derifatives

A common argument by those who favor government involvement or provision of healthcare is that private insurance companies spend too much money on non-medical uses. The so-called medical loss ratio, which measures the fraction of revenue that insurance companies pay out as medical expenses, is around 80 percent for many private insurance companies, meaning they spend about 20 cents of every dollar on non-medical expenses [although there is also dispute about what's counted as a medical expense, see below]. On the other hand, Medicare supposedly spends only 3% of its income on administration. From this, we can see that "Medicare provides health care much more efficiently than private companies."

I want to make clear that while this is by no means the only argument for government provision of health care, it is a top line argument. Reid makes the point multiple times in his book [pp. 37, 174, for example]. Paul Krugman, a Nobel-prize winning economist who is widely revered on the left, makes this argument.

Does this argument stack up? In my opinion, it does not. This Heritage foundation report by Robert Book discusses the issue in plenty of detail, but I'll summarize the key points here:

• The administrative costs for Medicare are underestimated, because various support functions, notably the collection of money, are handled by other agencies. With these figured added in, the correct number for Medicare looks more like 6%.
• The administrative costs for private insurance include all the thing you normally think of &mdash marketing, the CEO's exorbitant pay, denying care to the sick &mdash but it also includes things like nurse hotlines and other wellness programs that do not directly take the form of paying claims to outside doctors. [You may have heard about this in the news recently; with the new law requiring certain medical loss ratios, insurers will move to reclassify things like this outside of administrative costs.]
• Most importantly by far, the basic concept of the percent of money spent on administrative costs is deeply deeply flawed. A percentage is a ratio of two things. On top you have the administrative costs, and on bottom you have the total costs. Medicare patients on average are much older and sicker than customers of private insurance, so for medicare, the denominator is much bigger. But do we really care about the ratio, or the numerator? According to some reasonable measurements, medicare actually spends more dollars per patient in administrative costs than private insurance. Certainly the numbers are at least close. [Note that if the administrative costs naturally scaled linearly with the amount of care consumed or the number of doctors visits, Medicare might still look efficient. However, Medicare spends less than half a percent of its money processing claims.]

• Paul Krugman bashes the study in a blog post.
• Robert Book, the author of the study, replies to Krugman in the comments section.
• Krugman elaborates on his argument, although he doesn't directly acknowledge Book.
• Book responds to Krugman again in another comment.

• If you insure a healthy 25 year old who never goes to the doctor, the medical loss ratio for that person will be 100%, no matter how little you charge them. Private insurance has a lot of these people compared to Medicare. This is the "ratio argument" made vivid.
• Krugman considers Medicare and Medicare Advantage to be a good apples to apples comparison, because they serve "similar populations." His argument is that [government-administered] Medicare has a much lower expense ratio than [private] Medicare Advantage plans. Government efficient, private inefficient.
• Book points out that Medicare Advantage patients are much healthier than the rest of Medicare, so the populations are not comparable.
• Book also points out that the high administrative ratio that the CBO reports for Medicare Advantage includes administrative expenses by doctors, whereas the low number for Medicare includes only plan-level expenses, so the expense ratios are not even an apple-to-apples comparison.