PPACA established minimum MLR standards for insurers offering group or individual health insurance coverage using a new MLR formula that differs from the way MLRs have traditionally been calculated. To implement the PPACA MLR provisions, HHS issued an interim final rule that provided specific definitions and methodologies to be used in calculating the new MLRs, and that addressed other areas, including adjustments to the MLRs to address the circumstances of certain types of plans, and oversight and enforcement. Insurers will begin reporting PPACA MLRs to HHS in June 2012. In the private health insurance industry, the MLR is a commonly used indicator, measuring the proportion of premium dollars an insurer used for medical claims, as opposed to other functions, such as marketing, actuarial activities, or profit. While many states have minimum MLR standards or MLR reporting requirements, PPACA established federally required minimum MLRs for insurers operating in the individual and group insurance markets. The MLR formula specified in PPACA differs from the way MLRs have traditionally been defined. The traditional MLR is generally calculated by dividing an insurer’s medical care claims by premiums. In the PPACA MLR formula, the numerator includes insurers’ expenses for activities that improve health care quality—such as patient-centered education and counseling, care coordination, and wellness assessments—in addition to claims. Further, the denominator of the PPACA MLR subtracts from insurers’ premiums all federal taxes and state taxes and licensing or regulatory fees (see fig. 1). In addition to establishing the new MLR formula, PPACA directed NAIC to establish recommended definitions and methodologies for calculating MLRs, subject to certification by the Secretary of HHS. NAIC submitted its recommendations to HHS on October 27, 2010, and HHS issued its interim final rule implementing the PPACA MLR requirements in PPACA on December 1, 2010, with an effective date of January 1, 2011. According to HHS, the interim final rule adopted NAIC’s recommendations in full, and included the following key areas.  Activities that improve health care quality. These include activities designed to increase the likelihood of desired health outcomes in ways that can be objectively measured. The activities must be primarily designed to: (1) improve health outcomes; (2) prevent hospital readmissions; (3) improve patient safety; (4) implement, promote, and increase wellness and health activities; and (5) enhance the use of health care data to improve quality, transparency, and outcomes. Insurers are also allowed to include health information technology (IT) expenses needed to accomplish activities that improve health care quality. Also specified were certain activities that do not qualify as those that improve health care quality, such as provider credentialing.  Federal and state taxes and licensing or regulatory fees. These include all federal taxes and assessments, excluding taxes on investment income and capital gains.  Levels of aggregation for MLR reporting. Insurance companies are required to report MLRs separately for their individual, small group, and large group markets for each state in which they are licensed to operate.  Credibility adjustments. All insurers experience some random variability in their claims, where actual claims experience varies from expected experience. The impact of these deviations is less for health plans with a larger customer base. To help address the disproportionate impact of claims variability on small health plans, adjustments to MLRs are permitted for these plans. Specifically, MLRs for plans with less than 1,000 life years will be considered “noncredible” and will be presumed to meet the MLR requirements;  1,000 to less than 75,000 life years will be considered “partially credible” and may receive an upward adjustment ranging from 1.2 to 8.3 percentage points, depending on size, and a further adjustment if they have high deductibles; and  75,000 life years or more will be considered “fully credible” and will not receive an adjustment. HHS estimates show that for 2011 a small fraction of insurers that offer plans in the individual, small group, or large group markets would be considered fully credible, but these insurers account for the majority of the total life years covered by these types of plans. About half of insurers that offer plans in the small and large group markets and a little less than a third of insurers that offer plans in the individual market would be partially credible and could apply a credibility adjustment.  Years of data to include in calculating the MLR. Beginning in 2013, insurers’ MLRs will be calculated based on a 3-year period of the accumulated experience for the current reporting year and the 2 preceding years. Because insurers will not have 3 years of MLR data for 2011 and 2012, MLRs for these years will be calculated as follows: (1) MLRs for 2011 will be calculated on their experience for 2011, (2) MLRs for plans that are fully credible in 2012 will be calculated based on their experience for 2012, and (3) MLRs for plans that are partially or noncredible in 2012 will be calculated based on accumulated experience from 2011 and 2012. HHS’s interim final rule also addressed areas that NAIC did not specifically include in its recommendations, which focused primarily on the definitions and methodologies used for calculating the MLR. Some key areas are summarized below.  