Final regulations - Medical loss ratio rules for Blue Cross and Blue Shield organizations 

January 6: The Treasury Department and IRS today released for publication in the Federal Register final regulations (T.D. 9651) for use by Blue Cross and Blue Shield organizations on computing and applying the medical loss ratio under section 833(c)(5).

Today’s regulations [PDF 208 KB] finalize regulations that were proposed in May 2013 with certain modifications made in response to comments received by the IRS and Treasury.

The final regulations are effective for tax years beginning after December 31, 2013.


Section 833 provides that a Blue Cross and Blue Shield organization (or other health care organization meeting certain requirements) is entitled to favorable treatment for federal income tax purposes, which includes:

  • Treatment as a stock insurance company
  • A special deduction based on the company’s level of claims, liabilities, and expenses incurred in connection with cost-plus contracts relative to the company’s adjusted surplus
  • Computation of unearned premium reserves based on 100% rather than 80% of unearned premiums (which generally would decrease the company’s taxable income)

The Patient Protection and Affordable Care Act (referred to as the “Affordable Care Act”) added section 833(c)(5) to the Code, which provides that the favorable tax treatment under section 833 will not apply to an organization unless the percentage of total premium revenue expended on reimbursement for clinical services—i.e., the medical loss ratio (MLR)—is not less than 85%.

The Affordable Care Act also added section 2718 of the Public Health Service Act to require a health insurance issuer to report to the Department of Health and Human Services (HHS) the percentage of total premium revenue expended on reimbursement for clinical services and activities that improve health care quality, and to require the health insurance issuer to pay its enrollees a rebate if that ratio is less than a prescribed percentage. HHS has issued regulations on these calculations.

In November 2010, the IRS issued Notice 2010-79 to provide interim guidance on the application of section 833(c)(5). Additional interim guidance was subsequently provided in Notice 2011-4, Rev. Proc. 2011-14, Notice 2011-51, and Notice 2012-37.

In May 2013, proposed regulations were issued (78 Fed. Reg. 27873) which provided that, in general, the MLR computation under section 833(c)(5) would be the same as the medical loss ratio computation under the HHS regulations. However, under the proposed regulations, expenditures for “activities that improve health care quality” would not be included in the numerator for purposes of the section 833(c)(5) computation.

The proposed regulations also provided rules regarding the consequences of failing to satisfy section 833(c)(5).

Final regulations

The final regulations adopt the proposed regulations with two modifications, as explained in the preamble to the final regulations.

  • Transition rule for MLR computations - The final regulations retain the three-year rule for amounts used to compute a company’s MLR, but allow a phased-in approach. As of the 2016 tax year (assuming a calendar year taxpayer), a company’s total premium revenue and total premium revenue expended on clinical services provided to enrollees for the tax year at issue as well as for the two preceding tax years will be taken into account in computing a company’s MLR. Under the transition rule, however, for the 2014 tax year, total premium revenue and total premium revenue expended on clinical services provided to enrollees amounts for only 2014 will be taken into account; the computation for 2015 includes premium revenue and expenditures for 2014 and 2015.
  • No material change - The final regulations add a paragraph to clarify that an MLR failure under section 833(c)(5) will not cause an “existing Blue Cross or Blue Shield organization” to lose its status as such an organization under the material change rule in section 833(c)(2)(C). Reg. section 1.833-1(d)(2) clarifies that failure to meet the 85% MLR threshold will not be treated as a “material change in the operations of such organization or in its structure,” and thus will not cause a pre-1986 Act Blue Cross or Blue Shield organization to lose its tax status overall—despite that it would not be eligible for certain special tax treatment (such as the section 833(b) special deduction) in any year it fails to satisfy the MLR test.

The final regulations retain the rule in the proposed regulations that excludes “activities that improve health care quality” from the MLR numerator. Although several commentators requested that such amounts be included, the IRS and Treasury concluded that such a change would not be supported by the statute.

For more information, contact Monica Coakley, KPMG’s national tax leader for healthcare or Jean Baxley, an insurance tax director in KPMG’s Washington National Tax practice:

Monica M. Coakley

+1 (615) 248-5639

Jean Baxley

+1 (202) 533-3008

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