Private Health Insurance

Transcription

1 Asia Pacific/Australia Equity Research Health Insurance Research Analysts Andrew Adams andrew.adams@credit-suisse.com James Cordukes, CFA james.cordukes@credit-suisse.com Private Health Insurance COMMENT Structurally challenged Back to basics model: There are currently five regulatory reviews underway that affect the private health insurance industry (PHI). The reviews focus on affordability and the role of PHI within the national health system. These reviews will likely highlight that the PHI industry is not operating efficiently and is unsustainable under the current regulatory settings and community rating principle. We believe solving these structural challenges will require significant regulatory change. However, in this report we discuss two potential 'quick wins' which include a restriction on the number of policies to a small number of simplified and standard products and a rebalancing of PHI objectives between consumers and PHI funds through a reduction in industry excess capital through three years of minimal (2-3%) premium rate increases. Vicious cycle of policy 'innovation': In response to consumer concerns over affordability PHIs are creating policies with coverage exclusions at lower premiums. This policy discrimination ultimately undermines the community rating principle. The more policyholders who downgrade, the more the industry will need to increase premiums. We estimate that if policy downgrading continues the industry could require premium increases of ~10% p.a. to reflect ~6% claims inflation and a further ~4% to cover lost premiums from policy downgrades (net of reduced benefits). The industry needs to restrict the constant launch of new products and offer a small number of simplified and standardised products. Excess returns in a regulated protected environment: We estimate the PHI industry is carrying more than double the required capital (including buffers) and has $3.5bn of excess capital. Even carrying this excess capital the PHIs are earning an ROE of 17% which once excluded inflates the ROE to ~50%. Given PHI is a regulated industry a target ROE of ~12.5% is more appropriate (which is still above the 10% targeted by the CTP insurers). By lowering their target ROEs and reducing excess capital the industry could pass through premium rate increases of ~2.5% p.a. for three years, assisting to address the affordability concerns. Investment view: While there is minimal risk to core health insurance earnings in the short term, we see earnings uncertainty in outer years either from structural challenges, recommendations from current reviews or changes to the regulatory settings in the May 2016 Budget. MPL is trading at a 29% P/E premium to the ASX200 while NHF at a 22% P/E premium to the ASXsmalls. Despite the recent pullback in share prices, with earnings at risk in coming years we consider current premiums to be unjustified and hence maintain our UNDERPERFORM rating on MPL and NHF. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION Client-Driven Solutions, Insights, and Access

2 Industry reviews The Private Health Insurance (PHI) industry is going through a number of regulatory reviews currently, increasing the uncertainty in the sector, in our view. The key theme from all of the announced reviews is policyholder affordability and the role of PHI in supporting the national health system. The reviews will highlight to the Government that the current funding model for the healthcare system is unsustainable (including both the public and PHI funded healthcare) and that the PHI industry is not operating efficiently or as intended and is facing structural challenges underpinned by the community rating principle (which is in part being circumvented by policy innovation), an ageing population and an eroding value proposition. While all of the noise recently is coming from PHIs and hospitals, there are some quick and easy gains to be made by going back to basics in the industry. Restricting the level of policy selection to a small number of simplified and homogenous products and reducing the excess returns being generated by the PHIs themselves, will significantly assist the affordability and simplicity of PHI in the market. The key reviews potentially impacting PHI currently are: 1) Reform of the Federation White Paper This issue paper lays out the development of Australia s health care arrangements since Federation, outlines the pressures on current arrangements, and canvasses questions about how the current split of roles and responsibilities between the Commonwealth and the States and Territories could be changed to alleviate some of the pressures and lead to improved health for Australians. The paper does not aim to sort out all of the problems in our health care arrangements. Consistent with the objectives of the White Paper, it seeks to identify areas where governments could make a difference, while being mindful of the wider pressures facing our health care arrangements. Governments can ensure that the allocation of roles and responsibilities in health is not holding back the system s performance in being able to deliver better outcomes for Australians. 2) Primary Health Care Advisory Group (PHCAG) The Australian Government is aware that Australia s health system is under increasing pressure to provide better quality, affordable and accessible healthcare, based on universal access to Medicare. A long-term strategy is needed, to offer a better patient journey for those with complex and chronic health conditions; to investigate innovative care and funding models; better recognition and treatment of mental health conditions; and greater connection between primary health care and hospital care. The role of the PHCAG will be to examine opportunities for the reform of primary health care in improving the management of people with complex and chronic disease. 3) Parliamentary inquiry into Chronic Disease Management Chronic disease has been identified as Australia s biggest ongoing health challenge, incurring significant and increasing costs. However, many chronic diseases can be efficiently managed in primary health care settings, reducing costs and taking pressure off the specialist and hospital systems. This inquiry seeks to find examples of best practice in chronic disease prevention and management, leading to possible improvements in care and ensuring a better spend of taxpayer money. Private Health Insurance 2

