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Healthcare Markets, Part Deux

I heard yesterday that my Paper on healthcare markets tentatively titled Healthcare Market Structure And Its Implication For Valuation Of Privately Held Provider Entities: An Empirical Analysis will appear in the Summer Edition of Business Valuation Review - barring unforseen delays. In addition to speaking in part on this topic at the AICPA/ASA BV Conference, I will also present portions of it at the AICPA Healthcare Conference in September and the Tennessee Society of CPAs Healthcare Conference on December 2.

Now that the paper has been accepted for publication - after pre-submission peer review and critique -  I think it is reasonable to state that it has fairly dramatic implications for the use of out-of-market transaction data when using the Guideline Publicly Traded Company method or the Guideline Merged and Acquired Company method.

Gas Stations, Accounting Firms and Medical Practices

I continue to encounter resistance to the idea that a coding analysis is necessary to value a physician practice when you can get the data; codes indicate not only the source of revenue in the practice, e.g., office encounters versus tests, but also the character of services being provided and the underlying illness of the patient base.  A subspecialist who relies on referrals and therefore the consult codes for his or her income is in a very different position than a primary care physician who relies on codes 99212, 99213 and 99214 for his or her income.  Incorrect use of a higher level code can dramatically overstate the revenue in the practice while a lower level code can understate the revenue. Further, a Payor Analysis is necessary to see how much revenue comes from Medicare, Blue Cross, Medicaid and so on, and how much of each of those revenue sources is actually collected.

I recently analogized this to trying to value a gas station without knowing how much of the sales were for gas, how much for candy, soda, sandwiches and/or groceries, and how much for renting space to the Dunkin Donuts!  Similarly, I have never heard anyone suggest that you can value an accounting practice without knowing how much revenue came from accounting, bookkeeping, tax and consulting - and what the billing rates were for each staff member providing services in those areas and what portion of the billing was realized in cash collections!

Nuff said.

Post-Transaction Compensation

I received a question the other day inquiring as to the basis for  my statement in the November 2005 Journal of Accountancy that "the IRS says physician compensation in a valuation model should agree with any post-transaction employment contract."  I thought my response to that question would assist a lot of other appraisers.

This concept originally appeared in a letter attached to the valuation submitted in connection with the exemption ruling for the Friendly Hills Transaction as described below:

Quote from my book:

“The Friendly Hills HealthCare Foundation was the first ruling by the IRS in favor of tax exemption for an Integrated Delivery System (IDS) involving physician compensation in tax-exempt settings.  Certain aspects of the Ruling, including the use of the Discounted Cashflow Method, were later elaborated upon in the 1995 Exempt Organization Continuing Professional Education Technical Instruction Program Textbook.  Notably, the value determined in Friendly Hills was based, in part, on an agreed-upon reduction in physician compensation.”

“In fact, the valuation submitted in connection with the Friendly Hills transaction  contains a letter signed by the managing partner stating that the partners recognized they were selling a portion of their earnings and that their future incomes would be less by virtue of that sale.  In relevant part he states “... It has been clearly stated to the partners that, in the past, their compensation reflected not only the value of their medical services, but also the profits attributable to their ownership of the Network; that the latter element will be replaced by a cash payment, which they can invest ... that the Medical Group’s income will thereafter be derived from arms-length contract for medical services; and that these rates will necessarily be significantly lower than the total historical income they have been receiving ...” (emphasis added).  (Friendly Hills Valuation Report)”

See the 1994 Exempt Organization CPE text INTEGRATED DELIVERY SYSTEMS (eotopicn94.pdf) and 1995 Exempt Organization CPE text INTEGRATED DELIVERY SYSTEMS AND JOINT VENTURE DISSOLUTIONS UPDATE (eotopicl95.pdf).  Note in particular bottom of page 8 forward in 1994 text and the general discussion of compensation in 1995.  You can obtain these at http://www.irs.gov/pub/irs-tege/. These are still cited as recently as 2004.

Fundamentally, why would a hospital buy a practice for a value based upon the physicians receiving X compensation for their future services, when the Employment contract provided they would be paid X+?  You would not buy my practice, or I yours, for a $1 million and continue to pay me/you everything it generates, I suspect.  For a hospital to do so raises serious inurement and excess benefit issues, and more importantly, Stark and AKS issues.

MPFS Proposed Rule changes to Stark

Imaging remains under attack on all fronts it seems. CMS suggested in the 2008 Proposed Rule that it may limit the applicability of the in-office ancillary services exception and prohibit use of per click mechanisms where physician-lessors of equipment also refer to the facility-lessee; perhaps more significant, so-called "under arrangements" structures would be constrained or eliminated.

Legislation currently in Congress would replace the current single conversion factor with six - with a lower one for imaging! - and pay for the SCHIP expansion with further reductions in imaging reimbursement.

All of these potential changes increase the risk of future cashflow from Medicare-sourced procedures and need to be considered in an appraisal or valuation.

