Administrative Costs in Health Care: A Primer
I actually started looking into administrative costs a few weeks ago. But then, as if to prove the prescience of my research, Paul Krugman, Greg Mankiw, Tyler Cowen and a handful of others began arguing about the subject. And I'm not convinced any of them have it right.
Administrative costs are one of the more confusing issues in health-care reform. Start with the term: What counts as an "administrative cost" for a health insurer? We all agree that paying bills counts. But does profit? What about disease management? Advertising? A nurse who dispenses health advice over the telephone?
Hard to say. But all of them get grouped under administrative costs at various times. Indeed, I've spent the last few weeks looking into studies and talking to experts, and there's not perfect unanimity on how to measure any of this. But most seem to think that Medicare's administrative costs are significantly undersold in the public debate. An apples-to-apples comparison would not leave you with the 2 percent of total Medicare spending often bandied about in debate. That doesn't count, for instance, Medicare's premium collection, which is done through the tax code, and thus through the IRS. Nor does it count most of Medicare's billing, which is outsourced -- and this might surprise people -- to private insurers like Blue Cross Blue Shield and listed under vendor services rather than program administration. A more straightforward estimate, according to experts I've spoken to, would be in the range of 5 to 6 percent.
Nor is it easy to measure administrative costs among private insurers. For one thing, which private insurers? When the Congressional Budget Office examined this issue, it found that administrative costs -- including advertising and profits -- accounted for 12 percent of the average insurer's dollar. But that hid substantial variation among insurers. Among employer-based plans, the largest firms had the lowest costs. Plans covering companies with at least 1,000 employees had a mere 7 percent in administrative costs. Those covering companies with fewer than 25 employees spent 26 percent of premiums on administration. And the individual market was a mess: 30 percent.
This tells us a couple of things. First, size matters. The most important predictor of administrative costs is not whether the plan is public or private, but whether it is large. Second, the bulk of these costs are not helping humanity. Some conservative wags have been suggesting that Medicare's administrative costs are too low. But none of those wags, I'd wager, would prefer the small-group market to the large-group market. Others have argued that the difference in administration is that private insurers do an excellent job ferreting out fraud. unless you believe that only holds true for small business insurers, there's no evidence for that claim.
Indeed, there's little argument that large-group insurance plans offer better value than small-group insurance plans. The reasons are obvious enough: Because they don't need to spend as much money on advertising or dealing with brokers or pricing the risk of applicants, large group insurers can spend more delivering efficient medical care. The administrative efficiencies are part of that.
But administrative costs among payers -- that is to say, insurers -- are only part of the story. And they may not even be the most important part. The hospitals and physicians who have to deal with these payers are spending tremendous sums of money too. Hospitals have billing departments. They employ people to argue over claims and navigate the rules of the dozen or so different insurance plans they contract with. And here the experts were unanimous: The problem is that the system is fractured. There's no standardization. Remember the old Tolstoy quote, every unhappy family is unhappy in its own way? Well, every insurer is complicated in its own way. And that complexity costs a lot of money.
As of now, no one I spoke with knew of good data separating the costs of dealing with Medicare and with private insurers. But there are studies comparing Canada and the United States that show a single payer vastly reduces administrative spending. Few think we could achieve those savings today, even if we did convert entirely to a single payer. But there's certainly a level of savings between here and there that we could reach.
It's also important to note that you don't necessarily want administrative costs as low as they could possibly be. Some activities that are considered "administrative" are useful. Disease management, for instance, which accounts for some of the difference between Medicare and Medicare Advantage. Mental health counselors who are available by phone. Good-faith investigations into waste, fraud and abuse. Care coordination. Nurses who use e-mail or telephones to remind patients to take their drugs. Administration is not always wasteful.
But no matter how good you got at slashing administrative costs, they will never be a panacea to the problems of the system. Rick Kronick, a political scientist at the University of California at San Diego, has done some of the best work on administrative costs, and he summed the situation up quite well. "The main question," he said, "is why are health care costs going up at 2.4 percent a year faster than GDP? And most of the answers to that question have nothing to do with administrative costs. The answers are that we do more stuff and have more technology. Even if we could wring administrative savings out of the system, which I'm all in favor of and would be a good thing, we'd still be facing the question of how to slow the rate of cost growth."
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