To Protect Pathology Profits: Understand Managed Care

Special Report from the Pathology Income Symposium!

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CEO SUMMARY: On November 8, 1997, THE DARK REPORT convened a private symposium restricted only to pathologists. The sole purpose of this event was to identify how pathologists could preserve and enhance their income. Within the confidential setting of a plush resort in Scottsdale, Arizona, experts and pathologists dissected the market dynamics eroding pathology compensation. Strategies, tactics and knowledge necessary to maintain and increase pathology income were articulated, debated and graded. This article extracts critical knowledge provided by a managed care insider at that symposium. It is must reading for pathologists (and laboratory administrators) seriously concerned about beating the managed care beast before it devours them.

PATHOLOGISTS ARE PROBABLY the most vulnerable physician specialty within healthcare. Unlike the typical physician, pathologists neither see patients personally nor do they practice medicine in large clinic or group settings.

Another characteristic of the pathology profession compounds its intrinsic market weakness. Because they historically practiced in a hospital setting, pathologists never developed a comparable level of business acumen and experience as physicians in private practice. This leaves them exposed on matters of compensation and reimbursement. Pathologists typically lack the clout that surgeons, specialists and family practitioners can wield.

Obvious Consequences

The consequences are obvious. Now that money and economics drive healthcare, clinical skills alone are no guarantee of success. Managed care requires all physicians to develop business skills that complement their clinical expertise.

At THE DARK REPORT’S Private Symposium On Pathology Income in Scottsdale on November 8, experts in contracting, financial management and legal issues revealed business “secrets” unknown to most pathologists. Since managed care contracts are rapidly becoming the primary vehicle for defining provider relationships and reimbursements, that topic led off the Private Symposium.

Jake Dougrey, of Pathology Consultants and Associates in Cambridge, Massachusetts was hand-picked to lead contract strategy lessons at the Private Symposium. His unique career includes hospital administration and laboratory management. At the 700,000 member Tufts Health Plans, Dougrey was Manager of Ancillary Services. Prior to Tufts, he was involved in laboratory services at the 600,000 member Community Health Plan. In recent years, he’s handled managed care contracting at two of the largest outreach-based pathology practices in the United States. His experience is unmatched at understanding managed care from both sides of the table.

Two Fundamental Trends

“Given that clinical integration and managed care are two fundamental trends reshaping healthcare,” said Dougrey, “It follows that the contractual relationship between pathology practices and the healthcare community is now a critical success factor. But not all pathologists are willing to acknowledge this.

“These changes make it essential for all the pathologists in your group to understand how managed care fundamentally changes the way healthcare services are contracted and delivered,” he continued. “Second, it is critical for pathologists to understand how managed care operates. What are the financial incentives that encourage physicians to sign such contracts? Is risk-sharing a part of the contract?

“Most pathologists and laboratory administrators will be surprised to learn that sizeable reimbursement dollars can flow to providers through the risk-sharing segments of a managed care contract. Specifically, capitation payments made at the front-end are not the only source of revenue to the provider.

“That is why it is essential that you understand the financial design of managed care contracts,” he added. “The most important type of managed care plan to affect pathology will be the Medicare HMO model.”

“Keep in mind that Medicare is already the dominant payer for anatomic pathology services. Depending on the location of a pathology practice, Medicare can comprise anywhere from 20% to as much as 70% of the reimbursement collected by a pathology practice.

“Because Medicare is a predominant source of pathology compensation,” noted Dougrey, “I want to share with you how Medicare HMO programs incorporate risk-sharing into their contracts with hospitals and physicians. You will understand why pathologists do not get reimbursed in the same way as hospitals and physicians. It is because pathologists are invariably excluded from risk-sharing arrangements.”

Medicare Fastest Growing

Dougrey noted that 40 million senior citizens are covered by Medicare. Compared to commercial health insurance, the number of Medicare enrollees is growing four times as fast. Every month 80,000 Medicare enrollees shift from fee-for-service coverage to managed care Medicare risk plans.

“There is explosive growth in Medicare risk plans,” he continued. “In 1993, they covered 2.5 million lives. This almost doubled to 4.6 million by mid-1997. I want to make this point: the Medicare business, which comprises a large segment of anatomic pathology, is transforming itself at an incredible rate. Such rapid growth is why pathologists need to anticipate how their income will change as Medicare changes.”

