Administrative Costs

"The principles of Jefferson are the axiom of a free society"

Abraham Lincoln


A Nonpartisan Economic, Health and Public Policy Research Foundation

Administrative Costs

Many people believe that a public plan such as Medicare is more efficient  and has less administrative costs than commercial insurance.

But the comparison between public and private plans is a false comparison. Private insurance and public benefits are like comparing apples to oranges. Private insurance tries to manage care through price controls and rationing patients.  Medicare is mostly about paying the bills presented to it even if the payment is a fraction of what was billed.

Ways and Means Health Subcommittee Chairman Pete Stark (D., Calif.), for example, insists that "most private plans are poorly managed." Contrasting them with the supposedly sleek and efficient Medicare program, he labels commercial insurance profit seeking.

Here are four things administrative costs provide the private insurer under our current system:

First, private insurers try to build provider networks. These networks can include high-value providers (compliant with low cost regulations) and exclude low-quality providers. Except for criminal acts, Medicare is forbidden from excluding poor quality providers. It lets in everyone who signs up. Will the public plan have Medicare's indifference to exclusivity-- or invest in the cost of a network? Networks are the wrong approach.

Second, private insurers negotiate rates with providers. Medicare just fixes prices using a statutory and opaque regulatory scheme. Where Medicare's price control does not cover full provider costs (under-market payment), shortfalls are shifted to private payers who end up subsidizing the public program. Will a public plan negotiate rates or simply use fiat as a means of gaining subsidies from private insurance?

Third, private insurers must heavily invest to combat fraud -- or go out of business. These payers have every incentive to invest in antifraud personnel and strategies down to the point where return and investment are equal. This is very expensive. But anyone who tries to compare a public plan with private sector plans needs to consider Medicare's dismal record with regard to fraud, waste and other abuse.

In fact, the total amount of Medicare fraud is unknown. The government does not measure or estimate fraud in its programs; instead, it measures payments made "in error." According to Medicare's own most recent data, payments made in error amount to over $10 billion annually. (Medicaid's payment errors in 2007 equaled a whopping $32.7 billion, according to a report by the Department of Health and Human Services.) Others have claimed Medicare's payments made in error are much higher. Even with the inclusion of the budget of the inspector general for the Department of Health and Human Services, Medicare spends less than one-fifth of 1% on antifraud measures -- a small fraction of what private plans invest in their efforts to build a network of devoid of providers who will defraud them.

Worse, in four of the past five years Congress has turned back Medicare's pleas for $579 million of additional antifraud funding, on the grounds that these dollars subtract from the budget funds for curing cancer and anti-obesity campaigns. Based on experience, Congress will always under-invest in fraud. Yet according to a House of Representatives Budget Committee hearing in July 2007, return on investment for certain Medicare antifraud measures were estimated to be in excess of 13-1. Will a public plan also hemorrhage from fraud because of chronic Congressional underinvestment?

In a well run private system with no under-market payments, there are approximately 3-4% of physicians who are frauds. The current system contains many perverse incentives to upgrade coding and add more procedures than are necessary to make up for what they not getting in price controlled and under value payments from Medicare. They hide in the current system in the abundant gray areas. There is no good way to prevent fraud.  However, a good first step would be to  adopt a system that pays market value. A good second step would be to remove the gray areas. The “managed care system assumes that they are good doctors and bad doctors. The facts tell us differently. Most people respond to incentives which make sense and checks and balances.

Fourth, private insurers must incur the administrative cost of marketing. Medicare, of course, does not need to market. A public plan competing with other alternatives would have to market itself to the public, and this means tax dollars used to advertise against private plans. Or the public plan could "compete" by using heavily subsidized marketing channels not available to private insurers, such as Social Security mailings, welfare offices, unemployment check stuffers, and the constellation of government-funded "advocacy organizations."

None of these considerations should be interpreted as a defense of the status quo, or a denial of the fact that major health reform is needed. It is needed, and now.

There are indeed many places where commercial health insurance is inefficient -- for example, by trying to exclude the sick rather than compete for the business of managing their ailments more effectively. Moreover, the facilitation of a national insurance exchange could lower information and search costs for our increasingly mobile workforce.

But the impulse to "just pass something" -- a refrain heard often in the halls of Congress this spring -- is not good enough. There are more governmental paths to making things worse rather than better. As the case of Medicare's anemic anti-fraud efforts illustrates, less management and lower administrative costs do not necessarily mean the program is really less costly. Fraud losses are just categorized as additional spending rather than as administrative expense.

Ultimately, the desire of many advocates of a government-run health plan to exaggerate Medicare's efficiency derives from the fact that the program does not make a profit. These folks are motivated by the naïve assumption that most of the health sector's ills could be cured if profit-seekers were excluded.

The way to  really reduce costs especially administrative costs is to reform the design of health insurance and the heath care market place as well as the nature of the physician-patient relationship. We need to abandon third party procedure driven health care reimbursements and adopt lump sum payment to the patient’s reformed HSA from which they can pay all health care expenses directly with an electronic card. We also need to adopt insurance payments derived from protocols designed by physicians based on severity and experience.

As the Congress continues the health-care debate, today behind closed doors, and soon in the open, there should be an honest discussion of administrative costs and their value. Those who believe that health care should have no profit should be open with their views and not hide behind the false economy of Medicare.