I actually like this article by Ezra Klein. Often I’ve found his articles lacking in understanding of economics, an appreciation for incentives, etc. But this looks quite good. Well balanced and displaying a healthy skepticism about why Medicare’s adminstative costs are lower and if we can get such low costs in general for health care and if it is even desireable. Here are the last two paragraphs, and read the whole thing,

It’s also important to note that you don’t necessarily want administrative costs as low as they could possibly be. Some activities that are considered “administrative” are useful. Disease management, for instance, which accounts for some of the difference between Medicare and Medicare Advantage. Mental health counselors who are available by phone. Good-faith investigations into waste, fraud and abuse. Care coordination. Nurses who use e-mail or telephones to remind patients to take their drugs. Administration is not always wasteful.

But no matter how good you got at slashing administrative costs, they will never be a panacea to the problems of the system. Rick Kronick, a political scientist at the University of California at San Diego, has done some of the best work on administrative costs, and he summed the situation up quite well. “The main question,” he said, “is why are health care costs going up at 2.4 percent a year faster than GDP? And most of the answers to that question have nothing to do with administrative costs. The answers are that we do more stuff and have more technology. Even if we could wring administrative savings out of the system, which I’m all in favor of and would be a good thing, we’d still be facing the question of how to slow the rate of cost growth.”

Precisely.

For the sake of argument let us assume that Medicare’s administrative costs are lower than those of the typical health insurance company. Does this imply that Medicare is more efficient than the private company? I’ve been skeptical of this view point since one thing I’ve learned in economics is that firms want to maximize profits. You don’t do this by wasting money. In fact, at the profit maximizing level of output the firm is minimizing its costs. So, does it make sense that a health insurance firm is going to spend money it doesn’t have to on administrative costs?

One commenter put forward the idea that a CEO of a $10 billion dollar health insurance company is probably going to get paid more than the CEO of a $5 billion dollar health insurance company. Probably so, however, I’d also argue that the first CEO wont be CEO for long if he gets to the $10 billion mark by incurring losses of $5 billion. So I think we can rule this one out, or at the very least it needs quite a bit more to explain it than mere assertion.

So I’m still left thinking, “Really, the government is our model for efficiency?” This is the same government that has lost billions in the Pentagon and can’t find and probably never will. But when it comes to Medicare, which is an even bigger portion of the Federal government, nope they are so efficient we should implement the same standards globally. Even Paul Krugman indicates that this is true.

But the root source of Krugman’s beliefs disputes his views.

The higher administrative costs of private plans do not imply that those plans are less efficient than the traditional FFS program. Some of the plans’ administrative expenses are for functions, such as utilization management and quality improvement, that are designed to increase the efficiency of care delivery.—page 12

And via Greg Mankiw we now have this portion of testimony by Malcolm K. Sparrow, Professor of the Practice of Public Management at Harvard’s Kennedy School of Government,

The units of measure for losses due to health care fraud and abuse in this country are hundreds of billions of dollars per year. We just don’t know the first digit. It might be as low as one hundred billion. More likely two or three. Possibly four or five. But whatever that first digit is, it has eleven zeroes after it. These are staggering sums of money to waste, and the task of controlling and reducing these losses warrants a great deal of serious attention….

By taking the fraud and abuse problem seriously this administration might be able to save 10% or even 20% from Medicare and Medicaid budgets. But to do that, one would have to spend 1% or maybe 2% (as opposed to the prevailing 0.1%) in order to check that the other 98% or 99% of the funds were well spent. But please realize what a massive departure that would be from the status quo. This would mean increasing the budgets for control operations by a factor of 10 or 20. Not by 10% or 20%, but by a factor of 10 or 20.

Now at this juncture I want to say, “Why?” Why are Medicare’s Administrative costs so much lower, if they are indeed lower, than private industry? There has to be a reason and nobody that I know of has offered one. It is simply spouted as if it is true, always has been true, that private health insurance companies are dolts, always will be true, and if we just emulated Medicare we could save lots and lots of money that we could use to insure some of the uninsured you vile evil jerks!

