How Large a Burden are Administrative Costs in Health Care?

The Issue:

Health care spending is much higher in the United States than in other high-income countries. One aspect that sets the United States apart is a much higher share of expenses that are not directly related to providing goods or services to people in need of care. The U.S. health care system spends hundreds of billions of dollars each year on administrative costs. Would it be possible to reduce health care costs in the United States without affecting quality of care or medical outcomes by focusing on administrative costs? Given the share of health care resources that these costs command, a concerted effort by policymakers to reduce these costs could yield significant savings. Yet little is known about what influences these costs, and to what extent administrative spending deters fraud or improves the quality of health care.

Could lowering administrative costs decrease health care spending in the U.S. without affecting the quality of care?

The Facts:

• Estimates suggest that between 15-30 percent of overall health care spending, and one-quarter of the medical labor force, are involved in costs of billing, insurance management, hospital administration, and the like. “Administrative costs” refer to the “back-end” functions of the health care system, aside from direct patient care – including medical billing, scheduling patient appointments, hiring and managing staff, and investing in quality improvement efforts. There are no official data on their total size, but estimates extrapolated from micro-costing studies suggest that billing and insurance-related services alone comprise about 15 percent of health care spending, and total administrative costs may comprise about 30 percent.
• Billing and insurance-related costs make up the largest share of administrative costs. Health care requires 770 full-time workers per $1 billion of revenue collected, compared with 100 workers in other industries. This fact is linked to the complexity of the payment process, which is far more intricate and less standardized than other industries. Hospitals, for instance, tend to have more billing specialists than beds.
• International comparisons suggest that administrative spending levels are uniquely high in the United States. For example, the United States spends nearly twice as much per capita on health care as Canada, and administrative costs account for 39 percent of this difference, with the rest driven by higher intensity of care — patients in the U.S. tend to have a higher number of interventions and more complicated procedures — and by the fact that health providers in the U.S. have higher incomes than Canadian providers. Measures of administrative staff are also much higher in the U.S. than other high-income countries.
• One potential reason for higher administrative costs in the United States is the more fragmented and complex structure of the U.S. healthcare system. Many explanations for high administrative costs focus on the complex, multi-payer structure of the U.S. healthcare system. There are many payers for health services in the United States including federal, state and local governments, private insurance and individuals. There may be free-rider problems and coordination failures arising from a lack of consistent standards for transmitting detailed medical information. Some hypothesize that administrative costs may represent an “arms race” between insurers trying to reduce costs and providers trying to maintain revenue by maximizing billing.
• However, many administrative requirements have arisen for reasonable purposes. Documentation and verification are part of the process of ensuring that billing accurately reflects the services performed and that procedures provided to patients are medically justifiable. To that extent, documentation requirements respond to concerns about health care fraud and improper payments. Efforts to ensure appropriate use of care, and to measure quality of care, also require significant documentation of patients’ conditions and treatments.
• Within the United States, billing complexity varies dramatically across insurers, with Medicaid exhibiting much higher levels than other insurers. A higher level of complexity means more time and effort are required to process a claim. Researchers measure complexity using the claim denial rate, payment delays, and the number of interactions physicians and insurers require to resolve a claim. Based on these measures, the difficulty of billing Medicaid plans is two to three times higher than Medicare and commercial insurers. Within Medicaid, traditional fee-for-service plans have higher billing complexity than Medicaid managed care plans. What to make of these differences? The fact that such differences exist could indicate that there is room to improve in the programs that have greater complexity. But, it could also be that there are higher levels of fraud in Medicaid that require additional levels of documentation. Alternatively, it could be that Medicare is not spending as much energy on controlling administrative costs and ends up having more wasteful care as a result. There is not enough information to know at this point whether the extra complexity has an economic value.
• Various policy changes have been proposed to reduce administrative costs. These include standardizing pre-authorization requirements and integrating electronic medical record and billing systems to reduce the need for submitting extra clinical documentation. Medicare has recently proposed reducing the number of severity adjustments for physician office visit payments. But each of these policies has other potential consequences, which need to be considered carefully. For instance, uniform Medicare payments across office visits give physicians an incentive to treat simpler patients rather than sicker, more complex ones (see here). Medicare might be able to use its leading position in the health care industry to shift norms – something research has found to be relevant in other billing contexts (see here and here).
• It is not clear how a significant overhaul of the health insurance system would affect administrative costs. In particular, would switching to a single-payer system or a more centralized multi-payer system, as in some European countries, reduce administrative costs? The evidence suggests caution: while Medicare and Medicare Advantage have low administrative costs, fee-for-service Medicaid has some of the highest costs. In other words, government systems can perform differently in terms of administrative costs.