Determining Value & Physician Compensation When Purchasing a Practice

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  • No matter what resource you rely upon to stay abreast of healthcare news, you can’t help but come across an article or 2 or 3 or 4 about hospital and physician alignment. Everywhere you turn, hospitals and physicians (1st bullet)While different drivers in some but not all cases are bringing the parties to the table, the benefits can include things such as…(2nd bullet)…With the strength in numbers mentality.
  • So what’s in it for hospitals and health systems? Obviously there is a strong feeling that having the providers on board to participate in the decisions that affect care delivery will help achieve the first three bullets – increased efficiencies, ability to explore the provision of care in new outpatient arenas, while improving standardization and consolidation of services internally.With regards to the 4th bullet, the hospital has an interest, an obligation, actually, to ensure adequate coverage of key specialtys within the service community. If the physicians are not coming of their own accord, then the hospital often seeks ways to attract and maintain them. This also affects call coverage needs.Protecting their own turf is still a fundamental genesis for physician alignment. In certain metropolitan areas, you see this as one or two health systems began to revisit the employment of physicians and within 12-18 months, most systems in the area are actively doing the same thing, almost in a “get it before its gone” mentality.Finally, there is healthcare reform. While it is still “out of focus”, there is a strong feeling that healthcare reform initiatives will require hospitals to rely heavily on physicians to achieve certain objectives such as quality measures to survive themselves. Rather than risk having to try to get a lg number of loosley affiliated MDs on the same page, hospitals feel they have a better chance to succeed with a tighter affiliation.
  • And for the physicians?The first three relate to decreased reimb and increased exp – the margin on being a physicians has decreased significantly.The thought of major capital expenditures to update office, obtain EMR, stay competitive gives them heartburn.Coupled with the routine expenses, the cost of recruiting a younger associate (usually entailing a bank loan or decreased owner compensation) in hopes of transferring the business upon retirement is intolerable…and more look to the hospital for that purpose.Quality of life is explanatory – older generation tired of working harder for less, younger not interested in the hassle of running a businessGovernment oversightAnd again, the unknowns of healthcare reform.
  • As you can see from this slide, there are numerous ways that hospitals and health systems are aligning with physicians and they range from common to less common, highly integrated to less integrated, and every thing in between. Today we’re limiting our focus to the fairly common approach of physician acquisition and employment, or “Buy and Employ” as Carol calls it.
  • Stark:Exceptions typically require compensation to be set in advance, consistent with fair market value (FMV) and not determined in a manner that takes into account the volume or value of referrals.42 U.S.C. §1395nnAKS:Prohibits the knowingly and willful offer, payment, solicitation or receipt of remuneration for purposes of inducing or rewarding for referrals of services reimbursable by a federal health care program.42 U.S.C. §1320a-7b(b)IRS:Tax exempt hospitals/health systems must ensure that no part of its earnings “inure to the benefit of any private shareholder or individual. Transactions between tax exempt hospitals and physicians that are in excess of FMV could jeopardize the hospital’s tax exempt status.IRC Section 501(c)(3) and related regulations.
  • We enumerated earlier the various reasons that physicians are exploring these options. For those that have been entrepenureial at hear tin the past, the changes in the healthcare environment have been weight on them, and it can all be collapsed into this slide – the increased pressures are beginning to outweigh the rewards…
  • There is no better illustration of misaligned compensation structures than the 1990s employment cycle.Granted the regulatory environment was different (remember Stark was just beginning to roll out!) and setting base salaries without performance expectations didn’t work out too well.Learning from these past experiences, it is safe to say that a system’s compensation approach should be Review bulletsAdding a few others, it should be something that can be managed. Can the systems in place produce the data needed in a reliable form so an additional FTE isn’t needed simply to run the comp formula? If not, something needs to be addressed on the front end.It should also be written down as a compensation philosophy and agreed upon by the overseeing parties – this can be the c-suite, the Board, etc. This gives everyone a clear understanding of where the system is coming from in terms of compensation, it aides in compliance initiatives, and it gives systems a way to bow out gracefully if a physician is demanding something that can’t be given.
