Health Reform WK-EDGE IRS revises rules for computing and applying the medical loss ratio
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Friday, July 1, 2016

IRS revises rules for computing and applying the medical loss ratio

By Harold Bishop, J.D.

Revised regulatory guidance on computing and applying the medical loss ratio (MLR) and the consequences for not meeting the MLR threshold is available from the Internal Revenue Service (IRS). The revised IRS regulations reflect the enactment of a technical correction to section 833(c)(5) of the Internal Revenue Code (IRC) by the Consolidated and Further Continuing Appropriations Act of 2015 (Appropriations Act) (P.L. 113-235). The technical correction provided that in calculating its MLR numerator, a Blue Cross Blue Shield organization, and certain other organizations involved in providing health insurance, should include both the cost of reimbursement for clinical services and amounts expended for activities that improve health care quality. The revised regulations will apply to taxable years beginning January 1, 2016, but taxpayers may rely on the regulations for taxable years beginning after December 31, 2009 (Final rule, 81 FR 40518, June 22, 2016).

Background. Section 833(a) of the IRC provides that Blue Cross and Blue Shield organizations, and certain other organizations involved in providing health insurance, are entitled to: (1) treatment as stock insurance companies for purposes of sections 831 through 835 (related to taxation of non-life insurance companies generally); (2) a special deduction determined under section 833(b); and (3) computation of unearned premium reserves under section 832(b)(4) based on 100 percent, and not 80 percent, of unearned premiums for purposes of determining "insurance company taxable income" under section 832.

Section 833(c)(5) was added to the IRC by section 9016 of the Patient

Protection and Affordable Care Act (ACA) (P. L. 111–148), effective for taxable years beginning after December 31, 2009. Section 833(c)(5) provided that section 833 deductions did not apply to any organization unless the organization’s MLR for the taxable year was at least 85 percent. An organization’s MLR was its percentage of total premium revenue expended on reimbursement for clinical services provided to enrollees under its policies during such taxable year (as reported under section 2718 of the Public Health Service Act (PHSA) (42 U.S.C. §300gg–18)).

Section 2718 of the PHSA was added by section 1001 and amended by section 10101 of the ACA. Section 2718(a) of the PHSA requires a health insurance issuer to submit a report for each plan year to the Secretary of HHS concerning the percentage of total premium revenue, after accounting for collections or receipts for risk adjustment and risk corridors and payments of reinsurance, that the issuer expends: (1) on reimbursement for clinical services provided to enrollees under such coverage; (2) for activities that improve health care quality; and (3) on all other non-claims costs, excluding federal and state taxes and licensing or regulatory fees.

In addition, section 2718(b) of the PHSA requires that a health insurance issuer provide an annual rebate to each enrollee under such coverage, on a pro rata basis, if the ratio of the amount of the premium revenue the issuer expends on costs for reimbursement for clinical services provided to enrollees and for activities that improve health care quality to the total amount of premium revenue (excluding federal and state taxes and licensing or regulatory fees and after accounting for payments or receipts for risk adjustment, risk corridors, and reinsurance under sections 1341, 1342, and 1343 of the ACA) for the plan year is less than the prescribed percentage.

Technical correction. The Appropriations Act’s technical correction to section 833(c)(5) provided that in calculating its MLR numerator, an organization includes both the cost of reimbursement for clinical services and amounts expended for activities that improve health care quality. In addition, the technical correction provided that the consequences for not meeting the MLR threshold are only that section 833(a)(2) and (3) do not apply. Therefore, an organization with an insufficient MLR is still treated as if it were a stock insurance company under section 833(a)(1). The technical correction applies to taxable years beginning after December 31, 2009.

Final rule. The Final rule restates section 1.833–1 of the Income Tax Regulations (26 C.F.R. part 1) and incorporates the technical correction, which, in effect, retroactively amended the regulations to determine the MLR and the consequences of an insufficient MLR.

Section 1.833–1 generally provides that an organization’s MLR with respect to a taxable year is the ratio, expressed as a percentage, of the organization’s MLR numerator to its MLR denominator. Prior to the technical correction, the regulation only included in the MLR numerator an organization’s total premium revenue expended on reimbursement for clinical services provided to enrollees. Consistent with the technical correction, section 1.833–1(c)(1)(i) now describes an organization’s MLR numerator as the total premium revenue the organization expended on reimbursement for clinical services and activities that improve health care quality provided to enrollees under its policies for the taxable year. The final regulations also define the term "activities that improve health care quality" to have the same meaning as the term has in section 2718 of the PHSA.

The final regulations provide that the consequences for an organization that has an MLR of less than 85 percent are the following: (1) the organization is not allowed the special deduction set forth in section 833(b); and (2) it must take into account 80 percent, rather than 100 percent, of its unearned premiums under section 832(b)(4). In addition, an organization that has an MLR of less than 85 percent does not lose its eligibility to be treated as a stock insurance company under section 833(a)(1).

Companies: Blue Cross Blue Shield

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