Tiered-Provider Networks: Patients Face Cost-Choice Trade-Offs

As tightly managed care fell out of favor in the early 2000s and health care providers regained bargaining power, health plans and employers began looking for new ways to contain costs without restricting patients' choice of doctors and hospitals outright. One approach that attracted growing interest was the tiered-provider network -- a health insurance design that sorted hospitals and physician groups into different tiers based on cost or efficiency, then used financial incentives to steer patients toward lower-cost providers. Research from the Center for Studying Health System Change (HSC), drawn from 2002-03 site visits to 12 nationally representative communities, found that while the concept was gaining traction, real-world implementation was running into serious obstacles.

How Tiered Networks Were Supposed to Work

The idea behind tiered-provider networks was conceptually similar to the tiered-pharmacy benefits that had already become standard in most health plans. Just as drug plans charged patients less for generic medications and more for brand-name alternatives, tiered-provider networks would charge patients lower copayments or coinsurance for care at hospitals and physician groups identified as more cost-efficient, and higher amounts for care at pricier facilities.

The expected benefits were twofold. Patients would be channeled toward lower-cost providers, reducing overall plan spending. And hospitals and medical groups would face competitive pressure to improve their efficiency or accept discounted payment rates in exchange for placement in the preferred tier, where they would attract more patients. Unlike the restrictive managed care models that consumers had rejected, tiered networks preserved the patient's ability to choose any provider in the network -- they just made some choices more expensive than others.

Early Experiments Across Markets

By 2003, nine health plans in six of the 12 HSC communities had launched or were testing tiered-network products. The movement started around 2000-01, largely as a response to the growing negotiating leverage of prominent hospitals and large medical groups. In Seattle, where contract disputes between providers and health plans had created substantial network instability, Premera Blue Cross developed a three-tier design that sorted hospitals and medical groups based on the payment rates they required and the resulting average cost per episode of care. High-cost providers could seek reassignment to preferred tiers by agreeing to accept lower rates.

In Boston, tiered networks emerged as a way to differentiate more expensive teaching hospitals from community hospitals. During the 1990s, the proportion of patients admitted to teaching hospitals had risen steadily, and plans like Tufts Health Plan and Blue Cross and Blue Shield of Massachusetts launched two-tier products in 2001 with higher copayments for teaching hospital admissions -- $600 versus $350 for community hospitals. In Orange County, California, Blue Shield of California introduced a two-tier hospital network in early 2002 that used lower copayments to encourage patients to choose less expensive facilities. Health plans in Miami, Syracuse, and northern New Jersey followed with their own versions.

Wide Variation in Design

Plans varied considerably in how they built their tiers and in how they structured the financial incentives. Some plans based their tiers on straightforward measures like negotiated hospital payment rates, favoring methodological simplicity. Others, including Blue Cross and Blue Shield of Florida and Premera Blue Cross, used hospital and physician claims data to estimate the average cost of an entire episode of care, adjusting for patient severity. This approach was more complex but potentially more fair, since it could place a provider with higher per-unit prices into the preferred tier if that provider was effective at limiting unnecessary services and avoiding complications.

The mechanisms for steering patients also differed. Most plans relied on higher copayments or coinsurance at the point of service for care from non-preferred providers. Premera Blue Cross took a more flexible approach, allowing employers and consumers to select a network tier at enrollment and then adjust at the point of service, with premiums varying based on the tier selected as the base network. In Orange County, Blue Shield of California charged HMO members an additional $100 copayment and PPO members an additional 10 percent coinsurance for non-preferred hospital care.

Pushback from Hospitals and Physicians

Provider resistance proved to be one of the biggest barriers to tiered-network implementation. Hospital opposition surfaced even in markets where no tiered products existed, with some systems preemptively negotiating contract language that prohibited plans from sorting their facilities into tiers. In Indianapolis, Cleveland, Greenville, and Little Rock, health plans that took initial steps toward developing tiered networks in 2002-03 abandoned the effort after large hospital systems refused to participate and threatened to leave the network entirely.