Phase 3, Stark II regulations

Phase 3 of the Stark regulations came out yesterday (thanks to colleague Reed Tinsely for the early heads up). I am still plowing through the 500 or so pages, but the Safe Harbor for physician compensation based on the various compensation surveys is gone. Seems as though CMS received numerous comments from affected parties that the Safe Harbor was not workable - and they agreed! Now we are back to traditional tests of fair market value compensation rather than the artificial Safe Harbor.

http://www.cms.hhs.gov/PhysicianSelfReferral/04a_regphase3.asp#TopOfPage

Forthcoming Article

In the next edition of Financial Valuation and Litigation Expert I will have an article summarizing the changes in ASC payments by Medicare, the Medicare Physician Fee Schedule Proposed Rule and most importantly, CMS' hinted changes in the Stark law regulations, which will likely have significant impact on discount rates and/or cashflow forecasts for the affected sectors.

2008 ASC Final Rule

CMS published the Final Rule for the new Ambulatory Surgery Center payment system pegged to the Hospital OPPS rates, using a factor of 67% versus the 62% contained in the 2006 Proposed Rule.  Although the payments will be somewhat better than originally thought, the 5% spread is not indicative of the true difference because certain required adjustments have not yet been made.  One big winner in the Final Rule was the payment for cataract surgery, which was set at 8% higher than in the proposed rule and nearly 4% higher than the present payment.

Despite being pegged at the outset to OPPS rates, future increases in ASC rates will be based on the CPI for Urban Consumers while OPPS rate increases are based upon a separate "market basket" of cost inputs for hospital outpatient departments.  The market basket is usually higher than the CPI.

The new rates were supposed to be implemented using a 50-50 split with the old rates in 2008 and full implementation in 2009.  The Final Rule changed this to a 4-year phase-in using a 25-75, 50-50, 75-25 schedule.  Thus, those procedures who would lose under the new payments will lose less and those who would benefit will benefit less.

OIG Advisory Opinion No. 07-05

Opinion No. 07-05 involves the sale of a 40% interest at fair market value in an existing ASC by certain physicians to a tax-exempt hospital.  The fact pattern includes 94% of the interest owned by orthopedic surgeons and 6% by gastroenterologists and anesthesiologists.  The subject 40% interest is owned by the orthopods; the sale proceeds would not be invested in the ASC entity itself but would go directly to the orthopods. 

The OIG concluded that the proposed transaction raised issues under the AKS since not all the physicians were selling interests and more importantly, “the return on the investment would not be directly proportional to the amount of the capital invested by each investor. The amounts payable to the investors would be proportional to their ownership interest in the Company; however, because the Hospital would pay more per ownership unit than the Orthopedic Surgeons paid, the Orthopedic Surgeons would receive a higher rate of return on their remaining shares than the Hospital would receive on its newly-purchased shares.”

On the surface, this Advisory raises serious concerns about sales of interests in ASCs (and just about anything else regulated by the AKS for that matter) since the OIG’s conclusion is that the transaction poses a risk under the AKS.  Particularly problematic from a valuation standpoint is the OIG’s failure to recognize one of the fundamental tenets of Fair Market Value: namely, that the cash proceeds of the sale are exactly equal to the present value of the future returns on the underlying investment.  Therefore, the premise for the OIG’s adverse conclusion that “the Orthopedic Surgeons would receive a higher rate of return on their remaining shares than the Hospital” for the OIG’s adverse conclusion” is entirely false.  ‘Return’ is based upon the fair market value TODAY of the underlying shares which is exactly what the Opinion states the hospital is paying and the orthopods are receiving.  ‘Return’ includes both cash distributions and appreciation.  The orthopods are receiving cash for the appreciation to date and foregoing future cash distributions on the portion sold.

 

One can only hope that something more was in the submitted documentation from those requesting the ruling that gave the OIG cause for concern.

Anti Trust Policy

During my work on the in-progress 3rd edition of my book, I reviewed the current stance of the "Agencies" - Federal Trade Commission and Department of Justice - with respect to joint negotiations and similar activities by physicians (Improving Health Care: A Dose of Competition, July 2004). Predictably, I found no change in the longstanding opposition to same and continued strenuous enforcement activity. Several things were of particular interest, however.

Allied Health Professionals such as CRNAs or dental hygienists are an increasingly critical part of the healthcare delivery system. In many instances, they represent a critical profit center for the physicians (or dentists) who supervise them. In the case of CRNAs for example, in many states they cannot practice independent of physician supervision; in states where they are permitted to, hospital policy may preclude it. Although they do much the same work as anesthesiologists, they are paid less than half the salary.

Dental hygienists generally cannot practice independently of a dentist's supervision. Given the profitability of the typical hygienist in a dental practice - one of the principal value drivers of the practice - it is not difficult to see why the Agencies believe that a change in licensing would lead to lower prices. Therein lies the Agencies' problem with state-based licensing of Allied Health Professionals by Boards often controlled by the supervising profession (again, physicians or dentists) who have a vested financial interest in reducing potential competition.

I would observe as well that the move of mega-retailer Walmart and CVS into the in-store walk-in clinic using physician extenders gives this issue particular import.

Anti-trust enforcement is shared with the individual states' attorneys general and the Agencies pass along their recommendations. Therefore "stand by for news..."

UMDNJ

If you have not seen the most recent Chapter in the University of Medicine and Dentistry of New Jersey's problems with the federal government, download the federal monitor's report on the payments made to cardiologists for serving as part-time faculty. This is an important document from a variety of standpoints, not the least of which is educating oneself about what is and is not proper and the incredible things that get stated in e-mail.

http://www.umdnj.edu/home2web/federalmonitor/pdf/report111406c.pdf