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.