Risk: If the health fund’s new regulators decide to bring health funds into line with APRA’s risk structures for general insurers, the health funds may be required to put aside hundreds of millions in extra capital to meet claims. Photo: Glenn Hunt

Is the government availing its prospective investors in Medibank of everything they need to know? Is there any significant regulatory risk which should be imparted?

The risks are lower in health insurance than in general insurance; more predictable. The capital reserves of a health fund for instance won’t be wiped out by a tsunami or an earthquake.

A wave of hip replacements is more easily anticipated by the actuaries and regulators of a health fund than a general insurer can possibly estimate the damage from floods and fires. Even the spread of ebola on these shores would have little effect on private-health funds.

Private health is fundamentally discretionary. It gets you in the hospital door ahead of the hoi polloi in the public system; the curtains in your hospital room are pretty and the food is eminently superior.

The handling of an ebola outbreak would fall squarely on the public sector.

Buried in the detail of the Medibank prospectus is this line: “The functions of PHIAC will be split and transferred to APRA and the Department of Health by July 1, 2015, with a view to closing the agency.”

The Private Health Insurance Administration Council (PHIAC) is the private-health fund regulator, and the Australian Prudential Regulation Authority (APRA) is the supervisor for banks and general insurers. The two agencies are to merge and APRA will run the show.

Herein lies the regulatory risk for shareholders in Medibank. If the health fund’s new regulators decide to bring health funds into line with APRA’s risk structures for general insurers, the health funds may be required to put aside hundreds of millions in extra capital to meet claims.

Either the profits and dividends for shareholders would fall or premiums for policy-holders would need to rise – or both.

Fairfax Media understands there has been some consternation behind the scenes at Medibank and other health funds vis-a-vis the new regulator.

One departmental source said APRA was “more risk averse” than PHIAC, its resources were already stretched and it was already leery of mergers due to its history and the catastrophic collapse of HIH Insurance. APRA itself had been formed in 1998 via the merger of the bank prudential regulator (then RBA) and the Insurance and Superannuation Commission (ISC).

The bank side ran the agency and only three years later HIH collapsed, bringing critical and unrelenting focus on APRA’s regulatory capability.

“APRA has plenty on its plate already and the last thing it needs is a dilution of its focus by giving it additional responsibilities,” said the source. “It is also interesting that while the government fobs off many things to the FSI [Financial Services Inquiry], this change – effectively taking PHI [private health insurance] from the health portfolio and putting it into finance – proceeds.”

Over the past 18 months, PHIAC has been bedding down changes within the private-health insurance sector relating to the way the capital the funds are required to keep is calculated. This change has freed up some $1.5 billion in capital reserves, said a department insider, across the industry that were being held in excess of prudential requirements.

This was evident in the first-quarter earnings presentation of share-market listed private health insurer NIB, which boasted an increase in capital of up to $60 million thanks to PHIAC changing its standards.

For Medibank, the risk is that a move to APRA may entail APRA, over time, applying a general-insurance risk model to the private-health industry; thereby requiring funds to retain greater capital reserves and potentially cruelling a good investment prospect.

Another aspect involves how private-health policy premiums are set. Each year, around this time, the funds submit applications for a premium increase to the Minister for Health for approval. PHIAC plays a role in advising the minister if the increases are prudentially appropriate, but it has no say in the final decision.

The timing of the sale of Medibank means it will have to disclose what premium increase it will be seeking, given it is highly material information, but prospective shareholders will have no idea of whether this increase will be realised as the decision is usually not made until late-December.

In the minds of investors so far, the greatest risk in the Medibank float involves the lottery and lack of transparency of IPO pricing, thanks to the closed “book-build” process to subscribe for shares. This is also a risk for government – a similar process led to a debacle for the British government in its privatisation of the Royal Mail. It sold too cheaply.

Investors however could be forgiven for demanding more clarity on regulation. APRA will soon be in charge, APRA is more conservative than PHIAC. With its 30 per cent market share, Medibank presumably gained some $500 million in extra capital from PHIAC’s relaxing of the standards (though $300 million has been ripped out by government in dividends since).

Funny thing is, why did government insist on the merger anyway? Both agencies are “off-budget”, funded that is by those they regulate. The merger is budget neutral but will still reduce oversight.