Dougrey makes a critical point for pathologists. Even though most anatomic pathology work for Medicare patients is currently reimbursed through DRGs and fee-for-service arrangements, that is quickly changing. Dougrey is correct in pointing out that pathologists wanting to preserve and enhance their income, must understand managed care and adapt to its requirements.

“Given the importance of Medicare reimbursement to the typical pathology practice, I would now like to explain the details of a Medicare risk plan and how its provider contracts are structured. No pathologist will negotiate a successful win-win contract unless they understand the structure of the risk plan.

“First, the Medicare HMO gets a flat monthly payment from HCFA which includes Part A and Part B,” said Dougrey. “The risk group receives 95% of the ‘county specific rate,’ based on which county the enrollee enrolls and lives in. County specific rates vary widely. For example, in New York City and some Florida counties, the rate may be as high as $800 per month per individual. Rural counties in Arkansas and Mississippi can be as low as $300 per month.

“Let’s dissect the Medicare risk plan,” he said. “My model is based on a typical Medicare HMO arrangement, offered by the national managed care companies. Premium dollars from Medicare are distributed in three ways. First, 20% of the dollars come off the top and go to the managed care company. This pays for administration, marketing, information services, etc.”

Premium Splits, Risk Structure

Full risk payment to Medicare HMO includes Part A and B. Risk group receives 95% of county specific rates.

Premiums distributed as follows:
20% To Managed Care Company: responsible for administration, marketing and information.
45% To Hospital Fund: (risk shared equally between hospital and physicians.) Fund pays for inpatient, ER, outpatient surgery, home health, skilled nursing facilities.
35% Medical Fund: (physician group at full risk for surplus and loss.) Fund pays all office, ancillary, Part B specialists (outpatient and inpatient).

Hospital Fund Next

“Next, the hospital fund gets 45%. Claims are paid from this prepayment amount. Risk is shared equally between the hospitals and physicians. The hospital fund pays for inpatient ER, outpatient service, home health, and skilled nursing facilities,” he noted. “Keep in mind, Medicare requires that a certain portion of these monies go to pathologists for administrative directorship of the laboratory. Radiologists, anesthesiologists, and ER physicians are also compensated from this pool of funds.

“The final 35% goes to the medical fund. This is controlled by the physicians. It covers their services, along with some 15 to 16 ancillary services. Part B specialists (inpatient and outpatient) are included. This 35% pool is full risk. It means that 100% of any surplus is kept by them. It also means that 100% of any losses are absorbed by them.

Sweetheart Portion

“From my perspective, the sweetheart portion of this risk-sharing is the hospital pool,” noted Dougrey. “Physicians share this equally with the hospital. Although there are generally several hundred physicians in this pool, I have seen arrangements with as few as 15 doctors to share the risk pool with the hospital.

“Simple arithmetic shows us the lucrative potential of risk-sharing. If there are 1,000 enrolled members and monthly payments are $500 per month, then a total of $6 million per year will flow through the HMO. Right now, the Boston rate is about $500 per month. The table below shows how payments for the 1,000 enrollees are distributed.”

Dougrey continued. “Calculate the numbers for the medical fund. Assume the 1,000 enrolled members in our example are covered by one medical group. In the real world, it is common for a primary care physician to have five or six hundred Medicare patients in their practice.

“In fact, physicians with large Medicare patient populations are the ideal targets for Medicare HMOs. These doctors have established relationships with their patients extending back many years. When the Medicare patient opts for the HMO product, there is no switch in physician or patient records. Plus, the risk-sharing design of the Medicare HMO gives the physician a motive to convert his Medicare patients from fee- for-service to managed care.

“Back to the medical fund. It is designed to pay 70% of the premium dollars to specialists, even though the risk is carried by the primary care physicians carrying the contract. What is the logical thing for these physicians to do? They approach the specialists to negotiate lower rates than Medicare.

“This is a critical concept to understand,” emphasized Dougrey. “HCFA is reimbursing the Medicare HMO at 95% of the prevailing rates in that county. So physicians participating in the medical risk pool must somehow get the specialists to work for less than the Medicare fee schedule.

