It’s time for clients to try reference-based pricing. Here’s why it works

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In 2017, the U.S. spent $3.5 trillion on health expenditures.

That’s more than any other country and more than double the average among developed countries, according to the Committee for a Responsible Federal Budget. Every year, healthcare costs rise, putting additional strain on individuals, their families and their employers.

The system is broken. Any significant change will come with challenges, but change is needed. Several solutions have been proposed and one of those is reference-based pricing.

Medicare prices can be considered a benchmark for healthcare costs in general. In reference-based pricing, Medicare fees are taken as a starting point, and the insurer pays an amount related to that baseline. The amount varies, but it could be as low as 120% of the Medicare fee. This cost-containment strategy helps keep prices low and predictable.

Medicare uses a fee schedule to determine the rates paid to providers and suppliers, including physicians, ambulance services and clinical laboratory services, as well as durable medical equipment, prosthetics, orthotics and supplies.

The fees that Medicare pays tend to be significantly lower than the fees paid by private insurers. A 2018 report from the Congressional Budget Office looked at the costs associated with selected services. Commercial prices were higher than Medicare fee-for-service prices, and the difference was much greater for specialty care.

For example, the average commercial price for an office visit for an existing client was 11% more than the Medicare fee-for-service price and the average commercial price for an MRI was double the Medicare fee-for-service price.

Differences in hospital care can be especially steep, with big variations depending on where the care occurs. A study from RAND Corporation found that private insurers in Indiana paid a whopping 311% of Medicare hospital fees in 2017. Across the nation, relative prices were 293% of Medicare fees for hospital outpatient services and 204 percent of Medicare fees for hospital inpatient services.

The need for price transparency in healthcare

Imagine an employee needs knee replacement surgery. How much will it cost? The answer will depend on a number of factors, including what the hospital charges and what the insurer has negotiated. For the employee receiving the surgery, knowing what’s covered in-network is also important. Even if the hospital itself is in a network, one of the care providers may be out-of-network, resulting in a balance bill, also known as a surprise bill.

Surprise bills and price transparency are two key healthcare issues currently gaining political attention. In June, President Trump issued an executive order on improving price and quality transparency in healthcare. The order calls for a regulation requiring hospitals to post standard pricing information, including negotiated rates. It also calls for rulemaking to require providers, insurers and self-insured group plans to provide information on expected out-of-pocket costs before care is received.

Such information is needed. Currently, patients may not succeed in shopping for low prices even if they try. According to a survey from the Kaiser Family Foundation and the Los Angeles Times, 70% of people say they have engaged in cost-saving behavior, like asking about prices or negotiating a lower price, but 67% say cost information is somewhat or very difficult to find.

How to make reference-based pricing work

Proper communication and advance preparation are key to a successful transition to a reference-based pricing model. Although reference-based pricing is promising, its adoption can lead to disruption.

Some providers might not accept reference-based pricing. Currently, a hospital may charge a private insurer around 200 to 300% of Medicare fees and they may not be willing to take a set rate equal to 120 to 150% of these fees.

Even when providers accept the model, confusion may abound. The office staff might not know how to handle the new pricing arrangement which could lead to the patient being charged a large bill instead of a reasonable copay, at least until the details are ironed out.

However, for a group health plan that is successful in switching to reference-based pricing, the savings could be tremendous, especially when it comes to specialty and hospital care.

To predict the exact savings clients can expect, compare the average relative rates they’re paying the percentage they want to use under relative-based pricing. For example, let’s say an employer is currently paying an average of 200% of Medicare fees for hospital inpatient care. If they switch to a reference-based pricing system that pays 150%, they could be cutting one-quarter of these costs. Covered costs may also become more predictable.

Innovative approaches to control the cost of healthcare are needed, and reference-based pricing is a potential solution.

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