Pricing slugfest—can labs outlast blows?

September 2007
Feature Story

Karen Lusky

Not so long ago in the lab industry, talk of managed care trends and contracting tended to draw polite nods, perhaps even a few stifled yawns. Then came a couple of wake-up calls.

First, UnitedHealthcare chose Laboratory Corporation of America Holdings to be the sole national laboratory in the payer’s network of regional and local labs, effective last Jan. 1. Aetna followed suit, renewing its contract with Quest and giving LabCorp the boot, as of July 1.

Now the debate is on about how the shakeup is playing out and how various types of labs can and are positioning themselves to succeed in a payment arena where the gloves have come off and payers’ views and expectations of labs continue to unfold.

The chief concern among noncommercial labs vying for managed care business is pricing in the wake of the deals between the major payers and national labs.

And on one point, everyone agrees: UnitedHealthcare got the pricing ball started in a downhill direction.

Quest reportedly walked away from the United contract negotiations because of the proposed below-market rates, giving LabCorp the chance to enter new markets with its exclusive United agreement, says Joe Skrisson, CEO of Piedmont Medical Laboratory, Winchester, Va. PML is a joint venture for-profit independent laboratory owned by eight hospitals and two pathology groups and that has contracts with United and Cigna.

“Feeling the pain of losing some significant market share and dollars, Quest countered by getting an exclusive with Aetna,” Skrisson says.

And though “Cigna recently broke ranks and renewed with both LabCorp and Quest,” Skrisson adds, “the rest of us surmise that they probably renewed at a significant discount in reimbursement from their previous agreement.”

To consultant Tom Hirsch, the recent managed care contracting is like the days when labs decided to price aggressively on capitated rates to get other profitable business. “Yet there’s really not as much other profitable business to compensate for the lower fees charged to managed care,” says Hirsch, president of Laboratory Billing Solutions, Portsmouth, NH.

Jack Shaw, executive director of Joint Venture Hospital Laboratories, Allen Park, Mich., says United’s pricing with LabCorp has hospital outreach providers worried that the United deal lowers the reimbursement bar for them. How low is that? Shaw says reputable sources have told him that the fee schedule United offered LabCorp was less than 50 percent of Medicare for its noncapitated business.

LabCorp hasn’t revealed the UnitedHealthcare rates. But lab and managed care industry veteran Michael Snyder says he was involved in negotiations with United on behalf of other laboratories until about 30 days before the contract went to LabCorp.

“At that time, United was pushing for pricing 50 percent below the Medicare fee schedule,” says Snyder, a principal with Clinical Lab Business Solutions LLC, Flemington, NJ. (To put that 50 percent figure in context, Snyder says that when he worked at United until mid-2005, its fee schedule for LabCorp was about 65 to 66 percent of Medicare, and for Quest, about 70 to 72 percent.)

Snyder also points out that LabCorp has said it has a tiered rate from United so that even though “the rates for the CBCs, urinalyses, and chemistries are cheap, cheap, cheap…the molecular testing and pathology are at a higher price point.”

LabCorp also reportedly accepted significant monetary risk in the contract for so-called leakage, whereby physicians send lab testing to labs outside the United lab network, which costs the payer more money and shatters its actuarial assumptions.

Dark Report executive editor Robert Michel doesn’t foresee the UnitedHealthcare contract creating a structural change in how regional and national health insurers contract for laboratory testing services, but he says it has potentially upended a longstanding apple cart.

For a decade, Michel says, “LabCorp and Quest Diagnostics have maintained a relatively consistent status quo with managed care contracts” that have had similar pricing, terms, service levels, and carve outs. “And during that status quo period between the two national lab companies, regional labs learned how to position themselves in a way that has been financially sustainable.” LabCorp’s success in “evicting” Quest Diagnostics as a contract provider for UnitedHealthcare has upset that status quo, Michel says.

“It could lead to managed care plans getting accustomed to demanding the same low price from regional labs.” And “a company like Quest Diagnostics or LabCorp has an ability to subsidize loss-leader pricing and other terms in ways that smaller labs cannot,” Michel notes.

Skrisson of Piedmont agrees. “Regional laboratories…always have to worry about what the national labs are doing. PML just recently renewed with United for another year and at a significant cut in reimbursement. We all have serious concerns with the direction reimbursement is going in our lab industry….”

