High Loss Ratios Undermine the Affordability of Health Insurance
Nationwide, states are unveiling health reform proposals dealing with insurance company loss ratios. California Gov. Arnold Schwarzenegger (R) and Pennsylvania Gov. Ed Rendell (D) have both introduced reforms that require insurance companies to increase their loss ratios to 85 percent--meaning at least 85 percent of collected premiums must be used to pay direct health expenditures.
Conversely, the North Dakota legislature and Gov. John Hoeven (R) on April 13 enacted Senate Bill 2154, which actually lowers the legally allowed medical insurance loss ratio for individual and small group coverage to 55 percent and 70 percent, respectively.
Which reform will be more effective?
A loss ratio is the percentage of premiums spent on direct patient care. Loss ratios are, in effect, price controls, seeking to limit the cost of insurance by controlling one of its primary components--administrative costs.
Administrative expenses include all the costs required to conduct the business of health insurance and provide customer services to the insured. These expenses include:
- the cost of collecting premiums and crediting them to the correct accounts;
- the cost of processing medical claims accurately, including cutting and sending checks for services and providing payment explanations;
- monitoring efforts to ensure patients, especially those with chronic medical conditions, are getting appropriate care;
- customer service staff to answer questions--often 24 hours a day, seven days a week;
- agent commissions;
- costs imposed by state laws, including premium taxes, as well as fees paid to independent providers to review claims, assessments for high-risk pools, and timely claims payment requirements; and
- profit and general overhead costs.
Insurers and health plans incur significant costs in their efforts to process and monitor claims and care. Unfortunately, while those efforts surely reduce claims--thereby reducing upward pressure on premiums--critics see only the "costs," not the benefits. They are ignorant of the fact that those "costs" may actually save money.
Loss-ratio laws often refer to the individual and group health insurance markets as if they are synonymous. They aren't. Many factors--including group size, premium amount, and plan design--may affect the cost of administering a plan.
For example, agents selling health insurance to individuals will need to meet separately with each client to asses his needs. To cover their added time and costs, agents selling individual insurance will generally command higher commissions than agents selling in the group market. Selling to individuals is a very time-consuming and expensive process, but necessary for those without access to group coverage.
Other administrative expenses are associated with processes that help reduce health care costs and improve health outcomes.
Proper claims payment systems, for example, can reduce duplicate payments. Preferred provider networks provide discounts on medical services in exchange for access fees. Managed care departments work with doctors and patients to find the most cost-effective care--sometimes even if that care is more expensive in the short run.
Similarly, health insurers spend hundreds of thousands of dollars on fraud detection and prevention, which saves millions of dollars annually.
Some health insurers have spent millions of dollars on information systems to help consumers understand their medical choices, while others provide direct phone access to nurses who can help patients understand their medical conditions.
These efforts reduce health care expenditures and result in lower health insurance premiums.
Efforts to address "administrative expenses" by setting high loss ratios may actually result in a lower quality of care and higher health insurance premiums.
Some states, such as Wisconsin, have decided loss-ratio rules and other rate regulation provide consumers with little value if the insurance market is competitive. They correctly believe companies with loss ratios that are too low (e.g., paying only 40 cents in claims for every premium dollar taken in) will not be able to compete on price with companies that have higher loss ratios.
Other states regulate rates more extensively by reviewing not only the rates of each individual health plan, using a loss ratio, but also regulating the difference in rates between one plan and another.
The National Association of Insurance Commissioners (NAIC) has model laws, but it does not set loss ratios, because it recognizes loss ratios should not be applied uniformly without regard to product or how that product was issued.
Most states have generally followed that approach. Individual coverage usually faces a loss ratio between 55 and 65 percent, while small group health insurance plans face slightly higher loss ratios.
A few states have experimented with increasing loss ratios to artificially lower premiums and cut administrative expenses. Both Kentucky and North Dakota passed higher loss ratios as part of a series of reforms in the 1990s.
Kentucky's loss-ratio bill was part of larger health reform legislation that destroyed the state's insurance market. Not until the loss ratio was lowered to a more reasonable 65 percent did the individual market finally begin to recover.
North Dakota has faced a similar crisis. Carriers have abandoned the market, leaving consumers with fewer choices and higher premiums. With the passage of Senate Bill 2154 in April, which lowers the group loss ratio from 75 to 70 percent and individual products from 65 to 55 percent, policymakers in North Dakota expect a similar resurgence in the market.
No state has successfully implemented an 85 percent loss ratio.
Schwarzenegger and Rendell should tread carefully. High loss-ratio requirements have led to less competition, fewer choices, and ultimately, higher health insurance costs. Such requirements favor high-premium plans and undermine Health Savings Accounts--one of Schwarzenegger's favorite health insurance options.
J.P. Wieske (firstname.lastname@example.org) is director of state affairs at the Council for Affordable Health Insurance.