Welcome to reference-based pricing, the “Wild West” of self-funded healthcare, which has emerged as a game-changer for cost containment. “It's a lot of savings, but a lot of disruption,” said Jason Jurgill, Newfront vice president of employee benefits.

Reference-based pricing falls under the umbrella of self-funded healthcare, which is when employers take on the cost of healthcare claims themselves rather than going through a carrier and paying premiums. (To learn more about saving costs through self-funding, read our post on the self-funding trend.) Instead of traditional fee schedules or network discounts, organizations using reference-based pricing leverage publicly available data, such as Medicare rates or other benchmark data, to negotiate directly with healthcare providers and create cost-effective health benefit plans.

How does reference-based pricing work? 

Health care costs are not set in stone. For example, if a patient needs surgery for a broken ankle in Northern California, Medicare might set the rate at approximately $20,000. Because it’s a government program, Medicare rates are below market rate. Private insurance carriers, on the other hand, negotiate their own rates with the hospital and, as for-profit companies, pay higher rates. According to Congressional Budget Office data, private insurance pays more than twice as much than Medicare rates for hospital services. (That review also found that commercial insurers pay 129% of Medicare Fee-for-Service prices on physician services.) In a scenario where an employer uses a carrier, the insurance will cover much of the cost, with the injured employee covering out-of-pocket costs such as co-pays. But the insured will pay higher premiums because of the higher amounts their private insurer is paying healthcare providers. 

Reference-based pricing turns this on its head. In this case, the self-funded company doesn’t simply pay the same amount as what a private insurance carrier would. Instead, the self-insured company would compare data about the surgery cost to determine how much they’re willing to pay. How are self-reference prices set? With the help of a reference-based pricing vendor, such as Newfront, the employer collects publicly available data on the cost of medical services from the Centers for Medicare & Medicaid Services Healthcare Provider Cost Reporting Information System, which they can then compare against different types of hospitals and facilities. The costs can be on a scale depending on the severity of the injury or illness.

Because Medicare payments for inpatient and outpatient services are lower than a hospital’s actual cost of service, the self-insured employer might agree to pay 140% of the Medicare rate, so the hospital covers its costs but the employer ultimately saves more money than if they’d paid out the high insurance carrier rate. This translates into lower costs for the insured, as the employer passes on the savings to their employees.

The employer doesn’t necessarily ask for permission from the hospital but, rather, tells the hospital what they’re willing to pay, and then negotiate rates that healthcare providers are willing to accept. “It’s a lot more disruptive,” Jurgill said. “But the companies save 30 to 40% a year in their medical spending because of that arrangement.”

How reference-based pricing can lower the cost of medication

Reference-based pricing as part of a self-funded plan can deliver lower costs to employers and then their employees. But the benefits aren’t just limited to traditional costs like doctor’s visits and hospital stays.Employers can also use reference-based pricing to offer employees less expensive options for medications. “There's a drug on the market that  combines two main ingredients: ibuprofen and famotidine, which is basically Pepcid AC,” Jurgill said. “It is pharmacologically equivalent, it does the exact same thing, but the compound drug combines the two into one pill.” 

In a traditional insurance plan, employees might only have the option of offering the combination pill to their employees. With  reference-based pricing, they can evaluate costs and customize coverage, and might decide to offer employees the option of   taking a set of two cheaper pills rather than a prohibitively expensive single pill. They might even create an incentive plan where their employees get their medication completely for free, as long as they obtain the medications of choice.

Not just less expensive care, better care

Since reference-based pricing offers greater flexibility in choosing healthcare providers,  employees are not limited to a specific network of providers.  They are free to explore a broader range of medical professionals and facilities and have a better chance of designing plans that truly align with the needs of the organization and its employees.

Jurgill gave an example of a self-funded company which, after examining their claims and demographics, realized they had a large number of employees between the ages of 25 and 40, which meant they could anticipate above average family formation  over the coming years. They decided to compare the cost of baby delivery in their area. “They looked at three hospitals and, in the reference-based pricing world, you can actually see quality and cost metrics,” Jurgill said. 

Hospital A was the best hospital, Hospital B was the second best, and Hospital C was the third best—but Hospital A was also the cheapest. The company then designed a plan to incentivize employees to choose Hospital A for natal care and childbirth.

“They told employees, ‘Hey, if you’re going to be delivering a baby, we have this program that's available to you,” Jurgill said. “You don’t need to use it, but anyone that gets their baby delivered at Hospital A gets free diapers and wipes for a year.” Even with the diaper perk, the overall cost was still cheaper to the employer, a win for all involved.

How do you implement reference-based pricing?

Most companies don’t self-fund—and, therefore, don’t do reference-based pricing—until they have more than 500 employees. A group will have fairly predictable claims year-over-year when they have about 1,000 employees. (Read more here about when it makes sense to self-fund.) 

From an administrative perspective, there are a few additional steps to take when a company is self-funded, and using reference-based pricing. It’s best to partner with an experienced third-party administrator or vendor like Newfront to evaluate your current costs, determine if reference-based pricing is right for you, customize plans if it is, and assist with negotiations. Newfront can also help you plan how to educate employees about the reference-based pricing model and how it impacts their healthcare choices.

Considering implementing reference-based pricing as part of your employee benefits strategy? Talk to Newfront today.

About Newfront

Newfront is a modern brokerage transforming the risk management, business insurance, total rewards, and retirement services space through the combination of elite expertise and cutting-edge technology. Specializing in more than 20 industries and headquartered in San Francisco, Newfront has offices nationwide and is home to more than 800 employees serving organizations across the United States and globally. For more information, visit newfront.com and follow us on LinkedIn.