Valuing Healthcare Management Services Agreements


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In “Valuing Healthcare Management Services Agreements,” PYA Principal Tynan Olechny discussed the types of management services found in the healthcare marketplace. Her NACVA webinar presentation addressed the valuation of these services with a focus on how the appraiser can analyze the key economics of management services agreements. She also examined how the commercial reasonableness of these arrangements can be evaluated and assessed as part of the valuation process.

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Valuing Healthcare Management Services Agreements

  1. 1. Page 1April 3, 2014 Prepared for NACVA Webinar DISCLAIMER All rights reserved. No part of this work covered by the copyrights herein may be reproduced or copied in any form or by any means—graphically, electronically, or mechanically, including photocopying, audio/video recording, or information storage and retrieval of any kind—without the express written permission of the CTI, NACVA ,and the presenter. The information contained in this presentation is only intended for general purposes. It is designed to provide authoritative and accurate information about the subject covered. It is sold with the understanding that the copyright holder is not engaged in rendering legal, accounting, or other professional service or advice. If legal or other expert advice is required, the services of an appropriate professional person should be sought. The material may not be applicable or suitable for the reader‘s specific needs or circumstances. Readers/viewers may not use this information as a substitute for consultation with qualified professionals in the subject matter presented here. Although information contained in this publication has been carefully compiled from sources believed to be reliable, the accuracy of the information is not guaranteed. It is neither intended nor should it be construed as either legal, accounting, and/or tax advice, nor as an opinion provided by the Consultants‘ Training Institute (CTI), National Association of Certified Valuators and Analysts (NACVA), the Institute of Business Appraisers (IBA), the presenter, or the presenter‘s firm. The authors specifically disclaim any personal liability, loss, or risk incurred as a consequence of the use, either directly or indirectly, of any information or advice given in these materials. The instructor‘s opinion may not reflect those of the CTI, NACVA, its policies, other instructors, or materials. Each occurrence and the facts of each occurrence are different. Changes in facts and/or policy terms may result in conclusions different than those stated herein. It is not intended to reflect the opinions or positions of the authors and instructors in relation to any specific case, but rather to be illustrative for educational purposes. The user is cautioned that this course is not all inclusive. © 2013—1997 NACVA • 5217 South State Street, Suite 400 • Salt Lake City, UT, 84107—ALL RIGHTS RESERVED. The Consultants' Training Institute (CTI) is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted through its web site:
  2. 2. Page 2April 3, 2014 Prepared for NACVA Webinar The Presentation will include periodic online Polling Questions/Codes to assess continuous participation and to determine the program‘s effectiveness. You MUST respond to all polling questions (live) or keep track of all polling codes (recorded) in order to receive CPE credit. If you view the webinar with a Smartphone or Tablet you will NOT be able to answer polling questions that are required for obtaining CPE credit. If you are viewing this presentation as a recorded webinar it will not qualify for NASBA QAS CPE credit. You can however, obtain CPE credit per the instructions included with your recorded webinar purchase. How to obtain CPE credit for this webinar: © 2013 National Association of Certified Valuators and Analysts 2
  3. 3. Page 3April 3, 2014 Prepared for NACVA Webinar Agenda 2 Management Services Defined 3 Critical Factors in Valuing Management Services 4 Valuation Approaches Agenda 1 Introduction 2 2 Regulatory Considerations3 4 5 4 Case Studies6
  4. 4. Page 4April 3, 2014 Prepared for NACVA Webinar Introduction • Have been in existence in healthcare for decades and historically focused on administrative and/or operational tasks • Provide hospitals, ambulatory surgery centers (ASCs) and physician practices with operational and functional services • Common situations where healthcare provider might seek third-party entity for management services – Provider determines that outsourcing certain management functions will result in optimization of its operations – As part of an acquisition or joint venture – One provider seeks to affiliate with another by integrating some level of operations or one party provides expertise and infrastructure to the other
  5. 5. Page 5April 3, 2014 Prepared for NACVA Webinar • Management services or ―purchased services‖ are geared towards strengthening business aspects of an operation – Expertise, cost-efficiency, and economies of scale in business services • Outsourcing of medical and/or administrative services Clinical Operational Needs Non-clinical Operational Needs Medical Directorship Contract Negotiations Clinical Staff Legal and Financial Services Clinical Management Risk Management Billing Human Resources Support Operations Management Management Services Defined
  6. 6. Page 6April 3, 2014 Prepared for NACVA Webinar • Between ―like‖ provider entities – Hospital providing management services to another hospital • Between different types of providers – Physician practice and a hospital/health system • Between providers and third parties – ASC and third-party manager Types of Transactions
