[Federal Register Volume 79, Number 4 (Tuesday, January 7, 2014)]
[Rules and Regulations]
[Pages 755-758]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-00092]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9651]
RIN 1545-BL05


Computation of, and Rules Relating to, Medical Loss Ratio

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations that provide guidance 
to Blue Cross and Blue Shield organizations, and certain other 
qualifying health care organizations, on computing and applying the 
medical loss ratio added to the Internal Revenue Code by the Patient 
Protection and Affordable Care Act.

DATES: Effective Date: These regulations are effective on January 7, 
2014.
    Applicability Date: These regulations apply to taxable years 
beginning after December 31, 2013.

FOR FURTHER INFORMATION CONTACT: Graham R. Green, (202) 317-6995 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    Section 833 of the Internal Revenue Code (Code) provides that Blue 
Cross and Blue Shield organizations, and certain other qualifying 
health care organizations, are entitled to: (1) Treatment as stock 
insurance companies; (2) a special deduction 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. This 
document contains final amendments to 26 CFR part 1 (Income Tax 
Regulations) under section 833(c)(5). Section 833(c)(5) was added to 
the Code by section 9016 of the Patient Protection and Affordable Care 
Act (Affordable Care Act), Public Law 111-148 (124 Stat. 119 (2010)), 
effective for taxable years beginning after December 31, 2009. Section 
833(c)(5) provides that section 833 does not apply to an organization 
unless the organization's medical loss ratio (MLR) for a taxable year 
is at least 85 percent. For purposes of section 833, an organization's 
MLR is 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)).
    The Treasury Department and the IRS issued proposed regulations 
under section 833(c)(5) on May 13, 2013 (78 FR 27873). The Treasury 
Department and the IRS received four written comments in response to 
the notice of proposed rulemaking and notice of public hearing. After 
consideration of all comments, these final regulations adopt the 
provisions of the proposed regulations with certain modifications, the 
most significant of which are highlighted in the Summary of Comments 
and Explanation of Revisions. All comments are available at 
www.regulations.gov or upon request.

Summary of Comments and Explanation of Revisions

1. Determining the MLR

    The proposed regulations generally provided that an organization's 
MLR with respect to a taxable year is the ratio, expressed as a 
percentage, of the MLR numerator to the MLR denominator. The MLR 
numerator was defined as the organization's total premium revenue 
expended on reimbursement for clinical services provided to enrollees 
under its policies for the taxable year. The MLR denominator was 
defined as the organization's total premium revenue for the taxable 
year, after excluding Federal and State taxes and licensing or 
regulatory fees and after accounting for payments or receipts for risk 
adjustment, risk corridors, and reinsurance. The final regulations 
retain these definitions.
a. MLR numerator
    The proposed regulations provided that the MLR numerator does not 
include amounts expended for ``activities that improve health care 
quality.'' Two commenters requested that the MLR numerator include

[[Page 756]]

