What is a medical loss ratio?
When insurance companies sell health plans, they charge consumers a monthly payment for insurance coverage called a premium. Insurers then use some of the total premiums to pay medical claims, and some of the funds to defray the administrative costs associated with running an insurance company (such as marketing, staff salaries, underwriting, and broker commissions) and to generate profits. In some cases, large portions of premiums go toward administration and profit for health insurers. The percentage of total premiums that goes towards paying medical claims compared to the costs is called the medical loss ratio (MLR). The MLR is a tool that helps protect consumers and increase transparency in how premium dollars are spent.
Insurance has traditionally been regulated at the state level, and 34 states have minimum MLRs or other limits on insurers' administrative expenses. More states have MLRs in the small-group and individual insurance markets than in large-group markets.
State MLR requirements vary widely. North Dakota requires a 55 percent MLR for insurers in the individual market while New Jersey requires an 80 percent MLR. In addition, states define what constitutes medical care differently, so that the MLRs differ even more than the numbers suggest.
How does the federal law impact MLRs?
The Affordable Care Act (ACA) creates a new federal standard for the first time for MLRs for all insurers, which took effect in January 2011. Under the ACA, insurance companies that sell plans to large groups (100 employees or more) must have an MLR of 85 percent, while small group (under 100 employees) and individual market insurers must have an MLR of 80 percent. Insurers that do not meet these minimum MLRs must provide rebates to policyholders.
The ACA defines the MLR to include the percentage of medical claims paid and any funds spent on quality improvement activities. This more expansive MLR definition is designed to encourage insurers to maintain quality improvement programs that promote care management, patient safety and greater use of health information technology (HIT).
The ACA required the National Association of Insurance Commissioners (NAIC) to create the specific formula for calculating the MLR. In particular, the NAIC was charged with developing a definition of quality improvement that would capture activities that help achieve better health outcomes, while excluding activities that might be better labeled as cost containment or administrative. The NAIC found five quality improvement categories that would constitute eligible costs for the MLR:
- Improving health outcomes and reduce health disparities across specified populations
- Preventing hospital readmissions
- Improving patient safety, reducing medical errors, and lowering rates of infection and mortality
- Increasing wellness and promoting health activities
- Increasing the use of health care data through information technology to improve quality, transparency and outcomes
The NAIC recommendations were included in the U.S. Department of Health and Human Services (HHS) interim final regulation on November 22, 2010. The new federal MLR rules went into effect on January 1, 2011. Insurance companies that fail to meet the minimum MLR targets will have to begin issuing rebates to policyholders in 2012.
The ACA allows HHS to adjust the MLR requirements if they have the potential to destabilize the individual insurance market in a particular state. Some insurance companies argue that the MLR is too hard to meet and therefore they will simply stop selling policies in some markets. To keep insurance companies operating in their market, a number of states have requested, or plan to request and receive MLR adjustments for individual market insurers from HHS. The MLR adjustment would then apply to all insurers within a state. Because the ACA does not include a provision for small- and large-group insurers, they are likely not eligible for MLR adjustments.