Jacqui Pile, Shoks Mzolo & Rob Rose: The Financial Mail,
WITH price regulation looming for private healthcare, brokerage JP Morgan says SA's largest hospital group, Netcare, should consider shutting hospital doors.
"We believe the closed hospitals could easily be converted for use as hotels ahead of the 2010 World Cup... Netcare might decide that the hotel business is less problematic than hospitals, given the legislative issues," it says.
That may seem flippant, but given that the regulatory noose is slowly tightening around private hospital groups, investors might support such a radical move.
Of course, there would be some unhappy parties if private hospitals were to close: Health Minister Manto Tshabalala-Msimang, for one. Last year, she sent a clear message about her lack of confidence in public healthcare when she was treated at the private Wits Donald Gordon hospital, rather than use the public system she presides over.
It is ironic that Tshabalala-Msimang, who has benefited from treatment at private hospitals, is the architect of new rules that could ultimately drive those hospitals out of business. Her recent promise that "2008 will be the year of regulating private healthcare" has rattled investors in the private healthcare sector.
Now draft regulations released for comment three weeks ago give the minister unprecedented power to decide how much hospitals and doctors can charge.
Unless the regulations are softened, the minister will be able to appoint a "facilitator" to oversee price talks between hospitals and medical schemes. If prices can't be agreed, a "pricing tribunal" chosen by the minister will make a final ruling. There is no appeal.
"It's effectively price control," says Medi-Clinic CEO Koert Pretorius. "There is no incentive for medical schemes to engage in real price negotiations because it would then go to the tribunal anyway."
It's the lack of independence of both the facilitator and the tribunal that has providers fuming. They fear this is the first step to greater state intervention.
For investors, the signs are ominous. Netcare's shares have fallen 24% and Medi-Clinic's 16% this year - a total R7,4bn loss in value, while the JSE's all share index has risen 8%.
JP Morgan analyst Alex Comer says the fear of greater regulation comes as hospitals like Netcare face rising wage, electricity and other costs (it costs 4-6 times as much to run a hospital off generators than the grid), which are putting pressure on profits.
"Logically, we believe private hospitals have little to fear since the return on new-build hospitals is not excessive under the current pricing structure," says Comer. "But logic doesn't always prevail."
The department doesn't seem worried about sending investors packing. "It's a gut reaction," says deputy director-general Kamy Chetty.
"The private healthcare sector is unsustainable as it is. It's too expensive and fewer people will be able to afford those services over time," she says.
"We've been asking (private hospitals) to come up with solutions to make services more affordable for years, but they've shown that they're incapable of self-regulation," she says.
Hospitals deny Chetty's claim that "consensus" was reached over regulation. "We were called to a meeting in Cape Town in February at short notice," says Life Healthcare marketing GM Adam Pyle. "The minister read a prepared speech and gave us 15 minutes for questions. That's not what we consider consultation."
At issue, however, is government's belief that private healthcare has become unaffordable - and there is merit in this view.
In 1992, about 20% of South Africans were covered by a medical aid. This has dropped to 14% - due partly to rising medical aid costs.
About 56% of the R100bn spent on healthcare in SA each year is spent on the 7,4m medical aid members (plus 3m more who pay for private care out of their own pockets). The other 44% is spent on public-sector facilities for 37m people - a yawning gap.
But perhaps government should fix public healthcare rather than tamper with a functioning private sector.
Medi-Clinic director Mamphela Ramphele recently wrote in the SUNDAY TIMES that though she had three children in public hospitals, she wouldn't do that today. "That is how seriously the system has deteriorated," she said.
Netcare CEO Richard Friedland says government's focus on private health pricing is misplaced. "We think there are more fundamental issues at play. We have a public sector in crisis, not a private sector in crisis."
Chetty says: "We are addressing the challenges in the public sector through programmes such as the hospital revitalisation programme."
But shifting the responsibility of healthcare to the private sector is unfair, says executive director of Innovative Medicines SA (IMSA) Val Beaumont. Forcing down prices will only drive away hospital groups and doctors.
There's no doubt private healthcare has become more expensive. In the 2007 SA Health Review, the University of Cape Town's Health Economics Unit says with inflation stripped out, medical aid members were paying 53% more for specialists and 74% more for hospitals in 2005 than they were in 1997.
