Medicare Price Cuts Drive Labs to Sell or File BK

It is the first wave of lab restructuring and is market evidence of deteriorating lab finances

CEO SUMMARY: Professional investors are smart with their money. Thus, it is no surprise that clinical lab and pathology companies owned by private equity firms are the first to be sold or closed. These investors are acting in response to the cumulative negative financial impact of recent cuts to lab test prices. Even more worrisome to the entire profession of laboratory medicine is the consequence of Medicare’s proposed cuts to pathology testing and Part B Clinical Lab Prices for 2014 and 2015.

OCTOBER SAW THE FIRST WAVE of sales and bankruptcies among laboratory companies in reaction to both the actual and proposed cuts to the prices the Medicare program pays to clinical laboratories and anatomic pathology labs.

In just the past four weeks, a lengthening list of laboratory companies have either been sold or filed a bankruptcy action. Each of these transactions is evidence that successive cuts to lab test reimbursement are undermining the financial stability of a large number of laboratory companies across the nation.

At the same time, it is appropriate to remind everyone of the invisible damage done by these price cuts to the quality and the integrity of the lab test results produced by laboratories. Most directly, it can mean that financially-struggling labs begin reporting inaccurate lab test results that can negatively affect patient care and may go undetected for months or years by CLIA inspectors or assessors from lab accreditation organizations.

Another negative consequence to the sale and/or closure of individual lab organizations is reduced patient access to lab testing in many communities. These negative consequences will be particularly true for those lab organizations that make bad decisions as to where to cut costs in response to being paid less per test by government and private health programs.

Each time a laboratory company is put up for sale or a lab bankruptcy is filed, additional evidence is produced about the negative impact that recently-implemented and proposed price cuts are having on different clinical laboratory companies throughout the United States.

This wave of lab sales and bankruptcies began on October 7. That is the day when the sale of ConVerge Diagnostic Services, LLC, to Quest Diagnostics Incorporated was announced. Terms of the sale were not disclosed.

Pathology Lab Sold To Quest

ConVerge is an anatomic pathology company in Peabody, Massachusetts. Public sources indicate that it has annual revenue of $15 million, 22 employees, and nine pathologists.

Just 15 days later, on October 22, it was disclosed that Plus Diagnostics, LLC of Union, New Jersey, would be acquired by Miraca Life Sciences, of Dallas, Texas. There were 26 pathologists at Plus, a company that did a national business in anatomic pathology services.

Both Converge and Plus were owned by Water Street Healthcare Partners, a private equity company based in Chicago, Illinois. It is reasonable to assume, in the wake of cuts to pathology fees in recent years—and factoring in the impact of the proposed Medicare fee cuts as published in the 2014 Medicare Physician Fee Update—that Water Street’s principals could see no way to achieve their financial goals going forward.

Thus, the rapid sale of both anatomic pathology companies allowed Water Street HealthCare Partners to take the losses immediately, write off these investments, and redeploy the capital into other industries. It can be expected that other professional investors will make similar decisions to end their investment in lab testing companies.

Loss Of Investor Confidence

Loss of investor confidence in the clinical laboratory and anatomic pathology business was widely predicted last spring. These predictions were made after the Medicare program proved unprepared to administer claims submitted for the 114 new Tier 1 and Tier 2 molecular diagnostics CPT codes that became effective on January 1, 2013. (See TDRs, April 15, 2013, and June 17, 2013.)

It was a similar story in another laboratory sale. Also on October 22, the acquisition of Shiel Medical Laboratories by Spectra Laboratories, Inc., was announced. Shiel is based in Brooklyn, New York. It was founded in 1919, which made it one of the oldest clinical laboratory companies still operating in the United States.

Over the past decade, Shiel consistently posted solid rates of growth in the highly-competitive New York City market. It currently employs more than 630 people and is owned by CEO Jack Basch. The reason for the sale was not announced. Spectra Laboratories is a business division of Fresenius Medical Care AG & Co KGa, the national dialysis company. Spectra primarily provides testing for dialysis patients.

First Known Lab Bankruptcy

The first lab company known to have filed a bankruptcy petition is Laboratory Partners, Inc., of Palo Alto, California. On October 25, it filed a Chapter 11 bankruptcy petition in the United States Bankruptcy Court, District of Delaware.

Laboratory Partners is a substantial lab company. Under the name MedLab, it operates 12 laboratories in Ohio, Indiana, Illinois, Missouri, Michigan, Kentucky, Virginia, Maryland, and Washington, DC.

The majority of MedLab’s revenue comes from its long-term care clients. In Indiana and Illinois, it serves office-based physicians. In Indiana, MedLab also provides lab testing services to two hospitals.

In its bankruptcy documents, MedLab described the reasons for its financial problems. It said the major reason for shrinking revenue was the result of “government-imposed permanent reductions in rates of reimbursement.”

More specifically on this point, MedLab stated in the court documents that it operates “under a Medicare Clinical Laboratory Fee Schedule. In 2010, Congress reduced reimbursement rates under the schedule for clinical laboratory services, which directly affected the Debtors. This year the Medicare Physician Fee Schedule Proposed Rule was released, proposing additional cuts in laboratory reimbursement rates. Further cuts to the Fee Schedule will go in effect in 2014 and 2015. As expected, the reimbursement rate cuts are negatively affecting the company’s revenues.”

The laboratory businesses for which it filed Chapter 11 Bankruptcy petitions are:

Pathology Associates of Terre Haute, Inc., Terre Haute, Indiana.

