How Employers Can Reduce Healthcare Costs

John McCracken, PhD

Private employer healthcare spending reached $727 billion in 2018, making it their second largest expense behind wages and salaries.  Hospital services represented an estimated 44% of those costs, and in recent years hospital prices—not utilization—have been the key driver of their growth.  Addressing the prices paid for hospital services represents a tangible way for employers to reduce the increasing burden of employee healthcare expenses. 

In a recent nationwide analysis of healthcare prices paid by private payers, the RAND Corporation reported that across all hospital inpatient and outpatient services, employers paid an average of 247% of what Medicare would have paid for the same services at the same facilities.  The study calculated a relative price for each of 3,112 community hospitals, comparing the prices employers actually paid to the prices Medicare would have paid for the same service provided at the same hospital, including both professional and facility fees. 

The RAND study found that hospital prices paid by employers are highly variable across states, hospitals and sites of care.  In three states hospitals were paid relative prices averaging under 200% of Medicare, whereas those in five other states received prices averaging more than 325% of Medicare.  Moreover, variation between hospitals within most states was even wider than differences between the states.

The study also found that:

  • in 2018, the relative price paid by employers for inpatient services averaged 231% of Medicare while outpatient procedures averaged 267%;
  • there was virtually no correlation between employer prices paid and any publicly available measures of hospital quality or safety.
  • on average, between 2016-18 relative hospital prices paid by employers rose from 224% to 247% of Medicare;

One explanation of these high prices is that hospitals have used the negotiating leverage from increasing consolidation to extract higher prices from commercial payers.  Another explanation is that because Medicare underpays hospitals, they are compelled to charge higher prices to their commercially insured patients to remain financially viable.   From the employers’ perspective, however, the compelling question is whether it is reasonable to be paying hospital prices that are nearly 2.5 times Medicare rates, especially when the evidence reveals that there are frequently local hospitals available with similar or better quality scores that charge lower prices.

There are two reasons why employers find themselves in this situation.  First, many employers utilize discount-from-billed-charges contracts in which they pay a percent discount from hospital chargemaster rates.  The effect is to make employer plans vulnerable to list-price inflation, leaving hospitals and providers to drive rate setting.  The second reason is that most hospital managed care contracts are subject to gag clauses that prevent either payer or provider from revealing the negotiated prices.  This should become less of an issue in 2021 and beyond when the new hospital price transparency rule—if it is enforced by the new Biden administration—makes negotiated hospital prices, by payer and type of service, publicly available.  Price transparency by itself, however, will not be sufficient if employers don’t act on the information.

Actions Employers can Take to Lower Healthcare Costs

Many employers have relied on employee outreach and wellness programs to reduce their healthcare utilization. Despite their promise and widespread adoption, however, such programs have not been shown to materially affect spending.  Employers would be better served by focusing more directly on the prices negotiated on their behalf. 

The most effective step would be for employers within a given market to insist on using direct contracting, in which the hospital or health system agrees to lower pricing in exchange for employers collectively directing their patient volume to that hospital or health system. This approach links lower rates with higher patient volume and can also promote care coordination and clinical integration. 

Negotiating prices for specific services as a multiple of Medicare would also be a straightforward and transparent way for employers to gain better control over their costs.  Multiple-of-Medicare contracting as an alternative to discount-from-billed-charges would be easy to implement, since the employer would only have to specify the percentage of Medicare payments that it would accept.  The hospital contract wouldn’t have to specify the price for each service; instead, it would specify the overall percentage of Medicare that would be applied to all services.  In addition, employers could increase their use of bundled payments, reference-based pricing, global budgets and other forms of contracting that unlink prices from billed charges and limit price variability. These actions to change contract terms and move patients away from higher-priced providers would meet local provider resistance, but ultimately would result in a significant slowing in the rate of growth of prices paid by employers. 

In addition to benefit design approaches, employers could make their voices heard in Washington D.C. in opposition to further hospital and health system consolidation.  Data from the Healthcare Cost Institute finds that 70% of U.S. metropolitan markets are highly concentrated.  Efforts to promote competition in healthcare markets by opposing further consolidation would be listened to and likely well received by both sides of the aisle in Congress. 

Employers are major purchaser of services in the U.S. healthcare system.  For most, they are the second largest business expense after wages.  Demanding transparent information about provider pricing, negotiating contract terms that limit provider pricing power, and moving patient volume to lower priced hospitals that offer better value could significantly benefit employers, their employees and society at large. 

John McCracken is Director of the Alliance for Physician Leadership, an educational partnership between the University of Texas at Dallas and The University of Texas Southwestern Medical Center.  The Alliance offers an MS/MBA program in healthcare leadership and management exclusively for physicians.