Misaligned incentives: the medical loss ratio

Yesterday, I talked about E=CUP.

Today, let’s discuss some of the misaligned incentives in our health care delivery system.

First, the Minimum Loss Ratio (MLR). What’s an MLR? It’s a law that requires a specified percentage of premium dollars to be spent on claims costs. Under the PPACA, that ratio is 80% for small group and individual markets and 85% for large group markets. In other words, $0.80-$0.85 of every health insurance premium dollar must be spent on claims.

MLRs came about as a well-intended but half-baked policy. The idea was to discourage junk policies by limiting the ability to profit from claim denials.

But insurance companies are still companies—either for-profit, seeking a profit, or non-profit, seeking a surplus.

So how do those companies grow their profits or surpluses as their shareholders require?

There’s only so much you can squeeze out of the $0.15-$0.20 per dollar in premium. If you’re a CEO of a health insurance plan, you need more premium dollars to retain more profits. You can’t get there by cutting costs.

One mechanism is to increase what you pay in claims. Returning to yesterday’s equation, this means increasing Price (P).

E=CUP.

If we don’t address C or U but we increase P, E must increase.

In fact, the incentives created by the MLR not only drive upward pressure on P but also on Utilization (U) and Caseload (C).

The competition for C is supposed to create downward pressure on prices. Consumers often choose more affordable plans as they shop with real-world budgets.

But lower premiums drive lower profits due to the MLR. The MLR removes the incentive to negotiate the cost of care downward in the insured market.

Take a look at the knee MRI pricing below. The cash price and the lowest insured price (a D-SNP plan) are about the same. However, the biggest insurers in the state are paying ten times that amount.

The market power traditionally assumed to lead to better pricing has, in part, been negated by a policy decision encouraging higher prices.

E=CUP. Increased P = increased E in the absence of lower C & U.

The MLR is a well-intended policy that should be eliminated.

Tomorrow, we’ll dive into vertical integration and the challenges it poses.