Labs Can Be Misguided by Pull-Through Test Myth

Popular wisdom of the 1990s caused a precipitous decline in reimbursement

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CEO SUMMARY: For the first time in almost eight years, there are major disruptions to the status quo in managed care contracting for laboratory testing services. As was true in the 1990s, national lab companies are pursuing exclusive national contracts with the nation’s largest health insurers. In the 1990s, a similar competitive battle triggered a price war with disastrous consequences for the entire laboratory industry.

IT WAS DURING THE 1990S that the myth of pull-through business took the laboratory industry down a path of financial disappointment, if not financial disaster.

Now that the two blood brothers have upset the status quo in managed care contracting that existed for almost eight years, some labs have begun to again consider pull-through as part of their managed care strategy. For that reason, it is timely to review the corrosive effects visited upon the laboratory industry by application of the pull-through scheme during the 1990s.

Will Docs Split Specimens?

Pull-through was a business concept based on this simple assumption: We want to be the exclusive laboratory provider for the HMO. Because we are the exclusive provider, physicians won’t want to take the time each day to split laboratory specimens between more than one laboratory. Thus, if we hold this HMO contract, we will “pull through” the physicians’ non-HMO lab testing business, particularly the private pay and Medicare fee-for-service work.

Circa 1990-1992, as the earliest HMO contracts for lab testing services were negotiated in different regions across the United States—often with a single winning laboratory holding exclusive access— capitated pricing and full-risk utilization were often part of the terms. Capitated pricing was one reason these contracts represented a significant reduction in laboratory reimbursement when compared to typical fee-for-service arrangements.

However, many national and regional laboratory companies exaggerated these reimbursement reductions by bidding the HMO capitated contracts at prices based on the marginal cost (reagents and med tech labor) of high volume routine testing.

Why were they willing to bid a price that was below their fully-loaded cost of performing a test? It was because of the pull-through myth. That myth was simple, and went like this: “If my laboratory is the exclusive provider for this HMO, then the physicians will not want to split specimens between different labs. Thus, by winning this HMO contract, my lab will ‘pull through’ all the fee-for-service work, including Medicare specimens. The cumulative revenue from the pull-through, fee-for-service testing will be great enough to offset the money my lab loses on the HMO specimens and generate an overall net profit for physician referrals tied to the HMO contract.”

That idea became the popular wisdom in the laboratory industry. For a long time, it was accepted at face value. Plus, if a lab company saw a competitor using marginal cost pricing to win an HMO contract, it was likely to copy that strategy, under that assumption that “they must be doing it because it makes them money.”

Popular Wisdom Was Wrong

However, the reality proved much different than the popular wisdom. In many regional markets, physicians proved will- ing to split specimens in order to continue using their primary laboratory. Thus, the lab holding the HMO contract was often stuck performing tests only for HMO patients at a loss, because the physicians continued to refer non-HMO specimens to their primary laboratory.

More importantly, belief in pull-through as a justification to bid marginal cost pricing for HMO contracts caused laboratory reimbursement to go into a free fall. Two examples illustrate this situation.

Competition for exclusive HMO contracts was probably most intense in California. Not only were there many HMOs, but IPAs (independent physician associations) were also contracting for lab testing services. Capitated rates of 50¢ to 60¢ per member per month (PMPM) were common in the mid-1990s.

Capitated pricing in this range was a huge reduction in reimbursement for lab testing services. In 1993, during my tenure at Nichols Institute, an IPA with 5,000 lives in San Diego asked us to renew the lab testing contract with them at the then-prevailing capitated rate of 55¢ PMPM. Because it was a contract renewal, Nichols had utilization data from the previous years. It had been paid $220,000 under its fee-for-service contract the prior 12 months. If it accepted the 55¢ PMPM capitated price for the coming year, it would have received about $33,000 for the same services. That’s a reimbursement decline of 85%!

But, among lab executives of that time period, the belief in pull-through business to offset the loss-leader contract pricing was unshakable. Later in 1993, Nichols Institute bid 24¢ PMPM for an integrated delivery system’s health plan business. It lost that contract to Unilab, which offered a bid of just 19¢ PMPM!

So there was a feeding frenzy of laboratory sharks bidding for HMO business at the front end. The sad lesson was realized on the back end, when victorious labs learned that almost no pull-through business was generated by most HMO contracts. In fact, it was discovered, painfully and over many years, that an exclusive managed care contract could be helpful in obtaining pull-through business—but only if the lab’s sales reps conducted an intense sales conversion effort for each individual physician’s office account.

Using Up To Five Laboratories

The greatest illustration of the new market reality was Phoenix, Arizona. By 1996, a stroll down the hall of any medical office building would reveal that every physician office had between three and five laboratory collection boxes outside their door. If it meant access to the patients, then doctors in Phoenix were willing to split specimens among many laboratories. In that market, pull-through was virtually non-existent.

The legacy of those years remains with the lab industry today. Pricing for managed care contracts continues to be at rock-bottom levels because of the precedent established when labs rushed to offer payers pricing based on marginal costs. However, one bright spot today seems to be recognition that exclusive provider status on a managed care contract does not guarantee that the lab will enjoy an automatic rise in pull-through specimens.

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