Treatment of agents’ and brokers’ commissions and fees. HHS explicitly listed agents’ and brokers’ commissions and fees as nonclaims expenses. NAIC did not include any special treatment of these expenses in its recommendation to HHS, but raised concerns about the potential impact of the MLR requirements on the ability of these professionals to continue assisting consumers. HHS officials have continued to discuss this issue with NAIC. Legislation has also since been introduced to deduct agents’ and brokers’ fees from premiums in the MLR calculation.  Adjustment to the standard for a state’s individual market. In addition to providing for credibility adjustments, PPACA provided HHS with the authority to adjust the MLR standard for the individual market in a state if it determines that the application of the standard may destabilize the individual market in that state. Although NAIC’s recommendations to HHS did not specifically address adjustments to the MLR standard for the individual market, NAIC did raise concerns about the ability of many insurers to readily achieve an MLR of 80 percent. In the interim final rule, HHS established a process for states to apply for an adjustment to the MLR standard for the individual market in that state that included the information states must provide in their applications and the criteria HHS would use to assess the applications. As of July 25, 2011, 12 states and 1 territory had applied to HHS for an adjustment; HHS had granted an adjustment of the MLR in 5 states, did not grant an adjustment in 1 state, and was in the process of reviewing the remaining applications.  Oversight. HHS is responsible for direct enforcement of the reporting and rebate provisions of the MLR requirements, including that the reports are submitted timely, that the data comply with the definitions in the regulations, and that rebates are paid timely and accurately. The interim final rule provides a framework through which HHS may conduct audits to determine insurers’ compliance with the provisions and provides that HHS may, in its discretion, accept the findings of audits that state regulators may conduct of an insurer’s MLR reporting and rebate obligations, as long as specified conditions are met. The interim final rule also provides for the imposition of civil monetary penalties if insurers fail to comply with the requirements. HHS received public comments on the interim final rule from representatives of the insurance industry, consumers, state regulators, and others, covering a wide range of topics, such as the treatment of agents’ and brokers’ fees, the methodology for determining credibility adjustments, and the treatment of taxes. According to HHS officials, HHS has not determined when it will issue a final rule. PPACA MLRs will be reported to HHS every June and will reflect insurers’ experiences from the previous calendar year. The first set of these data will be submitted to HHS in June 2012, reflecting insurers’ experiences from 2011. In April 2011, insurers reported MLRs to NAIC using the PPACA MLR definition based on their 2010 experience. These data are not subject to the PPACA MLR provisions and will not be adjusted to account for credibility or other issues addressed in the provisions. Traditional MLR averages generally exceeded the PPACA MLR standards in each market, even without the changes in the new PPACA MLR formula that will generally further increase MLRs. However, traditional MLRs also varied among insurers, particularly among those in the individual market and smaller insurers. Since traditional MLRs were calculated differently than they will be under the PPACA requirements, it is difficult to predict, based on these data, what insurers’ MLRs would have been using the PPACA formula, or to predict the MLRs that insurers’ will report in the future. From 2006 through 2009, insurers’ traditional MLR averages generally exceeded the PPACA MLR standards—80 percent for the individual and small group markets and 85 percent for the large group market. This is even without the new PPACA MLR formula definitions or credibility adjustments that will generally further increase MLRs reported under the PPACA requirements. The average traditional MLRs reported for 2006 through 2009 were also relatively stable for all markets (see table 1). Since traditional MLRs were calculated differently than they will be under the PPACA requirements, it is difficult to predict, based on these data, what insurers’ MLRs would have been using the PPACA formula, or to predict the MLRs that insurers’ will report in the future. While traditional MLRs on average generally exceeded the PPACA MLR standards from 2006 through 2009, they varied, particularly in the individual market. For example, figure 2 shows that in 2009 traditional MLRs in the individual market were more widely distributed than those in the small and large group markets. Within this variation in the individual market, a larger proportion of insurers generally had lower MLRs; that is, they spent a lower percentage of their premiums on medical claims, as compared to insurers in the small and large group markets. Under PPACA, states may request adjustments to the MLR standard for the individual market if application of the standard may destabilize that market, for example, by causing insurers to exit the market, such that insurance options are limited in the state. Annual fluctuations in insurers’ traditional MLRs were also greater for insurers in the individual market. For example, 70 percent of insurers in the individual market experienced an average annual change in their traditional MLRs of more than 5 percentage points from 2006 through 2009, compared to 46 percent in the small group market and 39 percent in the large group market. Almost 12 percent of insurers in the individual market averaged annual changes greater than 20 percentage points, compared with about 4 