Reference Based Pricing Whitepaper

By Brian Murphy

Introduction

Reference based pricing (RBP) is not the “silver bullet” that is going to fix the complex

issues facing the healthcare insurance industry but can significantly limit plan sponsors’

responsibility by shifting awareness and costs onto healthcare consumers. Defined contributions,

as a technique for cost containment, have been applied by plan sponsors for decades to

everything from retirement plans to pharmaceutical drugs. Although applying defined

contribution strategies like RBP to healthcare expenses can be a cost saving measure, it is not

appropriate for all healthcare services. Successful implementation requires intensive

communication with members and consideration in planning. The pros and cons of RBP must be

considered before implementing.

Background

What is Reference Based Pricing?

The idea of RBP has been used globally for decades. A plan sponsor sets a limit on the

amount the plan will pay for a given service or procedure. This is known as the reference or

threshold price. If the consumer chooses to go to a provider that charges more than the threshold

price, the consumer is then responsible for the amount above the threshold price. Using a

reference pricing scheme can limit plan sponsor liability and shift responsibility onto consumers.

The basic principle is not complicated; however, proper implementation and planning can be

complicated.

Reference based pricing can be thought of as the insurer and the healthcare consumer

switching roles. Robinson and MacPherson call this a “reverse deductible” in their Health Affairs

article; however, sometimes this can be misleading. Suppose a plan sponsor sets a reference price

for $3,000 for a colonoscopy screening and the plan has an individual deductible of $200 and a

coinsurance after that of 20%. If the consumer decides to go to a provider that charges $5,000 for

that colonoscopy, the deductible and coinsurance still apply before the plan will pay out.

“Reverse deductible” can be misleading in that the “deductible” implies the insurer would be

paying out first. In actuality the member deductible is paid first, the insurer pays second, and the

member is balance billed for the remainder. If the individual deductible and coinsurance are

overlooked in theory, RBP could be thought of as a “reverse deductible.” The insurance is

paying a fixed amount and the consumer is responsible for any variation, therefore the roles have

changed.

An even more drastic display of the RBP savings can be seen in an example of knee or

hip replacement. Knee and hip replacements in California have an extreme variation in price

ranging from $15,000 to $110,000 (Lechner). Knee and hip replacements have a highly defined

process with little variation in quality. Setting a threshold of $35,000 can provide a significant

incentive to receive those procedures from providers within that price. Suppose the member

received a knee replacement for $100,000 with a $2,000 member deductible and 20%

coinsurance. The plan sponsor, prior to RBP, would be paying, after member cost-sharing, a total

of $78,400. With the threshold implemented, the sponsor would be paying $26,400 after member

cost-sharing, which would save $52,000 for the sponsor.

The Development of Referenced Based Pricing

Employers have been flirting with the idea of introducing defined contribution (DC) to

healthcare expenditures since the early 2000’s (Fronstin). The advent of the health fund plans

such as HSA and HRA followed by the movement of private healthcare exchanges are evidence

of the exploration of defined funding. DC methods have been successful in retirement plans, as

we have seen the shift from unsustainable defined benefit type plans to DC plans. Throughout

the past four decades, use of DC in retirement plans has gone from 16 percent to 69 percent

(Fronstin). Initial interest in DC plans was sparked because it offered more certainty than its

alternative. RBP is another form of DC and when applied to the appropriate services, can

significantly control plan sponsor financial responsibility. In 2012, 11 percent of employers with

500 or more lives had already employed some form of RBP (Fronstin).

Reference based pricing first debuted as a method for controlling high pharmaceutical

trends. The pharmaceutical trend was increasing at a higher rate than the overall general inflation

in Europe. This pricing began in Germany in 1989 and was later implemented in Australia,

Netherlands, Sweden, Denmark and even New Zealand (Ioannides-Demos). While there are

different methods used across varying countries, the same basic principles are applied. Similar

drugs were grouped into categories and a maximum reimbursement price was set for each

category. This endeavor led to the successful decrease in the rate of inflation in many, if not all,

of the countries who applied a RBP system.

How Does Reference Based Pricing Differ from Traditional Plans

RBP is a cost-saving strategy similar to coinsurance, deductibles, or copayments.

However, there are significant differences between RBP and traditional cost management

methods. RBP has more ‘consumerism’ attributes and shifts awareness onto healthcare

consumers, whereas traditional techniques focus primarily on the containment of cost.

Coinsurance and deductibles only expose consumers to the true cost of healthcare up to the

deductible amount or coinsurance percentage. The consumer is shielded from the cost of high-

ticket items. Copayments fail to expose the consumer to the true cost of healthcare services

(Robinson).