3 The committee will examine opportunities for Primary Health Networks to coordinate and support the prevention and management of chronic disease in primary health care, and will look at the roles of State and Territory Governments as well as private health insurers, in preventing and managing chronic disease. The committee will also examine ways in which multidisciplinary teams prevent and manage chronic disease and look at models of healthcare that improve outcomes for high end frequent users of medical and health services. 4) Medicare Benefits Schedule (MBS) Review A MBS Review Taskforce was established to deliver a healthier Medicare. The Taskforce is considering how the more than 5,700 items on the MBS can be aligned with contemporary clinical evidence and practice and improve health outcomes for patients. The Review is clinician-led and there are no targets for savings attached to the Review. The Terms of Reference for the MBS Review Taskforce do not preclude it from recommending new items or services be added to the MBS. 5) Private Health Insurance Review Figure 1: Estimated timeline of regulatory reviews The Australian Government is undertaking consultations to identify how private health insurance may be improved to deliver better value for money for consumers by building a stronger and more sustainable private health system. The Government is committed to ensuring consumers can access affordable, quality and timely health services through private health insurance alongside universal access to Medicare. The consultations will consider ways to: a) enhance the value of private health insurance to consumers; b) encourage increased efficiency of private health insurance; c) increase the effectiveness of Government incentives for private health; and d) improve the sustainability of the private health sector. The consultations will consider potential future roles for PHI within the context of broader changes being considered by the Government. The timelines for these reviews are varied and always subject to change and delays. Reform of the Federation White Paper Primary Health Care Advisory Group Parliamentary inquiry into Chronic Disease Management Medicare Benefits Schedule Review --> Private Health Insurance Review --> Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Source: Credit Suisse estimates We expect the Private Health Insurance Review to be the most influential review. The reviews will likely recommend changes around health insurance regulation including the pricing, rebates, community rating and number of products on offer. The May 2016 budget will also present an opportunity for the Government to alter some of the key regulatory settings of PHI including rebates for ancillary cover, the MLS threshold and rebate indexation. A key issue for the PHI industry is that it has deviated away from the core principals and the industry is now too complex and has introduced too many costs and inefficiencies. We outline below that a return to the simplified community rating model with regulated pricing and returns could address affordability in coming years. While many investors are of the view that MPL and NHF will benefit from increased policy coverage and high growth in revenue and earnings in coming years, we highlight that a period of low growth is also a potential outcome. Private Health Insurance 3

4 Conflicting mechanisms & objectives in PHI Community rating philosophy undermined One of the key features of the PHI industry being reviewed is community rating. By definition, this is different to many other forms of insurance, which are generally risk rated. Community rating prohibits insurers from discriminating on the basis of past or likely future health or risk factors such as age, pre-existing conditions, gender, race or lifestyle in the premiums that they charge. Community rating means that everyone pays the same premium for the same product and that insurers must provide cover to anybody who seeks it. People who are older or sicker do not have to pay higher premiums, based on their risk or health status. People who have fewer risks or better health pay higher premiums than they would if insurance was not community rated. While this is a key feature of Australia's PHI industry, we note that the ability for insurers to create different policies with a range of coverage and exclusions allows for a level of risk rating. In essence the product innovation focused on offering greater consumer choice is also undermining community rating. A true community-rated model would have a small number of standardised policies to choose from. There are now over 20,000 policies available in the market and this number continues to grow. Policies are being created with a range of options which include or exclude coverage items. These constant policy changes allow funds to discriminate against policyholders for the level of cover they require. By including/excluding pregnancy, joint replacements and hearing aids, for example, an insurer can attempt to discriminate by gender and age knowing that certain exclusions or extras will appeal to a particular demographics. In essence this allows the PHI to rate policyholders on health status. In recent years insurers have created new products to try and select and price for particular risks which has led to a significant increase in the number of policies available in the market. Product innovation has increased significantly in recent years, and while risk-equalisation is supposed to protect individual insurers from being selected against with regards to age and health profiles, the industry as a whole is suffering. In our view, product innovation is being used by insurers to try and attract lower risk policyholders (given that these are the customers more likely to move), which is resulting in increased churn in the industry. The increased churn is resulting in lower risk policyholders reducing their premium, hence negating the system of community rating. In the figure below we highlight a current policy function available on the NHF website. Customers have the ability to choose various coverage and limits, effectively creating their own policy. While this appears innovative and in the clients' best interest, we argue that this is not in the best interest of the industry and undermines the system of community rating. Private Health Insurance 4

5 Figure 2: NHF policy example, ability to mix and match coverage Source: NHF website Policy churn is encouraged The so-called product innovation in the PHI industry is encouraging policyholder churn. Insurers are pointing out that policyholders no longer need to pay for cover that they are unlikely to use, and hence by downgrading their policy they can save on their annual premium spend. While industry data on policy churn is incomplete we have tried to estimate the trends below. While exact numbers are unavailable, a number of industry players have called out churn and buy-down as increasing in recent periods. Listed companies, MPL and NHF, have both commented explicitly on policy downgrades in recent periods; At their FY15 result MPL noted that "premium revenue growth slowed due to increased membership lapses, cover reductions and changes to sales mix" NHF commented at their FY15 result that downgrading was present and lapse rates clearly indicated growth is not without headwinds. Private Health Insurance 5

6 Bupa health insurance managing director Dwayne Crombie had previously commented on policy downgrades facing their business and recently noted that "If consumers continue to downgrade or drop their health cover there will be serious knock-on effects for the whole system," (Health insurers warn any cut to the ancillary rebate will only hit consumers, SMH, 30 October 2015) ISU summarised the issue by explicitly disclosing the average premium movements and policy breakdown across its portfolio. There has been a significant increase in policyholders purchasing hospital or extras only cover, instead of the traditional combined covers. Within this, there has also been a move towards the cheaper, basic covers. Figure 3: ISU experience of consumers trading down in FY15 Source: ISU In a recent media release (8 Nov 2015), the Minister for Health Susan Ley noted that "Australians dumped or downgraded half-a-million all-inclusive private health insurance policies last year as record numbers flocked to cheaper cover with exclusions and excesses, official figures show." While the APRA data referred to by Ms Ley is not publicly available, it was noted that the number of non-exclusionary also known as all inclusive private health insurance policies with hospital cover fell by 500,471 to 3.5 mn in In contrast, there was a 558,619 increase in the number of health policies with hospital cover that exclude certain medical services and also require patients pay an excess and co-payment (gap). Private Health Insurance 6