  • There is no better illustration of misaligned compensation structures than the 1990s employment cycle.Granted the regulatory environment was different (remember Stark was just beginning to roll out!) and setting base salaries without performance expectations didn’t work out too well.Learning from these past experiences, it is safe to say that a system’s compensation approach should be Review bulletsAdding a few others, it should be something that can be managed. Can the systems in place produce the data needed in a reliable form so an additional FTE isn’t needed simply to run the comp formula? If not, something needs to be addressed on the front end.It should also be written down as a compensation philosophy and agreed upon by the overseeing parties – this can be the c-suite, the Board, etc. This gives everyone a clear understanding of where the system is coming from in terms of compensation, it aides in compliance initiatives, and it gives systems a way to bow out gracefully if a physician is demanding something that can’t be given.
  • Finally,
  • Determining Value & Physician Compensation When Purchasing a Practice

    1. 1. 0Determining Value & PhysicianCompensation whenPurchasing a PracticeJune 18, 2013Carol W. Carden, CPA/ABV, ASA,CFELori Foley, CMA, PHR, CMM
    2. 2. 1Learning Objectives• After this session, you willDescribe how Stark and anti-kickback statutes affect practiceacquisitionDescribe various compensation structures for post-transactionemploymentUnderstand valuation approaches for practice acquisition
    3. 3. 2Agenda• The hospital/physician alignment environment• Healthcare regulatory considerations• Valuation methods and issues related tophysician practices• Physician compensation considerations
    4. 4. 3The Hospital/PhysicianAlignment Environment
    5. 5. 4Hospital/PhysicianAlignment Transactions• Hospitals and physicians are actively seeking waysto strategically and financially align themselves.• Successful alignment transactions can result insubstantial benefits to all parties including patients.– Improved efficiencies and quality of care– Reduced costs and waste– Better bargaining power with third party payors
    6. 6. 5Hospitals & Health SystemsSeeking efficienciesDiversifying, focusing on outpatient and wellnesscareIncreasing emphasis on standardization,integration, and consolidation of servicesExperiencing physician shortages in keyspecialtiesCompetition from other systems as well asphysician owned outpatient centersCall coverage needsHealthcare reformHospitals &Health Systems
    7. 7. 6PhysiciansFinancially squeezed - decline in reimbursement,increased overhead and loss of incomeDifficulty obtaining malpractice coverage atreasonable ratesWorking capital requirementsInability or unwillingness ($$) to recruitExit strategyQuality of lifeIncreasingly complex government oversightPhysiciansHealthcare Reform
    8. 8. 7Physician Alignment VehiclesMore IntegrationLess IntegrationMore CommonLess CommonEquipment JVEMRCo-ManagementMedicalDirectorshipsShared SavingsReal Estate JVPhysician AdvisoryCouncilPHOQualityPhysicianServicesAgreementPhysicianLeasingAgreementPhysician Acquisition/Employment
    9. 9. 8Physician Practice Acquisitions –the “Buy and Employ” Strategy• Hospitals and physicians are entering into acquisition andemployment transactions at a torrid pace!• Transactions often make good business sense but alsoinvolve substantial risk.– Regulatory risk;– Financial risk (i.e., hospital‟s ability to successfully integrate andoperate the Practice without incurring substantial losses); and– Reputation risk (the two entities are now related).• Very competitive environment in many markets
    10. 10. 9“Buy and Employ” Transactions• Typical Transaction:– Hospital buys the practice at FMVo Usually structured as an assetpurchaseo Cash and AR normally excludedo Net after-tax proceeds can besubstantially different dependingupon the deal structure.“Buy andEmploy”Transactions
    11. 11. 10“Buy and Employ” TransactionsPhysicians employed by the hospital –• Generally under some type of productivitybased compensation arrangement(wRVUs)• Generally involves a period of guaranteedcompensation (assuming productivitydoes not decline substantially).• Often includes other types ofarrangements as well (e.g., co-management, call pay, quality incentives,etc.).“Buy andEmploy”Transactions
