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By Tom Hirsch
03/17/08
Competition has intensified between the nation's two biggest lab operators
as each has penned exclusive deals involving discounted prices with major managed
care companies. In turn, this has put into motion a price-cutting strategy
employed by a variety of payers that are using these national agreements as
leverage with regional and local labs in demanding even deeper discounts in
some instances. Even as payers are lowering rates with contracted labs, they
are stepping up efforts to eliminate leakage to more expensive out-of-network
labs. This article will examine the impact the contracting environment is having
on lab pricing and provide strategies that laboratories can use in future negotiations.
A Historical Perspective
"We had a period roughly 10 years ago when we went through some pretty tough
times and we started seeing capitated rates being given to managed care to
buy market share and some labs were able to gain ‘pull-through' business to
justify some of the lost leader pricing. However, the results were clearly
mixed," says P. Thomas Hirsch, President, Laboratory Billing Solutions. "For
the first time, this trend forced doctors to use multiple laboratories because
of exclusive agreements. Prior to capitated arrangements, doctors were able
to pick the laboratory they wanted to use based on service."
According to Hirsch, during this time margins ultimately suffered, as did
lab valuations, because the industry was viewed as a commodity because of the
pricing given to managed care. "The industry was also viewed as having excess
capacity and poor leadership. The multiples for which labs traded were five
times cash flow rather than the usual 10 or 12 for other industries. As a result,
the industry was not viewed favorably from an investment perspective. In addition,
we had difficult times with closer government scrutiny and compliance programs,
and some labs incurred large fines and penalties," he explains.
After the 1990s, we experienced gradual improvements in margins and pricing,
partly due to more disciplined management at the big laboratories. The labs
did a good job of evaluating their business and making some changes. However,
there were also other mitigating factors occurring in our environment. There
was the introduction of more esoteric testing that paid well and higher test
utilization due to the elimination of Medicare profiles. This had a profound
impact on reimbursement because doctors could start ordering individual tests.
Medicare would bundle all the individual CPT codes, however, not all the other
payers did initially, and the labs experienced an upward trend in reimbursement.
There was also more aggressive cost shifting to self-pay patients. Labs raised
their charges well in excess of inflation, which hit the self-pay patient harder.
Another factor was a greater focus on the anatomic pathology side of the business.
There were also favorable demographics of an aging population. Labs basked
in a period of relative prosperity because of all these factors and industry
multiples increased dramatically. Labs became a favorite of Wall Street and
have continued to prosper as the impact of the recent price concessions has
not fully sunk in," he says.
What is different now than 10 years ago? "There has been no breakthrough in
operating costs that is being passed on to managed care and the patient--particularly
the patient. When you look at the industry today, our cost of producing the
work has not changed dramatically despite many breakthroughs in technology.
Unit costs, unadjusted for mix, have increased close to the general rate of
inflation--even for the larger laboratories that have acquired large books of
business and nearly doubled in size. The idea that we can buy market share
and price on the margins, which is beneficial to us as an industry, has not
been borne out by what we have seen historically. Labs that grow dramatically
are not able to reduce their costs significantly through increased volume.
There were step function increases and other increases that forced our costs
to keep increasing. The prospect of doing routine work for a lot less money
and making it up on the esoteric testing also flies in the face of the business
economics. While close to 20 to 30 percent of a lab's revenues can be considered
esoteric, it only represents 3 to 5 percent of the test volume. In addition,
much of our test volume is viewed as a commodity and is priced accordingly
and, as result, we are looking potentially at overall lab reimbursement declining
10 percent or more because of contract pricing, which is significant," Hirsch
notes.
The following chart uses LabCorp as an example or cost versus revenue per
accession from 2000 through 2007.
"LabCorp had a fairly healthy increase on the revenue side over the years.
While volume is not listed, their business increased substantially overall
in terms of units of tests performed. The cost numbers went from $25 in 2000
to almost $30 a requisition in 2007. Even though the business almost doubled,
the unit costs have continued to increase. This brings home the point that
pricing work on so-called marginal costs is dangerous because increased volume
will not guarantee lower unit costs over the long term. In fact costs have
continued to rise at the labs that have exhibited the most significant growth,"
Hirsch notes.