amounts expended for ``activities that improve health care quality'' as 
reported under section 2718 of the PHSA, arguing that Congress intended 
to include amounts expended for ``activities that improve health care 
quality'' in the MLR numerator. Two other commenters agreed with the 
proposed rule that amounts expended for ``activities that improve 
health care quality'' should not be included in the MLR numerator.
    The final regulations retain the rule in the proposed regulations 
because the alternative is not supported by the statute. Section 2718 
of the PHSA provides that the MLR numerator is based on both 
``reimbursement for clinical services provided to enrollees'' and 
``activities that improve health care quality.'' By contrast, the 
express language of section 833(c)(5) provides that the MLR numerator 
is based on ``reimbursement for clinical services provided to 
enrollees'' without any reference to ``activities that improve health 
care quality.'' Accordingly, the final regulations provide that the MLR 
numerator in section 833(c)(5) does not include costs for ``activities 
that improve health care quality.''
b. Computation of MLR
    The proposed regulations provided that amounts used for purposes of 
section 833(c)(5) (that is, total premium revenue and total premium 
revenue expended on reimbursement for clinical services provided to 
enrollees) for each taxable year should be determined based on amounts 
reported under section 2718 of the PHSA for that taxable year and the 
two preceding taxable years, subject to the same adjustments that apply 
for purposes of section 2718 of the PHSA. In the preamble to the 
proposed regulations, the Treasury Department and the IRS requested 
comments as to whether organizations should, instead of using the 
three-year period used for purposes of section 2718(b)(1)(B)(ii) of the 
PHSA, compute their expenses and total premium revenue only for the 
taxable year for which the computation is being made under section 
833(c)(5), and whether adoption of the three-year approach would create 
difficulties with respect to the computation of the MLR for the 2014 
taxable year.
    Two commenters suggested that each organization described in 
section 833(c) be permitted a one-time, permanent election to compute 
its MLR over either the three-year period provided in the proposed 
regulations or over a one-year period based on the taxable year. The 
commenters further suggested that if a three-year period is used, 
transition relief should be provided to phase in the three-year period.
    In describing the MLR computation under section 833(c)(5), the 
statute provides that the elements in the computation are to be ``as 
reported under section 2718 of the Public Service Health Act.'' The 
Treasury Department and the IRS have concluded that this cross 
reference indicates that Congress intended that, to the extent 
consistent with the express language of section 833(c)(5), the meaning 
of terms and the methodology used in the MLR computation under section 
833(c)(5) should be consistent with the definition of those same terms 
and the methodology under section 2718 of the PHSA. Section 
2718(b)(1)(B)(ii) of the PHSA and the associated regulations issued by 
the Department of Health and Human Services use a three-year period to 
compute the medical loss ratio, allowing certain limited adjustments 
after the end of the year to determine expenses and premium revenue. 
(See 45 CFR 158.220(b) and 158.140.) Accordingly, the Treasury 
Department and the IRS have concluded that amounts used for purposes of 
section 833(c)(5) for each taxable year should be determined based on 
amounts reported under section 2718 of the PHSA for that taxable year 
and the two preceding taxable years, subject to the same adjustments 
that apply for purposes of section 2718 of the PHSA.
    In light of the comments received, the Treasury Department and the 
IRS have concluded that transition rules to phase in the three-year 
period provided in these final regulations are appropriate. 
Accordingly, the final regulations provide that for the first taxable 
year beginning after December 31, 2013, an organization's MLR will be 
computed on a one-year basis. Thus, for the first taxable year 
beginning after December 31, 2013, an organization's MLR is computed 
based on its total premium revenue expended on reimbursement for 
clinical services provided to enrollees for its first taxable year 
beginning after December 31, 2013, and its total premium revenue for 
its first taxable year beginning after December 31, 2013.
    For the first taxable year beginning after December 31, 2014, an 
organization's MLR will be computed on a two-year basis. Thus, for the 
first taxable year beginning after December 31, 2014, an organization's 
MLR is computed based on the sum of its total premium revenue expended 
on reimbursement for clinical services provided to enrollees for its 
first taxable year beginning after December 31, 2013, and for its first 
taxable year beginning after December 31, 2014, and the sum of its 
total premium revenue for its first taxable year beginning after 
December 31, 2013, and for its first taxable year beginning after 
December 31, 2014.
    For the first taxable year beginning after December 31, 2015, and 
for all succeeding taxable years, the final regulations provide that 
the MLR is determined based on amounts reported under section 2718 of 
the PHSA for that taxable year and the two preceding taxable years, 
subject to the same adjustments that apply for purposes of section 2718 
of the PHSA.
    The final regulations do not adopt the commenters' suggestion to 
allow organizations to make an election between the three-year period 
provided in the proposed regulations or the one-year period based on 
the taxable year. The statutory framework does not contemplate an 
election or provide for more than one method for computing the MLR. 
Further, any election would be administratively burdensome for the IRS.

2. Nonapplication of Section 833 in Case of an Insufficient MLR

    The proposed regulations provided that the consequences of having 
an MLR of less than 85 percent (an insufficient MLR) are as follows: 
(1) The organization is not taxable as a stock insurance company by 
reason of section 833(a)(1), but may be taxable as an insurance company 
if it otherwise meets the requirements of section 831(c); (2) the 
organization is not allowed the special deduction set forth in section 
833(b); and (3) if the organization qualifies as an insurance company 
under section 831(c), it must take into account 80 percent, rather than 
100 percent, of its unearned premiums under section 832(b)(4) as it 
applies to other non-life insurance companies.
    In response to the proposed regulations, two commenters requested 
that the consequences of having an insufficient MLR under section 
833(c)(5) be limited to the loss of only some of the benefits of 
section 833. Specifically, commenters posited that an organization that 
fails the MLR requirement under section 833(c)(5) should not lose its 
status as an insurance company under section 833(a)(1). Rather, the 
commenters argued that the organization should only suffer the loss of 
eligibility for the special deduction in section 833(b) and be subject 
to the less favorable computation of unearned premium reserves based on 
80 percent, rather than 100 percent, of its unearned premiums under 
section 832(b)(4). Another commenter agreed with the proposed rule that 
the consequences of

