PPOs were built off the early successes of HMOs. They sought to take the savings created by HMOs and expand provider bases to allow more choice for patients. As the PPOs started to build larger networks and attempted to bring costs down, they met resistance from key providers. Rather than hold the line and set reasonable prices, the PPOs acquiesced and agreed to pay providers—especially hospitals—pretty much anything they wanted using a discount-off-the-billed-charges model.

The problem was that there were no regulations on what hospitals could bill for services, so the PPO shell game of “discounting” went into effect. Today, the average for-profit hospital charges more than 700 percent of what Medicare would pay for services, while non-profit hospitals charge approximately 550 percent of Medicare. After the traditional 50 percent “discount” provided by the PPOs, employers often pay 300 percent of Medicare—often much more. Since the discounting levels from the PPOs are a tightly guarded secret, employers are unaware that they are paying three times what the largest payer in the country has deemed to be fair reimbursement.

The overpayment problem

The Accountable Care Act turned a spotlight on the employer-pays health care system, and a variety of companies started to publish data outing the PPO industry and the ridiculous “discount” reimbursement model. In reality, hospitals readily accept 130 percent to 150 percent of what Medicare would pay (sometimes less) for those willing to make cash-based payments. Intelligent employers started asking about ways to close the gap between the 300 percent of Medicare most are paying via the PPO models and what hospitals accept from cash-based payers.

America's overpayment model is two to five times what other developed countries pay for health care services. Everyone in the health care financing industry is well aware that insured consumers lack objectivity when seeking health care services. America's employer-paid health insurance system does not typically require that employees consider the cost of services. Employee/members make a small copay to accompany the reimbursement by the employer or insurance company.

As there is typically no transparency in fees for services charged by providers, patients simply seek health care with no regard for cost whatsoever and—just as bad—no idea of the providers’ historical quality of delivery. The provider industry (hospitals and doctors) is aware of this flaw in the purchasing system and takes full advantage through what many would suggest are egregious overcharges for services, and often even limits an employer's ability to audit or confirm payments and the accuracy of those payments.

What's fair?

Reference-based pricing (RBP) offers two remedies to this inflated, unfair system by using a defined-contribution model of health care benefit financing. First, an employer or sponsor of a group health plan determines a fair and just reimbursement for a medical service and defines such in its agreement with its membership (employees). A plan might define within its benefit model, for example, that it will reimburse up to $20,000 for a typical knee-replacement service.

While many providers may indeed bill and accept $20,000 for that service, some may not, so the defined-contribution model forces those seeking the service to decide what provider they want to work with relative to the overall value of the service to them. This is the consumerism we have talked about in the industry for years but have never fully implemented.

Defined contribution allows the member/user of services to decide for him or herself if the 70 percent of providers that will accept the defined payment amount will suffice, or if they choose to pay more out of their own pockets to seek a provider from the other 30 percent.

CALPERS put this model on the health care map a half dozen years ago in an attempt to control its own health care expenses. They quickly found that providers would readily accept reasonable payments for services in order to retain their business. In contrast, the PPO industry that most employers utilize today guarantees overpayment for services in almost all scenarios through their opaque contracting models, especially for hospital services.

How it works

While there are a number of delivery models for RBP, they all provide logical, fair and transparent reimbursement for medical services. RBP models fall into three categories:

A hard line-defined contribution model: “This is all we will pay.”
A pure negotiations model requiring that all claims be negotiated to mutual satisfaction.
A hybrid model that limits payments but uses multiple reference points to confirm reasonable reimbursements.

In most RRP-defined contribution models, employers target payment levels to hospitals of 120 percent to 160 percent of Medicare, which creates a savings of 50 percent to 60 percent relative to PPO payment levels. Since hospital charges typically equate to about 40 percent of overall health care costs for an employer-sponsored plan, this piece alone can provide overall savings of 20 percent to 25 percent or more for an employer, all other costs being equal.

Since RBP plans are exclusively administered by independent third-party administrators (TPAs) at this time, there are typically additional savings in administrative fees and the elimination of PPO access costs as well.

RBP programs can be quite effective in a “naked” state—meaning that no contracting of any kind is used for provider relationships, especially if the service provider offers member assistance with concierge steerage services. As with hotel concierges, a medical concierge steers users to the type of service they want and typically to a receptive provider.

Some RBP delivery models offer a hybrid solution of narrow- or high-value networking contracts. The best RBP plans remain true to form, make all providers available to patients at pre-determined reimbursement levels and use the direct contracted providers as “safe harbors” for members. Higher-quality RBP vendors will offer employers a variety of options relative to safe harbor relationships, as well as concierge steering mechanisms.

The bottom line

RBP programs are gaining in popularity due to their significant cost savings to both the employer and their employee/members. These savings often exceed 30 percent compared to the PPOs.

There remain some problems within the brokerage consultant industry, since many are tied financially to the old PPO programs and the BUCA (Blue, United, Cigna, Aetna) carriers, and also because many brokers are content with the status quo and not prepared to learn about new options.

Employers should seek advice from consultants who are not only familiar with RBP plans, but those who have detailed RBP to their clients historically—better yet, those that have already implemented RBP plans. RBP plans are not the perfect tool for all employers at this time, but recent upgrades in service options make them reasonable for at least 50 percent of the employer population.

Currently, none of the large BUCA carriers have an RBP application, so implementing a plan will require an employer to work with an independent TPA company. There are additional benefits to working with an independent TPA, including best-of-breed ancillary service choices for things like PBM, UR/UM, and disease management that are not always available with the PPO models where carriers require use of their in-house service options.

One potential downside of RBP models is when a non-direct contracted provider is utilized and a provider bills beyond what a health plan has decided to allocate for a particular service. This issue is called balance billing. For the most part, hospitals use balance billing as a form of health care extortion to try and force employer sponsors of health care plans to pay more than fair and reasonable reimbursement for services.

RBP vendors have a variety of ways of dealing with this cat-and-mouse game played by the hospitals. Some pay more to appease the hospital, while others draw a harder line to maintain the integrity of the employer-sponsored plan. Regardless, the issue of balance billing is mostly fabricated by the large PPO organizations and brokers who are still allied with them financially.

Due diligence

Most employees now take on 30 percent or more of an employer's health care costs, totaling thousands per year, when in the past, employers typically paid 95 percent of the plan costs themselves. So now employees are also affected by the excess overcharges that plague the current PPO system. Self-funded employers have a fiduciary responsibility to protect the co-mingled funds within their health care plans, and the current PPO payment system has most employers breaching this obligation.

Employers are seldom aware that in order to ingratiate themselves with providers, mostly hospitals, that the large PPO payers seldom do any reasonable due-diligence on hospital invoices before making payment. A review of more than 400,000 hospital bills over the last 15 years shows conclusively that this lack of diligence by the PPO payer is costing employers about 7 percent in overcharges and mistakes that are not caught in the claims adjudication process.

RBR and defined-contribution health care delivery will change the face of employer-sponsored health care plans by creating a meeting of the minds between those who offer health care services and those who utilize those services, and fair and reasonable payment levels will arise on both sides of the equation. Employers that utilize such plans will see an immediate reduction in their health care spend of 20 percent to 30 percent, and their member employees can finally start to see some relief—not only in their contribution rates, but also in their out-of-pocket costs.

Instant Insights /

Reference-based pricing sheds light on health care overpayment

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