A Guide to Monitoring Medicaid Managed Care
Chapter 7: 
Financial Data

The number of managed care plans participating in Medicaid fluctuated during the 1990s. A number of managed care plans left the Medicaid market in the late 1990s as their profits diminished. Some became insolvent. In contrast, earlier in the decade commercial plans were eager to enter the Medicaid market and sometimes used Medicaid as their entrée into a state. Newspaper accounts told of the excessive profits that some plans (and some unscrupulous managed care plan owners) received. 

In this ever-changing market, advocates can use financial data to better understand how managed care dollars are used. Among the questions an examination of financial data may answer are the following:

• Are my state's Medicaid managed care capitation rates adequate to pay for health services and to promote access to providers? 
• Are Medicaid managed care plans likely to leave the market due to poor financial performance? 
• How do costs associated with Medicaid managed care compare with costs associated with fee-for-service Medicaid? 
• What proportion of Medicaid payments to managed care plans are used for administrative expenses and profits? 
• What percentage of the Medicaid dollars go to patient care?

Financial Requirements for Medicaid Managed Care Organizations

Federal regulations require states to obtain proof that Medicaid managed care organizations have "adequate protections against the risk of insolvency." If plans do become insolvent, they must ensure that Medicaid enrollees will not be liable for the plans' debts or for payment for medical care that was covered under the plan. 1

Under federal law, most Medicaid managed care organizations that are at-risk for hospital care must meet state solvency standards that apply to private managed care organizations. 2

State solvency standards vary a great deal. States may require plans to maintain net worth above a certain dollar amount (e.g., $1 million) or net worth exceeding two or three months of "uncovered" health care expenditures. Uncovered expenditures are expenses that must be paid by the health plan, such as emergency care at a non-network hospital, and that are not furnished by health plan contractors. States typically require plans to maintain reserves of a certain fixed dollar value or of a certain amount per enrollee. 3

In addition, states may specify additional financial requirements for Medicaid managed care organizations through their contracts. A Nationwide Study of Medicaid Managed Care Contracts, Table 6.1, summarizes states' contractual requirements regarding licensure, capitalization, reserves, and reinsurance. That Table also lists the few states that have limited Medicaid managed care organizations' allowable administrative costs and/or profits. 4

Obtaining Data on Managed Care Organizations' Finances

Since most Medicaid agencies do not have the expertise to monitor finances, they often rely on state insurance commissioners to provide information about the solvency of licensed plans. These plans are subject to financial and reporting requirements under state law and state insurance commissioners are usually responsible for monitoring their financial condition. Most states require licensed health insurance plans to report annually and quarterly on their financial performance using forms developed by the National Association of Insurance Commissioners (NAIC). 5 To find out the specific reporting requirements in your state and obtain copies of the filings, contact your state insurance commissioner. File a freedom of information act request if necessary.

The NAIC "Annual Statement" contains report forms that gather information about licensed plans' assets, liabilities, revenue, expenses, net worth, cash flows, enrollment and utilization, and reinsurance. In some of the reports, information about plan income, member enrollment and utilization is available by "lines of business" (e.g., Medicaid, Medicare, commercial) while in other reports financial information is consolidated from the various lines of business to give an overall picture of the financial health of the plan.

Some Medicaid managed care organizations, however, are not licensed. Some states do not require licensure of plans that serve only Medicaid beneficiaries and not commercial enrollees, or plans that are only at-risk for some services. For these unlicensed entities, Medicaid agencies may be directly responsible for monitoring solvency (Medicaid agencies may still get help from the state insurance commissioners). Medicaid agencies typically require managed care contractors to file quarterly financial statements and annual audited financial reports. Both the federal Department of Health and Human Services and state Medicaid agencies have a right to audit the books of contracting managed care organizations. 6

Examining the Overall Financial Status of Medicaid Managed Care Organizations

You can examine managed care organizations' financial statements, talk with your insurance commissioner and Medicaid agency about whether managed care organizations continue to meet state solvency requirements, and interview managed care organizations about their profitability. In the financial statements, look at trends in key financial data over time. This chapter explains how to calculate profit margins, operating margins, medical loss ratios, and administrative expenses from the reports managed care organizations file with insurance commissioners. The measures described in this chapter provide a rough summary of Medicaid managed care plans' finances. Many additional financial performance indicators are often calculated by industry analysts and can provide more detail.7

The calculations in the following sections refer to Report #2 in the NAIC Annual Statement for HMOs (known as the Orange Book), "Statement of Revenue, Expenses, and Net Worth." See Example Plan in Chapter 7 Appendix.