LabCorp CEO David King told CAP TODAY he agrees that pricing has become more competitive in the aftermath of the United contract. But given that most of the big managed care plans have completed their contracting, King predicts prices will now stabilize.

Snyder agrees, noting that most of the large health plans have multiyear contracts. (LabCorp has a 10-year contract with United.) But Quest, which needs to recover its volume, may accept a few regional health plan contracts at a low rate, Snyder predicts.

Of course, pricing isn’t determined solely by how low labs are willing to go. It’s also driven by payers’ perception of the value of laboratory services. And in addressing this, LabCorp’s King created a bit of a stir at the Dark Report’s Executive War College last spring when he said the majority of clinical lab tests are commodities akin to electricity—indispensable, yes, but plentiful and indistinguishable. (In an interview with CAP TODAY, King stressed that laboratory services are not a commodity; rather, it’s many of the tests that labs provide that are commodities. By commodity lab tests, King means the 75 percent of a lab’s core tests, not the 25 percent that are anatomic pathology or specialized and esoteric tests.) And in working with managed care plans, trying to differentiate one lab’s commodity test, such as a CBC or glucose, from another lab’s commodity test is not realistic, King told War College attendees.

Marc Grodman, MD, president and CEO of Bio-Reference Laboratories, Elmwood Park, NJ, strongly disagrees that lab services are a commodity. “The lab industry has abdicated much of the credit for the value we created with the evolution of our services,” he says.

Still, a number of lab providers agree that payers do perceive lab services as such. Bud Thompson, president of Carilion Labs, Roanoke, Va., which provides outreach and esoteric lab services in Virginia, Tennessee, and the Carolinas, reports that United “more or less sat across from us and said 30 percent of Medicare is too much…it’s a commodity…anyone can do it.” (Carilion did end up getting a higher rate than that, he says.)

King says the challenge is to show managed care plans the value of laboratory testing—“not to say LabCorp’s CBC is better than some other lab’s CBC.”

“Even though there are tests that are a commodity product,” he says, “lab services drive as much as 80 percent of health care decisions.”

What do insurers value from labs? Dave Lamb, manager of ancillary services for Independence Blue Cross, Philadelphia, who spoke with King on a panel on managed care at the Executive War College, notes that at the most basic level, insurers exist to serve their members and physicians.

“And the No. 1 job for labs is ensuring our members and physicians have a positive interaction with the lab,” he tells CAP TODAY. “That positive experience will go a long way to endearing the lab to members and managed care plans.”

By positive experience, Lamb says he’s talking about “convenient draw stations, quick turnaround time, efficient data and claims and IT solutions,” and the physician being able to get the pathologist on the phone quickly to discuss a case or answer a question.

A lab’s ability to provide data is also becoming more important for payers that are beginning to use the data for pay-for-performance for physicians and disease management. Lamb says Independence Blue Cross uses lab data as part of the “disease management decisionmaking tree”—for example, making sure all patients with diabetes get A1c testing and females get their Pap tests.

“Personalized medicine is a big topic in the industry and we are looking at that area in terms of integrating lab data in decisionmaking trees,” Lamb says. “The more labs can integrate that data, the better the data we can provide to our partners as they work to improve patient health.”

Managed care expert Kerry Kaplan sees a “huge opportunity for labs” if protocols evolve that require physicians to follow an algorithm of lab testing to identify patients who truly need the “exorbitantly expensive” imaging or esoteric lab tests. “That will absolutely get the attention of payers…,” says Kaplan, who is president of Healthcare Connections, Natick, Mass. His advice: “Get close to your customers [managed care payers] and figure out what’s important to them and provide it so they don’t want to leave you.”

Some say hospital outreach labs can position themselves uniquely to meet payers’ needs, holding on to or even capturing business in the wake of the exclusive deals.

Michel says UnitedHealthcare, which has signed contracts with regional labs and hospital outreach programs since the LabCorp deal, understands that if it’s going to exclude Quest, it still has to give physicians local options beyond its choice of a single national laboratory provider.

The same holds true for Aetna and other managed care payers who, after all, abhor a monopoly.

