CEO SUMMARY: For decades, hospitals were reluctant to allow any outside lab company to run their inpatient lab operations because they preferred to maintain control over quality results and turnaround times. That attitude may be changing as health systems face increasing margin compression by moving to value-based reimbursement models and taking on more risk-based contracts. Hospitals usually don’t make much of a margin on inpatient testing. That makes partnering with an outside manager more attractive.
FOR ALMOST THREE DECADES, the one segment of clinical lab testing that the public lab companies could not crack was managing hospital inpatient testing. Now comes news from Denver of an inpatient lab testing deal that may presage more such agreements between hospitals and public lab companies.
Earlier this month, Quest Diagnostics Incorporated announced that it had an agreement with the HealthONE System, a division of HCA Healthcare, to manage the inpatient laboratory operations of six of HealthONE’s eight Denver-area hospi- tals. In a joint statement, Quest and HealthONE said that the agreement was designed to enhance the quality and value of diagnostic services and to improve efficiency of laboratory operations.
Historically, hospitals and health systems have been reluctant to turn over control and management of their inpatient laboratories to an outside entity, particularly such lab companies as Quest Diagnostics and Laboratory Corporation of America. The fact that Quest and LabCorp were strong competitors for the same outreach business that hospitals coveted for themselves was also a factor in why these types of deals rarely happened. However, healthcare’s ongoing transformation may be causing hospital and health system administrators to rethink the role of their clinical laboratories in the strategies of their institutions. If this is true, then the laboratory industry may see more hospitals willing to agree to have a public lab company manage their inpatient laboratories.
Hospital Lab Joint Ventures
One lab executive who has extensive experience in developing joint ventures involving hospitals and commercial lab companies is Noel Maring, who, since 2012, has been Vice President of Hospital Affiliations at Sonic Healthcare USA, based in Austin, Texas.
Previously, during his 17 years working for Pathology Associates Medical Laboratories (PAML) of Spokane, Washington, as Senior Vice President and Chief Marketing Officer for PAML, Maring developed a growth strategy that emphasized joint ventures with hospitals and lab companies across the West.
That included starting a lab outreach joint venture in Denver involving PAML and 12 hospital labs owned by Centura Health. Known as Colorado Laboratory Services, it was launched in 2010 and operates today. (See TDR, September 13, 2010.)
“It is too early to say that the Quest-HealthONE agreement in Denver is an early sign of a new trend,” said Maring. “These types of deals have been done for a number of years, but only on a sporadic basis.
Start of a Trend?
“On the other hand, even if it is too early to say we are on the start of a trend, this deal is evidence that some hospital CEOs are exploring ways to get more leverage from their clinical laboratory assets,” affirmed Maring. “It is consistent with what we see in the marketplace. Over the past 12 months, a number of hospitals have approached Sonic to explore different options with their outreach lab business and their inpatient lab business.
“This is a definite change because, in the past, hospitals were always sensitive about allowing an outside lab company to run their inpatient lab operations for them,” observed Maring.
“Hospital CEOs wanted to maintain control of inpatient lab operations to ensure that they were delivering timely, high-quality results and good customer service to their physicians on staff at the hospital,” he added. “It was outside their comfort zone to think about giving a lab company management control over a key service line such as their laboratory.
“But that is changing as healthcare’s transformation creates new care delivery models and new payment methodologies,” stated Maring. “Now hospitals are willing to discuss every aspect of laboratory testing. That includes whether to bring in a partner to run the inpatient lab operations and whether they should con- solidate all lab operations into one core lab that runs the inpatient and outreach testing activities.
Quest to Manage Six Labs at HealthONE Hospitals
EARLIER THIS MONTH, Denver’s largest healthcare system, HealthONE, selected Quest Diagnostics Incorporated to manage the inpatient lab testing operations at six of its eight hospitals.
HealthONE is a division of HCA Healthcare. It has more than 10,000 staff in the metro- politan Denver area. Quest Diagnostics will operate the labs in these six facilities:
- The Medical Center of Aurora
- North Suburban Medical Center
- Presbyterian/St. Luke’s Medical Center
- Rose Medical Center
- Sky Ridge Medical Center
- Swedish Medical Center
The other two facilities do not have inpa- tient labs, a HealthONE spokeswoman said. Financial terms were not disclosed.
Some employees in the HealthONE labs will transfer to Quest Diagnostics. The remaining HealthONE lab employees will continue to be employed at HealthONE, said Stephanie Sullivan, a HealthONE spokeswoman.
“Hospital administrators also recognize that they are being asked to take on greater financial risk with patients,” explained Maring. “It is why they’ve built or acquired other hospitals, ambulatory surgery centers, imaging companies, and other facilities in an effort to create integrated delivery networks and better manage a patient’s total health needs.
“Now that they’ve spent six years or more developing this network, they have the time to look at lab operations and develop a strategic direction for their labs,” he said.
“All this time, clinical laboratories were almost entirely left out of the mix,” observed Maring. “But today, hospitals and health systems are looking hard at their lab- oratory operations in order to make strategic decisions in two or three areas.
“First, hospitals are trying to decide whether to be in the lab outreach business at all,” he said. “Second, they want to have their labs benchmarked and then have those labs become as efficient as they can be.
“Third, as health systems have bought more hospitals in certain regions, they’ve tried to centralize their lab operations for more efficiency,” added Maring. “This con- solidation of lab testing across multiple hospitals creates opportunities to add to the lab test menu and realize further economies of scale for their lab operations.
