Does Medicare actually have higher administrative costs than private insurers?

Greg Mankiw links to an article that illustrates the challenges of interpreting raw numbers causally. This would really be a great example for your introductory statistics or economics classes, because the article, by Robert Book, starts off by identifying a statistical error and then goes on to make a nearly identical error of its own! Fun stuff.

Book sets up the story:

Many advocates . . . claim that a public health plan will save money compared to private health insurance because “everyone knows” that the largest government health program, Medicare, has lower administrative costs than private insurance. . . . Advocates of a public plan assert that Medicare has administrative costs of 3 percent (or 6 to 8 percent if support from other government agencies is included), compared to 14 to 22 percent for private employer-sponsored health insurance . . .

He then points out the problem with this raw comparison:

Medicare patients are by definition elderly, disabled, or patients with end-stage renal disease, and as such have higher average patient care costs, so expressing administrative costs as a percentage of total costs gives a misleading picture of relative efficiency. Administrative costs are incurred primarily on a fixed or per-beneficiary basis; this approach spreads Medicare’s costs over a larger base of patient care cost.

Excellent point. Don’t forget about the denominator, as we always tell our students.

The next step, I’d think, is to compare costs for different groups of potential patients, characterized by age, health status, and socioeconomic and demographic background variables.

But that’s not what Book does–instead he just compares average administrative costs per patient: $509 per primary beneficiary for Medicare, $453 for private insurers. But this can’t be right: of course, Medicare patients, who are older, sicker, and are going to the doctor and hospital more often, will have higher administrative costs! It seems silly to jump all over the first set of unadjusted numbers and then take the second set of unadjusted numbers at face value, leading to this claim:

If recent cost history is any guide, switching the more than 200 million Americans with private insurance to a public plan will not save money but will actually increase health care administrative costs by several billion dollars.

I don’t buy it–for essentially the same reason that I find Book’s first argument persuasive. It would seem to make more sense to compare comparable groups of people. (But see Book’s comment below, defending his calculations.)


I’m no expert in health policy. These are just my impressions as a teacher of statistics. It’s great to find such examples that are so relevant to policy. I was surprised to see Mankiw quote the above article without criticism; but I’m pretty sure he’s studied these issues in a lot more detail than I have, and so perhaps he has additional knowledge that makes him confident in the substance of Book’s reasoning.

In particular, I expect that Mankiw has spent some time talking with the faculty at Harvard’s world-class Department of Heath Care Policy. I don’t know if any of their professors are Eagle Scouts, but they do have this guy, who was the founding editor of the Journal of Health Economics, a member of the editorial board of the New England Journal of Medicine, vice chair of the Medicare Payment Advisory Commission, etc etc. Also on the board of directors of Aetna so it looks like he has experience on both sides. Perhaps Newhouse or one of his colleagues has done a more detailed study that support’s Book’s conclusions.

P.S. Krugman links to an article by political scientist Jacob Hacker that questions Book’s numbers. I doubt Mankiw reads my blog very often, but I expect he’ll respond to Krugman, so perhaps he’ll supply some more data to rebut this. Could be interesting.

P.P.S. Book responds on Krugman’s blog, explaining why in his opinion the Hacker report does not shoot down Book’s numbers. I’m still skeptical of his claim that, “The appropriate measure is administrative cost per person.” Perhaps he can address this.

P.P.P.S. Book does address the cost-per-person issue in a comment below. At this point, I’ll just have to say that the answer depends on specifics of billing, administrative costs, etc. I don’t think I have anything further to add. But I still think it will be a great teaching example.

10 thoughts on “Does Medicare actually have higher administrative costs than private insurers?

  1. Dr. Gelman,

    Thanks for the link. As one who I fondly (!) remembers an econometrics course I took in grad school based on your book, Bayesian Data Analysis, I appreciate that you took the time to comment on my article.

    I hope you have a few minutes to read this comment, so I can explain why the problem you identify in my article is not, in this particular case, actually a problem.

    You wrote:

    Of course, Medicare patients, who are older, sicker, and are going to the doctor and hospital more often, will have higher administrative costs!

    This is true, but only to a very limited extent. The only portion of Medicare administrative costs that is at all sensitive to "going to the doctor and hospital more often" is the cost of claims processing. As I pointed out in my article, claims processing accounts for only 4% of Medicare administrative costs — which is to say, less than 0.24% of total Medicare outlays. This amount is nearly small enough to be lost in the measurement error, never mind the estimation error when comparing Medicare as it stands now to any proposed alternative.

