CPA.net

"Where ignorance is bliss, 'tis folly to be wise"

Attributed to Thomas Gray's poem, Ode on a Distant Prospect of Eton College and written in 1742 (!), the title of this Post seems to be the state of some segments of the Healthcare Industry valuation and appraisal community these days. Discretion being the better part of valor, I'll let it go at that. (paraphrasing Falstaff in Henry The Fourth, Shakespeare)

UMDNJ Retrospective

The current wave of practice acquisitons by hospitals after a hiatus of some 10 years has caused some of us who were witnesses to the last cycle of acquisitions, which ended in the 1990s, to look at the historical lessons learned.

As anyone familiar with hospital admissions knows, orthopedics and cardiology are the two specialties that account for the largest share of hospital admissions. They also tend to be the most proftable as the plethora of for-profit surgical specialty hospitals would suggest. For those readers not familiar with this,  http://www.merritthawkins.com/pdf/2007_Physician_Inpatient_Outpatient_Revenue_Survey.pdf contains the 2007 survey by physician recruiting firm Merritt Hawkins about revenue contribution by specialty. Thus, it is not surprising that the principal acquisition target of many hospitals is cardiolgy practices. Whether it be the Cardiac Intensive Care Unit (CCU), open heart surgery, blood chemistry lab, SPECT, ultrasound, cardiac CT or MR, cardiovascular admissions are the lifeblood of most hospitals.

My BLOG post http://cpanet.typepad.com/cpanet/2006/11/umdnj.html about this time 3 years ago was a result of stories in the trade press including Daily Dose about the Community Cardiology Program established at the University of Medicine and Dentistry in New Jersey when its accreditation for cardiac surgery was threatened due to insufficient surgical volume. The link to the Monitor's Report in that post is no longer valid, the Report can now be found here http://www.umdnj.edu/ethweb/federalmonitor/index.htm. You can follow the links yourself to see what happened, but there were a number of fines and criminal guilty pleas. Also of some interest, as my original BLOG post noted, is the e-mail record that then US Attorney - and now Governor-elect of New Jersey - Chris Christie obtained.

I have long-advised my colleagues in writing, lectures and personally that as a healthcare appraiser you are not a lawyer, but you best have a sufficient understanding of tax exemption, Stark, the AKS, False Claims Act, antitrust and administrative sanctions to enable you to make a reasonable evaluation of the regulatory underpinnings of a proposed acquisition as well as to assess the representations of any legal counsel involved in the acquisition. And, if you feel your personal knowledge base is short, seek your own, independent, legal counsel.

Looking at my Post http://cpanet.typepad.com/cpanet/2009/12/shades-of-future-past-.html earlier this month, it seems that knowingly, or unknowingly, attempting an end run around the longstanding regulatory and, indeed, professional literature on when the replication cost approach is appropriate is not a particularly good idea, at least when it comes to cardiology practices.

IRS Nonprofit Guidelines

The IRS has posted a Guide Sheet for Examining Agents to be used in audits of tax-exempt entities, including hospitals. Of particular note are items 13 and 14 with respect to approval of compensation arrangements.

Payments to existing physician staff members (or physicians already located in the catchment area) such as those based on replication cost of Intangibles in a practice acquisition where the Income Approach shows no value could run the risk of being considered as compensation. Something to think about.

http://www.irs.gov/pub/irs-tege/governance_guide_sheet.pdf

Meanwhile, "back at the ranch," the instructor in Fair Market Value 101 is asking the students: "How many of you would pay $500,000 to replicate a business from which business you could earn no income?" Sampling of answers to follow...

2010 Medicare Physician Fee Schedule Final Rule

I will have some observations as I read through the document but meanwhile, here is the link.

http://www.federalregister.gov/OFRUpload/OFRData/2009-26502_PI.pdf

Medicare Advantage: Wha' Happened?

Fred Willard's routine about a failed sitcom called "Wha' Happened?"in Waiting for Guffman is an excellent metaphor for the Medicare Advantage Program. As my last Post on this subject suggested, MA's predecessors had some not insignificant success in driving down Average Length of Stay. In addition, there were arguably some equally significant changes – for a time – in how utilization was viewed in the medical community. Like any successful capitalist-oriented system, this success was in part motivated by economic incentives. Why were these significant successes in large part reversed?

