The Mechanics of Commercial HMOs’ Gross Profits: Why MLRs Should Remain Stable


Estimates and share prices for the commercial HMOs imply rising medical loss ratios (MLRs); stable MLRs are more likely, thus the sub-sector appears under-valued


Since 1961, 5 of the 6 MLR peaks and 6 of the 7 MLR troughs were the result of sudden changes in medical costs (price times utilization), rather than changing levels of price competition among insurers


Virtually all of these cost surprises were the result of either or a combination of two factors: 1) large accelerations or decelerations in medical price growth; and/or 2) an accelerating rate of change in employment


Ignoring large (and random) flu effects, MLR peaks and troughs almost never occur without a corresponding inflection in medical inflation or employment. Medical inflation currently is rapid but stable, and employment is more likely to rise (albeit slowly) than to fall rapidly. Viewed in an historic context, no empirically defensible reason exists to anticipate rising MLRs


Rising per-capita utilization at the national level presumably is misinterpreted as a source of rising commercial MLRs. National utilization is rising as a result of employment gains; however employment gains generally reduce per-capita utilization (and thus MLRs) among commercial beneficiaries. Both effects are results of job growth – new employees consume more than the uninsured, but less than ‘legacy’ employees; thus national rates of utilization rise, but commercial rates of utilization fall. New employees consume at about half the rate of ‘legacy’ employees immediately after being hired, and at about 80 percent the ‘legacy’ employee rate toward the end of their first year – but new employees pay the same premiums paid by legacy employees


At current valuations, the commercial HMOs imply any or a combination of: a spike in medical inflation, a spike in unemployment, and/or an inordinately severe flu season. Medical inflation is stable, employment is unlikely to fall very far or very rapidly, and flu severity is a random variable. On balance revenue growth (through enrollment gains and current rates of medical inflation) coupled with stable MLRs (eased by the addition of marginal enrollees with lower health consumption, but capped by MLR ‘floors’) is the far more likely outcome, thus our conclusion that the commercial HMOs are undervalued

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