In markets where tiered networks were launched, large hospital systems frequently used their clout and political connections to secure placement in preferred tiers despite having higher costs -- undercutting the core logic of the design. In smaller markets like Lansing, Michigan, plans questioned whether tiered networks were even viable when the community had only two hospital systems and both needed to be included in any marketable product.

Technical difficulties compounded the political challenges. Plans found that data limitations often made it hard to detect meaningful cost differences among providers within a single market. In some cases, the only providers with significantly higher costs were the ones offering unique and essential specialty services -- trauma care, transplant surgery, burn units -- that could not reasonably be placed in a non-preferred tier. Claims data used to build episode-of-care cost measures were often several years old, drawing criticism from providers that the tiers failed to reflect current practice patterns. Creating stable cost measures for individual physicians was especially difficult given the small number of patients any one doctor might treat within a particular plan.

The Choice-Cost Balancing Act

Finding the right balance between provider choice and cost savings turned out to be the central operational dilemma. If plans watered down their tiering criteria to keep the most popular (but expensive) hospitals in the preferred tier, the product would generate little cost savings. But if the community's best-known hospitals ended up in the non-preferred tier or refused to participate, employers and consumers would have limited interest in the product.

In practice, most tiered products excluded very few providers from their preferred tiers. Premera Blue Cross's three-tier product left only two of Seattle's hospitals outside the preferred tier. In Miami, Blue Cross and Blue Shield of Florida's three-tier design included all but two hospitals in the top tier. Blue Shield of California included every Orange County hospital in its preferred tier. These outcomes raised doubts about whether tiered networks could produce significant savings by steering patients to cheaper providers.

Several plans acknowledged that their tiered products offered only modest premium savings compared with single-network products. But some noted a less visible benefit: the tiering process itself gave plans additional negotiating leverage, since some high-cost hospitals agreed to lower their payment rates in exchange for preferred-tier placement. In this sense, tiered networks were functioning less as consumer steering mechanisms and more as bargaining tools in plan-provider negotiations.

The Quality Question

Concerns about quality of care added another layer of complexity. Observers worried that tiers based solely on cost could steer patients away from higher-quality providers that happened to be more expensive, making good care accessible only to those who could afford higher out-of-pocket payments. Tiered designs could also penalize hospitals that invested in quality improvement, medical education, or charity care if those activities pushed their costs into higher tiers.

Some plans began exploring ways to factor quality into their tiering formulas. Blue Shield of California revised its methodology to allow higher-cost hospitals into the preferred tier if they participated in quality initiatives involving public reporting of patient satisfaction data. Premera Blue Cross launched a pilot that generated comparative quality reports for a subset of medical groups in its tiered network, with the eventual goal of incorporating quality measures into tier assignments. But the absence of readily available, reliable quality data for hospitals and physicians remained a fundamental barrier.

Slow Uptake and Uncertain Future

Employer adoption of tiered-network products was slow in most markets, reflecting uncertainty about cost savings and reluctance to limit consumer choice. Enrollment appeared highest in Orange County and Seattle, where the products had been under development for several years. Blue Shield of California had made its tiered hospital network mandatory for all small employer groups and individual subscribers to boost participation. Premera Blue Cross moved roughly 35 percent of its 1.2 million statewide members onto its tiered platform, though employers could choose to use a single tier rather than offering a tier choice. Other plans considered their tiered products experimental, with only a handful of employer groups enrolled.

The long-term prospects for tiered networks remained uncertain. If the broader movement toward consumer-driven health plans continued to develop, tiered designs could become useful tools for helping consumers compare providers on cost and, eventually, quality. They could also stimulate price-based competition among providers -- but only if enough employers and consumers adopted the products to create meaningful market pressure. Rapidly rising premiums might push more employers toward tiered networks as a less objectionable alternative to strict managed care restrictions, but provider resistance and the technical difficulties of measuring cost and quality accurately would continue to limit their effectiveness.

Sources and Further Reading

Kaiser Family Foundation — Employer Health Benefits Survey — Annual data on employer-sponsored health insurance trends.

CMS — Health Insurance Marketplace — Federal marketplace information and enrollment resources.

Health Affairs — Peer-reviewed health policy research and analysis.

Robert Wood Johnson Foundation — Health policy research and programs.

Commonwealth Fund — Research on health care system performance and coverage.