Hirsch points out that hospitals have special leverage with managed care payers because payers need the hospitals more than they do the national labs. Even so, he adds, hospitals haven’t made that issue the “highest priority” when negotiating with payers on behalf of their labs.

It has been a high priority, however, for Joint Venture Hospital Laboratories, a 120-hospital network providing outreach lab services throughout Michigan and in the border areas of Ohio and Indiana. It landed a contract with UnitedHealthcare, effective Jan. 1 of this year, to cover the plan’s members in Michigan. JVHL also has Cigna and Aetna contracts.

JVHL’s Shaw says United recognizes the value of working with JVHL on behalf of its network hospitals because “we offer them an efficient way to have all the advantages of maintaining hospital labs’ presence in the market. We intake all the test encounter and results data from our hospitals and consolidate it into an…information set so United gets the value of working with 120 hospitals by working with one organization.”

One of the lessons JVHL has learned over the years, Shaw says, is, “You have to be financially competitive to work with managed care plans,” but that doesn’t necessarily mean you have to do the work for commercial lab rates.

One who views lab tests as a commodity will ask how much they cost to do, Shaw explains. But if a patient is admitted to the hospital for surgery or in an emergency, and the lab test results generated by the commercial lab aren’t in the hospital’s electronic health record, the hospital will have to repeat the testing. Once that happens, the plan’s savings from using that commercial lab vanish.

Thus, “the completeness of information” that hospitals doing both inpatient and outreach work provide trumps the “nickel and dime” savings that plans achieve from commercial labs. JVHL routinely makes that argument to managed care payers and has, as a result, “realized some value in terms of our pricing with most plans,” he says.

That pricing isn’t as much as JVHL would have liked, he concedes. “But it is enough for our hospitals to be willing to accept the plans’ contracts.”

JVHL has worked with health plans on utilization and results reporting for the past several years. It offers custom reporting of use per individual physician, physician group, specialty, and geography. “We work with [plans] to make sense of that data,” Shaw says. Pay-for-performance initiatives will, he predicts, increase the plans’ use of JVHL’s reporting capabilities, which Shaw describes as “more robust” than those of the commercial labs.

Some say JVHL is a poster venture of sorts that’s hard to replicate.

Pulling it off does require investment and know-how—and the right market helps, Shaw agrees. “Certainly in Michigan, we had a lot of strong hospitals already in the outreach business, so we have a good base to work from. And even though Quest and, to some degree, LabCorp had a presence, they didn’t dominate the market. So hospitals were willing to believe they could successfully work in the outreach market, which gave them a psychological leg up.”

But if a hospital network is to work effectively with managed care plans, local leadership is what’s needed most, in Shaw’s experience

“There has to be someone or some organization within the market that says we need to do this.” That person has to have the time and opportunity to go to the managed care company to ask what the hospitals have to do in order for the plan to work with them—and then make sure it happens.

Piedmont Medical Laboratory’s Skrisson suggests that the United and Aetna contracts should motivate hospital and regional laboratories that want to compete in the outreach market to seriously consider forming networks. “Regional and statewide networks provide members with greater influence and leverage with payers,” he says.

There is “safety in numbers and geography,” agrees Stan Schofield, president of NorDx, a regional laboratory in Scarborough, Me., who advises labs to avoid trying to do independent contracting with managed care. “You have to get in with more people,” he says.

NorDx, which is part of an integrated delivery system providing services in Maine and parts of New Hampshire, uses “single signature contracting,” Schofield says. That means the lab doesn’t sign contracts without the health system and vice versa. That way, the “insurers and managed care groups can’t say the lab is a commodity. If someone came in and said, ‘I am cutting your lab prices by 40 percent,’ my health system would hopefully say, ‘Your inpatient services just went up by 15 percent.’”

Clinical Lab Business Solutions’ Snyder says health plans call that “the balloon—you push on one side and it pushes out on the other side.”

But managed care plans are likely to start pushing back, some in the industry predict. Carilion’s Thompson suspects that “if Aetna and United can buy lab services at 50 percent of Medicare from national labs, they are going to have a hard time paying a hospital lab 100 to 150 percent of Medicare without offsetting that expenditure…on the hospital’s or health system’s inpatient or other outpatient services.”