7 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun November 2015 Figure 4: Exclusionary versus non-exclusionary policies Source: Minister for Health media release (8 Nov 2015) Another potential indicator of product buy down is any change in the portion of 'in hospital' services with no gaps. The chart below illustrates that in the last 12 months there has been a rapid drop in the portion of 'in hospital' services provided with no gaps from 90% in the five quarters between September 2013 and September 2014 to 84% in the September 2015 quarter. We believe this is indicative of product buy down. Figure 5: Recent drop in portion of in hospital services provided with no gaps Portion of 'in hospital' services with no gap payments 95.0% % % % Source: APRA, Credit Suisse estimates Private Health Insurance 7

8 Onemedifund Peoplecare ACA Teachers Health CBHS HCI TUH Reserve Bank Defence Health Phoenix HBF Police Health Westfund CDH Navy Health MDHF Doctors Health Health-Partners Health Fund St Lukes BUPA QCH HCF AU NIB Transport Healthguard HIF GMHBA Medibank CUA Health Latrobe Health.com.au GU Corporate November 2015 Retention rates falling PHI retention rates have fallen over the last two years. The Private Health Insurance Ombudsman (PHIO) reports retention rates which it defines as the portion of customers with hospital cover who have remained with a PHI fund for two years or more. The chart below left illustrates that the retention rate of the largest five health insurers has fallen from 87.2% in 2012 to 83.4% in 2013 and to 80.6% as at 30 June 2014 which is the latest available data. As illustrated in the chart below right most of the large health insurance funds have experienced falls in their retention rates with MPL's particularly pronounced. Figure 6: PHI industry retention rates falling Retention rate of five largest health insurers (weighted average) Figure 7: with a large drop in 2014 for MPL Retention rate by PHI 95.0% 93.0% 91.0% 89.0% 87.0% 85.0% 83.0% 81.0% 79.0% 77.0% 75.0% 95.0% 93.0% 91.0% 89.0% 87.0% 85.0% 83.0% 81.0% 79.0% 77.0% 75.0% Source: PHIO, APRA, Credit Suisse estimates Retention Rate (2yr min) of five largest PHIs Source: PHIO, Credit Suisse estimates AHM BUPA HBF HCF Medibank NIB MPL's retention rate as at 30 June 2014 was 79%. Note that this is a particularly tough measure of customer retention in that it only includes customers who have been with Medibank for at least two years and could be impacted by a period of strong growth in new customers. The retention rate is broadly consistent with MPL's 10% lapse rate in each of FY13 and FY14. Nevertheless MPL's retention rate is well below Bupa's 87%, NHF's 84% and HBF's leading 91% retention rate. Figure 8: MPL with a weak retention rate compared to rest of the industry 2014 Retention Rate (to 30 June 2014) of PHIs. Retention is defined as customers who have been with the PHI for at least two years % % 87.3% 86.6% 85.0% 83.8% % 75.0% % 6 Source: PHIO Private Health Insurance 8

9 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep November 2015 Rising churn and lapse rates Using APRA data we estimate the churn rate in the 12 months to September 2015 was 3.9%. However, given some misreporting we believe this number is potentially understated. With increasing competition and consumer awareness churn has increased in recent years from 1.5% in early 2008 and nearly doubled its levels. Interestingly churn has increased at a time when policyholder growth is slowing suggesting that while consumers have played a role in the increased churn the industry has also encouraged churn (refer chart bottom right). The churn rate has also increased the industry lapse rate to from 7% in December 2009 to 10% in September 2015 with the natural lapse rate largely unchanged at ~5%. Figure 9: Lapse rates rising PHI acquisition and lapse rate (12 month rolling) 14.0% 12.0% 1 8.0% 6.0% 4.0% 2.0% Figure 10: in turn driven by increase in churn PHI churn rate (12 month rolling) 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% Acquisition rate (12mth rolling) Lapse rate (12mth rolling) Churn (12mth rolling) Source: APRA, Credit Suisse estimates Figure 11: Lapse rates rising Total lapse rate, natural lapse rate and churn rate (12 month rolling) Source: APRA, Credit Suisse estimates Figure 12: in turn driven by increase in churn PHI churn rate(12 month rolling) and policyholder growth (YoY) 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% Source: APRA, Credit Suisse estimates Churn Rate Total Laspe Rate Natural Lapse Rate Churn Rate Source: APRA, Credit Suisse estimates Policholder growth (YoY) Private Health Insurance 9

