Soon to list Medibank Private is the undisputed king of Australian private health insurers (PHI). Medibank's 3.8 million members give it a market share of 30 per cent – more than HCF, NIB, and HBF combined.
For investors considering the upcoming float, market dominance like this is a big attraction. But PHIs aren't typical businesses operating under typical conditions.
Medibank can't easily use its market power, perhaps by lowering prices to force smaller players out, because regulation forbids the discounting of premiums by more than 12 per cent.
Furthermore, any premium hikes require the approval of the Health Minister, whose priority is, at least in principle, to protect the public from unfair pricing. There's nothing typical about those kinds of conditions.
So how do the private health insurers compete if they can't use price?
By differentiating their products, offering a mix of inclusions and exclusions that's as finely graded as they can administratively handle.
PHIs make mobile phone plan shopping simple by comparison. The industry's marketing expenditure has nearly doubled over the past seven years and there are now close to 30,000 different health insurance policies for you to choose from.
That sounds like a bad thing for the industry, and in a sense it is. The choice is so overwhelming that the consumer might find the whole thing too hard.
But the strategy has a pay off. While it may be difficult to get consumers to commit in the first place, once they do they don't want to replay the nightmare by changing providers. Health insurance policies are some of the stickiest purchases consumers will make, ever.
Only about 5 per cent of policyholders switch in any given year – roughly half the switching rate for other financial products such as life insurance and bank accounts.
The high customer captivity makes it easier for Medibank to upgrade members to more profitable products. It strategy also delivers a strong base and stable revenue, allowing investment in new products such as life, travel and pet insurance.
But is Medibank's approach the best in the business?
Not necessarily. In our view NIB's strategy makes better use of the industry's low churn rate by targeting members at the very beginning of the 'upgrade treadmill'. The young and healthy are drawn into NIB's net using low-cost policies with lots of exclusions, after which they upgrade to more expensive plans as they start young families and enter middle age.
Because the under-35s segment of the population is under-represented as a proportion of total policyholders, NIB has grown its member base at a faster rate than the overall market, increasing market share every year for the past 15.
And by selling to a younger market segment that requires less medical treatment, NIB produces better operating margins of about 4 to 5 per cent compared to Medibank's 3 to 4 per cent.
None of this means Medibank should be avoided in the forthcoming float. There's room to cut costs once the company lists in December and in the end it will all boil down to price and we don't know that yet.
But investing in the Medicare IPO purely because of its 'leading' market position would be a mistake. It may be the biggest but right now it's not the best.
John Addis is editor of Intelligent Investor Share Advisor (AFSL 282288). To unlock Share Advisor's stock research and buy recommendations, take out a 15-day free membership.
