The Network Arbitrage Game: How Employers Are Overpaying for Healthcare

Most employers think they're getting a deal on healthcare. They're not. The exposed rate data tells a different story — one where the same knee replacement costs wildly different amounts depending on which hospital and which network you're in, even within the same city.

In this episode, I break down the network arbitrage game: how hospital systems use their leverage to extract premium pricing, why your "broad network" plan is probably the most expensive option, and what the exposed price transparency data actually reveals about where the money goes.

We cover:

• Why the same procedure can cost 3-5x more at one hospital vs. another
• How hospital systems use "must-have" leverage to inflate entire network contracts
• What narrow and tiered networks actually save (and what they cost in access)
• The real math behind reference-based pricing
• Why most employers have never seen the exposed rates they're paying

This isn't theory — it's what the data shows.

Full sources and the deep dive: danmccoymd.substack.com

Transcript

SPEAKER_00 0:07

Here's something that should make every employer in America furious. You've been told repeatedly that the Affordable Care Act created a marketplace where individuals buy their own insurance, a parallel system, different customers, different products, no overlap with employer coverage. That's a lovely story, but it's also nonsense. Here's what actually happened. Insurance carriers figured out that employers with self-funded PPO plans are the perfect mark. The employer writes the checks for every medical claim, the carrier negotiates the rates, and here's the key part. If the carrier negotiates worse rates for the employer, the carrier doesn't lose a dime. The employer does. So when that same carrier needs lower rates on the ACA exchange, where they actually get to keep most of the margin, someone has to subsidize those discounts. I'll give you one guess who picks up the tab. This is called network arbitrage, and it's been silently transferring billions of dollars from employer health plans to exchange products for over a decade. Let's talk about something most people completely misunderstand about employer health insurance. When someone says Blue Cross covers my company, they usually mean Blue Cross administers the plan. The employer is the one actually paying the claims. This is called self-funding, and it covers roughly 65% of workers with employer-sponsored insurance. For large employers, over a thousand employees is closer to 80%. Now here's where the incentives get interesting. In a self-funded arrangement, the carrier makes money on administrative fees, maybe$30,$40 per month per member. On a$500-person plan, that's roughly$20,000 a month. That's their entire margin from the account. The actual medical costs, that's the employer's problem. But on the AC exchanges, those are fully insured products. The carrier collects premiums, pays the claims, and keeps the difference. Up to 20% under the medical loss ratio rules. On that same 500-person block, if the average premium is$600 a month, the carrier's margin is up to$60,000 a month, triple the self-funded fees. Which business would you like to grow? Carriers have very strong financial incentives to expand their exchange enrollment and a completely neutral incentive on whether self-funded clients pay$15,000 for the same knee replacement or$25,000 for the same knee replacement. If you're an employer, you should find this arrangement, well, concerning. Here's how the game actually works. When the ACA exchanges launched, carriers needed to build networks. Specifically, they needed to build narrow networks, HMOs, EPOs that could offer lower premiums to attract price-sensitive individual buyers. The problem, hospitals don't like giving discounts. They especially don't like giving discounts to new networks with uncertain volume. So the carrier came to the negotiating table with an offer. And I want you to follow this math because it explains everything. The carrier says, give us 75% of your commercial rates on our exchange HMO, and we'll give you 120% on the PPO. The hospital does the math, take a$25,000 knee replacement. On the PPO, they'd normally get$25,000. Under this deal, they'd get$30,000. On the exchange HMO, they'd get$18,750 instead of that$25,000 payment. If their PPO volume is four times their exchange volume, which it usually is, they come out way ahead, maybe significantly ahead. Then Carrier does the math. They're paying more on PPO claims, but those are self-funded. The employer pays the actual cost. They're paying less on the exchange claims where they get to keep the margin. Every dollar saved on the exchange claims goes to their bottom line. Every dollar extra on the PPO cost, well, it costs them nothing. Everyone wins, right? Well, except of course for the employer, who just got a$5,000 rate increase on knee replacements, a rate increase they never negotiated and will never see itemized. This is network arbitrage, using the bargaining power in one market to extract value in another. And it's been happening for over a decade. Now, some of you are thinking this sounds like a conspiracy theory, Dan. Where's the evidence? That's a fair question. Let me walk you through the mechanics and the data. When the exchanges first launched, they were, well, frankly, a mess. Remember 2014? Carriers lost money, several exited entirely. The conventional wisdom was that the exchange business, well, I'm going to use the word toxic. But something changed around 2017 and 2018. Carriers figured out how to make money. Enrollment grew, and critically, this is the important part, the carriers that stayed and thrived were the ones with the strongest commercial PPO networks. This isn't coincidence. It's a flywheel. If you're a carrier with a dominant PPO position in a market, you have tremendous leverage with the hospitals. You can walk