Medical Loss Ratios: A "Novel" Way For the Government to Intervene in the Health Insurance Industry

Yesterday, the Department of Health and Human Services certified a new rule requiring most health insurance companies to spend either 80 or 85 percent of their premiums on so-called "clinical services"—i.e., medical expenses—starting in 2011. The rule, which deals with health industry medical loss ratios, has been the subject of much controversy recently, and it will likely have a significant impact on the shape of the industry for years to come. As a result of the new rule, according to The Washington Post, "the government will reach in novel ways into the workings of the insurance industry to try to drive down bureaucracy, profits and executives' pay."

The Post is certainly right that federal MLR requirements represent a novel federal intrusion into the industry, but it's not clear that the law will produce better health outcomes or cost efficiency. For one thing, health insurance industry profits margins are already fairly—about 3.4 percent in 2008, according to one research firm's measure. So even if total profits seem high, there's not a lot of profit-related fat to be pulled out of each insurance dollar.

Nor is it clear that trimming administrative costs actually produces a cheaper, more efficient system overall. Administrative activities such as fraud prevention can actually help keep costs down. But when regulations make it harder for insurers to engage in activities like fraud prevention by limiting how much of any given dollar can be spent on those activities, the result is that it becomes harder to weed out unnecessary expenses.

If anything, mandatory MLRs encourage health insurers to drive overall spending upwards: Because profits and administrative costs will be limited to a small portion of each premium dollar, they end up tied to spending on medical services. So if an insurance company wants to expand the pool of potential profit dollars, one easy way to do that is by increasing spending on medical services and thus increasing premiums. And with some administrative cost-saving activities limited as well, that will be even easier.

HHS Secretary Kathleen Sebelius says the rules "guarantee that consumers get the most out of their premium dollars." I'm not sure they guarantee much of anything, but a better bet is that they'll result in insurers getting more premium dollars out of consumers.