The Medical Loss Ratio is the percentage of total premium revenue that an insurance company spends on medical care (and a few other minor things) for its members. PPACA requires a large group insurance premium pools to have an MLR of 85% and small group or individual premium pools to have an 80% MLR. The difference is because there are significant scale differences. For instance, the things that I do are required for both small and large groups but take the same amount of time, so my costs can be spread over 5,000 people or fifteen.
Most people in most years will never come close to costing the insurance company the full individual medical loss ratio slice. That is typical because insurance is a guaranteed small loss to avoid a possible large loss. Most people are reasonably healthy in most years or have frequent but cheap contact with the medical system in the form of PCP visits, physical therapy, perhaps a broken bone that needs nothing more than a cast or a single incident of kidney stones.
With the exception of the years when the Kids were born, my family has never had a personal medical loss ratio above 35%. And that is a good thing. That means we’ve been relatively healthy and what ailments have been minor, transitory and acute.
For individuals who have health insurance through their employer, one of the minor changes of PPACA is the addition of box 12-DD to your W-2. This is an annual report on how much your health insurance premiums cost you and your company in the previous tax year. The idea is to get people with group sponsored health insurance aware of how much their insurance actually costs. It is an awareness feature only.
Last year, the value in my box 12-DD was slightly more than $12,000 to cover my family. Once we apply the systemic medical loss ratio of 85% for large group products, the average insurance company payout for families in my group would be roughly $10,000.
In 2012, we came close to but under that number. The major expense was an uncomplicated labor and delivery for Kid #2 and the subsequent steady stream of well baby visits. I had my annual PCP visit and Kid #1 had her well-child visit, a few shots, and a few PCP visits with day care crud.
In 2013 (knocking on wood and throwing salt over my shoulder) we’ll cost the insurance company perhaps 30% of our medical loss pay-in. This is despite a tweaked ankle with physical therapy, two kids who collect all sorts of interesting daycare crud, regular PCP and ObGyn appointments and plenty of vaccinations for Kid #2.
A typical looking risk pool of 100 contracts might have an actual pay-out matrix like the one below:
|Contracts||Average MLR Cost||Total Cost||Group Cost % of Pool|
Within any single risk pool there should be a residual that is not covering the particular risk pool but is devoted to covering extreme tail risk of the million dollar claim. Group costs follow the Pareto rule where 20% of the people incur about 80% of the pay-outs, and 10% incur about half.
This is the argument for the young invincibles to opt-out. Odds are they won’t be in a high cost scenario so paying for a high cost scenario won’t benefit most of them, until a young invincible is in an auto accident or has a funny look growth under their arm pit or has a baby with significant post-birth complications.
Everyone else just looks at that chart and say that is insurance working, and hoping that they won’t be a high multiple of MLR user as that would mean they are healthy and lucky