Calculating Overall Profit Margins and Operating Margins

Profit margins and operating margins, two measures of financial viability, both compare the amount of income that a managed care organization retains after expenses with the managed care organization's revenues. The measures differ in that profit margins reflect income from all sources, including investments. Operating margins exclude investment income and non-health care-related revenue from the calculation.

a. Profit margins are the ratio of income to expenditures

To calculate profit margins as a percent of total revenues, divide income before taxes (line 24, report #2) by total revenue (line 7, report #2). Multiply this figure by 100 to express as a percentage.

Plan profit as a percent of total revenues = 
Income before taxes (Line 24) ÷ Total revenue (Line 7) 
To express as a percentage, multiply by 100.

EXAMPLE

-2,014,246 ÷  40,895,856 = -.049
 -.049 x 100 = -4.9%

During this year, the Example Plan lost money, and its 
profit margin was -4.9 percent.

Some for-profit plans complain that the use of pre-tax income from line 24 (income before taxes) creates an unfair comparison, since the for-profit plans pay taxes and the nonprofits do not. The for-profit plans point out that the taxes are not kept by the plans as profits. Advocates respond that the use of the pre-tax figure more accurately shows what these plans could return to the community or put into services if they were nonprofits. To develop profit ratios after taxes for a plan, substitute net income, line 27, for income before taxes in the numerator of the equation.

b. Operating margins are the ratio of operating income to insurance revenues

To calculate operating income, subtract medical and administrative expenses (total expenses, line 23, report #2) from insurance revenues (the sum of premium, fee-for-service, risk revenue, and aggregate write-ins for other health care related revenues-lines 1, 2, 3, and 5 on report #2). 

Divide this figure by the insurance revenues (sum of lines 1, 2, 3, and 5 on report #2) to get the operating margin ratio. 

If the ratio is a negative number, the plan is losing money before counting investment income and expenses. (The plan may still be making money overall after counting income or revenues from other sources.) For example, a value of -.02 means that on every dollar of insurance revenue, the plan is losing 2 cents.

EXAMPLE

Operating income = (line 1 + line 2 + line 3 + line 5) -
 line 23 = 
(40,698,616 + 0 + 0 + 0) - 42,910,101 = -2,211,485

Operating income / Insurance revenues = Operating margin 
-2,211,485 ÷ 40,698,616 = -.054 
To express as a percentage, multiply by 100. 
-.054 x 100 = -5.4%

Example Plan is losing 5 cents on every dollar 
of insurance revenues.

A national study examined operating margins of health plans that did and did not participate in the Medicaid program from 1992 to 1996. Data showed decline in financial performance for commercial plans participating in the Medicaid market. The declines after 1994 were the most dramatic for those with many Medicaid members. 8

Determining the Amount of Managed Care Payments That Go To Patient Care

Two calculations-medical loss ratio and plan administrative expenses-will help you examine the amount of a plan's revenue that goes to patient care. The calculations are described below.

a. What is a medical loss ratio?

"Medical loss ratio" is insurance-eze for the percentage of premium dollars spent on the provision of health care services. From the point of view of a managed care organization, especially an investor-owned corporation, which has to satisfy investors, the dollars spent on health services are a "loss." From the standpoint of consumers and the public interest, the medical loss ratio is more properly called the "care share."  9  Investors may want insurers to spend less on care in order to maximize company profits, but to the extent that health care is reasonably priced and medically necessary, people who pay the medical premiums (consumers, employers, and government agencies) seek to maximize their "care share."

For the purpose of calculating medical loss ratios, health care expenses are distinguished from profit and from administrative costs such as marketing. Health care expenses include physician services, outside referrals to physicians, emergency room and out-of-area services, and the costs associated with inpatient or outpatient care.

b. Calculating a plan's medical loss ratio

Medical loss ratio = Total medical and hospital expenses 
(Line 21) ÷ Total premium and health care revenues earned
 (Line 7 minus Lines 4 and 6) 
To express as a percentage, multiply by 100.

EXAMPLE

Medical loss ratio = 
(29,458,194 ? 40,698,616) x 100 = 72%

The medical loss ratio or care share for the Example Plan is
 72 percent. This means that the plan spends 72 cents of every
 revenue dollar on patient care.

