The MLR provision of the Affordable Care Act
In my professional opinion, one of the worst outcomes of the Affordable Care Act is due to the MLR (Medical Loss Ratio) provision of the law. This provision requires the health insurance company to spend 80% of every dollar on claims. On the surface, this seems like a great thing, and President Obama touts it is one of the laws strengths. However, sometimes a situation requires that you look deeper than the surface. The consequence is that the insurance company has only 20% of revenue to pay suppliers, operations, marketing costs, and profit combined.
Anyone who has run a business on any level whatsoever knows inherently that this is not do-able in the long run.
From my entry level Econ 51 class at the University of Missouri, I still can recite verbatim legendary professor Walter Johnson’s initial class lecture. “The purpose of a business is simple: The purpose of a business is to stay in business. To stay in business, a business must cover all of its variable costs, contribute to fixed costs, and make an acceptable profit.”
Without an acceptable profit, the business dies.
The provision also makes it nearly impossible for smaller insurance companies to survive (think about it using your common sense. If you are a smaller operation, how can you compete with the established name brand carriers when you are not allowed to make substantial marketing investments or to reap significant profits from your efficiency, better service, or innovative product design?)
The provision also leads to higher prices in and of itself. Once again, think about it using your common sense. If you were the insurance company, and you had 20% of revenues to run your entire operation, would you rather have 20% of $300 ($60), or 20% of $500 ($100)?
Duh. Pretty easy decision.
But I would stipulate that the greatest problem about health insurance in America was that it was already way too expensive in the first place. Instead of addressing why health insurance costs so much, the Affordable Care Act in general and this provision in particular throws gasoline on those costs.
This provision also causes the merger frenzy that we’ve seen in health insurance (Aetna buying Humana and Anthem buying Cigna). As we learned in Economics, these companies are chasing “economies of scale” which will allow them to reduce costs. All of this merger frenzy and consolidation directly hurts consumers by quantifiably reducing choices that were already severely limited.
Which in turn causes significantly higher prices, because as we learned in basic economics, competition spurs better prices. When there is no competition, the price necessarily goes up.
The provision also leads insurance companies on a “chasing their tails” endless circle of eliminating costs.