The Affordable Care Act requires health insurance plans to spend at least 85 percent of their premium income on medical care and no more than 20 percent on "administrative costs"—the portion of insurance premiums that are not spent on medical care.
Here’s one immediate problem: no one knows how to define “administration.” Just as there is no line item in the federal budget called “waste, fraud and abuse,” there is also no line item in any organization’s budget called “administrative costs.” Most of us think we vaguely know what it is. But pinning it down is sort of like trying to nail Jell-O to the wall.
Think about a doctor’s office and ask yourself what goes on there that you would be inclined to call “administration” or “overhead” and what you would call “medical care.” Arguably, the physical facility, the equipment, and the utilities are all overhead. The personnel who admit you and discharge you are engaged in administration, are they not? Ditto for the taking of your medical history and your vitals—and even ascertaining the nature of the complaint that brought you there. In fact, you could make a case that unless someone is actually drawing blood, giving you a shot or ordering a prescription, it’s all overhead.
Looking at it this way, you could argue that about 95 percent of everything that goes on in a doctor’s office is administration and overhead. Conversely, a clever accountant might also be able to argue the reverse—that only 5 percent is really overhead.
Now, let’s think about insurance companies for a moment. Insurers will no doubt see efforts to regulate "administrative costs" as an undesirable constraint. After all, overhead would seem to include sales efforts, efforts to ferret out fraud, and any other nonmedical expense. Sales commissions to insurance brokers who service health policies are also considered overhead. So is the activity of answering the enrollees’ questions about the plan.
It should now be clear that regulating the "medical loss ratio" (the portion of premiums spent on medical care) is not as straightforward as it might have initially sounded. Because "overhead" is highly open to interpretation, this regulation will likely become a source of intense conflict between insurers and regulators. Should anyone be surprised?
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