Is Medicare More Efficient than the Private Sector?

This post was written by Tom Saving and me and originally appeared at the Health Affairs blog. Readers may want to check out the extensive debate in the comments section.

Of all the issues bandied about in the recent debate over the debt ceiling, none generated more contention, more TV ads and more unseemly rhetoric than potential changes to Medicare.

Health economists generally believe that Medicare is on an unsustainable course and is desperately in need of reform. Yet public opinion polls show that most seniors disagree. They not only resist cuts in Medicare to solve the problem of federal deficit spending, they also resisted the spending cuts and delivery of care innovations envisioned by the Affordable Care Act (ACA), as well as the private insurance innovations envisioned by Rep. Paul Ryan (R-WI) and the House Republicans.

In short, most seniors would like to keep Medicare just like it is.

A similar view is held by a small, but vocal group on the left that favors single-payer national health insurance. The Physicians for a National Health Program, for example, claims that Medicare has lower administrative costs than private insurance and is able to use its monopsony (single-buyer) power to suppress provider fees. The group, which is resistant to managed care, favors “Medicare for all” and endorses a bill to do just that by John Conyers.

Paul Krugman, writing in The New York Times, also argues this way. He points to a chart (see Figure I) which seems to show that Medicare per capita spending is growing at a slower rate than private insurance. Krugman, along with others, touts the slower rate growth in the Canadian health care system (also called “Medicare”). In recent editorials, both Krugman and Robert Reich have joined the call for Medicare for everyone.

Are these unconventional critics right?

Let’s begin with a fundamental point that almost everyone tends to ignore. Medicare is not actually managed by the federal government. In most places it is managed by private contractors, including such entities as Cigna and Blue Cross. To argue that Medicare is more efficient is tantamount to arguing that when Blue Cross is called “Medicare” it is more efficient than when it is called “private insurance.” Further, there is nothing particularly special about the way Medicare pays providers. Private insurers tend to use the same billing codes and their payment rates are often pegged as a percentage of Medicare rates.

Claim Of Lower Medicare Administrative Costs Is Based On An Incomplete Comparison

What about the claim that Medicare’s administrative costs are only 2 percent, compared to 10 percent to 15 percent for private insurers? The problem with this comparison is that it includes the cost of marketing and selling insurance as well as the costs of collecting premiums on the private side, but ignores the cost of collecting taxes on the public side. It also ignores the substantial administrative cost that Medicare shifts to the providers of care.

Studies by Milliman and others show that when all costs are included, Medicare costs more, not less, to administer. Further, raw numbers show that, using Medicare’s own accounting, its administrative expenses per enrollee are higher than private insurance. They are lower only when expressed as a percentage — but that may be because the average medical expense for a senior is so much higher than the expense for non-seniors. Also, an unpublished ongoing study by Milliman finds that seniors on Medicare use twice the health resource as seniors who are still on private insurance, everything equal.

Ironically, many observers think Medicare spends too little on administration, which is one reason for an estimated Medicare fraud loss of one out of every ten dollars of Medicare benefits paid. Private insurers devote more resources to fraud prevention and find it profitable to do so.

Are Medicare Costs Growing More Slowly? No. What about the claim that Medicare’s cost per enrollee is growing more slowly? The problem with the diagram in Figure I is that it ignores the falling share of private out-of-pocket spending over the past 40 years, as the insurance share of the bill escalated and the changing demographic structure of the two populations as the private insured market aged. A more accurate picture is provided by the Congressional Budget Office (Figure II), which makes appropriate adjustments and calculates spending in excess of GDP growth for the public and private enrollee populations. As the figure shows, Medicare has been growing faster than the private sector. For that matter, Medicaid has also been growing faster.

Source: Krugman/New York Times; Centers for Medicare and Medicaid Services

Source: Congressional Budget Office

As the CBO acknowledges, its comparison is far from perfect. The “other” category includes the uninsured as well as out-of-pocket spending by Medicare enrollees. Still, there is no reason to believe that overall spending would have been lower if the entire country had been in Medicare for the past 35 years.

Looking forward, the CBO believes that Medicare will grow more slowly than the private sector. It will grow a lot more slowly if the provisions of the Patient Protection and Affordable Care Act (PPACA) are implemented without any changes. Under the act, Medicare will suppress provider fees so immensely that real per capita Medicare spending will grow no faster than real per capita GDP. Yet the rest of the health care system will be growing at twice that rate. As the Medicare Office of the Actuaries has explained, this means greatly reduced access to care for the elderly and the disabled. As we previously explained, a two tiered system will emerge before this decade is out. Because of the political ramifications of all this, almost no one believes that the PPACA will remain unchanged. Like the so-called “doctor fix,” the Medicare cuts in the law are likely to be restored.

