1. CCLA Annual Meeting 6 November 2014 San Diego, California ROBERT L. MICHEL Editor In Chief T HE D ARK R EPORT Spicewood, Texas rmichel@darkreport.com ph: 512-264-7103 fax: 512-264-0969 Labs in the Perfect Storm: Surviving Healthcare’s Transformation As Fee-for-Service Payment Disappears

2. Understanding Healthcare’s Five Biggest Sources of Change 1. Money (to pay for healthcare) 2. Reimbursement (to providers) 3. End of private practice model 4. Era of Personalized and Proactive Medicine informed by genetics 5. Adoption of QMS by providers

3. New Health Delivery Models n Medicare: u Accountable Care Organizations (ACO). u Value-Based Reimbursement. u Bundled Reimbursement. u Pay incentive for provider use of electronic health record (EHR) systems. u Pre-authorization of expensive molecular and genetic tests. u ICD-10 conversion looming. Assumptions You Know…

4. New Health Delivery Models n Private health insurance firms: u Medical Homes u Accountable Care Organizations (ACO). u Acquiring and operating medical groups. u Value-Based Reimbursement. u Narrow networks favoring low-cost providers u Consumer incentives to stay in network. u Pre-authorization of expensive molecular and genetic tests. Assumptions You Know…

5. Let’s Look at Money n Federal government pays more than half of nation’s $3.8 trillion health bill. n Medicare and Medicaid. n Veterans Administration, active duty, dependents. n Federal employees.

6. New Reimbursement Models n n Fee-for-Service is on the way out. n n In its place: value-based reimbursement. n n Expect to see: u u Bundled payments. u u Capitation. u u Pay for Performance (P4P). n n Transition is already underway with Medicare and private payer ACOs. Force for Change #2

7. Bundled Payments Challenge n Medicare implemented DRGs for inpatient services in 1980s. n This caused long-term consequences to for hospital-based physicians. n In ambulatory care market, how do providers get paid when their services are part of a bundled reimbursement involving a group of providers in an ACO or medical home? n No healthcare executive yet knows the answer to this question.

8. 2014’s Medicare Rules-PPS n Physician Fee Schedule (PFS). n Not implemented: Proposal to cap PFS payment rates at Hospital OPPS payment rates for services reimbursed at higher rates in the physician office setting than in the hospital outpatient setting. n “38 of the 39 pathology services affected would be reimbursed at rates that would not even cover direct cost inputs, as is statutorily required.”-ASCP.

9. 2014’s Medicare Rules-OPPS n Hospital Outpatient Prospective Payment System-OPPS. n Reimbursement for hospital outpatient and free-standing ASCs. n Ends some fee-for-service for clinical lab and anatomic pathology tests. n CMS will make a bundled payment (think DRG payment for inpatient care) that includes all of the patient’s care at the surgery center.

10. Physician Market Transforming n n Premise: traditional ambulatory service market has served office-based physicians. n n These physicians were self-employed or owners of their medical practice. n n That is no longer true. n n New practice models evolving. n n Add to this the Gen X and Gen Y differences in attitude, work ethics. Force for Change #3

11. # of Docs % of Independent Docs

12. Trend is Away from Inpatient Services n Community hospitals have interesting dilemma. n Emphasis now on keeping people out of hospitals. n Growing proportion of healthcare service episodes will be originate in outpatient and outreach settings.

13. Key Point Inpatient procedures growing by single digits each year. Outpatient procedures growing at double-digit rates annually. Labs must have access to outpatient and outreach specimens! Source: MedPac Report to Congress: Medicare Payment Policy, March 2014 +28.5% -12.6%

14. Figure 2. 2006-2011 Change in Inpatient Use Rates per 1,000 Source: Decline In Utilization Rates Signals A Change In The Inpatient Business Model, Health Affairs Blog, March 18, 2103; Grube, Kaufman, and York Minnesota–Down 14%! California–Down 7%!