Medical loss ratios are very rough measures of how much a plan spends on patient care. These ratios are a simple tool to alert consumers to plans that may be spending too little on patient care. They can also alert the public or insurance regulators to plans that are left with little or no revenue after paying for patient care, and which may therefore become insolvent. As a rule of thumb, medical loss ratios below 75 percent or above 90 percent should be examined further. 10

Advocates in Massachusetts used differences in medical loss ratios as the basis for testimony before the state legislature advocating for a moratorium on licensing additional for-profit HMOs. 11

c. What is the administrative loss ratio?

The administrative loss ratio is the percentage of premium dollars spent on administrative costs. Some administrative expenses are good for consumers. Quality assurance programs, for example, are administrative expenses that directly improve the quality of care for consumers. Other administrative costs, such as glossy advertising or high salaries for executives, add to health care costs without providing benefits to consumers. Although a number of variables will influence administrative costs, as a general rule of thumb, consumers should question administrative loss ratios greater than 16 percent. 12

d. Calculating administrative loss ratios

Administrative expenses as a percent of total revenues =
 Administrative expenses (line 22) ÷Total revenue (Line 7)
 To express as a percentage, multiply by 100.

EXAMPLE

(13,451,907 ? 40,895,856) x 100 = 32.9%

During this year, the Example Plan spent 32.9 percent
 of its revenue on administrative expenses.

e. Comparing your plans with the average

One key question is how your plan loss ratios compare to the average for similar plans. The weighted average allows you to take into account the different sizes of the plans' membership. The following example calculates a weighted average medical loss ratio. You can compute a weighted average administrative loss ratio by substituting reported administrative loss ratios in column 2.

Take a look at Plan A and Plan B below. Plan A has nearly twice as many members as Plan B. The average member of Plan A receives 72 cents of medical care for every dollar spent. Plan B members receive 16 cents more in medical care per dollar spent than do the Plan A members. To look at the impact on the average individual in the combined plans, you must count all five million people at 72 cents on a dollar and all 2.7 million at 88 cents per dollar. This means multiplying the number of people in each plan by their respective ratios first in order to get a fair average of all the individuals.

Sample Calculations for Medical Loss Ratios

To calculate the unweighted average:

1) Total the medical loss ratios in Column 2.

2) Divide the total medical loss ratio by the number of plans-4.23 ? 5 = 0.85

The unweighted average medical loss ratio is .85

To calculate the weighted average:

1) Total the enrollments for each plan in column 3-16,100,000

2) Multiply each plan's medical loss ratio by each plan's total enrollment-Column 2 X Column 3. The results are shown in Column 4, rows A through E.

3) Total Column 4-13,192,000 The result is shown in Column 4 in the Totals row.

4) Divide the total of Column 4 (13,192,00) by the total of Column 3 (16,100,000)-

13,192,000 ? 16,100,000 = 0.82

The weighted average medical loss ratio is .82.

Note: In this example, the weighted medical loss ratio average was lower than the unweighted average because the bigger plans have lower medical loss ratios than the smaller plans.

Why is the weighted average important? You will note that the medical loss ratio in Plan D is exactly average if you look at the weighted average. However, if you just compared it with the unweighted average, Plan D would appear below average. Weighted averages give a more accurate picture of how your plan compares to the average.

f. What are the problems with interpreting medical loss ratios and administrative loss ratios?

Administrative expenses are influenced by the following factors: type of managed care arrangement, accounting methods, size of membership, administrative requirements, and allocation of revenue and expenses among payors and across states. These factors confound plan comparisons of medical and administrative loss ratios. Comparing plans that have very different amounts of revenue may also be problematic. 

The type of managed care arrangement has a bearing on the administrative tasks that must be performed centrally. Administrative expenses will be high and medical loss ratios low among managed care plans that directly contract with physicians and perform utilization management and quality assurance functions. On the other hand, plans that contract with medical groups and delegate to them responsibilities for utilization management and quality assurance will have lower administrative expenses and higher medical loss ratios.

The National Association of Insurance Commissioners (NAIC) has issued guidelines that seek to standardize accounting methods and definitions such as "administrative expenses." However, plans differ widely in the extent to which they follow these guidelines.13  Some plans may consider utilization review costs as medical costs, whereas others treat them as administrative costs. One study found that such differences in accounting practices altered medical loss ratios by up to 5 percent among a sample of HMOs. 14

Plans with small memberships are less able to achieve economies of scale and may, consequently, show lower medical loss ratios and higher administrative expenses than large plans. (For example, larger HMOs can buy large quantities of supplies at discounted rates). 15  In addition, smaller plans tend to be newer plans, and often it takes time to develop efficient internal administrative processes. 

