Reference Pricing’s New Lab Winners and Losers

Which labs will benefit and which will lose if reference pricing were to become widespread?

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CEO SUMMARY: Expanded use of reference pricing by employers in coming years could trigger a cycle of cuts to lab test prices that would put the most pressure on the lab companies with the highest prices. Many hospital labs are viewed as having high prices. But because they run outreach specimens in the evenings and thus have a low marginal cost per test, they could choose to reduce prices to remain competitive while still producing acceptable profit margins for their parent hospitals.

BECAUSE ONLY A FEW LARGE EMPLOYERS currently use reference pricing as a way to cut the price of clinical laboratory tests, it is difficult to predict how fast this healthcare cost-control strategy will catch on among big employers and health insurers.

However, if employers and health insurers do expand use of reference pricing for clinical laboratory tests, then one consequence for the lab industry will be the creation of new winners and losers.

High-Priced Labs at Risk

It doesn’t matter whether the use of reference pricing to put downward pressure on lab test prices expands rapidly or goes forward at a measured pace. What will prove true is that clinical laboratories with higher prices will need to reduce their prices or accept less test volume.

The lab industry has plenty of experience with the consequences of sustained declines in lab test reimbursement. A major shakeout results. This happened in the mid-1990s when closed-panel HMOs used full-risk, capitated managed care contracts to win rock-bottom lab test prices. Facing a significant reduction in their reimbursement, a large number of independent lab companies either sold to a public lab company, merged with a regional lab, or went out of business.

Another cycle of price-cutting in recent years has squeezed many laboratories, particularly hospital lab outreach programs. In this cycle, managed care companies used three strategies to cut the cost of lab testing. One strategy was to use narrow networks to simply exclude higher-priced laboratories.

The second was to negotiate provider contracts that arbitrarily reduced the price paid for lab tests. The third strategy was to create a preferred provider panel and require patients to pay the full cost of the service if they used a non-panel provider.

The consequences of these actions over the past years can be seen in the decision by some hospitals and health systems to sell their lab outreach programs because of diminished profitability. In some cases, these outreach labs had made money for their owners for decades.

Whether High-Ticket Surgeries or Lab Tests, Reference Pricing Encourages Patients to Save

EARLY EVIDENCE INDICATES that reference pricing is to be a powerful tool that employers and payers can use to exert downward pressure on lab test prices. This potential is documented in a growing number of studies published in peer-reviewed journals. These studies document the ability of reference pricing to encourage patients to price-shop for healthcare services and select low-priced providers over higher-priced providers.

These studies include the example of CalPERS using reference pricing to drive down the price of joint replacement surgeries and similar high-ticket procedures in California in the years 2011 and 2012. This effort got national publicity at the time it was announced and again when the results were published. In the first 12 months of the program, CalPERS experienced a 30% reduction in the prices of these surgeries, while its patients got the same quality of care as employees in the control year. (See Strategy Lowers CalPERS’ Price of Joint Surgeries.)

But what has the greatest relevance for lab executives and pathologists is the study of reference pricing for clinical laboratory test prices published in JAMA Internal Medicine. That study is the subject of this issue of THE DARK REPORT.

Every lab manager should understand the path Safeway followed. Its use of reference pricing was simple and easy to understand for its employees. The study provides a road map that other major employers and health insurers can follow.

The financial outcomes from Safeway’s use of reference pricing will entice other employers to initiate similar programs. Consider the savings: in a reference pricing program involving 15,000 Safeway employees, it took only three years to cut the prices paid for lab tests by 32%! Total savings were $2.57 million in 36 months. The savings were divided between Safeway ($1.70 million, 59%) and its employees ($1.05 million, 41%).

Substantial Savings

Looked at in another way, for each employee, Safeway and that individual paid an average of $171.33 less in lab test costs over the three years of the study (or an average cost reduction of $57.11 per employee per year). These are substantial savings for a healthcare service that typically makes up 3% to 4% of an employer’s annual healthcare costs.

