Credibility adjustment factors and medical loss ratios

New research commissioned by the National Association of Insurance Commissioners (NAIC) looks at credibility adjustment factors for use in medical loss ratio (MLR) refund calculations. Here is some background on why this is important:

Section 1001 of PPACA includes §2718(c), which directs the NAIC to establish uniform definitions and standardized methodologies for calculating measures of MLRs to be used in the determination of refunds in those situations in which a health insurance carrier’s MLR is less than the threshold required by PPACA.  It further requires that such methodologies “take into account the special circumstances of smaller plans, different types of plans, and newer plans.”  These considerations have introduced the need to address the normal statistical fluctuations that occur in the claims experience of health insurers.  Such fluctuations tend to be greater for smaller plans and newer plans and vary for different types of plans.  In order to adjust for these normal statistical fluctuations, the NAIC and HHS are considering introducing credibility adjustments based upon the size of an insurer’s business that is subject to the MLR requirements of PPACA (similar to what is done for refund calculations for Medicare Supplement business). 

The calculation periods specified by §2718 appear to be based on annual experience up until January 1, 2014, at which time the refund formula is to be based on the average MLR for the previous three years for the plan.  This variation in calculation methodology may produce different patterns of statistical fluctuation that could be addressed through the use of these credibility adjustment factors and the accumulated membership exposure, although such application for multiple years may not capture all statistical variation due to changing characteristics of insureds from one year to the next.

We understand that the NAIC has not finalized its decision on how many different sets of credibility adjustment factors it will use to address its charge to take the circumstances of different plans into account and the differences in the calculation periods specified by the law.  The results of our analyses presented in this report provide sets of credibility adjustment factors that may be more or less detailed than what the NAIC will ultimately recommend to HHS.