Determining Value & Physician Compensation When Purchasing a Practice
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This document discusses considerations for valuing a physician practice and determining physician compensation when a hospital is acquiring the practice. It covers regulatory issues under Stark and anti-kickback laws, common valuation methods including asset-based and income approaches, factors for determining fair market value and commercial reasonableness, and structuring post-acquisition physician employment compensation.
Determining Value & Physician Compensation When Purchasing a Practice
- 1. 0 Determining Value & Physician Compensation when Purchasing a Practice June 18, 2013 Carol W. Carden, CPA/ABV, ASA,CFE Lori Foley, CMA, PHR, CMM
- 2. 1 Learning Objectives • After this session, you will Describe how Stark and anti-kickback statutes affect practice acquisition Describe various compensation structures for post-transaction employment Understand valuation approaches for practice acquisition
- 3. 2 Agenda • The hospital/physician alignment environment • Healthcare regulatory considerations • Valuation methods and issues related to physician practices • Physician compensation considerations
- 5. 4 Hospital/Physician Alignment Transactions • Hospitals and physicians are actively seeking ways to strategically and financially align themselves. • Successful alignment transactions can result in substantial benefits to all parties including patients. – Improved efficiencies and quality of care – Reduced costs and waste – Better bargaining power with third party payors
- 6. 5 Hospitals & Health Systems Seeking efficiencies Diversifying, focusing on outpatient and wellness care Increasing emphasis on standardization, integration, and consolidation of services Experiencing physician shortages in key specialties Competition from other systems as well as physician owned outpatient centers Call coverage needs Healthcare reform Hospitals & Health Systems
- 7. 6 Physicians Financially squeezed - decline in reimbursement, increased overhead and loss of income Difficulty obtaining malpractice coverage at reasonable rates Working capital requirements Inability or unwillingness ($$) to recruit Exit strategy Quality of life Increasingly complex government oversight Physicians Healthcare Reform
- 8. 7 Physician Alignment Vehicles More IntegrationLess Integration More Common Less Common Equipment JV EMR Co-Management Medical Directorships Shared Savings Real Estate JV Physician Advisory Council PHO Quality Physician Services Agreement Physician Leasing Agreement Physician Acquisition/Employment
- 9. 8 Physician Practice Acquisitions – the “Buy and Employ” Strategy • Hospitals and physicians are entering into acquisition and employment transactions at a torrid pace! • Transactions often make good business sense but also involve substantial risk. – Regulatory risk; – Financial risk (i.e., hospital‟s ability to successfully integrate and operate the Practice without incurring substantial losses); and – Reputation risk (the two entities are now related). • Very competitive environment in many markets
- 10. 9 “Buy and Employ” Transactions • Typical Transaction: – Hospital buys the practice at FMV o Usually structured as an asset purchase o Cash and AR normally excluded o Net after-tax proceeds can be substantially different depending upon the deal structure. “Buy and Employ” Transactions
- 11. 10 “Buy and Employ” Transactions Physicians employed by the hospital – • Generally under some type of productivity based compensation arrangement (wRVUs) • Generally involves a period of guaranteed compensation (assuming productivity does not decline substantially). • Often includes other types of arrangements as well (e.g., co- management, call pay, quality incentives, etc.). “Buy and Employ” Transactions
- 12. 11 Key Issues • The hospital and physician practice should be a good fit strategically. • 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
- 14. 13 Road 100 m Menu STARK LAW Prohibited self-referrals for Medicare and Medicaid patients. Navigating the Regulatory Environment ANTI-KICKBACK Knowingly and willful offers, payments, or receipts for referrals. IRS-NFP IRC Section 501(c) 3 requirements
- 15. 14 FAIR MARKET VALUE Compliance Issues Regarding Hospital-Physician Financial Relationships COMMERCIAL REASONABLENESS Overall Arrangement “WHY?” SENSE CENTS Range of Dollars Only “HOW MUCH?” Scope Key Question
- 16. 15 Commercial Reasonableness • Department of Health and Human Services Definition1 – An arrangement which appears to be “a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals.” • Stark Definition2 – “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 of similar scope and specialty, even if there were no potential designated health services (“DHS”) referrals.” • OIG Threshold 3 – Compensation arrangements with physicians should be “reasonable and necessary.” 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 Opinion No. 07-10, September 20, 2007, pg. 6, 10; “OIG Supplemental Compliance Program Guidance for Hospitals,” Notice, 70 Fed. Reg. 4858 (Jan. 31, 2005).