    12. 12. 11Key Issues• The hospital and physician practice should be a good fitstrategically.• Regulatory restrictions (e.g., fair market value)• Deal structure• Post-transaction governance• Keeping the physicians engaged and motivated• Ancillary services – impact on compensation• Due diligence
    13. 13. 12Healthcare RegulatoryConsiderations
    14. 14. 13Road100mMenuSTARK LAWProhibited self-referralsfor Medicare andMedicaid patients.Navigating theRegulatory EnvironmentANTI-KICKBACKKnowingly and willfuloffers, payments, orreceipts for referrals.IRS-NFPIRC Section 501(c) 3requirements
    15. 15. 14FAIR MARKETVALUECompliance Issues RegardingHospital-Physician Financial RelationshipsCOMMERCIALREASONABLENESSOverallArrangement“WHY?”SENSE CENTSRange ofDollars Only“HOWMUCH?”ScopeKey Question
    16. 16. 15Commercial Reasonableness• Department of Health and Human Services Definition1– An arrangement which appears to be “a sensible, prudent businessagreement, from the perspective of the particular parties involved, even in theabsence of any potential referrals.”• Stark Definition2– “An arrangement will be considered „commercially reasonable‟ in the absenceof referrals if the arrangement would make commercial sense if entered intoby a reasonable entity of similar type and size and a reasonable physician ofsimilar scope and specialty, even if there were no potential designated healthservices (“DHS”) referrals.”• OIG Threshold 3– Compensation arrangements with physicians should be “reasonable andnecessary.”1 63 Fed. Reg. 1700 (Jan. 9, 1998).2 69 Fed. Reg. 16093 (March 26, 2004).3“OIG Compliance Program For Individual and Small Group Physician Practices,” Notice, 65 Fed. Reg. 59434 (Oct. 5, 2000); OIG Advisory OpinionNo. 07-10, September 20, 2007, pg. 6, 10; “OIG Supplemental Compliance Program Guidance for Hospitals,” Notice, 70 Fed. Reg. 4858 (Jan.31, 2005).
    17. 17. 16Factors in Determining CRBusiness PurposeProvider AnalysisFacility AnalysisResource AnalysisIndependence & OversightCommercialReasonablenessDetermination
    18. 18. 17Fair Market Value• IRS Definition1– Fair market value (“FMV”) is defined as the amount at which property wouldchange hands between a willing seller and a willing buyer when neither isunder compulsion and both have reasonable knowledge of the relevant facts• OIG/Stark Definition2– The value in arm‟s-length transactions, consistent with the general marketvalue– The price that an asset would bring as the result of bona fide bargainingbetween well-informed buyers and sellers who are not otherwise in a positionto generate business for the other party, or the compensation that would beincluded in a service agreement as the result of bona fide bargainingbetween well-informed parties to the agreement who are not otherwise in aposition to generate business for the other party, on the date of acquisition ofthe asset or at the time of the service agreement1Estate Tax Reg. 20.2031.1-1(b); Revenue Ruling 59-60, 1959-1, C.B. 237.2Federal Register / Vol. 69, No. 59 / Friday, March 26, 2004 / Rules and Regulations.
    19. 19. 18Fair Market Value – Key Concepts• Determined from the perspective of hypothetical buyersand sellers without the ability to refer business to oneanother.• No consideration for post-transaction buyer synergies.However, such synergies often exist!• The financial terms of the transaction must makeeconomic sense based on the assets being sold/received.• Post-transaction compensation must be taken intoconsideration.
    20. 20. 19Valuation Methods and IssuesRelated to Physician Practices
    21. 21. 20Valuation Methodologies Typically Usedfor Physician Practices• Asset (“cost”) Approach– Derives an indication of value based on the anticipated cost toreplace, replicate, or recreate the asset.– Often considered a “floor” value.– Net Asset Value Method• Income Approach– Based on the entity‟s earning power (i.e., ability to generate positivecash flow in excess of the physician‟s fair market value compensation).– Primary methods include:o Discounted Cash Flow Methodo Capitalized Income Method
    22. 22. 21Net Asset Value (“NAV”) Method• Value is based on the entity‟s underlying assetsand liabilities.• Assets and liabilities are adjusted to theirrespective current values. The liabilities are thensubtracted from the assets to determine the entity‟snet equity (i.e., “net asset”) value.• Commonly used for physician practices that lackpositive cash flow (in excess of physician “fairmarket value” compensation).
