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Understanding network “discounts” and reference-based pricing


When your health plan includes a traditional insurance network, that network typically comes with discounts off the “full price” of the care when you see an in-network provider. But the term “full price” can be misleading. In this blog post, I’ll explain why providers set the prices they do, and how both networks and reference-based pricing (RBP) plans end up paying those providers.

(It’s important to point out that, in many cases, doctors aren’t the ones setting their prices or handling negotiations, especially if they work for a hospital system. When I say “providers” here, that also includes the administrators and billers who are often the ones handling the finances.)

But first, let’s talk about buying a car. When you go to the dealership, every car has a price tag on it. But no one actually expects to pay that price. You’re almost always going to negotiate down the price of the car.

The dealership knows this. So the price they put on the car isn’t actually what they’re expecting to get paid. They have a sticker price that’s more than they need you to pay. That way, they can still make money on the sale, even though you’re not paying “full price,” because the negotiations were based on an inflated number.

Negotiations between providers and big insurance networks (e.g. Cigna, United, or Aetna) examples of a big insurance network) work in a similar way. Doctors generally have a hard time getting insurance companies to pay what they’re asking. So they set the “full price” of medical care well above what they actually need. That way, when the insurance company is only willing to pay, say, 60% of what they’re asking, they can still make enough money to have a successful business.

But there’s a difference between these two scenarios. Unlike when you go to buy a car, the negotiation happens between the person paying (you) and the person being paid (the car salesman). That’s not the case with insurance networks. The network isn’t actually paying the prices they negotiate; you and your employer are. The network is just a middleman.

Because of this, the network’s negotiated prices are often still inflated. Why? Because both of the negotiating parties win this way. The provider gets to charge a higher price, and the insurance company still gets to claim that they’re giving you a “discount.”

One way that health plans have tried to avoid these inflated prices is through reference-based pricing. To explain how this works, let’s go back to the car dealership.

Growing up, I got to go to the dealership with my dad when he was buying a new car. My dad is a no-nonsense guy when it comes to stuff like this. He doesn’t want to play games, he just wants to pay a fair price and drive home in his new car.

The salesman he liked to work with understood that. So instead of trying to negotiate off the sticker price, he would go into his office and bring out the invoice showing what the dealership paid for the car. Then the two of them would try to agree on a fair margin; knowing how much the car had cost the dealership, how much did my dad need to pay in order for them to cover their costs, and still turn a reasonable profit? This way, they could find a price that was fair to everyone.

Reference-based pricing is designed to work the same way. Instead of starting from an inflated “sticker price,” your health plan looks at what it actually costs the provider to give you medical care. The best estimate of the provider’s cost is whatever Medicare would pay for that care. Medicare prices are designed to cover the cost of care, plus just a little more. They’re enough to keep the lights on, essentially. 

Of course, we want healthcare providers to be able to do more than just keep the lights on, so most reference-based pricing plans pay the provider the Medicare price, plus an added percentage on top of it. That way, the provider makes enough money to run a successful business, but you and your employer aren’t overpaying based on some arbitrary number. It’s a win-win situation.