Have you ever wondered how your insurance company uses the money you pay for your premium? As it turns out, in addition to spending those dollars on your health claims, insurance companies spend a portion of premium dollars on things like administration, executive salaries, overhead, profits, and marketing.
In fact, the U.S. spends1 more than $1,000 per person on healthcare administrative costs—five times more than the average in similar countries and more than the U.S. spends on preventative and long-term care.
One provision the federal government created to help counteract this problem is the medical loss ratio (MLR) requirement—a rule put in place to make sure insurance companies spend more money on actual medical expenses to keep health insurance costs down.
In this article, we’ll answer common questions about MLRs, such as how insurers calculate them and what they mean for you as a policyholder.
What is a medical loss ratio?
An MLR is a measurement of how much premium revenue insurance companies spend on medical claims from covered individuals as well as improvements to the quality of care they are offered.
What are the medical loss ratio rules?
The MLR standard is a policy created by the Affordable Care Act (ACA). It mandates that health insurance companies must use a larger percentage of their premium income on claims and quality improvement than they use on profit, marketing, and administration costs.
Expenses that qualify as improving the quality of care might include the following:
- Advancement of health information technology to improve quality, transparency, patient care, or health outcomes.
- Provider credentials to establish its ability to give proper healthcare.
- Programs to help support patient safety and care, such as managing serious health conditions.
- Hospital discharge planning to reduce frequent hospital readmissions.
The ACA, as well as some state laws, set MLR standards for different size markets. Individual and small group markets, which have health insurance policies geared toward organizations with 50 or fewer full-time equivalent employees (FTEs), are expected to spend at least 80% of their premium income on medical-related expenses, with 20% leftover for administration costs.
On the other hand, the large group market segment, which provides health insurance coverage for organizations with more than 50 FTEs, needs to spend at least 85% on medical-related expenses, leaving 15% for administrative costs.
In either case, if administrative expenses exceed those amounts, the insurer must remit rebates to their enrollees (we’ll talk more about rebates later).
How are medical loss ratios percentages calculated?
To do a medical loss ratio calculation, an insurer would divide the cost of medical services (things like medical claims paid and any expenses for healthcare quality improvement) by the total premiums collected over a period of time, minus any federal or state taxes, licensing, and regulatory fees paid in that same period.
For example, let’s say an insurer uses $850 out of a customer’s $1,050 monthly premium to pay for that customer’s medical claims. The insurer also pays $50 in taxes and fees, so we’d subtract $50 from the premium. They can calculate their MLR by taking $850 divided by $1000, which is 0.85, or 85%.
To make it easier, here is the equation and example of the calculation below:
Incurred claims/premium after taxes and fees = MLR
$850/$1000 = .85 (or 85%)
An MLR of 85% means that an insurer spent 85 cents of every premium dollar on appropriate medical and clinical services for the participant and won’t suffer any consequences for underspending on actual healthcare costs.
Why are medical loss ratio rules important?
Regulation of MLRs is one of the most notable consumer protections in the ACA. While it’s ultimately something insurance companies must keep track of, it should also matter to you as a policyholder.
The MLR minimum standards offer several benefits to you as a customer and peace of mind regarding how your insurer spends your insurance premium dollars. Let’s go over some of those benefits below so you can better understand how they can help you.
Increased transparency and accountability
The MLR standard doesn’t just mandate that insurance companies keep track of their spending internally—they must also report everything publicly. That means every dollar of your premium is charted and categorized for the world to see.
You can check out your insurance company’s MLR and review their past reports using the medical loss ratio search tool2 on the Center for Medicare & Medicaid Services website.
Each year's report is due by July 31 of the following year. So, for instance, an insurer must submit its yearly report for 2023 by July 31, 2024.
This kind of public availability of how insurance companies spend their premium income is a great way to keep companies accountable. It also helps keep you informed on which companies are compliant and provide a credible experience for you as a customer.
You can be sure your premium is being spent wisely
While the MLR rule helps cushion an insurer’s losses over time, it also provides consumer protections against overpriced qualified health plans.
Given that medical costs have been rising for the last several decades, it’s comforting to know whether or not your hard-earned money is being spent on the medical expenses and healthcare quality improvements you benefit from.
Additionally, considering the standard was set in place by the federal government, the rules apply to every state and health insurance issuer in the U.S. This way, you can be sure that wherever you go, you can expect the same standard for how your premium dollars are spent.
If your premium isn’t used responsibly, you’ll get a rebate
Health insurance carriers that fail to meet the MLR threshold must pay back excess profits or margins in the form of rebates to their participants. However, annual rebates aren’t based on a single year’s MLR. The ACA requires insurers to issue rebates to health plan participants based on their rolling average MLR from the previous three years.
Let’s say you’re a customer of an insurance company with a plan from the large group market, and your insurer only reports an 83% MLR. Remember, the requirement is 85% for large group markets, so there’s a 2% gap.
In this case, a 2% rebate would be paid back to all its policyholders to make up the difference. The rebate would be paid directly to you through a rebate check, a direct deposit, or a reduction in your premium cost.
In other cases, the rebate may go to the employer that paid the premium on the enrollees' behalf, and they’ll see that it’s used for their employees’ benefit.
So what would a 2% rebate look like for you in dollars? The cash rebate amount is calculated based on the amount of premium paid by the policyholder minus any taxes or fees associated with the premium.
For example, if a policyholder paid $1,000 for their premium and the insurer paid $50 in taxes related to that premium, the 2% rebate would be applied to the $950 difference, getting you a total rebate of $19.
That might not sound like a lot, but rebates add up. Between 2012 and 2022, health insurers have returned $10.8 billion3 in rebates to enrollees.
2023’s rebates are estimated to fall well under the high rebate totals of $2 billion issued in 2021 but slightly above the $1 billion issued in 2022. Insurers estimate4 they will issue $1.1 billion in MLR rebates across all commercial markets in 2023, which is similar to the amount in 2022. The average rebate an individual receives will vary.
With the creation of MLR rules, you can be sure that your insurance company will use most of your premium dollars toward medical expenses and improvements that will benefit you and your family. No matter where you live or what insurance company you choose, there are standards to ensure that no American’s premium is gone to waste.
These days, insurers may have difficulty predicting premiums due to inflation and the economy. If your employer offers alternative health benefits, such as an HRA through PeopleKeep, it could be your best bet to control rising premiums and plan costs in an unstable market.
This article was originally published on July 18, 2021. It was last updated on June 5, 2023.