Inside the Lab Industry: Labs’ Ability to Obtain Payer Contracts Limited, Observers Say

Gregory Solak expects to have an answer soon. The vice president for laboratory services for Kaleida Health has helped to painstakingly craft a relationship between the upstate New York hospital system and national player LabCorp not only to address their respective business interests but also to help secure a long-desired preferred provider organization (PPO) contract with BlueCross BlueShield of Western New York, the region’s predominant payer. Its PPO, Community Blue, has long had a laboratory relationship with Quest Diagnostics. And Kaleida, in need of millions of dollars of infrastructure improvement for its lab system, could not compete for the health plan’s lives. “In order to have a competitive bid, we needed to have the resources of a large publicly traded lab for infrastructure for the benefits they can provide,” Solak said. He added that Kaleida expects to hear what direction the Western New York Blues will go any day now. Although Buffalo is in upstate New York, its location on Lake Erie makes it significantly closer to Cleveland, Akron, Ohio, and Detroit than New York City. Along with the financial issues affecting health care nationwide, it has suffered all the economic pressures that have descended on Rust Belt cities over the past five decades, such as the loss of shipping and manufacturing. The city’s population is less than half of what it was in 1950 and is continuing to shrink. Under Financial Duress Kaleida, which operates five hospitals in the Buffalo area, including the 501-bed Buffalo General Medical Center, is the largest system in the region. But its size has not exempted it from financial duress. According to its 990 tax returns, it reported net income of $12 million in 2012, the most recent year available, on revenue of $1.1 billion. That’s a profit margin of just over 1 percent. While it comes on the heels of a $12 million loss in 2011, it’s still a fraction of the profits Kaleida posted earlier in the decade. The financial pressures have been compounded by recent capital projects, such as a replacement facility for its Women & Children’s Hospital of Buffalo. Kaleida’s lab system has been stuck at around 4.5 million tests performed annually for the past several years. Its  outreach revenue, at around $16 million a year, has also been growing relatively little. “We were looking at a $20 million investment (in our laboratory services) over the next three to five years to make sure we have all the emerging technologies, but access to capital given Kaleida Health’s focus on expanding its market share and replacing facilities has been a big concern,” Solak said. The supply chain agreement with LabCorp, which was engineered in 2012, sends most of Kaleida’s reference testing to LabCorp’s facility in Raritan, N.J. However, it allows access to LabCorp’s economies of scale, giving Kaleida access to what the national giant pays for key products and services. Huge Cuts in Supply Chain Procurement Costs “I have joked that Quest and LabCorp are the Wal-Mart, and we saw double-digit reductions in costs [for supply chain procurement],” Solak said. The deal also allows for Kaleida to receive new equipment at a discount as well that is baked into the agreement, according to Solak. As a result, the deal has cut the costs of operating Kaleida’s laboratory system enough that bidding for the Blues contract in a manner that is competitive with Quest Diagnostics finally made sense. And that likely makes a difference regarding Kaleida’s future. “We were able to survive and thrive by handling all the other [insurance carriers in the region], but not having the Blues is a big deficit,” Solak said. But the access to capital labs such as Kaleida’s is often a catch-22, as it often has to go hand in hand with access to revenues. Many medium-sized and smaller players are increasingly being shut out by commercial payers, say sector observers, and they need to find ways to gain entree in order to remain competitive. Cost is always going to be at the forefront. Richard Gentleman, a senior director of national ancillary contracting for Aetna, the Connecticut-based health insurer, noted that it has manifested specific purchasing power as a national payer. As such, Aetna considers clinical laboratory services to be a commodity. “The price point for services should be similar in Spokane and Georgia,” he said. And contracting labs should also have the IT infrastructure in order to provide Aetna with the ability to improve the medical management of its payers and spur wellness initiatives. “It’s the integration and information of packaging, and taking all that information and feeding it back to the plan [that we expect from labs],” Gentleman said. Meanwhile, with more cost-shifting over to patients, Aetna has been promoting price transparency tools for its enrollees so they will have an idea what their health care services will cost before they receive them, adding an additional layer of cost pressure on labs. According to Mike Snyder, president of Clinical Lab Business Solutions in New Jersey, population health initiatives—the linkage of testing data to the ultimate health care improvements and outcomes of patients—is where labs will have to prove their mettle to payers. “It’s the next big battle that’s brewing,” he said. Meanwhile, Snyder observed that the current environment for small and medium-sized labs to obtain payer contracts is “abysmal.” And while he acknowledged that Kaleida’s joint venture with LabCorp is one way to achieve traction with a payer, it has limited applicability in other regions of the country. “LabCorp was completely locked out [of the Buffalo market],” Snyder said. “If you go to other markets where both LabCorp and Quest have a dominance and are entrenched, they’re not as interested in joint venturing. Where it makes sense for them to cozy up to the hospital, they are absolutely doing it.” Otherwise, it makes more financial sense for Quest and LabCorp to purchase hospital outreach services than engage in joint ventures. The Messenger Model Another potential collaborative effort for labs, Snyder suggested, is a “messenger” agreement. Such agreements originally surfaced in the oil industry in the 1980s, but they are slowly gaining traction in other industries. Under a messenger agreement, hospitals or standalone labs (primarily the former) are grouped under a single taxpayer identification number, meaning any revenue received under the agreement flows to a single entity. However, they all make bids and negotiate for a nonhospital ancillary payer contract separately. Information sharing among the entities is barred so as to avoid collusion. Carent Laboratory Solutions, which includes 21 hospital-based lab facilities in Colorado and another lab in Nebraska, is an example of the messenger agreement model and has been in operation since the late 1990s. According to Snyder, the Mayo Clinic has been using the messenger model on behalf of its own clients. But for the most part, the messenger agreement model remains relatively rare. Snyder estimates there are perhaps a half-dozen such models throughout the country, and most primarily involve hospital labs. And standalone labs have been knocking on the door of these messenger groups to see if they can gain admission. Instead, it may be time for some labs to come to terms with the fact that contracts with big payers are not going to materialize and either explore other models, sell, or close down. “Not everyone has a seat at the table, and those that are the most vulnerable are the independent labs,” Snyder said. Takeaway: With the payer contracting environment for labs becoming increasingly straitened, many have to consider joint venturing or other forms of collaboration in order to remain competitive.