Differing administrative requirements are also associated with different service groups. One might expect higher marketing expenses among plans that must attract large numbers of individuals or small firms than among plans drawing their membership from large employers. 16 Administrative expenses for Medicaid managed care organizations also include the cost of administering EPSDT benefits and demonstrating compliance with Medicaid laws. 

Plans that operate across state lines may vary in the way they apportion their administrative expenses to each state. Similarly, plans may vary in the proportion of administrative costs that they allocate to the Medicaid program versus private payors. 

Because both "medical loss" and "administrative expense" are ratios, advocates should be cautious about interpreting results for plans with very different amounts of revenue. Differences in medical loss ratios may be due either to differences in medical expenditures (the numerator or upper number in the ratio) or to differences in revenue (the denominator or lower number in the ratio). For example, two plans with exactly the same number of enrollees and exactly the same medical expense will have different medical loss ratios if one has lower revenue; and in two plans that spend the same amount per enrollee on administration, the plan with the lower revenues will have the higher administrative loss ratio. 

For all the above reasons, medical loss ratios and administrative loss ratios should not be used in isolation. These measures serve the public by revealing plans with unusually low or high ratios and encouraging state agencies to investigate these plans. Along with other financial indicators (such as operating income), medical loss ratios and administrative loss ratios help to describe how a plan is spending its money and whether it is financially viable. 

Medical loss ratios and administrative loss ratios do not measure the quality of the care that a managed care organization provides. Advocates might turn to information from actuaries, information from other managed care plans, or information about prior fee-for-service expenditures (adjusted for trends in health care costs and differences in the covered population) to help determine whether the amounts that a plan spends on medical care per enrollee are appropriate. Financial data should be used in conjunction with more direct quality measures, such as patient satisfaction surveys and clinical performance measures, to determine whether plans are devoting adequate resources to patient care.

Examining State Medicaid Managed Care Capitation Rates

If you find that Medicaid managed care organizations in your state appear to be having financial problems or, conversely, that their profit and operating margins are very high, you may want to advocate a change in the rates that your state pays to Medicaid managed care plans. An Urban Institute publication, Medicaid Managed Care Payment Methods and Capitation Rates: Results of a National Survey,  contains helpful information about how states have set their managed care payment rates and how those rates vary nationally. 17 The study found an almost twofold variation in payment rates for relatively similar populations. Some of this variation is due to differences in managed care penetration, state cost-savings goals, geographic differences in price, and fee-for-service Medicaid experience. As policymakers look for ways to alter their payment rates, they might consider the following:

• How do rates in one state compare with those in neighboring states? 
• How would regulation of administrative expense affect managed care organizations? 
• Are rates now set by the state through administrative pricing, or are they determined by negotiation or competitive bidding? What effect would a change in pricing method have? 
• Should payments be adjusted based on the health status of enrollees? Should payments reflect adjustments for Federally Qualified Health Centers that serve the uninsured as well as Medicaid enrollees? 
• Should some services that are now covered in the managed care contract instead be carved-out? 
• Should the state or managed care organizations have different risk-sharing and reinsurance provisions? (That is, should the state do more to protect the plan in the event of unusually high claims?)

Examining The Total Cost Of Managed Care

Sometimes, advocates wish to compare the costs of managed care with other health care delivery systems (fee-for-service or primary care case management). The money paid to managed care organizations is only one part of total managed care program expenditures. The state's costs to administer and oversee managed care and the costs of outreach and enrollment, often paid to an enrollment broker, must be factored in to the overall expense of Medicaid managed care. In addition, advocates need to take into account the costs of any services provided outside of managed care, any changes in services provided, and any difference in population covered. This other cost data may be reflected in independent evaluations of a managed care program established under a Section 1915(b) waiver; in evaluations of Section 1115 waiver programs commissioned by HCFA; in state Medicaid budget and expenditure reports; and in contracts between the state and its managed care and enrollment contractors. Unfortunately, in many states, data on fee-for-service expenditures and utilization are inadequate. States report Medicaid expenditures by type of service to HCFA on HCFA 2082 and HCFA 64 forms. To these figures, advocates will need to add administrative costs and projections regarding changes in spending and utilization that would have occurred absent managed care.

