CEOSUMMARY: Effective on January 1, 2007, UnitedHealth Group will have one national contract laboratory. On that date, Laboratory Corporation of America becomes the preferred provider and Quest Diagnostics Incorporated becomes an out-of-network laboratory. With access to 34 million United Health beneficiaries at stake, competition is likely to intensify between these two lab companies.
IN THE TELEVISION SHOW “PROJECT RUNWAY,” super model Heidi Klum tells winners they are “in” and tells losers they are “out.”
That certainly describes what happened on October 3, when UnitedHealth Group, Inc. told Laboratory Corporation of America it was “in” and told Quest Diagnostics Incorporated it was “out.”
At stake was contract access to provide laboratory testing services to UnitedHealth’s 25 million beneficiaries across the United States. Because UnitedHealth spends $2 billion per year on laboratory testing, this development has major revenue and profit implications for both Quest Diagnostics and LabCorp.
Effective on January 1, 2007, Quest Diagnostics will no longer be a contract provider for UnitedHealth, with exceptions in several markets.
This development directly impacts the laboratory profession. First, it has the potential to cost Quest Diagnostics a significant amount of revenue and operating margin associated with its prior status as a national contract provider for UnitedHealth.
Second, it positions LabCorp to grab an increased share of lab testing done for UnitedHealth beneficiaries. Third, region by region, the new national contract may change the competitive status quo to the benefit of local laboratories. Each of these points will be discussed in order.
LabCorp disclosed some basic information about the new national contract it signed with UnitedHealth. This contract becomes effective on January 1, 2007, extends for 10 years, and makes LabCorp the exclusive national laboratory provider for UnitedHealth.
Regional Lab Networks
LabCorp becomes responsible for developing and managing “a series of regional laboratory networks in selected regions across the United States.” This is one way LabCorp and UnitedHealth will attempt to handle communities where UnitedHealth has beneficiaries and where LabCorp currently has little or no market presence.
On January 1, LabCorp becomes responsible for “managing the Oxford Health Plans laboratory network located in the Greater New York metropolitan region.” On the same date, LabCorp also becomes the “exclusive national capitated United- Healthcare laboratory provider for the HMO benefit plans of Pacificare Colorado, Neighborhood Health Partnership in Florida, Mid Atlantic Medical Services, LLC (MAMSI) in Maryland and Virginia, and [it] will remain the exclusive provider for HMO benefit plans for Pacificare of Arizona.”
$200 Million “At Risk”
LabCorp has an “at risk” clause in the contract. It stated that, during the first three years of the 10-year pact, it “has committed to reimburse UnitedHealth up to $200 million for transition costs related to developing an expanded net- work in the Oxford, MAMSI, and Neighborhood Health Partnership mar- kets, as well as in California and Colorado.” LabCorp officials told finan- cial analysts that this reimbursement would be recognized as a reduction in revenue over the life of the contract.
Many important details about the new contract remain undisclosed. For example, LabCorp has deflected questions about whether it accepted significantly lower pricing when compared to its existing national lab services contract with UnitedHealth. (See interview with LabCorp Executive Vice President on pages 9-15.) As well, few details were discussed about the operation of the regional laboratory networks for which LabCorp will have responsibility.
In public statements, LabCorp officials were exultant. They declared that the new contract will bring in an additional $3 billion over its 10-year life. That is an expectation that the company will increase its business by an average of $300 million per year.
New York And Chicago
Now for the downside. LabCorp lacks patient service centers, rapid response labs, and logistics networks in several regions of the United States where UnitedHealth has plenty of beneficiaires. In these markets, Quest Diagnostics has a dominant share and is the primary lab testing provider to UnitedHealth patients. Two very large metropolitan markets where this is true are New York and Chicago.
For LabCorp to succeed in these markets, it must either build infrastructure, or recruit local laboratories into its regional lab networks. To that end, it says it is currently in the process of building new patient service centers. LabCorp is also hiring additional sales representatives. It will need an expanded sales force to call on physicians and convince them to switch their lab business to LabCorp.
For Quest Diagnostics, loss of con- tract status is something of a role reversal. For more than a decade, it has enjoyed status as the nation’s largest laboratory company, with financial strength and a developed service network in most major cities. It has parlayed those assets into contract provider status with most major national and regional insurance providers.
Effective January 1, it loses its preferred provider status with UnitedHealth and will be forced to compete with that handicap in those markets where UnitedHealth has lots of beneficiaries. The immediate financial impact is uncertain, and consequences are likely to result from three factors.
Third, Quest Diagnostics will need to defensively protect its existing physician clients by sending sales reps into those offices to retain the business.
