MLR was first introduced with the Affordable Care Act (ACA). MLR was instituted to mitigate premium increases, help establish more transparency and accountability, and increase the value that consumers receive for their premium dollars.
MLR requirements mandate that health insurance companies use most of their premium dollars to provide health care and improve quality for plan enrollees. Individual and small group plans are mandated to spend at least 80% of premium dollars on medical expenses. Large group plans, Medicare Advantage plans, and Medicaid managed care plans must spend at least 85% on medical expenses and quality improvement initiatives.
Plans want to keep their MLR low but not lower than 80% or 85%. If a health plan’s MLR is lower than the requirement, they must issue rebates to their members to make up for overestimating what the medical spend would be.
It is important to consider the MLR because plans must provide rationale for an increase in premiums. MLR requirements restrict payers from increasing their premiums solely to increase profits. Profit margins across plans are variable, with some health plans profiting as low as 2%.
Risk adjustment is a methodology used to attach a person’s health status to a number (risk score). This process is used to help predict healthcare costs, and plans rely on providers to code accurately and completely to capture the patient’s entire health status.
Health plans receive funds based on their membership’s risk scores which can vary at the county level (more funds are given for higher risk populations). For example, Albany county has a risk score of 2.14, while Boulder county has a 0.81 risk score in Medicare Advantage for 2020. Risk adjustment is important because it is a way for health plans to appropriately budget and ensure they’re being compensated appropriately for their pool of members.
Risk adjustment is not the same as underwriting—a process insurance companies previously used to determine if a person was an acceptable risk, and if so, how much to charge in premiums based on their medical history. The ACA does not allow health plans to charge a member a different premium based on their medical history or preexisting conditions.
Additionally, risk adjustment protects members from adverse selection processes by spreading the financial risks across health plans in the market. Without risk adjustment stabilization, plans might opt for healthier members to lower risk and reduce projected medical spend.
Health plans can receive financial incentives when they meet or exceed certain quality metrics or enrollment goals. These bonuses are paid directly to the health plan, and they become a part of the monetary pool used to provide benefits for consumers. Though these payments are in addition to funds collected from premiums, plans are usually required to use a portion to enhance member benefits and make quality improvements. In 2021, the average bonus per enrollee in Medicare Advantage plans was $446.
Health plans are typically evaluated annually, and these evaluations determine if the plan qualifies for additional funds. The Centers for Medicare and Medicaid Services (CMS) has a quality incentive program for Medicare Advantage plans. Additionally, some states have created financial incentive programs for plans that offer Medicaid products. State health care agencies create their own frameworks for how Medicaid plans can qualify for quality bonuses.
Health plans invest in stocks, bonds, and other ventures to increase their profits. Health plans often offer multiple products and have members across multiple lines of business (Medicare advantage, Medicaid, individual, or group plans).
Insurance companies can also acquire other companies to diversify their revenue streams. Recently, there has been a shift (especially from large, national carriers) to become diversified health solutions companies rather than focusing specifically on being a health insurance company.