Bending the Cost Curve with Reference Pricing

Mitt Romney’s/Paul Ryan’s premium support/voucher plan was heavily derided during the dark days of Campaign 2012, but the devil was always more in the details than the theory. While the re-election of President Obama left premium support dead on the Medicare level, health insurers are increasingly turning to the ideas that drove it – choice, competition, and the power of a (carefully regulated) market – to address high costs on the procedural level. Call it the micro-voucherization of health insurance.

This is known by wonks as reference pricing, and its recent results in California are promising: the costs of hip and knee replacements fell by 19%, with no attendant decrease in quality. Using reference pricing is an assault on the status quo that holds the promise of “bending the curve” in a meaningful way, but it faces technical and political concerns that may consign it to the graveyard of promising-but-unfulfilled ideas.

Broadly-speaking, reference pricing is the act of offering a set amount of money for the purchase of a good, where the reference is an amount that can reasonably said to offer meaningful coverage for that good. Sometimes, reference pricing is focused on a given procedure – what I’ll refer to as “inputs-oriented reference pricing”; other times, a given outcome, or “outputs-based reference pricing.”

That’s pretty vague, so let’s use the colonoscopy procedure (which has recently received a lot of attention thanks to an informative New York Times article) to help color this in. The inputs-oriented approach would see the payer asking: given the choice to have a colonoscopy – a procedure which varies wildly in cost without varying wildly in quality – what’s a reasonable price to pay? It would decide this based on some combination of price, quality, and geography, and would inform consumers of its spending cap.

Say it finds that most of its insured population can reasonably access a high-quality colonoscopy for $10,000; if a consumer choose provider that charges $15,000, he or she would pay the $5,000 difference out of pocket. Choice is preserved, but at a cost. The simple chart above shows how this may work.

But, if you read the colonoscopy article, you may be asking a separate question: why pay for a colonoscopy at all?

A fecal occult blood test (FOBT), for example, is said to be just as effective as a colonoscopy for colon cancer screening, but it’s cheaper to perform. The outputs-oriented approach is procedure agnostic, and identifies only what is most cost-effective; if a high-quality colonoscopy in a geographic area is $1,200 and a FOBT is $200 (just as a stylized example; these aren’t actual prices), the insurer would pay for $200 of the total cost; chart below[1]. Again, the consumer has freedom to choose what procedure he or she would like, but would pay the difference out of pocket.

Stylized examples aside, reference pricing is catching on in America. The 19% decrease referenced above came from the California Public Employees’ Retirement System’s (Calpers) use of reference pricing for hip and knee replacements. To accomplish this, Calpers went to individual hospitals and made an agreement: charge no more than $30,000, and the hospital will be included in the health plan. Those that didn’t agree weren’t included in the plan[1].

Safeway, the self-insured grocery chain, has also used reference pricing in limited circumstances, including for colonoscopies and lab tests.

And it’s very common in the formularies of pharmaceutical reimbursement; generics are often covered 100% but brand-name drugs will cost the insured extra. A variety of systematic reviews have found that reference pricing typically leads to reductions in pharmaceutical expenditures without an attendant decrease in health outcomes or increase in physician office visits.

So, if scaled to many procedures, reference pricing looks a bit like an insurance plan that contains a bundle of vouchers: one for hip replacement, one for FOBT, et cetera. It’s the micro-voucherization of health insurance[2].

Bending the Curve: Can Reference Pricing Scale?

Reference pricing comes with controversy, and it’s unclear if scaling it to hundreds of procedures is even feasible. It not dealt with, these concerns will seriously hinder the opportunities to use reference pricing to bend the cost curve.

For starts, reference pricing can seem arbitrary: who decides on what the optimal mix of cost, quality, and access is? The analysis is complex, pulling in massive amounts of difficult-to-obtain data from participants who may be unwilling to divulge it. And getting that information to the consumer is also a heavy lift; it’s unclear how a consumer would know he or she will only get a certain amount for a given procedure. The current system doesn’t appear up to the task.

There’s controversy surrounding the outputs-oriented approach, which relies on comparative effectiveness research (CER) to choose between interventions. CER has become a political football and is disparaged for a variety of reasons – some of which are clinical, some of which are political, and some of which use the words “death panels.”

Finally, reference pricing is most effective in situations where cost variation is significantly greater than quality variation; understanding which procedures fit that description is more difficult than it seems. Time-bound/emergency procedures bring up similar concerns.

