The Quiet Revolution in Health Insurance, Part III Reference Based Pricing

John Owens | 11-8-2017

This is the third of a three-part series highlighting alternatives to the traditional fully-insured healthcare insurance model. 

As I mentioned in the previous blogs in this series, a quiet revolution is occurring in the healthcare insurance industry. Over the last several years, more small businesses are foregoing their Managed Care PPO plans (think traditional fully-insured, health insurance plans) and exploring other less-commonly-known cost-containment alternatives.

We mentioned Level Funding in the first blog and talked about the Dirty Secret of “Charge Masters” and how there is no rhyme or reason behind the pricing of medical services. Consider a knee replacement surgery for example. Some hospitals will charge as much as 400 percent more than what is customarily paid under Medicare reimbursement.

There are no regulations on what hospitals can bill for procedures, so the Managed Care PPO plans amount to little more than a shell game of “discounting” over-inflated pricing. It’s not unusual to see non-profit hospitals charge 400 to 500 percent more than Medicare allows—with for-profit hospitals charging even more. Since the PPO discounting agreements with the providers are like a CIA-guarded secret, employers (and their employees, as health-care consumers) are unaware that they are paying substantially more than Medicare—the largest payer in the country.

Which leads us to another piece of the quiet revolution happening now—Reference Based Pricing (RBP) or sometimes called Cost Plus Pricing.

With RBP, employers set a pricing cap on the maximum amount they will pay for medical services based on a pre-determined rate, and NOT on a discount of the provider’s Charge Master. An employer, typically working with a third-party administrator, will determine a fair and reasonable reimbursement for a procedure often using the Medicare’s reimbursement model. And, unlike “negotiated discounts” with PPOs that are not transparent, Medicare reimbursement rates are completely open to the public.

Most RBP plans begin with what Medicare will pay as a flat rate and add some percentage above the Medicare allowable charge. This kind of plan is also known as “bottom-up” or “value-based” pricing.

For example, RBP plans usually pay:

  1. Outpatient charges: 100% of Medicare allowable up to 150%

  2. Inpatient charges: 100% of Medicare allowable up to 200%

So, going back to our knee replacement example, the RBP plan might define $20,000 as a fair and reasonable reimbursement and many providers will accept this rate for providing the service. But some may not. By knowing these rates, a patient can then shop around and find a provider for the needed medical procedure and compare prices, essentially becoming an informed consumer. This level of due diligence by consumers is only now beginning to emerge in the American health care system. 


The Benefits of Reference Based Pricing

The cost benefits of RBP can be significant to an employer. Companies that have switched from a PPO plan to the RBP model have seen as much as 20% to 25% drop in prices for employee health care services. Alternatively, companies still using a traditional employer-sponsored plan for health care have typically seen costs rise between 3% to 6% year over year over year.

What RBP can mean for a small business is:

  1. Savings can exceed 20% compared to the PPO model.

  2. It eliminates wide price variances by fixing reimbursement costs from provider to provider.

  3. It exposes the prices of procedures not disclosed under current PPO/Provider agreements.

  4. The RBP model creates a more competitive marketplace for providers to compete for patients, and possibly eliminates unnecessary procedures.

  5. It significantly reduces the cost of claims and the cost of disputed claims.


The Potential Downside of Reference Based Pricing

A potential downside of RBP occurs when a provider charges above what a health plan has allocated for a service. Once more, let’s use our knee replacement example: the RBP plan will pay $20,000, but the provider’s fee is $25,000. What happens to the extra $5,000? Some hospitals other medical providers will choose to collect the extra $5,000 directly from the patient. This practice is called balance billing in that the provider is billing the patient for the portion of the charges not covered by the RBP plan.

RBP administrators have a variety of ways of dealing with balance billing. Some will pay more to appease the hospital, while others use legal counsel to maintain the integrity of the employer-sponsored plan. However, recent studies show balance billing occurs in a small percentage of claims and will likely remain small in a fair and competitive market.

The onus also falls back on the employees to be consumers and shop for the best cost of a procedure. For this reason, a company transitioning to this type of plan needs to educate its employees early and often about how each one of them is responsible for finding the best price for a procedure.


An Additional Challenge

Here’s a little peek behind the curtain of insurance sales: The current insurance broker compensation structure is likely aligned with the PPO model. What I mean by this is that many insurance advisors are compensated, directly or indirectly, by the inclusion of a PPO on the Managed Care plan. As a small business owner, you may find that your broker will push back on RBP instead of helping you explore this option. If so, our suggestion is to find a broker who is compensated by a fee and not an overall commission derived, at least in part, from the PPO network premiums.

As we’ve seen, “discounting” charges in the traditional PPO network amounts to a shell game. RBP plans use a transparent pricing model based on actual costs, also known as bottom-up pricing. The quiet revolution is starting to have a voice as employers find alternatives to manage their costs. Bottom line, it is getting more difficult for insurance administrators to talk about the positives of PPO network discounts since most plans are being funded increasingly from the contributions of members’ paychecks. Reference Based Pricing may be the economic alternative to breaking this strangle hold and ultimately unleashing real market competition in health care funding. 


Need help in deciding what health care insurance is best for you and your employees? Contact John Owens, Vice President of Lewer Benefits Group for a personalized consultation. Reach him at  1+(800) 821-7715, ext. 109 or by email at

Author: John Owens

John Owens is Vice President of Lewer Benefits Group. He is a renowned medical insurance consultant with more than 36 years of employee benefit experience. He assists small business clients in designing affordable and sustainable health and benefit programs.