The Obama Administration’s ambitious healthcare reform is poised for its initial test run this upcoming year. The Affordable Care Act introduces a wide range of regulations that aim to reduce the costs of healthcare for Americans. One controversial component of this legislation will set a limit on how much revenue insurance companies can use for administrative costs, marketing, employee bonuses, and dividend payments to shareholders. In other words, there will be a mandated minimum percentage of revenues that must go to healthcare expenses and healthcare quality improvements. If insurance insurance providers fail to meet these limits, they will be compelled to pay out rebates to their subscribers to make up the difference. Legislators hope that this new requirement will convince providers to streamline their overhead costs and sell policies at lower premiums.
The budget limits for insurance companies are measured by the medical loss ratio (MLR), which is defined as the percentage of revenues used for healthcare expenses and healthcare quality improvements. According to the new regulations, large insurance provide will have to maintain an 85% MLR and smaller firms will be expected to maintain an 80% MLR.
The idea is not new; limits on the medical loss ratio have already been implemented in 34 states by state legislatures.  This begs the question of whether federal intervention will be able to accomplish more than the states could by their own efforts. It also casts doubt on the assumption that medical loss ratio limits are helpful to begin with. Any legislation of this magnitude has the potential for serious unintended consequences. Iowa, Maine, Georgia, and South Carolina have already requested waivers for exemption from the new plan over fears of market destabilization. 
If we think about how insurance works for a minute, we can see that the whole idea of a fixed MLR requirement is at odds with the general concept of insurance. Insurance companies provide a financial service by accumulating money when claim rates are low and disbursing the money when claim rates rise, which stabilizes costs for consumers. MLR requirements demand that the accumulation process is arbitrarily reset at the end of the year. This prevents efficient techniques like front-loading in which savings are built-up during a customer’s younger years in preparation for the costly senior years. In accordance with a mathematical theorem called the law of large numbers, larger companies will experience lower fluctuations in claim rates. However, smaller firms will be put at increased risk. In response to these concerns, the Affordable Care Act includes a provision for “credibility adjustments”, which allows the government to make discretionary exceptions to the MLR limits for smaller firms.
We recognize that 2718(b) allows the NAIC to “take into account the special circumstances of smaller plans, different types of plans, and newer plans, …” … We expect other types of insurers will ask for special treatment as well. – The Consumer Representatives to the NAIC 
In essence, smaller insurance companies will be forced to rely on the good grace of politicians for permission to survive.
But this is not the full extent of the trouble for smaller firms. MLR limits also place constraints on marketing budgets, which could be a death sentence for startups that haven’t yet established a brand name. And potential investors will likely redirect their capital to more lucrative sectors that don’t come with built-in upper limits on dividends. Without investment capital, it will become virtual impossible to disrupt the established industry giants.
Even the biggest insurance companies will be hurt. Lack of administrative funding will produce a brain drain of management talent to other, less regulated industries. And there will be less money to run insurance fraud investigation departments, resulting in higher premiums due to losses. Some services such as nurse hotlines may also take a hit if they don’t qualify as healthcare quality improvements.
The one sure-fire way to lower profit margins and increase value for consumers is to promote competition. The Affordable Care Act does just the opposite, in the unfounded belief that telling companies how to do their job will somehow outweigh this economic truth. It seems that there will never be enough evidence, theoretical or empirical, to convince the world that central planning just doesn’t work.
America does have a healthcare problem, but it’s not because of greedy insurance executives. It is because the government is enforcing a doctor cartel on behalf of the American Medical Association to keep doctor’s salaries artificially inflated, the Food and Drug Administration is making it more expensive than necessary to bring new drugs to the market, insurance regulations are stifling competition amongst providers, and liability laws are forcing doctors to purchase expensive malpractice insurance that ends up diverting money to lawyers and malpractice insurance companies. In short, it is government regulations that are causing our problems; further regulations are only going to make matters worse. And the salt on the wound is that we are paying quite a hefty sum to have this mistake implemented. The Congressional Budget Office estimates that reforms will cost $940 billion over a 10 year period, adding to our tax burden and $13.8 trillion national debt. 
 “Health Policy Brief: Medical Loss Ratios,” Health Affairs, Nov. 12, 2010. http://www.healthaffairs.org/healthpolicybriefs/brief.php?brief_id=30
 Letter to NAIC by NAIC consumer representatives, Oct. 8, 2010. http://www.naic.org/documents/committees_conliaison_1010_mlr_comments.pdf
 “Health Care Reform Bill: Cost, Details, Changes Released,” Huffington Post, March 18, 2010.
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