Escalator Clauses, Rising Prices, And Why We Should Care

escalatorYou may have asked yourself why health prices rise inexorably. Are escalator clauses, the automatic price increases common to many managed care contracts, the driving force behind trend factors?


Posted by Jeanne Pinder on January 7, 2017

Summary: You may have asked yourself why health prices rise inexorably. Are escalator clauses, the automatic price increases common to many managed care contracts, the driving force behind trend factors? Bill Rusteberg, an independent insurance consultant in Texas, posted on his blog recently about escalator clauses, which he said commonly add 5 percent a year to a provider’s annual billing. I was interested, and called him to chat about it. Bill, who’s been in the health care industry for 44 years, advises and assists plan sponsors or companies in managing their health insurance, on a fee basis. He’s based near Victoria, Texas, in the south central part of the state. Here’s the text of our interview, lightly edited for clarity.

Jeanne Pinder: You posted on your blog about escalator clauses and whether they’re the driving force behind trend factors. What is an escalator clause?

Bill Rusteberg: It’s a pay raise guaranteed by the managed care contract, where providers are guaranteed an automatic increase in pay every single anniversary of the managed care contract. So if there’s a 5 percent escalator clause, that’s really a 5 percent raise every year.


JP: This is automatic? In every managed care contract?

BR: I would say probably 99 percent of them.

When we negotiate direct agreements on behalf of our clients, we strive to remove them.

Just recently we tried to renew an existing contract that we have with a large hospital corporation that we’ve been using for three years now, and each year I tried to renegotiate the escalator clause and remove it from the agreement.

This year we were still unable to do it. So we’re terminating that agreement January 1.

JP: Is that common, to terminate an agreement because of the escalator clause?

BR: It’s not common at all, because people don’t know about them. These contracts are negotiated by third-party intermediaries. The contents of the contracts or the agreements are kept secret. So companies that sponsor employee benefits or health insurance — they really have no clue or no idea what they agreed to pay providers because they’re not allowed to see the contracts.

JP: When you actually are negotiating these contracts, you’re negotiating directly as essentially as a contracting agent on behalf of your clients?

BR: I actually am assisting the client in direct contracting.

And if that’s successful then the agreement of a contract is directly between the provider and the employer. So I’m a facilitator — I’m not a party to the contract.

How contracts are negotiated

JP: Let me ask you again about escalator clauses and contracting. How often are managed care contracts negotiated or renegotiated?

BR: It’s going to vary.

I can talk about Blue Cross a little bit. I’m a little bit familiar with them.

Their hospital contracts are usually multi-year contracts, typically three years long, and I suspect that’s true of the other carriers. Otherwise these “rental” managed care networks — their contracting may undergo renegotiation every so often, but there’s no rhyme or reason to it.

JP: So when you wrote your blog post, you said that you were reading an actuarial document that said and I quote “medical cost trends include components for many driver net unit price increases driving at the effect in general the 5 percent increase in a schedule will drive 10 percent overall costs increase.” Can you talk about that a little bit?

BR: That is incredibly interesting reading and it was written by an actuary in an actuarial study that I happened to find on the internet. It was a quite lengthy discussion on managed care contracts and escalator clauses and trend factors. That one paragraph really kind of summed it up.

It was the beginning and the end of his article. And basically he just confirms from an actuarial standpoint. The chicken came before the egg. And in this case the chicken is these managed care contracts that lay these managed care eggs throughout the industry. That’s one of the major factors that’s driving costs up.

As low as 4% and as high as 12%

JP: So could we then assume that the many managed care contracts incorporate to a large degree that escalator clause of 5 percent or so?

BR: I’ve seen it as low as 4 percent and as high as 12 percent. So it’s it’s across all across the board. What I have seen since the passage of the Affordable Care Act is a rapid escalation in hospital chargemaster rates, and in return that’s also going to affect their care provider contracts.

So we have seen a rapid increase in health care costs in in many of our defined group plans.

And the only the only explanation in some cases is the chargemaster, and the escalator clauses, and that renegotiated contract — a combination of those three things.

For example we have a client with 7,200 member lives — a large group spending millions and millions of dollars on their medical plan, This is a public entity, tax-supported. Eighteen months ago, in one year alone, they had to dip into their reserves to the tune of $6 million, and there were no serious ongoing claims.

This group is 100 percent credible — 100 percent credible means that it usually stands on its own actuarially. So there’s only one explanation, and that explanation is a combination of the escalator clause taking effect on a new contract that was negotiated, we think,  by Blue Cross Blue Shield at area hospitals in that area.

So that’s a pretty significant increase.

We’re seeing it in other groups as well. And thd anguish on the part of the plan sponsor is “how do we know what’s driving this, and what can we do to stop it?”

And that plan sponsor would be, for example, the tax supported entity, or an employer or anybody else who is paying to insure a cohort of people. In this particular example, it is a public school district here in Texas.

JP: The downstream consequences of that $6 million is that they have to dip into their cash reserves?

