Medical Loss Ratio regulation: Not a winning strategy

California is considering imposing a mandatory minimum Medical Loss Ratio (MLR) on health plans operating in the state. The law would require health plans to spend at least 85 percent of their premium revenue on medical care. Backers say it would keep costs down by cutting “wasteful administrative costs and excessive profits.” Unfortunately they don’t know what they’re talking about. Here are a few reasons why the California approach won’t achieve its goals:

  • All the plans in the state already meet the criteria –so no one will have to change their current operations. That’s because plans will be be allowed to include in the MLR some items that are often classified as overhead, such as disease management programs and nurse call lines
  • Over time, minimum MLRs are likely to put a squeeze on the individual and small group market, where MLRs are lower. There’s a good reason why MLRs are lower there: administrative costs to serve those markets are higher on a percentage basis. For example, medical costs for young, healthy people are a small fraction of the costs for older people. This provides a much smaller base over which to spread administrative costs, which tend to be more fixed (less variable) than medical costs on a per person basis. In a simple example, if a young person’s premium is $5000 per year and an older person’s is $10,000, the plan can spend $1500 in admin costs on the older person but only $750 on the younger. As plans look to expand it will mean more emphasis on the already well-served Medicare and larger group market, and less on small groups and individuals –the very ones that find coverage hard to get now!
  • Minimum MLRs will encourage the proliferation of high-end, gold-plated plans that cost more. This will allow more dollars per patient in administrative spending and profit and increase the number of uninsured
  • The focus on administrative cost/profit control will dampen health plans’ appetite for holding down medical costs. They’ll be less keen to invest in new systems and plans that keep a lid on medical costs if they won’t have the chance to make an “excess” profit from their success

If MLRs are too low today –and maybe they are– it’s because complex, extensive regulation keeps barriers to entry high. If it were easier for new plans to enter the market maybe they’d compete the “excessive profits” away.

September 3, 2008

5 thoughts on “Medical Loss Ratio regulation: Not a winning strategy”

  1. David:
    Thanks for writing this article.
    I never thought how MLRs could encourage insurers to offer more comprehensive plans. You seem to have quite an analytical mind.
    I understand that in California, there is no regulation regarding renewals on individual policies.
    If true, I guess that will change if this law goes into effect.
    Can you comment on Ca’s regulation which deters new plans from entering the market?
    In Texas, we have as part of the insurance code, a provision allowing for “experimental policies.”
    Is that option not available in Ca?
    I understand how these regulations would apply to commercial insurers, but what about non commercial insurers, such as self-funded VEBAs.
    Don Levit

  2. David asked me to comment on this. So I will.

    First, it’s a little tough to suggest that the people proposing this dont know what they’re talking about unless you really believe that there is no waste or excessive profit in the individual market. Of course there is.

    Current regulation in the individual market in California means that once someone is accepted into a plan, their rates can only increase at the same rate of the group they’ve joined (age/sex/region adjusted).

    That means that insurers do three things. 1) Try like hell to make sure no one with any possible medical condition gets near an individual plan. 2) If they do, kick them out using illegal tactics. (Recently cracked down on). 3) Increase rates for the groups as much as possible–I’ve had increases of over 20% each of the last 4 years (By the way this inspires people to drop insurance, which sends them back to point 1).

    Is the way to deal with this to enforce an 85% MLR ratio? No of course not.

    The way to deal with this is to have comprehensive insurance reform a la Holland or single payer. But this is America and that’s heresy to say, so we get BS regulations proposed like this.

    Having said all that, it’s not true that most insurers have MLRs greater than 85%, and it’s certainly not true in the individual market in California.

  3. Matthew:
    Thanks for your reply.
    When you say that rates can increase by the group they have joined, does the amount of people in the group continue to increase as new applicants join?
    Or, do insurers typically close off blocks when a new policy form is issued (thus having to increase rates further for not allowing “new blood” into the group)?
    Are the renewal increases you have had the last 4 years higher than the new business rate increases?
    Are long-term customers in individual plans usually paying higher premiums than others with similar characteristics newly applying for similar benefits?
    Don Levit

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