As Congressional budget battles heat up—or roll along, depending on your time perspective—the 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 fix—the arrangement that accounts for much of the difference between health spending in the U.S. and other places—is 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 else’s 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 Stanford’s 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.)

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