California is in the middle of an historic drought, with the government setting limits on how long people can sing in the shower. Farmers in the state may soon need to cut back on planting or production, as ground water dries up. But California is still fruitful ground for testing promising ways to improve how health care consumers, otherwise known as patients, shop for health care services. Specifically, California has shown that health care markets can be whipped into shape through the power of reference pricing.

In reference pricing, patients are given a maximum number of dollars from insurance to cover a given health care procedure with the understanding that if they choose to receive care from a more expensive provider, they will be responsible for any charges exceeding that limit. As I wrote in a previous post, California already used reference pricing to address high costs for knee and hip replacement. While many health care providers were charging $25,000 or $30,000 for the procedure, some were charging $60,000, $70,000, even $100,000.

The state of California realized it couldn’t continue to pay these exorbitant prices. It could have decided to force people to receive care from affordable providers. It could have regulated the price of these procedures. But instead the state took a different approach. It set a $30,000 limit on what it would reimburse patients. Overnight, state employees became discerning shoppers, avoiding high cost providers. Almost as quickly, providers began lowering their prices.

The wonders of efficient marketplaces.

Encouraged by the success of this program, California expanded the use of reference pricing to include surgical procedures performed in ambulatory centers. Take cataract surgery for example. This procedure can be performed in a hospital or in an ambulatory surgical center. Both types of locations will have operating rooms. Both with employee anesthesiologists and surgeons. They will typically use the same equipment and sometimes the same doctors. But usually the hospitals will charge significantly more for the procedure.

California decided to set a reference price of $2,000 for cataract removal. It did so because the price was well within normal charges for almost every ambulatory surgical center in the state. Nevertheless, only three hospitals in California — count ‘em: three — came in under that price at the time the policy went into effect:

And if you glance at the figure above, it’s not that hospitals charge just a little bit more than $2,000 for the procedure. In fact, the tenth cheapest hospital charged over $4,000 for cataract removal. The 20th cheapest — $6000! That is triple the price of literally dozens of ambulatory surgical centers.

With the $2,000 reference price in place, California state employees (CalPERS, in the picture below) became significantly more likely to receive care in ambulatory centers compared to people insured by Anthem, who didn’t face this reference price:

As a result of this shift, the state experienced an almost 40 percent decline in cataract payments.

Reference pricing is not a cure-all for our nation’s high health care costs. For starters, people with acute medical problems, like broken bones and heart attacks, aren’t in a position to comparison shop for health care services. In addition, reference pricing is only effective if patients can get ready access to health care prices.

But we should embrace innovations like reference pricing for health care services like cataract surgery and hip replacement, procedures that vary dramatically in price and which consumers have time to shop for.

With reference pricing, health care providers are free to charge whatever they want to for the health care services they provide. And consumers are free to turn elsewhere when these prices are unreasonable.

Peter Ubel is a physician and behavioral scientist who blogs at his self-titled site, Peter Ubel and can be reached on Twitter @PeterUbel. He is the author of Critical Decisions: How You and Your Doctor Can Make the Right Medical Choices Together. This article originally appeared in Forbes.

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