The Changing Face of Healthcare: Understanding the Medical Loss Ratio

The Affordable Care Act created a new regulation designed to bring down the cost of healthcare through the use of a new medical loss ratio standard.  This is an extremely complex regulation and this article will spell out what it actually required of the various parties it regulates.  Essentially, this is a new reporting and rebate requirement for health insurance issuers. 

Generally speaking, insurance issuers will be required to submit reports for the large group, small group, and individual markets in each state the issuer does business.  In each market, a medical loss ratio standard is set.  For individual and small group markets (groups of 100 or fewer employees), issuers must spend 80 percent of premiums on “medical care”.  In large group markets (groups of 101 or more employees), issuers must spend 85 percent of premiums on “medical care”.  If the medical loss ratio standards are not met for any market, issuers must rebate premiums to all plan enrollees on a pro rata basis.  The regulation allows the Secretary of HHS to adjust the MLR standards for a state’s individual market if it is likely that the MLR standard will destabilize that market.  Under the MLR regulation, HHS also may impose civil monetary penalties on noncompliant health insurance issuers.  It is also important to note that States can set higher MLR Standards for their markets than required by these regulations.     

The term “medical care” was at the heart of the MLR debate.  The National Association of Insurance Commissioners (NAIC) was charged with creating uniform definitions of activities reported under this requirement and standardized methodologies for calculating the medical loss ratio.  HHS has adopted the NAIC’s final MLR regulations. 

These new regulations apply to health insurance issuers offering group or individual health insurance coverage.  The regulations create special rules for expatriate plans, “mini-med plans”, and newer plans due to their special circumstances.

Issuer’s Reporting Requirements

The MLR regulations require issuers to submit an annual report to the Secretary of HHS for each plan year (note that plan year is defined as a MLR reporting year).  The report must contain information related to earned premiums and expenditures in various categories, including:

• Reimbursements paid for clinical services provided to enrollees,
• Activities that improve healthcare quality, and
• All other non-claims costs, including an explanation of the nature of such costs, but excluding federal and state taxes and licensing or regulatory fees.

This report also must include information regarding any rebates to plan enrollee’s that the issuer was required to make because of failure to meet the MLR standards.  These reports give a level of transparency that is unprecedented.  HHS will post these reports on a website where consumers can see how their premium dollars are being spent.

The due date of this new reporting requirement will be the June 1st that follows the MLR reporting year.  This means that for the 2011 MLR reporting year, reports must be submitted to the Secretary by June 1, 2012.  This allows issuers to report claims for services provided during the MLR reporting year that are processed and paid in the three months following the end of the MLR reporting year. It also gives issuers another two months to compile and submit the required data. 

Activities that Improve Health Care Quality

One of the main questions arising from the MLR debate was: “What is included in the “activities that improve healthcare quality” portion of the medical loss ratio?”  Parties from both sides lobbied for various definitions of the equation that would favor either the insurance issuers or the consumers.  In the end, most observers agree that consumers defeated the issuers in the fight. The final MLR regulation allows non-claims expenses incurred by a health issuer to be counted as a quality improvement activity only if the activity meets all of the following requirements.  The activity must be:

1. Designed to improve health quality;
2. Designed to increase the likelihood of desired health outcomes in ways that can be objectively measured and that produce verifiable results and achievements;
3. Directed toward individual enrollees, for the benefit of specified segments of enrollees, or provide health improvements to the population beyond those enrolled in coverage (as long as no additional costs are incurred due to the non-enrollees); and
4. Grounded in evidence-based medicine, widely accepted best clinical practice, or criteria issued by recognized professional medical associations, accreditation bodies, government agencies or other nationally recognized health care quality organizations.

Generally, any health information technology expenditure that clearly improves healthcare, prevents hospital readmissions, improves patient safety, reduces errors, or promotes health activities and wellness will also be classified as a quality improvement activity.

Activities that are NOT to be reported as quality improvement activities are:

1. Those activities designed primarily to control or contain costs;
2. Concurrent and retrospective Utilization Review;
3. Fraud Prevention Activities;
4. Development, execution, and management of a provider network;
5. Provider credentialing;
6. Marketing expenses;
7. Costs associated with calculating/administering individual enrollee or employee incentives;
8. Clinical data collection without any subsequent data analysis;
9. Establishment and/or maintenance of a claims adjudication system; and
10. 24-hour customer service/or health care professional hotline addressing non-clinical member questions

It is important to note, that despite a strong attempt by brokers and agents, commissions were excluded from this category of “activities that improve healthcare quality”, essentially excluding them from the medical care portion of the equation.  This will greatly impact how agent and broker compensation will be structured and paid by insurance issuers. It will likely mean downsizing of agents and brokers by insurance companies purely due to fee structure and budgetary concerns. 

“Special Circumstance” Plan’s Reporting Requirements

As previously mentioned, the MLR regulations also created separate reporting requirements for so-called “special circumstance” plans.  These plans include expatriate plans, “mini-med” plans, and newer experience plans. 