    Furthermore, claims processing cost is linear (actually, affine) in the number of claims, not the dollar value of those claims. There is a small difference between processing a hospital claim vs. a physician claim, but the cost of processing a claim $50 doctor visit is the same as for a $300 doctor visit.

    In short, the fact that Medicare patients need more health care is only a very small contributor to administrative cost. Even if, due to some amazing stroke of luck with regards to health, there were a year without Medicare claims, Medicare’s total administrative costs incurred would not change very much. Of course, in that happy event the administrative cost would be 100%, which just goes show how silly it is to express health care administrative costs as a percentage of total program costs.

    It is also clear from a moment's thought that this is not a good way to compare programs. If you insure a healthy 25-year-old who never goes to the doctor (or at least, not enough to exceed the deductible), a health plan's administrative cost for that person is 100% of total costs, no matter how efficient the administration is. And, private insurance has a lot more people like that than Medicare does. However, you can still compare administrative cost per person in a case like that, and by that standard Medicare is more expensive than private health plans. This point stands unrefuted, even given your point (and Krugman's quote of Hacker — which incidentally was written six months before the article Krugman claims it refutes).

    In claiming that switching the 200-plus million Americans on private insurance to a public plan would increase administrative costs, I admit there was an element of aping the claims of the "other side" to make the point. They assume administrative costs are X% of total costs, so they take the total costs of private insurance, apply that percentage, and assume the difference will magically appear as cost savings. I was basically saying: Use that logic and apply it to administrative cost per person, and now it looks like costs would go up rather than down.

    Of course that's not a realistic way to estimate administrative costs of a new plan. But it's at least slightly less bad than the "percent of patient care costs" approach, since at least it uses the right dependent variable!

    There are, however, several good reasons to believe that administrative costs would go up, not down, if a public plan were expanded to all or a large fraction of those currently uninsured or privately insured.

    First, since administrative costs are mainly enrollment and management costs, in the transition there would be a huge cost to expand administrative capacity to enroll large numbers of people in a short time. There are currently about 42 million people enrolled in Medicare. It's been estimated that a "public plan option" would result in almost 120 million people losing their private insurance and switching to the public plan; creating a "single-payer" system would involve enrolling the 260 million Americans not currently in Medicare. There is no reason to believe that even the per-person costs would stay as low as they are if the program were quadrupled or nearly octupled in size, at least during the ramp-up period.

    Second, a substantial portion of Medicare's administrative cost goes into determining prices to pay for medical services. These prices are set based, for example, on surveys of doctors who already perform those procedures for non-Medicare patients, and on surveys of hospital costs for non-Medicare patients. In short, Medicare is free-riding on the experience of the private sector. If the private sector disappeared or shrank substantially, Medicare would have to incur additional costs to obtain that information.

    (If you're interested in my response to the Hacker quote that Krugman gave, see my post here.)

    Thanks again, and if you have any more comments on my statistics — or anything else — I'd love to hear them. My goal is to get this right, not to slam the political opposition (except perhaps to the extent that they might be the same thing! :-) ). If you're interested, I can send you a draft of my longer paper on this topic, of which the article you saw was a sort of "advance excerpt"). That has a lot more detailed discussion of the quantitative issues than I could put into 1200 words for a short article.

    –Robert Book

  2. One of the insightful comments on Krugman's article indicates how arbitrary the selected figures can be :

    16. July 6, 2009
    10:01 am

    The big lie here is hidden in another paper (

    “In order to allocate a reasonable proportion of these costs for general government functions to Medicare, we use the share of Medicare spending in total federal outlays, and then apply that proportion to the costs of general government as shown in Table 5.”

    In other words, the authors decide that Medicare is responsible for about 15% of “general government” costs, and therefore add about $10 billion to its reported administrative costs in 2005. Of course, this makes Medicare look a hell of a lot worse than it actually is; its real administrative costs for that year were around $9 billion, not $19 billion.

    — David

    Guess the old adage may now change to " lies, damn lies and figures on healthcare adminstrative costs."

  3. "Of course, this makes Medicare look a hell of a lot worse than it actually is; its real administrative costs for that year were around $9 billion, not $19 billion."

    Of course you have a link to that number, don't you?

  4. To determine if 'per person' or '% of outlays' is a better measure; you really need to understand what activities are performed as part of the administrative duties.

    Book says: "…claims processing cost is linear (actually, affine) in the number of claims, not the dollar value of those claims. There is a small difference between processing a hospital claim vs. a physician claim, but the cost of processing a claim $50 doctor visit is the same as for a $300 doctor visit."

