The fiduciary imperative of reference-based pricing: A legal and financial analysis

The landscape of American health care has undergone significant transformations in the past decade, with the emergence of numerous innovations and cost-saving measures. One of the most impactful developments is the rise of reference-based pricing (RBP), a pricing model proving to be a game-changer for employer-sponsored health insurance plans. This article argues that, given the demonstrated benefits of RBP, CFOs, VPs of HR, and other plan fiduciaries under ERISA are now under a fiduciary obligation to evaluate the potential incorporation of RBP into their health insurance plans – at least with respect to employers that are large enough to consider particularly self-funding their health plans. 

Fiduciary obligations under ERISA

ERISA imposes a fiduciary duty on plan administrators to act solely in the interest of plan participants and beneficiaries and for the exclusive purpose of providing benefits and defraying reasonable expenses of administering the plan. To fulfill this duty, fiduciaries must adhere to certain principles, including prudence, diversification, and adherence to plan documents.

The duty of prudence requires fiduciaries to act with the care, skill, prudence, and diligence that a prudent person would use in a similar situation. This duty is not merely a passive obligation; rather, it compels fiduciaries to actively engage in the management and oversight of plan assets, constantly seeking opportunities to enhance the value and cost-effectiveness of the plan.

Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir. 1982) emphasizes the importance of fiduciaries acting with prudence and diligence in managing ERISA plans:

“In every case charging breach of ERISA fiduciary duty, … the central inquiry is whether the fiduciary has acted ‘with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.’”

According to ERISA Section 409(a), fiduciaries breaching their duties can be held personally liable for any losses incurred by the plan as a result of their breach. They may be required to restore the plan to the financial position it would have been in had the breach not occurred, which can include reimbursing the plan for any losses or restoring any profits made through the improper use of plan assets. In addition to personal liability, fiduciaries who breach their duties under ERISA may be subject to civil penalties. For example, under ERISA Section 502(l), the Department of Labor (DOL) may assess a civil penalty against a fiduciary who breaches their duty, which can be up to 20% of the amount the fiduciary is required to restore to the plan because of their breach.

Also, plan participants, beneficiaries, and the DOL may bring legal action against plan fiduciaries who are alleged to have breached their duties. These lawsuits can result in significant legal costs, reputational damage, and potential liability for the fiduciaries involved.

Reference-based pricing: an overview

Reference-based pricing is an innovative health care pricing model that establishes a “reference price” for medical services and procedures based on the average cost of those services in a specific region. By capping the reimbursement rate for health care providers, RBP can significantly reduce health care costs for both employers and employees while maintaining quality care and expanding provider choice.  

The most common reference used in RBP is a multiple of Medicare reimbursement rates; for example, the plan pays 120% to 150% of Medicare.  This makes it incredibly difficult for providers to deny payments as the federal government, through Medicare and Medicaid, is often a provider’s largest client.  Hence, when an employer plan promises to pay 20% to 50% more than the federal government, providers are, by and large, satisfied and only push back on plans about 4% to 8% of the time, depending on the jurisdiction.  

Medicare rates are considered a reliable benchmark because they are based on the cost of providing medical services and procedures across different geographic regions in the United States. By using Medicare rates plus a markup as a reference point, RBP aims to establish a transparent and abundantly fair pricing structure for health care services.

Numerous studies and empirical evidence have demonstrated the effectiveness of RBP in reducing employer costs, typically by 20% to 40% in the first year of implementation.  This is because Medicare plus 40% is still roughly half of what large, preferred provider networks pay to hospitals for the very same services. Furthermore, RBP has gained the explicit endorsement of the federal government, confirming its legality and viability as a cost-containment strategy.

The fiduciary imperative to evaluate RBP

Given the significant cost savings and expanded provider choice associated with RBP, it is increasingly difficult to argue that a plan fiduciary can discharge their duties under ERISA without at least evaluating the potential benefits of RBP for their health insurance plans. This is particularly true considering the federal government’s endorsement of RBP and its growing adoption by employers nationwide.

To be clear, this argument does not contend that every plan fiduciary must adopt RBP; rather, it posits that the duty of prudence compels fiduciaries to seriously evaluate the potential benefits of RBP for their health insurance plans. Failure to do so could expose fiduciaries to potential liability for breach of their ERISA obligations as they would, in fact, be arguing that their legacy plan, paying an average of 224% of Medicare, is a reasonable and prudent choice for the plan and its participants.

The role of prudence in evaluating RBP

The duty of prudence plays a central role in a fiduciary’s obligation to evaluate RBP. To fulfill this duty, fiduciaries must act with the care, skill, prudence, and diligence that a prudent person would use in a similar situation. This requires fiduciaries to be proactive in seeking out and considering potential cost-saving measures, such as RBP, that could improve the financial health and overall efficiency of their health insurance plans.