- 17. 16 Factors in Determining CR Business Purpose Provider Analysis Facility Analysis Resource Analysis Independence & Oversight Commercial Reasonableness Determination
- 18. 17 Fair Market Value • IRS Definition1 – Fair market value (“FMV”) is defined as the amount at which property would change hands between a willing seller and a willing buyer when neither is under compulsion and both have reasonable knowledge of the relevant facts • OIG/Stark Definition2 – The value in arm‟s-length transactions, consistent with the 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 1Estate 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. 18 Fair Market Value – Key Concepts • Determined from the perspective of hypothetical buyers and sellers without the ability to refer business to one another. • No consideration for post-transaction buyer synergies. However, such synergies often exist! • The financial terms of the transaction must make economic sense based on the assets being sold/received. • Post-transaction compensation must be taken into consideration.
- 20. 19 Valuation Methods and Issues Related to Physician Practices
- 21. 20 Valuation Methodologies Typically Used for Physician Practices • Asset (“cost”) Approach – Derives an indication of value based on the anticipated cost to replace, 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 positive cash flow in excess of the physician‟s fair market value compensation). – Primary methods include: o Discounted Cash Flow Method o Capitalized Income Method
- 22. 21 Net Asset Value (“NAV”) Method • Value is based on the entity‟s underlying assets and liabilities. • Assets and liabilities are adjusted to their respective current values. The liabilities are then subtracted from the assets to determine the entity‟s net equity (i.e., “net asset”) value. • Commonly used for physician practices that lack positive cash flow (in excess of physician “fair market value” compensation).
- 23. 22 Discounted Cash Flow (“DCF”) Method • Value is based on the entity‟s projected net cash flows discounted to present value. • Requires projections of revenues, expenses, capital expenditures, etc. • Risk of the cash flows is factored into the discount rate. • Commonly used for physician practices – especially large practices with substantial ancillary revenue and/or mid-level providers.
- 24. 23 Capitalized Income Method • Relies upon a single period earnings steam as a proxy for future years (as opposed to projections). • Value is determined by capitalizing the earnings stream. • Generally difficult to use for physician practices – past is not always a reliable indication of the future for most practices!
- 25. 24 Valuation Methodologies Typically Not Used for Physician Practices • Market Approach – determines an indication of value based multiples derived from similar businesses/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 that are sufficiently similar
- 26. 25 …does not have remaining profits after physician compensation the NAV method will likely be appropriate …has profits remaining after FMV physician compensation an income approach will probably be required Which Method is Appropriate? IT DEPENDS… If the Practice…
- 27. 26 Enterprise vs. Intangible Value • The sum total of the tangible and intangible assets can not exceed the entity‟s total enterprise value • Example: – If the enterprise value = $2 million (e.g., determined from DCF Method) – And the tangible assets (e.g., cash, accounts receivable, equipment, etc.) = $1,200,000 – Then, (with limited exceptions) intangible assets can not exceed $800,000
- 28. 27 Assessing Intangible Value Determining whether a physician practice has intangible value (within the limitations of FMV) is primarily based upon cash flow. If intangible value exists, there should be an economic benefit of ownership (i.e., in excess of FMV compensation). Physician groups that generate positive cash flow (above the physician‟s “FMV” compensation) will normally have some level of intangible value. Practices that do not produce such positive cash flow, generally will have little or no intangible value.
- 29. 28 Certain Practices Are More Likely to Have Intangible Value • Large multi-specialty practices with mid-level providers and/or significant ancillary services are more likely to have intangible value because they generate revenue in excess of the physician‟s personal efforts. • Small highly specialized practices (e.g., general surgeons) are less likely to have intangible value because substantially all revenue is professional fees generated by the physician(s).
- 30. 29 Intangible Assets Acquired Should be Separable and Transferrable • For an intangible asset to be transferrable to a buyer, it must be separable from the seller. • Intangible assets that are separable generally have contractual or other legal rights (e.g., non-competition agreements, clinical trial contracts, etc.). • Intangible assets that are not separable are generally components of goodwill (e.g., employee workforce). Source: ASC 805-20-25-1 through 25-10.
- 31. 30 Practice vs. Personal Goodwill • Practice goodwill is an asset of the entity that produces economic benefits to its owners apart from their personal goodwill. – Factors generally influencing enterprise goodwill include: the entity‟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.
