More loss ratio games

Mainstream media are politicians are figuring out what actuaries have always known – how you define a loss ratio is as important as what that loss ratio should be.

Recall that Obamacare requires an 80% loss ratio for individual plans and small group plans and an 85% loss ratio for large group plans. Simple enough, except, as discussed here, the loss ratio depends on the definition of loss and the definition of premium. The NAIC is developing guidelines.

So over the past few days, the American Academy of Acturies has noticed a couple more bumps in the road, one minor and one troubling.

The easy one first: Obamacare has two definitions for medical loss ratio!

One is the

. . . ratio of the incurred loss (or incurred claims) plus the loss adjustment expense . . . to earned premiums.

The other medical loss ratio is the sum of

“reimbursement for clinical services provided to enrollees” to “total premium revenue;” and

“activities that improve health care quality” to total premium revenue.

The two defs sound similar. Are they the same? Who knows?

The latter loss ratio is used to determine whether the insurer owes rebates for failing to hit the minimum loss ratio. AAA innocently asks

whether it would be desirable to view the  . . . [two MLRs] . . .  as being the same quantity, or whether it is instead necessary to view them as being different quantities?

AAA concludes having two loss ratios “could lead to significant confusion among stakeholders.”

Ultimately, though, I think the two loss ratio problem is typical of overarching legislation. In 2,000-plus pages drafted multiple times during midnight pizza-party-cum-bull sessions, a few inconsistencies creep through. They get cleaned up soon enough and no baby seals get clubbed in the process.

On to the bigger deal: MLR regulation threatens the individual health market, especially between now and 2014, at least in AAA’s view. Three problems here:

  1. The new law appears to apply to business already on the books. That business may have been priced under terms that fail to hit an 80% loss ratio. When the insurer rebates premium to hit an 80, it will end up losing money.
    A simple example – In a deal effective 1/1/10, an insurer charges $1 premium, with 75 cents going to losses, 22 cents to expenses and commissions and the last 3 cents left as profit.  But thanks to health care reform, that deal needs an 80% loss ratio. That means the premium needs to be 75/.80 =  93.75 cents. But 75 cents of loss + 22 cents expenses and commissions is 97 cents. The insurer loses 93.75 – 97 = -3.25 cents. Bummer!
  2. Individuals’ loss ratios drift upward over time. That’s because people tend to get sicker as they get older and if they were sick in the first place they would have a hard time getting covered. As a result, the loss ratio requirements discourage insurers from writing new business. I’ll explain a little further in the next item, which raises a similar issue. Suffice it to say that health care reform was supposed to encourage new writings, not discourage them.
  3. A company that has a lot of green business could have a hard time hitting the 80% MLR. Here’s a simple example. Suppose all policies are either in their first, second or third years and that their loss ratios are 50%, 80% and 110%, respectively. In a steady state, loss ratios would look like this:
Policy Age Premium MLR Losses
1 $100 50% $50
2 $100 80% $80
3 $100 110% $110
Total $300 80% $240

Notice that the program hits an 80% loss ratio even though its newer insureds are running at 50%. The high loss ratio on the long-term insureds makes up the difference.

Now suppose a company is able to double its writings one year. Over three years, results would look something like this:

Year 1
Policy Age Premium MLR Losses
1 $200 50% $100
2 $100 80% $80
3 $100 110% $110
Total Before Rebate $400 73% $290
Total After Rebate $363 80% $290
Year 2
Policy Age Premium MLR Losses
1 $100 50% $50
2 $200 80% $160
3 $100 110% $110
Total $400 80% $320
Year 3
Policy Age Premium MLR Losses
1 $100 50% $50
2 $100 80% $80
3 $200 110% $220
Total $400 88% $350
Total All 3 Years
Premium MLR Losses
$1,163 83% $960

Notice that in the first year, the insurer had to grant a rebate, because it had a lot of fresh policies. In the last year, those policies had all gotten old and become money-losers. So over three years, instead of running an 80% loss ratio, the program ran at 83%.

So AAA respectfully asks the NAIC to think about, in essence, creating an as-if loss ratio to eliminate these sorts of distortions. It also notes that the decision has to come soon. If an insurer wants to bow out of the market on Jan. 1, federal law requires it to announce its intent by June.

AAA has a summary of MLR issues here. The Association of Health Insurance Plans has a summary of current MLR requirements by state here.


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