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The Pitfalls of PPACA #1 – The Medical Loss Ratio Rule

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The Patient Protection and Affordable Care Act, signed into law by President Obama in March, is a significant step towards a more equitable health insurance system, potentially making coverage available to millions of the currently uninsured. Unfortunately, health care reform’s political strategy of let’s-just-apply-lots-of-bandaids-to-the-present-broken-system is likely to produce some disappointments.

Positive changes like assuring coverage for children with preexisting conditions are likely to be overshadowed by others that are equally well-intentioned but fatally flawed—like PPACA’s limits on insurers’ medical loss ratios.

Beginning in 2011, unless medical loss ratios (the percentage of premiums paid out for medical care) are at least 85 percent for large group health plans, and at least 80 percent for small group and individual plans, the plans will be required to offer rebates to enrollees.

Given that the MLRs of the ten largest for-profit health insurers dropped from 95 percent in the early 1990s to around 80 percent today (or, put another way, administrative expenses, overhead and profit jumped fourfold from 5 percent of premium to 20 percent in just over 15 years), it’s easy to see why this provision seemed so attractive to its principal backer, Senator Jay Rockefeller.

Two weeks after enactment of PPACA, the Federal Register invited comments on how the new MLR requirement should actually be interpreted. The 70-page response (including appendices) from the National Association of Insurance Commissioners demonstrates just how more complicated than the politicians’ understanding the issue really is. (A separate response from AHIP, the insurers’ lobbying group, argues for treatment of almost anything that reduces medical expense as part of the MLR “medical care” numerator.)

Although PPACA’s MLR definition is not only imprecise but also quite different from that currently used by state insurance regulators, NAIC does estimate that most large and small group health plans will meet the new requirement, thanks to PPACA’s exclusion of state and federal taxes from non-medical costs (and implicitly assuming that the impact on MLRs of the currently uninsured will not be significant).  In other words, most group plans are likely to be unaffected—and if AHIP is at all successful, may even be tempted to increase their profit percentages while boasting compliance with the PPACA limits.

Individual plans present a very different case, and one where the political cure may be much worse than the disease. NAIC comments “Some issuers would likely have aggregate MLRs below 80% in at least some states even after the [tax] adjustments…”  The reasons for individual plans’ possible MLR problems include the higher administrative costs of such plans, the typically more restricted benefits (thereby reducing medical care costs relative to non-medical costs), and greater year-to-year volatility.  So, are plans with MLRs below the 80 percent threshold going to pay rebates to enrollees or, alternatively, slash administrative costs or profit?

Probably not, except for a few plans so close to the MLR thresholds that non-medical costs can be cut with minimal pain. No insurer will want to pay rebates, not only for the obvious reason of not wanting to see dollars going out the door, but because this will be perceived by consumers as a signal that premiums are too high. Equally, cutting profit for investor-owned plans will cut share value, something that insurance executives with stock options will certainly resist. Administrative costs could be cut by reducing care management and fraud detection efforts (assuming AHIP fails in its lobbying to include these as medical expenses), but doing so would simply increase the costs of care—and premiums.

Insurers are going to be left with a couple of strategies. One is to increase both benefits and premiums in order to reduce the impact on the MLR percentage of non-medical costs, an actuarially risky approach that could result in plans attractive only to high utilizers. The other is simply to withdraw from the individual market—one that plans like American National Insurance are already starting to choose.

It’s easy to criticize the shareholder profits and CEO incomes of investor-owned insurers (and the inefficiencies of some of their non-profit competitors), but this kind of political micromanagement isn’t the answer. While there is certainly a case for consumers knowing how their premium dollars are being spent, legislating expense ratios—rather than encouraging effective market competition—is more likely to lead to loss of coverage than to lower premiums.

Roger Collier was formerly CEO of a national health care consulting firm. His experience includes the design and implementation of innovative health care programs for HMOs, health insurers, and state and federal agencies.  He is editor of Health Care REFORM UPDATE (reformupdate.blogspot.com).