Another element will make it easier for other employers and health insurers to implement their own reference pricing programs for clinical laboratory tests. Companies such as Castlight Health have large databases to identify price-cutting opportunities. They also have the mobile apps and website services that allow patients to compare prices and select lower-priced providers, including labs. (See Castlight Health’s Data Should Concern Lab Execs.)

Now the arrival of reference pricing provides employers with a new strategy to reduce the price of lab tests. As this happens, it will further aggravate the existing poor financial environment, particularly for those labs with the highest test prices.

The labs most vulnerable to revenue and volume erosion as a result of employer use of reference pricing are hospital labs and hospital lab outreach programs, specifically those labs that continue to use inpatient pricing on their lab test claims. Because of this high-price strategy, some hospital lab outreach programs generate net collected revenue that produces an average revenue per requisition that is double the $40 to $50 per requisition of commercial lab companies.

Employers will want to use reference pricing to make patients aware of high test prices. Some hospital labs using inpatient prices have test prices that may be up to 20 times more than the lowest-cost labs. These labs could experience a significant reduction in both revenue and specimen volume.

For these hospital labs to retain their outreach business, they would have to be smarter about their pricing decisions. However, these labs do have a card they can play to improve their price competitiveness. Because these tests are generally run in the evening, hospital labs actually have a low marginal cost per test that would allow them to be competitive using prices nearer to the market level.

Will There Be Winners?

Most lab professionals would believe that Laboratory Corporation of America and Quest Diagnostics Incorporated are positioned to benefit from reference pricing programs. That’s because each has among the industry’s lowest average cost per test.

But success in an era of reference pricing will not be automatic. The Achilles heel of LabCorp and Quest Diagnostics may be their payer mix. It is widely-believed that the two companies offer prices for routine, high-volume tests at or below cost to their biggest managed care customers. These losses are offset, in large part, by revenue from Medicare Part B test claims.

Prices at LabCorp and Quest for their reference and esoteric tests also have better profit margins. Another higher-priced part of their payer mix are tests sold to patients paying cash or who have high-deductible health plans and are out-of-network. What is unknown is how much revenue erosion in these portions of their payer mix might occur if employers implemented reference pricing programs that set the upper limits for prices at the current amounts of the Medicare Part B Clinical Laboratory Fee Schedule.

The one prediction that can be made with confidence is that, going forward, clinical laboratories with the highest prices will be under the most pressure to lower those prices. These labs are at greatest risk of losing revenue and volume.

Perfect Storm May Be Heading For Clinical Lab Industry

LOOKING INTO THE FUTURE, the lab industry may soon need to weather a perfect storm which brings together multiple forces, each of which causes cuts to lab reimbursement and pushes down lab test prices.

If this turns out to be the mother of all financial storms for the lab industry, then the most powerful force will be the Medicare program. CMS officials are ready to implement PAMA lab test market price reporting on January 1, 2017. The market data reported by certain labs will be used to establish new Part B clinical laboratory test prices that would become effective on January 1, 2018.

Expectations are that CMS will implement price cuts to the maximum allowed by the PAMA statute. That would be cuts of 15% each in 2018, 2019, and 2020; followed by cuts of 10% each in 2021, 2022, and 2023.

Another force pushing its way into the perfect storm would be expanded use by employers and health insurers of reference pricing. If these programs generated comparable results to those experienced by Safeway, then employers might enjoy a 30% reduction in the prices they pay for lab tests in just a few years. It will be the highest-priced labs that take the biggest financial hit from these reference pricing programs.

Of course, other, more modest forces will feed into the perfect storm. In the years to come, employers and payers will continue to use narrow networks, restrictive coverage guidelines, and outright price cuts to their lab test fee schedule to push down test costs. These time-tested tools will continue to be deployed.

Add up all of these forces and it may make old-timers in the lab business wish for the good old days of HMO capitated, full-risk contracts for lab testing services.




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