Endnotes

1 42 CFR § 434.50 and 42 CFR § 434.20.

2   Social Security Act § 1903 (m) (1). Exempted from this requirement are managed care organizations that do not provide both inpatient and physician care, that are public entities, whose solvency is guaranteed by the state, and that are controlled by Federally Qualified Health Centers (FQHCs).

3   National Association of Insurance Commissioners, Compendium of State Laws on Insurance Topics (Kansas City, MO: National Association of Insurance Commissioners, 1999).

4  As of 1999, California, Hawaii, Maine, Missouri, New Jersey, and Rhode Island have limited administrative costs in their Medicaid managed care contracts. Massachusetts, Pennsylvania and Utah have limited administrative costs for behavioral health plans. Arizona, Missouri, New Jersey, Pennsylvania and Vermont have limited managed care plans' profits. Montana and Vermont limit profits for behavioral health plans. S. Rosenbaum, et al., Negotiating the New Health System: A Nationwide Study of Medicaid Managed Care Contracts, Third Edition (Washington, DC: George Washington University Center for Health Services Research and Policy, 1999), p. 6-14 et. seq.

5  See  a list of state filing requirements, and Health Maintenance Organization Annual Statements (Philadelphia, PA: Global Financial Press, 1999) for report forms.

6   Social Security Act § 1903(m)(1).

7 Other financial performance indicators include the following:

• Net income or loss tells the amount of revenue after expenses and should be greater than zero. 
• Overall loss ratio shows the extent to which revenues from premiums (including Medicaid, fee-for-service, Medicare, and other premiums) cover expenses. In a financially sound managed care organization, the expenses/total premium revenue should be less than 100 percent. 
• Current ratio is the amount of current plan assets divided by current liabilities.
• Days cash on hand is the number of days the health plan is able to cover operating expenses with its current available cash.
• Days in receivables shows the number of days of revenue that members (or the government) owes the health plan in premiums. If more than 30 days of revenue are owed the plan and/or if the current ratio is low, the plan may be unable to meet its short-term obligations.

8  Michael McCue, Robert Hurley, Debra Draper, and Michael Jurgensen, "Reversal of Fortune: Commercial HMOs in the Medicaid Market," Health Affairs 18, no. 1 (January/February, 1999): 223-229.

9   Alan Sager of the Boston University's School of Public Health suggests use of the term "care share" to refer to the percentage of the health insurer's total revenue or premium revenue that is spent on health care.

10  Medical-loss ratios typically range from 71 percent to 96 percent, with an average around 87 percent. Insurance commissioners question loss ratios lower than 75 percent or higher than 90 percent. Standard and Poor's Managed Health Care Reporter, 17 (1997) as cited in L. Rivera, P. Lee, K. Olson, and B. Harris, Making Sense of Managed Care Quality Information (Los Angeles, CA: National Health Law Program and Center for Health Care Rights, 1998) p.8.6., and information from Julia Philips, Life and Health Actuary, Minnesota Department of Commerce, June 2000.

11   The Access and Affordability Monitoring Project at Boston University's School of Public Health, testimony before the Joint Committee on Health Care (March 11, 1997). For more information, contact Deborah Socolar and Alan Sager at 617-638-5042.

12  National Committee for Quality Assurance (NCQA) recommended administrative loss ratios of less than 16 percent in HEDIS® 3.0, 1997. NCQA plans to retire its financial stability indicators in 2001. A few states require administrative expenses of 15 percent or less in their Medicaid managed care contracts. See footnote 4 for a list of states with administrative loss ratio limits.

13   J.C. Robinson, "Use and Abuse of the Medical Loss Ratio to Measure Health Plan Performance," Health Affairs 16, no. 4 (July/August, 1997): 176-177.

14  N. Turnbull, and N. Kane, "The Impact of Accounting and Actuarial Practice Differences on Medical Loss Ratios: An Exploratory Study of Five HMOs," Inquiry 36, no. 3 (Fall 1999): 343-352.

15   5 D. Wholey, R. Feldman, J.B. Christianson, and J. Engberg, "Scale and Scope Economies Among Health Maintenance Organizations," Journal of Health Economics 15 (1996): 657-684.

16  Robinson, supra, p.180.

17  J. Holahan, S. Rangarajan, and M. Schirmer, Medicaid Managed Care Payment Methods and Capitation Rates: Results of a National Survey (Washington, DC: Urban Institute, 1999).