In responding to the assertions of hospital outreach labs about their competitive advantages over commercial labs, LabCorp’s King says he doesn’t see hospitals’ access to outpatient and inpatient lab results as putting LabCorp at a significant disadvantage. That’s because, in his experience, the coordination of such data within a hospital is, in many cases, “really uneven.”

The one thing a hospital has that King would like more of is outcomes data. “That way, we could see a patient had this lab test and course of treatment and outcome. I think that would be helpful to develop programs to guide treatment. But we have the ability to interface [test] results to most hospital systems and most electronic medical record systems.”

And “universal EMRs, once the government comes up with the standards, will make that much easier,” King says. “We build many customer interfaces to go into hospitals, doctors’ offices, etc., and if there is a standardized EMR with standard data sets, that will be an enormous efficiency for the health care system.”

Labs can also differentiate themselves in the managed care market by providing more esoteric testing. Even though Carilion Labs’ average price as a ratio to Medicare has dropped materially in contract negotiations over the past few years, Thompson says it’s making more on a unit basis this year compared with last. And that’s due to test mix changes—the lab is doing more esoteric testing and AP, Thompson says. (He conjectures that LabCorp might have decided to take a “haircut” [with the United contract] on the routine testing and protect pricing on its more complex esoteric or AP business.)

There’s also still room for labs to sidestep managed care by providing premium service to physician offices. “There is a market,” Hirsch says, but it’s not “gigantic. You can get away with it in an affluent market where people have a lot of private insurance or can afford to pay out of pocket.”

As one example, Hunter Laboratories, an independent lab in Campbell, Calif., doesn’t deal with managed care, says its CEO Chris Riedel.

“Typically in Northern California, there are pockets that have heavy managed care and some with light managed care,” Riedel explains. “We have found that as long as a physician practice doesn’t have more than 30 percent managed care, they are very willing to send the managed care work to the contracted provider and the fee-for-service work to a high-service provider like us. It doesn’t cost the doctor or the patient anything to do that.”

Will lower managed care pricing undermine the ability of laboratories to maintain satisfactory service?

Low pricing could have a noticeable effect on access and support services, Shaw says, such as pick-up frequency and electronic connectivity. “We have seen some of that [happening with] commercial labs and, certainly, the hospitals also have to cost-effectively provide these same services. It will be interesting to see if this becomes an increasing issue to the plans.”

Wachovia Securities analyst William Bonello says pricing is unlikely to lead to national labs cutting back on “touch points” that bring in business. “Quest is clearly talking about cutting some substantial costs, but I don’t think they are intending to reduce patient service centers or things like that,” he says. Instead, Quest is focusing on streamlining processes within the lab, “which should, in theory, not only reduce costs but could improve turnaround time and customer service.”

LabCorp is working to build its infrastructure for the United contract. “So you could see some temporary disruption as LabCorp has taken on a huge chunk of new business, as have some of the regional labs,” Bonello says.

But Hirsch maintains that “labs will be going through a difficult time until reimbursement stabilizes and everyone recognizes that they can’t continue to do a quality job in the current pricing environment and make the margins they have previously.”

Many worry that the lower pricing may cause the real giant in the insurance world—Medicare—to put its foot down.

Says Shaw: “The biggest long-term consequence is that Medicare may say, ‘Hey, wait a minute. We’re paying twice what United is paying.”

Snyder agrees, saying the lab industry is now “waving a red flag in front of the bull.”

Consultant David Nichols, MBA, predicts the pricing in the United and Aetna contracts will lead the Centers for Medicare and Medicaid Services to continue to freeze reimbursement, or to reduce it more aggressively via the competitive bidding process.

Competitive bidding may end up serving as a benchmark for a pricing strategy for the CMS to set a new standard fee schedule for labs, says Nichols, president of Nichols Management Group, York Harbor, Me.

“As the economy softens,” Nichols says, “there will be more pricing pressures from employers to reduce their health care costs. Believe it or not, this last decade has been a Pax Romana”—the period of relative peace in Rome.

Nichols’ advice to labs: “Be proactive and don’t wait for change…partner, sell, or acquire companies, develop or bring on new products.” Whatever you do, he urges, don’t stand still.