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All Da King's Men

Does Medicare Have Lower Administrative Costs ?

By Da King Published: July 9, 2009

One of the talking points used by those favoring a single-payer health care system is that Medicare's administrative costs are FAR lower than those of private insurance companies. Here's liberal columnist and writer Joe Conason (whose latest book was titled 'The Right-Wing Propaganda Machine and How It Distorts the Truth') parroting that point at

Private insurers consistently spend more on overhead and administration than Medicare. To anyone who shares the broad prejudice against government, the difference will be startling, although these numbers are very well known to health experts. The average overhead cost of Medicare is roughly 2 or 3 percent, far below the administrative costs of private insurers, which range between 27 and 40 percent.

Wow. According to Conason, there would be a 25-37% savings in overhead if we go to a universal Medicare-type government single-payer insurance plan. That's GREAT ! Sign me up !

Well, there is one teeny weeny little problem with Conason's statement...

It's a big ole pile of stinking cow flop. Not even remotely factual. For a guy who wrote a book about right-wingers distorting the truth, Conason is distorting the bejesus out of the truth. Here's why:

First of all, the 2% figure for Medicare's administrative costs comes from a Congressional Budget Office (CBO) estimate. That much is true. However, the CBO expresses administrative costs as a percentage of Medicare's total patient costs. Because Medicare patients are elderly and suffer from more health issues than the general population, Medicare patients incur a lot more per patient expense than the general population demographic that is covered by private insurers. That distorts the real administrative costs of Medicare. Here's the Council For Affordable Health Insurance (CAHI) to explain:

Medicare calculates administrative costs as a ratio of identified administrative costs divided by claims. In 2003, the average medical cost for Medicare was estimated to be about $6,600 per person per year (because of the nature of Medicare’s beneficiary pool of older and disabled people), while the average medical cost for private health insurance, excluding out-of-pocket cost, was $2,700 per person per year. Because of the higher cost per beneficiary, Medicare’s method of calculation makes administrative costs, albeit unintentionally, appear to be lower than they really are. Indeed, if the numbers were adequately “handicapped,” they [Medicare] would be in the 6 to 8 percent range.

To illustrate this, let's assume that both Medicare and private insurers have a fixed per patient administrative overhead of $132 per patient, exactly the same. If we express this as a percentage of patient costs, that makes it appear to be a 2% administrative overhead for Medicare (based on $6600 spent per patient), and a 4.9% overhead for private insurers (based on $2700 spent per patient), 2 1/2 times as much. This would make Medicare appear to be more efficient from an administrative standpoint even if their administrative costs were identical to those of private insurers. That's the first way administrative costs are skewed.

Second, Medicare doesn't include everything as administrative cost in the same way that private insurers are required to do. These are Medicare's hidden costs that don't appear in the CBO estimate. Here's more information from CAHI:

Company Policies — Executives and boards of directors consider, debate and decide company policy; in Medicare that function is often handled by Congress and its legislative staff. Setting program policy requires time and money not reflected in Medicare’s official administrative cost estimates. Just imagine all of the congressional and administrative staff time and effort devoted to creating, debating, promoting, opposing and ultimately passing the Medicare Modernization Act of 2003. One might compare it to a huge new corporate venture or restructuring. Yet not a dime of the money and time spent on that months-long public debate appear in Medicare’s administrative costs.

Management — Businesses must include management costs in their administrative costs: Medicare doesn’t. The salaries of those professionals at the Centers for Medicare and Medicaid Services (CMS), from Dr. Mark McClellan down, are excluded from Medicare’s administrative cost estimates, as are the building costs to house that part of the leadership team. Private insurers don’t have that luxury.

Raising Capital — Private industry has to raise capital, usually by selling stock or borrowing funds. And if an insurance company borrows money to pay for a building, it must pay interest on the loan. In other words, in the private sector there is a cost of capital. Of course, the federal government also raises capital and borrows money to pay Medicare claims, and it even pays itself interest on some of that borrowed money. But it includes none of these costs in its administrative estimates; it simply takes (or will take) the money from taxpayers. And while Medicare’s “cost of capital” is big now, it will grow exponentially in the future as Medicare outlays grow faster than the Part A payroll tax [the Medicare/SocSec unfunded liability has reached $107 trillion].

