CEO SUMMARY: January 1, 2007 can be considered the start of a new epoch in managed care contracting for lab test services. News of Aetna’s decision to favor Quest Diagnostics Incorporated with a five-year contract as its only national laboratory provider shows the direction this new epoch is apt to take. Eventually it may become increasingly more difficult for regional laboratories to renew contracts on favorable terms.
IF NEGOTIATIONS FOR THE NATIONAL LAB TESTING CONTRACT with Aetna, Inc. were round two of the championship fight between the nation’s two heavy-weight lab companies, then Quest Diagnostics Incorporated outsparred Laboratory Corporation of America.
On March 1, LabCorp issued a statement, saying it “will no longer be a contracted laboratory provider for Aetna Inc. (NYSE: AET), effective July 1, 2007.” Later in the day, Aetna acknowledged the contract decision in favor of Quest Diagnostics.
A reporter wrote that Allen Karp, Vice President of Healthcare Delivery for Aetna, had stated that, “Aetna’s decision to change providers is part of a larger effort by insurers to trim costs without impacting the health services they offer. This is an area where we can look at the total costs and use our leverage and size to drive better prices,” Karp said.
In the days following the announcement, LabCorp said Aetna represents under 4% of its annual revenue. With 2006 revenue of $3.6 billion, that means Aetna contributes no more than $144 million per year. By contrast, LabCorp’s revenue from UnitedHealth Group in 2006 was also in the range of 4%, or about $144 million.
Quest Diagnostics now gains an exclu- sive national relationship with Aetna. The contract is for five years, beginning July 1, 2007. Aetna insures just under 16 million members. It is strongest in the Northeast, a region where LabCorp is working intensely to gain major market share from its rival, Quest Diagnostics.
Loss of the Aetna contract complicates LabCorp’s growth strategy. It was hoping to be a network laboratory for all the major health insurance plans in regions such as New York and Philadelphia.
Contracted With All Payers
That way, when it approached physicians currently using Quest Diagnostics or a local laboratory, LabCorp could offer “one stop shopping.” It would mean that the physician’s staff could send all their specimens to LabCorp and would not have to differentiate specimens based on the patient’s insurance plan and the laboratories contracted to serve that health plan.
Quest Diagnostics has countered that strategy by negotiating terms with Aetna that make it the sole national laboratory in Aetna’s provider network. It can be expected that the two blood brothers will negotiate furiously against each when contracts with other national and regional payers come up for renewal. Each lab company will have a goal of negotiating to be a sole source provider. So the negotiations are likely to be intense, and payers are likely to find that, for them, it’s a buyer’s market.
In fact, THE DARK REPORT believes that the 10-year contract between UnitedHealth and LabCorp, which took effect on January 1, pushed the entire laboratory industry into a new epoch for managed care contracting. The five-year pact that Quest Diagnostics signed with Aetna provides us with the first evidence that each of the two blood brothers will negotiate with intensity to gain a sole source contract that excludes their primary competitor.
Hospital Lab Outreach
For independent lab companies and hospital outreach programs, this new epoch can have significant implications for their long-term access to managed care patients. This new epoch is also likely to result in an accelerated reduction in reimbursement for laboratory testing services, even if regional and local labs can preserve access with their community’s major health insurance plans.
If reimbursement declines, it will be because each of the two blood brothers, with their significant economies of scale, are willing to offer rock-bottom pricing to major managed care companies as a way to negotiate a sole source contract that excludes their national competitor. Many of these managed care contracts may also be designed to exclude local lab providers—or put the national laboratory in a preferred position. The lab network that Quest Diagnostics created for Oxford Health Plans, and that LabCorp now manages, is an example of this contract strategy.
Lab administrators and pathologists should recognize that this new epoch in laboratory contracting is a result of changes in the national healthcare marketplace during the past decade. Because of the different marketplace today, new business strategies become both attractive and feasible to managed care companies and the two blood brothers.
Now In Uncharted Territory
LabCorp’s brassy decision to put $200 million on the table for UnitedHealth, on top of other contract concessions, in exchange for a 10-year exclusive contract and UnitedHealth’s commitment to push physicians and patients to comply with network requirements is a case in point. Until now, no other lab company had been willing to introduce this strategy into the managed care marketplace.
The same can be said for UnitedHealth. It is presenting much public evidence that is willing to be tough with physicians who send lab testing out of network. It is also willing to be tough with patients by requiring them to pay significant co-pays, deductibles, and out-of-pocket charges whenever their lab tests are performed by an out-of-network laboratory. Until now, no major managed care plan has used a get-tough stance to pressure physicians and patients to comply in this way.
Not only do the actions of LabCorp and UnitedHealth represent a different attitude about the healthcare marketplace today, but these actions come with risk. Both companies could end up losing more than they gain.
In the case of UnitedHealth, its effort to limit the choice of physicians and patients comes at a time when employers are encouraging their employees to accept high deductible health plans (HDHPs) and Health Savings Accounts (HSAs). By intent, these plans must offer patients a choice of providers. That’s because the goal is to encourage patients to shop for the best value in providers just as they shop for the best value in houses, mortgages, and life insurance. So UnitedHealth’s effort to restrict choice of laboratories comes at the same time that employers are moving to buy health benefit plans that offer more choice.
Triggering A Bidding War
For LabCorp, the risk comes from the potential for its deal with UnitedHealth to trigger a bidding war with Quest Diagnostics each time an important managed care contract comes up for bid. Another risk is that it loses its access to managed care patients because Quest Diagnostics is now motivated to negotiate contracts that exclude LabCorp as a provider.
In the eight weeks since January 1, LabCorp has successfully inked a contract with Horizon Blue Cross Blue Shield of New Jersey that excludes Quest Diagnostics and Quest has signed a contract with Aetna that excludes LabCorp. Not only do these moves illustrate the potential “tit for tat” that may come to dominate contracting for lab services, but they also show that either of the two blood brothers can gain and lose big chunks of business—depending on the outcome of a single managed care contract renewal decision.
THE DARK REPORT advises lab directors and pathologists in local laboratories to take affirmative steps to build their value proposition with important payers within their communities. There are powerful indications that the new epoch in managed care contracting can end up making it more difficult for independent labs and hospital lab outreach programs to retain access and acceptable pricing to the important managed care plans in their markets.
Consolidation Set Up New Managed Care Strategies
CONSOLIDATION IS THE PRIMARY CULPRIT behind the willingness of large managed care companies and the two blood brothers to adopt new business strategies.
Over the past 10 years, consolidation has changed the managed care industry. Now the three largest companies are: WellPoint, Inc. (34 million beneficiaries), UnitedHealth Group (26 million beneficiaries), Aetna (16 million beneficiaries), and Cigna Corp. (9 million beneficiaries). Collectively, these four managed care giants insure 85 million of the 186 million Americans who have private health insurance. (See TDR, July 11, 2005.) This has concentrated the buying power of the nation’s largest health insurers. It motivates them to try new strategies to more actively cut the cost of laboratory testing.
During the same decade, Quest Diagnostics and LabCorp consolidated much of the commercial laboratory sector. During that time, LabCorp has always played “Avis” to Quest Diagnostics’ “Hertz.”
Thus, LabCorp’s bold move to seize the UnitedHealth business on a long-term, exclusive basis is a strategy to disrupt the existing market status quo and hope it can ride the ensuing turmoil to increased market share. That is certainly a valid business strategy. However, it comes with a downside. Anytime a company disrupts its market status quo, the outcome is uncertain. That’s because new forces are set in play—forces which cannot be controlled by any single company.