CEO SUMMARY: Consolidation of the healthcare industry may be continuing, but the process is not profitable for some of the country’s largest corporations. Clinical laboratories will continue to be impacted by the financial fortunes of these major players. Here’s why the troubles at MedPartners and Aetna/U.S. Healthcare presage more financial pressure.
TWO MAJOR COMPANIES in the healthcare industry made major announcements last week. Their activities reflect the impact of ongoing consolidation to healthcare services.
The most unexpected news came from MedPartners Inc. of Birmingham, Alabama. The physician practice man- agement (PPM) company reported a fourth quarter loss of $840.8 million.
For laboratory executives, the reasons given for the loss are most instructive. Write-down of goodwill related to acquisition of physician practices is a major portion of the loss. Goodwill is the difference between the asset value of the business and the actual price paid for the business.
Because MedPartners is writing down such a large amount, this is evidence that it either overpaid for the doctor’s business at the time of acquisition, or the subsequent financial performance of the practice was significantly less than expected.
This was exactly what commercial laboratories experienced during the acquisition binge of the 1988-1994 period. Goodwill was a substantial amount of each laboratory acquisition. When the acquiring laboratory failed to retain significant portions of the acquired business, they were eventually forced to write down huge amounts.
Similar Write Downs
Within 90 days of each other in early 1997, Quest Diagnostics Incorporated wrote down $445.0 million, Unilab, Inc. wrote down $70.2 million, and Physician Clinical Laboratories wrote down $36.3 million. This was 43.2%, 35.6% and 41.0% respectively, of the laboratories’ balance sheet intangibles. Laboratory Corporation of America has more than $800 million of intangibles, but has yet to announce a similar write down. (See TDR, April 21, 1997.)
MedPartners’ write-down of good-will was accompanied by another revealing fact: clinic expenses soared 71% in 1997, from $706 million to $1.21 billion! Overutilization at its clinics in southern California was claimed to be a contributing factor.
Within days of MedPartners’ disclosure, Aetna, Inc. announced that it would purchase the managed healthcare operations of New York Life Insurance Co. for as much as $1.35 billion. New York Life Insurance is exiting healthcare to concentrate on its core businesses of life insurance, annuities, and asset management.
Aetna Becomes Bigger
Aetna will add 2.2 million customers to the 13.7 million it already serves. New York Life’s healthcare business is known as NYLCare. Its biggest HMOs are in Washington, D.C., Houston, and Dallas. It also has HMOs in Illinois, Maine, New Jersey, New York, and Washington. Aetna intends to operate the larger HMOs within NYLCare on a freestanding basis during the near future.
The decision of Aetna to acquire more healthcare assets concerns many financial analysts. Aetna reported a significant loss for 1997. It has struggled to integrate its regional operations with those of U.S. Healthcare, which it purchased in 1996.
For clinical laboratories, Aetna’s acquisition of NYLCare further concentrates the buying clout of Aetna. An RFP process for laboratory ser- vices has been under way at Aetna for some time. Announcement of the laboratory providers for Aetna/U.S. Healthcare is expected in the near future. A limited or exclusive provider panel will affect regional and hospital laboratories in many cities around the United States.
Taken together, the announcements by MedPartners and Aetna reveal that consolidation of healthcare is continuing. But the process of consolidation is creating financial challenges to which no effective solutions are known.
The clinical laboratory industry was the first in healthcare to undergo widespread consolidation. The abysmal financial performance of publicly traded laboratories during the years 1995-96-97 is well-known. Between posted losses and government fines paid in the “Lab Scam”? investigation during those years, the clinical laboratory industry bled almost $2 billion of red ink.
Although the clinical laboratory industry was first to undergo widespread consolidation, the process continues within other healthcare segments. Activity seems to be concentrated primarily among hospitals, physicians and insurance plans. The diagnostics industry has yet to see extensive consolidation, but it will occur.
The key lessons to be learned from the experience of MedPartners and other PPMs is that large size does not automatically translate into success. Healthcare is still a local business. National solutions cooked up in a corporate headquarters thousands of miles away have yet to prove they can make money in local markets.
If size does not guarantee financial success, then Aetna’s acquisition of NYLCare may prove to be unprofitable. That would be bad for clinical laboratories. If health insurance companies are unprofitable, then it is difficult, if not impossible, to raise reimbursement levels for clinical laboratory services.
It is important for laboratory executives to understand the dynamics of the healthcare marketplace. Even as the three national laboratories struggle to regain financial stability, there is a window of opportunity for nimble regional competitors to increase their market share in that community.
But such sales and marketing activity is going to have to take place with the knowledge that insurance plans are struggling to make money. They are going to want to reduce current levels of laboratory reimbursement. That is why it is critical to keep an eye on the national healthcare market while competing at the local level.