From Modest Beginnings, Two Lab Networks Find Success

Newsmaker Interview - Part One Of Two Parts

“For 20 years, our regional laboratory network here in Detroit has played an important role in helping member hospital laboratories build their lab outreach programs.”

—Jack Shaw, Executive Director, Joint Venture Hospital Laboratories

CEO Summary: During the 1990s, hospital laboratories in Detroit, Michigan (1992), and Seattle, Washington (1996), banded together to form regional laboratory networks. In both networks, one primary goal was to protect and expand access to managed care patients by contracting with health insurers as a single entity that offered regional coverage. Now, almost two decades later, each regional laboratory network is prospering. In this exclusive two-part interview, THE DARK REPORT brings together the executive directors of both networks to discuss the reasons why their respective networks have lasted two decades, along with useful lessons learned about managing regional lab networks.

Part One of Two Parts

INTRODUCTION TO INTERVIEW: One hot lab industry trend during the mid-1990s was regional laboratory networks (RLN). In many communities across the nation, local hospital laboratories decided to organize a collaborative network.

The regional laboratory network trend turned out to be relatively short-lived, with a few notable exceptions. One such exception is found in Detroit, Michigan, where Joint Venture Hospital Laboratories Network (JVHL) has helped its member hospitals and health systems maintain dynamic and growing laboratory outreach programs for almost two decades.

Another exception is PACLAB Network Laboratories, a thriving regional laboratory network based in Seattle, Washington. It was founded in 1996 and has grown into one of the larger clinical laboratory organizations in the Seattle- Tacoma metro area.

Both regional lab networks are power-houses in their service area. For example, JVHL has 128 hospital labs in a network that covers the entire state of Michigan, and spills over into several neighboring states. It holds 23 managed care agreements covering 2.8 million members for outpatient and physician office laboratory services.

It is a similar story for PACLAB, which became operational in 1996. It combines the resources of five of the region’s most established health systems and hospitals. That allowed PACLAB to form Washington’s only statewide laboratory system. Like JVHL, PACLAB holds a number of important managed care contracts, covering several million lives.

Integration and shared effort is a major factor that contributes to the success of these regional laboratory networks. By integrating aspects of the lab testing services of their respective hospital laboratory members, both regional laboratory networks are able to deliver added value to physicians and payers in the community. Moreover, these added value services would be expensive and difficult for any member laboratory to offer by itself.

To unlock the secrets behind the success of these two regional laboratory networks, THE DARK REPORT recently interviewed their executive directors. It was a no-holds-barred session, full of can- did insights on the challenges of operating a regional laboratory network.

Jack Shaw is the Executive Director of JVHL. He was present at the birth of this network in 1992 and has guided this organization since that time. At the time that PACLAB was formed in 1996, Stu Adelman was present. He served as PACLAB’s Executive Director from that time until July 2011, when he resigned to accept an executive position at another laboratory organization in the Seattle metro.

Together, these two individuals represent 35 years of experience in managing a regional laboratory network. They carefully guided their lab networks through the tumult of the 1990s, when HMOs and full-risk, capitated contracting significantly eroded reimbursement of lab testing services. Throughout the 2000s, both lab networks continued to evolve in response to new market developments.

In part one of this two-part interview, Adelman and Shaw discuss the ups and downs of creating a functional regional laboratory network. They reflect on the elements that contributed to the sustained financial and clinical success of their respective lab networks. In part two of the interview, Shaw and Adelman identify the lessons learned from their combined 35 years of lab operations. They also offer candid recognition of circumstances that, if handled differently, would have increased the success of their respective regional laboratory networks. —Editor

The Interview:

EDITOR: Gentlemen, each of you has unique perspectives on the management and operation of regional laboratory networks that stretches back 20 years for you, Jack; and 15 years for you, Stu. Would you start by describing the important differences between JVHL and PACLAB?

SHAW: JVHL’s core membership involves five health systems in the Southeast Michigan market area that operate a total of 20 hospital laboratories. As many as 126 hospital laboratories participate in its various managed care contracts. The primary mission of JVHL is to provide access to managed care plans in this region. It handles contract negotiations and manages the relationship with each health insurance plan. JVHL receives payments from payers and disburses these receipts to the member laboratories. It also pulls together utilization and results data and other information from member labs that must be assembled and submitted to the different health plans on a regular basis.