- 33. 32 Transaction Drivers - Physicians Decreasing Reimbursement Lifestyle preference/ Quality of Life Decreasing reward… Increasing pressure… Healthcare reform Operating costs
- 34. 33 Key Elements of Successful Compensation 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. 34 Key Elements of Successful Compensation Alignment Simple, understood, and explainable Clearly defined and consistently applied Open and transparent Fiscally responsible Legally compliant
- 36. 35 Components of Physician Compensation Physician Compensation Philosophy Base Compensation Incentive Component Quality Measures Good Citizenship Leadership
- 37. 36 Components of Physician Compensation Models include • Salary plus bonus • Productivity based • Straight salary • Revenue sharing (partial/equal) Base Compensation
- 38. 37 Components of Physician Compensation Influenced by: • Specialty area • Physician‟s experience and credentials • Typically tied to historical compensation and/or industry benchmarks • Often has minimum production thresholds; may be 100% at risk if pure “eat what you treat” Base Compensation
- 39. 38 Components of Physician Compensation Many shapes and forms but most common is $ per wRVU in excess of threshold. Other measures: • Patient encounters • Charges Base Compensation With Production
- 40. 39 Components of Physician Compensation Definition of wRVU matters - • Personally performed vs. credit for others • Base year vs. annual wRVU updates • Impact of modifiers & denials Base Compensation
- 41. 40 Components of Physician Compensation • Achievement of quality, operational efficiency, patient satisfaction goals • Baseline levels determined using the facility‟s historical and clinical data and/or comparable national or regional data, with incentives paid to reflect incremental improvement Incentive CompensationIncentive Compensation
- 42. 41 Components of Physician Compensation • Can be based on improvement or achievement of specific targets • Incentives should be objective, verifiable, suppo rted by credible medical evidence, and individually tracked Incentive CompensationIncentive Compensation
- 43. 42 Components of Physician Compensation According to Sullivan Cotter’s 2011 Physician Compensation and Productivity Survey: • 72% of compensation plans include quality • Currently 3-5% of pay is tied to quality & patient satisfaction, expected to increase to 7-10% in coming years Quality Measures
- 44. 43 Components of Physician Compensation Examples include standards related to: • Chronic disease management • PQRS measures – Percent of patients that have BMI measured and documented – Documentation/verification of current medications in the medical record Quality Measures
- 45. 44 Components of Physician Compensation “Playing nice in the sandbox” • Complete documentation within designated timeframe • Attendance at requisite number of meetings, trainings • Community involvement • Supervision of non-physician providers Good Citizenship
- 46. 45 Components of Physician Compensation • Identifies expected behaviors ahead of time. • Motivates the physician to care about the details of the business in addition to clinical care. • Paying for that which should be expected? Good Citizenship
- 47. 46 Components of Physician Compensation Participation in leadership roles may take substantial time and energy and draw away from clinical care. • PCMH • EHR selection and implementation, champion • Peer review LeadershipLeadership
- 48. 47 Compensation Plans Are Not Static “Physician Compensation: Shifting Incentives”, HealthLeaders Media/Intelligence, October 2011 A recent HealthLeaders study indicates that systems regularly modify their compensation plans: 41 % of respondents modify every 1-2 years 21% leave them unchanged for more than 5 years 38% every 3-5 years
- 49. 48 Payment for Ancillary Services • If physician/clinic is a department of the hospital, then revenue from designated health services (DHS) cannot be shared with the providers • If employment is structured to meet the “group practice exception” under the Stark regulations, then DHS revenue can be shared with providers provided that it is not allocated based on the volume or value of the provider‟s ordered DHS services. – Allocations can range from equal to proportional based on professional (not technical) services provided by the physician. • Often a financial decision based on the site of service differential
- 50. 49 Compensation and Regulatory Issues • Post-transaction compensation structure factors in to the practice valuation. – 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 (addressed earlier) must also be considered with regards to physician compensation.
- 51. 50 Contact Information Carol Carden, CPA/ABV, ASA, CFE Principal (865) 673-0844 ext 213 ccarden@pyapc.com Lori Foley, CMA, PHR, CMM Principal (404) 266-9876 lfoley@pyapc.com
Editor's Notes
- #5: 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.
- #6: 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.
- #7: 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.
- #8: 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.
- #14: 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.
- #33: 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…
- #34: 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.
- #35: 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.
- #48: Finally,