I was pleasantly surprised to open a letter from my health insurer only to discover a check made out to me, for $113. Apparently BlueCross’s Medical Loss Ratio (MLR) was too high, according to the Affordable Care Act, and so the government was forcing BlueCross to mail me a partial refund.

I will not be depositing this check, as it is BlueCross’s money that the government is forcing them to send me at gunpoint. (Even here, it appears BlueCross may have to ultimately credit my account anyway, but I can at least make a symbolic protest.) Although the provision is undoubtedly a great political stroke—most Americans will love Obama for getting them some of “their” money back from the big insurance companies—it will have unintended consequences. Meddling from Washington will only lead to higher insurance premiums and worse service.

Here is how my letter from BlueCross explained the check they had sent me:

This letter is to inform you that you will receive a rebate of a portion of your health insurance premiums. … The Affordable Care Act requires BlueCross … to issue a rebate to you if BlueCross … does not spend at least 80 percent of the premiums it receives on health care services, such as doctors and hospital bills, and activities to improve health care quality, such as efforts to improve patient safety. No more than 20 percent of premiums may be spent on administrative costs such as salaries, sales and advertising.


As I said, this is a brilliant move politically. The average American, understandably upset with the upward march in health insurance premiums, will view this as a commonsense blow against greedy companies. Yet anyone conversant with basic economics can see the potential for massive backfiring.

In the first place, there is competition in the health insurance market. It’s true, there are massive government interventions that distort the outcome, hardly rendering it a “free market.” Even so, consumers still do have (limited) choices among health insurers, and if one of them is charging premiums far above what is necessary to do business, it leaves an opportunity for rivals to slightly undercut them, and gain market share. To assume that health insurers can “charge whatever they want” is naïve, and reflects a lack of understanding regarding how markets work.

Given this, what will be the likely consequence of the Medical Loss Ratio requirement of the new health care legislation? Note well, the legislation doesn’t require companies to stay in business, and it doesn’t set specific values for the level of premiums that can be charged for a certain type of coverage. (Or at least, the Medical Loss Ratio clause doesn’t establish this. I personally don’t claim to know what’s in the entire 906 page behemoth, but my understanding is that it doesn’t set actual price controls for every type of potential policy.)

Instead of limiting premiums, then, the MLR clause merely caps what percentage of premiums can be spent on administrative expenses. Suppose then that a company takes in $100 million in premiums, and—before ObamaCare—would have picked the profit-maximizing level of administrative spending of $21 million. Now the federal government comes along and says that this percentage is too high. What will the company do in response?

Most people seem to think the company will simply slash administrative expenses by $1 million. By why would we assume that? After all, the law will also be satisfied if the company raises premiums by $5 million, so that its current administrative spending of $21 million ends up being 20 percent of total premiums. Faced with these two alternatives of complying with the regulations—either cutting executive salaries and other administrative expenses by $1 million, or jacking up premiums by $5 million—why would the person who hates insurance companies think the former is the likely outcome?

Don’t misunderstand, I am not claiming that all insurance companies will simply raise premiums to become compliant. In reality, the new market outcome will likely be some combination of the two approaches, i.e. a reduction in administrative spending and an increase in premiums, for those companies that aren’t currently compliant. My point is simply to underscore that there is a gaping loophole in the Medical Loss Ratio requirement, and a loophole that should be very ominous to precisely the people who will presumably cheer when they get their partial refund checks.

In case the health insurance industry is too complicated, consider a simpler analogy: Suppose the Obama Administration passed the “Affordable Snacking Act,” and required movie theaters to limit the price of a large popcorn to only 25% of the price for an adult matinee ticket. Does anyone really think the outcome of this would be merely a massive reduction in popcorn prices across the country? Or, is it more likely that theaters would do a combination of the following? (a) Reduce popcorn prices, (b) slightly increase ticket prices, (c) cut back on expenses at the snack counter, by laying off workers (leading to longer snack lines) and reducing the size of a “large popcorn,” in order to compensate for the loss in profitability of that portion of the business.

The same holds in health care insurance. In reality, there is a whole spectrum of customer service that a company can provide; this is partly what the “administrative expenses” cover. If the federal government forces a particular insurer to cut back on this spending, the outcome isn’t merely going to be lower salaries for the fatcats. There may also be layoffs in clerical positions, fewer people manning the phones to deal with inquiries about coverage or understanding a recent bill, and so forth. In short, people will become even more exasperated with the quality of “free market” health care, and will be that much more receptive to total federal control down the road.

Come to think of it, maybe these consequences weren’t so “unintended” after all.

Robert P. Murphy is author of The Politically Incorrect Guide to Capitalism. His blog is Free Advice. Follow him on Twitter.