Understanding Medical Cost Ratio (MCR): A Key Health Insurance Metric

Medical cost ratio (MCR), commonly known as medical loss ratio or medical benefit ratio, compares a health insurance company’s healthcare-related costs to its revenue premium. The ratio is frequently used to determine the financial strength of an insurance companyLife and Health InsurersLife and health (L&H) insurers are companies that provide coverage on the risk of loss of life and medical expenses incurred from illness or injuries. The customer - the purchaser of the insurance policy - pays an insurance premium for the coverage., as it informs the percentage of revenue that goes towards medical claims.

Every insurer must use the same method to calculate MCR. Every year an insurer calculates MCR and must file reports with the U.S. Department of Health and Human Services.

Summary

• Medical cost ratio (MCR) compares an insurance company’s healthcare cost to its revenue generated through premiums.
• The ideal MCR for a large group is 85% and 80% for a small group.
• Under the Affordable Care Act (ACA), an insurance company must assign 80% of their premium to activities that develop the healthcare sector. If the insurance company fails to allocate 80% of its premiums, rebates must be paid to the policyholders.

Medical Cost Ratio Formula

The medical cost ratio is calculated as follows:

Understanding Medical Cost Ratios

A health insurance company collects premiums from its customers every month and a portion of the premium may be paid by their employer based on the terms of their employment contract. Hence, individuals that receive their health insurance through their employers are divided into subgroups called large and small groups. According to the federal government, a small group is a company with 1-50 employees and a large group comprises more than 50 employees.

Once an insurance company collects the premium from its customers the premium is retained until a medical claim is filled. The claim can range from doctor visitation to treating a range of illnesses.

The ideal MCR should be 85% for large groups and 80% for small and individual groups. An 85% ratio means for every $1, the insurance company makes a $0.15 profit, and $0.85 is used to treat the individual that raised the claim. The $0.15 profit can be used to cover costs and reinvest back into the business.

The Affordable Care Act (ACA) and Medical Cost Ratios

Under the Affordable Care Act (ACA)Affordable Care Act (ACA)The Affordable Care Act (ACA), also known as Obamacare, is a healthcare reform that includes a list of provisions that open opportunities for Americans to, an insurance company must allocate 80% of their premium to the development of health quality and clinical services in order to improve the quality and value provided to the insured individual.

If an insurer does not allocate 80% of their premium to improve the value and quality of health care, the insurer will need to refund additional funds to the customer. For example: In 2012, 21.5 million refunds were given out in the U.S.

MCR Formula under the Affordable Care Act

• Claims are the payments made by insurance companies to policyholders for the cost of medical care and prescription drugs.

• Quality improvement expenses are determined based on the overall improvement in patient safety or patient outcome, patient wellness, prevention of hospital readmission, or improvement in informational technology employed in hospitals to enhance reporting, transparency, and excellence.

On the other hand, fraud prevention activities, and insurance broker and agent compensation fees are considered an administrative expense under the Affordable Care Act MCR.

• Premium is the revenue earned by an insurance company from the monthly payments of their policy
• Taxes, licensing, and regulatory fees include federal, state, and local taxes on the revenue earned by the insurance company. Taxes on capital gainsCapital GainA capital gain is an increase in the value of an asset or investment resulting from the price appreciation of the asset or investment. In other words, the gain occurs when the current or sale price of an asset or investment exceeds its purchase price. and investment income are not included. Not-for-profit insurance companies are subject to either state premium taxes or community benefit expenditures, whichever is higher.

More Resources

CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™Program Page - CBCAGet CFI's CBCA™ certification and become a Commercial Banking & Credit Analyst. Enroll and advance your career with our certification programs and courses. certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

• Actuarial Life TableActuarial Life TableAn actuarial life table is a table that displays the probability that a person of specific age will die before their next birthday. The tables are in
• HMO vs. PPO: Which is Better?HMO vs PPO: Which is Better?Getting the best healthcare often requires choosing between an HMO vs PPO. You need to be able to make an informed decision on which plan will work best.
• Mutual Insurance CompanyMutual Insurance CompanyA mutual insurance company is a privately-held insurance company that is 100% owned by its policyholders. These companies are established with the sole
• Variable Life InsuranceVariable Life InsuranceVariable life insurance is a form of life insurance that combines the characteristics of life insurance and investment. Characteristics: policy loans