce premiums or get a holiday for a while."

As for the argument that it would be easier to raise capital as a company, than as a "friendly society", it is an issue with which he is all too familiar.

"I've been through this argument many, many times. It's some of the Fonterra argument as well: 'Get outside capital in and the world's rosy'. Well it ain't that easy and the people who put outside capital in want a return - they want their pound of flesh. That's the way the world works."

While he stresses that it's up to members to make up their own minds, it appears clear where his own beliefs lie. Commercial profits, he emphasises, have to come from somewhere: either lower costs, lower payouts, or higher premiums. And that will affect not just current members, but future members as well.

"If you take the argument that 'I want it to be around not just for my kids, but for my grandkids as well', if we become just another for-profit, a lot of the uniqueness of Southern Cross will have changed ... All our own origins and all our internal mechanisms are that not-for-profit is good as long as we don't get fat and lazy and take it for granted - and the market will tell us if that's the case real quick because our premiums will start to drift."

As for Bruce Sheppard's hints that the society could indeed be a little overweight, and could do with a bit more exercise, Hawkins concedes there is still some work to do in getting on top of the paper war.

In many cases the health sector has been particularly slow in joining the digital age, he agrees. But he insists he has been impressed at the society's overall efficiency.

"I expected to come in here and see a whole lot of cardigan-wearing people, like government departments, and look, it's not. I have been really surprised - pleasantly surprised - at how good it is.

"It's not perfect but it's pretty good and it's a pretty unique institution and it's been around a long, long time so we've got to make sure we don't stuff it up."