What Is the Medical Cost Ratio (MCR)?

Medical cost ratio (MCR), also referred to as medical loss ratio, is a metric used in the private health insurance industry. The ratio is calculated by dividing total medical expenses paid by an insurer by the total insurance premiums it collected. A lower ratio likely indicates higher profitability for the insurer, as it signifies a larger amount of premiums are left over after paying customer insurance claims.

Under the Affordable Care Act (ACA), insurers are required to allocate 80% or more of their insurance premiums toward customer medical expenses or other services that improve healthcare. Insurers who fail to abide by this standard must return the excess funds back to consumers. These rebates amounted to nearly $2.46 billion in 2019, based on figures filed through October 16, 2020.

How the Medical Cost Ratio (MCR) Works

Medical insurers collect premiums from customers in exchange for assuming liability for funding future medical insurance claims. The insurer reinvests the premiums they collect, generating a return on investment. In order to be profitable, the insurer must collect premiums and generate investment returns greater than both the claims made against its policies and its fixed costs.

One key metric that insurance companies monitor is medical cost ratio (MCR). This metric consists of total medical expense claims that were paid divided by total premiums collected. Expressed as a percentage, a higher figure indicates lower profitability, as a large portion of collected premiums are redirected to fund customer claims. Conversely, a lower number indicates higher profitability, as it shows substantial premiums are left over after covering all claims. 

Insurance companies selling large plans (usually more than 50 insured employees) must spend at least 85% of premiums on healthcare. This means their MCR can be no lower than 85%. Insurers that focus on small employers and individual plans must spend at least 80% of premiums on healthcare, meaning their MCR is no lower than 80%. The other 20% can go toward administrative, overhead, and marketing costs. This split between healthcare and non-healthcare related spending is known as the 80/20 rule.

If an insurer generates an MCR below the 80% or 85% threshold, the excess premiums must be rebated to customers. This regulation was introduced in 2010 by the Affordable Care Act.

Real World Example of the Medical Cost Ratio (MCR)

Consider the case of XYZ Insurance, a hypothetical medical insurance company. In its most recent fiscal year, XYZ collected $100 million in premiums and paid out $78 million in claims to customers, resulting in an MCR of 78%. With those numbers, XYZ would be considered a profitable operation compared to most other medical insurers. 

Under ACA rules, however, the 2 percentage points of extra premiums XYZ collected beyond the 80% threshold must be rebated to customers or directed toward other healthcare services. These rebates amounted to nearly $2.46 billion in 2019, based on figures filed through October 16, 2020, compared with $706.7 million two years earlier.