Prudent fiduciaries must engage in a comprehensive analysis to determine whether RBP is appropriate for their specific plan. This analysis should involve:

1. Researching the latest industry data and studies on the effectiveness of RBP in reducing costs and maintaining or enhancing the quality of care;
2. Consulting with industry experts, actuaries, and legal counsel to assess the feasibility of implementing RBP within the plan’s existing framework;
3. Comparing the projected cost savings and provider network expansion of RBP with the current plan structure; and
4. Communicating with plan participants to gauge their preferences and concerns regarding potential changes to the plan’s pricing model.

The impact of federal government endorsement and legal precedents

The federal government’s endorsement of RBP solidifies its position as a legally viable and effective health care pricing model. Fiduciaries must consider federal regulations, guidance, and legal precedents that support the use of RBP when evaluating its potential benefits. The endorsement by the federal government serves as a strong signal to fiduciaries that RBP is a legitimate and beneficial option for health insurance plans.

The federal government’s recognition and guidance on RBP can be seen in the regulatory framework and through recent relevant judicial decisions.

1. Patient Protection and Affordable Care Act (PPACA) and RBP: PPACA encourages the adoption of innovative payment models, such as RBP, to promote cost containment and improve the quality of care. PPACA’s focus on transparency, cost control, and value-based care created a favorable environment for the adoption of RBP strategies.

2. Department of Labor (DOL) guidance: The DOL, which is responsible for enforcing ERISA regulations, has provided guidance on RBP through various advisory opinions and FAQs. These documents provide a framework for how RBP can be compliant with ERISA and other applicable regulations.

For example, in its 2016 FAQs About Affordable Care Act Implementation Part 31 (issued jointly with the Department of Health and Human Services and the Department of the Treasury), the DOL clarified that a plan utilizing RBP will not violate the ACA’s prohibition on annual or lifetime dollar limits, as long as the RBP is applied to a set of essential health benefits and the plan pays at least 60% of the total allowed costs for those benefits.  

3. Court decisions: have upheld the legality of RBP practices when challenged. These decisions serve as an indirect acknowledgment that RBP is a lawful and effective cost-containment strategy.

For instance, in the case of Montefiore Med. Ctr. v. Local 272 Welfare Fund, No. 12 Civ. 9250 (S.D.N.Y. 2014), the court held that a self-funded health plan using RBP did not violate ERISA’s fiduciary duty provisions. The court reasoned that the plan’s adoption of RBP was consistent with the plan sponsor’s fiduciary duty to manage the plan in the best interests of its participants.  

Industry trends and best practices

As RBP becomes more prevalent in the health care industry, fiduciaries should stay informed about industry trends and best practices. They must consider the experiences of other employers who have successfully implemented RBP and assess whether these successes could be replicated within their own plans. By staying current with industry developments, fiduciaries can make well-informed decisions about the potential benefits and risks of RBP.

Several prominent employers across various industries have adopted reference-based pricing (RBP) as a cost-containment strategy for their health plans. While specific employer names might not be publicly available due to privacy concerns, some well-known organizations have implemented RBP, including:

1. The State of Montana: In 2016, Montana’s state employee health plan adopted an RBP model that caps payments to medical providers at a percentage above Medicare rates. The move helped the state control healthcare costs and has been considered a success.

2. Purdue University: In 2018, Purdue University introduced an RBP option for its employees as part of its health care offerings. The university reported significant cost savings and positive feedback from employees participating in the RBP plan.

3. Rosen Hotels & Resorts: Rosen Hotels & Resorts, a Florida-based hotel chain, adopted an RBP model as a part of its self-funded health care plan. The company has experienced substantial cost savings while maintaining high-quality care for its employees.

4. The City of Kirkland, Washington: In 2017, Kirkland implemented an RBP model for its employee health plan. The city saw a reduction in health care expenses and improved transparency in medical pricing.

These examples represent just a small sample of employers that have adopted RBP as a part of their health and welfare plans. As the success of RBP models becomes more evident, and as more employers recognize the benefits of adopting RBP, it is likely that an increasing number of organizations will consider implementing RBP strategies for their healthcare plans.

Conclusion

In the ever-changing American health care landscape, CFOs, VPs of HR, and other plan fiduciaries must prioritize cost-effective, participant-focused solutions like reference-based pricing (RBP). Fulfilling fiduciary duties under ERISA requires a thorough analysis of RBP, including examining industry data, consulting experts, comparing projected savings and network expansion, and communicating with plan participants. As RBP becomes increasingly vital to fulfilling fiduciary obligations, failure to do so may not only result in missed opportunities for cost savings and enhanced participant choice but also expose plan fiduciaries to potential personal civil and criminal liability for breach of their ERISA duties.

Craig Gottwals is a health care attorney and senior vice president at McGriff Insurance Services. He has taught employee benefits and human resources for sixteen years at the University of California, Davis.