ADELMAN: PACLAB is currently comprised of 13 hospital laboratory members. The general manager of PACLAB is Pathology Associates Medical Laboratory (PAML). From its inception in 1996, PACLAB’s primary purpose has been to create and manage all aspects of a laboratory outreach program. PACLAB’s sales reps call on office-based physicians around the campus of each member hospital laboratory to win new business. PACLAB also handles all aspects of managed care contracting for the network and its member labs. Outreach revenue is off-set by the network’s costs and the remaining funds are distributed regularly to the member hospitals.

EDITOR: Has PAML’s role in providing management services to PACLAB given this lab network more corporate business expertise than what is available to JVHL? I know that PAML provided the working capital and management resources needed to develop standardized testing across all labs in the network, along with helping to build a single, integrated lab informatics capability.

JVHL was started with limited operating capital and operates on a no-frills budget.

–Jack Shaw

SHAW: That is one major difference. JVHL was started with limited operating capital and operates on a no-frills budget. Our operating budget of just over $2 million per year drives $100 million in annual healthcare spending in Michigan. We want to operate as inexpensively as possible so that every possible penny can be sent back to the hospitals participating in JVHL. By operating in this manner, we have steadily grown into a substantial business.

ADELMAN: You are correct, Jack, in that PACLAB has a much larger operating budget. We also have a unique distribution model where we pay our member hospitals in three different ways. First there is an infrastructure-based reimbursement that reflects the operational costs incurred by each member from its participation in PACLAB. There is reimbursement for whatever a member lab puts in, including specimen processing, phlebotomists, couriers, and the like. That is about a third of PACLAB’s costs and there is a percentage for margin.

EDITOR: What about the second and third source of payment to members of PACLAB?

ADELMAN: The second way is marginal test cost reimbursement. For each test that a member lab performs, it is paid based on a discounted fee schedule plus a percentage for margin. The third way involves the profit sharing portion that is returned to each PACLAB member on a regular basis. Because PACLAB operates an effective laboratory outreach program—including an ongoing and aggressive sales and marketing campaign—it incurs more administrative and operational costs than JVHL. These are significant differences that make it difficult to directly compare PACLAB and JVHL.

EDITOR: It is interesting that, whereas PACLAB operates as a consolidated and standardized lab outreach program active on all the campuses of its member hospitals, JVHL has just a few full time employees over the past 20 years and has not provided a sales force in the field to help JVHL member labs increase their share of the lab outreach market.

SHAW: That is an important distinction. JVHL never sells directly to office-based physicians. Our member hospital labs do their own outreach sales and marketing. Rather, JVHL sells its network as a single solution to health plans and managed care companies. That has always been a large part of what I do. We let each of JVHL’s 128 hospitals manage their own territories by giving them the tools to service the various managed care contracts. The contracts negotiated by JVHL are door openers for the sales reps of our member labs.

EDITOR: Jack, what lessons has JVHL learned about managed care contracting with payers in Detroit and across Michigan?

SHAW: In its early years, JVHL gave its member labs a quiver full of exclusive payer contracts. Over time, we migrated away from that exclusivity strategy because we believed our member hospital labs could compete effectively against the commercial lab companies.

EDITOR: Was there any trade-off from this change in strategy?

SHAW: Yes! Once we decided JVHL did not need to have only exclusive managed care contracts on behalf of our member labs, it meant we did not have to be so willing to offer payers only substantial discounts to get contracts. We do our contract negotiations on incremental cost structures because that makes us able to compete with the commercial labs, but introducing non-exclusive contracts allowed JVLH to increase the revenue per test that it generates for the hospitals.

ADELMAN: This was done differently at PACLAB, because our network had very few contracts. In fact, the only major contract we had was with Regence, the Blue Cross company in Washington. Back in 1996, that was the contract that kicked PACLAB into start mode, since hospital labs believed Regence was going to accept only one bill from one provider. That motivated the members of PACLAB to get together. As PACLAB grew and evolved, it used the member labs’ contracts that they had through the hospital and that hospital’s billing ID number. One hospital might have had much better terms for its lab outreach program than another—but PACLAB took it all, whatever was available. It was eight hospital labs that came together in 1996 to finalize this network agreement with PACLAB that, among other things, allowed PAML to bill on their behalf.