percent of insurers in both the small group and large group markets. Beginning in 2013, insurers will calculate their PPACA MLRs based on 3 years of data, which could partially mitigate the impact of variations often experienced by insurers from year to year. Traditional MLRs were also more varied for smaller insurers in all three markets from 2006 through 2009. For example, figure 3 shows that in 2009 traditional MLRs for smaller insurers were more widely distributed than those for larger insurers, with a higher percentage of smaller insurers generally reporting lower MLRs. The credibility adjustments in PPACA allow smaller insurers to upwardly adjust their MLRs. Data for figure 3 are aggregated across all states that an insurer operates in. However, since insurers are required to report their PPACA MLRs at the state level, it is likely that in 2011 and beyond, more insurers will have less than 75,000 life years in a market at the state level and will be eligible for a credibility adjustment. The insurers we interviewed said their PPACA MLRs will be affected by changes in the MLR formula, primarily due to the deduction of taxes and fees in the denominator, and to a lesser extent, the addition of expenses for activities to improve health care quality in the numerator. Insurers also said that the PPACA MLR requirement to report MLRs by state will affect their PPACA MLRs. Insurers said they expect the precision of their PPACA MLR data to improve in 2011 and beyond, in part because their 2010 MLRs were based on best estimates. Most of the insurers we interviewed reported that the deduction of taxes and fees in the denominator of the PPACA MLR formula would contribute to the largest change in 2010 MLRs compared to the traditional MLR formula, but some insurers said the effect of the deductions vary by state and may vary in 2011 and beyond. One insurer told us that the effect of deducting taxes and fees for their 2010 MLRs was more than double the effect of including their expenses for activities to improve health care quality in the numerator. Another insurer told us that the effect of taxes and fees would vary by state because state taxes, such as premium taxes and other state assessments, can vary. Further, one insurer said that while the deduction of taxes and fees was the largest component that affected their 2010 MLRs, and resulted in increased MLRs, if the insurer were to experience a loss in profits in a future year, and therefore a reduction in its income taxes, the effect of this deduction could result in a decrease in MLRs. Regulators from several state insurance commissioners’ offices also told us that they believed the deduction of taxes and fees in the PPACA MLR formula would likely have the largest impact on MLRs reported by insurers in 2010. Most of the insurers we interviewed also said including expenses in the numerator of the PPACA formula for activities to improve health care quality contributed to changes in the 2010 MLRs compared to what they would have been under the traditional formula. However, including these expenses had less of an effect on their MLRs than the deduction of taxes and fees. One insurer estimated that the inclusion of these expenses in the PPACA MLR formula would increase their MLRs by 0.5 percentage points, but this was a fraction of the total estimated 2.0–2.5 percentage point increase in their MLR overall, which the insurer said was primarily due to the deduction of taxes and fees. Another insurer estimated that the impact of including their expenses for quality improvement activities would be less than 2 percentage points, but the deduction of taxes represented the largest component driving the increase in their 2010 MLRs. In addition, two insurers said that including quality improvement expenses would have very little impact on their PPACA MLRs. Examples of activities that improve health care quality that insurers included in their PPACA MLR were disease management programs, wellness activities, 24-hour nurse phone lines, and care coordination. Insurers that issue insurance plans in more than one state said that disaggregating MLRs by state will likely result in some variation in their MLRs across states. For example, one insurer said that a higher proportion of their premium dollars are spent on administrative expenses in one of their states because they tend to sell lower benefit plans, which they said have high administrative costs relative to premiums, in this state. While this insurer historically reported a single MLR combining data across two states, they said the disaggregation by state required for the PPACA MLR resulted in lower MLRs in the state with lower benefit plans compared to the other state. For example, MLRs in this state were 1.5 percentage points lower in the individual market and 4.5 percentage points lower in the small group market than the MLRs in the other state. Another insurer said that prior to the PPACA MLR requirements they priced insurance plans for the small group market to employers located in two states as a single market. When they calculated the PPACA MLRs separately for each state they noted variations between the two MLRs because medical costs were different in each state. All of the insurers we spoke with said that their PPACA MLRs for 2011 and beyond will be more precise than the 2010 MLRs reported to NAIC for several reasons. Because HHS’s interim final rule on PPACA MLRs was published in late 2010, insurers told us that they used their best estimates to apply the PPACA definition to experiences incurred earlier in the year. They said their PPACA MLRs for 2011 and beyond will be more precise because they will not be based on estimates and