CEO SUMMARY: This will be one of the most challenging years facing the clinical lab industry since the early 1990s, when closed panel HMOs were the disruptive force that generated deep cuts in lab test prices. However, unlike HMOs of that era, the CMS scheme to collect private payer lab test prices and use that data to set Medicare clinical laboratory test prices is proving to be an indiscriminate tool that is poised to undermine the financial integrity of many labs.
IT IS NOT THE FIFTH YEAR since passage of the Protecting Access to Medicare Act of 2014 (PAMA). It may also be the first year that damage and disruption to the nation’s long-established infrastructure of top-flight clinical laboratories becomes visible because of this law and its implementation.
If this proves to be true in 2019, then every clinical laboratory organization will need a strategy to anticipate and respond to specific types of disruptive developments. The challenge will be to understand how implementation of PAMA by the federal Centers for Medicare and Medicaid Services (CMS) will be the cause of direct and indirect consequences on the clinical laboratory marketplace as it exists today.
A direct consequence would be how successive years of 10% and 15% fee cuts to the Medicare Part B Clinical Laboratory Fee Schedule (CLFS) change the financial stability of different classes of clinical labs.
One example of an indirect consequence would be changes in the lab marketplace that result from decisions by private health insurers to follow Medicare’s example and cut the prices they pay for clinical lab tests.
At this time—as a result of the first year of deep cuts to Medicare lab test prices—disruption to the sector of clinical labs that primarily serves nursing homes and long-term care (LTC) facilities is the most visible consequence of the PAMA law and CMS’ implementation of the market price reporting requirement.
After all, independent labs that serve nursing homes typically get 50% to 80% of their revenue from tests performed for Medicare patients. Studies by the National Independent Laboratory Association (NILA) show that most of these community labs operate on an annual net profit margin of 3% to 4%.
For this sector of labs, cutting Medicare lab test fees by 10% in one year for the high-volume automated tests that make up the bulk of their test volume is enough to tip them from a small annual profit to a loss. When CMS cuts Medicare test prices by a further 10% in 2019 and 10% again in 2020 (as is expected), it is a safe bet that few of these labs will survive.
But where this story gets more interesting—and where it has immense potential to fundamentally reshape the clinical laboratory market as it exists today—are the other direct and indirect consequences of the PAMA law implementation.
Early evidence of these developments can be seen in the actions and reactions of industry players, whether they be big public lab companies, independent lab companies, hospital/health network labs, or private health insurers.
In its strategic assessment of these developments, The Dark Report predicts that one major disruption to the clinical lab market caused by PAMA will be to continue and even accelerate the ongoing consolidation of lab testing within the United States. More smaller labs will disappear and big labs will grow bigger.
The two obvious beneficiaries from an acceleration of lab industry consolidation will be Laboratory Corporation of America and Quest Diagnostics. If events play out consistent with early evidence, in just a few more years the United States may end up with a duopoly in the clinical lab market that is unusual for any industry. The two companies’ duopoly would hold an unprecedented market share of all lab testing done in this country.
The Dark Report’s analysis indicates that LabCorp and Quest will continue to gobble up independent lab companies, mostly because these companies lack the economies of scale to survive on the deep price cuts enacted by Medicare program officials (and copied by their private health insurer counterparts). Thus, these labs will likely sell to the national lab companies. Or, if they simply go out of business, the national labs will end up cherry-picking the best clients of these now-defunct labs.
The first direct consequence is expected to be acceleration in the ongoing concentration of lab testing marketshare in the hands of the nation’s billion-dollar lab companies.
Second Source of Disruption
There is a second source of significant disruption from the PAMA statute and CMS’ implementation of the market price reporting requirement that recent events will trigger.
This disruption will happen as a large number of community hospitals and health systems decide to dump their lab outreach businesses because the PAMA price cuts move their lab’s margins from positive to negative. Quest and LabCorp are the likely buyers for most of these hospital lab outreach programs and Sonic Healthcare would also benefit from this development.
Increased Market Share
Were this to happen, it means that the two blood brothers would be favorably positioned to build their collective national market share of lab test referrals from office-based physicians to a level approaching 80% to 90% or more. After all, what labs would be left serving the patients of office-based physicians if: a) most independent lab companies had sold themselves to one of the big labs; and, b) many of the nation’s hospitals and health systems had also sold their laboratory outreach programs to the billion-dollar lab companies?
This prediction is based on two disruptive developments associated with PAMA that will accelerate what we can call the consolidation of hospital lab outreach testing into the hands of the two national lab companies.
The first disruptive element is the most obvious. Deep cuts to the Medicare CLFS will occur in the six years from 2018 through 2023. That will reduce the revenue that hospitals generate from their lab outreach programs.
Hospitals and health systems see their primary mission as inpatient care and integrated care. If a hospital laboratory outreach program ceases to contribute margin because of the fee cuts enacted by Medicare, it would be a rational strategy for these institutions to exit the lab outreach business. What would add motivation to this decision is the fact that the two billion-dollar lab companies would offer tens of millions of dollars in cash to purchase those lab businesses.
