The Reason Health Care Is So Expensive: Insurance Companies

By Jeffrey Pfeffer
April 10, 2013

As Congressional budget battles heat upor roll along, depending on your time perspectivethe cost of health care in America receives a lot of attention. Unfortunately most of the discussion is largely off the mark about where the preventable, unnecessary costs really are. Yes, there is certainly over treatment, particularly of people in their last days of life. Yes, doctors under a fee-for-service arrangement do have financial incentives to do too much, and the fear of malpractice can lead to overtesting and overtreatment. As the recent article in Time by Steven Brill illustrated, pricing of medical care is neither invariably transparent nor sensible. And it would certainly be nice if care were better coordinated across functional specialties. But the thing that few people talk about, and that no serious policy proposal attempts to fixthe arrangement that accounts for much of the difference between health spending in the U.S. and other placesis the enormous administrative overhead costs that come from lodging health-care reimbursement in the hands of insurance companies that have no incentive to perform their role efficiently as payment intermediaries. More than 20 years ago, two Harvard professors published an article in the prestigious New England Journal of Medicine showing that health-care administration cost somewhere between 19 percent and 24 percent of total spending on health care and that this administrative burden helped explain why health care costs so much in the U.S. compared, for instance, with Canada or the United Kingdom. An update of that analysis more than a decade later, after the diffusion of managed care and the widespread adoption of computerization, found that administration constituted some 30 percent of U.S. health-care costs and that the share of the health-care labor force comprising administrative (as opposed to care delivery) workers had grown 50 percent to constitute more than one of every four health-sector employees. What remains missing even in the discussion of the enormous administrative burden is not just how large, both in absolute dollars and as a percentage of health costs, it is, but also how few incentives there are for insurance companies to stop wasting their and everyone elses time. Most large employers, including mine, Stanford University, are self-insured, which means they pay for their own medical claims. These large employers invariably hire health insurance companies to administer their health-care dollars,

doing things such as paying claims. Employers typically reimburse the insurers the amount of money they pay out to health-care providers plus a percentage of these costs. In Stanfords case, we pay Blue Shield 3 percent of the amount, about $3 million a year. (Note that the overhead costs of Medicare are less than one-third as much at slightly less than 1 percent.) Because insurers are paid a fixed percentage of the claims they administer, they have no incentive to hold down costs. Worse than that, they have no incentives to do their jobs with even a modicum of competence. To take one small personal example, I have reached the age of Medicare eligibility but, because I continue to work full time, have primary health insurance coverage through my employer. Blue Shield, of course, wants to be sure it doesnt pay for any claim it doesnt have to, so I was asked to attest to the fact that I have no other insurance. No problem there, except such attestations seem to be required on almost a monthly basisrequiring my time on the phone (and on hold) with Blue Shields customer service, an oxymoronic term if there ever was one, and also requiring my doctor and laboratory to call me, call Blue Shield, or both, and thus also waste their time and resources. This story and the many others of the same sort but even worse, magnified across the millions of people subjected to private health insurance companies, is why American health care costs so much and delivers so little. Unless and until we as a society pay attention to the enormous costs and the time wasted by the current administrative arrangements, we will continue to pay much too much for health care.