PERSPECTIVE ON HEALTH REFORM : Good Profits Can Mean Good Care : Crusaders are looking for ways to cap administrative costs and profits. They risk crippling innovative new health plans.
The path to health-care quality, says the California Medical Assn., is to reduce administrative costs and health-plan profits. To support that assertion, the doctors’ group released a study on the profits and costs of administration of California health plans, suggesting that some plans spend too little on direct medical care. In response, state Assembly member Burt Margolin, the chairman of the Assembly’s Health Committee, proposed a bill that would limit combined health-plan profits and administrative costs to 15% of premiums collected.
We do not know how much an efficient, high-quality provider of health-care services should spend on profit and administrative costs. But we do know that the Assembly does not know, either. There are valid reasons for relatively high overhead costs and plenty of reasons for not mandating limits on such costs. Not all profits and administrative costs are wasteful. Profits are necessary to finance expansion; administrative costs support quality measurement and analysis of how to improve services and reduce future costs. Limits on profits and administrative costs could seriously damage the managed-care industry. It would make it hard for new managed-care organizations to start, for good ones to finance expansion and for all to manage appropriately.
The medical association suggests that the health plan spending the least on direct medical care apportions 18.2% of revenues to administration and takes 12.7% of revenues as profit. But to achieve these figures, interest expense is charged to administration and the profit they list is the pretax gross. In addition, these amounts are not unreasonable in comparison with other industries. Applying the same analysis for Hewlett Packard, for example, a world-class industrial competitor known for quality, reveals that in 1992, administration and profit accounted for 36.1% and 8.1% of revenue respectively. Profits of other California companies in 1992 ranged from 1% on average for wholesalers to 19% on average for energy companies. Health-plan profits fall squarely within this range.
Limits on administrative costs would be susceptible to gamesmanship and accounting tricks. Health-plan managers currently use cost-accounting as a tool to help them manage the delivery of care; within broadly accepted accounting practices, each plan has different methods. Tomorrow, under a limit on administrative costs, you can be sure that items charged to administration costs will include the bare minimum.
Low administrative costs do not necessarily suggest superior management or superior health care. In Medicare, for example, the government has relatively low administrative costs, but Medicare is renowned for the administrative headaches it causes hospitals, doctors and patients. In addition, low administrative costs for Medicare do not translate into low overall costs. Medicare outlays continue to grow at unacceptable rates despite government’s ability to lower reimbursement rates and shift costs to private payers. And the program spends billions on unnecessary and inappropriate care.
Another reason not to impose ceilings is that the most successful managed-care organizations need to reinvest profits to finance expansion. Small health plans also have relatively high administrative costs because they have fewer subscribers over which to spread them. The medical association reported that WellPoint Health Networks Inc. had the lowest direct-care spending in 1992. The report did not state that WellPoint had the highest sales in 1992 of any California company incorporated since 1990. They need profits to support this high growth rate. A limit on administrative costs and profits would create an undesirable barrier to entry for new health plans such as WellPoint.
We Californians are to blame more than California health plans for high administrative costs. Our employer-provided health insurance that subsidizes inefficient health plans, our demand for the most expensive health care without regard for value-for-money and our failure to hold health plans accountable for cost or quality allow substantial waste in the system. Many California physicians must also share responsibility; by demanding fee-for-service payment from individual patients instead of a fixed monthly payment for each plan member, they are refusing to take responsibility for managing the cost and quality of the care they deliver. This forces health plans to spend more on administration to manage the doctors. Unchecked, fee-for-service medicine has incentives to provide more, but not necessarily better, care.
Under a true free-market approach, health plans would compete on the basis of cost and quality. But this is possible only when consumers have incentives to choose health plans on the basis of value--and information with which to compare plans. At that point, health plans will have an incentive to maintain the administrative costs that will allow them to most efficiently manage the cost and quality of their plans. And they will maintain the profits necessary to fulfill capital and expansion requirements.