BR: Yeah. They had to dip into their cash reserves. It’s even worse than that, because they had to dip into the tune of $6 million above and beyond what they were contributing into the plan during the same period of time.

So the loss was much greater than $6 million. But specific to the reserve fund, it was $6 million.

What’s the tradeoff? Books, salaries etc.

JP: That $6 million comes out of reserve funds which might be used for textbooks, teacher salaries, building new schools, or fixing the broken toilet in the bathroom, am I right?

BR: That’s right.

JP: Let me ask you a forward looking question. What happens next?

BR: What we’re seeing in the marketplace now is employers are becoming more savvy  — they’re becoming more educated.

They’re starting to understand the secrets of managed care and the secrets of our health care delivery system. They’re beginning to realize where the revenue streams are going.

They’re angry, and what they’re doing about it is they are attempting to do direct contracting with community providers with a lot of success. There are also those [providers] that they can’t successfully negotiate agreements with. They are starting to use to great extent reference-based pricing, which is a growing phenomenon.

Over 10 percent of the market is now headed towards reference-based pricing. I was talking to a hedge fund last year that’s very interested in investing in health care startup companies. They did their research and they’ve determined that reference based pricing is going to dominate the market 55 to 60 percent.

For your readers, what that means is when a company goes reference based pricing, they’re basically walking away from managed care contracts and not having any contract. And what they feel to be fair and equitable payment to them to the providers.

Reference-based pricing: Using a common yardstick

JP: Can you do a quick description of reference based pricing?

BR: Reference-based pricing is very simple. Using some industry-accepted benchmarks — it’s mainly Medicare pricing, which has been in place for years, that most hospitals and doctors accept. You compare your historical claim and benchmark against Medicare to determine how much above Medicare is your managed care contract really paying out of your funds.

So you’ll find most employers will find that that benchmark percentage is north of 200 percent of Medicare. Sometimes it’s four and five hundred percent of Medicare.

So what the employer is doing in reference-based pricing: they use Medicare benchmark rates as a reference and they pay, say, 20 percent above that. So 120 percent of Medicare is what their plan will pay.

That gives the provider a 20 percent margin over and above what they would have received if the patient had been a Medicare recipient. So you are benchmarking against data points.

And you can also benchmark off the cost-to-charge ratio. Hospitals that accept Medicare must file a report every year showing their cost basis by department. As public information — they have to attest to it. So you can access that information and benchmark your claims on that as well where you can say, for example, our plan is going to be a cost plus 15 percent or Medicare plus 20 percent, whichever is greater. Basically, that’s what we’ve been doing here in Texas since 2007 with great success.

Here’s a story. We picked up large group January 1, 2016 — over 5,000 employee lives. They were with Blue Cross Blue Shield.

They moved to a third-party administrator and they accessed a rental network. They had been running 100 percent of the facility claims — that’s hospital claims and outpatient surgical centers — through a database to compare and benchmark against Medicare.

But it’s really really interesting. I won’t name the hospital systems. But there’s one hospital system the employees go to for cancer treatment in Houston, Texas. And the average plan payment there is 448 percent of Medicare that was negotiated. We have hospitals closer to the community this group is in — four hospital systems within driving distance. The average reimbursement through the PPO rental network runs from a low of about 200 percent of Medicare to a high of 440 percent.

Well, when you convert a group like that into a reference based pricing, think 120 percent of Medicare, you’re actually cutting their costs 40 to 50 percent.

Yes, employees will get more money

JP: That goes straight to the employer’s bottom line?

BR: Well, it goes to the employee’s paycheck too — because it frees up a whole lot of money for raises.

That is quite frankly the best kept secret. That employees and their dependents forever have been paying 100 percent of the cost of their insurance.

They may say the employer pays for the employee-only rate, for example. But that’s that’s really coming out of the employee’s pocket. They factor that in when they figure wages and bonuses — so employees are really paying 100 percent of the cost.

JP: Can you gaze into your crystal ball? You and I have talked about a number of factors that were in place since before the Affordable Care Act came into being, then during the Affordable Care Act. And now the big question on everybody’s mind is what’s next after the new president gets inaugurated? What do you see coming on down the pike?

BR: I see the employer mandate is probably going away. I see the individual mandate is probably going away. I think there’s a 50/50 chance of that happening.

I see the pre-existing conditions clause remaining the same. That’s a good thing. Covering children aged 26, I think that’s going to continue.

So a lot of the good positive things about the A.C.A., I think are going to remain.

I think employers are going to be given more freedom to design their programs that best fit their needs. I think that’s going to open up a lot of opportunity — for employers to get more reference-based pricing, to do more high deductible plans funded into a health savings account.

It’s going to give them a lot more flexibility. Right now their hands are pretty much tied to some pretty strict benefit mandates that are very  expensive.

So I see that happening and I see a big movement to allow companies to do more direct contracting, and I see hospital systems and doctors more willing to do that. So it’s going to be a good, dynamic changes that I believe will slow down this medical inflation rate that we’re seeing.

JP: Thank you so much, Bill.