Wha' Happened? A little-understood phenomenon called the Underwriting Cycle probably explains a lot of it. Insurance - and Health Insurance - like the numerous other sectors of the Economy, has a Business Cycle. (This Health Insurance cycle closely tracks the performance of the S&P 500.) Utilization-restricting payments to providers – Capitation – are favored by Health Insurers when profit margins are tight: at the Bottom of the Underwriting Cycle. When profit margins are Fat: at the Top of the Underwriting Cycle, Health Insurers favor fee-for-service, because the profits inherent in the Capitation risk-shift inure to the Provider under Capitation rather than the Insurer. When margins are tight, Health Insurers only profit by limiting Provider payments via low capitation rates or poor fee-for-service rates. Poor fee- for-service rates tend to lead to excessive utilization which makes up for the low rates, while in capitation there is no way for Providers to make up for the low rate other than controlling utilization.

The near collapse of the Health Insurance Industry at the end of the 1990s (e.g., Oxford, Harvard Pilgrim) led to both an extreme need for profit and Consolidation of weaker players. Thus, the increasing market power of Insurers due to their Antitrust exemption coupled with the need to take back the utilization-limiting profits inherent in Capitation from providers contributed to the demise of the Capitation model.

The final straw breakin' the ol' Camel's back was the Medicare Modernization Act of 2003. Health Insurers were looking for a vein of Gold and found it in the MMA, which modified the historical Capitation model for Medicare HMOs and made it a cost-plus Model wherein the Insurers' profit was more or less guaranteed off the top. As I said in an earlier post, don't take my word for it, read it for yourself at http://www.medpac.gov/.

To borrow a paraphrase of an old proverb that the MMA missed:The camel who's nose is in the tent tonight will probably be all the way in a few night's hence. The sudden concern about Antitrust issues seems to be designed to get the camel out of the tent and back into the cold reality of Competition. They are awnry critters, however....

Fair Market Value and the OIG

There was some discussion of this topic at the Healthcare Conference to be sure. Here is a quote from Advisory Opinion 09-09, footnote 5:

"Our conclusion might be different if the valuation of the respective contributions of the investors included intangible assets. For example, given the circumstances of the Proposed Arrangement, we might be concerned if the valuation were based on a cash flow analysis of the Surgeon ASC as a going concern. Because the Surgeon Investors are referral sources for the Surgeon ASC, a cash flow-based valuation of that business potentially would include the value of the Surgeon Investors’ referrals over the time that their ASC was in existence prior to the merger with the Hospital ASC. The result might be that the Surgeon Investors would receive a greater return on their capital investment than the Hospital, which could reflect the value of their referrals to the Surgeon ASC. (In these circumstances, the Hospital ASC, being newly developed at the time of the proposed merger, may have little or no cash flow record, but we might be similarly concerned with a valuation based on a cash flow analysis of a hospital-owned ASC for which the hospital could influence referrals.) We do not assert that a cash flow-based valuation or other valuation involving intangible assets would necessarily result in a violation of the anti-kickback statute; the existence of a violation depends upon all the facts and circumstances of a particular case."
http://oig.hhs.gov/fraud/docs/advisoryopinions/2009/AdvOpn09-09.pdf

This comment harkens back to the Thornton letters (1992/1993) http://oig.hhs.gov/fraud/docs/safeharborregulations/acquisition110293.htm
http://oig.hhs.gov/fraud/docs/safeharborregulations/acquisition122292.htm 

and Advisory Opinion 07-05
http://oig.hhs.gov/fraud/docs/advisoryopinions/2007/AdvOpn07-05C.pdf,

the latter of which caused considerable consternation.    At issue is that the OIG appears to define "capital invested" as cash and tangible assets rather than the term used in "fair market value" (market value of invested capital) which includes intangible assets. As the quote indicates, intangible assets may be problematic from a AKS standpoint, given all the facts and circumstances.

Thanks to my colleague Tim Smith for elucidating my thinking on this.

