Background to hospital funding reform
This chapter traces the history of hospital funding arrangements in
Australia. It commences with an examination of the pre‑Medicare and
Medicare eras and concludes with an overview of the historic National Health
Australia's health system is funded and administered by several levels
of government and supported in part by the non-government sector. Whilst the
Commonwealth and the states and territories share many roles in policy, funding
and regulation, service delivery is largely undertaken by the states and territories,
local governments, and the non-government sector.
The Commonwealth is the largest contributor of government funding to
health services and its direct areas of responsibility include:
Pharmaceutical Benefits Scheme;
Medical Research Grants; and
Education of Health Professionals.
States and territories are mainly responsible for areas including the:
Management and administration of public hospitals (including
Delivery of preventative services; and
Funding and management of community and mental health services.
Shared Commonwealth-state responsibilities include:
Funding of public hospitals;
Registration and accreditation of health professionals;
National mental health reform; and
Aboriginal and Torres Strait Islander health services.
Public hospitals are seen as the most significant area of shared funding
between the Commonwealth and the states and territories.
Since the First World War, efforts to reach agreement in terms of funding
arrangements and funding priorities for public hospitals have highlighted the considerable
differences between the levels of government.
Past negotiations around new health funding models and the signing of new
healthcare agreements between the Commonwealth and states and territories have
often been marked by disputes and allegations of cost shifting. As a
consequence, health and hospital funding has often been referred to as the
Hospital funding pre-Medicare
Federation – 1949
Demand for public hospitals increased between the world wars but many hospitals
struggled to raise enough revenue to cover their costs. While private health
insurance was in operation, it was very limited. In 1928 and 1938 national
health insurance schemes were proposed by the respective governments but were
successfully opposed by businesses and the medical profession.
Following the Second World War, the relationship between the Commonwealth
and the states and territories was impacted by a succession of attempts by the
Commonwealth to gain additional heads of power, including a power for 'national
health' in 1945. Whilst the 1945 referendum was defeated, the Commonwealth was
able to provide funding to the States and Territories through the Hospital
Benefits Act 1945.
This legislation specified that all people must have access to the public wards
of hospitals free of charge; however, there was no intrusion by the
Commonwealth into the organisation and management of hospitals.
A year later, the 1946 referendum to give the Commonwealth new powers
for a range of social services was successful. This gave the Commonwealth
authority to provide pharmaceutical, sickness and hospital benefits as well as deliver
and fund medical and dental services.
It led to a new Pharmaceutical Benefits Scheme (PBS) but the medical profession
could not be convinced of the proposed national health insurance scheme.
In 1948, the Chifley government passed the National Health Service
Act 1948 which allowed the Commonwealth to 'maintain and manage hospitals,
laboratories, health centres and clinics, and to take over any of these
services from the states',
but it was never fully implemented.
Under Medibank, the predecessor to Medicare, hospital funding was delivered
via a cost-sharing arrangement, with the Commonwealth providing conditional
grants to the states equivalent to 50 per cent of gross operating costs. The
states would be required to fund the remainder from their own revenue.
To implement the hospital aspect of Medibank, the Whitlam government
negotiated separate funding agreements with each of the states. These
agreements sought to ensure:
that all public patients in public hospitals received free treatments
and access to medical services;
hospital benefits were paid directly to hospitals not to
the end of the honorary system of hospital medical work; and
grants were made to the states to compensate them for the loss of
revenue that resulted from abolishing hospital fees and means-tests.
It took until 1 October 1975 before all states had agreements in place
with the Commonwealth and the hospital aspect of Medibank could be deemed as
The Medibank program had only been operating for a few months when the Whitlam
government was dismissed on 11 November 1975. Although the incoming Fraser
government had indicated during the election that it would maintain Medibank,
within months changes had been made. Medibank II was launched in 1976, Medibank
III in 1978 and Medibank IV in 1979.
In 1981, following the Jamison Committee of Inquiry into Efficiency and
Administration of Hospitals,
the nature of the funding for hospitals from the Commonwealth changed from
specific purpose funding to per capita block grants.
Following the election of the Hawke government in 1983, legislation was
introduced to return to the original Medibank model, albeit with grant based
funding. The 'new' universal scheme was named Medicare
and began on 1 February 1984.
Under Medicare the Commonwealth signed bilateral agreements with the states
and territories in which the basic arrangement consisted of the Commonwealth
providing funding in exchange for the states and territories providing free public
hospital treatment as public patients. The first agreement extended until 1988
and thereafter each agreement was for five years.
The first round of Commonwealth payments to the states and territories consisted
of Identified Health Grants and a Medicare Compensation Grant.