It’s What Big Labs Predict
Indeed, this scenario is regularly touted to Wall Street by executives of the two Blood Brothers. Medicare price cuts are also a primary reason given by the growing number of hospitals and health systems that have publicly announced the sale of their lab outreach programs over the past 24 months.
The second disruptive element that may accelerate the decisions of hospitals and health systems to sell their lab outreach programs is their classification as “applicable labs” for the next data collection cycle of PAMA market price reporting. In its 2019 final rule for private payer lab test price reporting, CMS defines hospitals that bill lab tests with the CMS 1450 14x claims as applicable labs required to report that data.
This presents most hospital and health network CEOs with a big challenge. Their organizations often lack the sophisticated financial systems and analytical tools required to report how much their clinical laboratories were paid for each type of lab test by each payer’s health plan, along with the volume of claims that were paid.
What magnifies this problem is that the PAMA law established penalties of up to $10,000 per day for failure to report, or reporting incomplete or inaccurate information.
Thus, how many hospital CEOs will be willing to devote considerable cash and staff time to collect and prepare data on prices and claims volume for every test for every health plan of every private payer? Will investing money and labor in PAMA price reporting be justified if the price cuts to the Medicare CLFS have shrunk or eliminated the profit margins generated by their hospitals’ clinical laboratory outreach programs?
Taken together, just these two considerations would indicate that a significant number of hospital and health system CEOs would consider it reasonable and good timing to sell their laboratory outreach program. But there is another factor in this decision matrix that must be considered.
Strategies to Deal with Disruptive Forces
WHEN CLINICAL LABORATORIES PREPARE their strategic plans for 2019 and beyond it will be challenging, given that there are multiple disruptive factors at play in the healthcare and lab industries and the pace of disruption is faster than at any time in the past 25 years.
But there is good news. Today, a handful of clinical lab organizations are responding to these challenges by launching innovative lab testing services and collaborative arrangements. These are services and products that quickly help physicians improve patient care and thus earn appropriate renumeration from health insurers, accountable care organizations, and large physician groups.
To help lab administrators and pathologists learn more about these innovative lab testing services, the 24th annual Executive War College on Lab and Pathology Management on April 30 is presenting sessions featuring the leaders of these successful laboratory organizations.
From Health Partners in Minneapolis, Rick Panning, Senior Administrative Director, Laboratory Services, along with a primary care physician, will discuss how the lab is supporting tight integration of care delivery. One effective strategy is to move selected tests for specific healthcare conditions out of the core lab and into the clinic. They will discuss the specific ways these actions are boosting patient care and delivering other benefits.
In Arizona, Sonora Laboratory Services is leveraging its information technology and analytical capabilities to deliver services in healthcare big data/population management, along with products that directly support clinical care. CEO David Dexter will share his lab’s vision for combining lab test data with other types of information in ways that add value—and for which payers will reimburse his lab.
Reducing Risk, Getting Cash
That factor is the willingness of the national lab companies to pay a generous price to buy a hospital’s laboratory outreach program. If a hospital or health network can get millions or tens of millions of dollars in cash for selling the lab outreach program to one of the big public lab companies—and, at the same time, avoid the onerous task of collecting and reporting its lab’s private payer price data (along with the risk of $10,000-per-day federal penalties)—then these are compelling reasons why a substantial number of hospitals and health systems may opt for the strategy of selling their lab outreach programs.
Today, the broad outlines of the disruptive factors triggered by the PAMA law and its implementation are coming into view. But that is not the end of the disruptive elements that will challenge clinical laboratories and anatomic pathology groups in 2019 and beyond.
Private payers will push their own price cuts on clinical laboratories. It is common for health insurers to follow Medicare. Thus, the CLFS price cuts that happened in 2018 and 2019 will be watched and copied by private payers.
Restrictive Coverage Rules
Another disruptive factor are restrictive coverage guidelines for specific tests and the use of pre-authorization involving ever larger numbers of clinical lab tests. Health insurers will continue to narrow networks. Every hospital laboratory outreach program that continues to submit claims using inpatient pricing will be at highest risk for losing network status.
Add to that audits that are tougher and make more use of extrapolation and statistical sampling. Medicare’s use of such audits is well established and many private insurers are going down this same path with their audits.
A disruptive factor that needs a fuller discussion than is possible here is healthcare’s shift from fee-for-service payments to value-based reimbursement arrangements. Health insurers and accountable care organizations (ACOs) are hungry for data and clinical collaborations with laboratories that directly support improved patient outcomes while helping to better manage the total cost of care.
Labs and Big Data
This factor is disruptive because, for labs to succeed in a healthcare system that pays on value, they will need more sophisticated information technology and analytical capabilities. That requires a capital investment at a time when prices labs are paid for tests are declining year after year.
The key point that lab executives and pathologists should take away from this analysis is that 2019 is going to bring serious challenges. Those labs that survive and prosper will think strategically and develop effective responses to each source of disruption.
Contact Robert L. Michel at firstname.lastname@example.org.