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California's new "medical cost ratio" law will increase premiums

MedSave Admin | September 11, 2008

The California legislature passed a bill at the end of its 2008 session that requires health insurance companies to pay out benefits totaling 85% of the amount collected in premiums. This is called a "medical cost ratio requirement". Due to a quirk in the budgeting process, one political writer expects this to become law without the governor's signature as soon as October 1, 2008 and will be phased in beginning in 2009.

We hope (and expect) that some of the specialty health insurance policies and low cost supplemental insurance policies would be exempt from the rule. In a sense, this would be good for MedSave.com's business but we are alarmed that this business gain would come at the expense of affordable regula health insurance for Californians.

Until now, the highest medical cost ratio requirement in any state in the U.S. was 75%. At the75% mandated loss ratio requirement, most insurance companies pull out of a market because they cannot earn enough profit to justify their cost of capital. Those companies that cannot pull out of a market (like in New Jersey where withdrawal triggers a $1 million penalty) simply stop answering the phone on calls from that state. If pressed the company employees say something like, "we do offer coverage but I don't know anything about it". By comparison, the 85% ratio seems impossible.

It is clear to anyone without any expert inside knowledge of the insurance industry that the easiest way to increase the medical cost ratio while maintaining the firm's revenue for overhead and profit is to sharply increase the premium and cover more expenses (i.e. favoring HMOs and managed care). This is basic mathematics, not high level business strategy. If we crunch the numbers, it would take a 42% increase in premium revenue to boost the average insurance company's medical expense ratio from 75% to 85% while maintaining steady coverage for overhead and keeping profits the same. This is an oversimplification since this estimate ignores increased reserve requirements, increased costs of handling more claims and the lower return on capital. In other words, a real-life increase would have to be much larger than 42% for the insurance company to continue operations.

We don't know how this will work and have not read any comment on how insurers will react. Several responses are likely:

1. some insurance companies will stop offering coverage in California

2. few of the new innovative products will be introduced in the future

3. The accounting practices used by non-profit health insurers will give them an advantage.

4. Insurers will change accounting practices and business practices including outsourcing more services to and increasing burdens on medical providers.

5. The dominant managed care and HMO providers like BC/BS, and Kaiser will increase market share. Traditional indemnity insurers will lose market share.

6. Consumer dissatisfaction with health insurance will increase.

7. Overall cost of insurance will increase

8. the lower priced insurance plans, including HSA insurance, unless exempted from the loss ration requirement, will disappear from the market.

Tags : Health, Insurance, california, reform, Health_old

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