That’s a pretty daunting list of concerns, and simple answers remain elusive. But it’s clear that reference pricing, at some level, can exert downward pressure on the costs of some procedures, and bending the curve will ultimately result from 1,000 small changes, not 10 big ones. If recent trends continue, the micro-voucherization of health insurance may be one of those small – but significant – changes.


1. Theoretically, the insurer would first decide a) which procedure is more cost-efficient, then b) use the inputs-oriented approach to define the appropriate reference price for that procedure.

2. This isn’t pure reference pricing, but it provides one path for large insurers to exert downward influence on the price of health services. A purer form would be to simply set the cap – to provide the micro-voucher for a procedure – and let the market drive down costs, as health care consumers choose.

3. To a point, of course; some procedures don’t seem a good fit – emergency surgery comes to mind. It’s not mean to be all-encompassing.

Mike Miesen is a former hospital operations consultant and current freelance journalist, covering American health policy and international development from east Africa. Follow him on Twitter @MikeMiesen. An earlier version of this post appeared at Project Millenial.

12 replies »

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  2. I do like the Calpers example – they’re the primary buyer of service, negotiating/contracting direct with providers/hospitals. This is a bit more of a knee replacement ‘center of excellence’ direct contracting play than an RBP play. The pharma/generics example: I like that too. But difference here v using RBP anywhere else in healthcare is that for drugs, the FDA makes the call on ‘interchangeability’ of options. OK, statins have no quality variance among options. Generics approved. RBP that all day. Colonoscopies? Surgeries? As you state Mike, need to be real careful here. Is goal to cut costs, or improve value and outcomes?

  3. RBP is no different than any other managed care steerage mechanism. Narrow network = lower coinsurance, out of network, you cover cost. This doesn’t create efficiencies in healthcare – it simply shifts costs to patients for high ‘over-RBP’ providers/services. Managed care tactics like this are really managed finance tactics, and sure haven’t worked for the last 30 years at ‘bending the cost curve.’

    If high utilization of high cost providers is the fundamental problem, and quality isn’t correlated with price (shocker), let’s consider the market mechanics at play here. Who receives the services? Patients. Who pays for the services? Patients+Employer(or govt) for vast majority of insured population. Who provides those services? Healthcare Providers. Who sets the prices? “Payers” aka third party administrators, like Aetna, who really don’t pay for anything.

    “Free market pricing” results when buyers and sellers come together in a transparent, competitive market. How again are buyers (employers/patients) and sellers (providers) brought together in our healthcare landscape to set price?

    Also, see how much Safeway has saved on shifting employees to lower cost lab tests when 90% utilization was already below reference price. The savings come when RBP is applied to services that not only have wide price variance, but also wide utilization variance. Like Hernia surgery. I wouldn’t call that a commodity procedure where quality doesn’t vary, and really wouldn’t like being forced to a low cost surgeon because of RBP, so Safeway can generate some stronger cash flow statements….

  4. The misinformation in this is really embarrassing and dangerous. The idea that FOBT is as sensitive and specific as colonoscopy is laughable. Even the reference sited states the opposite. Here is what the Preventative Taskforce site actually says is the relative sensitivity and specificity for all the tests. Just read from left to right;:

    Sensitivity: Hemoccult II < fecal immunochemical tests ≤ Hemoccult SENSA ≈ flexible sigmoidoscopy < colonoscopy

    Specificity: Hemoccult SENSA < fecal immunochemical tests ≈ Hemoccult II < flexible sigmoidoscopy = colonoscopy

    Anybody with any medical knowledge would know this. You should not be writing a healthcare blog.

  5. Even if the cost of a colonoscopy comes down to $2000, I wonder if we are still spending too much.

    According to what Arnold Kling describes as ‘premium medicine’, people who are in perfect health are judged to “need” several thousands of dollars of screening tests each year (of which colonoscopies are just one example).

    This certainly helps make health insurance unaffordable for many individuals and businesses.

    America may well be winning the ‘war on cancer’, but we make go broke winning it. We may someday trade a few earlier deaths for more money during the years before death!

  6. Agreed on the first point – reference pricing theoretically shifts risk away from the insurer and onto the provider and patient. But the goal is to have that risk be essentially zero; if two providers have similar outcomes for a given procedure, but one is twice the cost, the provider is practicing inefficiently, and reference pricing’s use of competition will force the provider to get leaner or get out of the game.

    Are there drawbacks to that? Definitely. And it’s possible that an unscrupulous insurer will only pay for low-cost, low-quality procedures, which would be a bad outcome for all. But I agree with you that it’s a step in the right direction.