    23. 23. 22Discounted Cash Flow(“DCF”) Method• Value is based on the entity‟s projected net cashflows discounted to present value.• Requires projections of revenues, expenses, capitalexpenditures, etc.• Risk of the cash flows is factored into the discountrate.• Commonly used for physician practices – especiallylarge practices with substantial ancillary revenueand/or mid-level providers.
    24. 24. 23Capitalized Income Method• Relies upon a single period earnings steam as aproxy for future years (as opposed to projections).• Value is determined by capitalizing the earningsstream.• Generally difficult to use for physician practices –past is not always a reliable indication of the futurefor most practices!
    25. 25. 24Valuation Methodologies Typically NotUsed for Physician Practices• Market Approach – determines an indication ofvalue based multiples derived from similarbusinesses/interests that have been bought/sold.– Guideline Public Company Method– Merger and Acquisition Transaction Data Method• Normally not used for physician practices because:– No publicly-traded physician practices– Lack of reliable transaction data involving practices thatare sufficiently similar
    26. 26. 25…does not haveremaining profitsafter physiciancompensationthe NAV methodwill likely beappropriate…has profitsremaining afterFMV physiciancompensationan incomeapproach willprobably berequiredWhich Method is Appropriate?IT DEPENDS…If thePractice…
    27. 27. 26Enterprise vs. Intangible Value• The sum total of the tangible and intangible assetscan not exceed the entity‟s total enterprise value• Example:– If the enterprise value = $2 million (e.g., determined fromDCF Method)– And the tangible assets (e.g., cash, accountsreceivable, equipment, etc.) = $1,200,000– Then, (with limited exceptions) intangible assets can notexceed $800,000
    28. 28. 27Assessing Intangible ValueDetermining whether a physician practice has intangiblevalue (within the limitations of FMV) is primarily based uponcash flow. If intangible value exists, there should be aneconomic benefit of ownership (i.e., in excess of FMVcompensation).Physician groups that generate positive cash flow (abovethe physician‟s “FMV” compensation) will normally havesome level of intangible value.Practices that do not produce such positive cash flow,generally will have little or no intangible value.
    29. 29. 28Certain Practices Are More Likely toHave Intangible Value• Large multi-specialty practices with mid-levelproviders and/or significant ancillary services aremore likely to have intangible value because theygenerate revenue in excess of the physician‟spersonal efforts.• Small highly specialized practices (e.g., generalsurgeons) are less likely to have intangible valuebecause substantially all revenue is professionalfees generated by the physician(s).
    30. 30. 29Intangible Assets Acquired Should beSeparable and Transferrable• For an intangible asset to be transferrable to a buyer, itmust be separable from the seller.• Intangible assets that are separable generally havecontractual or other legal rights (e.g., non-competitionagreements, clinical trial contracts, etc.).• Intangible assets that are not separable are generallycomponents of goodwill (e.g., employee workforce).Source: ASC 805-20-25-1 through 25-10.
    31. 31. 30Practice vs. Personal Goodwill• Practice goodwill is an asset of the entity that produces economicbenefits to its owners apart from their personal goodwill.– Factors generally influencing enterprise goodwill include: theentity‟s name, reputation, location, phone number, etc.– Generally transferrable• Personal goodwill is an asset of the individual (i.e., physician).– Factors generally influencing personal goodwill include:personal reputation, credentials, education, relationships, etc.– Generally not transferrable• Often difficult to distinguish in a physician practice.
