What Is the Medical Cost Ratio (MCR)?

The medical cost ratio is a comparison of a health insurance company's healthcare-related costs to its revenues. The medical cost ratio is one of several indicators of an insurer's financial standing. It is used by all major healthcare companies to determine that they are adhering to regulations and meeting their fiscal requirements.

It may also be known as the medical care ratio, medical loss ratio, and medical benefit ratio.

How the Medical Cost Ratio (MCR) Works

Health insurance companies work by collecting premiums from their customers, or insured parties. Sometimes these premiums come directly from insured individuals, but more often they come from employer-sponsored plans in which an individual employee is only required to pay a portion of the annual health insurance premium.

The healthcare company retains these funds until a medical claim is filed. These claims can arise from visits to doctor offices, hospitals or other medical care facilities and for reasons varying from illness to elected medical procedures. They also cover prescriptions, and in some instances, telehealth services.

The medical cost ratio should be 85% or less in order to indicate financial health for larger employer plans and 80% for smaller employer and individual plans. This indicates that the health insurer is spending 85% of its earnings paying out on healthcare costs, and putting 15% towards non-medical costs such as profits, overhead expenses and reinvesting into the company for larger plans. For smaller and individual plans, the ratio should be 80% and 20% (sometimes known as the 80/20 rule).

How to Calculate the Medical Cost Ratio

The calculation used to determine the ratio is the cost of the total medical claims paid out plus adjusted expenses, which are then divided by the total premium collected. These figures are reported annually to the secretary of Health and Human Services.

Any reports indicating the limits are being exceeded must be backed by supporting reports or proof of rebates to the customers. The requirement for rebates is relatively new and was written into regulations when the Affordable Care Act (ACA) was signed by President Barack Obama.

The Affordable Care Act and the Medical Cost Ratio

A health insurance carrier that pays $8 in claims for every $10 in premiums collected has a medical cost ratio of 80%. Under the Affordable Care Act, health insurance carriers were mandated to allocate a significant share of the premium to clinical services and the improvement of healthcare quality. Health insurance providers are required to divert 80% of premiums to claims and activities that improve the quality of care and offer more value to the plan's participants.

If an insurer fails to spend the required 80% on healthcare costs, it will have to rebate excess funds back to the consumer. As a historical example, ACA carriers distributed rebates totaling $469 million to consumers in 2015. Of the total, Florida insurers paid out over $59 million, and Minnesota carriers owed no rebates.