As the debate over health care costs continues, wasteful spending—outlays for health services that could be eliminated without harming consumers or care quality—deserves unflagging attention from researchers, clinicians, and policy makers. The Institute of Medicine estimated that waste consumed 30 percent of US health dollars in 2009. Donald M. Berwick and Andrew D. Hackbarth, working from a 2011 baseline, pegged the midpoint of reasonable waste estimates even higher, at 34 percent. A crude extrapolation of these figures, given the steady rise in overall health expenditures, implies that wasted spending now comfortably exceeds $1 trillion annually (see Exhibit 1), a sum that could fund the entire Medicaid program twice over.

Exhibit 1: Causes Of Waste In The US Health Care System

Sources: Waste categories and magnitudes based on work by Berwick DM, Hackbarth AD. Eliminating waste in US health care. JAMA. 2012;307(14):1513-6. Original estimates based on 2011 spending levels have been extrapolated to 2016 using National Health Expenditures (NHE) data. 1Health consumption expenditures include all NHE, less investment (research, structures, and equipment) and public health outlays by federal and state governments. 2Includes 55.4 million Medicare enrollees, 71.2 million Medicaid enrollees, and 6.5 million children covered by CHIP per the Centers for Medicare and Medicaid Services data, less 10 million lives covered by both Medicare and Medicaid in 2016, per the American Community Survey. 3Includes 173.1 million lives covered by employer-sponsored insurance in 2016, plus 17.5 million covered by a plan purchased directly, of which the majority bought plans on an Affordable Care Act exchange. To avoid double counting, this figure excludes 7.3 million individual Medigap plans.

These and similar studies often critique health care as if it were a single $3.3 trillion industry. However, the health sector is a mosaic of smaller markets for particular services or products, each further subdivided by the varying rules, pricing models, and administrative mechanics of a particular provider-payer pair. Exhibit 2 illustrates this segmentation by service category and payer type. For example, medical equipment manufacturers derive roughly three-quarters of their revenue from out-of-pocket payments, while pharmaceutical vendors rely on patient payments for less than 15 percent of drug bills. This shapes each industry’s sales and marketing strategy, and is likely to affect patterns of spending and waste. From another perspective, more than 90 million Americans carry coverage under a risk-adjusted, quality-rated plan funded by either Medicare Part C or a state-run managed Medicaid program. The economic incentives and administrative requirements in these coverage segments are distinct from the traditional fee-for-service model, and there is evidence that this structure can shape the choice of facilities and use of preventative services.

Exhibit 2: Breakdown Of 2016 Health Expenditures, By Source Of Funds (% of total cost in each category incurred by each payer type)

Source: National Health Expenditure data released by the Centers for Medicare and Medicaid Services. Figures include all health consumption expenditures, with the exception of public health activities.

Furthermore, these subsegments are hardly static—Exhibit 3 highlights similarly important variations in the relative growth of these segments. And, as Kenneth Thorpe has observed, the underlying drivers of spending growth “differ sharply by the source of health insurance,” with enrollment and disease prevalence the major factors for Medicare and Medicaid, while the cost of individual cases is the primary culprit in the privately insured population. Detailed analysis of private claims confirms this latter point, finding relatively flat usage of most health services from 2012 to 2016, with price hikes explaining most of the overall cost increase.

Exhibit 3: Heat Map: 2011–16 Growth In Health Consumption Expenditures (Shading on category labels [for example, hospitals] reflects the pace of total cost growth in that category, relative to the overall trend, using the same thresholds explained in the legend.)

Source: National Health Expenditure data released by the Centers for Medicare and Medicaid Services. Figures include all health consumption expenditures, with the exception of public health activities.

This review examines waste and spending together in a market-specific context, to generate new insights from several recent studies. We explore a few major themes of this market-specific approach to analyzing waste, including incentive structures, administrative complexity, and differences between private and public payers. We draw some preliminary conclusions about how waste may vary across these markets and highlight areas for further research and policy change.

