Medicare Administrative Expense Reality Check

Discussions concerning the cost carriers incur in administering health insurance often compare the private sector to similar costs incurred by Medicare. Many claim the cost of Medicare administration is about two percent of claims costs. Meanwhile, the private sector is accused of spending 20, 25 percent or more. These charges are made so often and with such conviction that they’ve taken on the aura of truth. Thus the question: is it true or just an urban myth?

The answer is that the cost of administering Medicare is substantially higher than stated and the cost of administering private insurance is lower. At least that’s the conclusion of a January 2006 study entitled Medicare’s Hidden Administrative Costs: A Comparison of Medicare and the Private Sector. To be sure, the cost of administering Medicare is substantially less than the cost of administering private coverage (although this doesn’t count the the free-ride Medicare receives on the cost of its capital and customer service services provided by Congressional offices). 

The study concludes the actual comparison is more like 5.2 percent versus 16.7 percent (or 8.9 percent if commissions, profits and premium taxes are excluded). However, the Medicare percentage benefits from the higher cost it pays out per beneficiary which increases the denominator. The payout per beneficiary is in turn driven by the average age of those participating in Medicare — and even it’s younger beneficiaries incur higher than average claims.  In 2003 the average medical cost per beneficiary for Medicare was estimated at about $6,600; the average per person medical cost for those in private health insurance was closer to $2,700 (out-of-pocket costs are excluded from both figures).  When adjustments are made to equalize these differences the Medicare administrative costs would be closer to 6-to-8 percent range.

The report identifies several hidden expenses surrounding Medicare. For example, Medicare reports its administrative costs as a percentage of identified administrative costs divided by claims. Seems simple enough, but as the report points out, there’s a lot more to administering a health plan than just paying claims. For example, there’s an entire bureaucracy involved in managing Medicare, the Centers for Medicare and Medicaid Services (CMS). Yet the salaries of these professionals are not included in Medicare’s administrative costs. Nor are the marketing costs incurred by CMS to promote Part D. Nor Medicare’s use of the tax apparatus to collect “premiums.” By overlooking these and other hidden costs, advocates of government-run health care greatly underestimate the true cost of administering Medicare.

The report also points out another myth inherent in the whole cost of administration argument: some administrative costs add value. Disease management programs can help reduce overall medical care spending while improving the quality of life for insureds. The private sector also pays taxes, government fees and incurs the cost of compliance with government mandates and reports. Good or bad, these costs are beyond the control of private health plans.

What all this comes down to is that administrative costs are inherent in any system. And not all administrative costs are bad. The key question is whether a health care coverage provider — public or private — is efficient or not. Artificial ratios don’t get to that question.

8 thoughts on “Medicare Administrative Expense Reality Check

  1. I have not read the entire study… I was wondering if the study looked into the administrative costs per claim that is processed??? It seems that percentage wise, Medicare is lower, but per person, private insurance is best. We get to see the average total amount of claims paid, how about comparing it to number of claims processed and leave the other components out like taxes, profit, salaries, and ect… Thanks!

    Clay

  2. Regarding good administrative costs, you write:

    Disease management programs can help reduce overall medical care spending while improving the quality of life for insureds.

    Got any numbers on that? And some explanation of what “disease management programs” might mean?

    • Thanks for the question. Disease management programs are services provided by many carriers to help insureds with chronic conditions obtain and maintain appropriate care. For example, it may involve nurses contacting diabetics to remind them of the need for a check-up or other treatment. The theory behind these programs is that by incurring additional medical costs now, future and larger medical costs can be avoided. I have seen documents showing how these programs improve the quality of life and reduce overall medical costs, but I don’t have them handy. If anyone else out there does, please let us know.

  3. When you dig further into the source of the study you cited, you get this: “One of the main organizations working to subvert consumer protection in state health insurance laws and regulation by eliminating essential mandates, as well as other reforms, is the Council for Affordable Health Insurance. The CAHI is a front group for the least reputable of America’s small group health insurance companies like UICI of Dallas, which sells insurance through the Mega-Life Health Insurance and Mid-West National Insurance Companies. UICI is under investigation or has been investigated in half a dozen states for insurance fraud and has been sued in several states for insurance fraud and securities fraud. UICI’s questionable activities have been documented in articles published by the Wall Street Journal, Mobile Register and Boston Globe. Families USA has written an issue brief, The Illusion of Group Health Insurance, Discretionary Associations, which documents the predatory business practices of UICI and similar companies that are exploiting small businesses and the self employed.” Source: thehealthcareblog.com and independent blog about health care policy.

  4. So Medicare’s administrative costs are about half that of private health insurance ? Can you explain why we shouldn’t offer Medicare to everyone and let private insurance companies compete if they can ?- as FEDEX and other shipping companies compete with the US Postal Service.

  5. Alan thank you for the clarity of your explanation. This is a question I hear often from clients and it has always been somewhat difficult to answer.

    I hope the folks in Sacramento take the time to read the report. It is a shame that if you say something often enough people will take it as truth.

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