3 Approaches to Setting Healthcare Prices

Leave a Comment
February 14th, 2013
Categories: Healthcare Reform

healthcare pricesHealthcare Reform has accelerated the use of different methods to pay for medical services. Although moving away from fee-for-service payment is widely considered to be a step in the right direction, how we pay for services is only half of the challenge. The other half lies in determining the right amount of payment.

Alternatives to fee-for-service payment have their advantages and disadvantages but they all share the same goal of ensuring that providers are rewarded for delivering high-value services rather than rewarding them for a high volume of services. It is also imperative that the payment system does not inadvertently penalize providers for improving the quality of care that they deliver.

The ideal payment method may vary by provider/facility, payer, state regulatory environment and even by geographic region. That being said, setting the appropriate payment level for services is universal to all payment methods and is imperative to realizing the potential of payment reform on the healthcare system. If services are priced too low, providers won’t be able to deliver quality care and if they are priced too high, there will be no incentive to provide efficient care.

So how should prices for healthcare services be set? Below we highlight 3 ways to set prices and their advantages and disadvantages with regard to marketplace competition, provider/payer size, and quality.

  1. Government Regulation or “All-Payer” Rate Setting – This approach would allow the government to set the prices that providers charge for healthcare services. This differs from the current method used in the Medicare and Medicaid programs where the government simply states what they will pay not what the provider can charge. In effect, this system ignores private insurers and their members and actually shifts the costs of under-compensated care onto them.
    By setting the amount a provider can charge all healthcare payers, this cost shifting can be avoided. The State of Maryland has a special congressional waiver that allows the state to set rates for hospitals for all payers though its Health Services Cost Review Commission. This approach still requires the regulator to set the “right” price for services and can discourage price competition on services where multiple providers exist.
  2. Negotiated Pricing between Payers and Providers – Negotiation is the approach currently used by commercial insurers and providers to determine the amount of payment for services rendered.  Often times, the Medicare payment methodology is used to determine the relative values among healthcare services. Medicare payment levels are also used to measure the insurers proposed payment relative to the allowed Medicare payment. This ratio of payment levels is often at the center of the negotiation between insurer and provider.
    Negotiation of price promotes price setting based on the overall cost of delivering services and the value of those services to insurers and their members. As with any negotiation, the power and size of the negotiators plays a major role in the outcome of the negotiation. If a region has a dominant health system or insurer, the outcome of the negotiation will often sway in their favor, with smaller providers getting paid less and smaller insurers paying more. Negotiated payments with providers usually include contractual requirements for confidentiality of payment levels. This promotes a lack of pricing transparency that has a devastating impact on the ability of consumers and employers to identify high-value providers.
    This approach also leads to providers receiving different payment amounts for the same service from different patients, which means that provider profitability is dependent on their mix of patients. Because of this, cost shifting can occur onto those payers with less leverage or patients with little.
  3. Competitive Pricing – This method of setting prices allows providers to define the appropriate price for their services and gives them the opportunity to attract additional volume based on greater efficiency and lower costs. This approach requires that there be 2 or more providers of similar quality for the consumer to chose from. It also requires a drastic increase in the availability of provider cost and quality information to facilitate the comparison of providers by consumers.
    Price-based competition is actually quite common for healthcare services that are not covered by insurance and relatively rare for services that are covered by insurance. In the laser vision correction and cosmetic surgery sectors there is a great deal of price competition and no shortage of transparency. It is important to note that costs have steadily gone down in these industry sectors even as providers have offered new technologies and techniques to their patients. One of the driving factors of this competition is the much greater consumer price sensitivity. Insurance typically shields consumers from most or all of the price differences among providers. This creates an environment where consumers are indifferent to the cost differences between providers and therefore do not present a motivating factor for providers to compete on price. High-deductible, HSA and other “consumer directed” plans have made some inroads in this area.

As we mentioned earlier, all 3 of these approaches to setting healthcare prices have their merits and challenges with their feasibility dependent on the region and health system in which they are implemented. It is also important to note that a single method of price setting is not necessary for all services. The best solution may likely be a mix of approaches that takes into account payer/provider competition, utilization of services and the overall financial stability of the health system. Which approach do you think is most applicable to your region, health system or US healthcare as a whole?