The Occasional Pamphlet

…in the upper 90’s… apparently from Health Care for America Now! via logarchism.com.

The Patient Protection and Affordable Care Act (ACA) limits the “medical loss ratio” (MLR) that an insurer can have — the percentage of collected medical premiums that must go to medical services for the insured. The minimum MLR mandated by the law is 80-85% depending on the particular market. (For simplicity, let’s call it 80%.)

On its face, this seems like a good idea. If an insurer’s MLR is really low, say 50%, they’re keeping an awful lot of money for administration and profit, and it looks like the premium-payers are getting a raw deal. By limiting MLR to at least 80%, premium-payers are guaranteed that at most 20% of their money will go to those costs that benefit them not at all. But there may be unintended consequences of the MLR limit, and alternatives to achieving its goal.

Because of the MLR limit, an insurance company that spends $1,000,000 on medical services can generate at most $250,000 in profit. They’d reach this limit by charging premiums totalling $1,250,000, yielding an MLR of 1,000,000/1,250,000 = .80. (Of course, they’d generate even less profit than this, since they have other costs than medical services, but $250,000 is an upper bound on their profit.) They can’t increase their profit by charging higher premiums alone, since this would just blow the MLR limit. The only way to increase the profits (governed by the denominator in the MLR calculation) is to increase medical services (the numerator) as well — pay for more doctor visits, longer stays, more tests, just the kinds of things we’re already spending too much on with our moral-hazard–infested medical care system. The MLR limit embeds an incentive for insurance companies to push for more medical services, whether needed or not.

And why 80%? Medicare has had an MLR in the upper 90%’s for a couple of decades, and private insurers used to make a go of it in that range as well in the early 1990’s. (See graph.) Other countries have MLR’s in the mid-90’s as well. An MLR limit of 80% means that once an insurer reaches 80% MLR, the regulation drops any incentive to improve further.

Wasn’t this moral hazard and inefficiency just the sort of thing the ACA was supposed to resolve by using market forces? When people buy insurance premiums on a transparently priced exchange, if one insurer is less efficient or egregious in profit-taking (therefore with a low MLR), it should end up outcompeted by more efficient and leaner insurers. No need to mandate a limit; the market will solve the problem.

If you think that the market forces in the health care exchanges won’t compete down adminstrative overheads and profits (that is, raise MLR) on their own and that regulation is necessary to prevent abuse, then you’re pretty much conceding that the market doesn’t work under the ACA, and that we should move to a single-payer system. MLR limits are not a way of achieving a more efficient insurance system but rather an admission that our insurance system is inherently broken. The MLR limit looks to me like a crisis of faith in the free market. What am I missing?