The grants not only provided for funding for hospitals but also for new
community health services.
By November 1986, the maximum gap
had increased from the initial $10 to $20; the in-hospital rebate was set at 75
per cent, with private health insurance to cover remaining 25 per cent.
The second round of Medicare agreements saw a return to specific funding
grants with the Identified Health Grants and a Medicare Compensation Grant
being replaced with new Hospital Funding Grants. These grants were 'absorbed'
into the pool of general revenue assistance.
The base grant during this period of the agreements was adjusted for
inflation and weighted population growth, as well as an adjustment for the
treatment of HIV/AIDS patients and the development of incentives programs
including 'casemix' systems,
day surgery and early discharge programs.
The Medicare Agreements Act 1992 contained the key principles
underpinning the agreements. These Medicare Principles specified that:
Principle 1 (Choices of Services): Eligible persons must be given
the choice to receive public hospital services free of charge as public
Principle 2 (Universality of Services): Access to public hospital
services is to be on the basis of clinical need;
Principle 3 (Equity in Service Provision): To the maximum
practicable extent, a state will ensure the provision of public hospital
services equitably to all eligible persons, regardless of their geographical
The third round of Medicare Agreements commenced from 1 July 1993. The
new agreements were still based upon the three principles in the Medicare
Agreements Act 1992, however there were some changes to the funding
arrangements between the Commonwealth and the states and territories. The base
grant continued to be calculated in the same way—adjusted for inflation and for
weighted population growth, but two bonus payment pools were introduced to
encourage improved public access.
There were also additional payments including incentives packages for reforms
relating to improvements in quality and management of services.
These 'performance-based funding' measures were countered by penalty
provisions which were enforced when levels of public patient access fell below
the specified base threshold.
Australian Health Care Agreements
The development of Australian Health Care Agreements (AHCAs) in 1998
were characterised by acrimonious disputes between the Commonwealth and the states
and territories over the scope of the agreements.
Despite the fact that the ACHAs largely re-stated the Medicare
Principles, the AHCAs were seen as a significant departure from the Medicare
Agreements in that they encompassed greater scope for altering future funding
levels and enabled flexibility in service provision. They also included a
stronger focus on the provision of equitable access to public hospital services
regardless of geographic location.
In contrast to the Medicare Agreements, variations to AHCAs base grant
were made on the basis of a weighted population index, changes in hospital
output costs, changes in the veteran population and private health insurance
Controversially, the agreements included a new provision which enabled
grants of financial assistance to be made by the Commonwealth, to entities
other than a State, such as a hospital or 'other person'.
The extension of the Minister’s power to make grants to 'other persons' was
seen at the time as a 'considerable departure from traditional and current
The negotiations for the AHCAs for 2003–2008 were characterised by
fraught negotiations between the Commonwealth and the States and Territories
that included a walk-out by the states over funding arrangements.
Preliminary negotiations at COAG in April 2002 Health Ministers
established nine expert reference groups, to provide advice and recommendations
on specific areas, such as the interaction between hospital funding and private
health insurance, which would inform the process of negotiation for the new
AHCAs. Notably, these reference groups were co-chaired by a non-government
clinical expert and a senior government official. Unfortunately input from the
reference groups ultimately had little substantive impact on the new agreements
which were signed in August 2003.
An important condition of the new AHCAs was that each State and
Territory had to increase funding so that the growth in the States' and
Territories' own funding for hospitals would match the cumulative rate of growth
in Commonwealth funding over the five year life of the agreements.
The Commonwealth contributed an estimated $42 billion during the life of
the 2003–08 agreements whilst the states collectively contributed about $58 billion.
However, in contrast to previous agreements, about 4 per cent of AHCA payments
to the states and territories were conditional on the states complying with various
The increased emphasis on accountability went further with the new AHCAs
requiring the Commonwealth to publish an annual report, The state of our
public hospitals, which 'considers how the states...are performing in the
delivery of public hospital services and records their expenditure on public
Development of the Intergovernmental Agreement
National Health and Hospitals
The National Health and Hospitals Reform Commission (NHHRC) was
established in early 2008 to provide advice on progressing health reform.
Its reports consistently gave strong support for the use of
...as the principal mode of funding for both public and private
hospitals, where the level of funding is linked to the volume of services
hospitals provide using casemix classifications.
The NHHRC also argued that activity based funding would provide a
'powerful incentive' for hospitals to perform as efficiently as possible.
In its first report, Beyond the Blame Game (April 2008), the
NHHRC provided advice to inform the negotiations around the Australian Health
Care Agreements. The report took a long-term view of the health system,
identifying key health challenges, developing performance indicators and
benchmarks and a set of design and governance principles to underpin the health
system of the future.
