Looking At Medicare Administrative Costs

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.

FILED UNDER: Bureaucracy, Economics and Business, Health, US Politics, , , , , , , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.


  1. This is not the spare change you are looking for.

  2. I’ve been forced to form a corporation here in CA just in order to get health insurance. That adds thousands of dollars per annum in perpetuity — bookkeeping, lawyers, time spent on bullshit, etc…

    Basically private insurers force me to spend money and in the meantime leave all my assets at risk. Factor that in.

    Give me a government plan, I’ll take it.

  3. Michael says:

    Yet the bulk of administrative costs are incurred on a fixed program-level or a per-beneficiary basis.

    Can you be a little more specific that “bulk”? Is it a 90/10 split, or a 60/40 split? Better yet, lets get a break-down per-program, per-beneficiary and per-claim administrative cost percentage. Otherwise you’re comparing oranges to apples, while complaining that they are comparing apples to oranges.

  4. Barry says:


    After laying out his reasons, he states:

    “You should always remember:

    1. Don’t believe anything Heritage says.

    2. If you find what Heritage is saying plausible, remember rule 1.”

  5. DL says:

    As the spouse of a visiting nurse with a laptop, I’ll estimate that 40% of her time is spent with trivia pursuit of questions and answers for some governmental entity.

    The game; wink, wink,is how to ask the questions.

  6. floyd says:


    Ever heard this one?
    “Hi, I’m from the Government and I’m here to help you!”
    I hear it’s one of the top three.

  7. Steve Verdon says:


    We can say the same for anyone who has an agenda, that includes Krugman, you, me, Obama, etc. Right on down the line. Evaluate the argument, the data, and the methods, then decide on those. Krugman’s way is nothing short of an ad hominem: they are poopy heads and therefore wrong.

    Edit: What is even more hilarious is that Krugman is quoting an “Institute” with a “K-Street” address. A lobbying group–i.e. a propaganda group. Shorter Krugman: my propaganda beats your propagands. Just like in the Sunday morning chop-socki flicks I used to watch as a kid.


    Can you be a little more specific that “bulk”? Is it a 90/10 split, or a 60/40 split? Better yet, lets get a break-down per-program, per-beneficiary and per-claim administrative cost percentage.

    You will likely never get the last two due to privacy reasons. As for the splits, look at the link, see where the data takes you. For example, look at this table that is at the link, there are a nubmer of sources some it appears you can download data from.

    Michael Reynolds,

    Yes, because you have a pre-existing condition. As such you cannot get insurance. You cannot get insurance because you already are in the state that you wish to insure against. It is like wanting to buy car insurance after you have been in an accident. It sucks, but that is how insurance works.

  8. Steve Verdon says:

    Okay, so it looks like the websites for “Our Future” is in trouble (probably due to Krugman’s link). But I googled around for this CBO analysis of Medicare and Medicare Advantage, here is what I found.


    Then there is this part from the CBO testimony,

    HMOs and PPOs incur substantial administrative costs to establish and maintain networks of providers, to acquire and maintain enrollment, and to manage utilization. To the extent that they negotiate payment rates with providers that are higher than Medicare’s payment rates for services furnished in the fee-for-service sector, those plans may also incur higher costs for medical services. Private health plans that participate in Medicare have higher administrative costs per enrollee than the
    traditional Medicare program does because of their smaller scale of operations and their costs associated with network development and retention, care management, marketing, and reinsurance.

    Geez, didn’t see that in Krugman’s blog post.

    And here is the actual report that Hacker is relying on. Here is the relevant section from the report,

    Administrative Costs. Private health plans that participate in Medicare have higher administrative costs per enrollee than the traditional Medicare program because of their smaller scale of operations and their costs associated with marketing, utilization management, network development and retention, and reinsurance. Administrative costs and return on investment account for about 11 percent of private plans’ costs of delivering Medicare benefits, whereas the administrative costs of the fee-for-service Medicare program (as reported by CMS) account for less than 2 percent of its expenditures.17 There is some disagreement among analysts about the size of that difference in costs, however. Some analysts contend that the latter estimate understates the administrative costs of the Medicare program because it excludes some costs that should be allocated to Medicare, such as portions of the salaries of legislators, legislative staff, and CMS administrators; depreciation on certain federal office buildings; and the costs of collecting Medicare premiums and payroll taxes.18 Following that reasoning, however, a portion of those additional costs should also be allocated to the Medicare Advantage program.

    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.

    Whoops didin’t see that in Hacker or Kurgman’s “writings”…oh what the Hell, propaganda. See Barry, its a double edged sword. Not quite the “apples to apples” comparison…according to Hacker’s own source…the CBO.

    Now to be fair, I don’t know where the Heritage propaganda puts the Medicare Advantage people. Are they Medicare or Private? There are a fair number of them, so taking them into account would be a good idea.

  9. ptfe says:

    It’s a valid point that Medicare costs are vastly different from private insurance costs, but I’m equally skeptical of the assertions in the HF article. For example, it’s not clear how one might separate administrative costs for Medicare spent only on primary beneficiaries from the overall Medicare expenditures. And given that secondary beneficiaries rarely use Medicare costs (they’re insured) but have associated administrative overhead, this would skew the presented data in a way that would make private insurance look better (elderly care pushes down your ratio) while making Medicare look worse (administrative costs with no care to show for it).

    That’s just the most glaring of several assumptions made in this piece that strip away any real value. As a bonus, it’s much more relevant to compare Medicaid (not Medicare) and private insurance, though it’s more challenging — since Medicaid is distributed across multiple states — and still isn’t entirely valid (pears to apples, maybe?) But rather than take that route, this study compares the two most disparate elements, then tries to draw conclusions based on a lot of systemic assumptions.

    All in all, this doesn’t add much to the discussion, since it’s both extremely limited and glosses over some significant informational gaps.