10 Figure 13: Impact of policy cover downgrading The fundamental issue of product buy-down Increasing churn in PHI does not directly impact an insurer's profitability, unlike in an open insurance market, due to the protection of regulated pricing. However, the increase in churn across the industry is increasing the need to continue with high premium rate increases. Ironically, the issue of affordability is being driven by the insurers constantly creating new and cheaper policies, by way of policy exclusions. At a high level, the insurers are encouraging policy downgrades by offering products with coverage exclusions, which can be offered at a lower premium. Most policyholders do not use these coverage items that are now excluded, hence they are attracted to cheaper premiums with no change to their perceived cover. The issue is that this reduces the premium pool of the industry, but has limited impact on reducing the claims benefits paid by the industry. Under the broader principle of community rating the entire industry now needs a premium rate increase to offset the loss of premium created by the policies that downgraded. So in cyclical approach, policy exclusions and buydown, is driving up premiums across the industry. Total Industry premium pool --> Proportion of industry reduces coverage, reducing the industry premium pool --> Source: Credit Suisse estimates Industry premium rate increase needed to replenish the total premium pool Industry data clearly shows that the operation of risk-equalisation results in premium revenue transfers between younger (generally lower claiming) and older (generally higher claiming) persons. As demonstrated in the chart below, this has increased from $1.8bn in to $3.6bn in , a 96% increase in seven years. This reflects both an ageing insured population and increased utilisation of health services by this group. Private Health Insurance 10

11 Figure 14: Transfers of premium revenue as benefits by age cohort and Source: APRA While there is no available data on the age cohort of industry buydown, based on the principal that buydown is being driven by policy exclusions, it is reasonable to assume that the buydown is coming from younger policyholders. This is reducing the premium pool across the industry for the younger policyholders. The claims in the older age group are not being impacted, and hence the ability of the younger policyholders to fund the older policyholders is declining. Ageing population taking advantage of community rated health insurance One interesting observation in the recent APRA statistics was the two tiered growth between those who benefit the most from a community rated private health insurance system and those who benefit the least. The chart below illustrates the YoY growth to September 2015 in persons insured with hospital cover by age group. It shows that insured persons growth is strongest in the old category (>4% growth) and in the 85 to 95+ categories (>5% growth). While some of these segments are a relatively small component of total policies (e.g., 95+ age group) the 65+ age group accounts for a substantial portion of industry benefits. At the same time, the number of year olds with health insurance declined by 1% in the 12 months to September This highlights the affordability and value proposition that the health industry is facing particularly with younger customers. If this trend continues it creates a very negative operating environment for the health insurance industry. Under the community rating system generally premiums from younger insured persons subsidise the rising health care costs of the older generations. However, with year olds accounting for 50% of the growth in insured persons over the past 12 months this could put pressure on growth in benefits which would require larger premium increases and further discourage younger users from taking up private health insurance. Private Health Insurance 11

12 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q yr olds 5-9 yr olds yr olds yr olds yr olds yr olds yr olds yr olds yr olds yr olds yr olds yr olds yr olds yr olds yr olds yr olds yr olds yr olds yr olds 95+ yr olds Industry 23 November 2015 Figure 15: year holds accounted for 50% of growth in insured persons YoY growth in persons insured for hospital cover (12 months to September 2015) 1 8.0% 6.0% 4.0% 2.0% -2.0% Source: APRA, Credit Suisse estimates Actual premium rate increases achieved are below the approved rate In addition to our analysis above, highlighting policy churn, we also note that approved premium rate increases have not been achieved in recent years. This highlights that policyholders are opting to reduce their premiums, to offset the annual premium rate increases. Figure 16: Actual rate increases below approved rate PHI approved versus achieved premium rate increases (Year to June) 1 Figure 17: with gap widening recently PHI approved versus achieved premium rate increases (quarterly) 7.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% Average Premium Growth Policyholder Growth Adjusted Approved Price Increase Source: APRA, Department of Health, Credit Suisse estimates Gap (Discount / Buiy-down) Growth in Average Premium per Policy Approved Premium Increase Source: APRA, Department of Health, Credit Suisse estimates Private Health Insurance 12

13 Policy downgrades will likely lead to the need for more premium increases Policy downgrades may assist insurers to retain or attract policyholders, but the industry as a whole suffers, and ultimately this behavior increased the need of insurers to increase premiums further. Based on some industry level assumptions, we estimate that if 25% of policyholders aged 64 and below (which in turn represent 83% of policyholders) opted to downgrade their cover, and their average saving was 25%, the industry would need a ~4% premium rate increase to offset this (assuming that 50% of the premium reduction is offset by lower claims). This is over and above the 4-6% premium rate increases needed annually to cover claims inflation. Effectively if this policy downgrading continues, the industry could be facing periods of ~10% premium rate increases, which ironically would likely increase downgrades further. Figure 18: Industry premium increase required to offset downgrades % of Aged 64 and below that downgrade % of premium saving of downgrade Source: Credit Suisse estimates 5% 10% 15% 20% 25% 30% 5% 0.2% 0.3% 0.5% 0.6% 0.8% 0.9% 10% 0.3% 0.6% 0.9% 1.3% 1.6% 1.9% 15% 0.5% 0.9% 1.4% 1.9% 2.4% 2.8% 20% 0.6% 1.3% 1.9% 2.5% 3.1% 3.8% 25% 0.8% 1.6% 2.4% 3.1% 3.9% 4.7% 30% 0.9% 1.9% 2.8% 3.8% 4.7% 5.6% Therefore, while the industry blames claims inflation as the driver behind the need to increase premiums each year, the deviation from the fundamental community rating approach is also a key driver, in our view. As mentioned above, the industry needs to restrict the constant launch of new products and move back to a restricted number of products in our view. Similar to CTP, this would allow the regulation of pricing to be more effective in our view. Private Health Insurance 13