[[Page 757]]

having an insufficient MLR under section 833(c)(5) include the loss of 
automatic stock insurance company status under section 833(a)(1).
    Section 833(c)(5) provides that ``this section [833]'' shall not 
apply to any organization unless the organization satisfies the MLR 
requirement in section 833(c)(5). This language does not contemplate 
disallowance of some, but not all, of the benefits associated with 
treatment under section 833. Because the benefit of automatic stock 
insurance company status is provided to section 833(c) organizations in 
section 833(a)(1), this benefit is lost upon a failure to satisfy the 
MLR under section 833(c)(5). Accordingly, the Treasury Department and 
the IRS have concluded that for an organization described in section 
833(c) that fails to satisfy the MLR requirement under section 
833(c)(5): (1) The organization is not taxable as a stock insurance 
company by reason of section 833(a)(1), but may be taxable as an 
insurance company if it otherwise meets the requirements of section 
831(c); (2) the organization is not allowed the special deduction set 
forth in section 833(b); and (3) if the organization qualifies as an 
insurance company under section 831(c), it must take into account 80 
percent, rather than 100 percent, of its unearned premiums under 
section 832(b)(4) as it applies to other non-life insurance companies.
    In the proposed regulations, the Treasury Department and the IRS 
declined to adopt a proposal to allow an organization that would have 
otherwise failed to satisfy the MLR by a de minimis amount to pay an 
amount to the IRS to retain eligibility for the benefits of section 833 
because the statutory framework does not contemplate a penalty or other 
payment to the IRS. The Treasury Department and the IRS requested 
comments on whether there are other possible means consistent with the 
statute of mitigating the consequences of having an insufficient MLR.
    In response to the proposed regulations, two commenters requested 
that, in limited circumstances, an organization with an insufficient 
MLR be permitted to rebate premiums to one of the following to satisfy 
the section 833(c)(5) MLR requirement: (1) The Secretary of Health and 
Human Services; (2) policyholders; (3) a State Comprehensive Health 
Insurance Plan or other health related program, foundation, or 
guarantee fund association; or (4) a risk adjustment, reinsurance, or 
risk corridor program under the Affordable Care Act. Another commenter 
suggested that allowing any rebating of premiums to comply with section 
833(c)(5) would fail to address consumers' needs for affordable 
coverage at the time of purchase. The Treasury Department and the IRS 
continue to consider whether, and, if so, how to permit organizations 
to address de minimis failures to satisfy the MLR under section 
833(c)(5).

3. No Material Change

    Commenters requested clarification that an organization's loss of 
eligibility for treatment under section 833 by reason of section 
833(c)(5) will not be treated as a material change in the operations of 
such organization or in its structure for purposes of section 
833(c)(2)(C). Section 833(c) restricts the application of section 833 
to any existing Blue Cross or Blue Shield organization, and any other 
qualifying organization meeting the requirements of section 833(c)(3). 
Section 833(c)(2)(C) defines the term ``existing Blue Cross or Blue 
Shield organization'' to mean any Blue Cross or Blue Shield 
organization if such organization was in existence on August 16, 1986, 
such organization was determined to be exempt from tax for its last 
taxable year beginning before January 1, 1987, and no material change 
has occurred in the operations of such organization or in its structure 
after August 16, 1986, and before the close of its current taxable 
year.
    The final regulations adopt this suggestion. Consistent with the 
annual determination of whether an organization's MLR under section 
833(c)(5) is at least 85 percent, which allows eligibility for 
treatment under section 833 to be recovered if lost by reason of 
section 833(c)(5), the Treasury Department and the IRS have concluded 
that a change in an organization's eligibility for treatment under 
section 833 solely by reason of section 833(c)(5) will not be treated 
as a material change in the operations of such organization or in its 
structure for purposes of section 833(c)(2)(C).

4. Accounting for Unearned Premiums

    In Notice 2011-4 (2011-2 IRB 282 (December 29, 2010)) and Rev. 
Proc. 2011-14 (2011-4 IRB 330 (January 11, 2011)) (both of which are 
available at www.irs.gov), the Treasury Department and the IRS provided 
procedures for an organization to obtain automatic consent to change 
its method of accounting for unearned premiums because of the 
application of section 833(c)(5). Two commenters raised questions about 
the continued application of Notice 2011-4. The guidance provided in 
Notice 2011-4 and Rev. Proc. 2011-14 continues to apply in its current 
form and is not superseded by these final regulations. See Sec.  
601.601(d)(2)(ii)(b).

Applicability Date

    These regulations apply to taxable years beginning after December 
31, 2013.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866, as 
supplemented by Executive Order 13563. Therefore, a regulatory 
assessment is not required. It also has been determined that section 
553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does 
not apply to these regulations and because the regulations do not 
impose an information collection on small entities, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to 
section 7805(f) of the Code, the proposed regulations preceding these 
regulations were submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comments on its impact on small 
business. No comments were received.

Drafting Information

    The principal author of these regulations is Graham R. Green, 
Office of Associate Chief Counsel (Financial Institutions & Products). 
However, other personnel from the Treasury Department and the IRS 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *


0
Par. 2. Section 1.833-1 is added to read as follows:


Sec.  1.833-1  Medical Loss Ratio Under Section 833(c)(5).

