Saturday, February 23, 2013

Does its 3% admin cost mean Medicare is efficient?

Many people believe the admin cost for original Medicare (Part A and Part B) is lower than private insurance admin cost, because  Medicare's cost is "only 3%".  These people also believe that private insurance admin costs are much higher, up to 20% or 30%.  So Medicare, they believe, is obviously more efficient.  Well, let's look at it.  
Based on CBO projections of Medicare benefit costs for 2013, a 3% admin cost for original Medicare is equivalent to about $31-$32 per month, per enrolled person.  

Here are my calculations:

1.  CBO Part A and Part B benefit costs         $528 bn 
2.  Less M'Care Advantage benefit costs        $145 bn
3.  Net Part A and Part B benefit costs           $383 bn

4.  Allowance for admin @3%  (divide by:)      0.97  
5.  Cost of benefits + admin                            $395 bn
6.  Base administration cost ($395-$383)       $   12 bn
7.  Plus CBO mandatory admin add-ons        $      2 bn
     (ACA mandated e.g. quality, fraud, others)             
8.  Total admin cost                                        $    14 bn
9.    CBO Medicare enrollment                           51 mn
10.  Less M'Care Advtge enrollment                   14 mn
11.  Net Medicare enrollment                              37 mn

The monthly per person admin cost is therefore $31-$32      
                         $14 bn / (37 mn x 12)

Private large-group admin costs
Current admin costs for large groups generally run in the range of $20 to $25 per person per month.  I’ve seen lower and I’ve seen higher, but most fall within that range.   (By “large” group plans, I mean plans covering more than 20,000 persons; large, but nowhere near as large as Medicare.)

Comparing these results suggests the typical per-person admin cost for large private group plans is distinctly less than original Medicare, using the assumption that original Medicare admin is "only 3%" of its total cost.  Even if one excludes the ACA-mandated add-ons from the analysis, the Medicare admin cost per person, per month works out to $27 which still leaves large private groups with an admin cost advantage.

This result makes sense for several reasons.  Most important, seniors have higher medical costs than the working-age population, mainly because of chronic conditions related to age.  That's why Medicare premiums are so much higher than for working age people. But higher claims don't mean higher admin expenses; it does not cost 100X's as much to adjudicate a $10,000 claim vs a $100 claim.  A (%) of premiums uses the much higher Medicare premiums in the denominator.  Using this higher denominator produces a lower answer, which says nothing about the actual relationship between admin costs.  So comparing Medicare admin expenses to other insurance as a percentage of premiums is faulty.  Comparing admin expenses to enrollment is analytically superior.  Keep in mind that private insurance companies administer original Medicare under contract with HHS; there is no reason their admin charges should differ greatly between their large private groups and their Medicare contracts.  Nor is Medicare otherwise regarded as an efficient federal bureaucracy.  (If there is one.)

So yes, “3%” may be arithmetically correct – but it's misleading nevertheless.  It leads to the mistaken notion that Medicare is more efficient than private insurers when in fact the reverse is most likely true.   

Whenever you hear someone claim that Medicare admin is "only 3%" the smart follow-up questions are "3% of what?" and “compared to what?”  The preceding analysis suggests an answer for both of these follow-up questions.   

I've relied on CBO Medicare projections for 2013.  The private plan information is from my own experience working in three major insurance companies, a national consulting firm, and head of benefits for a large employer.  The analysis is approximate, but I believe basically sound.

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