To Your Health

How Congress plans to get insurers to spend money on actual health care.

What does “health care spending” mean?

One of the biggest lingering criticisms of the Democrats’ health care reform plan is that it doesn’t control costs. This line persists in part because it’s hard to refute in simple terms. As Atul Gawande has explained, the Senate bill doesn’t have just one way to keep health care spending down. It includes dozens of pilot programs that, if effective, can be replicated across the country.

But for those who want a single, clear example of how reform will attempt to keep the cost of health care—or, at least, the cost of insurance—down, there’s no easier-to-grasp concept than the medical loss ratio.

The medical loss ratio, or MLR, is the amount of each dollar an insurance company spends that goes toward paying for medical procedures, doctor’s consultations, chiropractor visits—in other words, actual health care. The rest of the money goes to administrative costs, marketing, executive bonuses, company profits, etc. The Senate version of the health care bill would set the MLR at 85 percent for large group plans and 80 percent for small group and individual plans; the House sets everyone’s rate at 85 percent. (The original proposal by Sen. John D. Rockefeller of West Virginia had the ratio at 90 percent, but the Congressional Budget Office rejected the number as unrealistic.) Also, there’s a bonus: If companies don’t reach the 80 percent or 85 percent threshold at the end of the year, they have to rebate the difference to their customers.

For major insurance companies, this wouldn’t change much. The average MLR of for-profit insurance plans offered to large employers is about 84 percent, according to a Senate analysis. Small employers, or companies with 50 or fewer workers, wouldn’t feel much pain, either, since their average MLR is 80 percent—right on target.

The real change would come in the individual insurance market, where the average MLR is 74 percent and can be as low as 66 percent. “The reason it’s important is because you do have bad apples—people who are price-gouging on the individual market,” says Peter Harbage of Harbage Consulting, a Sacramento-based health policy consulting firm. “That’s where you see the worst loss ratios, because an individual has no market power.” When California tried to implement health care reform in 2007, insurers that made money on the individual market put up the most resistance.

There’s one problem: What, exactly, constitutes “spending on health care”? The Senate bill states that health care spending includes not just “reimbursement for clinical services provided to enrollees” but also “activities that improve health care quality.” Some types of spending aren’t so clear-cut. Take disease management, for example. Disease management is an approach to health care that emphasizes teaching patients how to take care of themselves, resulting in better health for the patient and savings for the insurance company.

The process of disease management—checking in with a patient and tracking his or her progress—could be considered an administrative cost. At the same time, disease management has been shown to improve people’s health, so it can also be defined as spending on health care. So which is it: Part of the MLR numerator (health care spending) or part of the denominator (health care spending plus administrative spending)?

One could argue that lots of administrative costs go toward improving health care. Overhead gets a bad rap in the world of health care, since it sometimes goes toward screening out unhealthy beneficiaries. But surely some amount of paperwork is necessary to improve a person’s health. What about improving health information technology—for instance, creating a national database that collects health records? Surely that improves the overall quality of health care.

On its own, establishing a national MLR might not have a huge effect. Yes, it would force insurance companies to cut administrative costs. But they could fudge their numbers by cutting back on coverage to produce a favorable-looking MLR. (Or they could always just lie.) That’s why MLR is just one piece of a larger puzzle. When combined with other provisions like guaranteed issue (insurers can’t deny your claim because of pre-existing conditions), ending the practice of rescission (they can’t deny your claim because of a new condition), and an individual mandate (everyone has to be insured), MLR gets teeth.

Capping all the “bad” parts of insurance spending—the administrative costs, the profits—might seem like a blunt instrument. But that’s part of its appeal. In the past, insurers have been able to choose between paying for someone’s health care and pocketing the money instead. Now they have to choose between paying for unnecessary paperwork and pocketing the money instead. The money for health care stays in its own separate box. That’s the theory, anyway.

MLR isn’t a measurement of how “good” a plan is. In measuring a plan’s effectiveness, the better yardstick is its “actuarial value,” which estimates what share of health care spending for a given population is covered by a plan (as in, for the average 25-year-old male, this health plan will cover 90 percent of your expenses). MLR instead measures a plan’s efficiency. But combined, the two measurements provide a good snapshot of how much a plan spends—its actuarial value—and how well it spends—its medical-loss ratio.

Will imposing a medical loss ratio actually cut administrative costs? Probably. Will cutting administrative costs fix health care? Probably not. MLR is just one cog in the machine. But when it comes to changing the incentive structure in which insurance companies operate, it may be a pretty effective cog.

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