California Pension System Tests New Money-Saving Strategy

A pilot program in California is using "reference pricing" to cap health-care costs. Can the strategy be used by others?
December 12, 2013

What does grocery store chain Krogers and the California Public Employees' Pension System (CalPERS) have in common? The world's fourth largest retailer and the country's largest pension system are trying to tame health-care costs by using something called "reference pricing."

What is reference pricing? It is a variation on price caps: The payer, in this case Kroger or CalPERS, sets the price it will pay for, say, hip replacement surgery or an MRI. Beneficiaries are free to pick any provider they wish to use, but if the price is above the one the payer set (the reference price), the consumer pays the difference. Reference pricing is used mainly for prescription drugs, imaging tests and elective procedures where providers are widely available and there is not much variation in quality.

To see why CalPERS has turned to reference pricing, I caught up with David Cowling, who heads up the pension plan's Center for Innovation. What follows is an edited version of our conversation.

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Why did CalPERS start a reference pricing program?

It is part of CalPERS' overall strategy to use value-based purchasing, and it is part of our road map of things to do to make consumers more cost conscious.

When we looked at what our health-care cost drivers were, we saw that hip and knee replacement surgeries were increasing over time pretty dramatically. Knowing what we know about our population -- it's growing older and nearly all hip and knee replacements are done on people over forty -- utilization was going to go up. That led us to think about ways to do something on hip and knee replacement surgery. When we delved into it, we found that prices varied widely across the region and within regions. It's also important to think about quality. There's not a lot of variation in quality for these procedures and quality had no link to cost.

Reference pricing for hip and knee replacement surgery has been in place for two years s for about a quarter of your membership (those enrolled in an Anthem PPO). What kind of savings have you had?

Currently it's $5.5 million over the first two years.

Given that CalPERS overall health costs are $7.5 billion a year, that doesn't sound like much.

It doesn't, but every single penny saved goes back to lowering premiums for our members. It's also a test of the reference pricing strategy. If people start doing reference pricing for a whole bunch of different things, savings are going to accumulate over time.

Another aspect of it was to disrupt the marketplace and increase transparency. In 2008, Anthem enrollees were pretty much split evenly in using hospitals that became referenced-based pricing (RBP) facilities and those that did not [53.2 percent RBP versus 46.8 percent non-RBP]. By 2011, the second year of the pilot program, those percentages had shifted to 64 percent using RBP hospitals versus 36 percent using non-RBP. So reference pricing induced enrollees to choose RBP providers and that changed the market. Non-RBP hospitals started lowering their prices. In 2010, the year before reference pricing went into effect, non-RBP hospitals were charging $43,308 for Anthem enrollees; in 2012, they were charging $27,149. For non-CalPERS Anthem enrollees, the price dropped from $39,923 in 2010 to $36,127 in 2012. The prices at RBP hospitals stayed about the same.

Have there been significant costs in setting up the program? As I understand it, you offer members free travel costs if there is not a reference-priced facility in their area? Has that been expensive?

There have not been a lot of travel costs associated with the program. That's because we have for almost all procedures a facility within a region. There are only one or two regions in the state that don't have such facilities and they are not very populated. The cost of that is minimal.

Have there been hurdles in setting up the program?

The biggest hurdle is making sure members are educated about the program. We're still trying to improve that.

We paid to have an evaluation done on our cost-benefit and also to make sure that there's the same quality across the board. That study hasn't come out yet but Anthem has done a clinical quality study that shows outcomes are the same in RFB facilities as in non-RFB facilities. We wanted to show that to address concerns of members. The finding makes sense since, with hip and knee replacement, quality is usually correlated with volume. We have a volume gate, and many of our facilities are well-known, recognized names.

Any lessons learned to share with our readers?

The setting of the reference price is a little bit of an art. It was important for us to have the least member friction as possible, to insure we had facilities regionally so people didn't have a travel problem. Some other [companies with] RFP programs have people go to facilities far away. We didn't want that.

Is what you've done with reference pricing replicable by other government agencies?

There are other states thinking about a similar type program. I've been contacted by agencies that implement health programs and by pension programs.

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