Expect Changes in How Calif. Labs Set Test Prices

With hundreds of millions of dollars at stake, California healthcare regulators are acting tough

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CEO SUMMARY: What a difference two years makes. Back in April 2009, when then-Attorney General Jerry Brown joined the whistleblower lawsuit alleging that seven or more California lab companies had violated state law on pricing provider services, the popular wisdom among lab executives was that this case was going nowhere. Now, in recent weeks, the nation’s largest lab has disclosed an “understanding” with California officials that includes a settlement of as much as $241 million.

FOR MORE THAN 20 YEARS, deeply-discounted laboratory test prices have been an oft-used sales strategy for many lab companies in California. Now it appears that two state government enforcement actions may soon change how laboratories set prices for lab tests in the Golden State.

As this happens, several things are likely to occur. First, state officials may end up collecting several hundred million dollars from the different laboratory companies that are targeted by these two state enforcement actions. One of the nation’s two largest lab companies issued a press release last month and disclosed that its negotiations with California healthcare regulators involve a possible payment to the state of $241 million.

Second, last year’s settlement agreement between Westcliff Medical Laboratories, Inc., and the California Department of Health Care Services (DHCS) should be considered a template for the terms that DHCS officials probably want as they negotiate settlement agreements with other laboratories. In this agreement, there was a requirement for Westcliff to regularly audit the prices it charged its clients compared to the prices it charged Medi-Cal.

If it identified instances where a client got a lower price for an assay than what the lab billed Medi-Cal for the same assay, Westcliff was to refund the difference back to Medi-Cal. This policy is consistent with DHCS’s interpretation of the state law on pricing.

Two Schools of Thought

Third, there is uncertainty as to how laboratories may decide to price lab tests in California once the state’s Attorney General and DHCS officials have completed these enforcement actions. There are two schools of thought on this matter.

Some lab executives point out that, if the DHCS’s interpretation of the state statute on pricing prevails, then most laboratory companies would raise all laboratory test prices to at least equal the Medi-Cal lab test fee schedule. Were this to happen, profits at these laboratories would increase.

On the other hand, there are also those who speculate that larger lab companies may choose to continue offering deeply-discounted prices to certain customers and only for specific tests. These lab companies would then charge Medi-Cal the same low prices for those assays as their most favored clients in order to comply with DHCS’s interpretation of state laws.

Lab executives who describe this scenario also make the point that public lab companies have generally been willing to use marginal cost pricing to capture market share. So why would these lab companies enforce price discipline on themselves now if they believed that offering deeply-discounted pricing to selected customers while giving those same low prices to Medi-Cal could help them win and keep extra market share?

Media Have Not Done Stories

So far, the media in California have paid little attention to the wider public policy implications of the whistleblower lawsuit and related enforcement actions by DHCS. There has been no media investigation into how and why the DHCS’s enforcement actions might cause patients, physicians, and health plans to pay significantly more money for laboratory tests. That would be an unfavorable public policy outcome.

Another interesting issue involves how DHCS has suspended Medi-Cal payments to Quest Diagnostics Incorporated, under a six-month agreement that expires on March 1, 2011. At the same time, Quest Diagnostics continues to provide testing to Medi-Cal patients.

This summer, Medi-Cal suspended payments to as many as 30 laboratory companies for what it alleged to be violations of state law on pricing for lab services. However, within weeks it restored payments to these lab firms while settlement talks con- tinued. (See TDR, December 17, 2010.)

Thus, what are the policy issues that caused state officials to handle Quest Diagnostics differently than the other laboratory companies which received suspension letters from DHCS, but later had their Medi-Cal payments restored? The state is not saying.

DHCS Also Audited LabCorp

On this point, Laboratory Corporation of America has publicly stated that it responded to a DHCS audit during third quarter. Like Quest, LabCorp “believes that it has properly charged the Medi-Cal program under all applicable laws and regulations.” It has similarly denied the accusations.

Quest has announced that DHCS suspended payments to it for Medi-Cal lab test claims. On the surface, it appears that DHCS is treating Quest Diagnostics differently, compared to other laboratory companies operating in California.

Some lab executives in the Golden State have suggested that DHCS’s approach toward the nation’s largest laboratory company may be a sign that the “too big to fail” principle is operative. They observe that DHCS cannot afford the negative publicity were its enforcement actions against laboratory companies in the state to disrupt healthcare services.

Further, because Quest Diagnostics holds such a dominant market share in California, laboratory executives believe that state healthcare regulators want to settle that case in order to establish a precedent. That settlement agreement would then establish the parameters that DHCS would use in its negotiations with other clinical laboratories.

Court Dates Grow Near

With the nation’s largest laboratory company disclosing an “understanding” with the nation’s most populous state and mentioning a number of $241 million, it would appear that California’s healthcare regulators are holding strong cards at this moment. Also helping the state is the fact that trial dates for the two blood brothers are set for later in 2011. At trial, if they did not prevail, these lab firms would face the risk of treble damages and up to $10,000 for every one of the millions of Medi-Cal claims involved in each case.

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