Reference Pricing and Demand

Steering Patients

In order to understand the implications of reference pricing, the drivers of demand for colonoscopies has to be understood. Colonoscopies are used to detect cancers and precancerous polyps, and they are a recommended technique for this, being that the physician can examine the colon visually. Other techniques are not as effective. The reality is that polyps and even early stage colon cancer are often asymptomatic, but of course early detection has the best outcomes for patients. For this reason, the most effective early detection technique and for the ability to detect and remove precancerous polyps, the colonoscopy is recommended (ACA, 2015). Other techniques exist, but they are not perfect substitutes for a colonoscopy -- the fecal test is not as effective as a colonoscopy and is therefore not a substitute for one. That said, patients do not always make their decisions based on medical data, but economic analysis assumes that patients are rational.

With a $500 reference price, patients would be oriented to seek out the lowest-cost provider. While the lowest quartile of providers charge less than $536 (the $36 is basically irrelevant in the economic analysis), but they are not necessarily distributed uniformly around the country. Likely, these low-cost colonoscopies are available in areas where factor costs such as labor are low, or where payers demand low-cost medical services. Assuming perfectly even distribution of low cost colonoscopy providers, however, patients are likely to seek out these providers where possible, in order to eliminate out-of-pocket costs.

However, the average price is much higher, and consumers may choose to pay the added cost. Indeed, a rational consumer would pay the added cost, given that colon cancer costs a lot more than a colonoscopy. Most patients at risk for this are older, so are more likely to be at a point in their career where they can afford a few extra hundred dollars for the average-priced colonoscopy. On the whole, the $500 reference price would orient the market (both consumers and providers) to colonoscopies that cost closer to that price. However, while the reference price should help to skew the market towards lower prices, providers that are priced substantially higher than $1,000 are likely catering to a market that can reasonably afford the higher cost for better care, and will not see the expense as anything more than a good investment in future health. Only in the middle of the market -- people old enough to need a colonoscopy but without surplus income, would the reference price drive such a patient to a low cost provider. Where such patients are common, there will be providers that emerge to provide low-cost colonoscopies -- where there is demand in the market, supply will emerge to fill that demand as the market moves towards equilibrium.

A $25 reference price is somewhat different. Instead of covering anywhere from 33 to 100% of the cost of a colonoscopy, the $25 covers basically nothing. With this reference price, the rational consumer would still pay for the colonoscopy, though would likely be more price sensitive, since they are receiving no assistance. The price that the market demands would decrease. The reference price influences demand depending on the price elasticity of demand. Rational people over 50 still would demand colonoscopies, because the fecal test is not a perfect substitute, so the price elasticity of demand should actually be fairly low. There will, however, be those who for whatever reason would substitute the fecal test, if they had to pay for their colonoscopy. This is likely the same market that would avoid paying for a colonoscopy, and would therefore seek out the $500 one in order to avoid out-of-pocket payments. While there is no medical case for this, not everybody has the money to pay the out-of-pocket expenses. That is the market that would be price sensitive, and which would switch from colonoscopy to fecal test if the reference price dropped to $25.