How Did Consumers Benefit from the Medical Loss Ratio and Rebate Requirements?

A recent study published by the Commonwealth Fund examined the effects of the medical loss ratio (MLR) requirement on premiums and costs. Specifically, the authors, Michael McCue and Mark Hall, compared the insurers’ public financial statements filed with the National Association of Insurance Commissioners from 2010, before the rule became effective, to 2011, the first year the rule was in effect. Instead of focusing solely on the rebates paid, they also looked at changes in the relationship between the total premium, overhead (administrative costs + profit), and medical payments.

McCue and Hall explained that an insurer can improve the MLR by cutting overhead or reducing the premium. The savings from reduced nonmedical costs may not necessarily be passed on to the plan members. For example,suppose Plan A charges a premium of $1,000, pays medical expenses of $750 and administrative expenses of $200 and keeps the remaining $50 as profit. Its MLR is 75 percent. It must pay consumers the difference between the premium charged and the required  MLR—80 percent in the individual market. Its profit is gone. In the group markets, where an 85 percent MLR is required, Plan A loses $50.

To improve its MLR, the plan could reduce the premium or the administrative costs, or both.If Plan A reduced its administrative costs to $100 and its profit to $30 and applied all of it to reducing the premium, the resulting premium would be $880. The $750 in medical costs would reach the 85 percent MLR required of group plans with $2 to spare.

But, McCue and Hall point out, the plan could reduce its administrative costs to $120 and keep the premium at $1,000. If it paid $750 for claims, it could pay the penalty of $50 (for individual plans) or $100 (for group plans) and still make a profit. The savings in administrative costs would benefit the plan, but not its members.

To see whether, or how much, the MLR requirement benefited consumers, McCue and Hall compared the administrative expenses from 2010 to 2011. In the individual market, insurers reduced their administrative costs and profit by a total of $560 million while enrollment grew by nearly 250,000. Thus, the cost per member per month dropped significantly. The changes varied widely among states.  The per capita overhead (administrative costs + profit) dropped in 35 states. Per capita administrative costs fell in 39 states, while per capita profit dropped in 34.

In the group markets, more of the savings in administrative costs stayed with the insurers. In the aggregate, small group plans reduced their administrative costs by $190 million and made profits of $226 million.The average MLR remained about the same, 83.6 percent.  Enrollment grew. The average per capita administrative cost fell, and the per capita profit rose. In 28 states, the profit per member rose (or the loss per member fell).

Although large group plans paid $386 million in rebates, they cut their administrative costs by 785 million. As a result, the authors found, overall profits in the large group market grew by $959 million.The changes in costs and profits in the large group market varied among states, however. Administrative expenses fell in 26 states. In 19 states, the operating profits of large group plans fell in 2011; in six, they fell by $50 per member or more. But in ten states, per capita profit grew by more than $99 per month.

The authors concluded that the MLR rule was a substantial factor in the changes in administrative costs in all three markets. In the individual markets, both administrative costs and profits dropped; consumers benefited because premiums did not rise as much as medical expenses. According to McCue and Hall, historical pricing patterns commonly resulted in MLRs below 80 percent in the individual market, so that these insurers had to cut profits (or increase losses) to attain the 80 percent MLR. Eventually, some individual insurers may leave the market.

But overall, the insurers in the group markets increased profits by at least as much as they lowered their costs, and they did not reduce premiums. The legislative purpose to lower costs to consumers was not accomplished. It may be necessary to regulate rates, tighten the MLR rules or increase competition to achieve that objective.