15. 10 12 21 51 66 70 16 17 15 5 7 12

16. Personalized, Proactive Medicine Informed by Genetics n During your career: reactive medicine and acute care. n Coming soon to a provider near you: u Proactive Medicine. u Personalized Medicine (Precision Medicine). u Genetic analysis; whole human genome sequencing. Force for Change #4

17. New Clinical Care Paradigms n Keep patients out of hospitals! n Detect disease early, when it is more easy to treat. n Actively help patients manage their chronic diseases. n Use incentives to encourage positive lifestyle choices and activities. n Support these goals with genetic knowledge as it is developed.

18. Age of Genetics n Remember your history? Agricultural Age ends about 1780...

19. Then came… Industrial Age through end of 20 th Century... Henry Ford Industrialist

20. That Gave Way to… Information Age in 1990s... Bill Gates World’s Richest Man! And what did he own?

21. Now we begin… Genetic Age in 2010s... James Watson Described structure of DNA Kary Mullis Developed PCR Method Nobel Prize!

22. Exome Is Important n The exome is the part of the genome formed by exons, the sequences which when transcribed remain within the mature RNA after introns are removed by RNA splicing. n It differs from a transcriptome in that it consists of all DNA that is transcribed into mature RNA in cells of any type. n The exome of the human genome consists of roughly 180,000 exons constituting about 1% of the total genome. n Mutations in the exome are thought to harbor 85% of disease-causing mutations. n Source: Wikipedia.com

23. Important! Companion Diagnostics n Majority of prescription drugs don’t work on many people, or negative reactions. n Companion diagnostic is a test used as gatekeeper for therapeutic drug. n Example: 1998-FDA cleared Herceptin for breast cancer… n …but only if patient has HER2Neu Mutation.

25. Gene Sequencing n November 19, 2013: FDA cleared Illumina’s MiSeqDX instrument and reagents. n January 9, 2014: Quest Diagnostics to use Ilumina platform for next gen sequencing. n January 20, 2014: LabCorp to use Illumina platform. n Illumina says a whole human genome sequence can be done for $1,000.

26. Adoption of QMS n Quality Management System (QMS). n ISO 9001 (certification). n ISO 15189: Medical Laboratories (accreditation). n CLSI Document GP-38. n Perfect complement to Lean, Six Sigma, process improvement methods. Force for Change #5

27. CMS Encourages QMS n Det Norske Veritas (DNV) granted deeming status in September 2008. n DNV offers hospitals accreditation to Medicare COP and ISO 9001. n American Association of Laboratory Accreditation (A2LA) granted deeming status in March 2014. n Can now accredit labs to CLIA and Medicare COP and ISO 15189.

28. Adding Value as Providers n Goal is to improve patient outcomes while reducing the cost per episode of care. n Preventive services can cost a bit more money, but contribute to millions in cost savings. n Example of John T. Mather Memorial Hospital in Port Jefferson, NY. n 248 beds, lab runs 2.3 million tests annually.

30. What’s Obamacare’s Role? n Remember at all times—the government’s money pot is empty. n Healthcare utilization increasing at steady pace, but Medicare cannot sustain funding for this growth. n ACOs, medical homes, value-based reimbursement are happening independent of ACA. n All of this happens regardless of Obamacare, which restructures health insurance!

31. CMS “Attack on Labs” Paid $8.2 billion for Part B CLFS in 2010. 1,140 unique lab tests, per HCPCS codes.

32. What OIG Said n a total of 20 tests were included in this evaluation. n These tests accounted for… …47% of the volume and… …56% of the expenditures for CLFS. n Lab tests reimbursed by Medicare in 2010.

33. What OIG Found n In 2011, Medicare paid between 18% and 30% percent more than other insurers for 20 high-volume and/or high-expenditure lab tests. n Medicare could have saved $910 million, or 38%, on these lab tests if it had paid providers at the lowest established rate in each geographic area.