EDITOR: Stu, your story about events in Washington in the mid-1990s is similar to what was unfolding in Detroit at about the same time. Jack, wasn’t JVLH created specifically to allow its member hospital labs to participate with managed care contracts in Detroit?

SHAW: Yes. In fact, the health plan owned by four Detroit health systems was preparing to grant a sole-source lab outreach contract to a commercial lab. At the time, this health plan—rather than work with its owner hospitals’ labs—said it was proceeding with its intention to issue a sole-source lab outreach contract.

EDITOR: So JVHL came together because the four health systems wanted their laboratories to continue to provide lab testing to this health plan, is that true?

SHAW: Yes. Therefore, it was necessary to form JVHL so it would look and act as a “single laboratory” across the plan’s market region. JVHL would consolidate all claims submitted by the four health systems as required by this health plan and handle it as a single claims and reimbursement stream. JVHL was required to manage all operations under this contract and accept capitation (which was distributed equitably to member labs). Essentially, JVHL came into existence to look like a large commercial lab company.

EDITOR: How receptive was the health plan to this regional laboratory network strategy?

SHAW: They were willing to talk to us. We presented the regional lab network plan to this health insurer and convinced it to take a chance on us. That was a big step on the plan’s part because JVHL had no history to show that it could fulfill the expectations of this payer. But we were given a one-year contract to prove ourselves. It was the jump start to JVHL.

EDITOR: How did this first managed care contract help JVHL?

SHAW: By the end of the first year, it was clear that the regional laboratory network was functioning and that other hospital laboratories were interested in joining JVHL. That was when we developed a strategy to compete effectively against the commercial labs in our market. Within four years, we had contracts with four other health plans.

EDITOR: What came next?

SHAW: In 2000, we had the opportunity to enter into a statewide contract. But to do that, it was necessary for JVHL to expand to 100 or more hospitals so that our network would have the access required by this health insurer. Once we had a statewide network, we started filling in the gaps. Today, JVHL holds 123 contracts with 128 hospitals. JVHL restricts its managed care contracts only to the contracts that hospitals can’t negotiate for themselves. We have local and regional contracts, and we have contracts with all the national payers in our market, including Cigna, Aetna, and UnitedHealthcare.

EDITOR: In addition to the primary function of managed care contracting, what else has JVHL done?

SHAW: Creating a statewide service net- work was a major milestone. JVHL is now actively building an interfaced informatics platform so it can move into what we call the information decade of our existence.

EDITOR: Stu, are there similarities in the PACLAB story, given what happened in Washington when PACLAB obtained a contract with Regence Blue Cross at the time of PACLAB’s founding in 1996?

ADELMAN: Having an important managed care contract was a jumpstart for PACLAB as well. PACLAB also benefited from PAML’s business and sales expertise at the time it was founded. PAML had a professional sales team that, from the outset, helped to drive the outreach success of PACLAB.

EDITOR: Isn’t there a bit more to this story of PACLAB’s launch?

ADELMAN: That is true. PAML is owned by Providence Health and the Providence hospitals agreed not to compete in Western Washington—meaning the Seattle/Tacoma area. That would be PACLAB’s turf. By offering PAML’s sales team and billing resources to PACLAB, the Providence hospitals took a significant step in helping PACLAB launch operations and quickly become profitable.

EDITOR: You mention that PACLAB had access to PAML’s billing expertise. Why was that useful?

That success allowed us to add additional hospitals over time because the hospital administrators aw that lab outreach was profitable. It put their lab in a completely different focus.

–Stu Adelman

ADELMAN: In general, hospitals—at least those in Washington—do a poor job of collecting the numerous small bills that are a large part of outreach lab test billing and collections. Basically, hospital billing departments tend to write off those lab bills. By using PAML’s billing depart- ment, PACLAB was able to collect a high proportion of those small lab test bills.

EDITOR: What other factors came into play?