Healthcare Reform: Different Costs for Different Places

I have been watching some of the “talking heads” from both political parties waxing philosophical about Healthcare Reform.  On Sunday’s programs, there seemed to be a competition between “Medicare for All” (MFA (or Museum of Fine Arts?)) as seen at http://www.youtube.com/watch?v=f3BS4C9el98) and something I’ll call “Multi-State Health Insurance” (MUSHI or MUSH, for short) where federal law would trump state licensing of insurers operating within their borders.

Let’s dispense with Medicare for All (MFA).  Readers of this BLOG will be familiar with Medicare as it is followed and reported on closely.  Medicare Part A, which covers Hospital, Skilled Nursing Facilities (SNFs or Sniffs) and various other costs, is supposedly paid for out of the 2.90% payroll tax (charged on ALL payroll, irrespective of earnings), one-half of which is paid by the employer and one-half by the employee.  These taxes go into a “Trust Fund”, which will be bankrupt by 2019 according to the Trustees 2009 Report (http://www.cms.hhs.gov/ReportsTrustFunds/) (it has long been actuarially bankrupt, much like the Retirement Plans of many “old economy” employers and airlines).  Medicare Part B, which pays for Physicians Services, Outpatient Services etc. is in large part funded out of general tax revenues!  You can see what is covered by Part A and Part B at

http://www.medicare.gov/Library/PDFNavigation/PDFInterim.asp?Language=English&Type=Pub&PubID=10116.

More importantly from the standpoint of the insured or Medicare Beneficiary, the co-insurance, co-pays and deductibles work like this: For Part A, Beneficiaries generally pay no monthly premium since the costs are to be paid from the (bankrupt) Trust Fund.  The Deductible charged to the Beneficiary during the first 60 days of Hospitalization is $1,068; after 60 days and until 90 days it is $267 per day; after 90 days it is $534 per day.  For Skilled Nursing Facilities the Coinsurance is $133.50 per day for days 21 through 100 of each benefit period.

http://www.mymedicaresupplementinsurance.com/2009_Medicare_Deductibles_Copays.html. 

For “standard” beneficiaries, Part B insurance costs $96.40 per month; it can be as much as $308.30 if the Beneficiary is filing a joint return with more than $426,000 of Income.  The costs in excess of the premium paid by Beneficiaries are paid from general tax revenues of the U.S. Treasury, or more accurately, by adding to the Deficit.  The Part B deductible payable by each Beneficiary is $135.  The co-insurance, however, is 20% of ALL Medicare Allowed Charges and there is no ceiling on this co-pay.  There are also significant limitations on outpatient therapies (e.g., physical therapy) as well, for example.

http://www.cms.hhs.gov/apps/media/press/factsheet.asp?Counter=3272

 

It is not clear to me how attractive Medicare-style coverage would be to many employees of larger companies.  I would encourage you to express your view to your Congress-folk.  Speaking for myself, Medicare would be very unattractive as a coverage without Medicare Supplemental Insurance, which many Medicare beneficiaries pay a significant monthly premium for.

Onto MUSH. Speaking for myself, I would truly like to believe that if I lived in New York City I could buy health insurance at the same rate as folks living in rural Pennsylvania if only the licensing of insurance companies was a Federal Right and not a State Right, as one Congressman suggested Sunday.  Constitutional limitations notwithstanding, I am disinclined to believe that residents of one of NYC’s Five Boroughs could buy Health Insurance at, say, Kutztown, PA rates, irrespective of insurance company licensing.  It costs a lot more to live in Manhattan than Kutztown. Rent is higher, food is higher, wages are higher, and I recall that utilization of healthcare services is much higher.  Therefore, the cost for a given diagnosis is much higher in NYC than in Kutztown.  And, lo and behold, the cost of insurance reflects the higher costs (Duh).  This is easily borne out by Medicare data (See my article Healthcare Market Structure and Its Implication for Valuation of Privately Held Provider Entities: An Empirical Analysis, Business Valuation Review, Volume 27, Number 2 (Summer 2008) where Kings County (Brooklyn), New York County (Manhattan), and Nassau County (part of Long Island) are among the 20 most expensive counties for healthcare costs in the nation.  Or, you can read about different market areas in a report by the Government Accountability Office (GAO) at http://www.gao.gov/products/GAO-08-880.)