    32. 32. 31Employed-PhysicianCompensation Planning
    33. 33. 32Transaction Drivers - PhysiciansDecreasingReimbursementLifestylepreference/Quality of LifeDecreasingreward…Increasingpressure…Healthcare reformOperating costs
    34. 34. 33Key Elements of SuccessfulCompensation Alignment Directly linked to goals and objectives Encourage/reward hard work and production Balance individual and team responsibility Clarify performance expectations Aligned with reimbursement environment
    35. 35. 34Key Elements of SuccessfulCompensation Alignment Simple, understood, and explainable Clearly defined and consistently applied Open and transparent Fiscally responsible Legally compliant
    36. 36. 35Components of Physician CompensationPhysicianCompensationPhilosophyBase CompensationIncentive ComponentQuality MeasuresGood CitizenshipLeadership
    37. 37. 36Components of Physician CompensationModels include• Salary plus bonus• Productivity based• Straight salary• Revenue sharing(partial/equal)Base Compensation
    38. 38. 37Components of Physician CompensationInfluenced by:• Specialty area• Physician‟s experienceand credentials• Typically tied to historicalcompensation and/orindustry benchmarks• Often has minimumproduction thresholds; maybe 100% at risk if pure “eatwhat you treat”Base Compensation
    39. 39. 38Components of Physician CompensationMany shapes and forms butmost common is $ perwRVU in excess ofthreshold.Other measures:• Patient encounters• ChargesBase CompensationWith Production
    40. 40. 39Components of Physician CompensationDefinition of wRVUmatters -• Personally performed vs.credit for others• Base year vs. annualwRVU updates• Impact of modifiers &denialsBase Compensation
    41. 41. 40Components of Physician Compensation• Achievement ofquality, operationalefficiency, patientsatisfaction goals• Baseline levels determinedusing the facility‟s historicaland clinical data and/orcomparable national orregional data, withincentives paid to reflectincremental improvementIncentive CompensationIncentive Compensation
    42. 42. 41Components of Physician Compensation• Can be based onimprovement orachievement of specifictargets• Incentives should beobjective, verifiable, supported by credible medicalevidence, and individuallytrackedIncentive CompensationIncentive Compensation
    43. 43. 42Components of Physician CompensationAccording to Sullivan Cotter’s2011 Physician Compensationand Productivity Survey:• 72% of compensationplans include quality• Currently 3-5% of pay istied to quality & patientsatisfaction, expected toincrease to 7-10% incoming yearsQuality Measures
    44. 44. 43Components of Physician CompensationExamples include standardsrelated to:• Chronic diseasemanagement• PQRS measures– Percent of patients thathave BMI measured anddocumented– Documentation/verificationof current medications inthe medical recordQuality Measures
    45. 45. 44Components of Physician Compensation“Playing nice in the sandbox”• Complete documentationwithin designatedtimeframe• Attendance at requisitenumber ofmeetings, trainings• Community involvement• Supervision ofnon-physician providersGood Citizenship
    46. 46. 45Components of Physician Compensation• Identifies expectedbehaviors ahead of time.• Motivates the physician tocare about the details of thebusiness in addition toclinical care.• Paying for that which shouldbe expected?Good Citizenship
    47. 47. 46Components of Physician CompensationParticipation in leadershiproles may take substantialtime and energy and drawaway from clinical care.• PCMH• EHR selection andimplementation, champion• Peer reviewLeadershipLeadership
    48. 48. 47Compensation Plans Are Not Static“Physician Compensation: Shifting Incentives”, HealthLeaders Media/Intelligence, October 2011A recent HealthLeaders study indicates that systemsregularly modify their compensation plans:41 % of respondents modify every 1-2 years21% leave them unchanged for more than 5 years38% every 3-5 years
    49. 49. 48Payment for Ancillary Services• If physician/clinic is a department of the hospital, then revenuefrom designated health services (DHS) cannot be shared with theproviders• If employment is structured to meet the “group practice exception”under the Stark regulations, then DHS revenue can be shared withproviders provided that it is not allocated based on the volume orvalue of the provider‟s ordered DHS services.– Allocations can range from equal to proportional based on professional (nottechnical) services provided by the physician.• Often a financial decision based on the site of service differential
    50. 50. 49Compensation and Regulatory Issues• Post-transaction compensation structure factors in to the practicevaluation.– Health systems cannot pay for a revenue stream twice – once with the“purchase” and then on-going in the physician compensation plan.• Fair market value and commercial reasonableness (addressedearlier) must also be considered with regards to physiciancompensation.
    51. 51. 50Contact InformationCarol Carden, CPA/ABV, ASA, CFEPrincipal(865) 673-0844 ext 213ccarden@pyapc.comLori Foley, CMA, PHR, CMMPrincipal(404) 266-9876lfoley@pyapc.com

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