Editor’s Note: The post below, on the “medical loss ratio” (MLR) rule issued yesterday by the Department of Health and Human Services, is the latest in a series of posts by Timothy Jost on the implementation of the Affordable Care Act.  Earlier posts by Jost provide analyses of regulations and guidance implementing provisions of the Act governing health insurance exchangescoverage for pre-existing conditionsappeals of coverage denialscoverage for preventive services, a patient bill of rights, grandfathered plans, tax exempt hospitalsthe small employer tax credit, the Web portal and reinsurance for early retirees, and young adult coverage. Jost was involved in the drafting of the MLR rule as a National Association of Insurance Commissioners consumer representative.

On November 22, 2010, the Department of Health and Human Services released its interim final rule implementing the requirements of the new section 2718 of the Public Health Services Act (added by section 10101 of the Affordable Care Act), entitled, “Bringing Down the Cost of Health Care Coverage.”  This provision is usually referred to as the “medical loss ratio” (or MLR)  requirement, although the term “medical loss ratio” appears nowhere in section 2718. 

This provision of the ACA received relatively little attention in the debate leading up to the enactment of the legislation, but has proved to be one of the Act’s most important and controversial provisions.  Citi’s November 13 Managed Care Weekend Update investment newsletter stated “it’s hard to think of a single event that could have as much impact on the valuations of the managed group for years to come” as the MLR rule. 

Section 2718 requires health insurers (including grandfathered but not self-insured plans) to report to HHS each year, the percentage of their premium revenue that the insurer spends on 1) clinical services for enrollees, 2) “activities that improve health care quality,” and 3) all other non-claims costs, excluding federal and state taxes and licensing or regulatory fees.  Beginning in 2011, insurers in the individual and small group market must spend at least 80 percent and insurers in the large group market at least 85 percent of their premium revenues (excluding federal and state taxes and licensing and regulatory fees) on health care and quality improvement activities.  Insurers that fail to do so will have to rebate the difference to their enrollees.  States can require higher minimum MLR percentages, but HHS can also adjust state MLR requirements downward where necessary to prevent destabilization of the individual market. 

Medical loss ratios have long been of interest primarily to investors.  An insurer that could achieve a low MLR by holding down expenditures on health care for its enrollees was a good investment.  About two thirds of the states have required insurers to report their “anticipated loss ratio.”  About 30 states require insurers in their individual markets to achieve MLR targets while about 20 states impose MLR targets on their group or small group markets, but the state MLR targets tend to be lower than the ACA targets. Congress concluded that higher MLRs were achievable, and warranted.

The NAIC’s Involvement

In an unusual move, Congress asked the National Association of Insurance Commissioners, a nonprofit organization representing the nation’s state and territorial insurance commissioners, to “establish uniform definitions of the [MLR activities] and standardized methodologies for calculating measures for such activities.”  Section 2718 requires HHS to “certify” the NAIC recommendations.

Given the NAIC’s expertise in insurance regulation, it was a natural partner for HHS for taking on this complex task.  The NAIC promptly appointed two working groups to draft its response.  One group, headed up by Lou Felice of New York, was given the task of devising a form for insurers to use to report the components of the MLR.  This group was responsible for drafting the definitions to be used for the reports, including the definition of “quality improvement activities.”  A second group, headed by Steven Ostlund of Alabama, was asked to establish the methodologies to be used for calculating the MLRs.  Both groups hosted conference calls up to twice a week and lasting for one to two hours, which reportedly sometimes involved several hundred regulators and “interested parties.”  The “form” group finished first, with its results approved unanimously (after minor amendments) by the full NAIC at its August meeting.  The methodology group took longer, but the regulation it devised (which incorporated the earlier approved definitions) was approved unanimously, after considerable debate, by the NAIC at its October meeting. The rule then went to HHS for its certification.

The interim final rule issued by HHS largely certified the NAIC rule as written.  It did, however, address several issues that were not within the purview of the NAIC and create additional exceptions to the rule.