In other words, Medicare’s really low administrative costs might come at a cost of hundreds of billions of dollars. If we emulate them in private health insurance then we will not be saving any money but losing money. Not only that, but we will likely accelerate the rate of increase of health care costs. After all we are going to having more wasteful spending on procedures that are not needed and any legislation on the issue will likely make access to health care easier for those who don’t already have access.

Now let us take a look at a graph that Dave Schuler dug up and posted today. Notice that for the 0-64 age range the U.S. is quite competitive with other countries, including the vaunted France. In fact, in eye-balling the chart the U.S. does better in terms of spending.

Note that the problem for U.S. health care spending is due to those 65 and older. Without them the U.S. spending on health care would be very low, even compared to places like France. If part of the reason why the spending on those 65+ is due to low administrative costs of Medicare and we force private health insurance to become more like Medicare then we could end up making the portion of the graph that is 64 and younger larger. We could exacerbate the problem, not make it better.

So answering this question of why are Medicare’s administrative costs lower is somewhat important. If there is research that answers this, I’d like to see it. But the distinct lack of such evidence leads me to believe it doesn’t exist. That nobody has asked the question let alone answered it.

Are they lower? This article by the Heritage Foundation makes an interesting point.

Medicare beneficiaries are by definition elderly, disabled, or patients with end-stage renal disease. Private insurance beneficiaries may include a small percentage of people in those categories, but they consist primarily of people are who under age 65 and not disabled. Naturally, Medicare beneficiaries need, on average, more health care services than those who are privately insured. Yet the bulk of administrative costs are incurred on a fixed program-level or a per-beneficiary basis. Expressing administrative costs as a percentage of total costs makes Medicare’s administrative costs appear lower not because Medicare is necessarily more efficient but merely because its administrative costs are spread over a larger base of actual health care costs.

When administrative costs are compared on a per-person basis, the picture changes. In 2005, Medicare’s administrative costs were $509 per primary beneficiary, compared to private-sector administrative costs of $453. In the years from 2000 to 2005, Medicare’s administrative costs per beneficiary were consistently higher than that for private insurance, ranging from 5 to 48 percent higher, depending on the year (see Table 1). This is despite the fact that private-sector “administrative” costs include state health insurance premium taxes of up to 4 percent (averaging around 2 percent, depending on the state)–an expense from which Medicare is exempt–as well as the cost of non-claim health care expenses, such as disease management and on-call nurse consultation services.

If you are measuring administrative costs as the ratio of total costs then I can see this being true given the two different populations that are being covered. Further, when we look at this post by Bryan Caplan that argues that there isn’t so much adverse selection as many argue but in reality advantageous selection then it makes even more sense.

Caplan argues that contrary to what the theoretical models predict what we see in market with regulations that mandate insurance is that it isn’t to bring the low risk individuals back into the market, but to make sure that the high risk individuals are buying insurance and often at a subsidized rate. I know that is how the insurance regulations work here in California. The insurance requirements aren’t so much that a low risk driver will buy insurance, but that the high risk one’s will.

Since mandates requiring health insurance are far less prevalent then it is possible that the dominant type of individual that has private health insurance is the healthy and under 65. These people are going to require less health care and by similar reason less health care costs. As such, the ratio of administrative costs to total costs is going to favor Medicare. I would think that at the very least we’d want to know what the per-capita administrative costs. After all, suppose the above is true, that the reason why administrative costs for Medicare are “low” is that people are looking at the ratio of administrative costs to total costs. If everyone were to move onto Medicare than you’d have quite a few healthy people move on and incur exactly the same costs as the unhealthy currently in the program. But total costs would not go up by the same proportion since we are talking about bringing in healthier people. Since the numerator is going up faster than the denominator administrative costs must rise. And if private insurers really are doing it cheaper on a per-capita basis, then such a move would actually cost billions not save us billions.

Via Greg Mankiw.

Image by Flickr user Brooks Elliot, used under the Creative Commons License.