34. Far-Reaching New Law For Labs n “Protecting Access to Medicare Act of 2014” became law April 1, 2014. n Six primary elements to the new law. n A case of some GOOD, more BAD, and plenty of UGLY! n Potential for the most radical disruption to the clinical lab testing marketplace in four decades!

35. 6. Market-Based Lab Rates n Setting Prices with Market Data. n Certain labs will be required, beginning on January 1, 2016, to report private payer payment rates and volumes for each of their tests. n Private payers include health plans, Medicare Advantage plans and Medicaid managed care organizations. n Shall not include information with respect to a laboratory test for which payment is made on a capitated basis or other similar payment basis.

36. 6. Market-Based Lab Rates n The payment rates calculated under the Act will be effective starting January 1, 2017. n The payment rates calculated under the Act will be effective starting January 1, 2017. n Reductions to payment rates resulting from the new methodology are limited to: u 10% in 2017 u 10% in 2018 u 10% in 2019 u 15% in 2020 u 15% in 2021 u 15% in 2022

38. Just six tests represent 35.6% of CLFS dollars and $1.73 billion in payments to labs These 20 Tests are 47% of volume and 56% of CLFS dollars totaling $2.72 billion

39. Let’s Do Some Arithmetic n Medicare Part B CLFS spend in 2010: $8.2 billion. n Quest and LabCorp have 15% Medicare business in their payer mix. n Assume the two labs do a total of $12.5 billion in yearly revenue. n 15% of that is $1.9 billion per year. (Which also represents about 22.9% of what Medicare paid out for CLFS in 2010.) n OIG’s 38% fee cut would reduce their revenue by $722 million per year.

40. Smaller Lab Arithmetic n Assume: u Small lab revenue: $10 million/year. u Medicare is 50% of payer mix, or $5 million. n 57% of Medicare tests is: $2.8 million n Cut by 30% (2017-19): -$840,000 n Cut by 45% (2020-22): -$882,000 n Thus, in 2022, this lab’s Medicare revenue is now just $3.3 million. n Lab’s total revenue shrinks to $8.3 million.

41. Let’s Model a Test n Base Year:$10.94 n 2017 10%:$ 9.85 n 2018 10%: $ 8.61 n 2019 10%: $ 7.97 n 2020 15%: $ 6.77 n 2021 15%: $ 5.75 n 2022 15%: $ 4.89 CPT 82025 CBC w/Auto Diff $353 Mill (7.2%) $10.94

42. Conclusion: Challenges Ahead for All Providers n On multiple fronts, providers will see less fee-for-service payment and reduced budgets for most services. n Market poised for fundamental restructuring and much disruption to status quo. n Innovative providers will rely on vendors for help across all aspects of management and operations.

43. But Don’t Forget! n There are 320 million Americans who continue to need clinical lab tests and anatomic pathology services. n Someone will do this work. n Message is for your laboratory to get out ahead of these trends. n Be one of the labs that do this work… by delivering clinical value.

44. Theranos: Myth or Reality?

45. What Is Theranos? n Based in Palo Alto, California. n Founded 10 years ago. n Elizabeth Holmes, 19, dropped out of Stanford. n Much mystery about its true mission. n Equal mystery about its proprietary diagnostic technology.

46. Theranos Says It Can Deliver… n Because people don’t like needles, it can collect a specimen with a needle stick on the fingertip. n Only requires a small amount of specimen, between 25 to 50 microliters. n Theranos can report results to physicians and patients in four hours. n Will charge only 50% of Medicare Part B lab test prices.

47. Meet Elizabeth Holmes n Photo

48. n Holmes' background is right out of the phenom playbook. n Growing up in Texas, Holmes taught herself Mandarin and launched a business in high school selling C++ compilers to Chinese universities. n She applied for her first patent while at Stanford, where she majored in chemical engineering. n In the summer before her sophomore year, she went to Singapore to work at the Genome Institute on the SARS virus. Background on Holmes

49. Helping Consumers? n Holmes, who hates needles, zeroed in on blood tests as a starting point. n If blood tests were easier, cheaper and more convenient—Theranos aims to put a lab within a mile of any city dweller— people could take multiple tests over time and see signs of a disease or condition before it's too late, Holmes argues. n San Jose Mercury News, July 15, 2014

50. Wall Street Journal September 2013 n First national media outlet to write about Theranos. n Coincided with press release about Walgreen’s agreement. n Disclosed venture capital investment of $100 million at that time.