What The Rule Says

The numerator of the MLR formula includes “reimbursement for clinical services” and expenditures for quality improvement activities.  Clinical services reimbursement include not only direct payments for services and supplies but also changes in contract reserves (where an issuer holds reserves for later years when claims are expected to rise as experience deteriorates) and reserves for contingent benefits and lawsuits.  Payments under capitation contracts with providers may be counted fully as claims, but insurers must count as administrative rather than claims costs payments made to third part vendors (such as behavioral health or pharmacy benefit managers) that are attributable to administrative services. 

The controversial task of deciding what are and are not “quality improvement activities.” Defining “quality improvement activities” was one of the most contentious aspects of the NAIC process.  Insurers argued that virtually everything they did, including network management and utilization review, affected the quality of care.  The NAIC settled on the definition of quality improvement activities found in section 2717 of the ACA itself.  Under this definition, activities that improve health care outcomes, reduce medical errors and improve patient safety, encourage wellness and prevention, and reduce rehospitalizations are counted.  Related IT expenses as well as the cost of healthcare hotlines also count.  The cost of collecting and reporting quality data for accreditation purposes, as well as the proportion of accreditation fees attributable to quality improvement activities, are also quality improvement under the NAIC rule.   HHS by and large accepted the NAIC definition, adding only expenditures for facilitating the “meaningful use” of certified electronic health record technologies. 

The HHS rule, like the NAIC rule, states that only activities “capable of being objectively measured and of producing verifiable results and achievements” can be counted as quality improvement.  The preface to the HHS rule states: “While an issuer does not have to present initial evidence proving the effectiveness of a quality improvement activity, the issuer will have to show measurable results stemming from the executed quality improvement activity.”  How this is to happen, however, is not described in the rule itself. 

Fraud prevention. Insurers pushed hard to include fraud prevention activities as quality improvement.  The ACA does not allow insurers to count fraud prevention costs in the numerator, but the rule does allow insurers to offset their fraud detection and recovery expenses against actual recoveries if fraud recovery activities are successful. Prospective utilization review may be countable as quality improvement to the extent it is intended to ensure appropriate treatment, but concurrent and retrospective utilization review activities are administrative costs.

Federal taxes — a win for insurers. The HHS rule allows insurers to exclude all federal taxes except for taxes on investment income from the denominator.  The chairs of the congressional committees that drafted the ACA had written to HHS stating that they had intended only the federal taxes imposed by the ACA to be excluded from the denominator, but, in a major victory for insurers, HHS rejected this reading of the statute. 

MLRs are calculated separately for each licensed entity within a state by market segment (individual or small or large group).  Experience can be aggregated to the state in which the contract is located for employers with employees in multiple states.  Affiliated insurers can also aggregate their experience where they combine to offer an employer in- and out-of-network coverage.  The demand of large national insurers that they be allowed to aggregate their total business at the national level, however, was rejected by both the NAIC and by HHS.  Association health plans selling individual coverage must report their experience in the state in which individual certificates of coverage are issued.

Insurers are required to allocate expenses among categories based on “a generally accepted accounting method that is expected to yield the most accurate results.”  They must describe to HHS how this is done and maintain records of the underlying data, but the flexibility allowed plans in determining how to allocate expenses may lead to abuse.

Accounting For Smaller, Expatriate, And Mini-Med Plans

The biggest problem faced by the rule drafters was implementing the ACA’s requirement that the MLR methodologies “be designed to take into account the special circumstances of smaller plans, different types of plans, and newer plans.”  Issuers with a small population in a particular state may experience health care costs well below 80% one year and well above the next because of the presence or absence of a few large claims.  Following the lead of the NAIC, HHS decided to address this issue by providing for “credibility adjustments,” essentially reducing the 80 or 85 percent target for smaller issuers.  The adjustment will be based on the number of members issuers have in particular states, and further adjustment will be allowed based on the average size of deductible for the issuer’s plans, recognizing that higher deductible plans are more volatile.

Issuers with fewer than 1000 members in a state are deemed “non-credible” and will be excused from paying rebates, and issuers with up to 75,000 members are deemed “partially credible” and will receive some adjustment.  Experience is cumulated for up to three years for small insurers, however, and if an insurer comes in under the target for each of the first three years, it will need to pay a rebate based on its actual experience.  HHS estimates that 68 percent of insurers will be “non-credible” in at least one state, 30 percent partially credible, and only 2 percent fully credible.  The non-credible entities will cover 1 percent of enrollees, however, while the fully-credible will cover 50 percent of enrollees.  The HHS rule also follows the lead of the NAIC in making provision for new entrants, allowing them to delay paying rebates until they have had a full year’s experience. 

