May 2007: Volume 33, Number 5
Managed Care Contract Shakeups for Lab Testing
Is a Price War Underway?
By Julie McDowell
The managed care contract market for laboratory tests was upended last fall when one of the nation’s largest health insurance providers, UnitedHealthcare, severed its ties with Quest Diagnostics and instead tapped LabCorp as its national laboratory under a 10-year agreement. Soon after this announcement, another major insurance provider, Aetna, terminated its relationship with LabCorp and shifted its business to Quest. While neither reference laboratory is divulging the contracts’ financial details, many lab industry insiders are speculating that these contracts provide the insurance companies with testing services far below current prices—in some cases, 45%–55% less than what Medicare pays for the tests. In order to stay competitive, regional reference and hospital outreach laboratories will likely be forced to knock down their test prices, or face being locked out of certain markets. The result, experts say, is a pricing war that will erode test fees and shrink profit margins. In the short term, however, these changes could potentially open up the outreach testing market for hospital and regional independent labs, but only if they can afford to operate under these new pricing constraints.
According to Dennis Weissman, President of the clinical laboratory consulting company, Dennis Weissman & Associates, LLC, and Founder and Executive Editor of Washington G-2 Reports (New York, N.Y.), this situation is nothing new. He believes that the current lab testing market is reminiscent of negotiations made between national reference laboratories and health maintenance organizations (HMOs) in the mid–to–late 1980s. However, since then, buyouts and consolidations have reconfigured both the laboratory and managed care industries. Back then, the contracts were somewhat different—the laboratories agreed to capitated pricing where one set price would cover all testing for an HMO member during one month. “When the laboratories came to these capitated agreements with the managed care providers in the early 1990s, they almost went broke because they were agreeing to ridiculously low prices, and a pricing war ensued,” he explained. “The wreckage wasn’t only focused on the big labs, but some of the smaller laboratories that felt they were forced to complete. There were a lot of problems in terms of pricing in the lab industry, and it took almost two decades for both big and small labs to recover.”
The Rebirth of the Lab Market
After the managed care crunch of test prices twenty years ago, Quest Diagnostics (Lyndhurst, N.J.) emerged as the leader in the reference testing market—particularly in the northeastern part of the country—with a 13% share of the $45 billion diagnostic testing market in 2006, compared with LabCorp’s (Burlington, N.C.) 8% market share, according to Quest officials. But industry experts predict that Quest’s market share is now threatened. Before UnitedHealthcare (Minneapolis, Minn.) signed on with LabCorp, Quest’s contract with the healthcare insurance company accounted for approximately 7% of the company’s annual revenue. The company will keep some of that revenue with the Aetna contract, but will likely fall short, since UnitedHealthcare has 28 million members, compared with Aetna’s 15 million.
What has lead to these major changes between managed care companies and the national laboratories? “I don’t think LabCorp could move market share based on service, so they decided to buy the business,” said Thomas Hirsch, who ran a hospital-based independent laboratory in New England for 20 years that LabCorp eventually purchased. “I think it’s a bad sign for the industry now that Quest has signed an exclusive deal with Aetna. Other insurance carriers are aware of these deals, and will want the same pricing. We are going to see a move to depress reimbursement across the industry over the next few years because of this initiative, which is terrible because the cost of doing work has not been reduced in accordance with this contract pricing.”
Market Snapshot: Outreach Testing
While Quest Diagnostics and LabCorp dominate the managed care lab market, many regional independent and hospital laboratories feel that they are holding and even gaining market share, according to a survey of 150 respondents conducted by Chi Solutions (Ann Arbor, Mich.) in 2006. Survey respondents included hospital outreach and regional independent laboratories.
Last year’s survey also found significant growth in both revenue and test volume among 139 respondents between 2003 and 2005. On average, test volumes grew at an overall rate of 8.3%, or 4.1% annually, while outreach revenue grew 17.4% for all respondents, or 8.7% annually.
For additional information, including how to purchase the most recent report, the Sixth Comprehensive National Laboratory Outreach Survey, visit www.chisolutionsinc.com.
Courtesy Chi Solutions
A Risky Strategy?
In terms of pricing, LabCorp’s strategy may be to sacrifice some of its short–term profitability by increasing revenue potential through “pull–through” testing, said Hirsch, who is now President of Laboratory Billing Solutions (Portsmouth, N.H.), an outreach billing service for hospitals and smaller independent labs. This means that once a lab contract is in place, clinicians and laboratory directors will begin sending all testing specimens to the contracted lab, even if it’s out-of-network for some insurance plans. These pull–through tests are not part of the LabCorp contract, and therefore would typically be reimbursed at higher prices. “They are hoping that some of the better–priced testing will accompany the contracted specimens,” he explained. “But that is a very risky and dangerous strategy.”