    I don't know where he gets his data to support this claim. If processing a claim is a manual task, with no additional audit/work for different size & type of claims; then using per person is probably a better measure. However, if claims processing is automated (via IT), then administrative costs are non-linear; you would have a large upfront cost of setting up the system, after which you would see decreasing costs on a per person basis.

    Nevertheless, focusing only on costs may miss the big picture. As Mankiw points out in his blog post (Costs versus Efficiency): "Low administrative costs are not to be confused with high administrative efficiency"

  5. The other problem, of course, is that the Medicare budget does not include a number of administrative costs that private insurers incur. Medicare incurs those costs but they appear in other parts of the US government budget. (This is a huge problem in comparing health spending in different countries–in many cases what the US counts as health spending is counted as social spending in other countries. Work by OECD suggests that when accounting differences are taken into account, health spending in other countries increases by up to 25 percent.)

    The Medicare costs not in the Medicare budget include items like building management, the managerial time put in by Congress, fee collection, research on better ways to do things, premium collection, the costs of debt service (a big deal given that Medicare is insolvent), and the costs of investigating and controlling fraud.

    The tax funding of Medicare distorts economic decisions. This generates another unmeasured administrative cost. Finally, Medicare does not have to incur the costs that private companies incur in order to comply with the tax code.

    As papers by Benjamin Zycher, Merrill Matthews, and Mark Litow make clear, private plan administrative costs appear to be in the 11 to 14 percent range for direct purchase insurance. The costs of administering employer group insurance are said to be lower, but estimates of those costs do not include the cost of the human resources departments needed to do employee health insurance administration.

    When all costs are included, the true cost of delivering Medicare benefits appears to be around 25 percent, about double the cost in the private sector.

    The pursuit of profit gives private firms a big incentive to pay close attention to cost control, including the reduction of administrative cost. In government, people do not face the same set of incentives with the result that administrative costs are generally higher.

    One of the morals in this case is that before one starts analyzing data it is important to understand what it is, and what it is not.

  6. Please correct my misunderstanding. The table you refer to shows indirect admin costs of 9.6, and direct admin costs of 11, totalling 20.6 billion in admin costs. I realize you refute this above, however when we apply overhead for the company I work for, we use a similar approach. Please explain why this is incorrect, I just want to understand.

  7. "But this can't be right: of course, Medicare patients, who are older, sicker, and are going to the doctor and hospital more often, will have higher administrative costs!"

    If older people have more and bigger claims that should reduce the overhead per person because:

    1) It costs nearly the same to process a $1000 claim as a $100 claim.

    2) Maintenance of the individual's record overhead is the same no mater the number of claims (name, address, eligibility…)

    3) Collecting premiums (taxes) has the same overhear whether it is small are large.

  8. Bizarre,

    This is realy bizarre, it tells me that some people are wearing blinders and have NEVER been in an office full of medicare paitents or dealt with medicare paitents.

    There realy is "Class War" in America!

    I know it's wikipedia but it says:
    Medicare contracts with regional insurance companies who process over one billion fee-for-service claims per year. In 2008, Medicare accounted for 13% ($386 billion) of the federal budget.

    This looks like it cost around $386 per service-claim, can't we compair apples to apples, WTF, you guys are supposed to be the brains and you can't agree on or figure a Unit-Cost for both?

    No wonder this country is screwed! wow, how embarrasing, we can put a man on the F-ing moon 40 years ago but we can't figure out what it costs for Medicare V Private Insurance today? I'm gonna send a letter to NASA i'm sure they can figure it out!

    First off, People don't care where they get their health care, in fact they would rather get it from a Private source, I know NOBODY who prefers Medicare to Private Insurance…

    but because of Fraud, Greed, and Abuse Private Health Insurance is a FAILURE for The People! (unless you discount the sick and the poor, which I know some of you do)

    *HCA systematically defrauded Medicare, Medicaid and other federally funded health care programs through schemes dating back to the late 1980s. HCA will pay an additional $11 million to resolve separate allegations of improper HCA billing practices.

    *Why Corporate Fraud Is On The Rise –

    *Rex Healthcare, of North Carolina, has agreed to pay $1.9 million to settle allegations that it fraudulently charged Medicare by improperly classifying patients for inpatient services.

    The "IG wants authority to boot corporate execs from Medicare for fraud" I agree, any corporations found guilty of fraud should be excluded from doing business with our government!

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