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Managing Medicare's Costs

Medigap policies and medical loss ratios

In the early 1990s several of the country’s largest HMO plans were spending about 25 cents of each premium dollar on administrative costs. With only 75 cents of each dollar left to pay doctors and hospitals, large employers whose own overheads were less than 10 percent began ask why health insurers needed to spend 25% of their revenue on administrative costs. Employers also wondered whether insurers were asking for double-digit premium hikes almost every year just to support overhead that included sumptuous executive salaries.

The perception among large employers that health insurance had become too expensive was described in a 1995 New York Times article. Some firms were saying no to hefty premium hikes and were soliciting bids from other insurers. As an example of insurance that appeared to be overpriced, the article cited U. S. Healthcare Corporation, a regional insurance company with more than two million policyholders. In 1994 it spent only 73% of its premiums on medical costs and paid its CEO almost $4 million.

Still, that was a relatively modest salary compared to the compensation of the seven largest for-profit HMO executives. They received an average of $7 million in cash and stock awards in 1994, according to the article. At the other end of spectrum, in California the non-profit Kaiser Permanente health plan paid its CEO one-third as much and spent 96% of its premiums on medical care.

With the focus on health insurers’ high administrative costs, people came to know the term “medical loss ratio” or MLR, which is the percentage of premiums that an insurance company spends for medical care. High MLR’s are good for consumers and bad for insurance companies because they increase the risk of losses. It’s not that unusual for a small health insurance plan to post a 105% MLR in a year with high claims costs, which means that it has spent 5% more for medical care than it has received in premiums.

Despite the widespread criticism in the early 1990s of health insurers who spent too much on overhead, there were no federal MLR requirements until two years ago. The only exception was a 1990 law, still in effect, that applies only to Medigap policies.

While the Affordable Care Act in 2010 didn’t modify the Medigap requirement, it did impose MLR rules on other kinds of health insurance. Individual and small group plans must now spend 80% of their premiums for medical care and large group plans 85%. These standards went into effect in 2011, and plans that don’t meet them have to refund the difference to policyholders.

Even though a high MLR adds value for consumers, it may not be enough by itself to keep premiums under control. Insurers often will have steep premium increases without initial resistance from policyholders, as happened in the early 1990s. It is difficult for employers and sometimes individuals to switch to another insurance company.

The Affordable Care Act requires “rate reviews” for premium increases of more than 10%, and the government recently said that the reviews saved consumers $1.2 billion in premiums last year. When MLR’s and rate reviews are combined, insurers have little choice but to squeeze their overhead costs and offer lower commissions to agents.

Medigap policies appear to be out of sync with because their requirement is so low – a 65% MLR for individual policies and 75% for group policies. That’s why many industry observers expect Congress to raise MLR’s for Medigap policies in the next few years. Also, the relatively low MLR requirements for Medigap policies mean that many of the 10.5 million policyholders pay higher premiums than they probably should. Medicare Advantage plans look better in comparison, since they must spend at least 80% of their revenue on medical care.

The national average MLR for Medigap policies in 2010 was 81%, according to a report from the Department of Health and Human Services (DHHS). That average could be misleadingly high since it is dominated by one company, UnitedHealthcare, that issues almost one out of three Medigap policies.

Endorsed by AARP, the UnitedHealthcare policies are group coverage (you have to join AARP to buy a policy) and so must comply with the higher 75% MLR standard. If you take these plans out of the mix, then the average MLR is probably lower. The DHHS report also indicated that 14 states had an MLR of 75% or lower. The District of Columbia had the lowest average MLR (72%) and Michigan the highest (a hard-to-believe 131%, which may be a misprint).

Larger insurance companies will have higher MLR’s than smaller ones. Owing to their name recognition they pay lower sales commissions than smaller companies. And their economies of scale make it easier to keep overhead low. What’s more, they can withstand the occasional high claims year more easily than can smaller firms. These advantages enable them to have slightly more stable premium increases over time, as the DHHS report indicated.

For these reasons, it’s prudent for seniors to purchase a Medigap policy from a larger company. People have no way of knowing how much a particular insurer spends for medical care, but their size gives larger insurers the edge. There are exceptions, though. The Missouri Department of Insurance, for example, publishes a Medigap complaint index that gives each insurance company a score based on the number of complaints the state receives, weighted by market share, about each company’s Medigap policies. In Missouri’s index, two large insurers have twice as many complaints per 1,000 policyholders as the average. The majority of complaints are about larger-than-expected premium increases.

The argument for not raising the MLR for Medigap policies is that the insurance companies insurers have no means of controlling their medical costs. When a retired person sprains his toe and decides he wants to get three doctors’ opinions and an MRI to determine whether he really needs a cast, then the Medigap insurer must cover those costs if Medicare does.

Managed care plans routinely decline coverage for unnecessary procedures but fee-for-service Medicare rarely does because the rules are lenient and subject to manipulation. To be covered by Medicare, a procedure needs only to be medically necessary in the opinion of a physician, who sometimes has a financial incentive to order more services.

One approach that seniors can use is to purchase a less comprehensive Medigap policy such as Plan L or Plan N. Both of these plans provide good coverage, with Plan L having the added benefit of a low out-of-pocket limit. Someone who uses an average number of medical services during the year will save $300 or so in these plans compared to buying the popular and overly comprehensive Plan F. And if Plan F costs $2,000 a year, which is close to the national average for Medicare beneficiaries, then the savings from owning either Plan L or Plan N is the same as improving the MLR for Plan F’s by 15%. ◊◊

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