Premiums and Commissions — One of the most common complaints is that the private sector has to pay agents to market and sell its products, which, critics contend, the government doesn’t have to do. Well, not exactly. You may have noticed that CMS has been heavily involved lately in promoting the new Medicare drug benefit. Nothing wrong with that, but those are marketing costs, which are ignored in Medicare’s administrative numbers. Premiums are the primary way private insurers obtain the funds they use to pay claims. But the government also has to bring in funds in order to pay Medicare claims. How does it do that? Through taxes. Employers, the IRS and the Social Security Administration are, in effect, the sales force and collection arm for the Medicare program. Workers and employers currently split the 2.9 percent payroll tax that funds Medicare Part A. Employers, of course, have to handle the administrative functions of getting that money to the government. Thus, that part of Medicare’s “premium collection” actually shows up in employers’ administrative costs — including, ironically, those of insurers collecting that 2.9 percent for the government — rather than Medicare’s. Revenue to pay the government’s share of Part B — 75 percent of the program’s costs — comes from general revenues collected by the IRS. And the Social Security Administration collects the 25 percent of the Part B program that comes from seniors’ Social Security checks. Yet again, those “collection costs” are ignored in Medicare administrative cost estimates.

Claims Processing and Fraud — Medicare pays claims, millions and millions of them. The claims volume is so heavy that there is little time to do anything else — like scrutinize and review the providers’ bills, check with providers if something looks amiss and withhold payment until discrepancies have been resolved. Rather, Medicare is set up to catch problems primarily in cases of massive fraud and abuse, and it does that through the Inspector General in the Department of Health and Human Services, not CMS. In other words, while insurers see claims oversight as responsible stewardship and a collaborative effort to ensure proper payment, HHS operates more as a policing effort [Medicare fraud is estimated at $60 billion per year].

Premium Taxes — Every state imposes a tax on premiums collected, usually running in the 1 to 3 percent range. Those taxes are factored in as part of a company’s administrative costs. Obviously Medicare has no equivalent. But it highlights the point that part of the insurance industry’s administrative costs are not because the private sector is inefficient, but because government is taxing it and imposing regulations and unfunded mandates (that is, it tells the private sector to do something, but doesn’t reimburse its costs). There is something a little disingenuous about imposing unwanted taxes and regulations on an industry and then criticizing it because its administrative costs are higher than the untaxed government program.

Now you know a little more of the truth about administrative costs, and how the numbers are so heavily skewed in the government's favor. But the question remains, does Medicare have lower administrative costs than the private sector ? With all it's unfair advantages, you'd think so. CAHI admits it's very difficult to estimate the true costs of administering Medicare. In a 1994 study, CAHI found Medicare's administrative costs to be significantly higher than those of the private sector, but CAHI came up with a the following results in it's 2003 study:

we calculate Medicare’s administrative costs to be 5.2 percent in 2003, while the private sector runs 8.9 percent when commissions, profit and premium taxes are excluded, and 16.7 percent when those factors are included.

Medicare is still less by 3.4% according to CAHI's 2003 study, until profit and taxes are added in. Because profit and taxes are fluid, obviously those number can change, but they are still a factor. Yahoo Finance shows the average net profit margim in the health insurance industry to be 3% right now, for what it's worth.

A recent article by the Heritage Foundation actually showed that the per patient administrative overhead for Medicare was higher than the equivalent private insurance overhead from the years 2000-2005. Heritage based it's numbers on CMS (Medicare) data and Census Bureau extrapolations. There's a graph at the link explaining the numbers. After Heritage published it's results, the worst economist in the world and former Enron adviser, Paul Krugman of the NY Times, attempted to refute the Heritage Foundation with some statistics of his own (while ignoring Heritage's actual data and simultaneously launching ad hominem attacks against Heritage). Then Heritage attempted to refute Krugman's refutation. And so it goes.

Are Medicare's administrative costs cheaper ? I don't know. Maybe a little, or maybe not at all. Beats me, but I know one thing for sure. Guys like Joe Conason are lying through their teeth. Where did he pull those figures about private insurer overhead being 27-37% from anyway ? I never could find any corroborating info on that. Maybe he pulled it from his "anal"ytic file.

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