Terre Haute Medical Laboratory, Inc., Terre Haute, Indiana.

Biological Technology Laboratory, Inc., St. Louis, Missouri.

Suburban Medical Laboratory, Inc., Cuyahoga Falls, Ohio.

MedLab Ohio, Inc., Cincinnati, Ohio.

Kilbourne Medical Laboratories, Inc., Cincinnati, Ohio.

Laboratory Partners, Inc., Palo Alto, California.

The CEO of MedLab is Bill Brandt. He is a turn-around expert who granted an interview to THE DARK REPORT. His comments about the reasons for the decision to file a Chapter 11 bankruptcy action are found on pages 7-9.

In Operation Since 2004

MedLab’s owner is Laboratory Partners, Inc., of Palo Alto, California. Founded in 2004, Laboratory Partners’ CEO is Richard Daly, a former executive at several lab and diagnostic companies. He has kept a low profile in the laboratory industry since his firm acquired its first laboratory company about seven years ago.

It should be noted that the sales of several laboratory companies and the lab bankruptcy action mentioned above are only those that have been publicly disclosed. Other lab closures and sales are occurring, but have been kept out of the public eye.

For example, THE DARK REPORT knows of two pathology group practices, reportedly in the Northeast United States, where the pathologists are negotiating to become employees of the hospitals that their respective pathology practices have served for many years. This news has not been made public because the final agreements have yet to be finalized.

A Toll On Lab Finances

Lab administrators and pathologists across the United States will want to track these developments. Aggressive price cutting by the Medicare program and the national health insurers is about to take its full toll on the clinical lab organizations and anatomic pathology practices that so capably serve patients in this country.

There will be more bankruptcies. There will be more forced sales of clinical lab organizations. With their deep pockets, the two national laboratory companies will be waiting to pick up these assets at bargain-basement prices. However, given past and proposed lab test price cuts, this may turn out to be a Pyrrhic business strategy for the nation’s largest lab companies.

For anatomic pathology, it will be a similar story. Because the majority of the nation’s 3,300 independent pathology group practices currently operate with four or fewer pathologists, they will be particularly hard hit due to the reduced reimbursement for their technical and professional services.

It may take some time before the deeper impact of multiple price cuts to various pathology services can be assessed. One reason why that is true is because the majority of pathology groups are private, are small, and tend to be slow in restructuring their core business activities.

Shrinking Reimbursement for Clinical Lab Tests Is Major Reason Lab Owners Are Deciding to Sell

OVER THE COURSE OF 2013, several substantial laboratory organizations either put themselves up for sale or ceased operations and went out of business. A common theme in these decisions has been the dramatic and sustained reduction in reimbursement for lab testing services by Medicare and private payers.

Take California, as an example. Two major hospital laboratory outreach programs were put up for sale during 2013. In April, Dignity Health disclosed that it would sell its clinical laboratory outreach business in California and Nevada to Quest Diagnostics Incorporated. The transaction included the sale of 56 lab sites and patient service centers.

Dignity Health operates 40 hospitals. The sale involved a significant volume of lab testing. For example, the Stockton Record wrote, in a story it published about the 25th anniversary of Dignity Health’s HealthCare Clinical Laboratories, that “it was reported the 26,000-square-foot facility employed

365 workers… served customers from Long Beach to Mount Shasta; handled 3 million transactions a year; and earned gross revenue of approximately $80 million annually.”

Another major lab sale involved John Muir Health in Walnut Creek, California. On September 3, 2013, it agreed to sell its MuirLab business to Laboratory Corporation of America.

Reduced Lab Test Prices

This laboratory outreach program was struggling to maintain financial stability. Along with the reductions in Medicare Part B clinical lab test fees, as an out-of-network laboratory for a number of private payers, it was hit with the requirement that patients had to pay more out-of-pocket when their lab testing was done by MuirLab.

LabCorp acquired the 26 patient services centers operated by MuirLab, along with its client list. LabCorp did not purchase MuirLab’s core lab facility in Walnut Creek (which John Muir Health closed). It also did not acquire the nursing home clients that were being served by MuirLab. It was estimated that MuirLab’s annual revenue was about $70 million.

It should not be overlooked that, on January 2, Quest Diagnostics announced that it had completed its purchase of the laboratory outreach program of the UMass Memorial Medical Center. Annual revenue of this lab outreach program was believed to be about $90 million.

Two Lab Companies Closed

Also during 2013, the lack of payment or unfavorable coverage decisions by Medicare contractors for tests billed under the new molecular test CPT codes has played a role in causing at least two lab companies to close their doors.

It was in April when Pathwork Diagnostics, Inc., of Redwood City, California, ceased testing operations and closed permanently. Low reimbursement for its proprietary cancer tissue-of-origin test was one reason why its investors decided to pull the plug on the lab company, which had been founded in 2006. (See TDR, May 28, 2013.)

Another private laboratory company caught in the molecular CPT code fiasco was Predictive Biosciences (PB) of Lexington, Massachusetts. It closed its doors for good on May 31, 2013, despite the fact that almost 1,000 urologists were regularly ordering its proprietary molecular tests for bladder cancer.

Upon learning that the Medicare contractor had made an unfavorable coverage decision for the most important of its three proprietary molecular tests, the investors on Predictive Biosciences’ board of directors voted to close the laboratory and cease doing business. These investors recognized the intent of payers to further reduce the prices paid for lab tests. (See TDR, July 8, 2013.)

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