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politicaljulesMarkKevin HCalvinNate Recent comment authors
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politicaljules
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politicaljules

The way I read the new rules is that 80% will be the number. Which is laughable because PriceWaterhouseCooper’s analysis currently puts the average number at 87% and can be seen here: http://www.americanhealthsolution.org/assets/Health-Care-Costs/II.-Premium-Dollar.pdf I was able to easily use the internet to google that fact, so mandating rules that only 80 cents of every dollar must be spent on the patients is actually the wrong direction!! Sebillius is giving health insurance companies a raise by lowering the bar from 87 to 80 and she is taking 7 cents AWAY from patients while she manipulates the news and lies to the… Read more »

Mark
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Mark

What is A.H.I.P. doing to reduce illegal denial of funding to Providers after massive settlement funds mandated in the last several years? UHC/Ingenix price fixing out of Net services; Dr. Love vs. the Blues, etc.

Kevin H
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Kevin H

I don’t know where Barry gets his data regarding broker commissions but he is way off base. A 2009 report from the American Academy of Actuaries detailing the administrative expenses of various BC/BS plans shows that the median marketing costs IN TOTAL represent only 3% of premiums. Broker commissions are part of those marketing expenses but will fall significantly below the 3%. Broker commissions are already being cut and that trend is likely to continue and with guarantee issue is justified to some extent. However, brokers perform a valuable service to their clients in helping them select the benefit plan… Read more »

Calvin
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Calvin

“Insurers are going to be left with a couple of strategies. One is to increase both benefits and premiums in order to reduce the impact on the MLR percentage of non-medical costs, an actuarially risky approach that could result in plans attractive only to high utilizers. The other is simply to withdraw from the individual market—one that plans like American National Insurance are already starting to choose.”
Wouldn’t another (and the intended) option be to reduce non-medical costs? Shareholders and profit-motivated CEOs remain unaffected, operations are streamlined, waste is removed from the system.

Nate
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Nate

“No insurer will want to pay rebates, not only for the obvious reason of not wanting to see dollars going out the door, but because this will be perceived by consumers as a signal that premiums are too high.” Not so sure about this, it is getting very common in auto insurance to refund premium either directly, or deductible reduction. Minimum premium and self funding both refund premium the way some carriers do it and it has been well received. For some reason a large portion of the public doesn’t grasp the downside of giving interest free loans, i.e. taxes… Read more »

Nate
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Nate

“Given that the MLRs of the ten largest for-profit health insurers dropped from 95 percent in the early 1990s to around 80 percent today”
Very misleading when taken out of context, usually by people that don’t understand insurance. Mid to high 90 loss ratios, or even over 100s where common at that time becuase of investment returns. Those loss ratios say nothing about efficency and are only sustainable durung periods of unusally high returns.

Jim Lynch
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The MLR regulation really won’t make that much difference, as Obamacare will standardize coverage across products. That makes each insurance policy a commodity that can only compete on price, so loss ratios will creep up as competitors will limit price increases. This will happen regardless of any MLR regulation.
http://actuarialopinions.wordpress.com

Christopher George
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Christopher George

The MLR of medicare is high, because a large number beneficiaries recieve medical treatment. If there were medicare for all the MLR would fall drastically.

jd
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jd

Barry nailed it.
I’ll just add that the loss of smaller players like American National Insurance will consolidate more members into fewer plans, with no underwriting. Big efficiency gain and also a drop in the fluctuations in expenditures from small risk pools that Roger mentioned, improving MER stability. Oh, and don’t forget that the individual market is going to triple in size, also improving stability and efficiency in a guaranteed-issue world.

Barry Carol
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Barry Carol

The biggest single administrative cost in the individual market is broker commissions. These can range from 10%-15% of the premium and even more on the first year premium in some states. This model worked in the past because of medical underwriting. Insurers got to choose who they wanted to offer insurance to and exclude perceived bad risks. Under reform, people can’t be turned down if they have pre-existing conditions and policies will have to achieve some minimum actuarial rating. When the exchanges come on line in 2014, if there are only a handful of insurers offering a small number of… Read more »

MD as HELL
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MD as HELL

Medicare is a financial failure. How could anyone want Medicare for all when soon there will be Medicare for none?

George G
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I alos agree the MLR is imperfect. I alos agree the it would have been better to have a Medicare type program. I guess we will need to figure out how to live with this compliocated and open to minipulation compromise.

Mark Spohr
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Mark Spohr

I agree that the MLR is an imperfect band-aid and that it will be “gamed” by the insurance industry. It would have been much better to just have a “Medicare for all” insurance system where the MLR is over 90% but we have to preserve the profits of our private insurance companies who are the lifeblood of politicians so we have the present ugly compromise.