  7. Thanks for your comment; you make a lot of excellent points.

    The stylized example for the price of colonoscopy/FOBT was poorly-constructed, you’re right – we’ve changed the piece to reflect a more reasonable (but still stylized cost). And the cost is what the insurance company/insuree would pay the facility for the procedure, just for clarification.

    Note that I don’t recommend disallowing colonoscopies. The USPSTF guidance I linked to didn’t either, but it weighed the clinical costs/benefits of the procedure. In fact, it said that visual colonoscopy has significant benefits over FOBT as a single procedure. But it also has drawbacks, and may not be the optimal procedure every time; CER can help elucidate when it’s best and when it’s not, and insurers could follow suit with their pricing models.

    The point I was attempting to make was a narrower one, and perhaps I should have picked a different set of tests/procedures (I didn’t want to use the generic “blue pill vs. red pill” example that’s so common).

    In this case, the discussion isn’t about “crappy product” vs. “non-crappy product” – it seems to me that if there are cheaper products that are outcome-similar to more expensive products, there’s no reason for health insurers to pay for the more expensive product. Figuring out whether a given product does that is a heavy lift (as I note in the article), but a better goal than simply letting the status quo hold. Do you disagree?

  8. A notable concern however, is that the decision to set reference pricing allows the insurance carriers to assure that their contribution is protected. While their risk is that they have to remain relatively competitive to attract lives and corporations to their plans, providers have little leeway to insure that their costs are covered.

    The competition should occur primarily at the provider level based on their contract with the patient.

    That being said, reference pricing certainly places more skin in the game for all involved and is a step in the right direction.

  9. I love the idea of reference pricing. Let everyone charge whatever they want! Market forces will correct the rest. And yes, the author is not very knowledgeable. FOBT costs maybe $20 but detects cancer only (not polyps). Much better to get a colonoscopy. In most outpatient centers under $2000 (or should be)


    I am a board certified gastroenterologist

  10. Where to start…

    1. A fecal occult blood test costs 12,000? For wiping a piece of stool on a card and having it tested for blood? And to follow up on Bob Hertz’ comment – a colonscopy is 10,000?? Maybe this is just meant for the sake of example (but badly done nonetheless). If the question is one of charges, that doesn’t even begin to come close to cost, so that is a different conversation entirely and requires a focus on hospital pricing structures, and a discussion about overhead cost allocation, payments to insurance cos, etc.

    2. I have a family h/o colon ca, so screening is a big deal. I am also incidentally a physician. To compare the fobt to a screening colonoscopy is like comparing an apple to a truck. Dysplastic polyps that may predispose to a malignancy, esp w a significant family history, will not cause any bleeding prior to a much advanced stage and thus would not be detected on a FOBT. Allowing only the latter test defeats the entire purpose of early detection.

    3. I am also a quality consultant for hospitals. And I work primarily with Orthopedic programs. Quality measures for surgical procedures, esp some of the more common Ortho ones like hip and knee surgeries, are very misleading. Assessment of outcomes has nothing to do with days in hospital or functional outcomes, but about whether or not someone developed delirium, renal dysfunction, plum complications, etc while in hospital. Telling me that one hospital does or does not have these complications (and thus, poor quality measures) doesn’t actually tell me whether or not they walk faster or recover their functional status more easily.

    4. Lastly, I order tests and consultations every day that are run by the hospital’s quality/approval committee. I am struck by the utter lack of ability and/or knowledge of those in positions of power in this area. Pharmacy formularies that have a crappy product because it’s cheaper don’t account for the amount of wasted provider time in requesting the better product for approval and trying to write cogent arguments on behalf of a patient. They also don’t account for the suffering of the patient forced to try said crappy product before they can get the medication that will actually help then. Ditto for outside or specialty consultations.

    Data looks wonderful when it’s in theory and when the details haven’t been examined further. It looks very different when you’re in the trenches as either the patient or provider.

  11. Good article, but what kind of monstrous loading is in these prices?

    I had a colonoscopy, I was put under, the test was done, I went home after about 3 hours.

    Why should this cost $10,000 or even close? How about $1000 to pay the anesthetist, the doctor, and the rental on the machine.

    Maybe the prices quoted here were just illustrative. Any institution which actually charges that much for a simple test should be in court over price gouging.

    (Note — I do NOT respect hospital overhead. If a hospital needs $10,000 per outpatient procedure, that hospital is over built, over indebted, over equipped, over staffed and over paid.)