The Argument Based On Government Single-Buyer Market Power: Five Problems

What about the argument that government can use its power as a single buyer to suppress providers’ fees? There are five problems with it.

Health care markets are local. First, we don’t buy health care in a national market. We buy locally. And in local markets, private entities are often as big, or bigger, than Medicare (the auto companies in Detroit, for example, or the mine workers and their employers in West Virginia). There is nothing the US government can do that a lot of private companies and unions cannot also do. Similarly, if Canada is seen as the ideal, nothing is stopping the auto companies and the UAW from creating a global budget and rationing care for auto workers just the way the Canadians do it. That they choose not to do so is telling.

Side effects of suppressing provider fees. Second, there are negative consequences from unduly suppressing provider fees. Doctors can leave the city, the state, or even the country where they live and go elsewhere. Able people can also avoid the profession altogether. If we paid doctors only the minimum wage, for example, medicine would attract only those people who can earn no more than the minimum wage doing something else. The suppression of provider payments ultimately harms patients as highly qualified providers exit the market. The effects of price controls in health care will be similar to their effects in other markets.

Cost-shifting. Third, the suppression of provider payments shifts costs from patients and taxpayers to providers. Shifting costs, however, is not the same thing as controlling costs. Providers are just as much a part of society as patients. Shifting cost from one group to the other makes the latter group better off and the former worse off. It does not lower the cost of health care for society as a whole, however. In fact, it introduces a cost to society as the supply of providers falls.

Political pressures and lobbying. Fourth, the argument overlooks the fact that public insurance in a democracy is ultimately subject to pressures at the ballot box. Providers get to vote too. They also can make campaign contributions and lobby. Patients can also exert political pressure. Political competition in a democracy constrains public policy in much the same way that economic competition constrains the behavior of private firms in the marketplace.

You can get Medicare price controls without Medicare. Finally, if it really were desirable to have everyone pay low prices we do not need to enroll everyone in Medicare to achieve that outcome. We could instead impose Medicare-type price controls on the entire health care system. In fact, one organization advocates that very thing. Doing so would run into all the problems listed above, however.

The Best Medicare Advantage Plans Deliver More Than Traditional Medicare

What about the observation that private sector Medicare Advantage plans are costing the government more than what Medicare would have paid? Some of the “over payments” represent Congressional interference (e.g., the desire to make sure the plans serve rural areas) and some represent poor administration of the program. A more basic issue, however, is that these plans are not just providing Medicare services. They are also providing a less expensive, more efficient form of medigap coverage — mainly to low-income seniors who could not otherwise afford supplemental insurance. If we are indifferent about whether seniors have this insurance, that is one thing. But if we are going to insist that everyone have it, integrated private plans are probably much superior to more subsidies for the current Medicare/medigap arrangement.

For our purposes, the most interesting characteristic of Medicare Advantage plans is that many of them are already doing what the Obama administration says it wants to do with Medicare as a whole — without any prodding or nudging from the federal government. That is, many of these plans are using coordinated/integrated/managed care systems to achieve fewer admissions, fewer readmissions and fewer hospital days than conventional Medicare. By contrast, the Obama administration’s plan to encourage Accountable Care Organizations is so bogged down in bureaucratic rulemaking that our most cost effective health organizations are refusing to participate.

On Innovation, Medicare Follows Rather Than Leads

What about the argument that Medicare is needed in order to spur doctors to practice medicine efficiently? As in the case of Medicare advantage plans, all too often, Medicare is a follower, not a leader, on the innovation front. It is more likely to slow things down than to speed things up. What spurs private firms to be efficient is competition for consumers, not regulation.

In health care, many private sector entities are already doing what the administration says needs to be done:

  • Concierge doctors are consulting by email and telephone, keeping electronic medical records (EMRs), prescribing electronically and offering same day or next day appointments.
  • Walk-in clinics are posting (transparent) prices, using evidenced-based medicine by following computerized protocols, and keeping EMRs as well.
  • Cosmetic and Lasik surgeons routinely offer “bundled” prices, compete for patients based on price and quality and have lowered the real price of their services over the past decade.
  • There are lots of successful examples of coordinated care, integrated care, managed care, medical-home care and home-based care (see, for example, here) — almost all of it developed despite Medicare incentives not to do so and in some cases saving Medicare millions of dollars without any compensation.