A Long–Term Partnership
While declining to speak about the pricing details of the contract, LabCorp spokesman Brad Smith did reveal that discussions with UnitedHealthcare began in October 2005, when the insurance provider announced they were looking for a national laboratory partner. The insurer was looking to curb testing costs, but company officials also wanted to capture patient data.
“During our initial discussions with UnitedHealthcare, we believed that they would select the two national labs to contract with them in the markets where each of us is strongest,” said Smith. “However, it became very clear to us that UnitedHealthcare wanted one partner. We ultimately signed a 10-year agreement with them, which ensures that this will be a two-way reciprocal commitment.” Under the contract, which began Jan. 1, LabCorp will be the exclusive national laboratory and will also work with regional and local reference laboratories to manage testing for the insurance provider. In addition, LabCorp is now managing the Oxford Health Plans laboratory network, located in the greater New York metropolitan area. The reference laboratory is also now the exclusive national capitated laboratory provider for the HMO benefit plans of PacifiCare of Colorado and Arizona, Florida’s Neighborhood Health Partnership, as well as Mid Atlantic Medical Services (MAMSI) in Maryland and Virginia.
The 10-year commitment is important because of the investment that LabCorp will need to make to expand its testing infrastructure to service the UnitedHealthcare contract. “We had long been interested in expanding our presence in the northeast, but we needed an anchor plan because we needed to build out additional infrastructure,” said Smith. In the past, managed care providers were only interested in contracting with the laboratory if the expanded services were already in place. “But these contracts were only two or three years long, and if we don’t believe we can get the volume through the infrastructure, it’s hard for us to commit to build out,” he added.
As part of the negotiations, UnitedHealthcare also required that LabCorp provide testing services in the immediate area. “United said that they would commit to a long–term contract if we committed to be close to all the existing patient access sites,” Smith said. LabCorp responded swiftly, building over 400 patient service centers and hiring 1,200 people between October 2006 and January 2007. UnitedHealthcare was concerned, however, that their savings in testing costs would be lost to transition costs. To offset these expenses, LabCorp is committing to invest up to $200 million over the first three years of the contract to cover relevant transition costs. LabCorp will not necessarily pay this full amount, as they are only required to pay to the extent that they do not capture accessions in certain markets.
In addition, company officials have launched a media campaign called “Choose LabCorp”, featuring print and radio advertisements in the northeast, particularly New York, in order to raise brand awareness. “Although the contract is across the country, a big initial focus is on the New York market,” said Smith. “There was information out there to say we weren’t in that market, but in reality, we have facilities in Raritan, New Jersey, Long Island, and Albany, although not in the metropolitan New York area. We wanted to get our name out there so people could be comfortable as we implemented our additional infrastructure.”
In response to speculation about the United-LabCorp contract’s low test prices, Smith would only say the agreement remains competitive. “I’m obviously not going to release what our pricing is, but we believe that our profit margins in connection with this relationship will be at or above existing margins, which are leading the industry,” he said. “But when you are talking about a 10-year agreement, a competitive price is going to be part of the equation.”
Nevertheless, even Quest believes that this contract means the dawn of a new competitive environment. Prior to LabCorp’s media campaign, Quest had begun promoting their “My Lab is Quest” Web site in newspaper and radio advertisements nationwide. “It appears that we have a competitor that is willing to gain market share at any cost, through low price and very high leakage guarantees,” said Quest spokeswoman Nancy Fitzsimmons. “We believe that price will be under pressure in the short term—the next twelve to eighteen months—because of managed care consolidation and aggressive competition. Again, we believe our differentiated services will allow us to compete on more than price. However, we are committed to maintaining our leadership position and will take action, where necessary, to defend it.”
There was also concern that UnitedHealthcare was threatening to penalize physicians who refer testing services to an out-of-network lab. For UnitedHealthcare customers, Quest is now considered out-of-network. According to a UnitedHealthcare directive released last November, any physician who continues to refer patients to out-of-network labs after March 1, 2007, would be subject to a $50 fine, as well as sanctions such as a change in eligibility and a decreased fee schedule. This move has angered many physician groups, including the American Medical Association (AMA). “UnitedHealthcare has again damaged its relationship with physicians by introducing a protocol that imposes heavy-handed sanctions for referring to out-of-network laboratories. Physicians across the country have been angered by the inclusion of unnecessary and punitive penalties in United’s protocol,” said AMA Board Member J. James Rohack, MD, in a released statement. “The AMA believes United could help mend its significantly damaged relationship with the nation’s physicians if it acts now and voluntarily removes the sanctions from its national protocol.”