they will have a full year of data that they collected according to the new PPACA MLR categories. A regulator from one state insurance commissioner’s office described 2010 as a “test” year and said it will help insurers better prepare to report their 2011 MLRs. The regulators also agreed that the 2010 MLR data would not be a clear indicator of insurers’ expenses for quality improvement activities because insurers’ may vary in how precisely they report these expenses. In addition, some insurers told us they had never reported MLRs both by state and by insurance market prior to the PPACA MLR requirements, and were having challenges developing reasonable bases for allocating expenses across states and insurance markets for their 2010 reporting. However, they expected these issues to be resolved for 2011. For example, one insurer told us that their medical quality activities are centralized and apply to all markets, but they must now apportion their expenses for these activities by market, then to each of their insurance companies, and then by state. This insurer said that they implemented a new timekeeping system late in 2010 to better account for the time that their staff spend on these activities to address these allocation issues and expect to produce more precise data for their 2011 MLRs and beyond. Most of the insurers we interviewed also told us that their 2010 MLR data may be less precise than data reported in future years because of challenges they had in identifying and allocating health IT expenses. For example, one insurer told us that their health IT is a centralized function that is also used for other lines of insurance business, such as Medicare and Medicaid, which they said are not subject to PPACA MLR requirements. Another insurer said that determining their health IT expenses was less clear relative to the other subcategories of activities to improve health care quality in that it was hard to identify how much of their internal IT system infrastructure uniquely supported the other eligible quality activities. In addition, one insurer that only operates in a single state said that identifying expenses for health IT was challenging when factors such as facilities and employees’ salaries had to be considered. However, all of these insurers anticipated that these issues would be largely resolved when they report their 2011 PPACA MLRs. Almost all of the insurers we interviewed were reducing brokers’ commissions and making adjustments to premiums in response to the PPACA MLR requirements. These insurers said that they have decreased or plan to decrease commissions to brokers in an effort to increase their MLRs. One insurer said they started making reductions to their brokers’ commissions in the fourth quarter of 2010 for their individual and small group plans to increase their 2011 PPACA MLRs in these markets and, as a result, premiums were not as high as they otherwise would have been. This insurer said these reductions will take effect gradually because they are only being applied to new sales or when groups renew annually. Another insurer lowered commissions to their brokers in the individual market in the first quarter of 2011, such that premiums were increased less than they otherwise would have been, which they expect to result in an increase in their PPACA MLRs for 2011. In addition, one insurer said they are considering reducing premiums in 2012 partly in response to the PPACA MLR requirements and also in conjunction with a reduction in the number of in-network physicians—the combined strategy would help to lower enrollee premiums and increase their MLRs. A regulator from one state insurance commissioner’s office said that some insurers in that state have not applied for premium increases and are making adjustments to lower premiums as a strategy to increase their MLRs, and commented that reducing premiums is the best strategy for insurers to improve value for consumers. Insurers we interviewed varied on how the PPACA MLR requirements might affect their decisions on activities to improve health care quality. One insurer said that they may reduce their expenses on activities that HHS does not consider quality improvement activities in the PPACA MLR formula, such as retrospective utilization review (a review of a patient’s records after the medical treatment has occurred) and increase expenses for activities that qualify, such as prospective utilization review. Another insurer said that they are no longer focusing as much on preauthorization for inpatient admissions because this is not an eligible quality improvement activity in the PPACA MLR formula. This insurer also said the PPACA MLR requirements provide an incentive to spend more money on quality improvement activities, which will affect their decisions on implementing new activities in the future. Conversely, five other insurers told us that the PPACA MLR requirements are not a factor in decisions about their activities to improve health care quality. Insurers we interviewed also varied on how the PPACA MLR requirements may affect where they do business. For example, one large insurer that operates in multiple states said that they have exited the individual market in one state where they did not have a large market share, in part, because of the MLR requirements, and they are evaluating whether to exit this market in other states where it might be difficult to meet the PPACA MLR requirements. One for-profit insurer told us that they plan to exit or stop issuing new business in the individual market in multiple states as well as consolidating some of their insurance companies in some states in which they did not think they would meet PPACA MLR