Adrian Gore, CEO of the country's largest medical aid administrator, Discovery, says the "rate of inflation [when it comes to hospitals] is unacceptable and must be challenged".
"We do not believe hospitals should be less profitable. In fact, our country needs well-capitalised and successful private hospitals. But there is a need for collaboration between the hospital groups and other industry stakeholders to rein in inflation," he says.
The tinder that lit the current row was a report released in March by the Council for Medical Schemes (CMS), which said "if the present conditions are permitted to continue, coverage by medical schemes will decline and become more inequitable".
The CMS argues that hospital costs have increased because the three largest hospital groups - Netcare, Medi-Clinic and Life Healthcare - create a cartel that allows them to bully medical aids into unjustifiable tariff increases. "The existence of a de facto oligopoly market for hospital services implies that prices and costs will become increasingly distorted in the absence of regulation," it said.
These three hospital groups now account for 87,8% of all hospital beds in SA, up from 50% in 1996. A 2005 study from brokerage UBS shows "private hospitals have pricing power, owing to their dominant market position".
And hospitals haven't done themselves any favours in the public eye either. Their "transparency" is deservedly in the spotlight after the "rebate" exposé. This dates back to 1998, when a deal was struck that allowed hospitals to hike tariffs to compensate them for removing mark-ups on medicines. As a result, the cost per admission in 1999 climbed 25% to reflect the changing dispensation.
The CMS says "it now transpires that these mark-ups were not removed, but instead replaced with hidden rebates".
This meant medical aids paid for both the mark-ups (now in hidden rebates) as well as higher hospital tariffs - pushing up costs. After the issue exploded, Netcare said it would phase out rebates.
In this context, consumers remain doubtful about how transparent hospitals are about prices.
This is fuelled by statements such as those made by the Hospital Association of SA (Hasa), which pledges hospitals to "increased transparency regarding rebates". But it adds "the manner in which [transparency] will be implemented will depend on negotiations between individual hospital groups and [medical aids]".
Why this reluctant commitment to transparency? If they were serious, there wouldn't be any qualifiers in their pledge.
"This is something hospital groups should have been thinking about a long time ago," says an insider. "It's now difficult for providers to argue against regulations that increase transparency."
But Hasa says the increasing prices are not because hospitals are price setters in an uncompetitive market. Rather, CEO Kurt Worrall-Clare says increased spend is because more people are using private hospitals more frequently.
Between 2002 and 2006, Hasa says admissions grew 13%.
"The market power concentration argument does not take into account that from 1995 to 2002, tariff negotiations between hospital groups and medical schemes were conducted collectively" between Hasa, the Board of Healthcare Funders (representing medical schemes), and the SA Medical Association (representing doctors). This bargaining council was outlawed by the competition commission in 2002. But any "consolidation" among private hospitals could not have affected negotiating power before then.
Another reason for increased expenses, says Hasa, is that while the amount of medical aid members is constant, the quality of this group has changed. So, whereas in 2002, the average age for a medical aid member was 36, this is now 42.
Hasa says: "On average prices increased by 1,7% above inflation in the eight years from 1999 to 2006. Considering higher medical inflation and consistent increases in nursing costs over this period, the private hospital sector has been effective in containing price increases."
Staff costs haven't helped either - especially nursing costs. Netcare's results for the year to September showed a 62% jump in "staff costs" to R6,1bn. And it wasn't due to new hirings, because Netcare now employs 27 730 people in SA and the UK - a rise of only 4,5% from the year before. This clearly illustrates a sharp increase in salaries.
But Alex van den Heever, who penned the CMS report, says: "[The hospitals'] analysis is patent nonsense." He says no actual information on nurse salary increases has been provided by hospital groups. But Worrall-Clare counters: "You can't be flippant about the costs of salaries for private-sector hospitals."
He says nursing salaries make up 72% of a hospital's expenses. "It's simply wrong to say that those costs don't [affect] medical inflation," he says.
But medical professionals are leaving SA in droves - 10 000 medical students a year are emigrating (see page 36). It doesn't take an economic genius to work out that with 42 000 vacancies for nurses, those able to fill the posts can demand higher salaries.