Genuine reform would seek ways to encourage more such private sector activity. The Ryan proposal would allow a more flexible and robust Medicare Advantage program, in which health plans would compete on price and quality for patient dollars.


Comments (17)

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  1. Kartik says:

    Most medicare enrollees have private supplemental insurance to cover drugs and other services that Medicare doesn’t pay for. Plus Medicare’s reimbursement rates are the fault of price controls. Private health insurance would work better if there was a national market AND we return insurance back to it’s traditional meaning – covering only major catastrophes (like heart surgery, cancer care, transplants, etc). We can use HSAs to pay for routine care.

  2. Carolyn Needham says:

    This is a great piece. I always hear the left making the arguments about Medicare being more cost effective than private sector care, and this refutes those points succinctly.

  3. Ken says:

    This is an excellent post — correcting a lot of wrong ideas that need correcting.

  4. Charlie Hall says:

    “The problem with this comparison is that it includes the cost of marketing and selling insurance as well as the costs of collecting premiums on the private side, but ignores the cost of collecting taxes on the public side. It also ignores the substantial administrative cost that Medicare shifts to the providers of care.”

    Wrong. The lack of marketing expenses and the ease of collecting premiums are an inherent benefit of a single payer system like Medicare. And the ability of a single payer to control costs is also an advantage if you care about cost control.

    “As the figure shows”

    The figure does not show that at all — the blue line is well below the red line!

    ” And in local markets, private entities are often as big, or bigger, than Medicare (the auto companies in Detroit, for example, or the mine workers and their employers in West Virginia). There is nothing the US government can do that a lot of private companies and unions cannot also do.”

    Uh, the mine workers’ benefit plans went bankrupt, as did the Blue Cross Blue Shield plan in WV. The power of a monopolistic payer to control costs can be seen in Hawaii, where two not for profit insurers have 90% of the market. Despite the highest cost of living in the US, health care costs remain relatively low.

    “But if we are going to insist that everyone have it, integrated private plans are probably much superior to more subsidies for the current Medicare/medigap arrangement.”

    That may be true. France and Israel cover their entire population with such plans, and have great health care systems. But there aren’t very many — I think France has 13, and Israel 4. By comparison, there are thousands of health insurers in the US. Their competition is only creating inefficiency.

    “The Ryan proposal would allow a more flexible and robust Medicare Advantage program”

    No, because it would not fund such programs at a level that current services could be provided. And the author in effect admits this when he writes, “Like the so-called “doctor fix,” the Medicare cuts in the law are likely to be restored.” The same will be true of the Ryan plan. Instead of saving money, the cuts will not be allowed to stand, and the only winners will be the investors in the private health insurance companies.

  5. Patrick Skinner says:

    Nice Article John.

    Anyone know if PPACA requires Seniors to buy a medicare supplement? If not, isn’t it putting an ‘undo’ burden on the rest of society? What about Long Term Care – if a senior doen’t have it, isn’t it putting an ‘undo’ burden on their family or society? Disability Insurance? Life insurance? Education? Where do you draw the line?

  6. Greg Scandlen says:

    Tom Saving writes —

    “The problem with the diagram in Figure I is that it ignores the falling share of private out-of-pocket spending over the past 40 years, as the insurance share of the bill escalated and the changing demographic structure of the two populations as the private insured market aged.”

    In addition, the comparison overlooks the cost of mandated benefits on the private plans from both state and federal legislators. Medicare’s core benefits have barely changed while private insurance is every legislator’s little hobby horse, allowing them to implement social policy without raising taxes.

  7. Devon Herrick says:

    The privately managed, Medicare Part D drug plans have consistently come in under budget estimates that were made when the program was implemented. This is arguable the only government entitlement program that has cost less than estimated. Proponents of a single-payer system will argue the program would save even more if the government were to (set price controls) and dictate what Medicare is willing to pay for drugs. This may be true with respect to the cost of drugs; but I’m not convinced the savings would make up for the waste, fraud and abuse that is so prevalent in Medicare and Medicaid. Another concern: when I reach Medicare age as I hope not to be taking the same drugs today’s seniors take because price control removed the profit margin necessary to develop marginal drugs.

