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Morningstar | Diagnostic Lab Industry Aims to Improve Medicare Reimbursement With Addition of Hospital Labs

Now that the diagnostic industry has begun to see the full and more-dramatic-than-expected effect of reductions in the Medicare clinical lab fee schedule that were rolled out in 2018, the industry is fighting back more strenuously. Most recently, the industry has prompted the introduction of a bipartisan bill, the Laboratory Access for Beneficiaries Act, in the House. While this doesn’t shift our fair value estimates for narrow-moat LabCorp or Quest Diagnostics, it should ratchet up pressure on the higher-cost hospital-based labs to comply with reimbursement reporting requirements contained in the Protecting Access to Medicare Act. Our fair value for narrow-moat Sonic Healthcare is also unchanged.

When PAMA laid out the conceptual framework for shifting Medicare diagnostic test reimbursement over to a “market” price, based on the rates private payers paid for those tests, Congress left it up to the Centers for Medicare and Medicaid Services to figure out the best way to implement the program and collect that price data from diagnostic labs. Unfortunately, in the first round of rate-setting in 2016-17, CMS required only 100 hospital-based labs to comply with the collection and submission of data. Of those 100 labs, only 10 complied. As a result, the new Medicare test prices were heavily skewed toward LabCorp and Quest, the largest independent labs with the lowest cost structures. Fortunately, for the current round of data collection, CMS is now requiring roughly 90% of hospital-based labs to meet reporting requirements, which we think should help improve the Medicare reimbursement outlook.

The LAB Act primarily aims to delay the collection and reporting period (which is supposed to be happening now) by a year, in order for more hospital-based labs to upgrade to IT systems that can handle test volume and reimbursement data at a very granular level. Currently, few hospital-based labs are equipped to report diagnostic tests by volume, payer, price, and plan.

Considering the severity of the first round of cuts, as expected we’ve begun to see smaller independent labs close their doors or put themselves up for sale. This generally bodes well in the longer term for LabCorp and Quest, which have built the businesses on serial acquisitions of smaller labs. However, this dynamic raises issues over patient access to CMS, which seeks to create a balance with cost efficiency.

For example, this spring, LabCorp acquired the privately held Metropolitan Medical Laboratory, which served the Quad Cities metro area (Davenport and Bettendorf, Iowa, separated by the Mississippi River from Moline and Rock Island, Illinois), which has a total population of approximately 385,000 people. LabCorp intends to integrate most of that business with its large-scale lab operations, but will not continue the Metropolitan Medical mobile lab services for nursing homes, long-term care facilities, and home-bound seniors. Those patients risk losing access to diagnostic tests, which will be a concern for CMS. If the weighted median private payer reimbursement included more of the higher-cost hospital-based labs, this should help preserve access for more patients.