RBP gives the consumer a budget and the tools necessary to make a cost-conscious

decision. It exposes consumers to the wide variation in costs of medical services. The healthcare

consumers are now responsible for the remainder of provider bills under a RBP system.

Consumers are more inclined to make wise financial decisions when they are responsible for the

bill.

Which Procedures are Best for Reference Based Pricing?

Reference based pricing simply does not work for all healthcare expenses. It works best

for routine procedures that can be scheduled and have a high variation in cost with little

correlation to quality. As many as 900 procedures fall into this category, but those best for RBP

have a wide price variation that is not necessarily linked to quality (Rich). Services that are best

suited for RBP are those that the consumer has time to shop around for. These include laboratory

services, routine surgical procedures, hip replacements, colonoscopy screenings, CT scans, MRI,

knee replacements and rotator cuff repair (Rich). These procedures have a high variation in price

from provider to provider with a low variation in quality. But referencing too many procedures

that are considered “high volume” may lead to member confusion as to where to go for which

service (Lechner).

Clinical exclusions for urgent care need to be taken into consideration. Referenced prices

should be waived when completed during emergency care. The consumer has no opportunity to

shop for an emergency procedure. These referenced procedures are more likely to require a

certain level of care and are more prone to complications, which may cause these procedures to

cost more (Rich).

An Example of Reference Based Pricing

CalPERS Experiment

The most well-known and widely reviewed example of successful RBP in the United

States is the California Public Employees’ Retirement System (CalPERS) experiment in 2011.

CalPERS noticed an extreme variation in the amount charged for inpatient hip and knee

replacement surgery. In some instances, providers charged $15,000 while other providers

charged as much as $110,000. As the second largest healthcare insurance purchaser in the U.S.,

the use of a referenced price saved $2.8 million in the first year of implementation with Anthem

Blue Shield Blue Cross (Lechner).

This particular use of RBP was successful for a number of different reasons. First, the

reference price was set at $30,000 for hospital procedures for both hip and knee replacement.

This price was decided on after looking at the wide variation from $15,000 to $110,000 paid for

knee and hip replacements across California. The threshold price was not set too low, whereas it

would limit the number of providers. Secondly, specific hospitals were designated and

aggressively communicated to plan members as being within the price threshold or “designated.”

Third, the geographical location of these hospitals was also taken into consideration, so no

member would have to travel more than 50 miles for the procedures. Lastly, despite the varying

prices across southern and northern California, one reference price was set intentionally to

streamline member communication (Lechner).

Considerations in Implementing Reference Based Pricing

Establishment of the Threshold Price

The establishment of the threshold price is an important decision. A threshold price set

too high may limit the consumer’s incentive to shop around for the best price, which could limit

cost savings. A threshold price set too low may inhibit provider choices, which could limit the

perceived value of the plan in consumers’ eyes (Rich). Setting geographical variations on the

threshold may be an appropriate measure for dealing with prices that vary significantly by

geographical area. As seen in the CalPERS example, employers may want to set a single

threshold for ease in communication and to limit member confusion.

The Medicare price is another good tool to take into consideration when determining the

threshold. Medicare prices appropriately take factors into consideration such as teaching status

and location which can be useful in setting the threshold (Williams). This is often the basis used

for setting the reference price.

Lack of Accessible Data

Another important factor to take into consideration is the accessibility of data. In the

determination of the threshold price, more data may be required than any one employer may

have. While the actual charges may be accessible, the negotiated rates may not be as easily

available. Insurers may be reluctant to divulge the negotiated rates, in fear of disrupting good

relationships with their network providers (Taufen).

For instance, let’s suppose ABC Insurer releases the information on a specific

procedure’s negotiated rate and Provider A receives $10,000 and Provider B receives $15,000.

Now let’s suppose, based on the information provided by the ABC Insurer, a substantially large

employer sets the reference price at $12,000 for that procedure. Provider A is now receiving

most, if not all, of Provider B’s market share due to the ABC Insurer’s disclosure of negotiated

rates. This could drive a wedge between Provider B and ABC Insurer.

Communication with Plan Members

Proper communication upon the rolling out of an RBP scheme is vital to success. A main

focus on communication is to educate consumers as to which providers are within the threshold.

This needs to be smooth and uncomplicated because if complications arise, plan members will

likely be unhappy. In the case of CalPERS, the sponsor decided to set one threshold across all of

California to aid in smooth communication to plan members. Another reinforcement that

sponsors can use to guide members to providers is pre-authorization. This gives an opportunity

to intervene before a consumer receives care from a provider that is not within the threshold

(Rich).