  8. Simon says:

    @Charlie, can you follow up on your claim that the lack of marketing expenses and the ease of collecting premiums an inherent benefit of a single payer system like Medicare? You might have a point on marketing with a single payer as people don’t have a choice, but have you seen Andy Griffith, or other PPACA ads on TV? These ads are probably not under the administrative costs of Medicare, but they are advertisements for Medicare. There will also likely be advertisements similar to what the private sector does now on how to enroll, options for coverage, etc. in the future.

    Actual administrative costs for Medicare would include tax collection and compliance, but these are piggy backed on the IRS and therefore not counted. Health care is complicated, and regardless of the fact the IRS collects taxes already, someone will have to manage all the exemptions, and conditions for taxes in the PPACA. It is estimated that the IRS will need 16,000 new employees to administer the PPACA for tax compliance. This number is probably inflated, but regardless these costs will probably not directly attributed to Medicare specifically. Also fraud and abuse is not aggressively enforced now, and administrative costs will increase if they choose to tackle that.

  9. Bruce says:

    Krugman is an idiot. So is Reich. Neither one knows anything about health care.

  10. Dr. Allen Unruh says:

    In the near future Medicare, Medicaid and SS and interest on the debt will take the entire federal budget. That’s not counting Obama Care which will bankrupt America rapidly. The Medicare czar Berwick said Doctors need to forget about the oath of Hippocrates and look at the value of a patient not based on their autonomy, but based on what’s best for the greater good. What’s best for global budgets. Health care is an inexact science and further we get away from the doctor and patient the more inexact it is. It is all about power and control by nameless, faceless and heartless bureaucrats.

  11. Harry Cain says:

    The two central (and understandable) failings in the design of Medicare, in my view, were (1) it copied the then popular private insurance (defined benefit) models (Blue Cross for Part A and the big commercial insurers for Part B); if Congress had followed the Social Security model, and made Medicare a defined contribution program, market forces could have kept the program much better disciplined. (2) Congress left for itself all the Medicare policy decisions, making it a political/lobbying free-for-all (your fourth point). Unless those two original sins are corrected, we’re going nowhere. (Incidentally, another reason Medicare administrative expenses are “under-reported” is that none of the policy-making costs are included, none of the really enormous costs of the literally tens of thousands of lobbyists doing their thing to influence Medicare policy decisions.)

  12. John Seater says:

    First, Krugman is not an idiot. In fact, he is brilliant. He really did deserve his Nobel Prize. Unfortunately, he has decided that he is so smart that he can write columns about areas of economics and other topics that he has not studied. He thus makes ridiculous statements. Try “pain in the rear,” “embarrassment to the economics profession,” or even “fool,” but avoid “idiot.”

    Second, regarding the government’s monopsony power, it is true that the government can create such a power for itself by outlawing private competitors. However, if it is to behave in a socially optimal way, it would set the price at the same level that the private market does, not at a monopsonistically lower price. The latter results in a socially inefficient *reduced* amount of whatever good is being produced compared to what the market would provide. That is unquestionably a bad idea. (Note: I am aware that the foregoing *might* not hold if there are substantial failures in the private market, but no one yet has been able to meet my challenge of providing *even one* example of a serious market failure in any aspect of health care that is not the result of government intervention in the market. Messing up the market by creating a government monopsony to cure other messes created by previous government mistakes sounds pretty dumb to me.)

    Also, I see every reason to believe that the government will be less diligent in seeking the lowest costs and best quality of product if it is the monopsony buyer. Monopolists and monopsonists have no incentive to be inventive, productive, or efficient. Monopolies usually are inefficient and generally are lackadaisical innovators. Why would we expect different behavior from a monopsonist? In addition, we are talking about the government, which has no profit motive or any other market motive to do anything efficiently, whether it is a monopsonist or not. Why should we think the government would be more efficient here than in providing, say, postal services?

    It is true that monopsonists might have lower costs because they don’t have to spend resources battling the competition. That is always the promise held out in creating public monopolies or monopsonies. Historically, it has always ended up a false hope, with a lot of inefficiency, graft, and low quality precisely because competition was suppressed.

    In short, both economic theory and economic history (i.e., evidence) tell us that monopsony is a bad idea.

