A key detail in the recent health insurance reforms may not seem like a big deal now, but in the long run, it could threaten insurers' profitability.
If you invest in the health insurance industry, you're probably familiar with medical loss ratios (MLRs), which measure what portion of the premiums that insurers take in get spent on actual care. In general, the lower the number, the greater the profit potential, and the wider the smiles on shareholders' faces. But new regulations require that health insurers post MLRs of at least 85% for plans sold to large companies, and at least 80% for plans sold to individuals and small businesses.
Some observers rejoice about this, suggesting that insurers will now have to spend more on their customers, delivering better care. In theory, that might be true, but many big insurers already sport MLRs in safe territory. Here are six of the largest firms; I've bolded the MLRs that fall below the new standard:
2009 MLR, Individuals
2009 MLR, Small Groups
2009 MLR, Large Groups
|UnitedHealth Group (NYSE: UNH )||70.5%||81.1%||83.3%|
|WellPoint (NYSE: WLP )||74.9%||81.2%||84.9%|
|Humana (NYSE: HUM )||68.1%||80.0%||88.2%|
|Coventry Health Care (NYSE: CVH )||71.9%||78.2%||86.0%|
|Aetna (NYSE: AET )||75.7%||84.2%||87.2%|
|CIGNA (NYSE: CI )||88.1%||92.1%||85.2%|
Data: 2010 Staff Report for Sen. John Rockefeller.
For context, Medicare has long boasted an MLR of 97% or above.
Bringing up numbers
Companies with subpar numbers will be expected to pay their customers a refund, but I suspect that most companies will find a way to get their numbers up. They may try to reclassify some of their expenses as medical, thereby boosting their MLR. WellPoint has begun doing so, and has caught some flak for it. Commissions to agents may get cut, too.
Some covered companies will succeed in getting temporary waivers, in order to maintain coverage for their employees -- as McDonald's (NYSE: MCD ) and 29 other companies and organizations recently did to protect their minimal "mini-med" coverage. But once the waivers expire, such employers will have some tough decisions to make.
Savvy investors should keep an eye on these MLR numbers, because they're now likely to be even more tied to a company's attractiveness in the market. Even before the new regulations, Aetna's stock plunged 20% three years ago when its MLR slipped 1.5 points, from 79.4% to 77.9%.