Physician Patient

Managed Care Costs: Where Do Minnesota HMOs Spend Our Money?

Advocates of HMOs claim that HMOs can reduce health care costs without damaging quality of care. HMO advocates argue that HMOs save money primarily by reducing unnecessary services (1, 2, 3). There can be no question that HMOs have cut utilization of certain services, most notably hospital and mental health services, and that HMOs have achieved these reductions with two mechanisms — financial incentives, and utilization review (4, 5). HMO advocates and some policy makers and observers have erroneously concluded that if HMOs are reducing health care utilization rates then, HMOs must be reducing total heath care costs.

This syllogism — that lower use of hospitals and other services must mean that HMOs are cutting health care costs — would be true if the Minnesota health care industry had no administrative costs. But, of course, that is not so. Like every other sector of Minnesota’s economy, the state’s health care system has administrative (or overhead) costs. This is true for both sectors of Minnesota’s health care industry — the insurers and the providers (the doctors, hospitals and other health care professionals who give medical care directly to patients).

The debate about whether Minnesota’s HMO-dominated health care system is an efficient one has focused almost exclusively on the impact Minnesota’s HMOs have had on health care utilization. Relatively little attention has been paid to the impact HMOs have had on health care administrative costs. This is due in large measure to the paucity of reliable information on how HMOs spend their revenues. HMOs claim that their overhead costs are typically in the range of ten to 15 percent.

The Minnesota Physician-Patient Alliance (MPPA) sought to determine what portion of HMO revenues is spent on health care (that is, health care goods and services delivered directly to patients) and what portion is spent on administrative services (all services that do not qualify as direct health care services). MPPA examined the expenditure and revenue data available to the public for Minnesota’s three largest HMOs — Medica (a subsidiary of Allina), HealthPartners, and Blue Plus (a subsidiary of Blue Cross Blue Shield). In 1996, these three HMOs together received $3.3 billion to enroll 2.2 million of Minnesota’s 4.6 million residents (6). Together with their myriad of affiliated companies they administer and control health care for over 70% of Minnesotans (7). This report summarizes the results of our research.

The principal data sources for this report are the 1996 HMO reports to the Minnesota Department of Health (DOH). These reports contain data on total revenues and expenditures. Total revenue includes revenues from all sources, including premium payments and payments by tax-financed government programs. The HMOs are required to report their expenditures using expenditure categories used by DOH which were developed by the National Association of Insurance Commissioners(8). Some HMOs break their expenditures down more finely than others. For example, mental health and chemical dependency services, and funds withheld from physicians, are reported separately by some HMOs and not by others.

Percentages for hospital administration costs have been estimated, based on statistics provided by the Forecasting/Data Unit of the Department of Health of the State of Minnesota(9). The average administration costs of all Minnesota hospitals was reported to be 12.5% of total revenues. This percentage was applied to the percentages of total costs of the individual HMOs which they reported as being paid to hospitals.

Percentages for administration costs of physician clinics have been estimated by a similar procedure. The data for administration costs of physician clinics was extracted from data from the Medical Group Management Association(10). The information used for the accompanying charts was computed from data contained in a table in that publication entitled, “Operating Cost as a Percent of Total Net Medical Revenue by Geographic Section for Multispecialty Practices,” using median data for the Midwest Section (which includes Minnesota practices).

Salaries, benefits, and payroll taxes for administrative personnel were counted in arriving at the percentage representing physician administration costs. In addition, administration supplies and expenses and information services costs were added. Other operation costs, such as rent, depreciation, property taxes, outside legal and accounting, repairs and maintenance, etc. were included as “physician office costs”. The costs used represented 14.7% of net revenues of the physician clinics represented in the survey. By applying this percentage to the amounts reported by the HMOs as paid for physician services, the resulting percentages used in the accompanying charts were derived.

The most important findings are these:

  • HMO expenditures for health care for patients may have been as low as 60%. Conversely, expenditures for administration may have been as high as 40%.
  • These estimations are necessarily imprecise because the Minnesota Department of Health and the HMOs have elected to use an accounting system that fails to properly separate administrative spending from spending on health care.
  • Each of the three largest Minnesota HMO’s (Medica, HealthPartners and Blue Plus) are embedded in complex webs of profit and non-profit companies including for-profit subsidiaries, some of which are offshore.
  • Only 15% of 1996 Minnesota HMO dollars went directly to physician compensation.
  • Less than 4% of HMO dollars were spent on mental health and chemical dependency services.

