A comprehensive look at the administrative costs of private vs public healthcare in the United States.
Most Americans will always assume that the private sector is more efficient than government when it comes to performing a task or providing services to people. In many cases this is true. However, that doesn’t mean it’s always true. There are things that governments do quite well. Most would agree that the government is great at collecting and spending money.
This is essentially the primary function of health insurance. Yes, insurance companies in the private sector also have to do risk modeling to determine eligibility. Public insurance like Medicare is only concerned with eligibility requirements which eliminates much of the risk modeling.
Insurance companies don’t actually perform any healthcare delivery. They only pay for it. So when comparing private vs public healthcare insurance, a good measure is administrative cost. Administrative cost makes up any funds that aren’t paid out to the healthcare system. It’s essentially the cost to run the business of health insurance.
In this article we are going to look at the administrative cost of the programs handled by the Centers for Medicare & Medicaid Services (CMS). Those are mainly Medicare and Medicaid. We will then compare the administrative cost of those public programs with the cost of administration for private sector health insurance companies.
Two Administrative Measures of U.S. Public Healthcare
There is always a lot of confusion when the topic of U.S. public health insurance administrative costs are discussed. This is mainly due to CMS releasing two very different sets of numbers every year. Opponents of public healthcare are quick to point this out, and chalk it up to discrepancies between the methods. This typically leads them to conclude the numbers should not be trusted.
Defenders of public healthcare don’t do themselves any favors by taking the two different measures and quoting them as a range. For instance, they will say U.S. public health insurance administrative cost is between X% and Y%.
This is solely due to a lack of understanding of the methodologies of both reports. Both of them report on administrative cost, but due to the complex nature of the United States healthcare system, they each compile a different set of administrative cost. The two reports are the National Health Expenditure Accounts (NHEA) and the other is the Medicare Board of Trustees Report.
We will use these two reports to compare private vs public healthcare insurance. I will also explain that both reports are a legitimate tally of administrative cost. The differences are due to the nature of certain administrative cost. And those differences are key to figure out which is more efficient when comparing private vs public healthcare insurance.
National Health Expenditure Accounts (NHEA)
The NHEA is an annual report that looks at both private and public healthcare costs. It gives a very comprehensive look at all healthcare spending in the U.S. and has an extensive breakdown of how that money is spent. The chart below shows a comparison of private vs public healthcare insurance administrative cost over the past 50 years using NHEA. The data represented in the chart can be found here. Using this measure, it’s obvious that the public sector has always been much more efficient than the private sector when it comes to administrative costs. However that is not the only takeaway. I would not be very good at interpreting data if I didn’t point out that over the over the past 20 years U.S. public healthcare administrative cost has been on the rise.
It also appears that private healthcare has done a good job of lowering these costs over the past 10 years. The chart also implies that if trends continue public healthcare may not be more efficient in the future.This raises the question as to why administrative costs have risen for CMS over the past two decades. To answer these questions, a brief understanding of U.S. healthcare law is required.
In 1996 the Health Insurance Portability and Accountability Act (HIPAA) was passed. This law enacted sweeping changes in the U.S. healthcare industry. New standards were put in place for electronic healthcare transactions. National identifiers were created for providers, health insurance plans, and employers. This required drastic changes for any organization involved in the delivery of healthcare in the U.S.
A year later in 1997 the Children’s Health Insurance Program (CHIP) was enacted. This provided coverage to 8 million children. These changes are apparent in the graph for both public and private insurance.
As you can see, the administrative cost for both rose sharply in the mid to late 90’s coinciding with HIPAA and CHIP. However, in the early 2000’s the administrative cost for the private healthcare sector began to decrease, while the public sector’s administrative cost continued to rise. This occurred due to administrative cost shifting from the private healthcare industry to the U.S government.
To understand why this cost shifting took place we need to briefly look into the history and basic structure of Medicare. Medicare consists of the following parts.
- Part A, which is hospital insurance to cover hospital stays
- Part B, which is medical insurance. This covers doctor visits and other medical services.
- Part C, which we’ll cover in a moment
- Part D, which is a prescription benefit
Medicare Part C
In 1985 rules from the Tax the Equity and Fiscal Responsibility Act (TEFRA) of 1982 were implemented so that Medicare could contract with risk based private insurance companies. This program has had various names over the years. Early on there were various pilot plans, then “Medicare+Choice”, and it is now known as Medicare Advantage. It is also referred to as Medicare Part C. Medicare Part C allows the beneficiary to elect to use a Medicare Advantage plan.
A beneficiary in this plan still pays their physician services (Part B) premium and, if taken, their prescription drug services (Part D) premium directly to Medicare. The beneficiary then receives insurance for all healthcare services through the private insurance company they chose through Medicare Advantage (Part C).
Medicare then pays the Medicare Advantage private insurance company a risk adjusted payment every month for each beneficiary they cover. Basically the federal government is doing a lot of enrollment and most all of the premium collection for the private insurance companies in Medicare Advantage.
Part C has been around since the early 80’s through small pilot programs, but the Balanced Budget Act of 1997 formally gave Medicare beneficiaries the option to choose private plans through part C. Through the Medicare Modernization Act of 2003, Part C was branded as “Medicare Advantage”. This Law also defined Medicare part D, which was fully implemented in 2006.
The re-branding Part C as Medicare Advantage clearly worked as enrollment grew from 5.4 million in 2005 to over 13 million in 2013. This cost shifting from private insurance companies to CMS is apparent in the chart, and you can clearly see an acceleration in that shifting when Medicare part D was implemented in 2006 giving private insurance companies the ability to offload some the administrative cost of prescription drug plans.