Medicare Risk Plan Premium Distribution

Assume $500 per beneficiary per month and 1,000 enrolled members. Premiums distributed as follows:
Managed Care Company (20%) $100,000 monthly-$1,200,000 yearly
Hospital Fund (45%) $225,000 monthly-$2,700,000 yearly
Medical Fund (35%) $175,000 monthly-$2,100,000 yearly
FUND TOTALS $500,000 monthly-$6,000,000 yearly

“Ophthamology demonstrates how money is spent spent on specialists. A typical ophthalmologist generates, on a fee-for-service basis, almost $20 per month for each Medicare recipient living in their county. For this reason, contracting physicians in the medical risk-sharing pool want to negotiate discounted pricing from ophthalmogists.

“It works the same for radiology and pathology,” said Dougrey. “Compare the cost of radiology against pathology for a commercial population. Radiology costs are double those of pathology until people hit 62-years old. By the age of 70, pathology expenses equal radiology expenses.

“Within the Medicare risk pool, it becomes clear that pathology costs are three to five times those of a commercial population. While handling ancillary contracts at the managed care plans where I worked, I frequently saw data which showed radiology and pathology expenses of $14 to $18 per member per month for each specialty! This is a big number compared to the total capitated payment coming to the primary care physicians in the risk pool. It is why pathologists are asked to accept reimbursement at less than Medicare rates.

Risk Pool Physicians

“This brings us to another critical strategy used by the risk pool physicians,” he said. “We now understand why they want to negotiate fees which are less than Medicare with specialists, including pathologists. But there is another essential business requirement to make the risk pools work. That requirement is ‘eliminating risk.’

“Physicians participating in the medical fund risk pool can limit their exposure by getting specialists to accept capitated reimbursement instead of discounted fee- for-service. Any specialist accepting capitated reimbursement is assuming risk.

“This twin process of negotiating lower fees and minimizing risk through
capitated reimbursement arrangements, makes it clear why large regional and national companies make good partners for the subcontracts,” added Dougrey. “Why? Because their sophisticated organization allows them to reduce the cost of services. They are also more sophisticated in dealing with capitation reimbursement. Remember, once a specialist accepts a capitated reimbursement plan, utilization control now rests with the specialist.”

Radiology costs are double those of pathology until people hit 62-years old. By the age of 70, pathology expenses equal radiology expenses.

After Dougrey’s explanation of how incentives direct the contracting physicians’ behavior in the medical risk pools, he turned to the hospital fund. “Reducing bed days is what drives the hospital fund’s risk sharing component. Compare the number of bed days per 1,000 beneficiaries. New York City, at 5,000 bed days, is almost twice the national average of 2,600 bed days. But Southern California has only 1,000 bed days. New York City, up until 1997, had a very different payment mechanism for hospitals than Medicare DRGs. Southern California has extensive experience with Medicare HMOs.

“With hospitals and physicians sharing the risk in the hospital fund segment, what business strategies are used to eliminate risk and maximize reward?” asked Dougrey. “Simply put, it is a switch away from Medicare DRGs, and putting patient reimbursement onto a per diem arrangement.

“Under DRGs, pressure for utilization management came from the hospital. The drive was to get the patient out as soon as possible. So hospital administration and nurses managed utilization based on length of stay.”

By dropping DRGs and moving to a per diem, and by including physicians in the risk pool with the hospital, there is a significant change in case management and utilization review. Incentives now draw physicians directly into review of the hospital utilization.”

Hospital Bed Day Savings

“Let’s look at the arithmetic,” he continued. “Go back to New York City, with 5,000 bed days per 1,000 Medicare beneficiaries. Shave 100 bed days off that number and what happens? Assume a per diem of $1,000. At the end of the year, the hospital and the physicians in the risk pool would split $100,000.

“In my experience, I’ve seen groups with 2,000 members and the surplus in the first year was $600,000. This was split equally between the hospital and physicians. So the medical group got $300,000 at year-end from its split of the hospital risk pool. This is on top of whatever they earned from their medical pool, comprised of the capitated rate and the risk pool.”

Financial Impact

“By understanding the financial impact of these business arrangements,” said Dougrey, “you can see the worthwhile incentives which attract the primary care physicians’ participation in the medical pool of a Medicare HMO.