  7. 7. Page 7April 3, 2014 Prepared for NACVA Webinar • Refer to instances whereby hospital and physicians collaboratively manage and operate a particular hospital service line or program, such as orthopedics, cardiology, or oncology – Shared vision – Formal alignment in patient care delivery – Improved program outcomes – Enhanced association between hospitals and physicians – Operational excellence – Effective decision-making structure New Trend: Co-Management and Service Line Management Arrangements
  8. 8. Page 8April 3, 2014 Prepared for NACVA Webinar • Accounting & Financial Management – Budget development – Internal financial statements – Billing services – Managed care contracting – Malpractice premium negotiation – Oversight and monitoring • Operations – Day-to-day oversight and administration – Staffing and scheduling – Equipment and supply procurement – Policies & procedures – Regulatory compliance – Assistance with credentialing Examples of Management Services
  9. 9. Page 9April 3, 2014 Prepared for NACVA Webinar • Human Resources – Review of staffing levels – Recruitment and retention – Training and orientation – Appointment and evaluation of clinical and non-clinical staff • Leadership – Medical director services – Medical staff activity participation – Management and/or advisory committee participation • Strategic Planning – Development of strategic plan – New program development – Participation in strategic planning process • Other – Quality and process improvement – Patient and community outreach – Assistance with accreditation Examples of Management Services
  10. 10. Page 10April 3, 2014 Prepared for NACVA Webinar Traditionally • Fixed fee or cost of providing services plus profit factor • Percentage of net patient revenue (i.e., billing) • Mark-up percentage on cost (i.e., employee leasing) Today Compensation for Management Services • Fixed fee based on certain pre-defined services plus • ―At risk‖ component based on achievement of defined quality outcomes and metrics (i.e., reducing infection rates, attaining patient satisfaction, etc.) “Traditional” “Modern”
  11. 11. Page 11April 3, 2014 Prepared for NACVA Webinar Regulatory Considerations You‘re not paranoid -- they really are after you.
  12. 12. Page 12April 3, 2014 Prepared for NACVA Webinar Regulatory Considerations • Federal False Claims Act • Federal Anti-kickback Laws (fraud and abuse laws & regs) • Stark Laws (physician self-referral laws & regs) • IRS Private Inurement Regulations (affecting tax-exempt organizations) • State Anti-kickback and Self-referral Laws • Provider-based Status Rules
  13. 13. Page 13April 3, 2014 Prepared for NACVA Webinar • ―The price at which the property or service would change hands between a willing buyer and a willing seller, neither being under a compulsion to buy or sell and both having reasonable knowledge of the relevant facts.‖ (Estate Tax Reg. 20.2031.1-1(b); Revenue Ruling 59-60, 1959-1, C.B. 237) • This definition is consistent with the Stark Law definitions of fair market value and general market value, which are defined as follows: – Fair Market Value: the value in arm‘s-length transactions, consistent with the general market value. – General Market Value: the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party, or the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement. (Federal Register / Vol. 69, No. 59 / Friday, March 26, 2004 / Rules and Regulations) Fair Market Value Defined
  14. 14. Page 14April 3, 2014 Prepared for NACVA Webinar Commercial Reasonableness Definition • The Centers for Medicare & Medicaid Services (―CMS‖) formerly interpreted the requirement of ‗commercial reasonableness‘ to designate an arrangement appearing to be ―a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals.‖ (63 Fed. Reg. 1700 - Jan. 9, 1998) • CMS further clarified its intent in subsequent Stark Law commentary which states that ―an arrangement will be considered ‗commercially reasonable‘ in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician (or family member or group practice) of similar scope and specialty, even if there were no potential designated health services (―DHS‖) referrals.‖ (69 Fed. Reg. 16093 - March 26, 2004)
  15. 15. Page 15April 3, 2014 Prepared for NACVA Webinar Fair Market Value___________________________________________________________________ Cents___________________________________________________________________ Scope: Range of Dollars Only Key Question: “How Much”? Commercial Reasonableness___________________________________________________________________ Sense___________________________________________________________________ Scope: Overall Arrangement Key Question: “Why”? Compliance Issues Regarding Financial Relationships Two Components
  16. 16. Page 16April 3, 2014 Prepared for NACVA Webinar Presence of Legal Agreement FMV Assessment of Services & Fees Define Scope of Services and Areas of Need Understand Legal Structure • Administrative and operational services • Clinical responsibilities • Incorporation of quality incentives • Contracts between: Physician group and hospital Hospital and management company formed to execute management services ASC and ASC management company • Duties and responsibilities • Provision of terms • Termination of agreement • Compensation • Appraiser with experience in healthcare transactions • Consideration of other arrangements (i.e., call coverage, medical directorship, physician lease, or leaseback agreements) • Commercial reasonableness Critical Factors in Valuing Management Services