ADELMAN: There was another problem that PAML helped PACLAB overcome. Not surprisingly, at the beginning, members were a bit wary of each other. There was also a thought that, maybe PAML, as PACLAB’s general partner, eventually wanted to take over their lab businesses. However, over time, PAML’s CEO, Thomas Tiffany, Ph.D., consistently acted in the best interest of the PACLAB network, even leaving money on the table at times. That was significant in those early days because people saw how Dr. Tiffany put the network first and trust started to grow.

EDITOR: How long did it take for PACLAB to produce revenue and positive operating margins?

ADELMAN: That was the other factor that helped establish trust among the PACLAB members and PAML. Even in the first year, the PACLAB hospitals had significant cash distributions from our regional laboratory network. In other words, after those cash distributions in the first year, the member hospital CFOs saw that laboratory outreach testing could be profitable when it was run and billed professionally. With that, each member’s hospital laboratory went from being an expense center to being a revenue generator.

EDITOR: What was the next chapter in the PACLAB growth story?

ADELMAN: Not surprisingly, the financial success of PACLAB was quickly noticed throughout Seattle. That success allowed us to add additional hospitals over time because the hospital administrators saw that lab outreach was profitable. It put their lab in a completely different focus.

EDITOR: How do you mean? What changed within these hospitals?

ADELMAN: Once hospital administration saw the financial and clinical benefits of their laboratory and its role within PACLAB, thereafter, when the lab needed instrumentation or staff, they got it. Having PACLAB checks come in every month changed the whole philosophy of how the hospitals viewed their labs.

EDITOR: Did the governance structure of PACLAB play a role in this, as well?

ADELMAN: Definitely. PACLAB’s structure directly contributed to our success. At each member hospital, the CEO, CFO, and the lab administrator were engaged in the entire operation. Because these leaders helped to make decisions about PACLAB’s strategy and business operation, they were part of the process that led to our success.

EDITOR: This is a key point, since many pathologists and clinical lab administrators regularly grumble about the fact that the administration of their parent hospital or health system does not recognize the value of the laboratory. My question for Jack is this. How did JVHL educate and involve the administration of its member hospitals?

SHAW: The governance and operation of JVHL was and is primarily supported by the administrative directors of labs or— one step up—the VP for ancillary services. JVHL learned early that it was important to have a pathologist from its core hospitals at the table. While pathologists may not always have the business acumen of the hospital administrators, they add important insight and input. Further, it has been a pathologist who has served as chair of JVHL’s Executive Committee for the past 15 years and they have been good businessmen.

EDITOR: Were pathologists in Detroit supportive of JVHL as a clinical lab testing network?

SHAW: That answer is an easy “yes!” Early on, it was the pathologists who helped convince the hospital administrators that there was a good business opportunity in lab outreach.

ADELMAN: I would like to ask Jack about JVHL’s approach toward building the lab outreach business of its member hospitals. Was there a specific strategy and how did it differ from our PACLAB model, which used sales reps employed and managed by PACLAB to win new clients for the member hospitals?

SHAW: That is a good question and strikes to the heart of our different strategy. In contrast to PACLAB, JVHL did not try to assume responsibility for the sales and marketing of a member hospitals lab outreach business. JVHL concentrated on pieces of the lab outreach business with which we believed the hospitals did not historically have success. Negotiating and servicing managed care lab outreach contracts was our primary focus. JVHL does all the managed care contract billing and has developed a very sophisticated reimbursement operation to support the contracts.

EDITOR: Does JVHL handle the entire lab outreach billing for member hospitals, or just the managed care contract billing?

SHAW: While JVHL could handle the out- reach billing operations of our member our member hospitals (and we might be able to improve on their collection experience—particularly for the smaller claims), JVHL concentrates on the billing of its managed care contracts’ claims.

EDITOR: What type of claims volume does JVHL handle currently?

SHAW: At this time, we handle about 400,000 claims a month and each claim is for a managed care contract that is held by JVHL. This claims volume represents about 30% to 35% of the total lab out- reach business of our member hospitals. That statistic shows the importance of JVHL’s managed care contract strategy in aiding our members to build the size and revenue volume of their individual lab outreach programs.

EDITOR: Jack and Stu, we will need to stop here. Thank you for sharing the insights about the creation and the strategic goals of your regional laboratory networks. In part two of this interview, we will explore the insights and management lessons learned that other hospital and health system labs can apply to their own outreach testing programs.

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