Reference pricing as a solution to “doc shock”

The following post is co-authored by Austin Frakt and Nicholas Bagley.

Spurred by intense competition on the new health-insurance exchanges, insurers have been casting about for new and better ways to offer their products at the lowest possible price. One way they’re cutting costs is by narrowing the networks of physicians and hospitals that their enrollees can visit for care. Consumers, finding that their preferred plan doesn’t offer coverage for their favorite doctors and hospitals, are experiencing “doc shock,” or soon may.

It doesn’t need to be this way. Though “preferred” or “network” contracting – the establishment of networks of health care providers willing to accept lower payments – is a standard cost-reduction technique, it’s not the only approach. It’s certainly not the best for consumers.

Reference pricing is an appealing alternative. With reference pricing, insurers set the price they’re willing to pay for a given service or procedure, typically pegging it to a price at which it can be obtained at good quality – the reference price. A policyholder can then obtain that service or procedure at zero out-of-pocket cost at any provider willing to match that price. For providers that charge more, the policyholder—not the insurer—pays the difference.

Although reference pricing for medical services isn’t common, there are encouraging signs of good performance where it has been implemented. James Robinson and Timothy Brown studied CalPERS, California’s insurance program for public employees, when it set reference prices for knee- and hip-replacement surgery. They found the reference-pricing initiative had profound effects on the market. CalPERS patients shifted their site of knee- and hip-replacement surgeries to lower-priced hospitals. High-cost providers came under a ton of pressure to lower their prices.

And that’s exactly what they did. As Robinson and Brown documented, higher-priced hospitals reduced their prices down toward the reference price. Meanwhile, no CalPERS policyholders were left without any coverage with their preferred providers. They were free to obtain knee and hip replacement surgeries at any facility they pleased. So much for doc shock.

As it stands, there’s no legal impediment to reference pricing on the exchanges. The Affordable Care Act only requires exchange plans to cover essential health benefits. It doesn’t dictate how much plans have to pay for those benefits. It only dictates what proportion of health care costs plans have to cover overall — their “actuarial equivalence.”

That legal flexibility, however, does present a risk that reference pricing could shift the risk of high costs to policyholders. What if the reference price were set so low that no providers would accept it as full payment? This is a serious concern, but one that should be mitigated by a provision of the ACA requiring plans to guarantee the adequacy of their provider networks. Specifically, plans must “assure that all [covered] services will be accessible without unreasonable delay.” Assuming that the rule is properly enforced—and it should be—insurers can’t set reference prices so low that benefits are effectively unavailable.

If reference pricing offers a much-needed alternative to tightly restricted networks, why do so few exchanges plans do it? There are at least two reasons. First, reference pricing is hard. When an insurer offers a fixed price for hip-replacement surgery, what precisely does that cover? Does it include the costs of treating an infection acquired in the aftermath of surgery? Or can the hospital bill separately for that treatment? Resolving those sorts of line-drawing problems would require considerable innovation from insurers.

Second, providers may successfully resist reference pricing. If enough popular hospitals or physician groups refuse to accept reference prices as full payment for their services, people may be unwilling to purchase plans that reference price. Plans that reference price could lose customers—not attract them.

These challenges notwithstanding, widespread agitation over constricted networks suggests that insurers should give reference pricing another look. Restricted networks are so unpopular that it’s possible—maybe even likely—that consumers would flock to plans that offer them more choices of hospitals and physicians. In the newly competitive market on the health-care exchanges, they should certainly have that option.

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