Last time, we followed Sarah's hip replacement through Medicare: an $85,000 bill that produced $21,400 in actual revenue, set by a DRG formula. That was the government's price. Now we leave Medicare behind — because that's not the world most of your employees live in.
Picture two companies in the same city. Both send an employee for a total hip replacement. Same hospital. Same orthopedic surgeon. Same implant. Two patients could go in on the same morning, into the same operating room, and come out with identical outcomes.
Then the bills are priced. One employer's plan pays roughly $32,000. The other pays $78,000 — for care that was clinically identical. Neither patient was sicker. Neither surgery was harder. Nothing about the medicine explains the gap.
Same hospital · same surgeon · same implant · 2.4× difference
The only thing that changed was the contract sitting between the employer and the hospital. That contract — not the scalpel — is what sets the price. Here's how five of them work.
Model 01Percentage of Billed Charges
This is the one that quietly hurts employers the most. The plan agrees to pay a percentage of whatever the hospital bills — say, 60% of that $85,000 chargemaster number. The problem is that the hospital controls the chargemaster. When the starting number is arbitrary and the hospital sets it, a "discount" off that number is close to meaningless. Raise the charge, and the discounted price rises right along with it.
Employer pays a share of billed charges. The hospital sets the charges, so the leverage runs the wrong way. This is how a hip replacement lands at $78,000 while the hospital would have accepted a fraction of it from another payer.
Model 02Percentage of Medicare
Now flip the reference point. Instead of pricing off the hospital's invented number, the plan prices off Medicare's — the one number in healthcare that's transparent, formula-driven, and roughly the break-even point for most hospitals. A plan might agree to pay 150% or 200% of what Medicare would have paid for that DRG.
Because Medicare set Sarah's allowed amount at $21,400, a plan paying 150% of Medicare lands near $32,000 — for the exact same operation Employer B paid $78,000 for. The hospital still makes a healthy margin over its break-even. The employer just stops pricing off a number the hospital gets to make up.
Employer pays a multiple of the Medicare rate. The reference point is transparent and defensible. The employer's cost is anchored to a real benchmark instead of the hospital's asking price.
Models 03–05: Case Rates, Per Diems, and Bundles
Between those two extremes sit three more structures, each of which shifts risk differently:
A single negotiated price for the whole hip replacement. Predictable for the employer; the hospital absorbs the risk if the case runs long or complex.
A fixed amount for each day of the stay. Now the length of stay drives the bill — an incentive that doesn't always point toward efficient care.
One price covering surgery, the stay, and recovery through a defined window. The provider owns the total cost of the episode, aligning incentives around getting it right the first time.
Five structures. One surgery. Five different prices — before anyone touches a scalpel.
This Isn't a Rounding Error
If this sounds like an edge case, the national data says otherwise. Researchers at RAND re-priced billions of dollars in commercial hospital claims against what Medicare would have paid for the identical services at the identical facilities.
And here's the finding that should end the debate about whether this is about the medicine: RAND concluded that most of the variation in what hospitals charge is explained by hospital market power — not by how sick the patients are, and not by each hospital's mix of Medicare and Medicaid patients. In other words, the price gap tracks negotiating leverage, not clinical need.
The surgery didn't change. The contract did.
So Why Does One Employer Catch This and the Other Doesn't?
Here's the part that matters for you, and the reason this series exists. Whether an employer ends up at $32,000 or $78,000 usually comes down to a single structural fact: can the employer see the contract, and can it act on what it sees?
A fully insured employer typically can't. The carrier owns the network contract, sets the terms, and hands the employer a premium. The employer never sees the allowed amounts, never sees the pricing basis, and has no lever to move it. From inside that arrangement, the $78,000 and the $32,000 look identical — both just disappear into "the premium."
An employer that controls its own plan sees all of it. The claims, the pricing basis, the contract structure — all visible, all negotiable. That visibility is the entire difference between paying the hospital's asking price and paying a price anchored to something real.
The Takeaway
The price of Sarah's hip replacement was never really set in the operating room. It was set in a contract most employers never read — and many aren't allowed to. The question isn't "why does the same surgery cost different amounts?" You now know why. The better question is: which side of that contract is your company on?
Coming next: the contract you're not allowed to read — how fully insured pricing actually works, where the money goes, and what changes the moment an employer takes control of its own health plan.
— Tess