Two New Market Forces
“While hospitals and health systems were getting bigger through acquisitions, they were also experiencing two market forces that now drive their business decisions,” he stated. “Both factors affect hospital lab revenue and those factors are compelling hospitals to take additional steps to suc- ceed in their growth strategies.
“The first market factor is a change in reimbursement for lab tests,” continued Maring.
“For several years, reimbursement for outreach lab testing has been quite lucrative for hospitals. As long as tests were paid for under the hospital fee schedule, the lab generated strong revenues,” he said. “But now there is plenty of evidence to indicate that the days of exceptionally high outreach laboratory reimbursement are numbered for hospitals. As we move to value-based reimbursement, with bundled payments or risk sharing arrangements, lower lab reimbursements will affect health system margins.
“Even if a hospital lab still operates on fee-for-schedule reimbursement for some contracts, the revenue hospitals will receive in the future will be lower than it was compared with what the lab generated for its parent hospital just a few years ago,” he said.
“From their lab outreach business alone, some hospitals have enjoyed payment that has been in the range of 150% to 200% of Medicare. That’s great, of course, but those days are ending,” added Maring. “There is plenty of evidence that, in the future, payment for lab outreach testing will be, at best, equal to what Medicare pays and will probably be significantly less than Medicare fees.
“The second market factor is the risk that hospitals must assume as they operate under new models of care delivery such as accountable care organizations,” emphasized Maring. “In these arrangements, labs in hospitals become cost centers.
“When a hospital gets paid under a risk model such as capitation, labs and every other department are no longer generating revenue. They all become cost centers, which means they all have to operate at peak efficiency.
“Some larger health systems have their own insurance plans,” he said. “When that happens, every department becomes a cost center because, as an insurance company, the hospital is paying itself.
“As more hospitals take on risk contracts to deliver patient care, we see them responding in two ways,” Maring noted. “First, hospitals are looking closely at the value of their outreach lab operations. That value may be at its peak right about now.
Forecast: Lower Revenue
“Second, over the past nine months, a number of hospitals have sent out requests for proposals (RFPs),” he added. “They want to know whether Sonic Healthcare is interested in buying or partnering with them on their laboratory outreach business. There’s more of this activity now than I’ve seen in many years.
“At the same time, as Sonic Healthcare gets these RFPs, then I must assume that Quest Diagnostics and LabCorp are getting the same requests,” observed Maring.
Contact Noel Maring at 512-439-1677 or NMaring@SonicHealthcareUSA.com.
Health System CEOs Now Ask Three Questions About Operating or Selling Their Laboratories
WHEN IT COMES TO LABS, “Hospital administrators have three basic questions they want answered,” stated Noel Maring, Vice President of Hospital Affiliations at Sonic Healthcare. “One, is our lab cost effective?
“Two, can we use our outreach lab operations to generate operating cash in a value- based reimbursement environment?” he said. “Three, should we sell our outreach lab and use those funds to reinvest in areas that are more strategic for our health system?
“I expect that, if hospitals have not already asked those questions, they will be asking them about all aspects of the lab business, including the inpatient lab busi- ness,” he predicted. “That seems to be what HCA has done with HealthONE. But HCA is not alone in looking at labs strategically.
Sell Lab or Partner?
“The second and greater trend for hospitals right now involves their outreach business,” he added. “Hospitals want to know if they should get out of that business. They also want to know if they should sell or partner with someone to run that business.
“And if they partner with a lab company such as Quest or LabCorp or Sonic, will they let that company run the inpatient lab operations too?” he asked. “We’re talking with several hospitals that are currently considering these questions.
“To understand how hospital systems will approach the issue of lab management, you have to think of these health systems as falling into three categories,” advised Maring. “First, there will be large systems that have made significant investments in streamlining their lab operations and will continue to operate clinical laboratories for inpatients, outpa- tients, and outreach. Northwell Health in New York (formerly North Shore Long Island Jewish) is a good example of a large system that will most likely retain its lab operations.
“Northwell invested heavily in its lab in recent years,” he noted. “It built a core lab and moved from hospital billing fee schedules to commercial lab fee schedules to retain managed care contracts. They are big and have enough employed physicians so that it makes sense for them to stay in the lab business.
“Second are health systems that are medium-sized or small and that are considering their options for their labs,” he continued. “At a minimum, they ask if they should sell their outreach business. If the answer is no, will they be able to maintain the margins they’ve had?
“Typically, these health systems perform inpatient testing and let’s assume they do some modest lab outreach of about $10 million per year,” he stated. “The contribution margins from those outreach lab programs are often in the 30% or higher range because they billed using the hospital fee schedule mentioned earlier. The margins have been high because the hospitals already need to operate their labs on a 24/7 schedule to support inpatient testing needs. Thus, for a modest lab outreach program, the marginal costs are relatively low.
“The problem for these mid-sized hospitals is that patients are complaining about the high out-of-pocket costs for lab testing,” he noted. “Thus, that high cost of outreach lab testing to patients is becoming a source of concern for hospital administrators.
Lab Economies of Scale
“The third group is comprised of hospitals that recognize that, either because of competition in their regional market or because of the difficulty of achieving the needed economies of scale in their lab, it makes sense to work with a partner,” noted Maring. “That could include finding a partner to man- age their inpatient lab operations, as Quest Diagnostics is doing for HealthONE in Denver.”