into a negotiation and say, we need better rates on our exchange product, and we have a lot of PPO volume that might need to find a new network. The hospital, well, they capitulate. Their exchange rates improve, your premiums drop, more members sign up, your exchange business grows, which gives you even more leverage for the next negotiation. Meanwhile, carriers with weaker PPO positions can't extract the same concessions. Their exchange premiums stay high, members leave, eventually they exit the market entirely. By 2020, roughly a third of U.S. counties had only one or two carriers on the ACA exchange. This is why. It's not because the ACA failed, it's because the carriers with the strongest employer networks used them as leverage to dominate the individual market. And every time they did it, the employers paid more. Let's look at the numbers that make this visible. The USC Schaefer Center published a study comparing what ACA exchange plans paid for hospital procedures versus what commercial plans paid. Same hospitals, same insurers, same surgery. The finding? Exchange plans paid 89% of commercial rates on average. For joint replacements, the gap was even larger, like$20,842 on exchange plans versus$24,570 on a commercial plan. That's a$3,700 difference. Same hospital, same surgeon, same artificial hip, 20% more if your employer is paying. And this is consistent with what Rand found in their hospital price transparency study that private commercial insurers pay an average of 254% of Medicare rates, with some states exceeding 300%. Exchange plans consistently negotiated better rates at the same facilities. Now, defenders of this system will say, well, exchange plans have narrower networks, they're more efficient. Right, they're more efficient because the carrier negotiated better rates using leverage from the PPO network, where they had no incentive to negotiate better rates because the employers are paying the actual claims. It's not that HMOs are inherently cheaper, it's that carriers had every reason to make them cheaper and no reason to do the same for the employers. The data also shows something else revealing. 73% of exchange enrollees have incomes near the poverty level. That's not surprising for exchange plans. Hospitals know that, and if they don't take these patients at lower rates, they might get nothing at all. So they accept the discount. But that discount has to come from somewhere, and that somewhere is the employer PPO contract that gets renewed at 7% year over year or more, with the carrier shrugging and saying healthcare costs are rising. Healthcare costs are rising, but they're also being redistributed. So what do you actually do with this information? First, understand that your carrier has divided loyalties. They make more money on their exchange business than they do administering your self-funded plan. If there's a conflict between your interest and their exchange growth, guess which one wins? Second, start asking a question that will make your carrier very uncomfortable. What do exchange plans pay at the same hospitals in your network? If the answer is 10, 15, 20% less, and probably it will be, so don't be surprised, you're looking at the arbitrage in real time. That's not a market rate, that's a subsidy. Third, look at your rate negotiations for this lens. When your carrier presents their competitive hospital rates, as competitive compared to what? If you're paying 120% of what exchange plans pay at the same facilities, that's not a discount, that's a tax. Fourth, and this is the uncomfortable one. Consider whether your carrier choice is actually costing you money. The carriers with the strongest exchange market share might be the worst deal for your employees. They have the most leverage to extract concessions from hospitals and the least incentive to share those concessions with you. Some employers are starting to catch on. Direct contracting with hospitals are going around the carrier entirely. Reference-based pricing, which is paying a fixed multiple of Medicare rather than whatever the carrier negotiated. Coalition purchasing, banding together with other employers to negotiate as a block. These approaches bypass the carrier's conflicted incentives entirely. But most employers are still renewing their PPO contracts every year, watching their costs climb 6%, 8%, and believing that the carrier's explanation is it's just the market. It's not the market, it's actually the mechanism. Here's what I want you to take away from this. The story you've been told is that employer health insurance is the gold standard. It's comprehensive, it's expensive because it covers more. The reality is that employer health insurance has become a subsidy vehicle. You're paying premium rates not because you're getting premium access, but because your overpayment funds discounts that make exchange plans competitive. The ACA didn't just create a parallel insurance market, it created an arbitrage opportunity. And employers, particularly self-funded employers who don't control their own negotiations, are the ones that are being arbitraged. This isn't a bug in the system, it's actually the business model. The carriers aren't doing anything illegal. They're doing exactly what you'd expect a rational economic actor to do. Maximize margins where they get to keep the money, minimize effort where they don't. The question is whether employers are going to keep paying for a system that's designed to extract value from them. Because right now, the network arbitrage game has one consistent winner, and it's not the people writing the checks. If you found this useful, hit subscribe and the notification bell so you don't miss future episodes. I go deeper on topics like this over on my Substack, links in the description, where I'll share the full data sources and a framework you can use to evaluate your own carrier arrangement. I hope you found this useful, and until next time, I'll see you then.