First, after January 1, in situations where a physician continues to refer specimens from UnitedHealth beneficiaries to Quest Diagnostics for testing, Quest will need to begin collecting deductibles, co-pays, and out-of-pocket payments from UnitedHealth patients, as required by their specific health plans. That is likely to increase Quest’s costs to service this business, as well as increase its level of bad debt.
Second, after January 1, Quest Diagnostics will be filing claims with UnitedHealth as an out-of-network provider. Its reimbursement will vary, depending on the any-willing-provider laws of individual states and other relevant regulations. In some cases, it may even end up being paid more as a non-network provider.
Steps To Retain Clients
Third, Quest Diagnostics will need to defensively protect its existing physician clients by sending sales reps into those offices to retain the business. That will raise its cost of doing business. It may also affect Quest’s ability to generate new clients in selected markets, since the sales staff will be distracted by the need to respond to LabCorp’s increased sales and marketing program.
For UnitedHealth, there are several risks. Because physicians like choice for their ancillary service providers, UnitedHealth may increase alienation by making it more difficult for them to utilize Quest Diagnostics. UnitedHealth may also see increased dissatisfaction by patients as they express their displeasure at having to pay co-pays and deductibles because their physician is using an out-of-network laboratory.
Offsetting these risks is the fact that UnitedHealth has LabCorp at risk for $200 million during the early years of this 10-year contract. So United Health has a degree of confidence that it will see the money it spends on lab testing decline by that amount during the early years of this new contract.
THE DARK REPORT makes two observations about this new development in the competitive bidding for managed care contracts. One, because this event puts the honor and reputations of the two blood brothers into the spotlight, it may lead to increasingly rancorous competition between the two lab companies. That’s because Wall Street investors will be carefully looking for evidence that one lab firm is gaining market share over the other, and neither company will want to be seen as losing to the other.
Two, because the exclusion of Quest Diagnostics from the UnitedHealth contract radically alters the current competitive status quo, it is likely that the lab industry will see the two blood brothers intensify bidding for other large managed care contracts as they come up for renewal.
UnitedHealth Takes Steps to Prepare For LabCorp as Sole National Lab Provider
TO PREPARE FOR THE JANUARY 1, 2007 IMPLEMENTATION of UnitedHealth Group’s new exclusive national laboratory contract with Laboratory Corporation of America, the insurer has already distributed question and answer briefing papers to beneficiaries, physicians, and brokers.
On the subject of the laboratory provider network, UnitedHealth emphasizes that local laboratory providers will be part of the mix, stating:
3. Does this mean that LabCorp is UnitedHealthcare’s only contracted laboratory provider? In the overwhelming majority of the country, UnitedHealthcare’s laboratory network will continue to include a combination of other regional and local laboratory service providers. In addition, in many areas we will be contracting with new providers and adding to the breadth of our network.
UnitedHealth warns that when a physician uses a laboratory that is out-of-network, beneficiaries will be required to pay some monies out of pocket, as follows:
10. How will this affect UnitedHealthcare members? As long as physicians use one of the many UnitedHealthcare participating laboratories, there will be no effect on the patient who is a UnitedHealthcare member. However, after January 1, 2007, if patients or their specimens are referred to non-participating laboratories (including Quest Diagnostics), then UnitedHealthcare, its customers and its members will be subject to higher health care costs due to the nature of the various health care benefit plans offered and selected by purchasers and consumers. This would be an unfortunate result of physician inattentiveness to this issue and UnitedHealthcare will do all we can to work with physicians to prevent such consequences.
LabCorp will expand its service infrastructure significantly. UnitedHealth describes it thusly:
11. Does the elimination of Quest Diagnostics create gaps in our network of lab providers? No. UnitedHealthcare has successfully expanded and will continue to expand our network of regional and local laboratory providers to round out our network in New York, Connecticut, Illinois, Missouri, California, and Colorado where Quest has historically rendered a higher volume of lab services. LabCorp will also be working to strengthen its presence in these markets. Specifically, LabCorp currently plans to add 377 new patient service centers by January 1, 2007 – 24% of which will be located in New York, Connecticut, and New Jersey. This represents about a 10% expansion in LabCorp’s retail locations. By January 1, 2007, LabCorp plans to add another 250 sites located in MinuteClinics (located within CVS retail pharmacies). Also, another 170 new LabCorp locations are expected to be available in Q1 2007 at SmartCare walk-in clinics.
UnitedHealth also alerted its brokers and physicians to the impending sales effort that will occur as network laboratories initiate their sales programs to office-based physicians, observing:
12. Will the remaining contracted laboratory service providers be calling on physicians who were Quest Diagnostics’ users in the interest of gaining their business?
Yes, we expect LabCorp and other contracted laboratory providers to call on Quest Diagnostics’ customers to sell their services. UnitedHealthcare will support their efforts by briefing our Network Management and clinical staff to remind physicians that they are required to use contracted laboratory providers effective January 1, 2007.