The consumer watchdog is taking Medibank to court for allegedly misleading customers over changes to benefits that left some customers out of pocket while in hospital.
The Australian Competition and Consumer Commission is accusing Medibank of unconscionable conduct, and deliberately failing to notify customers of its AHM subsidiary about new limits on pathology and radiology benefits that kicked in from September 2014.
Some customers only became aware of limits to pathology and radiology benefits when they were unexpectedly confronted with expenses while receiving hospital treatment, the ACCC said.
It also alleges Medibank did not publicise the changes for fear it may hurt its reputation ahead of its $5.7 billion share market float in November 2014.
"Medibank knew or expected that many members incorrectly thought all of their in-hospital medical expenses were covered," the ACCC said.
"Medibank calculated there was a risk that the publicity around the benefit change would damage Medibank's brand and reputation, and have a negative impact on its planned initial public offering of securities."
Medibank issued a brief statement to deny the allegations.
"Medibank takes its obligations under the Australian Consumer Law seriously, and has appropriate processes in place to ensure compliance," it said.
"We have been working cooperatively with the ACCC throughout its investigation."
Morningstar analyst David Ellis said the legal action is a blow to the insurer and could having a lasting impact.
"These legal matters can take quite a number of years and if it does go to a public court case and damaging accusations about Medibank's behaviour are revealed, then there could be serious consequences for their brand and reputation," Mr Ellis said.
"However, it will depend on how strong the ACCC's case is and how strong Medibank's defence is."
The ACCC will seek measures including compensation orders and financial penalties against Medibank in the case.
Finance Minister Mathias Cormann spearheaded the privatisation and float of Medibank.
In a statement, Senator Cormann said the federal government was not liable in any way, despite being the owner of Medibank at the time the benefits changes were made.
Senator Cormann said it would be inappropriate to comment further because the matter was now before the courts.
Retail investors paid $2 per share, and institutional investors $2.15 per share, in Medibank's IPO.
On Thursday, its shares dropped 17 cents, or 5.5 per cent, to $2.91.
