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Administrative Costs

Administrative costs stem from resources used to manage or administer an organization. While they are common to all organizations, administration costs are of particular importance in the U.S. healthcare sector because of the complex nature of health services and the interaction between public and private insurers and providers of care. Another indication of the importance of administrative costs is that virtually all proposals for reforming the U.S. healthcare system include reducing the administrative burden as a key component. It is essential to note, however, that administrative costs are not always negative. Even the most efficient and productive organization must incur a certain level of administrative costs. The challenge is to eliminate only administrative costs that are wasteful or unnecessary. Specifically, this entry defines administrative costs, discusses the magnitude and types of administrative costs, and reviews health policy issues related to administrative costs.

Definition

Organizations produce outputs, which are goods and services sold to individuals or other organizations. For example, a hospital produces services such as cardiac care or orthopedic surgeries. In producing these outputs, organizations use inputs, which are resources such as labor, capital, and supplies. A hospital, for example, uses nursing care, medical supplies, equipment, and facilities to provide cardiac care. An organization's costs depend on the quantity of inputs used and the price of the inputs. Nursing costs, for instance, depend both on how many nurses are employed and on the wages they earn.

Costs can be categorized as direct costs or indirect costs. Direct costs can be linked precisely to a given output. For example, direct costs for cardiac care in a hospital would include nursing salaries, medical supplies, and equipment for the cardiac-care unit. Indirect costs, then, are the remaining costs, which are more general in nature. The cost of utilities for the cardiac-care unit, for instance, cannot readily be distinguished from the cost of utilities for the orthopedic surgery unit or the intensive-care unit.

Administrative costs and support costs are the two main categories of indirect costs. Administrative costs stem from the managerial activities that are necessary for an organization to operate effectively, while support costs arise from other general activities needed for the smooth functioning of an organization. In a hospital, for example, costs of the human resources and quality assurance departments and salaries of upper management would be classified as administrative costs, while support costs would include expenses for facilities maintenance and housekeeping services.

Magnitude

Administrative costs in the nation's healthcare sector are substantial. At the broadest level, healthcare organizations can be categorized as being either providers of patient care or insurers. Healthcare providers include hospitals, physician practices, nursing homes, home health agencies, and many others. Insurers include public programs, such as Medicare and Medicaid, and many private insurers, such as Blue Cross and Blue Shield. Organizations in the healthcare sector incur numerous costs stemming from the complex nature of health services, the fragmented payment system, and the extensive regulation of health services.

On the provider side, administrative costs account for a considerable proportion of total costs. For example, administrative costs for hospitals and physician practices typically account for approximately 25% of total costs, while the percentage of total costs going to administrative costs in nursing homes is usually of the order of 20%. Using estimates of health expenditures from the Centers for Medicare and Medicaid Services (CMS), administrative costs in the nation's hospitals were of the order of $150 billion in 2005, while for physician practices and nursing homes, administrative costs were about $100 billion and $25 billion, respectively. Another way to measure the magnitude of administrative costs for providers is to examine the percentage of employee time spent on non-patient-care activities. Case studies indicate that in hospitals, for example, as much as 30% of staff time is devoted to documentation and recording, with more routine management activities, such as budgeting and supervision, accounting for about 7% of staff time.

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