Bending The Cost Curve With Reference Based Pricing

By Mike Miesen

“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.”

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.

Editor’s Note: 

In our opinion, Reference Based Pricing with limited balance billing advocacy and legal defense services is the “grown-up” way of offering employer sponsored health insurance.. We have all been worried about the effects of balance billing…………..upset employees, lawsuits, dinged credit, etc. But, if an employer educates his workers (Ah yes, just another chore for HR), for the first time plan participants will  understand that they have skin in the game. It’s called individual responsibility……………money changes behavior.

 Balance billing advocacy and legal representation could continue to be important for emergency hospital admissions, while non-emergency services can be shopped for the best pricing and outcomes.

 There are service providers active in this market and more to enter, we expect.