"One of my concerns is that it could get worse before it gets better. One
factor is competitive bidding with Medicare--although I doubt it could work.
In addition, other payers might demand the same reimbursement concessions that
United Healthcare has achieved. Despite advances in IT and the advent of new
diagnostic methodologies, the business economics for labs remain mostly unchanged.
For example, 15 years ago, our IT legacy systems cost a lot of money and while
they are less expensive today, we are spending more money on integrating electronic
medical records or for physician office systems," Hirsch says.
"While the testing platforms have become more efficient, our technology costs
have increased and we have a smaller labor pool to draw from as our current
employees are getting older. We also have higher logistic expenses. In fact,
there have not been breakthroughs in how we process work that reduces the cost
per test. While we have achieved some benefits, others things have increased
in cost. Phlebotomy is a good example. We are lucky to get $3 from Medicare
in reimbursement and nothing from anybody else. Clearly, phlebotomy costs increased
and we have not figured out a way to train someone to draw 40 patients an hour.
The cost structure is a challenge for the lab industry," he points out.
"The intermediate term prospects do not look promising as long as our customer's
perception of our services as a commodity is reinforced by our own pricing
initiatives. Favorable demographics and other trends that we had 10 years ago
are not going to help us this time," Hirsch concludes.
Implications and Strategies for Outreach
The outreach-testing environment is here to stay for a number of reasons,
however, its health needs to be closely monitored," says David Nichols, President,
The Nichols Management Group, Ltd. "not only is it here to stay, but outreach
has been growing and will continue to do so. Wall Street analysts as well as
hospital administrators are always asking why there is growth in hospital laboratory
outreach testing. There are five primary reasons. The first that comes to mind
is that incredible consolidation in the industry has created a void for local
laboratories. There are no longer regional laboratories that service local
markets. One of the biggest reasons is that hospitals are increasingly seeking
ways to bond with their physician staff. Hospitals recognize the risks that
result if they alienate physicians who can create ancillary service companies
that will skim off the cream of their profits. As a result, hospital administrators
nationwide are looking for ways to bond and get closer with their physicians,
either through electronic programs, laboratory testing, or other ancillary
services."
According to Nichols, many pathologists are also supportive of hospital outreach,
either directly or through a joint venture, because they can ride the coattails
of its success. "If a hospital outreach program is very successful, there are
usually going to be more anatomic specimens related to that. With greater anatomic
specimens, pathologists can hire sub specialists who create more value for
the practice. There is a lot of commercialization and commoditization of pathology
services nationwide and pathologists who are under threat want that volume
secured in the local market," he explains.
"In addition, a minority of administrators view laboratory outreach as a way
to create a vehicle to monetize their lab assets. Finally there is a myriad
group of consultants and industry veterans that are out there showing the way,"
Nichols adds.
"In addition to these drivers for outreach, it has significant, inherent advantages.
First, and most important, is the magic of having a hospital provider number
versus an independent clinical laboratory provider number. This advantage is
huge and a hospital provider number for a laboratory can typically secure advantages
between 30 and 100 percent of independent clinical laboratory reimbursement
in the market. There is little capitalization required for hospitals to get
into the outreach market--they have fixed costs, they need the lab, and they
need the people in the lab," he says.
"Finally, there's a local advantage of politics--through contract linkage,
draw site locations, real estate, and the much trumpeted not for-profit card.
However, despite these advantages, the needs of these outreach programs need
to be closely monitored because they're frequently working with a staid workforce,
relatively mediocre management, and bureaucratic bungling of these hospitals.
Frequently, they can lead to a better financial performance. However, hospitals
may have better options relative to investment so their money and time. They
can get a better return from certain areas of healthcare as opposed to the
laboratory," Nichols says.
"I would also like to speak about the competitive environment that exists.
Save for a few metropolitan areas in the country, competition among outreach
is rarely from other health systems but rather from national laboratories.
Being the first to market in outreach in a metro area has very significant
advantages. Typically, once an outreach lab is established at beachhead in
a metro area, few other hospitals want to get into that business," he notes.
The competition with national labs is not that ferocious," Nichols comments.
