It has been nearly 6 months since President Barack Obama signed into law the Patient Protection and Affordable Care Act (PPACA). Although many of the proposed healthcare changes are still several years away from being implemented, some provisions affecting health insurers are having an impact, including the requirement on medical loss ratios (MLR).

Beginning in January 2011, health plans will be required to report their MLRs, which is defined as the percentage of each premium dollar that insurers spend on paying actual medical claims. The remaining percentage of each premium dollar falls into the category of nonmedical expenses, including salaries for executives and other personnel within the insurance company, advertising, administration, and profits.

Under the new PPACA guidelines, health plans that fail to meet the minimum requirements will have to issue rebates to enrollees based on the difference between the minimum standard MLR and their actual cost of covering medical claims.

The legislation sets the minimal standard at 85 percent for insurance policies in the large group market (100 or more employees) and Medicare Advantage plans and at 80 percent for coverage in the individual and small group (fewer than 100 employees) markets. PPACA gives states the option of defining small groups as fewer than 50 employees until 2016 as well as the option of establishing a higher minimum MLR requirement.

The MLR mandate is expected to have significant implications for health insurance companies and will likely affect health plan design, coverage, pricing, administration, network contracting, health management, and profitability. Although some of the changes may take several years to fully materialize, the health plans in group markets face an immediate challenge. They must set their 2011 rates now to meet the mandate, even though the specific regulatory requirements and technical definition of MLR remain unclear.

What we do know
By April 2011, all insurers will be required to report their MLR for calendar year 2010; member rebates for noncompliance with the minimum MLR standards are expected to begin by the end of 2011. The minimum MLR requirements apply to insured patients who are in individual and group coverage plans (including grandfathered plans), but do not cover Administrative Service Only (ASO) plans.

Between 2011 and 2014, the PPACA allows the secretary of the Department of Health and Human Services (HHS) to adjust the individual market MLR percentage on a state-by-state basis if it is determined that applying the 80 percent requirement could destabilize the individual market in such a state. Insurers will be able to include expenditures on activities that improve “healthcare quality” as medical expenses for the purpose of calculating MLRs, although the definition of “healthcare quality improvements” has yet to be defined. Starting in 2014, a 3-year running average will be used to calculate any required rebates.

Recently, the six largest for-profit health plans self-reported their 2009 MLRs; these ranged from 68 percent to 88 percent in the individual healthcare market, from 78 percent to 92 percent in the small group market, and from 83 percent to 87 percent in the large group market.

What we don’t know
No formal definition of expenses to determine if they are categorized as medical care or administrative costs has yet been made. The National Association of Insurance Commissioners (NAIC) accounting rules have previously defined “medical loss” as the cost of medical claims a health plan has actually incurred plus the amount of money the health plan sets aside to pay future claims.

The new MLR calculation, however, allows health plans to define medical expenses more broadly. Although most of the key elements have been established, some critical cost elements remain to be defined. Among these are disease management, health coaching, outcomes measurements, examination fees, fraud and abuse expenses, and provider credentialing fees.

Because HHS has yet to accept the NAIC’s recommended definition of medical costs, insurers have no defined standard for calculating their MLR, despite the rapidly approaching deadlines. Companies do not know whether they will have to submit MLRs separately by health plans, subsidiary, market, or state. This may prove to be a formidable task due to the significant geographic variability in health plans and coverage.

It also remains to be determined how and when rebates will be calculated and distributed. The tentative rebate schedule has not been finalized, but additional definitions and timeline are expected to be announced before the end of 2011. Insurers are expecting more detailed information concerning the 2011–2014 transition period, which will likely have a significant impact on healthcare premiums and potential rebates.

What we should be thinking about
During the next few months, health plans will begin setting rates for 2011. The insurance companies will need to strike a delicate balance between appropriate pricing and the impact that final MLR definitions will have on their current expenditures and allocations. Health plans are expected to focus on setting their 2011 rates to comply with the MLR calculations as currently understood. This means that the insurance companies must determine how to classify all of their expenses accurately following HHS regulations, identify ways to improve healthcare quality and profitability, understand the implication of new group size definitions on planning processes and structure, and work with member services and communications teams to determine an approach to clarify and communicate MLR information to patients.

MLR mandates and potential rebates require health plans to rethink profitability at both the business and marketing levels. If plans are unable to operate at very low administrative costs (below 5 percent to 9 percent), they may find that the mandated minimum MLRs affect their financial viability. Some insurance companies may have trouble meeting these requirements, as well as other legislative and regulatory requirements outlined in the PPACA, which may lead to increased consolidation within the healthcare sector.

Successful health insurance plans will need to find ways to alter their operating structure and lower their costs to remain competitive in the marketplace and compliant with the new regulations imposed by the PPACA, especially the MLR. Physicians and hospital administrators will need to understand these challenges (and the corresponding uncertainties) as they start preparing for 2011.

The Washington Health Policy Fellows include John H. Flint, MD; Alok D. Sharan, MD; Ryan M. Nunley, MD; Manish Sethi, MD; Adrian Thomas, MD; Taruna Madhav, MD; A. Alex Jahangir, MD; Aaron Covey, MD; James Genuario, MD, MPH; Sharat K. Kusuma, MD; Samir Mehta, MD; and Anil Ranawat, MD.

Editor’s note: This is the fourth in a series of articles on redefining health care in America prepared by the AAOS Washington Health Policy Fellows. The series takes a close look at various aspects of the healthcare reform legislation signed by President Obama earlier this year.

Did you know?

• The Medical Loss Ratio (MLR) is the percentage of each health plan premium dollar that insurers spend on actual medical claims.
• In 2011, under the new healthcare reform law, the minimum MLR for large group plans (100 or more employees) and Medicare Advantage plans will be 85 percent; the minimum MLR for individual and small group plans (fewer than 100 employees) will be 80 percent.
• In 2009, the six largest for-profit health plans reported MLRs ranging from 68 percent to 88 percent in the individual market; from 78 percent to 92 percent in the small group market; and from 83 percent to 87 percent in the large group market.
• The new MLR calculation allows health insurance companies to define medical expenses more broadly than previously allowed by the National Association of Insurance Commissioners.