Expert: How Reference Pricing and Consumerism Reduce Healthcare Costs

Reference pricing leverages a shopping model with an allowance component to give employees an incentive for comparing providers for particular procedures by shifting any costs above a target price to the patient. It’s a consumerism approach that encourages employees to become informed about their healthcare especially with respect to costs.  The Employee Benefits Research Institute estimates industry-wide savings of $9.4 billion or 1.6% of total aggregate US healthcare spend, so it has the potential to lower healthcare costs for the country.

Blue Cross Blue Shield developed the shopping model in 2011 for the California Public Employees Retirement System (CalPers) and has the most documentation.  This benefit design involves making an employee responsible for all the costs over a procedure’s reference price. Because costs vary by area, reference prices vary by cost region. So prices in Dallas are based on local procedure costs and unique to our cost region. Similarly Oklahoma City has its own cost region with its own set of unique prices. It’s like having an allowance for certain procedures but if you go over your allowance you will have to fund the procedure through savings.

The payer gives a target price for a procedure and tools for comparing providers. Employees use the tools to shop to find providers who will perform procedures below the reference price. In some instances payers allow a patient to share in the savings. So if the employee selects a provider who performs the service below the reference price, the patient actually gets part of the difference between the target and actual price. Imagine getting money back for a colonoscopy. Might be worth the effort.

For this model, a reference price is a target amount on shoppable services like radiology, colonoscopies, and knee replacements among others. Insurance companies calculate reference prices for procedures that are not emergent or urgent where an employee can plan in advance.

Here’s an example. Mary, a Dallasite, turns 50 and needs to schedule a colonoscopy. She understands the reference price is $2,050 for the DFW area. Her benefit plan makes her pay 100% over the reference price but also shares 50% of the savings for services below it. Using her transparency tools Mary searches for colonoscopy screening and schedules an appointment with a provider who charges $1,800, $250 below the reference price. To reward Mary for her selection, the payer sends her a check for $125. Had she chosen another provider for say $3,000, Mary would have had to pay $950 for the procedure.

The model encourages consumerism by financially incentivizing patients to take active role in their healthcare decisions. Patients must consider costs instead of just accepting provider referrals.  It has proven remarkably effective for reducing costs for simple, shoppable procedures like radiology, knee replacement and colonoscopies.

In 2011, CalPers implemented reference pricing for knee/hip replacement. Members responded by taking their business to lower cost hospitals. Costs for the company dropped on average by 20 percent, saving CalPers and the patients more than $5.5 million over two years. What’s more is that higher priced hospitals that lost business dropped their prices to be more competitive. Thank you Adam Smith for the use of the invisible hand.

Like most things, the model has some limitations. We must remember, providers bill according to the procedures they perform, not on a diagnosis or symptoms. While patients understand their symptoms they typically don’t understand what procedures to price unless it’s very straightforward. A patient knows his knee hurts and thinks he needs a knee replacement but doesn’t realize the full extent of what’s involved (knee examination, an x-ray, reading the x-ray, procedure to replace her knee, anesthesia, room cost, physical therapy, etc). Providers must tell him the necessary procedures.

At the onset employees had limited tools to shop for procedures/providers.  However, today we have new technologies and consumer friendly smart phone apps with much better, intuitive designs that explain the benefits, show relevant prices, and guide consumers through the process.

Back to the allowance metaphor.  Remember how they helped us become better consumers by considering tradeoffs? Similarly, reference pricing helps train patients that medical expenses have costs and limited resources. Just as our parents gave us a fixed amount, companies and payers do the same with an allowable limit (the reference price). They use it to reteach employees to act responsibly through financial incentives – just like our parents.

Richard is President of Katalact Group, a nationally focused healthcare management consulting company and has nearly 20 years of experience in the industry.  He served on the leadership team for Yaro Health, a startup healthcare navigation app based in Chicago.  Previously, he served in several leadership roles including Operations Director for Blue Cross Blue Shield, Director of Product Management for Aetna, and Product Manager for both ADP and Humana.