14 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY90 FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 23 November 2015 Excess returns for regulated insurers As highlighted above, insurer behaviour is contributing to the need to constantly increase PHI premiums. Further to this, in a regulated environment, we question why insurers are allowed to generate such high levels of profitability. Over the past decade, excess capital has been accumulating as a result of profits exceeding the growth in capital requirements and more recently with the changes in the capital standards. The Australian PHI industry has generated a healthy ROE over the last ten years, averaging 17.3%, with the average in the last five years slightly higher (18.0%). The industry ROE has been lifted by the strong returns of BUPA in recent years, who in addition to market-leading margins also runs a relatively capital light business. The fall in the ROE in FY08 and FY09 was due to a negative contribution from investment income in the period. The key driver of this was HBF who had a ~50% allocation to equities when the equity markets fell in 2008 (industry allocation was ~15%). Figure 19: PHI industry ROE % % 1 5.0% Figure 20: Key players ROE Medibank BUPA HBF HCF MBF ROE Average Source: APRA data, Credit Suisse estimates Note FY14 is the latest available statistics by PHI. Source: APRA data, Credit Suisse estimates While the industry ROE has been above 17% in recent years, based on our analysis, the ROE is actually understated due to the amount of excess capital that the industry is currently holding. If the industry were to hold an excess capital position in line with MPL's target 12% level, we estimate that the ROE in the last ten years would have been over 50%. If we take a slightly more conservative approach and assume an additional 2% capital buffer up to the 14% level, the average ROE would have been 44%, dropping a little below this average in recent years. Figure 21: PHI industry ROE (adjusted basis) Figure 22: PHI industry equity % of premium Adj ROE Average Industry Lower Target (12% of FY1 Premiums) Upper Target (14% of FY1 Premiums) ROE adjusted for equity base equivalent to 12% of FY1 premiums. Source: APRA data, Credit Suisse estimates Source: APRA data, Credit Suisse estimates Private Health Insurance 14

15 FY90 FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Industry ACA AUHL BUPA CBHS CDH CUA Defence DHF GMHBA GUC HBF HCF HCI H'guard HIF H'Partners HPL Latrobe Mildura MPL Navy NHBA NIB Peoplecare Phoenix Police QCH QTUH RBHS RT St Luke's TFH Transport Westfund 23 November 2015 While the industry's excess capital has been declining in recent years, we believe it can be reduced further. In our view PHIs are holding more than double the 'adequate' level of capital including buffers. It is also worth noting that the industry has returned ~$3.5bn by way of dividends or capital transfers in the last five years. In the FY14 annual report PHIAC noted that "over the past decade, capital has accumulated as returns have exceeded the growth in capital requirements." Figure 23: PHI equity % premiums Figure 24: FY14 equity % premiums NIB Medibank BUPA HBF HCF Capital % Premiums Minimum (proxy) Source: APRA data, Credit Suisse estimates Source: APRA data, Credit Suisse estimates With the industry maintaining a strong capital position and generating high ROEs, we question the sustainability of returns given the industry operates in a regulated environment. This is no doubt a question that will be explored in detail in coming years as the role of PHIAC is transferred to APRA (effective 1 July 2015). APRA is yet to release any update on capital requirements or review of pricing process. If we look firstly at the role of PHIAC, which was reported as: PHIAC is an independent statutory authority that reports to the Minister for Health. It works closely with other regulatory bodies including the Private Health Insurance Ombudsman (PHIO) to ensure that consumers have access to an industry which is competitive, efficient and financially sound. Based on our analysis PHIAC has achieved their goal of 'financially sound' but we are less convinced that consumers have access to a 'competitive' and 'efficient' industry. Consumers have worn ~6% annual premium rate increases over the last decade, at a time when PHIs have delivered 17.5%+ ROEs and retained significant levels of capital. In our view, regulated price increases need to also take into account prior year performance and capital position, which could justify a period of below-inflation premium increases. With the abolishment of PHIAC in 2015 there is a risk that the PHI pricing process and regulatory oversight functions are reviewed. While we are not critical of the role PHIAC has played in recent years, it does appear that the pricing process is skewed in favour of insurers over consumers. Based on our calculations, by gradually lowering the excess capital over the next three years and reducing the target ROE to 12.5% (which is still above the 10% target ROE that the general insurers target for their regulated CTP businesses), the industry could reduce premium rate increases to just ~2.5% p.a. over the next three years (assuming claims inflation runs at 5% p.a.). This is well below the ~6% premium rate increases we have seen in recent years and could assist with the rising affordability issues. Some more pro-active actions around cost savings could actually result in flat premiums for a period of time. Note, that given MPL and NHF carry less excess capital than the industry, some of the smaller players could have the opportunity to offer premium rate reductions which could put a lot of competitive pressure on MPL and NHF. Private Health Insurance 15

