Posted on January 11, 2006

CAHI's claim of Medicare's hidden administrative costs


Medicare’s Hidden Administrative Costs: A Comparison of Medicare and the Private Sector
By Merrill Matthews, Ph.D.
The Council for Affordable Health Insurance
January 10, 2006

Executive Summary

One of the most common, and least challenged, assertions in the debate over U.S. health care policy is that Medicare administrative costs are about 2 percent of claims costs, while private insurance companies’ administrative costs are in the 20 to 25 percent range.

It is very difficult to do a real apples-to-apples comparison of Medicare’s true costs with those of the insurance industry. The primary problem is that private sector insurers must track and divulge their administrative costs, while most of Medicare’s administrative costs are hidden or completely ignored by the complex and bureaucratic reporting and tracking systems used by the government.

This study, based in part on a technical paper by Mark Litow of Milliman, Inc., finds that Medicare’s actual administrative costs are 5.2 percent, when the hidden costs are included.

In addition, the technical paper shows that average private sector administrative costs, about 8.9 percent - and 16.7 percent when commission, premium tax, and profit are included - are significantly lower than the numbers frequently cited. But even though the private sector’s administrative costs are higher than Medicare’s, that isn’t “wasted money” that could go to insuring the uninsured. In fact, consumers receive significant value for those additional dollars.

We also raise an important, although heretofore unrecognized, issue that gives Medicare an inherent advantage on administrative costs. Because of the higher cost per beneficiary, Medicare administrative costs appear lower than they really are. If the numbers were adequately “handicapped” for comparison with the private sector, they would be in the 6 to 8 percent range.

Finally, like the private sector, Medicare also has to obtain funds to pay claims. But the cost of raising that money, or borrowing it if the government doesn’t collect it from taxpayers, is excluded from Medicare administrative cost calculations. While we don’t in this paper draw any conclusions about what we shall call the “cost of capital” and its impact on Medicare’s administrative costs, we do want to highlight that those costs exist and that taxpayers, both today and in the future, must bear those costs.

Comment: The Council for Affordable Health Insurance (CAHI) is an association of insurance carriers advocating for market-oriented solutions to the problems of our health care system. Their bias for affordable private health insurance is at odds with our bias for affordable publicly-funded health care for everyone. They have now released a report “exposing” Medicare’s hidden administrative costs.

It is important to be aware of this report and the paper of Mark Litow of Milliman, Inc. on which this report is based. Opponents of single payer reform will use the concepts presented to dismiss the charge that private insurers are responsible for much more administrative waste than is our Medicare program.

When we are challenged, our best quick response would be to use their own numbers. After they have adjusted the numbers by applying their biased assumptions, the percent of private sector administrative costs is still over three times the administrative costs of Medicare (16.7 percent and 5.2 percent, respectively). The actuality of the administrative excesses is not in dispute - only the degree of the egregiousness of the excesses.

The opponents will also point out that the percent of administrative costs for Medicare beneficiaries is lower because the per person health care costs are higher than in the relatively healthy private insurance sector. But shouldn’t the administrative spending be directed primarily toward claims processing, especially since Medicare enrollment is a low-cost, once-in-a-lifetime event? Why should a greater percentage of health care dollars be used to administer private insurance programs with a much lower rate of claims processing? The administrative costs of claims processing is related much more to the volume of claims and much less to the number of beneficiaries. Thus their “handicapped” numbers are specious.

In another section of their report they claim that administrative costs “add value.” Most of us have difficulty recognizing the value of marketing costs, medical underwriting, brokers’ fees, excessive executive compensation packages, insurer profits, and other such administrative excesses. This claim alone, that these excesses add value, should destroy the credibility of this report.

The most important component of administrative waste was totally left out of this report - the administrative burden placed on the providers of health care. The recent Health Affairs report by J. Kahn and his colleagues demonstrated that just the billing and insurance related costs of private insurance consume about 21 percent of premium dollars, in a large part due to the administrative burden of physicians and hospitals. A single, administratively-streamlined system of claims management would dramatically reduce the waste of our current fragmented system.

And what is their conclusion?

“However, the issue is not and should not be which segment, private sector insurers or government-run plans, has the lowest administrative costs. The issue should be which does the best job of providing quality health insurance coverage for the best price. When one looks at all of the money pouring into Medicare, even with the price controls imposed by the government, the answer has to be the private sector.”

And we’re leaving these guys in charge? It almost makes you want to cry.