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.