Federally mandated loss ratio standards are going into effect for insurance companies in 2011.  These standards will mandate that insurers in the small group market have a loss ratio of no less than 80% and insurers in the large group market will be required to have a loss ratio of no less than 85%.  The theory is that if you reduce insurance company expenses and profit, rates will decline.

Unfortunately the new loss ratio standards, along with other Health Reform initiatives, may have the unintended effect of causing premium rates to increase at an accelerating pace. How can this be?  Here’s how:

  1. Insurance companies, the largest of which are publicly held, will be required to limit their expense and profits to what appears to be a lower percentage than is currently required by most state insurance departments.
  2. Simple arithmetic tells you that a smaller percentage piece of a bigger pie can be a bigger absolute piece.  Therefore while it is in the insurance companies’ interests at present to aggressively combat medical trend because it helps their bottom line, I submit that those interests will quickly change under the new rules.  Why control medical costs if the end result is that profits go down?  You can argue that because all states have loss ratio standards currently the same analysis should apply right now, and there is some merit to that argument.  However, the more such ratios are compressed the less room there is for profit growth and the less incentive there is to control medical costs.
  3. Finally, and probably the most compelling reason why premium rates will not decline is that the Federal Government has taken over the mantle from the states as the health insurance cop.  The Feds are requiring that plans provide substantial minimum benefits.  For example preventive care is mandated to be covered at no cost to the patient.   While over time this should help keep people healthier and consequently keep costs under control the time horizon for the aggregate beneficial effects is probably well after 2014, when health reform takes effect in its entirety.  Additionally the mandates regarding preexisting conditions, adult dependents, and unlimited benefits, will cause increasing costs for all plans.

Are the Feds clueless?  Not at all, I think that they know exactly what they are doing.  As rates continue to rise the current party in power will ignore the fact that it is the law causing the problem and blame private plans, in an attempt to give credence to its desire to move to a single payer.

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