Expatriate Plans & “Mini-med” Plans

Expatriate plans generally cover employees working outside their country of citizenship, and employees working outside the employer’s country of domicile. “Mini-med” plans often cover the same types of medical services as comprehensive medical plans but have unusually low annual benefit limits.  Due to these plans’ special circumstances, issuers of these plans will report their experience separately from the other markets.   Reporting will be on a quarterly basis, and the medical loss ratio calculation of claims and quality-improving activities is multiplied by a factor of two, to add credibility to the ratio.  This special separate reporting requirement will last only in 2011 at which time HHS will determine what is appropriate for 2012.

Newer Experience

Due to unique circumstances for plans with newer experience, issuers can defer both the premium and claims experience, as well as the life-years, for policies first issued after the start of the MLR reporting period (after January 1, 2011) to the next MLR reporting year.  That is, if these policies account for more than half of the issuer’s experience in a market segment for an individual state.  This rule was created to alleviate the issue of unpredictable claims. 

Calculating and Providing the Rebate

Calculating the MLR and rebate employs a complex equation developed by the NAIC.  Insurance issuers will be responsible to make this calculation.  The calculation allows issuers to apply credibility adjustments to partially credible groups. A credibility adjustment modifies the reported MLR of an issuer by adding reliability to an otherwise unreliable statistic.  Partially credible groups are those that have between 1,000 and 75,000 life years.  A life year is the number of member months divided by 12.  Groups with 75,000 life years are considered fully credible and will not be allowed to make a credibility adjustment.  Groups with 1,000 or fewer life years are not credible and therefore are not required to rebate premiums to plan enrollees.  

Rebating Premium if MLR Standard is not Met

The MLR regulations require that if the medical loss ratio standard is not met for a market, premium rebates must be made to plan enrollees.  Notice of rebates to enrollees is required only if issuers have not met the MLR standard.  The rebate paid to each enrollee is based on the earned premium paid by (or on behalf of) the enrollee, minus taxes and other permissible adjustments taken by the issuer.  Rebates are made on a pro rata basis.  There are special rules for de minimis rebates, unclaimed rebates, and situations where rebates may force an issuer into insolvency.  Rebates must be made annually and paid by the August 1st following the MLR reporting year, which means the first rebates are due by August 1, 2012.

Issuers can choose the form of rebate for current employees, but not for former employees.  For former employees, issuers must disburse checks to enrollees.  For current employees, the issuer can disburse rebates as either a premium credit or a cash lump sum.  This lets the issuer decide which form is less of an administrative burden. 

Simplified Example of Rebate Calculation:

Assume a plan has 200 participants.  Each participant pays $9,000 dollars each in premiums (we assume participants pay equal amounts, even though that is generally not true).  The total premiums would be $1,800,000.  Since this plan is in the large group market, it would be subject to the 85 percent MLR standard (we assume this plan is fully credible, but a credibility adjustment could make this much more complicated).  That means that $1,530,000 (85% of $1.8 million) must be spent on medical care, as defined by the NAIC.  Now, assume the issuer only spends $1,200,000 for the plan year on medical care.  This means that $330,000 ($1,530,000 - $1,200,000) must be rebated to plan enrollees.  Since plan enrollees paid equal amounts of premiums, they would each receive a rebate of $1,650 ($330,000 divided by 200 plan participants).  Note that rebates are paid on a pro rata basis, so enrollees that pay higher premiums are entitled to higher rebates. 

Impact of MLR Regulations:

This example should give a taste of how important this regulation is to both issuers and consumers.  It will radically change how insurance issuers operate in the industry.  This article has been an overview of the basic requirements of this complex new regulation.  MLR regulations will subject issuers to greater transparency and complex spending requirements. The practical effect of this regulation on health insurance issuers will be a squeeze on their business.  Some issuers are already operating at a high level and will have no problem satisfying these new spending requirements.  Others will struggle to meet these new MLR standards.  We will likely see several insurance issuers merge to streamline their business models and adapt to these new requirements.  Only time will tell what effect the new MLR requirements will have on health insurance issuers, agents, and brokers in the healthcare industry.  

About the Author:

Arthur Tacchino is an Assistant Professor of Health Insurance at The American College.  Arthur received his J.D. from Widener School of Law and his B.S. of Economics from Susquehanna University.  Arthur is currently designing courses for The American College’s new premier healthcare designation, the Chartered Healthcare Consultant™ (ChHC™).  Professionals who want to learn more about the MLR and other aspects of healthcare reform can reserve a place in the ten-week webinar course Essentials of Healthcare Reform by visiting TheAmericanCollege.edu/healthcare.  The courses of the ChHC™ curriculum provide a competitive advantage for benefits consultants and other industry leaders who want to differentiate themselves in the complex new world of healthcare reform.