How I Figure 50% of Healthcare Spending Goes to Administrative Expenses

I got an email this week from my hospital system introducing the team of administrators who are managing the CME (continuing medical education) credit card they give to providers. You see, providers are given an annual stipend that they can only use for CME activities, such as trips to medical conferences, and this is the card we are supposed to use for those expenses. I read the email and looked around to see if anyone else thought it was ludicrous that there is a whole “team” of people dedicated to something like this.

The issue of unnecessarily high administrative expenses in the U.S. healthcare system has been on my mind ever since the recent article in JAMA detailed the “6 waste domains” in our healthcare system and pegged administrative expenses as the biggest one. So, today, I’m going to explain how I calculate administrative expenses in our healthcare system. I believe it’s more intuitive than other approaches because it follows the flow of money through the healthcare system and shows each point where some of the money is siphoned off for administrative expenses. Disclaimer: I’m using nicely rounded numbers and lots of assumptions for the sake of clarity.

Money enters our healthcare system when the patient pays insurance premiums. Let’s say the amount of each dollar paid to an insurer that gets spent on actual care is around 85 cents (their “medical loss”), which means 15 cents goes to administrative expenses in the form of insurance overhead:

 

 

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And then what about the 85 cents that is being paid to healthcare providers? Studies have used reports submitted to Medicare to estimate the percent of hospital revenue that goes to administrative expenses, and they come up with about 25% in the 1990s, but it has been rising. So if we guess that about 29% of those 85 cents paid to hospitals and other facilities goes to administrative expenses (like teams of people managing CME credit cards, plus armies of coders, “revenue cycle managers,” and so many more), that works out to be 25 cents in additional administrative expenses:

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Of the 60 cents left, it’s going to actual care, such as paying caregivers and buying other care-related things like drugs and devices, right? Not so fast. First off, let’s assume about half of that 60 cents goes to drugs and devices (both of which are generally overpriced, but that’s a different subject I’ve written about before). This leaves 30 cents of every healthcare dollar for caregivers. And if 100% of caregivers’ time were devoted to care, we would be dancing and singing every day we go to work. Instead, we spend a great portion of our time on “the system,” dealing with insurance issues, federally mandated trainings, documentation time ensuring billing and diagnostic codes are accurate and thorough, etc. etc. etc. When accounting for all of those factors, it adds up to much more than the estimated 15% of my time dedicated to administrative tasks. I’d peg it closer to 30%. Others would probably say 50%. Things seem to be worse here in the U.S. compared to in the motherland. Anyway, that means roughly 15 cents of every dollar can be attributed to caregiver overhead:

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I will not include in here the additional money providers have to be paid to compensate for the high cost of medical training and malpractice insurance. So, overall, I’m guessing that 50 cents of every dollar that enters the healthcare system goes to non-care things, which we call administrative expenses. Now, this number is very different from the number researchers came up with in the study cited above, which estimated that the overall administrative cost was around 30%, but they’re adding things up differently. That’s fine. We’re counting differently. But the important thing is looking at each of those siphoning points and understanding why they have higher-than-necessary admin costs. I won’t go into detail on that today, but I believe the main factor is the complexity of the system. So. Much. Complexity. We need a simpler healthcare system. I have described a few options here and here. The simplicity we could achieve may come partly by direct efforts to simplify, but I believe it will be more a side-benefit of making the other changes that are necessary in our system.

 

Are Patients Smart Enough to Choose Higher-value Providers and Insurers?

I’ve been hearing the argument lately that healthcare is so complex that patients are incapable of making good decisions. I (mostly) disagree. Here’s how I break this argument down:

Treatment decisions: This is when the patient weighs the different treatment options’ risks and benefits and decides on the one that is right for them. This certainly cannot be done without the assistance of a physician, who needs to simplify those risks and benefits and help clarify which ones are most relevant to the patient. Shared decision making! These decisions are important and determine many aspects of healthcare spending and patient outcomes and satisfaction, but they are not integral to fixing the healthcare system.

