The United States is the global leader in medical innovation. You can measure that by Nobel Prizes or biotech R&D or where breakthrough treatments are developed or commercialized. And as University of Michigan economist Miles Kimball points out, one reason healthcare spending is lower in other advanced economies is their ability to “ cheaply copy drugs and medical techniques developed in the US at great expense.”
But healthcare innovation isn’t just about miracle drugs and cutting-edge technology. Innovation can happen in how healthcare services are delivered and paid for. And it is in this area that the Affordable Care Act is particularly harmful to innovation. The law’s “medical loss ratio,” or MLR level is supposed to suppress costs by requiring insurance companies to pay out on health claims at least 80% of the revenue they take in from premium payments. The 20% left over can be used for administration and profits. (Medicare has a 98% MLR. Then again, it also suffers from $60 billion a year in annual fraudulent payments.)
Here’s the big problem: Obamacare’s MLR rule heightens the entry barriers to entrepreneurial, innovative new companies entering the market against large, established insurance players who can spread their fixed cost across a deep customer pool. AEI healthcare expert Scott Gottlieb calls the MLR caps ”the single worse decision” Obamacare planners made. Gottlieb:
The Affordable Care Act was designed so that you can only profit as much as the government says you can profit. … But you can lose as much money as you want. .. So your downside is uncapped, by and large, and your upside is tightly regulated. You basically guarantee that the only people who can play in this market are the incumbent players. And you’ve seen no entrepreneurial capital get into this marketplace for the purpose of launching a plan on the exchange.
With the exception of some hospitals trying to do it out in California — who are going to fail like they did in the 1990s — you’ve seen no new players in this marketplace. And that’s because when a new plan launches, early on its medical loss ratio is typically around thirty of forty percent because they need a lot of operating margin because launching a new plan costs a lot of money and you lose money in the early years. So when you tell an insurance company they can only take 20 percent of their premium revenue for their operating margin … a new insurance plan can’t launch unless they are willing to lose substantial amounts of money in the initial years.
MLR rules also are biased toward existing practices and technology. A big battle when developing the MLR rules was over what activities would count or not count as healthcare expenditures versus administrative expenditures. Wellness programs, for instance, were determined to count as healthcare spending but with narrow limits, as Ben Wanamaker and Devin Bean of the Clayton Christensen Institute explain:
While federal regulations allow for wellness programs to count as health care expenditures, certain restrictions narrow the scope of these programs, including strict limits on accepted clinical practice, reliance on criteria issued by professional medical associations, and accounting regulations for cost-cutting activities. New entrants attempting to implement disruptive technologies that fall outside the narrow scope of insurance-sponsored wellness programs are thus further hindered. … MLR limits increase the already- large entry barrier for to new entrants in the insurance market. They prevent new entrants from succeeding in the market because they mandate a “size and scale wins” profit model.
Disruptive innovation transforms industries by lowering prices, creating new products and services, and increasing value. But that sort of transformative change typically comes from the new guys on the block who are locked into existing business models. In this case, Obamacare has created a gated community with a big sign: Entrepreneurs Keep Out.
Follow James Pethokoukis on Twitter at @JimPethokoukis