The Final Report: A Healthier Future For All Australians (June
2009), built on the previous reports, making 123 recommendations and identifying
three reform goals:
- Tackling major access and equity issues that affect health
outcomes for people now;
- Redesigning our health system so that it is better
positioned to respond to emerging challenges; and
- Creating an agile and self-improving health system for
Intergovernmental Agreement on
Federal Financial Relations
In 2007 the Rudd Government announced its intention to progress through COAG
a range of reforms affecting intergovernmental financial arrangements. When
COAG met in December 2007, it:
Recognised that there was a unique opportunity for
Commonwealth-State cooperation, to end the blame game and buck passing, and to
take major steps forward for the Australian community.
Following much negotiation, the Intergovernmental Agreement on
Federal Financial Relations (IGA) was signed in November 2008. The IGA
...improve the quality and effectiveness of government services
by reducing Commonwealth prescription, aligning payments with the achievement
of outcomes and/or outputs and giving States the flexibility to determine how
to achieve those outcomes efficiently and effectively.
As part of this new COAG reform agenda, a program of major health reform
was agreed, including targeting elective surgery waiting times, aged care,
public dental programs and preventative health.
Additionally, from 1 July 2012 the National Healthcare SPP was to be replaced
by National Health Reform (NHR) funding, which would be subject to the terms
and conditions agreed in the NHRA.
National Healthcare Agreement
Within the IGA the health sector was covered by the National
Healthcare Agreement (NHA)
which detailed the objectives, outcomes, outputs and performance indicators,
and clarified the roles and responsibilities of the Commonwealth and the states
and territories in the delivery of health services.
The respective roles and responsibilities of the different tiers of
government were classified into three distinct categories:
...those shared by the Commonwealth with the states and
territories; those for which the states and territories were solely
responsible; and those for which the Commonwealth alone would be responsible.
The NHA also set out the key principles for the provision of a range of
jointly funded health services. National objectives in prevention, primary and
community care, hospitals, aged care, social inclusion and indigenous health,
sustainability and the patient experience were agreed.
The IGA committed the Commonwealth to provide funding of $60.5 billion
over five years to the States and Territories to deliver health services. This
the introduction of a more generous indexation formula of 7.3 per
cent per annum;
an additional $750 million to relieve pressure on public hospital
an increase to the SPP base of $4.8 billion over the forward
a package of reforms under the new hospitals and health workforce
reform National Partnerships of $1.7 billion, including a $1.1 billion health
The NHAs also put into effect activity based funding (ABF) which had
been agreed to by COAG in November 2005:
The Commonwealth and the States have also agreed to provide a
basis for more efficient use of taxpayer funding of hospitals, and for
increased transparency in the use of those funds through the introduction of Activity
Based Funding. It will also allow comparisons of efficiency across public
While the states and territories were not be able to redistribute Commonwealth
health funding from one sector to another, neither the IGA or NHA specified any
conditions in respect of how States or Territories allocated their own funding within
This was in contrast to the previous series of AHCAs.
The IGA also established National Partnership Payments (NPPs) which were
underpinned by National Partnership Agreements (NPAs). The NPPs encompassed
defined payments for defined periods that could only be used for specific
projects/priority areas as detailed in the agreements.
While the NHA set the broad policy and funding framework, NPPs were structured
to drive more specific health outcomes such as those relating to Hospitals and
Health Workforce Reform, Preventative Health, Public Hospitals and Indigenous
Health. In later years they also expanded to cover health infrastructure,
mental health, public dental services, vaccines and other health services such
as bowel cancer screening, kids' health checks and antimicrobial surveillance.
The National Health and Hospitals
The National Health and Hospitals Network Agreement (NHHNA) was signed
on 20 April 2010 by all states and territories apart from Western Australia.
The NHHNA was structured so as to establish:
the Commonwealth as:
- – the majority funder of public
Local Hospital Networks (LHNs) with responsibility for the
management of hospitals within their networks...
the states as:
- – responsible for system-wide
public hospital service planning, policy and performance (in conjunction with
LHNs) and capital planning...
As the majority funder of public hospital services under the NHHNA, the
Commonwealth agreed to fund 60 per cent of the national 'efficient price' for
hospital services, as well as guaranteeing $15.6 billion in top up funding over
However, in 2010 the NHHNA arrangements were superseded and under the
Gillard Government negotiations began for a National Health Reform Agreement. Although
the funding arrangement has changed it was expected that various components of
the NHHNA, such as the establishment of Local Hospital Networks would be
retained under any new agreement.
