Health Policy$ense

Mergers, Monopolies, and the Medical Loss Ratio

cross-posted with US News

Health insurers are merging everywhere you turn in the newly reformed and more heavily regulated health insurance system. Anthem announced last week it will buy insurance giant Cigna for over $54 billion, acquiring more than 53 million new patients. And Aetna, earlier this month, announced its agreement to buy Humana, the nation’s fifth-largest health insurer.

Ordinarily, as consumers, we ought to worry about having fewer sellers because that will lead to higher market power and higher prices. However, in the two markets most affected by these mergers, there is now a regulatory protection that might offset vulgar premium and price increases. For both the Medicare Advantage and Obamacare exchange markets, insurers must, by law, pay out some fraction of premiums to cover customer medical claims and activities; the regulated minimum of that fraction – the medical loss ratio – is 80 percent for exchange plans and 85 percent for Medicare Advantage plans.

Some commentators have pointed to these rules to reassure us: If a merged firm increased its premiums for policies with the same administrative cost and the same medical benefits paid out enough to get under 80 percent paid out, it would have to refund the excess to buyers.

Feel better? If so, consider an insurer that is just at the limit, collecting 20 percent of the premium dollar as profits and administrative costs, and paying out the remaining four-fifths. If it gets more market power through a merger, what could it do to increase profits? One answer is obvious: Cut administrative costs so more of that 20 percent share fell to the bottom line. Most of us would probably applaud reduced administrative costs as a matter of principle – except that, in this case, all the savings from avoiding that paper-pushing waste would go the insurer, not its customers.

But things can get worse. At least some of that administrative cost is probably being used to help hold down low-value medical claims;the insurer pays people who arrange for deals with lower-cost hospitals and doctors or who monitor and discourage low-value care. So it would not be surprising if the shift from administrative cost to profits also led to higher medical care costs – and, of course, higher claims. (Some insurer expenses for activities that improve quality but also hold down costs, like efforts to reduce the need for hospital re-admissions, can be included in the "medical" part of the ratio. But not all claims-cost reducing expenditures qualify.)

An insurer in an ordinary competitive market would not want to let claims balloon because that would cut into profit dollars. But the medical loss ratio rules do not constrain premiums or profits; they only constrain the ratio of premiums to claims costs. So once the insurer gets the administrative cost ratio down as low as it can (and so maximizes the profit margin), it will actually make more profit dollars by letting claims go up. If, say, its profit margin is 10 percent of that 20 percent, total profits (and return on equity, which is the key firm objective) will be higher if claims and premiums are higher, since 10 percent of a larger number will be more than 10 percent of the current figure.

There were some reasons, some of them plausible and some of them vindictive, for putting the medical loss ratio rules in place as part of the legislation. But combine these rules with greater monopoly, and we have the worst of both worlds: higher insurance premiums and higher health care costs, to boot.