"Outside of the industry, people don't really understand it, but hospital outreach
lab programs are closely linked to the national laboratories either through
contracting schemes or the reference laboratory relationship. I predict that
this will evolve into even closer relationships with the national laboratories
as a result of a push-pull dynamic. In other words, payers are going to push
this relationship closer. It is no secret that managed care companies see this
vast expanse between hospital outreach and independent lab reimbursement and
that it will not be there much longer, which will push the players together.
Moreover, the national laboratories will pull the payers together. Collectively,
national labs have $8 billion in sales and they would need to achieve a rough
benchmark of 10 percent growth to prosper--that's $800 million in new sales
in 2008. Half of the entire $20 billion resides in the hospital market. Their
growth will come form working with hospitals," he emphasizes.
"You would anticipate that hospitals may patronize other niche players instead
of the national labs that compete with them directly in the local physician
market. However, largely this not happened despite their technical resources.
These niche laboratories have largely lacked scale, business acumen, and a
sense of urgency to serve their hospital clients," Nichols comments.
On another note, he says that contracting threats abound. "We know that exclusives
don't last. However, the pricing damage does--i.e., revenue per specimen is
falling and falling very fast. Outreach laboratories that are either for profit
or new have experienced a change in control and need to seek a new Tax ID number,
which results in a new provider number for managed care and insurance companies.
With a new provider number, labs have experienced a 20 to 40 percent reimbursement
decline obtaining contracts," Nichols says.
"Having just created a new laboratory that went live September 1, 2007, I
was tasked with soliciting 20 new contracts. The good news is that I was able
to secure 20 new contracts. The bad news is that they were very significant
reductions from the proforma that my company had put together a year before
it was established. That is not a pleasant thing to swallow when you are in
front of a board of directors. To provide a sense of the magnitude of the decrease,
the proforma was approximately 128 percent of reimbursement from a major government
payer and it ended up being barely more than 100 percent," he illustrates.
Which leads to the issue of the pricing forecast. "I think we are in a free
fall that all labs will soon experience. Until the promise of personalized
medicine arrives, which is likely about five years off, we are going to see
average revenue per specimen decline. Every payer across the country wants
to see ULP--United-Like Pricing," Nichols emphasizes.
According to Nichols, the good news is that labs can survive this new phase
in the industry cycle--just as they have before. "Outreach labs are well positioned
to survive because they have anchor clients--hospitals and institutions that
are not going away and they need the equipment and the people. Likewise, national
labs are not going away simply through their sheer mass of scale and new acquisitions.
A third reason is that labs have a new entrance into the industry from are
private equity backed startups. Those start-ups that will be at risk are the
ones that are based on unrealistic business plans and expectations," he says.
"To survive and prosper under these new market conditions, the first thing
you want to do is be a leader in your primary market using a three-legged stool
model--base business retention, acquisitions, and new sales. The basics of keeping
a base business has extended beyond simply picking up the phone and following
through on what you will do with a specimen. It has expanded into IT, providing
interpretive reporting and data. Secondly, you need acquisitions, joint ventures,
and partnerships because new sales will only get you so far. Finally, you need
to have a strategic advantage, which is sales and marketing," he explains.
"You need dominate the local market to the extent you can. Moreover, if you
can't be the lead dog, choose your partners very carefully because you are
going to be hooked to the same sled. Keep in mind that some lab networks and
joint ventures have prospered and others have not. You may find that one of
the labs that you had viewed as a competitor can become a partner and help
you to survive this harsh environment, which is forecast to become significantly
colder," Nichols concludes.
What Happened to Lab Reimbursement?
"By 2010, CMS predicts that healthcare costs in America are going to rise
to $2.75 trillion and the expense to employer groups is going to be nearly
a trillion dollars. The good news for lab is we should be somewhere around
$110 billion in revenue. Unfortunately, however those other two numbers are
going to overshadow ours and pricing pressures are not going to be relieved
soon," says Michael Snyder, President, Laboratory Management Services, LLC
and Principal, Clinical Lab Billing Solutions.
"With that good news, let's discuss that has happened to lab reimbursement
recently. One of the big issues, which we do not have a perspective of in our
industry, is that health plan revenue is flat and they follow a simple formula
similar to ours--revenue minus expense equals profit. The revenue has become
flat because employer groups will not tolerate double-digit increases any more.
