There are few minutiae of health care economics that policy wonks love to fight about more than insurers’ administrative costs. These are costs for things like management and marketing that are not directly related to care delivery. Are they too high or too low? To many, this would seem a strange question. Who wants to pay more in administrative costs? I’ll get to that.
First, let’s recognize that debates over administrative costs are usually proxies for debates over whether the public or private sector can deliver health insurance, or even health care, more efficiently. One thing that should be indisputable is that private administrative costs are higher. To my mind, Kip Sullivan settled this issue convincingly in a recent article in the Journal of Health Politics, Policy and Law. He compared the administrative costs for Medicare as reported by the trustees of the program to those available from the National Health Expenditure Accounts (NHEA). I made the figure below from the data in his paper. (Kevin Drum, a political blogger for Mother Jones, added the details in red.)
According to Sullivan, the trustees’ calculation of administrative costs does not include those incurred by private Medicare Advantage and Part D (drug) plans. It only includes the administrative costs for the publicly administered, fee-for-service part of Medicare. However, both the public and private administrative costs are included in the NHEA estimate. That one also happens to be growing larger than the trustees’ estimate, with noticeable jumps at the start of Medicare Advantage (actually, for its predecessor, Medicare+Choice) and the program’s privately administered drug benefit. (One reason why NHEA and the trustees’ estimates may diverge earlier is that there was some private provision of the Medicare benefit even before Medicare+Choice.)
Sullivan concludes, as do I, that private plans incur higher administrative costs than the federal government for administering the Medicare benefit. In doing so, he also explains that the trustees’ calculation includes administrative costs some claim it omits. These are costs for work done on behalf of Medicare by various agencies and programs, such as the Treasury Department, Internal Revenue Service, Social Security Administration, Centers for Medicare & Medicaid Services (including the cost of its buildings and costs for work by its contractors for quality improvement and claims processing), Department of Health and Human Services, Medicare Payment Advisory Commission, Area Agency on Aging, Department of Justice, Federal Bureau of Investigation, and Railroad Retirement Board, and the cost of demonstration projects.
Most people accept that Medicare’s administrative costs are lower than those of the private sector. But some argue that they’re too low because not enough is spent on fraud detection, prevention, and recovery. That’s entirely possible. However, it is also true that estimates of how much fraud is out there are likely higher than reality.
In an insightful report on Medicare fraud, Steve Parente and colleagues note that a prior estimate of the annual cost to Medicare of fraud put the value at $60 billion. Another estimate that included public and private payers ranged from an annual cost of $75 billion to $250 billion per year, suggesting that fraud is a substantial problem for the entire health care system, not just for public programs. However, the authors write that, “Prior estimates of fraud or abuse were based on assumptions, not detailed claims analysis coupled with objective examination and validation of patient data and provider practices.”
This does not inspire confidence. But Parente et al perform an analysis that is more reassuring. Using Parts A and B Medicare claims supplemented with medical practice records, they estimated that $20.7 billion annually could be saved in Medicare through “by implementing fraud and abuse payment prevention technologies without the need to access detailed medical records. A separate [1-time] retrospective recovery financial benefit is estimated at $17.5 billion.”
Recovery of these billions for taxpayers should move forward, as long as the money recovered exceeds the cost of recovering it. However, given the figures above, the amount of efficiently recoverable dollars of Medicare fraud is not likely to be especially large relative to the roughly half-trillion dollar per-year cost of the program.
Administrative Costs of Private Insurers
Turning to commercial market administrative costs, Cutler and Ly suggest they’re inefficiently high, and they pose a good question: why hasn’t private enterprise brought them down? As the authors point out, it’s an obvious collective action problem: one insurer cannot move the entire system by itself—and even if it invests in streamlining its own operations, doing so may not capture a sufficient return to justify the investment.
Cutler and Ly hypothesize a second potential reason for the persistence of high administrative costs in health care. They suggest that a complex system might be valuable to insurance payers if it lowers what they ultimately pay for health care. For example, denying claims saves an insurance company money if a service is never reimbursed or if the value of payments for services that are eventually reimbursed is reduced by the time payment is made. Delay may also discourage physicians from providing some services entirely.
If Cutler and Ly are right, then reducing administrative hurdles in paying for health services might actually increase health care spending. In fact, there is precedent for that in the realm of implementing systems for electronic medical records. To the extent that administrative hurdles are reduced in ways that don’t promote health, that’s just waste of another sort.
However, administrative cost is layered on both wasteful and efficient care. As such, even if it deters payment of claims or use of medical services, administrative cost is almost certainly inefficiently high in the commercial market, even if it is too low in Medicare.
About the author: Austin B. Frakt, PhD, is a health economist and an assistant professor at Boston University’s School of Medicine and School of Public Health. He blogs about health economics and policy at The Incidental Economist and tweets at @afrakt. The views expressed in this post are that of the author and do not necessarily reflect the position of Boston University.
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