Another main objective of communication campaign is to break consumer’s perceived

connection between quality and price. The relationship between quality and price is a natural

trend in consumer buying habits. A pricy product is thought to be more valuable; however, in

most cases of RBP-applied procedures, this is not the case. Procedures are specifically chosen

that have a routine process. An inflated charge does not have a direct correlation to quality of

outcome measures such as returned visits or post-operation complications, and it is important

that this be communicated to members.

The Pros and Cons of Reference Based Pricing

Pros of Reference Based Pricing

Before implementation can be undertaken, both the pros and cons of a RBP scheme

should be taken into consideration. There are many upsides to implementing such a program. For

example, RBP shifts not only costs but cost awareness onto healthcare consumers, something

that coinsurance and deductibles can only begin to do. RBP is a consumerism tool that

encourages consumers to shop around.

Also, consumers are not limited to a network and can choose to go to any provider. This

makes RBP an attractive alternative to more limited HMO platforms. As of 2013, 76 percent of

all employers in the U.S. were using a PPO or POS style plan, which utilized a fee-for-service

compensation structure (Mercer). A reference based structure is readily applicable to these types

of plans.

Another positive outcome of the CalPERS experiment with referenced pricing is the

onset of hospital competition. Upon the implementation of the program, several non-designated

providers went into renegotiations with Anthem. The program was implemented in 2011 and by

September of 2012, nine hospitals renegotiated with Anthem to a price within the threshold.

Hospitals lowered their accepted prices to gain access to the CalPERS huge market share of 1.3

million members (Lechner).

Finally, the implementation of a referenced price requires no legislation or oversight and

can be used with current regulations. Guidance on the out-of-pocket maximum (OOPM) imposed

by the Affordable Care Act is optimistic relating to whether it applies to payments in excess of

the threshold price. As of right now, the OOPM does not apply to balanced billing methods such

as RBP (Jost).

Cons of Reference Based Pricing

While there are many upsides to a RBP scheme, there are significant downsides as well.

Small employers may have a hard time enjoying a referenced pricing system because they simply

do not have the information necessary to set a threshold price on their own. Insurer’s

unwillingness to release information can be a real hurdle and may inhibit small to mid-size

employers from gaining access to the necessary information to apply RBP.

The scope of the cost savings is limited. CalPERS saved $2.8 Million, which only accounted

for 0.26 percent of their total healthcare spending of $1.1 billion (Lechner). A potential solution

to limited cost savings would be to implement RBP to many different procedures. But this is not

practical due to the potential for member confusion; RBP cannot be applied to many different

procedures under one plan. Due to the routine nature of procedures that work with RBP, having

to communicate different designated providers for many procedures can confuse plan members.

The member uptake is essential to RBP success.

Uncertainty about the Affordable Care Act’s out-of-pocket maximum still linger. While

guidance has been issued and currently the payments made above the threshold do not apply to

the OOPM, critics are uncertain whether that will remain the case. Guidance released by the

Employee Benefits Security Administration (EBSA) and the Department of Labor (DOL) claim

that the ACA’s OOPM applies to only cost-sharing methods, which does not include “balanced

billing amounts for non-network providers, or spending for non-covered service” (Jost). The

DOL and EBSA extend this to reference pricing, assuming the “designated” providers to be in-

network and “non-designated” providers to fall out-of-network. This simply is not the case. A

non-designated provider can be within the network and vice versa. Since guidance may change

regarding the application of RBP balanced billing to the OOPM, plan sponsors should consider

whether or not now is the right time to implement RBP.

The type of procedures which reference pricing is right for is severely limited. It cannot be

applied to all services. Emergency and clinical services for care given in an urgent manner need

to be excluded. Routine and standard procedures with little correlation between quality and price

are best for RBP, which significantly limits cost savings potential. In the CalPERS experiment,

we saw the application of RBP to hip and knee replacement, which, of the 1.3 million members,

affected only 450-500 members (Lechner).

Conclusion

Referenced based pricing may be an attractive alternative, but it comes with serious

limitations. The healthcare industry continues to look for new defined contribution methods to

limit uncertainty and slow rising healthcare costs. The fundamental concept has been around for

decades and has met success in pharmaceuticals and medical devices across Europe. The

experiment of medical procedure has proven successful as seen in the CalPERS experiment. The

new twist has the potential to bring additional cost savings to both plan sponsors and plan

members. RBP can bring cost-savings to specific services for specific employers. Given such

limited cost savings, scope of procedures, and intense communication required, the plan sponsor

needs to determine if the benefits are worth their time and effort or if it could be better spent

elsewhere.

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Pharmaceutical Expenditure, Resource Utilisation And Health Outcomes."Pharmacoeconomics 20.9

(2002): 577-591. Academic Search Premier. Web. 31 Aug. 2014.

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from a California Pioneer." HSC Research December 2013.30 (2013). Print.

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2013. Web.

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