By AVERY JOHNSON
One of the most critical aspects of the federal health overhaul for insurers is shaping up as a mixed bag for the industry, as regulators issued draft rules Thursday on how the companies must account for how much they spend directly on patients’ medical care.
The overhaul stipulates that insurers’ medical-care spending for individual and small-business health plans must equal at least 80% of the premiums they collect on those plans. For large-company health plans, the spending requirement is at least 85% of the collected premiums.
That will limit how much money insurers have left for administrative expenses and profits. If their medical spending falls below the new thresholds, they will have to pay out rebates.
Just what insurers can count as medical expenses and how they must tally the numbers have been left up to regulators at the National Association of Insurance Commissioners. The regulators hope to finalize the rules at an Oct. 21 meeting in Orlando, Fla., and then the Department of Health and Human Services will have the final say.
The draft rules could change. Still, they give the clearest picture yet of how insurers will have to adjust their business models. Health insurers said late Thursday they needed more time to read the document carefully.
The pivotal issue is the proportion of premiums that insurers spend on medical care, known as the medical-loss ratio. Insurers had hoped regulators would opt for an aggregated ratio that reflected all of a company’s various business units. Instead, the draft rules require insurers to account for MLRs separately at every business unit in every state.
That’s a blow to the industry because MLRs tend to vary widely, even within the same company. At Aetna, for instance, Aetna Life Insurance Co. had a 70% MLR in 2009, while another unit in New Jersey had a ratio of 139%, according to a Goldman Sachs Group analysis confirmed by the insurer.
If companies can’t aggregate their various units’ MLRs, it will be harder for them to avoid rebates at units where they might have below-average MLRs, said Matthew Borsch, a Goldman Sachs analyst.
That could hurt competition, said Bill Hoagland, vice president of public policy at Cigna Corp. “You might find you can’t make the ratio, and you’d drop out,” he said.
“We’re getting pushback [from industry],” said Sandy Praeger, Kansas insurance commissioner and head of NAIC’s health and managed-care committee. “There’s a real concern that they are not going to meet these guidelines, at least not initially.”
But in a potentially positive development for insurers, regulators may allow them to deduct many taxes from total premiums before calculating their MLRs. That would boost the ratios because their medical spending would be weighed against a smaller pool of premiums.
“Our concerns have been heard, but we still have other concerns we hope will be listened to,” said Cigna’s Mr. Hoagland.
Insurers had lobbied to have certain costs, such as anti-fraud and “utilization review” spending, counted as medical expenses, but the draft document doesn’t allow those. It does allow some non-medical costs, such as spending on wellness activities, to count as medical expenses.
“Fraud and abuse prevention was identified as a key goal of health-care reform, but these guidelines will turn back the clock on health-plan programs that are protecting patients from fraud and helping to ensure they receive the right care at the right time,” said Robert Zirkelbach, spokesman for America’s Health Insurance Plans, an industry trade group.
One wild card is companies’ ability to deduct many taxes from their total premiums before making an MLR calculation. Though the draft rules allow for this, the issue heated up this summer when lawmakers including Sen. Max Baucus (D., Mont) and Rep. Henry Waxman (D. Calif.) sent a letter to HHS saying that the overhaul law didn’t intend such deductions.
“If HHS wants to take a more narrow view, they’ll have to do it,” said Ms. Praeger, the Kansas regulator. “We recognize this is still an open issue.”
Some health-insurance companies will have to work harder than others to meet the new medical-care spending requirements. According to a Senate Commerce Committee report from April, UnitedHealth Group Inc.’s MLR in its business selling policies to individuals in 2009 was 71% and Humana Inc.’s was 68%. WellPoint Inc. and Aetna Inc. both had average MLRs of about 75% in the individual health-insurance market that year. Cigna, meanwhile, was well above the new threshold, with an 88% MLR.
Small insurers fear their size will make it harder for them to pare down administrative and marketing expenses. Some smaller companies, including American National Insurance Co. of Texas, have already quit the individual health-insurance market, saying they can’t meet the new spending standards.
Now, as the regulations take shape, other small insurers could follow suit. In addition, larger insurers with small amounts of business in some states could exit those markets. That could leave consumers stranded well before 2014, when new rules will require insurers to accept all applicants and new health-insurance exchanges will be in place. It could also trigger industry consolidation, industry experts say.
The Obama administration argues that the law will promote, rather than weaken, competition. “Many states across the country have implemented medical-loss ratio requirements, and the level of consumer choice has not been affected,” said Jay Angoff, director of HHS’ Office of Consumer Information and Oversight.
At least two states, Maine and Iowa, have asked for a waiver from the rules until 2014 to give health insurers more time to adapt. In a letter sent Tuesday to HHS, Iowa Insurance Commissioner Susan Voss said that, without such an allowance, “federal standards will disrupt our individual health-insurance market.”
Ms. Praeger, the Kansas official, said regulators were limited by what the law will allow them to do. She said the industry’s arguments for a more gradual phase-in of the rules make sense, but that the law stipulates the new rules must go into effect in 2011.
The draft rules respond to insurers’ concerns about competition by allowing insurers with smaller amounts of business an adjustment that will boost their numbers. Indeed, industry watchers said the rules could have been—and may still be—more unfavorable to insurers.
“Insurers can lobby for more, but I don’t think anyone’s got anything to complain about,” said Robert Laszewski, president of health-care consulting firm Health Policy & Strategy Associates.
Write to Avery Johnson at avery.johnson@WSJ.com