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Yesterday, President Obama invoked the rebates that consumers will get from their health plans this year as proof that his signature health legislation is benefiting Americans. But this aspect may be one of Obamacare’s most ruinous provisions.
Under the Affordable Care Act, insurers have to spend at least 80 percent of the premiums they receive on providing direct care to patients. This 80 percent is referred to as the health plan’s medical loss ratio. It’s a measure of the total claims paid out by the company (its loss) divided by total revenue for the company.
An 80 percent MLR means a health plan has 20 percent of its revenue left over for covering administrative costs and profits. Under Obamacare, health plans that don’t spend at least 80 percent of premium revenue on patient care have to refund the extra money to beneficiaries. This limits how much the health plans can earn in profits and caps how much they can spend on their administration and overhead.
An estimated 8.5 million Americans will receive rebates as a result of the provision, a fact that President Obama yesterday touted as part of a renewed push by the White House to sell the health law to Americans. “Last year, millions of Americans opened letters from their insurance companies. But instead of the usual dread that comes from getting a bill, they were pleasantly surprised with a check,” the President said. “Another 8.5 million rebates are being sent out this summer, averaging around a hundred bucks each,” he said.
But the reality isn’t quite as rosy as the pitch.
Only about a third of Americans will actually get the money. These are people who purchased insurance on their own, directly from a health plan. For Americans who get their coverage at work, the rebate will instead flow directly to their employer.
Worse still, the entire scheme will help the largest insurers like Aetna [NYSE:AET] and United Healthcare [NYSE:UNH] lock in market share – often at the expense of consumers. The caps on medical loss ratios give the largest health insurers an incentive to push up their rates. It also makes it hard for new health plans to enter the market. As a result, the rebate scheme will restrict price competition and cost consumers money.
First, the provision gives health insurers an economic incentive to inflate their premiums. If the plans overshoot, and end up pushing their prices too high (collecting more premium money than the government lets them keep) then they will rebate the difference to consumers. Most consumers will be happy to get the check. But if instead, health plans undershoot and collect less premium revenue than they were entitled to keep, the government doesn’t share in the loss. Health plans would rather rebate excess profits than have to eat an avoidable loss.
Second, the forced rebates will impede the entry of brand new health plans into the marketplace. The rebates will also drive existing health plans to consolidate. Both of these consequences favor the largest health insurers. The provisions will help the big players further extend their already dominant market positions.
This is because loss ratios (the money health plans spend on direct patient care) typically rise over time, as plans age. New health plans usually launch with lower medical loss ratios. The extra premium money that they pocket is typically spent on start up costs. Over time, as their overhead costs diminish, and their healthcare costs rise, the medical loss ratios trend toward a mean of around 80 percent.
For these reasons, the requirement that even newly launched health plans have to spend at least 80 percent of their premium money on the costs of providing healthcare makes it difficult for brand new plans to enter the market. It also drives smaller plans to consolidate. Since the amount of money that health plans can spend on overhead costs is capped by the government, health plans will have a strong incentive to consolidate into larger entities to gain economies of scale.
Finally the MLR caps will also limit innovation. Right now, expenses that are on a pre-approved, government list of “activities that improve health care quality” are not included in the cost of administration and so don’t count against the 20 percent cap on what plans get to spend on overhead. If a health plan comes up with a new business approach that it believes improves quality and outcomes, it will be forced to count the costs against its allowable profits. It can’t incorporate the cost into the total money it spends on healthcare if the new scheme isn’t on the government list.
This makes plans reluctant to invest in their businesses unless the realized costs can be fully and immediately offset by a reduction in other expenses.
The White House is aware of these consequences, and some in the Administration celebrate these marketplace changes. There’s a view in the Obama Administration that promoting the formation of a small number of very large, national insurers will create efficiency and make the industry easier to regulate. But it will also limit competition on price and products and will ultimately disadvantage consumers.
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