16 MPL and NHF valuations As a result of the recent pullback in the MPL and NHF share prices, they no longer screen as expensive. On most metrics they are screening as relative fair value. However, we note that the growth expectations in coming years are very strong, more so for MPL than NHF. As we outline above, this growth is at risk in our view, and under this scenario the high multiple that MPL and NHF are trading on would no longer be justified. Figure 25: P/BV versus ROE (12mth fwd) 5.0x 4.5x 4.0x P P E - = - / - E BV BV NIB Medibank Figure 26: PE (12mth fwd) vs EPS growth (2 Yr) 30.0x Ramsay Health Care 25.0x Healthscope 3.5x 3.0x 20.0x Sonic Healthcare NIB Medibank 2.5x 2.0x 1.5x Healthscope Steadfast Sonic Healthcare Austbrokers IAG 15.0x 10.0x Suncorp Austbrokers Steadfast IAG Primary Health Care QBE 1.0x Primary Health Care Suncorp QBE 5.0x 0.5x 0.0x 5.0% % % 0.0x -1.0% 1.0% 3.0% 5.0% 7.0% 9.0% 11.0% 13.0% 15.0% Prices as of 19 November 2015 Source: Credit Suisse estimates, I/B/E/S, IRESS Prices as of 19 November 2015 Source: Credit Suisse estimates, I/B/E/S, IRESS Figure 27: Global valuation comparison Reuters Ticker Credit Suisse Rating IBES Cash Local Currency Target price Price Market Cap. Market Cap. EPS 12mth fwd IBES Cash EPS 3yr CAGR IBES Cash PE 12mth fwd P/BV current Cash ROE 12mth fwd Div Yield 12mth fwd (local) (local mil) US$m (local) % (x) (x) (%) (%) MPL MPL.AX UNDERPERFORM AUD ,417 4, % 19.5x 4.4x 22.5% 3.8% NIB NHF.AX UNDERPERFORM AUD ,668 1, % 20.6x 4.7x 22.9% 3.3% General insurers IAG IAG.AX OUTPERFORM AUD ,883 9, % 14.6x 2.0x 13.7% 5.4% Suncorp SUN.AX NEUTRAL AUD ,215 12, % 12.6x 1.3x 10.1% 6.8% QBE QBE.AX NEUTRAL AUD ,633 12, % 12.0x 1.2x 9.9% 5.3% Austbrokers AUB.AX NEUTRAL AUD % 13.6x 1.9x 14.0% 4.9% Steadfast SDF.AX OUTPERFORM AUD , % 14.0x 1.3x 9.3% 4.2% Healthcare Ramsay Health Care RHC.AX OUTPERFORM AUD ,737 9, % 28.1x 7.2x 25.6% 1.9% Sonic Healthcare SHL.AX NEUTRAL AUD ,440 6, % 17.7x 2.5x 13.9% 4.0% Healthscope HSO.AX NEUTRAL AUD ,936 3, % 25.2x 2.1x 8.4% 2.7% Primary Health Care PRY.AX UNDERPERFORM AUD ,877 1, % 13.6x 0.8x 5.5% 5.4% International peers Aetna AET.N #ERR: NOT COVERED USD R: NOT COVE ,262 37, % 13.3x 2.3x 17.6% 0.9% Cigna CI.N #ERR: NOT COVERED USD R: NOT COVE ,812 34, % 14.6x 2.9x 19.8% Health Net HNT.N #ERR: NOT COVERED USD R: NOT COVE ,970 4, % 16.7x 2.8x 16.6% Humana HUM.N #ERR: NOT COVERED USD R: NOT COVE ,344 25, % 19.5x 2.5x 12.7% 0.6% Wellpoint WLP.N #ERR: NOT COVERED USD R: NOT COVE ,067 54, % 12.7x 1.5x 12.0% 1.8% United Health Group UNH.N #ERR: NOT COVERED USD R: NOT COVE , , % 16.3x 3.1x 18.8% 1.3% Prices as of 19 November 2015 Source: Company data, Credit Suisse estimates Private Health Insurance 16