The HHS rule recognizes two exceptions for “different types of plans” not recognized in the NAIC rule:  expatriate plans and “mini-meds.”  Plans that insure individuals working outside the U.S. or aliens working in the U.S. have unusual expenses.  The NAIC asked that they be treated specially under the MLR rule, and HHS agreed.  Mini-med plans, which have annual limits below $250,000 (and which have received a waiver from HHS from the general ACA requirements restricting annual limits), also receive special treatment.  For 2011, both expatriate and mini-med plans need only reach a 40 percent MLR in the individual and small group and 42.5 percent MLR in the large group market.  They must report their experience quarterly, however, and HHS will reach a decision based on these reports how they will be treated going forward.  The treatment of mini-meds is the most disappointing aspect of the rule for consumers. 

HHS  May Adjust State MLR Targets To Prevent Market Disruption

The HHS rule also addresses several issues that the NAIC concluded were not within its jurisdiction.  HHS rejected industry demands that the MLR rule be phased in over the next three years, recognizing that the ACA does not allow this.  Section 2718 does, however, allow HHS to “adjust” (not waive, as has been commonly but erroneously reported), the MLR target in particular states where strict enforcement of an 80 percent target would “destabilize” the individual market.  Under the HHS rule, states that believe that their markets risk destabilization will need to apply to HHS and provide detailed information as to the basis for their fears.  This information will be made public and the public will be given a chance to respond.  HHS can hold a hearing if necessary, but must respond promptly to state requests. 

One of the criteria that HHS may consider is whether implementing the MLR rules as written may leave consumers unable to access agents and brokers.  Brokers and agents, whose commissions can account for 5 percent or more of premiums, fear reduced income as insurers become more efficient.  They had asked that their commissions be excluded from premium revenue and from administrative costs.  Commissions have always been considered an administrative cost and the ACA is clear that commissions must be considered part of the premium and as administrative costs.  Brokers and agents are powerful politically, however, and the NAIC asked HHS to try to help them.  HHS followed the law and did not exclude the brokers and agents from the MLR, but will take their commissions into account in addressing market destabilization.

Under the HHS rule, rebates must be paid by August 1 of the year following the year for which the MLR data are reported.  Rebates must be paid to individuals who paid the premium, although insurers may pay the rebate to employers if the employer agrees to distribute to employees their share of the rebate.  Insurers must also report to their enrollees how the rebate was calculated.  Insurers who fail to comply with the law are subject to civil fines to be assessed by HHS up to $100 per day per individual affected by the violation.

The Benefits Of The MLR Rule Outweigh The Costs

The purpose of the MLR rule is to drive insurer efficiency, not to produce rebates.  The cost analysis of the rule suggests that once the adjustments allowed by the rule are applied—excluding taxes from the denominator, adding quality improvement expenses to the numerator, and making credibility adjustments—most insurers will make the target, with the average MLR in the individual market being 86.5 percent in the individual market and 90.8 percent in the small group market for 2011.  MLRs will also increase going forward.  An estimated 30 percent of enrollees in the individual market will receive an average rebate of $164 for 2011, but this will represent only 2 percent of all premiums written ($521 million).  Over the 2011 to 2013 period, an estimated total of $3 billion will be paid in all markets to about 15 million enrollees.  Insurers will also face a cost of about .02 percent of total premiums for the one-time costs gearing up for the rule and .01 percent of total premiums for annual compliance costs.

The benefits of the rule, on the other hand, are significant.  74.8 million Americans are covered by insurance subject to the rule.  The rule will drive more efficient provision of this insurance, greater transparency of administrative costs, and greater attention to quality improvement.  If insurers raise their premiums unreasonably in relationship to their costs, they may well owe a rebate.  Congress concluded that the benefits of this approach to insurance regulation outweighed its costs, and the HHS cost analysis of its rule concurred.  Apparently the market also concluded the costs of the rule are manageable—health insurers’ stock prices went up after the rule was released.