What We Know, And Don’t, About The Prevalence Of Waste Across Markets

Despite much attention to the overall scale of waste, the allocation of that burden is not well-understood. Given the scale of the care delivery ecosystem and limited availability of comparable claims and clinical data, the extant literature tends to provide highly aggregated system-level estimates or a narrow look at a specific clinical service or care setting (for example, health care-associated infections in the hospital setting). Despite those limitations, we can draw several intriguing insights into variations in waste and who bears the brunt of that unnecessary spending:

Private insurers—and ultimately employers and individuals who pay premiums—account for a disproportionate share of the waste attributable to administrative complexity and billing bureaucracy. Patients and private insurers may be particularly exposed to the cost of unnecessary or low-value outpatient services, such as diagnostic imaging for uncomplicated headaches. Given its membership demographics, Medicare is heavily impacted by the cost of failures of care coordination, in hospital and skilled nursing facilities.

In 2012, Berwick and Hackbarth’s meta-analysis estimated the relative incidence of waste within Medicare and Medicaid, and across the heath system as a whole (see Exhibit 1). If we compare their reported figures to overall health consumption expenditures (HCEs) by certain payer types, the Berwick and Hackbarth assessment found waste on the order of 31 percent of HCEs within Medicare and Medicaid, but 41 percent across the rest of the system, which is predominantly funded through private insurers. Waste rooted in administrative complexity—estimated at 14 percent of private payer outlays—accounts for the bulk of the difference. Berwick and Hackbarth’s conclusion is supported by other research in this area. For example, using cross-country data, David U. Himmelstein and colleagues found that administrative overhead consumes 25 percent of outlays on US hospitals, which is far higher than in countries that do not rely on multiple private payers, with the difference due to “the complexity of the reimbursement system.” While the existence of many private payers imposes an administrative burden on provider organizations, private payers also account for a disproportionate share of the administrative overhead that occurs within coverage organizations. Per National Health Expenditure (NHE) data, private insurers absorb administrative overhead (and profits) equivalent to $600–$700 annually per member, as compared with approximately $200 for Medicare’s traditional fee-for-service model, whose nationally consistent coverage and large scale approximate the performance of the less fragmented payer models in many other developed countries. Indeed, private insurance companies account for approximately 83 percent of the total net cost of health insurance in the US.

Macro waste estimates shed less light on the relative burden of waste arising from clinical practice, but increasing availability of claims data does permit some emerging conclusions. For example, Minnesota’s all-payer claims database suggests that patients paid approximately 17 percent of the cost for many low-value procedures out of pocket, as compared with the 12 percent of overall costs paid out of pocket in the state. These charges covered such services as prostate-specific antigen (PSA) screening in men older than age 75, diagnostic imaging for uncomplicated headaches or low back pain, and unnecessary pre-operative testing. Commercial insurers were also disproportionately affected, absorbing more than half of these unnecessary costs, well ahead of their 38 percent share of overall health expenses. Separate research has established that Medicare and (particularly) Medicaid pay lower rates for many clinical services than private payers and that Medicaid tends to deny or review the largest fraction of claims. Providers may therefore be more likely to promote low-value services to the buyers who pay higher prices and impose fewer reimbursement hurdles; this variance may also reflect the efficacy of prior authorization or payment rules under government programs.

Berwick and Hackbarth judged that Medicare and Medicaid programs were much more exposed to failures of care coordination—the costs arising from “complications, hospital readmissions, declines in functional status, and increased dependency, especially for the chronically ill.” Specifically, they found that 3 percent of Medicare and Medicaid outlays were wasted through care coordination failures, as compared with <0.5 percent of spending by other payers. This likely stems from Medicare’s membership, which includes the elderly, disabled, and those with end stage renal disease or amyotrophic lateral sclerosis (ALS), all groups that tend have more complex needs and that are more likely to suffer major declines in functional status if that care falls short.

