What's in a Medical Loss Ratio?

Today’s Managing Health Care Costs Indicator is 80%

Health care reform requires that commercial health plans spend at least 80% of their collected premium on delivering medical care.  The idea of this rule is to prevent bloated administrative costs, including executives with sky-high compensation, high profit margins for shareholders of public companies, and massive administrative structures which add cost but not value to health care.  But the devil, of course, is in the details.  The Times  reports that health plans are frantically lobbying to reclassify some costs as medical costs.

Insurers have focused on the “medical loss ratio,” or MLR, for years. Wall Street analysts routinely issue “sell” ratings for health plans with high MLRs, and regard health plans which have low MLRs as likely to ‘outperform’ the market.   That’s why many plans sought to keep their MLRs low to please Wall Street, even if now they will need to keep MLR high to please regulators.  But MLRs are like most of accounting – and are far more subjective than they might at first appear.

How do health plans spend their premiums?

They pay for health care delivery – cut checks to doctors, hospitals, pharmaceutical companies, medical device companies, and all sorts of other parties who directly deliver health care.   Those payments are unequivocally part of the medical loss ratio – there is no argument.

BUT – some health plans, like Kaiser Permanente, pass more of their premium dollar on to their delivery system (the Permanente Medical Organization for outpatient and professional care). The Kaiser delivery system does some of the medical management that would be done by one of the national health plans (like Anthem, Aetna, Cigna or United) for providers not in an integrated system.  So, there is general agreement that the cost of medical management programs, whether done by providers or done by health plans, can also be counted in the MLR.

There are some things health plans do which pretty obviously should NOT be counted in the MLR.  For instance, a health plan sponsors a local baseball team, or purchases advertisements on television.   I don’t think anyone would argue that this should be part of its medical loss ratio. Same goes for stock dividends, or bonuses for the senior leadership team.  These are administrative expenses, plain and simple.

Then, there are health plan activities that might improve health care delivery, but feel very much like health plan administration.   Aetna argues that its fraud detection programs should count as part of the MLR. Anthem wants to count its physician credentialing activities.  AHIP wants MLR to include any health plan expense to move from ICD9 to ICD10, a method of classifying diagnoses.

The Washington Post reported that Anthem/Wellpoint recategorized a half billion dollars of expenses from administrative to MLR in April. 

Many health plans are also seeking to exclude payments to brokers from the definition of premiums collected, since these premiums were not available to the health plan, and the brokerage commissions are critical to making health insurance available (much as it’s often hard to sell a home without a realtor). 

There’s also another problem of small numbers.  Health plans will be judged state by state, and some health plans have very small populations in some states.  These small enrollments might have a low (or high) MLR based on chance alone, and this regulation could cause health plans to further consolidate or to forego expansion to contiguous states, diminishing competition.  The Maine insurance regulator has requested a waiver from the 80% rule, fearing that one of two remaining health plans in that state would abandon Maine if forced to lower its profit margin.  

My business school accounting professor, Mike Kirschenheiter, asked us to recite  “There is no truth in accounting” at the beginning of each class session.   He went on to point out that subjective decisions inherent in accounting should be made with a clear vision of the goals.   In this instance, the goal is that health care premiums are used to improve health care.   We should keep this in mind as regulators clarify what is counted in the “medical loss ratio.”