Unilab Pushes Insurers To Increase Cap Rates

Action may trigger lab industry movement to raise capitated lab rates in California

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CEO SUMMARY: California’s financially destructive capitation rates plunged two more laboratories into bankruptcy. Unilab’s actions indicate that even the largest laboratory company in the state can no longer survive without reimbursement relief. The question remains as to whether managed care plans will agree to pay more for laboratory testing.

INDICATIONS ARE THAT CAPITATED RATES for laboratory testing in California may soon begin increasing. If so, it would mark a new phase in that state’s evolution toward managed healthcare.

Were reimbursement levels for laboratory testing to increase, one direct cause would be Unilab Inc.’s efforts to renegotiate prices. It is widely known that Unilab recently sent out letters to an unconfirmed number of managed care plans for which it is contracted to provide laboratory services.

In these letters, Unilab requests that rates for laboratory testing covered under these contracts be renegotiated. In some cases, Unilab is using these letters to trigger a 90-day notice that it intends to cease providing services per terms of the contract.

Unilab officials have not issued public statements concerning this situation. Nor did they return telephone calls placed to their headquarters by THE DARK REPORT.

Unilab is the largest clinical laboratory operating within California. With $200 million in revenues, it does almost double the physicians’ office business of the combined California operations of Smithkline Beecham Clinical Laboratories, Laboratory Corporation of America and Quest Diagnostics Inc. (formerly Corning Clinical Laboratories).

Because of Unilab’s sizeable market share in California, any success the company has in renegotiating rates upward will definitely affect market pricing for all laboratories in the state.

Laboratory competitors acknowledge that capitation rates for many large contracts in the state are commonly priced under 50¢ per member per month (PMPM). A sizeable number of contracts have been bid in the 20¢-30¢ range.

For this reason, Unilab’s actions are not a result of market dominance, but rather financial weakness. “During the last five years, Unilab followed a suicidal pricing strategy,” stated one commercial laboratory owner who requested to remain anonymous. “They were relentless in their pursuit of market share. They were willing to acquire specimen volume at any price.

“Now the chickens have come home to roost,” he continued. “Unilab no longer has enough fee-for-service revenue to subsidize this managed care testing. Medicare reimbursements are declining and MediCal (California’s Medicaid program) has shifted to the HMO model, accompanied by capitated laboratory contracts. Unilab now finds itself having to provide substantial volumes of laboratory tests at capitated rates which are too low to recover costs.”

Significant Losses

During the previous two years, Unilab reported significant losses. During this same time, the company’s stock tumbled from $6 to under $1 per share. Unilab’s eroding financial condition triggered the company’s campaign to renegotiate test prices paid by their existing contracts.

The scope of Unilab’s renegotiation strategy is immense. It is believed that Unilab holds more than 100 sizeable managed care contracts throughout the entire state. If Unilab aggressively negotiates from a position of “either pay high- er reimbursement or we cease testing services,” there could be a dramatic realignment of contract relationships between laboratories and managed care plans throughout the state.

Contrast Unilab’s renegotiation strategy with that used by Physicians Clinical Laboratories (PCL). Early last year PCL assessed the economics of their 14 managed care contracts in Southern California.

Dropped Seven Contracts

PCL determined that the combination of reimbursement and utilization on seven contracts was unprofitable and not worth renegotiating. PCL Chief Financial Officer Rich Brooks explained the strategy, “We projected that, after terminating service on these contracts, our costs would decline by $850,000 per month. Revenue loss associated with those contracts would total $150,000 per month.

“In dropping these seven contracts, we cut our negative cash flow by $8.4 million dollars per year,” he said. “Knowing what money-losers these contracts were, it surprised us that other laboratories were willing to pick up these contracts without any significant increase in reimbursement.

“We are aware of Unilab’s strategy. PCL was contacted by several large managed care plans who received Unilab’s renegotiation letter and wanted to explore options with other laboratories such as ours.”

PCL shares the perspective of several laboratories surveyed by THE DARK REPORT. They are telling managed care companies that they will not provide laboratory services unless rates are significantly above 50¢ PMPM.

Two California Labs File For Bankruptcy

Two California laboratories filed Chapter 7 bankruptcy just one week apart. On January 31, 1997, Diversified Laboratory Services of Montclair filed for bankruptcy and ceased operations. The lab specialized in long term care accounts.

On February 7, 1997, Cancer Screening Services of Hollywood also ceased operations after filing for bankruptcy. The company was a high-volume, low-cost cytology laboratory.

No Consensus

There is no consensus about what level of capitation rates the market needs to pay for laboratories to cover costs. Few details are known about the first contracts for which Unilab renegotiated new capitation rates. Indications are that cap rates were increased from 30% to 150% per individual contract. Most rates, however, are still under $1.00 PMPM.

At least one large contract was raised from a 50¢ level to $1.25 PMPM. Although that may seem like a significant increase, $1.25 PMPM does not allow Unilab to recover the full costs of testing. Also, the specific tests carved out of this rate would affect the financial impact of the renegotiated cap rate for that managed care contract.

“Based on my experience here at PCL, I would estimate that Unilab has a direct cost per test between $11-$12.50 which would convert to $1.25 PMPM using a 10% utilization factor,” stated Brooks. “That means a capitated rate of $1.25 still does not allow Unilab to recover the total cost of performing the test.”

Because $1.25 PMPM does not allow the majority of laboratories to recover the full cost of providing tests, capitation rates must increase in California if laboratories are to regain financial health. Unilab’s renegotiation strategy will definitely trigger changes to the way laboratory services are priced in state because its renegotiation letter is causing many managed care plans to open pricing discussions with alternative laboratory providers.

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