National Health Reform Agreement
The National Health Reform Agreement (NHRA) was signed in August
2011. It implemented the National Health Reforms as agreed by COAG in February
2011 under a Heads of Agreement on National Health Reform. It also complemented
the NHA and included the parties':
...commitments in relation to public hospital funding, public
and private hospital performance reporting...
The provisions of the NHRA were enacted by the National Health Reform
Act 2011. The NHRA was created with the aim of delivering a nationally
unified and locally controlled health system through:
Introducing a number of financial arrangements for the
Commonwealth and states and territories in partnership
Confirming state and territories' lead role in public health and
as system managers for public hospital services
Improving patient access to services and public hospital
efficiency through the use of activity based funding (ABF) based on a national
Ensuring the sustainability of funding for public hospitals by
the Commonwealth providing a share of the efficient growth in public hospital
Improving the transparency of public hospital funding through a
National Health Funding Pool
Improving local accountability and responsiveness to the needs of
communities through the establishment of local hospital networks (LHNs) and
New national performance standards and better outcomes for
As part of the NHRA several initiatives forecasted as part of the NHHNA were
implemented. This included the establishment of Local Hospital Networks to
deliver decentralised and specialised hospital services across jurisdictions
and work with Medicare Locals to deliver integrated care.
Under the NHRA Commonwealth funding would be deliver via the following
on the basis of activity based payments where practicable,
however block funding
and public health funding
will continue where applicable;
45 per cent of efficient growth
of activity based services would be funded by the Commonwealth from July 2014
whilst 50 per cent would be funded from 1 July 2017;
45 per cent of growth in the efficient cost
of block grants would be funded by the Commonwealth from July 2014 whilst 50
per cent would be funded from 1 July 2017;
an additional $16.4 billion in Commonwealth funding would be
provided through the revised funding arrangements between 2014-15 and 2019-20.
This is in addition to what would have been provided through the National
Commonwealth funding would be dependent upon the provision of
data by the state and territories to the National Bodies including data on the
provision of services to patients; public or private status of the patient, the
nature of the service provided and where the service was provided.
The following National Bodies were established under the NHRA to
administer key financial arrangements:
The Administrator of the National Health Funding Pool—its role is
to administer the National Health Funding Pool, to oversee payments into and
out of the state pool account for each state and territory, and to report on
various funding and service delivery matters.
National Health Funding Body (NHFB)—its primary function is to
assist the Administrator of the National Health Funding Pool (the
Administrator) in enabling and supporting more transparent and efficient public
hospital funding and reporting.
Independent Hospital Pricing Authority (IHPA)—its role is to
implement Activity Based Funding for Australian public hospital services by delivering
an annual National Efficient Price (NEP).
National Health Performance Authority (NHPA)—its role is to
monitor and report on the performance of public and private hospitals, primary
health care organisations and other bodies that provide health care services to
Australian Commission on Safety and Quality in Health Care
(ACSQHC)—its primary function is to lead and coordinate national improvements
in safety and quality in health care. 
The funding from Commonwealth and state and territory governments under
the NHRA is paid into a NHFP (administered by the NHFPA). Each state and territory
also has a separate fund (known as its state managed fund) for receiving
Commonwealth NHR block funding via the NHFP, receiving block funding directly
from the state or territory itself, and for making payments of block funding by
the state or territory to LHNs.
Figure 1 below illustrates how the funding between the Commonwealth and the
states and territories flows.
Figure 1—National Health Reform funding flows
The signing of the NHRA by the states and federal governments in 2011
was an historic point for hospital funding in Australia. This was the first
time that hospital funding arrangements were mutually agreed and set out for
the longer-term. It was also the first time that a mechanism had been created
that encouraged cooperation, through aligned incentives, between the states and
federal government to ensure that funding was used efficiently.
Long-term certainty of funding for Australia's hospitals was a
significant casualty of the disastrous 2014-15 Budget. Chapter 3 examines the
impact that the 2014-15 Budget decision has had on hospital funding, while the
remaining chapters of this report detail the effect on individual states and
The Senate Select Committee on Health's examination of the issues around
hospital funding, through its extensive hearings and the submissions received,
has been relatively brief in comparison to the work which went into the National
Health and Hospitals Reform Commission in 2008. The NHHRC's work was
comprehensive, and laid the foundation for the NHRA; it mapped a way forward to
end the 'blame game' between the states and federal governments on hospital
However, the committee notes that the same issues that were identified
by the NHHRC are coming to the fore since the 2014-15 Budget decision. The
following chapters demonstrate that with one decision in the 2014-15 Budget,
the Coalition Government has put hospital funding back ten years, to face the
same issues all over again.
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