Four Trends for Hospitals and Physicians – Management Arrangements, HOPD vs. ASC, Call Coverage and Mergers

Recently we have seen a resurgence in four key areas in the healthcare arena as it relates to hospitals and physicians and the compensation and financial relationships between them. There are a number of factors driving each of these four trends including: (i) consistent downward pressure on reimbursement, (ii) uncertainty about the future, (iii) efforts to control costs and achieve economies of scale and (iv) the search for ways to more tightly bind physicians and a hospital’s referral base to the hospital. Below is a brief summary of our observations on these four trends.

1. Management and Co-Management Arrangements. We have seen a renewed interest in both management and co-management type arrangements between hospitals and physicians for various service lines. This is likely due in large measure to the elimination of the “under-arrangements” or “contractual joint venture” model of hospital-physician collaboration. Under the management agreement or co-management agreement, a group of physicians or a newly-formed management entity owned at least in part by the physicians takes responsibility for managing certain clinical and/or administrative functions related to the operation of a particular hospital service line. Because this is often a financial relationship between a hospital and referring physicians, the management agreement or co-management agreement needs to satisfy the Stark exception for personal services arrangements and management agreements. For example, the arrangement would need to cover all of the services to be furnished by the physician or physician management company; the services contracted for do not exceed those that are reasonable and necessary for the legitimate business purposes of the arrangement; the compensation to be paid over the term of each arrangement is set in advance, does not exceed fair market value, and is not determined in the manner that takes into account the volume or value of any referrals or other business generated between the parties; the agreement must be in writing; the agreement must be for at least one year, etc. The key concept for management agreements is that the compensation must reflect fair market value paid for services actually performed by the physician or the physician entity. The best way to obtain an accurate fair market value assessment is to engage a third party appraiser to conduct a valuation. In this context we always strongly recommend obtaining a third party valuation. Under this model, a small percentage of the overall fee paid can be devoted to the achievement of certain quality or efficiency measures or benchmarks. We have seen hospitals and physicians using this model where equity ventures are not possible due to legal or economic constraints, and also in other areas where it makes more financial sense to have a management agreement versus an equity arrangement.

2. HOPD vs. ASC. Another recent trend that we have noticed is that the decision between operating a provider-based hospital outpatient department (“HOPD”) versus a free-standing ambulatory surgery center (“ASC”) has become a much closer call when considering physician alignment and financial involvement. Over the last ten years or so there was tremendous growth in the free-standing ASC space with an increasing number of physician-hospital joint ventures, and in non-certificate of need states, a growth of physician owned surgery centers. Recently this trend has shifted. As you probably know, Medicaid reimburses ASCs at approximately 60% of the current HOPD rates. As a result, often times in terms of overall gross revenue or reimbursement, a hospital outpatient department will generate more revenue than an ASC. However, physicians cannot own directly in an HOPD. In an ASC, although physicians can own equity interests, there is also risk associated with that investment. In other words, when a physician invests capital in a surgery center, there is a lot of upside if the center is financially successful. By the same token there is also substantial downside risk in that the investment may be lost or additional capital calls will be required to keep the surgery center operating. In addition, an equity investment in a surgery center could also require debt guarantees which will not be required in HOPD management relationship. Similar to the management arrangement model discussed above, parties often choose to use a management arrangement in connection with an HOPD in order to more closely align physician interests with the outpatient services being provided. The downside of a management arrangement from a physician’s perspective is that the income is generally fixed and does not vary no matter how successful the HOPD is. On the other hand, there is not as much risk as investing in an ASC.

3. Call Coverage and Employment of Physicians. We have seen renewed interest in both compensating physicians for call coverage as well as direct employment of physicians by hospitals. Using cardiology as one recent example, reimbursement cuts have caused that particular specialty to move strongly towards direct employment by hospitals. Just a few years ago this would have been unheard of in the cardiology specialty. Other specialties have experienced this in the past. In addition, due to a number of factors including lifestyle choices and shortage of certain specialties, a number of hospitals are moving towards compensating for call coverage. There are two exceptions to the Stark law that are potentially applicable to call coverage arrangements – the personal services arrangement exception and the fair market value exception. From an Anti-Kickback Statute perspective, there are also two recent OIG advisory opinions that deal directly with the issue of call coverage. In those advisory opinions, OIG highlights a few characteristics that weigh in favor of permissible arrangements. For example, in call coverage arrangements it is critical that the agreement cover substantial, quantifiable services provided by the physician, and the compensation is consistent with fair market value. It is also helpful if the call coverage compensation is offered uniformly to all physicians in the relevant specialties rather than just a select few. Care should also be taken that the call coverage arrangement is not compensating physicians for services for which they are also reimbursed by insurers or patients resulting in the physician being paid twice for the same services.

4. Mergers and Acquisitions. Over the last year or so we have seen an increase in the number of mergers and acquisitions, both in the hospital and physician area as well as continued interest in the areas of surgery centers, dialysis facilities and radiation oncology facilities. Again, this is being driven in part by physician apprehension about future reimbursement rate cuts, on the one hand, and a desire by hospitals to more closely align their physicians’ interests with their own economic and clinical goals, on the other hand. Although financing is still not readily available for leveraged acquisitions, there has been a loosening of the credit market and at least anecdotally, quality deals are being funded to the extent that debt is required.