Figures 1 through 3 present the breakdown of expenditures for the three HMOs examined. Table 1 presents a breakdown of the expenditures of all three HMOs added together. Table 1 and the pie charts in the figures are divided into two parts — “administration and other,” and “health care services.” The first category — “administrative and other” — accounted for up to 38.4% of expenditures by the HMOs in 1996. This is three to four times higher than the ten-to-15 percent overhead figure reported by the HMOs. The second category –“health care services” — accounted for 61.4% of all spending. If the three HMOs examined in this study accurately reported their expenditures on health care services to the Department of Health, these data indicate that as little as 60% of the money received by these HMOs was spent directly on patients.

This conclusion must remain tentative until the HMOs provide a breakdown of expenses currently lumped under a category called “other professional services.” This category shows up in Table 1 as a sub-category of “administration and other” along with “administration and taxes” and “incentive pool and withheld funds”. The latter two categories clearly consist of administrative expenses. But the other professional services category, which accounted for 18.8 percent of all spending, is harder to judge. The DOH defines this category to include a remarkably broad melange of services, some of which qualify as health care and some of which do not.*


Distribution of total expenditures by Medica, HealthPartners and Blue
Plus, 1996.
Administration and Other

administration and other
and taxes
pool and withheld funds*
professional** services
Health Care Services
office costs
Hospitals 21.0
and other medical
Dental 2.4
Health Care Services
not 100% due to rounding)

This category includes a host of workers who may or may not be “professionals” but are certainly not health care professionals (technicians, paraprofessionals, janitors, quality assurance analysts, administrative supervisors, secretaries, and medial record clerks). Because the DOH does not require HMOs to break this “other professional services” category into “administrative spending” and “other professional health care services,” it is impossible to determine what proportion of the 18.8% of HMO expenditures devoted to this category actually goes to patient health care. Because the HMOs have become quite sensitive to public criticism about overhead costs in the last five years, it is reasonable to assume that the HMOs have pushed every service that could reasonably be called a health care service into the “health care services” category, and, therefore, that the “other professional services” category is for services not rendered to patients. But this is speculation. Only the HMOs can answer the question. Does all of the 18.8% in “other professional services” qualify as administrative spending? It is difficult to perceive of a rationale for an accounting system that places janitors, quality assurance analysts, and administrative supervisors in the same category as nurses, podiatrists, and optometrists.

Doctors and hospitals also incur administrative costs. In 1996, the clinics and hospitals which treated patients insured by Medica, HealthPartners and Blue Plus spent 7.6% of the revenue they received from these three HMOs on administrative functions, including responding to HMO demands for information, paperwork, claims processing, denials and utilization review.

Only 15% of HMO expenditures was spent on physician compensation, including salaries and benefits. Note also that the percent of expenditures devoted to mental health services appears to be unusually small. The 2.1% spent on mental health services is smaller even than the 2.4% spent on dental services. The 2.1% figure is also small compared to the 9% spent on mental health by large employers in 1989.(11) However, it is possible that whenever HMOs report more precisely the expenditures now lumped under “other professional services” that the mental health slice of the pie might be higher.

The HMOs examined here are sizable entities in their own right. But these three HMOs are embedded in complex webs of for-profit and non-profit entities. Figures 4-6 map the structure of these webs. The complexity of these entities makes any attempt to audit the HMO reports much more difficult and expensive. These figures show that each non-profit HMO has many for-profit subsidiaries. Also, two of the three Minnesota non-profit HMOs send millions each year out of state to “vendors”, (United Health Care & Aetna/US Health Care). Each has offshore insurance subsidiaries. Each has mental health affiliates and some are for-profit. No detailed accounting between each HMO and its affiliates is available to the Minnesota public. We are unable to determine where Minnesota non-profit HMOs really spend our health care dollar.

This study concludes that the administrative costs of Minnesota’s largest HMOs are almost certainly considerably higher than the ten to 15% figure proclaimed by the HMOs. This result is consistent with other studies that suggest that HMOs cannot save money because they have such high overhead costs. In a little-noticed study published in 1993, Minnesota’s commissioners of health and commerce reported that administrative spending by Minnesota’s HMOs rose by 354% between 1980 and 1991 while HMO spending on administration rose 502%.(12) Other studies of national level data have found the same pattern.(13, 14) These reports indicate that as HMOs spread, administrative costs rise. These studies, coupled with the body of literature indicating that HMOs have cut health care utilization rates, suggest that HMOs are directing the savings extracted from patient care into administrative costs, not into reductions in premiums.

