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Friday, January 3, 2025
Administrative Costs Aren't Waste
The murder of Brian Thompson has rejuvenated debate on the American health care industry, which had been a relatively sleepy topic since the failed attempt to repeal the ACA in 2017. Prior to the passage of the ACA in 2010, the American health care industry was decried as high cost, inefficient, and poor quality. Documentarian Michael Moore released Sicko in 2007 documenting all the problems with American healthcare: our life expectancy was comparatively low even though we spent more money than any other advanced nation in the world; health insurance companies caring only for profit, would deny legitimate claims; hospitals and physicians charged too much; there was too much emergency care which was higher cost; the system treated symptoms not causes; health insurance was too expensive and people with pre-existing conditions couldn’t purchase it at all; and 45 million people were uninsured.
While the ACA did nothing for most of those problems, the debate about healthcare practically disappeared after its passage. There were individual issues here and there—surprise billing, individual mandate, public option—but the topic never became a major national issue the way it was from 2004-2010 until last month.
Time will tell if this persists, especially once President Trump takes office and begins working on his agenda which will focus more on immigration, taxes, and regulations, but the recent uptick has resurfaced some of the same arguments from 15 years ago.
The Debate So Far
Noah Smith, an economist and writer, argued that the criticism of insurance companies is misplaced. Smith’s core argument is that because insurance companies are not very profitable, they cannot reasonably be thought of as the source of the large problems in healthcare. Essentially, the anti-insurance company bastion are arguing that insurance companies are collecting premiums and then doing everything they can to not pay for their beneficiaries’ care, and pocketing the difference, but if their profits are low, then the degree to which they could be squeezing those in need, must also be low.
In response, Matt Bruenig argued the opposite, that health insurers are the worst aspect of America’s health care system, and bear a disproportionate share of the blame for the problems. The crux of his argument is that 16% of money spent on health insurance goes to administrative costs. On top of that, another 19% of hospital revenue goes to administrative costs. He concludes, then that for every $100 spent on health insurance, only $68.04 actually goes to health care.
Firstly, he omits some important elements, out-of-pocket costs bypass insurance altogether and go to the hospital. Hospitals aren’t the only entities that insurance companies pay. Physicians and clinics both have lower administrative costs according to the CBO analysis he cites. The CBO report he references also doesn’t seem to include administrative costs outside of CMS, such as the Centers for Medicare and Medicaid Innovation or MedPAC; both of which represent government spending to support Medicare. Further, Avik Roy points out how Medicare administrative costs can be misleading.
Administrative Costs Can Help Reduce Overall Costs
Bruenig’s core argument is that these administrative costs are completely wasteful, but that’s not entirely true. Firstly, there’s profits. Profits are incentives for both sides to reduce costs. And these are low for insurance companies, below 5%, lower than other insurance products and most other industries. Hospitals’ profit margins are even lower.
Insurance companies reduce costs in many ways beyond the most infamous. They research the value of new and existing procedures; they use network design to nudge beneficiaries to the most efficient hospitals; and they find design their cost structures to incentivize better-value care. There’s no better example of what the benefits of administrative costs can achieve than the example Bruenig believes supports his argument—Medicare Advantage. While we tend to think of Medicare as a fully government-run and administered insurance product, it is actually divided roughly equally between the traditional Fee for Service Medicare (FFS) that everyone basically understands, and Medicare Advantage (MA), which allows seniors to choose a private plan that offers all the services of traditional Medicare with extra benefits.
Medicare Advantage Deflates Bruenig's Argument
Bruenig points to sources that claim that Medicare Advantage plans have much higher administrative costs, 17% versus 1.3% for FFS. Though the numbers he uses aren’t entirely accurate1 or instructive, what Bruenig and most others don’t realize is that Medicare Advantage plans provide the same services to seniors that traditional Medicare provides, but at a lower cost. So, whether in spite of the higher administrative costs or because of them, the private payers achieve lower overall costs than the public payer.
Medicare Advantage plans are private insurance plans paid based on many factors, interacting in complicated ways. What’s important to know is that every year these plans estimate the cost of covering their beneficiaries. This estimate is submitted to the government as a “bid.” The government compares this bid to what it pays to cover similar seniors2 and pays the plan their bid plus some of the difference between the plan’s bid and what Medicare expected to pay for that beneficiary.
MedPAC reports that, on average, Medicare Advantage plans’ bids are 79% of traditional Medicare’s costs, suggesting that the private plans can provide the same services as Medicare inclusive of administrative costs, for 21% less than Medicare.
To be sure, there are many countervailing facts that muddy this comparison. Many people believe that MA plans manipulate the system by attracting healthier people within the risk groups and then “up-coding” them into a less-healthy risk group to boost their payments. However, even after these elements are factored in, MedPAC concludes that the bids are about the same as Medicare’s actual costs, meaning that even accounting for favorable selection, up-coding, administrative costs, and profits, MA plans cost about the same as traditional Medicare, and there is reason to believe that their estimate of up-coding is excessive.3
Lastly, the bids are inclusive of administrative costs and profits so are above what the plans actually spend on direct healthcare for their beneficiaries. Bruenig uses the Medical Loss Ratio (MLR), to determine what actual costs are, which seems appropriate. He points to a KFF analysis that found that 83% of MA plans’ revenues goes to actual healthcare1, which would imply that the administrative costs are allowing these private plans to find a way to provide the same healthcare services to seniors for 17% less than traditional Medicare.
Private plans provide the same services to Medicare beneficiaries at lower cost than traditional, government-run Medicare
When all of this information is taken together, it shows that Bruenig is incorrect to say that the administrative costs in health insurance represent an enormous, wasteful drain on resources, and the Medicare Advantage program, contrary to his assertion, undercuts his argument. Given MedPAC’s analysis, one could conclude that administrative costs do serve to lower health care costs, but perhaps not by more than the administrative costs add to it. As with most topics, it’s a complex issue with many interacting and constantly changing components that defies simple analysis.
Footnotes
1In reality, the MLRs for MA plans are higher than 83%. By law, they must be 85% without incurring penalties. 83% was specific to 2020, which was an uncharacteristic year due to Covid. Most years KFF found MA MLRs fell between 85 and 87%. Also, KFF’s analysis leaves out money that plans spend on health benefits that beneficiaries receive. Including them as administrative costs is inappropriate.
2Medicare risk adjusts payments to account for differences in age, sex, previous diagnoses, and geography.
3To estimate up-coding in 2024, they took their 2021 estimate, and extrapolated a 2024 estimate based on the 2017-2021 trend, which was higher than other years. While it wasn’t necessarily wrong, it’s an estimate based on three-year old, atypical experience in an extremely dynamic environment.