requirements. Several other insurers said that the PPACA MLR requirements will not affect decisions on where they do business. For example, one not-for-profit insurer said that serving the communities where they operate is part of their mission and, therefore, they will not be exiting any markets in the states they serve. Another insurer is considering eliminating some of their high and mid-level deductible plans, but not exiting any markets. We obtained written comments from HHS which are reprinted in appendix I. HHS commented that the PPACA MLR provision will increase transparency in the health insurance marketplace and the value consumers receive for their premium dollar. HHS also provided technical comments, which we incorporated as appropriate. Additionally, we provided a draft of this report to NAIC for comment. NAIC responded that the report was fair, factual, and helpful and provided technical comments, which we incorporated as appropriate. As arranged with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies to the Secretary of Health and Human Services, the Administrator of the Centers for Medicare & Medicaid Services, and appropriate congressional committees. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staffs have any questions about this report, please contact me at (202) 512-7114 or at dickenj@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made key contributions to this report are listed in appendix II. In addition to the contact named above, Gerardine Brennan, Assistant Director; George Bogart; Julianne Flowers; Drew Long; Lisa A. Lusk; Linda McIver; Jessica C. Smith; and Janet L. Sparks made key contributions to this report.

Summary: To help ensure that Americans receive value for their premium dollars, the Patient Protection and Affordable Care Act (PPACA) established minimum "medical loss ratio" (MLR) standards for health insurers. The MLR is a basic financial indicator, traditionally referring to the percentage of premiums spent on medical claims. The PPACA MLR is defined differently from the traditional MLR. Beginning in 2011, insurers must meet minimum MLR requirements or pay rebates to enrollees. While insurers' first set of data subject to the MLR requirements will be for 2011, and is not due until June 2012, insurers prepared preliminary PPACA MLR data for 2010. GAO examined: (1) what can be learned from the traditional MLR data reported by health insurers prior to PPACA; (2) what factors might affect the MLRs that insurers will report under PPACA; and (3) what changes in business practices, if any, have insurers made or planned to make in response to the PPACA MLR requirements. GAO analyzed premiums, claims, and traditional MLR data for nearly all insurers for 2006- 2009 and interviewed a judgmental sample of seven insurers--selected to provide a range based on their size, profit status, and the number of states in which they operated--about their experiences using the PPACA MLR definition. From 2006 through 2009, traditional MLRs on average generally exceeded PPACA MLR standards. This is even without the additional components in the new PPACA MLR that will generally increase MLRs. However, traditional MLRs also varied among insurers. Traditional MLRs within the individual market varied more than those within the small and large group markets, and a larger proportion of individual market insurers generally had lower MLRs. Additionally, traditional MLRs varied more among smaller insurers than among larger insurers in all three markets. Some components of the PPACA MLR requirements may mitigate the implications of some of these variations. The insurers GAO interviewed said their PPACA MLRs will be affected by changes in the MLR formula and their ability to provide more precise data in 2011 and beyond. Most of these insurers reported that the deduction of taxes and fees in the PPACA MLR formula would contribute to the largest change in their 2010 MLRs. Including expenses for activities to improve health care quality was also cited as a factor affecting insurers' MLRs but to a lesser extent. In addition, because insurers had limited time to respond to HHS's interim final rule on PPACA MLRs, which was published in late 2010, they said that their 2010 MLRs were based in part on best estimates. Insurers said they expect their ability to provide more precise PPACA MLR data will improve in 2011 and beyond. Most of the insurers GAO interviewed were reducing brokers' commissions and making adjustments to premiums, as well as making changes to other business practices, in response to the PPACA MLR requirements. Almost all of the insurers said they had decreased or planned to decrease commissions to brokers in an effort to increase their MLRs. Insurers varied on how the PPACA MLR requirements might affect their decisions to implement activities to improve health care quality. While one insurer said that their decision to implement new activities would be affected by whether or not an activity could be included as a quality improvement activity in the PPACA MLR formula, other insurers said that the PPACA MLR requirements are not a factor in such decisions. Insurers also differed on how the PPACA MLR requirement may affect where they do business. One insurer said that they have considered exiting the individual market in some states in which they did not expect to meet the PPACA MLR requirements, while several other insurers said that the PPACA MLR requirements will not affect where they do business. In commenting on a draft of this report, the Department of Health and Human Services (HHS) said that the MLR provision will increase transparency in the insurance market and value for consumers' premiums.