How to save a quarter-trillion dollars in health care spending every year

Administrative spending accounts for about one-quarter of the nearly $4 trillion spent on health care annually in the United States, making it a natural place to look for savings. Yet despite attempts to lower such costs, they have remained stubbornly high for decades. Is it possible that all this spending is really necessary?

No, it is not. For the past two years, we, along with colleagues from the consulting firm McKinsey & Company, have been examining administrative health care costs in detail — and comparing them with similar costs in other industries. Of the roughly $1 trillion in annual health care administrative spending, we estimated the United States could save $265 billion annually, or roughly 6% of total health care spending, by applying technologies and processes proven to work already. For context, that is more than Medicare fee-for-service spent on inpatient and outpatient hospital care combined in 2019. Put another way, this would amount to $1,300 for each adult in the United States.

If we achieved savings of that magnitude, we would be able to trim the health care bills of financially stretched Americans even as we invest in behavioral health and other underfunded areas of care.

We are aware of the dangers of overpromising: It is common to claim that financial challenges can be solved by cutting unnecessary administrative spending. But based on careful examination of the practices of other industries and on-the-ground experiences with health care organizations, we believe these savings could be captured within three years without hurting quality or access. We're additionally optimistic because the pandemic has shown that health care organizations can change their ways quickly when they need to (witness the rapid rise of telemedicine in the last two years).

The bad news is that there is no single measure to unlock these savings. Past reforms, which did lead to some savings, often involved touting quick fixes — "If only we had a standardized claim form!" (That reform was mandated, but insurers responded by requiring unique "claims attachments.") But we have learned from other industries that simplifying administrative functions requires sustained effort from all parties and a lot of little wins. The big bang is out; steady progress is in.

To estimate potential savings, we began with the cost drivers for insurers, hospitals and physician groups, and we identified five general areas of administrative spending — including financial transactions (such as claims processing and prior authorization) and customer and patient services (such as call centers and self-service applications). We then quantified what portion of administrative spending was unnecessary by applying interventions that have been successful in health care or other industries and could be instituted within three years.

Surprisingly, we found that individual organizations can achieve the majority of savings on their own — cutting against the conventional wisdom in health care that only sweeping, systemic reform can make a difference. Consider insurer call centers. Our research found that the average insurer gets 0.5 to 1.0 calls per member per year — ranging from complex questions about benefits and out-of-pocket costs to simple queries about ID cards.

Telephone companies and banks have reduced the simpler interactions by 50% — by using self-service technologies such as apps (to check balances, say). If insurers adopted similar solutions for activities such as explaining a patient's benefits or pinging providers when a claim status has been updated, they could cut total call volume by 20 to 30% annually. This and similar back-office interventions adopted by individual organizations could generate $175 billion in annual savings.

A second savings opportunity would involve greater collaboration among various stakeholders, such as insurers and physicians. The U.S. health care system is built to put these groups at odds with each other: Getting approval for an elective procedure such as back surgery may require multiple rounds of back-and-forth between a provider and the insurer. Is the clinical condition severe enough to justify surgery? Is the surgery at an in-network facility? Some checks and balances are reasonable, but standardizing the information that insurers require could dramatically simplify this process. These types of cooperative interventions could deliver another $35 billion in annual savings.

Finally, other industries have cut administrative costs by standardizing certain industrywide practices: Retail stores no longer use their own product codes, for instance, but rather have adopted Universal Product Codes (UPCs). In health care, there could be a centralized claims clearinghouse to transmit billing information — as well as harmonized physician and nurse licensure across states, and shared records between insurer and hospital computer systems. If insurers, hospitals, physician groups and government agencies came together to create such systems, that could deliver another $55 billion in annual savings.

Why haven't organizations already captured these dollars for themselves? A few have. But the lack of wide-scale action to date is likely due to a few factors, including simple prioritization. With so much going on operationally, administrative savings fall low on the list, particularly when the magnitude of possible savings through individual interventions has not been known.

Savings that require coordinated action at a small or large scale await a leader to facilitate them. In banking, the effort to create a centralized claims clearinghouse started when a handful of the banks in California became worried about the unsustainable volume of paper checks passing among them. After the banks set up the first regional automated clearinghouse among themselves, nonprofits, industry associations and government agencies helped push for national adoption.

Health care could benefit from a similar setup. For example, CAQH — a nonprofit alliance of health plans and related associations — promotes standards for claims forms in health care today. But the process is slow, and the standards are not universally followed. There's a collective-action problem: The financial incentive for any one insurer to change is limited if all insurers do not do the same. The problem could be solved by a model resembling the one in banking: Spurred by key actors, including nonprofit groups and government agencies, a collection of the biggest payers and providers might adopt a centralized clearinghouse — simplified, consistent and universal.

How to ensure that savings from increased administrative efficiency get to consumers? Market forces are already pushing in this direction. Consumers increasingly vote with their feet, switching insurers and doctors due to high prices and poor service. Further, as competition in the employer market has increased, employers are demanding that cost savings be passed back to them — even as they insist that insurers invest in behavioral health and digital tools that promote wellness. Rooting out administrative waste is one way to find the money for these investments.

Saving a quarter-trillion dollars in health care through administrative simplification is not a pipe dream, nor does it require single-payer health care (as some have suggested). It is realistically attainable using interventions already deployed in other industries. Health care organizations got into this administrative mess through benign neglect. Only sustained effort will get us out.

David Cutler, the Otto Eckstein professor of applied economics at Harvard University, is co-author of "Survival of the City: Living and Thriving in an Age of Isolation." Nikhil R. Sahni is a partner at McKinsey & Company and a fellow at the Harvard economics department.