Detailed research has indeed found adverse events affecting Medicare patients in hospitals and skilled nursing facilities to be both disturbingly common and very costly. A study of hospital care in 2008, for example, found that 27.0 percent of admitted Medicare beneficiaries experienced an adverse event causing temporary or lasting harm, and these events accounted for roughly 3.5 percent of Medicare’s expenditures on inpatient care during the period studied. Medicare patients admitted to skilled nursing facilities (usually after hospital discharge) were even more likely to suffer an adverse event, with 33 percent experiencing temporary or lasting harm. More than half of these events prolonged the skilled nursing facility stay or necessitated hospitalization, and those resulting hospitalizations account for an additional 2 percentage points of Medicare’s inpatient care costs. Assuming no change in adverse event frequency, the cost of these clinical breakdowns would have exceeded $15 billion in 2017, given the overall rise in Medicare outlays for hospital care. Some surveys have found a substantially lower overall incidence of adverse events when all patients are included, which would reinforce the conclusion that Medicare likely bears a disproportionate share of the waste caused by failures of care coordination.

Are We Making Progress In Trimming Waste? It’s Complicated

Differential growth across these markets suggests that the waste attributable to administrative complexity is likely on the increase, consuming a larger slice of overall health expenditures (see Exhibit 4). Privately sponsored coverage—where this waste is most prevalent—has increased only marginally over the past five years, as a share of total health consumption expenditures. However, the growth of Medicare Advantage and Managed Medicaid programs have inserted private insurance companies into the reimbursement cycle for a much larger fraction of patients and spending. For example, private insurers now manage 73 percent of Medicaid beneficiaries, up from 59 percent in 2013. While private insurer participation in Medicare or Medicaid may have other virtues, their role does increase the net cost of administering coverage, although the impact on provider workflows and staffing is more ambiguous.

Exhibit 4: Accounting For The Increase In US Health Costs

Source: National Health Expenditure data released by the Centers for Medicare and Medicaid Services.

For waste rooted in unnecessary or low-value care—“overtreatment,” in Berwick and Hackbarth’s framework—the growth picture is mixed. Overall, patient out-of-pocket expenses have declined as a share of total health consumption expenditures, from 12.6 percent in 2011 to 11.4 percent in 2016 (per NHE data). However, both direct patient charges and private insurance payments have remained a consistent portion of the clinical services category that encompasses many of these low-value diagnostics and procedures, while this cost category has grown at a 6.8 percent compound rate over the past five years. To the extent that low-value services are disproportionately charged to patients and commercial insurers, these growth trends suggest that the cost of overtreatment likely remains a fairly consistent portion of overall spending.

Finally, there is reason for guarded optimism on Medicare’s costs from care coordination deficits. While overall hospital costs are growing faster than overall health expenditures, Medicare has successfully contained its own hospital costs (see Exhibit 3). Furthermore, recent research finds meaningful improvements in patient safety within hospitals, suggesting fewer adverse events and less resulting cost.

Future Directions For Research And Policy

Several policy considerations emerge from this review. First, all-payer claims databases would permit greater fidelity in understanding the burden of waste, identifying opportunities to curtail unnecessary spending, and measuring the efficacy of any efforts to tackle the problem. Second, certain payers would benefit disproportionately from different priorities—the Centers for Medicare and Medicaid Services might focus on care transitions for Medicare patients, for example, while private insurers target overtreatment through member education, lower reimbursement for low-value diagnostics, or greater investments in primary and preventative care. Finally, given the scale and growth of waste rooted in administrative complexity, there may be scope for regulatory intervention to standardize claim coding and payment rules, to cut administrative costs for privately administered coverage (whether employer- or government-sponsored). Such a framework could limit payer and provider outlays on claim editing tools and coding staff to navigate differences across commercial plans, leaving insurers to negotiate provider prices, market their plans and networks, and improve the member experience.