Does Medicare Actually Have Higher Administrative Costs than Private Insurers?

Greg Mankiw links to an article that illustrates the challenges of interpreting raw numbers causally. This would really be a great example for your introductory statistics or economics classes, because the article, by Robert Book, starts off by identifying a statistical error and then goes on to make a nearly identical error of its own! Fun stuff.

Book sets up the story:

Many advocates . . . claim that a public health plan will save money compared to private health insurance because “everyone knows” that the largest government health program, Medicare, has lower administrative costs than private insurance. . . . Advocates of a public plan assert that Medicare has administrative costs of 3 percent (or 6 to 8 percent if support from other government agencies is included), compared to 14 to 22 percent for private employer-sponsored health insurance . . .

He then points out the problem with this raw comparison:

Medicare patients are by definition elderly, disabled, or patients with end-stage renal disease, and as such have higher average patient care costs, so expressing administrative costs as a percentage of total costs gives a misleading picture of relative efficiency. Administrative costs are incurred primarily on a fixed or per-beneficiary basis; this approach spreads Medicare’s costs over a larger base of patient care cost.

Excellent point. Don’t forget about the denominator, as we always tell our students.

The next step, I’d think, is to compare costs for different groups of potential patients, characterized by age, health status, and socioeconomic and demographic background variables.

But that’s not what Book does–instead he just compares average administrative costs per patient: $509 per primary beneficiary for Medicare, $453 for private insurers. But this can’t be right: of course, Medicare patients, who are older, sicker, and are going to the doctor and hospital more often, will have higher administrative costs! It seems silly to jump all over the first set of unadjusted numbers and then take the second set of unadjusted numbers at face value, leading to this claim:

If recent cost history is any guide, switching the more than 200 million Americans with private insurance to a public plan will not save money but will actually increase health care administrative costs by several billion dollars.

I don’t buy it–for essentially the same reason that I find Book’s first argument persuasive. It would seem to make more sense to compare comparable groups of people.


I’m no expert in health policy. These are just my impressions as a teacher of statistics. It’s great to find such examples that are so relevant to policy. I was surprised to see Mankiw quote the above article without criticism; but I’m pretty sure he’s studied these issues in a lot more detail than I have, and so perhaps he has additional knowledge that makes him confident in the substance of Book’s reasoning.

In particular, I expect that Mankiw has spent some time talking with the faculty at Harvard’s world-class Department of Heath Care Policy. I don’t know if any of their professors are Eagle Scouts, but they do have this guy, who was the founding editor of the Journal of Health Economics, a member of the editorial board of the New England Journal of Medicine, vice chair of the Medicare Payment Advisory Commission, etc etc. Also on the board of directors of Aetna so it looks like he has experience on both sides. Perhaps Newhouse or one of his colleagues has done a more detailed study that support’s Book’s conclusions.

P.S. Krugman links to an article by political scientist Jacob Hacker that questions Book’s numbers. I doubt Mankiw reads my blog very often, but I expect he’ll respond to Krugman, so perhaps he’ll supply some more data to rebut this. Could be interesting.

P.P.S. Book responds on Krugman’s blog, explaining why in his opinion the Hacker report does not shoot down Book’s numbers. I’m still skeptical of his claim that, “The appropriate measure is administrative cost per person.” Perhaps he can address this.

P.P.P.S. Book does address the cost-per-person issue in a comment here. At this point, I’ll just have to say that the answer depends on specifics of billing, administrative costs, etc. I don’t think I have anything further to add. But I still think it will be a great teaching example.

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About Andrew Gelman 26 Articles

Affiliation: Columbia University

Andrew Gelman is a professor of statistics and political science and director of the Applied Statistics Center at Columbia University. He has received the Outstanding Statistical Application award from the American Statistical Association, the award for best article published in the American Political Science Review, and the Council of Presidents of Statistical Societies award for outstanding contributions by a person under the age of 40.

His books include Bayesian Data Analysis (with John Carlin, Hal Stern, and Don Rubin), Teaching Statistics: A Bag of Tricks (with Deb Nolan), Data Analysis Using Regression and Multilevel/Hierarchical Models (with Jennifer Hill), and, most recently, Red State, Blue State, Rich State, Poor State: Why Americans Vote the Way They Do (with David Park, Boris Shor, Joe Bafumi, and Jeronimo Cortina).

Andrew has done research on a wide range of topics, including: why it is rational to vote; why campaign polls are so variable when elections are so predictable; why redistricting is good for democracy; reversals of death sentences; police stops in New York City, the statistical challenges of estimating small effects; the probability that your vote will be decisive; seats and votes in Congress; social network structure; arsenic in Bangladesh; radon in your basement; toxicology; medical imaging; and methods in surveys, experimental design, statistical inference, computation, and graphics.

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1 Comment on Does Medicare Actually Have Higher Administrative Costs than Private Insurers?

  1. Read this report by Milliman a very honest firm. It was performed for The Council for Affordable Health Insurance (CAHI) a research and advocacy association of insurance carriers active in the individual, small group, HSA and senior markets. CAHI’s membership includes insurance companies, small businesses, providers, nonprofit associations, actuaries, insurance brokers and individuals. Since 1992, CAHI has been an active advocate for market-oriented solutions to the problems in America’s health care system.

    There are many strengths to private health insurance, administrative costs are not one of them.

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