HCI3 Update from the Field: How Much Price Premium Can Quality Demand?

Submitted by francois.debrantes@hci3.org on Friday, October 18, 2013 - 01:13

Newtown, CT – October 11, 2013

How much of a price premium can excellent quality demand? This is a question that we will be answering over the next several months and for which we already have insights to share. Health care is becoming a retail market, despite the hue and cry to the contrary. This transformation is occurring because of the continued shift of health care insurance benefits to something akin to classic indemnity, very similar to what most consumers experience with property and casualty insurance. In this retail market, there will be (and should be) differences in price between providers, albeit not at the same level as we see today. What typically drives price differences in all other industries is the perceived (and oftentimes real) difference in the value of the services or goods received. We know that current price differences in health care are driven by market power and/or by regulatory protection/ineptitude and other market distortions. So let's take a concrete example. A year ago we published an analysis comparing the total episode costs for knee replacement surgery for commercially insured plan members and Medicare beneficiaries. The average cost of the hospital stay for consumers under age 65 was about $17,000 and can vary significantly, doubling or more. The total episode cost, including post acute care and all relevant professional services averages $25,000. What we've noticed is that the price paid for the facility (essentially room and board and supporting services) can also vary from simple to double. In others words, the price premium can be as high as 100%. The other finding in that report was that, overall, the costs associated to avoidable complications were modest, averaging about 10% of the total episode costs.

What this means to you – Assume for a moment that a team – surgeons, facility, clinicians and other providers – can perform these surgeries at close to a zero defect rate. According to our report, that would reduce the average total episode cost by about 10%. If the facility wanted to increase its average price it could justify a 15% premium and the total episode cost would still come out to about the market average of $25,000. Could it increase its price by 20%, 30%, 40%? Perhaps. However, the recent reference pricing program launched by CalPERS suggests that the market would not bare a significant premium. Given this simple math, how can any facility justify a price premium of 100%? The short answer is that it can't. The opacity of today's health care market coupled with a "pass-the-buck" attitude and a lax regulatory environment has allowed these outrageous price premiums to metastasize. The result is that employers and consumers are paying far more than they should. Beyond that, this pricing practice has also encouraged a very lazy and profligate way of managing health care organizations. Think about it. If you could artificially inflate your prices by 100% relative to market average, would you still be worried about cost control? Would you work tirelessly to weed out waste and inefficiencies? Would you vigorously embark on LEAN management? Of course not. So no wonder that health care execs are headed for the door at a rapid clip. They know the good times are over, and none too soon for those who have been paying the bill.