The ACA Medical Loss Ratios – “COST-PLUS” Health Insurance in Disguise


By Jeff Evans

I recently read an opinion piece that effectively summarized much of what many of us, in the health insurance and employee benefits business, have already figured out.”

The ACA Medical Loss Ratios – “COST-PLUS” Health Insurance in Disguise

Published on August 3, 2016

Jeff Evans

Insurance Advisor at The Securance Corporation Agency

I recently read an opinion piece that effectively summarized much of what many of us, in the health insurance and employee benefits business, have already figured out. I have included much of the information from the opinion piece, by an anonymous author, in this article.

Why medical costs will really skyrocket under the Patient Protection and Affordable Care Act (“ACA”)?

Since the introduction of the ACA, all health insurance companies want medical costs to rise as much as possible. Why? They want medical costs to rise because they are now “Cost Plus” providers. Unfortunately, increased medical costs have a positive direct correlation to their profits.

Let me break it down.

Under the ACA health insurers are required to provide consumer rebates if they do not meet a set financial target known as a medical loss ratio (MLR), which is the amount of premiums spent on medical care vs. company expenses and profits. For example, if an insurer collects $100,000 in premiums and spends $85,000 on medical care, the MLR is 85%.

In theory, the higher the MLR, the more value a policyholder receives for his or her premium dollar. The ACA requires a minimum MLR of 80% for individual and small group insurance plans; and a MLR of 85% for large group plans (100 employees or more). Congress imposed MLRs to provide “greater transparency and accountability around the expenditures made by health insurers and to help bring down the cost of health care.”

The short version is that health insurance companies, under the ACA, are now allowed to only charge 15%-20% more in premiums than they pay out. It is supposed to limit the amount of profit health insurance companies can make.

However, as a for-profit business reporting to stockholders, a company must continually increase its stock value which is typically done through increasing revenue.  So, if a percentage cap is put on how much a company can make, then how do they increase revenue?  The only way is to increase the basis of your percentage, the premium.  This essentially turns the carriers into “Cost-Plus” contractors who now want, and frankly need, healthcare costs to rise as much as possible annually. This allows the company to charge the consumer higher premiums so that the 15-20% fixed profit increases.

I am surprised this has not been discussed more up to this point.  In fact, I have only heard it mentioned a couple of time.  Most of the time when I bring this up people are amazed, “wow, I didn’t think of it like that . . .“  I am confident that was not the original intent of the law, at least I hope not.  But I am certain that neither those that passed the ACA, the providers, nor the health insurers want it brought up.

Take a look at the Big Carriers’ stock prices over the last 8 years.  I wish I had bought their stock years ago, some of them are up as much as 400% during that period, as illustrated in the following chart.

As a result of the MLRs, in order to make their profits higher, health care costs must be higher. If the average hospital costs for an appendectomy rises 50% next year, in theory, health insurance companies will be able to charge 50% higher premiums and the 15-20% profit margin will be greater.

So, ironically, the health insurance companies that used to try to keep health care costs down now need them to rise as much as possible. They might lose a little more this year but next year they have the potential to make a lot more. And, of course, hospital companies and providers want to raise costs as much as possible so their profits go up also. Now, under ACA, everyone except you, the patient/consumer, wants medical care costs to rise as much as possible.

Additionally, since there is little competition between health insurance companies to keep your premiums low, and you are now required by law to purchase health insurance, health insurance premiums are rising 40%-50% per year. So guess what? The health insurance companies will charge 15-20% on top of that increase and their profits will go much higher every year costs go up! They would love it if every appendectomy cost $1 million dollars next year.

Contracts that allow a provider to charge their cost plus an additionally percentage are known as “Cost-Plus” contracts.  These contracts need the base cost to be as high as possible in order to maximize their revenue. It is “Cost-Plus” government contracts in the defense industry that led to $500 hammers. Now, instead of hammers, its medical procedures which already start at $50,000 so you can imagine how bad this will be in a few years unless something is done.

Most good businesses do not want their providers to have “Cost-Plus.” They want their providers to compete through quality, efficiency and cost.  However, the ACA MLRs have eliminated their incentive to become too efficient because if they exceed the 15-20% they have to give it back through rebates.  So, basically, if it’s getting close to year end and they are running close to 15% or 20%, it is to their advantage not to be too diligent in claims review.

You have probably experienced the total financial assault that our medical establishment commits on us since no one limits them and there is no cost transparency.  Think about it, we shop for everything, cars, appliances, clothes, . . . everything.  Rarely do we just pay the first price that is thrown at us.  But have you ever done that with healthcare?  Probably not, very few people have.

In many countries the government limits what doctors and hospitals can charge by procedure. Since they know what the average is they know what procedures should cost. This means that all providers, like hospitals, have an incentive to figure out ways to deliver medicine cheaper because that is the only way they can increase profits. Doctors and hospitals have to maintain high quality level or they are cut from the program completely and can’t practice medicine at all.

In Japan, for example, doctors and hospitals are limited by law how much they can charge. Doctors, for example, can only charge so much per stitch for cuts. As a result, they must find ways to do things cheaper to make a profit. As a result, Japan developed the least expensive MRI machine in the world which costs $2,000 for the whole machine, not per treatment.  That machine is, of course, banned in the USA.

Something has to change.  Some level of transparency has to be established.  Transparency will allow for more efficient competition.  Insurance companies also need to be allowed to compete based on ingenuity, efficiency, and ability. I do not know of any industry that has flourished under government over-regulation.

Jeff Evans

Insurance Advisor at The Securance Corporation Agency