17 24-Nov Dec Dec Jan Jan Feb Feb Mar Mar Mar Apr Apr May May Jun Jun Jul Jul Aug Aug Aug Sep Sep Oct Oct Nov November 2015 Figure 28: MPL Financial Summary Financials Medibank Private Limited MPL.AX Rating: UNDERPERFORM Target price: $2.20 In A$mn, unless otherwise stated Year ending 30 June Profit and loss FY14A FY15A FY16F FY17F FY18F ASX code: MPL.AX Share price: $2.33 Health Insurance Premium Revenue 5, , , , ,935.9 No. of shares (m) 2,754 Rating UNDERPERFORM Complementary Services Revenue Market cap (A$m) 6,417 Target price $2.20 Total Revenue 6, , , , ,588.4 Weighting - ASX % TSR -1.9% Claims Expense (incl. risk equalisation) (4,884.3) (5,092.9) (5,365.2) (5,648.9) (5,959.5) Weighting - insurance 8.65% 12mnth Fwd PE 20.1x Other Cost of Sales (533.8) (509.6) (489.7) (503.3) (518.5) Gross Profit , , ,110.4 Valuation ratios: FY14A FY15A FY16F FY17F FY18F Management Expenses (693.7) (653.5) (653.5) (665.5) (683.0) Statutory EPS (cps) Operating Profit Underlying EPS (cps) Net Investment Income Underlying EPS Growth 3.7% 13.6% 8.9% Interest Expense P/E 22.0x 21.2x 18.7x 17.1x Other Income/(Expenses) (8.1) (8.0) (8.1) (8.3) (8.6) DPS (cps) Profit Before Tax Payout ratio (% Underlying EPS) 75% 75% 74% Tax (102.6) (114.0) (123.6) (140.3) (152.8) Net Dividend yield 3.5% 4.0% 4.3% Underlying NPAT Franking level 100% 100% 100% Significant Items / Abnormals (127.7) (6.5) Gross Dividend Yield 5.0% 5.8% 6.2% Statutory NPAT Closing Shares (mn) 2, , , ,754.0 Key Ratios: Avg Basic Shares (mn) 2, , , ,754.0 Gross Margin 14.9% 14.8% 14.8% 14.8% 14.6% Book Value per share ($) MER 10.9% 9.9% 9.5% 9.2% 9.0% ROE (Underlying) 18.5% 21.5% 20.7% 22.2% 22.7% Operating Profit Margin 4.0% 4.9% 5.3% 5.6% 5.6% P/BV 4.4x 4.3x 4.0x 3.8x Investment Yield 5.5% 4.4% 2.9% 3.9% 4.4% NTA per share ($) Tax Rate 28.4% 28.1% 29.0% 29.0% 29.0% ROTE (Underlying) 23% 26% 25% 27% 27% Growth: P/NTA 5.4x 5.2x 4.8x 4.5x Revenue Growth 8.8% 3.3% 4.6% 5.0% 5.1% Claims Growth 9.0% 3.4% 4.5% 5.1% 5.3% Balance Sheet FY14A FY15A FY16F FY17F FY18F Gross Profit Growth 7.5% 2.6% 4.9% 4.4% 4.1% Cash Management Expenses Growth 1.1% (5.8%) 1.8% 2.6% Financial Assets 1,491 1,972 2,025 2,083 2,151 Operating Profit Growth 29.9% 25.3% 14.8% 9.1% 6.7% Trade and Other Receivables Investment Income Growth (21.1%) (17.6%) (28.7%) 36.7% 18.3% DAC Normalised Profit Growth 6.0% 12.9% 3.7% 13.6% 8.9% PP&E Intangibles Divisionals FY14A FY15A FY16F FY17F FY18F Other Assets Operating Profit by Division: Total Assets 2,974 3,141 3,278 3,459 3,660 Health Insurance Trade and Other Payables Complementary Services Claims Liabilities Corporate overheads (24.5) (23.5) (23.9) (24.3) (24.8) Unearned Premium Liability Operating Profit Borrowings (incl sub-debt) Health Insurance: Other Liabilities Premium Revenue 5, , , , ,935.9 Total Liabilities 1,580 1,699 1,787 1,872 1,966 Gross Claims (4,953.4) (5,123.6) (5,394.2) (5,663.8) (5,962.8) Contributed Equity State Levies (45.6) (46.7) (49.0) (51.5) (54.3) Retained Earnings 1,288 1,336 1,385 1,481 1,588 Risk Equalisation (net) Reserves Other Claims Expense (2.1) Minorities Net Claims Cost (4,884.3) (5,092.9) (5,365.2) (5,648.9) (5,959.5) Total Equity 1,394 1,442 1,491 1,587 1,694 Gross Profit Management Expenses (518.2) (512.6) (518.5) (528.8) (544.7) MSCI IVA (ESG) Rating B Credit Suisse View Operating Profit TP ESG Risk (%): 0 Key Ratios - Health Insurance: TP Risk Comment: Overall, we view MPL's board to be composed of 9.0 highly experienced directors, with a diverse skill base. In addition, since Gross Margin 13.5% 14.2% 14.3% 14.2% 14.1% 6.0 we believe that MPL has appropriate policies and procedures in place MER 9.2% 8.6% 8.3% 8.0% 7.9% we include 0% downside in our target price in relation to ESG issues. Operating Profit Margin 4.4% 5.5% 6.0% 6.2% 6.2% 3.0 Policyholders 1, , , , , MSCI IVA Risk (%): Neutral Policyholder Growth 1.5% 0.9% 1.4% 1.1% 1.3% MSCI Risk Comment: We see the MSCI rating as a fair assessment of Stock Local Sector the ESG risks. Premium Growth 5.7% 5.1% 5.5% 5.2% 5.3% Global Sector Country Net Claims Growth 5.5% 4.3% 5.3% 5.3% 5.5% Gross Profit Growth 7.2% 10.1% 6.2% 4.7% 4.3% Source: MSCI ESG Research Management Expenses Growth 0.7% (1.1%) 1.1% 2.0% 3.0% Operating Profit Growth 24.1% 33.8% 14.1% 8.4% 6.0% Share Price Performance 52wk range: Complementary Services: Revenue Net Claims Cost (533.8) (509.6) (489.7) (503.3) (518.5) Gross Profit Management Expenses (151.0) (117.4) (111.2) (112.3) (113.5) Operating Profit Key Ratios - Complementary Services: Gross Margin 25.7% 20.5% 20.5% 20.5% 20.5% MER 21.0% 18.3% 18.0% 17.7% 17.4% Operating Profit Margin 4.7% 2.2% 2.5% 2.8% 3.1% Revenue Growth 41.5% (10.7%) (3.9%) 2.8% 3.0% Net Claims Growth 58.0% (4.5%) (3.9%) 2.8% 3.0% Gross Profit Growth 8.8% (28.7%) (3.8%) 2.8% 3.0% Management Expenses Growth (0.7%) (22.3%) (5.3%) 1.0% 1.0% Operating Profit Growth 89.8% (57.7%) 8.1% 15.6% 15.8% $2.60 $2.50 $2.40 $2.30 $2.20 $2.10 $2.00 $1.90 $1.80 $1.70 $1.60 Andrew Adams James Cordukes, CFA andrew.adams@credit-suisse.com james.cordukes@credit-suisse.com Prices as of 19 November 2015 Source: Company data, Credit Suisse estimates Source: Reuters MPL.AX XJO XXJ Private Health Insurance 17