But UnitedHealthcare spokesman Tyler Mason insists that there has always been a financial disincentive for physicians who refer patients to out-of-network labs. In addition, the provider has been hearing complaints from members who are referred to non-participating labs and then have to pay more. “If we continually have the situation where members are being referred out-of-network and the members are not requesting that, and after multiple conversations between the health plan and the physicians, there could be a financial penalty for sending people out-of-network, although we don’t anticipate using it widely and when it does happen it will be applied with much care,” he said. “There are a small percentage of physicians that just are not willing to help the members and work with the health plan to refer the patients in network. At that point we have to take some sort of action on behalf of our members to address that behavior.” Currently, officials with the New Jersey Department of Banking have requested that the insurance provider suspend fines for physicians in their state while they review the legality of the protocol. Mason said that the company has agreed to their request, and insisted that the provider believes that financial penalties will not be widely implemented.
Opportunities for Lab Outreach Testing
While the UnitedHealthcare contract named LabCorp as its “exclusive” national laboratory, there is ample room in the contract for hospital, regional, and local reference laboratories to do business. Until LabCorp is fully able to service this contract, UnitedHealthcare will have to contract with these laboratories. United will then be reimbursed for these expenses—up to $200 million—by LabCorp during the first three years of the contract. “We have no desire to be the sole provider of clinical laboratory services for United everywhere,” said Smith. “That is not the model that anyone contemplates. While we are the only national provider, there are 1,500 other clinical laboratory providers, so it’s a big network.”
In fact, regional laboratories in the New York region might see an increase in business. Because the LabCorp infrastructure is not established in the New York area yet, they are forced to contract with local laboratories. “Since United ceased their contract with Quest, they have to rely very heavily on regional labs to prevent leakage to Quest,” said Michael Snyder, who previously worked at both LabCorp and United and is now the Principal of Clinical Lab Business Solutions, a laboratory management consulting firm based in Readington, N.J. “United has contracted with just about every laboratory who has put up their hand for a contract.”
Many of Snyder’s clients are currently negotiating contracts with insurance providers in the midst of this decline, where pricing is currently about half of the Medicare fee schedule. He is trying to push these prices up for his clients, but the pricing depends on how badly a provider needs a lab in a certain area. “I’m advising my clients to go after these regional contracts right now, if they can afford to,” he explained. “Yes, the price is lower, but it’s an opportunity to really gain some market share.” Both hospital outreach and reference laboratories have been gaining market share on Quest and LabCorp in recent years, and these regional contracts can further propel them forward (See box). “They are able to pick up business and demonstrate the quality of their services,” he said. “By entrenching themselves with the physicians and laboratory directors at this time, it’s going to make it difficult for LabCorp and Quest to take that business away in the future with new contracts. It’s going to make it really tough for the health plans to cut them out in the future.”
In order to become more competitive with LabCorp and Quest, Snyder is also advising his clients to come up with added-value services to offer the provider. For example, one of the lynchpins in the United-LabCorp contract is the ability of the laboratory to standardize patient and test data. United wants to analyze this data not only to track individual patient health, but also disease management information, such as how many patients have symptoms that could develop into chronic conditions like diabetes and cardiovascular disease. “When we were negotiating with United, they were impressed that we had worked with other networks to develop ways to standardize test data that doesn’t come from our lab system,” said LabCorp’s Smith. “In addition, we worked with them on a project to develop a lab-data gateway to combine data from multiple laboratory providers and normalize it for use.”
Regional and hospital outreach laboratories must also develop similar additional services, said Snyder. There are some predictive modeling and disease management programs that testing data could inform. Beyond these tools—which are still in their infancy—health plan providers are most interested in ‘ease-of-use’ service and price. Providers contract with LabCorp and Quest because it’s one-stop-shopping. “If we can make labs look like a single contract, then we’ve done the same thing,” said Snyder. “What’s needed is a management mechanism to handle the data and contract details, which would make it easier for the labs and health plans to work together. The plans understand the benefits of this and are talking to us about it. In this sense, even though the labs are doing testing at a lower price, they are also pointing out to the health plans the value of the lab business.”