Insurance plan decisions: This refers to patients choosing which insurance plan they will get. There are actually usually two rounds of decisions for this. The first-round decision is done by the employer, which narrows down the many options in the region to just a few. Then the employee does the second-round decision of choosing one of those options. A similar process happens with Medicaid in many states–Medicaid contracts with a few different insurers, and the enrollee chooses one. And even Medicare Advantage has a similar two-round decision. Patients need to understand what their likely care expenses will be that year (super tough to predict for many people!) and then choose the plan that seems most likely to cover those care needs with the lowest out-of-pocket spending. And since out-of-pocket spending is a combination of many things (deductible, copays, coinsurance, other alternative payment schemes like reference pricing or multi-tiered networks), this can get pretty complex, and would likely be impossible for a majority of people to easily identify the plan that would be best for them. The two-round decision most people face simplifies this quite a bit by narrowing down the options (at the risk of agency costs), but sometimes there are still too many options. And for those dealing with the open market without a first-round decision narrowing down their options, ways to simplify their selection are an absolute necessity. That’s why I like the idea of dividing plans into different standardized tiers according to their coverage, networks, and out-of-pocket requirements. Software-encoded decision algorithms, which have a patient put in their information and then identify the plan best suited to them, are also great.

Provider decisions: Patients get to choose which providers they go to for care. Lumped in this category is also imaging options (like my experience shopping for an MRI), lab options, and any other medical services they may need. These provider decisions are subject to two rounds of decisions just like insurance plans. The insurer does the first-round decision by narrowing down the provider options (the “in-network providers”), and then the patient typically chooses one of those. What do you need to understand to be able to choose the best provider? I’ve talked about this elsewhere. Patients need simple, salient quality metrics, and they need to know their expected overall out-of-pocket costs. Relatively well-educated people can use well-structured information like that and 80% of them will make the right decision. I don’t know what percent of people with less education can make the right decision when there’s an obvious right answer, but certainly it will be much lower.

So, can patients make good provider and insurer decisions? I believe most of them can if they have the right information and the incentives to consider both cost and quality of the options available to them. It will never be 100%, but that’s okay, because we don’t need 100% of people to make a perfectly rational high-value decision in order to get the changes necessary to start fixing healthcare.

The Impact of Single Payer on Healthcare Spending

warren sanders
Image credit: politico.com

One of the main reasons people are pushing for a single-payer system in the U.S. (termed “Medicare for All” these days) is to achieve universal access to insurance coverage. But what about its impact on total healthcare spending? This is how I think about that question.

First, remember that there are two aspects of spending that we need to be thinking about. The level of spending is how much we’re currently spending, and the trend of spending is how much that amount is increasing over time.

Level of Spending. Even though a single-payer system will increase the number of people with insurance, it’s possible it could still reduce the level of spending overall (although estimates vary widely). How could it save money? The overall cost to administer health insurance would probably go down simply due to sheer economies of scale (of course, this is debated too). Plus, the amount of advertising done by a single government-run insurer will be less than the amount currently being spent by private insurance companies. Single payer allows greater price control as well, so that could be a huge savings (although, if it means paying all providers current Medicare rates, that could be catastrophic).

Trend of Spending. Healthcare spending continues to increase faster than inflation, mostly due to medical innovation, rising prices, and an older and sicker population. Would single payer affect our trend of spending? Well, sort of. It can refuse to increase prices, which is a very tempting spending reduction mechanism that our government has tried in healthcare before (ahem, SGR). But with the relative administrative simplicity single payer would bring to providers, there would be at least some wiggle room for price reductions. Or it could refuse to cover low-yield or really expensive drugs and treatments (rationing), which we generally don’t take well to in this country. Unfortunately, there just aren’t a lot of effective ways single payer can directly impact the trend of spending, which is ultimately the most important one.

I know I’m leaving out lots of other impacts Medicare for All would have on the level and trend of spending, but I think I’ve covered most of the major ones.

So does this mean we are doomed then? Even if we get universal coverage, there’s no way to avoid total fiscal collapse secondary to runaway healthcare spending? No! Implemented correctly, single payer could do a great job helping to avoid many episodes of care, and it could also enable the costs of delivering the care that cannot be avoided to go down immensely. I’ve explained how already.

So let’s just keep all this in mind as Medicare for All is being debated. People can quibble about the projected savings/costs and various other numbers all day long, but the important part in the long run is how it’s implemented.