HMO advocates claim to be in favor of “empowering the consumer” with information. If Minnesota’s consumers and voters are ever going to be able to evaluate the Minnesota experiment in HMO management of the health care system, they will need to know where their health care dollar is going and why HMO overhead appears to be so high. But consumers will never have that information if the HMOs do not report more precisely. MPPA is particularly concerned about the HMO expenditure data now reported under the rubrics “administration and taxes” and “other professional services.” Together, these categories accounted for 29% of all HMO spending. We believe Minnesotans should know how much of this 29% was accounted for with expenditures on: advertising, lobbying Congress and our state legislature, HMO utilization reviewers who quarrel with doctors, claims processors, and other “services” that do not constitute health care. The single most important reform the DOH could make would be to require HMOs to extract from the “other professional services” category, and report separately, all true health care services. Utilization review, administrative nurses, janitorial services and other services that do not qualify as health care services could either be reported in a new category (for example, “other health care support services”) or could be folded into the administration category.

MPPA recognizes that some administrative spending is inevitable in any form of health care system. Minnesotans who pay health care premiums cannot possibly evaluate whether existing levels of administrative spending are too much or too little when information on this question is so inadequate.

This study required over 200 hours of research by MPPA including by our volunteer researcher, a retired CPA, a former chairman of the Minnesota State Board of Accounting and president of the Minnesota Society of CPA’s. The question of how Minnesota HMOs spend our health care dollar is one of the most important questions one could ask about Minnesota’s health care system. It is not enough to know that HMOs are reducing health care utilization rates. Until we know whether HMO administrative costs have declined or have at least not increased, we cannot say with any confidence that we are making headway against health care inflation.

Minnesotans should not have to rely on HMO officials for information on how much of our health care dollar is going to HMO overhead. Nor should Minnesotans have to rely on our volunteer efforts. Accurate annual reports on where HMOs spend our money should be the responsibility of the HMO’s and a state agency. MPPA calls on Governor Arne Carlson and the Attorney General’s office to develop a plan by which the Department of Commerce or some other state agency will issue accurate reports annually on HMO administrative spending. This annual report should be based upon an audit of the financial records of all of the enterprises affiliated with the non-profit HMOs.

We call on Minnesota’s HMOs to open the books of their non-profit companies and of their affiliates and explain to Minnesotans where their health care dollars are really spent. We call on them to detail their relationships with for-profit vendors and subsidiaries. We call on them to explain the rationale by which so many millions of health care dollars are spent on care management and administration rather than on true health care. Minnesotans deserve a health care system that spends its health care dollars directly on true health care.


  1. “Health Maintenance Strategy,” Medical Care 9:291-298 (May-June 1971); Paul M. Ellwood, Jr., Nancy N. Anderson, James E. Bilings, Rick J. Carlson, Earl J. Hoagberg, Walter McClure.
  2. “Cutting Cost Without Cutting the Quality of Care,” New England Journal of Medicine 198:1229-1238 (June 1, 1978); Alain Enthoven.
  3. “A Consumer-choice Health Plan for the 1990s: Universal Health Insurance in a system designed to promote quality and economy (second of two parts),” New England Journal of Medicine 320: 94-101 (Jan 12 1989); Alain Enthoven and Richard Kronick.
  4. “Managed Care Plan Performance Since 1980: A literature analysis,” JAMA 271: 1512-1519 (May 18, 1994); Robert H. Miller and Harlod S. Luft.
  5. “Use of Outpatient Mental Health Services in HMO and Fee-for-Service Plans: Results from a randomized controlled trial,” Health Services Research 21: 453-474 (August 1986); Kenneth B. Wells, Willard G. Manning, Jr., Bernadette Benjamin.
  6. “1996 HMO and CISN Financial Data”, Minnesota Council of Health Plans, Minneapolis Star & Tribune 3/3/197.
  7. Minnesota Managed Care Review 1997, Allan Baumgartner, October 1997.
  8. “NAIC Annual Statement of Instructions for HMO’s for 1997,” Minnesota Department of Health and the National Association of Insurance Commissioners, 1997.
  9. The Forecasting/Data Unit of the Department of Health of the State of Minnesota.
  10. “Operating Cost as a Percent of Total Net Medical Revenue by Geographic Section for Multispecialty Practices,” using median data for the midwest section, from cost survey: 1997 report based on 1996 data; Medical Group Management Association, Englewood, Colorado, September 1997.
  11. “Covering Mental Health and Substance Abuse Services”, Health Affairs 16:120-130 (July-August 1997); Jeffrey A. Buck and Beth Umland.
  12. Study of Health Care Management Companies, Table 2, p. 8; (March 1993); Minnesota Commissioners of Health and Commerce. (The administrative increase is calculated by the authors from the data presented in Table 2).
  13. “Who Administers? Who Cares? Medical administrative and clinical employment in the United States and Canada,” Am Journal Public Health 86:172-178 (February 1996); David U. Himmelstein, James P. Lewontin, Steffie Woolhandler.
  14. Study of Health Care Management Companies, p. 7; (March 1993); Minnesota Commissioners of Health and Commerce.

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