“I believe we will see these Medicare HMOs continue to grow,” he said. “For pathologists, this is a key insight. If you look at total population in areas of the United States where man- aged care is well-established, maybe only 10% to 20% of the population is left to push into managed care plans. In markets such as these, the managed care plans already recognize that marketing to this segment steals patients away from other plans.

“This is why managed care plans see Medicare HMOs as a great growth opportunity. They take 20% off the top and capitate the rest with hospitals and physicians. Plus, as these Medicare HMOs become bigger, the managed care plans develop more sophistication and expertise at putting them together and making them work.

“For physician groups, the same is true. As they grow bigger, they gain more experience and capability to serve these Medicare HMOs. This is one reason why you see physician groups establishing their own systems, including relationships with specialists, nursing homes and outpatient therapies.”

Pathologists Should Question Future

“WITHIN THE PATHOLOGY PRACTICE that I represent, we continually ask the following questions,” said Jake Dougrey of Pathology Consultants and Associates. “Who is our customer today? Who will be our customer in three years? How do we align our incentives with these emerging customers? I recommend that your pathology practice discuss these five questions as they develop a viable business plan:

One, does the pathology practice have a business structure that supports future developments in the healthcare marketplace?
Two, is the pathology practice able to serve patients in both the inpatient and outpatient populations? I look at the AmeriPath business model and I feel strongly that they realized this trend in the pathology marketplace. They are acquiring pathology practices that are anchored in the hospital but also have significant outpatient revenue. Thus, they can serve both patient populations.
Three, can your pathology practice partner with hospitals, IPAs, PHOs, specialists, medical groups or other pathologists? This is an open-ended question, but it is precisely the strategy that you and your colleagues should debate and develop.
Four, what happens to Part A pathology payments in a per diem environment? Every time contract renewal discussions occur and the hospital administrator tells you his DRGs are decreasing and his Medicare is declining, you must be prepared. Your negotiating tactic must include recognizing the shift to per diem and the risk share which benefits the hospital.
Five, who represents my contract in contract negotiations? Some pathologists do it themselves, some pathologists have shared contract people and some pathologists leave it to the hospital to represent them in contract negotiations. It may be time to change the way your pathology practice is represented in contract negotiations.”

Physician Incentives

“Obviously you can see one consequence of this. Physicians with risk in the medical pool have a direct incentive to move the patient out of the hospital and into the outpatient setting. For pathologists, this key insight reveals how and why Medicare managed care plans will direct patients away from the hospital, and hospital-based pathology practices.

“These are the reasons why pathologists must respond to the threat of Medicare HMOs,” concluded Dougrey. “The shift away from hospital-based pathology is now taking place.

“To develop effective business strategies, I recommend that pathologists use five market drivers to frame their plan. First, remember that Medicare managed care is considered a growth opportunity by managed care plans and physician groups who understand population demographics.

“Second, it is the incentives, the risk pool pay-offs, that are the larger deal in a Medicare HMO provider contract. The economics make better sense when the potential rewards of the risk pool are understood.

“Third, pathologists must demonstrate value to all their customers. Be it a medical group, an IPA, or a PHO, success depends on showing these people how you bring value to their part of healthcare.

“Fourth, provide coverage to the entire population, to in/outpatient and physician office patients.

“Five, strategic business partners will be critical to success in this effort. Who will you align yourself with? It is essential to find appropriate strategic partners.

“Six, actively participate in structuring payment arrangements. Rather than taking what’s given to you, seize the initiative and propose reimbursement for pathology services in a different structure. If you have demonstrated added-value, then you are better positioned to get a more generous reimbursement arrangement.”


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Scheduled for January 28, 1998, the hearing involves the FDA’s Hematology and Pathology Devices Panel. Should the review process lead to FDA approval of the AutoPap System for primary screening, it will mark the first time that an automated cytology system has approval for primary screening.

Beginning in 1998, CPT codes covering automated cytology are now available. That helps all three automated cytology companies currently offering products in the marketplace. Should NeoPath gain authorization to market AutoPap as a primary screener, then all the pieces are in place for this technology to demonstrate its economic and clinical efficacy through performance in day-to-day clinical use.


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