51. Theranos and Walgreens n In September, Theranos and Walgreens announced a deal to open Theranos "wellness centers" at one Walgreens in Palo Alto as well as 20 stores in Phoenix. n The goal is to expand to all 8,200 Walgreens stores nationwide. n Theranos' main revenue stream is payment from customers or their insurance providers for lab tests. n The company has other revenue streams through its long-term strategic partners, which it declined to discuss.

52. Fortune Magazine June 2014 Elizabeth Holmes becomes a “cover girl.”

53. Revealed in Fortune Story… n “The company has performed as many as 70 different tests from a single draw of 25 to 50 microliters collected in a tiny vial the size of an electric fuse.” n “…her company uses ‘the same fundamental chemical methods’ as existing labs do.” n “Its advances relate to ‘optimizing the chemistry’ and ‘leveraging software’ to permit those conventional methods to work with tiny sample volumes.”

54. Revealed in Fortune Story… n has $400 million of venture capital. n Its investors say that the company is valued at $9 billion.” n Holmes has 50% interest in Theranos. n No published studies about the methods and technologies used by Theranos. n Company is highly secretive.

55. Revealed in Fortune Story… n On Theranos technology: n Richard A. Bender, M.D, “an oncologist who is also a medical affairs consultant for Quest Diagnostics,” was quoted by Fortune as saying “I don’t know what they’re measuring, how they’re measuring it, and why they think they’re measuring it.” n Theranos is using laboratory-developed test (LDT) exemption.

56. Board of Directors n Elizabeth Holmes, Chairman & CEO n Ramesh “Sunny” Balwani, President & COO n Henry Kissinger, former Secretary of State n George Shultz, former Secretary of State n William Perry, former Secretary of Defense n Sam Nunn, former U.S. Senator n Gary Roughead, retired Navy Admiral n James “Mad Dog” Mattis, retired four-star Marine General n Richard Kovacevich, Ex-Wells Fargo Chairman & CEO n n William H. Frist, M.D., former U.S. Senator n n Riley P. Bechtel, Chair, Bechtel Corporation n n William H. Foege, M.D., Former Director of the CDC

57. Lab Testing at Walgreens n Agreement announced in September 2013 that Theranos would offer testing in all 8,200 Walgreens stores nationwide. n One Walgreens in Palo Alto, CA. n About 40 Walgreens in Phoenix, AZ. n CLIA lab in Palo Alto. n 400,000 sq. ft. manufacturing facility in Fremont, CA.

58. Walgreens in Palo Alto

59. Palo Alto Lab Facility

60. Manufacturing in Fremont

61. Let’s Discuss Theranos’s Stated “Advantages”

62. Blood Collection n Is patient’s dislike of needles addressed by a finger stick collection? n What diagnostic issues are associated with a finger stick specimen that may be run on standard lab analyzers? n Other issues?

63. Proprietary Testing n Assume that Theranos is using LDTs. n Is Theranos first buying kits from major IVD companies? n Then does it use micro-quantities of reagents with its instrumentation, performed as LDTs?

64. What Is Business Model? n Is goal to perform testing in pharmacies for 4-hour test results? n Will this require compliance with CLIA regulations? n Can Theranos recruit and afford to pay med techs and clinical lab scientists to staff these in-pharmacy lab testing activities? n Can it do this and make money?

65. “In a chronically leaking boat, energy devoted to changing vessels is more productive than energy devoted to patching leaks.” –Warren Buffett Final Thoughts on Change… “The greatest danger in times of turbulence is not the turbulence— it is to act with yesterday’s logic. –Peter Drucker -30-