  17. 17. Page 17April 3, 2014 Prepared for NACVA Webinar • Management arrangements can be valued based on the following approaches: • Cost Approach: Value indication as if the services were performed internally; involves a calculation of the cost to replace or replicate • Market Approach: Value as indicated under the principles of a free market, such that supply and demand forces will determine prices of business assets; market data is analyzed to determine what is actually being paid in the marketplace for comparable services • Income Approach: Value indication determined by the accrued economic benefits of an asset • Build vs. Buy: Would it be more cost-effective to perform management services internally? • Yes, Build: Cost Approach • No, Buy: Market Approach Valuation Approaches
  18. 18. Page 18April 3, 2014 Prepared for NACVA Webinar • Gain an understanding of the scope of services Each agreement has its own unique set of considerations and services If the agreement is vague, appraiser should interview the hospital‘s legal counsel Wording of agreements should be taken into careful consideration ―Assist with billing and collection functions‖ vs. ―perform billing and collections‖ • Determine appropriate level of staffing and resources Nature of company being managed differs greatly (i.e., physician practice vs. hospital outpatient department) Historical and projected revenues will impact the level of management services required Level of complexity, diversity and comprehensiveness of services will impact resources required Cost Approach Considerations
  19. 19. Page 19April 3, 2014 Prepared for NACVA Webinar • Determine costs of providing services For required staffing, various salary surveys should be analyzed to determine appropriate compensation amounts Differentiate between clinical and administrative duties Reasonable markups to reflect the risk that the management company is assuming by employing required staff should be included Agreements including other services may require additional resources If facility space is part of the arrangement, the determination of appropriate markups or fair market value rent should be conducted by a qualified real estate appraiser Cost Approach Considerations (continued)
  20. 20. Page 20April 3, 2014 Prepared for NACVA Webinar • Identify market comparable data with similar components or risk profiles as the subject arrangement ASCs • Management arrangements are prevalent • Is the provision of clinical staff included? • Is the ASC management company a minority owner in the ASC? Publicly traded companies providing management services • Analyze data and make comparability adjustments • Weigh importance of tasks being evaluated against market comps • Compare risk/responsibility of management company to market comps • Consider revenue size of market comps to determine whether management fee as a percentage of revenue is appropriate for subject Market Approach Considerations
  21. 21. Page 21April 3, 2014 Prepared for NACVA Webinar • Determine the value of the economic benefits that would accrue to either side of the management services arrangement – To analyze the seller‘s benefits, consider the profit level of the management company given the calculated management fee and compare with market- based rates; the amount of the management fee should appropriately reflect the level of risk that is being assumed by the management company – To analyze the buyer‘s benefits, determine the value of the benefits that would accrue to the managed organization from the services provided by the manager (i.e., isolate the financial impact to those results achieved by management company‘s efforts) or evaluate the total earnings, margins, and returns of the organization given its purchase of the management services – Analyses have practical limitations Income Approach Considerations
  22. 22. Page 22April 3, 2014 Prepared for NACVA Webinar Necessity of Specialized Expertise Oversight and Monitoring Legitimacy of the Business Purpose Appropriateness of Management Services • Does the proposed arrangement represent a reasonable necessity for the operation of the managed entity? • Is the management agreement necessary to further a legitimate business purpose of the managed entity? • Are the particular duties of the management company clearly defined? • Are the management services a necessary addition to the managed entity‘s current managerial or administrative staff? • Does the management agreement require the services of physicians or other specialized staff? • If so, does the management company possess the requisite expertise and experience to perform the management services? • Is there a written agreement that clearly defines the terms of the agreement? • Does the managed entity engage in routine monitoring efforts to ensure that the required services are actually performed? Commercial Reasonableness
  23. 23. Page 23April 3, 2014 Prepared for NACVA Webinar Project: Assessment of FMV compensation for a potential management services agreement to provide clinic start-up services, administrative and management services, personnel and human resources, and billing services. • Scope of services: Administrative services • Type of transaction: Between management company and physician practices • Presence of legal agreement: 1-year renewable agreement • FMV assessment of fees: Cost and market approaches • Compensation: Total annual payment Case Study #1
  24. 24. Page 24April 3, 2014 Prepared for NACVA Webinar Project: Assessment of FMV compensation for the co-management of cardiology services between a hospital and physician practice • Scope of services: Clinical and administrative services • Type of transaction: Between hospital and physician practice • Presence of legal agreement: 3 years • FMV assessment of fees: Cost and market approaches • Compensation: Fixed fee for provision of defined administrative and medical directorship services with ―at risk‖ payment for achievement of identifiable quality metrics Case Study #2
  25. 25. Page 25April 3, 2014 Prepared for NACVA Webinar Contact Information Tynan P. Olechny, MBA/MPH, CVA Principal, PYA 404-266-9876