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Capped profits reward higher spending
If less than 85 cents of each premium dollar goes to care, the insurer has to give the difference back to the employer. That caps profit at 15%. From the insurer's standpoint, the only way to increase profits is to increase total spending, which is not what anyone wants an insurance company to be incentivized to do.
The cap came with Obamacare, and the second-order consequences were not considered. Capping insurer profits sounds good as a headline.
With the cap in place, growing earnings is hard. Insurers that chased government business now find Medicare and Medicaid losing money. Making operations more efficient, so that 9% of premium doesn't go to admin tasks, grows earnings without delivering a worse product.
How does the 85% rule work?
The Affordable Care Act of 2010 set a minimum medical loss ratio of 85 percent for large-group plans and 80 percent for individual and small-group plans. Insurers must spend at least that share of premiums on medical care and quality improvement. If they fall short, they owe rebates to policyholders. The Kaiser Family Foundation tracks these rebates each year.
What counts as spending on care?
The rule counts payments for claims and also spending on activities that improve quality, such as care coordination programs. Administrative costs, marketing, and profit fall outside it. Insurers can therefore reclassify some activities into the quality category, which has been a subject of regulatory debate. Federal rules set the definitions.
Why does a cap tied to spending matter?
When profit is limited to a percentage of premiums, higher premiums mean a larger absolute profit. Premiums in turn follow the claims the insurer expects to pay. Economists have noted this feature of percentage-based rules for decades. The same logic applies to cost-plus contracts in other industries.
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