Transaction Costs in the Provision of US Health Care
June 28th, 2007
“In 2003 Medicare spent less than 2 percent of its resources on administration, while private insurance companies spent more than 13 percent.”
Source: Paul Krugman and Robin Wells, The Health Care Crisis and What to Do About It, New York Review of Books, Volume 53, Number 5, March 23, 2006.
This implies that a massive 11% of private insurance companies expenditure goes on pure transaction costs (monitoring, enforcement, litigation etc etc).
More Details
Krugman and Wells aregue that the two main problems of the US system are:
- Its lack of universal coverage
- Its extremely high per capita cost of healthcare provision (compared to other countries developed countries)
With regard to the second item they argue that much of the massive differential in per capita costs of health care in the United States is due to the uniquely high level of private (rather than public) provision in the US system. This is for two reasons. First, centralized, public provision, results in much lower transaction costs compared to private provision. Second, centralized, public providers can bargain more effectively with suppliers to obtain lower prices. As evidence for the first point they state:
The cost advantage of public health insurance appears to arise from two main sources. The first is lower administrative costs. Private insurers spend large sums fighting adverse selection, trying to identify and screen out high-cost customers. Systems such as Medicare, which covers every American sixty-five or older, or the Canadian single-payer system, which covers everyone, avoid these costs. In 2003 Medicare spent less than 2 percent of its resources on administration, while private insurance companies spent more than 13 percent.
At the same time, the fragmentation of a system that relies largely on private insurance leads both to administrative complexity because of differences in coverage among individuals and to what is, in effect, a zero-sum struggle between different players in the system, each trying to stick others with the bill. Many estimates suggest that the paperwork imposed on health care providers by the fragmentation of the US system costs several times as much as the direct costs borne by the insurers.
June 29th, 2007 at 6:08 pm
Well, there are lies, damned lies, and statistics, aren’t there?
Let me first preface my comment by saying I’m every bit the advocate for healthcare reform that the great Paul Krugman is. And I’m a card-carrying liberal Democrat who’s all for an egalitarian solution to our healthcare delivery and finance problems.
But there’s just one problem with the on-going suggestion that Medicare somehow has lower admin costs than private insurance. I’m in the health insurance analysis business, and can tell you from publicly available information that there is no inherent difference in Medicare admin costs versus the private commercial insurers admin costs for, say, a privately insured 35-year-old.
The misunderstanding arises from expressing the admin costs as a percent. Does anybody bother to ask, as a percent of what? The ratio we’re talking about, in the health benefits business, is known as the administrative cost ratio, or ACR. You get that number by dividing the average monthly amount spent on administration of the health benefit by the average monthly premium.
So ACR = admin/premium.
Knowing that, you have to realize that the average monthly premium for our hypothetical commercially insured 35-year-old runs around $300 per-member, per-month these days. So if, as we know, commercial insurers are spending 13 percent on admin, then that’s about $39 PMPM, which is about right.
But here’s where the statistics start to mislead. It costs much more to treat folks in Medicare. That only makes sense. These folks are older, some of them are sick, some of them are dying. The average monthly premium for Medicare folks — and I’m using private Medicare HMOs for my basis, but their costs are about 10 percent lower than the government-provided Part A/Part B fee-for-service plan that most seniors use — runs in the neighborhood of $750 to $900. Add on the 10 percent higher costs of non-managed fee-for-service Medicare and you’re at around $1,000 a month for each senior. If we believe Krugman’s assertion — and we should, because it is probably correct — that Medicare’s admin costs are around 2 percent, well, what’s 2 percent of $1,000? Around $20. Throw in the fact that Medicare doesn’t have to account for the money it borrows (which commercial insurers do, under admin), throw in the fact that Medicare can’t market or advertise, and has no sales costs (which commercial insurers must, under admin), and throw in the fact that Medicare can house all its workers in rent-free, peroperty-tax-free buildings (which commercial insurers can’t, so adds to admin), and you easily make up that other $19 per-member, per-month.
So I’m making two points here. First, when they say commercial insurers’ admin is 13 percent and Medicare’s is 2 percent, just remember that it’s 13 percent of $300 versus 2 percent of $1,000, NOT 13 percent and 2 percent of the same number.
But the other point is, once you know that, you realize that it is not voodoo, or some inherent goodness of government processing systems or the ability to negotiate better rates that gives Medicare an admin advantage over commercial private insurance. Its no marketing, it’s no interest/borrowing costs, and no rent/taxes that makes up what is actually a smaller difference than what the out-of-context numbers might lead you to believe. And it is an advantage that will go away the minute you start trying to expand Medicare to cover all the commercially insured folk. In other words, Medicare-for-All will make Medicare more like commercial insurance, not the other way around.
January 8th, 2008 at 12:30 am
I believe the key to quality healthcare is in choosing the right plan. While the healthcare system does need improvement if Americans take the time to research and find the right plan it can at least be manafeable. The Medicare system is getting better also. There are many more options these days for medicare insurance. I think it all depends on making wise decisions
July 24th, 2008 at 1:51 am
I could agree more with you Michael. All we need here is a careful searching to obtain a wise decision on choosing the best medicare insurance. There are a lot of free resources about this insurance thing available online. Some even provide counseling services…
-Anne
November 10th, 2008 at 5:00 pm
In assessing the savings under Medicare, my assumption was that Krugman was saying that commercial insurance spends about 75-80% of their total income on the actual delivery (medical loss ratio) while Medicare spends about 97% on health care delivery. The waste is in excessive costs for marketing, general administration, and salaries like the $50 million or so for the CEO of United Health Care and like the $15-20 million for the CEO of Wellpoint. If, indeed, we are spending about $7,300 per man/woman/child in the US, one would think we could find a better way to keep the number from escalating at a rate 5-6% higher than CPI every year.