Assessing the role of reference pricing in healthcare

Reference pricing for medical procedures constrains costs by capping the amount an insurer will pay for a procedure and making the patient pay the extra amount. In California, Calpers has been successful in using reference pricing for knee surgery, as described in a recent Wall Street Journal article (Comparison Shopping for Knee Surgery).

In Friday’s letters section, a physician from New York endorses reference pricing and uses the Calpers experience as a cudgel to beat up on a government role:

“Not only is it economically sound in encouraging competition and skin in the game, which always leads to lower prices and better quality like every other commodity and service in the free market, it literally requires zero legislation or bureaucracy. I am certain Calpers saved more money applying this principle than any convoluted scheme Washington has in mind.”

Reference pricing is a great cost-saving idea and I’d like to see more of it. But it’s a pretty poor argument for the superiority of the free market in healthcare. Consider:

• Medicare pays somewhat different rates for different hospitals, but those are intentional differences based on geography and teaching status. Meanwhile private payers pay a much wider range of prices –for no explicit reason. Look closely at the wording in the original article: “Calpers was upset after noticing it paid between $20,000 and $120,000 for the same procedure across the state, without commensurate differences in outcomes.” Noticing? Why did it take so many years (decades even) for Calpers to wake up and even notice what was going on? Unfortunately health plans and employers have not shown an interest in price differences nor a willingness to do much about them.
• In reference pricing schemes, the Medicare price is often used as the reference price. In other words, commercial health plans and employers are just trying to copy what Medicare already does! Not only that, but they tend to set the price higher than the Medicare price because they lack sufficient negotiating power, skills, or incentives.
• Reference based pricing only works for a subset of procedures. Knee replacement is a good one because it’s elective and easy to characterize. But there will be problems trying to extend this approach to other big areas of cost where the patient doesn’t have time to decide in advance where to go and where the services to be received are unpredictable. Meanwhile Medicare pays a set price and doesn’t wait around to “notice” that things are out of whack.

I do agree with the letter writer that greater patient activation is a positive thing. But it’s naive to assert that applying free-market principles is a panacea. As a country we have chosen a mixed government/free-market model. Both the public and private sectors have a lot of work ahead of them to improve quality and constrain costs.

A closer look at the Calpers reference pricing experiment reveals just how poor a job the private sector has done, while revealing some of the advantages of a big payer like Medicare that has the power to dictate pricing.