What Next for the MLR Cycle?

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We’re convinced MLRs remain stable through 2012 and potentially 2013, though we see significant risks of price competition in 2014. Consensus calls for rising MLRs into 2012 and 2013; we think this is premature, so we expect further outperformance from health insurers relative to both the SP500 and the rest of healthcare

The MLR cycle is far more cooperative than competitive; underwriting profits change more as a result of trend reversals in per beneficiary claims cost than as a result of price competition among underwriters

2nd-derivative changes to employment or medical prices are the main causes of MLR peaks and troughs; in the immediate term employment is more likely to improve than worsen, and medical prices generally are decelerating – both of which augur an improving MLR trend

MLR floors are in effect a predictable underwriting cost. Under the theory of cooperative pricing insurers should consistently price to a modest expected rebate, which so far is consistent with results. MLR floors encourage higher (pre-rebate) premiums and a smoother MLR cycle, since insurers must more carefully avoid losses

As 2014 approaches, hospitals’ pricing power grows, as the marginal enrollee in 2014 is far more likely to recognize a hospital brand name than an insurer brand name, suggesting enrollment has much to do with the hospitals a plan includes in-network. We expect this hospital pricing effect to hit in 2014, but acknowledge it could reach back to 2013, and this is the primary risk to our call that MLRs remain stable in both 2012 and 2013

We’re less concerned with Blues’ reserves, believing the plans need large reserves ahead of an expected enrollment expansion in 2014. Factoring in potential enrollment gains, Non-profit Blues’ ‘true’ reserves are about 8 percent lower than they appear. And, when we factor in the much less predictable nature of the marginal enrollee – which compels a higher reserve – Blues’ capital levels seem even less remarkable

To our minds the key risk to the underwriting cycle comes in 2014; the one-time nature of this large enrollment expansion presumably will lead insurers to prioritize enrollment gains over short-term MLRs, though we admit this type of price competition has not been seen in other one-time expansions (managed Medicare in 1994 or Medicare Part D in 2006)

Beyond 2014, we see spiraling per beneficiary costs on the exchanges as a result of adverse selection. Premiums should be able to stay ahead of the costs, though the exponential nature of the cost trend amplifies actuaries’ forecasting errors, which will tend to raise MLRs. Most important, adverse selection is unsustainable, forcing a change in the rules of the Health Insurance Exchanges (HIEs). What these rules might be and how they might affect insurers is practically impossible to predict; presumably risks are to the downside

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