In The Wall Street Journal,  Keith Lemer, CEO of The WellNet Healthcare Plan, a health-care services company, argues that the “discounts” at the heart of most preferred provider organization (PPO) operating models are actually “accounting tricks.” Perverse incentives have been created by medical loss ratio (MLR) rule of the Affordable Care Act.

The net effects have been to drive further increases in healthcare costs and prevent price transparency.

To allow PPOs to advertise big discounts, providers simply inflate their billed charges on a whole range of services and treatments.

Many large insurers have turned to self-insurance plans as a way out of this “price spiral:”

When businesses self-insure, they pay employee health claims directly. That creates an incentive for businesses to question—and push back on—providers’ price increases. Self-insuring businesses can strengthen their leverage by using “reference-based pricing,” which caps payments for “shoppable”—nonemergency—services at the average price in a local market.

Lemer argues that the effects are positive for overall healthcare costs and may lead to behavioral change:

Patients have a reason to shop around for the best value, while providers are pressured to keep their prices below the cap. The most expensive doctor is not always the doctor with the best outcomes.

He cites as evidence the experience of  the California Public Employees’ Retirement System. Under its a reference-pricing program, costs for hip and knee replacements, which previously ranged from 15,000 to $110,000, were standardized around a reference price of $30,000. The results:

Predictably, patients flocked to providers charging that price or less and shunned higher-cost facilities. Over the next couple of years, the number of California hospitals charging below $30,000 for a hip replacement jumped by more than 50%. In the first year Calpers saved an estimated $2.8 million on joint replacements.

Other healthcare observers see reference-based pricing as essential to a broader strategy of “narrowing networks” to eliminate high-cost providers.

The most aggressive trend that achieves the savings gained through narrowing networks is reference-based pricing.  This strategy all but eliminates the traditional “network,” driving savings by avoiding “big insurance” and network contracts.

Using a reference-based pricing model, hospitals reimbursements can lead to significant savings. Lower costs and increased transparency are attractive, of course, but there are cons, too, including “disruption from non-participating providers” and “lack of leverage for small employers.” Getting it right requires a carefully coordinated plan.