Will “Free Testing” Ploy Financially Affect Labs?

Wider use of marketing strategy could lead lab industry into unwelcome financial turmoil

CEO SUMMARY: It’s a marketing scheme which public lab companies have quietly used for years. Now there is evidence that the use of “Waiver of Charges to Managed Care Patients” (free testing) seems to be on the increase, raising new questions about how and why competitive practices are changing. Will the two blood brothers use their increasing clout to bring more intense competitive pressures against regional labs?

REMEMBER THE TAG LINE FROM THE movie Jaws? It said “Just when you thought it was safe to go into the water…”

That describes the lab industry and the revelation in this issue of THE DARK REPORT that several public lab companies have come up with another wacky and destructive pricing scheme; one that has many financially disruptive elements similar to the “below-cost” capitated lab test prices of the 1990s. Sales reps of the two blood brothers call this new scheme “Waiver of Charges to Managed Care Patients.” In reality, however, it boils down to an arrangement where they will perform lab tests on certain patients “for free.”

Antikickback Guidelines

In selected situations which meet the requirements set out by an OIG Fraud Alert issued December 19, 1994, any provider, including laboratories, can “waive charges” for services provided to managed care patients for which it is not a contract provider as a way to continue providing services to the physicians’ patients which are covered by other health plans. This can be only be done in situations where “free testing” generates no benefit to either the physician or his patients. (See pages 2- 4 in this issue.)

This sales tactic should get the full attention of all lab executives and pathologists who compete against the two blood brothers. To date, it has not been used very often. But that situation may be changing. A growing number of local laboratories report that the national labs have introduced “free testing” as a competitive marketing tool in situations where they do not hold the managed care contract.

If this is true, and if the biggest lab companies are willing to more aggressively promote “waiver of charges” arrangements in regional markets, why is this happening now?

More importantly, is the laboratory industry seeing the earliest stages of a market cycle where the public lab companies, under intense pressure to boost specimen volume and net profits, believe this is an effective tool for protecting existing business and building market share?

These are serious questions about a serious issue. Let me frame the issue this way: In our industry, the leading lab companies are going to physician-clients with this proposition: “To make it more convenient for you to use our laboratory, we will take non-contract managed care work and perform those tests for free. All your other work can continue to come to us and we will be your ‘sole source’ for laboratory testing.”

Uncannily Similar Argument

Does this sound familiar? It’s deja vu. It is uncannily similar to the argument used by public lab companies starting in 1988, when the first capitated, full- risk lab services contracts were signed with managed care plans.

Clever laboratory executives at that time had this logic: “We’ll bid the managed care contract at a price below our cost to do the testing. Our sales reps will then convince physicians that, since our lab holds the managed care contract, they should give us both their contract specimens as well as their fee-for-service specimens. That non-managed care business will provide the profits needed to offset the losses incurred on the managed care testing we do.”

“Free Testing” Not Smart

I’d like to point out a simple truth: offering to do testing free or at below cost is never a long term strategy for success. The below-cost managed care prices established by public lab companies ten years ago continue to drag down overall reimbursement for lab testing services even today.

So the lab industry has lived through one cycle of public labs bidding below costs to protect and expand market share. The result was a string of bankruptcies and near-death financial struggles for those public lab companies which operate today.

Are the nation’s larger commercial labs embarking on a new cycle of offering “below cost” pricing? Will use of the “waiver of charges” marketing scheme expand? As it does, will independent commercial labs and hospital outreach programs feel the need to respond in kind to protect their business?

Formal Policies In Place

The Fraud Alert of December 19, 1994 is known to all the major lab players. Each of these companies has a formal policy, protocols, and the forms necessary to document compliance. (See page 4.) THE DARK REPORT has called Quest Diagnostics Incorporated and Laboratory Corporation of America to verify their policies governing “waiver of charges.” As of press time, neither company had provided a spokesperson knowledgeable on this topic.

As noted on pages 2-5 of this issue, Quest Diagnostics is using the “free testing” tactic in Detroit as a response to losing the Health Alliance Plan (HAP) contract to Joint Venture Hospital Laboratories (JVHL). In Greensboro, North Carolina, Spectrum Laboratory Network is actively using the “free testing” scheme in its regional market. Its CEO, a veteran of the capitated pricing wars of California in the 1990s, is introducing this marketing ploy in its region.

Because the use of this “free testing” scheme is still in its infancy, there is still time to influence how it is used and ameliorate the potentially negative impact it can have on the entire lab industry. In that spirit, I’d like to pose some thoughtful questions to you.

First, is it any surprise that public lab companies are willing to give away free lab testing as a way to maximize their short-term market benefit? They did it in the early 1990s with money-losing cap rates. The “waiver of charges” scheme is consistent with this past precedent.

Second, it must be acknowledged that the nation’s biggest labs are launching what is really a “price war” to retain access to specimens where they are not the managed care company’s contract laboratory. Price wars only benefit financially strong companies. Thus, is this an example of anticompetitive behavior? Are national labs demonstrating their willingness to subsidize free testing financed by the profits from their national lab system to squeeze regional providers? Certainly once the local labs are put out of the game, the national labs will cease offering free testing and try to raise rates.

Third, how will payers respond when they see a (non-contract) national lab willing to perform testing for free to gain access to the physician’s other lab testing specimens? My conversations to date with insurers in Detroit indicate that this will only create downstream pricing problems for labs serving that region.

Will Medicare Notice?

Fourth, and not the least, what will be the reaction of Medicare officials should the “waiver of charges” scheme be used more frequently by clinical laboratories. Doesn’t the concept of offering free test- ing on patients covered by a specific managed care plan in order to gain access to other lab specimens, including Medicare patients, run counter-intuitive to the thinking and expectations of Congress and Medicare regulators?

These are tough questions. I believe that if the use of “waiver of charges” marketing schemes widen, it will have negative and long-lasting impact on the lab industry over the long run.

How Below-Cost Cap Rates Created Big Revenue Gap

PUBLIC LAB COMPANIES were willing to lose substantial amounts of money in the early 1990s to capture capitated, full-risk managed care contracts.

Two examples illustrate how big the gap became between the cost of providing this testing and the reimbursement paid by managed care companies for lab testing services. During the 1996-97 period, a CFO of a public lab company in California discussed the financial consequences of offering to do lab testing for less than the cost of the work.

He calculated that, on a fully-expensed basis, it cost his lab about $2.50 per member per month (PMPM) to provide lab testing services to a commercial population. However, the typical managed care contract at this time was paying between 50¢ and 70¢ PMPM. His lab was subsidizing the cost of testing by more than $20 per year per member!

MetPath (now Quest Diagnostics) provides another example of the gap between cost and revenue. At the time MetPath purchased Nichols Institute in 1994, executives from Teterboro told the Nichols executive team that the future growth of managed care testing was the company’s biggest financial challenge. At that time, MetPath’s national revenue per requisition averaged $25. Its cost per requestion averaged $20. For managed care requisitions, the revenue averaged about $10.

MetPath had a strategic dilemma, said these execs. In 1994, managed care contracts represented only 10% of the company’s total revenue. But projections indicated it would grow to 40% within two to three years. Thus, what could MetPath do to close the gap between its $20 per req average cost and the $10 per req average revenue from managed care contracts?

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