18 Nov-14 Dec-14 Dec-14 Jan-15 Jan-15 Feb-15 Feb-15 Mar-15 Mar-15 Apr-15 Apr-15 May-15 May-15 Jun-15 Jun-15 Jul-15 Aug-15 Aug-15 Sep-15 Sep-15 Oct-15 Oct-15 Nov November 2015 Figure 29: NHF Financial Summary NIB Holdings NHF.AX Rating: UNDERPERFORM Target price: $3.50 In AUDmn, unless otherwise stated Year ending 30 June Profit and loss (A$mn) FY14A FY15A FY16F FY17F FY18F ASX code: NHF.AX Share price: $3.80 Premium Revenue 1, , , , ,121.1 No. of shares (m) 439 Rating UNDERPERFORM Claims Expense (net of reinsurance) (1,040.0) (1,151.4) (1,288.9) (1,404.9) (1,504.7) Market cap (A$m) 1,668 Target price $3.50 Risk Equalisation Levy (190.6) (185.5) (195.9) (208.5) (224.4) Weighting - ASX % TSR -4.9% State Levies (28.2) (28.2) (29.8) (32.3) (34.7) Weighting - insurance 2.25% 12mnth Fwd PE 21.5x Premium Payback Liability Movement 3.3 (1.9) Gross Profit Valuation ratios: FY14A FY15A FY16F FY17F FY18F Acquisition Costs (67.9) (79.3) (89.7) (97.3) (102.1) Basic EPS (Normalised) (cps) Claims Handling / Underwriting Expenses (94.2) (99.9) (113.3) (122.7) (129.4) Diluted EPS (Normalised) (cps) Underwriting Result Diluted EPS Growth 4.1% 8.4% -4.9% 19.7% 11.6% Other Revenue P/E 23.9x 22.0x 23.1x 19.3x 17.3x Other Expenses (7.5) (12.0) (62.2) (63.6) (64.7) Diluted Cash EPS (Norm.) (cps) Operating Profit Diluted Cash EPS Growth 4.1% 8.4% -0.2% 19.7% 11.1% Finance Costs (2.7) (3.4) (7.0) (7.8) (7.8) P/E 23.9x 22.0x 22.1x 18.4x 16.6x Investment Income Ordinary DPS (cps) Profit Before Tax Special DPS (cps) Income Tax (29.4) (34.3) (30.6) (36.7) (41.0) Ordinary Payout ratio (% Normalised EPS) 69% 67% 65% 65% 64% Minorities Net Dividend yield 5.3% 3.0% 2.8% 3.3% 3.7% Normalised Profit Franking level 100% 100% 100% 100% 100% Investment Experience Gross Dividend Yield 7.5% 4.3% 4.0% 4.8% 5.3% Non-recurring Items (0.2) Closing Shares (mn) Reported Profit Avg Basic Shares (mn) Book Value per share ($) Divisionals FY12A FY13A FY14F FY15F FY16F ROE (Normalised) 20.2% 22.2% 20.3% 22.3% 22.8% Premium Revenue 1, , , , ,121.1 P/BV 4.7x 4.8x 4.5x 4.2x 3.8x Australian Resident HI 1, , , , ,827.9 NTA per share ($) International (Inbound) HI ROTE (Normalised) 28% 31% 36% 41% 39%...nib New Zealand P/NTA 6.4x 6.6x 8.6x 7.4x 6.3x Net Underwriting Result Australian Resident HI BALANCE SHEET (A$m) FY14A FY15A FY16F FY17F FY18F International (Inbound) HI Cash nib New Zealand Receivables Financial Assets Key Metrics FY14A FY15A FY16F FY17F FY18F Property, Plant and Equipment Growth: Deferred Tax Assets Premium Revenue Growth 15.6% 9.6% 11.3% 8.8% 7.2% Intangibles Policyholder Growth 5.6% 8.9% 7.4% 3.1% 2.2% Deferred Acquisition Costs Average Premium Growth 1 0.7% 3.9% 5.6% 5.0% Other Assets Gross Profit Growth 17.6% 13.4% 13.7% 9.3% 7.3% Total Assets ,051 1,119 Underwriting Result Growth 0.5% 19.6% 14.5% 11.2% 11.4% Payables Operating Profit Growth 4.3% 13.0% 15.8% 16.9% 11.9% Overdraft Cash Operating Profit (ex amort.) Growth 4.3% 13.0% 20.7% 16.2% 11.5% Outstanding Claims Liability Normalised Profit Growth 4.1% 8.4% -4.9% 19.7% 11.6% Unearned premiums Key Ratios: Current Tax Liabilities Claims Ratio 84.2% 83.6% 83.3% 83.2% 83.2% Borrowings Gross Margin 15.8% 16.4% 16.7% 16.8% 16.8% Premium Payback Liabilities Management Expense Ratio 10.9% 11.0% 11.2% 11.1% 10.9% Other Liabilities Net Underwriting Margin 5.0% 5.4% 5.6% 5.7% 5.9% Total Liabilities Actual Investment Return 5.6% 5.7% 2.7% 3.4% 3.4% Share Capital Tax Rate 29.6% 31.3% Retained Profits Reserves MSCI IVA (ESG) Rating NHF.AX Credit Suisse View Minorities (0) (1) (1) (1) (1) 12.0 TP ESG Risk (%): 0 Total Equity TP Risk Comment: We value earnings pressure from 9.0 regulatory change with further downside pressure from Share Price Performance 52wk range: regulatory control of pricing and affordability concern from policyholders. 3.0 MSCI IVA Risk (%): $4.00 $ MSCI Risk Comment: $3.60 Environment Social Governance $3.40 Stock Local Sector Country Global Sector $3.20 $3.00 Source: MSCI ESG Research $2.80 $2.60 $2.40 $2.20 $2.00 Andrew Adams James Cordukes, CFA andrew.adams@credit-suisse.com Prices as of 19 November 2015 Source: Company data, Credit Suisse estimates james.cordukes@credit-suisse.com Source: Reuters NHF.AX XJO XXJ Private Health Insurance 18