Medical Loss Ratio: What it Is and How it Works

Let’s start off by explaining what a Medical Loss Ratio (MLR)  even is. Like any business, health insurers have “overhead” expenses—administrative costs, marketing, utilities, etc.—that are not directly related to paying claims or improving care or service. Naturally, a portion of the premiums you pay for health insurance goes to cover those kinds of costs. 

To help ensure transparency, encourage care efficiency, and provide the best value to patients, the Affordable Care Act established the Medical Loss Ratio (MLR) requirement. Under this provision, insurance companies (payers) must spend at least 80-85% of an insured member’s premium on care, rather than administrative costs or accumulating profit. If the insurer fails to reach that minimum, then the difference gets issued as a rebate to members. 

So, for example, if a member pays $1.00 for insurance, and $0.85 is used for their actual care, the insurer wouldn’t owe a rebate. But if only $0.75 goes toward their actual care, the insurer owes the member a rebate of $0.10. 

Sounds pretty great, right? When explained in the above summary, yes. But as with most things healthcare-related, it’s slightly more complicated than that. 

The MLR requirement has resulted in significant rebates since its inception but it hasn’t been a cure-all for high insurance premiums. We see this in the yearly rebate average. For example, the Kaiser Family Foundation reported preliminary numbers for 2020 showing insurers across all size markets will issue an estimated total of $2.7 billion in rebates, compared to $1.4 billion in 2019. Since rebates are so much higher this year, that means insurers expected higher costs and set premiums higher as a result.

At first glance, it might not seem like a big deal for premiums to be set high since, theoretically, the MLR requirement should kick in and refund excess premiums. But members often choose medical coverage based on how affordable the premium is, and choosing the wrong coverage (or no coverage), or foregoing treatment (or having to choose between groceries and health care) is a very big deal indeed.

Not to mention, the average member doesn’t know for sure if they’ll get a rebate or not. Even if they do, the rebate isn’t always sent as a lump sum of cash. Insurers can offer it as a discount on a future premium, or they can send the rebates directly to an employer. If the latter is done, employers can choose what to do with the rebate so long as it benefits employees. 

For insurers, since profit margins are restricted to 15-20 percent, there is little incentive to decrease costs. In fact, you could argue there's an incentive to increase overall cost so total profit increases...which is the exact opposite of what MLR was intended to do. Not only is this an issue for the members paying higher premiums (even if they are getting a rebate) but it also leads to increased overall healthcare spending instead of reducing it.

There are clear pros and cons to today's MLR requirements. It certainly may help drive insurers to improve efficiency, but unfortunately, the downside is that the current provisions disincentivize insurers to push for decreased overall costs and instead incentivize an increase in premiums to cover costs. 

In a for-profit model, current MLR requirements will likely continue to lead to an increase in costs and a corresponding increase in premiums. 

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