In many healthcare businesses, the legal and regulatory risks of the business center on policing the line between permissible referring physician relationships and illegal referring physician kickbacks. That line can be thin and blurry. Lab transactions are no different. The relationship between the lab and the physicians referring tests to the lab can be complex and intertwining. Given the recent increasing interest in the lab sector among financial acquirers and sponsors, it is imperative to understand these relationships and their regulatory subtleties.
It is often the case that in order to evaluate the risks of a particular healthcare business, you need to understand both the market of what people permissibly do and the market of exactly where people try to get close to the line. A general understanding of the regulatory limits is insufficient if you are hoping to understand whether a particular business model or practice is too dark of a shade of gray when everywhere in the market are various shades of gray. Too conservative an approach can lead to lost opportunities. Too aggressive (or blind) an approach can lead to absorbing excessive amounts of risk.
All that is true of lab transactions, too. An understanding of the current state-of-the-art practices that should be carefully scrutinized is critical in order to evaluate the regulatory risks of an investment in a lab deal. The following is a brief summary of a few of these practices and the key regulatory risks embedded in them.
Technical component (TC), professional component (PC), and split billing
Diagnostic pathology tests have two components: a technical component (TC) and a professional component (PC). The TC includes preparing the sample or slide and running the actual diagnostic test. This is typically billed by the lab. The PC includes selecting the test method, overseeing quality, reviewing abnormal results, and being available to discuss the medical significance of lab results with clinicians. This is typically billed by the pathologist. Many labs bill globally for both the TC and PC of a lab test, though some engage in “split billing” under certain circumstances. The practice of split billing itself is not illegal or impermissible per se, but some parties engage in questionable related practices. The discount billing arrangements described below are examples of such practices.
In-office laboratories
Physician practices are finding in-office laboratory opportunities increasingly attractive as revenues from their professional fees and other ancillary services dwindle. In a prior iteration of this concept, many physicians had off-site “pod” laboratories where they would rent a small office and employ a pathologist on a part-time basis to exploit a perceived “loophole” in the in-office ancillary services exception to the Stark Law, which is concerned with physician self-referral particularly with regard to Medicare and Medicaid. The pod laboratory model is now almost entirely prohibited. These operations have begun moving in-house, to the physician offices.
Depending upon how they are structured, the ability to operate in-house labs may be restricted by state and federal law. Often, an outside lab consults with or assists physician practices in implementing in-house labs. The outside lab can also receive other referrals or business from these same physician practices, which implicates the federal anti-kickback statute. Where a physician practice purchases a portion of the services related to the lab test, the federal purchased diagnostic test rule (or “Anti-Mark-up Rule”) can significantly limit the amount the practice is able to charge Medicare for the purchased services. This can limit the economic viability of in-house lab arrangements to only commercial payors.
Discount billing
The Centers for Medicare and Medicaid Services (CMS) Office of the Inspector General (OIG) Advisory Opinion 99-13 examined an arrangement where an outside laboratory was billing physician practices at a discounted rate (below cost) for non-Medicare, private-payor-reimbursed lab work. Separately, the lab was billing Medicare at its full rates on other tests. The commercial pay discounts were not expressly conditioned upon receiving the full-rate Medicare referrals from the physician practice, but the parties acknowledged that most of the practice’s Medicare-reimbursed referrals were also sent to the same outside lab. OIG found this arrangement problematic and warned that these types of discounts (especially if below cost) could be viewed as an inducement for referrals of Medicare business. Although not illegal per se, these arrangements can be suspect.
Other billing issues
In addition to billing- and reimbursement-related issues that are described above, scrutiny is also growing for medically unnecessary tests, out-of-network billing practices, and “balance billing” tactics. Through its Recovery Audit Contractor (RAC) program, CMS is more aggressively pursuing recoupment of overpayments from providers of all types. This is particularly true for labs, where Medicare payments from clinical laboratory services increased by 92% from 1998 to 2008. RAC auditors are essentially “deputized” third parties who have been granted the authority to independently audit Medicare billing records and who also share in any amounts recovered.
Without a robust understanding of these very nuanced regulatory issues, investors are faced with the prospect of making a go/no-go decision with potentially significant undiscovered liabilities lurking after closing. Such an understanding is important for lab managers and decision makers as well.
Geoffrey Cockrell (left) and Bart Walker (right) are attorneys with the Private Equity and HealthCare Life Sciences Groups at McGuireWoods LLP.
