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Over at the New Republic, Jon Cohn reports that the Affordable Care Act gives Kathleen Sebelius great latitude in regulating insurers. And Cohn thinks that she is likely to use it.

“It's not impossible,” to regulate private sector insurers, Cohn writes. “Countries like the Netherlands and Switzerland both have adopted this model with considerable success. But it's a difficult task, particularly in a country like ours without the same tradition of strong regulation and enlightened corporate management.

“The architects of the Affordable Care Act understood this and, to the extent they could, they packed the law with regulations designed to force insurers change their behavior. But, by design and necessity,” Cohn notes, “the law was relatively vague on a lot of matters, leaving final determination of the rules to the Secretary of Health and Human Services and her department.”

Let me add that this is what many commentators don’t understand. Because the Accountable Care Act doesn’t spell out exactly how it’s going to pare costs and reduce waste in various areas, opponents claim that the legislation won’t rein in health care spending. But the very vagueness of the law leaves both the Secretary of HHS and Medicare with unprecedented power to reform care without interference from lobbyists.

“The good news,” Cohn observes, “is that Secretary Kathleen Sebelius has recruited some of the country's most respected and seasoned regulators to carry out this task. And, so far, they seem determined to get aggressive with the insurance industry. Very few people outside the world of health care policy seem to have noticed this. But, if you're interested, I have a longer explanation in an article I wrote for the American Prospect, whose 20th anniversary issue includes a special report on health care reform implementation.

“One surprising thing I learned, while reporting, was that insurers seemed to be playing nice--that, notwithstanding the scorched earth strategy they'd pursued during the legislative debate, they'd made their peace with reform and were sending signals of cooperation. But that was earlier in the summer and, just recently, they've started to make noise about regulation of the so-called medical loss ratio.

“Here's the background--again, from my Prospect story:

“‘The Affordable Care Act sets a minimum threshold for what's known as the ‘medical loss ratio’-- the percentage of premium dollars that go into medical care (a ‘loss’ from Wall Street's view) rather than into overhead or profits. For plans sold to small businesses or directly to individuals, that ratio must be at least 80 percent; for plans sold to large groups, it must be at least 85 percent,’” Cohn explains.

This means that, beginning in 2011, health plans that don’t spend 80% of premiums on medical care when covering small groups (or 85% when covering large groups) will be required to return the difference between the minimums and actual spending to sponsors and consumers. According to Carl McDonald, a Wall Street analyst at Oppenheimer who follows insurers, if  the new law had been on the books in 2009, the six largest for-profit health insurance companies would have been required to refund $1.9 billion in that year alone for spending too much on profits, CEO pay and administration. In other words, if Sebelius enforces this provision in the ACA, it has the potential to save billions over ten years; see the table below. (Thanks to Health Care for America Now for calling attention to McDonald’s calculations—mm.)  

“For big insurance companies that sell predominantly to big employers, the medical loss ratio shouldn't be hard to meet,” Cohn continues. “With their economies of scale, these insurers and employers together provide coverage at relatively low administrative cost (although, it should be noted, Medicare's overhead is even lower). But smaller insurers that deal primarily with individuals or small businesses will have a tougher time. Among other things, they typically lose 8 percent of premiums on commissions to agents and brokers who sell policies on their behalf. (Once the insurance exchanges exist, much of that cost will disappear.) These are also the insurers most likely to bilk consumers, since individuals buying coverage on their own typically lack the knowledge -- or ability -- to bargain as shrewdly as corporate benefits managers do. (The exchanges should also help with improved information and bargaining leverage.)”

This is why I continue to predict that many insurers that now sell in the individual market may well go out of business. (Or, go into a different business. Some may decide to sell supplementary insurance that covers “extras” including cosmetic surgery for aging boomers. ) As Cohn indicates, too often these insurers rely on “bilking consumers” to make a profit, and many are not large enough to use economies of scale to keep administrative costs down. By contrast, a public option that competed with private insurers has the size to enjoy lower administrative costs, and if it followed Medicare reform by shifting away from fee-for-service payments, it might well be able to offer better coverage at a lower price. This is why I think that, in the end, we may well wind up with a public option as part of the mix.

“There's leeway in the rule in two key places,” Cohn adds. “The law doesn't dictate a precise formula for calculating the medical-loss ratio. It's up to the administration which ‘care management’ activities count as medical care, whether taxes should be part of the calculation, and the extent to which carriers can average out the ratio among different plans. . .

Cohn concludes: “The Affordable Care Act stipulates that the HHS Secretary consider the commissioners' recommendations when writing regulations. But it doesn't say she has to follow it. If indeed the commissioners recommend scaling back the regulation, it will be interesting to see whether Sebelius goes along.”

Read More: http://www.healthbeatblog.com/2010/08/on-regulating-insurers-.html