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Busting the Adminstrative Cost Benefit Myth

Busting the Adminstrative Cost Benefit Myth

By Tom Bevan - June 27, 2009

In his Newsweek column this week (One Nation Under Medicare) liberal pundit Jonathan Alter made the following assertion about the administrative costs of Medicare:

But the administration of Medicare is a miracle of low overhead and a model, despite all the fraud and abuse, of what government can do right. Three percent of Medicare's premiums go for administrative costs. By contrast, 10 to 20 percent of private-insurance premiums go for administrative costs. Roll that figure around on your tongue. When you swallow and digest it, you'll understand that any hope of significantly reducing health-care costs depends on a public option.

How is it possible, you may wonder, that the federal government, which is notoriously inefficient in almost everything it does, is suddenly a model of efficiency and able to create a "miracle of low overhead" when it comes to Medicare? Such a claim flies in the face of common sense.

Yet there was Paul Krugman yesterday morning, repeating the claim almost verbatim:

And that’s why the public plan is an important part of reform: it would help keep costs down through a combination of low overhead and bargaining power. That’s not an abstract hypothesis, it’s a conclusion based on solid experience. Currently, Medicare has much lower administrative costs than private insurance companies, while federal health care programs other than Medicare (which isn’t allowed to bargain over drug prices) pay much less for prescription drugs than non-federal buyers. There’s every reason to believe that a public option could achieve similar savings.

In fact, President Obama has made this claim several times. This statistic about Medicare's low administrative costs has become one of the linchpins in the argument for a "public option" on health care. The only problem, not surprisingly, is that it's hogwash.

The explanation is really quite simple, and it's provided here by Robert Book of the Heritage Foundation. The statistic cited by Alter and Krugman uses administrative costs calculated as a percentage of total health care costs (For Medicare it's roughly 3 percent and for private insurers it's roughly 12 percent).

But here's the catch: because Medicare is devoted to serving a population that is elderly, and therefore in need of greater levels of medical care, it generates significantly higher expenditures than private insurance plans, thus making administrative costs smaller as a percentage of total costs. This creates the appearance that Medicare is a model of administrative efficiency. What Jon Alter sees as a "miracle" is really just a statistical sleight of hand.

Furthermore, Book notes that private insurers have a number of additional expenditures which fall into the category of "administrative costs" (like state health insurance premium taxes of 2-4%, marketing costs, etc) that Medicare does not have, further inflating the apparent differences in cost.

But, as you might expect, when you compare administrative costs on a per-person basis, Medicare is dramatically less efficient than private insurance plans. As you can see here, between 2001-2005, Medicare's administrative costs on a per-person basis were 24.8% higher, on average, than private insurers.

So, contrary to claims of Alter, Krugman, and President Obama, moving tens of millions of Americans into a government run health care option won't generate any costs savings through lower administrative costs. Just the opposite.

This confirms two things most Americans already know: 1) government is rarely, if ever, more efficient than the private sector, and 2) if something sounds too good to be true, it almost always is.

Tom Bevan is the co-founder and Executive Editor of RealClearPolitics and the co-author of Election 2012: A Time for Choosing. Email: tom@realclearpolitics.com, Twitter: @TomBevanRCP

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