Recently, private hospitals have gambled on expanding overseas. With imminent regulation at home, who can blame them?
Last year, Medi-Clinic spent R17bn on buying control of Switzerland's largest hospital group, Hirslanden. Netcare also recently bought control of the UK-based General Healthcare Group (GHG).
Though Medi-Clinic says it will go ahead and build a 140-bed hospital in Cape Town, future projects will depend on the final regulations.
One of the accusations levelled at hospitals is that they have been making "super-profits". But this doesn't appear to be borne out by data that the FM found.
In 2005, FirstSouth Securities found that JSE-listed hospitals earned returns on their cash of 12% - less than half the 25% from the pharmaceutical sector.
This year, Medi-Clinic made operating profit of R1bn on revenue of R5,3bn (a margin of 18,8%). Interestingly, this is the largest margin that Medi-Clinic has made in the past seven years.
For the year to September, Netcare's earnings margin (before tax and depreciation) was 19% in SA, which is healthy enough. But in the UK, this margin was 24,8%. Its overall operating profit margin is now 16,1%.
These margins don't appear excessive when compared with global hospital groups, the Hospital Corporation of America, and Asia's largest group, Apollo Hospitals.
But one of the more convincing arguments against the "super-profits" claim comes from Worrall-Clare. He says that if all hospital profits were wiped out entirely, this would reduce medical aid contributions by just R139/month - from R2 500/month to about R2 361/month.
But looking at margins doesn't always tell the full story: a company can still be making excessive profits and yet have low margins, if it is inefficient. In the CMS report, Medical Schemes registrar Patrick Masobe argues that the private healthcare sector is overcapitalised.
He points out that in a normal market, inefficient companies will be exposed through price competition. But the "increased level of hospital concentration has blunted (competition)".
This inefficiency manifests in under-utilisation of beds and underused, expensive technologies, says the CMS report. It shows SA has more MRI (magnetic resonance imaging) units and CTS (computed tomography scanners) per million inhabitants than Canada, France, Germany, Sweden and the UK.
The CMS report notes that occupancy of beds is 53% (below the world average), and says: "In a price-competing market no such oversupply would survive."
Hasa refutes this. "We're already hitting capacity constraints during the week," Worrall-Clare says. "And a shortage of doctors and nurses means the potential to use facilities out of peak times is seriously limited."
Hasa says based on the three largest groups, 2006's occupancy rate was 65%.
But if there is inefficiency, it shouldn't be addressed through regulation. Competitive forces should address this, and if they aren't working, the competition commission should take an interest.
For Tshabalala-Msimang, this is the last throw of the dice. A close-Mbeki ally, she is unlikely to be included in a new cabinet led by either Jacob Zuma or Kgalema Motlanthe next year
Says one industry player: "Regulation of the private hospital sector is one more notch in her belt before she goes."
But when it comes to private hospitals, stricter regulation isn't the answer.
Though government may be trying to lower private healthcare costs, and take stress off the public sector, price regulation may have the opposite effect.
If private hospitals downgrade their investments, it will merely shift more people to the strained public sector.
Surprisingly, the department's approach to the latest regulations has attracted widespread criticism, both from within and outside the minister's circle.
Discovery's Gore warns: "We don't believe a regulated approach will necessarily lead to cost reductions; it may well lead to market distortions and negative unintended consequences." He says "modest regulatory interventions" would be better.
Says Medi-Clinic's Pretorius: "It's impossible to get prices fixed at the right levels: either they're too high and you get oversupply or they're too low and you close hospitals. Consumers suffer."
But there is much scope for compromise. For one, hospitals should finally be transparent about their pricing.
Collective bargaining would also counter concerns that the hospital oligopoly bullies through high prices.
But government's draft regulations have failed in one crucial respect - by providing for the facilitator and tribunal to be appointed by the ministry.
A politically independent facilitator and tribunal is a key ingredient if the regulations are to gain currency with providers. It's understood that this recommendation was made to Tshabalala-Msimang, but she ignored it. As JP Morgan's Comer says: "Ministers could choose to pursue populist policies and undermine private healthcare in SA. But then where would they go when they got sick?"