Reference Based Pricing: A Game Changer?

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.

Simply put, the system is broken. Although Americans are used to it and any significant change will come with challenges, change is needed. Several solutions have been proposed. One of these solutions is reference-based pricing.

The Appeal of Reference-Based Pricing

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.

The average commercial price for an office visit for an existing client was 11 percent more than the Medicare fee-for-service price.

The average commercial price for a brain magnetic resonance image (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. According to Becker’s Hospital Review, a study from RAND Corporation found that private insurers in Indiana paid a whopping 311 percent of Medicare hospital fees in 2017. Across the nation, relative prices were 293 percent of Medicare fees for hospital outpatient services and 204 percent of Medicare fees for hospital inpatient services.

Medicare prices can be considered a benchmark for healthcare costs in general. In reference-based pricing, the 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 percent of the Medicare fee. This cost-containment strategy helps keep prices low and predictable.

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 American Healthcare to Put Patients First. The order directs the Secretary of Health and Human Services to propose a regulation that will require 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 percent of people say they have engaged in cost-saving behavior, like asking about prices or negotiating a lower price, but 67 percent say cost information is somewhat or very difficult to find.

The Impact of Reference-Based Pricing

Although reference-based pricing is promising, its adoption will lead to disruption.

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

Even when providers accept the model, confusion may abound; the office staff might not know how to handle the new pricing arrangement. This 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 you can expect, you have to compare the average relative rates you’re currently paying to the percentage you want to use under relative-based pricing. For example, let’s say you’re currently paying an average of 200 percent of Medicare fees for hospital inpatient care. If you switch to a reference-based pricing system that pays 150 percent, you could be cutting one-quarter of these costs. You’d also be making covered costs more predictable.

According to Modern Healthcare, the State of Montana Benefit Plan switched to a reference-based reimbursement model in 2016 and has saved $13.6 million as a result. Other states, including North Carolina, are also working on reference-based pricing models. According to North Carolina Health News, state treasurer Dale Folwell has released details regarding the contracts he wants. The rates would vary based on different factors, including the type of care, the type of provider and the size of the hospital.

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

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