When each of my three children was deciding which college to attend, I made the case that in-state public universities could fulfill their higher-education goals.
Then I made each of them an offer: I would pay the tuition and housing costs at the in-state public university of their choice. If they decided to attend an out-of-state or private university, I would contribute what I would have paid if they attended the in-state school. They would be responsible for the balance of the costs.
All three eventually graduated from in-state public universities.
I used what is known as “reference pricing” to influence their choice of schools. That same principle is emerging in healthcare to combat apparently inexplicable price variation.
Insurers or employers use reference pricing to set the price they are willing to pay for a service or procedure, typically pegged at a cost that can be obtained at a good-quality provider. The policyholder or employee can get the service or procedure with no out-of-pocket costs at a provider who charges the reference price or less. If the provider charges more, the patient pays the difference.
In a sense, reference pricing could be considered a reverse deductible. The payer picks up the first part of the total charge and the patient pays for the rest.
Stated differently, reference pricing is similar to indemnity insurance, under which the insurer pays a predetermined contribution toward the insured service and the policyholder pays the rest. However, reference pricing in healthcare sets the insurer’s or employer’s contribution high enough to ensure that patients have a choice of high-quality providers.
Unlike almost any other market, consumers rarely know what they will pay for health services until after they receive them. Prices vary significantly, even for common procedures such as mammograms and colonoscopies. Moreover, there is no consistent evidence that higher medical prices yield higher quality.
For example, a recent study in the journal Health Affairs illustrated that although hospitals that are more expensive tend to have higher prestige and brand-name recognition, there is no clear evidence that these hospitals are actually providing better healthcare. The average low-price hospital charged 77 percent of the overall average price for the entire group of providers. The average high-price hospital charged 1.3 times that average.
Reference pricing works best for products and services that have a wide variation in price but small differences in quality. Reference pricing has been used successfully to lower costs and increase value in drug prescription plans. Payers are now setting their sights on bigger-ticket services.
Reference pricing is less effective for complex procedures that require multiple services, such as hip and knee replacements. However, that has not stopped a few providers considered “centers of excellence” from negotiating a set price with large employers for the joint replacements and cardiac surgery.
Reference pricing also does not apply to emergency care that does not allow time for selectively choosing where to get the best price.
The goal is to save money by directing people toward lower-cost providers while also motivating high-price providers to lower prices to protect market share. Reference pricing seems to move the market price of services by rewarding price-competitive providers. It also attempts to steer consumers away from passively following doctors’ referrals and toward becoming price-conscious shoppers of medical services. And it promotes price transparency, which is sorely lacking in U.S. healthcare.
The goal is to save money by directing people toward lower-cost providers while also motivating high-price providers to lower prices.
Reference pricing is common in Europe’s national health insurance systems.
Hip and knee replacement prices at California’s most costly hospitals dropped by about one third in 2011 after the California Public Employees’ Retirement System (CalPERS) required its workers and retirees to pay for all costs above the established reference price of $30,000. For the 41 California hospitals identified as “value” hospitals that initially charged below the reference price, patients paid co-insurance of $3,000.
The market shift was dramatic. The “value” hospitals saw a 21 percent higher volume in CalPERS patients in the first year. The more expensive hospitals had a 34 percent decrease in CalPERS patients. Remarkably, about half of the expensive hospitals reduced the prices they charged CalPERS patients, many by a substantial margin.
CalPERS saved an estimated $2.7 million on joint-replacement surgeries in 2011 alone. During a speech at the Dallas-Fort Worth Business Group on Health’s annual conference, Mike Taylor, senior vice president at Aon Hewitt, said the CalPERS case was “a classic example of transparency and market pressure,” and argued that health plans need to be aligned with the potential growth of reference pricing.
Grocer Safeway established reference pricing for colonoscopy screenings for its employees covered under certain Safeway-sponsored health plans. In the San Francisco Bay Area, where the cost of screening colonoscopies ranged from $900 to $7,200, it pegged the facility price for colonoscopies at $1,250.
In the program’s first year, a significant number of employees were steered away from the most expensive providers without a decrease in the rate of screenings. Safeway built an online portal for employees to illustrate the out-of-pocket costs at colonoscopy providers.
The company has expanded reference pricing to pharmaceutical drugs, laboratory, and elective high-technology imaging procedures.
WellPoint, the nation’s second-largest U.S. insurer, began offering a reference-pricing program in January for employers with at least 100 employees. The company allows employees to pay only a set amount for medical services and charges workers if they choose more costly care.
Aetna began offering reference-based pricing to self-insured companies with at least 250 workers in most markets in 2013. The program includes 11 procedures such as imaging and colonoscopies.
According to a 2013 Mercer survey of employers with at least 500 workers, no Dallas-Fort Worth employers are using reference pricing. However, 6 percent of Texas employers and 10 percent of U.S. companies are doing so.
The number of employers that plan to use reference-based pricing will grow to nearly 70 percent by 2018, according to a 2013 Aon Hewitt employer survey.
Bruce Sammis, chief executive officer of Lockton Dunning Benefits in Dallas, said there is “not a ton” of dollars in reference pricing, but employers have to manage all of their healthcare costs. He said it works best for high-volume, commoditized procedures.
Robyn Bayne, vice president and Dallas-Fort Worth health and benefits practice leader for Aon Hewitt, said there is a lot of interest in reference pricing among DFW employers, despite the lack of takers. Some employers are reluctant to use reference pricing because they fear it cannot be explained clearly or used simply by employees.
The success of reference pricing depends in part on how receptive employees are. They are likely to become more amenable to it as high-deductible health plans continue to sweep across the U.S. benefits landscape.
Large companies are increasingly offering employees only one medical-insurance option: a plan with a high deductible, tied to a health savings account or health reimbursement account.
Two out of three companies with 1,000 employees or more offered at least one such plan in 2013. That is expected to grow to nearly eight out of 10 in 2014. For about 15 percent of companies, an account-based plan was the only option in 2013—double the rate in 2010.
One out of three workers with employer-sponsored insurance—including half of those at small businesses—have deductibles of more than $1,000 for individual coverage. The number of employers offering HDHPs grew by 50 percent from 2010 to 2011.
The success of reference pricing also depends on more user-friendly transparency of prices and quality. And, remarkably, some health plans are unwilling to disrupt relationships with providers by shopping for better pricing.
Ultimately, reference pricing is a benefit strategy, rather than a pricing strategy. For example, it does not involve renegotiating provider contracts. It does require employers and health plans to stand up and say they will not stand for needless healthcare price variability.