A quick and easy means of comparing cost differences is to look at Medicare Advantage rates by County.The 2009 Monthly Medicare Advantage rate for residents of Kutztown,which is part of Berks County,is $802.  For a resident of New York, it is $1,127, which is 25% higher.  This is not a perfect comparison as there are limitations built into the Advantage rates which would tend to understate New York cost in my experience.  Medicare has a different benefit structure than commercial or HMO polices for the non-Medicare population – and those policies have numerous benefit structures themselves!  If you have looked at the breakdown of insurance companies in a doctor’s medical billing system, you will often see dozens of different categories from the same insurance company reflecting different policies/benefits or the ASO policies described in the previous post below.

Upshot? Health insurance premiums are less in Pennsylvania because the cost of healthcare services is less.  Changing insurance laws is not going to change that, even in the long-term – unless local economies collapse and cost of living differentials disappear.

Bottom line is that you should not hire an actor to repair a fighter plane, even if he/she played a mechanic on TV or flew first class to LA.  You can fill empty space with noise, but the empty space will still be devoid of thought.

Other BLOG posts dealing with Healthcare Market structure implications are at http://cpanet.typepad.com/cpanet/market_approach/.

2010 MPFS Proposed Rule: Practice Expenses RVUs

These proposed changes are pretty astounding and I wonder whether the intense lobbying by specialty societies before the release of the Final Rule in early November will leave them in place. There are truly dramatic reductions in the Practice Expense component for specialties including Cardiology, Interventional Radiology, Radiation Oncology, Radiology and Nuclear Medicine. Because RVU changes are required to be revenue neutral, these decreases are offset by not quite as dramatic increases for Ophthalmology, Optometry, Family Medicine, Internal Medicine and (surprise) Physical Therapy.

The data-file in the link below was exported to excel from the Proposed Rule using Adobe and then converted to pdf. I've highlighted the larger increases in yellow and the decreases in red.

Download Highlight 2010 MPFS Proposed Rule RVU Changes_0709

2010 MPFS Proposed Rule: Imaging

This is likely to be the first of several posts as I explore the more than 1100 pages in the Proposed Rule. First no-surprise is that Imaging gets hammered once again. As recommended by MedPAC and initially contained in legislation that did not pass last Fall, the utilization assumption for high-tech imaging equipment costing more than $1.0 million is to rise from 50% to 90%, resulting in a dramatic reduction in the practice expense component/technical component payment per scan.

Quoting the Rule: "We believe the studies cited by MedPAC suggest what we have long suspected, that physicians and suppliers would not typically make huge capital investments in equipment that would only be utilized 50 percent of the time." (Duhhh)

This Proposed Change begs a significant Valuation issue. The drop in revenue and even greater drop in contribution margin cannot be quantified via the discount rate; it has to be accounted for in the cashflow forecast and dramatic differences in value will result from the quantification assumption. Good time to check with Industry experts like Doug Smith at Barrington Lakes Group about what operators are expecting and doing with transactions. Doug's Imaging Chapter in BVR's Guide to Healthcare Valuation is an eye-opener about the valuation of Imaging Centers.

AHLA Tax & Finance Practice Group Member Briefing

My article Converting Physician Practices to Tax-Exempt Status: Is There an Upside to the Downturn? was published earlier this week as a Member Briefing by the American Health Lawyers Association. I would like to thank the editors, who included Travis Blaisdell at Mintz Levin, for their efforts in translating my submission into a form appropriate for the AHLA audience.  After my Journal of Accountancy article and ABA Health Lawyer article with Reed Tinsley, this is the third most edited article I have had published. The article contains some observations that are particularly important in the current environment.  Among these are the

1. Import in an appraisal of considering the tax impact of a liquidation when a taxable practice converts to exempt status

2. Continuing importance of the DCF method in determining whether and to what extent a practice has Intangible Value. I continue to believe that absent extraordinary circumstances, the Cost Approach should not supplant the Income Approach as the appropriate reference point in Healthcare Valuation.

3. Valuing the Transaction reflected in the transaction documents as required by the Derby case discussed elsewhere in this BLOG

4. Considering local law as to the enforceability of noncompete and similar provisions

5. Considering limitations on obtaining both debt and equity capital in the current environment on the discount rate and/or the consideration of marketability.

See this earlier Post: http://cpanet.typepad.com/cpanet/2009/03/exempt-organization-cpe-text.html