Why The CVS Aetna Deal Makes Sense

ACA’s MLR Requirement Plays a Role
By Fred Goldstein

Many people have been surprised by the announcement that CVS is interested in purchasing Aetna.  Why would a PBM want to own a health plan?  There has been speculation that the move by Amazon to get into the pharmacy space may be a reason.  But there is another more rationale reason and its based upon a flaw in the Affordable Care Act.

            The flaw is known as the Medical Loss Ratio requirement and it reads like this from the CMS website:


The Affordable Care Act requires insurance companies to spend at least 80% or 85% of premium dollars on medical care, with the rate review provisions imposing tighter limits on health insurance rate increases. If an issuer fails to meet the applicable MLR standard in any given year, as of 2012, the issuer is required to provide a rebate to its customers.


This requirement was put in place as a way to ensure that health plans did not make money by underutilizing medical care.  But it had the unintended consequence of insuring that costs never went down. Here’s why.

            Let’s assume that a hypothetical health plan offers a product at a $5,000 premium.  Based on this premium, they must spend 80% or $4,000 on medical care and the remaining $1,000 goes to cover administrative expenses and profit. At the same time, it’s fairly common knowledge that 30% and possibly more of healthcare costs are associated with waste, fraud and abuse.  So, let’s use some data from America’s Health Insurance Plans (AHIP) and come up with a scenario.

            Perhaps a health plan wants to go after some of this waste, fraud and abuse and targets inpatient hospital costs. Per AHIP this represents 15.8% of a health plan’s spend or $790 in our hypothetical scenario. So now the health plan puts in programs and negotiated pricing that reduces inpatient costs by 10% or $79. Now let’s assume that all other medical costs remain the same. The health plan is now below the 80% MLR requirement and must rebate $79 back to the customers; they can’t keep even a piece of it as a reward for their efforts. Next year under the same scenario, if nothing else changed, they would need to come in with a lower premium (meaning they’ll have a smaller 20% for their admin and profits) or rebate the money again. This is why health plans do not take a meat cleaver to the pork.

            BUT… Now let’s introduce a new owner of the health plan, a PBM, which per the same AHIP report represents 22.1%, or $1,105, of our hypothetical health plan premium.  The PBM will tell the health plan to sharpen up and use the meat cleaver. Why? Because instead of rebating the savings to the customer, the PBM can increase its cost and or utilization up to $79 to keep the health plan in good graces with the government MLR requirement.

             In this hypothetical, $79 is equivalent to 7.2% growth for the PBM and is a way, as the owner, to pull more profits out of the health plan which are not allowed to be taken by the health plan under the ACA’s MLR requirement.  Now in the pharmacy case, some of this could be due to better adherence, or higher price or more utilization, some potentially good, some not so good.  In any case, if the PBM is really smart they will take a meat cleaver to every area except pharmacy costs and shoot for the whole hog.

            And that potential growth strategy is another unintended consequence of the MLR requirement.


Fred Goldstein is the founder of Accountable Health, Inc. A version of this article originally appeared at The Health Care Blog.