Final MLR Rule Will Help Health Insurers Avoid Taxes

The U.S. Centers for Medicare and Medicaid Services issued its final rule on the minimum Medical Loss Ratio regulation, including relatively minor technical adjustments and preserving the spirit of the regulation by requiring health plans to spend 80 to 85 percent of premiums on medical costs.

Nevertheless, we believe the changes are modestly positive for the commercial health insurance industry, Susquehanna Financial analyst Chris Rigg wrote in a note to clients.

Under the final rule, insurers' medical loss ratios should come in modestly higher than under the prior rule, all other things being equal. Most notably, plans will be allowed to include a small portion of ICD-10 conversion costs in medical expenses. Broker and insurance agent fees will also still be included in insurer's allowable administrative costs.

The International Statistical Classification of Diseases and Related Health Problems, 10th Revision (known as ICD-10), is a medical classification list for the coding of diseases, signs and symptoms, as maintained by the World Health Organization. The code set allows more than 14,400 different codes and permits the tracking of many new diagnoses.

The final rule allows more costs to be included in the calculation of an insurer's MLR and allows insurers to include ICD-10 conversion costs of up to 0.3 percent of an issuer's earned premium in the relevant state market to be considered quality improvement activities for each of the 2012 and 2013 reporting years.

While this should modestly increase the medical cost ratio (a good thing), we do not believe it will materially impact industry earnings, said Rigg.

UnitedHealth Group Inc. (NYSE:UNH) estimates it will spend $510 million from 2010 to 2015 on ICD-10/HIPAA-5010 compliance costs.

The Health Insurance Portability and Accountability Act (HIPAA) of 1996 protects health insurance coverage for workers and their families when they change or lose their jobs.

How Final MLR Rule Helps Avoiding Taxes

The final rule allows for individuals to avoid taxes on MLR rebates. Under the prior rule, rebates paid directly to group health plan subscribers (individuals) would have been taxable.

Under the final rule, taxation of rebates can be avoided if the group policy holder (typically an employer) uses the rebates to reduce the employee portion of the annual premium (either for all employees or only for employees enrolled during the plan year for which the rebate was calculated).

Importantly, the rebate is used to reduce premiums in the year the rebate is paid and not the year for which the rebate is owed. While a majority of this benefit accrues to the employee, it does reduce the administrative cost burden of paying rebates since under the prior rule rebates were to be paid only to those enrolled in the plan during the year for which the rebate was calculated.

The analyst said the final rule will keep the expatriate plan multiplier adjustment at 2.0 times. There was some uncertainty around this provision and he views the preservation of this multiplier as incrementally positive for the industry, particularly Aetna, Inc. (NYSE:AET) and Cigna Corp. (NYSE:CI) given that expatriate MLRs typically run well below the minimum thresholds.

The final rule will phase down the mini-med plan multiplier. Like expatriate plans, mini-med plans typically run MLRs below the minimum thresholds (mini-med plans offer enrollees limited medical coverage for very low monthly premiums).

Under the prior rule, mini-med plans were to receive an adjustment to their MLR in the form of a 2.0x multiplier. The final regulation phases the multiplier down from 1.75x in 2012 to 1.5x in 2013 and 1.25x in 2014.

We do not expect this change to materially impact industry results given limited financial exposure to these plans. Importantly, under health reform 'mini-med' plans will be banned altogether beginning in 2014, said Rigg.