Health insurance reform and the importance of the medical loss ratio

Last weekend, I eagerly went to a town hall hosted by Congresswoman Doris Matsui. The topic was the current health reform process, and I was interested to hear the discussion and possibly have a chance to participate in the forum. (For additional news coverage of the town hall, see the article in the Sacramento Bee). No one threw a chair or defaced public property, but it was clear that health reform was a hot topic and there was a great deal of shouting, clapping, booing and placard waving. Constituents voiced their frustrations, and perspectives about health insurance reform in many ways and from many different perspectives. A common theme, however, was heard as one participant after another voiced frustration with high health insurance premiums, limitations of care, and escalating personal costs of care. I didn't have an opportunity to ask a question of Representative Matsui, but I think it was particularly revealing that so many people asked her to comment on how the reform process would address insurance company practices.

In reality, the current health reform is health insurance reform, rather than full system reform. Health insurance is one, and only one, part of the larger system of health care in this country. I think many people would agree that aspects of care delivery, patient safety, pharmaceutical sales policies and other elements of the health care system are in need of reform. Nevertheless, health insurance companies are a major driver of cost of care in the US health care system, and the town hall discussion was so focused on health insurance policies and company profits that the term medical loss ratio was actually mentioned several times. Though not a concept well known outside the circle of health economists, it is one that serves to illustrate the importance of the current reform efforts.

The medical loss ratio is a term which describes the ratio between what a health insurance company pays out in claims for actual health care services, and what the company spends on sales, marketing, administration, and profit. If a relatively healthy person is insured at company A, and paying a premium of approximately $2500 per year (1) but does not visit the doctor regularly or uses minimal health services, the health insurance company can devote most or all of that premium towards non-health related expenses (advertising, shareholder dividends, etc). In this case, their medical loss ratio is relatively small. Compare that to a person with multiple medical conditions who sees a physician multiple times a year, and you can imagine that the insurance company is paying more per month towards health services for that person and less money towards non-health expenses. Right now, there are no federal laws that require health insurance companies to devote any percentage of premiums towards health services. This means that if a really sick person is insured at company A, the company might require that individual to pay a certain percentage of care out-of-pocket in order to limit the companys' medical loss. Essentially, a health insurance company is likely to earn more profit if it has to pay less for health services. To "drive down medical loss," a health insurance company could choose to selectively insure relatively healthy people so that the company will be more profitable.

This is one of the main reasons we need the current reform effort to succeed; so that policies developed at the national level will limit the degree to which insurance companies can drive down their medical losses. Yes, health insurance companies are a business and therefore have a responsibility to demonstrate profit to shareholders. In most markets, the incentive to increase profits can provide a powerful stimulus to innovate, create and drive further efficiencies in an industry. However, in the health industry, this profit incentive also stimulates creative mechanisms to drive down medical loss, such as rescinding health coverage for people who are found to have pre-existing conditions, or raising premiums to unrealistically high levels in the hopes of losing some customers who cannot afford the rate increase. This results in higher costs (both monetarily and clinically) for the sickest people in our country and for all of us who pay insurance premiums.

The basic premise currently serving as a foundation for ideas and proposals within the House and Senate health reform bills is that health care is, primarily, a business. As one who believes there are serious market failures in the system (as illustrated by the medical loss ratio), I have struggled with the business premise as a place to begin forming my opinions about the current reform effort. It's not that I believe health care is not a business, but that it is much more than a market-based business. I believe health care represents a service, a public good, and a business that serves both individuals and communities nationwide. This changes the ways we could structure our economic and policy analyses of the current system and of reform. That said, I do accept that (a) reform must start somewhere and (b) the current economic climate makes a "start from scratch" approach less-than-feasible. Nevertheless, I hope the current reform effort is a starting place for further discussion about improving the overall health care of the nation, and not just a debate about how to create fair health insurance policy.

(1) Trends and Indicators in the Changing Health Marketplace. Exhibit 3.5: Average Monthly Employee Premium Contributions. http://www.kff.org/insurance/7031/ti2004-3-5.cfm
Accessed 10/15/09.