    (a) In general. Section 833 does not apply to an organization 
unless the organization's medical loss ratio (MLR) for a taxable year 
is at least 85 percent. Paragraph (b) of this section provides 
definitions that apply for purposes of section 833(c)(5) and this 
section. Paragraph (c) of this section provides

[[Page 758]]

rules for computing an organization's MLR under section 833(c)(5). 
Paragraph (d) of this section addresses the treatment under section 833 
of an organization that has an MLR of less than 85 percent. Paragraph 
(e) of this section provides the effective/applicability date.
    (b) Definitions. The following definitions apply for purposes of 
section 833(c)(5) and this section.
    (1) Reimbursement for clinical services provided to enrollees. The 
term reimbursement for clinical services provided to enrollees has the 
same meaning as that term has in section 300gg-18 of title 42, United 
States Code and the regulations issued under that section (see 45 CFR 
158.140).
    (2) Total premium revenue. The term total premium revenue means 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 Patient Protection and Affordable 
Care Act, Public Law 111-148 (124 Stat. 119 (2010)) (42 U.S.C. sections 
18061, 18062, and 18063)) as those terms are used for purposes of 
section 300gg-18(b) of title 42, United States Code and the regulations 
issued under that section (see 45 CFR Part 158).
    (c) Computation of MLR under section 833(c)(5)--(1) In general. 
Starting with the first taxable year beginning after December 31, 2015, 
and for all succeeding taxable years, an organization's MLR with 
respect to a taxable year is the ratio, expressed as a percentage, of 
the MLR numerator, as described in paragraph (c)(1)(i) of this section, 
to the MLR denominator, as described in paragraph (c)(1)(ii) of this 
section.
    (i) MLR numerator. The numerator of an organization's MLR is the 
total premium revenue expended on reimbursement for clinical services 
provided to enrollees under its policies for the taxable year, computed 
using a three-year period in the same manner as those expenses are 
computed for the plan year for purposes of section 300gg-18(b) of title 
42, United States Code and regulations issued under that section (see 
45 CFR Part 158).
    (ii) MLR denominator. The denominator of an organization's MLR is 
the organization's total premium revenue for the taxable year, computed 
using a three-year period in the same manner as the total premium 
revenue is computed for the plan year for purposes of section 300gg-
18(b) of title 42, United States Code and regulations issued under that 
section (see 45 CFR Part 158).
    (2) Transition rules. The transition rules in paragraphs (c)(2)(i) 
and (c)(2)(ii) of this section apply solely for the first taxable year 
beginning after December 31, 2013, and the first taxable year beginning 
after December 31, 2014.
    (i) First taxable year beginning after December 31, 2013. For the 
first taxable year beginning after December 31, 2013, the numerator of 
an organization's MLR is the total premium revenue expended on 
reimbursement for clinical services provided to enrollees under its 
policies for the first taxable year beginning after December 31, 2013, 
and the denominator of an organization's MLR is the organization's 
total premium revenue for the first taxable year beginning after 
December 31, 2013.
    (ii) First taxable year beginning after December 31, 2014. For the 
first taxable year beginning after December 31, 2014, the numerator of 
an organization's MLR is the sum of the total premium revenue expended 
on reimbursement for clinical services provided to enrollees under its 
policies for the first taxable year beginning after December 31, 2013, 
and for the first taxable year beginning after December 31, 2014, and 
the denominator of an organization's MLR is the sum of the 
organization's total premium revenue for the first taxable year 
beginning after December 31, 2013, and for the first taxable year 
beginning after December 31, 2014.
    (d) Failure to qualify under section 833(c)(5)--(1) In general. If, 
for any taxable year, an organization's MLR is less than 85 percent, 
then beginning in that taxable year and for each subsequent taxable 
year for which the organization's MLR remains less than 85 percent, 
paragraphs (d)(1)(i) through (d)(1)(iii) of this section apply.
    (i) Automatic stock insurance company status. The organization is 
not taxable as a stock insurance company by reason of section 
833(a)(1), but may be taxable as an insurance company if it otherwise 
meets the requirements of section 831(c);
    (ii) Special deduction. The organization is not allowed the special 
deduction set forth in section 833(b); and
    (iii) Premiums earned. The organization must take into account 80 
percent, rather than 100 percent, of its unearned premiums under 
section 832(b)(4) as it applies to other non-life insurance companies, 
provided the organization qualifies as an insurance company by meeting 
the requirements of section 831(c).
    (2) No material change. An organization's loss of eligibility for 
treatment under section 833 solely by reason of section 833(c)(5) will 
not be treated as a material change in the operations of such 
organization or in its structure for purposes of section 833(c)(2)(C).
    (e) Effective/applicability date. This section applies to taxable 
years beginning after December 31, 2013.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: January 2, 2014.
Mark J. Mazur,
 Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2014-00092 Filed 1-6-14; 8:45 am]
BILLING CODE 4830-01-P