  13. wanda j. jones says:

    John–This is a particularly good topic and column, as it touches on the very real gap between people who know the health system and those who only comment on it as academic pundits. Krugman and friends are all idiots, as they tacitly assume that the government can do what it decides to do in the name of serving the public and noxious outcomes will not be seen–the health care system will just keep ticking along. Some consequences they do not take into account:

    1) Doctors are not slaves; the inevitability of setting limits on doctor income will drive them out of the profession and reduce the number who will come in, just as Boomers increase Medicare enrollees by 76 million in just the next two decades. Instead, the government should be incenting doctors to stay, with all kinds of awards, forgiven education loans and so on.
    Doctors who promote single payer have to be looked at as under-educated, overly-idealistic professionals whose background does not prepare them to consider consequences for all the stakeholders involved, or to consider the harm from laying more taxes on the half of the public that will be paying for the other half.

    2) Government programs energize organizations adept at manipulating elected officials. A single payer program will benefit healthcare unions at the expense of the general tax-paying public. For example, SEIU, in California, is promoting a bill that would require agencies changing contract providers to keep old employees on for 90 or 60 days after the contract change. Also, the California Nursing Association was able to get a law spelling out the exact number of nursing hours per patient day required, even though there is a shortage of nurses; this has increases the entry salary for RNs to as much as $140,000.

    Add to that the potential for these union members to suddenly become “Federal employees” with all the extra benefits that that entails and you have a cost nightmare to contend with. As a country, we have to work harder to bring new immigrant groups into the heath professions to help care for the numbers of people represented by their group, as they are particularly disadvantaged from doing so now by virtue of English proficiency, education, or expectations for their future fortune.

    3) Legal costs, both within and outside of the government will increase substantially as beneficiaries find new barriers to care in the form of waiting lists–for serious surgery, for expensive meds, and for any kind of residential care, as the capacity will not grow commensurate with the demand. There will be class action suits regarding non-compliance with the details of any form of regulation, including “privacy,” “Quality,” and “transparency.”

    4) Absent the normal give and take between a local market and its service organizations, a demand will arise for public input to the decisions being made about costs and care. Politicians will try to satisfy that demand through public hearings, to little avail. Then, they may offer a specialty court for only healthcare cases. Then, they may require providers to let the public come to their Board meetings, where both the Board and the public will be dissatisfied with the actual scope of decision-making permitted to the local organization. Finally, some person who recalls the old “area-wide planning agency” movement of the Sixties and Seventies will propose that government establish these anew, so that more hashing out of policy and budgets can take place, with, commensurately little effect. but more costs.

    There is no substitute for market intelligence to generate appropriate provider response. The government now distorts market response in remarkably mis-guided ways, as with underwriting rural hospitals that averages 1 patient per day, just so there can be an emergency room with 1 paid doctor. What is needed is a not for profit ambulatory care clinic, and a good “distance medicine” connection to a regional healthcare organization.

    5. We are witnessing now the poverty of Congress in being able to cognitively navigate through a problem with more than a single toggle switch. Go down the road a bit: Just as they are for Medicare and Medicaid, the government would be the de facto Board of Trustees for any future single payer program, just as they will be for Obamacare. It is not to be expected that they would provide a knowledgeable and steady hand at the tiller, so the health programs could be expected to see-saw with each change of administration as the incoming one would have to disavow the poor performance of the previous administration, just as is happening now. Under single payer, there will be a black market in direct consumer/provider agreements, just to get timely care outside of the controls of the government plan. It will be obvious that single payer will make scoff-laws out of beneficiaries, providers, suppliers, educators, and even business, as it will seek to avoid the last vestiges of responsibility for their employees’ health since it is now officially the responsibility of the national government.

    Are there things that can be done to reduce the overall increase in costs? Yes, and there are signs that many of them are being done spontaneously. Ask that in a future blog, and we will sing out.

    John Seater is right in his observations about monopsony, and everyone who said that Paul Krugman is an idiot is right.

    This is a very valuable discussion, if it leads to an underground movement to undermine the use of false numbers in policy statements. Too much of that went into Obamacare.

    Wanda J. Jones
    New Century Healthcare Institute
    San Francisco

  14. Gregory E. says:

    They’re both complete morons – maybe take a look at and understand what’s going on? Great post by the way.

  15. Benji says:

    So private health is better? Really interesting but I saw something similar at but all good nonetheless although, will be share this.

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  17. McMike says:

    This is a stale thread I know, but… I would really like to see some evidence that the chart Figure I is inaccurate.

    Your claim that it ignores the falling share of private out of pocket. This is counter to my personal experience and observations, wherein out of pocket, high deductibles, and co-pays are skyrocketing while benefits are shrinking and premiums increases are off the chart.