Reference pricing is not a new concept. Generally defined as a mechanism by which a payer with sufficient market strength can impose a fee structure on high-cost procedures such as hip or knee replacement, it has also been applied to high-cost diagnostic imaging and laboratory services. It’s designed to save money for third-party public and private payers.
Since its inception, reference pricing has been used by government health plans. These plans imposed a fee schedule on the market, which providers could either accept or reject. One of the most successful early uses of reference pricing was for certain classes of prescription drugs. However, reference pricing has much broader applicability in terms of medical services and has the potential to affect every segment of the health care industry, including government-sponsored health care exchanges.
The most publicized recent example of reference pricing is the experience of CalPERS (1.3 million covered lives) in paying $30,000 for a knee or hip replacement at hospitals across California. Previously, the prevailing Anthem Blue Cross of California network contract price ranged from $15,000 to $110,000. Implementing reference pricing in 2011, CalPERS saved $7,000 for each surgery (30% savings per procedure). However, because the program included only 450 to 500 enrollees in Anthem PPOs, the estimated savings of $2.8 million amounted to only 0.26% of total health care spending ($1.1 billion for Anthem enrollees). Thus, the program had limited potential to address overall cost trends or utilization.
Without a formal agreement on reference pricing, there is no prohibition against balance billing by physicians and hospitals.
CalPERS’ reference pricing program was expanded from 45 hospitals in 2011 to 54 hospitals the following year, when arthroscopy, cataract surgeries, and outpatient colonoscopies were added. The largely successful initiative has helped to create a fad among many purchasers, especially employer-sponsored health plans, to consider reference pricing as a strategy for reducing costs. Some people now perceive this pricing tool as a silver bullet to reduce costs without a downside risk.
These people are uninformed. Actually, there are six factors that threaten to limit the effectiveness of reference pricing.
- Scope of procedures. Reference pricing has so far focused mainly on two high-cost elective procedures, hip and knee replacements, performed at hospitals. Yet savings are available on a much wider range of diagnostic and therapeutic services.
- Covered fees. Reference pricing usually applies to just the institutional portion of costs — the facility fee — and does not include the professional fee. The reason is that hospitals generally do not employ physicians and therefore cannot bind physician billing in a contract.
- Balance-billing potential. Because professional fees are not included in a reference price package, physicians are free to bill patients in one of two ways: at the contracted rate if they are part of a PPO network (as distinguished from the hospital’s PPO agreement), or for billed charges if they are not part of a contracted network.
Across the country, many physicians and physician groups have canceled their managed care network contracts in recent years, particularly in states, such as Texas and California, that have “corporate practice of medicine” statutes.
The result is predictable and unfortunate. Patients are shocked when they receive an unanticipated bill in the thousands of dollars for physician services. They’ve assumed — reasonably enough — that because the hospital is part of their contracted network, the on-staff physicians are contracted as well. That may not be the case. Even if the physician is a part of the patient’s contracted network, he or she is not under contract for the reference price the hospital has agreed to accept. Unless physicians agree in advance not to balance bill, they are free to do so. There is no mechanism built into reference pricing that prohibits balance billing by physicians.
- Arbitrary pricing. Reference pricing imposes a limit on facility-based fees based on some percentage of the Medicare fee schedule. This fee schedule generally raises the Medicare rate by some percentage that the payer judges to be fair. For example, it might be set at 60% above the prevailing Medicare rate for institutional fees in a geographic area. This rate needs to be acceptable to enough hospitals in the service area to be deemed by the market as providing adequate service access. If it’s too low, hospitals may not agree to accept it, and they may leave the payer in the lurch, unable to provide adequate access to services in the locale. Thus, the reference price is determined by what the market is likely to bear, rather than by a hospital’s costs to provide that service.
- Savings alternatives. Reference prices are generally lower than PPO network rates and far lower than billed charges. Reference prices are based on what other payers, such as Medicare, have established in the past and may not accurately reflect the rates that providers are currently willing to accept for expensive procedures in a local market.
- Repricing’s administrative challenges. Third-party administrators do not always have the technical expertise to accurately reprice services based on Medicare rates.
Medicare fee schedules are complicated. They encompass more than 10,000 CPT and HCPCS services and are priced by RVU adjustments for each ZIP code. Hospital institutional and technical fees are priced by ZIP code-specific DRG codes.
To generate a Medicare-referenced price fee schedule, most TPAs must acquire expensive software from a third-party vendor that specializes in Medicare reimbursement data.
If an employer-sponsored health plan wants to implement reference pricing as a meaningful cost-reduction strategy, three objectives should be met. Reference pricing should:
- Include a much broader array of services than the limited number of diagnostic and therapeutic interventions currently included in most reference-pricing plan designs.
- Achieve a larger available savings as a percentage of the total medical expenditure by accessing the cash discount market.
- Protect patients from balance billing.
Self-funded employer-sponsored health plans can select a more comprehensive cost management design by combining a reference price for a particular service or billing category with cash rates for all other services not covered by reference pricing. Thus, reference prices for specific procedures can be linked with a wraparound of lower-priced cash rates for bundled billing categories. This wraparound strategy meets the objectives of including all services (institutional, professional, and technical fees) and further reducing medical expenditure (lower cash rates for services).
In addition, bundling services for guaranteed cash price is generally accompanied by the employer-sponsored health plan waiving any patient deductible and coinsurance. This serves as an incentive for employees to participate. Likewise, it enhances beneficiary access to medical services in the private health care market by removing the obstacle of patient liquidity concerning high deductibles.