In a competitive market for a product or service you would not worry about what the vendor’s cost structure is; you would assume that the price is set by the market and it is the seller’s problem how it allocates the revenue received among the cost of delivering the good or service, general admin costs and profits. Health insurance is actually a pretty competitive market, but for many years some states felt it necessary to mandate that a certain percent of premium had to be spent on medical claims, so-called medical loss ratio regulations, and this concept was picked up and applied nationwide in the reform law. As with any government action, unintended (but obviously predictable, except apparently to the people who write and pass these regulations) consequences occur. A report from the Robert Wood Johnson Foundation examines insurer responses in light of the federal MLR requirement. (RWJF Brief) As the authors properly note, the most important thing about the MLR rule is how insurers get to the required level. The intent of the regulators is that they do so by reducing administrative expenses and profits, which theoretically would mean premiums could stay the same or even be less. But insurers could easily also react by allowing health claims expense to rise; the higher claims expense is, the higher premiums can be, and the more absolute dollars are in the administrative and profit bucket.
The researchers constructed a raw MLR measure, a net MLR measure, an administrative cost ratio and an operating margin ratio. They looked at the ratios before the federal MLR rule went into effect and for two years after, which may be too short a period to determine all the long-run responses to the regulation. There were also issues with the completeness and accuracy of the data they used. The MLR did increase in both the individual and small group market between 2010 and 2012. In the individual market the change appeared to be the result of allowing health claims to grow much more rapidly than premiums, and than national health spending growth, while in the small group market, which was already as a whole close to the minimum MLR, it rose slightly due to slower health claim growth and premium growth that increased even less. The number of insurers in the individual and small market declined over the period, and while the researchers say the insurers who left had small market shares, any decline in the number of market participants can make a market less competitive. In the individual market, there also was a decline in both the administrative cost ratio and the operating margin, with the margin going negative. The data ends at 2012, and we now know, based on both 2015 and especially 2016 pricing, that the combination of negative margins and rising claims costs is leading to tremendous premium hikes in the individual market. The small group market also experienced a decline in administrative cost ratios, but operating margins were stable and slightly positive. It should be noted that this percent of premium method of analysis has flaws, and that a better method is to track per member per year costs and compare those to total premiums. That allows an analysis of the absolute dollar spent trends.
One method that insurers use in reaction to the MLR rule is to argue over how premiums are calculated and what bucket certain expenses fall into. That’s productive. Another likely consequence of the MLR rule, for which this study provides evidence, is that it pushes some insurers out of the market, which may raise MLRs in the short run, but lessens competition, likely leading to higher premiums in the long run. It should be obvious that premium level is far more important than MLR to consumers, in fact consumers should care less about the MLR. And most importantly, which the study also suggests is occurring, it lessens the incentive to manage health spending carefully, since higher medical claims get the MLR to the required level, but also allow higher premiums and greater margin dollars. So all in all, we are left wondering why we don’t just rely on a pretty competitive health insurance market to set prices, instead of having a regulation that may very well result in higher prices to consumers.