So, what would public healthcare administrative cost look like if the administrative cost of Medicare Advantage and private insurance Part D plans we subtracted from CMS administrative cost? Well that’s exactly the purpose of the second report from the Medicare Board of Trustees.
Medicare Board of Trustees Report
The Medicare Board of Trustees annual report accounts for CMS overhead differently from the NHEA. The trustees report excludes the cost of administering Part C and Part D for private insurance companies. This cost for administering the private plans make up nearly all the difference in the Medicare Board of Trustees report and NHEA final CMS administrative cost number.
As you can see below where I’ve added the trustees report to the chart, when you exclude the work the government is doing on behalf of the private sector, the administrative cost of running Medicare and Medicaid are much lower. For those interested in looking at the data, the two Medicare trust funds are covered on page 246 and 248 of the linked trustees report.
You may also notice that both CMS reports show nearly the same administrative cost until the middle of the 1980’s. That coincides with the time the U.S. government started experimenting with contracting with private insurance through Medicare Part C. The trustees report also shows the upward cost trend in the mid 90’s that coincides with the implementations of HIPAA and CHIP. However, since they aren’t accounting for the cost they are absorbing from the private healthcare insurance companies, their report shows administrative costs declining during the increase in Medicare Advantage (Part C) enrollment. Clearly the public sector has greater administrative efficiency in the context of private vs public healthcare insurance.
Private vs Public Healthcare: Addressing Criticism
There is a lot of misleading information in the press and on the internet regarding U.S. healthcare. This is especially true when comparing private vs public healthcare insurance. Many so called experts get it wrong due to the complex nature of the subject. The 24 hour news cycle has perpetuated many of these myths as investigative journalism has taken a backseat to the presentation and delivery of the news.
One criticism I almost always encounter when discussing private vs public healthcare administrative cost is that these reports do not account for premium collections. They claim this is handled by the IRS, and therefore assume it’s not in either of the reports released from CMS. This is incorrect for two reasons. Firstly, the Social Security Administration handles the collection of most premiums, and the Railroad Retirement Board handles the collection for former rail employees. Secondly, both of those costs are attributed to CMS by the Office of the Actuary. These costs are tallied in both reports.
The U.S. Treasury administers the Medicare trust funds. All activities performed by the IRS, SSA, CMS, and about a dozen other agencies in regard to the trust funds are accounted for and shows up in the Office of the Actuary reports and attributed to CMS. The U.S. government may not be good at a number of things, but ask anyone who owes back taxes. They excel in accounting. All of the costs for administering the Medicare trust funds are accounted for. You can view the methodologies here. Page 90 begins to show how these tasks performed by other agencies are accounted for and counted towards Medicare administrative costs.
I’ve also heard the criticism that even if one agrees with this data, they can’t ignore that the cost per beneficiary is much higher with public healthcare insurance. It is true. The cost per beneficiary is much higher within Medicare and Medicaid when considering private vs public healthcare. However, this is an apples to oranges comparison.
Medicare beneficiaries are high risk health-wise. Many of the nations poor within Medicaid are high risk as well. It only stands to reason that they will cost much more to cover. Private insurance can also deny services, where Medicare and Medicare cannot. There is a whole host of reasons that illustrate why cost per beneficiary is not a good metric when comparing administrative cost of private vs public healthcare systems.
The numbers shown in the NHEA and Medicare Board of Trustees Report use the same methodologies across the board. This is a much better apples to apples comparison. Not only that, but the data clearly shows that introducing the private sector into public healthcare insurance has inflated administrative costs by almost 400%. Even in spite of the cost incurred by Medicare from private healthcare insurance, the public sector is still nearly 2 times more efficient.
Private vs Public Healthcare: Possible Reasoning
When speaking with people about the merits of private vs public healthcare, people always look at me incredulously when I go over the numbers on administrative cost. The jokes of an inefficient government have been told so long people don’t even think to consider the facts. If we think objectively about private vs public healthcare administration I think this data isn’t all that surprising. Consider the following
- Private Healthcare increases their profits when they can deny coverage. This means additional overhead to process claim denials.
- Private insurance is risk based, which means developing and maintaining risk models which creates additional overhead.
- The Chief Executive Officer of the The Center for Medicare and Medicaid services was paid $165,300 in 2013. The CEO of Unitedhealth Group (the largest private healthcare provider) was paid $28 million. The year before they received $34 million.
- CMS manages over 1/2 trillion dollars yearly with 6000 employees. Unitedhealth Group manages about 122 billion yearly, but require 165,000 employees.
Once you consider this in the context private vs public healthcare administration, it becomes obvious to reason why the public sector is so far ahead in administrative efficiency. Not that this is a scientific way to look at it by any means, but these are reasonable facts that could explain the efficiency gap in private vs public healthcare.
Private vs Public Healthcare: Results
This data shows beyond most reasonable doubt that the U.S. government is much more efficient in administering our nations healthcare insurance than the private sector.
This isn’t the only measure one should use when deciding healthcare policy. There are many other things that could be considered when comparing private vs public healthcare that are outside the scope of this article. Level of coverage, and services provided are two that come to mind.
However, it’s hard not to look at this data and wonder why congress isn’t taking a hard look at Medicare Part C. Considering that the difference when excluding the administration of private insurance is almost 400%, we are talking about 10’s of billions of dollars in inefficiencies.
It’s unfortunate that the current healthcare debate in the United States has been misconstrued. Many people who are against public healthcare usually assume that the government will be inefficient or negligent when it comes to their healthcare. Yet the government isn’t performing the healthcare services. They are just paying for it. And as I’ve said, the U.S. government is very good at spending money. This data proves that not only are they good at spending money when it comes to paying for your healthcare, but they do it efficiently. As a matter of fact, it’s something they do almost 7 times more efficiently than the private sector.
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