The decades-long rise in American healthcare prices has put continual pressure on employers, the largest class of health insurance providers in the U.S. Most have accelerated their efforts to cut costs in recent years, including a broad-based transition to self-insurance. The newest experiment getting employers' attention? It's called reference pricing.
Reference pricing is no more than a cap on a medical expense, where the employer or other benefit provider agrees to pay for a particular service (minus whatever copay or deductible the patient is responsible for) only up to a specified price. The idea is to discourage employees from choosing expensive care when there are sufficient quality providers who charge a far lower price. Additionally, employers hope to motivate providers to keep prices below the set price points, or risk losing business from their members.
A few high profile firms are leading the way, including the California Public Employees' Retirement System (CalPERS), Safeway, and Kroger. Beyond these three, Kaiser Health News cites a study by benefits firm Mercer saying that about 10 percent of large employers currently use some form of reference pricing, and 22 percent are considering it. Reference pricing programs received the blessing of the federal government in May, 2014.
CalPERS began its experiment in 2011 with total hip and knee replacement procedures. The reference price was set at $30,000 (for the facility fee only, which typically makes up 75% to 80% of the overall cost on joint replacements). In the first 9 months, members choosing higher-value hospitals for such procedures increased by more than 25%. Average prices fell from more than $42,000 before the initiative to $27,148 in the same time period, with a savings of some $5.5 million in the first two years of the program. In addition, 15 hospitals lowered their prices to a point below the reference price within the 2 years.
This is certainly a significant accomplishment in reducing the costs of employer health benefits, but it's really just scratching the surface. Reference pricing has the potential to produce much better results. The bar can be raised in several ways.
Before its foray into reference pricing, CalPERS saw facility fees for joint replacements ranging from $15k to over $100k at various hospitals in California. But this was not the entire price for such surgeries. Capping a hospital's fee and not a physician's fee is a recipe for cost shifting by hospitals, who more and more are buying out the physicians and increasing their non-facility charges.
The bundling of multiple vendors' fees into one price is preferred. And happily, some providers are already starting down this path. A high quality surgical hospital in Omaha, Nebraska recently published an all-inclusive price (including the facility fee, physician fee, anesthesiology fee, and more) for three total joint replacements, including hip and knee joints. Both rates are well below the average price CalPERS allows for the facility fee alone.
It's not just hospitals that are creating bundled prices for services; surgery centers and imaging centers are getting into the act as well, to the satisfaction of patients and employers alike. This looks to be a new trend that reference pricing strategists should adopt sooner rather than later.
Despite results published by CalPERS and others as to the savings from reference pricing, no individual facility prices have been listed publicly. This is unfortunate. Full public access puts a provider's pricing under greater scrutiny, and encourages lower-cost competitors, which only benefits members.
Insurance carriers would take issue with this of course, as the negotiated prices are typically proprietary (though California law prevents gag clauses in such contracts as of 2013). And there's also the frequently raised argument about whether transparent and competitive pricing hurts hospitals, or whether it would turn into a race to the bottom, cheapening care.
Let me first say that all the hospital executives I've ever talked to know that transparency is coming (whether they like it or not). Most are working to prepare for it. Second, and more importantly, quality facilities who keep their costs down are unlikely to suffer when exposure and competition increase. The number of local and remote patients making choices based at least partially on price is growing quickly. This trend is already causing patient outflows for some facilities choosing not to publish their prices.
Insurers negotiating contracts with providers behind closed doors aren't primarily concerned about getting the most affordable, quality care for their members. Nor do small or medium insurers in a given market have much leverage to bring provider prices down. Insurer revenues come from subscriber premiums, and they need a long list of big name, high-traffic providers in their network to attract as many subscriber as possible. This gives providers the edge in negotiations.
Hence insured rates are rarely as low as they could be, and are often exceptionally high.
Moving to direct-pay pricing doesn't eliminate the need for insurance of course (though it does wreak havoc on carriers' current modus operandi). But a more direct relationship between price and demand gives patients more leverage with providers, keeping rates at more reasonable levels, regardless of who the insurer is.
The vast majority of Americans are forced into receiving care from only a subset of providers. This greatly reduces the effectiveness of competitive forces, and keeps patients from driving volume to some of the most affordable centers and clinics.
Opening up the playing field to all providers across the country is a wake-up call for large providers who have taken patient traffic for granted. It will result, rather quickly, in the lowering of rates. It will also prod facilities to become more efficient in order to cut costs, and to compete better in terms of customer service and care quality, an area where big systems frequently fall behind.
When a provider's source of patients shifts from insurance networks to employers and direct payers, employers and direct payers have more influence. This will inevitably lead to lower rates across the board.
It is encouraging to see so much effort in the last several years toward pushing the envelope on all of these points, which will have the effect of lowering healthcare costs not only for employers and groups like CalPERS, but also for those paying for their own care, for governments, and for the nation as a whole. What we've seen from reference pricing is just the tip of a very large iceberg.
Randy Cox is Founder and CEO of Pricing Healthcare, an open, independent, online marketplace for direct-pay healthcare.