As a result, health plans are trying to figure out how to cut costs. They did
so by coming up with a new benchmark for negotiations, which is the LabCorp/United
Healthcare contract. While the names will change at some point in the future,
this is the new and current benchmark," he says.
"Health plans are also further evolving to contain costs, other than to continually
cut prices and compress the commercial side of the business. They are pushing
out in other directions, such as increasing patient responsibility, drastically
cutting out-of-network payments to labs, and steering business to the low cost
provider--even within networks. The following charts demonstrate utilization
versus the distribution of costs. Most notably, there is a huge discrepancy
at hospital labs with respect to the distribution of units versus revenue.
While I am a fan of hospital outreach, this is a big issue for health plans.
They have been compressing the commercial side and are working on ways to reign
in this cost with the hospitals," Snyder explains.
"While I'm not trying to scare labs, you need to be aware of these tactics
so you can change your perspective and adjust your business model appropriately.
Increasing co-pays and co-insurance for patients that utilize hospitals is
one of the tactics. Another is increasing denials to hospital labs. Health
plans are looking at their data and realizing that hospitals are using a billing
system meant for the inpatient side and writing off anything that is under
$50. I would encourage you to fix your billing systems. They are also threatening
to exclude hospitals that have moved to an independent Tax ID number. The moment
you move to an independent Tax ID number, you become a commercial lab and go
from an averages of 120 percent to 42 percent of reimbursement under the CMS
fee schedule. You need to think carefully about your business strategy. Health
plans are also warning their HRA and HSA members about excessive charges from
hospitals and labs. Finally, there are using steering tactics to move to the
low cost provider," he says.
"As far as what's on the agenda, we have discussed tightening the variation
in pricing between in-network testing groups, fewer contracted labs, and a
move to bring outreach testing to a more commercial-like setting with respect
to pricing. Our greatest advantage is in our information, however, we have
no standard for sharing it. The government is working on this and health plans
are starting to recognize this. We need to set standards in regards to how
we can exchange and share data. Finally, we are going to need for labs to assist
in patient education. Educating physicians is a long, hard road and the best
way to accomplish this is to influence the patients," Snyder explains.
"As far as strategic alternatives, there are things that we can do to modify
our business model. The first is to become a full service laboratory. If you
are a clinical lab only doing core testing, you are leaving money on the table.
The April edition of Laboratory Economics discussed that core testing
is about 40 percent of CMS in this particular fee schedule. However, an 88305
CPT code was at 86 percent of the CMS fee schedule. Again, if you are only
doing core testing, your survivability is going to be tough. You need to really
think about your business model and become a full service laboratory," he says.
"Another negotiation tactic is to accept higher co-pays and deductibles. Pricing
is going to go lower on the fee schedule and no one want to go out and collect
co-pays and co-insurance. However, it is something that we are going to have
to do and it means that we will need to modify our billing systems and our
relationships with patients," Snyder adds.
"We also need to capture quality clinical data. I am working on a network
solution for managed care and laboratories and am astounded at the number of
laboratories who push back at sharing data. They are not pushing back because
they believe the data is valuable, but because it is too difficult to move.
We need to figure out how to move that data so that we can provide real value.
Enhanced reporting capabilities can also improve the quality of data for physicians
and patients. We have to create a face to the public through the reporting
and educating patients on the value of testing," he relates.
"To compete, you also need to provide what physicians want--Electronic Medical
Records. Finally, you need to join networks for contract negotiations. It is
very difficult for plans to negotiate, especially with hundreds of outreach
programs within the same market of hospitals. You can do a better job by creating
a single point of contact through networks.
"If we are really working on a total healthcare solution and we want to demonstrate
the value of our industry, we have to come up with new solutions so we can
get into collaborative relationships with health plans and other members of
the healthcare society at large--we are a very valuable resource for healthcare.
This does not necessarily mean that we have to collaborate and do this under
the flag of one of the national laboratories. It is something that we can do
as an industry and I encourage labs to rethink their business models and to
think in a perspective of the larger health care solution," Snyder concludes.
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