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Let the market, not contracts, set price for health care

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An overview of Sutter Health Alta Bates Summit medical center on Monday, June 27, 2016 in Berkeley.
An overview of Sutter Health Alta Bates Summit medical center on Monday, June 27, 2016 in Berkeley.Liz Hafalia / The Chronicle 2016

The state’s antitrust lawsuit against Sutter Health is a welcome move to stop Sutter from inflating health care costs across the Northern California market.

The lawsuit alleges that Sutter has illegally used its market power to compel commercial health plans to contract with all or none of its hospitals, extract exorbitant prices and prohibit use of financial incentives to encourage use of lower-cost providers.

The problem is not just Sutter, however, but insurance-contracted provider networks (preferred provider organizations and health maintenance organizations), where insurers negotiate medical service prices, keep those prices hidden and make other private deals that maximize revenue at purchaser and consumer expense.

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Even if the state prevails in its lawsuit against Sutter, unions and purchasers of employee health benefits will continue to overpay whenever they buy services from contracted networks. PPO-contracted rates have no rational relationship to provider costs or quality, vary widely by provider, and are undisclosed to the public.

An alternative pricing model, called reference-based reimbursement, is becoming more widely used. According to a 2014 survey of 1,230 employers covering more than 10 million employees, 10 percent of those employers have adopted some version of reference-based reimbursement and 68 percent said they planned to do so in the future.

Health care plans that replace PPO networks with a market-based reference-based reimbursement model will pay California hospitals 140 percent to 180 percent of Medicare allowable charges, rather than 250 percent to 350 percent and up.

Initially, PPOs and HMOs curbed health care costs. Insurers negotiated price discounts with their contracted providers in exchange for more patients. In the mid-1990s, for example, PPOs typically paid hospitals about 106 percent of Medicare allowable charges.

Today, California hospital markets are highly consolidated, enabling hospitals to demand rates that are 250 percent to 350 percent of Medicare allowable charges or even higher. Insurance companies go along with this because they have no product to sell without them and their profits are a percentage of the premium (the higher the premium, the more money they make).

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The results have been disastrous.

Since 2002, family premiums have soared 234 percent, compared with a 36 percent increase in the inflation rate. Last year, the average cost of an employer-sponsored PPO plan for a four-person family was nearly $27,000, or 44 percent of median household income in California.

The principal employer strategy has been to shift the financial burden to employees. Today, 81 percent of workers face deductibles that average $1,505 for an individual and higher for families. One in 10 workers has a $3,000 deductible.

Most families can’t afford an unexpected $500 expense without borrowing money, much less pay thousands of dollars for medical care before their plan begins to pay. In California, 55 percent of Latinos and 50 percent of those in poor or fair health did not get recommended care because of the cost.

California governments confront $150 billion in unfunded (mostly retiree) health care liabilities ($91.5 billion for the state alone, according to a recent report by state Controller Betty Yee’s office). Officials warn that these liabilities are crowding out core services, cannot be sustained and will require service cuts, revenue increases or both.

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The city of Marion, Ind., adopted a reference-based reimbursement strategy in 2012. Escalating health benefit costs loomed large in the city’s deficit, leading to a depletion of cash reserves and a downgrade of its credit rating. The city set up a self-insured plan that paid providers based on their costs. It cut the city’s health benefit costs in half, allowing the city to rebuild reserves and restore its credit.

Early reference-based reimbursement plans, Marion included, have used Medicare as the reference for provider reimbursement. Other approaches, however, may be more legally defensible. In California, for example, the Supreme Court let stand a ruling that market-based reimbursement of non-contracted providers is reasonable, whereas their billed charges are not.

Market-based reimbursement uses publicly available data sources to determine what specific providers are paid for their services from all market payers, including government and private insurers. In effect, the market is the reference point for determining fair payment.

Self-insuring is necessary, meaning employers pay medical bills directly rather than buy insurance. How much could California employers and employees save if providers were paid market rates rather than PPO rates? Probably enough to reduce employer plan costs by 25 percent while also eliminating deductibles, coinsurance and co-pays.

The question now is whether employers and unions will use market-based reference-based reimbursement approach to stop escalating health benefit costs and their destructive, decades-long impact on family and public budgets.

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Tom Dalzell is the business manager and Sally Covington is the senior health benefits adviser for IBEW Local 1245. To comment, submit your letter to the editor at SFChronicle.com/letters.

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Guest opinions in Open Forum and Insight are produced by writers with expertise, personal experience or original insights on a subject of interest to our readers. Their views do not necessarily reflect the opinion of The Chronicle editorial board, which is committed to providing a diversity of ideas to our readership.